There are a multitude of issues and terms to address when companies merge or when one company acquires another. One aspect of the deal that is often overlooked is insurance. Specifically, directors and officers liability insurance, also known as D&O insurance, is an essential part of any merger or acquisition and must be carefully considered in order to avoid significant liability down the road. Companies should not overlook the option of representations and warranties coverage when planning a merger or sale.
This is especially true in the current climate. Merger and acquisition activity since the latter half of 2020 has seen unprecedented growth. Some bankers have said that the M&A market has gone into “overdrive” and the number of mergers and acquisitions is “far beyond the historical norm.”[1] With this increased M&A activity, litigation resulting from the transaction – including shareholder lawsuits – is inevitable. According to Cornerstone Research, 82% of the significant deals announced in 2017 and 2018 were challenged by shareholders, resulting in roughly three lawsuits filed per challenged deal.[2]
Suffice it to say, the risk and exposure in a merger or acquisition is high, for the companies involved but also individual executives. This article addresses some of the key insurance issues that decision makers should keep in mind to mitigate that risk and maximize coverage.
D&O Insurance
D&O liability insurance is meant to protect directors and officers if they are named as individual defendants in lawsuits for acts taken in their roles as such. D&O insurance protects the insureds in the event of suits by plaintiffs such as employees, shareholders, competitors, investors, and customers. Some D&O policies also provide coverage for the company.
D&O policies usually provide coverage for legal fees incurred as well as amounts paid by the insureds in judgments or settlement disbursements. If the directors and officers are entitled to indemnification from the company by way of company bylaws or their employment contracts, that indemnity obligation is typically backed financially by a D&O policy.
Change in Control Provisions
D&O insurance policies typically insure against certain “Wrongful Acts” as defined by the policy that the company or other insureds allegedly commit. These policies often contain a “change in control” provision that limits the available coverage for these “Wrongful Acts” if there is a change in company ownership. Before any merger or acquisition, it is crucial to review and understand any change in control provisions and corresponding notice requirements to keep the intended insurance in place, uninterrupted, or secure new coverage.
Change in control provisions are generally triggered upon the happening of a named event (i.e., mergers, acquisitions, or change in voting control). When that triggering event occurs, coverage under the policy changes. While the change in coverage will depend on the specific policy language, the provisions typically provide that the policy will not insure “Wrongful Acts” that occur after the triggering event and will only cover acts that occurred prior to the change in control. That is, the policy will cover acts and omissions which occurred in the regular course of business, but not those after a change in control when circumstances (e.g. management, business goals, or other essential characteristics of the insured) have been altered. When the triggering event occurs and the coverage terminates, the policy is placed into run-off (discussed below). Note that the change in control provisions in some D&O policies are even stricter and eliminate all coverage, even for acts and omissions that predate the change in control.
Questions of change in control are highly fact-specific and are determined by the policy language, deal specifics, and the governing law. Therefore, it is important to understand these nuances before any deal, especially because once the provision is triggered, it can create unintended gaps or even eliminate all D&O coverage.
A change in control provision can also include notice conditions that require the insured to provide notice to the insurer within a specific time frame (either in advance of a deal or after its completion) to preserve coverage for the new entity. Like all notice requirements in an insurance policy, it is imperative that an insured not overlook these notice requirements, or the company risks losing coverage.
Tail or Runoff Coverage
D&O insurance policies are typically written on a “claims-made” basis, which generally means that the policy covers claims made while the policy is in effect. As addressed above, if a merger or acquisition triggers a policy’s change in control provision, then any claims based on conduct after the transaction date may not be covered and any claims presented for pre-transaction conduct will only be covered through the end of the policy period (likely a matter of months after the transaction). This creates a potential gap in coverage because the acquiring company’s policy will not respond on behalf the selling company’s directors and officers for pre-transaction conduct.
How, then, do you cover claims for pre-transaction conduct that are made after the policy expires? The answer is “tail” or “runoff” coverage. This coverage extends the D&O insurance policy for a certain period of time beyond the standard policy period. Essentially, the D&O insurance policy is held open for a certain number of years to address claims that may arise after the deal is closed. Typically, the tail or runoff period is six years.
Accounting for tail or runoff coverage is critical because it safeguards the directors and officers of the selling company in the event the acquiring company refuses to protect them or, in the case of bankruptcy, is not there to protect them. Accordingly, the purchase of a tail or runoff policy should be a critical deal point for the selling company in any negotiation.
Bump-Up Clauses
Following a merger or acquisition, it is not uncommon for shareholders of the purchased entity to file suit claiming that the consideration paid for the purchased shares was inadequate and seeking recovery of the difference between the amount they received in the transaction and what they claim is the actual value of those shares. Such a claim may implicate the “bump-up” clause found in many D&O policies. “Bump-up” provisions are generally found in the policy’s definition of Loss, and state that Loss does not include those amounts of any judgment or settlement that represent the amount by which the consideration paid in connection with the purchase of securities is increased.
Although such provisions are common, they vary substantially from policy to policy. For example, many bump-up provisions do not bar coverage for defense costs for claims asserting inadequate consideration. Others apply only to claims made under specific insuring clauses;[3] and yet others apply only when the amount representing the increase in consideration is paid by the insured corporation, and not by any director or officer.[4] Therefore, it is worthwhile to take a careful took at any D&O policy’s definition of “Loss,” both at the time of negotiation of the policy and in connection with any claims under the policy.
R&W Insurance: Coverage for the Merger or Acquisition Itself
While insurance considerations in corporate transactions are often focused on ensuring that there is adequate and available coverage in place if a company or other insured faces potential liability, insurance coverage is also available for the deal itself. This kind of insurance is called Representation and Warranties (R&W) insurance. Like the name suggests, R&W insurance protects a buyer or seller in a corporate transaction, like a merger or acquisition, from losses arising from inaccurate representations or warranties made by the seller or target company during the transaction. For example, a buyer-side R&W policy can protect the buyer by paying losses if the target company presents inaccurate information, misrepresents information, or fails to disclose particular liabilities. R&W insurance can also mitigate risk if a seller offers little or no indemnity protection for the deal itself.
[3]See, e.g.,Genzyme Corp. v. Federal Ins. Co., 622 F.3d 62, 72 (1st Cir. 2010) (“bump-up” provision applied only to Insurance Clause 3).
[4]See, e.g., Arch Ins. Co. v. Murdock, 2019 WL 2005750, at *9 (Del. Super. Ct., May 7, 2019) (definition of Loss did not include “any amount representing the increase in the consideration paid (or proposed to be paid) by the Policyholder in connection with its purchase of any securities or assets”).
Non-disclosure agreements (“NDAs”) serve a pivotal role in advancing research and development. NDAs enable parties to collaborate using information that its owners would otherwise be unwilling to share absent the protections NDAs afford. While NDAs can take many forms and be individually tailored to each situation, the basic premise is typically the same: at least one party possesses confidential information (for example, a new product, valuable research, special know-how, etc.) that it will share with the other party in furtherance of a common goal (producing the product, using the research, performing a task requiring the know-how, etc.). In exchange, the receiving party agrees to keep that information secret and not otherwise take the knowledge for its own use without permission. Sometimes the collaboration is successful; but other times, despite the parties’ best efforts, the project stalls and the sides part ways – amicably or not.
As with any contract, disputes may occur, particularly when the results fall short of the goal. Litigation is sure to arise when, a year or two later, a company announces a product that its former collaborator finds a bit too similar to the aborted joint project. No one likes to be sued, but being accused of (and possibly found liable for) misusing someone else’s confidential information can be especially troublesome for a business. The other company is a thief in the plaintiff’s eyes (and pleadings) – an accusation that can turn away customers or investors, and generate negative public opinion. Even if the breach resulted from a misunderstanding, others may now be reluctant to share sensitive material with the accused company for fear of being its next “victim,” which can harm sales, development, and more.
The potential for this public relations headache is why extra care and attention should be paid to ensuring compliance with an NDA. Unfortunately, various factors can make this task difficult, particularly in larger companies that handle numerous NDAs or where a great number of people may be involved. Below are some suggestions your company can take when entering and working under an NDA that may strengthen certain defenses in a later litigation, or hopefully help avoid a dispute altogether.
1. Make Employees Aware
An NDA’s terms most directly apply to the engineers, scientists, technicians, or others actually working with the received confidential information. But many of them never actually see the document, which is often signed and retained by an executive or general counsel. This is a critical mistake – those with the greatest need for the information should be aware of their responsibilities in protecting it. Provide a copy of the NDA to any employee you expect will access the received confidential information and get at least a written acknowledgement from those employees that they have received and reviewed the agreement. This can even be made mandatory within the NDA itself. For example, a form to be executed by the receiving employee may be included as an Appendix to the agreement. The employee can sign and return the form upon receipt. Copies of such acknowledgements can also be exchanged among the parties.
This practice serves several purposes. First and foremost, it lessens inadvertent disclosure by employees, who are now explicitly aware of their obligations not to misuse or divulge confidential information. A better-informed employee can more easily avoid information-sharing mistakes. Second, requiring written acknowledgements may limit the number of employees exposed to the confidential information. Employees (or their supervisors) with only a tangential or trifling need to see the material may decide it is not worth the effort of complying with the rigid formalities of the NDA, thereby shrinking the potential pool of responsible employees to only those truly requiring access. Finally, obtaining written acknowledgements is a great way to track viewers or custodians of the confidential information. For example, if materials need to be collected for return to the disclosing party, the signed forms provide a self-contained list of employees who should be asked for such documents to return. You will also know exactly who your most likely witnesses are should a dispute arise.
2. Set Automatic Calendar Reminders
An NDA seldom includes only a single date or deadline. In addition to an expiration date for the agreement, the NDA will typically recite another (usually later) date when confidentiality obligations cease. For example, although the NDA’s basic terms could expire (or be cancelled) tomorrow, the parties may still have to avoid disclosing or using confidential information for another three years. An NDA can also have deadlines for renewing or extending the agreement (e.g., thirty days before expiration), for returning or destroying confidential information in the receiving party’s possession (e.g., ten days after expiration), and for submitting notices to the other side regarding various aspects of the agreement, among other things. So, there are potentially many dates to track from a particular NDA, and if your company sees hundreds of agreements a year, remembering all those dates is impossible.
Every company has a computerized calendar in some form, but people do not often think to input contract dates in their calendars, particularly for NDAs. Setting automated reminders for as many of these dates as possible is a great way to make sure your company does not miss an important milestone and potentially expose the company to litigation. Having calendar alerts also minimizes the possibility of entirely overlooking actions that need to be performed. Many agreements expire long after work on the project has already ceased, so deadline actions triggered by the expiration date might otherwise slip through the cracks because the NDA or the disclosing party is no longer front of mind. For example, forgetting to return confidential material to the disclosing party can create long term issues for potential dispute, either by creating implications that your company used the information still in its possession or by providing an opportunity to mistakenly use it contrary to the agreement. Rather than simply executing the NDA and filing it away, automated reminders should be set for your company’s protection.
3. Centralize Storage
Not all confidential information warrants protection by armed security guards and simultaneous key turning (although the disclosing party may believe differently), but the concept of centralizing and limiting access to the received materials is instructive. Accidental disclosure or misuse is more likely to occur when access is unfettered and employees have documents lying unsecured on their desks. When possible, physical embodiments of the confidential information (e.g., printed documents, prototypes, samples) should be kept in a single, preferably securable location, such as a lockable cabinet. It may also be advisable to have employees sign in and out when removing and returning the materials. That way, it can be easier to track who has what and where.
Digital information is trickier, but comparable procedures can be implemented to secure the material. Many companies (particularly after COVID-19 accelerated the transformation to remote work) now have centralized servers or cloud-based document storage options. If the disclosing party allows, it is preferable to set up a folder or other similar structure in the server or cloud and encourage employees to store documents referencing or relating to the confidential information in that location, rather than on their local hard drives. This reduces unnecessary and uncontrolled proliferation and lessens the danger from localized security breaches; it is, however, crucial that these central locations have appropriate security safeguards to prevent unauthorized outside access – so it is ideal to have the folders containing confidential information password protected or restricted to particular internal users. Many document management software programs can limit access to specified folders to select individuals or groups, and wall off others. In some of these programs, the very existence of the file or folder may be invisible to employees without proper credentials. In short, it is much easier to maintain control over confidential information when it resides in one or two known and secured locations, as opposed to being scattered between offices or individual personal computers.
4. Document Interaction
Make sure at least one person involved with the confidential information is a good note taker. Work performed under an NDA often involves multiple meetings, telephone calls, and/or video conferences, both internally and with the disclosing party. It is important to document these calls/meetings carefully and contemporaneously, and then store those notes safely. The minutes should ideally list all of the attendees and the subject matter discussed. For instance, issues may arise when it is discovered for the first time during a deposition years later that Bob, an employee unaware of the NDA, showed up at just one of many meetings about the confidential information and then started using what he learned there in his own work. By tracking attendees, your company can know who was at the meetings and whether follow-up is needed with them to emphasize their responsibilities under the NDA (and obtain a signed acknowledgement, as discussed above).
Moreover, some confidential information may only be communicated verbally during one of these meetings, rather than in a document or physical manifestation. Meeting notes help establish whether (or not), when, and to whom such information was communicated. Without a document trail showing the receipt (or non-receipt) of confidential information, these notes may be the only physical evidence available regarding information exchange. If a disclosing party claims they told your company’s employees of their special widget during a meeting and legitimate documentation from that meeting exists indicating the contrary, your company is already in a better position than engaging solely in a battle of employee memories. Of course, when technically possible and if all parties agree, recording a meeting via audio/visual means can accomplish this task as well.
5. Demand Clarity
Many NDAs require that information deemed confidential be marked as such – for example, by placing a “Confidential” or similar label on appropriate documents. The receiving party benefits from this requirement because it allows the receiving party to clearly distinguish between information that needs protection and information that does not. But these NDAs are usually very forgiving for the disclosing party if they forget to label – unmarked information must typically be treated as confidential regardless, and if specifically brought to its attention, the disclosing party has a grace period to revise labels as appropriate.
It is in your company’s own best interest to make sure a disclosing party is following the rules. If information is received that may only arguably be confidential and is not marked, bring it to the disclosing party’s attention and get the issue resolved right away. The disclosing party may otherwise believe the information is confidential, the receiving party may believe it is not based on the lack of marking, and now a fact-finder or jury is deciding who is right. Avoid that later dispute and make the disclosing party be clear up front.
6. Proactively Limit Overreach
A disclosing party’s solution to the above problem might be to mark everything confidential and save themselves the trouble. But this overreach can be just as difficult for a receiving party as a lack of sufficient marking, since it inhibits clarity on what is permissible under the agreement. An NDA always defines the scope of confidential information, and usually excludes information previously publicly available or already known to the receiving party. To protect your company from overreach, search for articles, published patent applications, advertisements, or other similar publicly available information relevant to the project. Better still, request copies of that information from the disclosing party. Collect all of it, preferably before the collaboration gets heavily underway, and store it in a secure place with date stamps.
This research serves two primary purposes. First, having it on hand during the collaboration helps those working on the project to know, at the time, which received information needs protection and dissuades the disclosing party from over-designating. Second, doing the research up front shows diligence from the start, which will have better appeal to a fact-finder or jury in the event of a dispute. Third parties (judges, arbitrators, jurors) may perceive research conducted after the fact as an effort to excuse a breach, whereas early research can lessen the impression of wrongdoing.
7. Exercise Your Rights
Perception can have a powerful impact on a fact-finder or jury. When the evidence suggests one side received everything and gave nothing, the odds of successfully defending a breach suit may drop, even if – technically – that side is right under the letter of the contract. There is a worthwhile benefit in being able to show some important contribution to the project. Accordingly, particularly when the NDA is mutual, be sure your company is protecting its own information. For example, conspicuously label your company’s own confidential information appropriately when sharing it with the other side, and remember to request return or destruction of any of your company’s confidential information in the other side’s possession. Even when the NDA is not mutual, be sure to contemporaneously document everything your company gives to, or shares with, the other side during development to establish that the flow of information is not a one-way street. Juries are more willing to side with a party that actively collaborated in the process than a party that sat back and raked in the other side’s content.
There are no guarantees when it comes to litigation. But by following these steps before, during, and after an NDA’s term, your company can reduce the opportunities for breach (or perceived breach) and bolster its defenses with diligence.
Thryv, Inc. v. Click-to-Call Techs., LP, 140 S.Ct. 1367 (2020)
Facts: This case concerns whether a party may appeal a decision by the Patent Trial and Appeal Board (“Board”) as to whether institution of inter partes review is permissible under 35 U.S.C. § 315(b)’s “time bar” provision.
Click-to-Call owns a patent claiming technology for anonymous phone calls. In 2001, the exclusive licensee of Click-to-Call’s patent sued a predecessor of Thryv for patent infringement. The suit was voluntarily dismissed without prejudice. Twelve years later, in 2013, Thryv petitioned the Board to institute inter partes review of the patent. In opposing the petition, Click-to-Call argued that the prior 2001 lawsuit triggered § 315(b)’s time bar on the institution of inter partes review, which prohibits review “if the petition requesting the proceeding is filed more than one year after the date on which the petitioner, real party in interest, or privy of the petitioner is served with a complaint alleging infringement of the patent.” 35 U.S.C. § 315(b).
The Board rejected Click-to-Call’s argument and instituted inter partes review, holding that § 315(b)’s time bar did not apply when a complaint is dismissed without prejudice. The Board decided the merits of the inter partes review, and Click-to-Call appealed to the Federal Circuit. The Federal Circuit dismissed the appeal for lack of jurisdiction, holding that 35 U.S.C. § 314(d)’s bar on appeal of the Board’s institution decisions precludes judicial review of the Board’s application of § 315(b). After the Supreme Court addressed the scope of § 314(d) in Cuozzo Speed Technologies v. Lee, 136 S. Ct. 2131 (2016), however, the Court granted certiorari, vacated the judgment, and remanded to the Federal Circuit.
The Federal Circuit panel reached the same decision on remand, but after a split court decided en banc in another case that time-bar determinations under § 315(b) are appealable, the Click-to-Call panel granted panel rehearing and held that the Board should have declined to institute the inter partes review because the 2001 patent infringement complaint triggered § 315(b)’s one-year time bar. Thryv then filed a petition for certiorari, and the Supreme Court granted review.
Held: The Board’s decision as to whether institution of inter partes review is time-barred by § 315(b) is final and not appealable.
Reasoning: The Court held that § 315(b)’s time limitation on the filing of a petition for institution of inter partes review provides an integral condition on institution. The Court noted that the language of § 315(b) itself provides a circumstance in which “[a]n inter partes review may not be instituted.” Because § 315(b) merely places a condition on institution, disputes about whether a petition fails to comply with § 315(b) raise an ordinary dispute as to whether the Board should institute inter partes review. Such ordinary disputes fall within the ambit of the Court’s holding in Cuozzo that § 314(d) bars review of matters “closely tied to the application and interpretation” of statutes related to the institution decision.
The Court found that its conclusion was consonant with the purpose and design of the America Invents Act to reform the patent system to efficiently weed out bad patent claims. The Court noted that appeals of § 315(b) decisions would unwind the Board’s merits decision on patentability; since a patentee would only need to appeal on § 315(b) grounds when it lost on the merits of its patent, § 315(b) appeals would only save patents that the Board would have canceled. The Court further noted that because § 315(b) does not bar all review of a patent, merely review by a certain petitioner, it was unsurprising that a statutory scheme so consistently elevating resolution of patentability over a petitioner’s compliance with § 315(b) would preserve the Board’s adjudication of patentability by making § 315(b) decisions unappealable.
Justice Gorsuch dissented, joined in part by Justice Sotomayor. The dissent would have adopted a narrower interpretation of § 314(d), in which the only final and unappealable decision related to institution would be the Board’s finding that a petitioner has or has not shown a “reasonable likelihood” that a challenged patent is unpatentable.
Facts: This case concerns the patent eligibility of patent claims purportedly directed to a natural phenomenon.
Illumina owns patents directed to methods for preparing a fraction of cell-free DNA that is enriched in fetal DNA. Illumina sued Ariosa Diagnostics for infringement of these patents, and Ariosa moved for summary judgment that the asserted claims were invalid under 35 U.S.C. § 101. The district court granted Ariosa’s motion, holding the claims patent-ineligible. On appeal, the Federal Circuit reversed, finding the claims were directed to a patent-eligible “method of preparation.” The panel granted rehearing and issued a modified opinion retaining its original holding.
Held: Patent claims reciting physical steps changing the composition of a naturally occurring mixture of DNA based on human-engineered parameters, rather than merely observing the composition, are not directed to a natural phenomenon, and are thus eligible for patenting under 35 U.S.C. § 101.
Reasoning: The court highlighted two key points of the claims-at-issue that distinguished them from claims merely directed to a patent-ineligible natural phenomenon. First, the claims recited a “method of preparation,” analogous to a method of treatment in that the claims are not directed to a natural phenomenon, but rather to a patent-eligible method using the natural phenomenon. The claims used the natural phenomenon because they required discriminating and removing certain DNA fragments based on human-engineered size thresholds to optimize the sample for genetic testing, not merely observing the size of the DNA fragments. Second, the court found that the discriminating and removing steps not only apply the natural phenomenon, but also do so in concrete, physical process steps changing the composition of the DNA mixture. Both factors distinguished the case from Ariosa Diagnostics, Inc. v. Sequenom, Inc., 788 F.3d 1371 (Fed. Cir. 2015), which found a method of detecting fetal DNA patent-ineligible; the court explained that, in contrast to this case, Ariosa involved a patent directed to merely detecting a natural phenomenon after a sample had been prepared or extracted.
Judge Reyna dissented. In his view, the claims were patent-ineligible because the claimed advance was a natural phenomenon, and the method steps did not transform the nature of the claims into patent-eligible subject matter. He argued that the claimed method steps that the majority found to concretely apply the natural phenomenon were routine and conventional, and that the patent’s written description described the claimed advance forming the basis of the present invention as the discovery of the natural phenomenon. According to Judge Reyna, Ariosa was decided on the same considerations, and thus bound the panel to conclude that the claims-at-issue in this case were patent ineligible.
Facts: This case concerns the patent eligibility of patent claims purportedly directed to a natural law.
American Axle owns a patent claiming methods for manufacturing automobile driveline propeller shafts (i.e. shafts that transmit power from the engine to the wheels) with liners to attenuate vibrations transmitted through the shaft assembly. American Axle sued Neapco for patent infringement, and Neapco moved for summary judgment that the claims were patent ineligible under 35 U.S.C. § 101. The district court granted Neapco’s motion, holding the claims patent ineligible. On appeal, the Federal Circuit initially affirmed the district court’s grant of summary judgment in its entirety, but the panel granted rehearing and revised its decision to vacate and remand the district court’s decision as to certain claims.
Held: Patent claims reciting a mere result from applying a natural law, without limiting the claims to particular methods of achieving the result, are not eligible for patenting under 35 U.S.C. § 101.
Reasoning: The court found the claim that it held ineligible to merely claim a desired result from applying a natural law. The court noted that Supreme Court and Federal Circuit precedent have consistently rejected claims that state a goal without a solution as patent ineligible—claims must have the specificity to transform the claim from reciting merely a result, to reciting a specific way of achieving the result. The court explained that, while this concept has typically applied to cases holding claims ineligible as directed to abstract ideas, the principle necessarily applies to other categories of patent-ineligible subject matter. The court rejected the patentee’s arguments that persons of ordinary skill in the art would find applying the natural law difficult in practice, and that the claims were thus not merely directed to claiming a result, and found that the patentee had failed to claim the physical structure or steps needed to achieve the result.
Judge Moore dissented. She would have held that the claims, in fact, contain a specific, concrete solution to a problem, and that any need for trial and error in performing the method raised an enablement problem under 35 U.S.C. § 112, not a § 101 patent ineligibility problem. Judge Moore argued that because the claims, specification, and prosecution history did not mention the name or formula of the asserted natural law, the claims could not properly be considered directed to the natural law.
Facts: This case concerns whether prior art disclosing the administration of a biological substance when made by one process, anticipates a method of treatment patent claim reciting the administration of the same biological substance when made from another process.
Biogen owns a patent claiming a method for immunomodulating, or treating a viral condition by administering “a recombinant polypeptide produced by a non-human host.” Biogen sued Serono for patent infringement. A jury found Biogen’s patent invalid as anticipated, but the district court granted Biogen’s post-trial motion for judgment as a matter of law that the patent was not anticipated, finding as one ground that the “produced by a non-human host” limitation overcame shortcomings in the prior art. On appeal, the Federal Circuit vacated and remanded.
Held: Under the product-by-process doctrine, method of treatment claims may not be distinguished from the prior art based on the manufacturing process of the administered drug product.
Reasoning: The court noted that the product-by-process doctrine has long held that old products are not patentable, even when made by a new process. The court then rejected Biogen’s arguments that this doctrine is limited to composition claims, and thus not applicable to the method of treatment claims at issue here. The court explained that no logical reason exists for why nesting a product-by-process limitation within a method of treatment claim, rather than a composition claim, should change how the novelty of the limitation is evaluated, especially when neither the composition nor the method of administration of the composition are novel. The court noted that, when the novelty of a method of treatment claim rests entirely on the novelty of the composition administered, which in turn rests on the novelty of a product-by-process limitation, the anticipation analysis for the composition and for the method of treatment will necessarily result in the same conclusion.
GlaxoSmithKline, LLC, v. Teva Pharms. USA, Inc., 976 F.3d 1347 (Fed. Cir. 2020)
Facts: This case concerns whether a generic drug company induces infringement of patents claiming certain methods of administering a drug, when the generic drug’s label does not specify those uses.
GlaxoSmithKline (GSK) owns a patent on a method for using a drug (that was originally approved for treating hypertension) to treat congestive heart failure. GSK sued Teva for patent infringement. The jury found that Teva had induced infringement of GSK’s patent, but the district court granted Teva’s motion for judgment, as a matter of law, that it had not induced infringement. The district court reasoned that GSK had not sufficiently proved that Teva’s actions caused physicians to administer the generic drug to treat congestive heart failure simply because physicians would have known of the possible uses of the generic drug from GSK’s promotion of the branded drug. On appeal, the Federal Circuit reversed the grant of JMOL and reinstated the jury verdict.
Held: Promotion of a generic drug’s therapeutic equivalence to the branded drug can provide sufficient evidence to find that the generic drug company induced infringement of patents claiming uses of the drug that are not present on the generic drug’s label.
Reasoning: Noting that a plaintiff can prove the intent element of induced infringement through circumstantial evidence, the court held that GSK had presented sufficient evidence from which the jury could have reasonably issued its verdict of induced infringement. The court highlighted in particular several Teva press releases and reference documents for physicians that emphasized that Teva’s drug was an AB-rated equivalent of the branded drug, and the testimony of a physician that this equivalence would lead a physician to prescribe the generic drug for all uses of the branded drug, not just the uses on the generic drug’s label. The court held that the district court had applied an incorrect legal standard when it granted JMOL, because when the provider of an identical product knows of and markets the same product for intended direct infringement activity, the criteria of induced infringement are met.
Chief Judge Prost dissented. She would have affirmed the district court’s ruling because, in her view, GSK presented no evidence establishing that Teva actually caused the infringement of the patent method, and because the record established that doctors relied on other sources of information, not Teva, in deciding to prescribe the generic drug for the patented method of treatment. Chief Judge Prost argued that the majority’s holding improperly nullified the practice of “skinny labeling” under 32 U.S.C. § 355(j)(2)(A)(viii), in which a generic drug manufacturer can “carve out” certain patented uses of a drug from its labeling, so that it may sell a drug for unpatented uses without risking liability for still-patented uses.
Personalized Media Commc’ns, LLC, v. Apple Inc., 952 F.3d 1336 (Fed. Cir. 2020)
Facts: Personalized Media Communications (PMC) owns a patent claiming methods for enhancing broadcast communications with user-specific data. Apple petitioned for inter partes review of the patent, and the Patent Trial and Appeal Board found the claims unpatentable. PMC challenged the Board’s claim construction on appeal, and the Federal Circuit reversed the Board’s decision as to the improperly-construed claim.
Held: A patent applicant’s repeated and consistent remarks can define a claim term, even if those statements are not a clear and unmistakable surrender of claim scope sufficient to rise to the level of disclaimer.
Reasoning: The court explained that the Board erred in finding the prosecution history irrelevant because it did not clearly and unmistakably surrender claim scope. The court noted prior holdings that prosecution history is relevant to the meaning of disputed claim terms, even where prosecution history statements do not rise to the level of unmistakable disavowal. The court noted that here, where the claim term had no plain or ordinary meaning, and where the specification provided no clear interpretation of the claim, repeated and consistent remarks in the prosecution history would be especially relevant to the claim’s interpretation, and, in fact, decisive as to the meaning of the claim.
Godo Kaisha IP Bridge 1 v. TCL Commc’n Tech. Holdings, Ltd., 967 F.3d 1380 (Fed. Cir. 2020)
Facts: This case addresses whether proof of compliance with a technical standard can be used to show infringement of a standard-essential patent.
Godo Kaisha IP Bridge 1 (IP Bridge) owns two patents essential to the LTE wireless communication standard. It sued TCL for infringement of these patents. At trial, IP Bridge introduced evidence showing that the asserted claims are essential to mandatory sections of the LTE standard, and that the accused products comply with the LTE standard. The jury found that TCL infringed the patents. On appeal, the Federal Circuit affirmed.
Held: Proof of compliance with a technical standard can be used to show infringement of a mandatory standard-essential patent, and is a question to be resolved by the trier of fact.
Reasoning: The court noted that in, Fujitsu Ltd. v. Netgear Inc., 620 F.3d 1321 (Fed. Cir. 2010), the court held that a district court may rely on an industry standard in assessing infringement. The court highlighted Fujitsu’s note that, although a patent’s claims cover an industry standard, the claims might not cover all implementations of the standard, so the accused product’s standard compliance alone might not provide sufficient evidence to establish the accused product’s infringement. The court pointed out that in cases like this one, where a patent covers mandatory aspects of a standard, however, infringement can be proved by merely showing compliance with the standard. The court rejected TCL’s argument that the district court must determine, as a matter of law, and a part of claim construction, whether the scope of the claims includes any device that practices the standard. Instead, the issue of whether the asserted claims are, in fact, essential to all implementations of an industry standard, was a question to be resolved by the trier of fact, in the context of an infringement trial.
Facts: This case addresses whether a patent license agreement applies to child patents of the licensed patents.
Cheetah Omni owns patents directed to optical communication networks. Cheetah sued AT&T for patent infringement. AT&T’s supplier of the accused products, Ciena, moved to intervene, and, after the district court granted the motion to intervene, moved for summary judgment that Cheetah’s prior license agreement with Ciena included an implied license to the patents-in-suit, which were a continuation, and a continuation-in-part of an expressly licensed patent. The district court granted the motion for summary judgment. On appeal, the Federal Circuit affirmed.
Held: Granting a license for a parent patent creates an implied license for a child patent.
Reasoning: The court noted that in TransCore, LP v. Electric Transaction Consultants Corp., 563 F.3d 1271 (Fed. Cir. 2009), the doctrine of legal estoppel required that a licensee received an implied license to a related, later-issued patent that was broader than and necessary to practice an expressly licensed patent. The court extended this holding to expressly apply to continuation patents with narrower claims than the parent patent in General Protecht Group, Inc. v. Leviton Manufacturing Co., 651 F.3d 1355 (Fed. Cir. 2011). The court rejected Cheetah’s arguments that General Protecht applied only to licenses executed before the continuation patent was issued; the court explained that the timing of the patent issuance was not essential to General Protecht’s rationale, and, in fact, the policy concerns made General Protecht’s rationale more appropriate for already-issued continuation patents. Finally, the court noted that the naming of certain patents expressly in the license agreement did not evince a clear mutual intent to exclude other unnamed patents from falling within the general definitions in the agreement.
Hologic, Inc. v. Minerva Surgical, Inc., 957 F.3d 1256 (Fed. Cir. 2020)
Facts: This case addresses whether the doctrine of assignor estoppel applies to prevent the assignor from raising as a defense that the patentee is collaterally estopped from asserting claims found unpatentable in an inter partes review.
Hologic owns patents claiming methods for determining the presence of uterine perforations prior to performing endometrial ablation of a uterus. Hologic sued Minerva Surgical for infringement of these patents. The district court granted Hologic’s motion for summary judgment that assignor estoppel barred Minerva Surgical’s invalidity defenses to Hologic’s patent infringement claims because Minerva Surgical’s founder assigned both of the patents-in-suit to Hologic’s predecessor.
In parallel, Minerva Surgical petitioned for inter partes review of one of the patents. The Patent Trial and Appeal Board found those claims unpatentable, and the Federal Circuit affirmed. The district court applied collateral estoppel to give the Board’s decision as to these claims preclusive effect in the district court suit. On appeal, Hologic argued that this decision would allow the America Invents Act (which established inter partes review proceedings) to abrogate the assignor estoppel doctrine in district court patent infringement suits. The Federal Circuit disagreed and affirmed the district court’s decision.
Held: Assignor estoppel does not bar challenges of a patent’s validity in inter partes review proceedings, nor does it bar the application of collateral estoppel in a parallel district court proceeding to foreclose the patentee’s assertion of claims cancelled in inter partes review.
Reasoning: The court noted that the Federal Circuit has repeatedly upheld the applicability of the assignor estoppel doctrine, but noted that the doctrine only bars assignors from challenging the validity of a patent-in-suit. For example, under the Federal Circuit’s precedent, an assignor could argue that the patentee is collaterally estopped from asserting a patent found invalid in a prior proceeding. Because the Federal Circuit had previously held that an assignor who is no longer the owner of a patent may file a petition for inter partes review of the patent, and that an assignor can assert that a prior holding of invalidity collaterally estops the assertion of those claims, the district court did not err here. It affirmed that assignor estoppel did not prevent Minerva Surgical from asserting that Hologic was collaterally estopped from asserting the claims held invalid and cancelled in the inter partes review.
Judge Stoll, who wrote the court’s opinion, wrote in a separate opinion that she believed that the court should reconsider its precedent on the application of assignor estoppel en banc to resolve the contradiction that assignor estoppel bars assignors from challenging the validity of the assigned patent in district court, but not in Patent Office proceedings. However, the en banc court denied rehearing. The Supreme Court recently granted certiorari to further review this decision.
In re PersonalWeb Techs., LLC, 961 F.3d 1365 (Fed. Cir. 2020)
Facts: This case relates to the application of the Kessler doctrine to bar suits against an accused infringer’s customers after the accused infringer prevails in a patent infringement suit.
PersonalWeb owns several patents directed to creating unique identifiers for data stored on a computer to avoid storage of duplicate data with different file names. In 2011, PersonalWeb sued Amazon.com, Inc. and Amazon Web Services, Inc., as well as one of Amazon’s customers, Dropbox, Inc., for patent infringement. After claim construction, PersonalWeb stipulated to the dismissal of all claims against Amazon with prejudice, and the court entered final judgment against PersonalWeb.
Later, beginning in January 2018, PersonalWeb filed dozens of new lawsuits against website operators, many of whom were Amazon’s customers. Amazon intervened in defense of its customers, and the cases were consolidated by the Judicial Panel on Multidistrict Litigation. The district court granted Amazon’s motion for summary judgment, holding that claim preclusion barred PersonalWeb’s infringement claims based on activity occurring prior to the final judgment in the 2011 suit, and that the Kessler doctrine barred PersonalWeb’s infringement claims based on activity occurring after the final judgment in the 2011 suit. On appeal, the Federal Circuit affirmed.
Held: The Kessler doctrine, which gives a “limited trade right” to continue to sell a product adjudged as non-infringing without being subject to additional harassing suits alleging continuing sale of the product infringes, applies even to cases voluntarily dismissed with prejudice by the patentee, and blocks subsequent allegations of infringement against the original defendant and its customers.
Reasoning: The court held that claims of noninfringement or invalidity do not have to be actually litigated before the Kessler doctrine can be invoked. Federal Circuit precedent holds that the Kessler doctrine is a close relative of claim preclusion, without the temporal limitations of claim preclusion, rather than an early version of non-mutual collateral estoppel. PersonalWeb’s stipulation to dismiss its suit against Amazon with prejudice, and the final judgment based on that stipulation, adequately stood as an adjudication on the merits for preclusion purposes that Amazon was not liable for the acts of infringement alleged by PersonalWeb. That final judgment established a right protecting Amazon’s product from subsequent infringement challenges—directed both at Amazon itself and Amazon’s customers. The court explained that holding otherwise would leave the patentee free to engage in the same type of harassment the Supreme Court sought to prevent in Kessler.
In re Google LLC, 949 F.3d 1338 (Fed. Cir. 2020)
Facts: This case addresses whether the mere presence of third-party data centers hosting a company’s servers within a district counts as a “regular and established” place of business within the district to establish patent venue under 28 U.S.C. § 1400(b).
Super Interconnect Technologies LLC (SIT) sued Google for patent infringement in the Eastern District of Texas. SIT asserted that venue was proper in that district under 28 U.S.C. § 1400(b) because Google had committed acts of infringement in the district and had a regular and established place of business in the district. SIT claimed that the regular and established place of business was Google’s servers within the district, which Google used to provide local caches for its data.
The servers were not hosted within data centers owned by Google. Instead, Google contracted with internet service providers (ISPs) to host Google’s servers within the ISP’s data center; Google’s servers were installed in the ISP’s server racks within the data center. The ISPs provided power and network access for the servers, installed the servers on racks of their choice, and maintained the servers; no Google employee installed, maintained, or physically accessed any of the Google servers in the ISP data centers.
Google moved to dismiss the complaint for improper venue. The district court denied the motion, finding that the servers qualified as a regular and established place of business. Google petitioned the Federal Circuit for a writ of mandamus; the court granted the writ.
Held: To have a “regular and established place of business” in a judicial district, a defendant need not own real property or have a leasehold interest in real property; leased server rack space may serve as a place of business. However, an employee or agent of the defendant must be conducting business at the purported “place of business” for it to count as a “place of business” for patent venue. The court determined that the Eastern District of Texas was not a proper venue for this dispute.
Reasoning: The court noted that In re Cray, Inc., 871 F.3d 1355 (Fed. Cir. 2017) held that to establish a “regular and established business” in a district for patent venue purposes, a defendant must have a physical, geographic location in the district, from which the business of the defendant is carried out. The court agreed with prior district court decisions that leased shelf space or server rack space can serve as such a place.
