Introduction

On December 24, 2020, after four years of extensive negotiations, the European Union (EU) and the United Kingdom (UK) reached an agreement in principle on a EU-U.K. Trade and Cooperation Agreement in an eleventh hour effort to avoid a “no-deal Brexit.”  The UK had departed the EU in January 2020 following conclusion of the Withdrawal Agreement.[1]  The Withdrawal Agreement included an 11-month transition period, during which the UK agreed to continue to apply EU law and procedure, and, except for participation in EU institutions and governance, the EU continued to treat the UK as if were a member state (and not as a third country).  The transition period, which expired on December 31, 2020, was intended to give the UK and EU time to negotiate a framework for future cooperation. 

If, as seemed likely as recently as early December 2020, no acceptable[2] trade agreement were concluded by the deadline at year-end, then the U.K. and the EU would have had to fall back on default World Trade Organization (WTO) rules[3] to manage their economic ties.  With respect to goods, this would have led to imposition of fresh tariffs and a variety of border controls and new customs duties entering into force on January 1, 2021.  Based on prevailing terms, exports from the EU to the UK would have been subject to an average 3.1 percent tariffs and 1.4 percent “nontariff barriers.”  There would also have been 3.3 percent tariffs on goods going from the UK into the EU and the European Economic Area (EEA).[4]  The major impact, however, would have been felt on cars and agricultural goods, which would have been subject to 10 percent more, and dairy products, which would have been subject to an additional 36 percent.

In connection with legal services in a no-deal Brexit, from and after January 1, 2021 the EU regulatory framework allowing UK law firms and lawyers to provide services and/or establish and practice in EU member states would simply have evaporated.  Instead of being subject to a single EU-wide legal framework, UK lawyers and law firms would be subject to myriad rules and regulations in each of the 27 EU member states and ultimately would only be entitled to those rights granted by the national regulators in those states to “third country” (i.e., non-EU) lawyers. 

From the EU’s perspective, the free trade agreement (FTA) with the UK was the most important agreement they had to negotiate.  Their hope was to use the EU-Japan and EU-Canada FTAs as models.  The European Commission would also address the ability of individual EU member states to reach bilateral agreements with the UK.  

Notwithstanding negative prognostications in the media, negotiation of a UK-EU Trade and Cooperation Agreement (the “Agreement”) was successfully concluded, to much fanfare and jubilation, on Christmas Eve.  The representatives of the EU member states have agreed to provisional application of the Agreement beginning January 1, 2021, but, in order to have long-term binding status, the Agreement must be ratified by the Council of the EU, the European Parliament and the U.K. Parliament.  

Some “Cheerful Facts”[5] About Lawyering in the UK

Three separate jurisdictions comprise the UK — England and Wales (jointly), Scotland, and Northern Ireland — each of which divides the practice of law between solicitors and barristers (the latter known in Scotland as “advocates”).  Regulation of the legal profession is likewise subdivided:

Foreign lawyers (including U.S. lawyers) practicing in the UK are required to register in some capacity with only one of these authorities (known as “competent authorities”), though it is permissible to register with more than one provided they regulate the same group (either solicitors or barristers/advocates).  One cannot, however, be registered simultaneously with one of the bodies  regulating solicitors and one of the bodies regulating barristers.  Upon registering with a competent authority, a foreign lawyer  acquires rights of practice similar to that legal profession in that jurisdiction (including the right to do the work reserved to the local profession, subject to certain restrictions in specified proceedings); likewise, the foreign lawyer becomes subject to the rules, regulation, and discipline of that competent authority. 

Thus a U.S., European,[6] or other non-UK lawyer wishing to practice transactional or regulatory law in London would likely want to register with the SRA.  Were that lawyer to register, instead, with the Law Society of Scotland, he or she would only be able to perform the subset of legal work that Scottish solicitors are permitted to do in England and Wales. 

When the UK was part of the EU, a number of community-wide directives, layered atop the Legal Services Act 2007 (LSA)[7] and the SRA’s implementing standards and regulations, applied to British regulation of EU lawyers practicing in the U.K.  These edicts included:

(1) the Council Directive of 22 March 1977 to facilitate the effective exercise by lawyers of freedom to provide services (77/249/EEC), prescribing the rights of EU lawyers to practice on a temporary basis in other member states under their professional titles; and

(2) the Lawyers’ Establishment Directive,[8] prescribing the rights of lawyers who, in general, (A) are licensed in a member state of the EU, (B) are EU nationals, and (C) comply with the requirements for practicing in the UK[9] on a permanent basis under their home professional title (e.g., a Rechtsanwalt in Austria, an avocat in France, a Δικηγόρος in Greece). 

Similarly, UK lawyers who practiced in EU member states enjoyed an array of privileges, including the authority to:

• establish themselves under home title in any member state;
• provide advice in both home and host country law;
• provide advice on EU law;
• provide temporary cross-border legal services, without the need to register with the host country’s bar; and
• be admitted as a lawyer in another member state, either by practicing that country’s local law (including EU law) for three years or by passing prescribed examinations, without ever establishing themselves in the other state.

Note that this congeries of practice authorizations for foreign lawyers was far broader than is available to UK lawyers in any other jurisdiction, including the United States. 

All of that changed with Brexit.

The U.K. – EU Trade and Cooperation Agreement

The Agreement is complex.  A summary of the Agreement prepared by Her Majesty’s Government (HMG) itself runs to 34 pages.  The majority of the Agreement focuses on trade in goods, even though approximately 80 percent of Britain’s economy is based on services.^[10]  Judging solely by the numbers of pages involved in comparison to the total length of the Agreement, it appears that only 5 percent of the provisions dealt with trade in services.  Nevertheless, a few services were accorded specific attention, and trade in legal services was one of those^[11]  – the only profession to merit such recognition.^[12] 

HMG listed this in its internal scorecard — which was publicly released just prior to finalization of the Agreement — as a victory.  It is, however, the only victory on that scorecard accompanied by a footnote, and if one takes the time to pore through the document and construe the footnote, one discovers that the text giveth and the footnote taketh away. 

The Agreement does not create anything more than an exoskeleton, or framework, for potential mutual recognition of professional qualifications.  Similarly, there is nothing in the Agreement that would provide for the mutual recognition of court judgments.  This framework, which is modeled after the EU-Canada FTA, may be elaborated in more detail in the future.  

Likewise the Agreement does not provide for any harmonized, EU-wide right for UK lawyers to practice law.  Rather, as of January 1, 2021, UK  practitioners, like lawyers from any other non-EU country, are subject to 27 different regulatory regimes, each determining how third-country lawyers may practice within the particular jurisdiction and each with its own set of rights, obligations, and restrictions.  Section 7 of Title II, Chapter 5 in Part Two of the Agreement sets forth a basic right for UK solicitors to offer in an EU member state professional services relating to their home jurisdiction law (i.e., UK law) and public international law but excluding EU law, subject to the vagaries of individualized restrictions in the aforementioned 27 regulatory regimes.  Thus, as a result of Brexit, UK lawyers have lost the ability in EU member states to advise on host state law and EU law.  Furthermore, those lawyers will be subject to domestic restrictions (set out in the annex to the Agreement)  did not apply previously. 

In short, with respect to substantive law practice, the Agreement provisions themselves do not confer anything that would not likely have been the default regulatory regime in a no-deal Brexit, to wit: the General Agreement on Trade in Services (the “GATS”). 

In terms of cross-border practice, the Agreement does constitute some improvement over the default rules of the GATS with respect to independent professionals, short-term business visitors, and intra-corporate transferees.  Nevertheless, the annexes refer to the ability of the 27 member states to adopt “non-conforming measures,” which might encompass a number of individualized requirements such as visas, working permits, or even economic tests.  

Thus, depending on the local regulations in the countries in which a U.K. lawyer or law firm operates, an array of challenges is likely to present itself, including:

• Restrictions on providing services in EU member states on a temporary basis using home state qualification (“Fly in – Fly out” or “FIFO”).
• Restrictions on use of the UK limited liability partnership (LLP) structure.
• Loss of rights of audience[13] before the EU courts, unless a UK lawyer independently holds alternative EU/EEA (but not Swiss) qualifications.
• Restrictions on practicing with, or sharing profits or equity with, non-EU lawyers.
• Loss of the protection of the EU legal professional privilege[14] in front of EU courts and other EU institutions for communications between UK-qualified lawyers and their clients (other than for non-in-house[15] UK lawyers who have requalified as EEA lawyers).

One of the key challenges for UK law firms is structuring their international practices.  As a result of Brexit,  the UK is now considered a third country, which means that mutual recognition has gone by the wayside and the LLP form of business organization, common to many law firms, will no longer be honored in the EU.  This inconvenience may necessitate restructuring (such as by relocating an LLP’s headquarters or converting EU offices into local partnerships or subsidiaries).  Some London firms appear to have activated some of those contingency plans in advance by restructuring their LLP operations in Germany. 

Following the Brexit vote, solicitors in England and Wales sought an end run around some of these issues by joining the roll of the Law Society of Ireland.[16]  By becoming registered, and dual-qualified, in Ireland, UK-based lawyers and their firms hoped to be able to retain the protection of the legal professional privilege, rights of audience, ability to practice in EU countries, and FIFO rights.[17]  This maneuver was sometimes referred to as the “Irish backdoor.”  In November 2020, however, the Irish backdoor was firmly shut when the Law Society of Ireland announced that “only solicitors who are practising (or intending to practise) in Ireland from an establishment in Ireland will be provided with practicing certificates.”  Eliminating that strategem may well lead to more UK law firms establishing offices in Ireland solely in order to avail themselves of EU practice benefits.

The French government has been more accommodating with respect to the LLP structure.  According to the website of the Law Society of England and Wales, in December (i.e., prior to the Agreement), France enacted an Ordinance grandfathering the rights to practice of law firms operating in France as branches of UK LLPs.  The Ordinance confirmed that even though a LLP would not be recognized as a valid legal structure in France, UK law firms that had previously established LLP branch structures in France under the EU Lawyers Establishment Directive would be permitted to continue operating using their existing structure after January 1, 2021[18] and this was so irrespective of the outcome of trade negotiations between the UK and the EU. 

It will be interesting to see not only how the UK and the EU understandings about lawyer licensing are fleshed out in the coming months but also whether other EU member states enter into bilateral agreements with the UK that affect trade in legal services. 

[1] Officially titled “Agreement on the withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union and the European Atomic Energy Community [Euratom],” the Withdrawal Agreement is a treaty prescribing the terms of the U.K.’s withdrawal from the EU and Euratom.  This treaty was a renegotiated version of an agreement that had on three occasions been rejected by the House of Commons, which led to Queen Elizabeth II’s acceptance in July 2019 of the resignation of Theresa May as Prime Minister and the accession to that post of Boris Johnson.

[2] Press accounts attributed to EU diplomats the belief that the U.K. is trying to gain an unfair advantage by asking for a zero-quota, zero-tariff deal.

[3] E.g., the General Agreement on Tariffs and Trade  (GATT), which actually was the progenitor of the WTO.

