Almost every bankruptcy practitioner has counseled a client who was on the receiving end of a complaint seeking to avoid a transfer as a preference.^[1] But one of the little-heralded aspects of the Small Business Reorganization Act of 2019 (SBRA)^[2] was an amendment to 11 U.S.C. 547(b) that places additional pre-suit burdens on trustees, debtors-in-possession, committees, or any other plaintiff in a preference case.^[3]

Specifically, Congress amended § 547(b) to include the italicized language below:

(b) Except as provided in subsections (c), (i), and (j) of this section, the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property—

As Collier has noted, “it is unclear whether the ‘reasonable due diligence’ requirement is an element of the preference claim.”^[4] Since the SBRA became effective on 20 February 2020, a few courts have had an occasion to review what the new language means and how it affects the prosecution and defense of preference claims.

One of the first cases to consider this issue was Husted v. Taggart (In re ECS Refining, Inc.).^[5] The court found that the new language in § 547(b) “now requires that the trustee satisfy a condition precedent, i.e., reasonable due diligence and consideration of known or knowable affirmative defenses.”^[6] The court analyzed these conditions as having three prongs: “(1) reasonable due diligence under ‘the circumstances of the case’; (2) consideration as to whether a prima facie case for a preference action may be stated; and (3) review of the known or ‘reasonably knowable’ affirmative defenses that the prospective defendant may interpose.”^[7] The court also noted that the section “is silent on whether satisfaction of the condition precedent is an element or an affirmative defense and on whether satisfaction is a pleading requirement.”^[8] The court further noted that the due diligence requirement was in the same section which gave rise to the trustee’s substantive claims^[9] and that Congress had specifically laid the burden of proving the avoidability of a transfer at the feet of the trustee under § 547(g).^[10]

Accordingly, the court held that “due diligence and consideration of affirmative defenses, is an element of the trustee’s prima facie case.”^[11] Turning to the pleadings themselves, the court found that the trustee’s “use of pre-Iqbal/Twombly notice style pleadings and a very general nature of the allegations in the First Amended Complaint suggest a lack of pre-filing due diligence,”^[12] and that reasonable inferences did not suggest that the trustee had fulfilled the three prongs required by the new statutory language. Based on that and other deficiencies, the court granted the defendants’ motion to dismiss the trustee’s claim with leave to amend.^[13]

The court in Sommers v. Anixter, Inc. (In re Trailhead Engineering)^[14] took a slightly different path. In its motion to dismiss, the defendant contended that the complaint had no allegations regarding the trustee’s due diligence, or review of the defendant’s affirmative defenses, and therefore failed to plead all of the elements of a preference claim.^[15] The court found that it did not have to determine whether “reasonable due diligence” was an element of a preference claim because the complaint contained sufficient allegations.^[16] The court noted that the complaint specifically alleged that the trustee had examined documents including the debtor’s bank records, invoices between the parties, correspondence, and the operative contract.^[17] The trustee had also included a chart of the relationships between the relevant entities.^[18]

Accordingly, the court found that the complaint contained sufficient allegations relating to the trustee’s reasonable due diligence. So, while the court did not explicitly find that the new language created a new element, it nevertheless implicitly found that the complaint needed to contain sufficient allegations to satisfy the requirement.

The decision in Faulkner v. Lone Star Car Brokering, LLC (In re Reagor-Dykes Motors, LP)^[19] covered three complaints filed against separate defendants; all three defendants filed motions to dismiss, contending that the trustee failed to allege sufficient facts to carry its burden of “reasonable due diligence.” The court acknowledged that the SBRA was intended to deter the filing of abusive lawsuits.^[20] It also recognized the lack of clarity regarding the new requirement: “Whether the due diligence language creates an additional pleading requirement is unclear. But a trustee (or debtor-in-possession) must, in bringing a preference action, exercise due diligence and consider the party’s ‘known or reasonably knowable affirmative defenses under subsection (c).’ § 547(b).”^[21]

As to the first defendant, the court cited to Sommers and noted that the complaint at issue contained some allegations relating to that defendant’s prepetition relationship with the debtor.^[22] These allegations included “a description of the relationship between the Debtors and [Defendant] Lone Star—transport services on credit­—and details of the specific transactions….”^[23] The court declined to dismiss the complaint against that defendant because the “allegations—or lack thereof—do not reflect an abusive filing. Lone Star has not answered the suit; its affirmative defenses are unknown.”^[24] As for the other two defendants, however, the court noted that the complaint failed “to provide any information beyond conclusory allegations that the Trustee performed reasonable due diligence under the circumstances and that the transfers were for antecedent debt.”^[25] The court stated:

The transfers lack context—what kind of services or goods did either Earl Owen or Meyer Distributing provide? How were these business relationships structured? It appears the Trustee considered only what was reflected on a bank statement. Were these transfers on account of ordinary business practices, simultaneous value, a cash on delivery agreement, or was new value provided for these transfers? None of those questions can be answered with any certainty since there is no information in the complaints about the nature of these transfers.^[26] 

The court then dismissed the complaint against those two defendants, granting the trustee leave to amend.^[27]

Weinman v. Garton (In re Matt Garton & Associates, LLC)^[28] followed the Husted court’s reasoning and stated that “[a]rguably, the new due diligence requirement is an element of a preference claim under Section 547.”^[29] In the operative complaint, the trustee alleged he had: reviewed pleadings and conducted an informal interview with the defendant; listened to the defendant’s views on the litigation; conferred with counsel for the debtor’s bank (from which some of the transfers had been made on behalf of the defendant); reviewed the books and records of the debtor; subpoenaed bank and credit card statements and other materials; and, after the filing of the initial complaint, undertook additional investigation and requested additional documents after identifying new potential transfers.^[30] The court found that these allegations satisfied the trustee’s burdens under § 547(b).^[31]

In Insys Liquidation Trust v. Quinn Emmanuel Urquhart & Sullivan, LLP (In re Insys Therapeutics, Inc.),^[32] the court followed Sommers and Weinman and declined to rule on whether the revisions to the statute created a new element for preference claims. The court did find, however, that if the new statutory language regarding due diligence was an element, it was met by the trustee. Here, the trustee allegedly sent a letter to the defendant prior to initiating the complaint demanding return of the transfers at issue and invited the defendant to advise the trustee of its defenses; the trustee further alleged that, to the extent any defenses were presented, the trustee took them into account while also reviewing the debtor’s books and records.^[33]

The court in Arete Creditors Litigation Trust v. TriCounty Fam. Medical Care Group, LLC (In re Arete Healthcare LLC)^[34] also declined to decide whether due diligence is an element for a claim under 547(b); however, the court did note that if due diligence is an element, then the allegations in that particular complaint were insufficient.^[35] The court found that “[t]he Trust merely stated that it had performed ‘reasonable due diligence’, ‘investigat[ed] into the circumstances of the case’ and ‘[took] into account the Defendant’s reasonably knowable affirmative defenses under 11 U.S.C. § 547(c).’ The Amended Complaint also ‘acknowledges that some of the transfers might be subject to defenses.’”^[36] The court then dismissed the amended complaint, stating: “If due diligence is an element, merely paraphrasing the element will not satisfy Rule 8.”^[37]

Taken as a whole, courts have uniformly required trustees to allege facts reflecting their due diligence. This is likely to differ from case to case because some debtors have records that are in much better shape than others. Simply filing suit against every entity that received a check from the debtor in the last 90 days prepetition would be problematic under any of these cases; something more is now required. Whether that “something” is the minimally accepted allegation in Lone Star, or the more fulsome descriptions in Sommers and Weinman, may vary from court to court.

