In-house counsel is responsible for advising internal clients on a wide variety of risks associated with day-to-day business operations, including the insolvency and bankruptcy of a business partner. These risks are inherent—and often hidden—in nearly every transaction. It is important that in-house counsel is familiar with certain fundamental bankruptcy concepts to effectively counsel their business teams and, if at all possible, mitigate those risks. Among the most common insolvency and bankruptcy concepts are the scope of the automatic stay, the treatment of executory contracts (assumption and rejection), “free and clear” asset sales, fraudulent conveyances, and preferences. Counsel can address the uncertainty associated with these concepts by following the five simple rules set forth below, each of which allows in-house counsel to educate their business teams, set appropriate expectations with stakeholders, and improve documentation, and all of which lessen the impact of an insolvency event or bankruptcy case.

Five Bankruptcy Risk Factors to Consider with Each Transaction

1. Automatic Stay

Know the impact of the automatic stay on property rights. When a party (a debtor) files for bankruptcy, the filing automatically triggers an extremely broad stay provision. Under 11 U.S.C. § 362, an automatic stay immediately enjoins the commencement (or continuation) on any process or action against the debtor or its assets. Analyzing the consequences of the contract being stayed at each phase of performance will help you assess the risks associated with the agreement. For example, (a) if your contract requires notice, you may be stayed from giving the notice; (b) if the counterparty has property of yours in its possession or has knowledge (e.g., provides operational support) critical to your operations, you may be unable to quickly gain access to the property or force compliance with the agreement or turnover of the critical information; (c) you will be unable to sue to enforce your rights; and (d) you may be unable to stop performance. Analyzing the consequences of the contract being stayed at each phase of performance will also allow you to consider whether there are means for mitigating the risk. Counsel should consider mitigating the company’s risks by establishing mechanisms that are enforceable in the event of a bankruptcy and are outside of the scope of the automatic stay, including certain automatic triggering events that do not require pre-notice, escrow agreements, letters of credit, and rights against guarantors.

2. Treatment of Contracts in Bankruptcy

In bankruptcy, with very limited exception, a debtor has the right to reject, or assume and assign, a contract. The decision to reject or assume a contract often does not occur until plan confirmation, creating uncertainty for the contract counterparty.

Rejection. Know how to protect ongoing business operations if a contract is rejected. Outline each phase or provision of the contract and consider what happens if the contract counterparty files bankruptcy and rejects the contract under 11 U.S.C. § 365. For example, although suppliers often consider the risk factors associated with a customer filing bankruptcy and failing to pay, customers that rely on the supplier for critical materials or information often do not give equal weight to the possibility that the critical supplier could reject the contract. This can be particularly disruptive when the customer relies heavily on the specialized knowledge of the supplier or holds confidential or proprietary information critical to the customer’s operations. If the contract is rejected, the customer may be forced to seek alternative services, providers, and other resources to operate its business without the ability to enforce transition service provisions and purchase options. A grant of security, escrow agreements, and letters of credit can mitigate the risks associated with rejected contracts.

Assumption and Assignment Rights. Know how an assigned contract may impact business interests and proprietary information. Under 11 U.S.C. § 365, a debtor also has the right to seek to assume a contract for its own continued performance, or assume and assign a contract to a third party. Although the debtor may assume or reaffirm its obligation under the contract, the debtor/assignee must cure any outstanding payment defaults as well as provide adequate assurance of the assignee’s ability to continue performing under the contract. Counsel should consider a debtor’s right to assign the contract to a competitor or a third party and whether a termination provision will be effective to protect those proprietary interests. This is an inherent risk and one difficult to protect against at the outset of a relationship, but may be worth a warning to the business team as a risk factor. In some circumstances and jurisdictions, a debtor cannot assume or assign a license without the licensor’s consent. Well-crafted termination and assignment provisions in license agreements may allow the licensor to obtain greater protections than an ordinary vendor. Fortunately, there are processes and notices that must be given, which will afford the nondebtor counterparty an opportunity to evaluate the effect of the proposed assumption and consider whether there are protections available before the contract is assumed.

3. Sales “Free and Clear”

Know how to protect your interests if the debtor intends to sell your property. 11 U.S.C. § 363 allows the debtor to sell its assets (which can include all assets as a going concern) “free and clear” of existing liens, claims, and encumbrances (commonly referred to as “363 sales” in chapter 11 cases). An order approving a 363 sale typically contains numerous “bells and whistles” that will further protect and benefit the purchaser while at the same time potentially jeopardizing the interests of the nondebtor, including loss of a real property interest (tenant lease rights) and lost or delayed recovery of personal property interests critical to business operations (molds, plans, and specifications). For this reason, 363 sales can be both a benefit and a curse. Buyers interested in purchasing assets can often better insulate themselves from some risks inherent in purchasing from a distressed seller. For entities doing business with a debtor whose assets are sold in bankruptcy, it is critical to obtain advice on how the sale may impact your interests and determine whether proactive measures must be taken. Some courts have held, for example, that real property could be sold “free and clear” of leasehold interests. As a result, tenants who thought they could rely on a notice provision associated with assumption or assignment of leases in a bankruptcy suddenly find themselves out in the cold. In addition, if the debtor holds your proprietary information, you may find that the debtor is selling that information to a competitor. Suppliers to the debtor often agree to enter into new contracts with the purchaser and afterward learn that they are now subject to claims by the selling debtor. Had the supplier been proactive, it might have arranged to protect against those claims in the sale process. Counsel should consider whether a properly perfected security interest would improve the business’s controls over its interests. Counsel should also be aware that, under most circumstances, it will be unable to prevent the sale of property, but that other means of protecting interests, like termination rights, might be effective even after a sale is consummated.

4. Fraudulent Conveyances

Know the indices of fraudulent conveyances/transfers when assessing a prebankruptcy asset purchase. A transfer for less than reasonably equivalent value made while the transferor was insolvent or caused it to become insolvent may be subject to later claims for recovery of losses associated with that transaction under 11 U.S.C. § 548. In-house counsel should be cautious when a deal sounds too good to be true and weigh the risks against the business goals. Specifically, counsel should be aware that in the event the counterparty to a transaction later files bankruptcy, prior transactions with that entity might be closely scrutinized. Be mindful that creditors’ committees and trustees may obtain broad authority from a bankruptcy court to examine transactions involving a debtor and determine whether actions prejudicial to creditors (whether by wrongdoing or otherwise) have occurred. For example, what if your company pays or provides value to the “wrong party”? In that instance, your company purchases assets from company “A,” but the owner of company A asks you to transfer the purchase price to the related company “B.” This transaction will almost certainly be scrutinized by a committee or trustee. As a result, one should always consider whether the “right party”—the entity that provided the value—is paid. Another indicia of concern is if the deal sounds too good to be true, it may be. Assume, for instance, a company is in financial trouble and begins selling noncritical assets and is desperate for cash, and your company is keen to buy the undervalued asset (a “great deal”). In-house counsel will be wary of interfering with the deal, but if one or more of the indices of a fraudulent transfer are present, discuss the potential risks with the deal team and allow them to make an informed business decision. Also consider options for reducing risk, such as obtaining a fairness opinion from a third-party expert to evaluate the value of the asset and the price to be paid. The business team should also be advised to conduct diligence carefully with respect to indemnified claims to ensure that any indemnity is funded to an escrow with a financially stable third party pursuant to a negotiated escrow agreement. Another option is considering whether it is feasible and beneficial to purchase through a 363 sale, discussed above.

5. Preferences

Know how to make informed decisions about preference risks and mitigate the impact on the business. A preference is a payment or other transfer of value of the debtor that may be subject to avoidance (clawed back) under 11 U.S.C. § 547. For noninsiders to the debtor, a payment made by an insolvent entity 90 days before the bankruptcy case is filed (or 120 for “insiders”) on an “antecedent debt” is subject to claw-back provisions as part of the bankruptcy process. In-house counsel often ask whether they should accept such payments or transfers even if they are likely to be avoidable as a preference; the short answer is “yes.” It is almost always advisable to take the money and use it as leverage in the event a committee or trustee seeks to recover the transfer. Although there are defenses to preference claims, asserting defenses can be costly, both in the value of time spent by in-house counsel and the business teams, and in attorney’s fees. Consider strategies to avoid preference exposure altogether. For example, payments received in advance of providing goods or services are not subject to preference recovery because they are not payments on an antecedent debt. Conversely, a prebankruptcy settlement may seem innocuous, but the payments are, by their nature, almost always susceptible to attack. Structure the settlement agreement so that unless and until the last payment is made and 91 days has passed, no claims or consideration are released. As with other bankruptcy risks, establishing protections in advance of bankruptcy filing, such as letters of credit, security interests, or guarantees, can mitigate against the potential pecuniary loss associated with preferences.

By familiarizing yourself with these five fundamental bankruptcy concepts, you can counsel your business teams and mitigate those risks, if not eliminate them. A practical guide for spotting and analyzing these issues follows.