[4] The EEA is a free-trade zone created in 1994 and is composed of the EU member states together with Iceland, Norway, and Liechtenstein.

[5] With apologies to “I Am the Very Model of a Modern Major General” from W.S. Gilbert & A. Sullivan, The Pirates of Penzance (1879).

[6] “European” refers to countries in what has traditionally been referred to as the “Continent,” regardless of whether they are members of the EU.  Lawyers hailing from one of the 27 (at current count) EU member states will be specifically referred herein to as “EU lawyers”).

[7] Enacted by Parliament in 2007 to liberalize and regulate the market for legal services, the LSA encouraged more competition and established a new mechanism for complaints by consumers of legal services.  Section 1 of the LSA identified eight regulatory objectives: (1) protecting and promoting the public interest; (2) supporting the constitutional principle of the rule of law; (3) improving access to justice; (4) protecting and promoting the interests of consumers of legal services; (5) promoting competition in the provision of legal services; (6) encouraging an independent, strong, diverse, and effective legal profession; (7) increasing public understanding of the legal rights and duties of the citizenry; and (8) promoting and maintaining adherence to a set of professional principles.  The latter encompassed, inter alia, acting with independence and integrity, maintaining proper standards of work, acting in clients’ best interests, and preserving client confidentiality. 

[8] Directive 98/5/EC of the European Parliament and of the Council of 16 February 1998 to facilitate practice of the profession of lawyer on a permanent basis in a Member State other than that in which the qualification was obtained.

[9] For EU purposes, the UK constituted one member state, so the Directive did not affect transfers between Scotland, Northern Ireland, and England and Wales.

[10] Topics such as fisheries were apparently major bones of contention. 

[11] The others were delivery, telecommunications, international maritime transport, and financial services.

[12] Considerable lobbying of HMG was done, it must be acknowledged, by the Law Society of England and Wales, with the backing of the Ministry of Justice. 

[13] In the terminology of English law, a “right of audience” is akin to what is referred to in the United States as admission to practice before a particular court.

[14] The EU incarnation of this privilege has some similarities, but is not identical, to the attorney-client privilege.  The scope of the EU legal professional privilege concerns communications relating to a Commission administrative or enforcement procedure.  It does not concern a company’s right to withhold privileged documents from private parties or relate to other governmental authorities. 

[15] The 2010 decision of the European Court of Justice in Akzo Nobel Chemicals Ltd. and Akcros Chemicals Ltd. v. Commission held that the privilege cannot be claimed with respect to communications between company employees and in-house lawyers. 

[16] In anticipation of Brexit, from January 1 – November 12, 2019, 1,817 new solicitors from England and Wales had their names entered on the Roll of Solicitors in Ireland,  See Allen & Overy, Linklaters and Eversheds lead race to register UK lawyers in Ireland ahead of Brexit, The Global Legal Post, Dec. 3, 2019.

[17] As the only English speaking common law jurisdiction left in the EU, Ireland has emerged as an important location for UK and other firms post Brexit.

[18] This grandfathering only applies to existing law firm structures.  From and after January 1, 2021, it is no longer possible for a firm to establish a new branch of a UK LLP in France.  Moreover, existing firms grandfathered under the Ordinance are not permitted to increase or transfer the ownership interest and/or voting rights held by UK entities and/or UK individuals in the branch structure after January 1. 

On December 8, 2020, the Commodity Futures Trading Commission (“CFTC”) approved a major overhaul of its Part 190 regulations governing commodity broker bankruptcy cases.^[1] The ABA played a lead role in proposing and fostering these rule changes, and the ABA Part 190 Subcommittee was honored with the CFTC “Chairman’s Award for Regulatory Excellence” by CFTC Chairman Tarbert.

Background.

A special liquidation subchapter of the Bankruptcy Code (subchapter IV of chapter 7), and the Part 190 regulations promulgated by the CFTC, apply to the bankruptcy of a U.S. futures commission merchant (“FCM”) or derivatives clearing organization (“DCO”). Unlike regulated U.S. securities markets, there is no customer account insurance program covering participants in U.S. derivatives markets. As a result, segregation of customer property is the hallmark protection for commodity broker customers. The CFTC’s Part 190 regulations, which largely rely upon and complement the segregation framework, are of paramount importance both for protecting customer property and reducing the potential systemic impact of a commodity broker insolvency.

In the aftermath of three high-profile FCM bankruptcies, MF Global,[2] Peregrine Financial Group,[3] and Sentinel Management Group,[4] the CFTC implemented a number of rules in the general regulations under the Commodity Exchange Act to improve customer protection. Among others:

• The CFTC formalized an FCM’s obligation to deposit funds into segregation to cover customer debit balances,^[5] and required an FCM to cover undermargined amounts in customer accounts and establish “targeted residual interest” amounts of excess funds they will maintain in segregation. It also imposed restrictions on an FCM’s ability to withdraw more than 25% of its residual interest without specified approvals.^[6]
• The CFTC made extensive rule changes related to risk management, audit and financial reporting standards, capital charge grace periods, and depository institution acknowledgement forms.^[7] These included rules requiring that any custodian holding customer property must agree to provide the CFTC and industry self-regulatory organizations with direct, daily access to view customer segregated account balance information.^[8]
• To address problems identified during MF Global pertaining to MF Global’s use of affiliated foreign carrying broker accounts, the CFTC limited the ability of an FCM to opt out of foreign segregation schemes, and limited the amount of customer property that can be held in foreign accounts to only the amounts necessary to meet margin requirements, plus a small buffer.^[9]
• In response to MF Global complications related to customer account transfers,[10] the CFTC rules now require a DCO to collect margin on a “gross” basis from clearing member FCMs.[11]
• In response to bankruptcies where the scope of permitted investments was perceived to have contributed to excessive risk-taking, the CFTC imposed strict limits on the types of investments in which an FCM could invest their customer’s funds (an FCM is the derivatives equivalent of a securities broker-dealer), eliminated credit rating-based investment criteria, and prohibited the use of so-called “internal” repurchase transactions.^[12]

These rule changes were critical to restoring customer and industry confidence. The Part 190 regulations are also important for customer protection and instilling confidence, as they address the other side of the coin: how customers are protected if their commodity broker fails. However, the Part 190 regulations had remained largely unchanged since they were promulgated in 1983 – when cleared derivatives markets were far less diversified and long before the advent of electronic trading, email, and nearly continuous 24-hour markets – and needed to be modernized.

ABA Part 190 Subcommittee.

In February 2015, the ABA Derivatives and Futures Law and Business Bankruptcy committees jointly formed the ABA Part 190 Subcommittee. The subcommittee included over 45 member attorneys who work extensively in the areas of derivatives law, bankruptcy law, or both. Members included in-house counsel at DCOs, as well as representatives from several regulatory organizations and U.S. government agencies, and counsel for the trustees in the MF Global, Peregrine, and Sentinel bankruptcy cases.

Following 2½ years of work, the ABA Part 190 Subcommittee submitted proposed model rules to the CFTC for consideration in September 2017. Following a multi-year effort that included follow-up consultation with the ABA subcommittee, the CFTC proposed a comprehensive set of revisions to Part 190 in April 2020. The CFTC unanimously approved the proposed rules for public comment at an April 14, 2020 open meeting during which CFTC leadership recognized the work of the ABA Part 190 Subcommittee. After receiving public comment (including a comment letter from the ABA Part 190 Subcommittee) and making additional changes, the CFTC unanimously approved final amendments to the Part 190 Regulations at its December 8, 2020 open meeting. The revisions will become effective 30 days after the adopting release for the rules is published in the Federal Register.[13] CFTC Chairman Tarbert honored the ABA Part 190 Subcommittee at the December 2020 open meeting with the CFTC’s “Chairman’s Award for Regulatory Excellence” recognizing its work and contributions to the Part 190 rulemaking effort.

The Part 190 Rule Changes.

The changes to CFTC Part 190 are comprehensive and overall received wide support from commenters. The rule changes reflect important themes such as enhancement of rule clarity and transparency, modernization, improvement of customer protections, and the establishment of a process for administering the liquidation of a DCO. The CFTC, adopting the recommendation of the ABA subcommittee, reorganized Part 190 into three subparts:

• Subpart A contains general provisions applicable in all commodity broker bankruptcy cases. It explains the CFTC’s statutory authority to adopt the rules, the organization of Part 190, core concepts embodied in the Part 190 Rules, the scope of the Part 190 Rules, and rules of construction.
• Subpart B contains extensive provisions specific to an FCM bankruptcy proceeding (every commodity broker bankruptcy to date has involved an FCM). The subpart B rules retain many basic concepts found in the current rules, including customer class and account class distinctions, pro rata distribution of customer property, and the priority of public customers over non-public customers. New subpart B contains additional important changes to enhance customer protection and modernize the rules. Although the specifics of the rule changes are well beyond the scope of this article, the changes include (among others):
• a more customer-friendly template for the proof of claim form;
• recognition that hedge positions will likely be treated the same as other commodity contract positions;
• clarifications regarding the treatment of customer-posted letters of credit;
• an expansion of the definition of customer property to include the residual interest that an FCM is required to maintain in segregation under CFTC rules;
• detailed rules concerning delivery accounts and for completing deliveries under commodity contracts that move into a delivery position before they can be liquidated;
• rules governing transfers of customer accounts and property to other FCMs;
• rules governing partial transfers or liquidations of customer positions; and
• updated rules detailing how customer claims are to be calculated.
• Subpart C contains provisions that are specific to a bankruptcy proceeding in which the debtor is a DCO. They apply if a DCO becomes the subject of a liquidation proceeding under the Bankruptcy Code, and are also intended to provide guidance if the clearing organization were instead to become subject to an alternative orderly liquidation proceeding administered by the Federal Deposit Insurance Corporation.

Although no U.S. DCO has ever been the subject of a bankruptcy case, the new subpart C rules drew significant attention during the comment process given the importance of clearing to financial market stability and the substantial volume and diversity of cleared derivatives. Several factors have led to major increases in the volume of derivates that are centrally cleared, such as mandated clearing for certain swaps asset classes and available clearing for others, increased standardization of swaps transactions, and lower execution costs, among others.. The ability of a DCO to address and absorb an outsized swaps default has (fortunately) not been tested outside of simulations. There is continued debate around what role, if any, market participants should have in commenting on the recovery, resolution, or wind-down plans of a DCO.

Although the rule changes were comprehensive and received wide support, there are some open issues.

Issues to Address.

The rule changes do not fully address a lingering question about the CFTC’s authority to promulgate rules that provide – in the event of a customer property shortfall – that the debtor’s general assets are included within the scope of customer property, as that likely requires a legislative fix.[14] The CFTC Reauthorization Act of 2019 proposes to amend the Commodity Exchange Act to provide that all of the commodity broker’s general estate property may be included as customer property, to the extent of a customer property shortfall, and if enacted would resolve this question.[15]

The new rules also do not fully address the treatment of customer property held by an FCM outside of segregation, including property for commodity “deliveries” that is supplied by the customer more than 10 days prior to the delivery period. The CFTC has indicated it may consider rules to shore up the protection of unsegregated property associated with deliveries.