As to the presence of an employee or agent, the court explained that 28 U.S.C. § 1400(b), the patent venue statute, must be read in conjunction with 28 U.S.C. § 1694, the service statute for patent cases, together compelling that a “regular and established place of business” within the meaning of the venue statute only exists if the defendant also has an “agent . . . engaged in conducting such business.” The court further noted that the statute required any agent to be conducting the defendant’s business. Likewise, these statutes compel the conclusion that the agent must be regularly, physically present at the place of business. Thus, a third party taking actions on behalf of the defendant, such as maintenance, that are merely connected to the defendant’s conduct of business—but do not themselves constitute the defendant’s conduct of business in the sense of production, storage, transport, and exchange of goods and services—would not make the third party an agent for purposes of establishing venue. The court left open the question of whether a machine could be an “agent” for purposes of establishing venue.
Judge Wallach concurred to note his view that Google’s end users in the district could count as agents of Google’s business in the district if their voluntary or involuntary sharing of information generated on Google’s servers provides data that Google monetizes as the core aspect of its business model in the district. He encouraged the district court to consider this question.
Valeant Pharms. N. Am. LLC v. Mylan Pharms. Inc., 978 F.3d 1374 (Fed. Cir. 2020)
Facts: Mylan Pharmaceuticals Inc. (“MPI”), a West Virginia-based corporation, sought to market a generic version of a drug sold by Valeant Pharmaceuticals North America LLC, Valeant Pharmaceuticals Ireland Ltd., Dow Pharmaceutical Sciences, Inc. (“Dow”), and Kaken Pharmaceuticals Co., Ltd. (collectively “Valeant”), who reside in a number of locations, including Japan, Ireland, and Delaware. Valeant sued MPI and related companies, Mylan Inc. (a Pennsylvania corporation) and Mylan Laboratories Ltd. (“MLL”) (a corporation based in India) for infringement in the U.S. District Court for the District of New Jersey.
MPI sought dismissal on venue grounds. Valeant’s justification for bringing suit in New Jersey was the planned marketing and sale of MPI’s product in the district if MPI’s product was approved. The District Court found in favor of MPI, dismissing the relevance of planned future acts of infringement to the venue analysis in ANDA cases. Valeant appealed.
Held: Venue in Hatch-Waxman cases is proper only in districts where actions related to the Abbreviated New Drug Application (“ANDA”) submission occur.
Reasoning: The Federal Circuit affirmed the District Court’s decision that venue was not proper in New Jersey for MPI and Mylan Inc., but reversed and remanded as to foreign defendant MLL. The Federal Circuit held that venue under 28 U.S.C. § 1400(b), the venue statute for patent cases, requires a past act of infringement and cannot be premised on future acts of infringement, such as where a product is likely to be distributed. The Federal Circuit held that the Hatch-Waxman Act defines only one act of infringement—an ANDA submission. As a result, venue is proper only where acts related to the ANDA submission took place. Because the District Court found that no act related to MPI’s ANDA submission took place in New Jersey, the Federal Circuit affirmed the District Court’s decision. With respect to MLL, the Federal Circuit held that venue was proper because MLL was subject to venue in any judicial district as a foreign entity. The Federal Circuit remanded for the District Court to address the substance of MLL’s motion to dismiss under Rule 12(b)(6).
Facts: Rovi Corporation and Rovi Guides, Inc. (collectively “Rovi”) filed a complaint with the International Trade Commission (“ITC”) arguing that Comcast, its customers and related companies infringe Rovi’s patents and should be barred from importing its X1 system set-top boxes under Section 337 of the Tariff Act of 1930. Rovi’s patents are directed towards an interactive TV guide system for remote access to television programs similar to that used by Comcast’s X1 system, and the key piece of that system is Comcast’s X1 set-top box.
Comcast imported the X1 set-top box through two other companies, ARRIS and Technicolor, and then distributed them to its customers. The Administrative Law Judge, affirmed by the full commission, found that the set-top boxes violated Section 337 because Comcast’s customers directly infringed Rovi’s patents. The Commission issued a limited exclusion order barring the importation of Comcast’s set-top boxes – including importation by ARRIS and Technicolor on behalf of Comcast.
Comcast appealed the Commission’s order on the grounds that exclusion was improper because the set-top boxes did not infringe Rovi’s patents at the time of importation and only did so later when they were connected to Comcast’s domestic servers and used by customers.
Held: Importation of a good can violate Section 337 of the Tariff Act of 1930 even if the actual infringement is not present at the time of importation.
Reasoning: On appeal, Comcast argued that in order to infringe Rovi’s patents, the X1 set-top boxes must be connected to Comcast’s domestic servers and its users’ mobile devices. Therefore, at the time of importation, Comcast’s set-top boxes were non-infringing. Comcast relied on Suprema, Inc. v. U.S.Int’l Trade Comm’n, 796 F.3d 1338 (Fed. Cir. 2015), which found that the importation of a product could be blocked where that product will infringe after importation. Comcast argued that Suprema should be limited to its facts and that Comcast’s case was distinguishable because its set-top boxes do not necessarily have to infringe after importation.
The Federal Circuit, however, affirmed the decision of the ITC and reasoned that the principle laid out in Suprema included Comcast products because the set-top boxes were specifically designed to be used in conjunction with the X1 system.
The Federal Circuit further declined Comcast’s motion to dismiss the appeal on the grounds that the patent had already expired. The Court agreed with Rovi that, because the Federal Circuit decision on the appeal impacted other pending matters, the Court should decide the appeal.
§ 1.2 Copyright Cases
§ 1.2.1 Supreme Court decisions
Georgia v. Public.Resource.Org, Inc., 140 S.Ct. 1498 (2020)
Facts: The case concerns whether the government edicts doctrine, which states that “officials empowered to speak with the force of law” cannot claim copyright in materials they create in the course of their official duties, renders a state’s official code annotations uncopyrightable.
The Official Code of Georgia Annotated (“OCGA”) comprises every active Georgia statute along with annotations, such as summaries of judicial decisions applying to specific provisions, lists of law review articles, and other reference materials. Under a work-for-hire agreement, the GA Code Revision Commission commissioned Matthew Bender & Co. to prepare the OCGA.
Without permission, Public.Resource.Org (“PRO”) distributed copies of the OCGA and posted the OCGA online, where the public could download copies free of charge. Georgia then sued PRO in district court, and the district court entered a permanent injunction against PRO to cease distribution activities and remove the online copies. The Eleventh Circuit reversed and the Supreme Court granted certiorari.
Held: The Court held that the OCGA annotations are ineligible for copyright protection.
Reasoning: The Court held that “[u]nder the government edicts doctrine, … legislators may not be considered the ‘authors’ of the works they produce in the course of their official duties as … legislators.” This holding was based on precedent, which explained work product generated by judges in the course of their official duties was not copyrightable. This was juxtaposed to precedent in which official reporters had obtained copyrights in explanatory materials for judicial opinions, because the reporters had “no authority to speak with the force of law.” The policy behind the holding here is that “no one can own the law” and “because officials are …empowered to make and interpret law … their ‘whole work’… must be ‘free for publication to all.’”
First, the Court determined that the purported author, the GA Code Revision Commission, was a legislator. The Court determined that, although the Commission was not identical to the Georgia legislature, the Commission functioned “as an arm of [the legislature] for the purpose of producing the annotations.” The Court also noted that the Commission was created by the legislature and consisted largely of legislators, received funding and staff from the legislature, and obtained approval of the annotations from the legislature. The Georgia Constitution stated that the work of the Commission “is within the sphere of legislative authority.”
Additionally, the Court concluded the annotations were created in the scope of the Commission’s official duties. Although the annotations did not purport to provide authoritative explanations of the law, the Commission’s preparations of the annotations were nonetheless drafted under the umbrella of Georgia’s legislative authority, and thus fell under the government edicts doctrine.
§ 1.2.2 Circuit Court decisions
Skidmore v. Led Zeppelin, 952 F.3d 1051 (9th Cir. 2020) (en banc)
Facts: In the late 1960s, Randy Wolf obtained a copyright on his song “Taurus” which he had written for his band, Spirit. Years later, after Wolf had passed away, the trustee of his estate, Michael Skidmore, brought suit against the famed rock band Led Zeppelin for copyright infringement. Skidmore alleged that Led Zeppelin’s hit song “Stairway to Heaven” infringed the first few bars of “Taurus”.
At the time, the two bands had played at the same venues and knew of each other. Moreover, Led Zeppelin’s members admitted to owning a copy of an album that contained “Taurus”. The copyright obtained for Wolf, however, was for an unpublished version of the song and consisted of a single sheet of transcribed music deposited with the Copyright Office.
At trial the Court limited the scope of the Taurus Copyright to the one page of sheet music deposited with the Copyright Office rather than the full version released on the album. As a result, during trial the District Court declined to allow Skidmore to play a full version of the song. Additionally, the District Court declined to give the “inverse ratio rule” instruction to the jury. This instruction states that when there is a large amount of evidence supporting “access” to the subject work, the burden of proof required for showing that there is “substantial similarity” between the subject work and the alleged copy is reduced. The jury ultimately found in favor of Led Zeppelin. Skidmore appealed, arguing to the Ninth Circuit that the district court’s actions were improper and warranted reversal.
Held: The decision of the district court is affirmed and the Ninth Circuit’s precedential acceptance of the “inverse ratio rule” is overruled.
Reasoning: On the issue of the scope of the copyright, the Ninth Circuit found that the district court did not err in limiting the scope of the copyright to the transcribed sheet deposited at the time of the registration of the copyright. The Copyright Act of 1909 provided no protection for recorded works and thus was limited to either published musical notation or, if the copyrighted material was unpublished, the transcription of the music deposited with the Copyright Office.
Addressing the “inverse ratio rule,” the Ninth Circuit realized it was one of only two circuits still upholding the use of the rule and decided to reexamine whether it should continue to do so. The Ninth Circuit concluded the logic upholding the “inverse ratio rule” was flawed and unfairly favored certain copyright owners. Specifically, the Ninth Circuit reasoned that, logically, while increased access presented more opportunity to copy a work, that does not inherently mean that it is more likely that any one work is a copy or is substantially similar to the copyrighted work. Additionally, the rule inherently favored more notable copyright holders. The “inverse ratio rule” effectively lowered the bar for showing someone had infringed a work that was better known. For these reasons, the Ninth Circuit overruled its prior holdings relying on the inverse ratio rule.
Corbello v. Valli, Case No. 17-16337 (9th Cir. 2020)
Facts: In the late 1980s, Rex Woodward collaborated with a member of the band The Four Seasons and wrote a factual autobiography telling the “whole story” of The Four Seasons. After completing the book and years of attempting to sell it, the pair were unable to sell it to a publisher. In the early 2000s, a musical called Jersey Boys was released on Broadway, which depicted the life and careers of The Four Seasons. Woodward’s widow Donna Corbello learned that the creators of Jersey Boys had access to Woodward’s manuscript while they created Jersey Boys. Corbello brought suit against 14 defendants (including the original members of The Four Seasons) and alleged copyright infringement, among 20 other causes of action in the District Court for the District of Nevada. After a lengthy procedural history, the District Court granted the defendants’ motion for judgment as a matter of law finding no copyright infringement.
Held: The court affirmed the District Court’s judgment as a matter of law.
Reasoning: In analyzing the claim of copyright infringement, the court focused on whether the two works were similar and whether the defendants had copied any protectable aspects of Woodward’s book. In analyzing the similarities between Woodward’s book and Jersey Boys, the court employed the Extrinsic Test analysis, wherein: (1) the plaintiff identifies the similarities between the copyrighted work and the accused work; (2) of those similarities, the court disregards any that are based on unprotectable material or authorized use; and (3) the court must determine the scope of protection to which the remainder is entitled “as a whole.” Of the six similarities that Corbello identified, the court determined that each similarity failed the Extrinsic Test because they were all primarily composed of non-protectable elements of the work, such as historical facts, common phrases, and scenes-a-faire.
Facts: This case is an appeal from a suit brought by a group of aerosol artists, headed by Jonathan Cohen, against a land owner on whose property they had, for years, been producing aerosol art. The space in question, known as 5Pointz, was owned and operated by G&M Realty, but had been a largely undeveloped collection of old warehouses for many years. Seeking to make some money off the property, the owner rented it to a group of aerosol artists. Over the course of several years, the artists turned 5Pointz into a mecca for the aerosol art form, attracting international recognition and many tourists every year.
The dispute began when the land owner, having an opportunity to develop the property into luxury apartments, declined to renew the artists’ lease and expressed a desire to demolish the structures which the aerosol art now adorned. Not wanting to see their art destroyed, the artists made several efforts to obtain ownership of the property, ultimately filing suit under the Visual Artists Right Act (“VARA”) to prevent the destruction of their work. The act grants artists “moral rights” in their work and allows them to prevent use of the art in a way that would harm their reputation and prevent the art’s destruction if it has achieved “recognized stature.”
The artists were able to obtain a temporary restraining order banning the art’s destruction early on in the case, but when the TRO expired, the district court declined to grant the artists a preliminary injunction barring its destruction. The land owner then whitewashed and demolished the aerosol art of 5Pointz.
At trial, the district court concluded that many pieces of art had in fact achieved recognized stature and that the defendants had acted willfully in their destruction of the art when they did not give the artists an opportunity to remove and preserve their pieces prior to demolishing the structures. The district court granted the artists statutory damages of $6,750,000. The defendants appealed to the Second Circuit.
Held: The district court did not err in finding the aerosol art had achieved “recognized stature” or in awarding statutory damages to the artists.
Reasoning: The Second Circuit reviewed the district court’s determination that the aerosol art had achieved “recognized stature” for clear error. The property owner’s main argument was that the district court failed to take into account the temporary nature of the aerosol art. The Second Circuit, however, concluded that the specificity of the drafting of VARA makes plain that it does not bar temporary works from achieving “recognized stature.” Further, recent examples, such as the temporary sculpture “The Gates” in New York City’s Central Park or the works of Banksy, the critically acclaimed street artist whose works were frequently only meant to be temporary, had nonetheless achieved “recognized stature.” Thus, defendants’ argument that the art was temporary was not enough to show clear error in the district court’s decision.
The Second Circuit further dismissed defendants’ argument that because the artists knew the buildings would be torn down eventually, the artists cannot claim to be wronged by their destruction. The Second Circuit countered by noting that VARA accounts for this eventuality by clearly requiring that, where art is built into the structure of a building, the owner must obtain written understanding from the artist(s) that their art may be destroyed if the building is. Where that is not in place, the owner must provide the artist(s) 90 days to remove the art. Defendants, in this case, did not afford the artists such an opportunity.
The Second Circuit found no issue with the district court’s reliance on expert testimony based on images of the art, rather than the works themselves. Likewise, the Second Circuit found no clear error in the district court’s consideration of the fact that Jonathan Cohen “curated” 5Pointz by pre-selecting artists who painted, even though such curation took place prior to the creation of the actual works. The Second Circuit also dismissed concern over the district court’s focus on the stature of 5Pointz as a whole in addition to the individual works. The Second Circuit reasoned that a work’s stature can certainly be improved by hanging in the Louvre, thus 5Pointz can have a similar effect on aerosol art.
Finally, the Second Circuit reviewed the district court’s damages award for clear error and found none. The district court was justified in finding defendants’ destruction of the art willful, because defendants were well aware of the artists’ VARA claims at the time of destruction and seemed to have needlessly and maliciously whitewashed the art as quickly as possible rather than affording the artists 90 days to remove their art. Moreover, the district court did not err in finding that the artists were entitled to the full statutory damages for each work of art, despite previously finding that the artists’ actual damages were too difficult to calculate. Such a determination did not mean the artists were not likely to get any revenue for their works, it simply meant they were hard to determine.
David Zindel v. Fox Searchlight Pictures Inc. et al., Case No. 18-56087 (9th Cir. 2020)
Facts: This case addresses whether questions of substantial similarity in copyright infringement may be properly decided at the pleadings stage on a motion to dismiss, without additional evidence such as expert testimony.
David Zindel (“Zindel”) alleged copyright infringement of his father Paul Zindel’s play, “Let Me Hear You Whisper,” by Fox Searchlight Pictures’ (“Fox”) film and book, “The Shape of Water.” According to the complaint, Zindel’s play tells the story of a lonely cleaning woman who works the graveyard shift at a scientific laboratory conducting experiments on animals for military purposes during the Cold War. She forms an emotional bond with one of the creatures after discovering that it chooses to communicate exclusively with her. Upon learning that the laboratory plans to vivisect the creature for research, she decides to free the creature into the ocean via a rolling laundry cart.
The complaint alleged that “The Shape of Water” similarly centered on a cleaning woman named Elisa working at a laboratory performing experiments for ominous military purposes in the Cold War era. Elisa discovers an aquatic creature of heightened intelligence stored in a glass tank. Elisa begins a romantic relationship with the creature after discovering it chooses to communicate only with her. As in Zindel’s play, protagonist Elisa hatches a plan to free the creature into the ocean via a laundry cart when she learns the scientists in the lab plan to cut it open for research.”
The district court dismissed Zindel’s complaint, finding that the plot of Zindel’s play was too general for copyright protection, and that the two works were not substantially similar as a matter of law.
Held: The Ninth Circuit reversed and remanded, finding that at the pleadings stage, reasonable minds could differ on the substantial similarity of Zindel’s and Fox’s works.
Reasoning: The Ninth Circuit found that the district court dismissed Zindel’s action prematurely. The court found that “reasonable minds could differ” on whether “Let Me Hear You Whisper” and “The Shape of Water” shared substantial similarities at the pleadings stage. The court found that additional evidence, such as expert testimony, would aid in the necessary literary analysis for determining the “extent and qualitative importance” of the commonalities Zindel alleged the two works shared. Thus, additional evidence could clarify whether the alleged similarities constituted copyright infringement or were unprotectable literary tropes.
Daniels v. Walt Disney Co., Case No. 18-55635 (9th Cir. 2020)
Facts: This case addresses the viability of copyright protection and subsequent infringement claims in connection with “lightly sketched characters.”
Emotional intelligence and child development expert Denise Daniels (“Daniels”) created “The Moodsters,” five color-coded anthropomorphic characters each correlated with a human emotion. Daniels’ entity, The Moodsters Company, published a “bible” for The Moodsters in 2005. The bible serves as a pitchbook for media and entertainment companies. The Moodsters Company went a step further and posted a YouTube pilot episode of “The Moodsters” with the same characters in 2007. Daniels pitched The Moodsters to Disney, among other entertainment companies. Disney did not pick up The Moodsters. In 2015, Disney released the film “Inside Out,” which was about five anthropomorphized characters correlated with human emotions living inside the mind of an 11-year-old girl.
Daniels and her company filed suit against Disney, alleging copyright infringement of the individual Moodsters characters and the ensemble of characters as a whole. The district court granted Disney’s motion to dismiss, finding that Daniels failed to show that The Moodsters met the necessary standard for copyright in a character. In reaching its ruling, the district court applied the Towle test (DC Comics v. Towle, 802 F.3d 1012 (9th Cir. 2015)) for the copyrightability of graphically depicted characters. Daniels appealed to the Ninth Circuit.
Held: The Ninth Circuit affirmed the district court’s ruling, finding that The Moodsters characters did not meet the threshold for copyright protection under the Towle test, and further failed to meet the standard for protection outlined in the Warner Bros. “story being told” test (Warner Bros. v. CBS, 216 F.2d 945 (9th Cir. 1954)).
Reasoning: The Towle test affords a character copyright protection if the character (1) has “‘physical as well as conceptual qualities,’” (2) is “‘sufficiently delineated to be recognizable as the same character whenever it appears’ and ‘display[s] consistent, identifiable character traits and attributes,’” and (3) is “‘especially distinctive’ and ‘contain[s] some unique elements of expression.’” The district court and Ninth Circuit agreed that The Moodsters characters met prong one of the test. The Ninth Circuit found that the second prong was an “insurmountable hurdle” for Daniels. The court explained that characters lacking “a core set of consistent and identifiable character traits and attributes” are not protectable, because they are “not immediately recognizable as the same character[s] whenever [they] appear.” The court further clarified that characters “too lightly sketched” could not be protected by copyright. The court analyzed the consistency in the depiction of The Moodsters’ physical appearance, character traits, and other attributes over time to determine if The Moodsters were sufficiently delineated. The court found that they were not, because the significant changes in the characters’ physical appearances over time made it difficult to conclude that The Moodsters in 2005 versus 2015 were the same set of characters. The Moodsters also did not have consistent character traits and attributes. While the characters represented five consistent emotions, their degree of consistency was insufficient to afford them copyright protection. The Ninth Circuit further found that The Moodsters did not meet the third Towle prong because each Moodster character merely represented a single emotion with generic characteristics that were not “especially distinctive.”
Finally, the Ninth Circuit analyzed The Moodsters using the Warner Bros. “story being told” test. The court explained its choice by noting the Towle test was not the exclusive test for determining the copyrightability of a character. The “story being told” test affords characters copyright protection if they constitute “the story being told” in a work, not as “‘only the chessman in the game of telling the story’ but one that ‘so dominate[s] the story such that it becomes essentially a character study.’” The court found that The Moodsters lacked character development and necessary character study since they were introduced only in a pitchbook, with even less development in the YouTube pilot. The Ninth Circuit determined that The Moodsters were more like “chessmen” telling the story, unqualified for copyright protection themselves. Thus, the Ninth Circuit affirmed the district court’s granting of the motion to dismiss.
Tresóna Multimedia, LLC v. Burbank High School Vocal Music Association, et al., Case No. 17-56006 (9th Cir. 2020)
Facts: This case clarifies (1) whether a licensee of a single copyright co-owner possesses standing to sue for copyright infringement and (2) whether rearrangements of short song segments in a transformative performance piece constitute a fair use.
Burbank High School’s music department includes nationally recognized show choirs, rumored to have inspired the television series “Glee.” The school’s music director, Brett Carroll, hired a music arranger to create custom sheet music for two shows performed by one of the show choirs, “In Sync.” The shows included stanzas from several songs, including “Magic,” “(I’ve Had) The Time of My Life,” “Hotel California,” and “Don’t Phunk With My Heart.” In Sync performed shows with arrangements of these four songs on several occasions.
After In Sync’s performances, licensing company Tresóna Multimedia, LLC (“Tresóna”) sued Carroll, Burbank High School, the Burbank High School Vocal Music Association Boosters Club and several individual Boosters Club parents (collectively, “Burbank High”) for copyright infringement. Tresóna alleged that the Burbank High show choir failed to obtain licenses for their use of segments of the four pieces of copyrighted sheet music. Tresóna claimed it possessed the exclusive right to license sheet music for the four songs. While Tresóna was assigned the rights to “Magic” from the song’s sole owner, Tresóna’s rights to the other three songs were assigned from fewer than all the co-owners of those songs. Both parties moved for summary judgment.
The district court held that Tresóna lacked standing to sue for copyright infringement of the three songs for which it did not possess a license from all co-owners of the copyright interest in the songs. For the “Magic” claim, the district court determined that Carroll was entitled to qualified immunity. It further found that the other named defendants could not be held liable for direct or secondary copyright infringement, but did not grant Burbank High’s request for attorneys’ fees. Both parties appealed.
Held: The Ninth Circuit affirmed the district court’s ruling on summary judgment in favor of Burbank High, but reversed the district court’s denial of attorneys’ fees, remanding for a calculation. The court affirmed that Tresóna lacked standing to sue for copyright infringement on “Magic,” and found that In Sync’s arrangements and performances of all songs constituted a fair use.
Reasoning: The Ninth Circuit affirmed the grant of summary judgment as to “(I’ve Had) The Time of My Life,” “Hotel California,” and “Don’t Phunk With My Heart.” The court cited Ninth Circuit precedent holding that when a single copyright co-owner independently attempts to grant an exclusive license, the licensee does not have standing to sue alleged third-party infringers. The court explained that this rule is intended to prevent one joint owner’s assignment from limiting the rights of joint co-owners without their consent.
With respect to “Magic,” the court focused on fair use rather than qualified immunity, noting the limited applicability of qualified immunity doctrine. Carroll used “Magic” in his capacity as a music teacher and transformed it significantly from its original use in a film. Thus, the educational and transformative nature of the use at a non-profit school weighed in favor of fair use on the factor relating to the purpose and character of the use. On the factor relating to the nature of the copyrighted work, the court weighed this against a finding of fair use given the creative nature of “Magic.” With respect to the third factor, substantiality of portion used, the court found Burbank High’s use of only 22 seconds of the song weighed in favor of fair use. Finally, the court also found the fourth factor, the market effect of the use, weighed in favor of fair use. The Ninth Circuit explained that the small excerpt of the song used was not a substitute for the entire song, and the song’s use in an educational environment served a different function. Therefore, Burbank High’s use of “Magic” was a fair use and did not constitute copyright infringement.
Finally, the Ninth Circuit decided that attorneys’ fees were warranted because Tresóna misrepresented the nature of its copyright interest in three of the songs, made objectively unreasonable arguments, and the fair use determination was sufficient on the merits to qualify Burbank High for an award of attorneys’ fees.
Charles v. Seinfeld, 803 F. App’x 550 (2d Cir. 2020)
Facts: This case clarifies when copyright infringement claims begin accruing if copyright ownership is itself disputed.
Producer and director Christian Charles (“Charles”) allegedly worked with comedian Jerry Seinfeld (“Seinfeld”) to develop the pilot for the television series “Comedians in Cars Getting Coffee” in 2011. In February 2012, Seinfeld rejected Charles’ request for back-end compensation in connection with the series. Seinfeld asserted and clarified that Charles’ involvement with the series was on a work-for-hire basis. “Comedians in Cars Getting Coffee” premiered in July 2012 and did not credit Charles.
In 2018, Charles brought suit against Seinfeld and others associated with the series, alleging copyright infringement based on his claimed authorship of the show. Seinfeld moved to dismiss Charles’ claim, arguing that it was time-barred under the Copyright Act. The district court agreed and granted the motion to dismiss. Charles appealed to the Second Circuit.
Held: The Second Circuit affirmed the district court’s ruling, holding that claims of copyright ownership accrue “when a reasonably diligent plaintiff would have discovered that ownership was disputed.” The court held that if copyright ownership is the central issue in an infringement case and the ownership claim is time-barred, “the infringement claim itself is also time-barred, even if any allegedly infringing activity occurred within the limitations period.”
Reasoning: The Second Circuit held that the dispositive issue in Charles’ claim was copyright ownership. This was evidenced in his own filing, which explained that “[r]esolution of this case depends upon the answer to one simple question: who is the author of the [‘Comedians in Cars Getting Coffee’] Pilot?” Hence, Charles’ copyright infringement claim accrued when he was put on notice that his claim of ownership was disputed. Charles was put on notice as to the dispute in 2012, when Seinfeld (1) rejected Charles’ request for back-end compensation, (2) told Charles that his contributions were made on a work-for-hire basis, and (3) the show premiered without crediting Charles. Thus, Charles’ 2018 copyright infringement claim was time-barred by the Copyright Act’s three-year statute of limitations.
Facts: The case concerns whether the district court abused its discretion when refusing to allow a subpoena of an alleged online copyright infringer’s internet service provider (“ISP”) to discover the identity of the alleged online copyright infringer.
Strike 3 is an adult film producer and distributor that faces “rampant online piracy.” In order to police infringement, Strike 3 uses investigators and forensic software to monitor peer-to-peer file sharing networks and determine IP addresses engaging in acts of infringement. Strike 3 then files lawsuits against “John Doe” defendants based on the IP addresses. However, since ISPs are the only entities that can link an IP address to its subscriber, Strike 3 cannot serve its copyright infringement complaints without first subpoenaing the subscriber’s ISP for information identifying the anonymous defendant. Accordingly, Strike 3 filed a Rule 26(d)(1) motion seeking leave to subpoena Comcast for records identifying the subscriber linked to a particular IP address.
The district court denied Strike 3’s motion after applying a multi-factor balancing test and found that Strike 3’s need for the subpoenaed information was outweighed by a privacy interest in view of the “particularly prurient pornography.” Additionally, the district court characterized Strike 3 as a “copyright troll” and stated it would not indulge Strike 3’s “feigned desire for legal process” by “oversee[ing] a high-tech shakedown.” The district court denied Strike 3’s motion and dismissed the complaint without prejudice. Strike 3 appealed, and the D.C. Circuit reversed the denial of the Rule 26(d)(1) motion and remanded.
Held: The D.C. Circuit found that the district court abused its discretion in denying Strike 3’s Rule 26(d)(1) motion.
While the D.C. Circuit recognized that courts have broad discretion over discovery, the district court abused its discretion in three aspects. First, the D.C. Circuit held that the content of a work is per se irrelevant to a Rule 26(d)(1) motion. The Court stated that a “mere fact that a defendant may be embarrassed to have his name connected to pornographic websites is not a proper basis on which to diminish a copyright holder’s otherwise enforceable property rights.”
The second abuse was the district court’s reasoning that even if the motion was granted, Strike 3 could not “identify a copyright infringer who can be sued” for purposes of stating a plausible claim against the IP subscriber. The D.C. Circuit stated that the “mere possibility that an unnamed defendant may defeat a complaint at a later stage is not a legitimate basis to deny a Rule 26(d)(1) motion,” and that at this stage of discovery, a court need not rule on the claim’s plausibility. Rather, Strike 3 should have the opportunity to name the defendant.
Third, the district court “failed to afford Strike 3 the benefit of all reasonable inferences, and instead relied on extra-record sources to question Strike 3’s motivation in seeking the requested discovery.” Rather than giving reasonable inferences to the facts before it, the district court instead looked outside of the record to determine Strike 3’s “copyright troll” behavior.
Estate of Smith v. Graham, 799 Fed. Appx. 36 (2d. Cir. 2020)
Facts: This case concerns whether defendants’ sampling of “Jimmy Smith Rap” (“JSR”) in “Pound Cake/Paris Morton Music 2” (“Pound Cake”) constitutes fair use.
In 1982, Jimmy Smith recorded an album containing a spoken-word track recording titled “Jimmy Smith Rap” (“JSR”). On September 24, 2013, Cash Money Records and Universal Republic Records released the album Nothing Was the Same (the “Album”) by Aubrey Drake Graham, a/k/a Drake. The last song on the Album is “Pound Cake/Paris Morton Music 2.” The opening to “Pound Cake” samples about 35 seconds of JSR. While some words from JSR were rearranged or deleted, no words were added.
The district court granted defendants’ motion for summary judgment on the grounds that the alleged copyright infringement was fair use. Plaintiffs appealed, and the Second Circuit affirmed.
Held: Drake’s sampling of JSR is fair use since it is a transformative new use of the old material.
Reasoning: The Second Circuit found Drake’s use of JSR was transformative and held that “Pound Cake,” unlike JSR, sends “a counter message—that it is not jazz music that reigns supreme, but rather all ‘real music,’ regardless of genre. …‘Pound Cake’ emphasizes that it is not the genre but the authenticity of the music that matters. In this manner, ‘Pound Cake’ criticizes the jazz-elitism that the ‘Jimmy Smith Rap’ espouses.” By doing so, it uses the copyrighted work for “a purpose, or imbues it with a character, different from that for which it was created.” The Second Circuit also held that Drake’s sampling was reasonable in relation to the transformative purpose of the copying. Lastly, the Second Circuit held there was no evidence that “Pound Cake” usurped demand for JSR or otherwise caused a negative market effect.
§ 1.2.3 Notable district court decisions
Sinclair v. Ziff Davis, LLC, 18-CV-790 (KMW), 2020 WL 3450136 (S.D.N.Y. June 24, 2020)
Facts: Stephanie Sinclair is a photographer who advertises her work on her own website and Instagram. Ziff Davis is a digital media company that owns multiple online brands and print tiles including Mashable, a media and entertainment content platform. Sinclair posted a copyrighted photo on her Instagram account which she set to be publicly viewable. Sinclair was subsequently contacted by Mashable who was interested in using her photo in an article about female photographers. Mashable offered Sinclair $50 for a license to use her photo, but Sinclair declined.
Despite Sinclair’s declination, Mashable used an embedded link to display the photo in its story. The embedded link allowed Mashable to display Sinclair’s Instagram content on its own website using Instagram’s API (application programming interface) without actually having Sinclair’s photo on Mashable’s own servers. Instead, the embedded link allowed Mashable to retrieve content directly from Instagram’s servers and display it in its article.
Sinclair brought suit against Mashable and Ziff Davis for copyright infringement, and the defendants moved to dismiss. In its first pass, the District Court for the Southern District of New York dismissed Sinclair’s complaint. The court found that Sinclair had agreed to Instagram’s terms and conditions, which granted Instagram a partial license and ability to sublicense any content Sinclair publicly posted on Instagram. Instagram’s Platform Policy with users of its API further granted API users a sublicense to “embed” any content that was publicly available on Instagram.
After the decision, Sinclair brought a motion for reconsideration on the grounds that Instagram’s Platform Policy was not sufficiently clear for the court to grant a motion to dismiss.
Held: Instagram’s policies were insufficiently clear for the court to grant a motion to dismiss.
Reasoning: Instagram’s Platform Policy, on which defendants relied to show they had a sublicense to “embed” Instagram’s content, stated that Instagram “provide[s] the Instagram APIs to help broadcasters and publishers discover content, get digital rights to media, and share media using web embeds.” On review, the court concluded that while this statement could be interpreted to grant API users the right to embed Instagram’s publicly available content, there are other interpretations. This ambiguity prevented the court from deciding the issue on a motion to dismiss. The court, therefore, reversed its prior dismissal of Sinclair’s claims against Mashable.
The court, however, maintained its dismissal of claims against Ziff Davis, LLC. The court’s above reasoning did not change its earlier conclusion that Sinclair needed to plead Ziff Davis, LLC had “substantial continuing involvement” in Mashable, rather than mere control.
McGucken v. Newsweek LLC et al.,No. 1:19-cv-09617-KPF (S.D.N.Y. 2020)
Facts: This case addresses the viability of a copyright infringement claim arising out of the use of embedded social media content.
Photographer Elliot McGucken (“McGucken”) posted a photograph of a lake in Death Valley, California, to his public Instagram account. Newsweek published an article about the same lake the following day. As part of its article, Newsweek embedded McGucken’s Instagram photograph without obtaining his permission to do so. McGucken registered the photograph with the Copyright Office and sent Newsweek a cease-and-desist letter for its use of his photograph. When the article remained live with McGucken’s embedded Instagram photograph, he filed suit.
Newsweek moved to dismiss the suit, arguing that (1) by posting his photograph on a public Instagram account, McGucken granted Newsweek a sublicense to use the photograph via Instagram’s embedding feature, and (2) use of the embedded photograph constituted a fair use as a matter of law.
Held: The district court denied the motion to dismiss, finding that there was no evidence of a sublicense between Instagram and Newsweek and that Newsweek’s actions did not constitute a fair use of McGucken’s photo.
Reasoning: The court considered its previous decision in Sinclair v. Ziff Davis in reaching a conclusion regarding Newsweek’s sublicense arguments. While the court agreed with the general principle that Instagram possesses the right to sublicense publicly posted photographs to other users, it found no evidence of a sublicense between Instagram and Newsweek in this case. Next, the court determined there was no evidence of an implied license between the parties. Finally, the court looked at terms and policies outlined by Instagram and found no term expressly granting a sublicense to those who embed publicly posted content. Thus, the court held that there was not enough evidence to dismiss the suit at this stage, while acknowledging the possibility that Instagram’s “Terms of Use” may provide a sublicense for embedded photos.
Regarding Newsweek’s fair use argument, the court analyzed the required four factors laid out in 17 U.S.C. § 107: (1) the purpose and character of the use; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used; and (4) the effect of the use upon the potential market for or value of the copyrighted work. On the first factor, the court held that “the mere addition of some token commentary is not enough to transform the use of the photograph when that photograph is not itself the focus of the article.” On the second factor, the court found the nature of the work was neutral. On the third factor, the court also found this factor neutral because while the entire photograph was used, it would be difficult to use less than the full photograph given the nature of embedding content. Finally, the court found in McGucken’s favor on the fourth factor. The court cited to a Supreme Court ruling finding a presumption of market harm “when a commercial use amounts to mere duplication of the entirety of an original.” Thus, Newsweek’s motion to dismiss on fair use grounds was denied.
§ 1.3 Trademark Cases
§ 1.3.1 Supreme Court decisions
Romag Fasteners, Inc. v. Fossil Group, Inc., et al., 140 S. Ct. 1492 (2020)
Facts: This case concerns whether willful infringement is a prerequisite to an award of a trademark infringer’s profits.
Romag Fasteners, Inc. (“Romag”) and Fossil, Inc. (“Fossil”) entered into an agreement whereby Fossil was permitted to use Romag’s fasteners on Fossil’s leather goods. Upon Romag’s discovery that the foreign factories manufacturing Fossil’s products were using counterfeit fasteners that bore Romag’s “ROMAG” trademark, Romag filed a complaint with the U.S. District Court for the District of Connecticut alleging trademark infringement pursuant to 15 U.S.C. § 1125(a) based on Fossil’s alleged use of counterfeit metal fasteners.
At trial, Romag moved for an award of Fossil’s profits. While the jury awarded Romag $6.7 million of Fossil’s profits due to Fossil’s “callous disregard,” the district court declined to award Fossil’s profits to Romag because the jury did not find that Fossil acted willfully, which was a requirement for an infringer’s profits award under Second Circuit precedent. Romag appealed this decision to the Federal Circuit, which affirmed the district court’s ruling.
Held: The Supreme Court reversed the Federal Circuit and resolved a circuit split by holding that “willfulness” is not required as a precondition to an award of a trademark infringer’s profits.
Reasoning: In analyzing whether an award of an infringer’s profits requires a finding of willfulness, the court first examined the textual language of 15 U.S.C. § 1125(a). The relevant provisions covering remedies for trademark violations do not make a showing of willfulness a precondition to a profit award when the plaintiff proceeds under § 1125(c), as Romag did here.
Second, the court addressed Fossil’s reliance on language from the Lanham Act stating that an award of the defendant’s profits is “subject to the principles of equity,” and thus contains an implicit willfulness requirement. Fossil argued that historically, equity courts required a showing of willfulness before authorizing a profits remedy. The court rejected Fossil’s “principles of equity” argument and reasoned that the historical use of this phrase, as well as its use within other parts of the Lanham Act, does not read in a willfulness requirement.
Third, acknowledging the Lanham Act’s text does not have a willfulness requirement, the court reviewed the Lanham Act’s predecessor legislation, the Trademark Act of 1905. Given that many early trademark cases are still interpreted under the Trademark Act of 1905, the court deemed the Act’s textual implications relevant to Fossil’s arguments. Cases interpreted under the Trademark Act of 1905 inconsistently either read in or read out a willfulness requirement. Regardless, the previous Act’s language did not require willfulness for the award of an infringer’s profits.
Finally, the court grappled with both pre- and post-Lanham Act interpretations of “courts of equity” and the appropriate weight to give an infringer’s mens rea in determining whether or not to award an infringer’s profits. Based on this review, the court recognized that an infringer’s mental state is no doubt relevant to the decision whether or not to award profits; however, whether or not the infringement was willful is not an inflexible precondition to recovery of an infringer’s profits.