PRACTICAL GUIDE FOR ISSUE SPOTTING AND PRACTICE POINTERS

1. Automatic Stay and Rejection rights: Consider each “phase” of the contract and consider what happens if the contract counterparty files bankruptcy and the automatic stay takes effect and/or the contract is rejected.

(a) Examples of automatic stay considerations and warnings:

(i) All actions against debtor or its assets including the right by the nondebtor party to send notices to terminate the contract will be stayed.

(ii) Creditor will not be able to recover property in the debtor’s possession without relief from the court.

(iii) If written notices are required in order for parties to implement rights or interests, the stay will likely prevent the notice from being sent.

(b) Example of impact of rejection warnings:

(i) Transition service provisions may not be protected.

(c) Will the party be in possession of property rights or knowledge critical to your ongoing operations?

(i) Can you mitigate risks through an escrow?

(ii) Note: in context of licenses, escrow of source codes help, but often you need much more information in order to make use of the source code. Passwords/subsupplier/other operational info.

(d) Purchase options may be terminated.

(e) Debtor’s assets can be sold free and clear of all interests.

2. Assignment rights: Consider Debtors right to assign the contract to a competitor.

3. Fraudulent conveyances:

(a) Does the deal sound too good to be true? Why is that?

(i) Fairness opinions. Although not dispositive, a fairness opinion is considered by many courts to be strong evidence of value that can be considered.

(ii) Due diligence regarding seller solvency?

(iii) Strong arms-length proofs?

(b) Is the entity entering into the transaction (e.g., a sale transaction) the recipient of the value for the transaction? For example, is the purchase price directed to be made to an entity other than seller?

(c) Indemnified claims: Advise potential purchasers to conduct diligence carefully with respect to indemnified claims to insure that any indemnity is funded to an escrow with a reputable, financially stable third party, pursuant to a negotiated escrow agreement.

(d) General warning: If counterparty to transaction files, there is always a risk that the purchase will be investigated. Bankruptcy Rule 2004 permits extensive discovery of third parties, which can quickly become time-consuming and costly.

(i) Discovery can include depositions, written discovery, and production of documents.

(ii) Rule 2004 was intended to provide opportunities for “discovering assets, examining transactions, and determining whether wrongdoing has occurred.” Washington Mutual, 408 B.R. 45, 49 (Bankr. D. Del. 2009) (citing In re Enron Corp., 281 B.R. 836, 840 (Bankr. S.D.N.Y. 2002)).

(e) Mitigation of risk through bankruptcy sales. Should a purchase of seller’s assets through a bankruptcy sale be considered?

(i) Purchasers acquire assets free and clear of existing liens, claims, and encumbrances.

(ii) A sale in bankruptcy is subject to higher and better offers and the approval of a bankruptcy court nullifying fraudulent conveyance risk to a good-faith, arm’s-length purchaser.

(iii) Sale orders typically contain numerous “bells and whistles” that further protect and benefit purchasers.

(f) Note: Clients often ask whether they should take the money even though it may be subject to preference exposure. Most often the answer will be to take the money. Better to have been paid and have to give back then never to have been paid at all.

(g) Payments under a settlement agreement likely constitute prima facie preference payments, and a debtor or trustee in bankruptcy is likely to seek to avoid payment.

(h) Are there ways to mitigate risk? Think:

(i) Payments in advance

(ii) Guarantees

(1) Bankruptcy typically does not preclude a party from seeking to enforce its rights against a nondebtor third party, such as a parent entity, an affiliate, or individual owners.

(2) Guarantees are only as valuable as the guarantor giving them. Often entire enterprises (related entities) seek protection simultaneously in a jointly administered proceeding.

(3) There is a risk that an avoidance action could be brought to recover payment by insolvent guarantors (preference or fraudulent conveyance discussed below).

(4) Upstream guaranty payments are typically more susceptible to challenge than downstream.

(iii) Letter of credit (LC):

(1) Note: given that an LC is issued by a third-party bank, the automatic stay is not implicated, and the creditor may go directly to the LC issuer to be made whole.

(2) An LC is only as good as its language for the draw down.

(3) Carefully watch LC expiration provisions and try to set up notification system.

(4) Supply agreement should either expire prior to LC, or contain default provisions conditioning continued performance requiring LC’s maintenance (but if the contract is not terminated, the prepetition stay will likely prevent termination).

(iv) Security interests: Note: A security interest granted in the 90 days prior to bankruptcy on an antecedent debt will be subject to avoidance actions but generally better to take than not to take.

(v) Shorten credit terms (may minimize overall exposure depending on timing, but can destroy ordinary course defense).

(vi) Is it a commodity sale agreement and can it be formed as a forward contract? Seek front-end documentation bankruptcy consulting advice if you may fall into this business category for sales.

(vii) Retention of title until xyz occurs.

(1) Consider whether a purchase lease back/escrow of critical manufacturing items such as IP and manufacturing “know how” will help.

(2) Needs to be properly documented and monitored.

(3) Automatic stay will still prevent removal of property from debtor’s possession and thus creditor must seek relief from the stay.

(i) Assumption of contracts: Given that a debtor must cure monetary defaults in order to assume the contract, the debtor would have had to pay the supplier “in full.” Therefore, the prepetition payments to the creditor should not be considered a preference.

(i) Often the debtor or the purchaser of debtors assets seek to enter into new amended contracts upon the sale of debtor’s assets or emergence of debtor from bankruptcy. Often this is because the goal is to avoid paying the supplier in full. Warn clients at outset of bankruptcy case not to agree to new contract. Often sales team trying to sell to “new company” is unaware of desire of in-house counsel to have contract assume. Instead of entering into a new contract, suppliers should attempt to require assumption and amendment of the contract and waiver of cure amounts (negotiate the cure if the issue is the cure payment) rather than entering into a new contract.

(j) Earmarking: Payment made by a third party that is specifically designated as a payment of the debtor’s antecedent debt.

(i) The transaction should not negatively affect the debtor’s balance sheet, for example, by replacing an unsecured obligation with a secured obligation.

(ii) Involves a number of complex bankruptcy issues. Bankruptcy counsel should be consulted if client intends to receive an “earmarked” payment from a third party.

(k) Settlement agreement practice pointers and preferences:

(i) Preserve the claims being released for at least the 90-day preference period:

(ii) Springing release. Delay the reduction and effectiveness of any release of claims (and the dismissal of any pending litigation) until 91 days after the last payment is made and no insolvency proceedings filed.

(iii) Preservation of the claim: Provide for the preservation and reinstitution of the full amount of the client’s claim in the event any claw back is sought.

(iv) Escrow: Can be helpful in some circumstances (e.g., parties agree to mutual releases and X agrees to transfer an asset in exchange for Y payment).

I. Overview of the Attorney-Client Privilege and the Work Product Doctrine

Most attorneys are familiar with the basics of the attorney-client privilege, the attorney work product doctrine and attorney ethics rules to maintain client confidentiality. Although these precepts are governed by the law of the jurisdiction, the general protections are similar regardless of the jurisdiction.  The attorney-client privilege protects communications between a client and an attorney when the communication was made for the purpose of the client obtaining legal advice.[1] The work product doctrine generally prohibits discovering documents and other tangible items that were prepared in anticipation.[2] Attorney ethics rules require lawyers to keep confidential communications with their clients.[3]

It is particularly crucial to identify and protect these privileges when a client is under investigation by the government whether that investigation is a criminal or regulatory matter or a congressional investigation.  Privilege is treated differently in the context of congressional investigations. Recent developments illustrate the importance of being aware of privilege considerations at every stage of an investigation.  With the change of power in the U.S. House of Representatives after the 2018 midterm elections, congressional investigations and oversight hearings likely will thrive –  requiring corporate counsel to focus on the applicability of privilege in congressional investigations. Either way, it is important for both internal and external corporate counsel to be aware of and maintain these protections.

II. Government Investigations – Recent Developments

Recent court decisions and governmental guidance continue to shape the parameters of privilege in government investigations, and the considerations outside counsel should make and discuss with clients before and during investigations.  First, a recent decision in a United States Securities and Exchange Commission (“SEC”) investigation found waiver of work product privilege where information was shared with the government during the course of an investigation.^[4] 

In 2012, General Cable Corporation (“GCC”) retained Morgan Lewis & Bockius (“Morgan Lewis”) to advise on accounting issues.  Morgan Lewis conducted an internal investigation, and informed the SEC of the investigation.  As part of the SEC discussions, Morgan Lewis gave an oral briefing of witness interviews it conducted during the internal investigation.  GCC settled with the SEC in December 2016 and shortly thereafter, the SEC filed suit against three former GCC directors.  These directors attempted to subpoena Morgan Lewis documents relating to the internal investigation.  Morgan Lewis declined to produce the materials, stating they were protected by work product.  A court decision found that the “oral download” of the interviews to the SEC constituted a waiver of work product protection.^[5]

The court in Herrera stated that the waiver issue turned on whether the oral briefing to the SEC constituted a “sufficiently detailed” summary such that it was effectively the “functional equivalent” of the interview memoranda. The court stated that Morgan Lewis’ work product argument would be stronger if it had provided only “vague references,” “detail-free conclusions” or “general impressions” to the SEC staff.^[6]

Second, recent government guidance, including the Department of Justice’s Yates memo,^[7] gave rise to new concerns for the corporate client when it faces a government investigation. The Yates memo in particular, requires companies to disclose ‘‘all relevant facts about individual misconduct’’ to receive ‘‘any consideration for cooperation.^[8]’’  Furthermore, corporations must actively investigate wrongdoing to receive cooperation credit.^[9]  As a result, the corporate client may be in conflict with its executives or employees who the corporation has identified as engaging in the misconduct.  This will impact how the corporate client assesses the decision to cooperate with the government and the decision to participate in a joint defense or common-interest agreement.

