The Eastern District of Pennsylvania Bankruptcy Conference (EDPABC) is a non-profit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.

MATERIALS PREVIEW

Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.

The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.

This hypothetical from a previous forum, titled “Dr. Hibbert and Dr. Nick,” describes the highly contentious chapter 11 case of a joint venture formed by the two doctors. Dr. Hibbert filed for the joint venture after escalating disagreements resulted in Dr. Nick (through a family trust) seizing its medical equipment to open a competing practice next door. The hypothetical poses questions relating to the automatic stay, extensions of time under section 108 of the Bankruptcy Code and redemption rights, cause to appoint a chapter 11 trustee, and competing chapter 11 plans.

DR. HIBBERT AND DR. NICK

After completing their respective radiology residency programs, Dr. Hibbert and Dr. Nick open an outpatient imaging center together. The joint business venture is funded by a revolving loan from a traditional bank (the Bank) secured against medical receivables and a purchase money loan from Dr. Nick’s family trust (the Nick Trust) secured by the imaging equipment. The two doctors obtain a single National Provider Identifier (NPI) from the Centers for Medicare and Medicaid Services (CMS).

Several years later, the two doctors have a falling out. Dr. Hibbert accuses Dr. Nick of being a quack physician engaged in dubious patient acquisition and billing practices. Dr. Nick accuses Dr. Hibbert of stealing money from the company, defaming him in front of patients, and sleeping with his spouse.

Dr. Hibbert, who has sole check writing authority over the business’ deposit accounts, opts to fail to make the next payment due to the Nick Trust on the equipment loan. The Nick Trust opts to notice the default, accelerate the loan, and demand payment in full. Dr. Hibbert opts not to fund Dr. Nick’s next payroll check.

The Nick Trust then opts to utilize some self-help of its own. In full compliance with applicable law, the Nick Trust repossesses the imaging equipment and moves it into adjoining medical office space—newly leased by the Nick Trust. Without the imaging equipment, Dr. Hibbert is unable to provide patient services.

Four days later, Dr. Nick announces the grand opening of “Dr. Nick’s Medical Imaging Center.” Dr. Nick begins providing services to patients utilizing the imaging equipment. Dr. Nick also issues reimbursement requests for such services to CMS using the NPI.

Unable to continue to operate, Dr. Hibbert files a voluntary petition for chapter 11 bankruptcy protection on behalf of the joint business venture. Four days later, Debtor’s counsel sends a letter to the Nick Trust demanding the return of the imaging equipment and threatening sanctions for its willful violation of the automatic stay. The Nick family accountant, who solely controls the Nick Trust, ignores the letter.

Debtor’s counsel ultimately files a motion, pursuant to 11 U.S.C. § 542 and 11 U.S.C. § 362(k), seeking turnover of the medical equipment as estate property and sanctions against the Nick Trust. The Nick Trust responds that it lawfully repossessed the imaging equipment prepetition and has only passively retained it since its repossession.

Discovery confirms that the Nick family accountant, (a) repossessed the imaging equipment at the request of Dr. Nick with actual knowledge of Dr. Nick’s retaliatory goal vis-à-vis Dr. Hibbert, but (b) was unaware that Dr. Nick had been using the imaging equipment because Dr. Nick effectively concealed the same from the Nick family accountant.

Question #1

1. Has the Nick Trust willfully violated the automatic stay?
2. Citing the Third Circuit’s decision in In re: Denby-Peterson, the bankruptcy court holds that the Nick Trust did not violate the automatic stay willfully because the Nick Trust’s possession of the imaging equipment post petition had been passive. The issue is appealed to the Supreme Court, which grants the writ of certiorari to resolve the circuit split among the Second Circuit, the Third Circuit, and the Tenth Circuit. If you were a Supreme Court Justice, how would you decide the issue?

Assume that the bankruptcy court’s order is not appealed. Instead, new evidence comes to light that the Nick family accountant was aware that Dr. Nick had been using the imaging equipment and, in fact, had worked with Dr. Nick to accomplish his scheme of opening “Dr. Nick’s Medical Imaging Center.” With this new evidence in hand, Dr. Hibbert seeks reconsideration of the bankruptcy court’s order.

In response, the Nick Trust presents a written agreement among Dr. Hibbert, Dr. Nick, and the Nick Trust entitled the “Discounted Repayment Option Contract” (the Agreement). The Agreement provides that Dr. Hibbert will deliver the imaging equipment to the Nick Trust at the adjoining medical office space leased by the Nick Trust.

It further provides Dr. Hibbert and Dr. Nick with the option, but not the obligation, to make a discounted repayment of the equipment loan owed to the Nick Trust in exchange for a return of the imaging equipment. Under the terms of the Agreement, such discounted repayment must occur within seven days of the date of the Agreement.

If such discounted repayment is not timely made, the Agreement provides the Nick Trust with the option, but not the obligation, to retain the imaging equipment in full satisfaction of the equipment loan.

If neither option is exercised, the Nick Trust may pursue its common law rights and remedies. The Agreement is silent as to what the Nick Trust may do with the equipment while in possession of it.

The Nick Trust argues that it did not violate the automatic stay willfully because the debtor did not make the discounted repayment within the seven-day time period. Further, the debtor’s counsel’s demand letter was not sent until after the seven-day time period had expired.

The debtor’s counsel replies that the Agreement provides for a cure period with respect to the payment default under the equipment loan. The debtor’s counsel further argues that the Agreement is analogous to a common law equitable right of redemption. Therefore, 11 U.S.C. § 108(b) extends the time period under which the debtor may make the discounted repayment to the sixtieth day following the petition date. The argument being that the Agreement “fixes a period within which the debtor … may … cure a default, or perform any similar act.”

The Nick Trust sur-replies with the following arguments. Any and all cure rights under the agreement documenting the equipment loan have indisputably expired. Further, a discounted repayment is not a cure, or similar to a right of redemption, because payment in full is not being made.

Moreover, the Agreement is a standalone option contract. Because the Agreement creates options, and not obligations, the debtor is not in default of the Agreement. Because the debtor is not in default of the Agreement, 11 U.S.C. § 108(b) does not apply because there is no default to be cured. Further, the exercise of an option under an option contract is not similar to curing a default under the contract.

Question #2

1. Does 11 U.S.C. § 108(b) extend the deadline under the Agreement by which the debtor must exercise the option to make the discounted repayment?
2. Assume that the Agreement did not contain mutual options between the debtor and the Nick Trust. Instead, assume that the Agreement provided the debtor with the unilateral option to make the discounted repayment within the seven-day time period and that, if such discounted repayment was not timely made, the Agreement automatically and immediately terminated. Under these facts, the Nick Trust argues that 11 U.S.C. § 108(b) does not apply because the prerequisite of the existence of “an agreement” is no longer satisfied, i.e., 11 U.S.C. § 108(b) can only be used to extend cure or similar rights under non-terminated agreements. Can 11 U.S.C. § 108(b) be used to extend the post-petition termination of the Agreement?
3. Do any of these new facts impact your view as to whether the Nick Trust willfully violated the automatic stay?

The bankruptcy court ultimately orders the Nick Trust to return the imaging equipment to the debtor. With the equipment returned, Dr. Hibbert recommences the debtor’s operations.

Unhappy with the result, Dr. Nick and the Nick Trust pursue a scorched-earth litigation strategy in the bankruptcy case, using their combined equity and secured creditor rights to oppose every motion filed by the debtor, to bring their own motions, and to commence adversary proceedings against the debtor and Dr. Hibbert. Dr. Nick and the Nick Trust make it a point to ensure that every hearing in the case becomes a multiple-day affair. They instruct their counsel to summarily reject any requests made by the debtor, when legally permitted to do so, to be completely unhelpful to the debtor’s counsel, and to approach every issue with a tone of righteous indignation and rancor.

Their strategy results in a few initial victories in the bankruptcy court. As a result, Dr. Hibbert and the debtor’s counsel feel compelled to no longer take the high road and instead fight fire with fire. Thus, Dr. Hibbert and the debtor return the favor by pursuing their own scorched-earth litigation strategy.

Exclusivity under 11 U.S.C. § 1121 expires without the debtor filing a plan. At the first opportunity, the Bank files a proposed plan of liquidation. Dr. Hibbert responds with a competing plan of reorganization. Dr. Nick and the Nick Trust respond with their own competing plan of reorganization.

During the second day of oral argument on the parties’ respective first amended disclosure statements, the bankruptcy court makes the off-hand, somewhat joking comment, “There is so much acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust that I’m considering the sua sponte appointment of a chapter 11 trustee pursuant to the Third Circuit’s decision in In re Marvel Entertainment Group.”

Dr. Nick and the Nick Trust seize on the comment and the next day file a motion for the appointment of a chapter 11 trustee for “cause” pursuant to 11 U.S.C. § 1104. The sole basis for the motion is the alleged clear and convincing evidence of the “acrimony” among Dr. Hibbert, Dr. Nick, and the Nick Trust, which has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases.

Dr. Hibbert and the debtor oppose the motion, arguing that the level of acrimony in the case is legally insufficient and, in any event, Dr. Nick and the Nick Trust created the acrimony and, therefore, should not obtain relief based on it.

Because the Bank may or may not have properly perfected its security interest in the medical receivables—which issue has so far gone unnoticed because of the focus on the issues among Dr. Hibbert, Dr. Nick, and the Nick Trust—the Bank also summarily opposes the motion.

Question #3

1. If you are representing Dr. Nick and the Nick Trust, how would you present clear and convincing evidence of legally sufficient acrimony to carry your motion?
2. If you are representing Dr. Hibbert or the debtor, how do you present evidence of a lack of legally sufficient acrimony to carry your objection to the motion?
3. What facts are required to be proven by clear and convincing evidence to establish that the acrimony has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases?
4. At the hearing, the Bank concedes that the acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases. Nevertheless, the Bank argues that the acrimony in the case is legally insufficient for the appointment of a trustee because the appointment of a trustee is not the only effective way to move the case forward. Instead, the Bank argues that because competing plans have been filed, all that is left to do in the case is hold a vote on the plans. Is the Bank’s argument persuasive?
5. The bankruptcy court agrees with the Bank and does not appoint a chapter 11 trustee. As a result, the Bank’s proposed plan of liquidation is confirmed. Given that an independent, undistracted fiduciary may have uncovered the potential issues with the Bank’s security interest, has the case nevertheless reached an acceptable result?

List of Authorities for Question #1

11 U.S.C. § 542

(a) Except as provided in subsection (c) or (d) of this section, an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.

…

(b) Except as provided in section 362(a)(7) of this title, an entity that has neither actual notice nor actual knowledge of the commencement of the case concerning the debtor may transfer property of the estate, or pay a debt owing to the debtor, in good faith and other than in the manner specified in subsection (d) of this section, to an entity other than the trustee, with the same effect as to the entity making such transfer or payment as if the case under this title concerning the debtor had not been commenced.

…

(e) Subject to any applicable privilege, after notice and a hearing, the court may order an attorney, accountant, or other person that holds recorded information, including books, documents, records, and papers, relating to the debtor’s property or financial affairs, to turn over or disclose such recorded information to the trustee

11 U.S.C. § 362

(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—

…

(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;

(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

(4) any act to create, perfect, or enforce any lien against property of the estate;

…

(k)

(1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.

(2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages.

In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019)

Factual Background

Ms. Denby-Peterson purchased a Chevrolet Corvette, which was repossessed pre-petition by secured creditors following a payment default. Ms. Denby-Peterson subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). Denby-Peterson notified the secured creditors of her bankruptcy filing and demanded they return the Corvette. The creditors refused, prompting Denby-Peterson to file motions for turnover of estate property pursuant to 11 U.S.C. § 542 and for sanctions for willful violation of the automatic stay under 11 U.S.C. § 362(k).

The Bankruptcy Court held a hearing on these matters, granting the motion for turnover but denying the motion for sanctions. The sanctions motion was denied on the basis that there could be no willful violation of the stay absent violation of the turnover order, which obviously had yet to occur. Denby-Peterson appealed the denial of the sanctions motion, but the U.S. District Court for the District of New Jersey (the District Court) upheld the Bankruptcy Court’s rulings. Denby-Peterson then appealed once again, this time to the U.S. Court of Appeals for the Third Circuit (the Court).

Court’s Analysis

The Court was confronted with the question of whether passive retention of collateral seized pre-petition constituted a “willful violation” of the automatic stay. The Court answered this question in the negative and therefore upheld the District Court’s ruling affirming the Bankruptcy Court. The Court looked to the obligations governing turnover of collateral in 11 U.S.C. §§ 362 and 542 and found that these obligations were not “self effectuating.” While the turnover provision of § 542 is mandatory, the Court noted that it is not automatic—certain statutory conditions must be met to trigger the turnover obligations, e.g. 11 U.S.C. § 542(a). To allow a debtor to demand turnover absent fulfillment of these statutory conditions would be to allow the stripping of a creditor’s property without due process. Rather than approve Denby-Peterson’s self-effectuating interpretation of § 542 turnover, the Court instead held that the turnover provisions do not take effect until they are empowered by judicial order.

Turning to 11 U.S.C. § 362(k), the Court found that retention of property seized pre-petition did not constitute the necessary “exercise of control” to give rise to sanctions. Looking to the statutory language, the Court concluded that “exercise of control” requires an affirmative act on the part of the party accused of violating the stay. The Court held that mere passive retention of property already in a party’s possession did not rise to the level of an affirmative act. Without such an affirmative act, there was no “exercise of control,” and without that, there could be liability under § 362(k). To button the issue up, the Court referenced the Supreme Court’s decision in Maryland v. Strumpf, 516 U.S. 16 (1995), which allowed a bank to freeze and retain a debtor’s assets without violating the stay. The Court found that this ruling would not be reconcilable with a requirement that turnover of assets be automatic and self-effectuating.

Weber v. SEFCU (In re Weber), 719 F.3d 72 (2d Cir. 2013)

Factual Background

This case concerned a secured creditor (Creditor) seizing a debtor’s vehicle pre-petition owing to payment default. Debtor subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the Northern District of New York (the Bankruptcy Court), of which Creditor was aware. Creditor nonetheless failed to return possession of Debtor’s vehicle after becoming aware of its bankruptcy petition. Debtor subsequently filed an adversary proceeding requesting turnover of the vehicle under 11 U.S.C. § 542 and sanctions pursuant to 11 U.S.C. § 362(k). Creditor returned the vehicle following the adversary action, but maintained that it could not be liable for sanctions under § 362(k) as it had not been holding the vehicle in violation of any turnover order. This understanding had previously been articulated by the U.S. District Court for the Northern District of New York (the District Court) in the case of Manufacturers & Traders Trust Co. v. Alberto (In re Alberto), 271 B.R. 223 (N.D.N.Y. 2001). The Bankruptcy Court determined that Creditor was in compliance with Alberto, and therefore could not be subject to sanctions under § 362(k).

Debtor appealed that decision to the District Court, which overturned its earlier Alberto decision. Relying primarily on the Supreme Court case of United States v. Whiting Pools, Inc., 462 U.S. 198 (1983), the District Court found that Creditor had been required to return the vehicle as soon as it was aware of the bankruptcy filing. To retain control over the vehicle was “exercising control” over it in violation of § 362, meaning that Creditor was liable for sanctions under § 362(k). Creditor subsequently appealed the District Court’s decision to the U.S. Court of Appeals for the Second Circuit (the Court).

Court’s Analysis

The Court first determined that the text of 11 U.S.C. §§ 541 and 542 required that all of the assets of a debtor’s estate be returned to the debtor at the filing of a bankruptcy case; doing so was necessary to build and administer the estate. Citing heavily to Whiting Pools, the Court found that retaining property of the estate that was repossessed pre-petition effectively deprives the estate of that property. To avoid this, a creditor must return any estate property to the debtor at the filing of the estate. Doing so does not surrender the creditor’s interest in the property; it is merely a surrender of physical possession.

The Court next turned to the question of whether the turnover provision was “self-effectuating,” or, as the Alberto court had held, was only implicated upon entry of an order for turnover. The Court found that, by the language of § 541 detailing what constituted “property of the estate,” any property in which the debtor had an interest held by anyone anywhere at the time of the filing becomes property of the estate. The Court reasoned that this would be incompatible with the Alberto court’s ruling that turnover is not self-effectuating. By retaining control of the vehicle, Creditor had been “exercising control” over it; no affirmative act was necessary, as the property was unquestionably estate property which was in Creditor’s control. To retain control of estate property after the filing of the petition was a violation of the automatic stay.

The Court last addressed whether Creditor could still be liable for sanctions under 11 U.S.C. § 362(k) despite its reliance on the precedent of Alberto. Considering the question of whether the stay violation was “willful,” the Court determined that nothing prevented Creditor from surrendering Debtor’s vehicle at the time Debtor requested. Creditor simply chose to retain possession of the vehicle because it felt case law entitled it to do so. The “willful” in 11 U.S.C. § 362(k), according to the Court, meant only that the stay violation was a voluntary act. The Court did not read any specific intent requirement into § 362(k). Given that Creditor chose to retain the vehicle—and unwittingly violate the stay—of its own free will, the violation was “willful” under § 362(k) and the Creditor was liable for damages.

WD Equip., LLC v. Cowen (In re Cowen), 849 F.3d 943 (10th Cir. 2017)

Factual Background

Jared Cowen (Debtor) owned two commercial trucks, both of which were repossessed under questionable and possibly fraudulent circumstances. Debtor filed a chapter 13 petition in the Bankruptcy Court for the District of Colorado (the Bankruptcy Court) and demanded the creditors return his two trucks. Both creditors refused; one claimed that he had transferred legal title of the truck over to his own name pre-petition, and the other claimed that the truck had been sold to an unknown Mexican national for cash in an undocumented sale, though a bill of sale was later produced. Debtor filed a motion for sanctions for willful violation of the automatic stay owing to both creditors’ failure to turn over the trucks, which he alleged were property of his bankruptcy estate. The Bankruptcy Court agreed with Debtor, finding that the documentation showing that his legal interest in both trucks had been forged, the failure to return the trucks violated 11 U.S.C. § 362(a)(3), and awarding damages pursuant to 11 U.S.C. § 362(k). That order was substantively affirmed on appeal to the U.S. District Court for the District of Colorado (the District Court). The creditors thereafter appealed to the U.S. Court of Appeals for the Tenth Circuit (the Court), arguing that their retention of the trucks, or proceeds of the trucks, did not constitute an “act” to “exercise control of” estate property, as the trucks were seized pre-petition.

Court’s Analysis

The question before the Court was whether the passive retention of estate property seized pre-petition constitutes a violation of the automatic stay after notice of a bankruptcy filing. The Court noted that the Bankruptcy Court and the District Court seemingly subscribed to the “majority view” of this question, which holds that such activity is a violation of the automatic stay. In reversing the District Court, the Court held that the majority view took a policy-driven approach not supported by the text of the Bankruptcy Code. The Court put particular emphasis on the word “act” in 11 U.S.C. 362(a)(3): “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” The Court reasoned that the requirement that there be an “act” meant that an affirmative post-petition action on the part of the creditor was necessary to incur liability for a stay violation. Mere passive retention of property seized pre-petition did not rise to that level. The Court further elaborated that the majority view’s reliance on reading § 362(a)(3) in conjunction with 11 U.S.C. § 542 also was unsupported by the text, as the two provisions had no intertextual connection. The Court expressed its belief that if Congress had intended to add an affirmative obligation of turnover to the automatic stay provisions of 11 U.S.C. § 362(a)(3), it would have done so explicitly; Congress does not “hide elephants in mouseholes.” The Court finished by noting that its holding did not absolve the creditors of liability under § 362(k), as their fraudulent acts taken to effect and conceal their repossession of the estate property constituted “acts” within the scope of 11 U.S.C. § 362(a)(3).

List of Authorities for Question #2

11 U.S.C. § 108

(a) If applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor may commence an action, and such period has not expired before the date of the filing of the petition, the trustee may commence such action only before the later of—

(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or

(2) two years after the order for relief.

(b) Except as provided in subsection (a) of this section, if applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor or an individual protected under section 1201 or 1301 of this title may file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the date of the filing of the petition, the trustee may only file, cure, or perform, as the case may be, before the later of—

(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or

(2) 60 days after the order for relief.

Counties Contracting & Constr. Co. v. Constitutional Life Ins. Co., 855 F.2d 1054 (3d Cir. 1988)

Factual Background

The issue in this case was whether a life insurance policy’s grace period for premium payments was extended, and if so, for how long. Debtor held a life insurance policy on one of its employees through Constitutional Life Insurance Co. (Insurer). The life insurance policy included a statutorily mandated 31-day grace period for late premium payments. Debtor failed to pay the premium, but then filed for chapter 11 bankruptcy within the grace period. After having filed for bankruptcy, Debtor received multiple notices of its failure to pay the premiums. Debtor never paid the overdue premiums. The insured employee died shortly thereafter, and Debtor demanded payment under the policy.

Debtor’s argument was that 11 U.S.C. § 362(a)(3)’s prohibition against obtaining property of the estate operated to stay the grace period indefinitely. Insurer argued that, at most, 11 U.S.C. § 108(b)(2) had afforded Debtor a 60-day extension of the grace period, which had already expired. The parties voluntarily withdrew the reference to the U.S. District Court for the Eastern District of Pennsylvania (the District Court), which ruled in favor of Insurer. Debtor then appealed to the U.S. Court of Appeals for the Third Circuit (the Court).

Court’s Analysis

The Court ruled in favor of Insurer and affirmed the District Court’s ruling. The Court determined that 11 U.S.C. § 108(b)(2) operated to afford debtors an additional 60 days to take any action that they otherwise would have been able to take prior to filing for bankruptcy, so long as the time for doing so had not expired as of the bankruptcy filing. This was the case with the grace period for payment of the overdue premiums, so Debtor had an additional 60 days from the date of filing to pay those premiums and thereby keep the insurance policy in place. The Court explained that the purpose of 11 U.S.C. § 108(b) was to give debtors an opportunity to preserve those rights that they otherwise would have had during the administratively complicated time of a bankruptcy filing. As the grace period was a cure period, 11 U.S.C. § 108(b) plainly applied to the insurance policy, as it allowed debtors additional time to “cure a default, or any other similar act.” Allowing 11 U.S.C. § 362 to act as an indefinite stay of cure periods would be counter to public policy, as bankruptcy debtors would be able to enjoy whatever rights they otherwise may have had for the entire duration of the bankruptcy—a clearly unintended result, especially given the inclusion of § 108(b). The decision of the District Court was therefore affirmed.

In re Hric, 208 B.R. 21 (Bankr D.N.J. 1997)

Factual Background

Debtor filed for a petition for chapter 13 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Court). Prior to the filing of the petition, Debtor had defaulted on his mortgage payment and his home was subsequently foreclosed upon. The house was sold at a foreclosure sale, but the deed was never delivered to the purchaser. After the sale, but within the ten-day period provided by New Jersey law for the exercise of the right of redemption, Debtor filed his bankruptcy case. Debtor contended that, because no deed had been delivered, the sale had not been finalized and he was entitled to cure his default and pay the mortgage through the chapter 13 plan. The purchaser argued that the sale was finalized after its bid was recognized as the highest and the bidding was closed, and that at most Debtor only had sixty days from the date of the petition to exercise the right of redemption under 11 U.S.C. § 108(b).

Court’s Analysis

The Court first determined that 11 U.S.C. § 1322 permits a debtor to cure a mortgage default up until such time as the sale is finalized at auction, as the delivery of the deed is a ministerial act that may be subject to delays totally unrelated to the sale process. The Court found this to be in harmony with applicable New Jersey law. The Court then looked to 11 U.S.C. § 108(b)(2), which permits a debtor 60 days to “cure a default,” or “perform any similar act” which would be available to it under applicable nonbankruptcy law. Looking to New Jersey law, the Court found that New Jersey did not permit the curing and reinstating of a mortgage following foreclosure. However, New Jersey did afford a homeowner a ten day period within which to exercise its statutory right of redemption by paying off the mortgage in full. The Court determined that this was a “similar act” to curing a default, and that therefore Debtor had had 60 days from the date of the petition to pay the mortgage in full. Because more than 60 days had already elapsed as of the time of the decision, the Court held that the sale had been finalized.

In re Global Outreach, S.A., 2009 Bankr. LEXIS 993 (Bankr. D.N.J. 2009)

Factual Background

At issue in this case was whether 11 U.S.C. § 108(b)(2) extended the time period by which a debtor could perform under a contract. Global Outreach, S.A. (Debtor) entered into a contract with YA Global Investments, L.P. (YA). The agreement provided that YA would make a loan to Debtor, in exchange for Debtor placing title to certain properties into a holding company. By the terms of the agreement, if Debtor defaulted and failed to cure within fifteen days, then Debtor would have an additional thirty days to pay all outstanding monies under the loan and have the properties returned. YA gave Debtor notice of a default and reminded it of the fifteen-day cure period. After those fifteen days passed, YA sent Debtor another notice reminding it of the thirty-day redemption period. Within those thirty days, Debtor filed for bankruptcy in the Bankruptcy Court for the District of New Jersey (the Court).

The Court sua sponte raised the question of whether the provisions of 11 U.S.C. § 108(b)(2), which provide an additional sixty days for debtors to “cure a default, or take any similar act” under applicable nonbankruptcy law, applied to the case. YA argued that it did not, as the additional thirty-day provision was not a cure provision, but rather a repayment provision. Debtor argued that the repayment was a “similar act” to curing a default, and thus it had an additional sixty days to pay the loan in full.

Court’s Analysis

The Court agreed with Debtor and ruled that 11 U.S.C. § 108(b)(2) extended the time period by which Debtor could repay the loan in full by sixty days. In doing so, the Court relied upon Counties Contracting and Construction Co. v. Constitution Life Insurance Co., 855 F.2d 1054 (3d Cir. 1988) and In re Hric, 208 B.R. 21 (Bankr. D.N.J. 1997). The Court found that while it was true that the provision in question was not a cure provision, it was analogous to the right of redemption at issue in Hric. Therefore, because the Debtor was not seeking to cure a default under the contract (which right had expired prepetition), but was instead seeking to pay the entirety of the loan balance, 11 U.S.C. § 108(b)(2) granted it an additional sixty days from the petition filing within which to do so.

In re 1075 Yukon LLC, 590 B.R. 527 (Bankr. D. Colo. 2018)

Factual Background

At issue in this case was whether 11 U.S.C. § 108(b) extended the time for which a debtor could perform under an option contract. Debtor sold certain real property to Buyer pre-petition.

The parties simultaneously entered into a second agreement (the Option Contract) that provided for Debtor’s ability to repurchase the property if certain conditions were met. The Option Contract was subsequently amended to extend the deadline by which Debtor must exercise its repurchase option, and provided that the option automatically terminated at the deadline. Debtor filed its petition for chapter 11 bankruptcy in the Bankruptcy Court for the District of Colorado (the Court) approximately one hour before the option deadline.

Forty-three days later, Debtor filed a motion to exercise the option and repurchase the property. Debtor relied upon 11 U.S.C. § 108(b)(2), which allows a debtor 60 days to “file any pleading, demand, notice, proof of claim or loss, cure a default, or perform any other similar act” that the debtor may have been entitled to perform if the timeframe for doing so had not expired prior to the bankruptcy filing. Debtor contended that, because it was entitled to exercise the option to purchase the property, and the deadline to do so had not terminated prior to the bankruptcy filing, § 108(b)(2) gave it an additional 60 days to do so. Buyer objected, stating that allowing Debtor an additional 60 days from a predetermined, agreed-upon deadline was an impermissible modification of private contract rights.

Court’s Analysis

The Court agreed with Buyer and held that § 108(b)(2) did not apply to option contracts. In reaching this conclusion, the Court looked to the specific language relating to “curing a default.” In examining all other relevant case law, the Court found that any extension granted by § 108(b)(2) was in the nature of curing a default, e.g. exercising a statutory right of redemption. Therefore, the Court concluded that “similar act” in § 108(b)(2) meant an act similar to curing a default. The Court found that allowing an expansive reading of § 108(b)(2), as some other courts had done, would give it a broader effect than was intended. Indeed, doing so in the context of option contracts would give the debtor more rights than they had prior to filing a bankruptcy—a clear impossibility. Because there could be no default under an option contract, only the expiration of the option, there could also be no curing of a default under one. Without the ability to cure a default, the Court reasoned that there was nothing for § 108(b) to extend, and that the option had therefore expired on the originally agreed date.

List of Authorities for Question #3

11 U.S.C. § 1104

(a) At any time after the commencement of the case but before confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee—

(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor; or

(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor.

…

11 U.S.C. § 1112

(b)

(1) Except as provided in paragraph (2) and subsection (c), on request of a party in interest, and after notice and a hearing, the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause unless the court determines that the appointment under section 1104(a) of a trustee or an examiner is in the best interests of creditors and the estate.

…

11 U.S.C. § 105

(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.

In Re Marvel Entertainment Group, 140 F.3d 464 (3d Cir. 1998)

Factual Background

Marvel Entertainment Group, Inc. (Marvel) filed for chapter 11 bankruptcy in the Bankruptcy Court for the District of Delaware (the Bankruptcy Court). Marvel initially acted as a debtor-in-possession. From the outset, the bankruptcy was essentially dominated by two competing groups: a group of bond-holding entities controlled by Carl Icahn (the Icahn Interests), which effectively held all of Marvel’s stock, and a group of large creditors (the Lenders) and their agent, Chase Manhattan Bank (Chase). The Icahn Interests and the Lenders both used the bankruptcy to vie for control of Marvel through extensive litigation and contested financing proposals.

Eventually, the Icahn Interests gained control of Marvel by receiving authority to vote the stock that it held; this put the Icahn Interests in the position of being both a creditor and shareholder of the debtor and the debtor-in-possession. The Icahn-controlled debtor then began filing various adversary proceedings against the Lenders, which the Lenders described as retaliation for their refusal to enter settlement agreements. The acrimony between the two groups eventually led the District Court for the District of Delaware (the District Court) to withdraw the reference to the Bankruptcy Court and order the appointment of a chapter 11 trustee.

The District Court approved the appointment of a trustee (the Trustee), who subsequently moved for appointment of his law firm as counsel to the trustee (the Firm). The Firm disclosed that it was concurrently engaged in representing Chase in an unrelated matter involving the construction of an arts center; the fees for this engagement constituted 0.1 percent of the firm’s overall annual revenue, the representation was substantially concluded, and Chase had previously provided the Firm with a waiver of any and all conflicts of interests arising from the representation. The District Court denied the appointment of the Firm on the basis that it “taint[ed] the appearance of objectivity.” The Trustee appealed, which was consolidated with the Icahn Interests’ appeal of the order appointing the Trustee.