United States PTO v. Booking.com B.V., 140 S. Ct. 2298 (2020)
Facts: This case concerns whether the addition of “.com” to an otherwise generic term may create a protectable trademark under the Lanham Act.
Since 2006, Booking.com has managed a website where users can make reservations for travel and lodging. In 2012, Booking.com filed four trademark applications using “BOOKING.COM” as a word mark and for stylized versions of the mark.
The USPTO examiner rejected Booking.com’s application on the grounds that BOOKING.COM was generic based on the services for which it registered, namely online travel reservations. While the Lanham Act allows for “descriptive” terms that have a “secondary meaning” or a perceived designation in the minds of prospective customers, the examiner determined the marks were merely descriptive and lacked secondary meaning.
On appeal, the examiner’s decision was upheld by the Trademark Trial and Appeal Board (“TTAB”) and Booking.com appealed the TTAB’s decision to the U.S. District Court for the Eastern District of Virginia. The district court ruled that the addition of the top-level domain (TLD) of “.com,” implying an online internet commerce site, made the mark no longer generic. Specifically, the district court relied on Booking.com’s evidence that 75% of customers surveyed recognized “Booking.com” as a specific brand.
The USPTO appealed the district court decision to the Fourth Circuit, which upheld the district court’s ruling. The Fourth Circuit considered whether the term “booking.com” could be non-generic when it was a composite of two generic terms, “booking” and “.com.” The Court concluded that it could be considered non-generic because the composite was recognized by customers as a unique online service rather than a range of services. The USPTO appealed the Fourth Circuit’s decision to the U.S. Supreme Court.
Held: A term styled “generic.com” is a generic name for a class of goods or services only if the term has that generic meaning to consumers.
Reasoning: The Court concluded BOOKING.COM was not a generic term by laying out three guideposts for its reasoning: 1) a generic term names a class of goods or services, rather than any particular feature; 2) the distinctiveness of a compound term depends on its meaning as a whole, not its individual parts; 3) the relevant meaning of a term is its meaning to its consumers.
Applying these guideposts, the Court reasoned that in order to disallow BOOKING.COM as a trademark, the Court would have to find that the mark identified a class of online hotel reservation services. Because both parties agreed this was not the case, the Court reasoned BOOKING.COM cannot be considered generic.
Instead, the USPTO argued for a general rule that a generic name combined with a top-level domain (such as “.com”) makes the resulting combination generic. The USPTO’s argument equated the addition of “.com” to the addition of “Company” which was rejected by the Supreme Court as a means for making a term non-generic in an 1888 decision, Goodyear’s India Rubber Glove Mfg. Co. v. Goodyear Rubber Co., 9 S. Ct. 166 (1888). The Court rejected this argument because domain names such as “generic.com” can only be possessed by a single entity and therefore often signify a particular brand. The Court, however, stopped short of saying a “generic.com” domain was inherently non-generic. Instead, an applicant seeking a “generic.com” trademark must still show the mark is distinctive in the eyes of consumers.
Finally, the USPTO raised concerns that such a trademark would limit competition in the online hotel and travel reservation business by stifling the use of similar marks and domains using the term “booking”. The Court reasoned that because BOOKING.COM is a descriptive mark, it is harder to show a likelihood of confusion, thus making it easier to use similar marks and domains. Therefore, existing trademark law mitigates this issue. The Court further added that a competitive advantage is not a bar to a trademark registration.
Lucky Brand Dungarees Inc., et al. v. Marcel Fashions Group Inc., 140 S. Ct. 1589 (2020)
Facts: This case addresses whether res judicata encompasses “defense preclusion” when a trademark litigation defendant raises a new defense in litigation that it could have raised in previous trademark litigation between the same parties.
Marcel Fashion Group, Inc., (“Marcel”) sued Lucky Brand Dungarees, Inc., (“Lucky Brand”) for infringing its trademark in 2001. The parties entered into a settlement agreement that released Lucky from specific trademark claims in the future. Marcel sued Lucky Brand for trademark violations again in 2005. During the 2005 lawsuit, Lucky Brand did not raise a defense based on the previously negotiated release, and Marcel prevailed. Marcel sued Lucky a third time for ongoing trademark infringement in 2011. Lucky Brand moved for summary judgment, arguing that Marcel’s claims were precluded by res judicata on the basis of the final judgment in the 2005 lawsuit.
The district court granted Lucky Brand’s summary judgment motion, but the Second Circuit reversed. The Second Circuit held that Marcel’s alleged infringement occurred after the 2005 judgment (and therefore could not have been part of the 2005 judgment).
Held: The Supreme Court reversed and remanded the Second Circuit’s ruling, finding that Marcel’s 2011 lawsuit involved different conduct and claims than its 2005 lawsuit. Thus, Marcel was unable to preclude Lucky Brand from raising new defenses.
Reasoning: The Supreme Court has “never explicitly recognized ‘defense preclusion’ as a standalone category of res judicata,” and issue preclusion could not bar Lucky Brand’s unlitigated defense. Thus, the question before the Court was whether the 2011 suit and the 2005 suit involved the same claim. A unanimous Supreme Court concluded that “the two suits here were grounded on different conduct, involving different marks, occurring at different times. They thus did not share a ‘common nucleus of operative facts.’”
The Court reasoned that while Marcel’s claims in the 2005 and 2011 suits both involved trademark infringement claims by Marcel against Lucky Brand, the 2011 action did not involve alleged use of the “Get Lucky” mark. Additionally, the conduct at issue in the 2011 action occurred after the conclusion of the 2005 action. The Court noted claim preclusion generally “does not bar claims that are predicated on events that postdate the filing of the initial complaint.” The Court found that because Marcel could not be barred from suing Lucky Brand for infringing the same mark based on different infringing conduct, Lucky Brand could not be prevented from raising a similar (yet previously unused) defense to that different conduct.
Facts: This case addresses whether multi-color trademarks and product packaging marks that employ color without a well-defined peripheral shape or border can be inherently distinctive and thus registerable on the Principal Register without need for proof of acquired distinctiveness.
Forney Industries applied for a mark for use on the packaging of the welding and machining tools and accessories that it sells. Forney described the mark as consisting of “the colors red into yellow with a black banner located near the top as applied to packaging for the goods.” The examining attorney refused to register the mark, asserting that it was not inherently distinctive, and the Trademark Trial and Appeal Board affirmed the examining attorney’s decision. The Board held that no legal distinction existed between a mark consisting of a single color, and a mark consisting of multiple colors without additional elements. The Board then held that marks for colors applied to products and colors applied to product packaging are analyzed the same, and that under Supreme Court precedent, a particular color on a product or its packaging can never be inherently distinctive. The Board further held that a color may only be inherently distinctive when used in conjunction with a distinctive peripheral shape or border. On appeal, the Federal Circuit reversed.
Held: Multi-color trademarks on packaging can be inherently distinctive and thus registerable on the Principal Register without being associated with a well-defined peripheral shape or border.
Reasoning: The court explained that the controlling Supreme Court precedent held that trade dress can be inherently distinctive. And contrary to the Board’s interpretation of the precedent, while precedent held that color marks applied to product designs cannot be inherently distinctive because product design almost invariably serves purposes other than source identification, product packaging marks are more like trade dress and most often used to identify the source of a product. The court held that Forney’s multi-color product packaging mark was more akin to trade dress than product design marks, and accordingly could be inherently distinctive. The court noted that the Tenth Circuit had come to the same conclusion.
The court also explained that inherent distinctiveness turns on whether a mark makes such an impression on consumers that they will assume the trade dress is associated with a particular source. Multi-color marks such as Forney’s do not attempt to preempt all use of certain colors, but merely the particular combination of colors arranged in a particular design, which makes the mark not just a color mark, but also a symbol that could be source identifying. The source-identifying nature of the combination of colors in a particular design meant that the mark could therefore be inherently distinctive.
Future Proof Brands, LLC v. Molson Coors Bev. Co., Case No. 20-50323 (5th Cir. 2020)
Facts: This case concerns whether the product names “BRIZZY” and “VIZZY” are confusingly similar in connection with hard seltzer beverages.
Future Proof Brands, LLC (“Future Proof”) and Molson Coors (“Coors”) both sell hard seltzer beverages named after a variation of the word “fizzy.” Future Proof’s product is called “BRIZZY,” while Coors’ product is named “VIZZY,” to amalgamate its attributes of being fizzy and containing Vitamin C. Future Proof sought an injunction against Coors’ VIZZY product and asserted trademark infringement in the District Court for the Western District of Texas. The district court denied Future Proof’s motion for preliminary injunction.
Held: The Fifth Circuit Court of Appeals affirmed and held that Future Proof failed to prove the requisite elements for a preliminary injunction.
Reasoning: In analyzing whether Future Proof was entitled to a preliminary injunction against Coors, the court focused on whether Future Proof had demonstrated a substantial likelihood of success on the merits. The district court reviewed all eight likelihood of confusion factors. Future Proof challenged the district court’s ruling on factors one, two, six, seven, and eight.
Factor One: Type of Infringed Mark: The court affirmed the district court’s finding that this factor weighs against granting an injunction. The court found that Future Proof’s “BRIZZY” mark was suggestive, rather than descriptive; however, the court disagreed with Future Proof’s assertion that “BRIZZY” was strong. After reviewing evidence of third-party uses of other “IZZY” formative marks for beverages, the court determined that the district court’s conclusion that “BRIZZY” is a weak trademark was not clear error.
Factor Two: Similarity Between the Marks: Future Proof argued that the district court incorrectly determined that the second factor “only marginally” weighed in favor of granting an injunction. Future Proof primarily argued that the district court incorrectly weighted the importance of the “aural similarities of ‘brizzy’ and ‘vizzy.’” Future Proof stressed that aural similarities of the marks are important because alcoholic beverages are often ordered via verbal request, such as in a bar. However, Future Proof could not provide any evidence showing that their “BRIZZY” drinks are sold in bars or restaurants, where aural similarities could be an issue. Instead, Future Proof’s products are only available to buy at retail locations, where aural similarities would not cause confusion. The court upheld the district court’s finding that this factor weighed only marginally in favor of granting an injunction.
Factor Six: Defendant’s Intent: Future Proof argued that the district court’s finding that this factor goes against granting an injunction was in error. Future Proof argued that Coors’ executives were aware of Future Proof’s “BRIZZY” product. However, knowledge alone does not establish bad intent. Future Proof bore the burden to produce evidence showing Coors’ bad intent. Without such evidence, the court concluded that this factor did not support granting an injunction.
Factor Seven: Evidence of Actual Confusion: The district court dismissed Future Proof’s one example of consumer confusion and ruled that this factor did not favor an injunction. Future Proof presented evidence of a wholesaler mixing up the names “BRIZZY” and “VIZZY.” The court found that the district court incorrectly excluded this evidence because it ruled a “wholesaler” was not a regular consumer for confusion evidence purposes. Notwithstanding this limited reversal, the court affirmed the district court’s finding that a simple and “fleeting” mix-up of names does not constitute actual confusion; therefore, this factor weighed against granting an injunction.
Factor Eight: Degree of Care Exercised by Potential Purchasers: Future Proof disagreed with the district court’s finding that this factor does not favor an injunction. Future Proof advanced arguments that the goods at issue are relatively low cost (a 12-pack of Brizzy sells for $14.99) and that the consumers often purchase the goods in snap decisions. However, Future Proof did not produce any evidence or affidavits showing that the goods are often purchased in a snap decision, nor that Future Proof’s products were available in bars or restaurants where snap purchasing decisions are common.
The court found that the district court did not commit clear error in concluding Future Proof failed to show a likelihood of success on the merits.
VIP Products LLC v. Jack Daniel’s Properties, Inc., Case No. 18-16012 (9th Cir. 2020)
Facts: VIP Products LLC (“VIP Products”) produces and sells a novelty dog toy modeled after Jack Daniel’s Properties, Inc.’s (“Jack Daniels”) trademarked trade dress and bottle design. VIP Products’ toy was called “Bad Spaniel’s” instead of “Jack Daniel’s.” Jack Daniels sent VIP Products a cease and desist letter demanding VIP Products stop making the Bad Spaniel’s toy. In response, VIP Products filed a declaratory judgment action in the District Court for the District of Arizona requesting: (1) a finding of non-infringement, or in the alternative, (2) a finding that Jack Daniel’s trademark and trade dress were not entitled to protection. After a bench trial, the District Court found in favor of Jack Daniels and issued an injunction against VIP Products.
Held: While affirming the rulings regarding Jack Daniel’s trademarks and trade dress validity, the court reversed the district court’s finding against VIP Products for trademark dilution and infringement. The court reversed on grounds that VIP Products’ “Bad Spaniel’s” product is an expressive work entitled to First Amendment protection.
Reasoning: First, in addressing the validity of Jack Daniel’s trade dress and trademarks, the court focused on whether the designs were distinctive and non-functional. Considering the Jack Daniel’s trade dress as a whole, the court affirmed the district court’s finding that the designs were non-functional and distinctive.
Second, the court addressed VIP Products’ assertion of a nominative fair use defense. The court dismissed this defense because nominative fair use only applies in situations where the marks at issue are identical.
Third, the court addressed VIP Products’ First Amendment defense to trademark infringement and dilution. While the likelihood of confusion test usually applies for trademark infringement inquiries, the test may be inappropriate when works containing artistic expression are involved. In determining whether VIP Products’ “Bad Spaniel’s” toy was an expressive work, the court ruled that, while the toy was “not the equivalent of the Mona Lisa,” it was an expressive work nonetheless. In coming to their decision, the court likened this expressiveness inquiry to a similar case of Louis Vuitton Malletier S.A. v. Haute Diggity Dog, LLC. In Louis Vuitton, the defendants created novelty dog toys in the shape of purses bearing the name “Chewy Vuitton.” The Fourth Circuit held that the “Chewy Vuitton” toys were expressive, and this court found that a similar outcome for VIP Products’ “Bad Spaniel’s” toy was required. Given the expressive nature of VIP Products’ toy, the district court erred in not requiring Jack Daniels to satisfy the Rogers test. The Rogers test (derived from Rogers v. Grimaldi) involves showing that the defendant’s use of the mark is either (1) not artistically relevant to the underlying work, or (2) explicitly misleads consumers as to the source or content of the work, before trademark infringement can be found.
Accordingly, the court reversed and remanded the district court’s finding of trademark infringement pending resolution of the Rogers test inquiry.
Ezaki Glico Kabushiki Kaisha v. Lotte International America Corp., 977 F.3d 261 (3d. Cir. 2020)
Facts: This case concerns whether Ezaki Glico’s (“EG”) trade dress registration for its chocolate-dipped cookie sticks is functional.
EG, a Japanese confectionary company, is the creator of the famous Pocky stick cookies. The stick-shaped cookies are partially dipped in chocolate and have an uncoated end, which serves as a handle. In order to protect itself from competitors, EG filed for and received trademark and trade dress registrations and a method patent. As early as 1993, EG demanded that Lotte cease selling Lotte’s Peperro sticks, which were similar to EG’s Pocky product. In 2015, EG brought trade dress infringement and unfair competition claims against Lotte in New Jersey District Court. The district court granted summary judgment for Lotte, holding that the Pocky product trade dress was functional and not protectable. The Third Circuit affirmed.
Held: The Third Circuit held that the Pocky design trade dress registrations were invalid because the design was functional.
Reasoning: The Third Circuit emphasized that patent law, not trademark law, protects useful designs, and the functionality doctrine prevents trademark law from usurping patent law. EG argued that functional features needed to be essential before the functionality doctrine applies. However, the Third Circuit held that precedent defined functional as merely useful, not essential, and looked to evidence of functionality.
Although EG’s trade dress registrations were presumed valid, evidence showed that EG designed the Pocky product so that people could consume an easy-to-hold cookie without getting chocolate on their hands. The design also allowed EG to package multiple cookies in a box in order to promote sharing. Evidence also showed that EG promoted the Pocky sticks’ “convenient design.” Even though EG pointed to evidence of alternative designs, this was not dispositive to show the Pocky design was non-functional. Although immaterial to the outcome, the Third Circuit also held that the district court erroneously considered Lotte’s argument that EG’s method patent was evidence of functionality. EG’s “central advance” of the method patent did not overlap with the trade dress.
Tiffany and Company v. Costco Wholesale Corporation, 971 F.3d 74 (2d. Cir. 2020)
Facts: This case concerns whether the district court improperly granted summary judgment of trademark infringement to Tiffany in connection with Costco’s use of the term “Tiffany” in describing its engagement rings.
Tiffany, a producer of fine jewelry, owns numerous trademark registrations for “TIFFANY” and other related marks for jewelry-related goods. Tiffany raised, inter alia, trademark infringement claims against Costco when it learned that Costco began displaying engagement rings next to signs stating the rings had a Tiffany-style ring setting. Costco argued that its use of the term “Tiffany” was not infringing, and raised a fair use defense because the term was used “otherwise than as a mark … [and] in good faith only to describe” its ring setting. Costco pointed out that Charles Tiffany, the founder of Tiffany, created the Tiffany-style ring settings in the late 19th century. Costco’s rings were also unbranded, and the ring displays at issue resembled Costco’s other point-of-sale signs which listed ring-setting information.
The district court granted summary judgment to Tiffany because Costco’s fair use defense failed as a matter of law, and Costco failed to raise a genuine issue of material fact under any of the relevant Polaroid factors of actual confusion, good faith, and consumer sophistication. Costco appealed, and the Second Circuit vacated and remanded.
Held: Costco raised triable issues of material facts with regard to the Polaroid factors and, by extension, the ultimate issue of whether Costco’s actions generated a likelihood of customer confusion. Costco also raised triable questions as to the other factors pertinent to the fair use defense.
Reasoning: With regard to the Polaroid factor of actual confusion, the district court had found the testimony of six Costco customers and Tiffany’s survey expert on customer confusion to be unrebutted. However, the Second Circuit held that Costco had rebutted Tiffany’s evidence. Costco argued the testimony of the six customers out of the 3,349 customers who purchased Tiffany-style set rings was only de minimis evidence of confusion, and Costco’s own expert criticized the survey methodology and results of Tiffany’s expert. The Second Circuit held that the district court, in concluding otherwise, observed that these criticisms went to the weight of Tiffany’s evidence rather than its admissibility and that Costco’s expert did not perform his own survey to demonstrate affirmatively that Costco’s customers were not confused. However, the Second Circuit held the weight to be given to a particular piece of evidence could be determinative of whether a jury could find a genuine issue of material fact. Similarly, with regard to the Polaroid factor of consumer sophistication, the Second Circuit also held that the district court’s attribution of Costco’s competing expert report to “the weight that Tiffany’s evidence should be accorded” and its conclusion that Costco failed to provide competing affirmative evidence” was improper.
With regard to the Polaroid factor of good faith, the Second Circuit disagreed with the district court’s holding that no reasonable jury could have found Costco acted with good faith. Costco provided contrary evidence that it never attempted to adopt the TIFFANY mark, that its signs used the term “Tiffany” as a brand-independent description of a type of ring setting and merely reflected information provided by vendors.
The district court resolved Costco’s fair use defense on the basis of good faith alone for the same reasons that underpinned its analysis of the Polaroid good faith factor. Thus, the district court did not consider the other factors in Costco’s fair use defense. The Second Circuit held that Costco’s proffered evidence of its signs could allow a reasonable jury to conclude that Costco did not use the term “Tiffany” as a trademark. Rather, a reasonable jury could conclude that Costco used the term “Tiffany” to describe a ring setting.
§ 1.3.3 Other notable decisions
In re Stanley Brothers Social Enterprises, LLC, 2020 USPQ2d 10658 (TTAB 2020)
Facts: The United States Patent and Trademark Office (“USPTO”) denied Stanley Brothers’ trademark application for “CW” covering “hemp oil extracts sold as an integral component of dietary and nutritional supplements.” The USPTO reasoned that Stanley Brothers’ goods were per se unlawful under the Food, Drug, and Cosmetics Act (“FDCA”) and Controlled Substances Act (“CSA”). The FDCA prohibits “[t]he introduction or delivery for introduction into interstate commerce of any food to which has been added . . . a drug or biological product for which substantial clinical investigations has been made public . . .” The USPTO’s position was that Stanley Brothers’ “hemp oil extracts” are food to which CBD has been added, and that CBD was the subject of clinical investigations during prosecution of its trademark application. Stanley Brothers appealed this refusal to the Trademark Trial and Appeal Board (“TTAB”) arguing that its goods were permissible under the FDCA and CSA; therefore, refusal of its trademark application should be withdrawn. Stanley Brothers relied on three arguments: (1) the Industrial Hemp Provision of the 2014 and 2018 Farm Bills excludes industrial hemp from the FDCA sections at issue; (2) its goods are dietary supplements, not food, and are not subject to regulation by the FDCA; and (3) its goods fall under an FDCA exception that allows their use because they were incorporated into food products before any substantial clinical investigations involving the drug began.
Held: The TTAB rejected Stanley Brothers’ arguments and affirmed the USPTO’s refusal of Stanley Brothers’ trademark application.
Reasoning: First, the TTAB recognized that the Industrial Hemp Provisions of the Farm Bills permits authorized entities to grow and/or cultivate industrial hemp. However, there are no explicit allowances for entities to distribute or sell CBD or food products with CBD, such as Stanley Brothers’ oils. The TTAB thus rejected Stanley Brothers’ first argument.
Second, the TTAB addressed whether Stanley Brothers’ goods were correctly considered food products. Under the FDCA, “food” means “articles used for food or drink for man or other animals . . . and articles used for components of any such article.” Citing evidence that Stanley Brothers’ oils are marketed to be used in consumer beverages, the TTAB ruled that they are considered food products. Therefore, the TTAB rejected Stanley Brothers’ second argument that the products were dietary supplements rather than food.
Third, the TTAB addressed whether Stanley Brothers’ goods were marketed in food before any substantial clinical investigations began involving CBD. After finding that Stanley Brothers did not introduce any persuasive or probative evidence to support this last argument, the TTAB rejected it.
The TTAB affirmed that Stanley Brothers’ goods are per se unlawful under the FDCA. Because of this ruling, the TTAB did not reach whether or not the goods are also illegal under the CSA.
AM General LLC v. Activision Blizzard, et al., No. 17 Civ. 8644 (GBD) (S.D.N.Y. 2020)
Facts: This case addresses the balance between (1) First Amendment expression in artistic works (video games) using registered trademarks and (2) registered mark-holder rights granted by the Lanham Act.
AM General designs and manufactures military-grade vehicles branded as “Humvee.” The United States Armed Forces, as well as the militaries of numerous countries, routinely use Humvee vehicles as part of their operations. AM General holds a trademark registration for the HUMVEE word mark and asserts trade dress rights in design elements of the Humvee vehicle itself.
Activision Blizzard (“Activision”) makes Call of Duty, a highly successful and well-known first-person shooter video game franchise. Call of Duty comprises cinematic depictions of warfare intended to simulate military combat. Activision uses the Humvee vehicle as part of its video game design. Call of Duty players can even drive a Humvee. Activision also uses the Humvee as part of its advertising campaigns for Call of Duty games.
AM General brought suit against Activision for trademark infringement and trade dress infringement (among several other claims) in connection with Activision’s use of the Humvee vehicles. Activision filed a motion for summary judgment on all claims.
Held: The district court granted Activision’s motion for summary judgment on all claims, applying the Rogers v. Grimaldi test and finding that Activision’s use of the Humvee (1) had artistic expression related to the underlying work and (2) did not expressly mislead as to the source or content of the work.
Reasoning: The court applied the two-prong test in Rogers v. Grimaldi (875 F.2d 994 (2d Cir. 1989)) to analyze whether the Lanham Act should be interpreted narrowly in light of protected expression under the First Amendment. Under the two-prong Rogers test, courts in the Second Circuit must determine whether the use of the trademark (1) has any “artistic relevance to the underlying work whatsoever,” and (2) “explicitly misleads as to the source or the content of the work.” On the first prong, the court found that “[f]eaturing actual vehicles used by military operations around the world in video games about simulated modern warfare surely evokes a sense of realism and lifelikeness to the player who ‘assumes control of a military soldier and fights against a computer-controlled or human-controlled opponent across a variety of computer-generated battlefields.’” The court determined such depiction constituted artistic relevance.
In analyzing the second prong, the court applied the “Polaroid factors” (Polaroid Corp. v. Polaroid Electronics Corp., 287 F.2d 492, 495 (2d Cir. 1961)) for a likelihood of confusion determination. It found that six out of the eight factors weighed in Activision’s favor, or against a likelihood of confusion. The “evidence of actual confusion” factor weighed only “slightly” in favor of AM General. AM General’s consumer survey “found that 16% of consumers shown actual video game play from Activision’s games were confused as to AM General’s association with Call of Duty.” The court determined this survey was evidence of “some” confusion “at most.” Overall, the court found that the countervailing First Amendment consideration weighed against heavily considering the actual confusion evidence. AM General failed to show Activision’s uses of Humvee vehicles misled Call of Duty players as to the source of the Humvee mark and design. Thus, the court ruled in Activision’s favor.
Illinois’ Biometric Information Privacy Act, 740 ILCS 14/1 et seq. (BIPA) establishes safeguards and procedures relating to the retention, collection, disclosure, and destruction of biometric data. 740 ILCS 14/15. Passed in October 2008, BIPA is intended to protect a person’s unique biological traits – the data encompassed in a person’s fingerprint, voice print, retinal scan, or facial geometry. Id. But in the last few years, BIPA – with its statutory penalties of $1,000 for each negligent violation and $5,000 for each intentional or reckless violation – has quickly become the bane of corporate defendants. The situation became even worse after the Illinois Supreme Court’s decision in Rosenbach v. Six Flags Entm’t Corp., 2019 IL 123186. In Rosenbach, the Court held that a “violation [of BIPA], in itself, is sufficient to support the individual’s or customer’s statutory cause of action.” Rosenbach at ¶33 (emphasis added). In other words, a bare statutory violation confers standing on a BIPA plaintiff. See id.
What Would the Amendments Do?
The Illinois Legislature is currently considering three bills that would amend BIPA in several significant ways. Illinois House Bill 559 would protect companies that store an individual’s biometric information in the form of indecipherable mathematical representations or encrypted algorithms. Under HB 559, biometric information would, by definition, not include “biometric information that cannot be used to recreate the original biometric identifier.” HB 559 would also establish a one-year statute of limitations, beginning from the date that the “cause of action accrued,” and also establish a 30-day period in which the company could cure any alleged violation. If the private entity “actually cures the noticed violation” and provides notice to the aggrieved person, then the individual would no longer be able to bring an “action for individual statutory damages or class-wide statutory damages…” Illinois House Bill 559. These “statutory damages” have also been redlined. Under HB 559, aggrieved individuals would no longer be entitled to the statutory damages of $1,000 and $5,000. Instead, negligent violations would permit a plaintiff to recover only their “actual damages,” and willful violations would permit a plaintiff to recover their “actual damages plus liquidated damages up to the amount of actual damages.” Illinois House Bill 559. HB 559 has advanced out of the Judiciary Committee and has been placed on the calendar for debate before the House.
Illinois House Bill 560, meanwhile, would eliminate BIPA’s private right of action and would vest the state of Illinois (through the Attorney General, the appropriate State’s Attorney’s Office, or the Department of Labor) with the power to enforce the BIPA’s provisions. Illinois House Bill 560. HB 560 has not advanced out of the Rules Committee. Illinois Senate Bill 330 largely replicates the amendments found in HB 559, but provides definitions for what it means to cure the violation and for when a claim accrues. Senate Bill 330 remains in the Judiciary Committee.
Would Any of These Amendments Be Retroactive?
There are hundreds (if not a few thousand) of BIPA suits currently pending in the Illinois state and federal courts. If any of these amendments become law, the critical question would be which of these amendments are retroactive and could have an impact on the pending lawsuits?
Illinois has adopted the first step of the United States Supreme Court’s retroactivity analysis. People v. Stefanski, 2019 IL App (3d) 160140, ¶12 (citing Landgraf v. USI Film Products, 511 U.S. 244 (1994)). Under Landgraf, the first question is whether the legislature has clearly indicated the statute’s “temporal reach.” Id. If it has, and assuming there is no constitutional prohibition, then the legislature’s intent will be given effect. Id. If the legislature’s intent is not clear, then Illinois courts bypass the Landgraf analysis and proceed to determine whether the statutory amendments are procedural or substantive. Id. at ¶13. Procedural changes to a statute will be applied retroactively, while substantive changes will be applied prospectively. Id. The court in Perry v. Dep’t of Fin. & Pro. Regul. noted that distinguishing between procedural and substantive changes is not always easy, of course. Perry v. Dep’t of Fin. & Pro. Regul., 2018 IL 122349, ¶69. There is also a general presumption that an amended statute is “not to be applied retroactively.” Stefanski, 2019 IL App (3d) 160140, ¶13.
None of the three bills contains any statement on retroactivity. The Illinois courts, would therefore need to determine whether the amendments are procedural or substantive in nature. House Bill 560’s elimination of a private right of action would be a substantive amendment because it is an amendment that “creates, defines, and regulates the rights, duties, and powers of the parties.” Perry, 2018 IL 122349, ¶70. House Bill 559’s amendment to the definition of “biometric information” would likely also be viewed as a substantive change to the law, since it would eliminate an entire class of devices and conduct that were not previously immune from suit. Perry, 2018 IL 122349 at ¶71 (“Because [these amendments] alter the scope of information that is accessible, both amendments are substantive changes . . . [and] may not be retroactively applied…”).
The other amendments are not so clear. The amendment establishing a one-year statute of limitations could have retroactive application. Amendments which change “statutes of limitations are considered procedural,” which means they “may be given retroactive effect.” Wanless v. Burke, 253 Ill. App. 3d 211, 215 (3rd Dist. 1993). This can be especially true where the amendments affect a statutory right of action and not a common law right. See Stanley v. Denning, 130 Ill. App. 2d 628, 632 (2d Dist. 1970) (“In determining whether a statute is intended to operate retroactively, we believe that there is an important distinction between an amendment reducing an existing time limitation which affects rights, statutory in origin, as opposed to those originating in the common law.”). Where the legislature has created the right, it has the power to withdraw it. Orlicki v. McCarthy, 4 Ill. 2d 342, 351 (1954). The amendment to add a BIPA statute of limitations, if passed, could impact the limitations period for current and future cases, particularly because the current applicable limitations period is unsettled.[1]
The elimination of liquidated damages could also have a retroactive application. Statutory amendments that impact available remedies are often seen as procedural and not substantive. Dardeen v. Heartland Manor, Inc., 186 Ill. 2d 291, 299 (1999). Amendments to remedies may, therefore, be applied to a pending suit, “irrespective of when the cause of action accrued or the complaint was filed.” Id. In Dardeen, the Illinois Supreme Court held the repeal of a treble damage provision related solely to a remedy and was therefore procedural in nature. Id. A plaintiff has no vested right to “exemplary, punitive, vindictive or aggravated damages.” Id. Fifteen years later, though, the Illinois Supreme Court held that an amendment related to remedies was substantive because it created an “entirely new type of liability.” People ex rel. Madigan v. J.T. Einoder, Inc., 2015 IL 117193, ¶36. In Einoder, the Illinois Supreme Court held that the amendment could not be applied retroactively because it created a “substantive change in the law” by imposing “new liability on defendants’ past conduct.” Id. Whether the repeal of liquidated damages is seen as relating solely to a remedy (Dardeen) or as imposing a new burden on plaintiffs (Einoder) presents an intriguing question.
Conclusion
The proposed amendments to BIPA are intended to provide clarity and relief to corporate defendants. But even if passed, the amendments generate further questions about their retroactivity and the full extent of the relief that they might provide defendants.
[1] BIPA does not include a statute of limitations. Defendants have argued the one-year statute of limitations for privacy claims should apply (735 ILCS 5/13-201), while plaintiffs have argued for the five-year catchall limitations period (735 ILCS 5/13-205). The Illinois Court of Appeals is poised to decide what limitations period applies to BIPA claims in Tims v. Black Horse Carriers, Inc., Case No. 1-20-0563 (1st Dist.).
This article first appeared in the Banking Law Committee Journal. We invite you to read the rest of our Spring 2021 Edition.
On January 1, 2021, Congress enacted the Anti-Money Laundering Act (AMLA). The AMLA establishes new whistleblower protections for employees of financial services institutions. General counsel, employment attorneys, and human resource professionals need to be aware of these changes.
In recent years, the United States has seen many compliance personnel bring retaliation and whistleblower claims against their employers. The actions of financial institutions with respect to their compliance personnel are often under a microscope, as these institutions may be operating under a Consent Decree (or the threat of a Consent Decree) by virtue of regulators’ concerns about compliance with risk-related laws and regulations.
Nevertheless, while courts (and regulators) are protective of whistleblower rights, they also understand and are respectful of an employer’s right to remove personnel when the employer can demonstrate that the employee is indeed incompetent or insubordinate, and may even be an impediment to effective regulatory compliance.
The challenge for a financial services employer, then, is to establish that discipline against an employee in a compliance role was based on the employee’s incompetence or other inappropriate behavior, and that any whistleblowing activity he or she engaged in was not a consideration.
1. Principal Financial Services-Related Whistleblower Laws
A. Bank Secrecy Act
The Bank Secrecy Act (“BSA”), 31 U.S.C. 5323 et seq., prohibits financial institutions from discharging or otherwise discriminating against an employee because the employee (or any person acting pursuant to the request of the employee) provided information to any federal supervisory agency regarding a possible violation by the financial institution or any director, officer or employee of the financial institution of certain specified laws. The BSA also authorizes government payments to whistleblowers who provide original information leading to the government’s collection of fines, civil penalties or forfeitures relating to BSA violations.
The BSA, prior to passage of the AMLA, protected only complaints to the government, as opposed to internal complaints. Any employee or former employee has two years from the date of the alleged retaliatory act to file a civil complaint in federal district court. Remedies include reinstatement, compensatory damages, and any other “appropriate actions” to remedy the past discrimination.
These protections do not apply to any employee who deliberately causes or participates in the alleged violation, or who knowingly or recklessly provides substantially false information in the employee’s report. Further, these protections do not apply to FDIC insured banks.
Pre-AMLA, the BSA capped government payments at $150,000, however, and affords the Treasury Department discretion in deciding whether to issue an award in any amount up to that limit. These aspects have curtailed the impact of the BSA on money-laundering enforcement and made it much less effective than the bounty program established by the SEC under the Dodd-Frank Act (DFA).
B. FDIA
The Federal Deposit Insurance Act (“FDIA”) provides that no Federal banking agency, Federal home loan bank, Federal reserve bank, or any person who is performing, directly or indirectly, any function or service on behalf of the [FDIC] may discharge or otherwise discriminate against any employee with respect to compensation, terms, conditions, or privileges of employment because the employee (or any person acting pursuant to the request of the employee) provided information to any such agency or bank or to the Attorney General regarding any possible violation of any law or regulation, gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health or safety. 31 U.S.C. § 5328
C. FIRREA
The Financial Institutions Reform, Recovery, and Enforcement Act, 12 U.S.C. § 1831k (“FIRREA”), enacted during the savings and loan crisis of the late 1980s, permits a whistleblower to file a declaration with the U.S. Department of Justice (DOJ) describing one or more violations of FIRREA “affecting” a depository institution insured by the FDIC or any other agency or entity of the U.S. The declaration is not filed in court and is kept confidential by the DOJ for at least one year (and maybe longer). The DOJ is charged with investigating and (if successful and eligible for an award) the whistleblower can receive 20%-30% of any recovery up to the first $1 million recovered, 10%-20% of the next $4 million recovered, and 5%-10% of the next $5 million recovered.
In a FIRREA case, the Attorney General also has the discretion to award a whistleblower a portion of any criminal recovery under FIRREA, in addition to or instead of a civil penalty.
D. Dodd Frank
The Dodd-Frank Wall Street Reform and Consumer Protection Act, 15 U.S.C. § 78u-6(a)(6), protects whistleblowers who provide information regarding (or cooperate in the investigation of) any potential violation of U.S. securities laws. An employer may not discharge, demote, suspend, threaten, or harass, directly or indirectly, or in any other manner discriminate against an individual based on his or her whistleblowing.
Dodd-Frank only protects the employee against retaliation if the federal violation falls within the SEC’s jurisdiction. Examples of violations that fall within the SEC’s jurisdiction include accounting fraud, providing false information, insider trading and other violations of securities law. The statute of limitations is six years. Remedies include reinstatement, double the back pay owed, plus interest, reasonable attorneys’ fees, litigation costs, and expert witness fees.
E. Sarbanes Oxley
The anti-retaliation protections of the Sarbanes-Oxley Act (“Sarbanes Oxley” or “SOX”) protect employees of public companies[1] against retaliation in the terms and conditions of employment as a result of their providing information, causing information to be provided, or otherwise assisting in an investigation of alleged violations of mail fraud, wire, radio, or television fraud, bank fraud, securities fraud, any rule or regulation of the Securities and Exchange Commission (“SEC”), or any provision of federal law relating to fraud against shareholders. 18 U.S.C. § 1514A(a)(1)
To be protected, an employee must provide such information or assistance to, or the investigation must be conducted by, a Federal regulatory or law enforcement agency; any member or committee of Congress; or a person with supervisory authority over the employee (or other such person working for the employer who has authority to investigate, discover, or terminate misconduct).
An employee is not required to demonstrate that a violation has actually occurred. Rather, in order to be protected, an employee must demonstrate that he or she “reasonably believes” that a violation is occurring.
In Lawson v. FMR LLC, 134 S. Ct. 1158 (2014), the Supreme Court held that SOX may also provide whistleblower protection to employees of private contractors of publicly traded companies and their subsidiaries. Since Lawson, courts have generally limited the ruling’s application, holding that the contractor must have been integrally involved in the transaction to be covered by SOX.[2]
F. Federal False Claims Act and New York False Claims Act and the New York False Claims Act
The federal False Claims Act prohibits the knowing submission of false or fraudulent claims to the United States, or to a third party if the government has provided a portion of the money or will reimburse the third party. 31 U.S.C. § 3729. The application of this statute depends on the degree to which a bank is engaged in business with the federal government. Banks with government insured loans are covered by the FCA.
The NY False Claims Act closely tracks the federal FCA. It imposes penalties and fines on individuals and entities that file false or fraudulent claims for payment from any state or local government. N.Y. Fin. L. 91
2. Burdens of Proof
Generally speaking, a plaintiff in a whistleblower retaliation claim, a plaintiff must show that: 1) he or she was retaliated against for reporting inappropriate activity; 2) he or she reported that information to the employer and/or the government, depending on the particular statute’s purview; 3) the disclosure was required or protected by that law, rule or regulation within the SEC’s jurisdiction. Further, the employee must establish that he or she had a subjectively and objectively reasonable belief that the conduct in question violated the law.
If a Bank has entered into a consent decree, and if the compliance whistleblower raises issues around alleged inappropriate activity that was the subject of the consent decree, it is likely that a court would grant that the employee indeed had both a subjectively and objectively reasonable belief that unlawful conduct took place.