III. Congressional Investigations – Recent Developments

Congressional investigations are distinct from other government investigations in meaningful ways.  A key distinguishing factor is the treatment of the attorney-client privilege, a common law privilege that Congress generally does not recognize.

Congress maintains that it is not obligated to recognize common law privileges established by courts, such as the attorney-client privilege, work product doctrine, or other non-constitutional privileges.[10]  Congress bases this assertion on (1) the separation of powers, dictating that Congress is not bound by courts’ common law practices and (2) Congress’s inherent legislative right to investigate.  Congress has nearly limitless powers to investigate anything within the “legitimate legislative sphere.”[11]

Yet, Congress often respects the right of private parties to maintain the confidentiality of legal advice, and rarely compels the production of clearly privileged documents.  Congressional investigators typically use the threat of compelled production of privileged documents as leverage to extract other things from the corporation under investigation, such as an agreement to make witnesses available or to pursue far-ranging e-discovery.

Courts have never directly addressed the scope of attorney-client privilege in congressional investigations.  And, Congress has little desire to see the point tested, corporations often lack the will to test it, and courts often dodge resolving the question.

The most recent court challenge involving an assertion of privilege in a congressional investigation was in 2017 by Backpage CEO Carl Ferrer.  The D.C. Circuit dismissed Ferrer’s challenge to a subpoena issued by the United States Senate’s Permanent Subcommittee on Investigations (“PSI”) for mootness, and vacated a series of district court rulings in the case that seemed to open the door to an adjudication of Congress’s ability to compel privileged documents.[12]

Backpage withheld several documents from its production to PSI, citing attorney-client privilege. The Committee contended that the company had not explicitly asserted attorney-client privilege until late in the investigation, and the district court agreed, finding that Backpage waived its ability to object on privilege grounds.  PSI’s argument that Backpage asserted privilege too late opened potentially dangerous ground.  In finding that Ferrer had waived privilege, the court’s ruling seemed to suggest that attorney-client privilege existed before Congress.

But while the litigation and appeal developed, PSI completed its investigation into Backpage and subsequently informed the D.C. Circuit that it would not certify its continued interest in enforcing the subpoena.  The court dismissed the case for mootness and vacated the lower courts’ decisions.[13]  The Backpage case essentially restores the status quo ante, in which congressional investigation committees and those under investigation will bargain around Congress’s position on the attorney-client privilege without much guidance from a controlling court decision.

IV.  Key Considerations When Advising the Corporate Client on Protecting Privilege and Work Product

Given these recent developments, external and internal counsel should take certain steps when advising the corporate client on these protections.

First, counsel should brief corporate clients on the operation and importance of attorney-client and work product privilege as quickly as possible once the client is alerted to a government investigation.  In addition to explaining to the corporate client how both the privilege and work-product work and why these protections exist, counsel should be sure to advise clients that neither the privilege or work product is sacrosanct.  There are many scenarios, often not fathomable at the beginning of an investigation, that may lead to a later disclosure and the loss of privilege, such as disclosure to cooperate in a government investigation, to preserve the reputation of the company, a change in control at the client, or later conduct that waives the privilege.

Second, lawyers should work to develop a communication structure to ensure that privileges and work product are protected.  One area that should be clearly resolved when determining the communication structure is the role of a client’s general counsel or other internal counsel.  In-house counsel often wear two hats, leaving privilege at risk.  In the corporate context, the privilege applies to employee communications with corporate counsel “concern[ing] matters within the scope of the employees’ corporate duties,” where the employees are “aware that they were being questioned in order that the corporation could obtain legal advice.[14]”  If corporate counsel also discusses business matters with employees, privilege claims may be weaker. 

Further, as part of this communication structure, lawyers should work with clients to  establish a centralized communication structure at the beginning of an investigation, with outside counsel included on all key communications to ensure the efficacy of the privileges. 

Third, as is often the case in government investigations, lawyers must involve third parties such as auditors, experts, or public relations consultants.  Whether information and documents shared with these third parties will retain privilege or be afforded work-product protections depends on the circumstances.  The best practice in these situations is to execute a written common interest agreement between the third-party and outside counsel that clearly sets out, at a minimum, (1) the scope of the engagement; (2) the existence of a common interest; (3) the lawyer’s need for services in delivery of specified legal advice to client; (4) an agreement that the third-party will maintain confidentiality, including by safeguarding and marking records; and (5) an agreement that the third-party will direct substantive communications to the lawyer.

Similarly, lobbyists can be another tricky issue with respect to attorney-client privilege.  Many lobbyists were dual hats, as both lobbyists and lawyers.  Whether communications between a lawyer-lobbyist and a client are protected by the attorney-client privilege depends on a fact-specific inquiry of whether “legal advice” is being given.[15]  

Attorney-client privilege protects communications in which the lawyer-lobbyist is “acting as a lawyer.”[16]  The types of communications that likely would be protected include the legal analysis of legislation,[17] such as the interpretation and application of legislation to factual scenarios; legal advice on pending legislation;[18] and legal advice on how to proceed with lobbying efforts.[19]  Conversely, the attorney-client privilege does not protect communications with lawyer-lobbyists that do not provide legal advice.[20] Examples of communications that likely would not be protected include summaries of legislative meetings;[21] updates on legislative or lobbying activity; and updates on the progress of certain legislation.[22]

As a result, when corporate clients work with lobbyists, it is important to define the scope of work, particularly in what capacity the lobbyist will be advising the client.  A well-defined statement of work with a lawyer-lobbyist may faciliate protecting attorney-client communications in the instance that the lawyer-lobbyist is providing legal analysis on legislation.  However, if the lobbyist is not providing legal counsel, then, the engagement letter should be clear on that as well.

Fourth, when the government, whether prosecutors, regulators, or Congress request information that requires the client to waive its protections, outside counsel should carefully consider government requests for information balanced against the risk of waiver.  Usually, counsel can work with the government to negotiate waiver concerns; neither the United States Department of Justice nor the SEC require a privilege waiver in connection with cooperation credit.  To the extent a client decides to share information, keep it as high-level as possible. 

Fifth, counsel should advise clients to proceed cautiously with joint defense and common-interest agreements.  Joint defense or common-interest agreements allow parties to mount a common defense in civil or criminal matters while maintaining privilege over communications.^[23]  These can be with other investigated parties (e.g., other suspected co-conspirators), other co-investigators (e.g., Audit Committee or an outside audit firm), or client constituents (e.g., officers or employees).  Lawyers should work with corporate clients to assess balancing the benefits of joint defense and common-interest agreements against potential loss of cooperation credit.  If a client enters into any such agreement, counsel should reinforce for the client that privilege is vulnerable to attack, and anything shared as a result of the shared defense could end up in the government’s hands.

As these examples illustrate, privilege and work product considerations may conflict with a client’s ability to fully defend itself in the face of a government investigation.  It is important to discuss privilege issues with clients regularly, assess potential concerns at each stage of a government investigation, and develop both strategic and tactical approaches to either maintaining these protections or strategically determining to waive them.

[1] See eg. Upjohn Co. v. United States, 449 U.S. 383 (1981).

[2] Fed. Rules Civ. Pro. R. 26(b)(3)(a).

[3] See eg. ABA Model Rule 1.6.

[4] Order on Defendants’ Motion to Compel Production from Non-Party Law Firm, SEC v. Herrera, et al., No. 17- 20301 (S.D. Fl. Dec. 5, 2017)

[5] Order on Defendants’ Motion to Compel Production from Non-Party Law Firm, SEC v. Herrera, et al., No. 17- 20301 (S.D. Fl. Dec. 5, 2017)

[6] Id.

[7] Memorandum from Sally Quillian Yates, Deputy Attorney General, U.S. Dep’t of Justice (Sept. 9, 2015) (‘‘Yates Memo’’), available at http://www.justice.gov/dag/file/769036/download

[8] Id.

[9] Id.

[10] D. Jean Veta & Brian D. Smith, Congressional Investigations: Bank of America and Recent Developments in Attorney-Client Privilege, Bloomberg Law Reports (Nov. 6, 2010).

[11] Eastland v. United States Servicemen’s Fund, 421 U.S. 491 (1975).

[12] Senate Permanent Subcomm. on Investigations v. Ferrer, 856 F.3d 1080 (D.C. Cir. 2017).