From the defense side, however, it is unclear whether the trustee’s obligation to conduct due diligence truly presents a new and fruitful line of defense on its own. The authors could not identify any cases where a defendant sought sanctions under Rule 11 for a trustee’s failure to allege due diligence. It is notable that only two of the three defendants in In re Reagor-Dykes Motors prevailed on their motion to dismiss; and in each of those actions, the trustee filed amended complaints that the defendants ultimately answered and filed motions for summary judgment. Neither motion, however, made any mention of the trustee’s duty to conduct due diligence.

It seems highly unlikely that “due diligence” alone could be the basis for a motion for summary judgment. Even if a court was inclined to grant summary judgment based on the trustee’s lack of due diligence, the court necessarily would have to be entering summary judgment on whatever grounds the trustee should have discovered but for its lack of due diligence. Ultimately, if defendants keep pressing trustees to meet this new burden, the real measure of its effectiveness will be how many adversary proceedings are not filed.

1. Jeff Kucera, Partner, K&L Gates LLP, Miami, Florida, https://www.klgates.com/Jeffrey-T-Kucera. Carly Everhardt, Associate, K&L Gates LLP, Miami, Florida, https://www.klgates.com/Carly-S-Everhardt. Frank Eaton, Of Counsel, Linda Leali P.A., https://lealilaw.com/attorney/frank-eaton/. ↑

2. For general information on the SBRA, please see https://businesslawtoday.org/2020/02/small-business-reorganization-act-big-changes-small-businesses/. ↑

3. For the sake of simplicity, this article will refer to all such parties as “trustee.” ↑

4. 5 MYRON M. SHEINFELD ET AL., COLLIER ON BANKRUPTCY ¶ 547.02A (16th ed. 2020). ↑

5. 625 B.R. 425 (Bankr. E.D. Cal. 2020). ↑

6. Id. at 453. ↑

7. Id. at 454. ↑

8. Id. at 455. ↑

9. Id. at 456. ↑

10. Id. ↑

11. Id. at 454. ↑

12. Id. at 458. ↑

13. Id. at 459. ↑

14. Case No. 18-32414, 2020 WL 7501938 (Bankr. S.D. Tex. 2020). ↑

15. Id. at *7. ↑

16. Id. ↑

17. Id. ↑

18. Id. ↑

19. Case No. 18-50214-RLJ-11 (Bankr. N.D. Tex. 2021). ↑

20. Id. at *6. ↑

21. Id. ↑

22. Id. at *7. ↑

23. Id. ↑

24. Id. ↑

25. Id. at *11–12. ↑

26. Id. at *12. ↑

27. Id. at *15. ↑

28. Case No. 19-18917 TBM, 2022 WL 711518 (Bankr. D. Colo. Feb. 14, 2022). ↑

29. Id. at *31. ↑

30. See id. at *31–33. ↑

31. Id. at *33–34. ↑

32. Case No. 19-11292 (JTD), 2021 WL 5016127 (Bankr. D. Del. 2021). ↑

33. See id. at *10, n.9. ↑

34. Case No. 19-52578-CAG, 2022 WL 362924 (Bankr. W.D. Tex. 2022). ↑

35. Id. at *29. ↑

36. Id. ↑

37. Id. ↑

Plenty has changed since January 2022, when we last examined developing trends in the SPAC market. Since then, the macroeconomic environment shifted dramatically due to rising inflation, increasing interest rates, and the war in Ukraine; the PIPE market collapsed; traditional IPOs dried up; and the SEC came out with a set of controversial proposed SPAC rules.

All these factors have led to a drastic slowdown in SPAC activity. We’ve seen more withdrawals, an increase in liquidations, longer SEC review periods, more extensions and delays, more lawsuits, more bankers scaling down their SPAC operations, more attorney fees to address market uncertainty, and more negative shifts in sponsor economics and target valuation.

Still, this is not the time to throw your arms up in frustration and jump off the SPAC ship; it’s a time to learn, examine, correct, and improve.

With these goals in mind, we’ve identified a few interesting trends that may inform current and future plans for our SPAC clients and friends.

1. The number of securities class actions is holding steady.

When it comes to SPACs, Securities Class Actions (SCAs) are the elephants of lawsuits. These suits are the heavy hitters in terms of time spent and defense costs incurred. They are what companies most look to avoid and what ultimately drive their decisions on Directors and Officers (D&O) insurance. We track them closely because they inform the terms and pricing in the D&O insurance market and the structuring of the D&O policies we offer to our clients.

 Despite a larger number of deals in the market, and taking into consideration the lag between the merger and the filing of the lawsuit, the number of these suits is holding steady as compared to 2021. If the current trend continues, the number of SCAs should be about the same this year as what we observed in 2021.

2. The likelihood of a SPAC getting hit with an SCA post-merger is also holding steady.

A common question we hear is about the percentage of all de-SPACs that get hit with lawsuits. According to our data, 16% of companies that went through a de-SPAC in 2020 and 14% of companies that went through a de-SPAC in 2021 have been sued so far.

Interestingly, if we look at companies that went public via a traditional IPO, about 3% of those that IPOed in 2020 and 5% of those that IPOed in 2021 were sued within the first year of the IPO. That percentage is significantly lower than the rate at which de-SPACed companies are being sued. This means that it is considerably more likely that a de-SPACed company will be caught up in an SCA in its first year out of the gate than a traditional IPO company.

Why? Increased negative media and regulatory attention on SPACs might have something to do with it. Rushed deals at the height of the SPAC craze in 2020 and 2021 could have contributed to a few colorful SPAC missteps. A new, lucrative avenue of activity for the plaintiffs’ bar could also be a reason.

SPACs have also been targets of many short sellers’ reports. Many of these reports spurred an SCA shortly after their publication. In 2021, thirteen of the thirty-three SCAs filed that year (40%) stemmed from a short-seller report. By mid-May of this year, five out of sixteen suits (31%) have been based on short-seller activity.

It is worth noting that while these suits have been filed against SPAC entities in larger numbers than in previous years—whether prompted by a short-seller report or not—few of them have gone far enough through the legal process to determine whether they have merit.

3. The SPAC’s team is named in two-thirds of SPAC lawsuits.

Although there have been instances of SCAs brought against SPACs prior to the merger, most are filed after the merger. Many of our clients ask whether the SPAC’s original team of directors and officers is home free (meaning out of danger of a lawsuit) once the merger is closed. The response to that question is usually not.

In fact, about two-thirds of the SCAs filed in 2021 and 2022 named directors and officers of the SPAC entity as defendants in the lawsuit. Here is where the tail (aka run-off) on the SPAC’s D&O insurance policy comes into play.

As many of our readers know, the insurance policy that covers the SPAC is claims-made in nature. That distinction means that if the policy is not in place when the lawsuit is filed and the claim is made, it won’t respond. Since many of the lawsuits are filed after the merger, terminating the SPAC’s policy at the time of the merger without electing tail coverage leaves the SPAC’s directors and officers exposed.

How often are they exposed? Two-thirds of the time. Here are the numbers.

4. RWI for a SPAC could lead to post-merger D&O enhancements/savings.

More and more SPACs are looking to address claims of insufficient or shoddy diligence through the representations and warranties insurance (RWI) policy placement process.

At its core, the RWI policy is designed to protect the buyer (in this case, the SPAC) against two things: (i) the seller’s (in this case, the target’s) breaches of reps in the merger agreement and (ii) the target’s fraud. However, a valuable side benefit of these policies, especially now that the number of SPAC cases alleging insufficient diligence is growing, is the insurer’s close examination of the SPAC team’s due diligence.

This second layer of diligence by a disinterested third party over the SPAC team’s diligence is important for at least two reasons. First, it either validates the SPAC team’s diligence process or points out potential problems that could be corrected and properly disclosed between the signing of the merger agreement and the close of the deal.

Second, it is conducted by an experienced underwriting team and their top-tier legal counsel, who are usually well versed in the industry of the target and very knowledgeable about the array of potential risks present in that industry.