In most instances, an employee need only establish that his or her protected activity was a contributing factor, not necessarily a motivating factor, to the adverse employment action. The words “contributing factor” mean any factor which, alone or in connection with other factors, tends to affect in any way the outcome of the decision.
On the other hand, an employer can normally avoid liability if it can establish by “clear and convincing” evidence that it would have taken the same adverse action against a complainant absent his or her protected activity. Thus, even if the employee can establish that he or she was retaliated against in violation of these laws, the employer can prevail if it demonstrates that it would nevertheless have taken the same action against the employee because of conduct unrelated to their whistleblower activities.
In essence, this reverses the normal burden of proof under discrimination actions in which the burden always remains on the plaintiff.
Regardless of the test, for an employer to prevail in a whistleblower claim, it will need to establish that it took adverse action against the alleged whistleblower for reasons unrelated to any protected whistleblower activities in which she may have engaged. Instead, the employer will need to argue that any disciplinary action the Bank takes taken against the employee was based upon job performance problems or other non-protected activities.
Depending on the particular statute, a whistleblower who prevails in a retaliation claim can recover lost wages, the value of benefits, attorney’s fees, expert witness fees, compensation for emotional distress, punitive damages, liquidated damages, and, under some statutes, a percentage of any recovery the Government obtains in a criminal prosecution against the employer. Additionally, a court can order a terminated employee reinstated.
3. The AMLA
The AMLA bars employers from discharging, demoting, threatening or harassing employees who provide information relating to money laundering and BSA violations to the attorney general, secretary of the treasury, regulators and others, including their own employer.
The AMLA strengthens the incentive program because it (1) narrows the government’s discretion to pay an award, (2) increases the potential amount of whistleblower awards, and (3) implements protections specific to money-laundering whistleblowers, in a manner largely modeled after Dodd-Frank.
The AMLA covers a wide range of financially based organizations, including banks, branches and agencies of foreign banks, broker-dealers, insurance companies, operators of credit card systems, mutual funds, certain casinos, and travel agencies, among the twenty-six covered categories. (The full list of covered entities appears at 31 U.S.C. §5312.)
In addition, the law now places under the BSA’s purview any person or business that engages in the transmission of currency, funds or value that substitutes for currency, meaning that organizations dealing in cryptocurrency now come within the statute’s reach. Persons involved in the sale of antiquities are also now covered.
A. AMLA Whistleblowing Protection and Procedure
The AMLA defines “whistleblower” as any individual (or two or more people acting jointly) “who provides information relating to a violation of this subchapter … to the employer of the individual or individuals, including as part of the job duties of the individual or individuals, or to the [Treasury] Secretary or the Attorney General.”[3]
In other respects, the anti-retaliation provisions resemble protections under Dodd-Frank and the Sarbanes-Oxley Act. Complaints are filed initially with the Department of Labor and if they are not resolved within six months (assuming that the delay was not caused by claimant’s bad faith), employees can file actions in federal court and have a jury trial. Available relief can include reinstatement with no loss in seniority, compensatory damages, counsel fees, double back pay with interest added, and other appropriate remedies regarding the prohibited conduct.
B. Expanded Financial Incentives for Whistleblowers
The new statute provides that the secretary of the treasury “shall” pay an award to those who provide original information leading to successful enforcement of various money-laundering laws, if the SEC obtains sanctions of $1 million or more. As with Dodd-Frank, certain individuals, like regulatory and law enforcement officials and those who participated in the wrongdoing, are prohibited from receiving an award. To incentivize reporting, the AMLA replaced the BSA’s $150,000 award cap, which was discretionary in any event, with a payment ceiling of 30% of the government’s collection, if the monetary sanctions imposed exceed $1 million and which is now mandatory unless the reporting individual is disqualified.
Again, like Dodd-Frank, factors to be taken into consideration by the government when deciding the amount of the award include the significance of the information, the degree of assistance provided and the programmatic interest of Treasury in deterring violations. Treasury retains the discretion to make nominal payments, and there is no right to appeal the amount awarded. However, the “monetary sanctions” figure on which the reward will be based excludes forfeiture, restitution and victim compensation payments, and since the government frequently seeks large forfeiture judgments when resolving money-laundering actions, this provision may significantly limit whistleblower awards.
C. Importance of Investigation and Corporate Compliance Programs
Federal and state regulators have made clear, in recent years, that employers must implement and follow well designed investigation protocols to root out claims of retaliation and protect whistleblowers.
In January 2019, the New York State Department of Financial Services (“DFS”) issued a new directive on whistleblower policies (“DFS Guidance”). A few short months later, the U.S. Department of Justice Criminal Division (“DOJ”) issued an “updated” Evaluation of Corporate Compliance Programs Guidance (“DOJ Guidance”).
The DOJ Guidance emphasizes that there are three main questions for prosecutors to consider during a criminal investigation:
1) Was there a well-designed compliance program?
2) Was the compliance program effectively implemented?
3) Did the compliance program work as intended?
Prosecutors assess, among other things, whether policies, training and communication are sufficiently robust to encourage a culture of compliance and responsibility.
The company’s reporting process should emphasize disclosure of suspected misconduct and dissuade any fear of retaliation. There is also an emphasis on confidential reporting options.
The DFS Guidance articulated ten “pillars,” emphasizing the need to have in place reporting channels that are independent, well-publicized, easy to access, and consistent, with strong protections for a whistleblower’s anonymity.
The DFS Guidance also requires that the employer have in place established procedures for identifying and managing potential conflicts of interest, and that staff members are adequately trained to receive whistleblowing complaints, determine a course of action, and competently manager any investigation, referral, or escalation.
Further, the DFS Guidance demands that employers establish procedures for investigating allegations of wrongdoing, ensuring appropriate follow-up to valid complaints, protecting whistleblowers from retaliation, and providing confidential treatment of these complaints.
The DFS Guidance recommends, as well, that regulated employers give appropriate oversight of the whistleblowing function to senior management, internal and external auditors, and the Board of Directors. Perhaps most important, the DFS Guidance demands that the employer have in place a top-down culture of support for the whistleblowing function.
D. Importance of Documentation of Performance Problems
The relevant cases underscore the importance of documenting performance or disciplinary issues before taking adverse action against an employee who may have engaged in protected activity. In Johnson v. ACE Limited, ARB Case No. 10-052 (Jan. 30, 2012), a case brought under Sarbanes-Oxley, the Department of Labor Arbitration Review Board (“ARB”) found that although the complainant had engaged in protected activity, the employer had demonstrated by clear and convincing evidence that it would have fired him anyway because of his incompetence, his outside business interests and his insubordinate behavior when questioned about the outside business.
In Giurovici v. Equinix, Inc., ARB Case No. 07-027 (Sept. 30, 2008), the ARB found that even if the former employee could establish that he had engaged in protected activity, his claim would have failed because the company offered clear and convincing evidence it would have fired him anyway because of his well-documented record of poor performance and insubordination.
Similarly, in Pardy v. Gray, 2008 U.S. Dist. LEXIS 53997, at **17–18 (S.D.N.Y. July 15, 2008), the court held that the employer company established by clear and convincing evidence that it discharged employee for undisputed record of poor performance.
An assessment of the strength of the anticipated defense therefore must take into account the quality of contemporaneous documentation of the alleged whistleblower’s performance issues.
[1] Companies with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, or which are required to file reports under Section 15(d) of the Securities Exchange Act of 1934.
[2] We can posit a scenario where a bank is financing a transaction for a publicly traded company, and a bank employee claims that there is securities fraud in the processing of the transaction—for example, he or she could claim that individuals at the bank are using confidential information to engage in insider trading around the transaction. In that case, the employee reporting that activity might be a protected whistleblower under SOX.
[3] Institutions that are insured by the Federal Deposit Insurance Corporation (FDIC) and Federal Credit Union Act (FCUA) are exempt from these new protection provisions, but employees of those entities can still rely on existing whistleblower protections, like those provided by the Federal Deposit Insurance Act and the Federal Credit Union Act, when seeking redress from suspected retaliation.
This article first appeared in the Banking Law Committee Journal. We invite you to read the rest of our Spring 2021 Edition.
On December 15, 2020, the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“FRB”) (together the “Agencies”) issued a notice of proposed rulemaking (“Proposed Rule”) that would significantly update the Agencies’ guidance on data breach response. The Proposed Rule would impose prompt reporting requirements on banking organizations and their service providers with respect to certain data breaches and other cyber events.
Specifically, the Proposed Rule would require banking organizations to notify their primary federal regulators within 36 hours of becoming aware of a “computer-security incident” that rises to the level of a “notification incident.” In addition to covering incidents involving unauthorized access to customer information, it would apply to some events where data was rendered temporarily unavailable, such as ransomware and distributed denial-of-service attacks.
The rule would also require bank service providers to notify “at least two individuals” at an affected banking organization-customer immediately after experiencing a computer-security incident that it believes “in good faith could disrupt, degrade, or impair services provided for four or more hours.” A 36-hour deadline appears to be one of the most rigorous timeframes of any U.S. breach reporting scheme.
Below we provide context for the Proposed Rule and outline its key features.
Background
Banking organizations already are subject to reporting obligations of cyber events and data breaches under applicable federal and state laws. Notably, the new proposal would blow the dust off the federal interagency guidance—issued in 2005 and never before updated—that interprets the Gramm-Leach-Bliley Act and its Security Guidelines (“GLBA”) to require banks to develop and implement a response program to address unauthorized access to, or use of customer information that could result in “substantial harm or inconvenience to a customer.” This guidance only requires banking organizations (as defined therein) to report incidents to federal banking regulators where certain customer personal data is exposed.
In addition, the Bank Secrecy Act requires banking organizations, and other financial institutions, to file suspicious activity reports (“SARs”) under certain circumstances. In 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued an advisory instructing financial institutions with SAR filing obligations to file SARs for cyber-events and cyber-enabled crime. The SAR filing requirements are designed to detect cyber-related crimes and money laundering but not report cyber incidents more broadly. Further, banking organizations that experience a computer-security incident that may be criminal in nature are expected to contact relevant law enforcement or security agencies, as appropriate, after the incident occurs.
At the state level, some banking organizations are subject to more recent and specific reporting requirements. For example, the New York State Department of Financial Services (“NYDFS”) adopted a cybersecurity regulation in 2017, known as Part 500. Part 500 requires covered entities, including New York state-chartered banks and other financial organizations licensed by the NYDFS to conduct business, to implement an incident response plan as part of their cybersecurity program and to notify the NYDFS no later than 72 hours after determining that a cybersecurity event has (1) impacted the entity and notice is required to be provided to another regulator, or (2) a reasonable likelihood of materially harming a material part of the normal operation of the entity.
Banking organizations are also potentially subject to state breach notification laws that apply to businesses generally in all 50 states, although some of those requirements under state law can be satisfied by GLBA. California, for example, requires persons conducting business in California to notify California residents if their unencrypted personal information is acquired or is reasonably believed to have been acquired by an unauthorized person. If a single breach requires such a notification to more than 500 California residents then a business must submit a sample security breach notification to the California Attorney General. Many other states’ laws are modeled on California’s law.
OVERVIEW OF BANKING ORGANIZATION NOTIFICATION REQUIREMENT
The Proposed Rule would require banking organizations to notify their primary federal regulator of cyber incidents that amount to “notification incidents” no later than 36 hours after determining in “good faith” that a notification incident has occurred. The notification requirement is meant to serve as an “early alert” to regulators and is not intended to provide an “assessment of the incident,” which is all that can be reasonably expected in 36 hours.
Definitions of Banking Organizations
The Proposed Rule applies to “banking organizations,” as defined by the applicable federal regulator. For foreign banks, the Proposed Rule would only apply to their U.S. operations. Further, under the Proposed Rule if a banking organization is the subsidiary of another banking organization subject to notification requirements (e.g., a bank is a subsidiary of a bank holding company), the subsidiary banking organization is expected to alert its parent—in addition to notifying its primary federal regulator—of a notification incident “as soon as possible.” The parent banking organization must then determine whether it also has suffered an incident that requires notification.
On the other hand, the Proposed Rule does not require subsidiaries or banking organizations not subject to the notification requirement (e.g., nonbank subsidiaries of bank holding companies) to implement separate notification requirements. Instead, the Agencies expect that the parent banking organization of such subsidiary will appropriately notify its primary federal regulator if the incident at the subsidiary constitutes a notification incident for the parent.
Definition of Computer-Security Incident and Notification Incident
Under the Proposed Rule, a computer-security incident is an occurrence “that (i) results in actual or potential harm to the confidentiality, integrity, or availability of an information system or the information the system processes, stores, or transmits; or (ii) constitutes a violation or imminent threat of violation of security policies, security procedures, or acceptable use policies.”
A “notification incident” is a type of computer-security incident that “a banking organization believes in good faith could materially disrupt, degrade, or impair (i) the ability of the banking organization to carry out banking operations, activities, or processes, or deliver banking products and services to a material portion of its customer base, in the ordinary course of business; (ii) any business line of a banking organization, including associated operations, services, functions and support, and would result in a material loss of revenue, profit, or franchise value; or (iii) those operations of a banking organization, including associated services, functions and support, as applicable, the failure or discontinuance of which would pose a threat to the financial stability of the United States.”
For purposes of determining whether a computer-security incident falls under the definition of notification incident, “business line” is defined as “products or services offered by a banking organization to serve its customers or support other business needs.” The Agencies note that all banking organizations are expected to have a “sufficient understanding of their lines of business to be able to notify the appropriate agency of notification incidents that could result in a material loss of revenue, profit, or franchise value to the banking organization.” The Proposed Rule also includes a non-exhaustive list of events that would meet the definition of “notification incident,” such as a failed system upgrade or change that results in widespread customer or employee outages.
Timing of Notification Requirements
As noted above, the Proposed Rule requires banking organizations to notify their primary federal regulator within 36 hours of a “good faith determination” that a notification incident has occurred. In that regard, the Agencies recognize that the banking organization would not be able to determine whether an event meets the notification incident standard immediately upon becoming aware of the incident, particularly outside of normal business hours. As a result, banking organizations may take a “reasonable amount of time” to determine whether a computer-security incident meets the notification incident standard. Once a banking organization has made a determination that a computer-security incident meets the notification incident standard, then the 36-hour clock begins to run.
Contents and Format of Notification
The Proposed Rule neither prescribes the contents to be included in the notice nor requires that notification be given in any particular format. Any form of written or oral communication, via any technological means (e.g., email or phone call) or other means (e.g., live conversation) to a designated point of contact identified by the applicable primary federal regulator is sufficient. Any information provided by the banking organization related to the notification incident is subject to the Agencies’ confidentiality rules, meaning that confidential supervisory information will be protected.
IMPACT OF PROPOSED RULE
The Agencies do not believe that the Proposed Rule will impose significant burdens on banking organizations. They estimate that roughly 150 incidents rising to the level of “notification incidents” may occur on an annual basis, and believe that the communications leading to the determination of a “notification incident” would occur regardless of the Proposed Rule. Moreover, the notice requirements for banking organizations should not include the level of detail required for an SAR, though the Agencies expect banking organizations that experience a potentially criminal computer-security incident to contact relevant law enforcement or security agencies after the incident occurs.
The Proposed Rule affects state reporting requirements as well. For example, Part 500 requires banking organizations to report to the NYDFS if reporting of a cybersecurity event is required to another regulator, such as one of the Agencies. In light of NYDFS’s broad definition of “cybersecurity event,” any “notification incident” will almost certainly qualify as a “cybersecurity event.” Thus, any such notification incidents reported to the FDIC, OCC or FRB must also be reported to the NYDFS if the banking organization is subject to NYDFS supervision, though subject to the NYDFS’s 72-hour timeframe.
SERVICE PROVIDER NOTIFICATION REQUIREMENT
The Proposed Rule also imposes reporting requirements on “bank service providers,” defined as companies or persons providing services that are subject to the Bank Service Company Act to banking organizations. Specifically, if the bank service provider has a good faith belief that a computer-security incident could disrupt, degrade or impair services, including back office services, provided to a banking organization for four or more hours, the bank service provider would be required to immediately report the incident to any affected banking organization-customers. Additionally, bank service providers must notify at least two individuals at an affected banking organization, to ensure notice is received. The Agencies would aim to enforce these notification requirements directly against bank service providers. Indeed, any failure by a bank service provider to comply with the Proposed Rule would not be cited against the banking organization.
Overall, these notification requirements could impose significant obligations on banking organizations and their service providers. The greatest challenge may be figuring out how to meet the 36-hour standard. Further, there is a risk that increased regulatory visibility into potential cyber breaches may lead to increased scrutiny on banking organizations’ cyber practices. The Agencies seek comment on the proposal and outline some detailed questions for commenters. For example, the Agencies seek comments on the definitions as drafted, whether the 36-hour notification timeline should be adjusted, whether the “good faith” standard for banking organizations and bank service providers to notify the appropriate party is appropriate, among other questions. Comments must be submitted no later than 90 days after the publication of the Proposed Rule in the Federal Register.
1.1 Buyer recognizes that it has an obligation to respect human rights throughout its supply chains, in particular with respect to those human rights and principles enshrined in the United Nations Declaration of Human Rights, the ILO Declaration on Fundamental Principles and Rights at Work, and in applicable labor and employment laws.
1.2 Accordingly, Buyer commits to taking the human rights implications of its decisions into account at all times and to working towards the full implementation of the United Nations Guiding Principles on Business and Human Rights (UNGPs), the Organisation for Economic Co-Operation and Development’s (OECD) Guidelines for Multinational Enterprises, and the ILO Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy.
1.3 In particular, consistent with the UNGPs and the relevant OECD Due Diligence Guidance for Responsible Business Conduct (sector specific where available), Buyer will establish and maintain a human rights due diligence process appropriate to its size and circumstances to identify, prevent, mitigate, and account for how Buyer addresses the impacts of its activities on the human rights of individuals directly or indirectly affected by its supply chains.
1.4 Such due diligence will be both forward-looking and backward-looking, preventative, risk-based, and ongoing. It will involve meaningful engagement with stakeholders[1] through participation in regular, transparent, two-way consultation and the timely sharing of relevant information with stakeholders in a format that they can understand and access. Due diligence will also require Buyer to provide support for and participate in remediation where appropriate and necessary, in particular where it caused or contributed to an adverse impact.
1.5 All of the commitments undertaken by Buyer under this Responsible Purchasing Code of Conduct serve to advance and institutionalize human rights due diligence throughout Buyer’s own operations and supply chains so as to achieve or exceed the internationally recognized human rights standards identified in 1.1.
1.6 Buyer commits to improving alignment across its teams and business units on relevant aspects of human rights and procurement and to assign oversight and responsibility for the human rights performance of its supply chain to its senior management and executive board.
1.7 Buyer recognizes that its purchasing practices can either improve the human rights performance of its supply chains, or exacerbate and compound adverse human rights impacts for workers. Accordingly, Buyer will train and incentivize its procurement team to understand the direct links between Buyer’s purchasing practices and the labor conditions in its supply chains.
1.8 Buyer will at all times foster a culture of cooperation and partnership with its suppliers. Buyer will treat its suppliers fairly and with respect and will communicate with them clearly and promptly throughout their relationship.
1.9 Buyer will communicate externally all relevant information pertaining to its human rights policies, processes, activities.
2. Selecting suppliers.
2.1 Buyer will select suppliers that have the financial, managerial, and legal capacity to meet both the commercial and the human rights obligations under the contract.
2.2 Buyer will engage in dialogue with potential suppliers to ensure that they fully understand what is expected of them with respect to Buyer’s own human rights standards. This will include Buyer informing potential suppliers that they will be contractually required to cascade Buyer’s human rights standards to their own business relationships (i.e., beyond “tier 1”), that Buyer will expect to obtain, and supplier will be required to provide, throughout the life of the contract, all relevant information regarding supplier’s own business relationships, and that Buyer will provide support for such activities, where appropriate and feasible.
3. Negotiating the contract.
3.1 Buyer will negotiate its supply contracts so as to meet its production requirements, whilst respecting and promoting human rights. Should a conflict arise between these objectives, the latter shall take priority.
3.2 Buyer will not offer contracts on a take-it-or-leave-it basis or treat suppliers’ questions and negotiations as an automatic rejection of Buyer’s offer. Buyer will give suppliers an opportunity to negotiate the terms of the contract to ensure that both parties have a voice in structuring the arrangement and in advancing the human rights objectives of said arrangement.
3.3 Buyer will collaborate with suppliers to agree on a contract price that accommodates all costs of production, including costs associated with upholding responsible business conduct. For the avoidance of doubt, such costs shall, at a minimum, include minimum wages, statutory benefits, and health and safety costs required by applicable law or collective bargaining agreements.
3.4 Buyer will collaborate with its suppliers to agree on a timeline that ensures that orders will not trigger excessive working hours or unauthorized and unregulated sub-contracting. Should Buyer require short lead times, Buyer will negotiate contract terms that ensure that its suppliers can perform under the contract while meeting Buyer’s own human rights standards.
3.5 Buyer will formalize its arrangements with its suppliers in a written contract.
4. Performing and renewing the contract.
4.1 Should change orders (e.g., quantity increases or decreases, design alterations, timeline adjustment) be sought by Buyer during the contract term, Buyer will communicate updated requirements to its supplier clearly, promptly, and accurately. In cases where oral instructions containing change orders are provided, Buyer will confirm such instructions in writing as swiftly as possible.
4.2 When making changes to an order, Buyer will engage in a dialogue with its supplier to establish that the latter can adjust to the new requirements without running afoul of Buyer’s own human rights standards. If the supplier cannot adjust, Buyer will make commercially reasonable modifications to enable the contract to conform to Buyer’s own human rights standards, for example, by amending target delivery times and providing appropriate additional compensation. Likewise, should the supplier need to modify the contract/order so as to continue meeting Buyer’s human rights standards, Buyer will collaborate with the supplier to identify appropriate modifications.
4.3 Throughout the contract term(s), Buyer will engage in regular communication with its suppliers and provide on-going opportunities for suppliers to tell Buyer whether they can meet Buyer’s timelines without undue negative impacts on the human rights performance of the contract. Should a supplier require more time to deliver a product in order to continue meeting Buyer’s own human rights standards, Buyer will, where commercially practicable, endeavor to accommodate a new timeline.
4.4 If a new timeline cannot be agreed to and the supplier elects not to perform under the contract in order to prevent or mitigate attending human rights risks, Buyer will not retaliate. Specifically, Buyer will not block-list or sue a supplier that can establish that their decision not to perform under the contract was rooted in concern for upholding human rights standards.
4.5 Should a supplier need to engage in subcontracting to meet Buyer’s changed requirements, then, as soon as reasonably practicable after receiving the subcontracting request from the supplier, Buyer will review the request, and, if satisfied that the subcontract would not increase the risk of adverse impacts, Buyer will authorize such subcontracting.
4.6 In the event of a significant unforeseen increase in input costs during the contractual relationship, Buyer and supplier will negotiate adjustments to the contract price and/or make other modifications to accommodate those increases. Such increases may be incurred as a result of, for example, minimum wage rises, collective bargaining agreements, Buyer’s own commitments to paying a living wage, or unforeseen increases in material costs, other manufacturing costs, and/or currency fluctuations.
4.7 Buyer will regularly seek feedback from its suppliers on the impact of its purchasing practices on the human rights performance of their contracts and ensure that said feedback will not produce adverse consequences for suppliers. Recognizing that suppliers may be reluctant to provide such feedback candidly, Buyer may seek to collect information anonymously (e.g. via an annual survey) or partner with an independent third party that can aggregate the data and present its findings to Buyer. Buyer also commits to providing feedback to its suppliers so that they are able to improve their own policies and programs.
4.8 To aid suppliers in meeting their obligations under Buyer’s own human rights standards, Buyer will strive to provide reasonable material and practical assistance (e.g. financial, technological, training, capacity building) to suppliers throughout the contract term(s).
4.9 Buyer will collaborate with its suppliers to establish benchmarks for assessing the human rights performance of the contract(s), in order to enable Buyer’s procurement team to make informed assessments regarding whether to award, renew, or terminate the contract(s). When it comes time to renew the contract(s), Buyer will seek to reward suppliers for superior human rights performance.
4.10 Buyer commits to paying all suppliers in accordance with the terms agreed at the outset of the contract, without attempting to change payment terms retroactively. Should changes to payment terms be necessary, Buyer will ensure that such changes are mutually agreed, and not to the detriment of, suppliers. To support this commitment, Buyer will provide its suppliers with clear and easily accessible guidance—in supplier’s own language—on payment procedures and corresponding dispute resolution mechanisms.
5. Remediation for human rights harms
5.1 Buyer will ensure that effective, adequately funded, and governed operational level grievance mechanisms are in place to receive and address the concerns and grievances of affected or potentially affected stakeholders. These operational level grievance mechanisms will be consistent with the effectiveness criteria laid out in the UNGPs (legitimate, accessible, predictable, equitable, transparent, rights-compatible, a source of continuous learning, and based on engagement and dialogue).
5.2 Where there is a risk of an adverse impact or where an adverse impact has occurred, Buyer will collaborate with its suppliers and with affected stakeholders to identify the ‘root cause’ of the impact, so as to cease the impact and also prevent future harms.
5.3 In the event that a human rights harm occurs in connection with the contract(s), and Buyer caused or contributed to the harm, Buyer will participate in remediation, in collaboration with other buyers as appropriate, and in proportion to its responsibility for the adverse impact and/or its capacity to remediate the impact. Where Buyer’s activities did not cause or contribute to the adverse impact, but are directly linked to it, Buyer will use or build (in collaboration with other stakeholders) its leverage with its suppliers to prevent any future harms.
5.4 All remediation, whether carried out by suppliers or by suppliers in collaboration with Buyer (and other buyers as appropriate), will restore the affected person or persons to the situation they would have been in had the adverse impact not occurred, where possible. In all cases, remediation shall be proportionate to the scale and significance of the impact and shall be determined in consultation and engagement with impacted stakeholders and/or their representatives.
6. Disengagement and responsible exit
6.1 Should Buyer wish to disengage from its suppliers because of a potential or already-occurred adverse impact, Buyer will do so responsibly and as a last resort where (i) attempts at preventing or mitigating adverse human rights impacts have failed, (ii) the adverse impact(s) is irremediable, (iii) there is no reasonable prospect of change, or (iv) severe adverse impacts or risks are identified and the entity causing the impact fails to take immediate action to prevent or mitigate them.
6.2 Any disengagement, whether for commercial reasons, in response to an un-remediated human rights harm, a force majeure event, or for any other reason, will take into account Buyer’s sourcing volume and the potential adverse impacts related to disengagement, so that Buyer may identify appropriate measures for disengaging responsibly and for mitigating the hardship that termination may bring upon stakeholders. Decisions regarding mitigation will involve reasonable consultations with affected stakeholders.
6.3 Should Buyer decide to disengage, it will clearly communicate its intent in writing to its suppliers, with reasonable notice and a clear timeline.
6.4 If Buyer does disengage, it will pay its suppliers for any outstanding invoices and/or for costs already incurred in meeting the order prior to disengagement.
[1] Stakeholders are typically defined as those persons or groups who could be affected by a company’s activities, actions, and decisions. This comprises a broad group, including workers, workers’ representatives, trade unions (including Global Unions), community members, civil society organizations, investors, and professional industry and trade associations.
The development of an enterprise-wide culture to address human rights violations in the workplace is essential. These violations include not only modern slavery and child labor but also recruitment fees, confiscation of travel documents, travel permits, or room and board fees, insufficient pay, harassment, brutal hourly demands, restrictions on freedom of association, toxic exposure on the job site, and dangerous facility conditions. Only such a pervasive culture can identify the risks of a company’s involvement in potential human rights harms that could violate both current and emerging global regulations.[1] A generalized reference in Schedule P to observance by the supplier of all international human rights or a boilerplate reference to supplier codes cannot yield an effective tool to identify and manage the appropriate response to very real and ongoing threats to human rights given “salient risks” within a supply chain.[2]
OVERVIEW
The UN Guiding Principles on Business and Human Rights (UNGPs) were unanimously adopted by the UN Human Rights Council in June 2011. The Organisation for Economic Co-operation and Development Guidelines for Multinational Enterprises (OECD MNE Guidelines) were revised to include a new human rights chapter that was consistent with the UNGPs that same year. Since 2011, the UNGPs and the OECD MNE Guidelines have enjoyed ever-growing recognition in the international business community across sectors as documents that define responsible business conduct (RBC), notwithstanding characterization as voluntary standards and therefore “soft law.”
The UNGPs consist of thirty-one principles grounded in recognition of the following three pillars: (1) states’ existing obligations to respect, protect, and fulfill human rights and fundamental freedoms (UNGPs 1–10); (2) the role of business enterprises as specialized organs of society performing specialized functions, required to comply with all applicable laws and to respect human rights (UNGPs 11–24); and (3) the need to match rights and obligations to appropriate and effective remedies (UNGPs 25–31).
Schedule P must focus on the second of the three mutually supporting pillars of the “Protect, Respect, and Remedy” framework from the UNGPs: corporate responsibility to respect human rights. The UNGPs insist that corporate responsibility to respect human rights is a global standard of expected conduct for all business enterprises wherever they operate and independently of any states’ abilities and/or willingness to fulfill their own human rights obligations. The UNGPs further explain that such corporate responsibility also exists over and above compliance with national laws and regulations. To protect human rights and address adverse human rights impacts, companies must take adequate measures for the prevention, mitigation, and where appropriate, remediation of adverse impacts. Businesses are expected to (1) publicize a high-level commitment to respect human rights and embed it in the organization; (2) conduct human rights due diligence (HRDD); and (3) remedy harm that it caused or contributed to through a business relationship or through its own actions in tandem with another actor or harm linked to its operations, products, or services.
To comply with the UNGPs, a company must conduct due diligence to measure its human rights impacts according to substantive human rights benchmarks expressed in the International Bill of Human Rights (IBHR) and International Labour Organization (ILO) Declaration on Fundamental Principles and Rights at Work.[3]
Identifying a need to promote a common understanding of the meaning and scope of due diligence for RBC, the OECD developed OECD Due Diligence Guidance for Responsible Business Conduct (Guidance) in 2018 to provide practical support to enterprises on implementation of the OECD Guidelines, with explanations of its due diligence recommendations. The Guidance seeks to align with the UNGPs, the ILO Declaration on Fundamental Principles and Rights at Work, the ILO Conventions and Recommendations referenced with the OECD MNE Guidelines, and the ILO Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy. Note that the OECD has also developed sector-specific due diligence guidance for the minerals, agriculture, and garment and footwear supply chains and good practice papers for the extractives and financial sectors.[4]
The Guidance explains that enterprises should carry out due diligence to identify, prevent, mitigate, and account for how they address actual and potential adverse impacts in their own operations, their supply chain, and other business relationships as recommended in the OECD MNE Guidelines. Effective HRDD should, per the Guidance, be supported by efforts to embed RBC into policies and management systems to enable enterprises to remediate adverse impacts that they cause or to which they contribute. HRDD is an ongoing process that should commence prior to contract and must continue during the life cycle of the contract, including its end. It should be designed to assess and govern a business enterprise’s impact on human rights and not the impact of human rights on a business enterprise. After properly diagnosing risks, ongoing HRDD should ensure that corporate responses are fit to context and provide individuals with the type of support they need, actually mitigating and preventing further harm and producing positive human rights outcomes.
Schedule P should refer specifically to the salient risks that the business discovers in its supply chain after extensive HRDD, including not only the possibility of modern slavery and child labor but also, for example, environmental catastrophe, violence from company security forces, compromised workplace safety, or discrimination and harassment. Schedule P should be as clear as possible when defining salient risks within the supply chain.
Such clarity is not possible without comprehensive HRDD. Due diligence is mandatory in some European countries, and many other countries are now considering similar bills.[5] On April 29, 2020, the European Commissioner of Justice, Didier Reynders, announced that the European Union would propose new mandatory HRDD legislation in 2021. Whether that legislation or regulations promulgated under it will identify specific HRDD acts or a safe harbor process is yet to be seen.
The ETI Base Code,[6] founded on ILO conventions[7] and used widely across sectors, is an “internationally recognized code of good labor practice . . . used as a benchmark against which to conduct social audits and develop ethical trade action plans.”[8] “The provisions of the Base Code constitute minimum and not maximum standards” but nevertheless include nine categories, as follows: Some codes expand on these categories to include community-wide impact, environmental issues, and land rights. SMETA[11] is an audit methodology providing a compilation of what are recognized as practical and ethical techniques.[12] It includes a rating system for the severity of non-compliance when evaluating any one of the nine categories above, from “[b]usiness critical non-compliance” being the most severe to “[c]ritical non-compliance,” “[m]ajor non-compliance,” or “[m]inor non-compliance,” the last-named being the least severe.[13] The corresponding timescales for remediation range from zero to ninety days, with “business critical issues” requiring an immediate response (i.e., zero days) to correct the issue.[14] Once a customer begins or takes corrective action, an auditor verifies the adequacy of the business’s actions either remotely or onsite.[15] SMETA should be used to supplement a business’s systems, as it is not “intended as a standalone document.”[16]
Almost all codes adopt a similar approach, with varying emphasis and different levels of tolerance for certain non-compliances. The drafters of a company’s Schedule P could use the ETI Base Code and SMETA audit framework as a starting point to identify and map risks determined in the company’s essential, precontract due diligence. Schedule P should define what the buyer and supplier agreed will constitute important terms, such as “severity,” “salient risks,” and “child labor.” Schedule P also should include a process for handling discovered non-compliances that prioritizes attention to salient risks and expects buyer and/or supplier to respond based on their level of involvement depending on findings of “cause,” “contribution,” and “linkage.” A finding of “cause” should trigger a need to fix, remedy, and prevent, while a finding of “contribution” triggers a need to fix, remedy, and prevent through leverage and possible contract suspension and even termination. A finding of “linkage” should trigger efforts to prevent through leverage and possible contract suspension or termination.
MOVING BEYOND ABSTRACT TO THE CONCRETE
The contents of each company’s Schedule P policy statement will vary depending on the parties, the contract, and the salient risks at different tiers of the chain. Schedule P should be the result of extensive, ongoing HRDD. UN Guiding Principles 17 through 21 enumerate the due diligence process: (1) identify risks of harm to people and their environment; (2) respond to risk in an integrated fashion (which varies according to the mode of involvement; that is, cause, contribution, or linkage); (3) monitor and track performance; and (4) disclose risks and impacts to affected stakeholders.[17] This same process can be broken down to include: (a) risk mapping; (b) regular assessment; (c) actions to mitigate; (d) alert mechanisms; and (e) monitoring and evaluating for specific issues and possible routes to address those issues.[18] For example, there may be pollution of drinking water at one tier, security force violence at a second tier, and dangerous working conditions at a third. Boilerplate text to cover all potential risks will not result in the parties’ clear understanding of what needs to be done and may be useful only to identify a breach rather than guide conduct. Schedule P should not consist solely of a list of possible internationally recognized human rights that the supplier reviews and checks off as an assurance of current and ongoing compliance without true investigation. Rather, it should specify in practical and concrete terms the types of conduct by the parties that would constitute human rights abuse and identify which abuses justify suspension or even termination of the contract. Schedule P must also acknowledge the potential existence of other risks or abuses in the supply chain identified later or inadequately during the initial due diligence processes that may have to be addressed with a response other than, or including, suspension or termination.[19] Sector- and conduct-specific multi-stakeholder human rights standards, such as the Voluntary Principles on Security and Human Rights[20] and the Fair Labor Association’s revised Principles of Fair Labor and Responsible Supply Chains of Minerals from Conflict-Affected and High Risk Areas, as supplemented, might be incorporated or referenced where appropriate. A meaningful Schedule P is the result of extensive and ongoing due diligence and a history of dialogue between buyer and supplier that establishes clear and enforceable standards preserved in a written and understood action plan.
CRITICAL COMPONENTS OF A COMPLIANCE PROGRAM
At a minimum, the content of a Schedule P, which is consistent with international standards, should:
(1) specify and define clearly the salient human rights risks that the parties have identified in HRDD, the manifestation of which will constitute a breach of Schedule P, leaving flexibility for salient risks that were missed in any precontract HRDD;
(2) specify relevant statutes and regulations that the parties and all subcontractors or other agents are expected to comply with during the course of the contract or other relationship;
(3) specify the parties’ internal codes that all those in the supply chain are expected to know and honor;
(4) specify any multi-stakeholder standards that are relevant; and
(5) specify any relevant auditing protocols.
For companies looking for a more comprehensive list of Schedule P building blocks, a number of concrete tools are available to assist a company in designing an effective Schedule P statement that articulates its human rights policies. Schedule P should address precontract due diligence at length, and a concrete remediation plan should be derived therefrom. This seems logical: Buyer and seller should both be reluctant to enter into agreements without knowing in advance whether they might, and how they might, address hypothetical, let alone known, existing problems. Hence, Schedule P is expected to lead to some form of “remediation plan” that exists at the outset or that the parties agree to develop soon after signing. This plan would articulate long-term goals (on a prioritized basis) and interim steps that each party will take, either alone or in conjunction with others, as well as dates for achieving these steps and reporting and monitoring requirements.
One highly useful practical tool is the 2016 report, Doing Business with Respect for Human Rights: A Guidance Tool for Companies,[21] a collaboration between the Global Compact Network Netherlands, Oxfam, and Shift. The report provides practical guidance on how a company can set the overall tone on human rights through its policy commitments, how it can embed those commitments into the company’s DNA, how it can move from reactively to proactively assessing its impacts, how it can integrate its human rights policy into its interactions with business partners and act in response to discovered human rights risks, how it can evaluate its successes and failures, how it can make the stated commitments meaningful by engaging with stakeholders, and how to respond promptly and effectively to solve human rights problems.[22] Appendix B to the report provides a detailed summary of what should go into a policy commitment, including types of general and specific statements, implementation processes, and who is responsible for implementation, evaluation, and updates to the policy.[23]
Another widely used resource is the 2017 UN Guiding Principles Reporting Framework,[24] a collaboration between the Shift Project and international accounting firm, Mazars LLP. It consists of a short list of targeted questions designed to increase internal and external understanding of a company’s human rights policies and practices by assessing the quality of how the company identifies and manages each of its salient human rights risks.[25]
To be effective, the human rights expectations of the Buyer in the Model Clauses have to be articulated and then enforced at every level of the supply chain. The Supplier, as well as every lower tier supplier, must certify that it is fully familiar with all of the terms of the agreed upon Schedule P and the conditions under which the services are to be performed. Each tier supplier must enter into its agreement based on its own ongoing investigation of all human rights matters within the scope of its operations and cannot rely on the opinions or representations of other suppliers. Schedule P must, therefore, include a “perpetual clause” such that each supplier binds its lower tier supplier(s) to all of the performance obligations and responsibilities that Supplier assumes toward Buyer under Schedule P.