Court’s Analysis

The United States Court of Appeals for the Third Circuit (the Court) began by finding that it had jurisdiction to hear an appeal of an order appointing a trustee pursuant to 28 U.S.C. § 1291. The Court reasoned that, if it could not take jurisdiction at the time of the appeal, then the only alternative would be that the order appointing the Trustee would not be appealable until the completion of the bankruptcy case. The Court found that this would be an absurdity, as it would raise the possibility of having to redo the entire bankruptcy if the order appointing the Trustee were to be overturned.

Turning to the question of whether appointment of the Trustee was appropriate, the Court noted that the standard for appointing a trustee was simply “for cause” under 11 U.S.C. § 1104(a)(1). The question the case presented was whether “acrimony” between a debtor-in-possession and creditors constituted “cause” under § 1104(a)(1). Answering the question in the affirmative, the Court held that “acrimony” could constitute “cause” to appoint a trustee on a case-by-case basis, where disagreement between a debtor-in-possession and its creditors extends “beyond the healthy conflicts that always exist between debtor and creditor.” The Court noted that there existed a “strong presumption” in favor of leaving a debtor-in-possession in control of its own case owing to its familiarity with its own business and organization. However, the Court found that such presumption was inapplicable in this case, where the Icahn Interests had only recently taken control as the debtor-in-possession. The Court refused to adopt a per se rule for when acrimony rose to the level of cause, instead directing that it was a factual determination to be made by the court. The Court further found that, even if the acrimony in this case did not rise to the level of “cause” under § 1104(a)(1), it would nonetheless have been warranted by the more flexible “best interests” standard of § 1104(a)(2) owing to the intransigence of the two groups. The Court noted that “the debtor-in-possession’s interests conflicted with those of its creditors to such an extent that the appointment of a trustee may be the only effective way to pursue reorganization.”

The Court finally addressed the disqualification of the Firm as counsel to the Trustee. Reversing the District Court, the Court held that counsel may not be disqualified under 11 U.S.C. § 327(a) for the mere appearance of conflict alone. Instead, looking at the text of the statute, the Court held that disqualification was only permissible due to the existence of an actual or potential conflict.

U.S. Mineral Prods. Co. v. Official Comm. of Asbestos Bodily Injury & Prop. Damage Claimants (In re U.S. Mineral Prods. Co.), 105 Fed. App’x 428 (3d Cir. 2004)

Factual Background

This case concerned contentious bankruptcy proceedings between the debtor (Debtor) and an official committee of unsecured creditors (the Committee). The Committee was appointed to represent the interests of several asbestos injury-related claimants. During the proceedings, the Bankruptcy Court for the District of Delaware (the Bankruptcy Court) admonished the parties that failure to reach a confirmable plan would result in the appointment of a chapter 11 trustee. Debtor never contested that the Bankruptcy Court had the authority to appoint a trustee of its own accord; Debtor only maintained that a trustee was not necessary. The United States Trustee filed a statement opining that appointment of a trustee was necessitated by the acrimonious relationship between Debtor and the Committee, as well as by concerns over Debtor’s management engaging in self-dealing transactions. The Bankruptcy Court eventually appointed a chapter 11 trustee sua sponte at a hearing on the progress of any plan. Debtor objected to the appointment, arguing that a court cannot appoint a trustee under 11 U.S.C. § 1104(a) absent a motion to do so by a party-in-interest. Debtor further contended that it was not given adequate notice and hearing for the issue of appointment of a trustee.

Court’s Analysis

The U.S. Court of Appeals for the Third Circuit (the Court) rejected Debtor’s contention and affirmed the Bankruptcy Court’s order sua sponte appointing a trustee. The Court found that any requirement of a motion being filed by a party-in-interest had been “severely diluted” by the 1984 amendments to 11 U.S.C § 105, which permitted sua sponte action on the part of bankruptcy courts. This broad discretion, coupled with the “best interests” standards of 11 U.S.C. § 1104(a)(2) made clear that a bankruptcy court may sua sponte appoint a trustee when doing so is in the best interests of the estate. The Court also noted that § 1104(a) does not mention a “motion by a party in interest,” but merely a “request by a party in interest.” Even if such a request from a party-in-interest was a necessary prerequisite, the Court found that the United State Trustee’s statement would have satisfied such a requirement anyway.

From a factual perspective, the Court found that this standard had easily been met based upon the acrimonious relationship between the parties and the standards articulated in In re Marvel Entertainment Grp., Inc., 140 F.3d 463 (3d Cir. 1998). The Court also found that any applicable notice and hearing requirements had been satisfied, as Debtor was aware of the Bankruptcy Court’s intention to appoint a trustee, was aware of the United States Trustee’s statements in support of appointing a trustee, and itself argued that a trustee was not necessary. At no time during these proceedings did Debtor ever raise the issue of whether the Bankruptcy Court could appoint a trustee absent a motion. The Court therefore found that all of the necessary conditions for the Bankruptcy Court’s appointment of a trustee had been met.

Official Comm. of Asbestos Claimants v. G-I Holdings, Inc. (In re G-I Holdings, Inc.), 385 F.3d 313 (3d Cir. 2004)

Factual Background

The Debtor, G-I Holdings, Inc. (Debtor) filed for chapter 11 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). Debtor was the defendant in asbestos-related mass-tort actions prior to and during the bankruptcy. Pursuant to 11 U.S.C. § 1102(a), the United States Trustee appointed a committee of unsecured creditors to represent the interests of the asbestos-related claimants (the Committee). The Committee moved for appointment of a chapter 11 trustee, arguing that such appointment was warranted under 11 U.S.C. §§ 1104(a)(1) and 1104(a)(2). The Committee relied upon In re Marvel Entertainment Grp., Inc., 140 F.3d 463 (3d Cir. 1998), arguing that significant conflict existed between Debtor and the asbestos claimants which required the appointment of a trustee. The Bankruptcy Court denied the Committee’s request for appointment of a trustee. On appeal, the District Court of the District of New Jersey (the District Court) upheld the order of the Bankruptcy Court. The Committee appealed once again, this time to the U.S. Court of Appeals for the Third Circuit (the Court).

The Committee’s argument on appeal concerned the applicable burden of proof. The Bankruptcy Court based its decision in part on the presumption in favor of deferring to a debtor-in-possession rather than a trustee, as articulated in In re Marvel. The Bankruptcy Court found that the Committee had failed to meet this burden, as it had not shown by clear and convincing evidence that the circumstances required the appointment of a trustee. On appeal to the District Court, the Committee argued that the presumption in favor of leaving Debtor as debtor-in-possession should not apply because Debtor was a holding company, and therefore familiarity with its business operations was irrelevant. Furthermore, the Committee contended that there would be little to no cost associated with appointing a trustee, because it would only need to manage the asbestos claims. Finally, the Committee argued that Debtor had a “structural inability” to discharge its fiduciary duties to its creditors. The District Court noted that there was no support from In re Marvel or elsewhere for the Committee’s argument concerning the applicable burden of proof, and upheld the decision of the Bankruptcy Court. The Committee again appealed, arguing that (1) because of the factual circumstances, the presumption in favor of leaving Debtor as debtor-in-possession should not apply, and (2) because no such presumption existed, the Committee should only need to show that appointment of a trustee was warranted by a preponderance of the evidence, rather than by clear and convincing evidence.

Court’s Analysis

The Court looked to its earlier decisions in In re Marvel and In re Sharon Steel Corp., 871 F.2d 1217 (3d Cir. 1989) and found that both plainly provided that a party moving for the appointment of a trustee bears the burden of persuasion by clear and convincing evidence. The Court noted that its earlier language in In re Marvel concerning the “presumption” in favor of keeping a debtor’s current management in place merely was another way of describing this burden. The usage of the word “presumption,” taken in context within In re Marvel, simply reflected the fact that a movant must meet the heighted evidentiary burden of clear and convincing evidence for the relief it seeks. The “presumption” was not an independent factual issue that the moving party could rebut and dispel, separate and apart from the evidentiary burden. It was, rather, the evidentiary burden itself. It therefore could not be altered, as the Committee maintained, by facts which would undermine any putative presumption.

The Court further held that even if there did exist such a factual presumption, its existence or absence would have no bearing on the burden of proof. The Court’s precedents in In re Marvel and Sharon Steel both squarely held that a party moving for appointment of a trustee bears the burden of proof by clear and convincing evidence, with no caveats. Therefore, even if the Court were to accept the Committee’s first argument concerning the factual lack of support for such a presumption, there would be no logical coupling between that finding and a lowering of the burden of proof. The Court accordingly affirmed the order of the District Court, and the Committee’s motion for appointment of a trustee remained denied.

Kevan A. McKenna, P.C. v. Official Comm. of Unsecured Creditors (In re Kevan A. McKenna, P.C.), 2011 U.S. Dist. LEXIS 57985, Case No. 10-472 ML (D.R.I. May 31, 2011)

Factual Background

The debtor in this case was a law firm acting as a chapter 11 debtor-in-possession (the Debtor). Debtor’s case was fraught with conflict between it and the official committee of unsecured creditors (the Committee). The Committee moved for conversion of Debtor’s case under 11 U.S.C. § 1112(b). The Bankruptcy Court for the District of Rhode Island (the Bankruptcy Court) held a hearing on the motion and took the matter under advisement. The Bankruptcy Court then sua sponte appointed a chapter 11 trustee based upon the “totality of the circumstances” in the case. The Bankruptcy Court specifically singled out obstructive conduct on the part of Debtor’s principal among the reasons why it was appointing a trustee. Debtor appealed to the U.S. District Court for the District of Rhode Island (the Court), raising three issues. Firstly, Debtor argued that the Bankruptcy Court could not sua sponte appoint a trustee; a motion by a party-in-interest was necessary. Secondly, Debtor argued that it was deprived of notice and hearing on the issue of appointment of a trustee. Finally, Debtor argued that there was not a factual record established on which appointment of a trustee could be based.

Court’s Analysis

The Court began by explaining how 11 U.S.C. § 1112(b) and 11 U.S.C. § 1104 worked in conjunction to provide that, when considering whether to dismiss or convert a case, a bankruptcy court may also consider appointment of a trustee if doing so is in the best interests of the estate. The bankruptcy court must make the determination based upon which alternative is in the best interests of the estate, as drawn from the factual record. The Court found that a request of a party-in-interest was not necessary for appointment of a trustee, as 11 U.S.C. § 105(a) directs that no requirement of a motion or request prevents a bankruptcy court from otherwise sua sponte taking action necessary to implement or enforce court orders. The Court cited relevant case law for the proposition that § 105(a)’s directive includes the sua sponte authority to appoint a trustee. The Court next found that Debtor was afforded adequate notice and hearing through the motion to convert, which was fully briefed and argued. Any action under § 1112(b) to convert or dismiss must also necessarily entail the possibility of appointment of a trustee by the inclusion of § 1104, and so Debtor was effectively notified as to the possibility. Moreover, the motion to convert would have required the appointment of a chapter 7 trustee to administer the estate, which the Court found to be effectively analogous to the possibility of appointment of a chapter 11 trustee for notice purposes. As for Debtor’s final contention regarding the evidentiary record, the Court found upon review that the facts adduced in the conversion hearing did rise to the level of clear and convincing evidence. Debtor had repeatedly failed to comply with court orders, had repeatedly overdrawn its bank accounts and otherwise mismanaged its finances, and failed to file a disclosure statement within the timeframe required by the Bankruptcy Court. Taken together, these facts made clear that appointment of a chapter 11 trustee was in the best interests of Debtor’s estate.

Editors

§ 1.1. Introduction

In past years, we have tried to be comprehensive in our survey of developments in alternative dispute resolution, covering all cases pending or decided in the United States Supreme Court, all the materially substantive opinions issued by the federal Circuit Courts of Appeals, and all the materially substantive opinions issued by the highest courts in all 50 states (and the District of Columbia and the Commonwealth of Puerto Rico), together with comments on legislative and administrative developments. Every year, the volume of these opinions and developments increased as alternative dispute resolution became more and more widely accepted and used.

But, perhaps in part because of the courts beginning to catch up with backlogs from the continuing COVID-19 pandemic, and perhaps because alternative dispute resolution was in some situations over the past two years the only practical alternative for many disputes to reach a conclusion, trying to cover virtually all the individual opinions and activity we had covered in the past seems to have reached a level where including all of the increased volume of case law may detract from the value of a summary. So this year, while we have reviewed all the same source material (all the Supreme Court, federal Circuit Court, and highest state court opinions, together with legislative and administrative activity) we are not trying to report on virtually every decision. Instead, we have tried to include matters we consider particularly important, interesting, or unique.

To begin with, despite our projection last year that the United States Supreme Court might issue a useful decision in Henry Schein Inc. v. Archer & White Sales, Inc., No. 19‐963 (U.S. argued Dec. 8, 2020) in 2021, the Court ultimately dismissed the writ of certiorari in that case as having been improvidently granted. As a result, the Court did not issue any substantive arbitration decisions in 2021.

But the Court did grant certiorari in five cases that remain pending before the Court as of December 2021. Three of those involve splits among the federal Courts of Appeals regarding the propriety of “looking through” pleadings to establish federal jurisdiction and the limits of federal court’s authority to compel discovery in international arbitration under 28 U.S.C. § 1782(a).

In addition to the cases involving Circuit splits now under review by the Supreme, the federal Courts of Appeals continue throughout 2021 to grapple with what it means to be “engaged in commerce” for section 1 exemption under the FAA.

Furthermore, in our 2020 ADR Annual Review, we explained that the Antitrust Division of the Department of Justice (the “Division”) issued “Updated Guidance Regarding the Use of Arbitration and Case Selection Criteria,” which signaled an interest in increasing the use of arbitration. Although the arbitration guidance was ultimately published in the Federal Register, its impact remains unclear at this time.

We also discussed the Forced Arbitration Injustice Repeal Act (“FAIR Act”), which has been introduced in one form or another for many years and generally would invalidate pre-dispute arbitration agreements in the employment, civil rights, consumer, and antitrust contexts, and would require employers to litigate workplace disputes in court. The bill was reintroduced as H.R. 963 in February 2021, and the House Judiciary Committee signed off on the bill in early November 2021. Of course, it must still pass both the House and the Senate before being signed by the President, but this is something that litigators should continue to monitor.

§ 1.2. Legislative and Regulatory Developments

§ 1.2.1. Revised Uniform Arbitration Act

The Uniform Law Commissioners drafted and proposed the original Uniform Arbitration Act (the “UAA”) in 1955. It provided, among other things, basic procedures for the conduct of an arbitration by agreement. Forty-nine jurisdictions adopted the original UAA, including the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. Four states, Alabama, Georgia, Mississippi, and West Virginia, did not enact any version of the original UAA.

In 2000, the Commission revisited and substantially revised the UAA to produce the 2000 Uniform Arbitration Act (the “Revised UAA”). The Revised UAA allows for consolidation of separate arbitration proceedings, expressly provides for immunity for arbitrators from civil liability, authorizes the award of punitive damages and attorneys’ fees when such an award would be authorized in a civil action, and provides arbitrators with discretion to order discovery, issue protective orders, and decide motions for summary judgment, similar to a judicial proceeding.

Twenty-two states have adopted the Revised UAA, including Alaska, Arizona, Arkansas, Colorado, Connecticut, the District of Columbia, Florida, Hawaii, Kansas, Michigan, Minnesota, Nevada, New Jersey, New Mexico, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, Utah, Washington, and West Virginia. No new states adopted the Revised UAA in 2021, although legislation introduced in Vermont in 2019 was reintroduced in 2021. The progress of states enacting the Revised UAA can be tracked at www.uniformlaws.org.

§ 1.2.2. Uniform Mediation Act

The Uniform Mediation Act (the “UMA”), as promulgated by the Uniform Law Commission in 2001 after a joint drafting effort with the American Bar Association’s Dispute Resolution Section, and as amended in 2003 to incorporate the Model Law on International Commercial Conciliation, was adopted by Georgia in 2021. It also continued in effect in the District of Columbia, Hawaii, Idaho, Illinois, Iowa, Nebraska, New Jersey, Ohio, South Dakota, Utah, Vermont, and Washington. The progress of states enacting the UMA may be tracked at www.uniformlaws.org.

§ 1.2.3. The United Nations Convention on International Settlement Agreements Resulting from Mediation

On August 7, 2019, 46 countries signed on to the United Nations Convention on International Settlement Agreements Resulting from Mediation (the “Singapore Convention”). The initial signatories included (in addition to Singapore, of course) major States such as the United States, China, and India, but did not include, for example, Australia, the European Union, or the United Kingdom. Since then, Ghana and Rwanda have signed on as well.

As discussed in our 2019 compilation, the Singapore Convention provides, for the first time, an international process for the direct enforcement of cross-border settlement agreements arising out of mediation. To fall within the scope of the Singapore Convention, a settlement agreement must be in writing, must result from a mediation, must be between two or more parties who have their place of business in different States, and must involve, as the place of business of each party, a State that has acceded to or ratified the Singapore Convention. There are some substantial exceptions to its coverage, however: the Singapore Convention will not apply to settlement agreements that relate to consumer transactions, or to family law, inheritance issues, or employment law; to settlement agreements that have been approved by a court or concluded in the course of proceedings before a court and that are enforceable as a judgment in the State of that court; or to settlement agreements that have been recorded and are enforceable as an arbitral award.

Mediation is defined under the new Singapore Convention as “a process, irrespective of the expression used or the basis upon which the process was carried out, whereby the parties attempt to reach an amicable settlement of their dispute with the assistance of a third person or persons (the ‘mediator’) lacking the authority to impose a solution upon the parties to the dispute.” Presuming that the Singapore Convention does go into effect, a settlement agreement that qualifies will allow a party to use a simplified procedure for enforcement. That party will provide to the relevant authority in the State where the party seeks to enforce the settlement agreement two basic pieces of evidence: first, a copy of the signed settlement agreement; and, second, proof that the settlement agreement resulted from a mediation. This latter requirement can be satisfied by a mediator’s signature on the settlement agreement or by a document signed by the mediator confirming that there was a mediation.

Once it receives this evidence, the relevant authority (most likely a court) is required to “act expeditiously.” Under limited circumstances it may refuse enforcement. These include proof of the incapacity of a party to the settlement agreement; proof that the settlement agreement is null and void, inoperative, or incapable of being performed; proof that the settlement agreement is not binding, or is not final, according to its terms; proof that the settlement agreement has been subsequently modified; proof that necessary obligations for enforcement of the settlement agreement have not been performed or are not clear and comprehensible; proof that granting relief would be contrary to the terms of the settlement agreement; proof that the mediator committed a serious breach of standards applicable to him, her, or the mediation, without which breach the party seeking to avoid enforcement would not have settled; proof that the mediator failed to disclose circumstances raising justifiable doubts as to his or her impartiality or independence, which failure had a material impact or undue influence on a party, and without which failure the party would not have settled; proof that granting relief would be contrary to the public policy of the State in which enforcement is sought; or proof that the subject matter of the dispute was not capable of settlement by mediation under the law of that State.

While this is not a short list, it is likely that, as with arbitration awards under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”), enforcement of mediation settlements under the Singapore Convention is likely to be granted in most instances. Importantly, however, the Convention does not itself define the remedies for breach of a settlement agreement. Because permissible remedies are different in different countries, parties to international commercial mediation settlements will likely want to specify at least some remedies in their settlement agreements, and in doing so consider whether those remedies will be enforceable in the most likely jurisdictions of enforcement. Similarly, such parties will want to think carefully about choice of law decisions in their settlement agreements.

§ 1.2.4. State Codes

§ 1.2.4.1. California

While no significant statutes were passed this year by the California state government regarding arbitration, we reported last year on Assembly Bill No. 51 (“AB 51”). In February, the United States District Court for the Eastern District of California issued a preliminary injunction blocking implementation of AB 51. AB 51 was passed in 2019 to prohibit employers from requiring employees to waive any right, forum, or procedure established by the California Fair Employment and Housing Act or the California Labor Code. This includes a bar of any agreement that requires employees to opt out of a waiver or take any affirmative action to preserve their rights to a judicial forum, as would occur in an agreement mandating arbitration of an employment dispute.

AB 51 was set to take effect on January 1, 2020, but was challenged in court by the Chamber of Commerce of the United States of America, among other interested parties, alleging that the FAA preempted AB 51 and all legislation enacted under its mantle of authority. The District Court agreed with the plaintiffs and enjoined implementation of the laws enacted under AB 51 to preserve the mandate of the FAA. The court found that the challengers of the bill were likely to succeed on the merits because the FAA preempted AB 51 in two ways. First, AB 51 imposed restrictions on the formation of arbitration agreements that do not apply to contracts generally, violating the express direction under Section 2 of the FAA requiring courts and state legislatures to “place arbitration agreements ‘on equal footing with all other contracts.’” Second, AB 51 punished the exercise of a federally protected right to include arbitration agreements in employment contracts, directly impeding the FAA.

The District Court found that the challengers of AB 51 were likely to succeed on their strong arguments for preemption of the FAA, and granted a preliminary injunction blocking the bill from taking effect. The litigation is continuing.

§ 1.2.5. Rules of the International Chamber of Commerce

On January 1, 2021, the International Chamber of Commerce’s (“ICC”) 2021 Rules of Arbitration (the “2021 Rules”) became effective. These rules replace the ICC’s 2017 Rules of Arbitration (the “2017 Rules”). While the 2021 Rules do not significantly amend the predecessor 2017 Rules, there are several material changes to rules relating to the framework of ICC arbitration. We repeat them from our 2020 update for convenience below.

First, the 2021 Rules address virtual proceedings and communications by amending Article 26, which provides the rules for hearings. Article 26(1) has been updated to explicitly provide the arbitral tribunal with authority to conduct virtual hearings at its discretion either in person or virtually through “videoconference, telephone or other appropriate means of communication.” Although tribunals were not previously prohibited from conducting virtual hearings, clarifying the rules to explicitly provide this power addresses any doubts that may exist in a time where COVID-19 has led to a shift to the use of virtual proceedings. By including the “other appropriate means of communication” language, the ICC appears to have drafted this rule to anticipate evolving technology.

The framework of how arbitration is conducted under the ICC Rules has been further changed by amending the rules involving multi-party arbitration. One of the more significant changes in the 2021 Rules can be found in Article 7, which deals with the joinder of additional parties. Article 7(5) is a newly added provision that allows parties to make requests for joinder after the confirmation or appointment of any arbitrator in the proceeding. The 2017 Rules required that all parties, including the party sought to be joined, agree to such joinder, but the 2021 Rules contain no such requirement and instead leave it to the arbitral tribunal to decide the request. Article 10’s provisions on consolidation of arbitration have also been changed under the 2021 Rules. Under the 2017 Rules, Article 10 provided that the ICC’s International Court of Arbitration (the “ICC Court”) could consolidate two or more arbitrations where “all of the claims in the arbitrations are made under the same arbitration agreement.” This language created ambiguity as to whether consolidation was possible only for claims made under the same contract, or if it also applied when claims arise from multiple agreements with mirror arbitration clauses. The 2021 Rules address this ambiguity by amending Article 10(b) to apply to claims made under the same “agreement or agreements,” so arbitrations may be consolidated where they involve multiple agreements with mirror arbitration clauses.

The 2021 Rules also include multiple changes designed to address potential conflicts of interest in arbitration proceedings. First, Article 11, which contains general provisions, has been revised with the inclusion of Article 11(7) requiring parties to promptly inform the ICC Secretariat of any agreements where a non-party has an economic interest in the outcome of the arbitration through an agreement to fund a party’s claims or defenses. This change places the affirmative obligation on parties at the outset to inform of the involvement of litigation funders to address potential conflicts at the outset. Second, the 2021 Rules provide a new paragraph under Article 12(9) addressing the constitution of the arbitral tribunal. The ICC Court now has the power to appoint each member of the arbitral tribunal, even if this method differs from what the parties had envisioned in their arbitration agreement. However, this power is limited to “exceptional circumstances” that would avoid “a significant risk of unequal treatment and unfairness that may affect the validity of the award.” Third, Article 17 has been renamed to “Party Representation” and now requires parties to immediately notify the Secretariat, arbitral tribunal, and other parties of any change in their representation. Notably, the tribunal has been given the authority under this rule to exclude new representatives from participating in arbitration if necessary to avoid a conflict of interest with an arbitrator.

Other noteworthy updates in the 2021 Rules include a new provision in Article 36(3) allowing a party to apply to the Secretariat for an additional award for claims made in the arbitral proceeding that the tribunal has omitted to decide. Additionally, the pecuniary threshold to avoid application of the expedited rules has been increased from $2 million under the 2017 Rules to $3 million under the 2021 Rules for arbitration agreements concluded on or after January 1, 2021.

Lastly, the 2021 Rules reflect an effort to increase transparency, as a party may now, among other things, request that the ICC Court communicate its reasons for reaching its decisions, although the ICC Court is not required to communicate such reasons when exceptional circumstances dictate that it should not.

§ 1.3. The United States Supreme Court Docket

In early November 2021, the Court heard oral argument in Badgerow v. Walters, 975 F.3d 469 (5th Cir. (La.) 2020), cert granted, 141 S. Ct. 2620 (U.S. May 17, 2021) (No. 20-1143). In that case, the Court is considering a split among the federal Circuits regarding whether district courts possess subject matter jurisdiction over petitions to confirm or vacate arbitration awards to the extent “the underlying controversy between the parties arises under federal law.”

Denise Badgerow, a financial advisor formerly employed with REJ Properties, Inc. (“REJ”), began a FINRA arbitration action against three principals of REJ following her termination from the company. The three principals were also affiliates of Ameriprise Financial, so Badgerow later added a Title VII sex discrimination claim against Ameriprise in the FINRA arbitration. In her claims, Badgerow sought damages against the principals for tortious interference of contract and for violating a Louisiana “whistleblower” law. She also sought to hold Ameriprise jointly liable for the principals’ and REJ’s conduct. The FINRA panel dismissed all of Badgerow’s claims with prejudice.

Badgerow then sued in Louisiana state court to vacate the FINRA panel’s award, contending that the principals of REJ had committed fraud on the FINRA panel. She named only the REJ principals in the state court action. She did not name REJ itself or Ameriprise. When the principals removed to federal district court, Badgerow sought remand, arguing the district court lack subject matter jurisdiction because the claims asserted against the principals were based solely on state law.

The district court denied Badgerow’s motion to remand, holding that it had subject matter jurisdiction over Badgerow’s petition to vacate because she had asserted a Title VII declaratory judgment claim against Ameriprise in the arbitration. The court ultimately found that no fraud had been committed in the arbitration and confirmed the FINRA panel’s dismissal of all of Badgerow’s claims.

Badgerow then appealed to the Fifth Circuit. She argued there that the district court had lacked subject matter jurisdiction over the petition to vacate and, therefore, had improperly denied her motion to remand. The Fifth Circuit affirmed, in reasoning important to the review now granted by the Supreme Court.

The Fifth Circuit began by reviewing the Supreme Court’s decision in Vaden v. Discover Bank, 556 U.S. 49 (2009). In that case the Court adopted a “look-through” analysis for “determining federal jurisdiction in actions to compel arbitration under section 4 of the FAA.” Although the plaintiff’s petition to vacate in Badgerow was brought pursuant to section 10 of the FAA, the Fifth Circuit explained that motions brought under sections 9, 10, and 11 of the FAA are all subject to the same look-through approach. In particular, “a federal court should determine its jurisdiction by looking through an FAA petition to the parties’ underlying substantive controversy.” If the claims involved in the underlying dispute evidence that the dispute could have been brought in federal court, “then federal jurisdiction lies over the FAA petition.”

Badgerow had contended that because she only sought to vacate the dismissal of her claims against the principals and not her claims asserted Ameriprise, the federal declaratory judgment action against Ameriprise asserted in the FINRA arbitration could not be properly considered in the look-through analysis. But, according to the Fifth Circuit, Vaden says otherwise. Under Vaden, the court believed that its task was to determine whether “a federal court would have had jurisdiction over an action raising the same claims against the [p]rincipals that Badgerow brought in the FINRA arbitration proceeding—namely tortious interference and Louisiana ‘whistleblower.’” In making this determination, the court noted that Badgerow’s claims against the principals and Ameriprise “arose from the same common nucleus of operative fact,” and that the Title VII declaratory judgment claim against Ameriprise would have created sufficient federal jurisdiction to allow for supplemental jurisdiction over Badgerow’s state law claims against the principals. Accordingly, the Fifth Circuit upheld the district court’s jurisdiction and affirmed its denial of remand. Badgerow then petitioned for certiorari, which the Supreme Court granted.

As Badgerow explains in her opening brief on the merits, the question presented to the Supreme Court is “[w]hether federal courts have subject-matter jurisdiction to confirm or vacate an arbitration award under Section 9 and 10 of the FAA where the only basis for jurisdiction is that the underlying dispute involved a federal question.” Badgerow contends that federal courts do not possess such jurisdiction because the text of the FAA simply does not countenance a “look-through” approach to motions filed pursuant to sections 9 and 10 of the FAA. Section 4 of the FAA, allowing a party to compel arbitration, “has unique language that instructs courts, explicitly, to look through the petition to the underlying dispute.” This unique language, according to Badgerow, is the phrase “save for such agreement”. Because sections 9 and 10 of the FAA do not include similar language, Badgerow contends that courts cannot perform the same look-through for confirmation of arbitral awards under section 9 and vacatur of arbitral awards under section 10.

The respondents in Badgerow argue in opposition that motions to confirm or vacate arbitration awards are mere “adjuncts” to an underlying controversy between arbitrating parties. According to them, the FAA “authorizes various procedural devices that allow parties to enlist courts in facilitating arbitration.” These procedural devices include applications for stays under section 3, petitions to compel under section 4, applications for the appointment of arbitrations under section 5, and petitions to subpoena witnesses under section 7. Sections 9, 10, and 11, which allow for confirmation, vacation, or modification of arbitration awards, respectively, are no different, in their view. All of these applications and motions are simply vehicles for the courts to ensure that an underlying controversy is “successfully resolved through arbitration.” Similarly, the FAA’s repeated reference to such motions being filed in the “United States district court[s]” further shows that the FAA presupposes federal courts have jurisdiction over those motions. Therefore, if a federal court determines that it would have had jurisdiction over an underlying controversy, it necessarily has jurisdiction to hear FAA motions related to a disputed arbitration.

