This is a summary of the Hotshot course “Sandbagging: Market Trends,” which features ABA M&A Committee members Lisa Hedrick from Hirschler Fleischer PC and Nate Cartmell from Pillsbury LLP discussing market trends for sandbagging provisions, drawing on data from the ABA’s Private Target M&A Deal Points Study. Lisa and Nate talk about why so many deals are silent on sandbagging, the risk of being silent, and where they think the trend is heading. View the course here.
Sandbagging: Market Trends
The majority of deals covered by the ABA M&A Committee’s Private Target Deal Points Study are silent on the issue of sandbagging, thereby defaulting to state law.
76% of the deals in 2022 and the first quarter of 2023 were silent.
Up from 68% in the 2020 and 2021 deals.
12% of the deals included pro-sandbagging provisions.
Down from 29% in 2020 and 2021.
Only 5% of them included anti-sandbagging provisions.
Up from 2% in 2020 and 2021.
These numbers represent the general trend in this area since these figures were first tracked in the 2006 study.
The number of deals that are silent on the issue has generally been increasing.
The number of deals that include sandbagging provisions has correspondingly decreased.
Several developments account for this trend.
As a result of several Delaware Court of Chancery decisions since 2006, more lawyers consider Delaware a pro-sandbagging default jurisdiction.
This means that when acting as buyer’s counsel, lawyers were increasingly willing to choose Delaware as the governing law for their agreements and be silent on the issue.
However, the 2018 Delaware Supreme Court decision in Eagle Force Holdings v. Campbell has cast some doubt on the assumption.
The use of representation and warranty insurance in M&A deals has been increasing.
These policies generally exclude from coverage any loss resulting from a breach of a representation or warranty known to the buyer at closing.
So, if a buyer’s recourse post-closing is against the insurance policy and not the sellers, pro- or anti-sandbagging provisions become irrelevant.
Particularly in a sellers’ market where a buyer may have limited or no recourse beyond a rep and warranty insurance policy, bargaining for a pro-sandbagging provision may provide little or no value.
As lawyers have become more focused on these issues, they’re relying not on the representations themselves but on separate line-item indemnities (which are unaffected by knowledge) to protect buyers from losses associated with breaches of representations they suspect (or know) may not be true.
The rest of the course includes interviews with ABA M&A Committee members Nate Cartmell from Pillsbury LLP and Lisa Hedrick from Hirschler Fleischer LLP.
This is a summary of the Hotshot course “Sandbagging: Buyer and Seller Perspectives,” a discussion on buyer and seller perspectives regarding the issue of sandbagging featuring insights from ABA M&A Committee members. View the course here.
Buyer and Seller Perspectives
In this section we’ll look at the buyer’s motivation to include a pro-sandbagging provision in an acquisition agreement and the seller’s point of view.
Under most acquisition agreements, inaccuracies in the seller’s reps and warranties don’t excuse the buyer from its obligation to close, unless the inaccuracies rise to a certain level of materiality.
For the buyers, that becomes challenging if:
The buyer learns about an inaccuracy in the reps before closing; and
The inaccuracy isn’t so material that it gives the buyer the right to walk away.
The buyer might feel that the company it’s about to acquire isn’t what the seller had represented.
And, because it couldn’t claim that it had “relied” on the inaccurate representation in proceeding to close, it would have waived any right to damages.
Note — a buyer mighthave a claim if the rep was inaccurate at signing as well as at closing, but the buyer only had knowledge of the inaccuracy at closing.
The buyer could argue that while it may be deemed to have waived the inaccuracy in the rep made at closing because it was aware of the inaccuracy and closed over it, it could not have waived the inaccuracy of the rep made at signing if it was unaware of the breach at the time.
However, to date, anti-sandbagging jurisdictions appear not to have drawn such a distinction.
By proceeding to close with knowledge of the breach, a buyer waives both claims.
Sellersstress the injustice of:
A buyer learning of inaccuracies in the seller’s proposed reps before the acquisition agreement is signed or between signing and closing; and
“Lying in wait” to recover damages post-closing.
Rather than bringing the inaccuracies to the seller’s attention and perhaps renegotiating the purchase price.
There is another reason buyers want pro-sandbagging provisions in their agreements.
Let’s say that after closing:
A buyer discovers an inaccuracy in a rep and tries to recover under the indemnification provision for the breach.
The seller acknowledges that there was a breach.
Without a pro-sandbagging provision, the seller can challenge the claim by alleging that the buyer did in fact have knowledge of the breach as a result of the buyer’s due diligence review.
The buyer would then be subject to the cost and delay of an evidentiary hearing before being able to recover, and the result of that hearing would be uncertain.
The pro-sandbagging provision takes the knowledge issue off the table, both in terms of:
Making a claim; and
Getting paid quickly.
For the large (and growing) number of transactions in which the buyer obtains rep & warranty insurance, the debate over sandbagging is usually moot.
This is because under the terms of the insurance, the buyer is required to deliver a “no claims” certificate and can’t make a claim for breaches that:
It was aware of pre-signing; or
Came up between signing and closing.
A buyer may still seek inclusion of pro-sandbagging language when the seller is “backstopping” the insurance.
This means that the seller is responsible for claims not covered by the insurance.
A seller backstopping the insurance may seek a representation in the acquisition agreement saying that the buyer knows of no breaches other than those disclosed to the insurer in the no-claims certificate.
Sandbagging provisions only address a buyer’s ability to seek damages in contractfor inaccuracies in the reps and warranties in the agreement.
Pro-sandbagging provisions do not eliminate reliance as a required element for a tort claim:
Brought by the buyer under the so-called “fraud exception” found in the exclusive remedy provisions of most acquisition agreements; or
Brought for misrepresentations or omissions made by a seller to a buyer beyond those contained in the agreement itself (e.g., during buyer’s due diligence)
This course also includes interviews with ABA M&A Committee members Nate Cartmell from Pillsbury LLP and Lisa Hedrick from Hirschler Fleischer LLP.
This is a summary of the Hotshot course “Sandbagging: Sample Provisions,” a look at typical sandbagging provisions, including pro-sandbagging and anti-sandbagging provisions, that also includes drafting tips and perspectives from ABA M&A Committee members. View the course here.
Sample Provisions
Sample Pro-Sandbagging Provision
The right to indemnification, payment, reimbursement, or other remedy based upon any such representation, warranty, covenant, or obligation will not be affected by any investigation conducted or any Knowledge acquired at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of, or compliance with, such representation, warranty, covenant or obligation.
This provision says that a party’s right to indemnification (and other costs and remedies) based on a “representation, warranty, covenant, or obligation” won’t be affected by “any investigation conducted or any Knowledge acquired at any time” regarding the accuracy or compliance with those provisions.
It applies whether it’s before or after signing or closing.
This language expressly disclaims investigation and knowledge as a basis for challenging a right to indemnification.
Because of this, it allows the buyer who is aware (or should have been aware) of the inaccuracy of seller’s reps and warranties to close the deal and then recover damages even when the breaches were sufficiently material that the buyer could have refused to close.
Sample Anti-Sandbagging Provision
No party shall be liable under this Article for any Losses resulting from or relating to any inaccuracy in or breach of any representation or warranty in this Agreement if the party seeking indemnification for such Losses had Knowledge of such Breach before closing.