Conclusion.

The CFTC’s Part 190 revisions enjoyed wide support and represent a welcome modernization of the rules. The ABA Part 190 Subcommittee played an integral part in moving those rule changes to fruition. The continuing thoughtful attention of the CFTC, market participants, and ABA members practicing in the relevant areas of law is critical to the development of workable insolvency rules applicable to the ever-evolving derivatives marketplace.

[1] 17 C.F.R. §§ 190.01-190.19.

[2] In re MF Global Inc., No. 11-2790 (Bankr. S.D.N.Y. 2011).

[3] In re Peregrine Fin. Group, Inc., No. 12-27488 (Bankr. N.D. Ill. 2012).

[4] In re Sentinel Management Group, Inc., No. 07-14987 (Bankr. N.D. Ill. 2007).

[5] 17 C.F.R. §§ 1.22(c), 22.2(f)(6), 30.7(f)(1)(ii), 22.f(6).

[6] 17 C.F.R. §§ 1.11(e)(3)(i)(D), 1.23(c), 1.23(d), 30.7(g).

[7] CFTC, Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 Fed. Reg. 78,776 (Dec. 19, 2011); CFTC, Enhancing Protections Afforded Customer Funds and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations; Final Rule, 78 Fed. Reg. 68,506 (Nov. 14, 2013) (“Enhancing Protections”).

[8] 17 C.F.R. §§ 1.20(d)(6), 22.5, 30.7(d)(5).

[9] CFTC, Enhancing Protections, supra note 7.

[10] Even though the DCOs where MF Global was a member held sufficient margin calculated on an omnibus (i.e. net) basis, several DCOs did not hold sufficient customer margin to permit a transfer (or “porting”) of customer positions to other clearing members on a fully margined, customer-by-customer basis due to netting.

[11] 17 C.F.R. § 39.13(g)(8)(i).

[12] CFTC, Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 Fed. Reg. 78,776 (Dec. 19, 2011); CFTC, Enhancing Protections Afforded Customer Funds and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations; Final Rule, 78 Fed. Reg. 68,506 (Nov. 14, 2013).

[13] On January 20, 2021, the White House issued a “Regulatory Freeze Pending Review” memo ordering a freeze on all new rules until the new administration has an opportunity to review them.  Although the memo is technically not applicable to the CFTC as an independent agency, the CFTC could follow it, which would negatively impact the timing of publication in the Federal Register.  Even if delayed, however, the authors expect that the Part 190 revisions will ultimately be published without change, given the nature of the amendments and the CFTC Commissioner’s unanimous bipartisan approval of them.

[14] In re Griffin Trading Co., 245 B.R. 291 (Bankr. N.D. Ill. 2000), vacated as moot sub nom. Inskeep v. MeesPierson N.V. (In re Griffin Trading Co.), 270 B.R. 882 (N.D. Ill. 2001), the bankruptcy court found that the CFTC had exceeded its authority to regulate granted in the CEA and therefore that the regulation must be stricken.

[15]CFTC Reauthorization Act of 2019, H.R. 4895, 116th Cong. (2019). As of ^, 2021, Congress had not yet acted on this bill.

On December 8, 2020, the U.S. Supreme Court heard oral arguments in Facebook, Inc. v. Duguid, a case that should establish a nationwide standard for the “autodialer” definition adopted by the Telephone Consumer Protection Act (TCPA). The Court must resolve a split among federal appellate courts regarding that definition. While predicting the outcome of Supreme Court decisions based on oral argument is a risky venture, the likelihood of a decision in Facebook’s favor, with a narrower “autodialer” interpretation, seems greater than a decision supporting Duguid.

The U.S. Court of Appeals for the Ninth Circuit, the appellate court that issued the most recent opinion in Duguid, adopted an expansive view of the autodialer definition. According to this view, equipment can be regulated as an autodialer if it is capable of automatically dialing telephone numbers from a stored list, even in the absence of random or sequential telephone number generation. At least two other federal appellate courts have adopted this interpretation.

Three, and arguably four, federal appellate courts have adopted a narrow view of the autodialer definition, limiting it to equipment with the capacity to store or produce telephone numbers to be called, using a random or sequential number generator.

All federal appellate courts that have addressed this issue seem to agree that the TCPA’s autodialer definition is frustratingly imprecise. As a result, these courts, as well as the attorneys representing Facebook, Duguid, and the United States at oral argument, have had to channel their advocacy for one interpretation or another between a rock of grammatical rules and a hard place of congressional intent from 1991. The grammatical puzzle is whether the definition’s reference to random or sequential number generation applies to both the capacity to store telephone numbers and the capacity to produce them (the narrow interpretation, favoring defendants), or whether it applies only to the latter (the broad interpretation, favoring plaintiffs). At oral argument, both sides claimed to have grammar on their side.

The challenge regarding congressional intent from 30 years ago is to determine how to apply the TCPA to technology that no one in Congress at the time was contemplating, such as smartphones. Several justices signaled their sense that the TCPA had exhausted its useful life as a regulator of the everyday technology around telephone calls. At the same time, no justice offered a strong defense of the TCPA’s consumer privacy purpose.

The justices were clearly concerned about the prospect that the Ninth Circuit’s expansive autodialer interpretation could result in TCPA lawsuits arising from people’s routine smartphone use. Under the expansive approach, equipment can be regulated as an autodialer if it has the capacity to store numbers and dial them automatically. Justice Alito noted that this sounded like call-forwarding technology, while Justice Barrett made the more modern observation that iPhones come equipped with the ability to autoreply to calls when someone is driving or does not want to be disturbed.

Interestingly, Duguid was represented at oral argument by Bryan Garner, the co-author with Antonin Scalia of Reading Law: The Interpretation of Legal Texts, a popular book regarding statutory interpretation. This could be seen as an attempt to win over the Court’s bloc of justices who purport to be guided by a statute’s text above other considerations. Garner did his best to defend the expansive interpretation as the most sensible reading of the text, but he did not appear to have won over a majority of the Court. He had an even harder time convincing the Court that ordinary smartphone use would not attract TCPA lawsuits under the expansive view.

As noted at the outset of this article, we should all be cautious about guessing the outcome of Supreme Court decisions based on oral argument. Having said that, this article’s prediction is a majority opinion in Facebook’s favor, making the case that it is time to retire the TCPA and replace it with modernized standards regulating the way we communicate by phone today.

The COVID-19 pandemic has been a global shock to businesses everywhere.  Uncertainty about its path, duration and magnitude has wreaked havoc on many of our commercial clients.  The associated government-mandated shutdown orders have drastically impacted businesses’ ability to make timely rental payments.    

The Bankruptcy Code does not generally allow debtors to unilaterally abate or modify the terms of their property leases.  However, Congress may enact legislation amending the Bankruptcy Code in order to provide bankruptcy courts additional tools to offer rent relief to debtor-tenants.  Congress enacted the Consolidated Appropriations Act, 2021 (“CAA”), an approximately $2.3 trillion omnibus appropriations bill, which was signed into law on December 27, 2020.  The CAA not only funds the federal government, but also provides additional COVID-19 relief for businesses and individuals.  Significantly, the CAA includes nine amendments to the Bankruptcy Code, three of which directly impact commercial debtor-tenants. 

 This article aims to educate business law practitioners on how their commercial clients can get much needed rent relief based on case law and/or these newly enacted amendments.  First, we explore how courts have provided rent relief to commercial debtors based on:

• a force majeure clause in a tenant’s lease,
• temporary suspension of a bankruptcy case, or
• equitable rent relief.

Next, we review how the CAA amends Bankruptcy Code sections 365(d)(3), 365(d)(4), and 547 to extend the deadlines to perform rental obligations, assume or reject a lease, and preclude preference claims with respect to certain payments of rental arrearages.  The amendments to section 365(d)(3), allowing courts to extend the time for performance under a commercial lease, are limited to subchapter V small business debtors.  The other two amendments apply to all debtors.  All three amendments have a two-year sunset. 

A. Courts Considering Rent Relief Based on Lease Terms and Bankruptcy Code

The Bankruptcy Code generally requires a debtor in bankruptcy to pay its rental obligations during the bankruptcy case.  Notwithstanding this requirement, at least one court has relied upon a force majeure clause in a lease to offer rent abatement during bankruptcy.  The Bankruptcy Court for the Northern District of Illinois in Hitz Restaurant Group found that the Illinois governor’s executive order limiting restaurant capacity triggered the lease’s force majeure clause.[1]  The landlord had sought to enforce the obligation of the debtor to pay post-petition rent under section 365(d)(3) of the Bankruptcy Code. The debtor argued its obligation to pay post-petition rent was excused by the lease’s force majeure clause.  The court agreed with the debtor in part, allowing a 75% rent abatement in proportion to the percentage of floor space restricted by the ban on dining at the restaurant.  It is worth noting that while the specific lease at issue contained language offering potential for relief, other leases may not.  The lease in Hitz Restaurant Group included “governmental action” and “orders of government” provisions in the force majeure clause.  Moreover, other leases may explicitly exclude rent obligations from the scope of obligations excused by force majeure events.  What do your clients’ leases say? Can you amend the lease to include favorable language?

Other courts have looked to the Bankruptcy Code to grant rent relief for debtor-tenants.  Section 365(d)(3) of the bankruptcy code requires timely payment of post-petition rent, but allows courts to extend the time for performance, for cause, up to 60 days following the petition date.[2]  Yet some bankruptcy courts have used Bankruptcy Code sections 105 and 305 to defer payment of post-petition rent beyond the first 60 days of the case.[3]  In Modell’s Sporting Goods, the Bankruptcy Court for the District of New Jersey granted the debtors’ request to temporarily suspend the bankruptcy case, and defer rent payment, pursuant to sections 105(a) and 305(a).[4]  The bankruptcy case commenced on March 11, 2020, and two days later, the COVID-19 pandemic was declared a national emergency.[5]  The debtors subsequently requested an “Operational Suspension” of the bankruptcy case, including rent deferment, due to COVID-19-related disruptions to the planned liquidation sales of the debtors’ stores.  The court found that it was in the best interest of the debtors and creditors to grant the requested relief.  The court extended the suspension twice—it ultimately lasted until June 15, 2020—due to the continued impact of stay-at-home orders on the ability to conduct going-out-of-business sales.  To what extent do the current COVID-19-related governmental orders impact the progression of your clients’ Chapter 11 cases? 

Similarly, in Pier 1 Imports, the Bankruptcy Court for the Eastern District of Virginia granted the debtors’ request for a “breathing spell” to allow some debtor-tenants to defer rental payments pursuant to the court’s equitable power under section 105(a).[6]  The court “recognize[d] the extraordinary nature of the relief,” but found that the court’s “broad equitable powers” allowed such relief, notwithstanding section 365(d)(3) requiring timely performance of rental obligations and the limits on bankruptcy courts’ equitable powers.[7]  The court explained that “[d]eferring rental payments during an unprecedented financial crisis in order to provide a post-Petition Date ‘breathing spell’ for the Debtors is not inconsistent with similar relief the bankruptcy process otherwise provides for pre-Petition Date obligations.”