In this manner, Schedule P would be incorporated into every subsequent agreement or arrangement in the supply chain, insofar as it relates in any way, directly or indirectly, to the services or products in the chain. Each supplier agrees to be bound to the supplier that engaged its services in the same manner and to the same extent as the Supplier who contracted with Buyer in the master agreement. Where, in Schedule P and the Model Clauses, reference is made to Supplier and the work or specifications pertain to Supplier’s trade, craft, or type of work, such work or specifications shall be primarily interpreted to apply to the next tier supplier. To be precise, there would be a general reference to a requirement, say, for example, no forced labor, and a more specific section prohibiting the use of conflict minerals in a contract for electronics or no Uzbek cotton for a garment manufacturing contract.
It is the Working Group’s intention that Supplier shall have the benefit of all rights, remedies, and redress against a subsequent tier supplier that Buyer has against Supplier under the prime contract, and each lower tier supplier shall have the benefit of all rights, remedies, and redress against Supplier that Supplier has against Buyer under the prime contract, subject to the restrictions and limitations of the Model Clauses and only insofar as any of the foregoing is applicable to Schedule P. If deemed desirable and appropriate, both Schedule P and the Model Clauses can make it clear that Buyer has the direct right to claim a human rights breach by a supplier within the chain below the Supplier that is a party to the master agreement and that Supplier and each lower tier supplier has the same right in its role as a lower tier buyer vis a vis the lower tier supplier.
Even if Schedule P goes beyond traditional privity and applies up and down the chain, many insist that there is little likely enforcement of the Model Clauses or Schedule P that effectively addresses human rights representations without the inclusion of impacted stakeholders. “Next Generation Supplier Codes,” a phrase adopted by the Corporate Accountability Lab, include provisions and enforcement mechanisms that:
allow workers, survivors of deceased workers, land owners and impacted community members to enforce Schedule P [or Schedule Q], that is, provide third-party beneficiary language, and grant these third-party beneficiaries the ability to assign their rights to a labor union, nongovernmental organization, or other organizations providing legal assistance;
require notification and education of workers with respect to their rights;
require the supplier to disclose all its production factories so that the buyer may access and facilitate compliance monitoring; and
require the supplier to commit to refraining from retaliation against stakeholders who bring or consider bringing enforcement actions.
Sample third-party beneficiary clauses to be added to a buyer-supplier agreement can be found at Corporate Accountability Lab, “Towards Operationalizing Human Rights and Environmental Protection in Supply Chains: Worker-Enforceable Codes of Conduct” (February 2021), https://corpaccountabilitylab.org/publications.
A. Organizational Standards
UN Guiding Principles on Business and Human Rights (2011) a. Sponsor Organization: United Nations b. Link: https://www.ohchr.org/documents/publications/guidingprinciplesbusinesshr_en.pdf c. Description: The UNGPs are the authoritative global standard on business and human rights, and resulted from a six-year process of multi-stakeholder consultations, research and pilot projects, under the direction of their author, Harvard Kennedy School Professor John Ruggie, then the Special Representative of the UN Secretary-General on Business and Human Rights (SRSG). The UNGPs rest on three interrelated pillars: “the state duty to protect human rights, the business responsibility to respect human rights, and the need for greater access to remedy for victims of business-related abuse.” d. Supplementary/Interpretive Documents: i. The Corporate Responsibility to Respect Human Rights (2012) (https://www.ohchr.org?Documents/Publications/HR.PUB.12.2_En.pdf). The UN Office of the High Commissioner on Human Rights (OHCHR) drafted this document with the full approval of the SRSG, providing a comprehensive guide to the understanding and application of the second pillar of the UNGPs.
OECD Guidelines for Multinational Enterprises (2011 edition) a. Sponsor Organization: Organisation for Economic Co-operation and Development (OECD) b. Link: https://www.mnguidelines.oecd.org/mneguidelines c. Description: The OECD MNE Guidelines “provide non-binding principles and standards for responsible business conduct in a global context consistent with applicable standards.” They were revised in 2011 to substantially augment their human rights section, in order to align with the UNGPs. In doing so, the OECD imported virtually intact the HRDD process of the UNGPs. The OECD has continued to play an important role in providing concrete guidance to companies that do business in or with the OECD and resolves business and human rights disputes through its nonjudicial National Contact Process dispute resolution system. d. Supplementary/Interpretive Documents: i. OECD Due Diligence Guidance for Responsible Business Conduct (2018) (https://www.mneguildelines.oecd.org/OECD-Due-Diligence-Guildance-for-Responsible-Business-Conduct.pdf)
Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy (MNE Declaration) (1977, amended 2017) a. Sponsor Organization: International Labour Organization (ILO) b. Link: https://www.ilo.org/empent/Publications/WCMS_094386/lan–en/index.htm c. Description: The MNE Declaration is the ILO instrument influencing and guiding a number of international and regional organizations, national governments, and employers’ and workers’ organizations around the world. It provides direct guidance on social policy and inclusive, responsible and sustainable workplace training and practices and includes international labor standards and principles addressing specific work issues relating to forced labor, transition from the informal to formal economy, wages, safety and health, access to remedy, and compensation of victims.
ILO Declaration on Fundamental Principles and Rights at Work(1998) a. Sponsor Organization: ILO b. Link: https://www.ilo/declaration/thedeclaration/textdeclaration/lang–en/index.htm c. Description: The ILO Declaration commits member states to respect and promote principles and rights in four categories, whether or not they have ratified the relevant Conventions. These categories are: “freedom of association and the effective recognition of the right to collective bargaining; the elimination of forced or compulsory labor; the abolition of child labor; and the elimination of discrimination in respect of employment and occupation.” Member states that have not ratified one or more of the core Conventions are asked each year to report on the status of the relevant rights and principles within their borders, noting impediments to ratification and areas where assistance may be required. These reports are used to create a compilation of baseline tables, by country, and periodic global reports relating to the promotion of the fundamental principles and rights at work. d. Supplementary/Interpretive Documents: i. ILO Indicators of Forced Labour (2012). ii. https://www.ilo.org/global/topics/forced-labour/publications/WCMS_203832/lang–en/index
IRIS Standard (Version 1.1, 2019) a. Sponsor Organization: International Organization for Migration (IOM) b. Link: https://www.iris.iom.int/iris-standard c. Description: The International Recruitment Integrity System (IRIS) is the IOM’s global, multi-stakeholder initiative to promote ethical recruitment of migrant workers. IRIS is referred to under Objective 6 of the Global Compact for Safe, Orderly and Regular Migration and other intergovernmental frameworks. The IRIS Standard articulates what ethical recruitment means in practice and how labor recruiters can demonstrate compliance. The IRIS Standard and corresponding guidelines serve as a reference point for labor recruiters, employers, and state actors on how to integrate ethical recruitment principles into recruitment-related management systems, policies, regulations, processes, and procedures. To achieve this integration, the IRIS Standard defines operational indicators against which labor recruiters can be measured to assess compliance.
Human Rights Principles for Companies (January 1998) a. Sponsor Organization: Amnesty International b. Link: https://www.amnesty.org/download/Documents/148000/act700011998en.pdf c. Description: Amnesty International asserts that “the business community has a wide responsibility—moral and legal—to use its influence to promote respect for human rights. . . . [It] therefore developed an introductory set of human rights principles, based on international standards, to assist companies in developing their role in situations of human rights violations or the potential for such violations.” Its document deals with the responsibility multinational companies have to promote and protect human rights in their own operations. d. It recommends the development of explicit company policies, training, consulting nongovernmental organizations, and impact assessments. A checklist for use by companies forms part of the document.
ISO 26000: Guidance Standard on Social Responsibility (2010) a. Sponsor Organization: International Organization for Standardization (ISO) b. Link: https://www.iso.org/iso-26000-social-responsibility.html c. Description: ISO 26000:2010 is both an international consensus and guidance for assessing an organization’s commitment to sustainability and overall ESG performance. It is not a certification process “unlike some other well-known ISO standards. Instead, it helps clarify what social responsibility is, helps businesses and organizations translate principles into effective actions and shares best practices relating to social responsibility, globally. It is aimed at all types of organizations regardless of their activity, size or location.” d. Supplemental/Interpretive Documents: i. “Communication Protocol—describes appropriate wordings organizations can use to communicate about their use of ISO 26000. https://www.iso.org/files/live/sites/isoofg/files/standards/doc/en/iso_26000_comm_protocol_n.15.pdf. ISO 26000 basic training materials in the form of a PowerPoint and training protocol guidance.” https://www.iso.org.files/live/sites/isoorg/files/standards/docs/en/ISO_26000_basic_training_material_annexslides_2017.pptx ii. Documents that link ISO 26000 with the OECD Guidelines for Multinational Enterprises and the United Nations 2030 Agenda (Sustainable Development ) A. ISO 26000 and OECD Guidelines—Practical Overview of the Linkages https://www.iso.org/publications/PUB100418.html B. ISO 26000 and SDGS https://www.iso.org/publication/PUB100401.html
Doing Business with Respect for Human Rights: A Guidance Tool for Companies (2010, updated 2016) a. Sponsor Organization: Shift/Oxfam/Global Compact Network Netherlands b. Link: https://www.businessrespecthumanrights.org/image/2016/10/24/business_respect_human_rights_full.pdf c. Description: This is a paper on how to apply business responsibility to respect human rights under the UNGPs in practice. It provides practical guidance on how to prevent and address human rights impacts for use by company staff in the “sustainability or CSR function” as well as “procurement, sales, legal, and public affairs or risk and in different areas of operation, including business units and country subsidiaries.”
Blueprint for Embedding Human Rights in Key Company Functions (2016) a. Sponsor Organization: European Business Network for Corporate Social Responsibility (CSR Europe) b. Link: https://respect.international/wp-content/uploads/2019/11/Human_Rights_Blueprint_0.pdf c. Description: This blueprint by CSR Europe provides guidance for “embedding human rights across . . . [organizational functions].” Focusing predominantly on three key functions—human resources, risk management, and procurement. It provides examples of current practices taken by companies around each element and explains how these functions can contribute to the overall process of “effectively integrat[ing] human rights” into the corporate culture.
Children’s Rights and Business Principles (2012) a. Sponsor Organization: UNICEF/Save the Children/UN Global Compact b. Link: https://childrenandbusiness.org c. Description: Children’s Rights and Business Principles articulate the difference between the responsibility of business to respect, that is, doing the minimum required to avoid infringing on children’s rights; and to support, that is, taking voluntary actions that seek to advance the realization of children’s rights. These Principles call on businesses to put in place appropriate policies and processes, as set out in the UNGPs, including a policy commitment and a due diligence process to address potential and actual impacts on human rights. The Principles identify a comprehensive range of actions that all businesses should take to prevent and address risks to child rights and “maximize positive business impacts” in the “workplace, the marketplace and the community.”
FWF Code of Labor Practices (2016) a. Sponsor Organization: Fair Wear Foundation (FWF) b. Link: https://www.fairwear.org/wp-content/uploads/2016/06/fwfcodeoflabourpractices.pdf c. Description: The core of this Code is made up of eight labor standards derived from the ILO Conventions and the UN Declaration on Human Rights. The Code’s articulation of workers’ rights includes additional context for: (i) the limitation of working hours; (ii) the free choice of workplace; (iii) no exploitative child labor; (iv) no discrimination in employment; (v) a legally binding employment contract; (vi) safe and healthy working conditions; (vii) unrestricted freedom of association and the right to collective bargaining; and (viii) payment of a living wage.
GRI Sustainability Reporting Standards (2016, updated 2020) a. Sponsor Organization: Global Reporting Initiative (GRI) b. Link: https://www.globalreporting.org/standards c. Description: A flexible framework for creating standalone sustainability or non-financial reports, including ESG reports, which assist businesses, governments, and other organizations to understand and communicate their impacts on issues such as climate change, human rights, and corruption. Available as a free public good, “organizations can either use the GRI Standards to prepare a sustainability report in accordance with the Standards. Or they can use selected Standards, or parts of their content, to report information for specific users or purposes, such as reporting their climate change impacts for their investors and consumers.” Using reference to global standards of sustainability, the resultant report provides an inclusive picture of material topics, their related impacts, and how they are managed. There is a GRI Standards Report Registration System to register information reported using the GRI Standards.
International Criminal Court (Rome) Statute, Article 7 (1998) a. Sponsor Organization: International Criminal Court (ICC) b. Link: https://www.icc-cpi.int/nr/rdonlyres/ea9aeff7-5752-4f84-be94-0a655eb30e16/0/rome_statute_english.pdf c. Description: The Rome Statute is the treaty that established the International Criminal Court (ICC). As of November 2019, 123 states are party to the statute, which, among other things, establishes the court’s functions, jurisdiction, and structure. The Rome Statute established four core international crimes: genocide, crimes against humanity, war crimes, and the crime of aggression. Article 7 defines “crime against humanity” to include “enslavement,” “deportation or forcible transfer of population,” “imprisonment or other severe deprivation of physical liberty in violation of fundamental rules of international law,” and “other inhumane acts of a similar character intentionally causing great suffering, or serious injury to body or to mental or physical health,” “committed as part of a widespread or systematic attack directed against any civilian population, with knowledge of the attack.” “‘Enslavement’ means the exercise of any or all of the powers attaching to the right of ownership over a person and includes the exercise of such power in the course of trafficking in persons, in particular women and children.”
The Essential Elements of MSI (Multi-Stakeholder Initiative) Design (2017) a. Sponsor Organization: Institute for Multi-Stakeholder Initiative Integrity b. Link: https://www.msi-integrity.org/wp-content/uploads/2017/11/Essential_Elements_2017.pdf c. Description: This is a guide for how to craft a voluntary policy addressing business and human rights. It does not suggest specific areas of human rights to focus on or provide a framework for the topics that an initiative such as this should cover, but it does identify ideal qualities of the design and structure of such a policy. This guide is used by MSI Integrity to evaluate the strengths and weaknesses of a company’s initiative, but using an evaluation form such as this can provide guidance on how to write a comprehensive policy initiative for business and human rights.
UN Guiding Principles Reporting Framework (2015) a. Sponsor Organizations: Shift and Mazars b. Link: https://shiftproject.org/resource/un-guidling-principles-reporting-framework c. Description: The UNGPs Reporting Framework is a comprehensive reporting framework focused on the internal understanding and external reporting of a company’s human rights performance under the UNGPs. The Reporting Framework is a short series of questions to which any company should have answers, both to know whether it is doing business with respect for human rights and to show others the progress made. The Reporting Framework is supported by two kinds of guidance: implementation guidance for companies that are reporting, and assurance guidance for internal auditors and external assurance providers. It is used by over 150 major multinational publicly traded companies and is backed by governments, investor coalitions with approximately “$5.3 trillion assets under management,” investors, stock exchanges, law firms, and other reporting initiatives. d. Supplementary/Interpretive Documents: i. UNGPs Assurance Guidance (2017) https://ungpreporting.org/assurance The UNGPs Assurance Guidance is a “subject matter guidance that serves two purposes: one, to help internal auditors companies’ human rights performance, and two, to support external assurance providers’ assurance of companies’ human rights reporting.”
International Bar Association, Practical Guide on Business and Human Rights for Business Lawyers and the companion IBA Reference Annex to the Practical Guide on Business and Human Rights for Business Lawyers (2016) a. Sponsor Organization: International Bar Association b. Link: https://www.ibanet.org/Document/Default.aspx?DocumentUid+d6306c84-e2f8-4c82-a86f-93940d6736c4 c. Description: The first comprehensive practical guide for implementing the UNGPs into the practice of law worldwide. It was drafted by a team of international legal experts, following nearly two years of research and consultation, and was endorsed by all of the nearly 200 international bar associations and law societies that comprise the IBA.
B. Examples of Companies with Human Rights Initiatives
1. Alliance 8.7 Alliance 8.7 is a global partnership, chaired by the ILO, which fosters multi-stakeholder collaboration to support governments in achieving target 8.7 of the 2030 Sustainable Development Goals designed by the United Nations General Assembly in 2015 and part of UN Resolution 70/1, known as the “2030 Agenda”. It promotes (a) “accelerat[ed] action” “to eradi[cate] forced labour, modern slavery, human trafficking and child labour;” (b) research, data collection, and knowledge sharing on prevalence and “what works”; and (c) “driving innovation and leveraging resources.” The Alliance works globally through four thematic Action Groups and a Communication Group and support the national efforts of countries that have committed to accelerate action, organize national multi-stakeholder consultations, and set up respective time-bound action plans with measurable targets. https://www.alliance87.org
2. Business & Human Rights Resource Centre An independent, nonprofit global organization that provides resources and guidance for businesses “to advance human rights . . . and eradicate abuse.” Its website is in eight languages: English, Arabic, Chinese, French, German, Portuguese, Russian, and Spanish. The Centre has regional researchers based in Australia, Brazil, China, Colombia, India, Kenya, Jordan, Mexico, Myanmar, Philippines, Senegal, South Africa, Tunisia, the United Kingdom, Ukraine, and the United States of America. It draws global attention to businesses’ human rights impacts (positive and negative) in their region, seeks responses from companies when civil society raises concerns, and establishes close contacts with grassroots NGOs, local businesspeople, and other stakeholders. https://www.business-humanrights.org/en 3. Business for Social Responsibility BSR™ is a global nonprofit organization “that works with its . . . network of more than 250 member companies [and other partners] to build a just and sustainable world. From its offices in Asia, Europe, and North America, BSR™ develops sustainable business strategies and solutions through consulting, research, and cross-sector collaboration. It has developed several “collaborative [industry] initiatives, . . . including the Global Network Initiative and the Electronic Industry Citizenship Coalition, which [it] then spun off into independent institutions. More recently developed collaborative initiatives, including the Future of Fuels and the Future of Internet Power, and HERhealth and HERfinance, help companies across industries and sectors focus on cross-cutting issues like energy and women’s empowerment.” Environmental issues, particularly energy and climate, ecosystems services, and water, are a growing focus of its time and resources, fostering a “growing recognition at the highest level of business that sustainability is core to success.” https://www.bsr.org 4. Fair Labor Association The Fair Labor Association (FLA) is “a collaborative effort” of universities, civil society organizations, and socially responsible companies dedicated “to protecting workers’ rights around the world.” It is headquartered in Washington, D.C., with offices in China and Switzerland. “FLA places the onus on companies to voluntarily meet internationally recognized labor standards wherever their products are made.” It offers: (i) a “collaborative approach allowing civil society organizations, universities and socially responsible companies to sit at the same table and find effective solutions to labor issues;” (ii) “innovative and sustainable strategies and resources to help companies improve compliance systems;” (iii) “transparent and independent assessments, the results of which are published online;” and (iv) a “mechanism to address the most serious labor rights violations through a Third Party Complaint process.” https://www.fairlabor.org/sites/default/files/sci-factsheet_7-23-12.pdf
5. Labor Exploitation Accountability Hub “The Accountability Hub aims to improve both government and corporate accountability for human trafficking, forced labour and slavery in national and global business supply chains. . . .The Hub . . . provides a platform for . . . research and advocacy on accountability issues, including by fostering connections and information sharing among key stakeholders from different parts of the world. The main feature of the Hub is the publicly accessible Labour Exploitation Accountability Database, which provides a broad inventory of national laws and regulations addressing corporate accountability for severe labor exploitation in supply chains. The database is searchable by country, legal topic, and by keywords, and includes brief notes on the implementation of the collected legal mechanisms. Country summary pages also provide an overview of the national context and legal framework, and highlight key implementation issues.” https://www.accountabilityhub.org
6. Modern Slavery Registry Modern Slavery Registry was a central registry for statements published pursuant to Section 54 of the United Kingdom Modern Slavery Act, which “requires commercial organizations that operate in the UK and have an annual turnover above £36m to produce a statement setting out the steps taken to address and prevent the risk of modern slavery in their operations and supply chains.” The Registry was guided and supported by a governance committee which includes: Freedom Fund, Humanity United, Freedom United, Anti-Slavery International, the Ethical Trading Initiative, CORE Coalition, UNICEF UK, Focus on Labour Exploitation (FLEX), Trades Union Congress, UN Principles for Responsible Investment, and Oxfam GB. Modern Slavery Registry is now closed, however, because the government of the United Kingdom will launch its own registry in 2021. Historical records and guidance information are still available on their website. https://www.modernslaveryregistry.org https://www.gov.uk/government/publications/contacts-database-for-guidance-on-modern-slavery-reporting/contacts-database-for-guidance-on-modern-slavery-reporting
7. Responsible Business Alliance “Founded in 2004 by a group of leading electronics companies, the Responsible Business Alliance (RBA), formerly the Electronic Industry Citizenship Coalition (EICC) is a nonprofit comprised of electronics, retail, auto and toy companies committed to supporting the rights and well-being of workers and communities worldwide affected by the global supply chain. RBA members commit and are held accountable to a common Code of Conduct and utilize a range of RBA training and assessment tools to support continual improvement in the social, environmental and ethical responsibility of their supply chains.” https://www.responsiblebusiness.org
8. Shift Shift, founded in 2011 by core members of Professor John Ruggie’s United Nations Mandate Team, is internationally renowned as the “leading center of expertise on the UN Guiding Principles on Business and Human Rights.” It is chaired by Professor John Ruggie. “Shift is a non-profit, mission-driven organization headquartered in New York City,” whose purpose is to transform how “business gets done” to ensure respect for people’s lives and dignity. It “works across all continents” with businesses to help shape their practices, culture, and behavior and works with governments, financial institutions, civil society, and other stakeholders to embed the right requirements and incentives into businesses’ operating frameworks. https://shiftproject.org
9. Verité An “independent, non-profit, civil society organization, Verité . . . [has partnered,] since 1995[,] with hundreds of corporations, governments, and NGOs to illuminate labor rights violations in supply chains and remedy them to the benefit of workers and companies alike. . . . [It] provide[s] businesses with tools that help to eliminate labor abuses . . . , [endeavors] to empower workers to advocate for their rights . . . , create[s] publicly-shared resources that enlighten and drive action . . . [and] contribute[s] . . . to government labor and human rights policy.” Verité assists companies in “benchmarking policy,” “evaluating sourcing to field-based interviews,” and “developing a portrait of their supply chain that identifies risk and labor rights abuses.” “Verité has a history of work in over 70 countries, with a global network of experts in Africa, Asia, Europe, South America, North America and Australia.” https://www.verite.org
[1]See Elise Groulx Diggs, Mitt Regan, & Beatrice Parance, Business and Human Rights as a Galaxy of Norms, 50 Geo J. Int’l 309, 312 (2019) (articulating a “Galaxy of Norms” that supports the mapping of liability and the rings of responsibility arising from the rapidly evolving discussion of business and human rights (BHR) that includes both hard law and soft law norms).
[2]See Special Representative of the Secretary-General on the Issue of Human Rights and Transnational Corporations and Other Business Enterprises, Guiding Principles on Business and Human Rights: Implementing the United Nations ‘Protect, Respect and Remedy’ Framework, Human Rights Council, annex, U.N. Doc. A/HRC/RES/17/31, Principle 24 (Mar. 21, 2011) [hereinafter UNGPs]. The UNGPs expect businesses to prioritize their attention to salient risks of harm. A salient risk is a likely risk of severe harm to individuals, as seen from the perspective of the affected person. Greater weight is given to severity than to likelihood; a severe human rights harm has three attributes: (i) scale (the gravity of the harm, e.g., death, rape, or torture); (ii) scope (a large number of people harmed, e.g., poisoning of a community water supply, a factory collapse); and (iii) irremediability (the harmed person cannot be restored to the same position ex ante). To be considered severe, harm need not have all three attributes. See Office of the High Comm’r for Human Rights, United Nations Human Rights, The Corporate Responsibility to Respect Human Rights: An Interpretive Guide 8 (2012), https://www.ohchr.org/Documents/Publications/HR.PUB12.2 En.pdf [hereinafter Interpretive Guide].
[3] ILO, ILO Declaration on Fundamental Principles and Rights at Work and its Follow-up (2010), https://www.ilo.org/wcmsp5/groups/public/—ed_norm/—declaration/documents/publication/wcms_467653.pdf [hereinafter ILO Declaration]. The ILO published ILO Indicators of Forced Labour in October 2012, which presents the most common signs or “clues” that point to the possible existence of forced labor, in an effort intended to help “frontline” criminal law enforcement officials, labor inspectors, trade union officers, NGO workers, and others identify persons who are trapped in forced labor and who may require urgent assistance. In addition, companies must be aware of the International Recruitment Integrity System (IRIS) Standard created by ILO and IOM, which provides that labor recruiters comply with all applicable legislation, regulations, multilateral and bilateral agreements on labor migration, and policies related to the recruitment of migrant workers in the jurisdictions of origin, transit, and destination countries, including those pertaining to the immigration or emigration of migrant workers.
[5] The French law on the Duty of Vigilance, the Swiss Responsible Business Initiative, and the German Supply Chain campaign embed the UNGPs and OCED due diligence standards into law. Mandatory due diligence laws require companies to “identify, prevent, mitigate, and account for the negative human rights impacts of their activities or those linked to their business relationships.” European Coalition for Corporate Justice, Key Features of Mandatory Human Rights Due Diligence Legislation (2018), https://corporatejustice.org/eccj-position-paper-mhrdd-final_june2018_3.pdf. Find the latest news on mandatory HRDD at www.business-humanrights.org/en/mandatory-due-diligence.
[6] The Ethical Trading Initiative (ETI) is an “alliance of companies, trade unions, and NGOs that promotes respect for workers’ rights around the globe.” About ETI, Ethical Trading Initiative, https://www.ethicaltrade.org/about-eti (last visited Feb. 2, 2021).
[9] The UN Convention on the Rights of the Child (1989) provides: “For the purposes of the present Convention, a child means every human being below the age of eighteen years unless under the law applicable to the child, majority is attained earlier.” Convention on the Rights of the Child art. 1, open for signature, Nov. 20, 1989, 1577 U.N.T.S. 3. “In Spanish-speaking countries in Latin America, it is usual practice to distinguish between the boys and girls, on the one hand, and older adolescents, thereby recognizing that adolescents are more mature and can take on more responsibilities than younger children.” ETI Base Code, supra note 8, at 12.
[11] The Sedex Members Ethical Trade Audit (SMETA) “is designed to help auditors conduct high quality audits that encompass all aspects of responsible business practice,” including “labor, health and safety, environment and business ethics.” SMETA Audit, Sedex, https://www.sedex.com/our-services/smeta-audit/ (last visited Feb. 2, 2021); SMETA, Sedex, https://www.sedex.com/wp-content/uploads/2021/01/SMETA-flyer-1-1.pdf (last visited Feb. 2, 2021) (referencing general flyer about SMETA).
[20] Voluntary Principles Initiative, Voluntary Principles on Security and Human Rights (2000), http://www.voluntaryprinciples.org/wp-content/uploads/2019/12/TheVoluntaryPrinciples.pdf.
Authored by the Working Group to Draft Model Contract Clauses to Protect Human Rights in International Supply Chains, American Bar Association Section of Business Law*
David V. Snyder, Chair** Susan A. Maslow, Vice Chair** Principled Purchasing Project led by Sarah Dadush†
This project was born of challenge, frustration, and hope. There is little doubt that workers in international supply chains are being abused, in the most horrifying ways, even as they work to produce the staples of our everyday lives and indeed support much of our economy. Young children and enslaved people pick and process cocoa and coffee beans; they pick and process cotton; they sew clothes, weld steel, and assemble sporting goods; they mine rare minerals and extract valuable sources of energy. Many workers find themselves in injurious and even deadly working conditions, with people hurt and killed by the hundreds.[1] Supply chains can be riddled with modern forms of slavery, particularly debt-bonded labor.[2] Much has been invested in ameliorating these conditions but not enough. They continue,[3] and they are now sharpened and heightened by the enveloping crisis of the Covid-19 pandemic.
One of the crucial tools for addressing these problems is the contractual governance of supply chains. The Model Contract Clauses (MCCs) offered here seek to help companies implement healthy corporate policies in their supply chains in a way that is both legally effective and operationally likely. In general, the MCCs do not state the human rights performance standards themselves. The MCCs do not state what the working conditions must be like, how many fire exits are necessary, or what measures must safeguard against conflict minerals. The MCCs are designed for use across sectors, so the substantive standards will vary (clothing brands need no standards on conflict minerals, and electronics makers are not concerned with cotton sourcing). The human rights standards that the supplier must follow are assumed to be stated in what is here called Schedule P (P for Policy), and the standards that the buyer must follow are assumed to be stated in Schedule Q. Both Schedules P and Q are likely to take the form of codes of conduct, one for the supplier and one for the buyer. They are outside the scope of the MCCs themselves. This practice is typical. A purchase agreement consists largely, if not entirely, of legal obligations; the specifications for the goods themselves are often contained in separate schedules or in other documents. Although the Working Group cannot offer a model Schedule P because of the wide variation across industries, we do provide the Building Blocks for Schedule P for buyers that are starting to consider or are revising their expectations of their contracting partners. Because it is less industry-specific, a standard Schedule Q is offered, enumerating and explaining the responsible purchasing practices that buyers may be expected to follow.
The Model Contract Clauses offered below (MCCs 2.0) are designed as an improvement on and an alternative to those published two years ago (MCCs 1.0).[4] MCCs 1.0 were intended to harness supply contracts as one critical tool—among many—to put human rights policies into operation while managing company risk. Although many corporations have admirable human rights policies, mere policies can languish if they are not integrated into the operational and legal life of the company, and particularly into the company’s supply chains. MCCs 1.0 were drafted to give counsel a model to follow in operationalizing their companies’ human rights policies, easing the task for overburdened corporate counsel, and giving the benefit of extensive research conducted by the Working Group.
MCCs 1.0 met with considerable interest and enthusiasm, and the Working Group received extensive feedback that was often supportive, sometimes critical, and sometimes both. The great interest in the project also led to the informal augmentation of the Working Group with many voices from outside the Business Law Section, which is the official location of the Working Group (under the auspices of the Uniform Commercial Code [U.C.C.] Committee). With that feedback, the Working Group embarked on a new version of the MCCs. Version 1.0 envisioned a business model where buyers were confronted with troublesome suppliers who would violate the human rights of workers; the buyers would need to manage this problem through contractual control of their suppliers, and the MCCs could help them do so. Additional research reveals, however, that human rights violations at the supplier level are often rooted in the buyers’ own purchasing practices, particularly by timing demands, pricing pressures, and last-minute order modifications, as well as a lack of due diligence—turning a blind eye—to human rights issues. MCCs 2.0 accordingly assign contractual responsibility for human rights in the supply chain to the buyers as well as the suppliers. In these revised clauses, buyers commit to responsible purchasing practices while suppliers commit to responsible and ethical management of their workforce and their subsuppliers. Crucially, both buyers and suppliers are required to engage in “human rights due diligence.” These responsibilities are enforceable, although the legal remedies are not facile. MCCs 2.0 now include extensive provisions on human rights remediation as well as more standard contract remedies.
To many lawyers, the addition of buyer responsibilities is the most significant change from MCCs 1.0, but the shift from a regime of representations and warranties in MCCs 1.0 to a regime of human rights due diligence in MCCs 2.0 is at least as important. Several strong forces motivated this move. In any case, large multinational enterprises (MNEs) will likely find themselves subject to mandatory human rights due diligence. Human rights due diligence is already mandatory for companies meeting certain criteria under French law,[5] and regulatory efforts in a similar direction are well underway in European Union law.[6] Small and medium enterprises (SMEs) will benefit from a more realistic regime of due diligence rather than the strict liability of representations and warranties that, as a practical matter, will often be untrue and therefore routinely breached. In other words, MCCs 2.0 move from a demand that the supplier make a number of representations and warranties that both parties will perhaps know to be false, or doubtful, to a contractual expectation that all parties in the supply chain, from the buyer itself to its top-tier suppliers to the lowest level subcontractors, will all be duly diligent about human rights impacts. In some ways, due diligence is familiar as it is a constant in corporate practice. Still, many lawyers will find it new in two ways. Obviously, it is a move away from more traditional contract drafting that centers on standard “reps and warranties.” More fundamentally, human rights due diligence is not simply about assessment of corporate risk and assuring legal compliance but instead requires a consideration of stakeholders’ (including workers’) interests that are not identical to those of the contracting parties.
More broadly, MCCs 2.0 seek to align much more closely with the 2011 UN Guiding Principles on Business and Human Rights (UNGPs)[7] and with the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises as well as the OECD Due Diligence Guidance for Responsible Business Conduct.[8] The UNGPs and OECD Guidelines and Guidance have enjoyed wide uptake by many businesses already, and the ABA itself has officially endorsed the UNGPs, as have numerous other bar organizations.[9] Aside from human rights due diligence, the UNGPs and the Guidelines drove several significant changes in MCCs 2.0. Human rights remediation is generally prioritized over typical contract remedies (like money damages), and issues like pricing, changes of circumstances (such as Covid-19), timing, and modifications are addressed expressly. In addition, the Working Group discovered that while many companies already have committed to respect human rights in their corporate codes of conduct, many are looking for help in doing so in their supply chains. Accordingly, we are offering guidance with respect to what buyers may require of their suppliers in the form of “Building Blocks for Schedule P” as well as guidance in the form of a Schedule Q that states the buyer’s responsibilities. Schedule Q fills a gap in the supply chain governance arena because most codes of conduct apply to suppliers, not buyers. As there are few, if any, examples of buyer codes, Schedule Q is specific and detailed.
Some of these changes are path-breaking but necessary. As detailed below, the legislative move to mandatory human rights due diligence has already started. France led the way, with other countries considering similar legislation, and the European Union has announced that it will be moving in this direction in 2021. Large MNEs may already be subject to such rules because of their business in France or the Netherlands, and others may soon find themselves in a like position. That said, many companies find themselves very differently situated, and this project has always been intended for a broad range of companies, including SMEs. Further, different companies are in different places with respect to the commitments they want to make and the responsibilities they can undertake. For these reasons, the MCCs 2.0 retain a fully modular approach so that companies can choose the commitments that best reflect their positions, their goals, and their sector of activity. This is not a certification document; it is not a prix fixe menu. Companies are fully free to order their contractual provisions à la carte, choosing the clauses and the commitments that are right for them.
Version 1.0, the Chief Issues Addressed, and the Resolutions Retained in Version 2.0
This project was originally conceived as an effort in legal problem-solving, careful drafting, and research in order to move corporate commitments from mere policy statements to the legal and operational side of companies. It was instigated by a previous ABA project: after much effort and negotiation, the ABA adopted model principles against labor trafficking and child labor.[10] The Business Law Section had achieved some success in convincing companies to adopt these principles, but there was considerable concern that they were ineffective as mere policy statements. The Working Group was formed to operationalize them, in corporate parlance. The Working Group saw its mission as making corporate human rights policies legally effective and operationally likely. These twin goals remain our mantra.
The main challenge at the initial stage of the work was to solve the mismatch between commercial law rules and human rights law and standards. The problem is that goods made in unacceptable conditions might fully conform to product specifications. As we said then, “The background law does not deal easily with the problem of soccer balls that are perfectly stitched but that were sewn by child slaves.”[11] The problem manifests itself primarily with respect to conformity and remedies, and MCCs 1.0 took on the task of resolving those issues. The first version of the MCCs was geared to solve a commercial law problem and to assure that the clauses would be likely to work with typical purchasing documents. They were designed as a helpful resource for companies’ counsel.
The chief issues were making supplier obligations flow through the entire supply chain; allowing for traditional contract remedies along with human rights remediation even if suppliers’ defaults did not lead to defective goods (e.g., perfect shirts that were made in extremely dangerous conditions); conceiving of mitigation as something other than resale at market prices (because the goods may be “perfect” but nevertheless tainted by their reprehensible provenance); allowing a full range of remedies in a less than promising international transaction; and structuring the relationship through the use of disclaimers to limit the liability of buyers. MCCs 1.0 offered solutions to these issues, and for the most part they remain in MCCs 2.0, although no solution is ideal. They were (and are) as follows.
All responsibilities flow through the entire supply chain under broad definitions of subcontractors, employees, and representatives, and duties are imposed on all of them. See MCCs 2.0 ¶ 2.
In MCCs 1.0, goods are nonconforming and the buyer has a right of rejection and cancellation or avoidance if the supplier has violated Schedule P. See MCCs 1.0 ¶ 2. This right remains in MCCs 2.0 unless the buyer failed to engage in responsible purchasing practices. See MCCs 2.0 ¶ 3. If the buyer did contribute to the problem, the situation is more complex. See MCCs 2.0 ¶¶ 3(e), 6.2(f), 6.5(b).
Mitigation is reconceived (as is “acceptance” under U.C.C. § 2-606) in recognition of the possibility that reselling tainted goods might actually increase damages (e.g., through reputational harm and other consequential damage). Alternative mitigation could include donating the tainted goods to charity, for instance, unless other action is required by law, as when the U.S. trafficking statutes are implicated. See MCCs 2.0 ¶ 4.
Remedies are still specified in detail, taking into account the particular problems of tainted but otherwise conforming goods, reputational harm, informational issues, and so on. See MCCs 2.0 ¶ 6. Nevertheless, the MCCs 2.0 make clear that neither party should profit from breaches of ethical practice. See MCCs 2.0 ¶ 3(a). Further, remedies in MCCs 2.0 must be understood in conjunction with the commitment to human rights remediation of the problem (see ¶ 2) rather than termination of the relationship. This shift is discussed further infra.
Although some who have worked on the project have pushed hard to remove them, the disclaimers have been retained in modified form. Compare MCCs 1.0 ¶ 5.7 with MCCs 2.0 ¶ 7.
The treatment of disclaimers deserves further consideration. The problem is that a variety of legal doctrines may perversely discourage buyers from taking affirmative steps to identify and address human rights abuses in their supply chains. Typically, buyers have no enforceable duties to workers who are legally separated from the buyers, and in most international supply chains, the workers are legally remote from the ultimate buyers (although buyers are prohibited under U.S. law from importing goods made with forced labor). If the buyer takes affirmative steps, however, it may become liable to workers for failing to use reasonable care in an undertaking that it willingly undertook. Further, some types of control by buyers over suppliers may sacrifice the suppliers’ independent contractor status, which can be so important in shielding buyers from liability.[12] For these reasons, the disclaimers in MCCs 1.0 sought to maintain the legal independence of the suppliers, even though the buyer was imposing duties on its suppliers to keep the supply chain clean. For example, while a buyer might monitor its suppliers, MCCs 1.0 provide that the buyer assumes no duty to do so.[13]
Some buyers, of course, may have noncontractual legal duties to monitor, to disclose information, and so on; for instance, buyers who are federal contractors and therefore bound by the Federal Acquisition Regulation must “monitor, detect, and terminate the contract with a subcontractor or agent engaging in prohibited activities.”[14] And all buyers may have a duty to disclose the discovery of forced labor in their supply chains under some circumstances.[15] Further, buyers who commit to abide by the UNGPs or other norms may be under their own corporate duty to do just that, which will involve considerable involvement in keeping their supply chains clean.[16] Such buyers will monitor their suppliers on an ongoing basis to determine whether they are in compliance with Schedule P, and they must map their supply chains to determine whether their products are produced with human rights abuse at more remote links in the chain, below those suppliers with whom they have a direct contractual relationship. Such monitoring and mapping are fundamental to human rights due diligence under the UNGPs. None of this, however, means that contractual disclaimers are inappropriate. That buyers may have a regulatory or statutory duty, enforceable by the government, or their own corporate commitments to the UNGPs or other norms, does not mean that buyers will also want to incur parallel contractual (or tort) liability, enforceable by their contracting counterparties or other private plaintiffs, except as stated explicitly in the contract.