This provision says that a party will not be liable under the indemnification section for losses that relate to “any inaccuracy in or breach of any representation or warranty” in the agreement if the other party had knowledge of the breach before closing.
This language expressly disclaims a party’s ability to seek indemnification for damages resulting from a breach of which it had “Knowledge” (note this is a defined term) before closing.
Because of this, it precludes the buyer from making a claim if it:
Knew of the inaccuracy; and
Depending on the definition of Knowledge, possibly even when the buyer didn’t have actualknowledge but only “should have known” of the breach. (This is often called “constructive knowledge.”)
Definition of Knowledge
This is an area where the agreement’s definition of knowledge can have a major impact.
Sellers will want to define the term broadly, both in terms of:
Whose knowledge is imputed to the buyer; and
What qualifies as knowledge.
They’ll want constructive as well as actual knowledge to count.
Buyers will want the term to be as narrow as possible, wanting:
A limited knowledge group; and
Actual knowledge only.
Impact of Rep & Warranty Insurance
Even when agreements are silent on sandbagging, there’s another provision that sellers sometimes try to include: a rep by the buyer that at the time of signing it had no actual knowledge of any inaccuracy in the seller’s representations and warranties.
This rep won’t restrict a buyer with knowledge from bringing a claim post- closing in a pro-sandbagging jurisdiction.
But it will allow the seller to assert a competing claim of breach of buyer’s rep.
This rep is especially likely to be found in deals with rep & warranty insurance, where the buyer has to give the insurer a “no claims” certificate (which says that the buyer isn’t aware of any breaches other than those disclosed in the certificate).
If the seller is responsible for claims that go beyond the policy limit or are excluded from the policy (referred to as “backstopping” the insurance), the seller may insist that the buyer make that same rep in the acquisition agreement.
If the seller isn’t backstopping the insurance there’s no need for this protection.
This course also includes interviews with ABA M&A Committee members Nate Cartmell from Pillsbury LLP and Lisa Hedrick from Hirschler Fleischer LLP.
This is a summary of the Hotshot course “Sandbagging,” an explanation of sandbagging in private M&A deals, including a discussion on pro- and anti-sandbagging provisions and how different courts and jurisdictions handle the issue. View the course here.
What Are Sandbagging Claims and Provisions?
“Sandbagging” refers to when the buyer in a private M&A deal tries to enforce an indemnification claim that the seller breached a representation or warranty in the acquisition agreement, even though the buyer knew that the rep or warranty was false when it closed the deal.
Whether or not sandbagging claims are allowed is handled in one of two ways:
The acquisition agreement addresses the issue by including a sandbagging provision in the indemnification section of the agreement; or
The agreement is silent on the issue, in which case the governing law of the relevant jurisdiction will apply.
There are two types of sandbagging provisions:
Pro-sandbagging provisions.
Also known as “savings clauses.”
They allow the claims and are favored by buyers.
Anti-sandbagging provisions.
They prohibit the claims and are favored by sellers.
There are also pro-sandbagging jurisdictions and anti-sandbagging jurisdictions.
Parties often include sandbagging provisions in their acquisition agreements to clarify whether these claims are allowed, particularly since jurisdictions differ on that question.
Even in jurisdictions that are “pro-sandbagging,” there can be differences in the degree to which they allow sandbagging claims, so putting a provision in the agreement clarifies things.
The Courts and Sandbagging Claims
Understanding why jurisdictions have different default rules on sandbagging involves a little history.
Courts have followed one of two competing approaches:
One based in tort law.
The other based in contract law.
These approaches relate to the historical treatment of representations and warranties.
Historically, courts regarded warrantiesas promises that the buyer purchased as part of the purchase price, much like buying insurance.
A wronged buyer needed only to show that the seller’s promise was breached and that the buyer suffered damages in order to recover under contract law.
The buyer didn’t have to show any reliance on the warranties to recover.
In contrast, courts historically considered representationsas mere statements of fact made separate from the contract (even if they were contained in it) and made only to induce the other party to enter into the contract.
A misrepresentation was not considered a breach of contract, but a wrongful act that caused harm to the other party.
So the buyer’s remedy for a misrepresentation was based on tort law, and the buyer needed to prove that the untrue statement actually induced it to enter into the contract (that is, the buyer had to show reliance).
If a buyer had knowledge of the misrepresentation prior to signing, it would be hard for the buyer to argue that it had relied on the representation when signing or closing the deal.
U.S. case law no longer treats “representations” and “warranties” differently in the contractual setting.
However, the distinction between the tort-based remedy and the contract-based remedy is still found in how different jurisdictions approach a buyer’s right to recover damages for breach of a rep or warranty.
Jurisdictions that take the contract-based approach(where reliance isn’t necessary to recover damages) effectively permit sandbagging claims and are “pro-sandbagging jurisdictions.”
This is the “modern” – and majority – “default” rule.
Even among states adopting the modern approach, there are meaningful differences in how it’s applied, including:
Different outcomes hinging on whether the buyer learned of the inaccuracy from the seller or independently; and
Whether the outcome should differ depending on whether the buyer had knowledge at signing that the representation or warranty was false.
The states that take a tort-based approach, requiring proof of “justifiable” or “reasonable” reliance before awarding damages, are the “anti-sandbagging jurisdictions.”
Even if the buyer didn’t have actual knowledge of the inaccuracy, courts may inquire into the “reasonableness” of the effort made by the buyer to investigate the seller before signing – its “due diligence.”
Courts may deny recovery in situations where even a modicum of effort would have uncovered the inaccuracy.
If lawyers are comfortable with a state’s default rule, they may choose to have the contract governed by that state’s law.
This means they achieve the desired “pro-” or “anti-sandbagging” result without needing to argue to include a sandbagging provision in the agreement.
However, many lawyers either:
Aren’t comfortable with the default rules of the states that would be logical choices for governing law; or
Would prefer not to leave a determination up to the courts, which might interpret the default rule differently depending on specific circumstances.
As a result, those lawyers include the contractual language explicitly permitting or disallowing sandbagging.
The enforceability of these contractual provisions hasn’t been widely addressed by the courts.
But the decisions that have addressed the issue have favored enforceability even when the provision was the opposite of the jurisdiction’s default rule.
This course also includes interviews with ABA M&A Committee members Nate Cartmell from Pillsbury LLP and Lisa Hedrick from Hirschler Fleischer LLP.
Jonathan Kanter, Assistant Attorney General for the Department of Justice’s Antitrust Division, has been openly and repeatedly skeptical of merger remedies and settlements, making comments such as “merger remedies short of blocking a transaction too often miss the mark.” He has made clear that an injunction blocking a transaction “is the surest way to preserve competition.” Similarly, Chair of the Federal Trade Commission (“FTC”) Lina Khan made plain in a 2022 interview that “[the agency is] going to be focusing our resources on litigating, rather than on settling.”
This summer, however, the federal antitrust enforcers and, in one transaction, the state agencies have negotiated and agreed to settlements in three separate merger matters. While this might appear to be a sea change, merging parties should not assume that it is. The facts and circumstances of each matter are different, but the settlements provide insights into remedies and strategies merging parties should consider.