[13] Id.

[14] Upjohn Co. v. United States, 449 U.S. 383 (1981). 

[15] In re Grand Jury Subpoenas dated March 9, 2001, 179 F. Supp. 2d 270, 285 (S.D.N.Y. 2001); U.S. Postal Serv. v. Phelps Dodge Refining Corp., 852 F. Supp. 156, 164 (E.D.N.Y. 1994); Todd Presnell, The In-House Attorney-Client Privilege, 9 No. 1 In-House Def. Q. 6 (2014).

[16] Todd Presnell, The In-House Attorney-Client Privilege, 9 No. 1 In-House Def. Q. 6 (2014); In re Grand Jury Subpoenas, 179 F. Supp. 2d at 285.

[17] Robinson v. Texas Auto. Dealers Ass’n, 214 F.R.D. 432, 446 (E.D. Tex. 2003); vacated in other part, No. 03–10860, 2003 WL 21911333, at *1 (5th Cir. July 25, 2003).

[18] Weissman v. Fruchtman, No. 83 Civ. 8958(PKL), 1986 WL 15669, at *15 (S.D.N.Y. Oct. 31, 1986).

[19] Black v. Southwestern Water Conservation Dist., 74 P. 3d 462, 468-69 (Colo. App. 2003).

[20] Presnell, supra 15; In Re Grand Jury Subpoenas, 179 F. Supp. 2d, 285 (S.D.N.Y. 2001).

[21] North Carolina Elec. Membership Corp. v. Carolina Power & Light Co., 110 F.R.D. 511, 517 (M.D.N.C. 1986); Todd Presnell, supra 15.

[22] Presnell, supra 15.

[23] “The rule . . . is that where two or more persons who are subject to possible indictment in connection with the same transactions make confidential statements to their attorneys, these statements, even though they are exchanged between attorneys, should be privileged to the extent that they concern common issues and are intended to facilitate representation in possible subsequent proceedings.’’  Hunydee v. United States, 355 F.2d 183, 185 (9th Cir. 1965)

As individuals and institutions around the world are implementing a variety of strategies to combat climate change, investors are contributing to those efforts with their capital. Although not an exclusive list, two investor-led strategies that seek to combat climate change include impact investing and divestment. The following highlights the key aspects of these approaches.

Impact Investing

Per the Global Impact Investing Network (GIIN), “[i]mpact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.” Notably, these investments provide capital “to address the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education.” With regard to climate change specifically, the GIIN created a Climate Investing Track, which allows investors to focus on areas such as clean energy access and sustainable forestry, and the organization has future plans related to food, agriculture, and resilient infrastructure. Moreover, the GIIN also created ImpactBase, which is an online search tool that brings together fund managers, investors, and the greater impact investing community.

With respect to the origins of the term “impact investing,” the Rockefeller Foundation claims to have coined the term back in 2007, and its impact investing team has made a variety of environmental and climate-related investments around the world. It is also worth noting that foundations with impact investing practices, such as the MacArthur Foundation, also fund climate solutions projects through their grant-making programs. (The author gained exposure to worlds of impact investing and climate solutions during a law school internship with the MacArthur Foundation.) Additionally, because foundations play a crucial role in growing the impact investing community, networks such as Mission Investors Exchange are providing these philanthropic organizations with resources and connections to help “increase the scale and impact of their impact investing practice.”

Banks and other financial institutions are also facilitating climate-related investments. Goldman Sachs’s Environmental Policy Framework, for example, seeks environmental market opportunities related to clean energy, water, and other areas affected by climate change. Other investment vehicles include World Bank Green Bonds, which “specifically focus on tackling climate change issues that directly impact developing countries.” These bonds fund projects related to renewables, transportation, water and waste management, land use and forestry, among others. The United Nations also must attract capital to achieve its Sustainable Development Goals, some of which focus on clean energy, climate action, sustainable use of land and sea, and responsible consumption and production. With that said, however, although some investors are deploying their capital to support enterprises mitigating the effects of climate change, others are withdrawing their capital from enterprises contributing to it.

Divestment Strategies

The divestment movement began in 2011 when students at Swarthmore College advocated “that their school divest its billion-dollar endowment out of the largest companies that profit from drilling for and distributing fossil fuels.” Since then, this movement that began on U.S. college campuses has spread to 37 countries and has resulted in more than $6 trillion committed to fossil fuel divestment. With over 1,000 institutional investors pledging to divest, a significant amount of capital is on track to be diverted away from the coal, oil, and gas industries.

Nonetheless, questions remain as to the effectiveness of divestment, as well as the fiduciary duties of large institutional investors. In a Wall Street Journal article, New York University Professor Paul Tice wrote about the futility of the fossil fuel divestment movement, stating that “[i]n the long run, the effort to starve energy companies of capital will only make the oil and gas sector more attractive to investors.” With regard to fiduciary duties, the initial concern of institutional investors—who have a responsibility to maximize financial returns—was that the divestment from fossil fuels stocks might lead to a breach of those duties. With respect to the latter, however, “[t]he mounting financial risks associated with climate change and the prospect that a significant proportion of existing fossil fuel reserves will be stranded have led regulators to be explicit that climate change poses a threat to investor value and that fund fiduciaries have a legal duty to manage this risk.”

Finally, a notable alternative (or supplement) to divestment is shareholder advocacy. For example, As You Sow is a nonprofit located in Northern California that helps investors of public companies craft shareholder proposals related to carbon risk, methane reduction, fossil fuel funding, and energy section transition. Unlike divestment of stock holdings, “[s]hareholder advocacy leverages the power of stock ownership in publicly-traded companies to promote environmental, social, and governance change from within.” Such shareholder engagement exemplifies how environment, social, and governance issues are becoming more material to investors, and standard-setting organizations like the Sustainability Accounting Standards Board are helping those investors find “sustainability data to enhance their understanding of related risks and opportunities.” However, with respect to the divestment movement specifically, the key question looms: “What is the goal of such advocacy?” Is it to make fossil fuels companies transform into renewable energy companies, or is the goal to have these companies wind down their business and liquidate the profits to existing shareholders?

Conclusion

As the world tries to mitigate and adapt to changes in the environment, investors are playing a key role in combatting climate change. Impact investments are supporting enterprises in fields such as renewable energy, sustainable agriculture, and resilient infrastructure. Alternatively, divestment strategies are withdrawing financial support from fossil fuel industries. Thus, it is evident that investors across the globe are trying to combat climate change, and only time will tell whether these strategies lead to their desired financial, social, and environmental returns.

Josh Gutter is an attorney at Carlton Fields and member of the ABA Business Law Section’s Subcommittee on Governance and Sustainability. His practice focuses on corporate and transactional matters, including representations and warranties insurance. Mr. Gutter is also a certified public accountant. He can be reached at [email protected]

This article is excerpted from the forthcoming, multi-volume Financing Renewable Energy Projects: A Global Analysis and Review of Related Power Purchase Agreements, published by the Business Law Section.

The Paris Agreement and Its Consequences

In December 2015, the Conference of the Parties (COP21) to the U.N. Framework Convention on Climate Change convened in Paris to address threats posed by climate change. During the conference, 195 nations signed an agreement (the Paris Agreement) and pledged to limit the global average temperature rise to as close as possible to a maximum two degrees Celsius. The Paris Agreement is seen as the cornerstone of a global approach to preventing catastrophic climate change. (The United States has withdrawn from the Paris Agreement.)

The successor to the Kyoto Protocol, this agreement is the first universal, legally binding climate change deal designed to spur global growth of renewable energy development and provide the foundation for a low-carbon, sustainable future. The Paris Agreement unites not only nations, but also cities, regions, businesses, and investors toward a common goal to reduce carbon emissions and mitigate increasing global temperatures.

In July 2017 it was estimated that clean or renewable energy could achieve 90 percent of the energy-related carbon dioxide emission reductions required to meet the central goals of the Paris Agreement. This target requires reducing energy-related carbon dioxide emissions by 70 percent by 2050 compared to 2015 levels, which can be achieved only with the massive deployment of renewable forms of energy such as wind, solar, and hydro, combined with energy efficiency.

Based on the current and future needs for low-carbon technologies in 13 distinct sectors, renewables could account for two-thirds of primary energy supply in 2050, up from just 16 percent today. The transition to renewables will help limit global warming.

Scientists have recognized that the electricity sector must be completely carbon-free by 2050 and that clean and renewable energy sources must become the dominant source of electricity powering buildings, industry, and transportation to avoid the worst effects of climate change. Doubling the share of renewable energy by 2030 could deliver around half of the emissions reductions needed and, in combination with energy efficiency, keep the rise in average global temperatures within two degrees Celsius—the target of the Paris Agreement.

Financing Issues

One uncertainty ahead for renewable energy is the manner in which investors will react to the coming period in which project revenues have no government price support and instead depend on private-sector power purchase agreements or merchant power structures.