The Supreme Court held oral argument on these issues on November 2, 2021. Justice Thomas began the questioning by inquiring into Badgerow’s view that section 4 of the FAA creates federal jurisdiction, noting “[c]ounsel, we have said or suggested from time to time that the FAA doesn’t provide federal question jurisdiction. So how do you square that with the notion that Section 4 . . . provides such jurisdiction? Badgerow’s counsel responded by contending that section 4 is an exception to the traditional rule that a court is to only look to the well-pleaded complaint for determining jurisdiction. Justice Kagan followed up by suggesting “well, if we look to the well-pleaded complaint, the well-pleaded complaint says something about Section 9 and that arises under federal law.” Counsel responded by explaining that, with exception of section 4, the FAA does not create jurisdiction and that jurisdiction under sections 9 and 10 would predominantly arise only in diversity cases.

Justice Kagan, however, cast doubt on this argument by noting “isn’t that a little bit backwards, that it ends up that you put the diversity cases in the federal court system and you take all the cases that involve federal questions and say, oh, the federal courts don’t have anything to do with those cases?” And Justice Kavanaugh summarized what seemed to be the sense of many members of the Court by asking:

[D]oesn’t it make sense to have a – a uniform rule if you’re not going to have, oh, the Act itself confers jurisdiction, a uniform way to think about jurisdiction? And the uniform way that I understood it’s always been thought about was you look through to the underlying controversy, it’s pretty simple, and you do that kind of all the way through.

Despite the somewhat uphill fight Badgerow seems to face, Chief Justice Roberts did challenge the respondents on the issue of whether federal courts would have to handle many more FAA proceedings if the Court agreed with the “look through” argument, noting that “the consequence of your position is to federalize a lot more of FAA actions, procedures, than it seems would make sense if you buy the idea that this is a statute that doesn’t give generally federal jurisdiction. The Court will likely issue its decision this year.

The Court also granted certiorari in December 2021 in two cases that have since been consolidated: ZF Automotive US, Inc. v. Luxshare, Ltd., (U.S. Dec. 10, 2021) (No. 21-401), and AlixPartners, LLP v. The Fund for Protection of Investors’ Rights in Foreign States, 2021 WL 5858633 (U.S. Dec. 10, 2021) (Consolidated No. 21-401). In these cases, the Court is considering a split among the Circuits regarding whether a federal court’s authority “to render assistance in gathering evidence for use in ‘a foreign or international tribunal,’ encompasses private commercial arbitral tribunals[.]” As argued by ZF Automotive in its Petitioner’s Brief, the Fourth and Sixth Circuits have held that the federal courts possess such authority whereas the Second, Fifth, and Seventh Circuits have found that they do not.

In Luxshare, Luxshare applied under 28 U.S.C. § 1782 in a federal court in the Eastern District of Michigan to be allowed discovery against ZF Automotive and two ZF executives for use in a prospective arbitration proceeding between Luxshare and ZF that was to occur in Munich, Germany and pursuant to German Arbitration Institute (DIS) rules. Section 1782 allows a district court to require a person who resides in a respective district to “give his testimony or to produce a document or other thing for use in a proceeding in a foreign or international tribunal[.]” The district court granted Luxshare’s motion and allowed Luxshare to “obtain limited email production and to take one deposition.” As explained by the district court, courts generally consider four factors in deciding whether to grant a Section 1782 application:

1. whether the person from whom discovery is sought is a participant in the foreign proceeding;
2. the nature of the foreign tribunal, the character of the proceedings, and the receptivity of the agency abroad to federal-court judicial assistance;
3. whether the application conceals an attempt to circumvent foreign proof-gathering restrictions or other policies; and
4. whether the discovery sought is unduly intrusive or burdensome.

ZF largely contended that since it was going to be a participant in the German arbitration proceeding, the DIS arbitration tribunal more properly could compel discovery instead of the district court. However, the district disagreed, and relying largely on affidavits from Luxshare’s German counsel testifying that the DIS rules had no mechanism to compel the requested discovery, the district court found that the four factors weighed in favor of granting the application and, therefore, granted the same.

After ZF failed to provide the ordered discovery, Luxshare moved to compel, and, in response, ZF appealed and filed a motion to stay with the Sixth Circuit. While the matter was pending before the Sixth Circuit, the district court granted Luxshare’s motion to compel and ordered production within 14 days from a Sixth Circuit ruling “denying the motion to stay or dismissing the appeal.” ZF petitioned for a writ of certiorari before the Sixth Circuit issued a final decision on the appeal, which the Supreme Court granted in December 2021.

In Alix Partners, the Second Circuit considered issues similar to those presented in Luxshare but also considered whether a foreign investor may properly invoke Section 1782 to obtain an order compelling discovery from a U.S. company for use in an arbitration proceeding between the foreign investor and a foreign government. In affirming the Southern District of New York’s order compelling the disputed discovery, the Second Circuit found that Section 1782 provides such authority. Luxshare and Alix Partners undoubtedly present confounding jurisdictional issues with profound implications, and parties (and related nonparticipants) involved in international disputes should pay close attention.

In addition to Circuit splits presented in the above cases, the Court granted a petition for writ of certiorari regarding the Eight Circuit’s decision in Morgan v. Sundance, Inc., 992 F.3d 711 (8th Cir. (Iowa) 2021), wherein the Eight Circuit reversed a district court’s order that denied a motion to compel arbitration filed by Sundance, finding that the plaintiff had failed to show prejudice from Sundance’s delay in seeking arbitration.

Robyn Morgan, who worked at one of Sundance’s Taco Bell franchises, brought a collective action on behalf of herself others similarly against Sundance alleging Sundance violated the Fair Labor Standards Act by failing to properly pay overtime to its workers. Sundance moved to dismiss the complaint alleging that another similar suit had already been filed in Michigan. The district court denied the motion approximately four months later, and Sundance thereafter answered the complaint without asserting any right to arbitration. Sundance ultimately settled the Michigan action, and despite Morgan’s participate in the global mediation that led to the Michigan action settlement, Morgan’s action did not settle and, instead, continued to proceed. The parties, however, did not conduct any discovery. Following the failed mediation, and after the case had been pending for about eight months, Sundance moved to compel Morgan’s claims to arbitration. The district court denied Sundance’s motion finding that Sundance had “substantially invoked the litigation machinery primarily by waiting eight months to assert its right to arbitrate this dispute[,]” and, therefore, that Morgan would be prejudiced by being compelled to arbitrate.” The Eighth Circuit disagreed.

As explained by the Eighth Circuit, four months of the disputed eight-month period was due to the district court’s consideration of Sundance’s first-to-file motion to dismiss. The court also noted that Sundance’s first-to-file motion did not address the merits of the dispute and, instead, only focused on quasi-jurisdictional issues. Additionally, the court explained that Sundance’s participation in mediation should be considered an effort to avoid “invoking the litigation machinery,” not a substantial invocation of the machinery Further, according to the court, the parties spent little time actively litigating and spent no time regarding the merits of Morgan’s case. Accordingly, the court found that Morgan had not been prejudiced by Sundance’s eight-month delay and reversed the district court’s denial of Sundance’s motion to compel arbitration.

Morgan petitioned the Supreme Court to grant a writ of certiorari, which the Court granted in November 2021. Morgan principally challenged the Eighth Circuit’s ruling that Morgan failed to show prejudice by Sundance’s eight-month delay in seeking arbitration. The question presented, according to Morgan (citing AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011)) is whether “the arbitration-specific requirement that the proponent of a contractual waiver defense prove prejudice violate this Court’s instruction that lower courts must ‘place arbitration agreements on an equal footing with other contracts?’”

Noting a great variety of views among the federal Courts of Appeals and states’ highest courts regarding whether prejudice is required, and to what extent, Morgan asserts that “the Eighth Circuit placed itself firmly into the strong-prejudice camp.” As explained by Morgan, although the Eighth Circuit acknowledged that Sundance acted inconsistently with its right to compel arbitration, the court “refused to find this conduct constituted waiver . . . because ‘Morgan was not prejudiced by Sundance’s litigation strategy.’”

Although the case is in its early stages before the Court, the Court’s grant of Morgan’s petition perhaps does not bode well for parties who wait an extended time to seek arbitration. There, of course, is some strategy with first moving to dismiss claims early in the litigation and then seeking to compel arbitration later, if necessary. However, that strategy might need to be reconsidered in light of the Court’s acceptance of this case. Litigators should pay close attention to the Court’s disposition of this case.

Finally, the Court granted a petition for writ of certiorari regarding the 7th Circuit’s decision in Saxon v. Southwest Airlines Co., 993 F.3d 492 (7th Cir. (Ill.) 2021). In that case, the Seventh Circuit held that airport ramp supervisors are “transportation workers” exempt from the FAA.

A ramp supervisor in Saxon brought a putative class action against Southwest Airlines arguing that the company had failed to pay proper overtime to its ramp supervisors in violation of the Fair Labor Standards Act. Southwest moved to compel based on an arbitration provision that was contained in an employment agreement between it and the supervisor. In response, the supervisor argued that she exempt from the FAA because she was part of a “class of workers engaged in foreign or interstate commerce.” The district court disagreed and ruled that the supervisor was too far removed from interstate commerce to fall within the FAA exemption. The Seventh Circuit disagreed and reversed.

The Seventh Circuit first discussed the phrase “class of workers” contained in the section 1 FAA exemption and explained that the question was not whether the supervisor, on an individual basis, was engaged in commerce but, rather, whether Southwest ramp supervisors as a whole were engaged in commerce and whether the supervisor was a member of that class. The court then explained under United States Supreme Court precedent, “[t]o be engaged in commerce for purposes of § 1 . . . is to perform work analogous to that of seamen and railroad employees, whose occupations are centered on the transport of goods in interstate and foreign commerce.” Thus, according to the Seventh Circuit, the essential question was “whether the interstate movement of goods” was a central part of a ramp supervisor’s job.

Focusing on undisputed evidence that supervisors often acted as ramp agents when Southwest was short of workers and, therefore, required to “spend a significant amount of their time engaged in physically loading baggage and cargo onto planes” that traversed other states or countries, the court found that the supervisors were engaged in interstate or foreign commerce. The court similarly found that the supervisor was a member of the cargo loader class. In an putative attempt to placate Southwest’s concerns with its ruling, the court ruled that ramp supervisors could still be subject to arbitration “under state law or through an agreement outside of [their] contract[s] of employment.” Regardless, in the end, the court ruled that the supervisor was a transportation worker exempt from the FAA and, as such, reversed the district court’s ruling compelling arbitration.

Southwest, thereafter, filed its petition for writ of certiorari with the Supreme Court. As explained by Southwest, the essential question is:

Whether workers who load or unload goods from vehicles that travel in interstate commerce, but do not physically transport such goods themselves, are interstate ‘transportation workers’ exempt from the Federal Arbitration Act.

The Court granted certiorari in December 2021, and it will be interesting to see how the Court further defines what it means to be engaged in commerce for purposes of FAA exemption.

§ 1.4. Who Decides—The Court or the Arbitrator?

Swiger v. Rosette, 989 F.3d 501 (6th Cir. (Mich.) 2021). Where a party opposing arbitration challenges an arbitration agreement as a whole but fails to specifically challenge a delegation clause contained in the agreement, it is for the arbitrator to decide whether the claims are subject to arbitration.

A consumer brought suit against finance company executives arguing the executives and the finance company issued a loan to the consumer that violated Michigan state law and federal law. One of the executives moved to stay the case and compel arbitration based on an arbitration provision and delegation clause that was contained in the loan contract. Based on the delegation clause, the executive argued that the district court should compel arbitration of both the case itself and the case’s threshold arbitrability questions. Citing an opinion from the Second Circuit, the district court ruled that enforceability of the arbitration agreement had already been decided against the executive in a similar case and, therefore, denied the executive’s motion to compel arbitration. Finding that the district court should have enforced the delegation clause, the Sixth Circuit reversed.

Preliminarily, the Sixth Circuit explained that FAA allows parties to agree that an arbitrator will decide arbitrability questions, including whether parties have agreed to arbitrate at all or whether an agreement encompasses a particular controversy. As explained by the court, these delegation clauses “preclude[] courts from resolving any threshold arbitrability disputes, even those that appear wholly groundless.” Only when a party specifically challenges a delegation clause may a court consider the enforceability of such clause. Accordingly, a party must specifically attack a delegation clause and challenging the entire agreement itself will not be sufficient. The court then explained that when the consumer challenged arbitration, she challenged the enforceability of the entire arbitration agreement and failed to challenge the delegation clause specifically. Even on appeal, according to the court, the consumer failed to challenge the delegation clause. Accordingly, and due to the consumer’s failure to challenge the delegation clause, the Sixth Circuit ruled that the district court should have enforced it and referred the case to arbitration. The court, therefore, reversed the district court and remanded the case.

Bossé v. New York Life Ins. Co., 992 F.3d 20 (1st Cir. (N.H.) 2021). Where an arbitration provision includes an unmistakable arbitrability delegation clause, the arbitrator is to decide arbitrability, not the court.

An insurance agent brought suit against New York Life arguing that his business relationship with New York Life was improperly terminated due to his race. In response, New York Life moved to compel arguing that certain arbitration clauses contained in various agreements executed with the agent during his tenure with the company required the agent to arbitrate his claims. At least one of the clauses specifically stated that any disputes between the parties were to be decided by an arbitrator. Nonetheless, the district court ruled that the arbitrability determination was for it to decide, not an arbitrator. Specifically, the district court ruled that Section 2 of the FAA required an arbitration clause to bear some relationship to the respective agreement or contract. According to the district court, the subject arbitration clauses improperly required arbitration of “any” dispute between the parties and was not sufficiently limited to disputes bearing a relationship to the contract itself. Accordingly, the district court declined to enforce the arbitration clauses. The First Circuit reversed.

Relying on the U.S. Supreme Court’s decision in Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S. Ct. 524 (2019), the First Circuit explained that where parties have clearly and unmistakably delegated issues of arbitrability to the arbitrator, courts must enforce the parties’ expectations as reflected in the agreement and, therefore, defer to the arbitrator to decide the issue. Reviewing the language contained in one of the arbitration clauses, the court explained that the parties had not only agreed to arbitrate any disputes arising between them but also “‘any dispute as to whether such Claim is arbitrable.’” Additionally, another arbitration clause provided that the arbitration was to be administered by the AAA in accordance with its rules. As explained by the court, rule 6(a) of the AAA Employment Arbitration Rules and Mediation Procedures requires the arbitrator to decide whether claims are arbitrable.

Additionally, the court rejected the agent’s argument that a court must assess whether a dispute is encompassed by an arbitration agreement to properly determine whether arbitrability was delegated to an arbitrator. According to the court, that type of “short-circuiting” was explicitly rejected by Henry Schein. Furthermore, the court summarily found there was no support for the agent’s argument that an arbitration clause must bear some relationship to the underlying contract to be enforceable.

Accordingly, finding that the arbitration clauses unmistakably delegated the arbitrability determination to the arbitrator, the court reversed the district court and ordered the district court to compel arbitration.

Glacier Park Iron Ore Properties, LLC v. U.S. Steel Corp., 961 N.W.2d 766 (Minn. 2021). Absent clear and unmistakable evidence that parties have agreed to arbitrate arbitrability, the arbitrability determination is a function for the court.

Glacier Park initiated an action against U.S. Steel arguing that a lease agreement entered into between U.S. Steel and trust from which Glacier Park acquired assets and rights, was wrongly procured through a breach of the trust’s fiduciary duty. After filing the action, Glacier Park moved to compel arbitration. Although the lease did not clearly express that the parties agreed that the question of arbitrability was subject to arbitration, Glacier Park argued that under an older Minnesota “reasonably debatable” standard, the arbitrator should decide arbitrability. The trial court disagreed, finding that the FAA dictated the court, not the arbitrator, to decide arbitrability. The Court of Appeals affirmed.

On appeal to the Supreme Court, the Supreme Court agreed that the FAA applied because the case involved interstate commerce. Accordingly, the Supreme Court inquired into whether the lease evidenced that Glacier Park and U.S. Steel clearly and unmistakably intended to arbitrate arbitrability. In examining the arbitration provision, the Court noted that although the parties specified certain disputes were subject to arbitration, the provision did not provide that the arbitrability of the claim itself was subject to arbitration. As explained by the Court, parties to an arbitration must expressly state that arbitrability is subject to arbitration, and Glacier Park and U.S. Steel failed to do that. Accordingly, the Supreme Court affirmed the Court of Appeals and held that the question of whether the breach of fiduciary claim was arbitrable was a question for the court.

Melaas v. Diamond Resorts U.S. Collection Dev., LLC, 953 N.W.2d 623 (N.D. 2021). The court, not an arbitrator, decides whether a party provided the necessary consent to enter into an arbitration agreement.

A customer to a timeshare agreement sued Diamond Resorts seeking to void the agreement due to improper actions of Diamond Resorts during the execution of the agreement. Diamond Resorts moved to compel arbitration based upon an arbitration provision contained in the timeshare agreement. The customer contested arbitration arguing that she was a vulnerable adult and, therefore, could not have properly consented to entering into the agreement. The trial court compelled arbitration without considering whether the customer possessed the requisite capacity to consent to the agreement in the first instance. The Supreme Court found this was in error.

The Court first noted that because arbitration is a matter of consent, a court can only order arbitration if it satisfied that the parties actually agreed to arbitrate their disputes. Similarly, because there is a possibility that a party to an arbitration agreement lacked the mental capacity to consent to entering into the agreement, the court – not an arbitrator – must decide whether the agreement was properly formed. If the court determines that a valid arbitration agreement exists, it must order arbitration of the dispute. Accordingly, because the trial court failed to determine whether the timeshare agreement was properly formed, the Supreme Court remanded the case to the trial court to hold an evidentiary hearing to determine whether a contract containing an arbitration agreement properly existed.

§ 1.5. What Constitutes an Agreement to Arbitrate?

Foster v. Walmart, Inc., 15 F.4th 860 (8th Cir. (Ark.) 2021). Where there exist material disputes of fact as to whether parties have agreed to arbitrate, a court should proceed summarily to trial to determine the issue.

Gift card purchasers brought suit against Walmart after the gift cards turned out to be worthless due to third parties tampering with, and stealing, the funds that originally were included on the gift cards. Walmart moved to compel based on a notation that was contained on the back of the gift cards directing purchasers to “see Walmart.com for complete terms.” According to Walmart, if the purchasers had visited that website, they would have come across an arbitration provision which explained that the purchasers accepted arbitration by using or accessing the Walmart sites. The district court denied Walmart’s motion to compel finding that the purchasers never had notice of the arbitration clause and could not have consented to arbitration unless they saw the clause first. On appeal, the Eighth Circuit found that the issue more-properly should have been determined in a trial instead of being decided by the district court itself.

The Eighth Circuit first explained that its task was to determine whether the record revealed any material issue of fact as to whether the parties had an agreement to arbitrate and to the extent that it did, the FAA required the court remand the case for trial. The court then discussed the possible theories behind whether the parties agreed to arbitrate. The first possibility was the instant the plaintiffs purchased their gift cards. According to Walmart, the plaintiff purchasers had notice of the arbitration agreement because it directed them to Walmart’s website for the cards’ complete terms. Nonetheless, the court found that the arbitration clause that was contained on the website explained that the plaintiffs accepted arbitration only by using or accessing Walmart’s websites. Accordingly, as explained by the court, if Walmart wanted the arbitration agreement to be formed at the point-of-purchase, it should have expressly said so in the arbitration clause.

The next possibility for agreeing to the arbitration clause was at the moment the plaintiffs actually accessed Walmart’s sites pursuant to the language contained in the clause. Crucial to this determination, according to the court, was whether the plaintiffs had adequate notice of the “browsewrap agreement.” As explained by the court, to be bound, the plaintiffs were required to either obtain actual notice of the arbitration clause or inquiry notice. The court then noted that the record before it and the district court was “meager,” and, therefore, it was difficult to determine whether the plaintiffs possessed sufficient notice. Characterizing these issues as material disputes of fact, the court explained that the FAA required the district court to proceed summarily to a trial on the issue of notice. Accordingly, the Eighth Circuit reversed the district court and remanded the case for trial for determining whether the parties agreed to arbitrate.

Kauders v. Uber Technologies, Inc., 159 N.E.3d 1033 (Mass. 2021). No arbitration agreement is formed where a signatory does not have reasonable notice of the arbitration terms and does not provide a reasonable manifestation of assent to the terms.

Users of Uber’s phone application brought suit against Uber after drivers for Uber refused to transport the riders because they were blind and accompanied by guide dogs. Uber moved to compel arbitration based on an arbitration provision contained in the terms and conditions contained in the application, which was granted by the trial court. Following arbitration, the riders moved for reconsideration of the trial court’s order requiring arbitration due to an interim opinion issued by the First Circuit Court of Appeals holding that Uber’s registration process did not create a contract with the application’s users because it failed to provide reasonable notice of its terms and conditions. The trial court agreed with the riders that the application failed to provide reasonable notice of its terms and conditions, including the arbitration provision, and, therefore, there was no contract between the riders and Uber. Uber appealed contending the terms and conditions constituted an enforceable contract. The Massachusetts Supreme Judicial Court disagreed.

The Supreme Judicial Court first acknowledged that it had not yet had an occasion to address “what standard a court should use when considering issues of contract formation for online contracts.” Nonetheless, the Court noted that the standard for creating online contracts should not differ from ordinary contract formation. Accordingly, the Court delineated a two prong test for determining whether a party has agreed to the terms of an online contract: there must be both (1) reasonable notice of the terms of the contract; and (2) reasonable manifestation of assent to the terms.

As it relates to the first element, the Court explained that a rider’s mere agreement to use the application did not necessarily mean that the rider also agreed to the “Terms & Conditions” because the application did not require the user to actually click on the link or otherwise review the terms and conditions when creating an account.” Moreover, according to the Court, the page upon which the terms and conditions were hyperlinked focused on payment information and the link was minimally prominent on the page. Accordingly, the Court found that Uber failed to show that it provided the riders with reasonable notice of the terms and conditions, including the disputed arbitration provision. For the same reasons, the Court held that the drivers did not reasonably manifest assent to the terms and conditions. Because there was no reasonable notice of the terms and conditions and because the drivers did not reasonably manifest assent to the terms and conditions, the Supreme Judicial Court ruled that there was no enforceable arbitration agreement between Uber and the riders and, accordingly, remanded the case.

Hillhouse v. Chris Cook Construction, LLC, 325 So.3d 646 (Miss. 2021). An arbitration provision is unenforceable where it requires arbitration to take place in a non-existing forum.

Purchasers of a home brought negligence and contractual claims against a contractor following a flooding of their home. The construction company moved to compel based on an arbitration provision that was contained in the purchase contract. The trial court granted the construction company’s motion to compel despite the fact that the provision required mediation to occur before the Southern Arbitration and Mediation Association (“SAMA”) which had ceased to exist seventeen years prior to the parties entering into the contract. The purchasers appealed arguing that because SAMA did not exist at the time of the contract execution, the arbitration provision was unenforceable. The Supreme Court agreed.

The Supreme Court explained that the contract provided that all claims “shall” be subject to SAMA. Accordingly, arbitration before SAMA was an express contractual requirement. Because SAMA as a forum was an express contractual requirement, the Court explained that it could not rewrite the contract merely because the forum was unavailable. To do so, according to the Court, would be to choose a forum not anticipated by either party. The Court, therefore, reversed the trial court finding that the arbitration provision was unenforceable due to SAMA’s nonexistence and unavailability.

Fitness, Fun, & Freedom, Inc. v. Perdue, No. 20-0344, 2021 WL 653240 (W. Va. Feb. 19, 2021) (unpub.). Minor who enters into a contract containing an arbitration provision may disaffirm the contract, including its arbitration provision, upon reaching majority, even after suit is filed.

Parents of a minor who was injured at a trampoline park brought suit against the trampoline park after the minor broke his legs while using a trampoline at the park. Prior to going to the trampoline park, the minor completed a release of liability on the trampoline park’s website, forging his mother’s signature to the release. The release contained a broad arbitration provision requiring arbitration of any and all claims related to trampoline park and its equipment. Based on the arbitration provision, the trampoline park moved to compel. Thereafter, the parents amended their complaint to add the trampoline manufacturer as a defendant. In the amended complaint, the minor also disaffirmed the release because he had, by that point, reached the age of majority. Because of the minor’s disaffirmance of the release, including its arbitration provision, the trial court denied the trampoline park’s motion to compel. The Supreme Court of Appeals affirmed.

The Supreme Court first explained that a trial court’s review of a motion to compel is limited to two questions: (1) does a valid arbitration agreement exist, and (2) do the subject claims fall within its scope. The Court then noted that contracts entered into by minors are voidable and may be disaffirmed after reaching majority. The Court, therefore, found that because the minor disaffirmed the release, including the arbitration provision, upon reaching majority, the release was no longer valid. Accordingly, the Supreme Court of Appeals affirmed the trial court’s denial of the trampoline parks’ motion to compel.

§ 1.5.1. Issues of FAA Preemption

Harper v. Amazon.com Srvcs., Inc., 12 F.4th 287 (3d Cir. (N.J.) 2021). Where it is unclear whether claims are exempt from being arbitrated under the FAA, a court should first inquire into whether the respective claims are arbitrable under state law before ordering discovery regarding exemption under the FAA.

In Harper, a “flexible” “last mile” delivery driver for Amazon brought suit against Amazon alleging entitlement to additional wages and tips and related violations of New Jersey labor laws. Despite the existence of an arbitration provision in his agreement with Amazon, the plaintiff initiated suit against Amazon in the Superior Court of New Jersey. Amazon removed to federal court based on diversity jurisdiction and the plaintiff, thereafter, asserted a putative class action against Amazon. In response, Amazon moved to compel arbitration under the FAA but also argued that the plaintiff’s claim was also arbitrable under state law. The plaintiff argued that he was exempt under Section 1 of the FAA because he made deliveries across state lines. The district court denied Amazon’s motion to compel and ordered discovery to determine whether the plaintiff was included within the section 1 exemption. The district court expressly did not decide whether the plaintiff’s claims were arbitrable under state law. The Third Circuit found this was in error.

The Third Circuit first acknowledged that section 1 has been interpreted to cover employees in any transportation industry who are engaged in the interstate or foreign movement of commerce or are so closely-related to it so as to practically be a part of it. It is crucial to make a determination as to an employee’s status because a court must know whether a contract itself falls within our without the scope of sections 1 and 2 of the FAA. However, in some instances, as explained by the court, “the scope of the class of workers cannot be determined by examining the nature of the work performed by the class” and limited discovery may be ordered to obtain facts about the class of works. Nonetheless, if there are state law grounds for enforcing arbitration even if the FAA does not apply, courts must first consider and answer that question before ordering discovery. The court explained that this inquiry must take place because “[n]ot all state laws” are displaced by the FAA. Instead, only state laws which conflict with the FAA are preempted. Where a state law enforces arbitration, there is no conflict.

Accordingly, and in light of the above, the Third Circuit vacated the district court’s denial of Amazon’s motion to compel, and remanded the case to the district court to determine whether the case was arbitrable under applicable state law and ordered that such determination be made before “turning to questions of fact and discovery” regarding the applicability of the section 1 exemption under the FAA.

A Better Way Wholesale Autos, Inc. v. Saint Paul, 258 A.3d 1244 (Conn. 2021).

State statute requiring a party to move to vacate an arbitration award within thirty days was not preempted by the FAA.

A car purchaser initiated an arbitration proceeding contending that the car company failed to disclose certain charges in violation of the federal Truth in Lending Act and Connecticut’s Unfair Trade Practices Act, and the arbitrator ruled in favor of the car purchaser. The car company moved to vacate the arbitrator’s award thirty-six days later, arguing that the arbitration had exceed his powers. In response, the car purchaser argued that because Connecticut law required the car company to move to vacate within thirty days of the award, the car company’s application was untimely and the trial court, therefore, lacked jurisdiction to vacate the award. In support of its motion to vacate, the car company argued that the Connecticut statute was preempted by the FAA’s three month limitation period since the respective financing agreement provided that the FAA would apply. The trial court rejected the car company’s argument that the statute was unconstitutional and dismissed the car company’s application to vacate. Connecticut’s intermediate appellate court affirmed the trial court finding that the FAA did not preempt the thirty-day Connecticut statutory provision. The Supreme Court similarly affirmed the trial court finding the Connecticut statute was not preempted by the FAA.

As an initial matter, the Supreme Court acknowledged that the FAA does not expressly preempt state law on temporal requirements, not does it reflect any congressional intent to occupy the entire arbitration field. Accordingly, the Supreme Court considered whether there was a conflict between the FAA’s ninety-day provision to move to vacate and Connecticut’s thirty-day provision. In the end, the Supreme Court found that there was no such conflict because the thirty-day provision does not interfere with a party’s right to challenge an arbitration award and, in fact, furthers arbitration’s goal of resolving disputes timely. Accordingly, the Supreme Court affirmed the trial court’s dismissal of the car customer’s vacation application as being untimely.

§ 1.6. Jurisdiction Under the Federal Arbitration Act

Tantaros v. Fox News Network, LLC, 12 F.4th 135 (2d Cir. (N.Y.) 2021). State statute prohibiting mandatory arbitration clauses for employment discrimination claims “except where inconsistent with federal law” raised federal issue of whether claims brought pursuant to the statute were preempted by the FAA.

Fox News initiated an arbitration action against one of its political commentators arguing that the commentator failed to obtain prior approval before publishing a book, thereby breaching her employment agreement. A few months after Fox News initiated arbitration, the plaintiff brought suit against Fox News and some of its senior executives in New York state court alleging “sexual harassment, hostile work environment, tortious interference with business expectancy, and retaliation for her complaints of sexual harassment.” Thereafter, the New York state court granted a motion to compel arbitration filed by the defendants, compelling the plaintiff’s claims to arbitration.