Buyer reluctance to take on additional liability to private plaintiffs should come as no surprise; millions of dollars are spent in litigation over implied private rights of action. The disclaimers simply say that the buyer takes on no contractual duties beyond those explicitly stated; the buyer may or may not owe duties for some other reason, but the disclaimer expressly rejects private contractual enforcement of such duties. The disclaimers thus do important work in protecting buyers who choose to become more involved in managing their supply chains rather than burying their heads in the sand. In short, they help companies manage their risk while they comply with their duties, being clear that some companies may wish to limit who can sue under the contract for alleged breaches of those duties. And to be clear, as just noted, the buyer in MCCs 2.0 does take on some explicitly stated contractual duties, as discussed in the next section. The disclaimers as drafted in MCCs 1.0 are flat, but in version 2.0 the disclaimers are necessarily qualified: it would not be true to say that the buyer is taking on no obligation to monitor its supply chain, for instance. The buyer is taking on that and other responsibilities as part of its human rights due diligence in Article 1. Thus, the disclaimers remain in MCCs 2.0, but with exceptions for the obligations that the buyer takes on elsewhere in the agreement.[17]
The Move to Buyers Sharing Responsibility with Suppliers
A number of reasons have motivated the addition of buyer responsibilities, but two are compelling: protection for workers cannot happen successfully without buyer responsibility, and many buyers are now or will soon be legally required to take on this responsibility. These twin reasons are all the stronger because they are intertwined.
Buyers’ purchasing practices can play a key role both in protecting and in harming workers. Version 1.0 of the MCCs was conceived on the notion that problems in the supply chain are caused by irresponsible suppliers, not by the ultimate buyer. This is in tension with the UNGPs, the research that supports them, and more recent research in conjunction with the drafting of MCCs 2.0.[18] In short, if the MCCs are to be successful, buyers need to follow responsible purchasing practices.
Extensive research has shed light on the realities of international supply chain contracting and the role of buyers’ purchasing practices. The leaders of the Principled Purchasing Project, which is part of the Working Group, put together an extraordinary set of consultations during the summer of 2020. It is not necessarily the kind of rigorous empirical research from which findings may be generalized, but we did hear from many people in many sectors. Consultations were held with representatives of large Western buyers (including three companies that are certainly household names), with a third party that is often involved in remediation, with nongovernmental organizations and others from civil society, with investors committed to ESG values,[19] with representatives of multilateral international organizations, with standard setters and auditors, with union and labor advocates, with industry associations, and with suppliers from several countries in East and South Asia.[20] After these consultations and other research, the Working Group has no doubt that buyer demands, typically related to production times, price requirements, or change orders, can often cause or contribute to human rights violations. It has become clear that improving buyers’ purchasing practices is central to protecting workers from human rights abuses. To be effective, the MCCs must provide mechanisms for buyers to share responsibility with suppliers.
To the business-minded lawyer, effectiveness must always be the ultimate goal, but any lawyer’s mind is trained to home in on legal risks; developing legal requirements on human rights due diligence and increased legal enforcement of existing regulations heighten the need for buyers to focus on their responsibility. It is still true that policing supply chains carries risks,[21] and candid lawyers must acknowledge as much to their clients.[22] But the countervailing risks have been heavy for some time, and they are becoming even weightier now. When MCCs 1.0 were published, companies were already concerned with a variety of compliance obligations, particularly around federal trafficking, forced labor, and child labor statutes, as well as disclosure obligations under some state and foreign laws.[23] Many of these may have seemed like paper obligations, and companies seldom if ever felt the brunt of any enforcement. That has changed, and U.S. Customs and Border Protection has now seized numerous cargoes under Withhold Release Orders issued pursuant to antitrafficking laws.[24] Corporate boards and officers can no longer afford attractive but ineffective corporate policies. Few current risk assessments will be able to justify turning a blind eye to the problems.
And if U.S. Customs enforcement were not enough to spur action, new legislation has also begun to require companies to be responsible for their supply chains, and not just concerning child labor, forced labor, and conflict minerals, but also with respect to working conditions and workers’ health and safety. For many years, admittedly, companies had few seriously enforced legal incentives to clean their supply chains. That landscape changed when France passed its duty of vigilance law in 2017 and the Netherlands passed a similar Child Labor Diligence Act in 2019.[25] The EU is now showing every sign of following suit.[26] These changes are discussed in the next section, but the point for now is that both operational effectiveness and legal obligation, in practice and on paper, require buyers to take responsibility for their supply chains. MCCs 2.0 help them to do that.
The Move from Representations and Warranties to Human Rights Due Diligence
The same two reasons—operational effectiveness and enforced legal requirements—that compel the addition of buyer responsibilities within MCCs 2.0 also require the move from representations and warranties to human rights due diligence. For many MNEs there is not much of a risk calculus on this score; simply put, human rights due diligence is currently required by French law and Dutch law and will likely be required very soon by EU law.[27] Even for MNEs that are not subject to French and Dutch law and that will not be subject to EU law, and for SMEs in similar circumstances, the move still makes sense. The regime of representations and warranties, with their accompanying strict liability—if they are not true, there is breach—is unrealistic and ineffective, and often so much so as to be downright fictitious. Frequently, this regime is thought to lead to what is called a “tickbox” or “checkbox” approach to supply chain management in which buyers require a laundry list of representations of compliance from their suppliers. Suppliers mechanistically provide them by checking the boxes, and everyone goes home happy (although they may be more than a little resentful of time wasted filling forms). Little is achieved.[28]
The move from representation-and-warranty to due diligence is eminently practical, then and should be reassuring to the parties. The participants in the supply chain are no longer being asked, unrealistically and fictitiously, to literally guarantee perfect compliance with the human rights and safety standards in Schedule P and the principled purchasing practices in Schedule Q. Instead, they are being required to be duly diligent, on an ongoing basis, about achieving those goals. This is not mere aspiration; the parties are contractually obligated to use reasonable means to achieve the goal. But there is no longer strict liability for failure of perfect compliance. And there is no longer the knowledge, certain to both parties, that the human rights obligations of the contract are breached the moment it is signed.
Although warranty rather than due diligence is the usual style of contract drafting in common law countries, diligence obligations are no stranger to the common law. Notions of good faith efforts or best efforts are standard in many contracts for sales of goods,[29] and due diligence accords well with the obligation de moyens, which is sometimes even called an obligation de diligence, in the civil law.[30] To some, the switch may seem surprising; after all, if human rights are so crucial, should the parties not be expected to be strictly liable rather than merely to use appropriate efforts? Yet, given the size and complexity of many supply chains, the varying capabilities of different companies, from the largest MNEs to the most modest SMEs, due diligence is the better regime. These inescapable facts are recognized in the UNGPs. Under Guiding Principle 24, businesses are entitled to prioritize and focus their attention on the most severe human rights harms or on harms that would become irremediable in the event of a delayed response. Not everything can be made perfect, ever, much less all at once. Perfection is not and cannot be the standard. Priorities are necessary, as is reflected in MCCs 2.0, particularly sections 2.3(c) and 2.5.
Human rights due diligence is a prospective, retrospective, and ongoing risk management process that enables businesses to respect human rights by identifying, preventing, mitigating, and accounting for how they address the impacts of their activities on human rights.[31] To be effective, it requires understanding the perspective of potentially affected individuals or “stakeholders,” and engagement with stakeholders pervades each stage of the process. It is understood within the context of the UNGPs and the subsequent OECD Guidelines and Guidance.[32] The OECD Due Diligence Guidance provides enterprises with the flexibility to adapt due diligence to their circumstances, recognizing that the nature and extent of diligence will be affected by the size of the enterprise, the context of its operations, and other factors. Specific guidance for SMEs seeking to implement effective human rights due diligence processes can also be found in the Guidance.[33] In addition, the OECD has produced sector-specific due diligence guidance for the minerals, extractives, agriculture, garment and footwear, and financial sectors, as well as guidance that applies across sectors. Like the Guiding Principles, a key aspect of the OECD Due Diligence Guidance is to carry out and improve the diligence process on an ongoing basis. Although the language is not well suited for contract clauses, the following list provides a good, though not exhaustive, understanding of the concept. Human rights due diligence includes:
(i) embedding responsible business conduct into the culture of the company through leadership, incentives, policies, and management systems;
(ii) identifying and assessing actual and potential adverse human rights impacts, throughout the supply chain, that the contract-related activities may cause or contribute to, or that may be directly linked to the operations, products, or services contemplated by the contract;
(iii) ceasing, preventing, and mitigating such adverse impacts;
(iv) tracking and monitoring, in consultation and collaboration with internal and external stakeholders, the success of mitigation or prevention;
(v) communicating how adverse impacts are addressed, mitigated or avoided; and
(vi) providing for or cooperating in remediation where appropriate.[34]
As can be appreciated from this list, while due diligence is familiar to corporations and their counsel, human rights due diligence is not coterminous with the kind of due diligence undertaken for a merger or a public offering. Human rights due diligence goes beyond technical legal compliance and includes the need to look at risks through the perspective of the stakeholder, as learned through engagement with the stakeholder; the prioritization of responsive action by severity of impact on the stakeholder; the need to search on an ongoing basis for human rights risks throughout the entire supply chain, and not just the first few tiers; the development of leverage to influence contractual parties to refrain from, mitigate, or remediate harm to human rights; and the need to go beyond the limits of local law. In other words, human rights due diligence is a necessary part of ongoing supply chain management; it is proactive, forward and backward looking, responsive to actual or potential impacts, and requires meaningful and regular engagement with stakeholders. Under the present law, to some degree, and under the law as it is developing, those impacts are part of the inescapable responsibility of the contracting parties, and that is why they are the focus of the first obligation stated in MCCs 2.0.
Express Treatment of Human Rights Remediation
Human rights remediation receives extensive treatment in MCCs 2.0. In contrast, MCCs 1.0 provide for termination on breach but assume the parties would not actually move to termination except in the rarest and most egregious circumstances. Instead, the parties would work to remediate the problem by taking measures to stop and correct the harm and to address any grievances. Termination, generally speaking, is in no one’s interest. The buyer does not want to suffer the disruption and incur the delay or switching costs to transfer its business to new suppliers. The supplier certainly does not want to lose business. And except in the most extreme circumstances, the workers do not want to lose their jobs and their livelihood, such as it is. MCCs 1.0 give the buyer a termination right, which would increase the buyer’s leverage, as contemplated by the UNGPs and OECD Guidelines,[35] to require human rights remediation by the supplier. In this way MCCs 1.0 are similar to many loan documents that allow a lender to call a loan upon default, accelerating all amounts due and requiring immediate payment, even though in most circumstances everyone expects the loan to be sent to “workouts” where efforts can be made to salvage the loan. Of course, not all loan documentation works this way, and similarly, MCCs 1.0 provide an alternative for notice and cure if the parties wanted to provide contractually for human rights remediation.[36]
Because everyone should contemplate remediation in almost all circumstances, MCCs 2.0 flip the position of MCCs 1.0 and provide for remediation expressly and extensively.[37] In addition, remediation is not solely the responsibility of the supplier; the buyer must participate if it has caused or contributed to the problem.[38] These provisions are not only in keeping with the shared responsibility of buyers and suppliers but also seem especially appropriate in cases where the buyer has caused or contributed to the harm. On the other hand, and perhaps just as obviously, cases may arise where the conduct is so egregious that immediate termination is required, with no opportunity for remediation, and MCCs 2.0 provide expressly for this as well.[39] These cases involve what are often called zero-tolerance activities.
Force Majeure, Responsible Exit, COVID-19, and Other Disruptions
The radical disruptions of Covid have caused new problems in supply chains and exacerbated old ones. MCCs 2.0 address these problems with two innovative provisions.[40] MCCs 2.0 acknowledge that the intervention of an event like Covid, or a particularly vicious monsoon, or political unrest, or countless other events, could upset the supply chain in a way that the goods could only be produced in violation of the commitments in Schedule P. Often these violations occur because of unauthorized subcontracting. In the case of Covid, lack of personal protective equipment could make production unsafe. These events may or may not constitute a force majeure, and the outcomes of judicial decisions on this issue are notoriously unpredictable under the U.C.C. and international sales law.[41] Judicial resolution of disputes in international supply chains is often impractical anyway. For these reasons, the clauses themselves provide guidance.
Notably, they apply to any “reasonably unforeseeable, industry-wide or geographically specific, material change” regardless of whether the change constitutes a force majeure. A supplier may exit the relationship without default if staying in the relationship would force it to breach Schedule P. When it comes to buyers wanting to exit the relationship, for whatever reason, including a force majeure event or something similar, the clauses impose on the buyer a duty to “consider the potential adverse human rights impacts and employ commercially reasonable efforts to avoid or mitigate them,” regardless of the reason for exit. In light of claims that many buyers abandoned their suppliers when the Covid-19 lockdowns set in without compensating them—even for completely manufactured goods, and, in some cases, even for goods that had already been shipped—MCCs 2.0 add that “Termination of this Agreement shall be without prejudice to any rights or obligations accrued prior to the date of termination, including, without limitation, payment that is due for goods.”
These clauses hardly solve all the problems of force majeure, Covid, and similar events. Nothing can. But they bring human rights into the equation and may help the parties reach resolutions that take into account a broad view of the interests involved.
The Addition of Dispute Resolution in MCCs 2.0
Because the MCCs are drafted as an addition to a primary sales agreement, Version 1.0 contains no provision for dispute resolution. Presumably choice of law, choice of forum, arbitration, or the like would be treated in the main agreement. After publication of MCCs 1.0, the Working Group learned more about the special context of dispute resolution that involves human rights, and for that reason MCCs 2.0 add two relevant provisions.
Most prominently, clauses on nonjudicial dispute resolution have been added. For companies that prefer to litigate rather than arbitrate, litigation remains an option. (Alternative drafting is offered in MCCs 2.0 ¶ 8.6, so companies can choose arbitration or litigation.) Still, even companies that want judicial resolution of ultimate disputes may benefit from pre-litigation efforts at amicable resolution, and these mechanisms are set up in this new version. This kind of collaborative resolution is consonant with the more cooperative approach now taken in much cutting-edge supply chain management. Many companies will find the “up the line” scheme to be consonant with their management practices in many other business contexts.[43]
In addition, as MCCs 2.0 align more closely with the UNGPs, an “operational level grievance mechanism” is set up to address problems as they arise.[44] This mechanism is informal, but it is nevertheless required, and it must be fully functional. Again, its purpose—to be “legitimate, accessible, predictable, equitable, transparent, rights-compatible, a source of continuous learning and based on engagement and dialogue with affected stakeholders, including workers”—will align with many companies’ efforts toward collaborative supply chain management. Further, it is required for consistency with the UNGPs.[45]
Conclusion: Companies Can Choose the Commitments that Suit Their Needs and Goals
A modular approach is the central drafting strategy of the MCCs in both versions. The Working Group fully recognizes that not all companies are in the same place. Not only do they possess differing capabilities and face-varying contexts, they are simply in different positions in their approach to human rights. Some companies—often those that have been involved in the worst problems—have advanced far in taking responsibility for the effects of their business on human rights. Other companies have taken only a few steps, and many have not yet started on the path. The MCCs are drafted for all of these companies and are designed so that counsel, with a minimum of effort, can adapt them to the particular circumstances of each company.
The Working Group has faced calls to require buyers to agree to all of the clauses, to prohibit “cherry-picking,” and to mandate a particular allocation of responsibility. And the Working Group has faced criticism for failing to do so, or for rejecting goals that can only be aspirational. These calls and criticisms misconceive the place of the Working Group. We cannot impose duties or mandate compliance. Nor have we chosen an aspirational mission. We are a creature of the Uniform Commercial Code Committee of the ABA Business Law Section, and we see ourselves as practical lawyers. The original and ongoing goal to draft clauses that are “legally effective and operationally likely” can only be achieved if companies adopt the clauses. Otherwise the MCCs will be relegated to even greater irrelevance than the corporate policies that languish, unused, in the minute books of board meetings. Accordingly, the MCCs are drafted so that companies can eliminate clauses that do not fit their goals; they can use MCCs 1.0 if MCCs 2.0 are too much; they can adapt everything[46] to meet their needs. For many companies, the most critical step is the first one—to start taking measures to improve their contracts. If the Working Group can make it easier to take that first step, we will have accomplished one of our most important objectives. That is not our only objective, however. We hope to provide guidance for companies that would like to move into a leadership position. We have tried to achieve balance while understanding that different companies walk on different tightropes in different tents.
We began with the confession that challenge, frustration, and hope were the catalysts for this project, and their powerful combustion continues to move the project forward. After publication of MCCs 1.0, it became clear that an ambitious effort toward revision would be needed to meet the goals of the project, which at its center is focused on improving the human rights of workers and other stakeholders, practically and immediately, through contracts—one of the most potent tools available. At the same time, we know that more needs to be learned, that new methods of supply chain management are coming into use, that new laws are in the offing, and that more work will need to be done. For now, we believe MCCs 2.0 offer a practical tool for companies that want to commit to protecting workers and other stakeholders in their international supply chains. It is not an easy task. The problem is spread across the world and results from countless factors, including basic economic realities. It will not be fixed soon, and it will not be fixed by supply chain reform alone or by contract clauses standing by themselves. This is the challenge. And it is sometimes frustrating that the problem can seem intractable, particularly since so many people, with different missions, different incentives, and different perspectives, contend for so many different solutions. Still, we believe that every effort can help and that practical solutions offered for even the most complex problems can result in real improvements in the lives of real people. That is our ultimate objective.
The MCCs 2.0
CLAUSES TO BE INSERTED INTO SUPPLY CONTRACTS, PURCHASE ORDERS, OR SIMILAR DOCUMENTS FOR THE SALE OF GOODS
The text proposed assumes that buyers are located in the United States and that the applicable law is either (a) U.S. state law that implements the Uniform Commercial Code without material nonuniform amendment or (b) the United Nations Convention on Contracts for the International Sale of Goods (the CISG, a treaty to which the United States is a party and which applies to many international sales of goods under CISG article 1(1)(a)).
For the most part, substantive human rights standards and ethical purchasing practices are not contained in these clauses and are instead assumed to be specified in Schedule P and Schedule Q, respectively. For companies that do not already have substantive human rights requirements for their suppliers, “Building Blocks for Schedule P” is included separately to provide guidance. A pro forma Schedule Q is also provided separately. In the clauses below, please refer to the footnotes for explanations of risks, statutory and case law, and human rights guidance from the UN Guiding Principles on Business and Human Rights (the Guiding Principles or UNGPs)and the 2011 OECD Guidelines for Multinational Enterprises (the OECD Guidelines) as well as the 2018 OECD Due Diligence Guidance for Responsible Business Conduct (the OECD Due Diligence Guidance)).
1 Mutual Obligations with Respect to Combatting Abusive Practices in Supply Chains.
As of the Effective Date[47] of this Agreement, Buyer and Supplier each agree:
(a) Buyer and Supplier each covenants to establish and maintain a human rights due diligence process appropriate to its size and circumstances to identify, prevent, mitigate, and account for how each of Buyer and Supplier addresses the impacts of its activities on the human rights of individuals directly or indirectly affected by their supply chains, consistent with the 2011 United Nations Guiding Principles on Business and Human Rights.[49] Such human rights due diligence shall be consistent with guidance from the Organisation for Economic Co-operation and Development for the applicable party’s sector (or, if no such sector-specific guidance exists, shall be consistent with the 2018 OECD Due Diligence Guidance for Responsible Business Conduct (the OECD Due Diligence Guidance).[50]
(b) [Buyer and Supplier each] [Supplier] shall and shall cause each of its [shareholders/partners, officers, directors, employees,] agents and all subcontractors, consultants and any other person providing staffing for Goods[51] or services required by this Agreement (collectively, such party’s “Representatives”) to disclose information on all matters relevant to the human rights due diligence process in a timely and accurate fashion to [the other party] [Buyer].
(c) For the avoidance of doubt, each party is independently responsible for upholding its obligations under this Section 1, and a breach by one party of its obligations under this Section 1.1 shall not relieve the other party of its obligations under this Agreement.
(d) Human rights due diligence hereunder may include implementation and monitoring of a remediation plan to address issues identified by due diligence that was conducted before the Effective Date.
1.2 Schedule P Compliance Throughout the Supply Chain.[52] Supplier shall ensure that each of its Representatives acting in connection with this Agreement shall engage with Supplier and any other Representative in due diligence in accordance with Section 1 to ensure compliance with Schedule P. Such relationships shall be formalized in written contracts that secure from the parties terms [in compliance with] [equivalent to those imposed by] [at least as protective as those imposed by] Schedule P.[53] Supplier shall keep records of such written contracts to demonstrate compliance with its obligations under this Agreement and shall deliver such records to Buyer as reasonably requested.[54]
1.3Buyer’s Commitment to Support Supplier Compliance with Schedule P.[55]
(a) Commitment to Responsible Purchasing Practices. Buyer commits to support Supplier’s compliance with Schedule P by engaging in responsible purchasing practices [in accordance with Schedule Q].
(b) Reasonable Assistance. If Buyer’s due diligence determines Supplier requires assistance to comply with Schedule P, Buyer, if it elects not to terminate this Agreement under Section 5, shall employ commercially reasonable efforts to provide such assistance[,[56] which may include Supplier training, upgrading facilities, and strengthening management systems.[57]] Buyer’s assistance shall not be deemed a waiver by Buyer of any of its rights, claims or defenses under this Agreement or under applicable law.
(c) [Pricing. Buyer shall collaborate with Supplier to agree on a contract price that accommodates costs associated with upholding responsible business conduct, [including, for the avoidance of doubt, minimum wage and health and safety costs, at a standard at least as high as required by applicable law [and International Labour Organisation norms]].[58]]
(d) Modifications. For any material modification (including, but not limited to, change orders, quantity increases or decreases, or changes to design specifications) requested by Buyer or Supplier, Buyer and Supplier shall consider the potential human rights impacts of such modification and take action to avoid or mitigate any adverse impacts, including by amending the modification [consistent with Schedule Q]. If Buyer and Supplier fail to agree upon modifications and/or amendments that would avoid a Schedule P breach, then either party may initiate dispute resolution in accordance with Article 8.
(e) Excused Non-Performance. If (i) Supplier provides notice and reasonably satisfactory evidence to Buyer that a Schedule P breach is reasonably likely to occur because of a requested modification or because of a reasonably unforeseeable, industry-wide or geographically specific, material change to a condition affecting Supplier;[59] (ii) the parties cannot agree on a solution that avoids breach of Schedule P; and (iii) Supplier elects not to perform in order to avoid breaching Schedule P, then the parties hereby agree that this Agreement or a specific purchase order hereunder may be terminated in whole or in part by Supplier and that Supplier shall not be in default of its obligations under this Agreement as a result of such non-performance.[60]
(f) Responsible Exit. In any termination of this Agreement by Buyer, whether due to a failure by Supplier to comply with this Agreement or for any other reason (including the occurrence of a force majeure event or any other event that lies beyond the control of the parties),[61] Buyer shall (i) consider the potential adverse human rights impacts and employ commercially reasonable efforts to avoid or mitigate them; and (ii) provide reasonable notice to Supplier of its intent to terminate this Agreement. Termination of this Agreement shall be without prejudice to any rights or obligations accrued prior to the date of termination, including, without limitation, payment that is due for acceptable goods produced by Supplier pursuant to Buyer’s purchase orders before termination.[62]
1.4Operational-Level Grievance Mechanism.[63] During the term of this Agreement, Supplier shall maintain an adequately funded and governed non-judicial Operational-Level Grievance Mechanism (OLGM) in order to effectively address, prevent, and remedy any adverse human rights impacts that may occur in connection with this Agreement. Supplier shall ensure that the OLGM is legitimate, accessible, predictable, equitable, transparent, rights-compatible, a source of continuous learning, and based on engagement and dialogue with affected stakeholders, including workers. Supplier shall maintain open channels of communication with those individuals or groups of stakeholders that are likely to be adversely impacted by potential or actual human rights violations so that the occurrence or likelihood of adverse impacts may be reported without fear of retaliation. Supplier shall demonstrate that the OLGM is functioning by providing [monthly] [quarterly] [semi-annual] written reports to Buyer on the OLGM’s activities, describing, at a minimum, the number of grievances received and processed over the reporting period, documentary evidence of consultations with affected stakeholders, and all actions taken to address such grievances.
2Remediating Adverse Human Rights Impacts Linked to Contractual Activity.
2.1Notice of Potential or Actual Violations.
(a)Within _____days of (i) Supplier having reason to believe there is any potential or actual violation of Schedule P (a Schedule P Breach), or (ii) receipt of any oral or written notice of any potential or actual Schedule P Breach, Supplier shall provide to Buyer a detailed summary of (1) the factual circumstances surrounding such violation; (2) the specific provisions of Schedule P implicated; (3) the investigation and remediation that has been conducted and/or that is planned as informed by implementation of the OLGM process set forth in Section 4; and (4) support for Supplier’s determination that the investigation and remediation has been or will be effective, adequate, and proportionate to the violation.
(b)If Supplier reasonably believes that Buyer’s breach of Buyer’s obligations under Section 3 caused or contributed to the Schedule P Breach and that remediation of the Schedule P Breach requires Buyer’s participation under Section 2.3(e), Supplier shall notify Buyer and provide details supporting its claim. If Buyer rejects Supplier’s allegation, Buyer shall provide Supplier with its written explanation rejecting Supplier’s position. In such case, the Dispute shall be resolved under Article 8.
(c)Supplier hereby designates (name) (title) at (email address) and Buyer designates (name) (title) at (email address) to send/receive all notices provided under this Section 1 [and in addition notices shall be given as specified in Section ____ for general notices under this Agreement].
2.1Investigation.
(a)Upon receipt of a notice under Section 1, Buyer and Supplier shall fully cooperate with any investigation by the other party or their representatives. Without limitation, such cooperation shall include, upon request of a party, working with governmental authorities to enable both Supplier and Buyer or their agents to enter the country, to be issued appropriate visas, and to investigate fully.
(b)Each party shall provide the other with a report on the results of any investigation carried out under this Section; provided that any such cooperation in the investigation does not require Buyer or Supplier to waive attorney-client privilege, nor does it limit the defenses Supplier or Buyer may raise.
(a)If Buyer becomes aware of a Schedule P Breach[65] that has not been effectively remediated, Buyer shall, in collaboration with Supplier’s other buyers where legally appropriate,[66] require Supplier to prepare a remediation plan (a “Remediation Plan”).
(b)The purpose of the Remediation Plan shall be to restore, to the extent commercially practical, the affected persons to the situation they would have been in had the adverse human rights impacts not occurred. [The Remediation Plan shall enable remediation that is proportionate to the adverse impact and may include apologies, restitution, rehabilitation, financial and non-financial compensation, as well as prevention of additional adverse impacts resulting from future Schedule P violations.][67]
(c)The Remediation Plan shall include a timeline and objective milestones for remediation, including objective standards for determining when such remediation is completed and the breach cured.[68] Supplier shall demonstrate to Buyer that affected stakeholders and/or their representatives [and/or a third party acting on behalf of such stakeholders][69] have participated in the development of the Remediation Plan.[70] [The Remediation Plan may contemplate recourse to the dispute resolution mechanisms set forth in Article 8, as appropriate.]
(d)Supplier shall provide [reasonably satisfactory] evidence to Buyer of the implementation of the Remediation Plan and shall demonstrate that participating affected stakeholders and/or their representatives are being regularly consulted. Before the Remediation Plan can be deemed fully implemented, evidence shall be provided to show that affected stakeholders and/or their representatives have participated in determining that the Remediation Plan has met the standards developed under this Section.
(e)If Buyer’s breach of Section 1.3 has caused or contributed[71] to the Schedule P Breach or the resulting adverse human rights impact, Buyer shall participate in the preparation and implementation of the Remediation Plan, including by providing assistance [which may include in-kind contributions, capacity-building[72] and technical or financial assistance] that is proportionate to Buyer’s contribution to the Schedule P Breach and the resulting adverse impact.
(f)A Remediation Plan under this Article 2 or under Section 1.1(d) shall be a fully binding part of this Agreement.
(a)In the event of a breach by Supplier of its obligations under Schedule P, Buyer shall give notice under Section 1(a), which shall trigger a [commercially reasonable] cure period [as set forth under this Agreement] [as agreed by the mutual written agreement of the parties (each acting in good faith and in a commercially reasonable manner)].[74] Such breach shall be considered cured when Supplier has met the standards set out in Sections 1.4 and 2.3.
(b)If such breach is not cured within the period designated under Section 4(a), or is incapable of being cured, Buyer may [cancel] [avoid][75] this Agreement under 6.2(e) and, with or without such [cancellation] [avoidance], may exercise any of its remedies under Article 6 or applicable law.
2.5Right to Immediate Termination. Notwithstanding any other provision of this Agreement, this Agreement may be immediately [canceled] [avoided] by Buyer under 2(e), without providing a cure period, if Supplier has engaged in a Zero Tolerance Activity. A “Zero Tolerance Activity” shall be any of the following activities if they were not disclosed promptly by Supplier to Buyer during due diligence under Section 1.1: (a) activities that would cause Buyer to be the subject of prosecution or sanction under civil or commercial laws whether national, regional or international; (b) activities that would expose Buyer to criminal liability; (c) activities prohibited by the Foreign Corrupt Practices Act of 1977 (as amended); (d) instances where it becomes apparent that Supplier cannot, in the absence of assistance from Buyer under Section 1.3(b), perform this Agreement without material or repeated violation of Schedule P; and (e) others specified in Schedule P.[76] Such termination shall be effectuated in compliance with Section 1.3(f) on responsible exit.
3 Rejection of Goods and [Cancellation] [Avoidance] of Agreement.
3.1 [Strict Compliance. It is a material term of this Agreement that Buyer, Supplier, and Representatives shall engage in due diligence in accordance with Sections 1 and 1.2 so as to ensure compliance with Schedule P.]
3.2 Rejection of Nonconforming Goods. In the event of a Schedule P Breach by Supplier that renders the Goods Nonconforming Goods, Buyer shall have the right to reject them[77] unless Buyer’s breach of its obligations under Section 3 [and/or Schedule Q] materially caused or contributed to the Schedule P Breach. Goods are Nonconforming Goods if the Buyer cannot resell them in the ordinary course of business or if the goods cannot pass without objection in trade or if the Goods are associated with a Zero Tolerance Activity.[78]
3,3 [Cancellation.] [Avoidance.]The following shall be deemed to [substantially impair the value of this Agreement to Buyer][79] [constitute a fundamental breach of the entire Agreement][80] and Buyer may [cancel] [avoid][81] this entire Agreement with immediate effect and without penalty and/or may exercise its right to indemnification and all other remedies: (a) a breach by Supplier of Schedule P that relates to a Zero Tolerance Activity, or (b) Supplier’s failure to timely complete its obligations under a Remediation Plan. Buyer shall have no liability to Supplier for such [cancellation] [avoidance] but shall employ commercially reasonable efforts to comply with Section 3(f).
3.4 Timely Notice. Notwithstanding any provision of this Agreement or applicable law (including without limitation [the Inspection Period in Section ____ of this Agreement and] [articles 38 to 40 of the CISG] [and U.C.C. §§ 2-607 and 2-608]),[82] Buyer’s rejection of any Goods[83] as a result of noncompliance with Schedule P shall be deemed timely if Buyer gives notice to Supplier within a reasonable time after Buyer’s discovery of same.
4.1 Notice of Buyer’s Discovery. Buyer may revoke its acceptance, in whole or in part, upon notice sent [in accordance with Section ___] of Buyer’s discovery that the Goods are Nonconforming Goods unless Buyer’s breach of its obligations under Section 3 materially caused or contributed to the Schedule P Breach. Such notice shall specify the nonconformity or nonconformities that Buyer has discovered at that point, without prejudice to Buyer’s right to specify nonconformities that it discovers later.
4.2 Same Rights and Duties as Rejection. [Upon revocation of acceptance, Buyer shall have the same rights and duties as if it had rejected the Goods before acceptance.]
4.3 Timeliness. Notwithstanding any provision of this Agreement (including without limitation [the Inspection Period in Section ____ of this Agreement and] U.C.C. § 2-608), Buyer’s revocation of acceptance of any Goods under this Article 4 shall be deemed timely if Buyer gives notice to Supplier within a reasonable time after Buyer’s discovery of same.]
5 Nonvariation of Matters Related to Schedule P.
5.1 Course of Performance, Established Practices, and Customs. Course of performance and course of dealing (including, without limitation, any failure by Buyer to effectively exercise any audit rights) shall not be construed as a waiver and shall not be a factor in Buyer’s right to reject Nonconforming Goods, [cancel] [avoid][85] this Agreement, or exercise any other remedy. Supplier acknowledges that with respect to the matters in Schedule P, any reliance by Supplier on course of performance, course of dealing, or similar conduct would be unreasonable. Supplier acknowledges the fundamental importance to Buyer of the matters in Schedule P and understands that no usage or practice established between the parties should be understood otherwise, and any apparent conduct or statement to the contrary should not be relied upon.[86]
5.2 No Waiver of Remedy. Buyer’s acceptance of any Goods in whole or in part will not be deemed a waiver of any right or remedy[87] nor will it otherwise limit Supplier’s obligations, including, without limitation, those obligations with respect to indemnification.
6 Buyer Remedies.
6.1 Breach and Notice of Breach. Upon breach by Supplier, Buyer may exercise remedies to the extent provided in this Article 6. Prior to the exercise of any remedies pursuant to Section 2, Buyer shall notify Supplier in accordance with Section 2.1. Such notice, if with respect to an actual violation, constitutes notice of default under this Agreement.[88]
6.2 Exercise of Remedies. Remedies shall be cumulative. Remedies shall not be exclusive of, and shall be without prejudice to, any other remedies provided hereunder or at law or in equity. Buyer’s exercise of remedies and the timing thereof shall not be construed in any circumstance as constituting a waiver of its rights under this Agreement. Buyer’s remedies include, without limitation:[89]
(a)Demanding adequate assurances from Supplier of due performance in conformity with Schedule P [after Buyer makes similar assurances to Supplier of its due performance under Section 3 [and/or Schedule Q]].
(b)Obtaining an injunction with respect to Supplier’s noncompliance with Schedule P (in which case, the parties represent to each other and agree that noncompliance with Schedule P causes Buyer great and irreparable harm for which Buyer has no adequate remedy at law and that the public interest would be served by injunctive and other equitable relief).
(c)Requiring Supplier to terminate an agreement or affiliation with a specific factory, terminate a subcontract or remove an employee or employees and/or other Representatives.[90]
(d)Suspending payments, whether under this Agreement or other agreements, until Buyer determines, in Buyer’s reasonable discretion, that Supplier has taken appropriate remedial action following the expiration of the cure period indicated in Section 4(a).
(e)[Avoiding] [Canceling] this Agreement if permitted by Sections 4(b), 2.5, or 3.3.
(f)Obtaining damages, including all direct and consequential damages caused by the breach; provided, however, that damages shall be reduced proportionately to the degree that Buyer’s breach of Section 3 [and/or Schedule Q] caused or contributed to Supplier’s breach of Schedule P.
6.3 Damages. Buyer and Supplier acknowledge:
(a)Neither Buyer nor Supplier should benefit from a Schedule P violation or any human rights violation occurring in relation to this Agreement. If damages are owed that would result in a benefit to Buyer or Supplier, such amounts should go toward supporting the remediation processes set out in Section 4 and Article 2. A “benefit” is here understood to mean being put in a better position than if this Agreement had been performed without a Schedule P Breach. Nothing herein limits the right of a party to be put in the position it would have been in had this Agreement been performed without a Schedule P Breach.
(b)[If there are insufficient funds to pay damages and complete the remediation processes set out in Section 1.4 and Article 2, remediation shall take priority.]
(c)[It may be difficult for the parties to fix damages for injury to business, prospects, and reputation with respect to Nonconforming Goods produced in violation of Schedule P, and in such case, liquidated damages must be paid by Supplier to Buyer as follows: [insert amount or formula for calculation.]] [92]
6.4 Return, Destruction or Donation of Goods; Nonacceptance of Goods.
(a)Buyer may, in its sole discretion, store the rejected Nonconforming Goods for Supplier’s account, ship them back to Supplier or export them or, if permitted under applicable law, destroy or donate the Nonconforming Goods, all at Supplier’s sole cost, expense, and risk, except to the extent that Buyer has caused or contributed to the nonconformity by breach of Section 1.3 [and/or Schedule Q].
(b)Buyer is under no duty to resell any Nonconforming Goods produced by or associated with Supplier or its Representative who Buyer has reasonable grounds to believe has not complied with Schedule P, whether or not such noncompliance was involved in the production of the specific Nonconforming Goods. Buyer is entitled to discard, destroy, export or donate any such Nonconforming Goods. Notwithstanding anything contained herein to the contrary or instructions otherwise provided by Supplier, destruction or donation of Nonconforming Goods rejected [or as to which acceptance was revoked],[94] and any conduct by Buyer required by law that would otherwise constitute acceptance, shall not be deemed acceptance and will not trigger a duty to pay for such Nonconforming Goods.[95] Buyer and Supplier represent and agree that this Section and any related Sections are an effort to mitigate damages, as selling, profiting from, and being associated with tainted goods or Nonconforming Goods is likely to be damaging to Buyer, including to Buyer’s reputation.
(a)Supplier shall indemnify, defend and hold harmless Buyer and its officers, directors, employees, agents, affiliates, successors and assigns (collectively, “Indemnified Party”) against any and all losses, damages, liabilities, deficiencies, claims, actions, judgments, settlements, interest, penalties, fines, costs or expenses of whatever kind, including, without limitation, the cost of storage, return, export or destruction of Goods, the difference in cost between Buyer’s purchase of Supplier’s Goods and replacement Goods, reasonable attorneys’ fees, audit fees that would not have been incurred but for Supplier’s Schedule P Breach, and the costs of enforcing any right under this Agreement or applicable law, in each case, that arise out of the violation of Schedule P by Supplier or any of its Representatives. This Section shall apply, without limitation, regardless of whether claimants are contractual counterparties, investors, or any other person, entity, or governmental unit whatsoever.