Another potential issue may be rising interest rates. Record low rates of recent years have helped to reduce overall costs per megawatt (MW) and also attracted new capital from institutional investors into the financing of projects.

Private sources provide the bulk of renewable energy investment globally—over 90 percent in 2016—but public finance can play a key enabling role by covering early-stage project risk and getting new markets to maturity. Public spending on policy implementation far outweighs direct public investments. Project developers account for about two-fifths of private investment in the sector. Institutional investors—pension funds, insurance companies, sovereign wealth funds, and others—make up less than five percent of new investments.

Private investors overwhelmingly favor domestic renewable energy projects (93 percent of the private portfolio in 2013–2015), whereas public investment is more balanced between in-country and international financing.

Domestic Issues

Renewable goals and mandates in the United States are powerful mechanisms to encourage construction of renewable energy-generating facilities. For a quarter century the most significant renewable energy mandate was the Public Utility Regulatory Policies Act of 1978, which was passed in the wake of the oil crisis in the 1970s.

Since the mid-2000s, that role has been supplanted by state renewable energy mandates often known as renewable portfolio standards (RPS) or renewable electricity standards (RES). These terms are used interchangeably. The most common method for requiring the use of renewable energy sources is the imposition of a renewable electricity mandate in the form of an RPS or RES.

An RPS requires covered electricity suppliers to procure a certain percentage of their electricity from renewable resources or purchase renewable energy credits (RECs) from other sources to meet the statutory (or regulatory) standard. Such plans typically set a mid- to long-range goal and then phase in the mandate over time. Given that the RPS is a mandate, the law typically prescribes the use of sanctions and/or waivers (permission for temporary noncompliance) for shortfalls (i.e., failures to meet the RPS requirements).

The RPS imposes a reporting requirement on the covered electricity supplier, and the supplier then reports compliance through the delivery of RECs, which are earned through electricity generation from qualified renewable sources. If a covered supplier cannot acquire the required number of RECs, programs usually offer the option of making alternative compliance payments.

An RPS covers any entity stated in the statute and will specify what constitutes “renewable energy.” An RPS provides the mandate for bringing renewable energy online; however, other critical issues must be addressed to bring renewable energy to market, e.g., financing issues and transmission infrastructure.

Renewable energy projects are often dependent on tax credits and tax incentives to compete with other forms of energy. RPS programs are often proposed along with other programs, such as cap-and-trade programs, to reduce greenhouse gas emissions. RPS programs focus on increasing the mix of renewable sources of electricity; cap-and-trade programs are focused on emissions reduction strategies, i.e., whether to reduce pollution, climate-impacting emissions, or both.

More recent variations on RPSs involve energy efficiency resource standards under which utilities must spend certain amounts of money on energy efficiency measures or achieve a certain amount of demand reduction.

International Issues

The year 2017 was the eighth in a row in which global investment in renewables exceeded $200 billion, and since 2004 the world has invested $2.9 trillion in green energy sources. Overall, China was by far the world’s largest investing country in renewables at a record $126.6 billion, up 31 percent in 2016.

Solar energy dominated global investment in new power generation in 2017. The world installed a record 98 GW of new solar capacity, far more than the net additions of any other technology—renewable, fossil fuel, or nuclear. Solar power attracted far more investment at $160.8 billion (up 18 percent) than any other technology.

In total, $279.8 billion was invested in renewables, excluding large hydro, and a record 157 GW of renewable power was commissioned in 2017, up from 143 GW in 2016 and far out-stripping the net 70 GW of fossil-fuel generating capacity added (after adjusting for the closure of some existing plants) over the same period.

In the next five years, wind and solar will jointly represent more than 80 percent of global renewable capacity growth. With almost 70 percent of its electricity generation coming from various renewables, by 2022 Denmark is expected to be a world leader. In some countries such as Ireland, Germany, and the United Kingdom, the share of wind and solar in total generation will exceed 25 percent.

Between 2017 and 2022, global renewable electricity capacity is projected to expand by over 920 GW, an increase of 43 percent. This forecast is more optimistic than last year, but in all likelihood will be affected by a cut in solar tariffs by China.

Renewable energy investment in the United States was far below China at $40.5 billion, down six percent. It was relatively resilient in the face of policy uncertainties, although changing business strategies affected small-scale solar. China, India, and Brazil accounted for just over half of global investment in renewables, excluding large hydro last year, with China alone representing 45 percent, up from 35 percent in 2016.

Europe suffered a bigger decline of 36 percent to $40.9 billion. The biggest reason was a fall of 65 percent in the United Kingdom. Investment of $7.6 billion reflected an end to subsidies for onshore wind and utility-scale solar and a big gap between auctions for offshore wind projects. Germany also saw a reduction in investment of 35 percent to $10.4 billion, on lower costs per MW for offshore wind and uncertainty over a shift to auctions for onshore wind. The latter change was also one reason, along with grid connection issues, for a fall in Japanese outlays of 28 percent to $13.4 billion.

A recent decision from the U.S. District Court for the Southern District of New York dramatizes the ongoing legal liability to which banking and other financial institutions are exposed when an economic fraud and resulting scandal occur. In this longstanding matter, Defendants Credit Suisse, Deutsche Bank, and Merrill Lynch remain very much in harm’s way due to allegations relating to their conduct in connection with certain debt securities issued by the now infamous Enron Corporation—nearly 17 years ago.

This case was originally filed in the Southern District of New York in 2002: Silvercreek Management, Inc. v. Citigroup, Inc. The case was transferred to the Southern District of Texas as part of the Enron multidistrict litigation. Discovery was completed in 2006. Later that year, the court certified a plaintiff class, of which Silvercreek opted out. Upon opting out, the court stayed Silvercreek’s claim pending the outcome of the class action. The class action concluded in 2010, the stay was lifted that year, and Silvercreek filed its complaint in 2011. Silvercreek moved to remand to the Southern District of New York in 2016. The motion was granted, and after a settlement with JP Morgan Chase and Barclays, the remaining defendants filed a motion to dismiss in 2017. The court denied this motion, leading to the current motion for summary judgment.

Victims of financial deceit routinely and directly seek recompense from banks sitting close to or in the chain of an economic fraud, and especially when the perpetrator is in bankruptcy. Such was the case here.

Background

In late 2001, investment group Silvercreek Management Inc. purchased nearly $120M of debt securities from Enron mere months prior to Enron’s high-profile December 2001 bankruptcy filing. Silvercreek alleged that the defendants each knew of, and substantially assisted, Enron’s deceit by designing, marketing, funding, implementing, and distributing numerous transactions utilized and deployed by Enron to essentially “cook its books.” Silvercreek sued the defendants for aiding and abetting Enron’s fraud and negligent misrepresentations, conspiring with Enron to commit fraud, their own negligent misrepresentations, and claims under state and federal securities laws. The defendants moved for summary judgment on all claims.

The Opinion

Judge Oetken denied the defendants’ summary judgment motions on Silvercreek’s claims for aiding and abetting Enron’s fraud. The court held that fact questions existed for a jury as to whether defendants had actual knowledge and substantially assisted with Enron’s fraud. The court stressed that although “red flags” or “warning signs” were not an acceptable substitute for actual knowledge, circumstantial evidence could be sufficient to allow plaintiffs’ claims to get to a jury and, as to each of the defendants, held that such evidence in fact existed in this case. The record included statements by Deutsche Bank employees that they should “torch” Enron files because of “something funky . . . in those [Enron] books.” Similarly, a Credit Suisse employee allegedly referred to Enron as a “house of cards.” In contrast, the record against Merrill Lynch was “devoid of blunt statements.” Still, the court ruled that a jury could find, given the totality of the circumstances, that Merrill Lynch substantially and knowingly assisted in Enron’s fraud.

Likewise, the court denied summary judgment against all defendants as to plaintiff’s civil conspiracy claims: “[t]o establish a claim of civil conspiracy, plaintiff must demonstrate the underlying tort [here, fraud], plus the following four elements: (1) an agreement between two or more parties; (2) an overt act in furtherance of the agreement; (3) the parties’ intentional participation in the furtherance of a common purpose or plan; and (4) resulting damage or injury.” The court ruled that a “reasonable jury [could] find that Defendants knowingly agreed to further Enron’s underlying fraud in conducting certain transactions.”

The court also went through an instructive defendant-by-defendant analysis of the record and Silvercreek’s claims that both Merrill Lynch and Credit Suisse made negligent misrepresentations when marketing certain of the notes at issue. The court reaffirmed New York’s requirement that the liability for negligent misrepresentation can exist only when a “special relationship” of trust and confidence exists between the parties, and where the injured party plaintiffs relied on that relationship. As a general principle, a broker-customer relationship typically does not qualify as a “special relationship” trigger for a viable claim of negligent misrepresentation; however, the court noted that the existence of such a relationship is always fact intensive, with each case being different. Therefore, if defendants recommended Silvercreek make the Enron purchases knowing Silvercreek would rely on the information provided, and that the defendants’ conduct linked them to Silvercreek’s reliance, such a relationship could be established.