Notably, the Bankruptcy Court for the Southern District of Texas rejected similar arguments for rent relief.  In CEC Entertainment, the court denied the debtors’ motion to abate or reduce their rent obligations, notwithstanding the impact of COVID-19 in curtailing the debtors’ ability to operate key aspects of its business (operating a nationwide chain of Chuck E. Cheese venues).[8]  The court found nothing in the Bankruptcy Code nor in state law or the lease’s force majeure clauses permitting rent abatement.  The CEC Entertainment court disagreed with Pier 1 Imports, explaining that it could not override section 365(d)(3)’s unambiguous requirement of timely performance of obligations under commercial leases.  The court cited to Law v. Siegel, a United States Supreme Court opinion explaining that a bankruptcy court’s equitable powers under section 105(a) are limited by the express provisions of the bankruptcy code, and section 365(d)(3) “expressly prohibits delays beyond 60 days after the order for relief.”

B. The CAA Amends the Bankruptcy Code to Offer Rent Relief to Commercial Debtors

Some courts have found creative avenues in the Bankruptcy Code or force majeure clauses to offer rent relief to commercial debtor-tenants struggling as a result of the COVID-19 pandemic.  Sometimes, however, creative lawyering will not work, as reflected by the recent CEC Entertainment decision finding that section 365(d)(3) limits bankruptcy courts’ flexibility in crafting rent relief beyond the first 60 days of a case.  The recent enactment of the CAA, however, has expanded bankruptcy courts’ discretion to grant relief regarding commercial leases. 

First, the CAA amends section 365(d)(3) to allow courts to extend the time for performance of lease obligations beyond the normal extension period, but only in a subchapter V case.  Generally, a debtor operating in bankruptcy must timely perform all obligations under an unexpired lease of nonresidential real property.[9]  Section 365(d)(3) allows a court to extend, for cause, the time for performance—but not beyond 60 days after the petition date.  The CAA, however, extends the potential relief period by an additional 60 days—for a potential total of 120 days— only for certain small business debtors filing under subchapter V of Chapter 11.[10]  Where a subchapter V debtor is experiencing or has experienced a material financial hardship due, directly or indirectly, to the COVID-19 pandemic, a court may extend the time for performance of commercial lease obligations for 60 days after the petition date.  “What’s new” here is that the CAA allows courts to extend the relief period by an additional 60 days for subchapter V debtors if such a debtor continues to experience material financial hardship due, directly or indirectly, to the COVID-19 pandemic.  Further, if an extension is granted for an obligation, the obligation is treated as an administrative expense that has priority for payment in bankruptcy. 

Second, the CAA amends section 365(d)(4) to extend the initial deadline for any debtor-tenant—not just those filing under subchapter V—to assume or reject an unexpired lease of nonresidential real property by an additional 90 days to a total of 210 days after the petition date.[11]  Section 365(d)(4)(B)(i) already allows the court to extend the deadline to assume or reject a lease, for cause, by an additional 90 days.  Therefore, a debtor could potentially have as many as 300 days to decide whether to assume or reject an unexpired commercial lease without the consent of the landlord.  Yet, the court may grant further extension upon written consent of the landlord.  The CAA includes a two-year sunset after enactment, upon which the above amendments will be struck from the Bankruptcy Code on December 27, 2022.  However, the amendments apply to all debtors who file under subchapter V of Chapter 11 prior to the sunset.

Additionally, the CAA aims to incentivize a distressed company’s landlords and vendors to offer flexible payment terms by amending the preference provisions of section 547 to provide that any “covered payment of rental arrearages” cannot be avoided as preferences.[12]  “Covered payments” are defined as payments made pursuant to arrangements entered into between any debtor-tenant and their landlord on or after March 13, 2020 to defer or postpone payments owed under a lease; such arrangement may also include the debtor’s obligation to pay penalties or fees.  This amendment also includes a two-year sunset, after which it will be struck on December 27, 2022.  However, the amendment to section 547 applies in any bankruptcy case commenced prior to the sunset.  

Commercial tenants that take advantage of the relief offered under the Bankruptcy Code should be aware that if they decide to assume a lease, they must cure all back rent.  Section 365(b) generally requires that a debtor-tenant cure, or provide adequate assurance of prompt cure, of any default under the lease.

C. Conclusion

Recent decisions inform us how courts have been grappling with the Bankruptcy Code’s inflexibility with respect to leases of non-residential real property.  The Consolidated Appropriations Act, 2021 offers a measure of relief to debtors experiencing COVID-19-related financial woes by enacting amendments to Bankruptcy Code provisions relating to the treatment of lease .  Significantly, the CAA will likely give pause to bankruptcy courts who would otherwise emulate the Modell’s Sporting Goods and Pier 1 Imports courts’ use of sections 105(a) and 305(a) to defer commercial rent obligations beyond the first sixty days of bankruptcy—in contravention of 365(d)(3).  By providing for specific and limited rent-deferment relief to commercial debtor-tenants affected by the COVID-19 pandemic, and by limiting the extended relief to subchapter V small business debtors, the CAA expresses Congress’s intent that 365(d)(3)’s requirements for timely fulfillment of rent obligations should otherwise be strictly complied with.      

[1] In re Hitz Rest. Grp., 616 B.R. 374 (Bankr. N.D. Ill. 2020).

[2] 11 U.S.C. § 365(d)(3).

[3] 11 U.S.C. § 105(a) (allowing the court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title”), § 305(a)(1) (allowing a court to “suspend all proceedings in a case” if “the interests of creditors and the debtor would be better served by such…suspension”).

[4] In re: Modell’s Sporting Goods, Inc., et al., No. 20-14179-VFP (Bankr. D.N.J. 2020).

[5] Proclamation on Declaring a National Emergency Concerning the Novel Coronavirus Disease (COVID-19) Outbreak, March 13, 2020, https://www.whitehouse.gov/presidential-actions/proclamation-declaring-national-emergency-concerning-novel-coronavirus-disease-covid-19-outbreak/ (last accessed December 28, 2020).

[6] In re: Pier 1 Imports, Inc., et al., 615 B.R. 196 (Bankr. E.D. Va. 2020).

[7] See Law v. Siegel, 571 U.S. 415, 421 (2014) (section 105(a) “does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code”).

[8] In re: CEC Entertainment, Inc., et al., No. 20-33162, 2020 WL 7356380 (Bankr. S.D. Tex. Dec. 14, 2020).

[9] 11 U.S.C. § 365(d)(3).

[10] Under the Small Business Reorganization Act (SBRA) of 2019, Pub. L. No. 11654, 133 Stat. 1079, small business debtors may elect to file under subchapter V of Chapter 11 of the bankruptcy code if their debt does not exceed $2,725,625.  The debt limit was increased to $7,500,000 by the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, Pub. L. No. 116-136, 134 Stat. 281 (effective March 27, 2020 for a period of one year). 

[11] 11 U.S.C. §§ 365(d)(4)(A)(i), (B)(i).

[12] The CAA also precludes avoidance of covered payments of “supplier arrearages.”

We have been discussing the need for businesses to make public commitments to support equality, diversity, and inclusion (EDI).[1] These three related concepts are essential to a productive and happy workforce and a fair and just society for everyone. Equality comes from equal access to opportunities, free of discrimination. However, the full range of opportunities will only be available when there is respect for diversity and a willingness to include everyone in decisions regarding their lives. A related concept is social justice, which has been described as fair and just relations between an individual and society at large, as measured by the distribution of wealth opportunities for personal activity and social privileges.

Commitments are fine and necessary, but companies must do more by taking steps to embed EDI into their operations, decision making, and organizational culture and by making those values and norms part of the company’s DNA and the guiding principles for its employment policies and other business relationships. Changing the organizational culture is a difficult and challenging process that requires patience and attention to all phases of a worker’s journey through the company and the company’s relationships with customers, suppliers, and the members of the communities in which the company operates. Some of the steps that need to be taken were suggested by the International Labour Organization, which provided guidance on developing a corporate nondiscrimination and equality policy[2]: 

• Make a strong commitment from the top by signaling that senior management assumes responsibility for equal employment issues and is committed to diversity, thus sending a strong message to other managers, supervisors, and workers.
• Conduct an assessment to determine if discrimination is taking place within the organization.
• Set up an organizational policy establishing clear procedures on nondiscrimination and equal opportunities and communicating the policy both internally and externally.
• Provide training at all levels of the organization, in particular for those involved in recruitment and selection, as well as supervisors and managers, to help raise awareness and encourage people to take action against discrimination.
• Support ongoing sensitization campaigns to combat stereotypes.
• Set measurable goals and specific time frames to achieve objectives.
• Monitor and quantify progress to identify exactly what improvements have been made.
• Modify work organization and distribution of tasks as necessary to avoid negative effects on the treatment and advancement of particular groups of workers, including measures to allow workers to balance work and family responsibilities.
• Ensure equal opportunity for skills development, including scheduling to allow maximum participation;
• Address complaints, handle appeals, and provide recourse to employees in cases where discrimination is identified;
• Encourage efforts in the community to build a climate of equal access to opportunities (e.g., adult education programs and the support of health and childcare services).
• Set up bipartite bodies involving workers’ freely chosen representatives in order to determine priority areas and strategies, to counter bias in the workplace, and to ensure that all workers are committed to the organizational goals regarding diversity and nondiscrimination.

Iyer and Kirschenbaum noted that the EDI efforts of companies are often carried out separately from the business units that are primarily responsible for market expansion, the quality of customer service, or human resources. They encouraged companies to implement organizational structures and expectations of accountability that embedded EDI into operations, such as forming a permanent EDI working group or team with relevant experience and expertise drawn from throughout the company (e.g., engineers, data scientists, researchers, designers). They also suggested that companies focus exclusively on advancing inclusion and rooting out bias in key activities such as product design, marketing, and customer service. Similarly, hourly employees, women, and people of color need to be given a voice in the creation, implementation, and assessment of all employment-related processes. The working group created to develop the company’s commitments to action regarding racial equality and justice should also be involved in organizational change initiatives.[3]

Ideas about the composition of the EDI working group and the manner in which it carries out its responsibilities can be gleaned from Lee’s suggestions regarding the formation of a staff-led taskforce, working, or committee on EDI.[4] Lee’s first suggestion related to the composition of the group and the need to ensure that it includes a diverse team of employees so that discussions and actions will take into account the wide range of viewpoints throughout the workplace. Certainly, passion for EDI is an important qualification for serving within the group, and anyone who can bring that kind of energy to the issues should be considered. At the same time, an effort must be made to identify underrepresented groups and not only bring them on to the team but also consider why employees might be reluctant to participate. In addition to ensuring that the composition of the group is racially and ethnically diverse, there should be representation from all levels in the organizational hierarchy and from each of the key business groups or departments.