(b)Notwithstanding Section 5(a), Supplier’s obligation to indemnify Buyer shall be reduced proportionately to the degree that Buyer’s breach of Section 1.3 [and/or Schedule Q] caused or contributed to Supplier’s breach of Schedule P; in other words, for the avoidance of doubt, damages shall be borne by Buyer directly to the extent Buyer has materially caused or contributed to the breach of Schedule P. [96]
7Disclaimers.
7.1 Negation of Buyer’s Contractual Duties Except as Stated. Notwithstanding any other provision of this Agreement:
(a)Buyer does not assume a duty under this Agreement to monitor Supplier or its Representatives, including, without limitation, for compliance with laws or standards regarding working conditions, pay, hours, discrimination, forced labor, child labor, or the like, except as stated in Articles 1 and 2.[97]
(b)Buyer does not assume a duty under this Agreement to monitor or inspect the safety of any workplace of Supplier or its Representatives nor to monitor any labor practices of Supplier or its Representatives, except as stated in Articles 1 and 2.[98]
(c)Buyer does not have the authority and disclaims any obligation to control (i) the manner and method of work done by Supplier or its Representatives, (ii) implementation of safety measures by Supplier or its Representatives, or (iii) employment or engagement of employees and contractors or subcontractors by Supplier or its Representatives. The efforts contemplated by this Agreement do not constitute any authority or obligation of control. They are efforts at cooperation that leave Buyer and Supplier each responsible for its own policies, decisions, and operations. Buyer and Supplier and Representatives remain independent and are independent contractors. Nor are they joint employers, and they should not be considered as such.[99]
(d)Buyer assumes no duty to disclose the results of any audit, questionnaire, or information gained pursuant to this Agreement other than as required by applicable law, except to the extent Buyer must disclose information to Supplier as expressly provided in this Agreement.[100]
7.2 Third-Party Beneficiaries. [All buyers and suppliers in the supply chain have the right to enforce the relevant provisions relating to the human rights protections set forth herein and in Schedule P [and Schedule Q] and privity of contract is hereby waived as a defense by Buyer and Supplier provided, however, that there are otherwise no third-party beneficiaries to this Agreement. Individuals or entities, including but not limited to associations, workers, land owners, property owners, those residing, working and/or recreating in proximity to supply chain activities and any individual who is injured or suffers damages due to a violation of human rights have no rights, claims, causes of action or entitlements against Buyer or Supplier arising out of or relating to this Agreement, Schedule P, [Schedule Q] or any provision hereunder.] [There are no third-party beneficiaries to this Agreement].[101]
8.1 Dispute Resolution Procedures. The parties agree that the procedures set forth in this Article shall be the sole and exclusive remedy in connection with any dispute arising in whole or in part from or relating to Articles 1 through 7 or Schedule P [or Schedule Q], whether such dispute involves Buyer, Supplier, or a Representative[103] (a “Dispute”). Buyer and Supplier irrevocably waive any right to commence any action in or before any court or governmental authority, except as expressly provided in this Article 8. Notwithstanding anything contained herein to the contrary, however, at any point in the proceedings under this Article 8, the parties may agree to engage the services of a neutral facilitator to assist in resolving any Dispute.
8.2[Confidentiality.[104] All documents and information concerning the Dispute, including all submissions of the parties, all evidence submitted in connection with any proceedings, all transcripts or other recordings of hearings, all orders, decisions and awards of the arbitral tribunal and any documents produced as a result of any informal resolution of a dispute, shall be confidential, except with the consent of both parties or where, and to the extent, disclosure is required of a party (a) by legal duty, (b) to protect or pursue a legal right, or (c) in relation to legal proceedings before a court or other competent authority.]
8.3 Joinder of Multiple Parties. If one or more other disputes arise between or among parties to other contracts that are sufficiently related to the same or similar actual or threatened human rights violations, the parties shall use their best efforts to consolidate any such related disputes for resolution under this Article 8.
8.4 Informal Good Faith Negotiations Up the Line. The parties shall try to settle their Dispute amicably between themselves by good faith negotiations, initially in the normal course of business at the operational level. If a Dispute is not resolved at the operational level, the parties shall attempt in good faith to resolve the Dispute by negotiation between executives who hold, at a minimum, the office(s) of [TITLE(S)]. Either party may initiate the executive negotiation process at any time and from time to time by providing notice [in accordance with Section 1(c)] (the “Dispute Notice”). Within no more than five (5) days[105] after the Dispute Notice has been given, the receiving party shall submit to the other a written response (the “Response”). The Dispute Notice and the Response shall include (a) a statement of the Dispute, together with a recital of the alleged underlying facts, and of the respective parties’ positions and (b) the name and title of the executive who will represent that party and of any other person who will accompany the executive. The parties agree that such executives shall have full and complete authority to resolve the Dispute. All reasonable requests for information made by one party to the other will be honored. If such executives do not resolve such dispute within [twenty (20)] days of receipt of the Dispute Notice for any reason, the parties shall have an additional [ten (10)] days thereafter to reach agreement as to whether to seek to resolve the Dispute through mediation under Section 8.5.[106]
8.5 Mediation. If the parties do not resolve any Dispute within the periods specified in Section 4, either party may, by notice given in accordance with Section 2.1(c) (the “Mediation Notice”), invite the other to resolve the Dispute under the [insert name of rules] as in effect on the date of this Agreement (the “Mediation Rules”). The language to be used in the mediation shall be [language]. If such invitation is accepted, a single mediator shall be chosen by the Parties. If, within [______] days following the delivery of the Mediation Notice, the invitation to mediate is not accepted, the parties shall resolve the Dispute through [arbitration][litigation] under Section 8.6] [If the parties are unable to agree upon the appointment of a mediator, then one shall be appointed by the [insert title of official at the named institution]].
8.6 [In this clause, companies choose between arbitration (Alternative A) and litigation (Alternative B):] [Arbitration] [Litigation]. If and only if the parties (a) have chosen not to make use of Mediation under Section 5 to resolve the Dispute, or (b) have not, within [____] days following the delivery of the Dispute Notice, resolved the Dispute using such Mediation, then the Dispute shall be settled
[Alternative A for arbitration:] [by arbitration in accordance with the [name of rules of the arbitration institution] (the “Arbitration Rules”) in effect on the date of this Agreement.[107] The number of arbitrators shall be [one] [three]. The seat of arbitration shall be [seat] and the place shall be [place]. The language of the proceedings shall be [language]. [The provisions for expedited procedures contained in [section or article] of the Arbitration Rules shall apply irrespective of the amount in dispute. The parties further agree that following the commencement of arbitration, they will continue to attempt in good faith to reach a negotiated resolution of the Dispute.[108]]
[Alternative B for litigation:] [in accordance with ____ [here refer to the choice of forum and related clauses of the main supply contract].[109] Notwithstanding the commencement of litigation, if the parties are subsequently able to resolve the Dispute through negotiations or mediation, any resultant resolution may be made a consent judgment on agreed terms.]
8.7[Only for use with Alternative A for arbitration:] [Emergency Measures. Notwithstanding any provision of this Agreement or any applicable institutional rules, any party may obtain emergency measures at any time to address a Zero Tolerance Activity or any other imminent threat to health, safety, or physical liberty (including without limitation the holding of workers in locked barracks or the unavailability of accessible and unlocked emergency exits). In addition, a party may make an application for emergency relief to the [name of institution] (the “Arbitration Institution”] for emergency measures under the arbitration rules of the Arbitration Institution as in effect on the date of this Agreement.[110] If and only if the arbitral tribunal does not have the power to grant effective emergency measures or other specific relief may a party apply for relief to a court of competent jurisdiction that possesses the power to grant effective emergency measures.]
8.8[Only for use with Alternative A for arbitration:] [Arbitration Award. The arbitrator(s) may grant any remedy or relief set forth in Article 6 or elsewhere in this Agreement and that a court of competent jurisdiction could grant, except that the arbitrators may not grant any relief or remedy greater than that sought by the parties, nor any punitive damages. The award shall include compliance with a Remediation Plan as contemplated by Article 2 [The arbitration tribunal shall send a copy of each final order, decision and award to [title of official and name of institution] so that the public may have access to such documents, provided that, prior to sending any such document to such repository, such arbitration tribunal, in consultation with each of the parties, shall redact any information from such document that would (a) would reveal the identity of any party that wishes to remain anonymous; or (b) disclose any other information (including without limitation the amount of any award, any proprietary information or any trade secrets) that a party wishes to remain confidential.]]
* This report is the product of the Working Group and reflects its rough (and sometimes hotly debated) consensus. While produced under the auspices of the Uniform Commercial Code Committee of the American Bar Association Business Law Section, the report has not been approved or endorsed by the Committee, the Section, or the Association. Accordingly, the report should not be construed to be the action of either the American Bar Association or the Business Law Section. Nothing contained herein, including the clauses to be considered for adoption, is intended, nor should it be considered, as the rendering of legal advice for specific cases or particular situations, and readers are responsible for obtaining such advice from their own legal counsel. This report and the clauses and other materials herein are intended for educational and informational purposes only. The lawyer who advises on the use of these clauses must take responsibility for the legal advice offered.
** David Snyder as chair and Susan Maslow as vice chair served as principal drafters of this report, particularly the introductory text and Version 1.0 of the MCCs, see infra, which served as the groundwork for this Version 2.0. Much of the drafting of the new contract clauses in Version 2.0 was undertaken pro bono publico by a team at Linklaters LLP, see infra note †, although the ultimate drafting was done (and ultimate drafting decisions made) by Snyder and Maslow with the support or at least acquiescence of the Working Group. David Snyder is Professor of Law and Director of the Business Law Program at American University, Washington College of Law, in Washington, D.C., and would like to acknowledge grant funding from the law school as well as travel funding from the American Bar Association. He would also like to thank Katherine Borchert, Philip Killeen, Sophie Lin, and Alexandra Finocchio for excellent research assistance. Susan Maslow is a semi-retired partner at Antheil Maslow & MacMinn, LLP, in Bucks County, Pennsylvania. She is also chair of the Corporate Social Responsibility Subcommittee to Implement the ABA Model Principles on Labor Trafficking and Child Labor. Special thanks are due to Aditi Bagchi, Omri Ben-Shahar, Robert Hillman, Jonathan Lipson, Trang Nguyen, Kish Parella, and Salli Swartz.
† Sarah Dadush, Professor of Law at Rutgers Law School, led the Principled Purchasing Project to move the MCCs toward a more balanced allocation of responsibility for the human rights performance of supply contracts between buyers and suppliers. Specifically, the Project team produced MCCs that articulate the buyer’s obligations to behave responsibly in relation to its supplier in order to better protect workers’ human rights; the Project team also produced the Responsible Purchasing Code of Conduct, referred to as Schedule Q throughout the MCCs. The team is made up of Olivia Windham-Stewart, John F. Sherman III, and a team of lawyers acting pro bono publico from Linklaters LLP, and the Project benefited from a generous grant by the Laudes Foundation.
[2] The International Labour Organisation estimates that around 50 percent of victims of forced labor in the private economy are affected by debt bondage—around eight million people worldwide. See Global Estimates of Modern Slavery: Forced Labour and Forced Marriage, ILO (2017), https://www.ilo.org/wcmsp5/groups/public/@dgreports/@dcomm/documents/publication/wcms_575479.pdf; https://antislavery.org/slavery-today/bonded-labour.
[3]See, e.g., Annie Kelly, Nestlé Admits Slavery in Thailand While Fighting Child Labour Lawsuit in Ivory Coast, Guardian (Feb. 1, 2016), https://www.theguardian.com/sustainable-business/2016/feb/01/nestle-slavery-thailand-fighting-child-labour-lawsuit-ivory-coast (presenting Nestle’s instances of forced labor within its supply chains); Daniela Penha, Slave Labor Found at Starbucks-Certified Brazil Coffee Plantation, Mongabay (Sept. 18, 2018), https://news.mongabay.com/2018/09/slave-labor-found-at-starbucks-certified-brazil-coffee-plantation/ (finding slave labor in a Starbucks coffee bean supplier); Michael Sainato, Accidents at Amazon: Workers Left to Suffer after Warehouse Injuries, Guardian (July 18, 2018), https://www.theguardian.com/technology/2018/jul/30/accidents-at-amazon-workers-left-to-suffer-after-warehouse-injuries (revealing numerous instances of workplace injuries in Amazon’s factories); Martje Theuws & Pauline Overeem, Flawed Fabrics: The Abuse of Girls and Women Workers in the South Indian Textile Industry, SOMO Ctr. Res. Multinational Corps. 17–30 (2014), http://www.indianet.nl/pdf/FlawedFabrics.pdf (reporting on women’s labor conditions in five spinning mills: Best Cotton Mills, Jeyavishnu Spintex, Premier Mills, Sulochana Cotton Spinning Mills, and Super Spinning Mills); Pauline Overeem & Martje Theuws, Case Closed, Problems Persist: Grievance Mechanisms of ETI and SAI Fail to Benefit Young Women and Girls in the South Indian Textile Industry, SOMO Ctr Res. Multinational Corps. 21–23 (2018), http://www.indianet.nl/pdf/CaseClosedProblemsPersist.pdf (finding the grievance mechanisms for spinning mills did not provide remedy to affected workers and did not meet the requirements of the United Nations Guiding Principles).
[4] David V. Snyder & Susan A. Maslow, Human Rights Protections in International Supply Chains—Protecting Workers and Managing Company Risk: 2018 Report and Model Contract Clauses from the Working Group to Draft Human Rights Protections in International Supply Contracts, 73 Bus. Law. 1093 (2018) [hereinafter MCCs 1.0].
[5] French Corporate Duty of Vigilance Law, Loi 2017-399 du 27 mars 2017 relative au devoir de vigilance des sociétés mères et des entreprises donneuses d’ordre, [Law 2017-399 of March 27, 2017 relating to the duty of care of parent companies and sponsoring undertakings], Journal Officiel de la République Française [J.O.] [Official Gazette of France], Mar. 28, 2017, https://www.legifrance.gouv.fr/eli/jo/2017/3/28; see also Wet zorgplicht kinderarbeid [Dutch Child Labor Due Diligence Act], Wet van 24 oktober 2019, Stb., 2019, https://zoek.officielebekendmakingen.nl/stb-2019-401.html.
[6] The announcement was made in April 2020 by EU Commissioner for Justice Didier Reynders that the European Commission will introduce legislation on mandatory human rights due diligence in the first quarter of 2021 as part of the European Green Deal and the Covid-19 recovery package. See generally Eur. Parl. Comm. on Legal Affairs, Draft Report with recommendations to the Commission on corporate due diligence and corporate accountability (2020/2129(INL)) (Sept. 11, 2020); European Parliament Subcommittee on Human Rights, Briefings on Human Rights Due Diligence Legislation—Options for the EU (PE 603.495) (June 2020). For a recent update on EU developments, see Jonathan Drimmer et al., Pre-Draft of the EU Mandatory Corporate Due Diligence and Corporate Accountability Initiative: 10 Questions Businesses Need to Know, Paul Hastings (Oct. 5, 2020), https://www.paulhastings.com/publications-items/details/?id=da731c70-2334-6428-811c-ff00004cbded.
[7]See Special Representative of the Secretary-General on the Issue of Human Rights and Transnational Corporations and Other Business Enterprises, Guiding Principles on Business and Human Rights: Implementing the United Nations ‘Protect, Respect and Remedy’ Framework, Human Rights Council, annex, U.N. Doc. A/HRC/RES/17/31 (Mar. 21, 2011) (accessible at https://www.ohchr.org/Documents/Publications/GuidingPrinciplesBusinessHR_EN.pdf) [hereinafter UNGPs].
[9] The ABA House of Delegates endorsed the UNGPs in 2011 and has since been followed by the International Bar Association, the Law Society for England and Wales, the Japan Federation of Bar Associations, and the European Bars Federation [Fédération des Barreaux d’Europe (FBE)]. For a concise history of the background, content, and uptake of the UNGPs, see John F Sherman III, Beyond CSR: The Story of the UN Guiding Principles on Business and Human Rights, in Corporate Social Responsibility—Sustainable Business: Environmental, Social and Governance Frameworks for the 21st Century (Rae Lindsay and Roger Martella, eds., 2020) ch. 20, § 20.04, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3561206 (last visited Nov. 26, 2020).
[10] There are both ABA Model Business and Supplier Principles on Labor Trafficking and Child Labor (ABA Model Principles) and ABA Model Business and Supplier Policies on Labor Trafficking and Child Labor (Model Policies). The ABA Model Principles are the high-level articulation of the detailed material in the Model Policies. The ABA Model Principles also form Part II of the Model Policies. Only the ABA Model Principles were adopted by the ABA House of Delegates, so only the ABA Model Principles represent the official position of the American Bar Association. For a detailed discussion, see E. Christopher Johnson Jr., Business Lawyers Are in a Unique Position to Help Their Clients Identify Supply-Chain Risks Involving Labor Trafficking and Child Labor, 70 Bus. Law. 1083 (2015). For more information on the Model Principles Task Force, see the ABA Model Business and Supplier Policies on Labor Trafficking and Child Labor, http://www.americanbar.org/groups/business_law/initiatives_awards/child_labor.html.
[11] MCCs 1.0, supra note 4, at 1095. See generally Douglas A. Kysar, Preferences for Processes: The Process/Product Distinction and the Regulation of Consumer Choice, 118 Harv. L. Rev. 526 (2004).
[12] Consider the case law reviewed in Ramona Lampley, Mitigating Risk, Eradicating Slavery, 68 Am. U. L. Rev. 1707 (2019); David V. Snyder, The New Social Contracts in International Supply Chains, 68 Am. U. L. Rev. 1869, 1902-03 (2019). Note the “trenchant observation of Judge Johnston that current tort doctrine encourages Western buyers to divorce themselves from the supply chain as much as possible and to ‘ignore[] workplace safety’ as a means to ‘escape liability.’” Rahaman v. J.C. Penney Corp., No. N15C-07-174 MMJ, 2016 WL 2616375, at *9 n.68 (Del. Super. Ct. May 4, 2016). The complaint was originally filed in the United States District Court for the District of Columbia, naming Bangladesh as a defendant (No. 15-CV-00619-KBJ (D.D.C. filed Apr. 23, 2015)).
[15]See, e.g., 18 U.S.C. § 541 (2018); 19 C.F.R. § 12.42(b). Foreign laws may also impose similar legal duties on U.S. companies doing business in or with their countries. See supra note 5.
[17] MCCs 2.0 ¶ 7.1(a)-(b) (“Buyer does not assume a duty under this Agreement . . . except as stated in Article 1 and 2”).
[18] Sarah Dadush, Contracting for Human Rights: Looking to Version 2.0 of the ABA Model Contract Clauses, 68 Am. U.L. Rev. 1519, 1537-40 (2019) (citing Vijay Padmanabhan et al., The Hidden Price of Low Cost: Subcontracting in Bangladesh’s Garment Industry, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2659202 (2015)); John F. Sherman III, The Contractual Balance Between ‘Can I?’ and ‘Should I?’ Mapping the ABA’s Model Supply Chain Contract Clauses to the UN Guiding Principles on Business and Human Rights, Corporate Social Responsibility Initiative, Harvard Kennedy School, April 2020, Working Paper No. 73, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3574811.
[19] That is, environmental, social, and governance values.
[20] The consultations were held under Chatham House rules, so identifying information cannot be disclosed here. In all, over fifty people were consulted, representing roughly forty to fifty organizations.
[22]See Model Rule of Professional Conduct 2.1 (duty to provide candid advice to clients).
[23] MCCs 1.0, supra note 4, at 1095 (citing Trafficking Victims Protection Act of 2000, 22 U.S.C. §§ 7101–7114 (2018); 18 U.S.C. §§ 1589–1592 (2018) (criminal sanctions for forced labor, trafficking, and peonage); Trafficking Victims Protection Reauthorization Act of 2013 (TVPRA) (Title XII of the Violence Against Women Reauthorization Act of 2013, Pub. L. No. 113-4, 127 Stat. 54 (2013)); Trade Facilitation and Trade Enforcement Act of 2015 (TFTEA), Pub. L. No. 114-125, 130 Stat. 122 (2016); Cal. Civ. Code Ann. § 1714.43; Federal Acquisition Regulation, 48 C.F.R. §§ 52.222–50 to 52.223-7; UK Modern Slavery Act 2015, c. 30; French Corporate Duty of Vigilance Law, supra note 5; Directive 2014/95/EU, of the European Parliament and of the Council of 22 October 2014 Amending Directive 2013/34/EU as Regards Disclosure of Non-Financial and Diversity Information by Certain Large Undertakings and Groups, 2014 O.J. (L 330) 1); see also Australian Modern Slavery Act 2018 (Cth) No.153 part 2; Dutch Child Labor Due Diligence Act, supra note 5.
[24]See, e.g., U.S. Customs & Border Protection, CBP Issues Detention Order on Palm Oil Produced with Forced Labor in Malaysia (Sept. 30, 2020), https://www.cbp.gov/newsroom/national-media-release/cbp-issues-detention-order-palm-oil-produced-forced-labor-malaysia. After a long period when enforcement was rare, U.S. CBP has issued roughly 18 “withhold release orders” (WROs) in the last twelve months (as of Oct. 11, 2020). Some link this surge in enforcement to multimillion dollar settlements by buyers. See Andy Hall, Statement on Top Glove’s Estimated US$40m Reimbursement of Migrant Worker Recruitment Related Fees and Costs, Facebook, (Oct. 5, 2020), https://m.facebook.com/story.php?story_fbid=10157620591885677&id=675065676.
[27]See supra notes 5–6 and accompanying text. Although it is narrower because it is limited to child labor, the Dutch statute of 2019 similarly imposes a due diligence regime. See supra note 5.
[28] D. A. Baden et al., The Effect of Buyer Pressure on Suppliers in SMEs to Demonstrate CSR Practices: An Added Incentive or Counter Productive?, 27 Eur. Mgmt. J. 429, 435 (2009); see also James Harrison, Establishing a Meaningful Human Rights Due Diligence Process for Corporations: Learning from Experience of Human Rights Impact Assessment, 31, 2 Impact Assessment & Project Appraisal 107, 111, 115 (2013), https://www.tandfonline.com/doi/full/10.1080/146155 (explaining that due diligence “could degenerate into a ‘tick-box’ exercise designed for public relations purposes rather than a serious integral part of corporate decision-making.”); see also Ruggie & Sherman, supra note 16, at 460.
[30] For basic explanations of the obligation de moyens or de diligence and its relation to other kinds of obligations with stricter liability, such as the obligation de résultat or the obligation déterminée, see Martin Davies & David V. Snyder, International Transactions in Goods: Global Sales in Comparative Context 437-41 (2014).
[31] See the UNGPs, supra note 7, especially Principles 11, 17–22, 29, and 31.
[33]See OECD Due Diligence Guidance, supra note 8, at 9, 18, Annex Questions 6, 7, and Table 4.
[34] See the introduction to Section II of the OECD Due Diligence Guidance, supra note 8.
[35]See UNGPs, supra note 7, Commentary to Principle 19; OECD Guidelines, supra note 8, § II, art. 3.2.
[36]See MCCs 1.0, supra note 4, ¶¶ 2.3 (cancellation and avoidance), 2.5 (no right to cure), at 1099–1100 & n.30 (suggesting in a footnote an alternative clause for notice and cure to allow remediation).
[37] MCCs 2.0 ¶ 2 (remediation); see also id. ¶ 2.4 (right to cure). It is an interesting question of contract design to decide whether a contractual termination right, like that in ¶ 2.3 of MCCs 1.0, supra note 4, should be included in transactions that do not contemplate its use but instead contemplate remediation (or in commercial practice, a workout). A termination right that will seldom be used might be conceived as a supracompensatory remedy that in a competitive market will be undesirable. See generally Alan Schwartz, The Myth that Promisees Prefer Supracompensatory Remedies: An Analysis of Contracting for Damage Measures, 100 Yale L.J. 369 (1990). For that reason, the switch to the scheme in MCCs 2.0 is perhaps desirable. The relevant market may not be competitive, however, and for that reason a buyer with bargaining power may prefer the termination right. The greater buyer leverage might arguably increase the chance of forcing remediation as well, but this will depend on the particular facts of the market and the parties’ place in it, and even if so, overweening buyer power to terminate may undermine valuable cooperation and be counterproductive for that reason. These issues arise from holdup problems in supply chain contracting generally, and the Working Group fully admits that it has not solved those problems (and further believes that whoever does solve those problems will probably get a Nobel Prize in economics to show for it).
[43]See Ronald J. Gilson, Charles F. Sabel, & Robert E. Scott, Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum L. Rev. 1377, 1404 (2010); Ronald J. Gilson, Charles F. Sabel, & Robert E. Scott, Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration, 109 Colum. L. Rev. 431, 442 (2009); Susan Helper, John Paul MacDuffie, & Charles F. Sabel, Pragmatic Collaborations: Advancing Knowledge while Controlling Opportunism 9 Indus. & Corp. Change 443, 449 (2000). In addition, governments adhering to the OECD Guidelines set up a National Contact Point (NCP) to further the effectiveness of the OECD Guidelines by, among other activities, helping to resolve dispute. The NCP in the United States provides a nonjudicial grievance mechanism with a mediation and conciliation platform.
[45] UNGP 29, supra note 7. MCCs 2.0 have been very much influenced by the groundbreaking work in the Hague Rules on Business and Human Rights Arbitration (2019). At the same time, it should be noted that many are skeptical of arbitration in the context of human rights, particularly because of experiences in investment arbitration. Arbitration can be seen as favoring corporate interests over human rights, with biased arbitrators and confidentiality provisions that protect wrongdoers and hamstring balanced advocacy. For some of the leading discussion, see generally Kyle D. Dickson-Smith & Bryan Mercurio, Australia’s Position on Investor-State Dispute Settlement: Fruit of a Poisonous Tree or a Few Rotten Apples?, 40 Sydney L. Rev. 213, 219–20 (2018); Duy Vu, Reasons Not to Exit? A Survey of the Effectiveness and Spillover Effects of International Investment Arbitration, 47 Eur. J. L. & Econ. 291, 307 (2019); Alessandra Arcuri & Francesco Montanaro, Justice for All? Protecting the Public Interest in Investment Treaties, 59 B.C. L. Rev. 2791, 2792 (2018); Luke E. Peterson & Kevin R. Gray, International Human Rights in Bilateral Investment Treaties and in Investment Treaty Arbitration 12–13, 27 (2003). Much of the criticism, however, is based on investor-state dispute resolution, and there are significant distinctions between investor-state disputes and supply chain disputes. The former generally involve states and investors; the latter are generally disputes between two sets of businesses. The numerous international arbitrations between business entities should speak favorably about the positive aspects of arbitration. Article 8 of MCCs 2.0 gives parties both arbitration and litigation options, and the annotations provide further discussion of the issues involved.
[46] In this introduction, we have not tried to catalog all of the changes, or even all of the significant changes, from MCCs 1.0 to 2.0, but we are confident that counsel will readily identify problematic clauses in any case.
[47] An effective date may not be necessary, but the parties may prefer an “Effective Date” to be either the date of this Agreement or the date when all conditions precedent are satisfied. Alternatively, parties may want to set a period during which certain, but not all, obligations under this Agreement are effective. Presumably a certain level of human rights due diligence [hereinafter HRDD] will have been done by Buyer before engaging in extensive negotiations with prospective suppliers. Note that the HRDD contemplated in the following clauses goes beyond the customary know-your-customer, anti-money laundering, and other due diligences that companies may otherwise employ, as explained more fully in the introduction. See supra notes 27–34 and accompanying text. Note further that the Effective Date is referenced in Section 1.1(d) to include pre-signing remediation plans.
[48]See supra notes 27–34 and accompanying text (on HRDD under the UNGPs and OECD).
[51] “Goods” is assumed to be defined earlier in the Agreement (and not defined in Schedule P). See also infra Section 3.2 (on the definition of “Nonconforming Goods”).
[52] Guiding Principle 13 requires that businesses avoid causing or contributing to human rights harms through their own activities, address such impacts where they occur, and seek to prevent or mitigate adverse human rights impacts that are directly linked to their operations, products, or services by their business relationships. Accordingly, this clause seeks to embed obligations to comply with human rights through the entire supply chain. In keeping with the modular approach of these clauses, businesses may want to circumscribe their responsibility in line with the degree to which they are connected to the activities of the business.
[53] The content of Schedule P is beyond the scope of this document. Note, however, that some suggest the best practice is to avoid reference to specific laws in favor of a general reference because legislative initiatives are broader in some countries than in others. In the event that the drafter nevertheless wishes to require that Supplier specifically represent compliance with antitrafficking and similar legislation, consider avoiding the term applicable, which will limit required adherence by companies that do not meet the size or revenue requirements of certain legislation. This might present a problem where the law applies to Buyer, because of its size, but not Supplier, because of its (relatively small) size.
[54] UNGP 21, supra note 7, requires businesses to communicate externally, particularly where concerns are raised by affected stakeholders, and sets out standards for the form, frequency, adequacy, and confidentiality of such human rights reporting. See also UK Modern Slavery Act, supra note 23, § 54.
[56] As market standards are unlikely to provide adequate measures for what constitutes “reasonable assistance,” Buyer’s obligations are articulated in Schedule Q.
[57] Parties may consider deeming the cost of reasonable assistance to be a setup or mobilization expense associated with Supplier’s preparing to provide goods to Buyer. For example, if Schedule P obligations effectively require that Supplier make capital improvements to meet Schedule P targets that may go beyond the minimum requirements of applicable law, Supplier’s costs for such compliance may qualify for reasonable assistance from Buyer. Depending on the circumstances, Buyer and Supplier may determine that such assistance should be provided as a single payment at the beginning of the term of the Agreement or the parties may decide to spread assistance over time, over units delivered, or otherwise. Where assistance is provided over time, the parties should clearly state when such assistance might be suspended or whether such assistance would be accelerated on early termination.
[58] In cases where the parties want to support a “living wage” under the Agreement, they are encouraged to review their costing using established methodologies, such as Fair Wear’s labor-minute costing tools, and living wage estimates found at https://www.fairwear.org/programmes/lw-tools-and-benchmarks and to consult definitions such as that provided by the Global Living Wage Coalition, which defines a living wage as “[t]he remuneration received for a standard workweek by a worker in a particular place sufficient to afford a decent standard of living for the worker and her or his family. Elements of a decent standard of living include food, water, housing, education, health care, transportation, clothing, and other essential needs including provision for unexpected events,” and the ACT-endorsed definition, which is, “The minimum income necessary for a worker to meet the basic needs of himself/herself and his/her family, including some discretionary income.” This should be earned during legal working hour limits (i.e. without overtime). What Is a Living Wage?, Glob. Living Wage Coal., https://www.globallivingwage.org/about/what-is-a-living-wage/ (last visited Jan. 30, 2021); How Does ACT Define a Living Wage?, ACT, https://actonlivingwages.com/living-wages/ (last visited Jan. 30, 2021).
[59] For example, if a supplier lacks sufficient personal protective equipment (PPE) to protect its workers in a pandemic to allow for normal operations, it should not be found in breach.
[60] This provision is intended to address not only change orders but force majeure–like events that go beyond a simple change in conditions affecting a single supplier.
[61] This phrasing should be adapted to the phrasing of any force majeure clause in the main supply contract to be sure the provision can harmonize with the parties’ agreed approach to and definition of a force majeure event.
[62] It is not uncommon for buyers to exert their leverage—such as threats of termination—to require discounts or other benefits from suppliers. However, this type of behavior is unlikely to be upheld in courts, and this provision is meant to allow Supplier to enforce its rights despite any superior leverage that Buyer may have. Buyer is required to satisfy all obligations accrued prior to termination, including payment in full for goods produced without violation of Schedule P.
[63] Guiding Principle 29 provides that all businesses must have in place an OLGM to resolve human rights disputes early and directly through engagement and dialogue with stakeholders. It is part of the businesses’ ongoing HRDD responsibility. Guiding Principle 22 expects that businesses should cooperate with or participate in legitimate remedial processes when the businesses recognize that they have caused or contributed to an adverse impact. Legitimate processes can include state judicial and nonjudicial dispute resolution mechanisms, as well as nonstate nonjudicial mechanisms. Under Guiding Principle 31, all nonjudicial dispute resolution mechanisms, state and nonstate, should meet the effectiveness criteria enumerated in the text of the clause. See UNGPs, supra note 7.
[64] Remediation is both retrospective and prospective. It is retrospective because it attempts to make people whole for the harm they have suffered. It is prospective because it seeks to prevent recurrence. In this way, remediation is embedded within HRDD. The forms of remediation in the clause are based on the commentary to UNGP 25, supra note 7.
[65] Under UNGP 24, supra note 7, businesses are entitled to prioritize and focus their attention on the most severe human rights harms or harms that become irremediable if there is a delayed response. A “severe harm” is characterized by its gravity, the number of people affected, and the ability to make people whole. Seeid. UNGP 14 (defining in commentary what contributes to the severity of harm).
[66] Research suggests that cooperation among buyers who all purchase from the same troubled supplier can be especially effective, but buyers should keep in mind any applicable antitrust or competition laws. Counsel should consider, for example, FTC v. Superior Court Trial Lawyers Ass’n, 493 U.S. 411 (1990); Letter from A. Douglas Melamed, Acting Ass’t Att’y Gen., U.S. Department of Justice, to Kenneth A. Letzler, Arnold & Porter (Oct. 31, 1996) (Business Review Letter on Apparel Industry Partnership development of standards for manufacturing under humane conditions). The context of these authorities is different, however, and buyers should consider concerted efforts with the benefit of research and advice of counsel. Note that ethical and safety concerns do not necessarily allow activities otherwise proscribed by the antitrust laws. See National Society of Professional Engineers v. United States, 435 U.S. 679 (1978) (The association’s refusal to bid on price due to concerns about safety was per se an unlawful boycott). In response to the Covid-19 pandemic, the Department of Justice Antitrust Division issued a number of expedited Business Review Letters to provide requested guidance on permissible cooperation among competitors. At the time of writing, it is not known whether similar Business Review Letters may be available to facilitate human rights remediation if the parties implement appropriate safeguards to mitigate the risks of anticompetitive behavior.
[67] The bracketed language comes from the commentary to UNGP 25, supra note 7; companies committed to the UNGPs will likely want to retain the language for that reason.
[68] “Cured” may have different meanings in other contexts. In this case, a “completed” remediation or “cured” breach may include an ongoing activity (e.g., periodic monthly reports on compliance).
1.1. The Parties to this [Purchase Order/Agreement] acknowledge and agree that the terms of [Schedule P/Schedule Q] are intended to benefit and protect not only the Parties but also persons directly impacted by (1) Supplier’s activities performed under this [Purchase Order/Agreement] and (2) activities by subsuppliers that the Supplier contracts with to perform under this [Purchase Order/Agreement]. Such persons include but are not limited to workers, land owners, property owners, those residing, working, and/or recreating in proximity to supply chain activities who are injured or suffer damages due to breach of [Schedule P/Schedule Q], including survivors of those killed or disabled. Such persons are intended third-party beneficiaries to [Schedule P/Schedule Q].
1.2. All intended third-party beneficiaries of [Schedule P/Schedule Q] have the right to enforce [Schedule P/Schedule Q] against Parties in any court or tribunal that has jurisdiction over the [Buyer/Supplier or Purchase Order/Agreement].
1.3. Third-party beneficiaries may assign their rights to a labor union, nongovernmental organization, or other organizations providing legal assistance they select.
Parties adopting this language will need to consider its relation to other dispute resolution mechanisms and should note in particular the clause (¶ 1.2) on jurisdiction.
[70] The OECD Due Diligence Guidance recommends remediation be risk based, prioritizing the most severe risks for corrective action. OECD Due Diligence Guidance, supra note 8, at 34–35, Annex Questions 41-45 and 48-54. The appropriate remediation will depend on the nature and extent of the harm and the prioritization of risk. For example, many buyers choose to rate forced labor and child labor as high risk or Zero Tolerance; see Section 2.5. Buyer may refuse Goods originating from a factory where such Zero Tolerance breaches have taken place and may require rigorous comprehensive remediation of that factory while maintaining the contract with other factories operated by Supplier when appropriate.
[71] The OECD Guidelines (as well as the UNGPs) concern those adverse impacts that are either caused or contributed to by the enterprise, or are directly linked to their operations, products, or services by a business relationship, as described in paragraphs A.11 and A.12 of the OECD Guidelines. See OECD Guidelines, supra note 8, at 20. The OECD Guidelines further provide that an enterprise “contributes to” an adverse impact or harm if its activities, in combination with the activities of other entities, cause the impact, or if the activities of the enterprise cause, facilitate, or encourage by incentives another entity to cause a harm and is not limited to minor or trivial contributions. Id. at 23. As stated there, “The term ‘business relationship’ includes relationships with business partners,” including franchisees, licensees, joint ventures, investors, clients, contractors, customers, consultants,” advisers, entities in the supply chain, and “other non-State or State entities directly linked to its business operations, products or services.” Id. at 10, 23. The OECD Guidelines further provide that where a harm is directly linked to the operations, products, or services of a business, the business must use its leverage to influence the entity causing the harm to prevent or mitigate it. See id. at 24. Under UNGP 22, supra note 7, businesses are responsible for providing remediation where they caused human rights harm directly through their own operations and where they contributed to harm caused by others. Where Buyer fails to take reasonable action to address a Schedule P Breach promptly after becoming aware of it, Buyer may be deemed to have contributed to any ongoing harm.
[72] The term capacity building is found in the OECD glossary of statistical terms as the “[m]eans by which skills, experience, technical and management capacity are developed within an organizational structure (contractors, consultants or contracting agencies)—often through the provision of technical assistance, short or long term training, and specialist inputs (e.g., computer systems). The process may involve the development of human, material and financial resources.” Glossary of Statistical Terms: Capacity Building, OECD (Aug. 22, 2002), https://stats.oecd.org/glossary/detail.asp?id=5103.
[73] A right to cure is essential to the ability of Supplier to avoid the human rights harms to workers and others that may result from the termination by Buyer of the Agreement.
[74] Section 2.4 has been drafted broadly to provide Buyer and Supplier flexibility in crafting an appropriate industry-specific protocol for addressing Schedule P breaches by Supplier.
[75] “Cancel” for contracts governed by the U.C.C., “avoid” for those governed by the CISG. Both terms imply that the Agreement is being ended because of a breach. The agreement may be “terminated” even without a breach. See U.C.C. § 2-106(3). The drafting here follows the U.C.C. loosely in this regard but not strictly; the U.C.C. distinguishes between cancellation for breach of the agreement and termination “otherwise than for its breach.” In the drafting of this Agreement, “termination” may or may not be for breach of the Agreement.