Many SPAC teams have explored and obtained RWI policies in the last two years. Some of the deals that come to mind include the acquisitions of Utz, Opendoor, and Paysafe. And recently, D&O insurers have started taking note of teams and deals that are willing to go through the process of obtaining an RWI policy.

Like any additional vetting, diligence, or compliance process, the steps involved and the willingness of the team to go through them signal the maturity, veracity, and sophistication of the SPAC team and its acquisition target. All those factors reduce litigation risk and add to the comfort level of the insurer that is looking to insure the post-merger entity.

In fact, very recently, at least one of the leading SPAC D&O insurers, realizing the benefits of an RWI policy for a SPAC, has started to offer price reduction options on D&O premiums for SPACs that choose to obtain an RWI policy ahead of their merger. Additional D&O insurance breaks and better terms for the post-merger combined company may also become available.

Like the ever-evolving SPAC market, the insurance market for SPACs is also evolving and adapting. We are expecting to see additional new, creative solutions to SPAC risks before the year is out.

An earlier version of this article appeared in the Woodruff Sawyer SPAC Notebook.

We know it’s essential to keep as up to date as possible in the reps and warranties (RWI) market, which is both relatively small and rapidly developing.

This month we witnessed a very substantial drop in pricing as well as an equally substantial increase in the number of quotes and competitiveness of the market. In this article, we will update the data and look at emerging trends.

What New RWI Deal Activity in April Means Going Forward

Although the M&A market continues to flourish, we saw a drop in activity in the first quarter. That is entirely common in the M&A cycle, with the first quarter traditionally being the slowest. You will see below the Euclid Transactional submission rate analysis for the first quarter. This shows a marked decrease from 2021 last quarter but slightly above par with 2021 first quarter.

However, we do believe that around mid-March an air of hesitancy entered the market, which we believe is due to interest rate–related financing concerns and geopolitical instability. As reported by Paul Weiss, “March was the second consecutive month of decline in the number of transactions.” M&A at a Glance (April 2021) | Paul, Weiss (paulweiss.com)

Comparing Year over Year and Quarter to Quarter: An Historical View of Trends

The RWI Statistics

As we can see from the below data, the market has responded with alacrity to this change in conditions. While the activity may be on par with the first quarter of 2021, underwriters and markets ramped up in response to the growing activity last year and so face the level of activity in 2022 with more capacity and more staff.

Overall, the news was very good for our clients and those needing reps and warranties insurance. The average number of quotes went through the roof and the premium prices we are seeing are on par with the beginning of 2021, if not slightly more competitive.

The lowest quote we saw was 2.98%, a return to early last year in terms of pricing. Unlike last month this low number was not as much of an outlier as previously seen. We are pretty much in the 3.5–4.5% range for most quotes right now.

The average quote was down from 5.1% to 3.5% which is a substantial decrease and shows the market’s ability to quickly adapt to changing circumstances. To put this in context, if you bought a $10 million policy in March, you would have paid roughly $510,000, and if you bought that same policy in April, it was more likely to cost $350,000.

The average number of quotes went from just over four to ten per risk, showing the continued excess supply of underwriting capacity either due to reduced deal flow, increases in human capital, or new entrants to the market.

As we saw above, the lowest price came in at 2.98%, which is a significant drop. What’s just as noteworthy is that the highest pricing has also dropped from 5.9% in March to 4% in April, again a substantial saving for deals priced this month as opposed to the previous month.

Trends in RWI “Heightened Risk” You Should Know

Anyone experienced in the process of placing an RWI policy should be familiar with the areas of heightened risk listed on every NBIL. These are the deal-specific areas on which underwriters will focus during their review of the diligence conducted by the buyer’s team of advisors. Should diligence be lacking in one of these areas, underwriters will likely seek to incorporate an exclusion in the policy for that portion of the risk.

Ukraine and Russia continue to be an area of heightened risk. However, we have seen underwriters drop the blanket approach and focus on those deals where it’s likely to be an actual issue rather than wanting to dig deep on every deal.

Three Cases of RWI Litigation

Arbitration as the first port of call is standard in RWI policies. Litigation around RWI has historically been difficult to find. There are currently three active cases in the court system right now. They have been around for a while, but we think it’s worth exploring them a little.

The three cases are:

Novolex Holdings, LLC v. Illinois Union Ins. Co, Index No. 656825

This dispute centers around the seller’s knowledge of the intention of its third-largest customer to significantly reduce business. This is currently pending a decision on the Insured’s summary judgment motion.

You can find a more thorough analysis here: Novolex Case Brings Lessons On R&W Insurance – Lexology

WPP Group USA, Inc. v. RB/TDM Investors, LLC, Index No. 656825

This case centers on whether financial projections were misrepresented and is currently in discovery. It’s interesting to note that in the WPP case the insured had the right to decide between arbitration and litigation and chose litigation.

You can find a more thorough analysis here: WPP Grp. U.S. v. RB/TDM Inv’rs , 2021 N.Y. Slip Op. 30160 | Casetext Search + Citator

pH Beauty Holdings III, inc. v. Certain underwriters at Lloyd’s, case no 21-1586 BLS

This case centers on the failure to account for millions of dollars in promotion expenses, which resulted in an inflation of the purchase price.

You may find more details of the case here: PH Beauty sues insurers to cover losses of ‘inflated’ deal | Reuters

None of these cases are resolved at this point, and extensive discovery is expected. We, therefore, anticipate that unless a settlement can be achieved quickly or through arbitration, long-term disputes are likely to be the norm.

All relate to claims of more than $10 million. We would expect to see litigation come into play for higher limit claims and don’t see this trend moving down to smaller claims. All three cases relate either to the accuracy of financial statements or material customers. We hear from the market that claims around material customers are much more prevalent and rising recently. While this is not relevant to the above, we expect this cause of conflict to continue. Material contract claims are where we see Covid issues materialize in the sense that Covid is often the inciting incident leading to a failure of a supplier or the customer to be able to maintain existing conditions.

What does this mean for you? While these go through the courts, it will be interesting to see how this impacts the buyer’s desire to maintain the right to litigate in court, whether expressly or by remaining silent on venue options. We imagine insurers will resist, because by and large they want to arbitrate as the first port of call. In some cases, arbitration is the only method of dispute resolution.

Going Forward: RWI Trends to Keep an Eye On

The market has returned to early 2021 levels in terms of pricing and competition. We imagine this will continue into the foreseeable future as the war in Ukraine and domestic economics play out, affecting the M&A market and the number of submissions.

The market has come to terms with the Ukrainian situation far more nimbly than it did COVID-19 and we also expect this to continue.

We anticipate more negotiation and pressure on dispute resolution clauses and more diligence on material contract reps going forward.

An earlier version of this article appeared in the Woodruff Sawyer M&A Notebook.

On May 25, 2022, the Federal Trade Commission (“FTC”) filed in the U.S. District Court, Northern District of California, a Complaint against Twitter, Inc., and a Joint Motion For Entry Of Stipulated Order (signed by representatives for both parties), for civil penalties, permanent injunction, monetary relief, and other equitable relief. The primary underlying problem stemmed from Twitter’s allegedly deceptive use of account security data for targeting advertising: Twitter asked users to provide their phone numbers and e-mail addresses in order to protect the user’s account, and then Twitter profited by allowing advertisers to use this customer data to target specific users. As discussed below, Twitter, among other things, agreed to pay a $150 million penalty and agreed to stop profiting from its deceptively collected user data.

As alleged in the Complaint (¶27), “Twitter has prompted users to provide a telephone number or email address for the express purpose of securing or authenticating their Twitter accounts. … Twitter collected telephone numbers and email addresses from users specifically for purposes of allowing users to enable two-factor authentication, to assist with account recovery (e.g., to provide access to accounts when users have forgotten their passwords), and to re-authenticate users (e.g., to re-enable full access to an account after Twitter has detected suspicious or malicious activity). From at least May 2013 through at least September 2019, Twitter did not disclose, or did not disclose adequately, that it used these telephone numbers and email addresses to target advertisements to those users through its Tailored Audiences and Partner Audiences services.”