Amgen/Horizon
Most recently, the FTC announced a settlement of its challenge to Amgen Inc.’s $27.8 billion acquisition of Horizon Therapeutics plc. In May 2023, the FTC and six states—California, Illinois, Minnesota, New York, Washington, and Wisconsin—filed a complaint to block the proposed transaction. Although both are pharmaceutical companies, Amgen and Horizon do not have any competing drugs in their portfolios or development pipelines. According to the complaint, Amgen’s rationale for acquiring Horizon was to control certain high-revenue-generating pharmaceuticals in anticipation of the loss of revenues caused by the 2030 expiration of one of Amgen’s “blockbuster” drugs and the potential downward price pressure from Medicare and Medicaid negotiations under the Inflation Reduction Act. Specifically, the FTC alleged that Amgen was most interested in two Horizon “orphan drugs” for treating certain rare diseases: thyroid eye disease and chronic refractory gout. Orphan drugs are medicines developed to help treat or prevent rare diseases, which are defined in the Orphan Drug Act as conditions that each affect fewer than 200,000 people in the United States or for which there is no reasonable expectation of recovering the cost of developing and making available a drug for the condition.
Because product development and other costs are high and the number of people requiring the orphan drugs is low, the Food and Drug Administration awards the inventor a seven-year exclusivity period. Allegedly, Amgen was willing to pay a premium for Horizon because of the dependable profitability of these two drugs, which accounted for 72% of Horizon’s sales. The FTC claimed that other companies are in the process of developing drugs to compete with Horizon’s orphan drugs when exclusivity expires and that Amgen could use its blockbuster drugs to secure preferential treatment or exclusionary access from pharmacy benefit managers for its non-blockbuster drugs.
Despite Amgen’s pre-litigation offer to commit that it would not bundle other products with Horizon’s orphan drugs, the FTC and six states filed a lawsuit claiming that the acquisition would give Amgen the ability and incentive to engage in cross-product bundling that would exclude Horizon’s rivals and maintain its monopolies, harming patients in the long run.
First and foremost, the settlement accepted by the FTC prohibits Amgen from engaging in any cross-product bundling or exclusionary rebating schemes involving Horizon’s monopoly orphan drugs. The consent order will also prohibit Amgen from entering into an agreement to acquire any pipeline and post-clinical trial products, commercialized products, or interests in any business engaged in the development, manufacturing, or sale of any such products, biosimilars, or therapeutic equivalents that treat either orphan illness, without prior approval. A monitor will be appointed to oversee Amgen’s compliance, and the monitor’s reports will be submitted to the Commission and to the states.
Black Knight
In late August, the FTC also announced the settlement of its challenge to the $13.1 billion acquisition of Black Knight, Inc. (“Black Knight”) by Intercontinental Exchange, Inc. (“ICE”). Black Knight and ICE are direct competitors with their loan origination system software (“LOS”) and a number of ancillary services, including product pricing and eligibility engines (“PPE”). PPE is software that allows a lender to identify potential loan rates for a borrower, determine the borrower’s eligibility for a given loan, and lock in the loan’s terms for the borrower.
According to the FTC, ICE offers the dominant LOS in the United States, processing nearly half of all residential mortgages originated each year, and Black Knight has the second-largest LOS in the United States. Black Knight’s PPE is the industry leader, serving lenders that originate as much as 40% of the residential mortgages in the U.S. each year. ICE’s PPE is currently available only to lenders who use ICE’s LOS. The FTC alleged that because of ICE’s dominant LOS market share and the dependency of PPEs and other ancillary service providers on LOS integration, ICE will have the ability to disadvantage existing and potential ancillary service competitors, including competing PPE providers, by foreclosing or impeding LOS access.
In an effort to resolve the FTC’s concerns, Black Knight proposed divesting its LOS and certain ancillary products but not its PPE. The divestiture buyer, Constellation Web Solutions, Inc. (“Constellation”), would also act as a reseller for certain ancillary services acquired by ICE from Black Knight. The FTC rejected the proposed remedy because it allegedly failed to provide Constellation with the ability, resources, and incentive to replace the intensity of the competition between ICE and Black Knight.
As part of the FTC settlement, Black Knight and Constellation agreed that Black Knight will finance a portion of Constellation’s purchase price of Black Knight’s PPE via a promissory note, but within ten days of a trustee’s appointment, the promissory note will be transferred to the trustee. The trustee will sell the note to a third party within six months of the divestiture.
The DOJ’s complaint alleged that Assa Abloy and Spectrum are two of the three largest producers of residential door hardware in an already concentrated US industry. The agency alleged that the proposed transaction would harm competition in two relevant markets: (1) premium mechanical door hardware and (2) smart locks. The DOJ rejected Assa Abloy’s pre-ligation offer to settle because the proposed divestiture package did not include sufficient smart lock assets and contemplated continuing entanglements between the company and potential divestiture buyer. Consistent with its past statements, the DOJ argued that only completely blocking the transaction would eliminate its risk to competition.
The settlement accepted by the DOJ included Assa Abloy’s EMTEK and Schaub premium mechanical door hardware businesses, its Yale and August residential smart lock businesses in the United States and Canada, and other assets for multifamily smart lock applications in the United States and Canada. The settlement also included expanded intellectual property and commercialization rights in smart locks, additional residential mechanical lock assets, and the ability for the DOJ to seek additional relief later under certain circumstances.
Conclusions
Amgen is the first FTC conduct remedy settlement under current leadership, and Assa Abloy is the first merger settlement under the DOJ’s current leadership. It is too early, however, to determine whether the recent settlements reflect a significant shift in either agency’s approach to merger enforcement.
In Amgen, the FTC explained that a settlement likely would not have been sufficient if the deal gave a company control over products or services that its rivals use to compete or increased the risk of information exchange. Because such conduct can be achieved through “subtle and varied” means that are “difficult to detect,” the FTC would have been more reluctant to accept a conduct remedy in lieu of blocking the transaction.
The Commissioners’ statement about the settlement noted that there are “features” specific to the Amgen matter that suggest that the settlement’s bundling prohibition was sufficient to effectively prevent it, making it unnecessary to block the transaction. The FTC seemed comforted by the fact that Amgen’s conduct would be monitored not only by a settlement monitor and agency but also by the states and that the prohibited bundling should be readily detectable by reviewing Amgen’s future agreements. Accordingly, the consent order will require Amgen to submit all contracts with payers related to the formulary and placement of Horizon’s orphan drugs within thirty days of entering into each contract, and the states will have the individual right to enforce the order.
The Black Knight and Assa Abloy settlements reflect the importance of addressing the potential lessening of competition in all the markets about which the agencies are concerned and, to the extent possible, the complete disentanglement of the divested business from the merging parties. In this and past administrations, the agencies would be very skeptical of a remedy that includes a resale agreement involving the products or services of the merged firm. Parties should be aware that the goal is for the divestiture buyer to compete vigorously against the post-merger company; this includes ensuring that the divestiture buyer has access to all the elements needed to compete and that the merged parties do not have the ready ability to interfere with that access.