Another suggestion Lee offered was to establish clear goals, roles, and relationships in order to define the group’s scope of work and the way it operates internally and relates to those leaders with the authority to implement the group’s recommended actions. In general, members of the working group will still be expected to fulfill their regular day-to-day responsibilities, and so they will have only limited time to invest in the group’s activities. As such, consensus should be reached on which EDI issues are most pressing for the company. This process should begin with sharing stories and experiences with the members of the group, but the group should also go outside its own boundaries and seek input from other employees. Once the issues have been identified, the group needs to consider its internal and external capacities to do the work necessary to make an impact on each issue (e.g., are there members of the group with specific experience and skills that can be leveraged to develop effective solutions for an issue?) and make decisions about which issues the group can most influence. 

Lee’s suggestions were focused on what would initially be a largely volunteer effort organized and supported by the company that depended on employees willing to commit time to the working group, in addition to their other duties to the company. In contrast, Iyer and Kirschenbaum called for companies to form a permanent, full-time EDI working group or team. This would mean that members would be pulled off their previous assignments and be required to spend all of their time working on EDI issues with experienced colleagues from other divisions of the company.[5] The decision depends on a variety of factors, notably the size of the company and the ability of the company to reallocate resources to a full-time group. It might be best to start with a voluntary group, properly staffed and operating with the explicit and public support of the company’s leaders, and then determine how best to integrate the EDI working group into the company’s permanent organizational structure. While having a full-time team working on EDI issues is useful, care must be taken to ensure that the team continues to work well with the relevant departments and business units and that steps are taken to embed EDI directly into those groups.

Racial equality in the workplace cannot be achieved unless and until everyone in the organization appreciates and respects the diverse experiences of their colleagues and understands that diversity and inclusion will lead to a stronger organizational culture, a vibrant working environment. and an engine for innovative products and services that will support a sustainable enterprise. Racial discrimination in the workplace is an extremely sensitive issue that sometimes requires painful personal introspection and difficult conversations. Nonetheless, business leaders need to understand that racism can and will damage their companies in a number of ways. Certainly, racial discrimination will expose the company to potential legal liabilities, but even more corrosive is the role racism can play in dividing the workforce and undermining morale, teamwork, and productivity. In addition, in a world in which news spreads quickly over social media, incidents of racial discrimination can instantly and permanently tarnish a company’s reputation and brand, causing it to lose customers and making it more difficult for the company to recruit, engage, and retain diverse talent.

Racial equity training involves tackling sensitive issues such as internalized racial stereotypes and “unconscious bias,” which may affect decisions made within organizations as well as employees’ communication with one another in the workplace. Training sessions should be set up in ways that promote open and safe discussions about racism. Research indicates that companies that are willing and able to facilitate dialogue succeed in building stronger bonds and greater understanding. It should be expected that white employees who are challenged on their race-related beliefs during the training sessions will act defensively, often expressing emotions such as fear, anger, and guilt. They may also have concerns about how proposed diversity and inclusivity actions might undermine their historical “white privilege” and the opportunities and access to resources they have been accustomed to. Concerns from all sides need to be aired, but debating should be avoided, and all employees, regardless of race, need to clearly understand what is at stake and what their lives in the workplace will be like once changes have been implemented. It is at this point that all employees need to be educated and reassured about the benefits to everyone in the company from setting aside inequitable practices.

Racial equity training alone will not guarantee success, but it is an essential tool for establishing and continuing dialogue. Certain elements of the training need to be mandatory in order to demonstrate that the company has taken steps to ensure that all employees are aware of both their duties under the law and the company’s own internal policies and codes of conduct. Participation in training may also be required by business partners who are generally anxious to avert reputational damage from any association with companies that fail to promote a diverse and inclusive workplace free from racial discrimination. According to the Society for Human Resource Management (SHRM), companies should offer additional training and opportunities for dialogue beyond the mandatory sessions. In addition, SHRM recommends not making attendance compulsory since people who do not want to be there will often undermine the value of the meetings by displaying hostile or defensive actions. The training sessions should be led by experienced facilitators and should begin with an explanation of the ground rules for discussions so that everyone feels comfortable sharing their experiences and opinions. SHRM encourages companies to make learning interactive and experiential, avoiding long lectures from someone in the front of the room at a podium and ensuring that everyone walks out of the room armed with practical steps that they can immediately begin using to overcome unconscious bias.[6]

[1] Alan S. Gutterman is a business counselor and prolific author of practical guidance and tools for legal and financial professionals, managers, entrepreneurs, and investors on topics including sustainable entrepreneurship, leadership and management, business law and transactions, international law, and business and technology management. He is the co-editor and contributing author of several books published by the ABA Business Law Section, including The Lawyer’s Corporate Social Responsibility Deskbook, Emerging Companies Guide (3rd Edition) and Business and Human Rights: A Practitioner’s Guide for Legal Professionals. Alan is also currently a partner of GCA Law Partners LLP in Mountain View, California (www.gcalaw.com). More information about Alan and his work is available at his personal website at www.alangutterman.com. This article is adapted from the chapter on Racial Equality and Non-Discrimination, which was recently released on his website: https://alangutterman.com/wp-content/uploads/2020/07/EDI-_C1-Racial-Equality-and-Non-Discrimination.pdf.

[2] Questions and Answers on Business, Discrimination and Equality, International Labour Organization, https://www.ilo.org/empent/areas/business-helpdesk/faqs/WCMS_DOC_ENT_HLP_BDE_FAQ_EN/lang–en/index.htm#Q8

[3] L. Iyer and J. Kirschenbaum, How Companies Can Advance Racial Equity and Create Business Growth (April 8, 2019), https://www.fsg.org/blog/how-companies-can-advance-racial-equity-and-create-business-growth.

[4] Y. Lee, Diversity, Equity and Inclusion in the Workplace | Tips for Starting a DEI Committee, Idealist (July 18, 2019), https://www.idealist.org/en/careers/diversity-equity-inclusion-committee.

[5] L. Iyer and J. Kirschenbaum, How Companies Can Advance Racial Equity and Create Business Growth (April 8, 2019), https://www.fsg.org/blog/how-companies-can-advance-racial-equity-and-create-business-growth.

[6] A. Hirsch, “Taking Steps to Eliminate Racism in the Workplace”, Society for Human Resource Management (October 22, 2018), https://www.shrm.org/resourcesandtools/hr-topics/behavioral-competencies/global-and-cultural-effectiveness/pages/taking-steps-to-eliminate-racism-in-the-workplace.aspx

There are three main financial statements—namely, the balance sheet, the income statement, and the cash flow statement. This article will discuss the balance sheet, also known as the statement of financial position. The balance sheet is a “snapshot” of a company’s position at a particular point in time. The report takes a simple approach: at any given moment, what you own (assets) less what you owe (liabilities) is what you are “worth” (shareholders’ equity). It’s important to note that “worth” for financial reporting purposes is very different from the market value of the company. Here, we simply mean worth from a reporting perspective.

Assets are economic resources available for use in the future. Liabilities are obligations to outsiders, and equity is the claim of the owners after the obligations. Expressed as an equation,

Assets (owned) – Liabilities (owed) = Equity (worth).

More simply, A – L = E. This equation can also be expressed as A = L + E; this is commonly referred to as the balance sheet equation. The balance sheet presents assets on one side, equal to liabilities and equity on the other. Another way to think about the balance sheet is that assets are what the company owns—the resources they have available to use in the future to run the company; liabilities and equity are where the money comes from to buy those resources.

Here is a summary version of IBM’s most recent year-end balance sheet.

Note the time stamp, “as of December 31, 2019.” As of the close of business on December 31, 2019, IBM froze its books to count up where it was. Also note that these numbers are presented in millions of dollars; the cash balance of $8,314 means $8.3 billion of cash.

Assets

Assets are the tangible and intangible resources owned by the company. Almost all asset values are based on the cost to acquire these assets, not the current value of the assets. This is obviously an important distinction and is why we can’t use the reported asset amounts to determine the value of a company. For example, if IBM purchased land 50 years ago for $1 million, it’s still on their balance sheet for that amount, even though today it may be worth exponentially more.

In addition to cash, IBM had other current and long-term assets, amounting to just over $150 billion in resources owned by the company at that point in time. On the bottom half of the balance sheet are the sources for the capital used to acquire and use those resources. A distinction is made between short-term (current) and long-term assets and liabilities; current assets are expected to become cash within the next 12 months, whereas current liabilities are expected to be satisfied within the same 12 months.

The most common short-term assets are cash (and cash equivalents), accounts receivable, and inventory. Typically, the most significant of the long-term assets are “property, plant and equipment” (also referred to as “fixed” assets), goodwill, and intangible assets. There may also be deferred tax assets if the company has paid a tax to the IRS but not yet reflected the expense under the accounting rules.

If a company has goodwill or intangible assets, it is most likely because it has made an acquisition, and the purchase price exceeded the fair market value of the acquired company’s “net assets” (defined as assets – liabilities). With a few exceptions, internally produced intellectual property does not appear on the balance sheet as an asset. Instead, the costs to create the intellectual property are included as expenses on the income statement.

This can be important. For example, a company’s balance sheet may report more liabilities than assets; however, it likely owns economic assets that are not reflected on its balance sheet. Coca Cola’s most valuable asset, for example, is its formula, but that is not on Coke’s balance sheet because the costs to develop it were long since expensed, and GAAP makes no attempt to reflect the fair value of assets.

Sidebar 1: Deferred Taxes

There can be differences between when a company reports taxes for accounting purposes and when it pays them to the IRS. For instance, current tax rules allow a company to depreciate an asset more rapidly on their tax return than they do on their financial statements. This means depreciation expense this year will be higher on the tax return, and taxable income will be less than accounting income, lowering the taxes due this year. This is a temporary difference in taxable income and accounting income; total depreciation expense is the same over the life of the asset, but is allocated differently over the years. This creates a deferred tax liability because expenses have been taken earlier for the tax computation and eventually will have to be paid. Conversely, if the company accrues a workmen’s compensation expense but has not yet made the payment and thus cannot yet deduct the sum on its tax return, then the expense on its income statement will be higher than the deduction on its tax return, and its tax liability will be greater than the tax paid to the IRS. This results in a deferred tax asset for accounting purposes.

It is most important to understand that GAAP accounting rules rely upon significant judgment by management in valuing assets. For example, there are two different methods to value accounts receivable, four different methods to value inventory, and six different methods to value fixed assets. Management is allowed to decide which methods it uses (note that management must consistently apply the method it chooses and can’t change methods year to year). In addition, these methods require estimates of such things as the collectability of receivables, the potential obsolescence of inventory, and the useful life of fixed assets. These are just examples of the inherent judgment involved in all assets, with the exception of cash.

When a company is struggling financially, it is most important to understand what the numbers mean and the context of how the numbers are determined. First, remember that the reported amount of the assets do not purport to be the current market values. Second, management may be so biased as to use the allowable judgment to overstate the value of an asset in order to meet a loan covenant, or understate expenses to improve profit.

