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.

Auto-renewing arrangements are more and more ubiquitous, from TV channel subscriptions to meal-kit delivery plans—and the regulators are interested. Late last year, the Federal Trade Commission (FTC) and California took actions with respect to auto-renewing subscriptions. The FTC issued a policy statement in October 2021, and California’s governor signed into law amendments to the state’s Automatic Renewal Law (ARL) that same month. California’s ARL amendments took effect in July 2022, so now’s a good time to survey where things stand and what’s to come for businesses offering auto-renewing products or services to California consumers.

What are auto-renewing products or services?

Sometimes called “negative options,” auto-renewing products and services refer broadly to a category of transactions in which sellers or providers interpret a consumer’s failure to take an affirmative step to either reject or cancel an offer as assent to be charged for products or services.

What is required by law now?

There are at least two federal statutes implicated by auto-renewing products and services. The first is the Unordered Merchandise Act (UMA), which provides that “the mailing of un­ordered merchandise … constitutes an unfair method of competition and an unfair trade practice” violative of the FTC Act. Under the UMA, recipients of unordered merchandise may treat it as an unconditional gift and may use or dispose of it as they see fit. Recipients also may simply refuse delivery. Because the UMA applies only to mailed “merchandise,” courts have interpreted its coverage to reach “goods, wares,” or “any tangible item held out for sale,” but not “intangible” items such as memberships or subscriptions.

The second federal statute is the Restore Online Shoppers Confidence Act (ROSCA), which applies to “negative option” transactions, defined as “an offer or agreement to sell or provide any goods or services, a provision under which the customer’s silence or failure to take an affirmative action to reject goods or services or to cancel the agreement is interpreted by the seller as acceptance of the offer.” Under ROSCA, if a business charges or attempts to charge any consumer for goods or services online through a negative option, it must: (1) clearly and conspicuously disclose the material terms of the transaction before obtaining billing information; (2) obtain the consumer’s express informed consent before charging the consumer; and (3) provide “simple mechanisms” for a consumer to stop recurring charges.

Although different from ROSCA, California’s ARL imposes similarly rigorous information, notice, and consent requirements on businesses that make auto-renewal or continuous service offers to California consumers.

If a business is using an auto-renewal or continuous service plan that the consumer must cancel to stop automatic charges, the business must:

1. present the offer terms in a “clear and conspicuous” manner;
2. obtain consumer’s affirmative consent before charging his or her credit card; and
3. provide an acknowledgment including auto-renewal offer terms, cancellation policy, and details on how to cancel, including a toll-free phone number, an email or postal address, or other “easy-to-use” means for cancellation.

Additionally, the ARL requires that if a material change in auto-renewal terms occurs, the business must “provide the consumer with a clear and conspicuous notice of the material change and provide information regarding how to cancel in a manner that is capable of being retained by the consumer.”

Like the federal UMA, California’s ARL provides that if a business sends merchandise or products to a consumer under an automatic renewal of a purchase or continuous service agreement without first obtaining the consumer’s affirmative consent, the merchandise or products are deemed unconditional gifts to the consumer, and the business must bear their entire cost.

What changed?

In October 2021, the FTC issued an enforcement policy statement regarding “negative option marketing,” and the California governor signed into law amendments to the state’s ARL.

While the FTC’s policy statement neither constitutes a new rule nor binds the agency or businesses, it does signal the FTC’s intention to use its existing tools, including ROSCA and the Negative Option Rule (16 CFR Part 425), to ramp up enforcement efforts against companies using negative options to deceive consumers. The policy statement provides businesses guidance—but mostly reminders—about what is expected, including “clear and conspicuous” disclosure of offer terms; “express” and “informed” consumer consent, which the FTC says is not satisfied with a “pre-checked box”; and a simple and easy way to cancel negative option agreements. The policy statement itself does not use the term “dark patterns”—a fashionable term with a somewhat indefinite definition, which seems to generally cover user-interface designs or software that coax consumers to take some action they otherwise would not have. However, the Director of the FTC’s Bureau of Consumer Protection specifically put on notice businesses that “deploy dark patterns and other dirty tricks” to “trap” consumers into subscription services.

Separately, California’s governor signed into law Assembly Bill No. 390, which amended the state’s existing ARL. Starting July 1, 2022, the amendments’ effective date, businesses that enroll California consumers into auto-renewing or continuous service subscriptions must not only continue to comply with the current ARL requirements but also begin providing additional notices and new cancellation options to customers.

Specifically, the ARL amendments stipulate that when a business enrolls a customer in a subscription with a free trial or gift, or an initial discount period that is longer than thirty-one days, the business must provide a written or electronic notice three to twenty-one days before the expiration of the applicable period. For subscriptions with an initial term of one year or longer, businesses will have to give written or electronic notice to California consumers in a retainable form fifteen to forty-five days before the renewal date. In both cases, the notice must provide in a clear and conspicuous manner: that the subscription term will automatically renew unless cancelled by the consumer; the length and any additional terms of the renewal period; one or more methods by which the consumer may cancel prior to renewal; and the business’s contact information. If a business otherwise would be subject to both notification requirements because it offers a plan with a free trial period longer than thirty-one days and an initial term of one year or more, it must comply with only the latter notice requirement—delivering a reminder notice fifteen to forty-five days before the renewal date.