While the claims of all the parties were being arbitrated, the New York State Legislature passed a law declaring void mandatory arbitration clauses covering sexual harassment claims “‘[e]xcept where inconsistent with federal law.’” The law was later amended to cover all employment discrimination claims, not just sexual harassment claims. Based on the new law, the plaintiff sought a temporary restraining order and injunctions against being required to continue to arbitrate her employment claims and a declaratory judgment action that the new law prohibited enforcement of the arbitration agreement. The defendants removed to federal court arguing that the plaintiff’s new suit “necessarily raise[d] an issue of federal law: whether [the plaintiff’s] claim is consistent with the FAA.” The district court agreed, and relying on Supreme Court precedent, denied remand, finding that the plaintiff’s case arose under federal law. On appeal, the plaintiff argued the district court erred in failing to remand because: “(1) the action [did] not necessarily raise an issue of federal law because preemption [was] an anticipated defense; (2) any federal issue [was] not substantial; and (3) the exercise of federal jurisdiction [in the case] would upset the federal-state balance.” The Second Circuit disagreed.

The court first explained that although federal question jurisdiction is commonly based on a plaintiff specifically pleading a federal cause of action, a “special and small category” of cases brought pursuant to state law can implicate a federal issue. As explained by the court, federal jurisdiction will exist over this smaller set of claims if a federal issue is: “(1) necessarily raised, (2) actually disputed, (3) substantial, and (4) capable of resolution in federal court without disrupting the federal-state balance approved by Congress.”

As it relates to the first element, the court found that federal law was necessarily raised because the New York state statute specifically required the plaintiff plead her claims consistent with federal law. The court also found that the plaintiff’s claims presented a substantial question of federal law because “the issue [would] inform all future claims brought” under the New York state statute and because the case implicated the FAA and national policy favoring arbitration. Lastly, the court found that the exercise of federal jurisdiction in the case did not threaten the balance of federal and state responsibilities because although New York had a competing interest in interpreting its own laws, the New York legislature expressly drafted the disputed state law while being cognizant that federal law might be at issue. Accordingly, finding that “resolution of a significant federal issue” was necessary to the plaintiff’s claims, the Second Circuit affirmed the district court’s denial of remand.

Doe v. Trump Corp., 6 F.4th 400 (2d Cir. (N.Y.) 2021). Courts do not possess jurisdiction to grant a motion to compel arbitration filed by a nonparty to a lawsuit in response to a subpoena that was served on the nonparty.

In Trump Corp., business owners who had lost investments after entering into business relationships with a multilevel marketing company brought suit against the Trump Corporation and members of the Trump family alleging the defendants falsely represented that the marketing company was successful and that the defendants were independent of the marketing company. The plaintiffs did not name the marketing company as a defendant, presumably because the agreements between the business owners and the marketing company contained arbitration clauses. After suit was filed, the plaintiffs served a subpoena on the marketing company seeking documentation related to its relationship to, and communications with, the defendants. After the marketing company failed to produce responsive materials, the plaintiffs moved to compel production. In response, the marketing company moved to compel arbitration of the discovery dispute and the disputes between the plaintiffs and the defendants. The district court granted he plaintiffs’ motion to compel production, in part, and denied the marketing company’s motion to compel arbitration.

Regarding the marketing company’s motion to compel arbitration, the district court explained that the discovery dispute did not fall within the scope of the arbitration agreement because the lawsuit was about the defendants’ purported bad acts and did not relate to the plaintiffs’ obligations under the agreement between the plaintiffs and the marketing company. Additionally, the district court held that the marketing company lacked standing to compel the lawsuit between the plaintiffs and the defendants to arbitration because it was not a party to the lawsuit and, therefore, lacked standing to move to compel arbitration. Similarly, the district court held that it lacked jurisdiction to compel the discovery dispute to arbitration. The Second Circuit affirmed, finding that the district court’s lack of jurisdiction was dispositive as to whether the district court improperly failed to compel arbitration.

The Second Circuit opened its review with an acknowledgment that the FAA does not create federal jurisdiction and, instead, requires an independent jurisdictional basis over the parties’ dispute. Accordingly, a federal court can only compel arbitration if the dispute between the parties could be litigated in federal court if it were not for an arbitration agreement. In this respect, the court found that there was no “actual case or controversy” between the plaintiffs and the marketing company because the plaintiffs did not assert any claims against the marketing company and the marketing company had not intervened or otherwise been impleaded into the lawsuit. Accordingly, because there was no live case or controversy between the plaintiffs and the marketing company, the Second Circuit ruled that the district court properly found that it was without jurisdiction to compel arbitration. The Second Circuit, therefore, affirmed the district court’s denial of the marketing company’s motion to compel arbitration.

§ 1.6.1. Federal Appellate Jurisdiction Under Section 16 of the Federal Arbitration Act

Hamrick v. Partsfleet, LLC, 1 F.4th 1337 (11th Cir. (Fla.) 2021). Federal appellate courts lack jurisdiction to hear appeals based on a district court’s state-law-based denial of a motion to compel arbitration.

A final-mile delivery driver brought a collective action, on behalf of himself and those similarly situated, against U.S. Pack Holdings, LLC, a final-mile delivery company, arguing that U.S. Pack failed to pay wages owed under the Fair Labor Standards Act. U.S. Pack moved, pursuant to both the FAA and state arbitration law, to compel arbitration based on arbitration provisions that were contained in the plaintiffs’ independent contractor agreements with U.S. Pack. The district court denied U.S. Pack’s motion to compel finding that the drivers were exempt from the FAA due to section 1’s transportation worker exemption. Additionally, the district court ruled that U.S. Pack could not compel arbitration under state law because the parties expressly chose the FAA to govern the independent contractor agreements. U.S. Pack, thereafter, sought to appeal the district court’s denial based on both the FAA and state law. Although the Eleventh Circuit ultimately determined that the district court failed to properly consider whether the plaintiffs were in a class of workers that engaged in interstate commerce and, therefore, remanded the case so that the district court could conduct a proper analysis, the Eleventh Circuit ruled that it was without jurisdiction to review the district court’s decision regarding arbitration based on state law.

The Eleventh Circuit first acknowledged that the district court’s denial of U.S. Pack’s motion to compel was an interlocutory order. The court then noted that appellate courts generally are “precluded from hearing interlocutory appeals under the final judgment rule.” Nonetheless, as explained by the court, the FAA expressly allows appellate review of interlocutory orders denying motions to compel pursuant to the FAA. That allowance, however, does not apply to denials of motions to compel arbitration based on state law. Additionally, general pendent appellate jurisdiction which allows review of non-appealable decisions that are “inextricably intertwined” with appealable decisions, did not provide an avenue for the Eleventh Circuit’s review. As explained by the court, a determination of whether the plaintiffs were transportation workers under the FAA could be made without referencing or relying on state arbitration law. Thus, the court found that the district court’s FAA arbitration determination and its state law determination were not inextricably intertwined or interwoven. As such, the court dismissed for lack of appellate jurisdiction the part of U.S. Pack’s appeal that was based on the district court’s denial of arbitration under state law.

§ 1.7. Nonsignatories to an Arbitration Agreement

§ 1.7.1. Can Nonsignatories Compel Signatories to Arbitrate?

Reeves v. Enterprise Products Partners, LP, 17 F.4th 1008 (10th Cir. (Okla.) Nov. 9, 2021). Where a party to an arbitration agreement alleges substantially independent and concerted misconduct between a signatory and nonsignatory to an arbitration agreement, the nonsignatory may properly compel arbitration based on equitable estoppel.

Two welders brought a putative class action against an energy company after performing work for the energy company through third-party staffing agencies, for which the welders allegedly were not properly compensated. The employment contracts between the plaintiffs and the staffing agencies contained arbitration clauses. Accordingly, the energy company moved to compel arguing that the plaintiffs’ claims raised allegations of “substantially interdependent and concerted misconduct” by the energy company and the staffing agencies. Therefore, according to the energy company, the plaintiffs should have been equitably estopped from contesting arbitration. The district court rejected the energy company’s arguments and denied the company’s motion to compel. The Tenth Circuit reversed.

The Tenth Circuit first explained that an arbitration agreement’s scope, including who it binds, is a question of state law. Therefore, according to the court, its task was to determine whether the Oklahoma Supreme Court would allow the nonsignatory energy company to enforce the arbitration clause. However, as explained by the court, the Oklahoma Supreme Court had not yet addressed the applicability of concerted misconduct estoppel. Nonetheless, the court noted that two Oklahoma Court of Appeals cases affirmatively adopted “the two-prong misconduct equitable estoppel test,” finding that “equitable estoppel applied for nonsignatories in two circumstances[.] The circumstance applicable in Reeves, according to the Tenth Circuit, was where “the signatory raises allegations of substantially interdependent and concerted misconduct by both the nonsignatory and one or more of the signatories to the contract.”

The court explained that equitable estoppel is centered on “fairness,” and that the plaintiffs sought to hold the energy company liable based on duties imposed by the employment contracts but simultaneously sought to avoid the arbitration provisions contained in the contracts. Additionally, as explained by the court, the staffing agencies actually were the parties who paid the plaintiffs and not the energy company and, therefore, the plaintiffs’ allegations against the energy company and the staffing agencies were substantially interdependent essentially requiring the staffing agencies to become parties to the case. The court then noted that equitable estoppel seeks to prevent parties from “playing fast and loose with the courts” and that the plaintiffs carefully left the staffing agencies out of their pleadings. However, as explained by the court, the plaintiffs were nonetheless required to honor the arbitration agreements with the staffing agencies and arbitrate their claims against the energy company because the claims were based on the energy company’s and staffing agencies’ substantially interdependent and concerted misconduct. The Ninth Circuit, therefore, reversed the district court’s denial of the energy company’s motion to compel arbitration.

Setty v. Shrinivas Sugandhalaya LLP, 3 F.4th 1166 (9th Cir. (Wash.) 2021). Although a nonsignatory to an arbitration agreement can, in some instances, equitably estop a signatory from contesting arbitration, even under the New York Convention, the claims asserted by the nonsignatory must actually be related to the agreement that includes the arbitration provision.

On remand from the United States Supreme Court, the Ninth Circuit reconsidered its earlier decision that an Indian manufacturing company, which was not a signatory to a disputed partnership deed containing an arbitration agreement, could not equitably estop a competitor company and its principal, signatories to the deed, from avoiding arbitration of a trademark infringement claim. As the matter originally existed before the Ninth Circuit, the manufacturing company had appealed a district court order denying its motion to compel arbitration. Relying on the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”), the manufacturing company had sought to compel arbitration based on a partnership deed between the competitor and its principal that contained an arbitration provision. However, because the manufacturing company was not even in existence at the time the competitor and its principal entered into the arbitration agreement and, therefore, not a party to the agreement, the court summarily affirmed the district court’s denial of the motion to compel.

On appeal to the United States Supreme Court, the Court asked the Ninth Circuit to reconsider its ruling in light of the Court’s ruling in GE Energy Power Conversion France SAS v. Outokumpu Stainless USA, LLC, 140 S. Ct. 1637 (2020). In Outokumpu, the Court held that the New York Convention does not prohibit the enforcement of arbitration agreements by nonsignatories who can meet the elements of equitable estoppel. On remand, the Ninth Circuit “accept[ed] that a nonsignatory could compel arbitration in a New York Convention case” but that the manufacturing company’s allegations did “not implicate the agreement that contained the arbitration clause—a prerequisite for compelling arbitration under the equitable estoppel framework.” Quite simply, according to the court, the manufacturing company’s claims had no relationship to the partnership deed between the competitor and its principal. More specifically, the trademarks at issue, according to the court, were based on mere “prior use” of the contested marks over a period of time and were not based on the disputed partnership deed. Accordingly, finding that because the manufacturing company’s claims were not based on the disputed partnership deed, the court found that the company could not rely on equitable doctrine principles to enforce the deed’s arbitration clause as a nonsignatory. The court, therefore, again affirmed the district court’s denial of the manufacturing company’s motion to compel arbitration.

Doe v. Carmel Operator, LLC, 160 N.E.3d 518 (Ind. 2021). Although the doctrine of equitable estoppel may, in some instances, allow a nonparty to an arbitration agreement to enforce the agreement against a party to the agreement, the nonparty must show that it knew of, and relied upon, the agreement.

A guardian for an elderly resident of a senior living facility brought suit against the facility and a background check company after one of the facility’s employees sexually abused the resident. Both the facility and company moved to compel arbitration based upon a residency agreement between the resident and the facility. Although the company was not a signatory to the agreement, it contended that it was an agent of the facility and, therefore, explicitly contemplated by the terms of the agreement. Alternatively, the company argued that it was covered by the arbitration agreement under the doctrine of equitable estoppel. The trial court agreed with the company and compelled arbitration of the guardian’s claims. The Court of Appeals affirmed. The Supreme Court, however, reversed finding that the company was neither an agent of the facility nor entitled to the protections afforded by equitable estoppel.

As it relates to the company’s contention that it was agent and, therefore, protected under the agreement’s provision extending protection to the facility’s employees and agents, the Supreme Court found that there was no evidence that the facility controlled the company’s process for conducting the disputed background check. Thus, according to the Supreme Court, the company was not acting as an agent for the facility when it was conducting its background check of the subject employee. Furthermore, as it relates to equitable estoppel, the Supreme Court ruled that the company could not prove that it knew about the agreement or that it detrimentally relied upon the agreement. The Supreme Court expressly rejected the company’s suggestion that the Court adopt an alternative theory of estoppel based on “substantial interdependence” of the guardian’s claims against the facility and the company. Accordingly, finding that the company neither was an agent of the facility nor entitled to protection under the doctrine of equitable estoppel, the Supreme Court reversed the trial court’s order compelling arbitration of the guardian’s claims against the company.

§ 1.7.2. Can Signatories Compel Nonsignatories to Arbitrate?

O’Hanlon v. Uber Technologies, Inc., 990 F.3d 757 (3d Cr. (Pa.) 2021). Nonusers of rideshare services are not bound by arbitration provisions generally governing the use of service where the nonusers allege that the service is engaging in discriminatory practices.

Motorized-wheelchair users sued Uber alleging that Uber violated the ADA and discriminated against persons with mobility disabilities by failing to offer wheelchair-accessible vehicles in the Pittsburgh, Pennsylvania area. Uber moved to compel arguing that the plaintiffs were bound by the arbitration clause in Uber’s terms of use because the plaintiffs would not be able to bring any claims against Uber without effectively steeping into the shoes of an actual Uber user. Therefore, according to Uber, the plaintiffs should be equitably estopped from denying the enforceability of the arbitration provision. Similarly, Uber argued that the plaintiffs lacked standing to bring the suit in the first instance since they did not actually use the Uber application.

In denying Uber’s motion to compel, the district court found that the plaintiffs sufficiently had pleaded an injury in fact without actually having used the Uber application. Relatedly, the district court found that the plaintiffs’ claims were based on the ADA and not Uber’s terms of use. For the same reasons, the district court found that the plaintiffs could not be equitably estopped from contesting the enforceability of the arbitration provision contained in Uber’s terms of use. On appeal, the Third Circuit found that it need not address the standing issue because there is no obligation to address standing on an appeal from a motion to compel arbitration. Additionally, the Third Circuit ruled that, under Pennsylvania law, the plaintiffs could not be estopped from denying the of the arbitration provision.

The Third Circuit first noted that under Pennsylvania law, “only parties to an arbitration agreement are subject to arbitration[.]” However, according to the court, equitable estoppel may, in some instances, bind a nonsignatory to an arbitration clause when “the non-signatory knowingly exploits the agreement containing the arbitration clause despite having never signed the agreement.” A nonsignatory exploits a disputed agreement by embracing the agreement and directly benefiting from it. In those situations, a nonsignatory cannot later reject those portions of the respective agreement with which it disagrees. However, these principles do not govern instances where there is no evidence that the nonsignatory availed itself of the agreement or received any benefits under the agreement. Accordingly, a nonsignatory who does not avail itself of benefits under an agreement containing an arbitration clause can properly litigate its claims against another in court.

Considering the above, the court found that the plaintiffs had alleged that they had “not downloaded Uber’s app, used its service, or otherwise availed themselves of any aspect of Uber’s service agreement.” Indeed, according to the court, the plaintiffs have alleged that Uber’s discriminatory conduct prevented them from using the application in the first instance. Accordingly, the court found that the plaintiffs could not be equitably estopped from rejecting the Uber’s service agreement’s arbitration clause and affirmed the district court’s denial of Uber’s motion to compel.

Wagner v. Apache Corp., 627 S.W.3d 277 (Tex. 2021). A party that contractually assumes the obligations and responsibilities of another is bound by an arbitration provision that is contained in the assumed contract, despite not being an original signatory to the contract.

After purchasing and being assigned certain oil assets from Apache, Wagner Oil then assigned the assets to several other assignees. The subsequent assignment provided that the assignees would assume and agree to be bound for all obligations contained in the earlier assignment between Wagner Oil and Apache. The purchase agreement between Wagner Oil and Apache contained an arbitration provision that bound successors and assigns of Wagner Oil and Apache. Several years after Apache and Wagner Oil entered into the purchase and assignment agreement and after Wagner Oil assigned its rights to other assignees, individual landowners brought suit against Apache related to environmental contamination caused by Apache prior to selling its assets to Wagner Oil. Apache, thereafter, filed a demand for arbitration against Wagner Oil and its assignees seeking indemnity and defense. In response, Wagner Oil and its assignees filed a declaratory judgment action in a state trial court seeking a declaration that the Wagner Oil assignees were not parties to the original purchase agreement and, therefore, not subject to arbitration. The trial court agreed with the Wagner Oil assignees and denied Apache’s motion to compel arbitration. The Court of Appeals reversed, finding that the Wagner Oil assignees assumed the obligations under the original purchase agreement and, therefore, were bound by the arbitration provision. The Supreme Court affirmed.

The Supreme Court first expressed that under federal arbitration law, not only are signatories to arbitration agreements bound to arbitrate, but non-signatories can similarly be bound under various theories, including assumption. The Court then explained that the original purchase agreement between Wagner Oil and Apache expressly stated that the arbitration clause was binding upon the parties and their successors and assigns. Similarly, the original assignment between Apache and Wagner Oil provided that the parties’ successors and assignees would forever be subject to the assignment and the terms and conditions of the original purchase agreement. Furthermore, the assignment from Wagner Oil to the other assignees provided that the assignees assumed and agreed to be bound by all obligations imposed on Wagner Oil in its earlier assignment with Apache. Accordingly, the Court found that the Wagner Oil assignees expressly assumed Wagner Oil’s obligations imposed in the original purchase agreement and assignment and, therefore, were subject to the arbitration provision contained in the purchase agreement. The Supreme Court, therefore, affirmed the Court of Appeals and remanded the matter to the trial court so that it could order the parties to arbitrate.

NC Financial Solutions of Utah, LLC v. Commonwealth ex rel. Herring, 854 S.E.2d 642 (Va. 2021). State attorneys general are not bound by arbitration provisions contained in contracts between loan companies and consumers when seeking remedies on behalf of the consumers under state consumer protection laws.

The Attorney General of the Commonwealth of Virginia brought an action against an online lender for violations of Virginia’s consumer protection laws seeking, in part, the return of monies that were paid by state consumers. The online lender moved to dismiss the action contending that because the subject contracts with the consumers contained arbitration provisions, Virginia was required to arbitrate its claims against the online lender. Virginia responded by arguing that it was not a party to the consumer contracts and, therefore, was not bound by the arbitration provisions contained in the contracts. Relying on precedent from the United States Supreme Court, the trial court found that Virginia was not bound by the arbitration provisions. The Virginia Supreme Court affirmed.

The Supreme Court first acknowledged that the FAA reflects the liberal federal policy of favoring arbitration agreements. However, even this liberal federal recognition, as explained by the Court, cannot alter general state contract law regarding the scope of agreements containing arbitration provisions. Accordingly, the Court explained that a party cannot be compelled to arbitration unless it has agreed to arbitrate. The Court then discussed the U.S. Supreme Court’s opinion in EEOC v. Waffle House, Inc., 534 U.S. 279 (2002), wherein the U.S. Supreme Court found that because the EEOC was not a party to an arbitration agreement between an employer and an employee, the EEOC was not required to arbitrate claims it asserted on behalf of the employee against the employer. Finding that the principles elucidated in Waffle House applied in the instant NC Financial Solutions case, the Vermont Supreme Court held that Virginia was not bound by the arbitration provisions between the lender and the consumers. Accordingly, the Supreme Court affirmed the trial court’s order compelling arbitration.

§ 1.8. Scope of Arbitration Agreement

§ 1.8.1. Scope of Arbitration Clauses in Labor and Employment Actions

Cooper v. Ruane Cunniff & Goldfarb Inc., 990 F.3d 173 (2d Cir. (N.Y.) 2021). In employment matters, a claim relates to employment only if the merits of the claim specifically involve facts particular to a plaintiff’s own employment.

An employee brought a putative ERISA class action for breach of fiduciary duty against Ruane, a retirement management company, alleging Ruane mismanaged retirement monies contributed by the employee and his employer. Based on an arbitration provision between the employee and his employer that required the employee to arbitration all claims related to his employment, Ruane moved to compel. The district court granted the motion to compel, finding that the management company was entitled to enforce the arbitration provision under the doctrine of equitable estoppel. Additionally, the district court found that the employee’s claims related to his employment because the claims concerned Ruane’s alleged poor management of the retirement funds, which could be considered the employee’s compensation. On appeal, the Second Circuit reversed holding that the employee’s claims were not related to his employee. Because the court found that the employee’s claims were not encompassed by the arbitration provision in the first instance, the court did not address whether the employee was equitably estopped from contesting Ruane’s ability to enforce the arbitration provision.

In determining that the employee’s claims were not related to his employment, the court made several observations. As an initial matter, the court acknowledged that the FAA reflects a national policy of favoring arbitrations. However, as explained by the court, arbitration can be ordered only where a court is satisfied that parties to an arbitration agreement have agreed to arbitrate the particular dispute. Accordingly, the dispositive issue was whether the employee’s claim for breach of fiduciary duty related to employment. Analyzing the Ninth Circuit’s decision in United States ex rel. Welch v. My Left Foot Children’s Therapy, LLC, 871 F.3d 791 (9th Cir. 2017), the court explained the Welch court found that an employee’s False Claims Act claim was not covered by the phrase “any claims.” More specifically, the Welch court found that the employee’s claims, which were based on her employer’s alleged fraudulent submission of Medicaid claims to the government, were not “related to” her employment for purposes of that dispute. In reaching its conclusion, the Welch court explained that the subject matter of the employee’s FCA claim did not implicate facts particular to that employee’s employment. In addition to the Ninth Circuit’s Welch decision, the Cooper court cited opinions from the Fifth and Eleventh Circuits holding that sexual assaults suffered by employees at employer-provided residential dwellings were not related to the employees’ employment and, therefore, claims regarding the assaults were outside the scope of the respective arbitration agreements.

Similar to the plaintiffs in the aforementioned cases, the Cooper court found that none of the facts relevant to consideration of the merits of the plaintiff’s claims related to his employment. More specifically, the court explained that the employee’s claims principally rested on Ruane’s retirement investment decisions and did not concern the employee’s work performance, evaluations, supervisorial treatment, compensation, workplace conditions, or anything immediately related to the employee’s work experience. Furthermore, as explained by the court, nonemployees, such as other beneficiaries of the retirement plan, plan fiduciaries, and the Secretary of Labor, could have pursued similar claims. Accordingly, finding that the employee’s claims did not relate to his employment because the merits of the claims did not involve facts particular to the employee himself, the court ruled that the claims did not relate to his employment and, therefore, were not subject to arbitration. Accordingly, the court reversed the district court and remanded the case.

Cunningham v. Lyft, Inc., 17 F.4th 244, (1st Cir. (Mass.) 2021). Lyft drivers are not engaged in interstate commerce so as to fall within exemption provided under section 1 of the FAA.

Drivers who used the Lyft application to locate riders brought putative class action against Lyft alleging that Lyft improperly misclassified them as independent contractors instead of employees. Lyft moved to compel arguing that an arbitration agreement contained in the drivers’ terms of service required the plaintiffs to individually arbitrate their claims against Lyft. In response, the drivers contended they were engaged in interstate commerce, thus falling within FAA’s section 1 exemption and, therefore, not bound by the arbitration agreement. More specifically, the drivers contended that they were engaged in interstate commerce because they (1) transported passengers to and from the Logan Airport in Massachusetts for trips to and from other states and countries and (2) some drivers transported customers across state lines. The district court agreed that the drivers were exempt from the FAA and, therefore, denied Lyft’s motion to compel arbitration. The First Circuit reversed.

The First Circuit first discussed the U.S. Supreme Court’s decision in United States v. Yellow Cab Co. and explained that in Yellow Cab, the Supreme Court found that that when local cab drivers merely transferred passengers between their homes and the local railroad station, the drivers were not involved in interstate transportation under the Sherman Act. Instead, a passenger’s interstate journey began when the passenger boarded the train at the station. The First Circuit likened the Lyft drivers’ activities to those of the cab drivers in Yellow Cab and found that if the cab drivers were not affecting interstate commerce under the Sherman Act, then the Lyft drivers were not engaged in interstate commerce when transporting passengers to and from the Logan Airport.

The court then considered the drivers’ contention that they fell within the section 1 exemption because they occasionally transported passengers across state lines. Reviewing uncontested data in the record related to the distances and respective locations traveled by Lyft drivers, the court noted that the question was essentially whether a class of workers qualify for section 1 exemption when many, but not all, of those workers transport passengers across state lines and only for a small percentage of their trips. The court then acknowledged that there was a split between the two circuits that had already considered the issue.

The court explained in Int’l Brotherhood of Teamsters Local Union No. 50 v. Kienstra Precast, Inc., the Seventh Circuit found that cement drivers who traversed interstate for approximately two percent of their trips fell within the section 1 exemption. However, in Capriole v. Uber Technologies, Inc., the Ninth Circuit found that Uber drivers were not engaged in interstate commerce when they transported passengers across state lines only about 2.5% of the time. Agreeing with the 9th Circuit’s rationale, the Cunningham court provided three reasons why the Lyft drivers were not engaged in interstate commerce: (1) not all Lyft drivers transport passengers interstate, (2) the section 1 exclusion must be applied narrowly and Lyft drivers are not primarily devoted to moving goods and people beyond state lines, and (3) Lyft’s primary business is to facilitate local, intrastate trips.

The court, therefore, found that the Lyft drivers were not engaged in interstate commerce and, therefore, the FAA and the respective arbitration agreement governed the drivers’ claims. Accordingly, the First Circuit reversed the district court’s order denying Lyft’s motion to compel.

Capriole v. Uber Technologies, Inc., 7 F.4th 854 (9th Cir. (Ca.) 2021). Uber drivers are not sufficiently involved in interstate commerce to fall within the FAA section 1 exemption.

Drivers with Uber brought a putative class action against Uber alleging Uber failed to properly pay the drivers all compensation that was owed and improperly required the driver to pay certain business expenses. In response, Uber moved to compel based on arbitration provisions that were contained in its agreements with the drivers. The plaintiffs contested arbitration contending that they were engaged in foreign or interstate commerce. The district court disagreed and granted Uber’s motion to compel. The Ninth Circuit affirmed.

The Ninth Circuit first explained that the residual clause contained in section 1 of the FAA which covers workers engaged in foreign or interstate commerce must be interpreted narrowly. Echoing the United States Supreme Court’s decision in Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186 (1974), the Ninth Circuit explained that being “engaged in commerce” for purposes of section 1 exemption, was narrower than “affecting commerce” or “involving commerce.” Accordingly, and in determining whether the exemption applied, the court explained that what mattered most is the “nature of the business for which a class of workers perform their activities,” not the item being transported in interstate commerce or whether the transporters, themselves, cross state lines. Further, according to the court, the residual category of “any other class of workers” contained in Section of the FAA is constrained by the references to “seamen” and “railroad employees,” which immediately precede the text of the residual category. As such, according to the court, the determination of whether Uber drivers are engaged in interstate commerce must be assessed on a national level, instead of a narrower geographic region.

With the aforementioned parameters in mind, the court considered whether Uber drivers were engaged in foreign or interstate commerce. The court rejected the drivers’ contention that because they “sometimes cross[ed] state lines or pick[ed] up and drop[ped] off passengers at airports who [were] heading to (or returning from) interstate travel,” they were engaged in interstate commerce. Comparing the services provided by Uber drivers to those provided by local taxicab drivers, the court explained that Uber drivers are not engaged in interstate commerce because “their work predominantly entails intrastate trips[.]” More specifically, the court explained that only 2.5% of Uber trips between 2015 and 2019 started and ended in different states. Additionally, as explained by the court, only 10.1 of Uber trips taken in 2019 began or ended at an airport. Therefore, according to the court, interstate movement could not be said to be a central part of Uber drivers’ job description and most Uber drivers and riders would concede that Uber trips often are short and local, not involving crossing state lines or trips to transportation hubs.

The court then distinguished Uber drivers from Amazon Flex workers at issue in the court’s 2020 Rittmann v. Amazon.com, Inc. decision. In Rittmann, the court explained that AmFlex workers were engaged in interstate commerce because they “‘complete[d] the delivery of goods that Amazon ship[ped] across state lines and for which Amazon hire[d] AmFlex workers to complete the delivery’ as the last leg of a single, unbroken stream of interstate commerce.” As explained by the Capriole court, Uber drivers generally are “unaffiliated, independent participates in the [a] passenger’s overall trip,” instead of being “an integral part of a single, unbroken stream of commerce[.]”

Accordingly, and in light of the above, the court ultimately concluded that the Uber drivers did not fall within FAA’s interstate commerce exemption and affirmed the district court’s grant of Uber’s motion to compel.

§ 1.8.2. Scope of Arbitration Clauses in other Contracts

Selden v. Airbnb, Inc., 4 F.4th 148 (D.C. Cir. 2021). Race discrimination claims brought pursuant to Title II of the Civil Rights Act of 1964 are arbitrable.

A prospective African American renter who attempted to use Airbnb to rent a room in an occupied home brought suit against Airbnb after the prospective host denied his rent request but allegedly accepted rent requests from purported white individuals who requested the same room on the same dates. More specifically, the plaintiff alleged that Airbnb violated, among other laws, Title II of the Civil Rights Act of 1964, which prohibits race-based discrimination in public accommodations. Because the terms of service of Airbnb contained an arbitration clause, the district court compelled the plaintiff’s claims to arbitration. The claims were eventually arbitrated with the arbitrator ruling in favor of Airbnb.

Thereafter, the plaintiff moved to vacate the arbitrator’s award which was denied by the district court. On appeal, the plaintiff argued, among other things, that the district court erred by ordering arbitration of his discrimination claims, which, according to the plaintiff, were prohibited from being arbitrated pursuant to Title II. The D.C. Circuit disagreed.