The Complaint references a 2011 FTC settlement Decision and Order concerning Twitter in which Twitter settled allegations that it had misrepresented the extent to which Twitter protected the privacy and security of nonpublic consumer information. That FTC Order, among other things, prohibited Twitter from misrepresenting the extent to which Twitter maintains and protects the security, privacy, confidentiality, or integrity of any nonpublic consumer information. Premised on that 2011 FTC order, the Complaint alleges (¶29): “More than 140 million Twitter users provided email addresses or telephone numbers to Twitter based on Twitter’s deceptive statements that their information would be used for specific purposes related to account security. Twitter knew or should have known that its conduct violated the 2011 Order, which prohibits misrepresentations concerning how Twitter maintains email addresses and telephone numbers collected from users.”

In addition to the $150 million penalty, the Agreed Stipulated Order provides, among other things:

• Prohibitions against Twitter misrepresenting its data collection purposes and practices.
• Limitations on Twitter of the use of phone numbers or e-mail addresses specifically provided by users to Twitter to enable account security features.
• Requirement of notices to consumers concerning “Twitter’s Use of Your Personal Information for Tailored Advertising” alerting them that Twitter misused phone numbers and email addresses collected for account security to also target ads to the consumers, and to also provide information about Twitter’s privacy and security controls.
• Requirement that multi-factor authentication options be made available to access the customer’s Twitter account. There are many other widely adopted industry authentication options that do not require the consumer to provide a phone number (e.g., authentication apps, security keys, etc.).
• Requirement that Twitter maintain a comprehensive privacy and information security program that protects the privacy, security, confidentiality, and integrity of certain personal information (“Covered Information” as defined in the Order, ¶B) from the customer (e.g., first or last name, geolocation information, e-mail address, phone number, photos/videos, Internet Protocol address, User ID, Social Security number, driver’s license or other government issued ID, financial account number, credit/debit information, date of birth, biometric information, any combination of the above).
• Twenty (20) years oversight by the FTC.

The bottom line is this FTC Stipulated Order should serve as a caution to businesses: (1) be crystal clear about the purposes for which they are requesting consumer information; (2) only collect such information consistent with applicable privacy laws; and (3) have strong internal compliance controls in place to ensure that the use of that information is limited to those lawful purposes.

© 2022 Alan S. Wernick and Aronberg Goldgehn.

Introduction and Process

The Loan Syndications and Trading Association was formed more than twenty-five years ago, and since that time its mission has been to create a fair, orderly, efficient, and growing corporate loan market that provides leadership in advancing and balancing the interests of all market participants. As part of that core mission, the LSTA’s legal team works to standardize agreements that are typically used by loan market participants. Over the years, the LSTA’s suite of documents has grown, and it currently stands in excess of 200 documents, all of which are available to members on the LSTA website.

The agreements in that library must, of course, periodically be updated to reflect the latest legal, regulatory, and market trends and developments. At times, the LSTA staff initiates a project to create or update one of the LSTA’s forms, and at other times, ideas percolate up from members. That is how the project to update the LSTA 2017 Form of Revolving Credit Agreement (the “Revolver”), which includes a letter of credit subfacility, arose. Once an idea is approved as a new project, the LSTA then works with one of its committees, comprised of interested members, to create or update a form. The process is typically lengthy because all members have a voice in the project. Once the committee has agreed to the draft, it is circulated as an Exposure Draft to all individual LSTA members (currently, about 25,000 people). At that stage, no substantive comments are expected, but often numerous questions about the form are submitted to the LSTA. After about approximately six weeks, the draft agreement is then published in final form.

Antitrust Concerns

As the LSTA is a trade association, LSTA staff are very aware of antitrust concerns as they work with members, many of whom are competitors in the loan market, to develop a new form, because the courts have deemed trade associations to be possible “hotbeds of conspiracy.” The antitrust laws are designed to ensure that business is conducted in an open, competitive atmosphere and that competition is not unreasonably restricted. The challenging aspect of complying with antitrust laws is that the general language in which the statutes are written does not specify the exact conduct that would be considered a violation. When the LSTA works to create a new form for members, it is well aware of these concerns and always bears them mind as the consensus-building process gets underway.

New members often query how we can create and agree on new forms without violating the antitrust laws. LSTA members are permitted to negotiate and even ultimately agree on the language in a finalized LSTA form and view the published language as acceptable. However, they are always free to negotiate that form for their individual deals. That is the key distinction, and that is why we can successfully standardize language and agreements for the market and not violate antitrust laws.

The Updated Revolver Letter of Credit Subfacility

The 2017 Revolver was the first complete credit agreement published by the LSTA. The real impetus to update that form came from an LSTA member who was also Chair of the American Bar Association Business Law Section’s Letters of Credit Subcommittee. Working closely with him and other LSTA members, the LSTA was able to agree on certain letter of credit–related modifications to the form. At the April 2022 CLE program on this topic presented at the ABA Business Law Section’s Hybrid Spring Meeting (now available for viewing as on-demand CLE), the panel explained the background as to how letter of credit subfacilities came to be included in syndicated revolving credit agreements and reviewed the modifications. Among other things, the modifications address a greater recognition of the role of the Issuing Banks as distinct from the Administrative Agent, Swingline Lenders, and Lenders, and emphasize the independence of letters of credit as separate from the credit agreement and other loan documents. The letter of credit–related modifications also include clarification of the availability of letters of credit for subsidiaries of the main borrower and provide express mention of the separate entity or branch separateness doctrine that treats branches of banks as if they were separate legal entities for certain purposes, including with respect to letters of credit.

LIBOR SOFR Transition

In addition, the LSTA form includes very important modifications to reflect the termination of LIBOR and the adoption of Term SOFR in the loan market. The form includes various options to allow for usage of spread adjustments for Term SOFR, when applicable and selected. Drafters have provided new definitions of Term SOFR and changes to operational provisions to reflect the rate change. Standard yield maintenance provisions, such as the breakage indemnity, increased cost provision, inability to determine rates section, and illegality provision, have been updated as a result of the usage of Term SOFR. Finally, the Term SOFR–referencing form includes updated benchmark replacement language (in the unlikely event that Term SOFR ceases or becomes non-representative).

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.

The modern enterprise has access to large amounts of user data collected through numerous user mediums, databases, products, and servicing efforts. This vast data tranche is only as valuable as its use and application. Data can undoubtedly help engage more customers (or appropriate customers) with products tailored to need, but it can also mitigate risks, including preventing fraud loss, leftfield marketing, or personal bias in the underwriting process.

Cue in algorithms, including artificial intelligence (AI) and machine learning models, which are assisting in driving customer behavior. AI involves borrowing characteristics from human intelligence and applying those characteristics as algorithms in an automated fashion. Machine learning, a subset of AI, involves algorithms designed to identify data patterns to create rules, which improve over time based on continued experience.

Tech and financial services firms have only scratched the surface of the benefits that leveraging AI and machine learning bring to the industry. However, as AI further develops, entities must exercise caution, as data output is only as good as the input framework, and appropriate guardrails must be put in place.

Models are trained on historical data and may lack the ability to exercise judgment or apply context within environments in which they are initially deployed. In certain cases, it may not be possible to create a model that is intelligent enough to understand all possible scenarios and data. Despite intention, models that utilize AI and machine learning risk amplifying previously biased decision-making. This can create disproportionately negative effects on certain communities, particularly in credit underwriting. Complex relationships between seemingly unrelated variables, and the potential failure to understand the models’ conclusions, further lead to this risk.