As with the above matters and others, such as Microsoft/Activision and UnitedHealthcare/Change Healthcare, litigating the fix may be a successful strategy that allows the parties to shift some risk onto the agencies—they may either seriously consider accepting the parties’ proposed remedy in advance of litigation or be forced to shift their positions and accept a remedy package to avoid the risk of loss at trial and establishment of bad precedent. All reports suggest that the Assa Abloy judge was settlement-minded and that if the DOJ refused to consider any divestiture proposal, it was a risky tactic, and that if the merging parties refused to address the deficiencies the DOJ identified in the pre-trial proposed divestiture package, it was similarly risky. Accordingly, parties should not assume that the DOJ will significantly change its skepticism toward divestiture. Also, even if the DOJ accepts future settlements, it is likely that such settlements will, as the Assa Abloy settlement does, allow the agency to seek additional relief later if the divestiture fails to maintain the intensity of competition that existed before the merger in one or more areas or for one or more products.
September 17 is Constitution Day and Citizenship Day, and it is customary that the President of the United States proclaims the week of September 17 as Constitution Week.
The origins of Constitution Day and Citizenship Day are interesting because they illustrate how individuals or a small group of people can come up with and cause to be implemented ideas that contribute to strengthening the Rule of Law. This is worth noting because community commitment is an essential component of the Rule of Law.[1]
The origins of Citizenship Day date back to 1939, when William Randolph Hearst suggested creation of a holiday to celebrate American citizenship. As a result of his influence, in 1940 Congress designated the third Sunday in May as “I Am an American Day.” In 1952, a Louisville, Ohio, resident named Olga T. Weber petitioned the leaders of her municipality to change the day of the holiday to correspond with the anniversary of the signing of the United States Constitution in Philadelphia on September 17, 1787. They agreed. Weber then made the same request at the state level, and that too was approved. In 1953 Weber made a similar request to the United States Congress, and both the Senate and the House of Representatives approved the change. Consequently, President Dwight D. Eisenhower renamed the day “Citizenship Day” and moved it to September 17.
In 1997, Louise Leigh, a retired medical technologist from El Monte, California, founded a nonprofit organization called Constitution Day, Inc. with the goal of having a federally recognized Constitution Day. She had been inspired to do so after taking a course in Constitutional history sponsored by the National Center for Constitutional Studies. As a result of Leigh’s efforts, and with critical support from Senator Robert Byrd, Constitution Day became an official holiday in 2004, alongside Citizenship Day. (Senator Byrd added the “Constitution Day” amendment to an omnibus spending bill.)
You need not make any commitment of time and energy as significant as the efforts by Olga T. Weber and Louise Leigh in order to make a difference in terms of helping spread the word about Constitution Week. I have two suggestions for things you can do that would be “an easy lift.”
First, you can remind people that September 17 is Constitution Day and Citizenship Day and that the week following is Constitution Week. If they look at you and ask something along the lines of “So what?” you can share with them a few thoughts that were expressed in last year’s Presidential proclamation:
America is founded on the most powerful idea in history—that we are all created equal. That idea sparked our revolution, ignited a wave of change of across the world, and beats in the hearts of Americans today. It is central to our Constitution, and citizenship embodies a true faith and allegiance to give it full meaning in our everyday lives. . . .
When our Founding Fathers came together nearly 250 years ago, they set in motion an experiment that changed the world. They disagreed and debated but ultimately came together to forge a new system of self-government—a system balanced between a strong Federal Government and the States, held together by co-equal branches and a separation of powers. America would not be a land of kings or dictators; it would be a Nation of laws . . . .
As we have seen throughout our history, though, nothing about our democracy is guaranteed. America is an idea—one that requires constant stewardship.
A Proclamation on Constitution Day and Citizenship Day, and Constitution Week, 2022 (Sep. 16, 2022).[2]
Second, you can tell them about the annual “Civics Challenge” created by the Federal Judges Association (FJA). The FJA offers this annual challenge to high school students across the country as part of an effort to increase civic engagement, knowledge of United States history and government, and appreciation for our country’s citizenship process.
High school students, grades 9 through 12, can participate in this challenge if they have a teacher who is willing to participate. The students take the Civics Test that is given to individuals seeking United States citizenship. Any high school teacher can agree to administer and grade the Civics Test. The Civics Test must given, graded, and the results submitted by the participating high school teacher to the FJA by no later than December 31, 2023.
A student who achieves a perfect score on the Civics Test, as determined by the participating high school teacher, will receive an “Excellent Citizen” certificate, which will be mailed to the participating high school teacher. Such students will also have a potential opportunity to be invited to attend a federal court naturalization ceremony in their home judicial district presided over by a federal judge.
If you know a high school teacher, or know someone who knows a high school teacher, please mention this to that individual and let them know that they can contact the FJA coordinator, Susan DeCourcey, at the following email address: [email protected].
In case you are intrigued, the following is a sample of typical questions that appear on the Civics Test:
What does the Constitution do?
The idea of self-government is in the first three words of the Constitution. What are these words?
What are two rights in the Declaration of Independence?
What is the “rule of law”?
If both the President and the Vice President can no longer serve, who becomes President?
What does the judicial branch do?
Under the Constitution, some powers belong to the states. What is one power of the states?
What is one responsibility that is only for United States citizens?
The Federalist Papers supported the passage of the U.S. Constitution. Name one of the writers.
Name one American Indian tribe in the United States.
Name one U.S. territory.
Perhaps we should set up a testing booth at one of the American Bar Association Business Law Section meetings and see how we as a Section do?
World Justice Project, “What is the Rule of Law?,” https://worldjusticeproject.org/about-us/overview/what-rule-law (“The Rule of Law is ‘a durable system of laws, institutions, norms, and community commitment’ based on ‘four universal principles’: ‘just law’; ‘open government’; ‘accessible and impartial justice’; and ‘the government as well as private actors are accountable under the law.’”) (emphasis added) (last visited 9/7/23). ↑
The Governor of Delaware has signed into law amendments to the General Corporation Law of the State of Delaware (the “DGCL”) proposed by the Delaware State Bar Association and subsequently approved by the Delaware legislature. A number of provisions of the DGCL are affected, and the legislation addresses several significant topics, including simplifying the procedures required to ratify a defective corporate act because of a failure of authorization and simplifying the required contents of a certificate of validation under Section 204 of the DGCL; clarifying the record date for identifying which stockholders are entitled to notice of stockholder action via written consent; modifying the need for or reducing the minimum stockholder vote required for charter amendments effecting forward stock splits, reverse stock splits, and changes in the number of authorized shares of a class of stock; providing appraisal rights in connection with a transfer; continuance or domestication of a Delaware corporation to a non-U.S. entity; and creating a safe harbor in which stockholder approval would not be required for a mortgage or pledge of assets.
Authority to Sell Treasury Shares (Sections 152, 153, 157, and 160(b))
The amendments to Sections 152, 153, and 157 of the DGCL build on amendments adopted in August 2022 that expanded a board’s ability to delegate authority to an individual or entity to issue stock or options in the corporation, and also harmonized the procedures to authorize rights and options to purchase stock with existing procedural requirements to issue stock.
The amendments to Sections 152 and 153 of the DGCL, which govern the approval and issuance of stock, clarify that treasury shares may be sold for less than the minimum consideration required to issue stock, which is typically par value. In addition, Section 153 was amended to provide that (i) the consideration received for treasury shares may be greater than, less than, or equal to the par value of the shares, and (ii) the consideration a corporation may receive for treasury shares may consist of cash, any tangible or intangible property, or any benefit to the corporation, harmonizing Section 153 with language already contained in Section 152.