The D.C. Circuit first acknowledged that the question of whether Title II claims were arbitrable was a matter of first impression for the court. However, according to the court, there is nothing in Title II which forecloses arbitration. Although Title II states that district courts possess jurisdiction over proceedings brought pursuant to Title II, the court explained that “[a] statutory grant of jurisdiction neither guarantees a right to a federal court trial nor forbids arbitration as an alternate forum.” According to the court, if Congress wanted to prohibit arbitration of Title II claims, it expressly could have done so. Finding that there was no language in Title II overcoming “the FAA requirement to enforcement agreements to arbitrate,” the court ruled that the district court properly compelled arbitration of the plaintiff’s Title II claim.

§ 1.9. Waiver of Arbitration

Forby v. One Technologies, L.P., 13 F.4th 460 (5th Cir. (Tex.) 2021). A waiver of the right to arbitrate claims that are initially presented in a lawsuit does not extend to waiver of additional claims that are asserted in the future.

A consumer brought a class action against One Tech arguing that One Tech deceived consumers by advertising that it provided “free” credit reports while simultaneously charging the consumers for the reports. One Tech moved to arbitrate the consumer’s claims as initially filed but the Fifth Circuit ruled that One Tech waived its right to arbitrate those claims because it had sought to move to dismiss some of the consumer’s claims and did not move to arbitrate until obtaining a ruling on the motion to dismiss. However, after the case was remanded to the district court, the consumer added an additional federal statutory claim against One Tech. Arguing that the additional claim substantially reshaped the consumer’s case, One Tech again moved to compel the consumer’s claims contending that it could not have waived, at least, the additional claim. The district court denied One Tech’s motion explaining that the amended complaint did not alter the consumer’s case in any unforeseeable way. The Fifth Circuit disagreed and reversed.

The Fifth Circuit first explained that there is a strong presumption against waiver. Accordingly, as explained by the court, a party can only invoke the judicial process in a manner sufficient to evidence waiver for “a specific claim it subsequently seeks to arbitrate.” In other words, “waiver of arbitral rights is claim-specific[.]” Instead of litigating the consumer’s additional claim, according to the court, One Tech moved to compel the claim’s arbitration. Finding that One Tech could not have waived the consumer’s additional claim when it moved to dismiss the original claims because the claim had not yet been pleaded, the court ruled that One Tech did not waive its right to arbitrate that claim. Accordingly, the Fifth Circuit reversed the district court and remanded the case.

Health Care Authority for Baptist Health v. Dickson, __ So.3d __, 2021 WL 138859 (Ala. Jan. 15, 2021). A party waives its right to arbitration when it has notice that claims are potentially subject to arbitration but fails to seek discovery of the relevant documentation necessary to determine arbitrability and, instead, actively participates in litigation for two years in court.

Hospital patient in a putative class action brought breach of contract and related claims against a hospital and other defendants contesting the amount of insurance that was reimbursed by an insurer for services received at the hospital. In response, the hospital moved to dismiss the case for the patient’s failure to join the insurer as a party and because of improper venue. Although the hospital’s motion to dismiss was denied, the case was ultimately transferred to another trial court under the forum non conveniens doctrine. The hospital, thereafter, answered the patient’s complaint but failed to assert arbitration as a defense.

Instead, the parties continued to litigate the case in the trial court, including, among other things, requesting the court enter a joint class discovery and certification scheduling order. After the case had been pending for a little over two years, the hospital moved to compel arbitration arguing that the provider agreement between the hospital and the insurer required the patient to submit his claims to arbitration since his insurance policy with the insurer required arbitration. More specifically, the provider agreement between the hospital and the insurer provided for arbitration contingent upon whether there was an arbitration provision in the patient’s insurance policy with the insurer. The hospital argued that it did not learn of the right to arbitrate until it received a copy of the patient’s health insurance policy during discovery, which was only a couple of months prior to moving for arbitration. In response, the patient contended that the hospital waived its right to arbitrate because the hospital substantially invoked the litigation process. The trial court apparently agreed with the patient because it denied the hospital’s arbitration motion, although it did not provide a rationale for doing so. Nonetheless, the Alabama Supreme Court affirmed the denial.

As explained by the Supreme Court, the hospital knew that the provider agreement between it and the insurer contained an arbitration provision even though it was contingent upon the language used in the insurance policy covering the patient. Accordingly, the hospital should have more-diligently and timely sought a copy of the insurance policy so that it could determine where the patient’s claims were subject to arbitration. Instead, according to the Supreme Court, the hospital improperly waited over two years, and after the action had been transferred to another trial court and after class-related discovery had already began, to pursue arbitration. Due to its motions to dismiss or transfer and because of its participated in class-related discovery, the Supreme Court found that the hospital had substantially-invoked the litigation process before moving to compel. Additionally, the Supreme Court found that the patient had been prejudiced due to incurring litigation expenses that would otherwise have been avoided through arbitration. Accordingly, the Supreme Court found that the hospital had waived its right to arbitration and affirmed the denial of the hospital’s motion to compel arbitration.

§ 1.10. Confirmation and Vacatur of Arbitration Awards

Seneca Nation of Indians v. New York, 988 F.3d 618 (2d Cir. (N.Y.) 2021). Arbitration panel did not manifestly disregard the Indian Gaming Regulatory Act (“IGRA”) by requiring the Seneca Nation of Indians to continue making payments to the state of New York under a gambling compact between the Nation and New York after an express initial time period expired.

The Nation and New York entered into a gambling compact wherein the Nation was provided exclusive rights to maintain specified gambling machines in parts of Western New York in exchange for making graduated revenue-sharing payments to New York from the machines. The agreement provided for an initial 14-year term but that term automatically renewed for 7 years, unless one of the parties objected. The agreement also provided that the highest graduated amount, which expressly covered years 8 through 14 of the initial term, that the Nation would be required to pay to New York would be 25% of the monies made on the machines. The agreement did not expressly address the terms of the Nation’s payments to New York after the initial 14-year period ended, despite the agreement’s provision that the term would automatically extend seven years absent objection. Nonetheless, because neither party objected to renewal after the initial 14-year term ended, the agreement renewed for an additional 7 years.

A few months following the renewal, the Nation informed the State of New York that it did not intend to make any additional payments during the 7-year renewal period. In response, New York contended that it was entitled to continued payments at 25%, and the parties ultimately submitted the dispute to arbitration. Two members of a three-member panel ultimately found that the renewal provision was ambiguous and based on consideration of extrinsic evidence, ultimately determined that it would be “commercially unreasonable and against common sense to find that the word ‘renew’ would extend the Nation’s exclusivity without obligating the Nation to provide any continuing consideration to New York.”

Nonetheless, the Nation argued that the panel could not award additional payments because the Secretary of the Interior did not approve additional revenue sharing as purportedly required under the IGRA. The panel majority responded by explaining that it was simply finding that the renewal terms in the agreement, which had already been approved by the Secretary of Interior when the agreement was executed, included revenue sharing obligations – it was not approving “additional” payments. Accordingly, the Panel ordered the Nation to continue making the 25 percent payments during the seven-year renewal term.

The Nation moved to vacate the award in district court, arguing that “the panel majority manifestly disregarded IGRA’s requirement that the Secretary review and approve compact obligations or amendments—in this case, any payments beyond the 14-year term.” The district court affirmed the arbitration award, finding that the panel did not create a new payment obligation. Instead, according to the court, the Secretary had “approved the renewal provision, and the panel simply interpreted that approved provision to require further payments.” Thus, according to the district court, the panel did not manifestly disregard the IGRA. The Second Circuit agreed.

The Second Circuit first noted that although an arbitrator’s manifest disregard of either the law or the terms of an arbitration agreement remains a valid ground for vacatur, as long as the arbitrator provides “even a barely colorable justification for his or her interpretation of the contract,” the arbitration award will be affirmed. The Second Circuit explained that to prove a manifest disregard of law, it must be shown that an arbitrator knew of a relevant legal principle and “willfully flouted the governing law by refusing to apply it.” Considering these principles, the Second Circuit found that the panel did not manifestly disregard the IGRA.

The court explained that the IGRA merely requires the Secretary of Interior’s approval of gaming compacts but not “interpretations of existing contractual terms.” The contested renewal term, as explained by the court, had already been approved by the Secretary when the agreement was made. Accordingly, the parties were not required to again seek approval just because they disputed how the renewal term should be interpreted. Additionally, as explained by the court, the panel’s reliance on extrinsic evidence in interpreting the renewal term did not constitute a transformation of the compact requiring separate IGRA approval. Furthermore, according to the court, even if IGRA’s secretarial approval was required where an arbitrator issued an award based on extrinsic evidence, the requirement was not “well defined, explicit, and clearly applicable” and, therefore, it could not be said that the panel willfully flouted that purported requirement. Therefore, the court ruled that the panel did not manifestly disregard governing law and, as such, affirmed the district court’s denial of the Nation’s request to vacate the arbitration award.

§ 1.10.1. Timing for Moving to Confirm or Vacate

BST Ohio Corp. v. Wolgang, 176 N.E.3d 31 (Ohio 2021). Statutory timeframe for moving to vacate arbitration award does not prevent opposing party from seeking confirmation of the award prior to the end of the timeframe nor does it limit the court’s respective confirmation of the award.

BST initiated an arbitration proceeding against Wolgang arising out of the alleged mismanagement of a property that was jointly owned by BST and Wolgang. The same day the arbitrator issued its ruling, BST moved to confirm the award. In response, Wolgang petitioned to vacate the award in California but did not move to oppose the confirmation application in Ohio. The Ohio trial court eventually scheduled a hearing on the confirmation motion and Wolgang sought a stay of the confirmation hearing contending that under Ohio’s statutory scheme, it had three months to move to vacate, modify, or correct the award. During the hearing, Wolgang reiterated that it had three months to move to vacate the award and that the confirmation proceeding, therefore, was premature. During the hearing, the trial judge informed Wolgang that regardless of the three-month period, it should have filed a response to the application for confirmation. Wolgang failed to do so and approximately two weeks after the hearing (and before the three month period for moving to vacate had ended), the trial court denied Wolgang’s motion to stay and confirmed the arbitration award. Wolgang appealed and the Court of Appeals agreed that the because Wolgang had three months to move to vacate the award, the trial court prematurely confirmed the award. The Supreme Court disagreed.

Reviewing the language of the respective statute, the Court found that the three-month time period to move to vacate was an “upper limit” that could be limited by another party filing a pleading or motion requiring a response. Accordingly, the party opposing confirmation must take action to formally oppose confirmation regardless of the three-month deadline to move to vacate. Otherwise, a court considering a motion to confirm may properly confirm an award. The Supreme Court explained that Wolgang could have simply filed a placeholder motion explaining that it opposed confirmation and would be submitted more substantive briefing in the future. Wolgang, however, failed to do so and at its peril. Accordingly, the Supreme Court reversed the Court of Appeals.

§ 1.11. Waiver Of Appellate Review Of District Court Order Confirming Or Vacating Arbitration Award

Beckley Oncology Assocs., Inc. v. Abumasmah, 993 F.3d 261 (4th Cir. (W. Va.) 2021). Parties to an arbitration agreement may properly agree to waive appellate review of a district court’s order confirming or vacating an arbitration award.

A doctor initiated an arbitration action against a medical health facility arguing the health facility owed him certain incentive payments following his termination from employment. The arbitrator ultimately issued an award in favor of the doctor, and the health facility moved to vacate the arbitration award in federal district court. The district court dismissed the health facility’s complaint and confirmed the award. On appeal to the Fourth Circuit, the doctor argued that the health facility had waived its right to appeal the arbitration award because the respective employment agreement expressly contained a judicial appeal waiver. Recognizing that the validity of an arbitration provision waiving appellate judicial review was a matter of first impression for the Fourth Circuit, the court ultimately ruled that such a waiver was valid under the FAA.

Pointing to the Tenth Circuit’s decision in MACTEC, Inc. v. Gorelick, 427 F.3d 821 (10th Cir. (Col.) 2005), the court stated that the waiver of appellate review of an arbitration decision constituted a compromise wherein parties to an agreement trade the risks associated with contested appellate review for a “one-shot opportunity before the district court.” Furthermore, as explained by the Tenth Circuit, a party’s right to obtain review of a district court’s confirmation or vacation of an arbitration award only exists due to statute and, therefore, a party may waive that right. Lastly, according to the court, “reflexive appeal[s] of arbitration awards seem[] to be an increasingly common course, leading to arbitration no longer being treated as an alternative to litigation, but as its precursor.” Accordingly, the court dismissed the appeal finding that the parties had properly waived appellate review of the district court’s decision.

The rights and protections available to directors of corporations and managers of limited liability companies (LLCs) against liability, including rights to advancement of expenses, indemnification, exculpation, and D&O insurance, operate within a broader framework. That framework requires reference to the precise terms of the organizational documents of the company they serve and any additional contractual rights or benefits those directors and managers obtain by or through the company. In the context of private equity and venture capital backed companies, the rights and protections afforded to directors or managers must also be considered in light of any rights and protection given by the private equity or venture capital fund (or an entity affiliated with the fund) to directors or managers designated by the private equity or venture capital fund.

This outline addresses the rights and protections available to directors of Delaware corporations and managers of Delaware LLCs. While we recognize that differences in the laws of the jurisdiction of incorporation or formation of a particular fund or any particular portfolio company may affect the drafting of provisions establishing the rights and protections of directors or managers, or the availability of such rights and protections, the principles of Delaware law discussed herein are useful for illustrating the issues directors and managers of private equity and venture capital backed entities (and the sponsors) should consider. This outline does not expressly address the rights of officers, employees, or other agents of corporations or LLCs, although we note that many of the basic concepts set forth herein with respect to the contractual protections that may be afforded to directors and managers are also applicable to such other parties.

Under Delaware law, there are multiple layers of structural protection for directors of corporations and managers of LLCs against liability, including rights to advancement of expenses, exculpation, and indemnification. In addition, corporations and LLCs are entitled to purchase and maintain D&O insurance to protect directors and managers. All such protections operate within a system and must be considered together. Moreover, the specific language used to establish rights and protections must be consulted to determine the specific availability of rights and protections. Private equity and venture capital funds frequently want to ensure that the directors or managers that they appoint to a portfolio company receive a robust set of rights and protections from that portfolio company—and that the portfolio company is the so-called “indemnitor of first resort,” with no rights to seek contribution from the fund.

Exculpation

Section 102(b)(7) of the Delaware General Corporation Law (“DGCL”) permits a corporation to include in its certificate of incorporation a provision eliminating personal monetary liability for a director’s breach of fiduciary duties except (1) breaches of the duty of loyalty, (2) acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law, (3) transactions where a director derives an improper personal benefit, and (4) illegal dividends or stock repurchases. In general, the existence of an exculpatory provision contemplated by Section 102(b)(7) that is applicable to the maximum extent permitted by law will result in the dismissal of a claim for monetary damages based solely on a breach of the duty of care. No exculpatory provision, however, will operate to prevent an injunction for breach of the duty of care, nor will it result in a dismissal of claims where the plaintiff has adequately pled a breach of the duty of loyalty or bad faith (or any other non-exculpable conduct).

Section 18-1101(e) of the Delaware Limited Liability Company Act (“LLC Act”) provides that a limited liability company agreement may provide for the limitation or elimination of any and all liabilities for breach of contract and breach of duties (including fiduciary duties) of a manager to the company or to another member or manager or to another person that is a party to or is otherwise bound by the agreement. However, a limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing. Unlike the DGCL, which only allows for exculpation of directors against monetary damages to the corporation or its stockholders for a breach of the duty of care, the LLC Act allows the limited liability company agreement to provide broad rights to exculpation, subject only to the bad faith violations of the implied contractual covenant of good faith and fair dealing. Although the LLC Act provides for broad exculpation of managers, many limited liability company agreements will contain exceptions and qualifications on rights to exculpation, including standard of conduct or other requirements or conditions. Parties should take care in reviewing these exceptions and qualifications, specifically those relating to “gross negligence” (which is the standard for assessing a breach of the duty of care).

Indemnification

The DGCL contains three principal subsections dealing with indemnification of directors. Section 145(a) of the DGCL empowers a corporation to indemnify its directors against expenses, judgments, fines, and amounts paid in settlement incurred in connection with actions other than those brought by or in the right of the corporation, subject to a determination that the indemnitee has met the requisite standard of conduct. Section 145(b) empowers a corporation to indemnify its directors against expenses incurred in connection with the defense or settlement of an action brought by or in the right of the corporation, subject to the standard of conduct determination, and except that no indemnification may be made as to any claim to which the person has been adjudged liable unless the court determines such person is fairly entitled to indemnification. Section 145(c)(1) provides that to the extent a director has been successful on the merits or otherwise in defense of any action, suit, or proceeding referenced in Section 145(a) or Section 145(b), the director shall be indemnified against expenses actually and reasonably incurred by the director in connection therewith.

Under Section 145(f) of the DGCL, the rights to indemnification under Section 145(a) and Section 145(b) may be made mandatory through the certificate of incorporation, bylaws, resolution, or other agreement. The use of the words “shall indemnify” or “must indemnify” generally provides mandatory rights, while the use of the words “may indemnify” or “shall have the power to indemnify” generally connotes permissive rights. The specific language used will be critically important in determining the protection available to a director.

Nevertheless, even if rights are made mandatory, except where Section 145(c) obligates the corporation to indemnify the director against expenses, there must be a determination that the director met the standard of conduct necessary to obtain rights to indemnification. That determination must be made, with respect to a current director, by one of: a majority of the directors not party to the proceeding, a committee of such directors, independent counsel, or the stockholders. Private equity and venture capital funds may consider negotiating for the right for their director designees to have such determination made by independent counsel.

In considering rights to indemnification, it is important to highlight that the protection afforded under Section 145(b), which relates to indemnification for claims brought by or in the right of the corporation, including derivative claims, only provides protections against expenses—but not judgments or amounts paid in settlement. Due to the corporation’s lack of power to indemnify against such potential liabilities, corporations frequently seek insurance to provide coverage against such claims. Section 145(g) of the DGCL permits corporations to purchase and maintain insurance to protect directors against all manner of liabilities, whether or not the corporation would be permitted to indemnify the director.

Section 18-108 of the LLC Act provides that a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other person from and against any and all claims and demands whatsoever. Unlike the DGCL, the LLC Act does not contain any specific limitations on the availability of indemnification, such as the standard of conduct requirements in Sections 145(a) and 145(b) or any of the limitations on the type of liabilities for which indemnification is available under Section 145(b). Conversely, the LLC Act does not include any supervening rights to indemnification; thus, managers will not have any rights to indemnification unless (and only to the extent) they are provided by contract.

Advancement

Section 145(e) of the DGCL provides that expenses incurred by a current director of the corporation in defending a proceeding may be paid by the corporation in advance of the final disposition of the proceeding upon receipt of an undertaking by such person to repay the advanced amounts if it is determined that the person is not entitled to be indemnified. As with rights to indemnification, rights to advancement may be made mandatory pursuant to Section 145(f). Again, the specific language used to create the mandatory rights will be critical in determining the availability of rights. The use of the words “shall advance” will generally be construed to create mandatory rights, while the use of “may advance” or “shall have the power to advance” will generally be construed as permissive rather than compulsory.

Section 145(e) provides that such expenses incurred by a former director may be paid in advance upon such terms as the corporation deems appropriate. Section 145(e), by its terms, relates to the expenses a director incurs in defending a proceeding. Thus, where rights to advancement merely make mandatory the permissive advancement rights set forth in Section 145(e), a director generally will not be entitled to require the corporation to advance their expenses incurred in connection with affirmative actions brought by the director, subject to limited exceptions, such as affirmative defenses and compulsory counterclaims.

The basic philosophy behind advancement is that the corporation should pay the expenses incurred by its directors as those expenses are incurred to enable the directors to mount a defense against claims and to vindicate their actions. For that reason, it is often advisable to ensure that rights to advancement are not made subject to any conditions or other requirements other than the requirement, imposed under Section 145(e), that current directors must provide an undertaking to repay any amounts advanced if it is ultimately determined that they are not entitled to indemnification.

The Delaware courts have held that rights to indemnification and advancement are distinct rights that must be separately provided. Thus, a provision providing that the corporation shall “indemnify and hold harmless” directors, of itself, will not be sufficient to give directors separate rights to advancement of expenses. Each of the rights must be separately identified and made mandatory in order to ensure that directors have the protection of both layers.

Although Section 18-108 of the LLC Act does not expressly reference “advancement,” the Delaware courts have made clear that they defer completely to the contracting parties to create and delimit rights and obligations with respect to indemnification and advancement. The LLC Act does not include express restrictions or requirements on advancement rights (such as undertakings to repay amounts advanced). Again, LLCs are contractual in nature. Rights to advancement will not be assumed or implied unless they (and only to the extent) they are expressly provided by contract (i.e., the limited liability company agreement).

Indemnitor of First Resort

Private equity and venture capital funds often seek to ensure that the portfolio companies to which they designate directors include rights to indemnification and advancement of expenses via so-called “indemnitor of first resort” provisions in the companies’ governing documents or other agreements. These provisions are designed to ensure, among other things, that a private equity or venture capital fund that has its own obligation to indemnify or advance expenses of the persons whom it designates to the governing body is not subject to contribution in the event the corporation makes the payments.

These provisions generally require the portfolio company to expressly acknowledge that the director has rights of indemnification, advancement, and insurance from the sponsor; to agree that it is the indemnitor of first resort and that it is obligated to advance all expenses and indemnify for all judgments, penalties, fines, and amounts paid in settlement; and to waive any claims against the sponsor for contribution or subrogation. Where indemnitor of first resort provisions are included in portfolio company governing documents or other agreements, the private equity or venture capital fund should be made an express third-party beneficiary of the provision.

D&O Insurance

There are multiple issues that arise in connection with the purchase and maintenance of D&O insurance, and there are different types of insurance available.

In general, “Side-A” coverage insures individual executives of the company and provides for the advancement of defense costs where executives are not indemnified by the insured company. Side A coverages provides personal asset protection; it responds when the company is unable to indemnify the director (legally or financially). There are no retention amounts.

“Side-B” coverage pays for losses incurred by the insured company in indemnifying individual executives for claims against those executives. It provides balance sheet protection to the company and responds when the company has satisfied its policy retention for indemnifiable loss against individuals.

“Side-C” coverage provides “Entity Coverage.” It pays for “Losses” incurred by the company arising from claims against the company itself. For public companies, it usually for covers “securities claims” only. Side C coverage provides balance sheet protection for claims against the company and generally responds when the company is named in a securities claim.

In assessing D&O coverage, parties should consider various issues, if for no other reason than to set expectations. Major issues include resolving conflicts between the company and individuals if the company has the sole right to notice a claim or circumstance; whether individuals can recover “fees-on-fees” if they must sue the insurance company under the policy; whether individual insureds can obtain a copy of the policy when they need one; and the impact of “related” and “interrelated claims” provisions.

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

At the ABA Business Law Section’s 2022 spring meeting in Atlanta, the M&A Committee presented a CLE panel discussing case law regarding drafting MAE, indemnification, fraud carve-outs, and other miscellaneous provisions. That CLE panel, which included insightful commentary by Chief Justice Collins J. Seitz, Jr. of the Delaware Supreme Court, is available to view as on-demand CLE, free for Section members. Below is a summary of the decisions and topics discussed.

(i) MAE, Ordinary Course, and other Lessons learned from COVID Litigation

COVID-19 has exposed certain structural vulnerabilities in M&A agreements that can be exploited when there is an unexpected event, namely: the Material Adverse Effect definition, the “ordinary course” covenant, and the covenant bring-down condition. Deal points data from 2019–2021 showed Buyers’ and Sellers’ response to such vulnerabilities:

• MAE Definition. Two pro-Buyer developments: Rather than adhering to the standard single-prong definition (i.e., an MAE on the business, subject to carve-outs), there is an increased prominence of the dual prong definition (i.e., that an MAE also includes the ability to consummate/perform the transaction). Second, the “disproportionate effect” override continues (in most instances) to be tied to the industry within which the company operates rather than similar companies within that industry. One pro-Seller development: the exclusions to the MAE definition are more often expressed in relational terms that permit an expansive reading of the exclusions’ scope (i.e., language such as “arising under, resulting from or relating thereto” that does not require a direct causal link).
• “Ordinary Course” Covenant. One pro-Seller development: Early deal data from 2021 suggest that Sellers have become increasingly successful in negotiating an “efforts” based standard. Nevertheless, a majority of deals continue to impose an absolute obligation on the target to operate in the ordinary course of business, and those that do contain such a flat covenant are also likely to retain a “consistent with past practice” requirement.
• Closing Condition. The covenant bring-down condition continues to be tied to a Buyer-friendly “in all material respects” standard of materiality rather than the MAE standard.

There was a string of COVID “broken deal” cases brought in 2020 in the Delaware courts, with the first decided in the Delaware Court of Chancery on April 30, 2021.^[1] In December of 2021, the Delaware Supreme Court decided its first COVID “broken deal” case on appeal: AB Stable VIII LLC v. Maps Hotels and Resorts One LLC.^[2] AB Stable offered the following interpretative points regarding these three areas of structural vulnerability:

• MAE Definition. The exceptions to the definition of MAE do not need to refer to the root cause of the adverse development to be effective. In other words, there is no requirement that the definition reference “COVID” or a “pandemic” if the effect of the pandemic was itself described by the exception.
• “Ordinary Course” Covenant. “Ordinary course” means to operate in accordance with how a business has routinely conducted its business in normal circumstances, not how it or others in its industry operated in the pandemic. “Consistent with past practice” looks only at how such seller operated the business in the past. And a “reasonableness” standard is not implicit in the “ordinary course” obligation.
• Closing Condition. The MAE closing condition does not bleed into the covenant bring-down condition’s “in all material respects” standard. The court made it clear that the two provisions serve different purposes: (i) the MAE closing condition allocates the risk of changes in a target’s valuation, and (ii) the “ordinary course” covenant reassures a buyer that the target has not materially changed its business or practices during the pendency of the transaction. The “in all material respects” covenant bring-down condition does not require a showing equivalent to an MAE or even a showing equivalent to the common law doctrine of material breach, but rather only that a deviation occurred that significantly altered the total mix of information available to Buyer when viewed in the context of the parties’ contract, resulting in a meaningful change from Buyer’s reasonable expectations about how the business would be operated between signing and closing.

One can expect that the structural vulnerabilities discussed above will become the subject of further attention in M&A agreements as the parties seek to address their impact on closing certainty.

(ii) Indemnification, Fraud, and Reliance Lessons

The dense, highly negotiated agreements used in mergers or acquisitions often require courts to decide which party better interprets technical provisions concerning their indemnification obligations or rights, and the ability of parties to assert fraud claims. The variations of nonreliance, integration, exclusive remedies, and indemnification clauses, and the way the clauses interact with each other and the public policies underlying fraud claims, lead to a seemingly endless variety of interpretation questions. Together the decisions guide sellers and buyers as to how to limit (or preserve) their indemnification obligations (or rights) and exposure to (or ability to assert) fraud claims.

Concerning fraud claims, the Delaware Court of Chancery decision in Online Healthnow, Inc. and Bertelsmann, Inc., v. CIP OCL Investments, LLC et al.,^[3] analyzed how sellers can contractually seek to modify their exposure to post-closing fraud claims. Vice Chancellor Slights noted that they can do so in four ways: “(1) ‘what’ information the buyer is relying on, (2) ‘when’ the buyer may bring a claim, (3) ‘who’ among the sellers may be held liable, and (4) ‘how much’ the buyer may recover if it proves its claim.”^[4] The Vice Chancellor relied on what he described as the seminal decision in this area, Abry Partners V., L.P. v. F&W Acquisition LLC,^[5] to answer the “what” and “how much” questions, reiterating that parties may contractually disclaim reliance on extra-contractual statements, but may not contractually limit their liability for knowingly making false statements within the contract itself given Delaware’s “distaste for immunizing fraud.”^[6]

Vice Chancellor Slights then focused on the “when” and “who” questions in the case, analyzing an agreement that contained “remarkably robust survival, anti-reliance and non-recourse provisions that appear to atomize Plaintiffs’ claims across all of the recognized planes of contractual limitations.”^[7] Abry and its progeny make clear that “contractual limitations on liability are effective when used in measured doses,” but it would be “too much dynamite” to “invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.”^[8] That meant the survival provision could not cut off a claim for contractual fraud, and the non-recourse provision could not insulate a third party from liability if that party knew of and facilitated the fraudulent misrepresentations made in the acquisition agreement.^[9] On the specifics alleged, the plaintiff in Online Healthnow had adequately pled the parties knew of and facilitated the fraudulent misrepresentations through their participation in the sale process and drafting of the agreement.^[10]

Regarding indemnification and reliance cases, the number of cases discussing these points is such that a full discussion is beyond the scope of the CLE presentation or this summary. A number of those cases were thus discussed briefly,^[11] before using the recent Chancery decision in Spay Inc. v. Stack Media Inc.,^[12] as a case study. There, the court largely denied a motion to dismiss because the purchase agreement did not bar the asserted claims. First, the court determined that the limitation on survival applicable to non-fundamental representations and warranties did not by its terms apply to covenants.^[13] Because the purchase agreement failed to specify a survival period applicable to covenants, the covenants survived until expiration of the applicable statute of limitations.^[14] Further, the survival period applicable to non-fundamental representations and warranties was not applicable where the claim for breach was based on fraud (which was not defined in the agreement).^[15] The exclusive remedy provision specifically stated that such fraud was not exclusively governed by the indemnification regime in the purchase agreement, meaning claims for breaches based on such fraud could still be brought after expiration of the contractual survival period.^[16] The court did not address, but referenced in dicta that the survival period for representations may not apply to the closing certificate unless expressly stated.^[17]

(iii) Beware the Boilerplate

Sample, model, or previously used agreements commonly serve as the starting point for drafting transactional documents. Using those provisions and treating them as boilerplate that does not require customization, however, may result in outcomes not considered by the parties. Recent decisions construing boilerplate provisions, and particularly those relating to governing law, exclusive forum, and jury trial waivers, should make practitioners consider whether to modify those provisions to better reflect the interests of their clients.