It is paramount for institutions not only to understand AI-related risks, but also to develop appropriate governance, including processes and controls designed to effectively identify and manage risks and address adverse effects.

Dedicating sufficient resources to design, test, and manage AI and machine learning capabilities is table stakes. This requires a top-down approach, starting with the board of directors and senior management to ensure appropriate investments, commensurate with the size and complexity of the organization, are being made in capabilities that support AI and machine learning as well as risk management. Independent risk management functions (the second line of defense) and internal audit (the third line of defense) will be increasingly important.

Regulatory AI strategy continues to take shape, while still lagging behind industry use. In March 2021 the federal banking agencies issued a Request for Information seeking to better understand how AI and machine learning are used in the financial services industry and to identify areas where additional “clarification” could be beneficial. The Federal Trade Commission (FTC) has also issued guidance on the use of AI tools, such as in an April 2020 blog post, in which the FTC highlighted the importance of AI transparency. More recently, in October 2021, the White House Office of Science and Technology Policy announced the development of an “AI bill of rights,” designed to protect consumers from harmful AI consequences. In light of the growing regulatory focus, enterprises should understand risk around using AI and ensure appropriate governance.

Incorporating alternative data in each area of the product life cycle continues to provide important insight on identity, authentication, financial behavior, and collections potential. Although AI holds incredible promise, especially in financial services, there are also risks that each firm must be aware of and account for. These risks are both surmountable, and worth the effort. As regulator eyes continue to focus on AI, those building the algorithm, along with those governing its use, must sharpen the pencil to prevent blind spot results and promote equitable outcomes.

Views expressed are the authors’ alone. 

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.

On February 24, 2022, Russia launched what President Biden aptly termed “a brutal assault on the people of Ukraine without provocation [and] without justification.” The conflict has cost thousands of lives—countless civilians among them—and displaced millions, including almost two-thirds of Ukrainian children, according to UNICEF.

The war has also “caused severe economic dislocation” across global markets, with “record” U.S. gasoline prices, European gas six times dearer than last year, and skyrocketing food costs that risk the “greatest global food security crisis of our time.”

Now, the crisis may take on an additional dimension with Russia nearing a historic default on its sovereign debt.

Following the invasion, the United States, its NATO allies, and other nations around the world punished Russia with “unprecedented” sanctions, all but cutting it off from the global economy. One linkage between Russia and the financial system has remained, however: Russia’s sovereign bonds—contractual obligations to make payments to investors, largely based in the U.S. and Europe.

Prices for Russia’s bonds have collapsed, trading below 25 cents on the dollar, down from above 105 at the start of the year. In less than three months, Russia has already been on the brink of default twice, making payments with less than a day to spare earlier in May.

The situation is unique for a host of reasons—not least of which is the fact that Russia has the money. Sanctions, however, have circumscribed its ability to make payments to limited safe harbors, the most crucial of which allows U.S.-based investors to receive interest payments from Russia. That provision expires May 25, and the U.S. Treasury has indicated that it will not be renewed.

With Russia’s next interest payments due May 27, subject to a thirty-day grace period, a default appears increasingly likely. Such a default on foreign debt would be Russia’s first in over a century; in 1998, it defaulted, but only on domestic currency debt.

This article analyzes Russia’s debt structure, including certain key bond provisions; describes the interplay between sanctions and Russia’s payment obligations; and previews potential issues arising from a default—if one comes to pass.

Russian Debt Overview

Russia has total sovereign debt of just under $300 billion—a relatively “ low” level, in the IMF’s view, corresponding to about twenty percent of its $1.5 trillion GDP. (U.S. sovereign debt, by comparison, totals about 123.4 percent of GDP.)

Like many sovereigns, Russia has both so-called “local,” domestic-currency denominated debt, and foreign debt, denominated in U.S. Dollars and Euros.

The vast majority of Russia’s debt, totalling about $250 billion, is Rouble-denominated. In addition, as detailed in the table below, Russia has about $37.3 billion of foreign debt, with $31.7 billion denominated in dollars and 5.25 billion in Euros. The USD debt was issued across ten different series, maturing between 2023 and 2047; the Euro debt is in four series, maturing between 2025 and 2036.

Russia has about $37.3 billion of foreign debt, with $31.7 billion denominated in dollars and 5.25 billion in Euros. Source: Bloomberg data, CBonds data, and review of underlying bond documents.

Before February’s invasion—and notwithstanding sanctions after its 2014 annexation of Crimea—Russia was considered a reasonably safe credit, with a “still-strong balance sheet and increasingly robust external position.” This in large part reflected Russia’s $600 billion of foreign reserves, in theory more than sufficient to repay all of the nation’s debts.

Then, in one day, everything changed.

The chart below, based on Bloomberg data, shows the impact of Russia’s February 24 invasion (denoted by the red oval) on prices of sovereign bonds issued by Russia (in white), Belarus (blue), and Ukraine (gold). All three sets collapsed following Russia’s invasion.

Bonds issued by Belarus, Russia’s close ally, have been hardest hit, falling from near-par in January to 14.53 cents on the dollar by mid-May. Ukraine’s bonds fell below thirty cents on the dollar in early March, but subsequently recovered to the mid-40s by May. Russia’s obligations—many of which traded above par pre-invasion, reflecting relatively generous coupons—collapsed towards the thirties by mid-May and fell further this week. 

Sovereign bonds issued by Russia, Belarus, and Ukraine all collapsed following Russia’s invasion (denoted by the red oval). Chart based on Bloomberg data.

According to IMF estimates, about three-fourths of Russia’s debt is held by domestic investors, still leaving nearly $75 billion in the hands of foreign financial institutions.

Based on Bloomberg data, the single largest holder of Russian debt is Allianz, the German insurer and asset manager, with nearly $3.2 billion across rouble, Euro, and USD-denominated bonds. The next four largest are U.S.-based investment complexes: Capital Group, with $1.31 billion, Vanguard ($868 million), Legg Mason ($837 million), and Western Asset Management ($807 million).

Dozens of prominent European, Canadian, and Japanese investment groups—including, somewhat paradoxically, many ESG-focused vehicles—have respective exposures in the hundreds of millions. Because of this, a potential Russian default will impact investors around the world.

Key Contractual Provisions

“These are the worst-written contracts I have ever seen on the international markets,” observed a preeminent sovereign debt scholar. Indeed, the “booby-trapped” agreements include materially off-market provisions, appearing to, all things being equal, confer significant advantages to the issuer. For instance, “the bonds lack a waiver of sovereign immunity and, while they are nominally governed by U.K. law, they don’t appear to submit to a jurisdiction,” making enforcement much more difficult.

For our purposes, the contracts’ most distinctive provisions concern the relevant payment currency. Typically, this dimension of sovereign bonds is not much of a moving target, with the applicable currency clearly specified. Indeed, while intensive sovereign debt–related conflicts are not uncommon, the fracas usually center on other provisions, such as Argentina’s now-infamous pari passu clause.

Russia’s bonds, however, contain a relatively unique “Alternative Payment Currency Event” provision. The language purports to allow Russia to make payments in a currency different than the one specified in the event of “reasons beyond its control.”

In this respect, Russia’s outstanding obligations can be separated into three sets: (i) bonds predating the 2014 Crimea invasion, without any “Alternative Currency” provision; (ii) post-2014 bonds allowing for USD payments to be made in European currencies; and (iii) post-2018 bonds, contemplating payments in roubles.