In addition, the ARL amendments provide for “immediate” cancellation online. Under the current ARL requirements, if a California consumer accepts an automatic renewal offer online, the business must allow the consumer to cancel the offer exclusively online. The amendments are more prescriptive with respect to online auto-renewals, requiring that the consumer not only be able to terminate the offer “exclusively online,” but be able to do so “at will, and without engaging any further steps that obstruct or delay the consumer’s ability to terminate the automatic renewal or continuous service immediately.” The amendments further prescribe that the online termination method must be in the form of a “prominently located direct link or button” located within a customer account or profile, device or user settings, or an “immediately accessible termination email formatted and provided by the business that a consumer can send to the business without additional information.”

What now?

Now is probably a good time for businesses offering auto-renewal services or subscriptions to re-evaluate their related policies and procedures to ensure that they comply with ROSCA, California’s new ARL requirements, and other related state laws. And in light of the new ARL requirements, businesses might give special scrutiny to any multi-step consumer flows they require consumers to complete—such as taking customer satisfaction surveys, reviewing retention offers, or taking any other additional actions—before allowing them to cancel subscriptions or services. Neither plaintiffs’ bar nor regulators have been shy about enforcing the current ARL, which has been the source of numerous enforcement actions and multimillion-dollar settlements. There is no reason to think that will slow.

Many Americans are faced with repayment of outsized student loan debts. And, as each new class matriculates to college, they too join the ranks of those faced with the prospect of financing their education and repaying the amount borrowed over the course of their careers. With limited options for forgiveness and payment relief, many will struggle to repay for their college over a period of decades.

On the other hand, creditors and loan servicers face anxiety associated with collecting outstanding balances. They are tasked with complying with the Consumer Financial Protection Bureau’s new Debt Collection Rule and with navigating a regulatory environment where state attorneys general demonstrate an increased willingness to hold them accountable under state laws designed to curb deceptive acts and practices.

The Growing Problem

Many students now use student loans to pay for their college education. While these programs provide resources for students to achieve their goals of attending college, debt-saddled graduates struggle to make ends meet as they begin their careers. Increasing enrollment and a cost of education that well outpaces the growth of median household incomes means that these financial struggles are going from endemic to pandemic. These factors, further magnified by inflationary concerns, are fueling a public dialogue about how the nation is to confront this most rapidly growing sector of consumer debt.

Student loans can generally be of one of two types: private loans and federally-backed loans. Relief options for private loans, if any exist, are limited to those the loan servicer is willing to offer and vary by lender. Federal loans, on the other hand, present some unique characteristics. First, they come with a suite of repayment options, including include income-driven or income-based repayment options. Simply put, these programs derive the amount of the monthly payment on a loan from a borrower’s income (recertified annually) rather than on a traditional amortization schedule. Some of these programs offer loan forgiveness after completion of a set number of payments regardless of the amount of the unpaid balance (although a lingering problem remains in that a 1099 form may be issued for forgiven amounts, resulting an unwieldy amount of taxable income being reported for a borrower). One drawback to federal loans, however, is that the interest rate is set from inception and there is little ability to lower it absent refinancing into a private student loan—thereby losing the relief options available in the federal loan.

Another key feature of student loans is their (lack of) dischargeability. While federal loans do discharge upon proof of death, private loans do not. Moreover, neither private nor federal student loans are regularly dischargeable in bankruptcy. Indeed, 11 U.S.C. § 523(a)(8) provides only a limited exception for circumstances where lack of a discharge would impose an “undue hardship.” Courts have grappled with how to frame an “undue hardship.” One commonly used test, the Brunner test, looks to factors such as (1) a debtor’s ability to maintain a “minimal” standard of living if forced to repay the loan, (2) circumstances indicating that a state of affairs will continue for the life of the loans, and (3) a good faith effort to repay the loans.

More recently, courts have criticized the Brunner test as overly harsh and instead offered a more debtor-friendly analysis in considering whether failure to discharge student loans would cause an undue hardship. While borrowers may rejoice at recent overtures by courts expressing willingness to discharge loans in bankruptcy, it only compounds creditors’ frustrations in trying to collect amounts due.

Recent Relief Efforts

As part of the COVID-19 pandemic relief, payments and interest on federal student loans have been paused since March 2020. Interestingly, each passing month counts toward the number of payments to be made before loan forgiveness for those on Income Driven Repayment plans. Private student loans, however, are not affected by the pause, and payments under those programs continue to be required.

Another commonly discussed student loan relief program is the Public Service Loan Forgiveness (PSLF) program. Similar to income-driven plans, PSLF provides the opportunity for borrowers to obtain forgiveness for the balance of their federal loans after making a certain number of payments. PSLF is unique, however, in that the payment period is shorter, the forgiveness is excepted from being taxable income, and qualification is based upon employment in a public service role. And, in October 2021, the US Department of Education has provided the opportunity for borrowers to receive credit for past periods of repayment that would not have otherwise been counted toward loan forgiveness under PSLF.

Finally, an additional significant wave of student loan relief exists for borrowers who attended schools which subsequently closed. The recent relief efforts for these borrowers extends beyond students who attended classes within 120 days of closure who already had been eligible for discharge and is related to the deception on the part of the closed institutions.

Collection Issues Abound

Confronted with new loan forgiveness programs, changes in attitudes toward discharge, and political uncertainty about broader relief efforts, student loan lenders and servicers face an increasingly difficult climate. In collecting loans, servicers also must be careful to monitor new regulations, including the CFPB’s new Debt Collection Rule. Effective in November 2021, the Debt Collection Rule was created to implement the Fair Debt Collection Practices Act (FDCPA), focusing on debt collection communications, harassment or abuse by debt collectors, false or misleading representations, and unfair practices.