The amendments to Section 157 of the DGCL further modernize the statute by providing that, in addition to granting board authority to a person or body, including a committee of the board, to issue rights and options, the board may also delegate authority to determine the terms upon which shares may be acquired by the corporation upon the exercise of rights or options. As a practical matter, the amendments expand the delegation of authority permitted under Section 157 to include vesting terms, acceleration, and other typical features of equity awards.
In connection with the amendments to Section 152, 153, and 157, Section 160(b) of the DGCL was amended to clarify that a corporation may resell treasury shares resulting from the corporation’s redemption or repurchase of treasury shares out of surplus, in accordance with Section 153, so long as the shares have not been retired, and the corporation’s certificate of incorporation does not require the shares to be retired.
Ratification of Defective Corporate Acts (Section 204)
Section 204(c)(2) of the DGCL was amended to clarify that the determination as to whether any shares of valid stock are outstanding and entitled to vote on the ratification must be made at the time the board adopts the resolutions approving the defective corporate act. Similarly, Section 204(d) was amended to fix the board’s adoption of the resolutions ratifying a defective corporate act as the time for determining which shares constitute valid stock and which shares constitute putative stock entitled to vote on the adoption of the ratification of a defective corporate act, in circumstances requiring a vote of the holders of valid stock.
Streamlining the process to ratify a defective corporate act, a corporation is now required to file a certificate of validation only in circumstances where any section of the DGCL would have required the filing of a certificate in connection with the defective corporate act and such certificate was either (i) never filed or (ii) was filed, but to give effect to the underlying corporate act, the certificate must be amended. When a certificate of validation must be filed, Section 204(e), as amended, simplifies the required contents, including by eliminating the need to describe the underlying defective corporate acts and the nature of the failure of authorization relating to those acts.
Record Date for Stockholders Entitled to Notice of Stockholder Action by Written Consent (Section 228(e))
Section 228(e) of the DGCL has been amended to conform the determination of the record date to be used for purposes of identifying the stockholders entitled to notice of stockholder action taken by written consent with Section 213(b) of the DGCL. As amended, Section 228(e) now provides that the persons entitled to receive notice of action by written consent are persons who (i) were stockholders as of the record date for the action by written consent, (ii) would have been entitled to notice of the meeting if the action had been taken at a meeting and the record date for the notice of the meeting was the record date for the action by written consent, and (iii) have not consented to the action by written consent. The amendments further modernize the statute by permitting the notice required under Section 228(e) to be disseminated through a notice of internet availability of proxy materials, in accordance with current SEC rules.
Forward and Reverse Stock Splits (Section 242)
Amendments to Section 242 of the DGCL, which governs the requirements to amend the certificate of incorporation of a Delaware corporation, were implemented to address, in part, recent issues encountered by public corporations in securing the stockholder vote required to approve a reverse or forward stock split.
New Section 242(d)(1) of the DGCL provides that no stockholder approval is necessary for an amendment to the corporation’s certificate of incorporation for a forward stock split, provided that such class is the only class of such corporation’s capital stock then outstanding and is not divided into series. Further, the amendment may increase the number of authorized shares of such class of stock up to an amount proportionate to the subdivision.
The amendments to Section 242(d)(2) of the DGCL modify the voting requirement to a majority of votes cast rather than a majority of the shares outstanding for reverse stock splits and for amendments to certificates of incorporation to increase or decrease to the number of shares of a class of stock. The new voting standard applies if, (i) the shares are listed on a national exchange immediately before the amendment becomes effective and the corporation meets the listing requirements relating to the minimum number of holders immediately after the amendment becomes effective, and (ii) if the amendment increases or decreases the number of shares of a class of stock that has not opted out of the class vote pursuant to Section 242(b)(2), the votes cast for the amendment by the holders of such class exceed the votes cast against the amendment by the holders of such class. Abstentions have no effect on whether the required approval is obtained.
Section 242(d) of the DGCL continues to permit a corporation to opt in to the required stockholder votes under Section 242(b). Thus, a corporation must affirmatively opt out of the new Section 242(d). A general recitation of the vote generally required under Section 242(b) in the certification of incorporation will not be sufficient to opt out of Section 242(d).
Appraisal Rights (Section 262)
Subject to the “market out” exception, Section 262 of the DGCL has been amended to provide appraisal rights to stockholders in connection with a transfer, domestication, or continuance of the corporation in a foreign jurisdiction pursuant to Section 390 of the DGCL. In addition, appraisal rights have been eliminated for an entity that has converted to a Delaware corporation in connection with a merger, consolidation, conversion, transfer, or domestication authorized in accordance with Section 265 for an entity that has converted or domesticated into a Delaware corporation.
Section 262(k) of the DGCL was also amended to permit the withdrawal of an appraisal demand either within sixty days after the effective date of the transaction, or thereafter, if the withdrawal is approved by the corporation.
Conversions, Transfers, Domestications, and Continuances (Sections 265, 266, and 390)
Section 265 of the DGCL as amended adds subsection (k), which, in connection with a conversion pursuant to Section 265, permits the converting entity to adopt a plan of conversion setting forth the terms and conditions of the conversion. Newly added Section 265(c)(4) also requires the converting entity’s approval before the effective date of the conversion for any corporate action included in the plan of conversion. Similarly, the newly added Section 265(l) clarifies that any corporate actions included in the plan of conversion will be deemed to be authorized, adopted, and approved, as applicable, by the converted Delaware corporation, and do not require further action by the converted corporation’s board or stockholders.
Section 266(b) of the DGCL, governing the conversion of a Delaware corporation to another entity, has been amended to provide that a plan of conversion may be adopted setting forth: (i) the terms and conditions of the conversion; (ii) the terms of the instrument governing the internal affairs of the entity included as an attachment to the plan of conversion; (iii) the manner of exchanging or converting the shares of the converting corporation; (iv) any other provisions deemed desirable; and (v) such other provisions or facts as required by the laws applicable to the entity into which the entity is being converted. Section 390(b) of the DGCL was also amended to add a similar requirement pursuant to a transfer, domestication, or continuance to be adopted in accordance with Section 390(j) of the DGCL.
Section 390(b) of the DGCL was also amended to modify the voting requirement to approve a transfer, domestication, or continuance from all of the outstanding shares of stock of the corporation (voting or non-voting) to a majority of the voting power of the outstanding shares of stock of the corporation entitled to vote on the transfer, domestication, or continuance.
Safe Harbor—Mortgage or Pledge of Assets (Section 272)
Section 271 requires stockholder approval of a sale, lease, or exchange of all or substantially all of a corporation’s assets, subject to certain exceptions, while Section 272 of the DGCL governs the mortgage or pledge of the corporation’s assets. In response to Stream TV Networks, Inc. v. SeeCubic, Inc., 279 A.3d 323 (Del. 2022), new Section 272(b) of the DGCL provides a safe harbor clarifying that stockholder approval is not required under Section 271 with respect to the sale, lease, or exchange of property or assets securing a mortgage or pledged to a third party under certain circumstances. Importantly, the intent of the new Section 272(b) was not to preclude further development of the quantitative and qualitative analyses utilized by the Delaware courts to interpret Section 271.