[76]See supra note 70 (discussing risk prioritization). This clause attempts to balance the fact that certain violations of human rights are ultimately better addressed through the Remediation Plan process set forth above, as compared to other violations that cannot be tolerated even for an instant, the Zero Tolerance Activities. This is a difficult line to draw at times, and there is some divergence in practice and across legislation as to what may be tolerated and what is absolutely prohibited. Where these lines are drawn and what may or may not be permissible are issues for each Buyer and Supplier to address based on applicable laws and policies. Note also the Supplier’s right to immediate termination without default under Section 1.3(e) supra.
[78] Nonconforming Goods are presumably defined elsewhere in the Agreement, for example,, with respect to conformity to product specifications. This section clarifies that goods that conform to product specifications may nevertheless be rejected in the circumstances specified in the text. The U.S. Customs and Border Protection (CBP) has the authority to detain merchandise at a port of entry if information reasonably, even if not conclusively, indicates that it is mined, manufactured, or produced, wholly or in part, by forced labor, including convict labor, forced child labor, or indentured labor under WROs issued under 19 U.S.C. § 1307. If CBP issues a WRO against a Supplier or Representative, as it has done eighteen times between September 2019 and October 2020, importers of detained shipments are provided an opportunity to export their shipments or submit proof to CBP that the merchandise was not produced by forced labor. If the goods cannot be released into U.S. markets because of a WRO or otherwise sold where and when Buyer intended, Buyer must have the right to reject the Goods as Nonconforming Goods. Similarly, if Buyer cannot sell the goods in the ordinary course of business, it should have the right to reject the Goods unless Buyer’s own actions caused or contributed to the problem in a material way.
[79] Because the perfect tender rule of U.C.C. § 2-601 does not apply to installment contracts, installment contracts governed by the U.C.C. should include the phrase within the first bracket.
[80]The phrase within the second bracket is applicable for agreements to which the CISG applies, whether for a single delivery or an installment contract, under article 49.
[81]Cancellation occurs when a “party puts an end to the contract for breach by the other” under U.C.C. § 2-106(4). Avoidance is the appropriate term under CISG article 49.
[82] Articles 38–40 of the CISG require that Buyer examine the goods or cause them to be examined within as short a period as is practicable. Buyer loses the right to rely on a lack of conformity if Buyer does not give Supplier notice within a reasonable time after Buyer discovers or ought to have discovered a defect and, at the latest, within two years of the date of delivery (or other contractual period) unless Supplier knew or could not have been unaware of the defect. Because U.C.C. § 2-607(3)(a) provides a similar argument that Buyer’s failure to notify Supplier of a breach within a reasonable time bars any remedy, this contractual text is included to limit disputes about what constitutes a reasonable time. If the U.C.C. is referenced in the text, the applicable state version should be cited.
[83] “Nonconforming Goods” and “Inspection Period” are assumed to be defined earlier in the Agreement. Nevertheless, Nonconforming Goods are defined specifically for purposes related to human rights policies in Section 3.2.
[84] The clauses on revocation of acceptance are designed for use in contracts governed by the U.C.C. and are drafted with U.C.C. § 2-608 in mind. They should be omitted in contracts governed by the CISG. For this reason, Article 4 is bracketed.
[85]Cancel for agreements under the U.C.C., avoid for the CISG. See supra note 81.
[86] The first phrase uses the terminology of U.C.C. section 1-303, and the second phrase uses the terminology of CISG article 9(1).
[88] U.C.C. § 2-607(3)(a) requires notice of a breach within a reasonable time after constructive discovery of the breach. A buyer who fails to give such notice will find its claims barred, with many courts holding that pre-suit notice is required.
[89] This section reflects the remedies provided in the FAR, 48 C.F.R. § 52.222.50, relative to combating trafficking in persons. Additionally, the clause adds an insecurity provision under U.C.C. § 2-609. The clause also clarifies that injunctive relief may be necessary. In addition, while Buyer may want to work with a Supplier toward full compliance, Buyer should be prepared to face waiver arguments. The timing of the exercise of remedies is sensitive, and the exercise of remedies and any requests for damages may themselves have adverse impacts on human rights. This provision expressly recognizes that such careful consideration of the exercise of remedies by Buyer does not constitute a waiver. Note also that the remedies provisions here do not mention setoff; see 11 U.S.C. §§ 506(a)(1), 553 (2018) (setoff is a secured claim in bankruptcy), recoupment, claw back, or similar remedies; if those remedies are not already provided elsewhere in the Agreement, counsel may wish to consider making such rights explicit in this clause.
[90] Buyer’s ability to direct its supplier’s operations or require the removal of an employee or employees can give rise to claims of undertaking liability or liability under the peculiar risk doctrine. See Rahaman v. J.C. Penney Corp., No. N15C-07-174MMJ, 2016 WL 2616375, at *9 (Del. Super. Ct. May 4, 2016). There is also concern about becoming a joint employer and thereby opening exposure or liability. Counsel should consider very carefully whether it is better to have the power to make such demands (e.g., require that Supplier fire employees or other Representatives, or terminate or suspend a relationship with a particular factory) or whether it is more important to forego this power in an effort to maintain independent status and concomitant lower risk of liability.
[91] Some supply contracts will call for payment by letter of credit, which will complicate the right to suspend payment. When a documentary credit is involved, the supply contract and letter of credit should require presentation of a certificate of compliance with Schedule P. Under U.S. law, a false beneficiary’s certificate could allow an injunction against payment on grounds of “material fraud by the beneficiary on the issuer or applicant.” See U.C.C. § 5-109(b). Purposeful falsity of the certificate might perhaps be helpful even if suit must be in London or in a jurisdiction following English law, which requires fraud on the documents. The leading case from the House of Lords is United City Merchs. (Invs.) Ltd. v. Royal Bank of Can., [1983] AC 168, 183 (HL) (referring to “documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue”); see also Inflatable Toy Co Pty Ltd v. State Bank of NSW Ltd. [1994] 34 NSWLR 243 (Austl.) (applying Australian law). If the violation of Schedule P constitutes an illegal act, the illegality theory may also be useful in a suit governed by English law. In any case, the certificate should be required to be dated within a reasonably short time of the draw. Many banks probably will not object to the requirement of an additional certificate as certificates (e.g., by SGS) are commonplace in such transactions, and environmental certificates are similar to (and in some cases may be the same as) a certificate of compliance with Schedule P. While some banks may resist the requirement of such a certificate because of fear of injunction actions and the concomitant extension of the credit risk if the injunction is ultimately denied, most banks seem unlikely to be concerned by the requirement of one more certificate, and any additional credit risk from an injunction may be mitigated by a bond or other credit support as contemplated by U.C.C. § 5-109(b)(2) and comment 7, or by the civil procedure laws or rules of certain jurisdictions requiring posting of a bond, or by collateralization or bonding provisions in the reimbursement agreement itself. Still, despite all of these efforts, suspension of payment may be impossible in cross-border documentary credit transactions because frequently a foreign bank will have honored before the injunction can issue. Once one bank honors in good faith, the commitments along the chain become firm and cannot be enjoined. See U.C.C. § 5-109.
[92] U.C.C. § 2-718(1) on liquidated damages prohibits penalties, providing that “unreasonably large liquidated damages [are] void as a penalty.” The ultimate enforceability of these provisions will turn on whether the exercise of the remedy in the contractual clause was reasonable. Particular care should be exercised if Buyer demands liquidated damages in addition to other damages. These provisions are bracketed so that counsel can consider the most appropriate damages provisions in the relationship.
[93] Donation of goods manufactured or otherwise delivered with the use of forced labor may not be permitted by the U.S. Customs and Border Protection, Cargo Security, Carriers and Restricted Merchandise Branch, Office of Trade. Buyer’s only option as an importer may be to return or export the goods. Other countries may have similar restrictions on the possession and ownership of merchandise mined, produced, or manufactured in any part with the use of a prohibited class of labor.and such laws, restricting taking title to, or possession of, tainted goods, are beyond the scope of this document. These restrictions must be examined before donations are made.
[94] See supra note 84 (on revocation of acceptance).
[95] This section is drafted to address concerns that might be raised with respect to the U.C.C. § 1-305 mandate to place the aggrieved party in the position of its expectation, without award of consequential or penal damages unless specifically allowed, particularly with respect to minimizing damages. See also U.C.C. § 2-715 (consequential damages cannot be recovered if they could have been prevented). An attempt by Buyer to avoid mitigation might be seen as a lack of good faith. Nevertheless, reselling goods that are produced in violation of a human rights policy may be understood as increasing Buyer’s damages, rather than reducing them. Accordingly, Buyer should be entitled to discard, destroy, export, or donate to a charity any goods produced in violation of a human rights policy as an attempt toward mitigation, rather than against it.
[96] For example, if Supplier agrees to a change order requested by Buyer and the parties should know that Supplier will be unable to perform without violating Schedule P, indemnification to Buyer must be reduced to the extent, pro rata, that Buyer caused or contributed to the harm. This clause sets up a mechanism akin to a comparative fault regime.
[97] Federal contractors should note the FAR, 48 C.F.R. §§52.222-56, 22.1703(c), which requires contractors, within threshold limits, to “monitor, detect, and terminate the contract with a subcontractor or agent engaging in prohibited activities.” This disclaimer does not negate a duty arising under FAR or any other regulation or law; it simply disclaims any such contractual duty by Buyer. As discussed in the introduction, buyers may have duties under applicable laws, regulations, and their own corporate commitments; the purpose of these disclaimers is to negate liability based on this Agreement, except as stated in Articles 1 and 2.
[98] Again, note the FAR, see 48 C.F.R. §§52.222.56, 22.1703(c), and again, note that buyers may be subject to duties that do not arise by contract, as explained supra note 97.
[99]Note the possible conflict here with Buyer’s remedies under Section 6.2(c).See also supra note 90. This disclaimer is included to help negate claims of undertaking liability or liability under the peculiar risk doctrine. It could conflict, however, with some legislative efforts currently being considered and debated in the European Union.
[100] This provision emphasizes that Buyer is assuming a limited contractual duty to disclose, although Buyer may have duties to disclose under other standards (legal or nonlegal). For example, Buyer must determine if it provided false or misleading information to Customs and Border Protection and other officials in the event that goods are initially accepted and removed from the dock but are later determined to be tainted by forced or child labor. If the original information provided to CBP is false, a duty to amend may arise. See, e.g. 18 U.S.C. § 541 (2018); 19 C.F.R. § 12.42(b). As another example, under FAR, contractors and subcontractors must disclose to the government contracting officer and agency inspector general “information sufficient to identify the nature and extent of an offense and the individuals responsible for the conduct.” 48 C.F.R. § 22.1703(d).
[101] Third-party beneficiaries are a controversial issue. Two alternatives are given here. When licensing is involved, those parties choosing the first bracketed option will want to consider giving enforcement rights to licensors and/or licensees and not only buyers and suppliers. See also supra note 69 for a third alternative affirmatively granting third-party beneficiary status to stakeholders. The ultimate decision may be affected by the outcome of discussions with respect to a possible mandatory treaty on business and human rights. See The Second Revised Draft of a Treaty on Business and Human Rights by the Open-Ended Intergovernmental Working Group on Transnational Corporations and other Business Enterprises with respect to Human Rights (OEIGWG), established by U.N. Human Rights Council Resolution 26/9 (Aug. 6, 2020). It could also be affected by legislative developments in the European Union.
[102] These dispute resolution options should be considered in light of the dispute resolution clauses in the sales contract. Article 8 may or may not be suitable for all applications and should be considered in the context of Buyer’s existing internal policies and Buyer’s customary contractual terms regarding the resolution of disputes and claims, including Buyer’s standard form and template procurement agreements; the standard terms and conditions of Buyer’s purchase orders; and the Buyer’s supplier codes of conduct (Schedule P) or analogous documents that include, inter alia, administrative, operational, remedial and/or corrective action procedures, processes, sanctions, and penalties. Dialogue, settlement, and remediation of any controversy arising from a human rights abuse offer victims the most favorable and expeditious resolution, but it is also possible that both human rights abuse and other contractual breaches could be involved. The corporate culture of a company will likely determine whether arbitration or litigation is the preferred route to follow for breaches unrelated to Schedule P [or Schedule Q], provided that under no likely circumstance would a party agree to bifurcate its chosen resolution of such multiple disputes. A mediation-during-the pendency-of litigation clause is therefore included here.
[103] This Agreement explicitly provides that every supplier and buyer in the chain is bound to Schedule P [and Schedule Q] and the Agreement provisions relating to human rights protections. Involvement of Representatives is therefore contemplated in this clause. See generally International Chamber of Commerce Rules of Arbitration, art. 7 (2017) (“Joinder of Additional Parties”); and GE Energy Power Conversion Fr. SAS, Corp. v. Outokumpu Stainless USA, LLC, 140 S. Ct. 1637, 1645-45, 1648 (2020) (finding that in certain circumstances, nonsignatories may compel arbitration of international disputes and equitable estoppel may apply).
[104] Confidentiality is usually perceived as among the advantages of arbitration, including international commercial arbitration, over litigation and public filings. Confidentiality comes with drawbacks, however, particularly where the proceeding affects the public interest, as is likely true when a dispute relates to human rights. This provision is bracketed, and the parties should carefully negotiate and omit or adapt the text to reflect the form of confidentiality or transparency that best suits their efforts to mediate or arbitrate. Note that the UNGPs do not require full transparency. UNGP 31(e), supra note 7, expects that nonjudicial grievance mechanisms will keep parties informed and “provid[e] sufficient information about the mechanism’s performance to build confidence in its effectiveness and meet any public interest at stake.” The commentary states, “Communicating regularly with parties about the progress of individual grievances can be essential to retaining confidence in the process. Providing transparency about the mechanism’s performance to wider stakeholders, through statistics, case studies or more detailed information about the handling of certain cases, can be important to demonstrate its legitimacy and retain broad trust. At the same time, confidentiality of the dialogue between parties and of individuals’ identities should be provided where necessary.” Id. (quoting commentary). The Hague Rules on Business and Human Rights (BHR) Arbitration, supra note 45, call for total transparency of all proceedings. The Hague BHR Rules aim to fill the judicial remedy gap in the UNGPs and should be considered by those companies committed to the UNGPs. In any case, those who are not legally required to disclose discovered human rights abuses and who hope to protect any Dispute from public dissemination, especially before cure or remediation is in place, must verify the applicable chosen rules regarding confidentiality or should include express provisions in the arbitration provisions that deal with confidentiality. This section requires total confidentiality unless otherwise required. The bracketed portion of Section 8.8 below, however, allows for an agreed upon release of redacted final orders and awards.
[105] The number of days appropriate for good faith negotiations may vary based on the severity or breadth of the Schedule P Breach as well as Buyer’s ability to find another source for the products at issue.
[106] A commitment to enter into mediation need not be complex, and these Model Clauses use the short and simple clauses recommended by such institutions as the PCA and UNCITRAL. Other institutions that provide mediation services may not accept clauses such as these, and the drafter should consult with such other institutions to determine what text to employ. Reference should be made to Model Arbitration Clauses for the Resolution of Disputes under Enforceable Brand Agreements at https://laborrights.org/sites/default/files/publications/%20Model%20Arbitration%20Clauses%20for%20the%20Resolution%20of%20Disputes%20under%20Enforceable%20Brand%20Agreements.pdf. See also Clean Clothes Campaign et al., Model Arbitration Clauses for the Resolution of Disputes under Enforceable Brand Agreements, Int’l Lab. Rts. F. (June 24, 2020), https://laborrights.org/publications/model-arbitration-clauses-resolution-disputes-under-enforceable-brand-agreements.
[107] In selecting the applicable Arbitration Rules, the parties must be sure the scope of discovery and the cost allocation are acceptable and can add text deviating from what is provided within such provisions if not.
[108] The Singapore Arb-Med-Arb Clause, Sing. Int’l Arb. Ctr., siac.org.sg/model-clauses/the-singapore-arb-med-arb-clause (last visited Feb. 15, 2021): “Arb-Med-Arb is a process where a dispute is first referred to arbitration before mediation is attempted. If parties are able to settle their dispute through mediation, their mediated settlement may be recorded as a consent award. The consent award is generally accepted as an arbitral award, and, subject to any local legislation and/or requirements, is generally enforceable in approximately 150 countries under the New York Convention. If parties are unable to settle their dispute through mediation, they may continue with the arbitration proceedings.”
[109] If the parties do not wish to include mediation and/or arbitration provisions, the Model Clauses assume somewhere in the underlying master agreement they have included standard text addressing litigation issues such as the choice of law and choice of forum, consent to jurisdiction and service of process, and any desired waivers (e.g., of objection, of defense, of jury trial); these litigation provisions are not included in these Model Clauses.
[110] Several standard arbitration systems contemplate a financial harm ceiling for the application of expedited procedures, which will not be applicable in the context of the discovery of human rights abuses where the harm is not necessarily or primarily a financial harm to be suffered by one of the parties. The following alternate wording could be added: The provisions for expedited procedures contained in the Arbitration Rules shall apply, provided the discovered harm is ongoing and steps to immediately address and cure are possible but not being voluntarily implemented.
Superior Court, State of Delaware Leonard L. Williams Justice Center 500 N. King. St., Suite 10400 Wilmington, DE 19801 (302) 255-0634 phone (302)255-2273 fax [email protected]
Carla M. Jones
Potter Anderson & Corroon LLP 1313 N. Market St., 6th Floor Wilmington, DE 19801-6108 (302) 984-6122 phone (302)658-1192 fax [email protected]
Jennifer C. Wasson
Potter Anderson & Corroon LLP 1313 N. Market St., 6th Floor Wilmington, DE 19801-6108 (302) 984-6165 phone (302)658-1192 fax [email protected]
Introduction
This chapter summarizes the significant case law developments from state and federal courts across the country in 2020 concerning directors’ and officers’ liability insurance coverage claims. Noteworthy decisions included the following:
In re Solera Insurance Coverage Appeals, 2020 WL 6280593 (Del. Oct. 23, 2020). The Delaware Supreme Court held that an appraisal action brought under 8 C. § 262 was not covered “Securities Claim” within the definition of that term in a D&O policy.
Arch Insurance Company v. Murdock, et al., 2020 WL 1865752 (Del. Super. Jan. 17, 2020). The Superior Court of Delaware held that the Larger Settlement Rule governs allocation disputes under Delaware law when the parties cannot agree on allocation between covered and uncovered claims.
Pfizer Inc. v. U.S. Specialty Insurance Company, 2020 WL 5088075 (Del. Super. Aug. 28, 2020). The Superior Court of Delaware held that a settlement for less than an insurer’s policy limit did not affect attachment of higher-level excess insurance.
Allocation
Arch Insurance Company v. Murdock, et al., 2020 WL 1865752 (Del. Super. Jan. 17, 2020). The Superior Court of Delaware held that the Larger Settlement Rule governs allocation disputes under Delaware law when the parties cannot agree on allocation between covered and uncovered claims. The court found that the Larger Settlement Rule best protects the economic expectations of the insured, consistent with Delaware courts’ interpretation of insurance policies as a whole, and applies even when the policy’s allocation provision references the relative legal and financial exposures of the insureds.
In this case, certain excess insurers filed a declaratory judgment action regarding, inter alia, their obligation to indemnify the insureds for settlement payments arising out of two shareholder litigations, one brought in the Delaware Court of Chancery (In re Dole Food Company, Inc. Stockholder Litigation, 2015 WL 5052214 (Del. Ch. Aug. 27, 2015) (“Dole”) and one brought in the District of Delaware (San Antonio Fire & Police Pension Fund v. Dole Food Co., Inc., No. 1:15-CV-01140 (D. Del. Dec. 9, 2015) (“San Antonio”). Both sides filed motions for summary judgment on the issue of which allocation theory applied to the policies, since the underlying cases involved uninsured parties. The insureds advocated for the Larger Settlement Rule. This rule dictates that allocation between covered and uncovered claims is appropriate only if acts of the uninsured parties caused the settlement costs to be higher than they would have been, had only the insured parties settled the actions. Under the Larger Settlement Rule, the insurers often are liable for the entire settlement unless they can demonstrate that the uncovered liability actually increased the amount of the settlement. In contrast, the insurers argued that the insureds bore the burden of proving that a loss relating to the settlement was a covered “Loss” under the policy.
The court first looked at the policy language and found it unambiguous but unhelpful to the question before it, because the allocation provision only addressed circumstances in which the parties agreed to an allocation. The provision did not contain a formula or any other methodology to apply in the event that the parties disagreed. The court also noted that Delaware case law provided no guidance on the question, but that other courts had employed the Larger Settlement Rule when adjudicating allocation disputes. Important to the court was the overarching rationale for the rule, which was to protect the economic expectations of the insured. The court reasoned that this rationale was consistent with the way that Delaware courts interpret policy language in other insurance disputes and consistent with the policy as a whole, which is designed to cover the insured’s compensable Loss regardless of whether others are at fault. The Court explained that the allocation provision should be read consistently with that expectation unless it expressly contained a different allocation method, such as pro rata.
Significantly, the court rejected the insurers’ argument that the reference to the “relative legal and financial exposure of the insureds” in the allocation provision dictated a different result, noting that this language contemplated situations in which the parties worked together to determine the proper allocation. In addition, the court did not believe that the “relative exposure” language was inconsistent with the economic rationale behind the Larger Settlement Rule. Finally, the court opined that because the San Antonio action was relatively simple, and damages were pled against all defendants jointly and severally, the Larger Settlement Rule was dispositive in favor of the insureds on the allocation issue. Because the Dole complaint and settlement were more complicated, however, the court was not willing to grant summary judgment based on the factual record before it.
Claim
ISCO Indus., Inc. v. Great Am. Ins. Co., 148 N.E.3d 1279 (2019). The Court of Appeals of Ohio upheld that the renewal of a D&O insurance policy does not extend the time by which an insured may report a claim. The policy at issue contained a notice provision in which the insured was required to notify the insurer as soon as possible, but no later than 90 days, after the end of the policy for the claim to be covered. The appellant argued that subsequent policy renewals extended the claim-reporting period and that a claim filed over a year and a half after receiving notice of litigation should be covered. The court rejected this argument finding the plain language of the provision did not support this argument.
The appellant also argued that the insurer must still provide coverage if it has not been prejudiced in any way by the late notice under the notice prejudice rule. Adopting reasoning from similar cases in which federal courts applied Ohio law, the court suggested the specific 90-day notice requirement was unambiguous and that adoption of the notice-prejudice rule would effectively rewrite the parties’ contract. The court determined the notice-prejudice rule did not apply to D&O insurance policies with specific notice requirement deadlines.
EurAuPair Int’l, Inc. v. Ironshore Specialty Ins. Co., 787 F. App’x 469 (9th Cir. 2019). The Court of Appeals for the Ninth Circuit, affirming the district court’s decision, found that under California law, the notice-prejudice rule does not apply to claims-made-and-reported policies. EurAuPair International Inc., one of several federally authorized au pair programs, purchased claims-made-and-reported policies for consecutive policy periods. The first policy required the company to report claims to Ironshore, its insurer, “as soon as practicable but in no event later than thirty (30) days after the end of the Policy Period.” Finding that this language was unambiguous as to its requirement that EurAuPair report all claims by a certain date, the court declined to grant relief to EurAuPair on equitable grounds, as the company knew of the claim within the policy period and had thirty days after the policy expired to report it yet waited sixteen months to do so.
Landmark Am. Ins. Co. v. Lonergan Law Firm, P.L.L.C., 809 F. App’x 239 (5th Cir. 2020). Applying Texas law, the United States Court of Appeals for Fifth Circuit, reversing the district court’s ruling, found that absent a showing of prejudice, an insurer, Landmark, was not permitted to deny coverage under a professional liability policy due to the insured’s failure to comply with “immaterial” conditions of notice, where she complied with her “material” obligation to report a claim.
In the underlying action, Gaylene Lonergan, a Texas attorney, had helped a group of investors close on a real estate deal. When the deal turned out to be a scam, the investors sued Lonergan in state court, who was covered by a Landmark policy. While the state court case was pending, Landmark filed suit against Lonergan seeking a declaration that it did not have a duty to defend Lonergan under the policy because, among other things, she failed to “report” the claim to it during the policy period, as she was obligated to do by the policy. As part of her application to renew her insurance policy with Landmark, a note in the claim supplement contained “a concise synopsis of the underlying dispute” herself and the investors. Landmark argued that the claim supplement was insufficient to satisfy her obligation to “report” the claim to Landmark and the district court agreed.
On appeal, the Court of Appeals found that Lonergan did in fact report the claim. The court focused on the fact that Landmark did not dispute that it received the claim supplement during the policy period. Landmark argued that because the “Notice of Claim” provision in its policy obligated Lonergan to “send all claim information to: Attention: Claims Dept. [address],” and she failed to send them to the correct department, that she failed to adequately report her claims. The court concluded that Landmark’s direction of notice to the claims department could not be considered a material condition. Given the immateriality of the notice condition, Landmark could only be relieved of its duty to defend and indemnify only upon a showing that it was prejudiced by the breach. Here, it could not make such a showing.
Protective Specialty Ins. Co. v. Castle Title Ins. Agency, Inc., 437 F. Supp. 3d 316 (S.D.N.Y. 2020). The United States District Court for the Southern District of New York granted Castle Title’s motion for summary judgment and denied the Protective Specialty’s cross-motion for summary judgment. Protective Specialty underwrote two claims-made-and-reported insurance policies for Castle Title for different periods of time. In 2015, Castle Title was served with a subpoena requesting documentation of transfers and mortgages. In 2016, Castle Title was named a defendant in a lawsuit alleging that it had delayed the submission of real estate documents.
The instant action commenced when Protective filed suit against Castle Title seeking a declaratory judgment that Protective has no duty to defend or indemnify Castle Title in the 2016 lawsuit. Protective alleged that the 2015 Subpoena was a “claim” under the terms of the Policies, and that Castle Title failed to report it. Protective alleged that the unreported 2015 Subpoena and the 2016 Lawsuit should be treated as “related claims,” therefore Protective had no obligation to Castle Title under the two policies. The court rejected this argument, stating that the 2015 Subpoena was not considered a “claim” as it was not issued in a “litigation or arbitration” involving professional services. Rather, the subpoena was for the purpose of receiving a judgment, not questioning Castle Title’s professional services. Because the 2015 Subpoena was not considered a “claim” for the purpose of “related claims,” the court dismissed this cause of action.
Protective’s second cause of action was a claim for warranty exclusion, alleging that Castle Title made a false statement on its Application for Policy (AIP), which the court dismissed because Castle Title had no reason to believe that a claim was pending against it. On its AIP, Castle Title stated that it was not aware “of any incident or circumstance which may result in a claim.” Protective alleges that Castle Title should have known that the 2015 Subpoena was a “claim,” therefore absolving Protective of any obligation to cover Castle Title. The court found that 2015 Subpoena was not a “claim” as defined by the Policy, nor that it met the definition of “claim” in the context of insurance contracts.
Exhaustion
Pfizer Inc. v. U.S. Specialty Insurance Company, 2020 WL 5088075 (Del. Super. Aug. 28, 2020). The Superior Court of Delaware’s Complex Commercial Litigation Division held that a settlement for less than an insurer’s policy limit did not affect attachment of higher-level excess insurance. The parties filed cross-motions for summary judgment seeking a determination of whether the excess insurer’s policy attached. The excess policy at issue contained an exhaustion clause providing that the policy “shall attach only after all Underlying Insurance has been exhausted by actual payment of claims or losses thereunder.” The Superior Court explained that Delaware consistently follows the “Stargatt Rule” that excess policies attach regardless of “whether the insured collected the full amount of the primary policies, so long as [the excess insurer] was only called upon to pay such portion of the loss as was in excess of the limits of those policies.”
The Superior Court contrasted the Stargatt Rule with an alternative approach, known as the “Qualcomm Rule.” Under the “Qualcomm Rule,” settlements below policy limits bar attachment of a higher-level excess policy when the excess policy requires exhaustion by “actual payment of a covered loss.” The Superior Court noted that Delaware precedent had expressly rejected the Qualcomm Rule as “contrary to the established case law” of Delaware. Accordingly, because the exhaustion clause in the excess policy required only that the underlying policies be “exhausted by actual payment of claims,” the Superior Court held that a settlement in which an insurer pays and the insured agrees that the payment fully satisfies the policy accomplishes exhaustion through “actual payment.”
Insured
Turner v. XL Specialty Ins. Co., 2020 WL 3547954 (W.D. Okla. June 30, 2020). A federal judge from the Western District of Oklahoma entered an order granting a defendant insurer’s motion for summary judgment, finding that a former company executive’s legal expenses incurred in a separate action filed by another company executive to determine rights under a profit-sharing agreement were not covered by the company’s liability insurance policy. The court determined that there was no coverage because the former executive, Ryan Turner, was not involved in the lawsuit in his corporate capacity and thus as an “Insured Person” under the insurance policy, but rather as an individual equity holder under the profit-sharing agreement. As such, XL Specialties, the defendant insurer, did not breach the insurance policy when it denied coverage.
The court also found that Mr. Turner did not qualify for coverage under the policy, because he did not suffer a covered “Loss.” Rather, even though he was named as a defendant in the declaratory judgment action, the legal fees for which he sought reimbursement did not qualify as “Defense Expenses,” finding that the claims asserted by another party in the lawsuit did not amount to Turner being in a defensive posture, but rather were asserted for the benefit of himself and another party. Specifically, Turner had not disputed or opposed any relief sought by another party in the lawsuit. Instead, he only asserted counterclaims and crossclaims. Functionally, the court found that his posture in the declaratory judgment action was only nominally that of a defendant, as Turner, in actuality, sought affirmative relief. The court noted that its conclusion was supported by numerous federal and states courts who have dealt with a similar issue: whether an insurer’s “duty to defend” includes an obligation to prosecute affirmative counterclaims and crossclaims. Most federal and state courts, it noted, have found that an insurer’s duty to defend does not include such an obligation.
Securities Claim
In re Solera Insurance Coverage Appeals, 2020 WL 6280593 (Del. Oct. 23, 2020). The Supreme Court of Delaware recently set forth its view of whether an appraisal action brought under 8 Del. C. § 262 is a covered “Securities Claim” within the definition of that term in a D&O policy—and the answer is no. The Supreme Court’s holding reversed the Delaware Superior Court’s conclusions that a “violation of law” need not include allegations of wrongdoing to come within the policy, and that an appraisal action is a claim for a “violation” because it necessarily alleges a wrong; i.e., that the surviving company contravened the dissenting shareholders’ rights to the fair value of their shares. The Supreme Court limited its holding to the “violation” issue and declined to rule on the other issues the parties briefed, including the insurers’ argument (raised for the first time on appeal) that an appraisal action does not “regulate securities.”
The Supreme Court accepted this appeal on an interlocutory basis, after the Superior Court denied the insurers’ motion for summary judgment on coverage for an appraisal petition brought by certain shareholders seeking a fair value determination of their shares of Solera. The Supreme Court focused on the definition of “Securities Claim” in Solera’s D&O policies—and specifically whether such claims were “violations” of law. In determining that appraisal actions were not claims for violations of law, the Court considered the historical context of Delaware’s appraisal process, the text of 8 Del. C. § 262, and the case law interpreting the statute.
The Supreme Court began its analysis by considering the plain meaning of the word “violation,” but reached a different conclusion in doing so than did the Superior Court. While both the Supreme Court and Superior Court cited various dictionaries for guidance on the term’s meaning, the Supreme Court concluded that “violation” “involves some wrongdoing, even if done with an innocent state of mind.” Because appraisal actions are intended to be a “limited legislative remedy developed initially as a means to compensate shareholders of Delaware corporations for the loss of their common law right to prevent a merger or consolidation by refusal to consent to such transactions,” the Court reasoned that these proceedings do not adjudicate wrongdoing. To support its view, the Court recited the history of appraisal rights in Delaware, explaining that actions under § 262 are “neutral” proceedings designed only to determine the fair value of a dissenting stockholder’s stock. The fair value can be deemed higher than the merger price, but frequently is found to be lower than the merger price, so both sides bear some risk. And because the statute imposes few duties on the surviving company, appraisal petitions frequently contain no allegations of wrongdoing against the surviving company, including the petition at issue in Solera.
Finally, the Supreme Court explained that a long-standing line of Delaware precedent confirms that appraisal proceedings do not include an inquiry into wrongdoing—the only issue is the value of the dissenting stockholder’s stock. The court rejected Solera’s argument that appraisal cases have evolved to the extent that an appraisal petitioner must “show deficiencies in the sale process in order to overcome the contention that the share price reflected fair value,” making clear that there is no such presumption. To the extent that wrongdoing relating to the transaction is relevant to the fair value determination, the court reasoned that it goes only to the deference, or weight, to be given to the merger price—allegations of wrongdoing are appropriately adjudicated through breach of fiduciary duty, fraud, or other claims, not through invocation of the statutory appraisal remedy.
Wrongful Acts
Legion Partners Asset Mgmt., LLC v. Underwriters at Lloyds London, 2020 WL 5757341 (Del. Super. Sept. 25, 2020). The Superior Court of Delaware’s Complex Commercial Litigation Division granted an insured’s partial motion to dismiss, requiring the insurer to advance defense costs as the allegations presented in the counterclaim asserted a risk within the policy’s coverage. This action arose out of a lawsuit filed against Legion Partners Asset Management by a former employee, to which Legion responded with an arbitration action. In response, the former employee filed a counterclaim, at which time Legion notified the insurer, Underwriters, of their intent to seek coverage for defense costs. Underwriters denied Legion coverage.
The court first determined that Underwriters’ duty to advance was triggered. A policy that contains a duty to advance is implicated when “an action states a claim covered by the policy” and an insurer will be required to advance costs for any litigation that falls within the policy terms. The court also determined that Underwriters was required to indemnify Legion under the Policy because Legion sustained a “Loss” arising from a claim or counterclaim against the insured organization for a “Wrongful Act.” “Wrongful Acts” are broadly construed to include “any actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or act committed” by the insured organization. The counterclaim filed by the former employee asserts that Legion “allegedly acted against its investors’ interests and violated federal laws and regulations by leaking material nonpublic information,” therefore constituting a “Wrongful Act” within the scope of the policy. Additionally, the court determined that Underwriters had to indemnify Legion under the policy for its defense of the organization’s directors, as Legion incurred the “Loss” of defending the factual allegations lodged against its named directors.
Other Miscellaneous Cases
Korn v. Fed. Ins. Co., 2019 WL 4277187 (W.D.N.Y. Sept. 10, 2019), appeal dismissed (Dec. 19, 2019). Applying New York law, the United States District Court for the Western District of New York held that Federal Insurance Company, an insurer, did not owe a fiduciary duty to Marc Irwin Korn, its insured, when Korn was represented by independent defense counsel in a criminal lawsuit. It also found that Federal Insurance Company did not breach its contractual duties to Korn in paying defense costs, an action that exposed the policy limits.
Korn argued that Federal owed him a fiduciary duty based on a special relationship of trust and confidence, and that Federal’s failure to monitor his criminal defense attorneys, audit the legal fees they incurred, and replace counsel when Korn informed Federal that the firm was wasting the finances available for coverage constituted a breach of that duty. Here, because Federal did not represent Korn in his criminal case, there was neither a legal nor factual basis to conclude that Federal assumed responsibility for his defense in any way. Even if Korn did establish that Federal brokered the attorney-client relationship in the criminal action, it was not a rare situation in which a fiduciary duty existed.
Korn also argued that his policy required Federal to ensure that his criminal lawsuit reached a final resolution before the policy limits were exhausted. The court found that he did not identify any language from his policy that established such a requirement, and instead held that the policy neither required Federal to ensure a swift resolution of Korn’s criminal litigation, nor could it reasonably impose such a burden unless Federal assumed responsibility for Korn’s criminal defense. The court also found that Korn identified no obligation in the policy requiring Federal to follow its own guidelines to keep track of legal fees and oversee work performed for Korn’s benefit, noting that New York courts have consistently rejected that a cause of action based on failure to follow internal guidelines.
Hughes v. Xiaoming Hu et al., 2020 WL 1987029 (Del. Ch. Apr. 27, 2020). The Delaware Court of Chancery denied director defendants’ motion to dismiss a derivative claim, while reinforcing that directors and officers who neglect their oversight responsibilities may be personally liable for the resulting harm to the company and its stockholders. The plaintiff asserted that the defendants: (1) breached their fiduciary duties by willfully failing to maintain an adequate system of oversight, disclosure controls, and internal controls over financial reporting, and (2) were unjustly enriched through their excessive compensation which was based on inaccurate financial statements.
With no demand for litigation made, the court had to determine if the omission was excused because of the directors’ inability to make an impartial decision regarding whether to pursue litigation. To answer this, the court applied the Rales demand futility test. Rales dictates that a director cannot exercise independent and disinterested business judgment regarding a litigation demand when potential litigation might expose the director to adverse personal consequences, including money damages. Directors and officers responsible could be held personally liable if oversight failures result in losses to the company.
The court held that the members responsible for ensuring proper internal controls and reporting systems faced a substantial likelihood of liability because the controls in place were not meaningful and demonstrated their failure to act in good faith towards their fiduciary duty of loyalty. In making its determination, the court emphasized that these members met minimally only to comply with federal securities laws and when they did meet, they did not discuss or implement any procedures despite having known of material weaknesses in the company’s internal controls. It found these deficiencies supported a reasonable inference that the defendants failed to provide meaningful oversight over the company’s financial statements and system of financial controls and that no disinterested and independent majority could have considered a demand, rendering demand futile.
Ferrellgas Partners L.P., et al., v. Zurich American Insurance Company and Beazley Insurance Company, 2020 WL 4908048 (Del. Super. Aug. 20, 2020). The Superior Court of Delaware’s Complex Commercial Litigation Division entered an order requiring an insurer to immediately advance and reimburse an insured’s past and ongoing defense costs prior to a final and non-appealable money judgment.
In this action, an insured sought a declaratory judgment for advancement of defense costs pursuant to insurance policies issued by two insurers. In a prior ruling, the court granted the insured’s motion for partial summary judgment on this issue, declaring that one of the insurers had a duty to advance defense costs. The insurer did not file an application for interlocutory appeal of the decision. Notwithstanding the summary judgment ruling, the insurer refused to pay the invoices that the insured submitted, arguing that the summary judgment order was not a final and non-appealable money judgment and it was unable to determine the reasonableness of the defense cost invoices because they were heavily redacted.
The court rejected the insurer’s argument, holding that the insurer must comply with the summary judgment order and immediately advance and reimburse the legal fees and costs submitted by the insured. The court also ordered the parties to follow the protocol established by the Court of Chancery in Danenberg v. Fitracks, Inc., 58 A.3d 991 (Del. Ch. 2012) for invoice submission, review, and dispute resolution. Finally, the court awarded the insured its fees-for-fees incurred in connection with preparing and prosecuting the enforcement motion, so as to “be made whole.”
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