Specifically, the second set of “post-Crimea invasion” bonds provide the following language:

[I]f, for reasons beyond its control, the Russian Federation is unable to make payments of principal or interest (in whole or in part) in respect of the Bonds in U.S. dollars (an “Alternative Payment Currency Event”), the Russian Federation shall make such payments (in whole or in part) in Euros, Pound sterling or Swiss francs (the “Alternative Payment Currency”) (emphasis added)

The post-2018 vintages go a step further, providing that:

“[N]otwithstanding any other provisions in the relevant Conditions, if, for reasons beyond its control, the Russian Federation is unable to make payments of principal or interest (in whole or in part) in respect of the New Bonds in U.S. dollars, the Russian Federation shall make such payments (in whole or in part) in euros, Pound sterling or Swiss francs or, if for reasons beyond its control the Russian Federation is unable to make payments of principal or interest (in whole or in part) in respect of the New Bonds in any of these currencies, in Russian roubles on the due date at the Alternative Payment Currency Equivalent (as defined in the relevant Condition 7) of any such U.S. dollar-denominated amount. (emphasis added)

In other words, the post-2018 vintage USD-denominated bonds provide two sets of fallbacks, essentially stating that: (i) the obligations should be paid in USD, unless (ii) “for reasons beyond its control” Russia cannot use USD, in which case the payments will be made in “Euros, Pound sterling or Swiss francs”; unless (iii) for additional “reasons beyond its control” Russia cannot use those currencies, in which case the payments will be made in Russian roubles.

One impact of these provisions is that bonds with the Rouble fallback were determined ineligible as “deliverable obligations” by the Credit Derivatives Determinations Committee.

It is difficult to parse the evolution of this language without inferring a degree of premeditation in respect of anticipated future sanctions—why else would one include such oddly specific provisions?

Post-Invasion Sanctions

Following Russia’s invasion of Ukraine, the U.S. led a plurality of the world’s advanced economies in enacting a sanctions regime against Russia “unprecedented to a scale and scope that we haven’t seen since the Cold War.”

The restrictions span everything from terms of trade to asset ownership and participation in cultural events, such as the Eurovision competition, which Ukraine won. Along with the Russian state, the sanctions also target related entities, leading to financial stress at a range of companies, such as steelmaker Severstal.

Prior to the invasion of Ukraine, Russia stockpiled vast reserves totalling $630 billion, with nearly $500 billion in foreign currencies and the balance in gold. Indeed, in late January, before the invasion, The Economist observed that Russia’s cash pile was “more than enough to weather sanctions.”

However, in a strategy “beyond comparison to previous sanctions regimes, particularly involving a major power like Russia,” the U.S. and its allies deployed sanctions targeting Russia’s central bank and its assets worldwide, precluding Russia from utilizing as much as half of its total reserves.

The sanctions regime is largely made operable through directives to financial intermediaries, in this case essentially prohibiting them from transacting on behalf of the Russian central bank.

The interplay between the sanctions regime and Russia’s bond payment obligations has raised unique legal and commercial considerations.

Following its invasion of Ukraine, Russia had two sets of payments due on its foreign bonds—both of which were ultimately paid following down-to-the-wire acrobatics.

The first set of payments was due on March 16. Russia was able to make the payment using its now-frozen foreign reserves.

The second payment, due April 4 for a total of about $2 billion in principal and interest, came far closer to default, following the U.S. Treasury’s decision to block Russia from using its foreign reserves to make the payment. Russia initially tried to pay in roubles; however, this was deemed impermissible. At the very end of the bonds’ thirty-day grace period, Russia made the payment in dollars, avoiding a formal default by the narrowest of margins.

Interest Payments Carve Out Expiration

Thus far, investors have been legally permitted to receive payments on Russia’s bonds because of a carve-out to the sanctions regime. According to the U.S. Treasury FAQ regarding Russian debt transactions:

GL 9A also authorizes U.S. persons to receive interest, dividend, or maturity payments on debt or equity of the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation through 12:01 a.m. eastern daylight time on May 25, 2022.

On Tuesday, May 17, the U.S. Treasury indicated that this safe harbor would not be extended. “After May 25, 2022, U.S. persons would require a specific license to continue to receive such payments” in respect of Russian bonds. Treasury Secretary Yellen stated that “[w]e’re actively involved in an evaluation of the risks and impact of not renewing the license.”

This is particularly significant because Russia has two payments due on May 27. Though the contracts include a customary interest payment grace period, it is not clear how Russia would be able to deliver the payments.

The chart below, from the Bloomberg Terminal, shows Russia’s sovereign CDS curve as of May 19 (green) and a week prior (yellow). Two observations are particularly notable. First, the term structure is highly inverted, with near-term credit default swaps much more expensive than longer-dated protection, suggesting market perception of a near-term risk. Second, the change between the two lines illustrates the impact of the waiver expiration, with the market now pricing in a much higher likelihood of a Russian default.

Russia’s sovereign CDS curve as of May 19 (green) and a week prior (yellow). The change between the two lines illustrates the impact of the expiration of the safe harbor permitting U.S. investors to receive payments on Russia’s bonds. Chart from the Bloomberg Terminal.

What happens next? If Russia indeed defaults on its debts, a fight with its creditors appears almost certain. However, the outcome would be far from clear, in no small part due to the bonds’ distinctive provisions—as well as the unique dispositions of the debtor.

An additional, potentially underappreciated conflict may also loom. Many commentators have suggested using Russia’s frozen reserves to help rebuild Ukraine—which the Kremlin has decried as “theft.” Yet, those assets would, at least ostensibly, also represent a viable source of payment for bondholders, creating the risk of a zero-sum outcome with potentially profound normative and policy implications.

The evolution of Environmental, Social and Governance (ESG) concerns in the market — from an abstract concept bandied about in white papers a decade ago to over $1.6 trillion in 2021 global bond and loan originations^[1] — has demonstrated the increasing viability and mainstream adoption of these specialized financial products. But how exactly are financial products tied to ESG metrics? Do regulators intend to standardize performance measures? Will the EU, with its sustained focus on climate change and related initiatives, offer a blueprint for future domestic regulatory endeavors? Finally, as practitioners consider how to translate these concepts into credible contractual rights, what nuances should they be aware of to perfect collateral securing ESG debt issuances?

ESG Trends in Debt Capital Markets & Heightened Regulatory Oversight

The volume of high-yield bond issuances and sustainability-linked loan originations continue to set records globally. For instance, the volume of these ESG products in 2021 was more than double the total volume of 2020.^[2] Furthermore, such growth has not been limited to certain sectors or jurisdictions. 2021 global ESG bond issuances reached a new threshold of over $948 billion, with sizeable volume from the EMEA region, followed by the Americas and Asia Pacific (excluding Central Asia).^[3] While the tech and financial services industries accounted for a majority of these 2021 issuances and originations, it should be noted that energy and power, and oil and gas companies, also availed themselves of these products to a not-insignificant degree.^[4]

Investor demand appears to be accelerating in tandem with regulatory scrutiny. As ESG products become more sophisticated, they are becoming subject to heightened oversight from the U.S. Securities and Exchange Commission (SEC). In fact, in July 2021, SEC Chairman Gary Gensler stated that the agency planned to propose rules by the end of 2021 to mandate that publicly traded companies disclose the risks they face from climate change. Proposed rules were issued by the SEC on March 21, 2022.

Accordingly, as a practical matter, it would be prudent for borrowers and issuers to verify any climate and other ESG data they are disclosing to the public or utilizing as metrics when accessing ESG credit. Additionally, use of proceeds provisions in ESG credit agreements and offering memorandums should be narrowly tailored to reflect a borrower’s or issuer’s verifiable activities rather than aspirational goals. Finally, another emerging structural trend in ESG financial products is the increasing use of racial equity and diversity and inclusion data when drafting use of proceeds provisions and formulating key performance metrics. As the use of D&I data in ESG products becomes more prevalent, companies should consult with counsel on data collection methods and review disclosure standards in their industry when making representations and warranties in credit documents based on such data.