In an economic crisis liquidity, the ready access to the cash needed to fund operations becomes a particularly important indicator of a company’s ability to survive. Is the company’s cash position deteriorating, and if so how quickly? Does it have additional sources of cash available? Are the assets really worth as much as the amount reflected on the balance sheet? In considering whether assets are shown at the lower of cost or market value, has management considered current market conditions? (See Sidebar 2.) Might the market value of its assets, less its liabilities, actually exceed the going concern value of the company? If so, should the company consider liquidating its assets and distributing the proceeds to its creditors and shareholders?

When performing due diligence, each asset should be looked at and probed. Have any values been impaired? Are all receivables collectible in the current economic environment? Is inventory all usable, or is obsolescence a concern? Even in the case of buildings, the market values may have declined if there are vacancies or the tenants can’t pay the rent.

Sidebar 2: The Value of an Asset Can Change with Context

During the second quarter of 2020, Delta Airlines recorded an “impairment” charge of almost $2.2 billion. U.S. GAAP requires that the reported dollar amount of an asset cannot exceed its estimated future value to the company. Delta reduced the value attributable to certain aircraft. According to the notes to its financial statements, this write-down reflected the company’s current plans for these aircraft in light of the impact of the COVID-19 pandemic. It’s important to note that this write-down did not imply that these aircraft were in any way damaged or obsolete. The lower value on their balance sheet simply reflects the current situation; they have less utility to the company under current conditions, and their liquidation value is probably impaired at this time as well. What management is doing here is exactly what GAAP requires.

At the same time, management says that it has evaluated the reported value of its goodwill and intangibles and has concluded that those values have not been impaired, meaning that they are worth at least what they are being carried at on the balance sheet. Note that management summarizes the impact of the pandemic on the financial condition and operations of the company in a single note to the financials. Any user of the financial statements would be well advised to read it carefully.

In a crisis, a key first step is to consider the company’s strategy and plans to survive the crisis and then examine the assets from the standpoint of their likely value under that scenario. At the risk of overstating it, the reported value of the assets on the balance sheet, both individually and collectively, should not be mistaken for their market values or their liquidation values in a time of crisis.

Liabilities

Liabilities are obligations of the business. This includes obligations to employees, customers, vendors, and lenders. These are separated into short-term (those due within one year) and long-term liabilities. Liabilities are generally of two types: (1) noninterest-bearing liabilities, and (2) debt, which bears interest and has a due date. The usual short-term liabilities are accounts payable (monies owed to vendors) and accrued liabilities (estimated liabilities). It also includes any principal amounts on debt due in the next 12 months. If a company is in the enviable position of receiving cash from its customers before earning the revenue (like subscriptions paid in advance), the unearned or deferred revenue will be shown as a current liability. The most common long-term liabilities are long-term debt, deferred tax liabilities, lease obligations, and pension liabilities.

One issue that arises for all companies is “contingent” liabilities. These are liabilities that may inure to the company based on some underlying future event. For example, if a company is sued by a customer for a product liability claim, the company will be obligated only if they lose the lawsuit. In this case, the liability is not included on the balance sheet unless it is highly probable that the company will lose the lawsuit and the judgement can be reasonably estimated. Up to that point it may be required to disclose the potential liability in the footnotes, unless it is highly unlikely to lose the suit. The determination of the likelihood of winning or losing is made by management based on information from legal counsel.

Solvency refers to the comparison of a company’s assets with its liabilities. Insolvency means that the accounting value of the liabilities exceeds the accounting value of the assets (because A = L+ E, if liabilities exceed assets, the equity is actually negative). The term “insolvency” can also refer to a company unable to meet its obligations as they come due, though that may also be referred to as “cash flow insolvency” or a “liquidity problem.” This may have significant consequences, such as possible violation of financial or other contractual covenants. Under the corporate laws of many states, if there is balance sheet insolvency, payment of dividends or share repurchases can result in personal liability to directors.

Especially in times of stress, we are concerned about a company’s liquidity—its ability to meet its financial obligations as they come due. The most common measure of liquidity is current assets (those expected to generate cash within the next 12 months) divided by current liabilities (those that will consume cash during that same period). This is called the “current ratio.” However, recognizing that inventory is likely to be of little use in meeting short-term liabilities if revenues are down, a more rigorous measure counts current assets minus inventory in the numerator. That is called the “quick ratio.”

Hopefully, before a company faces either insolvency or liquidity problems, financial covenants provide lenders with an early warning that the situation may be deteriorating and may need attention. Legal counsel should advise their clients to be proactive in communicating concerns about performance against their covenants and to help them negotiate covenants that both take into account expected performance and allow flexibility where warranted.

Equity

Equity represents the claims of the owners on the company. Equity comes in two forms, money invested by the owners (contributed capital) and company-generated profits that are left in the company (retained earnings) and can be used to purchase additional assets, pay dividends, or reacquire shares. As of December 31, 2019, IBM had assets of $152.2 billion and owed $131.2 billion; the balance of the assets ($21.0 billion) was funded by the owners. (Note that, of course, Assets = Liabilities + Equity).

Contributed capital is typically reported in two elements: “common stock” (reported at par value—the “minimum value of the shares”) and “additional paid in capital” (the amounts received over par value). Also commonly included in equity is “treasury stock.” This amount, a negative number, represents the company’s shares that were repurchased from the equity markets. This is a common way to manage the financing of the company.

It is important to note that there are only three sources of capital available to any company for the purchase of assets. The company can: (1) borrow the money (liabilities), (2) sell equity positions to the owners (contributed capital), or (3) earn money on its own from running its business at a profit and leaving these funds in the company (retained earnings). Every company combines these three sources to fund the purchase of its assets and decides how much will come from each of the three sources.

This mix of liabilities and equity is called the “capital structure” of the company. Deciding on an appropriate capital structure is a key part of any company’s strategy. Debt is less expensive than equity and does not dilute the ownership of the shareholders. However, adding debt increases the company’s financial risk—the risk that it will not be able to meet its financial obligations when due. Over the last few decades, the availability of low-cost debt has motivated many companies to add a greater proportion of debt (leverage). The long-term success of this strategy depends upon the company’s ability to meet its debt obligations. It will be important to watch these companies carefully during this economic crisis. Is that increased level of debt affordable under the current scenario?

A company borrows money and sells equity to buy assets. These assets are employed to produce something of value for a market: products and/or services. The company sells the products and/or services produced by the assets to its customers, generating revenue and hopefully profits. The income statement reports on these activities, revenue, and expenses. Our next article looks at the reporting context for the income statement, what the numbers mean, and how to read the results.

In the beginning, law firm marketing departments had fewer employees than the mail room. Fast-forward thirty years: today, the rule of thumb is one marketing professional for every 20 to 25 attorneys, so a firm of 500 attorneys would have a marketing department with 20 to 25 professionals. Many firms also outsource specialized services such as digital marketing and database management.

If you are in a smaller firm or practicing solo, why do you care how large marketing departments are in large firms? You care, because you, too, need to be visible to your prospects and colleagues and engaged with your clients. We can look to the marketing professionals in larger firms to glean important ideas that are relevant to and appropriate for all practicing attorneys.

First, some definitions. Within the legal profession, marketing refers to activities that build brand awareness, including content management activities online and in print. These include brochures, newsletters, websites, videos, podcasts, other digital initiatives, database management, public relations, advertising, events, sponsorships, and so on.

Activities related to finding, wooing, winning and servicing clients come under the rubric of “business development.” This includes research on specific clients, their industries and markets, relationship building and tracking, and proposal and presentation preparation. It also includes training and coaching for attorneys, assistance with marketing and business development strategy, and business development plans for individuals, practice groups, and the firm itself.

Modern marketing departments are thinking strategically about ways to relate their personnel and services to defined client clusters. To this end, according to Calibrate Legal’s survey of North American law firm marketing departments, in larger firms there is an increased demand for:

• Strategic business development initiatives
• Digital marketing
• Lead generation and pursuits
• Data analysis and content marketing.

There is less demand for participation in 2021 conferences, events, sponsorships and inclusion in directories/awards. In -person events will also be de-emphasized in 2021: one-third of the responding firms plan to reduce them by 50% or more.[1]

Strategic Basics

The key word for 21^st century consumers is “me,” translated in marketing-speak to “personalization.” The onslaught of available information has forced people to triage. Any material sent to prospects or clients must be germane to their interests, needs, opportunities and pitfalls or they won’t look at it.

This means you need to be very clear about the personalization of your own practice. Everything you write needs to reflect who you are—what your brand is. Your brand distills what makes you different and how that difference comes through in what you do with and for your clients. It is your promise to them that sets their expectations as to how it would be to work with you.

To relate authentically to your clients, you need to know more about them than just their contact information and current matter number. You need to really understand their work life, home life, wants, needs, dreams, problems, opportunities, and so on. You need to be able to “walk a mile in their shoes.” This translates into a niche market focus, a sub-group of possible clients who really could benefit from your advice, expertise and experience.

Rather than seeking out any kind of client who wants you, analyze what you like to do and who benefits from your practice. Analyze your current client base going back several years and outline the characteristics of your best clients–the ones you want to replicate. Then narrow your focus:

Tie all the characteristics of your ideal client together in a “client persona.” The persona combines everything you need to know about your prospects and clients. These are the people you want to meet, get to know, and, over time, incorporate into your work life as friends, colleagues, referral sources, resources, and clients.

Marketing Initiatives

Once you know what you want to sell and who you want to sell it to, you need to create opportunities to connect either directly through networking or indirectly through your marketing materials and initiatives. Some suggestions that continue to work in the COVID-19 environment:

• Join organizations that your persona belongs to online or in-person. Join their professional, trade, or industry associations to learn what is important to them and how they approach the issues.
• Expand your brand online. Use your website and LinkedIn of course, but also whatever other sites your clients favor. Go where they go and join their conversations.
• Pick a marketing outreach tactic that is comfortable for you: newsletters, blog, videos, podcasts, white papers. Make the content timely and pertinent to your persona. Consider working with clients or colleagues on these endeavors.
  • If you work for a firm with a marketing department, use them. If you don’t, hire outside marketing service consultants and companies to help you, professionalize your efforts.
• Maximize your online references and reviews. “An estimated 75% of people searching for a lawyer use legal review sites, and 84% of those people trust reviews as much as personal recommendations.”[2]
• Regardless of your outreach tactics, when you meet someone you want to get to know, begin a series of contacts with them. Set up one-on-one meetings using zoom or the phone; send them information that refers back to your conversation, invite them to join you at an online networking event or webinar.
  • Remember it takes 8 to 12 personal “touches” on average to move forward from that first meeting to friendship.
• Don’t forget your current clients. People are anxious, worried what will happen in 2021. Be there for them as a sounding board. Call them just to say, “How are you doing?” Listen to them and offer advice if they want it. Often clients are just happy to have a willing ear.

In the end, whether your firm is large or small or you work alone, you can adopt the mindset of those in large marketing departments. “Remember, business development is all about relationships. Relationships that are built on trust, empathy and a deep commitment to help clients succeed.”[3] People hire people they like and trust who have the experience and expertise they need to move forward. Think positively about moving forward, craft a brand that resonates with your market niche, and make yourself relevant to them. Success will follow.

