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

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

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

Exculpation

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

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

Indemnification

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

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

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

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

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

Advancement

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

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

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

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

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

Indemnitor of First Resort

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

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

D&O Insurance

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

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

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

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

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

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

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

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

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

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

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

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

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

(ii) Indemnification, Fraud, and Reliance Lessons

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

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

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

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

(iii) Beware the Boilerplate

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

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

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

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

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

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

4. 2021 WL 3557857 at *1. ↑

5. 891 A.2d 1032 (Del. Ch. 2006). ↑

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

7. 2021 WL 3557857 at *1. ↑

8. Id. at *1 and *18. ↑

9. Id. at *20. ↑

10. Id. ↑

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

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

13. 2021 WL 6053869, at *5-6. ↑

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

15. Id. at *6-7. ↑

16. Id. ↑

17. Id. at *6, n. 56. ↑

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

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

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

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

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

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

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

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

Start with Being Self-Aware

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

Effective Vulnerability Can Build Trust

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

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

Identify Values for Your Team

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

Practice Active Listening

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

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

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

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

3. Id. ↑

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

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

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

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

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

1. Structuring Repricings

1.1. One-for-One Exchanges

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

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

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

1.2. Value-for-Value Exchanges

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

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

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

1.3. Use of Restricted Stock or RSUs

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

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

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

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

1.4. Repurchase of Underwater Options for Cash

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

1.5. Treatment of Directors and Officers

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

1.6. Key Repricing Terms

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

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

2. Shareholder Approval

2.1. NYSE and Nasdaq Requirements

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

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

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

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

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

2.2. Proxy Advisors and Institutional Investors

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

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

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

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

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

2.3. Treatment of Canceled Options

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

2.4. Proxy Solicitation Methodology

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

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

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

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

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

3. Tender Offer Rules

3.1. Application of the Tender Offer Rules

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

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

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

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

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

3.2. Requirements of the US Tender Offer Rules

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

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

3.3. Pre-commencement Offers

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

3.4. Tender Offer Documentation

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

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

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

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

3.5. Launch of the Repricing Offer

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

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

3.6. Conclusion of the Repricing Offer

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

4. Certain Other Considerations

4.1. Tax Issues

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

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

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

4.2. Plan Grant Limitation

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

4.3. Accounting Treatment

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

4.4. Section 16

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

5. Foreign Private Issuers

5.1. Relief from Shareholder Approval Requirement

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

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

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

5.2. Relief from US Tender Offer Rules

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

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

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

6. Alternative Strategies

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

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

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

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

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

7. Summary

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

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

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

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

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

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

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

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

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

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

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

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

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

12. Nasdaq Staff Interpretive Letter 2004-21. ↑

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

14. Id. ↑

15. Id. ↑

16. Id. ↑

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

18. Id. ↑

19. Id. ↑

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

21. Id. ↑

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

23. Id. ↑

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

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

26. Id. ↑

27. See NYSE Rule 452. ↑

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

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

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

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

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

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

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

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

36. Id. ↑

37. Treas. Reg. § 1.424-1(e)(2). ↑

38. Treas. Reg. § 1.422-4(a). ↑

39. Treas. Reg. § 1.422-4(a). ↑

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

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

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

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

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

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

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

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

48. 17 C.F.R. § 240.13e-4(h)(8)(i). ↑

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

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

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

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

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

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

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

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

(i) Variance in Interest Rate Benchmarks

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

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

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

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

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

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

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

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

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

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

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

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

(iii) Credit Spread Adjustments in Newly Originated Credit Agreements

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

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

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

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

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

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

(iv) Interest Period Variations

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

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

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

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

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

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

(vi) Remediation of Legacy LIBOR Credit Agreements

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

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

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

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

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

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

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

2. See id. ↑

3. See id. ↑

4. See id. ↑

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

6. See id. ↑

7. See id. ↑

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.