Given the anticipated regulations, investors are being compelled to move from mere awareness into a more proactive posture. Asset management firms, proxy advisors, and ratings agencies are purchasing and partnering with climate data firms. Market participants are also incorporating climate-related information into assessment platforms. Certain activist investors are committing to vote against boards of directors that don’t address climate change and are requiring companies to disclose and make tangible commitments. Banks are also changing lending policies and reporting on their own climate impacts.

As the U.S. financial markets continue to digest the impact of the churning ESG regulatory environment, it is helpful to look to Europe, with its more established climate action framework, as a possible precursor for how regulations will develop and be implemented domestically.

EU Update

In 2021, the European Union further accelerated its completion of the legislative edifice of sustainable finance. Notably, the European Union adopted the implementing legislation that allows it to put into practice the extraordinarily ambitious EU Taxonomy for sustainable activities adopted in June 2020.^[5] The EU Taxonomy covers the sustainability (or not) of all activities in all sectors of the EU economy by reference to the six EU environmental objectives: 1) climate change mitigation, 2) climate change adaptation, 3) protection of waters and marine resources, 4) the circular economy, 5) pollution prevention and 6) protection of biodiversity and ecosystems.

In order to be sustainable, economic activities must contribute to one or more of these six objectives (or to transitioning towards them) without causing significant harm to one or more of the other objectives. In addition, they must be compliant with social and governance protocols in accordance with strict, detailed criteria, which grants a full ESG dimension to the EU Taxonomy.

While the initial purpose of the EU Taxonomy was to determine the sustainability of investments by reference to the economic activities that they finance, the focus on the activities themselves has elevated the Taxonomy to a sort of overarching guide for the EU sustainability agenda. The more the EU economy will steer itself towards the Taxonomy, the more it will reach the EU environmental objectives, including climate change mitigation.

Hence, the Taxonomy plays a role in public policy (EU investment programs such as the COVID-19-pandemic-responsive Next Generation EU^[6]) and in finance policy; the ongoing EU green bond standard,^[7] for instance, will demand alignment with the EU Taxonomy of the green bonds issued in the EU.

The Taxonomy is science-based (technical screening criteria are developed for each activity) and hence subject to evolution, but it is also a legislative democratic process with opposing views within the EU legislative bodies (Commission, Parliament and Council (Member States)) when it comes to sensitive areas such as nuclear energy and natural gas. In February 2022, the EU addressed the taxonomy treatment of these last two areas of activity, which were still pending for the overall completion of the EU Taxonomy. The outcome, which attracted strong public attention, is that nuclear and gas-related activities are considered as EU Taxonomy-compliant under certain quality conditions.

The EU is also establishing clearer sustainability reporting obligations for all large companies, including financial companies, and all publicly traded companies, with the overall purpose of elevating sustainability reporting to the level of financial reporting. The revised Corporate Sustainability Reporting Directive,^[8] whose adoption is expected in Q2 2022, will establish clear and exhaustive sustainability reporting obligations for nearly 50,000 companies in the EU, compared with the current 11,000 companies subject to the previous, less demanding reporting requirements. The new EU sustainability reporting standards will be a “one-stop-shop,” providing companies with a single solution for the information needs of investors and stakeholders.

Also, the EU bank regulator (EBA) and the EU bank supervisor (ECB) are increasing the demands on banks concerning sustainability. On 24 January 2022, the EBA adopted its binding implementing technical standards (ITS) on ESG reporting covering Pillar 3 disclosures^[9]: how climate change may exacerbate other risks within institutions’ balance sheets, how institutions are mitigating those risks, and their ratios, including the Green Asset Ratio, on exposures financing Taxonomy-aligned activities and those consistent with the Paris Agreement goals. The EBA’s ITS has built on the Financial Stability Board Task Force on Climate-related Financial Disclosures (FSB-TCFD) recommendations, the European Commission’s non-binding guidelines on climate change reporting, and the EU Taxonomy.

The ECB will apply the EBA’s ITS. Since November 2020 the ECB was already applying supervisory expectations relating to risk management and disclosure.^[10] On 27 January 2022, the ECB also launched a supervisory climate risk stress test to assess banks’ preparedness for financial and economic shocks stemming from climate risk. The exercise will be conducted in the first half of 2022 after which the ECB will publish aggregate results.^[11]

Finally, the ECB’s fundamental climate-friendly monetary policy is being established. On 8 July 2021 the ECB adopted its action plan to include climate change considerations in its monetary policy strategy, covering, among others: implications of climate change for monetary policy transmission; disclosures as a requirement for eligibility of assets as collateral and for purchase programs; and climate change risks in the collateral and corporate sector asset purchase frameworks. With milestones in 2022 and 2023, the ECB sustainable monetary policy will be finalized in 2024.^[12]

UCC Issues for ESG Collateral

Finally, as the market adoption of ESG financial products continues to accelerate and regulatory disclosure standards continue to evolve in the U.S. and globally, practitioners need to confirm certain basic information to ensure that a security interest in any ESG collateral is properly created and perfected under the Uniform Commercial Code. The first consideration is whether the proposed collateral, such as carbon credits, can be made the subject of a security interest under UCC Article 9. ESG collateral is often in the nature of a government benefit. There may be statutory or regulatory limits on the ability of the holder of that benefit to transfer it, including creating a security interest in it. Next, counsel needs to determine how to perfect a security interest in the collateral. Again, statutes or regulations may displace the usual approach under the UCC of filing a financing statement. Finally, they need to examine how the security interest is enforced and whether a secured party or a buyer at a foreclosure sale can make use of the ESG collateral.

1. Source: Refinitiv Loan Connector ↑

2. Id. ↑

3. Refinitiv Loan Connector ↑

4. Refinitiv LPC, Refinitiv Loan Connector ↑

5. Available at: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en. ↑

6. See: https://ec.europa.eu/info/strategy/recovery-plan-europe_en. ↑

7. See: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/european-green-bond-standard_en. ↑

8. Available at: https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en. ↑

9. Available at: https://www.eba.europa.eu/eba-publishes-binding-standards-pillar-3-disclosures-esg-risks. ↑

10. Available at: https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimate-relatedandenvironmentalrisks~58213f6564.en.pdf. ↑

11. Available at: https://www.bankingsupervision.europa.eu/press/pr/date/2022/html/ssm.pr220127~bd20df4d3a.en.html. ↑

12. See: https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210708_1~f104919225.en.html. ↑

The views expressed in this article are those of the authors, and they do not necessarily represent the views of their institutions.

In 2014, Dr. Eddie Moore, Jr. developed a revolutionary change to the typical “one and done” or annual one-to-two-hour training on diversity, equity, and inclusion. Dr. Moore’s system, the 21-Day Racial Equity Habit-Building Challenge©, is appealing as it flows from the thought that it takes 21 days to develop lasting habits. For those who like challenges, especially self-challenges, Dr. Moore’s system intrigues. The purpose of the 21-Day Racial Equity Habit-Building Challenge© is to advance deeper understanding of the intersections of race, power, privilege, supremacy, and oppression. Participants in a Challenge complete a syllabus of 21 relatively short “assignments” (typically taking 15–30 minutes) over 21 consecutive days, that includes reading articles, poems, and other written material; watching videos; and listening to podcasts. The Challenge is enhanced when self-reflection is paired with participants sharing their observations and experiences.

In June 2020, the ABA Section of Labor and Employment Law stepped up to inspire meaningful and lasting action, given the global reckoning on racial equity prompted by the murder of George Floyd, and created a syllabus for a Racial Equity Habit-Building Challenge, adopting Dr. Moore’s approach. The Challenge focused on racism toward and the experience of the Black community. It was intended to be responsive to the need for allies to learn about racism in all its forms and develop the tools to be anti-racist without further burdening those who have been subject to such inequities by having them relive or explain the devastating impact of racial injustice. Though the Black community is not monolithic and the Challenge could not possibly highlight all of the diversity of experiences and opinions within a particular race, much less substitute for learning about the experiences of any other race, the syllabus served as an introduction for those seeking to learn more and to attempt to be effective anti-racist allies. The goal was to provide participants with the knowledge and tools to look at their and their organizations and communities’ actions through a racial equity lens and make meaningful change to address the inequities that exist in our organizations and society as a whole.