[1] Calibrate Legal, Law Firm Marketing/BD Department Size Study 2020, https://calibrate-legal.com/marketing-bd-survey-2020/.

[2] https://www.nivancontent.com/legal-marketing-statistics-2020

[3] Susanne Mandel, Chief Business development and Marketing Officer at Lowndes, quoted in ‘New Law Firm Strategies for Growth Amid the COVID-19 Pandemic and After,” Strategies+ blog, Legal Marketing Association, September 4, 2020.

Introduction

Events that have taken place in the United States and Canada over the past few months have highlighted the systemic racism that Black/African American communities continue to confront and battle in both society in general and professional settings, including the legal profession. Racism and biases have created barriers to the Black/African American community in all aspects of society, including within our respective business and legal communities.

The ABA National Lawyer Population Survey 10-Year Trend in Lawyer Demographics (the Demographics Survey) evidences that in 2009 Caucasians made up 88 percent of the profession, a figure that only went down to 85 percent by 2019. Further, the Demographics Survey indicates that between 2009 and 2019 there has been only a 5.2 percent change in the male to female ratio within the profession (men in 2019 accounting for 64 percent of the profession and women for only 36 percent).

Ethical Obligation to Provide Access to the Profession

The results of the Demographics Survey show that the profession has a long way to go in becoming accessible to a diverse membership. The profession generally, and each law firm individually, has an ethical obligation to take measures to improve access to justice, including accessibility to membership for all, especially those who have traditionally encountered barriers to entry and advancement in the profession. Meeting this obligation requires greater commitment to eliminating discrimination and racism in any form, and this needs to become a greater focus for us all.

We, as a profession, can and should do better and do more. 

General Initiatives Undertaken by Law Firms to Encourage Inclusion

In response to the underrepresentation of diverse attorneys in the profession, many law firms have increased their focus on initiatives meant to ensure they are able to attract diverse talent and retain that talent through meaningful engagement and advancement to senior leadership positions. Examples of these initiatives may include some of the following:

1. hosting sessions on cultural sensitivity and unconscious bias training;
2. providing financial support for diverse attorneys to become members of, and attend conferences held by, cultural or LGBTQ2+ bar associations or organizations;
3. educating through organized cultural programming such as diversity e-memos;
4. enrolling in organizations that assist with policy development and review to ensure that firm policies do not exclude or disproportionately burden any cultures, races, or sexual orientations/gender identities;
5. developing and implementing procedures for responding to client diversity reporting requests to ensure that legal teams are staffed by diverse attorneys at all levels (including senior/originating lawyers) and addressing the associated confidentiality/disclosure issues; and
6. developing and implementing affinity group policies and encouraging/causing the initiation of meaningful affinity groups.

Affinity Groups

Affinity groups play a central role in increasing diversity within law firms. They allow their membership to actively engage in communicating and gathering around a central unifying purpose and background to support one another and create a voice for their members. Through this approach, they can promote confidence, career growth, leadership potential, and success. They can also provide effective business and professional development opportunities through engagement with clients who share the personal characteristics of their membership.

To create a successful affinity group program, it is important to implement a policy that makes clear the parameters for establishing affinity groups. It is advisable that the proposed founder(s) commit to (1) serving a certain term of leadership (i.e., two years), (2) establishing the goals of the particular affinity group and its early planned initiatives, (3) acting as a mentor or champion of the membership, (4) completing sensitivity training to be able to assist membership in handling difficulties encountered, such as harassment or discrimination, and (5) regularly reporting to the firm’s diversity committee.

Given that affinity groups are an initiative of inclusion, consider making them open/welcoming of all firm members rather than just lawyers.

Examples of affinity groups may include: Asian, Black/African American, Latino/Latina, Jewish, LGBTQ2+, persons with disabilities (and their caregivers), mental wellness workers, and parents of young families.

Successful affinity groups may undertake initiatives such as the following:

• volunteering/partnering with community and youth outreach programs;

• hosting events during dates or periods of cultural significance (e.g., Black History Month, Pride);
• engaging in affiliations with law school student affinity groups to create mentorship opportunities and assist with recruiting;

• hosting/mentoring high school students from inner-city schools for exposure of youth with shared personal characteristics to law firm life (including programming addressing interactions with police and employers, relationship building with successful people who share their personal characteristics, and tours of financial districts and courthouses);
• circulating firm-branded calendars that list all of the holidays/dates of note for the culture/religion associated with affinity groups;
• hosting lunches and learns with speakers/panels discussing specific issues applicable to the culture or personal characteristics of the membership for CLE credit;

• organizing teams to run in the annual Pride runs/walks/charity team events;

• organizing initiatives to recognize and support antibullying campaigns (such as the International Day of Pink, which provides an opportunity to celebrate diversity and raise awareness to stop homophobia, transphobia, transmisogyny, and all forms of bullying);

• hosting “Let’s Walk” events to build community and promote health and exercise;

• hosting speakers or activities with the aim of reducing stigma and providing mental wellness education and coping strategies;

• providing firm members with mental health first aid training to provide ongoing support to colleagues who may encounter mental wellness difficulties, and the like;
• lobbying to enhance firm benefits, including mental wellness apps for all firm members; and

• creating spaces/forums (i.e., parents of young families) for those sharing challenges, experiences, and resources with one another.

1. Introduction

The National Venture Capital Association (NVCA) model stock purchase agreement form (Model Form) was recently updated in August 2020.  After reviewing the updates to the intellectual property related sections of the Model Form, certain language and concepts regarding allocation of intellectual property risk could be revised to better reflect the NVCA goals of providing fair terms between the investor and the company and promoting consistency among financing terms. [i]  

Any model forms project will cause reasonable and sophisticated practitioners to disagree as to whether certain proposed language is fair and would push companies and venture capitalists to reduce transaction costs by bringing the parties toward a middle ground that adequately protects and benefits both sides. So, there are inherent limitations in any attempt to craft language that can be used in all scenarios. The nature of a venture capital investment transaction is such that the intellectual property representations cannot be as complete as in a merger and acquisition transaction. Further, black ink on a document is valuable real estate in a venture stage stock purchase agreement, often with pressure from both parties to limit the length of the agreement.

However, even with all of the above understandings, these proposed revisions will for each modified representation, address at least one and often multiple of the following:

• limit a representation to something that a company can more reasonably make given their position as a young, emerging growth company;
• expand the scope of what a company should be reasonably responsible for given updates in technology and how companies interact with customers or engage in marketing;
• trade some valuable ink space currently used to address an often fixable (and thus less material) infringement risk for a more relevant infringement representation;
• use language that is more technically accurate and consistent with usage in the intellectual property litigation arena; and
• clean up a few minor drafting nits.

Ideally, this article should be read with a copy of the Model Form handy as some suggestions and comments below apply based upon specific word choices in the Model Form. All quoted language comes directly from the Model Form, with liberal quotations from the specific language of the applicable representation being discussed as a result of some arguments being dictated by, at times, the editing or exclusion of a small number of words. However, space constraints prevent quoting large portions of the Model Form and it is always helpful to read these suggested revisions within the context of the entire Section 2.8 of the Model Form. The term “Company” below has the same meaning as “Company” as used in the Model Form.

2. Encumbrances on Company Intellectual Property

The current draft of the Model Form in Section 2.8(c) applies to “Company Intellectual Property” which is defined in a manner that effectively includes both intellectual property that is owned by Company and intellectual property that is licensed by Company.  So all of the representations in Section 2.8(c) must be analyzed as to whether it is reasonable for Company to make representations about intellectual property Company doesn’t own.  

It is not reasonable for Company to represent that there are no options, licenses, agreements, claims, encumbrances or share ownership interests (“Encumbrances”) for the licensed intellectual property. Company is not in a realistic position to know about Encumbrances on licensed intellectual property, such as any other licenses that may have been granted in the same intellectual property or any liens that a third party may have granted in their intellectual property. Moreover, the existence of Encumbrances does not necessarily indicate anything negative about Company’s use of licensed intellectual property.

3. Licenses Entered into by Company

The Section 2.8(c) representation asks Company to make a representation that they have not entered into any licenses for intellectual property. That is unrealistic given the prevalence of software and technology within almost every business. Of course, Company may certainly disclose the existence of such licenses as an “exception,” but given that almost every entity conducting business of any type licenses at least some software, the representation would better reflect reality by asking Company to schedule out material third party licenses and represent that Company is not in breach of such third party licenses.

Recommended Revisions to Model Form: “2.8(c) Other than with respect to commercially available software products under standard end-user object code license agreements, there are no outstanding options, licenses, agreements, claims, encumbrances or shared ownership interests of any kind relating to the Company Intellectual Property that is owned in any manner by the company, nor is the Company bound by or a party to any options, licenses or agreements of any kind with respect to the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, proprietary rights and processes of any other Person. [Section 2.8(c) of the Disclosure Schedule lists all material licenses obtained by Company in intellectual property]. Company is not in material breach of any licenses in intellectual property.”

4. Definition of Intellectual Property

The Model Form defines the term “Company Intellectual Property” to include most of the traditional categories of intellectual property with an option to include mask works. The definition does not include an option to include rights of publicity, which is probably just as—if not more—important than an option to include mask works, since mask works are only applicable to semiconductors. Rights of publicity considerations are relevant for content that includes any images, names or likenesses of anyone. In addition to the obvious category of companies in the social media space, many companies display personnel images on their website or products in addition to their marketing materials. There is not universal agreement as to whether rights of publicity are intellectual property rights, so the catch-all language in the definition of “Company Intellectual Property” referencing “similar or other intellectual property rights” does not provide certainty as to whether the representations for intellectual property would also cover rights of publicity. There is a similar uncertainty as to whether the language in Sections 2.8(a) and 2.8(b) of the Model Form that reference violation of “proprietary rights” and “intellectual property rights” by Company would cover any violations by Company of an individual’s right of publicity. It is therefore important to consider whether Company is in a space where violations of rights of publicity may occur.

Recommended Revisions to Model Form: “(c) “Company Intellectual Property” means all patents, patent applications, registered and unregistered trademarks, trademark applications, registered and unregistered service marks, service mark applications, tradenames, copyrights, trade secrets, domain names, [mask works,] information and proprietary rights and processes, rights of publicity, similar or other intellectual property rights, subject matter of any of the foregoing, tangible embodiments of any of the foregoing, licenses in, to and under any of the foregoing, and in any and all such cases [that are owned or used by] [as are necessary to] the Company in the conduct of the Company’s business as now conducted and as presently proposed to be conducted.”

5. Problems with Open Source

The purpose of the open source representation in Section 2.8(g) is to elicit disclosures of use of open source software used “…in connection with any of its products or services that are generally available or in development” that would require Company to undertake certain obligations that may diminish the value of proprietary Company Intellectual Property.  The legal effects of using open source software is one of the most asked about diligence items for investors in technology companies or any company that has proprietary software; it is not surprising that there is an entire section of the Model Form devoted to this topic. Whether or not use of open source software is problematic for Company is very fact specific, so the related representation should be drafted in a manner that would encourage the Company to disclose any potentially problematic situations related to open source software so that investors can perform follow up diligence. The Model Form open source representation is too narrow in scope and seems to assume that Company may only be making harmful decisions about open source software in factual scenarios.