Under Section 272(b), no stockholder approval is required if the secured party (i) exercises its rights to sell, exchange, or lease the property or assets without the corporation’s consent under applicable law, or (ii) in lieu of the secured party exercising its rights, the board of directors agrees to an alternative transaction and the value of the property or assets is less than or equal to the amount of the liability or obligation being reduced or eliminated as a result of the transaction (the “asset value test”). Section 272(b) provides further that the consideration paid to the corporation or its stockholders will not create a presumption that the value of such property or assets is greater than the total amount of such liability or obligation being reduced.
New Section 272(d) of the DGCL provides further that a corporation’s certificate of incorporation must expressly state that stockholder approval is required for a sale, lease, or exchange permitted by Section 272(b). Merely stating in the certificate of incorporation that stockholder approval is required for a sale, lease, or exchange of assets will not apply to such sale, lease, or exchange pursuant to Section 272(b). Section 272(d) only applies to certificate of incorporation provisions that first become effective after August 1, 2023.
Newly added Section 272(c) of the DGCL also provides that, following the consummation of a transaction, the transaction cannot be invalidated for failure to satisfy the asset value test above if the transferee provided appropriate value for the assets and acted in good faith.
The term “Artificial Intelligence” is not helpful to our public discourse. Artificial Intelligence (AI) is not intelligent. The term encompasses too much, is poorly defined, and therefore can’t be discussed precisely.
But it is important for policymakers to understand what they are encouraging or prohibiting. Passing a law to “restrict artificial intelligence” is a dangerous exercise under current definitions.
Different functions of artificial intelligence create different problems for law and society. Generative AI creates not only new text, code, audio, or video, but problems with deepfakes, plagiarism, and falsehoods presented as convincing facts. AI that predicts whether a prisoner is likely to commit future crimes raises issues of bias, fairness, and transparency. AI operating multi-ton vehicles on the road creates physical risks to human bodies. AI that masters the game of chess may not raise any societal issues at all. So why would politicians and courts treat them the same?
They shouldn’t, but if people don’t understand the distinctions between functional types of artificial intelligence, then they won’t be able to make sensible rules. Our language is holding us back. We need to think differently about AI before determining how to treat it.
There can be useful arguments for defining artificial intelligence by the process used to create it. Large language models or other models built by shoveling tons of data into the maw of a machine-learning algorithm may be the purest form of AI. Politicians don’t understand the distinction between these models and other functioning forms of code, however, and they shouldn’t need to. Politicians don’t care how to build an AI model; they only care what it does to (or for) their constituents.
Some of what we think of as AI is nothing more than complex versions of traditional computational algorithms. Standard big-data mining can seem miraculous, but no machine-learning modules are needed to elicit the desired results. And yet, when regulators discuss strapping restrictive rules onto AI, they would include standard algorithms.
Science fiction writer Ted Chiang has defined artificial intelligence as “a poor choice of words in 1954,” preferring instead to call our current technologies “applied statistics.” He also observed that humanized language for computer activities misleads our thinking about amazing, but deeply limited tools, like effective weather predictors and art generators. There is sorting, excluding, selecting, and predicting in these applied statistical processes, but not context, thinking, or intelligence in the human sense.
Whether our problem is understandable-but-unfortunate humanization of these models, whether it is imprecise thinking about what types of technology constitute AI, or whether it is lumping together of disparate functionalities into a single unmanageable term, we are harming the discourse—and our ability to diagnose and treat dysfunction—by using the term “artificial intelligence” in the present manner.
If we wish to police AI, our society needs to define and discuss AI precisely.
In the explosion of commentary surrounding generative AI, hand-wringing about singularities devolved into an oft-expressed desire to regulate and otherwise “build guardrails” for AI. Society’s protectors, elected and otherwise, believe that we must stop AI before AI stops us, or at least before our use of AI foments foreseeable harm to populations of innocents.
What we casually call AI right now is a set of computerized and database-driven functionalities that should not be considered—and certainly should not be regulated—as a single unit with a single rule. AI consists of too many tools raising too many separate and unrelated societal problems. Instead, if we wish to effectively legislate AI, we should break the definition into functional categories that raise similar issues for the people affected by the technology in that category.
I propose a modest organizational scheme below to assist lawyers, judges, legislators, and regulators to 1) grasp the present state of AI and 2) design rules to regulate the functions of machine learning modules. Some of these lines blur, and certain technical or social problems are shared across classifications, but thinking of current AI solutions in legally significant functional categories will simplify effective rulemaking.
Each of these categories provides a unique set of problems. Legislators and regulators should be thinking of AI in the following functions.
Automating AI: Certain AI models automate processes within business or government without making decisions about the opportunities of specific people. Automating AI may streamline an accounting system, research the case law on burglary, or provide a system of forms for running a company. It can replace human workers in some tasks, and therefore has a social impact.
Generative AI: By predicting the output requested from a series of prompts, certain AI tools build a word-by-word or pixel-by-pixel product that can mimic (or copy) human-looking creations. This can lead to working software code and functioning websites, art in the vernacular of Jan van Eyck, papers discussing the use of symbolism in The Scarlet Letter, or legal arguments in a contract litigation. These products raise intellectual property and plagiarism questions, and they can be trained on improperly obtained material. This technology can produce deep-fakes that are indistinguishable from actionable proof. When Generative AI works poorly, it can generate absolute nonsense presented as true fact.
Physical Action AI: Driverless vehicles operate on the interplay between sensors and predictive algorithms, and so do many industrial and consumer technologies. These are systems that use AI to function in the physical world. This category of AI can include running a single machine, like a taxi, or managing traffic systems for millions of vehicles or Internet of Things devices. Legal concerns not only involve safe product design and manufacture, but tort law, insurance issues, and blame-shifting contracts that affect all activity where the laws of physics and moving bodies apply.
Strategizing AI: We all know about predictive machine-learning programs that mastered human strategy games like chess by playing millions of games. Strategizing AI makes predictions based on running simulations, and humans use it to choose effective strategies related to those simulations. Strategizing AI raises concerns regarding accuracy and reliability of the predictions.
Decisioning AI: This category is not defined by technology but by the technology’s effect on people. Algorithmic tools are used to limit or expand the options available to people. AI ranks resumes for human resource managers, highlights who should be interviewed for jobs, and evaluates the reactions of applicants in those interviews. For years algorithms have made prison parole recommendations, sorted loan applicants, and denied suspicious credit transactions. These decisions are subject to bias of various types, also raising issues of transparency, accuracy, and reliability. The EU and some US states have already regulated this category of AI. The Chinese government has elevated these tools into a societal scoring system that can affect every aspect of a citizen’s life and freedom.
Personal Identification AI: Also defined by its effects on humans, certain AI is being used to pick an individual out of a crowd and name them, to extrapolate whose fingerprint was pulled from a crime scene, or to identify a person carrying a specific phone over specific geography. Most Personal Identification AI uses biometric readings from face, voice, gait, or other traits tied to our bodies, but some is behavioral, including geolocation patterns, handwriting, and typing. This type of AI has been implicated in constitutional search and seizure issues, highlighted for findings that were biased against certain ethnic groups, and questioned for its trustworthiness.