Ultimately, the court found that Credit Suisse (but not Merrill Lynch) would have to answer the claims of negligent misrepresentation at trial. Specifically, the court held that there was evidence that could allow a reasonable jury to conclude that Credit Suisse directly solicited plaintiff’s investments, acted as broker for those purchases, and misrepresented existing facts as to Enron’s creditworthiness to establish the relationship required to sustain negligent misrepresentation claims. Although the relationship with Merrill Lynch was long standing, Silvercreek could not point to any specific facts distinguishing this relationship from the half-dozen other brokers and banks with which Silvercreek dealt. Notwithstanding dealing with other brokers and banks, the court would still have entertained the claim if Silvercreek had been able to show, with specificity, its reliance on Merrill Lynch’s statements.

What Does It Mean?

The decision and analysis in the Silvercreek case reinforces that banks will almost always be in the direct line of fire from plaintiffs whenever and wherever economic fraud strikes. The passage of time in the Enron scandal, or any “fatigue” that might have existed as a result of it, was of no moment to the court. These banks, absent a settlement or legal reversal, are now looking down the barrel of a jury trial on whether they knew of, aided, substantially assisted, conspired, and/or (in the case of Credit Suisse) made their own misrepresentations in connection with Enron’s fraud. This case should serve as a loud reminder to all financial institutions that their internal policies, procedures, supervision, and compliance protocols when making representations or soliciting investments must be robust. Personnel must also react to suspicions or concerns they see in e-mails, and must be equally mindful that such e-mails could form the basis of “evidence” against the bank—even 17 years later.

Mark A. Kornfeld is the co-chair of Quarles & Brady LLP Securities and Shareholder Litigation Practice Group, and is a partner resident in their Tampa office. Mark was one of the core attorneys contributing to the Madoff Recovery Initiative, where he served the Trustee and his lead counsel as the first chair of the Settlement and Expert Committees, and was one of the handful of attorneys to have interviewed Bernard L. Madoff in prison. Nicholas D’Amico is an associate in the Tampa office of Quarles & Brady LLP and is a member of the Business Law Group.

Although the legal industry understands the importance of sales and marketing efforts, there appears to be a disconnect between key decision makers and sales and marketing teams. According to the Legal Sales and Service Organization’s annual report, which tracks the emerging field of sales in law firms, 80 percent of legal sales professionals have an impact on revenue through sales; however, only 14 percent of survey respondents reported having a marketing/sales/business development seat on the firm’s management committee. How can a law firm effectively reach prospects and clients when it lacks resources or organizational structure to support sales and marketing efforts? Technology.

Technology has completely transformed the client intake process for law firms. Twenty years ago, the process looked very different than it does now—an individual in need of legal services would likely call a law firm, speak to a secretary or legal assistant, and then be connected with a lawyer or member of the legal team who could provide further assistance. There was no concrete process for determining who received the lead, and there was rarely any insight into how the individual connected with the law firm in the first place.

Law firms can now utilize customer relationship management (CRM) software, such as Salesforce, to assist with the client intake process. The ultimate goal of a CRM platform for the legal industry is simple: to help improve the relationship between law firms and clients. An American Bar Association (ABA) study found that 42 percent of the time, law firms take three or more days to reply to a voicemail or web-generated form from a prospective client. This delayed response time can be harmful when trying to build a relationship.

CRM platforms provide the ability to capture a lead, whether originating through a phone call or interaction with a law firm’s website, and help law firms keep track of where the lead is in the sales cycle. Understanding the status of each lead will help firms recognize trends that can improve the overall customer experience. For example, if the implementation of a CRM system helped a law firm identify that the longest step in the process was between initial contact and a follow-up from a member of the legal team, the firm could take necessary measures to shorten that timeframe.

Call-tracking and analytics systems are another technology platform helping law firms optimize the client intake process. Forty-nine percent of consumers expect a response from an attorney within a 24-hour window, according to FindLaw research; therefore, it is vital that firms use technology to shorten response time to a potential client’s phone call. Many call-tracking tools, such as Invoca, can integrate with CRM systems, allowing the data collected on those calls to be stored in an easily accessed platform.

If a law firm is trying to implement many different platforms, it can become overwhelming for the marketing or sales team to manage all the collected data. By partnering with technology companies that specialize in automating the sales and marketing process, law firms can streamline the lead generation and analysis process. These companies can build customized solutions that integrate the multiple platforms used by the firm.

In addition to customized solutions, technology companies can help law firms understand lead origination and, in turn, attribute the value of marketing efforts. A law firm will likely use a variety of different advertising or marketing efforts at once, so the ability to attribute how a lead came to the firm is extremely valuable in determining further marketing budgets. When firms can allocate the marketing budget in the communication channels that are most effective for clients, the overall relationship improves once again.

When law firms embrace technology, the overall client experience improves. With the help of a few tools—namely, a CRM platform and call-tracking systems—and a trusted partner to integrate various solutions, law firms will begin to understand clients and the intake process on a deeper level.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) was enacted in the wake of the 2008 financial crisis. Although reforms under Dodd-Frank primarily targeted large banks, they have affected banks of all sizes. During the years of implementation of Dodd-Frank, it became clear that the regulatory tightening in response to the crisis was becoming onerous especially for smaller community banks. In response, Congress, led by Senate Banking Committee Chairman Mike Crapo, passed the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, Pub. L. 115-174 (the Crapo Act). As a result of the relief provided by the Crapo Act, in addition to the current market environment for smaller banks, the industry expects to see increased merger and acquisition activity for both regional and community banks.

This new law provides meaningful relief for many financial institutions while keeping the basic framework of Dodd-Frank intact. However, many commentators have focused on the regulatory relief it grants to larger regional banking organizations. Specifically, it raises the asset threshold from $50 billion up to $250 billion for the systemically important financial institution designation at which enhanced prudential standards apply. These standards include, among other things, comprehensive, company-run stress tests. Prior to the Crapo Act, banking organizations had been reluctant to undertake mergers that would create a combined company exceeding $50 billion in assets because of the additional costs and regulatory scrutiny associated with enhanced prudential standards.

Although the Crapo Act reduces the regulatory burden for about two-dozen regional banks, it has a much more widespread effect on the nation’s community banks. (Federal Reserve Statistical Release, Large Commercial Banks as of March 31, 2018; see also Federal Reserve, National Information Center (there were 4,657 commercial banks, 481 savings banks, and 167 savings and loans chartered in the United States with assets less than $10 billion as of June 30, 2018)). Regulatory relief is granted to community banks through a few different avenues. (See Gregory J. Hudson & Joseph E. Silvia, Crapo Helps Community Banks, 135 Banking L.J. 456 (Sept. 2018 (discussion on how the Crapo Act reduces the regulatory burden for community banks)). This includes capital simplification, extended examination cycles, reduced reporting requirements, and increased simplicity for small bank holding companies to finance the acquisition of banks. More specifically, the Crapo Act lays out a capital simplification scheme through the establishment of the “community bank leverage ratio,” it raised banks’ eligibility for an 18-month exam cycle from $1 billion to $3 billion in assets, and made short-form call reports available for banks under $5 billion. Banking organizations with assets less than $10 billion are also provided relief from the prohibitions on proprietary trading and relationships with hedge funds and private equity funds under section 13 of the Bank Holding Company Act—the so-called Volcker Rule.

Finally, the Crapo Act reforms expanded the number of institutions eligible to use debt to facilitate bank merger and acquisition transactions. This was accomplished by amending the Federal Reserve’s Small Bank Holding Company Policy Statement (the Policy Statement), which we review below.

Small Bank Holding Company Policy Statement

On August 30, 2018, the Federal Reserve published an interim final rule in the Federal Register, which was effective the same day and implements relevant provisions of the Crapo Act by expanding the applicability of the Policy Statement through an increase in the Policy Statement’s asset threshold from $1 billion to $3 billion in total consolidated assets. The Policy Statement also applies to savings and loan holding companies with less than $3 billion in total consolidated assets.

Almost 40 years ago, the Federal Reserve acknowledged that small bank holding companies have less access to equity financing than larger bank holding companies; therefore, the transfer of small-bank ownership often requires acquisition debt, which was previously unavailable to them. Accordingly, the Federal Reserve originally adopted the Policy Statement in 1980 to allow small bank holding companies to assume debt at levels higher than typically permitted for larger bank holding companies. (Regulation Y, 12 C.F.R. § 225, Appendix C to Part 225 (Small Bank Holding Company and Savings and Loan Holding Company Policy Statement)). Under the Policy Statement, holding companies meeting the qualitative requirements described in Regulation Y may use debt to finance up to 75 percent of an acquisition, subject to the following ongoing requirements:

1. Small bank holding companies must reduce their parent company debt consistent with the requirement that all debt be retired within 25 years of being incurred. The Federal Reserve also expects that these bank holding companies reach a debt-to-equity ratio of .30:1 or less within 12 years of the incurrence of the debt. The bank holding company must also comply with debt servicing and other requirements imposed by its creditors.
2. Each insured depository subsidiary of a small bank holding company is expected to be well capitalized. Any institution that is not well capitalized is expected to become well capitalized within a brief period of time.
3. A small bank holding company whose debt-to-equity ratio is greater than 1:1 is not expected to pay corporate dividends until such time as it reduces its debt-to-equity ratio to 1:1 or less and otherwise meets the criteria set forth in Regulation Y. (See 12 C.F.R. § 225.14(c)(1)(ii), 225.14(c)(2), 225.14(c)(7)).