State attorneys general also have shown a recent inclination to police improper actions by student loan servicers and to levy penalties for such actions. For example, 39 state attorneys general announced a $1.85 Billion Settlement with student loan servicer Navient in January 2022 for practices that steered borrowers into forbearance rather than toward available payment relief programs like income-driven repayment. This settlement and the implementation of the FDCPA through the Debt Collection Rule should serve as a weathervane indicating a change on both the federal and state levels, and must be carefully monitored.

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.

“The Rule of Law and the Importance of Disabled Voices in the Legal Profession” is the tenth article in a series on intersections between business law and the rule of law, and their importance for business lawyers, created by the American Bar Association Business Law Section’s Rule of Law Working Group. Read more articles in the series.

The Law involves a great amount of problem-solving.^[1] “The Rule of Law comprises a number of principles of a formal and procedural character”^[2] that guide this problem-solving process. These “formal principles concern the generality, clarity, publicity, stability, and prospectivity of the norms that govern a society.”^[3] The Rule of Law, therefore, is essentially a framework for problem-solving that works to ensure more stable, predictable, and fair rules. However, stable, predictable, and fair—for whom?

There is universal agreement that the principle of equality before the law is a key component of the Rule of Law framework. Questions and conflicts abound, however, about what equality means and how it is to be achieved. Most people know that advancing the rule of law is a part of the American Bar Association’s mission. However, not many lawyers fully understand how (and even whether) including diverse voices within the legal profession advances the Rule of Law. This article gathers some perspective on the importance of empowering lawyers with disabilities, collected from the leadership of the ABA Business Law Section. It focuses on why and how including diverse voices in the legal profession, especially voices of people with disabilities, advances the rule of law.

Juan M. Sempertegui is a former chair of the BLS Lawyers of Color Subcommittee and a former president of the Hispanic Bar Association of the District of Columbia. When speaking of the importance of representation of people with disabilities within the legal profession, Mr. Sempertegui affirms that “so much about a lawyer’s job is to solve problems.” He notes that “how you solve those problems is based on your perspective towards the issues at hand. Someone with a disability, for example, has a new perspective; they look at issues and products in a different way than someone without a disability.” Moreover, Mr. Sempertegui has found that the differences in perspective held by individuals with disabilities grant them a unique problem-solving ability that is of great importance to the legal field.

Anat Maytal, a former chair of the Lawyers with Disabilities Subcommittee, views such inclusivity as benefiting not only clients, by creating a wider range of perspectives, but also fellow attorneys. Primarily she affirms that the experiences of people with disabilities contribute different, and necessary voices in the law. People who face disabilities, whether they have experienced them from birth or a young age, or have had to come to terms with them later in life, “[w]e have been exposed to many more situations where we have to deal with obstacles, where we have to advocate for ourselves, and find new solutions.” As a result, “one thing we bring to the table is that we face so many challenges and overcome them by figuring out what kind of workarounds we can get. We persevere.”

Ms. Maytal points out that in the legal field, things are not always going to go as planned. The opposing counsel is going to come at you with things you may not have anticipated, and you need to be able to think on your feet; you need to know that the normal way of doing things isn’t going to work. “For the disabled community, the regular way has never worked, so we always had to think, what’s another way that we can make this happen? You need that voice.” Furthermore, Ms. Maytal describes personal anecdotes where accommodations put in place by the disabled community also benefit able-bodied lawyers. For example one accommodation she requests in court is to have real-time captioning, or transcription of what is being said in real time. She explains that “the accommodations that we are talking about now, a lot of people who are not disabled appreciate for themselves. People who are able-bodied tell me ‘thank you’” for making them aware of those accommodations, she says, and sometimes even request it for themselves.

Ms. Maytal continues, “The pandemic has really done a lot of things for people who practice law and have disabilities, with getting people accommodations they need. If you have a mobility issue, you would still be required to come into the office… if you had a hearing disability, like me, you still had to shift to Zoom. At first, I thought it would be challenging, and it is, but I learned very quickly that I actually excel on this kind of platform where I can see everyone’s faces. On Zoom only one person can talk at a time. So, I am less likely to miss what is being said. I use Bluetooth, so I am able to hear everything directly through my hearing aid. Everything that I would want in a situation where I’m talking to a lot of people at once is right there, on Zoom, for me,” enabling a more even playing field.

Patrick T. Clendenen, of Clendenen & Shea, LLC, recognizes the importance of representation of the voices of people with disabilities within the legal profession, particularly through his work as a former BLS Chair. He notes that “the most poignant experiences that I have had around my efforts with Diversity, Equity, and Inclusion have been through my leadership in the ABA Business Law Section and seeing young lawyers—who have varying experiences—start out as fellows and blossom into full-blown Business Law Section leaders.” When speaking of the importance of Diversity, Equity, and Inclusion, he remarks, “Diversity should be viewed in the broadest possible perspective. Diversity builds its own community organically—you see your own work environment more broadly and work that new perspective into the way your clients see the world. It is important for legal service organizations to reflect the experiences and perspectives of the people that they serve. Diversity, particularly with respect to disability, builds innovation and creativity. A lot of people with disabilities have to think in different ways to solve problems including basic problems that most people don’t have to think about. Whether it’s seeing, hearing, testing their blood sugar, or getting around from place to place, so many aspects of daily life require building resilience. The resilience that different voices build within an organization gives an organization better results. Diversity brings more perspective to the table and increases an organization’s ability to solve problems because people come at things in different ways as they have encountered different things in their day-to-day lives, which is extremely valuable to legal service organizations.”