Differentiating AI (Data Analytics): Some algorithms simply decide which items should be included or excluded from a specific group. While this sounds like a simple task, sheer numbers and/or complexity can make the work impossible for humans. Differentiating AI can spot a growing cancer from a shadow on an X-ray much more effectively than teams of trained radiologists. It can predict which cell in a storm may drop a tornado. It helps decide which picture shows a cat and which shows a dog. Both Decisioning AI and Personal Identification AI are legally significant subgroups of Differentiating AI, but I am proposing that this classification will not include tools designed to identify people or make subjective decisions about people, but instead be limited to those that suggest factual groupings that might lead to real-world consequences.
Military AI: An amalgam of each of the other functional types listed here, the military builds its own strategizing models, decisioning models, and physical action AI. These tools raise some of the same issues as civilian versions, but an overlay of special purposes and the law of war create a unique category of considerations for military AI. Like most military tools and strategy, the rules for military AI will appear in international treaties and informal agreements between nation-states. Civilian authorities are unlikely to develop effective limitations for the military’s utilization of AI and algorithmic tools.
AI exists in extensive forms and functionalities, so attempting to regulate the entire set of technologies would be overreaching and likely ineffective. The above categorizations provide a safer place to start if we wish to regulate a vast and shifting technology. By adopting this thinking, AI management becomes less daunting and more effective.
This article is excerpted from To a High Court: Five Bold Law Students Challenge Corporate Greed and Change the Law by Neil Thomas Proto (FriesenPress, 2023). Proto’s first-person account chronicles the efforts of a group of law students—chaired by Proto at the time—to challenge an increase granted by the Interstate Commerce Commission to railroad freight rates nationwide, suing the U.S. and the ICC for violating the National Environmental Policy Act. Their lawsuit culminated in the landmark 1973 decision on Article III standing United States v. Students Challenging Regulatory Agency Procedures (SCRAP).
The Supreme Court, February 28, 1973
The Chief Justice calls the first case: “TheAtchison, Topeka and Santa Fe Railroad Company versus the Wichita Board of Trade, Number 72214.” The Court is being asked to review an order of the Interstate Commerce Commission. The order permits particular railroads to increase their charge to grain shippers by 100 percent to stop the train in transit, inspect the grain, and determine its grade. The agrarians object. They are the railroads’ captives. It was the rough and quixotic abuse of this dependence that spurred the Granger movement and the presidential efforts of William Jennings Bryan. It also moved literary realists like Theodore Dreiser and Frank Norris— abhorred, angry, seeking to further awaken the nation to the railroads’ intimidating grip on the land. Norris said it: “[T]he symbol of a vast power … leaving blood and destruction in its path; the Leviathan, with tentacles of steel clutching into the soil, the soulless force, the iron-hearted power, the monster, the Colossus, the Octopus.” In 1887, Congress created a national institution to regulate the railroads and to protect the public interest: the Interstate Commerce Commission. That attempt had not worked. Montana’s Senator Mike Mansfield sought yearly to legislate the Commission’s abolition. He could not do it.
The Chief Justice thanks the participants in a pro forma but polite way. He settles back into his chair. The attorneys representing the next set of adversaries move into place. George places his hand firmly around my forearm. “We got here,” he whispers evenly. John looks at the two of us and smiles. It is one of his cunning grins. He sits back, prepared to listen. He will not miss a word. Neither will I.
“We will hear argument next in 72535 and 562, United States and ICC against Students,” says Warren Burger, “and Aberdeen and Rockfish Railroad against Students.” The Chief Justice pushes his hair back, seeming to bring recognition to its whiteness. He adjusts his posture—erect, framed, subtly moving his head downward so as to assure himself that the attorneys for each side are prepared to argue their case. He obviously has done this before.
The solicitor general of the United States, Erwin Griswold, has taken his seat at the counsel table directly in front of the Chief Justice and slightly to his left. It is Griswold’s responsibility to represent the United States and the Interstate Commerce Commission. He is the former dean of the Harvard Law School and is experienced in Supreme Court argument. He is wearing his morning coat. Seated next to him is Hugh B. Cox, senior partner at Covington & Burling, Washington’s most prestigious law firm. He is representing the nation’s railroads. Cox also is part of the tradition. He is familiar to this setting and knowledgeable about its culture. He, too, is wearing a morning coat.
Seated at the other end of the table is the attorney for the appellee, Students Challenging Regulatory Agency Procedures (SCRAP). Peter Harwood Meyers is twenty-six years old and a 1971 graduate from the George Washington University School of Law. This is the third oral argument he has ever presented. The first two were in the SCRAP case in the court below.
Meyers is sitting erect, hands folded on the table, nodding slightly when the Chief Justice looks downward. Meyers has trimmed his hair to a fashionable length and is wearing a white shirt. While he has no morning coat, he looks comparatively better without the lavender shirt he wore in the court below. Also at the table, to Peter’s left, is Professor John Banzhaf. “B as in Boy, AN, Z as in Zebra, HAF.” That is the way he spells it for the press, an institution he is acutely sensitive to and depends on for success. He, too, is without a morning coat. Despite the respectful appearance of the two, I know for a fact they have not done this before.
We had decided to file this lawsuit against the Interstate Commerce Commission in May 1972 because the Commission had failed to prepare a detailed statement on the environmental impact of a rate increase granted to all the nation’s railroads on all freight. This obligation, we contended repeatedly to the Commission since fall 1971, was imposed on the Commission by a new law, the National Environmental Policy Act (NEPA). The increased rates are discriminatory. They encourage the extraction of natural resources, including iron ore and timber, and they discourage industrial use of recyclable materials such as scrap iron and steel and textile and paper waste. They also impede the ability of the nation’s cities to move enormous amounts of solid waste. We urged the Commission to consider the environmental consequences nationwide, the same geographic reach of the railroads’ own rate increase.
The Commission and the railroads disagreed. It is their custom to do so. The 1970 report by Ralph Nader’s study group characterized the Commission as a place where “the men in … upper staff … share a protective attitude to ward the transportation industry. They are afraid of change.” This custom of insulation has a legal counterpart. The Supreme Court has regularly deferred to the Commission’s decisions. The Commissioners can do largely what they have always done: resist the public and protect the railroads. They knew that fact going into our lawsuit. So did we.
SCRAP is holding its own. In an opinion written in July 1972, a specially impaneled three-judge district court agreed with SCRAP’s position. “[SCRAP] alleges,” Judge J. Skelly Wright wrote, “that this price increase will discourage the environmentally desirable use of recyclable goods and that … under the terms of NEPA, cannot take effect before a ‘detailed statement on the environmental impact of the proposed action’ is prepared.” The court stopped the rates from going into effect. The railroads and the Commission are uneasy; their relationship has been penetrated, restricted by law, pronounced by a court of law—at the request of five law students. Since the lower court’s decision, the nation’s railroads have been stopped from collecting approximately $400,000 a month for one recyclable material alone: iron and steel scrap. We got their attention. The railroads, along with the United States and the Commission, immediately appealed to the Supreme Court. It is the first time the full Court will interpret the meaning of NEPA. The Chief Justice has already made his views known. He is for the Commission.
There is, however, a threshold legal question. It stems directly from the Constitution. In Article III, the framers created the Supreme Court and limited its jurisdiction to deciding only “cases … and … controversies.” Any party that attempts to invoke the Court’s jurisdiction has to show that it has, in fact, been injured by the government’s action. A party able to make that showing is said to have “standing to sue.” It is not done easily. The Constitution does not tell you what is required. The specific requirements are set by the Supreme Court speaking through its decisions. The requirement has changed over time. Without “standing to sue,” the Court must dismiss the lawsuit.