As Professor John Coyle of the University of North Carolina School of Law has observed, there is a secret language of choice-of-law and forum selection clauses.^[18] As a result, to ensure that the law chosen by the parties applies to not only resolution of any interpretive questions arising under the contract (i.e., ambiguities) but also determination of their substantive rights and obligations, parties should expressly state that the contract shall be “governed” (as opposed to interpreted or construed) by the laws of the specified jurisdiction.^[19] Similarly, if the parties’ intent is to have the specified “governing” law apply not just to contract claims but also to tort or statutory claims relating to the contract, then many jurisdictions (among them New York^[20]) require that they expressly say so; inclusion of the phrase “and claims relating to this agreement” should eliminate any doubt as to the parties’ intent (most courts view “arising out of” as too narrow in scope). And a majority of U.S. courts (New York and Delaware—but not California—among them) distinguish between substantive law and procedural law when interpreting choice of law provisions. Since statutes of limitation are generally considered procedural in nature, a clause that provides the contract is to be governed by the law of a specified state, without more, runs the risk of selecting only such state’s substantive, not its procedural, law, resulting in the statutes of limitation of the forum jurisdiction, not those of the specified governing jurisdiction, being applied.^[21] To avoid that result, parties’ governing law provision should contain the phrase “including those laws applicable to statute of limitations.”

Finally, a word or two about exclusive forum selection clauses. What if the parties desire all claims relating to an agreement to be litigated exclusively in a specified jurisdiction? Would the following accomplish that goal: “The sole and exclusive jurisdiction for any litigation for enforcement of this Agreement shall be in the courts of [X]”? The answer is no—“enforcement” merely applies to the obligations set forth in the contract.^[22] As is true with respect to governing law, if parties want to ensure that all claims are adjudicated in a specific jurisdiction, they should replace “litigation for enforcement” with “litigation related to this Agreement.” And parties need to recognize that courts will refuse to enforce forum selection clauses if they believe the chosen forum would not apply a constitutional or statutory right, or the benefit of a fundamental public policy to which a party is entitled.^[23]

1. Snow Phipps Group, LLC v. KCake Acquisition, Inc., 2021 WL 1714202 (Del. Ch. Apr. 30, 2021) (Agreement signed March 6, 2020). ↑

2. 2021 WL 5832875 (Del. Dec. 8, 2021). ↑

3. 2021 WL 3557857 (Del. Ch. Aug. 12, 2021). ↑

4. 2021 WL 3557857 at *1. ↑

5. 891 A.2d 1032 (Del. Ch. 2006). ↑

6. 891 A.2d at 1061. The Delaware Supreme Court last year blessed this balancing of interests. Express Scripts v. Bracket Holdings Corp., 248 A.3d 824, 830-32 (Del. Feb 23, 2021). ↑

7. 2021 WL 3557857 at *1. ↑

8. Id. at *1 and *18. ↑

9. Id. at *20. ↑

10. Id. ↑

11. See, e.g., Fortis v. Johnson & Johnson, 2021 WL 4314115 (Del. Ch. Dec. 13, 2021) (unambiguous non-reliance provision is required to preclude extracontractual claims against a buyer based on factual misrepresentations); Sofregren v. Allergan, 2021 WL 1400071 (Del. Super. Apr. 1, 2021) (concluding omissions were not disclaimed in non-reliance clause); Infomedia Group, Inc. v. Orange Health Solutions, Inc., 2020 WL 4384087 (Del. Super. July 31, 2020) (concluding there is no distinction between omissions and concealment for purposes of non-reliance clause); Flowshare, LLC v. GeoResults, Inc., 2018 WL 3599810 (Del. Super. July 25, 2018) (standard integration clause by itself did not disclaim reliance). ↑

12. 2021 WL 6053869 (Del. Ch. Dec. 21, 2021). ↑

13. 2021 WL 6053869, at *5-6. ↑

14. Which of course would not begin to run until the covenant in question was actually breached. ↑

15. Id. at *6-7. ↑

16. Id. ↑

17. Id. at *6, n. 56. ↑

18. The following discussion draws heavily from Professor Coyle’s scholarship, and in particular “The Canons of Construction of Choice-of-Law Clauses,” 92 Wash. L. Rev. 631 (2017). ↑

19. While most courts view the terms as functionally equivalent, not so the Second Circuit. Arnone v. Aetna, 860 F.3d 97 (2d. Cir. 2017). (“The choice of law provision, in stating that the [contract] will be ‘construed’ in accordance with Connecticut law, sets forth only which jurisdiction’s law of contract interpretation and contract construction will be applied. In the context presented here, that provision is insufficient to bind this court to apply the full breadth of Connecticut law, to the exclusion of another jurisdiction’s law, in fields other than interpretation of the language in this contract.”) ↑

20. See, e.g., Knierieman v. Bache Halsey Stuart Shields, 427 N.Y.S.2d 423 (1980). ↑

21. See, e.g., Pivotal Payments Direct Corp. v. Planet Payment, Inc., 2015 WL 11120934 (Del. Super. Ct. January 4, 2016) (claims brought in Delaware court for breach of contract with a New York choice of law ended up having Delaware’s three-year rather than New York’s six-year statute of limitation apply). ↑

22. See, e.g., S-Fer Int’l, Inc. v. Paladian Partners, Ltd., 906 F. Supp. 211, 2134 (S.D.N.Y. 1995). ↑

23. Some states, like California, have a strong public policy prohibiting pre-trial waiver of jury trials; see West v. Access Control Related Enterprises, LLC, C.A. No. N17C-11-137 (Del. Super. Ct. Jan. 26, 2021) (California’s is rooted both in Constitution and statute). When the exclusive forum results in the litigation being permissible only in Delaware’s Court of Chancery, which does not provide for jury trials, or in New York state court where the practical effect would likely be validation of the pre-trial waiver, California courts have declined to enforce the forum selection clause and have permitted the matter to be litigated in California instead. Handoush v. Lease Finance Group, 254 Cal. Rptr 3d 461 (Ct. App. 2019) (New York forum selection); West v. Access Control Related Enterprises LLC, Superior Court of California, L.A. County BC642062 (July 29, 2020) (Delaware forum selection). ↑

Much has been written about authenticity in the fields of business and leadership, but by comparison, not so much in the legal field. Yet, for all the reasons authenticity is discussed in those fields, it is equally central to the practice of law. It fosters relationships, encourages collaboration, builds trust, and differentiates you from others.

Research shows that when we cater to others and hide who we are, it is cognitively and emotionally draining, which can undermine performance. And when we don’t know the preferences and expectations of our audience, we are more anxious, which also can hurt performance.^[1] When I started to think about how to bring authenticity to my practice, I thought of preparation for trial and, in particular, Federal Rule of Evidence 901—Authenticating or Identifying Evidence. The essence of the rule is in the first part: to authenticate an item of evidence, the proponent must produce evidence sufficient to support a finding that the item is what the proponent claims it is. What does that mean when it is applied to a person? At a basic level, I think of it as demonstrating that you are who you are. That’s not to say that “authenticity” should be an excuse to do only what is comfortable or to be completely unfiltered in any professional setting. Just as I would think through carefully what documents or testimony I would use or elicit to meet the standard under Rule 901, I also have to think through what personal qualities I have that would make me a better lawyer. Here, I identify four ways to bring authenticity to the practice of law.

Start with Being Self-Aware

Having a better understanding of yourself helps to create more relevant and motivating goals. If this were a trial, I would begin with a list of issues that need to be proven in order to prevail. Start making that list. What are the top five priorities for you professionally and personally? What are your personality traits? Keep in mind that we all have multiple versions of ourselves that show up depending on the context. Just as knowing your case inside and out is an important step toward success for a client, knowing yourself is equally important. If you are concerned that you have blinders on, then solicit feedback from colleagues and family members as you would from mock jurors. Others’ perception of you is an equally important part of the picture.

Effective Vulnerability Can Build Trust

By being vulnerable at the right time in the right situation, you can build trust and strengthen connections. Once, during jury selection for a case pending in the federal court in Connecticut, I watched a trial attorney from Texas ask—in a thick “Texan” drawl—whether potential jurors would give his client a fair chance and not be biased against the trial team’s “Texas-ness.” His delivery of his difference and vulnerability was very effective in turning around a potential distraction.

Humans are hard-wired to read each other’s expressions. Research shows that observing someone who is injured will trigger the brain’s “pain matrix.”^[2] Similarly, observing someone who is suppressing their feelings triggers physiological reaction in the observer.^[3] Research also shows that we are particularly sensitive to signs of trustworthiness.^[4] Finding the right context and the right method of delivery is not easy, but accepting the idea that vulnerability leads to trust and being curious about what context and method of delivery may be effective is a good first step.

Identify Values for Your Team

Throughout a trial, key pieces of evidence need to be made clear to the jury. Those key pieces of evidence are based on a thorough understanding of the facts and the law. The same applies to identifying and communicating core values to a team. Having a diverse team means thoughtfully addressing the challenges of working with people of different backgrounds. In fact, a study using fMRI to observe adults randomly assigned to two groups, one “leopards” and the other “tigers,” showed that even randomly assigned groups displayed in-group biases.^[5] If we are hardwired to pick up on differences, then shared values can act as a unifying thread that anchors a team toward a common goal.

Practice Active Listening

During trial, it is important to listen carefully to testimony. On cross-examination, the testimony may not be the same as the testimony obtained in a deposition, so unexpected answers may be potential areas for impeachment or further exploration. And on direct examination, the testimony may not be the same as you had prepared the witness to deliver, so unexpected answers may need to be remedied. Outside of trial, active listening is equally important but often difficult to do. Most people fall into four listening styles: (1) the analytical listener who aims to analyze a problem from a neutral starting point; (2) the relational listener who aims to build connection and understand the emotions underlying a message; (3) the critical listener who aims to judge the content of the conversation and reliability of the speaker; and (4) the task-focused listener who shapes a conversation towards efficient transfer of important information.^[6] Each style is effective, and developing the ability to shift between different styles can help improve listening and achieve conversational goals.

Properly authenticating documents during trial is a learned process that pays off in better results the more you practice. The same can be said for practicing authenticity in work and in life.

1. Gino, Francesca, Research: It Pays to Be Yourself, Harvard Business Review, Feb. 13, 2020. ↑

2. Lamm C, Nusbaum HC, Meltzoff AN, Decety J (2007) What Are You Feeling? Using Functional Magnetic Resonance Imaging to Assess the Modulation of Sensory and Affective Responses during Empathy for Pain. PLOS ONE 2(12): e1292. https://doi.org/10.1371/journal.pone.0001292. ↑

3. Id. ↑

4. Dirks, KT, and Ferrin, DL (2002) Trust in leadership: Meta-analytic findings and implications for research and practice. Journal of Applied Psychology 87(4): 611–628. https://doi.org/10.1037/0021-9010.87.4.611. ↑

5. Van Bavel, JJ, Packer, DJ, Cunningham, WA (2008) The Neural Substrates of In-Group Bias. Phycological Science 19(11): 1131–1139. https://vanbavellab.hosting.nyu.edu/documents/VanBavel.etal.2008.PS.Ingroup%20bias.pdf. ↑

6. Minehart, Rebecca D., Symon, Benjamin B. & Rock, Laura K., What’s Your Listening Style?, Harvard Business Review, May 31, 2022. ↑

Public companies in a number of sectors have recently experienced a significant decline in their share prices. In addition, the conflict in Ukraine and macroeconomic factors continue to impact the economy. Nevertheless, the labor market remains tight, and companies are struggling to retain talent. This goal can be undermined when stock options awarded during better times are “underwater” and have therefore lost much of their incentive value. Pressure can quickly mount on boards and management to address this mismatch by “repricing” such underwater options.

This is not the first time that a large number of public companies have faced this challenge. The need to conduct repricings occurs during prolonged downturns or sector realignments. There were a total of 264 stock option repricings announced between 2004 and 2009.^[1] This included high-profile companies, such as Alphabet (then Google), Intel, Starbucks, and Williams Sonoma.^[2] Since that time, generally favorable market conditions have made repricings less common, with only a handful occurring each year. It is therefore of particular importance that companies facing this challenge understand the lessons and practices from earlier waves of repricings.

1. Structuring Repricings

1.1. One-for-One Exchanges

Option repricings were traditionally effected by the relatively simple mechanic of lowering the exercise price of underwater options to the then-prevailing market price of a company’s common stock. This was achieved either by amending the terms of the outstanding options or by canceling the outstanding options and issuing replacement options. The majority of repricings that occurred during the 2001 and 2002 market downturn were one-for-one option exchanges. At that time, the majority of new options had the same vesting schedule as the canceled options, and only a minority of companies excluded directors and officers from repricings.

Two developments have made one-for-one option exchanges and inclusion of directors and officers the exception rather than the norm:

• In 2003, the New York Stock Exchange (“NYSE”) and the Nasdaq Stock Market (“Nasdaq”) adopted a requirement that public companies seek shareholder approval of option repricings absent express permissive language in the relevant plan. As a result, a large number of companies faced the need to ask (often unhappy) shareholders to provide employees with a benefit that the shareholders themselves would not enjoy. Since that time, the influence exerted by proxy advisors—ISS and Glass Lewis in particular—and large institutional shareholders on the outcome of repricing votes has made it difficult for companies to receive shareholder approval of one-for-one option exchanges due to the perceived unfairness to shareholders.
• Stock option grants were not accounted for as an expense on a company’s income statement until the adoption of Financial Accounting Standards Board Accounting Standards Codification Topic 718 (“ASC 718”) and its predecessor (Statement of Financial Accounting Standards No. 123(R)) in 2005. As a result, there was a limited accounting impact from a significant grant of replacement stock options if a company waited six months and one day from the prior grant, giving stock options a distinct advantage over other forms of equity compensation. ASC 718 now requires the expensing of employee stock options over the implied service term (the vesting period of the options). As a result, the accounting cost of a one-for-one option exchange can be very significant.

1.2. Value-for-Value Exchanges

Companies seeking to reprice their options now generally undertake a “value-for-value” exchange. A value-for-value exchange affords option holders the opportunity to cancel underwater options in exchange for an immediate re-grant of new options at a ratio of less than one-for-one with an exercise price equal to the market price of such shares.

Value-for-value exchanges are more acceptable to shareholders compared to one-for-one exchanges and are a prerequisite for proxy advisor support. A value-for-value exchange results in less dilution to public shareholders than a one-for-one exchange because it allows the reallocation of a smaller amount of equity to employees, which shareholders generally perceive as being fairer under the circumstances. In addition, the accounting implications of a value-for-value exchange are significantly more favorable than a one-for-one exchange. Under ASC 718, the accounting cost of new options (amortized over their vesting period) is the fair value of those grants less the current fair value of the canceled (underwater) options.

As a result, companies generally structure an option exchange so that the value of the new options for accounting purposes—based on Black-Scholes or another option pricing methodology—approximates or is less than the value of the canceled options, thereby making it “value-neutral.” If the fair value of the new options exceeds the fair value of the canceled options, that incremental value is recognized as an expense over the remaining service period of the option.

1.3. Use of Restricted Stock or RSUs

A common variation of the value-for-value exchange is the cancellation of all options and the grant of restricted stock or restricted stock units (“RSUs”) with the same or a lower economic value than the options canceled. Restricted stock is stock that is subject to a substantial risk of forfeiture at grant but vests upon the occurrence of continued employment. Restricted stock is nontransferable while it is forfeitable. RSUs are economically similar to restricted stock but involve the promise to issue the shares or an equivalent cash value at a time that is concurrent with or after vesting.

The US tax rules applicable to restricted stock are different from those applicable to RSUs. Although the taxation of restricted stock is generally postponed until the stock becomes vested (with the grantee treated as receiving ordinary income equal to the fair market value of the underlying stock on the vesting date), the grantee of restricted stock may elect to be taxed in the year of grant rather than waiting until vesting. If this election is made pursuant to Section 83(b) of the Internal Revenue Code (the “Code”), the grantee is treated as receiving ordinary income equal to the fair market value of the underlying stock on the date of the grant, rather than on the date of vesting. Future appreciation is taxed as capital gain (rather than as ordinary income) when the grantee disposes of the shares after vesting. There is no ability to make Section 83(b) elections with respect to the grant of RSUs, which are taxed upon delivery of the shares following vesting of the RSUs. Outside the United States, many companies grant RSUs to their non-US employees because RSUs generally permit deferral of taxation until delivery of the shares of stock underlying the RSU, whereas there may be different tax consequences for restricted stock in a non-US jurisdiction upon grant.

One benefit of both restricted stock and RSUs is that such awards ordinarily have no purchase or exercise price and provide immediate value to the grantee. Consequently, the exchange ratio will generally result in less dilution to existing stockholders than an option-for-option exchange. In addition, at a time when institutional investors and proxy advisors may advocate greater use of restricted stock and RSUs, usually with performance vesting conditions for executives, either alone or together with stock options and stock appreciation rights (“SARs”),^[3] such an exchange can be part of a shift in the overall compensation policy of a company. Finally, because restricted stock and RSUs ordinarily have no exercise price, there is no risk that they will subsequently go underwater if there is a further drop in a company’s stock price. This is an important consideration in a volatile market.

Income which certain officers recognize from the new restricted stock and RSU grants will be subject to the annual deduction limit of Section 162(m) of the Code, to the extent applicable. Section 162(m), in general terms, limits to US $1 million per year the deductibility of compensation to a public corporation’s CEO, CFO, and the next top three highest-compensated officers who served at any time during the corporation’s taxable year, as well as employees who were subject to Section 162(m) in a tax year beginning after 2016.^[4]

1.4. Repurchase of Underwater Options for Cash

Instead of an exchange, a company may simply repurchase underwater options from employees for an amount based on Black-Scholes or another option pricing methodology. The repurchase of underwater options generally involves a cash outlay by the company, the amount of which will vary based on the extent to which the shares are underwater and the extent to which such repurchase is limited to fully vested options. Such a repurchase would reduce the number of options outstanding as a percentage of the total number of common shares outstanding (referred to as the “overhang”), which is generally beneficial to a company’s capital structure. If a company repurchases its underwater options for cash rather than replacing them with other equity awards, the company will also need to consider how to provide future retention value to the employees.

1.5. Treatment of Directors and Officers

Due to the guidelines of proxy advisors and the expectations of institutional investors, it can be advisable to exclude directors and executive officers from repricings that require shareholder approval. Nevertheless, because directors and officers often hold a large number of options, excluding them can undermine the goals of the repricing, and may lead to executive retention and motivation issues. Due in part to these practical concerns, a majority of recent repricings have included directors and officers despite the risk of an adverse vote. As an alternative to exclusion, companies could permit directors and officers to participate on less favorable terms than other employees and could consider seeking separate shareholder approval for the participation of directors and officers to avoid jeopardizing the overall program. Where the method of repricing or the intention behind the implementation of a new program reflects a shift in the overall compensation policy of a company, such as the exchange of options for restricted stock or RSUs, proxy advisors and institutional investors are more likely to acquiesce in the inclusion of directors and executive officers.

1.6. Key Repricing Terms

The following are key items that a company conducting a repricing will need to consider:

• Exchange Ratio. The exchange ratio for an option exchange represents the number of options that must be tendered in exchange for one new option or other security. This must be set appropriately to encourage employees to participate and to satisfy shareholders. In order for a repricing to be value-neutral, there will usually be a number of exchange ratios, each addressing a different range of option exercise prices.
• Option Eligibility. The company must determine whether all underwater options, or only those that are significantly underwater and/or were granted before a certain date, are eligible to be exchanged. This will depend on shareholder perceptions and proxy advisor guidelines, as well as the volatility of the company’s stock and the company’s expectations of future increases in share price. In addition, if employees in countries other than the United States hold underwater options, the company will need to consult with its advisors to determine if there are any issues (e.g., adverse tax consequences to either the company or the employee) that would result if such employees were eligible to participate in the exchange, and it may elect to exclude employees in certain non-US countries.
• New Vesting Periods. A company issuing new options in exchange for underwater options must determine whether to grant the new options based on a new vesting schedule, the old vesting schedule, or a schedule that provides some other vesting mechanic between these two alternatives. Practices in this regard are quite varied, although a new vesting schedule is most common in order to garner shareholder support.

2. Shareholder Approval

2.1. NYSE and Nasdaq Requirements

Under NYSE and Nasdaq rules, a company listed on the NYSE or Nasdaq must first obtain shareholder approval of material amendments to equity compensation plans, including a proposed repricing, unless the equity compensation plan under which the options in question were issued expressly permits the company to reprice outstanding options.^[5] Nasdaq rules define a material amendment to include any change to an equity compensation plan to “permit a repricing (or decrease in exercise price) of outstanding options… [or] reduce the price at which shares or options to purchase shares may be offered.”^[6] Similarly, NYSE rules state that “any repricing of options will be considered a material revision of a plan.”^[7] Under NYSE rules, a plan that does not contain a provision specifically permitting the repricing of options will be considered to prohibit repricing.^[8] Nasdaq requires companies to use “explicit terminology” to clearly illustrate the possibility of repricing.^[9] Therefore, if a plan itself is silent as to repricing, any repricing of options under that plan will be deemed to be a material revision, requiring shareholder approval. In addition, under NYSE rules, any attempt to delete or limit a plan’s provision prohibiting the repricing of options requires shareholder approval.^[10]

The NYSE and Nasdaq define a repricing as involving any of the following:^[11]

• lowering the strike price of an option after it is granted;
• canceling an option at a time when its strike price exceeds the fair market value of the underlying stock in exchange for another option, restricted stock, or other equity, unless the cancellation and exchange occurs in connection with a merger, acquisition, spin-off, or other similar corporate transaction; or
• any other action that is treated as a repricing under generally accepted accounting principles.

It should be noted that neither the NYSE nor Nasdaq rules prohibit the straight repurchase of options for cash. Nasdaq has provided an interpretation stating that the repurchase of outstanding options for cash by means of a tender offer does not require shareholder approval even if an equity compensation plan does not expressly permit such a repurchase.^[12] In reaching this conclusion, Nasdaq noted that the consideration for the repurchase was not equity. As noted below, however, some proxy advisors still require shareholder approval for a cash repurchase program.

Shareholder approval of a repricing will likely be required for most domestic companies listed on the NYSE or Nasdaq since few companies’ equity incentive plans expressly permit a repricing. As discussed below, this is because the existence of such a provision, or a decision to conduct a repricing without shareholder approval, would result in proxy advisors recommending a vote against the compensation committee and possibly other board members. A discussion regarding the exception available to foreign private issuers is provided below.

2.2. Proxy Advisors and Institutional Investors

The leading proxy advisors, ISS and Glass Lewis, have taken a clear position on repricing provisions in equity compensation plans. The detailed voting guidelines on this topic published by ISS and by Glass Lewis have remained unchanged over the last several years. ISS uses an “equity plan scorecard” model that considers a range of positive and negative factors to evaluate equity incentive plan proposals.^[13] Under this approach, ISS will recommend a case-by-case vote on equity plans “depending on a combination of certain plan features and equity grant practices.”^[14] However, ISS guidelines indicate that certain overriding, or “egregious,” features trigger an outright negative recommendation on the plan. Specifically, it will recommend a vote against a proposal if “[t]he plan would permit the repricing or cash buyout of underwater options without shareholder approval (either by expressly permitting it—for NYSE and Nasdaq listed companies—or by not prohibiting it when the company has a history of repricing—for non-listed companies).”^[15] ISS considers the following to constitute a repricing: (i) the amendment “of outstanding options or SARs to reduce the exercise price of such outstanding options or SARs”; (ii) the cancellation of “outstanding options or SARs in exchange for options or SARs with an exercise price that is less than the exercise price of the original options or SARs”; (iii) the cancellation of “underwater options in exchange for stock awards”; or (iv) “cash buyouts of underwater options.”^[16]

Glass Lewis will consider the company’s past history of option repricings and express or implied rights to reprice when making its voting recommendations and will recommend a vote against all members of a company’s compensation committee if the company repriced options without shareholder approval within the past two years.^[17] Against this background, most companies are likely to seek shareholder approval for a repricing even if it is not required under their equity compensation plans.

Glass Lewis states that it has great skepticism with respect to option repricings, indicating that a repricing or option exchange program may only be acceptable “if macroeconomic or industry trends, rather than specific company issues, cause a stock’s value to decline dramatically and the repricing is necessary to motivate and retain employees.”^[18] In such a circumstance, Glass Lewis will support a repricing if:

• officers and board members cannot participate in the program;
• the exchange is value-neutral or value-creative to shareholders using very conservative assumptions;
• the vesting requirements on exchanged or repriced options are extended beyond one year;
• shares reserved for options that are reacquired in an option exchange will be permanently retired so as to prevent additional shareholder dilution in the future; and
• management and the board make a cogent case for needing to motivate and retain existing employees, such as being in a competitive employment market.^[19]

Similarly, ISS has previously stated that an option exchange “creates a gulf between the interests of shareholders and management, since shareholders cannot reprice their stock” and therefore it “should be the last resort for management to use as a tool to re-incentivize employees.”^[20] According to ISS, only deeply underwater options should be eligible for an exchange program.^[21] “Repricing underwater options after a recent precipitous drop in the company’s stock price demonstrates poor timing and warrants additional scrutiny.”^[22] Therefore, as a general matter, the threshold “exercise price of surrendered options should be the 52-week high for the stock price.”^[23] ISS cautions that this general rule should be considered along with other factors, such as “the timing of the request, whether the company has experienced a sustained stock price decline that is beyond management’s control,”^[24] and whether “[g]rant dates of surrendered options [are] far enough back (two to three years) so as not to suggest that repricings are being done to take advantage of short-term” declines in the company’s current stock price.^[25]

2.3. Treatment of Canceled Options

Upon the occurrence of a repricing, equity compensation plans generally provide for one of two alternatives: (1) the shares underlying repriced options are returned to the plan and used for future issuances; or (2) such shares are redeemed by the company and canceled so as to no longer be available for future grants. A company’s equity compensation plan should make clear which alternative it will use. In the case of an option repricing that results in the return of canceled shares to a company’s equity incentive plan, ISS considers the total cost of the equity plan and whether the issuer’s three-year average burn rate is acceptable in determining whether to recommend that shareholders approve the repricing.^[26]

2.4. Proxy Solicitation Methodology

Companies seeking shareholder approval for a repricing face a number of hurdles, not the least of which would be the fact that shareholders suffered from the same decrease in share price that caused the options to become underwater. It should also be noted that brokers are prohibited from exercising discretionary voting power (i.e., voting without instructions from the beneficial owner of a security) with respect to implementation of, or a material revision to, an equity compensation plan.^[27] Therefore, the need to convince shareholders of the merits of a repricing is magnified, as is the influence of proxy advisors and institutional shareholders.

The solicitation of proxies from shareholders by a domestic reporting company is governed by Section 14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules thereunder. Item 10 of Schedule 14A contains the basic disclosure requirements for a proxy statement used by a domestic issuer to solicit approval of a repricing. Pursuant to these requirements and common practice, issuers generally include the following items of disclosure:

• A description of the option exchange program, including a description of who is eligible to participate, the securities subject to the exchange offer, the exchange ratio, and the terms of the new securities.
• A table disclosing the benefits or amounts, if determinable, that will be received by or allocated to (1) named executive officers, (2) all current executive officers as a group, (3) all current directors who are not executive officers as a group, and (4) all employees, including all current officers who are not executive officers, as a group.
• A description of the reasons for undertaking the exchange program and any alternatives considered by the board.
• The accounting treatment of the new securities to be granted, and the US federal income tax consequences.

It is important that companies ensure that their disclosure includes a clear rationale for the repricing to satisfy the disclosure requirements sought by proxy advisors and necessary to persuade shareholders to vote in favor of the repricing.^[28]

Rule 14a-6 under the Exchange Act permits a company that is soliciting proxies solely for certain specified limited purposes in connection with its annual meeting (or a special meeting in lieu of an annual meeting) to file a definitive proxy statement with the Securities and Exchange Commission (the “SEC”) and commence its solicitation immediately. The alternative requirement would be to file a preliminary proxy statement first and wait ten days while the SEC determines whether it will review and comment on the proxy statement. A proxy statement containing a repricing proposal should be filed with the SEC in preliminary form and then in definitive form after ten days if there is no SEC review. This is because the purposes for which a proxy statement can be initially filed in definitive form are limited to the following solely in connection with an annual meeting: (1) the election of directors; (2) the election, approval, or ratification of accountants; (3) a security holder proposal included pursuant to Rule 14a-8; (4) the approval, ratification, or amendment of a “plan” (a “plan” is defined in Item 402(a)(6)(ii) of Regulation S-K as “any plan, contract, authorization or arrangement, whether or not set forth in any formal document, pursuant to which cash, securities, similar instruments, or any other property may be received”); (5) certain specific proposals related to investment companies and Troubled Asset Relief Program financial assistance recipients; and (6) an advisory vote on executive compensation, or for a vote on the frequency of the advisory vote on executive compensation. Repricing proposals could be viewed as seeking approval of an amendment to a company’s plan to permit the repricing and approval of the terms of the repricing itself. Nevertheless, the better interpretation is that approval of the terms of a particular repricing is separate from an amendment to the plan to permit repricing, since the repricing terms would generally still be submitted for shareholder approval due to proxy advisor requirements even if the plan permitted repricing. Accordingly, companies should initially file proxy statements for a repricing in preliminary form.

3. Tender Offer Rules

3.1. Application of the Tender Offer Rules

US tender offer rules are generally implicated when the holder of a security is required to make an investment decision with respect to the purchase, modification, or exchange of that security. One might question why a unilateral reduction in the exercise price of an option would implicate the tender offer rules since there is no investment decision involved by the option holder. Indeed, many equity incentive plans permit a unilateral reduction in the exercise price of outstanding options, subject to shareholder approval, without obtaining the consent of option holders on the basis that such a change is beneficial to them. In reality, however, the likelihood of a domestic company being able to conduct a repricing without implicating the tender offer rules is minimal for the reasons set forth below.

Because of the influence of proxy advisors and institutional shareholders, most option repricings involve a value-for-value exchange consisting of more than a mere reduction in exercise price. A value-for-value exchange requires a decision by option holders to accept fewer options or to exchange existing options for restricted stock or RSUs. This is an investment decision requiring the solicitation and consent of individual option holders.

A reduction in the exercise price of an incentive stock option (“ISO”) would be considered a “modification” akin to a new grant under applicable tax laws.^[29] The new grant of an ISO restarts the holding periods required for beneficial tax treatment of shares purchased upon exercise of the ISO. The holding periods require that the stock purchased under an ISO be held for at least two years following the grant date and one year following the exercise date of the option. The resulting investment decision makes it difficult in practice to effect a repricing that includes ISOs without seeking the consent of ISO holders, since they must decide if the benefits of the repricing outweigh the burdens of the new holding periods.