Given the strong connection between diverse voices within the legal profession and the ABA’s mission of advancing the Rule of Law, the BLS DEI Committee has worked to push the conversation on what a more inclusive legal profession might look like. The mission of the BLS’s DEI Committee is to lead the BLS’s efforts to recruit and retain (i) lawyers of color, (ii) women lawyers, (iii) lawyers with disabilities, (iv) gay, lesbian, bisexual, and transgender lawyers, (v) young lawyers, and (vi) law students (“Diverse Lawyers”) for active involvement in the work and leadership of the BLS. This approach is accomplished through four subcommittees: (1) Lawyers of Color Involvement, (2) Lawyers with Disabilities Involvement, (3) Lesbian, Gay, Bisexual and Transgender Involvement, and (4) Women’s Business Law Network.

The four subcommittees listed above meet jointly during the BLS meetings to demonstrate to the legal profession the benefit of an inclusive approach and the common experiences shared by business lawyers with different experiences. The shared approach is enhanced through joint meetings that show the legal profession that characterizing a person using one narrow characteristic fails to capture the entire person. Through these and other activities, BLS actively works to unlock talent and perspectives that value active involvement of diverse lawyers in the work and leadership of the BLS. Outreach is accomplished by insisting on a diversity of voices and viewpoints, including from first-generation lawyers, first-generation college students, lawyers of color, lawyers with disabilities, women lawyers, LGBTQ+ lawyers, and other diverse attorneys in BLS work and leadership. The key effort is also to go beyond these labels and to recognize that we all exist in and across our differences—and this tapestry of difference is what creates a vibrant, engaged, responsive, and stable legal community.

Finally, while there is much work to be done with respect to making the legal profession a community capable of holding and valuing diverse voices, this work will be left unfinished if law schools—the training grounds for our future colleagues—are not prepared to change how they see (and what they expect from) their entering first-year law students. The Paper Chase stereotype of law school as a cutthroat rat race where only the fittest survive continues to impact how law schools are run, how law students are trained, and what they are told about what this profession expects from them. The pipeline of talent that builds the legal profession, therefore continues to be at risk—when a “Paper Chase culture” lifts only certain kinds of voices.

It is only years after law school that many of us start to learn that the legal profession can also be a space of friendship, cooperation, mutual accommodation, and courtesy. Today, these values are most clearly reflected in those arenas where the legal profession provides its most healthful and meaningful contributions. So, why are we still training our lawyers on a model that we know will no longer serve them?

People with disabilities have had the right to a free and equal education since 1975, with the passing of the Education for All Handicapped Children Act. “The law opened the doors for those students to receive accommodations throughout their education.”^[4] In 1990, Congress passed the Americans with Disabilities Act that prohibits discrimination against people with disabilities in all areas of public life, providing people with disabilities the right to accommodations in school and work settings such as legal offices. However, the advancements in the law and the rights they create have yet to be fully realized, as disabled lawyers struggle, from the first day of law school onwards, for a space in the legal profession.

A 2019 article in the Yale Daily News provides several examples of how by design, even the most thoughtful law school activities can leave out disabled law students. Sarah Huttenlocher, a 2021 graduate, describes that challenge she faced with the no laptop policy in first-year lectures because her attention deficit hyperactivity disorder and Tourette’s syndrome, in addition to Ehlers-Danlos syndrome, made it difficult for her to sit still and focus for hours in large lecture classes: “When her attention begins to slip, it makes her body feel ‘intense,’ which causes her to ‘tic,’ or produce compulsive motions, such as nodding her head or moving her shoulders. When that happens in class, she tries to make the tic inconspicuous, but she fears other students will notice.” Her ability to focus in her first-year classes might have been improved if she could play a simple computer game, which in the past had “relieved some of her hyperactive impulses in other classroom settings.”^[5]

The article recognizes that “[s]tudents with mental illness in particular face discrimination for their disability and might be afraid to disclose it,” and the traditional approach to legal education is not suited to affording discreet accommodations. While professors “are not supposed to know which students receive testing accommodations for what disabilities…they might need to know a student’s disability if a reasonable accommodation is required, such as refraining from randomly calling on the student during class.”^[6] It should come as no surprise that the classic law school right of passage, the cold call, does not necessarily bring the best out of the brightest, as it might pose difficulties for students who have trouble focusing because of an anxiety disorder or a learning disability. The common answer that law schools provide in persisting with these methods is that they are preparing their students for the real world, for offices, courtrooms, and other settings that will not accommodate them. And this is a hard argument to defeat.

Ultimately, law schools are designed to ensure that the students who graduate find suitable employment—and business lawyers and their firms are the most prominent, powerful, and aspirational employers for most law schools. These same groups also hold considerable influences over both the bench and the bar. By changing the expectations within the profession of the profile of a “successful” law student, by valuing diverse voices and rewarding the kind of creativity and perseverance it takes to make it through an institution that was designed against you—by helping to build a professional environment that celebrates and champions difference, the business law community can have a significant impact on the texture of the legal profession and the structure of legal education, for years to come.