For example, the footnote states that many of the potentially “onerous” effects of using open source software only occur if there is a distribution of open source software within a product that was actually “released” to the public. While it is true that there must be a “distribution” of GPL licensed software[ii] in order for certain terms of the GPL 2.0 or GPL 3.0 license to apply, neither GPL 2.0 nor GPL 3.0 require that such distribution be made within a product. It is not uncommon for software developers to “contribute” modifications of open source software for use by other developers even if such modifications are not used within a product commercialized by such developer’s employer. So a distribution of open source software that is made as part of a contribution by Company employees to an open source project may have negative effects on the Company while not requiring any sort of breach of the Model Form open source representation.

The same footnote also states that the open source representation is intended to require disclosures for certain use of open source software related to any products that the “Company has released…” However, the actual language of the open source representation arguably only applies to any use of open source software in connection with any products that “…are generally available” [emphasis added] which would seem to not include any Company products that were formerly released and are no longer “generally” available.  Once open source software is distributed to anyone by Company, whether or not such distribution is ongoing or occurred only in the past (even if just sporadically), the potentially negative effects to the Company  of such distribution remain even though such past distributions arguably do not lead to any breach of the open source representation.  

To address the potential holes and ambiguities of the existing Model Form open source representation, the suggested revisions take away the qualifier that the use of open source software was done in conjunction only with any currently available product or service and simply reference any actions that would cause any Company Intellectual Property (besides the Open Source Software itself in some situations) to be subject to certain obligations. Whether past actions unrelated to currently available products diminish the value of Company owned  intellectual property will always be a very fact-based analysis and having an overly narrow open source representation would eliminate certain disclosures that should be subject to further analysis by investor’s counsel.

Recommended Revisions to Model Form: “(g) The Company has not embedded, used or distributed any open source, copyleft or community source code (including but not limited to any libraries or code, software, technologies or other materials that are licensed or distributed under any General Public License, Lesser General Public License or similar license arrangement or other distribution model described by the Open Source Initiative at www.opensource.org, collectively “Open Source Software”) in connection with any of its products or services that are generally available or in development in any manner that would materially restrict the ability of the Company to protect intellectual property owned in any manner by the Company proprietary interests in any such product or service or in any manner that requires, or purports to require (i) any Company IP Intellectual Property[iii] (other than the Open Source Software itself) be disclosed or distributed in source code form or be licensed for the purpose of making derivative works; (ii) any restriction on the consideration to be charged for the distribution of any Company IP Intellectual Property; (iii) the creation of any obligation for the Company with respect to Company IP Intellectual Property owned by the Company, or the grant to any third party of any rights or immunities under Company IP Intellectual Property owned by the Company; or (iv) any other limitation, restriction or condition on the right of the Company with respect to its use or distribution of any Company IP Intellectual Property (other than the Open Source Software itself).”

6. Software Licenses

Section 2.8(d) devotes a whole section to having Company represent that it “possesses” valid licenses for all software on computers and “software-enabled electronic devices” owned or leased by the company.  Rather than devote a whole section to licenses of only one type of intellectual property (software) and even then, only software used on certain machines, investor’s counsel should consider substituting Section 2.8(d) with a more targeted and applicable representation regarding the type of intellectual property that is material to Company’s business.   

While every company will use software, the risk that use of unlicensed copies of widely commercially available software such as Adobe Acrobat Reader or Microsoft Windows will cause irreparable harm to Company is relatively low outside of certain narrow and specific circumstances. Further, with the increased use of cloud computing services, it is likely that at least some of the material software used by Company will not be installed on Company owned or leased hardware but instead will be installed on hardware operated by the cloud service operator. Finally, the representation merely requires that Company have a “valid license” to “use” the software. The term “use” is considered imprecise in the context of software licensing since Company may need to do a broad range of activities with licensed software such as modifying, distributing and reproducing such software. The right to “use” software generally is not considered to cover modifying or distributing such software. If Company needed to distribute certain software as part of its business, the Model Form representation arguably does not address this concept.

While almost all investment targets use software, whether such software use justifies an entire subsection of Section 2.8 should be carefully considered given that other language may already partially cover the concepts. Since a drafting option under the Model Form for Section 2.8(a) and the definition of “Company Intellectual Property” creates a “sufficiency” representation that the Company has or can obtain all “necessary” rights in intellectual property for the conduct of the Company’s business, the additional language in Section 2.8(d) may not add much value if Company’s business is not materially affected by the status of their software licenses. Further, Company’s material inbound intellectual property licenses may not be in software but may be in patents (such as a biotech spinoff from a university), trademarks (such as a franchisee or merchandising partner), or non-software copyrights (such as an online publication). For any of these, substituting a more focused representation would be more valuable.

If a software use representation is still needed, it would be better to substitute the Model Form software representation with something not limited to certain hardware in order to definitely capture software that may be used in cloud services and that specifies that Company has adequately broad license rights in such software.

Recommended Revisions to Model Form: “(d) The Company has obtained and possesses valid licenses to use for all of the software programs that are used, modified or distributed by the Company in the conduct of its business and such licenses allow Company to exercise all rights exercised by the Company in such software programs when conducting its business present on the computers and other software-enabled electronic devices that it owns or leases or that it has otherwise provided to its employees for their use in connection with the Company’s business.”

Include the following explanatory footnote: This Section 2.8(d) is less critical if there is language in Section 2.8(a) that the company has obtained all rights in Company Intellectual Property necessary to conduct its business. If such language to cover the concept of Company having “sufficient” intellectual property already exists, consider substituting a different representation to cover an intellectual property risk that is not addressed in any manner by the existing Model Form language.

7. Infringement

Section 2.8(b) and Section 2.8(a) both deal with Company infringement of intellectual property, but the language in these sections is inconsistent. The language in Section 2.8(b) should be made more consistent with the language in Section 2.8(a) that addresses whether Company has received any notices alleging that Company (or its conduct of the business) has violated various intellectual property rights. Using the same language in both Section 2.8(a) and 2.8(b) as recommended below would bring the language in Section 2.8(b) more in line with the more accurate view that infringement occurs as a result of actions taken with regard to intellectual property and not by the intellectual property itself. The key difference is that Section 2.8(a) references violations of intellectual property rights by Company or resulting from conduct of the business while Section 2.8(b) references violation of intellectual property rights by Company’s products or services.

Recommended Revisions to Model Form: “(b) [To the Company’s knowledge,] no product or service marketed or sold (or proposed to be marketed or sold) by the Company’s conduct of its business (or proposed conduct of its business) does not or will not violates or will violate any license or infringes or will infringe any intellectual property rights of any other party.”

8. Conclusion

The Model Form intellectual property representations could be edited to be more accurate or applicable in almost all venture capital transactions.  Some of the above revisions should be applied regardless of the nature of the investment target, while others are best used depending upon the investment target. This exercise was a reminder that the intellectual property representations should be reviewed and possibly revised (even after taking into account those proposed revisions above that apply in all situations) only after taking into account the nature of the investment target. There is a common reluctance to engage in tinkering too much with the Model Form intellectual property representations in a venture deal, but if the goal of the representations is to both elicit necessary disclosures for diligence purposes and to help guide the investment target in the diligence process, then the intellectual property representations should be tailored to address certain specific topics that are not in the current Model Form.

[i] A considerably shorter article addressing some of these topics by the author appeared in the Fall 2020 edition of the ABA Venture Capital and Private Equity group newsletter “Preferred Returns.”  Space constraints in such publication prevented a more detailed analysis and inclusion of suggested revisions that appear in this article. 

[ii] The GPL 2.0 and GPL 3.0 licenses are among the most common open source licenses, and are believed by many to potentially create diligence issues given the nature of their terms. 

[iii] This is a minor error but should be corrected. “Company IP” should be replaced with the defined term “Company Intellectual Property.”

Emboldened by new laws, tax authorities worldwide are ramping up efforts to require tax advisors and taxpayers to provide enhanced information regarding tax schemes. Armed with additional disclosures, authorities are becoming more knowledgeable about the risk of abuse in  tax shelters and transactions designed to minimize or possibly avoid taxes. This global trend has been embraced in Latin America.

Just as the U.S. American Jobs Creation Act of 2004 amended the Internal Revenue Code to include expanded anti­–tax shelter reporting obligations, new legislation in Mexico and Argentina should yield similar information that will likely impact domestic and international tax planning. 

These legislative initiatives will need to be considered in connection with development of financial and estate plans incorporating financial products, including life insurance and annuities issued by foreign insurance companies to persons resident in Argentina and Mexico where foreign (offshore) LLCs or trusts are utilized. 

Pursuant to the Mexican Tax Code (as amended in December 2019), Mexican taxpayers and their advisors are required to report to the Mexican Tax Authority (SAT), tax structures designed or implemented to avoid the payment of income tax generated through foreign transparent entities such as LLCs, partnerships and trusts.

The Mexican Tax Code does not describe the types of tax structures that are subject to reporting; thus, there may be some ambiguity as to what constitutes a tax structure requiring reporting. Nevertheless, reporting will most likely be required if one of the objectives of the transaction is to avoid the payment of taxes through the use of transparent entities. Reporting must be made within 30 days of the implementation of the tax structure.

Argentina’s recently adopted Tax Resolution, which implements a reporting regime that covers domestic and international tax planning, is more comprehensive than Mexico’s legislation. Argentina’s new regulations provide a broad definition of reportable domestic and international arrangements, as well as examples of situations that are considered international arrangements per se, and thus reportable.

International arrangement is defined in the Argentina Tax Resolution as “any agreement, scheme, plan or any other action through which a taxpayer obtains tax advantages or other tax benefits involving Argentina and any other jurisdiction.” International tax planning arrangements that are required to be reported to the Argentine Tax Authority (AFIP) include transactions employing legal entities in such “other jurisdictions”: (i) to obtain benefits provided by treaties to avoid double taxation, (ii) that involve a low tax jurisdiction or (iii) where a taxpayer has rights as beneficiary, grantor, or trustee of a foreign trust.  

Argentinian taxpayers, tax advisors or any person assisting in implementing these tax planning structures are subject to this reporting obligation. International tax planning arrangements must be reported within 10 days of implementation. The Argentina Tax Resolution retroactively impacts tax planning arrangements implemented after January 1, 2019, and disclosure to AFIP must be made before January 29, 2021.

The reporting of an international arrangement does not automatically trigger a determination by AFIP in connection with the tax treatment or legitimacy of the transaction. However, AFIP, pursuant to the exchange of tax information treaties, may elect to share the information with the foreign jurisdiction involved in the international arrangement.

Estate and financial plans incorporating offshore financial products such as offshore life and annuities sometimes utilize foreign transparent entities established in low-income tax jurisdictions. In light of these recent regulatory reporting schemes, estate planning solutions for persons resident in these countries will need to consider the impact of the new reporting requirements on the sale of offshore investment products.