In the district court, the United States and the Commission challenged SCRAP’s “standing.” In its brief, the government made its case directly: “The plaintiff’s [SCRAP’s] lack of standing to maintain this action was settled by the recent decision of the Supreme Court in Sierra Club v. Morton,” rendered only a few weeks before our lawsuit was filed. According to the government, SCRAP has an even lesser claim: “The complainant in that case, Sierra Club, was a significant and respected organization, with a longstanding concern for the preservation of the environment…. S.C.R.A.P.’s purpose may be commendable, and the zeal of the five law students who comprise it perhaps should be encouraged. However, we respectfully submit that its concern for the public wellbeing does not give S.C.R.A.P. the requisite standing to maintain this action.”
The district court rejected the government’s argument. It concluded that SCRAP had “standing to sue.” But the question is not settled. The United States and the Commission, joined by the nation’s railroads, continue to raise it before the Supreme Court. If the members of SCRAP lack “standing to sue,” then the Commission’s failure to comply with NEPA cannot be reviewed by a court of law.
The solicitor general rises from the counsel table and steps with authoritative comfort to the podium directly in front of the Chief Justice. Solicitor General Griswold’s head moves slightly left to right, seeming to scan the bench as if acknowledging that everyone is present. Hugh Cox is seated to Griswold’s right. Cox is prepared, formidable in skill, and potent in the history and industrial force that buttress his position.
“I am representing the United States and the Interstate Commerce Commission,” the solicitor general states. “Mr. Cox is representing the appellant railroads in No. 72562. We have filed separate briefs, but there is no divergence between our positions.”
Finally, it is beginning. The line is drawn clearly. Now we will see whether it makes a difference that they have been here before and we have not.
The recent US Federal Trade Commission (“FTC”) proposal to ban employers from imposing non-competition clauses (“non-competes”) on their workers has sparked lively debate. Support comes from those who believe the proposed rule would encourage entrepreneurship and innovation and ultimately accelerate economic growth.[1] On the other hand, critics of the proposed rule argue that non-competes are necessary to protect confidential information, such as marketing strategies or pricing plans,[2] although much of the opposition is focused on whether the FTC has the legal authority to pass the rule.
It is difficult to predict whether the proposed rule will actually come to pass, but it received close to twenty-seven thousand public comments. It may be instructive to consider the treatment of non-competes in other common law jurisdictions like the United Kingdom (“UK”) and Singapore, where competing interests between the right of an employer to protect its confidential information, retain employees, and reduce competition are balanced against employees’ rights to market mobility, sometimes in slightly different ways and with different outcomes.
This article will attempt to briefly summarize the employment landscape in each jurisdiction with respect to non-compete agreements; highlight some differences between them; and in turn demonstrate the nuances between the jurisdictions, and their reputations as pro-employer or pro-employee jurisdictions.
I: Overview of New York’s Employment Landscape
In New York, restrictive covenants are “disfavored.”[3] However, they are generally enforceable if narrowly tailored to protect legitimate business interests such as trade secrets, confidential information, or customer goodwill and if they do not unreasonably restrict an employee’s right to earn a living. The duration and geographical scope of the non-compete must also be “reasonably limited.”
In the seminal case of BDO Seidman v. Hirshber, [4]the New York Court of Appeals held that a non-compete agreement that prevented an accountant from working for any client of his former employer for eighteen months, even if he had never worked on that client’s account, was overly broad and unenforceable. The court noted that such a restriction would effectively prevent the employee from working in his chosen profession, and was unnecessary to protect the employer’s legitimate interests.
The FTC proposal seeks to place a broad ban on non-competes, claiming that non-competes affect more than thirty million people in the private sector and if banned, would increase American workers’ earnings by $250 to $296 billion.
It is submitted that the new FTC rule would arguably produce limited practical changes in litigation outcomes in New York, whereas the potential practical impact of the rule in other arguably more pro-employer states like Maryland could be more significant.[5]
II: Overview of the UK’s Employment Landscape
Across the Atlantic, the enforceability of non-compete agreements is subject to common law principles and statutory regulations. Generally, non-compete clauses are enforceable only to the extent that they are reasonable and necessary to protect the employer’s legitimate business interests. The case of Tillman v Egon Zehnder Ltd[6] clarified the law on restrictive covenants and represents a good illustration of how the UK courts balance competing interests in this area. There, the Supreme Court held that the non-compete clause was unenforceable as it was too wide and prevented Tillman from holding even a minor shareholding in a competing business.
In Marathon Asset Management LLP v Seddon,[7]Seddon was sued for breaching his six-month non-compete clause. The Court of Appeal held that the non-compete clause was too wide and therefore unenforceable, as it prevented Seddon from working for any competing company, regardless of whether it was a direct competitor.
These cases demonstrate the UK’s increasingly strict approach to non-competes, where reasonableness and necessity are scrutinized and overly broad or restrictive clauses can be deemed unenforceable by the courts.
III: Overview of Singapore’s Employment Landscape
In Singapore, non-compete agreements are enforceable to the extent that they protect an employer’s legitimate business interests and are reasonable in scope, duration, and geographical coverage. Singapore is known as an employer-friendly jurisdiction, but its courts do strike down clauses that they deem overly restrictive or unreasonable. Indeed, in some respects, Singapore may be said to police the reasonableness of certain aspects of non-competes, for the benefit of employees, more strictly than New York.
For example, New York courts generally regard the use of non-competes to protect confidential information as legitimate. However, in Singapore, if the protection of confidential information is already addressed by another clause in the contract (e.g., a confidentiality clause), the Singapore courts have held that the employer must demonstrate that the non-compete clause covers a legitimate proprietary interest over and above the protection of confidential information or trade secrets, in order not to be regarded as an unenforceable restraint of trade.[8]
IV. Same but different
While the legal tests in each jurisdiction are very similar, their application to broadly similar facts can sometimes result in divergent outcomes, reflecting the public policy considerations of the respective jurisdictions. In the UK, courts have taken a relatively strict approach to the enforceability of non-compete clauses due to the country’s public policy of promoting competition and preventing the restriction of trade. As such, non-compete clauses must be narrowly tailored to protect the legitimate interests of the employer without unduly restricting the employee’s ability to work.
In Singapore, non-compete agreements are generally viewed as a legitimate means for businesses to protect their proprietary interests, within certain boundaries related to the duration, scope, and nature of the restrictions.
Given the substantial and often negative influence of large corporations on “labor market fluidity” in the US, with non-competes common even for fast-food workers, clerks, and low-level hospital employees, the FTC’s proposed rule should be welcomed by workers. Whether or not the rule is implemented, employers in the US would be well advised to start exploring alternative contractual, technological, and practical mechanisms to protect their confidential information, trade secrets, and goodwill.
This article originally appeared in International Law News, the quarterly magazine of the ABA International Law Section, in the Spring 2023 issue (Volume 50, Issue 3). Join the International Law Section to read the full issue and access other resources regarding international law.
Title 3 of Maryland’s Code Annotated for Labor and Employment, Section 3-716 only prohibits employers from requiring non-competes when the employee is earning equal to or less than $15 per hour. ↑