This marks the third time the Policy Statement has been amended. It was previously revised in 2006 to raise the asset threshold from $150 million to $500 million. In 2015, the asset threshold was raised further from $500 million to $1 billion, and the scope of the Policy Statement was expanded to include savings and loan holding companies.

Legislation Encourages Bank M&A Activity

When the Policy Statement was first adopted in 1980, there were more than 14,000 commercial banks, according to the FDIC’s Historical Statistics on Banking. Today, there are less than 4,900 commercial banks. Bank failures play a role in the decline in the number of banks, but so do mergers and acquisitions. Over the last 10 years, there were approximately 2,300 bank mergers in the United States.

There are a number of factors beyond just regulatory relief that could drive further consolidation across the banking industry. Yet, the reforms implemented under the Crapo Act will encourage merger and acquisition activity. Regional banks have been reluctant to complete acquisitions that would push their asset size above the $50 billion threshold due to the enhanced prudential standards that would then apply. However, the Crapo Act’s increase in that threshold allows many regional banks to complete substantial acquisitions while remaining well below the new $250 billion threshold.

In addition, the revised Policy Statement allows an additional 280 small bank holding companies to use debt to facilitate acquisitions of other smaller banks. As a result, there are now 3,670 holding companies that can take advantage of the Policy Statement. The increased asset thresholds for the applicability of the enhanced prudential standards, along with the increased asset threshold for small bank holding companies to take advantage of the Policy Statement, is expected to result in further consolidation of the industry through increased merger and acquisition activity.

Gregory J. Hudson is director of examinations at the Federal Reserve Bank of Dallas where he oversees the regulatory supervision of banks and holding companies. Joseph E. Silvia is senior counsel in the Banking and Financial Services Department and a member of the Bank Corporate Group in the Chicago office of Chapman and Cutler, LLP. Messrs. Silvia and Hudson currently serve as chair and vice chair of the ABA Banking Law Subcommittee on Community Banks and Mutual Savings Associations. The authors thank Mimi Connors for her assistance. The views expressed do not necessarily reflect the official positions of the Federal Reserve System.

Interpretation of the Federal Arbitration Act (FAA) has been a frequent issue considered by the U.S. Supreme Court this year. On October 29, 2018, the Supreme Court heard oral argument in Lamps Plus, Inc. v. Varela, No. 17-988. In Lamps Plus, the Court considered whether the FAA precludes a state-law interpretation of an arbitration agreement that would authorize class arbitration based solely on general language commonly used in arbitration agreements. The Court’s analysis in answering this question will necessarily implicate its prior ruling in a 2010 decision, Stolt-Nielsen, S.A. v. AnimalFeeds International Corp., wherein the Court held that in light of the fundamental differences between class and bilateral (one-on-one) arbitration, class arbitration cannot be required unless there is a specific contractual provision in the agreement that would support the conclusion that the parties agreed to arbitrate as a class. As a result of the decision in Stol-Nielsent, courts will not presume that an agreement to arbitrate exists based upon the fact that the agreement in question is silent on the issue of class arbitration or based upon the mere fact that the parties agreed to arbitrate at all.

Despite this precedent, a divided panel of the U.S. Court of Appeals for the Ninth Circuit, utilizing state contract construction canons, determined that the parties in the Lamps Plus dispute had agreed to class arbitration based upon the standard language in their agreement, which stated that “arbitration shall be in lieu of any and all lawsuits or other civil proceedings,” and which provided a description of the substantive claims subject to arbitration. The Ninth Circuit’s decision contradicts decisions by a multitude of other appellate courts, i.e., the Third, Fifth, Sixth, Seventh, and Eighth Circuits, all of which have concluded that the FAA preempts state contract law in determining this issue because the FAA requires affirmative evidence of consent as a matter of federal law.

By way of factual background, this case arose out of a class-action lawsuit initiated by Frank Varela against his employer, Lamps Plus, which had inadvertently released Varela’s personally identifiable information (PII) and that of other employees in connection with a third-party phishing scam. In response to Varela’s lawsuit filed in the U.S. District Court for the Central District of California, Lamps Plus sought to compel arbitration based upon the provisions of Varela’s employment agreement, which contained no provisions providing for class-action arbitration. The district court compelled class arbitration, finding that the mere absence of a reference to “class action” in the agreement was not alone determinative, but rather federal law required an absence of agreement on the issue.

Lamps Plus appealed, arguing that the FAA requires a specific contractual basis showing the parties’ intent to arbitrate class actions and contending that the district court could not read into the contract an agreement to class arbitration based on language relating to personal disputes. Further, Lamps Plus argued that even if the contract was ambiguous as to intent, U.S. Supreme Court precedent supported a resolution of such ambiguity in favor of arbitration. The Ninth Circuit subsequently upheld in part the district court’s ruling. Lamps Plus then filed a petition for certiorari.

Varela has opposed the appeal, contending that in the first instance, the Supreme Court lacks jurisdiction to hear the appeal. With respect to the merits, Varela argues that California contract law interpretive principles used by the district court were properly applied and, thus, should not be overturned. Although Varela agrees that interpreting private contracts is normally a question of state law and that the FAA requires enforcing agreements to arbitrate through that state law, Varela focuses on certain standards of contract interpretation. The Ninth Circuit recognized a reasonable layperson standard for interpreting the contracts. Varela thus points to specific language in the underlying contract that expressly waives Varela’s right “to file a lawsuit or other civil action or proceeding,” and argues that “proceeding” could reasonably be interpreted to include class actions according to California’s standard.

Lamps Plus contends that there are no jurisdictional issues because the dispute arises out of an appealable order dismissing Varela’s claims. Lamps Plus asserts that the district court’s decision to compel class arbitration was an adverse decision that is subject to appeal, and on matters of appellate jurisdiction, the Court must focus on the underlying substance of the dispute rather than the form. In response, Varela argued that not only did the circuit court lack jurisdiction over the appeal, but Lamps Plus lacked standing to even seek an appeal. According to Varela, section 16(b)(2) of the FAA explicitly prohibits appeals directly from interlocutory orders directing arbitration to proceed. Further, Varela contends that the determination by the Court granted Lamps Plus its desired relief—a dismissal of the individual claims brought by Varela. That the Court determined to direct class arbitration is not a decision adverse to Lamps Plus, even though it may not like the result.

Oral argument on this appeal seemed to indicate a potential split among the justices. Justice Kagan focused in particular on the language of the arbitration agreement, and her questions suggested that she believes the language of the agreement is broad enough to encompass class arbitration. Similarly, Justice Sotomayor seemed to recognize that state law controls the interpretation of arbitration agreements and did not seem inclined to embrace the “clear and unmistakable” standard put forth by Lamps Plus. However, certain of the other justices questioned Varela as to whether arbitration was the appropriate forum for resolving class claims, including a specific concern that allowing class actions to be handled in this manner could open the door for potential class members to be bound by an arbitration award even though they never agreed to arbitration in the underlying agreement.

This is the third issue involving the FAA before the Supreme Court in the past year. Looking at the one decision that has already issued may provide some guidance to where the Court could be headed when a decision on Lamps Plus issues next term. Earlier this year, the Court decided Epic Systems Inc. v. Lewis, in which the Court emphasized that Congress, through the FAA, was instructing courts to enforce arbitration agreements as written. In light of Lewis, and keeping in mind prior precedent under Stolt-Nielsen, it is possible that the Supreme Court may reaffirm the principles of Stolt-Nielsen and hold that class arbitration cannot be forced upon a party in the absence of specific and unambiguous contractual language authorizing class arbitration. Whatever the result, business lawyers must keep these recent decisions in mind when they draft arbitration agreements and contemplate the waiver of class arbitration.

The U.S. Supreme Court recently ended a nearly six-year legal battle regarding the constitutionality of the Professional and Amateur Sports Protection Act (PASPA). In Murphy v. National Collegiate Athletic Association, 138 S. Ct. 1461 (2018), the Supreme Court, with Justice Alito authoring the majority opinion, joined by Chief Justice Roberts and Justices Kennedy, Thomas, Kagan, and Gorsuch, held that PASPA violated the 10th Amendment’s “anti-commandeering” principle, which provides that if the Constitution does not give power to the federal government or take power away from the states, that power is reserved for the states or the people themselves.

In essence, the Supreme Court held that “PASPA’s anti-authorization provision unequivocally dictates what a state legislature may or may not do,” and further, there is no distinction between “compelling a State to enact legislation or prohibiting a State from enacting new laws.” Rather, the basic principle of anti-commandeering applies in each case, and Congress cannot issue a “direct order to state legislatures.”