With a similar goal, and after receiving positive and supportive feedback from those participating in the original Challenge, the ABA Diversity & Inclusion Advisory Council created a 21-Day Challenge Committee to create more Challenges and expand the reach of anti-racist education. The Council decided to create new Challenges to coincide with the commemoration of several heritage months and, with the support of ABA volunteer attorneys and staff, created syllabi in honor of Black History Month, Asian American and Pacific Islander Heritage Month, Hispanic Heritage Month, and Native American Heritage Month, which also highlighted intersectionality. The Council also sought to expand the Equity Habit-Building Challenges beyond race and ethnicity and, working with the ABA Commission on Sexual Orientation and Gender Identity, created a Challenge in honor of LGBT Pride Month as well. It is currently collaborating with the ABA Commission on Disability Rights on a Challenge in honor of Disability Pride Month in July.

Many individuals and organizations have contacted the ABA to express their gratitude to us for creating syllabi for and promoting the Equity Habit-Building Challenges. Indeed, law firms, companies, courts, bar associations, universities, hospitals, and the like have all written to the ABA to let us know that they are participating in the Challenges and how profoundly impacted they have been by the assignments of the Challenge. The response from the legal and other communities has been gratifying to us as members of leadership in the ABA. Dr. Moore has also been thrilled with the increased focus the ABA has brought to his 21-Day Racial Equity Habit-Building Challenge concept and our expansion of the Challenges beyond racial equity.

The ABA serves to advance the interests of justice and to provide examples of practicing law with integrity. Attorneys, in particular, can be forceful and mindful agents for change within our organizations, the broader legal community, and society in general. As employment attorneys who advise clients on diversity, equity, and inclusion and seek to promote DEI in our profession and communities, we recognize that we will all still make mistakes in our interactions, but we strive for greater understanding. Participants in the Challenge have told us that they feel more mindful, and more equipped to be supportive allies and have much needed, though sometimes difficult, conversations in the workplace and our broader communities.

Because the Challenge is intended to be adapted for specific audiences, it is an ideal project to be implemented in organizations of any size. Given we are in the middle of Asian-American and Pacific Islander Heritage Month, we want to encourage you to consider participating in the Challenge focused on the AAPI communities, available at this link: May ABA-Wide 21-Day Racial Equity Habit-Building Challenge © AAPI Heritage Month. The Challenges do not solve the systemic problem of racism and other “isms” in our society. In becoming more educated and mindful, however, we sincerely believe that the Challenge can affect meaningful and long-term change in minds, if not hearts, too.

The 21-Day Racial Equity Habit-Building Challenge© is the registered copyright of America & Moore, LLC, 2014.

Samantha C. Grant is a partner of Sheppard, Mullin, Richter & Hampton LLP in the Labor and Employment Practice Group. She is Chair of the ABA Diversity & Inclusion Advisory Council’s 21-Day Challenge Committee and Immediate Past Chair of the ABA Section of Labor and Employment Law. She also serves as Vice-Chair of the Minority Corporate Counsel Association’s Advisory Board.

Vanessa Kelly is a partner of Clark Hill in the Labor and Employment Practice Group. She is Co-Chair of the Women’s Affinity Group of the ABA Section of Labor and Employment Law and past Chair of the ABA Section of Labor and Employment Law’s Annual Legal Conference.

Artificial intelligence (AI) technologies are reshaping the way the legal industry operates. They are shifting focus from time-consuming and expensive workflows to efficient investigation of data and proactive ways to prevent emerging problems from spreading. More generally, use of AI is making legal services more accessible and providing lawyers with more powerful tools to find evidence and resolve cases in a fair and comprehensive way.

Use of AI Is Improving the Legal Industry in Three Main Ways:

• AI can make the process of analyzing large volumes of data more efficient and effective. AI models analyze combinations of large numbers of features to prioritize documents for analysis and review, extracting patterns from the data that can be hard to spot during a linear document review process. They can detect content too complex for keyword searches, such as emotions and conceptual relatedness. 
• AI can shift focus from document review to investigative data analysis. AI technologies may allow users to find evidence directly, for example through identifying anomalies in communication behavior or analyzing named entities, thus reducing the need for time-consuming and expensive linear review. 
• Pre-trained AI model libraries reduce cost and streamline workflows. They make it possible to transfer knowledge and expertise gained on previous cases to jump-start work on new cases that are related. They can also create innovative solutions tuned to the specific expertise of a particular law firm or legal service provider, including new legal workflows such as proactive investigations. 

AI Isn’t Replacing Lawyers—It’s Giving Them Superpowers

AI is reshaping the way legal professionals gain fast and powerful insights into data to uncover evidence. As lawyers and other legal professionals continue to adopt AI for use in their everyday activities and workflows, they can extend their abilities far beyond what can be achieved today. Leaning on AI to tap into enormous reservoirs of data and find potentially meaningful patterns, users can enhance how they perform every task they take on. By providing opportunities to extract valuable information from the data that can be further combined to uncover facts, events and stories and not merely find documents, AI has the potential to amplify legal minds and empower them with the information they need to make better fact-driven case decisions.

AI can also serve as a great equalizer and component to facilitating the rule of law. If effective deployment of AI can help legal professionals more quickly and cost-efficiently uncover critical information as they develop case strategy, it can help them better comply with obligations for proportionality and fairness and expand access to justice.

But, while AI will continue to play an increasingly important, it will not (and should not) eliminate or change the most fundamental parts of the legal process. AI should supercharge legal minds, but not seek to replace them.

AI in Action

While organizations all over the world have leveraged the power of AI, shedding light on just a couple of examples can make the case for the tremendous advantages it offers to investigations and legal teams.

In one instance, an international government investigation needed to organize a review of 12.5 million documents that included multiple languages on a tight production deadline. By using Reveal-Brainspace’s Continuous Multimodal Learning (CMML), the client was able to significantly reduce the review population from 1.8 million to 280,000 documents, an 85% reduction in review volume. In the end, the savings on this case totaled approximately 19,000 hours of review time and more than $750,000.

In another example, the investigations team at a major tech company used an AI model framework to build and train predictive risk models from previous investigation experiences. Previous case experiences, data models, and intellectual property were packaged into the Reveal “Model Library,” where the technology was deployed globally for repeatable and scalable risk testing. The use of the advanced AI platform increased the team’s audit capacity by an estimated 400%.

AI Adoption Requires Changing the Status Quo

As with each new technology, the biggest barrier preventing AI from improving the legal industry is the power of the status quo. The legal industry broadly, and individual organizations and professionals, are going to change their ways only if they perceive that the likely gain is significant enough to warrant the costs associated with changing.

Despite the massive time and cost savings that properly applied legal AI affords practitioners, many organizations still find that legal practitioners are hesitant to fully embrace the technology. However, as more and more large and reputable firms, legal service providers, and in-house legal teams adopt AI and tout its transformational power, others will have to take notice or find themselves at a massive competitive disadvantage.

Legal AI as a Force Multiplier in the Digital Age

It’s an exciting time to be working at the intersection of AI and the legal profession, as the last eighteen months have served as a tipping point for legal AI adoption. The work-from-home revolution has precipitated the largest legal shift to the cloud, and as a result, opened up an immense number of possibilities for cloud-native AI. The cloud has enabled many organizations to have greater access to legal AI and this shift, combined with the explosion in both variety and volume of data, has created a perfect storm to entice even the most tech-wary to start embracing legal AI.