In so doing, they also uphold the rule of law because ensuring a variety of voices within the profession bolsters the necessary work of achieving—for individuals, firms and for the profession at large—the highest quality framework for legal problem-solving.

1. Thanks to Sophia Stoute for her support in conducting interviews and for research support. ↑

2. Jeremy Waldron, “Rule of Law” Stanford Dictionary of Philosophy, available at https://plato.stanford.edu/entries/rule-of-law/ ↑

3. Id. ↑

4. Sara Tabin, “Thinking Differently,” Yale Daily News, May 19, 2019 https://yaledailynews.com/blog/2019/05/19/thinking-differently/ ↑

5. Id. ↑

6. Id. ↑

Although Elon Musk’s offer to acquire Twitter is still garnering headlines, another “going private” development also merits attention: Meade v. Christie,^[1] an Iowa Supreme Court decision dismissing shareholder class action claims against directors who approved a going private merger. The Meade dismissal was based on a director liability shield patterned on the Model Business Corporation Act (“MBCA”) template. As interpreted and applied in Meade, the MBCA shield is more protective than the comparable Delaware provision. Equally important, Meade answers procedural questions that aren’t fully resolved by the MBCA shield text, illustrating key pleading requirements for corporate litigants when director shield defenses apply.

The MBCA Director Liability Shield

The Iowa director shield statute at issue in Meade, sometimes also called a “director raincoat,” is patterned on MBCA Section 2.02(b)(4), which authorizes corporations to include in their articles of incorporation:

[a] provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take action, as a director, except liability for any of the following: (i) the amount of a financial benefit received by a director to which the director is not entitled; (ii) an intentional infliction of harm on the corporation or the shareholders; (iii); a violation of section 8.32 [a provision limiting distributions to shareholders when the corporation would become insolvent as a result]; or (iv) an intentional violation of criminal law.^[2]

These or similar shield laws, in effect in nearly every state, are designed to allow corporate directors to take business risks without worrying about negligence lawsuits. Directors are poor risk-bearers, the argument goes; their role is to manage the corporation, not to insure against losses.

Exceptions from Exculpation, Including “Intentional Infliction of Harm”

Although raincoat provisions protect directors from damage claims for ordinary “due care” violations, listed exculpation exceptions in shield laws prevent corporations from sheltering directors from damage exposure for more serious misconduct. And the Iowa director liability shield, like its MBCA counterpart in effect in at least 20 states, forbids exculpation for claims based on “intentional infliction of harm on the corporation or the shareholders.”^[3] A key holding in Meade is that this exception does not encompass claims against directors for “conscious disregard” or “intentional dereliction” of duty, an issue no appellate court in Iowa—and no reported opinion from any state that has adopted the MBCA director liability shield—had previously considered.

“Conscious Disregard” and “Intentional Dereliction of Duty” Distinguished

To put the interpretative issue in context, Delaware’s shield law forbids exculpation of directors for “acts or omissions not in good faith or which involve intentional misconduct.”^[4] In 2006, the Delaware Supreme Court, construing the “not in good faith” portion of this exclusion in In re Walt Disney Co. Derivative Litigation, stated that non-exculpable acts include both “conduct motivated by an actual intent to do harm” (subjective bad faith) as well as lesser forms of bad faith, like a director’s “conscious disregard for … responsibilities” or “intentional dereliction of duty.”^[5]

The distinctions drawn in Disney proved critical to the Iowa Supreme Court’s interpretation of the “intentional infliction of harm” shield exclusion in Meade. Reversing the trial court ruling that the Iowa shield law excluded claims for “conscious disregard” or “intentional dereliction” of duty, the Iowa Supreme Court noted: “In contrast to Delaware’s statute, Iowa’s director shield statute includes no exception enabling liability for ‘acts not in good faith.’”^[6] And as the court recognized, it is the “not in good faith” exclusion that forms the statutory predicate for the “conscious disregard” and “intentional dereliction of duty” shield exceptions Disney and other Delaware decisions have recognized.

The Meade court also found support in the MBCA’s Official Comments discussing the “intentional infliction of harm” standard, which the court quoted:

The use of the word ‘intentional,’ rather than a less precise term such as ‘knowing,’ is meant to refer to the specific intent to perform, or fail to perform, the acts with actual knowledge that the director’s action, or failure to act, will cause harm … .^[7]

Applying this standard to the alleged director misconduct in Meade, the Iowa Supreme Court concluded that the allegations in Meade’s petition were “insufficient”:

The bulk of the allegations … recite failures to perform duties or incompetent performance, none of which suffices. … The statute, in short, requires a plaintiff to show a director’s specific intent to harm the corporation or its shareholders, as opposed to recklessness or dereliction in performing (or failing to perform) their duties.^[8]

Policy Justifications for Meade’s Interpretation

In this Author’s view, the Iowa Supreme Court properly recognized that the intent standard contemplated by the MBCA’s “intentional infliction of harm” exception is more protective of directors than Delaware’s “not in good faith” standard. The latter, like corporate and securities law scienter standards generally, can be satisfied by a showing of recklessness or conscious disregard on a director’s part.^[9] The MBCA drafters, however, crafted the statute’s director raincoat in Section 2.02(b)(4) with the Delaware shield law as an obvious model but omitted the “not in good faith” exception and a similarly broad Delaware exclusion for director “duty of loyalty” violations. As one commentator has explained, the apparent concern was that creative litigants could easily re-cast claims based on honest errors in director oversight or decision-making (appropriately exculpable duty of care claims) as breaches of open-ended duties like good faith or loyalty.^[10]

And in MBCA jurisdictions, there is good reason to draw exculpation lines precisely. To the extent Delaware shield exceptions are vague or ambiguous, a constant stream of corporate litigation in chancery and appellate courts will inevitably clarify the contours of director exculpation. Outside of Delaware, however, few director liability claims are litigated, and even fewer reach appellate courts. If director exculpation is to achieve its intended purpose in these jurisdictions—to provide flexibility for director decisions without unreasonable liability risks—clear lines are needed.