The SEC staff has suggested that a limited option repricing/exchange with a small number of executive officers would not be a tender offer. In such an instance, the staff position is that an exchange offer to a small group is generally seen as equivalent to individually negotiated offers, and thus not a tender offer. Such an offer, in many respects, would be similar to a private placement. The SEC staff believes that the more sophisticated the option holders, the more the repricing/exchange looks like a series of negotiated transactions. However, the SEC staff has not provided guidance on a specific number of offerees, so this remains a facts-and-circumstances analysis based on both the number of participants and their positions and sophistication.^[30]

Not all equity incentive plans involve issuing ISOs, and thus the attendant ISO-related complexities will not always apply. As a result, foreign private issuers and domestic companies that have not granted ISOs and are simply reducing the exercise price of outstanding options unilaterally may also be able to avoid the application of the US tender offer rules. Foreign private issuers are discussed in more detail below.

3.2. Requirements of the US Tender Offer Rules

The SEC views a repricing of options that requires the consent of the option holders as a “self-tender offer” by the issuer of the options. Self-tender offers by companies with a class of securities registered under the Exchange Act are governed by Rule 13e-4 thereunder, which contains a series of rules designed to protect the interests of the targets of the tender offer. While Rule 13e-4 applies only to public companies, Regulation 14E applies to all tender offers. Regulation 14E is a set of rules prohibiting certain practices in connection with tender offers and requiring, among other things, that a tender offer remain open for at least twenty business days.

In March 2001, the SEC issued an exemptive order providing relief from certain tender offer rules that the SEC considered onerous and unnecessary in the context of an option repricing.^[31] Specifically, the SEC provided relief from complying with Rule 13e-4(f)(8)(i) (the “all holders” rule) and Rule 13e-4(f)(8)(ii) (the “best price” rule). As a result of this relief, issuers are permitted to reprice/exchange options for only certain selected employees. Among other things, this exception allows issuers to exclude directors and officers from repricings. Furthermore, issuers are not required to provide each option holder with the highest consideration provided to other option holders.^[32]

3.3. Pre-commencement Offers

The tender offer rules regulate the communications that a company may make in connection with a tender offer. These rules apply to communications made before the launch of a tender offer and while it is pending. Pursuant to these rules, a company may publicly distribute information concerning a contemplated repricing before it formally launches the related tender offer, provided that the distributed information does not contain a transmittal form for tendering options or a statement of how such form may be obtained. Two common examples of company communications that fall within these rules are the proxy statement seeking shareholder approval for a repricing and communications between the company and its employees at the time that proxy statement is filed with the SEC. Each such communication is required to be filed with the SEC under cover of a Schedule TO with the appropriate box checked to indicate that the content of the filing includes pre-commencement written communications.

3.4. Tender Offer Documentation

An issuer conducting an option exchange will be required to prepare the following documents as exhibits to a Schedule TO Tender Offer Statement:

• the offer to exchange, which is the document pursuant to which the offer is made to the company’s option holders and which must contain the information required to be included therein under the tender offer rules;
• the letter of transmittal, which is used by the option holders to tender their securities in the tender offer; and
• other ancillary documents, such as the forms of communication with option holders that the company intends to use and letters for use by option holders to withdraw a prior election to participate.

The offer to exchange is the primary disclosure document for the repricing offer and, in addition to the information required to be included by Schedule TO, focuses on informing security holders about the benefits and risks associated with the repricing offer. The offer to exchange is required to contain a “summary term sheet” that provides general information—often in the form of frequently asked questions—regarding the repricing offer, including its purpose, eligibility of participation, duration, and how to participate. It is also common practice for a company to include risk factors disclosing economic, tax, and other risks associated with the exchange offer. The most comprehensive section of the offer to exchange is the section describing the terms of the offer, including the purpose, background, material terms and conditions, eligibility to participate, duration, information on the stock or other applicable units, interest of directors and officers with respect to the applicable units or transaction, procedures for participation, tax consequences, legal matters, fees, and other information material to the decision of a security holder when determining whether or not to participate in such offer.

The offer to exchange, taken as a whole, should provide comprehensive information regarding the securities currently held and those being offered in the exchange—including the difference in the rights and potential values of each. The disclosure of the rights and value of the securities is often supplemented by a presentation of the market price of the underlying stock to which the options pertain, including historical price ranges and fluctuations, such as the quarterly highs and lows for the previous three years. The offer to exchange may also contain hypothetical scenarios showing the potential value risks/benefits of participating in the exchange offer. These hypothetical scenarios illustrate the approximate value of the securities held and those offered in the exchange at a certain point in the future, assuming a range of different prices for the underlying stock. If the repricing is part of an overall shift in a company’s compensation plan, the company should include a brief explanation of its new compensation policy.

3.5. Launch of the Repricing Offer

The offer to exchange is transmitted to employees after the Schedule TO has been filed with the SEC. While the offer is pending, the Schedule TO and all of the exhibits thereto (principally the offer to exchange) may be reviewed by the SEC staff, who may provide comments to the company, usually within five to seven days of the filing. The SEC’s comments must be addressed by the company to the satisfaction of the SEC, which usually requires the filing of an amendment to the Schedule TO, including amendments to the offer to exchange. Generally, no distribution of such amendment (or any amendments to the offer to exchange) will be required.^[33] This review usually does not delay the tender offer and generally will not add to the period that it must remain open.

Under the tender offer rules, the tender offer must remain open for a minimum of twenty business days from the date that it is first published or disseminated. For the reasons noted below, most option repricing exchange offers are open for less than thirty calendar days. If the consideration offered or the percentage of securities sought is increased or decreased, the offer must remain open for at least ten business days from the date such increase or decrease is first published or disseminated. The SEC also takes the position that if certain material changes are made to the offer (e.g., the waiver of a condition), the tender offer must remain open for at least five business days thereafter.^[34] At the conclusion of the exchange period, the repriced options, restricted stock or RSUs will be issued pursuant to the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933, as amended (the “Securities Act”) for the exchange of securities issued by the same issuer for no consideration.

3.6. Conclusion of the Repricing Offer

The company is required to file a final amendment to the Schedule TO setting forth the number of option holders who accepted the offer to exchange.

4. Certain Other Considerations

4.1. Tax Issues

Incentive Stock Options. If the repricing offer is open for thirty days or more with respect to options intended to qualify for ISO treatment under US tax laws, those ISOs are considered newly granted on the date the offer was made, whether or not the option holder accepts the offer.^[35] If the period is for less than thirty days, then only ISO holders who accept the offer will be deemed to receive a new grant of ISOs.^[36] As discussed above, the consequence of a new grant of ISOs is restarting the holding period required to obtain beneficial tax treatment for shares purchased upon exercise of the ISO.^[37] As a result of these requirements, repricing offers involving ISO holders should generally be open for no more than thirty days.

To qualify for ISO treatment, the maximum fair market value of stock with respect to which ISOs granted to an employee may first become exercisable in any one year is US $100,000.^[38] For purposes of applying this dollar limitation, all ISOs granted to the employee are taken into account; the stock is valued when the option is granted, and ISOs are taken into account in the order in which they were granted.^[39] Whenever an ISO is canceled pursuant to a repricing, any options and shares scheduled to become first exercisable in the calendar year of the cancellation would continue to count against the US $100,000 limit for that year.^[40] To the extent that the new ISO becomes exercisable in the same calendar year as the cancellation, the canceled options and shares (referenced in the immediately preceding sentence) reduce the number of shares that can receive ISO treatment (because the latest grants are the first to be disqualified).^[41] Where the new ISO does not start vesting until the next calendar year, however, this will not be a concern.

Section 409A Compliance. If the repricing occurs with respect to nonqualified stock options (i.e., options that are not ISOs), such options need to be structured so as to be exempt from (or in compliance with) Section 409A of the Code. Section 409A comprehensively codifies the federal income taxation of nonqualified deferred compensation. Section 409A generally provides that unless a “nonqualified deferred compensation plan” complies with various rules regarding the timing of deferrals and distributions, all amounts deferred under the plan for the current year and all previous years become immediately taxable, and subject to a 20% penalty tax and additional interest, to the extent the compensation is not subject to a “substantial risk of forfeiture” and has not previously been included in gross income. Nonqualified stock options are usually structured to be exempt from Section 409A. One of the conditions for this exemption is that the option have an exercise price at least equal to the fair market value of the underlying stock on the option grant date. A reduction in the option exercise price that is not below the fair market of the underlying stock value on the date of the repricing should not cause the option to become subject to Section 409A. Instead, such repricing of an underwater option is treated as the award of a new stock option that is exempt from Section 409A.^[42] While foreign private issuers may enjoy certain relief from the US tender offer rules as described below, there is no similar relief from US tax considerations for US taxpayers. This is most important where foreign private issuers’ home country rules allow for the grant of options with exercise prices below fair market value. In such case, care should be taken to ensure that grantees who are US taxpayers receive awards that comply with Section 409A.

4.2. Plan Grant Limitation

It should also be noted that a repriced option will count against any per-person grant limitations (typically an annual limit on the maximum number of shares which may be granted to an individual) in the applicable equity plan.

4.3. Accounting Treatment

Accounting considerations are a significant factor in structuring a repricing. Before the adoption of ASC 718 in 2005, companies often structured repricings with a six-month hiatus between the cancellation of underwater options and the grant of replacement options. The purpose of this structure was to avoid the impact of variable mark-to-market charges. Under ASC 718, however, the charge for the new options is not only fixed upfront but is for only the incremental value, if any, of the new options over the canceled options. As discussed above, in a value-for-value exchange, a fewer number of options or shares of restricted stock or RSUs will usually be granted in consideration for the surrendered options. As a result, the issuance of the new options or other securities can be a neutral event from an accounting expense perspective.

4.4. Section 16

The replacement of an outstanding option with a new option having a different exercise price and a different expiration date involves a disposition of the outstanding option and an acquisition of the replacement option, both of which are subject to reporting under Section 16(a). However, the disposition of the outstanding option will be exempt from short-swing profit liability under Section 16(b) pursuant to Rule 16b-3(e) if the terms of the exchange are approved in advance by the issuer’s board of directors, a committee of two or more nonemployee directors, or the issuer’s shareholders. It is generally not a problem to satisfy these requirements. Similarly, the grant of the replacement option or other securities is subject to reporting but will be exempt from short-swing profit liability pursuant to Rule 16b-3(d) if the grant was approved in advance by the board of directors or a committee composed solely of two or more nonemployee directors, or was approved in advance or ratified by the issuer’s shareholders no later than the date of the issuer’s next annual meeting, or is held for at least six months.

5. Foreign Private Issuers

5.1. Relief from Shareholder Approval Requirement

Both the NYSE^[43] and Nasdaq^[44] provide foreign private issuers with relief from the requirement of stockholder approval for a material revision to an equity compensation plan by allowing them instead to follow their applicable home-country practices. As a result, if the home-country practices of a foreign private issuer do not require shareholder approval for a repricing, the foreign private issuer is not required to seek shareholder approval under NYSE or Nasdaq rules.

Both the NYSE and Nasdaq require an issuer following its home-country practices to disclose in its annual report on Form 20-F an explanation of the significant ways in which its home-country practices differ from those applicable to a US domestic company.^[45] Alternatively, companies listed on the NYSE may disclose such home-country practices on the issuer’s website, in which case the issuer must provide in its annual report the web address where the information can be obtained.^[46] Under Nasdaq rules, the issuer is required to submit to Nasdaq a written statement from independent counsel in its home country certifying that the issuer’s practices are not prohibited by the home country’s laws.^[47]

Many foreign private issuers disclose that they will follow their home-country practices with respect to a range of corporate governance matters, including the requirement of shareholder approval for the adoption or any material revision to an equity compensation plan. These companies are not subject to the requirement under NYSE or Nasdaq rules of obtaining shareholder approval for a repricing. Companies that have not provided such disclosure and wish to avoid the shareholder approval requirements when undertaking a repricing will need to consider carefully their historic disclosure and whether such an opt-out poses any risk of a claim from shareholders.

5.2. Relief from US Tender Offer Rules

Foreign private issuers also have significant relief from the application of US tender offer rules if US option holders hold 10% or less of the company’s outstanding options.^[48] Under the exemption, assuming the issuer’s actions in the United States still constitute a tender offer, the issuer would be required to take the following steps:

• file with the SEC under the cover of a Form CB a copy of the informational documents that it sends to its option holders. This informational document would be governed by the laws of the issuer’s home country and would generally consist of a letter to each option holder explaining why the repricing is taking place, the choices each option holder has, and the implications of each of the choices provided;
• appoint an agent for service of process in the United States by filing a Form F-X with the SEC; and
• provide each US option holder with terms that are at least as favorable as those terms offered to option holders in the issuer’s home country.

A more limited exemption to the US tender offer rules also exists for foreign private issuers where US investors hold 40% or less of the options that are subject to the repricing. Under this exception, both US and non-US security holders must receive identical consideration. The minimal relief is intended merely to minimize the conflicts between US tender offer rules and foreign regulatory requirements and provides little actual relief in the context of an option repricing.

6. Alternative Strategies

There have been surprisingly few deviations from the repricing approaches described above. In the past, Microsoft and Google used different and more innovative methods to address the issue of underwater employee stock options, thereby providing an alternative to a traditional repricing. To date, other companies have not followed suit, but it is possible that others will consider these approaches in the future.

In 2007, Google implemented a program that afforded its option holders (excluding directors and officers) the ability to transfer outstanding options to a financial institution through a competitive online bidding process managed by Morgan Stanley. The bidding process effectively created a secondary market in which employees can view what certain designated financial institutions and institutional investors are willing to pay for vested options. The value of the options is therefore a combination of their intrinsic value (i.e., any spread) at the time of sale plus the “time value” of the remaining period during which the options can be exercised (limited to a maximum of two years in the hands of the purchaser). As a result of this “combined” value, Google believed that underwater options would still retain some value. This belief is supported by the fact that in-the-money options were sold at a premium to their intrinsic value.

Google’s equity incentive plan was drafted sufficiently broadly to enable options to be transferable without the need for Google shareholder approval to amend the plan. Many other companies’ plans would likely limit transferability of options to family members. Accordingly, most companies seeking to implement a similar transferable option program will likely need to obtain shareholder approval to do so. Note that ISOs become nonqualified stock options if transferred. The only options Google granted following its IPO were nonqualified stock options and, accordingly, the issue of losing ISO status did not arise. Finally, notwithstanding the benefits that Google’s transferable option program offers, it did not prevent the company from effecting a one-for-one option exchange and incurring a related stock-based compensation expense of US $460 million over the life of the new options.

In 2003, Microsoft implemented a program that afforded employees holding underwater stock options a one-time opportunity to transfer their options to JPMorgan in exchange for cash.^[49] The program was implemented at the same time that Microsoft started granting restricted stock instead of options, and it was open on a voluntary basis to all holders of vested and unvested options with an exercise price of US $33 or more (at the time of the implementation of the program, the company’s stock traded at US $26.50). Employees were given a one-month election period to participate in the program, and once an employee chose to participate, all of that employee’s eligible options were required to be tendered. Employees who transferred options were given a cash payment in installments, dependent upon their continued service with Microsoft.

The methods used by Google and Microsoft require consideration of tax and accounting implications and required the filing of a registration statement under the Securities Act in connection with short sales made by the purchasers of the options to hedge their exposure. To date, these methods have not been adopted by other companies, and it is to be expected that most companies will continue to conduct more conventional repricings to address underwater options.

7. Summary

The current market realignment has not yet continued for long enough to generally justify a significant number of repricings. Trends over the last decade have shown a tendency to avoid repricing when possible. Continued examples of market resilience and feasibility of alternative compensation practices have subsided the widespread occurrence of repricings. Nevertheless, while underwater option repricings may not rise to the levels following the financial crisis of 2008, companies will likely always require the ability to reprice underwater options upon certain market fluctuation or individual corporate circumstances, especially those that last for longer periods in tight labor markets.

This publication is provided for your convenience and does not constitute legal advice. This publication originally appeared as a White & Case publication and is protected by copyright. © 2022 White & Case LLP

1. See David F. Larcker, Allan L. McCall, and Gaizka Ormazabal, “Proxy Advisory Firms and Stock Option Repricing,” Journal of Accounting and Economics 56 (November–December 2013): 149–169. ↑

2. See Tomoeh Murakami Tse, “Firms Refloat Underwater Stock Options,” Washington Post, March 7, 2009. ↑

3. SARs are essentially net options, and provide for the delivery, in cash or shares (as applicable), of an amount equal to the spread (i.e., the excess of fair market value of the stock over exercise price) upon exercise. Broker-assisted cashless exercises of options have an economic effect similar to that of SARs but technically involve the payment of the exercise price to the issuer with a loan or other assistance from the broker. ↑

4. Prior to the enactment of the Tax Cut and Jobs Act of 2017 (the “2017 Tax Act”), “covered employees” subject to Section 162(m) included a public corporation’s CEO and its three highest paid officers (other than the CEO and CFO) who were serving as of the last day of the tax year. The 2017 Tax Act expanded the group of covered employees and provided that for tax years beginning on or after January 1, 2018, covered employees include the CEO, CFO, and the three highest paid officers serving at any time during the tax year, as well as any employee who was a covered employee for a tax year beginning after 2016. The 2017 Tax Act also eliminated the performance-based compensation exemption for equity awards granted after November 2, 2017. ↑

5. The New York Stock Exchange Listed Company Manual, Section 303A.08; Nasdaq Stock Market Listing Rules, Rule 5635(c); Nasdaq Interpretive Material IM-5635-1; and NYSE American LLC Company Guide Section 711 and related commentary. ↑

6. Nasdaq Stock Market Listing Rules, Rule 5635(c); and Nasdaq Interpretive Material IM-5635-1. ↑

7. The New York Stock Exchange Listed Company Manual, Section 303A.08; and NYSE American LLC Company Guide Section 711 and related commentary. ↑

8. The New York Stock Exchange Listed Company Manual, Section 303A.08. ↑

9. Nasdaq Stock Market Listing Rules, Rule 5635(c); and Nasdaq Interpretive Material IM-5635-1. ↑

10. The New York Stock Exchange Listed Company Manual, Section 303A.08. ↑

11. The New York Stock Exchange Listed Company Manual, Section 303A.08; Nasdaq OMX Listing Center, Nasdaq “Frequently Asked Questions.” ↑

12. Nasdaq Staff Interpretive Letter 2004-21. ↑

13. Institutional Shareholder Services, United States Proxy Voting Guidelines Updates, Benchmark Policy Recommendations, December 13, 2021.  ↑

14. Id. ↑

15. Id. ↑

16. Id. ↑

17. Glass Lewis & Co, 2022 Policy Guidelines, United States. ↑

18. Id. ↑

19. Id. ↑

20. Institutional Shareholder Services, 2014 Comprehensive US Compensation Policy, Frequently Asked Questions, March 28, 2014. ↑

21. Id. ↑

22. United States Proxy Voting Guidelines Updates, supra note 17. ↑

23. Id. ↑

24. 2014 Comprehensive US Compensation Policy, Frequently Asked Questions, supra note 20. ↑

25. United States Proxy Voting Guidelines Updates, supra note 17. ↑

26. Id. ↑

27. See NYSE Rule 452. ↑

28. It is worth noting that Item 402 of Regulation S-K requires that any repricing of an option held by a director or named executive be disclosed in a company’s annual proxy statement for the election of directors. See also Securities and Exchange Commission, Division of Corporation Finance, Current Issues and Rulemaking Projects Quarterly Update (March 31, 2001), Part II. ↑

29. For ISO purposes, a modification is any change in the terms of the option that gives the optionee additional benefits under the option, regardless of whether the optionee actually benefits from such change. Treas. Reg. § 1.424-1(e)(4). ↑

30. American Bar Association, Technical Session Between the SEC Staff and the Joint Committee on Employee Benefits, Question and Answers, May 9, 2001, https://www.americanbar.org/content/dam/aba/events/employee_benefits/technicalsessions/2001_sec.pdf. ↑

31. Exemptive Order, Securities and Exchange Act of 1934, “Repricing.” ↑

32. An issuer must satisfy a number of requirements to be eligible for the relief: (1) the issuer must be eligible to use Form S-8, the options subject to the exchange offer must have been issued under an employee benefit plan as defined in Rule 405 under the Securities Act, and the securities offered in the exchange offer will be issued under such an employee benefit plan; (2) the exchange offer must be conducted for compensatory purposes; (3) the issuer must disclose in the offer to purchase the essential features and significance of the exchange offer, including risks that option holders should consider in deciding whether to accept the offer; and (4) except as exempted in the order, the issuer must comply with Rule 13e-4. ↑

33. If the terms of the offer change (e.g., the option exchange ratio is changed) or other material changes are made to the disclosure in the offer to exchange, a supplement may need to be prepared, mailed to stockholders, and filed with the SEC as part of a Schedule TO amendment. This rarely occurs in an option repricing. ↑

34. If such change is made at a time when more than five business days remain before the expiration of the tender offer, no extension of the tender offer would be needed. If such change is made in the five-business-day period preceding the scheduled expiration of the tender offer, an extension would be necessary. ↑

35. Treas. Reg. § 1.424-1(e)(4)(iii). ↑

36. Id. ↑

37. Treas. Reg. § 1.424-1(e)(2). ↑

38. Treas. Reg. § 1.422-4(a). ↑

39. Treas. Reg. § 1.422-4(a). ↑

40. Treas. Reg. § 1.422-4(b)(5)(ii); Treas. Reg. § 1.422-4(d), example 5(iii). ↑

41. Treas. Reg. § 1.422-4(b)(3); Treas. Reg. § 1.422-4(d), example 2. ↑

42. Treas. Reg. § 1.409A-1(b)(5)(v)(A). ↑

43. The New York Stock Exchange Listed Company Manual, Section 303A.11. ↑

44. Nasdaq Stock Market Listing Rules, Rule 5615(a)(3). ↑

45. The New York Stock Exchange Listed Company Manual, Section 303A.11; Nasdaq Stock Market Listing Rules, Rule 5615(a)(3)(B)(i). ↑

46. The New York Stock Exchange Listed Company Manual, Section 303A.11. ↑

47. Nasdaq Interpretive Material IM-5635-1. ↑

48. 17 C.F.R. § 240.13e-4(h)(8)(i). ↑

49. Comcast Corporation implemented a similar program with JPMorgan in 2004. In that case, due to the structure of the option plan, Comcast repurchased the options and issued new options to JPMorgan with exercise prices and times to maturity identical to the repurchased options_. ↑

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (collectively, the “Regulators”) issued a joint “Statement on LIBOR Transition” (the “2020 Statement”)^[1] on November 30, 2020. The stated purpose of the 2020 Statement was to “encourage banks to transition away from [USD] LIBOR as soon as possible.”^[2] Included in the 2020 Statement was guidance that the Regulators believe that “entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly.”^[3] As a result, the Regulators have urged banks to “cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.”^[4]

On October 20, 2021, a new “Joint Statement on Managing the LIBOR Transition” was issued by the Regulators together with the Consumer Financial Protection Bureau, the National Credit Union Administration, and the State Bank and Credit Union Regulators (the “2021 Statement,” and together with the 2020 Statement, the “Regulators’ Joint Statements”)^[5]. The 2021 Statement offered additional guidance on the interpretation of the term “new contracts” and specified that the term would include “an agreement that (i) creates additional LIBOR exposure for a supervised institution; or (ii) extends the term of an existing LIBOR contract.”^[6] Additionally, the statement clarified that new draws under already existing committed credit facilities would not be viewed as new contracts for the purpose of the guidance under the Regulators’ Joint Statements.^[7]

As a result of the Regulators’ Joint Statements, the vast majority of syndicated loan agreements that have closed on or after January 1, 2022, have used interest rate benchmarks other than LIBOR, primarily SOFR. From statistics provided by LevFinInsights (graphs representing these statistics are reproduced below), the pivot from LIBOR to SOFR in the institutional syndicated loans market has been drastic. While over 70% of institutional syndicated loans that launched in December 2021 still referenced LIBOR, less than 5% of institutional syndicated loans that launched in January 2022 reference LIBOR. The move to SOFR has continued in a similar split in the months that have followed since the beginning of 2022, with approximately 99% of institutional syndicated loans that launched in May 2022 referencing SOFR.

The mechanics of the new SOFR-based institutional syndicated loans impact not only the regulated bank institutions (which are typically the parties that act as lead arranger and administrative agent of the credit facilities), but also institutional lenders (typically collateralized loan obligations (CLOs) and Debt Funds that become lenders under the credit facilities and are interested in trading the loans efficiently). Like the regulated banks, which are largely responding to the Regulators’ Joint Statements in moving credit facilities they help arrange away from LIBOR, the institutional lenders also appear to be eager to move to the new SOFR-based lending world. From statistics provided by Refinitiv (a graph representing these statistics is reproduced below), almost all the CLO notes issued in 2021 referenced LIBOR but almost all the CLO notes issued in 2022 reference SOFR.

As the market for SOFR-based credit agreements has continued to evolve over the course of the first half of 2022, market participants (lead arrangers, administrative agents, lenders, and borrowers) have continued to explore issues that are affected by the new SOFR-based credit agreements. Among specific topics of interest, participants have focused on:

1. the variance among the non-LIBOR referencing syndicated credit agreements (Term SOFR vs. Daily Simple SOFR vs. BSBY vs. any other credit sensitive rates);
2. interest rate benchmarks used for incremental facilities in legacy deals;
3. credit spread adjustments in newly originated credit agreements;
4. interest period variations;
5. trading mechanics of SOFR-based loans; and
6. LIBOR remediation and what impact the new SOFR-based credit agreements may have on Early Opt-in Elections and refinancing/repricings of existing LIBOR loans.

We briefly discuss the latest developments in each of these areas of focus below.

(i) Variance in Interest Rate Benchmarks

Because the Regulators have only encouraged the transition away from LIBOR, a number of interest rate benchmarks have arisen as potential replacements for LIBOR in loan agreements.

The most prominent of such benchmarks is SOFR, which stands for the Secured Overnight Financing Rate. SOFR has been recommended by the Alternate Reference Rates Committee (the “ARRC”)^[8] as its preferred alternative reference rate since June 22, 2017.^[9] Unlike LIBOR, SOFR is an overnight rate and in its pure form can present operational challenges for certain regular loan market activities, such as prepayments and loan trading. Therefore, SOFR’s use as Daily Simple SOFR in credit agreements has mostly been limited to bilateral or pro rata investment grade facilities that do not normally trade.

A related benchmark, which offers a forward-looking term rate (just as LIBOR is), is Term SOFR. Term SOFR rates “provide an indication of the forward-looking measurement of overnight SOFR, based on market expectations implied from derivatives markets.”^[10] CME Group publishes Term SOFR for interest periods of one month, three months, six months and 12 months, and each of CME Group’s rates have been formally recommended by the ARRC for use as replacement rates to LIBOR.^[11] Due to the forward-looking nature of Term SOFR rates and the fact Term SOFR has the same operational characteristics as LIBOR, Term SOFR has been the most widely used benchmark in the new syndicated loan agreements that have closed since the beginning of 2022. The same rate has been used in CLO issuances as well.

Other SOFR-based variations are available, such as SOFR compounded in advance using the Federal Reserve Bank of New York’s 30-, 90- and 180-day averages or SOFR compounded in arrears; however, these rates have not received widespread usage in the U.S. syndicated loan market.

Certain other potential benchmarks have been developed as potential replacements to USD LIBOR. These benchmarks all have in common the inclusion of a “credit sensitive component,” which more closely mirrors LIBOR in a time of credit stress. The most prominent of the credit sensitive rates are the Bloomberg Short Term Bank Yield Index (“BSBY”) and the American Interbank Offered Rate (“Ameribor”). Each rate is calculated using a proprietary formula and includes a means of capturing bank credit spreads. While the credit sensitive rates more closely resemble LIBOR than either SOFR or Term SOFR, none of them have been formally recommended by the ARRC and they are also not used as fallback or originating benchmark rates in CLO issuing indentures. As a result, there has been a comparatively low inclusion of such rates in broadly syndicated loan agreements. The credit sensitive rates are most likely to be used in certain regional U.S. bank bilateral or pro rata club syndicated transactions.

Lastly, especially in the first quarter of 2022, there were a few transactions that still used USD LIBOR at origination. These transactions were usually either (i) transactions evidenced by credit agreements that became effective in 2022 but were already committed before the start of 2022; or (ii) “fungible” incremental facilities to existing USD LIBOR credit agreements.

(ii) Interest Rate Benchmarks Used for Incremental Facilities in Legacy USD LIBOR Credit Agreements

During the first quarter of 2022 there were a minority of incremental facilities (also referred to interchangeably as accordions or add-ons) that were originated using USD LIBOR. From statistics provided by LevFinInsights (graphs representing these statistics are reproduced below), the pivot from LIBOR to SOFR in incremental facilities has been somewhat less drastic than in newly originated credit facilities, although a large majority still use SOFR rather than LIBOR.

While an incremental facility is viewed by many to fit squarely into the definition of a “new contract” used in the 2021 Statement, there are perhaps a few reasons why the use of USD LIBOR in incremental facilities is a “gray” area, especially for those incrementals that were originated in the early part of 2022.

First, incremental facilities are usually much smaller in size than the existing credit facility that exists in the original credit agreement. Given this, it is advantageous and sometimes essential that the new incremental loan be “fungible” with and trade together with the existing credit facility. Without fungibility, given the smaller size, it would be difficult to ensure liquidity in the incremental loan, and the ultimate impact is likely to be a higher interest rate charged to the borrower. The new incremental loan would not be fungible if it uses a SOFR-based interest rate while the existing credit facility continues to use a LIBOR-based interest rate. While an obvious answer may be to amend or refinance the entire credit facility, that is not feasible for all borrowers and can lead to much greater overall transaction costs. With this in mind, one argument that can be made for a LIBOR-based incremental loan is that such a LIBOR origination prevents a disruption to the leveraged loan market with respect to those borrowers that would incur increased transaction costs, and thus complies with the overall goal of regulators not to disrupt the market during LIBOR transition.

Another argument that can be made is that an incremental facility ultimately uses the same loan documentation as the original credit agreement. As such, the new incremental loans would switch from LIBOR to a replacement rate at the same time that the original credit agreement would switch pursuant to its LIBOR replacement mechanics. The new incremental loan would not require a separate amendment to achieve the transition of the entire facility.