Additionally, the Supreme Court held that no part of PASPA could be salvaged because it was unconstitutional in its entirety. The Supreme Court reasoned that no provision could be severed from the provisions directly at issue—the anti-authorization provision and the prohibition on state licensing of sports gambling schemes. The remaining provisions in PASPA—(1) prohibiting states from licensing or operating sports gambling schemes, (2) prohibiting private actors from operating sports gambling schemes “pursuant to” state law, and (3) prohibiting advertising of sports gambling—were too closely intertwined with the main provisions at issue and could not survive independently.

This decision has ushered in the next gold rush for the U.S. gaming industry. Delaware, Mississippi, New Jersey, Pennsylvania, Rhode Island, and West Virginia have legalized sports betting and are taking bets. Arkansas and New York[1] have legalized sports betting but have not started taking bets. In addition, one tribe in New Mexico launched sports betting in its casino in October. With this period of unprecedented sports wagering expansion, however, comes a rapidly evolving legal landscape and important hurdles of which both gaming and nongaming attorneys must be mindful as they counsel clients.

First, although PASPA has been overturned, the decision did not result in an unbridled legalization of sports betting. In the states that have authorized sports betting, it is still unlawful for individuals to conduct their own sports betting offerings without undergoing licensure and adhering to a strict regulatory framework. Moreover, as discussed below, the parties that can even obtain operational licenses are restricted. Thus, interested parties exploring this space must understand licensing requirements and operational restrictions.

Second, although interstate sports betting would be a windfall for licensed, sports book operators, interstate sports wagering remains unlawful under the federal Wire Act, 18 U.S.C. § 1084. The Wire Act currently prohibits the knowing use of a wire communication facility to transmit in interstate or foreign commerce bets or wagers, information assisting in placing certain bets or wagers, or any information that entitles the recipient to money or credit resulting from such a wager on any sporting event or contest. Until the Wire Act is repealed or amended, sports betting will be conducted on only an intrastate basis in those states that authorize sports wagering. As a result, each operator must comply with each jurisdictions’ requirements, whether regulatory or otherwise, which itself presents a host of issues. Most notably, depending on how uniform these requirements are from state to state, a multijurisdictional operator may have to develop an independent infrastructure and product in each jurisdiction to conduct its sports wagering operations.

Federal lawmakers are currently studying the various issues related to sports betting regulation. In September, the first hearing on sports betting was held by the House Subcommittee on Crime, Terrorism, Homeland Security, and Investigations (the Committee). Chris Krepich, press secretary for Committee Chairman Jim Sensenbrenner (R-Wis.), told Bloomberg Tax in an e-mail that the Committee is considering what role Congress should have as states begin to develop policies toward sports wagering, including a potential amendment to the Wire Act.

On November 15, 2018, Sensenbrenner sent a letter to Deputy Attorney General Rod Rosenstein urging the Department of Justice (DOJ) to work with the Committee to protect the public from nefarious organizations that may use online gambling sites to launder money and engage in identify theft. The letter posed three questions to the DOJ: (1) whether the 2011 Office of Legal Counsel opinion that reinterpreted the Wire Act to permit online gambling is currently supported; (2) whether any DOJ guidance is currently provided to states interested in authorizing sports betting; and (3) whether the DOJ foresees any legal and illegal issues that may arise regarding sports betting if Congress takes no action in response to the Supreme Court’s decision. Sensenbrenner noted at the September hearing that he was presented with three viable options for Congress: (1) re-enact a federal prohibition against sports betting; (2) give complete deference to states to regulate sports betting; or (3) adopt uniform federal standards. Congress taking no action, he stated, would be the worst option.

Whether federal lawmakers will seriously consider repealing/modifying the Wire Act is uncertain. However, even if they decide to act, a complete regulatory scheme will take significant time given the current political environment and outstanding issues. For example, if the Wire Act were amended to allow interstate sports wagering, a host of questions must be addressed, such as how taxation would work if the operator is located in a state different than the bettor, and which state would be entitled to the tax revenue. In the interim, states are pushing forward with their own legalization efforts.

Not surprisingly, similar to the federal legislative process, interested stakeholders have varying degrees of power and influence on a state-by-state basis. This includes the commercial/tribal gaming operators, state lotteries, local/state governments, and trade associations, just to name a few. Similar to New Jersey’s implementation of internet gaming, which requires any internet operator to partner with a land-based operator, the land-based operators who previously spent considerable capital to develop land-based infrastructure will likely demand similar partnerships for sports wagering if a third-party operator enters their marketplace. In contrast, the District of Columbia, which does not have casinos, has a bill pending that will authorize the D.C. Lottery to act as regulator and operator of mobile sports betting. Executive Director of the D.C. Lottery, Beth Bresnahan, told GamblingCompliance that of the 408 retail lottery locations, only about 20 percent are expected to participate. This may include kiosks that allow for straight bets or parlays. The current version of the bill grants the D.C. Lottery authority to offer online and mobile sports betting throughout the district, whereas private operators could offer retail betting, and any mobile betting is restricted to the confines of the establishment.

In addition to the aforementioned stakeholders, you have the professional leagues. The leagues initially pushed for their much maligned “integrity fees,” which effectively serve as a royalty fee. In short, the leagues feel entitled to receive some form of compensation from the sports book operators because authorized sports betting is based on professional league games. Although such a fee is not unprecedented, given that professional sports leagues in France and Australia receive a percentage of wagers made in those jurisdictions, the likelihood of such fees built into U.S. regulation is dwindling due to the extensive opposition received from the industry. As a result, none of the states that have enacted legislation authorizing and regulating sports betting have incorporated integrity fees.

In lieu of integrity fees, leagues have begun to partner with sports book operators for branding purposes. For instance, in August the NBA became the first major U.S. sports league to partner with a sports book operator, namely MGM, in a deal that is estimated to be worth $25 million. Pursuant to this exclusive partnership, MGM was named the exclusive official gaming partner of the NBA and receives the rights to use league highlights, logos, and a direct data feed. Additionally, to further promote sports betting integrity, stakeholders in the betting industry, including Caesars and MGM, formed the Sports Wagering Integrity Monitoring Association in November for the purpose of partnering “with state and tribal gaming regulators; federal, state and tribal law enforcement; and other various stakeholders to detect and discourage fraud and other illegal or unethical activity related to betting on sporting events.” See https://www.bna.com/nevada-sports-books-n57982093300/.

The other opportunities created by the recent decision that are often overlooked are those that have availed themselves in tribal gaming jurisdictions. In addition to the massive opportunities for commercial gaming jurisdictions, the same potential for success exists among tribal gaming jurisdictions. Some tribes have a monopoly on gaming in certain states pursuant to tribal-state compacts entered into between each sovereign nation and the state. Compacts often offer tribes within the state the exclusive right to offer gambling, with the exception of state-operated lotteries or limited amounts of racetracks. As such, many tribes have successfully operated casinos for many years and are capable of offering sports betting. Given the large amount of market share tribes hold, along with their established gaming facilities, there is great potential for sports betting success in tribal gaming jurisdictions.

These are just a few examples that highlight the significant lobbying and advocating in every jurisdiction by the stakeholders to maximize the potential benefits that each would enjoy.

Although the stakeholders and regulatory environment may vary from state to state, certain regulatory components, e.g., standards to ensure integrity, are fundamental to the make-up of an effective sports betting regulatory regime. So, although the regulations may vary based on the particular policy goals in each jurisdiction, the universal policy goal should be ensuring the operations are conducted in a fair and honest manner, and that the integrity of the industry is vital to its success. Without an effective regulatory framework, any short-term success will be followed by increasing issues that will weaken public confidence and support for the industry.

In summation, the Supreme Court’s decision is a big step forward for the sports wagering industry in the United States. That said, several impediments still exist, the largest of which is the Wire Act. Until the Wire Act is amended or repealed, sports book operators will be required to undergo licensing and establish sports wagering infrastructures in each jurisdiction where they operate. Additionally, interested operators will have to account for any interested stakeholders and their varying degrees of power and influence. For instance, in certain states such as New Jersey, sports book operators must partner with existing land-based casinos. In other states they must partner with the lottery or racetracks.

Lewis Roca Rothgerber Christie LLP’s gaming practice has been at the center of these issues in Nevada, the United States, and internationally. If you need assistance, whether it is providing advice, analysis, and/or evaluation of the numerous opportunities, regulatory frameworks, and issues that will arise in the coming years as legalized sports wagering expands, please do not hesitate to contact the authors: Karl Rutledge at [email protected], Glenn Light at [email protected], or Mary Tran at [email protected].

[1] Legislation to permit full-scale sports betting in New York failed in June 2018, but New York passed a law in 2013 to allow sports betting at four on-site locations. This law could be revived, and the New York State Gaming Commission is aiming to complete regulations “in the short term” for the four locations specified in the 2013 law. http://www.espn.com/chalk/story/_/id/19740480/gambling-sports-betting-bill-tracker-all-50-states.