Critically, director exculpation does not remove director decisions from judicial scrutiny in going private merger litigation. Such cases also typically include claims against controlling shareholders for failure to pay “fair value” for the public share stake. Under Delaware’s MFW decision, courts review the merger terms with business judgment deference, but only if disinterested and independent directors properly approved the transaction and provided appropriate disclosure when obtaining disinterested shareholder approval.^[11] In MBCA jurisdictions, Section 13.40(b)(3) requires similar approval by independent directors and by informed, disinterested shareholders before appraisal remedies become exclusive, or nearly so, for “interested shareholder” transactions.^[12] Shielding directors from liability will encourage their participation in the authorized disinterested approval processes. The controlling shareholder, who potentially benefits from any failure by directors to carry out appropriate measures, can remedy any process defects by proving the terms of the merger transaction were fair.

Key Procedural Rulings, Including a New “Heightened Pleading” Standard for Shield Exclusions

Meade is also noteworthy for novel procedural issues the Iowa Supreme Court addressed concerning the MBCA raincoat provision. In Delaware, directors must plead and prove the applicability of a liability shield as an affirmative defense,^[13] while in MBCA states like Iowa, a shareholder or corporate plaintiff who seeks damages from directors must establish that no shield defense “precludes liability.”^[14] Meade helpfully clarifies that, despite this proof burden, plaintiffs aren’t required to initially plead one or more shield exceptions when suing corporate directors because the MBCA expressly requires directors to “interpose” a shield defense.^[15] But the Iowa Supreme Court confirmed that directors can interpose the shield defense in a motion to dismiss prior to filing an answer. That ruling is significant because, as Meade also holds, once corporate directors have “interposed” a shield defense, an opposing corporate litigant must allege an applicable shield exception through “heightened” pleading.^[16] What does that mean?

In federal court, where heightened pleading rules have traditionally applied in certain civil cases, judges require pleading with “particularity” or “specificity”—a detailed “who, what, when, where, and how” description establishing all necessary elements of a claim.^[17] But as applied by the Iowa Supreme Court in Meade, heightened pleading in director litigation apparently entails something less demanding: the court must evaluate whether the corporate or shareholder plaintiff pled facts showing claims against directors that fall within one of the MBCA’s exceptions to exculpation. Meade’s petition did not show the directors’ “specific intent to harm the corporation or its shareholders,” the court held, but only “failures to perform duties or incompetent performance, none of which suffices.”^[18] If all the petition’s allegations show there is no such claim, the Meade court concluded, the case can be dismissed even before discovery begins.^[19]

The heightened pleading standard Meade endorses is, without question, more onerous than traditional state court “notice” pleading requirements that permit most cases to reach the discovery phase. But the MBCA shield exceptions are narrowly drawn, and corporate litigants have access to information about potential director misconduct from corporate and securities law sources outside of litigation discovery. And as the Meade court acknowledged, by protecting directors not only from paying damages, but also from the burdens of pretrial litigation over shielded claims, the new pleading standard advances the purpose of raincoat provisions: to reduce fiduciary litigation risks for directors and thereby encourage board service. If other MBCA jurisdictions embrace Meade’s procedural template, the “director raincoat” moniker might need to change—director “slicker suits” perhaps?

Professor Doré has authored an expanded version of this article that will be published in a forthcoming issue of the Drake Law Review. A copy of that article is currently available on SSRN.

Matthew G. Doré, Richard M. and Anita Calkins Distinguished Professor, Drake University Law School.

1. Meade v. Christie, 21-0098 (Iowa Sup. Ct., May 27, 2022). ↑

2. MODEL BUS. CORP. ACT § 2.02(b)(4) (2016). The comparable Iowa provision is IOWA CODE § 490.202(2)(d). ↑

3. States using the MBCA model director shield language, or something quite close to it, include Alabama, Arizona, Colorado, the District of Columbia, Hawaii, Idaho, Iowa, Maine, Michigan, Mississippi, Montana, Nebraska, New Hampshire, South Dakota, Utah, Vermont, Washington, West Virginia, Wisconsin, and Wyoming. ↑