Finally, some in the market have taken the position that an incremental facility is not a “new contract,” as the mechanics for the increase are contained in the existing loan agreement. In other words, the borrower is just activating a provision in their loan agreement that already exists, and therefore the requirement to move to USD LIBOR is not required pursuant to the 2021 Statement.

(iii) Credit Spread Adjustments in Newly Originated Credit Agreements

The size of the credit spread adjustment has been the most contentious and heavily negotiated term in SOFR-originated credit agreements. While SOFR is a rate that broadly measures the cost of borrowing cash overnight collateralized by Treasury securities,^[12] LIBOR is a rate that averages the rates at which large banks could fund themselves on the wholesale, unsecured funding market.^[13] Due to the unsecured nature of the transactions that LIBOR measures, the LIBOR rate is generally higher than SOFR; additionally, LIBOR historically has had larger upward fluctuations in times of economic stress. To capture the difference between the rates over different interest periods (e.g., one month, three months), both the ARRC and ISDA recommended the use of a five-year median spread adjustment,^[14] which compares the median LIBOR and Compounded SOFR figures over the five-year period from March 2016 to March 2021. The exact amounts that should be added to one-month, three-month and six-month SOFR contracts (whether of the Daily Simple, Daily Compounded, or Term SOFR variety) using this method are 0.11448%, 0.26161%, and 0.42826%, respectively.^[15] These amounts will be added in all contracts that transition from LIBOR to Term SOFR or Daily Simple SOFR relying on the ARRC hardwired fallback mechanics or pursuant to the federal Adjustable Interest Rate (LIBOR) Act.^[16]

While it would be consistent to have newly originated SOFR credit agreements use the same credit spread adjustments as will be used for fallback purposes, there is no requirement on market participants to do so. The most recent data shows that switching from LIBOR to Term SOFR plus the ARRC and ISDA recommended credit spread adjustment would lead to a very slightly lower interest rate for borrowers that use one-month interest periods to borrow, while borrowings of three-month and six-month interest periods would result in larger increases to interest rates. The interest rate savings on one-month interest periods are especially modest when considering that due to the rising interest rate environment, more borrowers are likely to choose longer interest periods in order to “lock in” their interest rate for a longer period. However, as both LIBOR and Term SOFR move differently, the differences between these rates (and whether LIBOR or Term SOFR adjusted by adding the ARRC and ISDA recommended credit spread adjustments results in a higher or lower interest rate) fluctuates regularly.

The below table illustrates recent data by showing a “point in time” comparison as of June 23, 2022, between LIBOR, Term SOFR, and Term SOFR adjusted by adding the ARRC and ISDA recommended credit spread adjustments.

June 23, 2022, Comparison of LIBOR, Term SOFR, and Adjusted Term SOFR

From the start of 2022, the newly originated SOFR-based credit agreements have included a mixture of different credit spread adjustments. On one side of the spectrum there are credit agreements that do not appear to add any credit spread adjustment to the Term SOFR rates.^[17] On the other side of the spectrum, some credit agreements have adopted the ISDA- and ARRC-recommended credit spread adjustments. The other two most popular options picked by market participants are: (i) adding a flat 0.10% credit spread adjustment across all interest periods; or (ii) adding 0.10%, 0.15%, and 0.25% credit spread adjustments for one-month, three-month, and six-month interest periods respectively. The flat 0.10% credit spread adjustment is more frequently adopted in investment grade or other “pro rata” credit facility agreements that are largely not traded in the secondary loan market. The formulation that includes 0.10%, 0.15%, and 0.25% credit spread adjustments for one-month, three-month, and six-month interest periods respectively is more frequently adopted in leveraged loan credit facility agreements than investment grade credit facility agreements. It is worth noting that if we reference the June 23, 2022, data, both the flat 0.10% and the 0.10%, 0.15%, and 0.25% credit spread adjustment formulations would lead to lower interest rates for borrowers across each of one-month, three-month, and six-month interest periods.

It remains to be seen if, after the LIBOR transition period has ended, some credit agreements will continue to reference a credit spread adjustment to SOFR or whether margin pricing will simply evolve to take into consideration a SOFR benchmark instead of a credit sensitive benchmark.

(iv) Interest Period Variations

The ARRC endorsement of the 12-month CME Term SOFR rate on May 19, 2022^[18] resolves one of the open questions of whether or not parties to a credit agreement could include a 12-month interest period. The remaining interest periods that are frequently included in LIBOR-based credit agreements but are not published by the CME as Term SOFR interest periods are one-week and two-month term rates.

With respect to a two-month interest period, we have not seen SOFR-originated credit agreements that include this interest period. For those credit agreements that originated using LIBOR and included a two-month interest period, administrative agents could interpolate the two-month interest period rate using the published one-month and three-month LIBOR rates if permitted pursuant to the terms of the credit agreement.^[19] Those credit agreements that contain certain ARRC-based LIBOR transition mechanics allow the administrative agent to remove the two-month interest period. The earlier credit agreements that did not include such a mechanic are still likely not to include the two-month interest period in the LIBOR transition amendment agreed by the parties. Many administrative agents have already notified borrowers that two-month interest periods are not available under their facilities as of the end of 2021.

With respect to the one-week interest period, there have been a few SOFR-originated credit agreements that have retained a quasi-one-week interest period. The most common alternatives used in the market either allow the borrower to make interest payments weekly using the Daily Simple SOFR rate or use the one-month Term SOFR published rate as the reference for the one-week interest period.^[20] Failing these mechanics, a borrower could still prepay and reborrow the loan on a weekly basis, but this option can only be used in revolving credit facilities and the borrower risks incurring breakage costs as well as having to remake the representations and warranties in the credit agreement each week upon the new drawing. For LIBOR-based credit agreements, the ability to interpolate a one-week LIBOR rate will depend on the wording of any interpolation mechanics. The results are likely to be similar as with respect to the two-month interest period with the one-week interest period most frequently dropped.

(v) Trading Mechanics of SOFR-Based Loans and the Secondary Trading Market

Historically, secondary trading of loans in the institutional market has been evidenced using the LSTA forms of Confirmation (whether the LSTA Distressed Trade Confirmation or the LSTA Par/Near Par Trade Confirmation), and recently a similar form has been developed by the LSTA for primary allocations (the LSTA Primary Allocation Confirmation) (collectively referred to as “LSTA Trade Confirmations”). Each of the LSTA Trade Confirmations incorporates a Standard Terms and Conditions document that, among other terms, includes a concept for when and how interest on a loan that is earned by a lender may be passed to a prospective lender during the period of time that passes after the parties have agreed to trade the loan but before such loan trade has settled. This concept includes a defined term for “Cost of Carry,” which has historically used LIBOR to calculate what is owed among the parties.

As noted above, since the start of 2022, both new syndicated credit agreements that evidence the loans that are being traded, as well as the indentures that evidence the notes that are used by the institutional lenders to fund themselves, are using SOFR to calculate interest. In line with this move to SOFR, the LSTA updated the LSTA Trade Confirmations and related Standard Terms and Conditions on December 1, 2021, to reference Daily Simple SOFR instead of LIBOR. This change more closely aligns the secondary trading documents with the relevant credit agreements.

(vi) Remediation of Legacy LIBOR Credit Agreements

On March 5, 2021, the Financial Conduct Authority (the “FCA”) announced the future cessation or loss of representativeness dates for the 35 LIBOR settings published by the ICE Benchmark Administration.^[21] The two key dates in the announcement were December 31, 2021 (after which all the interest period tenors for GBP, EUR, JPY and CHF LIBOR and the one-week and two-month interest period tenors for USD LIBOR either cease or lose representativeness), and June 30, 2023 (after which the remaining USD LIBOR interest period tenors would cease or lose representativeness).

The immediate impact of the March 5, 2021, FCA announcement was that a trigger in the ARRC-based LIBOR replacement mechanics was met and that all agreements referencing non-USD currency LIBOR rates should have been replaced or amended by December 31, 2021. As a result, the fourth quarter of 2021 included a lot of LIBOR replacement amendment activity with respect to the non-USD currency LIBOR rates. Some credit agreements referencing non-USD currency LIBOR rates were not immediately amended but instead a “suspension of rights” letter was delivered by the borrower in those credit facilities that acknowledged and agreed that the borrower would not borrow the non-USD currency loans until such time as the non-USD currency LIBOR rates were replaced.

With the non-USD currency LIBOR loans generally remediated, the focus from the beginning of this year and through June 30, 2023, shifts to USD LIBOR loans. The first six months of 2022 have seen a number of existing USD LIBOR loans remediated to SOFR through “organic” means such as refinancings or repricings. In those cases, given that either new lenders provide the financing that refinances the existing credit facility or 100% of the existing lenders have to vote to amend the agreement, the fallback mechanics of the existing credit agreement are irrelevant, and parties may negotiate and agree to their preferred benchmark rates, credit spread adjustments, etc. A primary purpose of the extension of the USD LIBOR cessation date of most tenors from December 31, 2021, to June 30, 2023, was to allow a greater portion of facilities to naturally transition to reduce the number of outstanding contracts which had no or inadequate fallback language.

The ARRC has recommended that, where feasible and appropriate to the circumstances, parties remediate their contracts ahead of USD LIBOR cessation.^[22] These proactive remediation efforts, rather than relying on the mechanics of the fallback language, may have a number of benefits for parties. We have not seen a great deal of consensual USD LIBOR replacement amendments to date. However, it is generally expected that this replacement process will increase in velocity through the second half of 2022 and into 2023, although that velocity will presumably be impacted by the then-current interest rate environment and how incentivized a borrower is to transition from USD LIBOR.

On June 21, 2022, the LSTA released different forms of benchmark replacement amendments that may be used by the market participants as they remediate their legacy USD LIBOR credit agreements. The forms are drafted to provide for either: (i) a “golden amendment” that contains in it all the relevant SOFR-based terms and definitions and is meant to apply to any type of credit agreement, no matter what defined terms of which sections of the existing credit agreement contains the relevant LIBOR provisions that are replaced; or (ii) a “cover amendment” with an annex, which is meant to be a redline of the existing credit agreement that shows the changes made to the agreement to replace LIBOR with SOFR (whether Term SOFR or Daily Simple SOFR). The advantage of using the “golden amendment” form is that the transaction costs for amending the credit agreement are much lower as the same form may be used for many credit agreements. However, a future amendment and restatement of that credit agreement may prove more challenging, as might properly cross-referencing sections in related loan documentation. As for the “cover amendment” with redline approach, the upfront costs of amending would be higher as each amendment is bespoke and follows the existing credit agreement. However, it is easier down the line to amend the agreement again and/or to follow where the new provisions are in the agreement.

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

1. https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20201130a1.pdf ↑

2. See id. ↑

3. See id. ↑

4. See id. ↑

5. https://www.federalreserve.gov/supervisionreg/srletters/SR2117a1.pdf ↑

6. See id. ↑

7. See id. ↑

8. The ARRC is a group of private-market participants convened by official sector agencies to identify a set of alternative U.S. dollar reference interest rates and to identify an adoption plan with means to facilitate the acceptance and use of these alternative reference rates. ↑

9. https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf ↑

10. https://www.cmegroup.com/market-data/cme-group-benchmark-administration/term-sofr.html ↑

11. See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Press_Release_Term_SOFR.pdf, with respect to one-month, three-month, and six-month Term SOFR, and https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2022/ARRC_CME_12-Month_SOFR_Term_Rate.pdf with respect to 12-month Term SOFR. ↑

12. https://www.newyorkfed.org/markets/reference-rates/sofr ↑

13. https://www.theice.com/iba/libor ↑

14. https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Recommendation_Spread_Adjustments_Cash_Products_Press_Release.pdf ↑

15. https://assets.bbhub.io/professional/sites/10/IBOR-Fallbacks-LIBOR-Cessation_Announcement_20210305.pdf ↑

16. https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-117HR2471SA-RCP-117-35.pdf ↑

17. Note, it is often unclear whether the parties negotiated to have no credit spread adjustment in these agreements or whether a credit spread adjustment has been added to the applicable margin. The LSTA credit agreement forms adopt a more transparent formula where the credit spread adjustment would be specified as an adjustment in the “Adjusted Term SOFR” or “Adjusted Daily Simple SOFR” definitions. ↑

18. https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2022/ARRC_CME_12-Month_SOFR_Term_Rate.pdf ↑

19. Note: one-week and two-month LIBOR rates ceased to be published after 2021. ↑

20. While the one-month Term SOFR rate likely is higher than a one-week Term SOFR rate would have been, using this approach simplifies the calculations of the administrative agent and borrower in determining interest owing at the end of the one-week period. ↑

21. https://www.fca.org.uk/publication/documents/future-cessation-loss-representativeness-libor-benchmarks.pdf ↑

22. The ARRC’s LIBOR Legacy Playbook published on July 11, 2022, https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2022/LIBOR_Legacy_Playbook.pdf ↑

For a small or midsize company CEO, undertaking a strategic M&A transaction is often a legacy-defining proposition. An acquisition of a direct competitor, another key industry player operating at a different level of the supply chain, or a promising high-growth entrant into the marketplace presents a truly unique opportunity to add unprecedented value to the organization.

For the GC of the acquiring company, this would seem like a tremendous opportunity. Being able to serve as the CEO’s right-hand strategic legal advisor on an acquisition can be a career game changer. It could mean that you help your CEO take the company into emerging global markets, onboard hundreds of new employees, build and distribute new industry-leading products, and generate additional revenue that will benefit the company’s investors and shareholders. But as GCs undoubtedly know, the hard part is getting the acquisition closed, and doing so in a manner that fits the company’s risk profile, minimizes liabilities, and satisfactorily meets any regulatory obligations. To get a transaction from exploratory conversations to a successful closing, a GC needs to assess how the legal team would support such a transaction and what type of external legal assistance would be required.

It starts with due diligence; every M&A transactional lawyer knows this. But for a small to midsize company GC, the first challenge before even tackling due diligence is figuring out the budget. How do you procure top-notch legal services to support this acquisition while obtaining value for money spent? Assuming the acquirer is not utilizing an investment bank or advisor, a relatively straightforward task such as coordinating review of a target company’s due diligence—often under significant time constraints—can be a daunting task. In-house legal teams of small to midsize companies rarely have personnel on staff with M&A expertise. Moreover, these teams are consistently stretched supporting a multitude of business areas and likely don’t have the resources to fully cover all the various phases of an acquisition.

Law firms are tremendous partners when it comes to advising on deal structures, negotiating sale and purchase agreements, asset purchase agreements, joint venture agreements, etc. They are similarly well-equipped to bring in specialists in the areas of tax, employment, executive compensation, benefits programs, litigation, real estate, and compliance investigations. However, their billable model can prove to be an obstacle for small to midsize companies to utilize their services for a comprehensive due diligence review. Legal technology vendors—particularly those that provide contract abstraction and summarization using AI technology—may be a significant help in many instances and can reduce hours spent manually reviewing applicable clauses in the target company’s commercial and operational contracts. While the software tools used for these abstractions do indeed drive efficiencies, teams of lawyers need to help manage these platforms and undertake certain administrative and operational tasks. Lawyers are also needed to utilize the insights to produce due diligence red flag memos and help pinpoint critical risks and liabilities. Law firms do often partner with legal technology vendors and offer these capabilities, but again, their billable model makes it challenging for many GCs to consider using them to assist in these areas.

Alternative legal service providers can help fill the void by operating at the intersection of the law firm and legal technology vendor. They can perform due diligence reviews and assist with post-closing planning and integration workstreams involving contract review, as well as provide end-to-end support with change of control notices and contract termination and assignment letters. ALSPs can provide a model utilizing quality legal support paired with AI technology to review thousands of contracts with significant cost savings. The buyer’s preferred law firm can take the diligence reports produced and drive negotiations of the deal documents to secure better terms for the buyer and shift the risk allocation appropriately.

The above outlines how law firms can work together seamlessly with ALSPs and legal technology vendors to add value, leveraging each of their strengths to avoid unexpected contract liabilities or other surprises. The glue that holds everyone together, however, is the in-house legal team. A critical component of a successful due diligence review and post-closing integration is having the right subject matter experts within one’s organization review the appropriate documentation and provide guidance as to risks. Departments such as finance, tax, marketing, operations, leasing, and compliance all have key roles to play within an M&A transaction, and these functions are vital to the success of the deal. Moreover, often small to midsize companies do not have formal corporate development or project management teams in place to coordinate deals because they do not have sufficient volumes of transactions to justify staffing them. In the event a buyer does not have such a team, or has limited resources in this area, the in-house legal team is called to step in and project manage diligence review, because very few other teams know the personnel working within these other corporate departments better than they do. The in-house team can help law firms and ALSPs get organized and coordinate among stakeholders. Small to midsize company GCs will find success if they can leverage resources within their in-house legal team to play a coordinator role should help be needed—and this institutional knowledge can be tapped into for any future deal that comes through the pipeline.

Beyond due diligence and negotiation of the deal, another area where the GC can help ensure the organization optimizes value associated with the acquisition is to ensure the legal teams are involved with post-closing planning and integration workstreams. This includes preparing, tracking, and executing termination and assignment notices with a host of suppliers, vendors, marketing agencies, distributors, and the like. Being proactive in this area allows the GC to save the company money right at the outset, which the CEO will undoubtedly appreciate. Reaching out to customers and key accounts and notifying them of new points of contact and the orderly assumption of those contractual relationships will surely make the organization’s sales and account teams happy that no customers are falling through the cracks following the acquisition. Lastly, harmonizing and integrating contract templates, workflows, and content of the acquired company’s contract lifecycle management (CLM) system will drive efficiencies across all business areas.

Pulling off a successful strategic acquisition is no small feat for any small to midsize company GC. Understanding when and how to leverage in-house legal resources and which services to engage from the ecosystem of external legal service providers will be instrumental to the GC getting the deal across the finish line while protecting the CEO’s reputation and the acquirer’s return on investment.

No industry seems untouched by the recent rise of union popularity. Recent examples include outdoor goods seller REI;^[1] the New York Times tech workers;^[2] Alphabet (parent company of Google);^[3] and more famously, retailer supergiant Amazon^[4] and coffee chain Starbucks.^[5] Several factors such as the current labor shortage, the Covid-19 pandemic, and high-profile union litigation gaining traction on social media have played crucial roles by increasing worker autonomy and contributing to one of the largest national labor movements seen in the U.S. in decades. While union membership has generally declined annually in the U.S. since 1983,^[6] labor action has not seen the same decline. Between October 2021 and March of 2022, union representation petitions filed at the National Labor Relations Board (“NLRB”) increased 57% from the same period in 2020–2021.^[7] Unique factors facing workers in recent years have caused a newfound rise of labor unions, a stark contrast to trends in recent decades.

According to data from the Bureau of Labor Statistics, a record 4.5 million U.S. workers left their jobs in November 2021,^[8] and more than 4 million workers left their jobs in every month from July 2021 through November 2021.^[9] Known as the “Great Resignation,” the ongoing event of record-breaking numbers of workers leaving their jobs has given workers the edge by creating a shortage in the labor market. In 2019, there was a high of approximately 7.5 million job openings in the United States; in 2021, there was a high of approximately 11.4 million.^[10] Possible causes of the labor shortage include wage stagnation, job dissatisfaction, burnout, and safety concerns related to the Covid-19 pandemic.^[11] The Covid-19 pandemic has driven workers to demand more from their employers—namely, better pay and better working conditions. According to Bloomberg Law’s database of work stoppages, in 2021, the final strike total reached 169, more than any year since 2012.^[12] Generally, periods of worker shortages give union members considerably more leverage as workers become harder to replace.^[13]

The social impact of the pandemic also significantly contributed to the recent spike in union involvement. In addition to accelerating the larger ongoing employee movement, the pandemic has brought work-life balance to the forefront. Further, according to a Gallup poll conducted in August 2021, 68% of Americans now approve of labor unions.^[14] Only 48% of Americans approved of labor unions in 2009, but the number has steadily increased since 2016 to reach the current highest reading measured since 1965.^[15] A recent CNBC survey found that a majority (59%) of U.S. workers across all industries indicated support for increased unionization in their workplaces.^[16] The recent uptick in labor union approval may at least partially be due to the rise of media coverage of unions. High-profile union victories that were widely reported on and broadcast on social media have assisted in increasing public awareness of the labor union movement. The first union win by employees at a Starbucks in Buffalo, New York, in December 2021 resulted in workers at 140 Starbucks in 27 states petitioning for unionization votes as of March, and today, well over 100 locations have unionized.^[17] Additionally, recently Amazon warehouse workers successfully voted to unionize an Amazon warehouse in Staten Island, New York City, NY.^[18] The historic vote came after workers at the the largest Amazon facility in Staten Island, which Amazon calls JFK8, formed an independent union called the Amazon Labor Union, which, despite the lack of ties to organized labor, succeeded in having its workers vote in favor of unionizing by a margin of almost 11 percent.^[19] Amazon is the second-largest private employer in the U.S. after Wal-Mart.^[20]

In addition to growing economic power and recent social support, the labor movement also may also flourish due to a newfound political support through the Biden Administration. For example, under the Biden Administration, in an advice memorandum released in May 2022, General Counsel of the NLRB Jennifer Abruzzo indicated that she would advise in future cases to broaden union access to public spaces.^[21] Notably, in a brief filed in April 2022 in Cemex Construction Materials Pacific, LLC, No. 28-CA-230115, General Counsel Abruzzo also advocated to reinstate the card majority rule set forth previously in Joy Silk Mills, 85 NLRB 1263 (1949), which would in most cases require employers to immediately recognize union status through the card majority rule rather than a drawn-out election.^[22]

Under the NLRB’s current standard that has been in place since it abandoned the Joy Silk standard in 1969, an employer presented with signed authorization cards indicating a union’s majority status is not required to recognize the union’s claim.^[23] Even though employers are free to recognize a union through signed authorization cards and without an election, employers frequently reject a union’s demand for recognition and instead insist on secret ballot elections.^[24] The elections also benefit employers by giving them the opportunity to lobby against unionization, and time for the union effort to lose momentum. Under Joy Silk, by contrast, in order to hold an election, an employer was required to establish a “good faith doubt” regarding the validity of the majority status; otherwise, the employer would be required to immediately recognize the union. Unions have long advocated for a card majority rule, and there is significant discussion of the impact reinstating Joy Silk would have on the prevalence of secret ballot elections.^[25] While some experts note that the reinstatement of Joy Silk would be unlikely to trigger the replacement of union elections altogether, others believe that, if sustained, the reinstatement may likely cause an increase in union organizing campaigns across the country, as unions will be able to take advantage of the newer, easier standard in recognizing union membership. ^[26]

Conclusion

While recent union wins fuel optimism for some labor activists, the Bureau of Labor Statistics reported in January that in 2021, just 10.3% of U.S. workers were in unions and just 6.1% in the private sector.^[27] Economists predict that despite the recent spike, overall, labor unions are still on the decline. One of the largest hurdles for unions is the decades of anti-union policy established in the United States.^[28] As noted above, unions need to win a highly contested election in order to have an opportunity for union representation. However, it is possible that the momentum of labor organizing continues in a significant way. A politically friendly climate, combined with skyrocketing employer profits, a tight labor market, general worker dissatisfaction, and the growth of social media attention directed towards labor organizing, has created an interesting opportunity for unions to gain lost ground from the last several decades of decline.

1. https://www.nytimes.com/2022/03/02/business/rei-union-new-york.html ↑

2. https://www.nytimes.com/2022/03/03/business/media/new-york-times-tech-union.html ↑

3. https://www.theverge.com/2021/1/25/22243138/google-union-alphabet-workers-europe-announce-global-alliance ↑

4. https://www.thecity.nyc/2022/4/1/23006509/amazon-warehouse-workers-union-win-staten-island ↑

5. https://www.forbes.com/advisor/investing/sbux-starbucks-union/ ↑

6. https://www.bls.gov/spotlight/2016/union-membership-in-the-united-states/pdf/union-membership-in-the-united-states.pdf ↑

7. https://www.cnbc.com/2022/05/07/why-is-there-a-union-boom.html ↑

8. https://www.bls.gov/news.release/jolts.t04.htm; https://www.nytimes.com/2022/01/04/business/economy/job-openings-coronavirus.html; https://www.cnbc.com/2022/01/04/jolts-november-2021-record-4point5-million-workers-quit-their-jobs.html ↑

9. https://www.bls.gov/opub/ted/2022/number-of-quits-at-all-time-high-in-november-2021.htm ↑

10. https://www.bls.gov/charts/job-openings-and-labor-turnover/opening-hire-seps-level.htm ↑

11. https://fortune.com/2021/08/26/pandemic-burnout-career-changes-great-resignation-adobe/ ↑

12. https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-striketober-fueled-q4-capped-huge-year-for-walkouts ↑

13. https://time.com/6107676/labor-unions/ ↑

14. https://news.gallup.com/poll/354455/approval-labor-unions-highest-point-1965.aspx ↑

15. https://news.gallup.com/poll/354455/approval-labor-unions-highest-point-1965.aspx ↑

16. https://www.cnbc.com/2022/06/02/majority-of-american-workers-want-more-unionization-at-their-own-jobs.html ↑

17. https://www.theguardian.com/us-news/2022/mar/16/us-union-victories-wave-labor-strategists; https://www.theguardian.com/us-news/2022/jun/14/starbucks-amazon-union-drives ↑

18. https://www.businessinsider.com/amazon-warehouse-new-york-staten-island-alu-union-nlrb-vote-2022-4 ↑

19. https://www.nytimes.com/2022/05/02/technology/amazon-union-staten-island.html ↑

20. https://www.usatoday.com/story/money/business/2019/03/30/largest-employer-each-state-walmart-top-us-amazon-second/39236965/ ↑

21. https://www.proskauer.com/blog/general-counsel-abruzzo-looks-to-overturn-board-precedent-again-this-time-seeking-to-broaden-union-access-to-public-spaces ↑

22. https://apps.nlrb.gov/link/document.aspx/09031d458372a363; https://www.jacksonlewis.com/publication/top-five-labor-law-developments-april-2022 ↑

23. https://www.natlawreview.com/article/nlrb-general-counsel-seeks-to-reinstate-radical-standard-union-recognition-and ↑

24. https://www.fordharrison.com/nlrb-general-counsel-seeks-to-limit-secret-ballot-elections-in-favor-of-union-recognition-based-on-card-count ↑

25. https://news.bloomberglaw.com/daily-labor-report/election-death-knell-unlikely-with-move-to-ease-union-organizing ↑

26. https://www.natlawreview.com/article/nlrb-general-counsel-pushes-to-skip-union-elections-reinstating-joy-silk-doctrine ↑

27. https://www.bls.gov/news.release/union2.nr0.htm ↑

28. https://www.piie.com/publications/chapters_preview/352/1iie3411.pdf ↑

Corporate counsel is often tasked with hiring outside counsel to handle important matters for the company. Finding highly specialized and talented lawyers to match up to the issues in a given case, on short notice, can be a challenge, especially when the corporation’s “go-to counsel” may not have the level of expertise required for a given matter. In narrowing down choices, corporate counsel should consider hiring a board-certified lawyer who has already been vetted for expertise and professionalism in a specialty area.

Board certification is administered by eight national private organizations with eighteen certification programs accredited by the American Bar Association. These private certification programs include specialty areas in bankruptcy, criminal trial advocacy, patent litigation, and complex litigation. Many state bar associations also administer board certification programs. For example, Florida has the largest number of certification specialty areas, at 27, which range from marital and family law to criminal law, construction, real estate, and workers’ compensation. Texas, California, North Carolina, and other states also have robust programs. There are approximately 28,000 lawyers in the United States who are board-certified specialists.

Selecting a board-certified lawyer provides an assurance of the lawyer’s expertise. Generally, all certifying programs require a lawyer to have practiced with substantial involvement in a specialty area for at least five years and to pass a rigorous examination testing their knowledge of the law in the specialty area. A board-certified lawyer must also be vetted by their peers for professionalism and ethics through a confidential peer review process. In addition, most candidates must satisfy a continuing education requirement in a designated specialty area. Typically, board-certified lawyers must apply to be recertified every five years and through that process, must demonstrate compliance with all board certification requirements.

Board-certified lawyers pride themselves on being up-to-date on current developments and legislation that impacts their legal specialties. For example, with constantly evolving business technologies and systems, lawyers who are board certified in Privacy Law by the International Association of Privacy Professionals (IAPP) are on top of emerging privacy legislation on state and global levels. In a legal landscape where, fewer cases are actually tried to verdict, lawyers board certified in Complex Litigation by the National Board of Trial Advocacy (NBTA) have, at a minimum, actively participated in one hundred contested matters, and NBTA lawyers board certified in Criminal Law have extensive jury trial experience and significant experience dealing with expert witnesses. Lawyers board certified in Business Bankruptcy Law by the American Board of Certification (ABC) must participate in at least thirty adversary proceedings or contested matters across a range of business areas. Thus, board-certified lawyers have focused legal acumen that is demonstrated and tested on a regular basis.

Selecting a board-certified lawyer has appeal for a number of other reasons beyond proven competency. First, board-certified lawyers have extensive experience in their jurisdiction and are familiar with local practices, the jury pool, and judges. Second, because these lawyers practice in a specific specialty area, they tend to know their colleagues on the opposing side. This type of knowledge and familiarity can be of assistance in amicably resolving disputes that could otherwise wind up in drawn-out, expensive litigation. Third, as board-certified specialists, these lawyers understand how to effectively manage the cost of litigation and can provide accurate budgets for use by in-house counsel when advising management. Finally, when faced with “bet the company” litigation, qualifications matter, and in-house counsel can sleep better at night knowing that board-certified counsel is capably acting in the best interest of the company.

At the very least, corporate counsel can use the board certification designation to narrow down the list of qualified candidates for consideration. On this point, corporate counsel should also consider consulting the American Bar Association Standing Committee on Specialization’s website for more information on board certification, specialty areas, and links to the national private organizations with ABA-accredited certification programs and states that run their own certification programs throughout the country. The ABA has been involved with board certification of lawyers for almost thirty years, and ABA accreditation is widely recognized as a valuable seal of approval for organizations conferring board certification. Additionally, the ABA has worked with states on incorporating ABA Model Rule 7.2 (formerly 7.4) into state ethics codes, and many states permit certified specialists to publicly disclose certification without any limitation if they are certified by a program that is accredited by the ABA.

Steven B. Lesser is a Shareholder at Becker & Poliakoff and Chair of the Firm’s Construction Law & Litigation Practice. Mr. Lesser is Florida Bar Board Certified in Construction Law and Chair of the American Bar Association Standing Committee on Specialization.