4. DEL. CODE ANN. TIT. 8 § 102(b)(7). ↑

5. In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 62-68 (Del. 2006) (emphasis supplied). ↑

6. Meade v. Christie, 21-0098, *17 (Iowa Sup. Ct., May 27, 2022). ↑

7. Id., citing MODEL BUS. CORP. ACT § 2.02, cmt. E. (2016). ↑

8. Id. ↑

9. See Matrixx Initiatives, Inc. v. Siracusano, 536 U.S. 27, 48 (2011). ↑

10. See Bryn R. Vaaler, 2.02(B)(4) Or Not 2.02(B)(4): That is the Question, 74 LAW & CONTEMP. PROBS. 79, 83-84 (2011). ↑

11. Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). ↑

12. MODEL BUS. CORP. ACT § 13.40(b)(3). ↑

13. See, e.g., Emerald Partners v. Berlin, 726 A.2d 1215, 1224 (Del. 1999). ↑

14. MODEL BUS. CORP. ACT § 8.31(a)(1)(i) (2016); IOWA CODE § 490.831(1)(a)(1). ↑

15. Meade v. Christie, 21-0098, *12-14 (Iowa Sup. Ct., May 27, 2022). ↑

16. Id. at *18-19. ↑

17. Summerhill v. Terminix, Inc., 637 F.3d 877, 880 (8^th Cir. 2011). ↑

18. Meade, 21-0098, *18 (Iowa Sup. Ct., May 27, 2022). ↑

19. Id. at *19-20. ↑

On June 16, 2022, Canada’s Minister of Innovation, Science and Industry (“Minister”) tabled the Artificial Intelligence and Data Act (the “AI Act”), Canada’s first attempt to formally regulate certain artificial intelligence systems as part of the sweeping privacy reforms introduced by Bill C-27.^[1]

The avowed purpose of the AI Act stems from a desire to regulate certain types of AI systems and ensure that developers and operators of such systems adopt measures to mitigate various risks of harm and avoid biased output (as such term is defined in the Act).^[2] The AI Act also establishes prohibitions related to the possession or use of illegally obtained personal information for the purpose of designing, developing, using or making available for use an AI system if its use causes serious harm to individuals.

The AI Act applies to artificial intelligence data processors, designers, developers, and those who make available artificial intelligence systems that are designated by regulation (to follow) as “high-impact systems.” The AI Act broadly defines an “artificial intelligence system” as a technological system that, autonomously or partly autonomously, processes data related to human activities through the use of a genetic algorithm, a neural network, machine learning, or another technique in order to generate content or make decisions, recommendations, or predictions.

Interestingly, the proposed AI Act does not apply to various Canadian federal government institutions or their AI systems, including products, services, or activities that are under the direction or control of certain Canadian government departments, including:

1. the Minister of National Defence;
2. the Canadian Security Intelligence Service, Canada’s domestic intelligence agency;
3. the Communications Security Establishment (Canada’s equivalent organization to the NSA); or
4. other federal or provincial departments or agencies as will be further defined in the regulations.

Under the AI Act, a person (which includes a trust, a joint venture, a partnership, an unincorporated association, and any other legal entity) who is responsible for an AI system must assess whether an AI system is a “high-impact system.” Any person who is responsible for a high-impact system then, in accordance with (future) regulations, must:

1. Establish measures to identify, assess, and mitigate risks of harm or biased output that could result from the use of the system (“Mitigation Measures”);
2. Establish measures to monitor compliance with the Mitigation Measures;
3. Keep records in general terms of the Mitigation Measures (including their effectiveness in mitigating any risks of harm/biased output) and the reasons supporting whether the system is a high-impact system;
4. Publish, on a publicly available website, a plain language description of the AI system and how it is intended to be used, the types of content that it is intended to generate, and the recommendations, decisions, or predictions that it is intended to make, as well as the Mitigation Measures in place and other information prescribed in the regulations (there is a similar requirement applicable to persons managing the operation of such systems); and
5. As soon as feasible, notify the Minister if use of the system results or is likely to result in material harm.

It should be noted that “harm” under the AI Act means physical or psychological harm to an individual; damage to an individual’s property; or economic loss to an individual.

If the Minister has reasonable grounds to believe that the use of a high-impact system by an organization or individual could result in harm or biased output, the Minister has a variety of remedies at their disposal, including:

1. Ordering persons responsible for AI systems (i.e. designers, developers or those who make available for use the artificial intelligence system or manage its operation) to provide records as described above;
2. Conducting an audit of the proposed contravention or engage the services of an independent auditor to conduct the audit (and the person who is audited must provide the Minister with the audit report and pay for the audit);
3. Ordering persons responsible for AI systems to implement measures to address anything referred to in the audit report; and
4. Ordering persons responsible for AI system to cease using it or making it available for use if the Minister has reasonable grounds to believe that the use of the system gives rise to a serious risk of imminent harm.

Seeking to balance the desire for increased transparency regarding artificial intelligence systems (and avoid the so-called “black box” phenomenon) against protecting/promoting business interests, the Minister can also order the publication of certain information regarding the AI system but is not allowed to publish the confidential business information of a person and the Minister must take measures to maintain the confidentiality of persons’ business confidential information.^[3]

That being said, the AI Act contains a number of exemptions that allows the Canadian Federal Government to share and disclose confidential business information regarding a particular AI system, including with specific government departments (including the federal Privacy Commissioner and the Canadian Human Rights Commission) and provincial counterparts. Additionally, the Minister may publish information related to an artificial intelligence system on a publicly available website, without the consent of the person to whom the information relates and without notifying that person, if the Minister has reasonable grounds to believe that the use of the system gives rise to a serious risk of imminent harm; and the publication of the information is essential to prevent the harm. The AI Act again provides that no confidential business information can be published through this method.

In keeping with the other reforms proposed under Bill 27, the AI Act introduces very stiff penalties for non-compliance, which are much higher than those currently available in Canada. Firstly, there will be administrative monetary penalties (“AMPs”) that will be levied for non-compliance, but the amounts for these will be determined under forthcoming regulations (the AI Act notes that the purpose of AMPs is “to promote compliance with this Part and not to punish”).

The AI Act also imposes fines for persons who violate Sections 6-12 of the Act (which contains obligations related to assessment, monitoring mitigation activities, etc. discussed above) or who obstructs—or provides false or misleading information to—the Minister, anyone acting on behalf of the Minister, or an independent auditor in the exercise of their powers or performance of their duties or functions. If the person is an individual, the person is liable on conviction on indictment to a fine at the court’s discretion, or on summary conviction to a fine of up to $50,000 CAD. If the person is not an individual, the person is liable on conviction on indictment to a fine of up to the greater of $10 million CAD or 3% of the person’s gross global revenues in its financial year before the one in which the person is sentenced. On summary conviction, a person that is not an individual is liable to a fine of up to the greater of $5 million CAD or 2% of the person’s gross global revenues in the person’s financial year before the sentencing.

The AI Act also establishes general offences regarding AI systems for misuse of personal information (which is defined under Bill C-27 as “information about an identifiable individual”).

A person commits an offence if, for the purpose of designing, developing, using, or making available for use an artificial intelligence system, the person possesses or uses personal information, knowing or believing that the information is obtained or derived, directly or indirectly, as a result of the commission in Canada of an offence under an Act of Parliament or a provincial legislature; or an act or omission anywhere that, if it had occurred in Canada, would have constituted such an offence.

Moreover, it is also an offence if the person, without lawful excuse and knowing that or being reckless as to whether the use of an artificial intelligence system is likely to cause serious physical or psychological harm to an individual or substantial damage to an individual’s property, makes the artificial intelligence system available for use and the use of the system causes such harm or damage; or with intent to defraud the public and to cause substantial economic loss to an individual, makes an artificial intelligence system available for use and its use causes that loss.

Every person who commits an offence under the above provisions of the AI Act risks even more severe fines and possible jail time. If the person is an individual, the person is liable on conviction on indictment to a fine at the court’s discretion or imprisonment up to five years less a day, or both. If the person is not an individual, the person is liable on conviction on indictment to a fine of up to the greater of $25 million CAD or 5% of the person’s gross global revenues in the person’s financial year before sentencing. If the person is an individual, the person is liable on summary conviction to a fine of up to $100,000 CAD or imprisonment up to two years less a day, or both. If the person is not an individual, the person is liable on summary conviction to a fine of up to the greater of $20 million CAD or 4% of the person’s gross global revenues in the person’s financial year before sentencing.

While drafted at a high level with much detail to follow in forthcoming regulations, there is no doubt that the AI Act represents an absolute sea change in the proposed regulation of certain artificial intelligence systems in Canada. Until now, there has not been any attempt to have a targeted statute focusing on the mitigation of bias in Canadian artificial intelligence systems per se and to date, Canadians have instead relied on a patchwork of existing privacy, human rights, and employment legislation and various ethical guidelines and model codes established by diverse institutions, such as the Montreal Declaration for a Responsible Development of Artificial Intelligence spearheaded by the Université de Montréal,^[4] to protect their interests. While the AI Act is currently only in its first reading, this Act represents a significant change in how Canadian developers and operators of certain AI systems must begin to proactively address certain harms and unintended consequences that this dynamic technology may inadvertently bring or otherwise face significant consequences.

1. An Act to enact the Consumer Privacy Protection Act and the Personal Information and Data Protection Tribunal Act and to make consequential and related amendments to other Acts, also known as the Digital Charter Implementation Act, 2022 (First Session, Forty-fourth Parliament, 70-71 Elizabeth II, 2021-2022, First Reading, June 16, 2022). Bill 27 is comprised of three parts: Part 1 will enact the Consumer Privacy Protection Act and is intended to repeal Part 1 of Canada’s federal private sector Personal Information Protection and Electronic Documents Act; Part 2 will enact the Personal Information and Data Protection Tribunal Act, which establishes an administrative tribunal to hear appeals of certain decisions made by the federal Privacy Commissioner under the Consumer Privacy Protection Act; and Part 3 will enact the Artificial Intelligence and Data Act. ↑

2. The AI Act defines “biased output” to mean content that is generated, or a decision, recommendation or prediction that is made, by an artificial intelligence system and that adversely differentiates, directly or indirectly and without justification, in relation to an individual on one or more of the prohibited grounds of discrimination set out in section 3 of the Canadian Human Rights Act, or on a combination of such prohibited grounds. It does not include content, or a decision, recommendation, or prediction, the purpose and effect of which are to prevent disadvantages that are likely to be suffered by, or to eliminate or reduce disadvantages that are suffered by, any group of individuals when those disadvantages would be based on or related to the prohibited grounds. ↑

3. “Confidential business information” is defined in the AI Act as business information that (a) is not publicly available; (b) in respect of which the person has taken measures that are reasonable in the circumstances to ensure that it remains not publicly available; and (c) has actual or potential economic value to the person or their competitors because it is not publicly available and its disclosure would result in a material financial loss to the person or a material financial gain to their competitors. ↑

4. For a more detailed discussion of the existing patchwork of AI laws and model codes in Canada, see, Lisa R. Lifshitz and Myron Mallia-Dare, “Artificial Intelligence in Canada,” chapter 25 of The Law of Artificial Intelligence and Smart Machines, Theodore F. Claypoole, editor, American Bar Association, 2019. ↑