This is a summary of the Hotshot course “Sandbagging,” an explanation of sandbagging in private M&A deals, including a discussion on pro- and anti-sandbagging provisions and how different courts and jurisdictions handle the issue. View the course here.
What Are Sandbagging Claims and Provisions?
“Sandbagging” refers to when the buyer in a private M&A deal tries to enforce an indemnification claim that the seller breached a representation or warranty in the acquisition agreement, even though the buyer knew that the rep or warranty was false when it closed the deal.
Whether or not sandbagging claims are allowed is handled in one of two ways:
The acquisition agreement addresses the issue by including a sandbagging provision in the indemnification section of the agreement; or
The agreement is silent on the issue, in which case the governing law of the relevant jurisdiction will apply.
There are two types of sandbagging provisions:
Pro-sandbagging provisions.
Also known as “savings clauses.”
They allow the claims and are favored by buyers.
Anti-sandbagging provisions.
They prohibit the claims and are favored by sellers.
There are also pro-sandbagging jurisdictions and anti-sandbagging jurisdictions.
Parties often include sandbagging provisions in their acquisition agreements to clarify whether these claims are allowed, particularly since jurisdictions differ on that question.
Even in jurisdictions that are “pro-sandbagging,” there can be differences in the degree to which they allow sandbagging claims, so putting a provision in the agreement clarifies things.
The Courts and Sandbagging Claims
Understanding why jurisdictions have different default rules on sandbagging involves a little history.
Courts have followed one of two competing approaches:
One based in tort law.
The other based in contract law.
These approaches relate to the historical treatment of representations and warranties.
Historically, courts regarded warrantiesas promises that the buyer purchased as part of the purchase price, much like buying insurance.
A wronged buyer needed only to show that the seller’s promise was breached and that the buyer suffered damages in order to recover under contract law.
The buyer didn’t have to show any reliance on the warranties to recover.
In contrast, courts historically considered representationsas mere statements of fact made separate from the contract (even if they were contained in it) and made only to induce the other party to enter into the contract.
A misrepresentation was not considered a breach of contract, but a wrongful act that caused harm to the other party.
So the buyer’s remedy for a misrepresentation was based on tort law, and the buyer needed to prove that the untrue statement actually induced it to enter into the contract (that is, the buyer had to show reliance).
If a buyer had knowledge of the misrepresentation prior to signing, it would be hard for the buyer to argue that it had relied on the representation when signing or closing the deal.
U.S. case law no longer treats “representations” and “warranties” differently in the contractual setting.
However, the distinction between the tort-based remedy and the contract-based remedy is still found in how different jurisdictions approach a buyer’s right to recover damages for breach of a rep or warranty.
Jurisdictions that take the contract-based approach(where reliance isn’t necessary to recover damages) effectively permit sandbagging claims and are “pro-sandbagging jurisdictions.”
This is the “modern” – and majority – “default” rule.
Even among states adopting the modern approach, there are meaningful differences in how it’s applied, including:
Different outcomes hinging on whether the buyer learned of the inaccuracy from the seller or independently; and
Whether the outcome should differ depending on whether the buyer had knowledge at signing that the representation or warranty was false.
The states that take a tort-based approach, requiring proof of “justifiable” or “reasonable” reliance before awarding damages, are the “anti-sandbagging jurisdictions.”
Even if the buyer didn’t have actual knowledge of the inaccuracy, courts may inquire into the “reasonableness” of the effort made by the buyer to investigate the seller before signing – its “due diligence.”
Courts may deny recovery in situations where even a modicum of effort would have uncovered the inaccuracy.
If lawyers are comfortable with a state’s default rule, they may choose to have the contract governed by that state’s law.
This means they achieve the desired “pro-” or “anti-sandbagging” result without needing to argue to include a sandbagging provision in the agreement.
However, many lawyers either:
Aren’t comfortable with the default rules of the states that would be logical choices for governing law; or
Would prefer not to leave a determination up to the courts, which might interpret the default rule differently depending on specific circumstances.
As a result, those lawyers include the contractual language explicitly permitting or disallowing sandbagging.
The enforceability of these contractual provisions hasn’t been widely addressed by the courts.
But the decisions that have addressed the issue have favored enforceability even when the provision was the opposite of the jurisdiction’s default rule.
This course also includes interviews with ABA M&A Committee members Nate Cartmell from Pillsbury LLP and Lisa Hedrick from Hirschler Fleischer LLP.
Jonathan Kanter, Assistant Attorney General for the Department of Justice’s Antitrust Division, has been openly and repeatedly skeptical of merger remedies and settlements, making comments such as “merger remedies short of blocking a transaction too often miss the mark.” He has made clear that an injunction blocking a transaction “is the surest way to preserve competition.” Similarly, Chair of the Federal Trade Commission (“FTC”) Lina Khan made plain in a 2022 interview that “[the agency is] going to be focusing our resources on litigating, rather than on settling.”
This summer, however, the federal antitrust enforcers and, in one transaction, the state agencies have negotiated and agreed to settlements in three separate merger matters. While this might appear to be a sea change, merging parties should not assume that it is. The facts and circumstances of each matter are different, but the settlements provide insights into remedies and strategies merging parties should consider.
Amgen/Horizon
Most recently, the FTC announced a settlement of its challenge to Amgen Inc.’s $27.8 billion acquisition of Horizon Therapeutics plc. In May 2023, the FTC and six states—California, Illinois, Minnesota, New York, Washington, and Wisconsin—filed a complaint to block the proposed transaction. Although both are pharmaceutical companies, Amgen and Horizon do not have any competing drugs in their portfolios or development pipelines. According to the complaint, Amgen’s rationale for acquiring Horizon was to control certain high-revenue-generating pharmaceuticals in anticipation of the loss of revenues caused by the 2030 expiration of one of Amgen’s “blockbuster” drugs and the potential downward price pressure from Medicare and Medicaid negotiations under the Inflation Reduction Act. Specifically, the FTC alleged that Amgen was most interested in two Horizon “orphan drugs” for treating certain rare diseases: thyroid eye disease and chronic refractory gout. Orphan drugs are medicines developed to help treat or prevent rare diseases, which are defined in the Orphan Drug Act as conditions that each affect fewer than 200,000 people in the United States or for which there is no reasonable expectation of recovering the cost of developing and making available a drug for the condition.
Because product development and other costs are high and the number of people requiring the orphan drugs is low, the Food and Drug Administration awards the inventor a seven-year exclusivity period. Allegedly, Amgen was willing to pay a premium for Horizon because of the dependable profitability of these two drugs, which accounted for 72% of Horizon’s sales. The FTC claimed that other companies are in the process of developing drugs to compete with Horizon’s orphan drugs when exclusivity expires and that Amgen could use its blockbuster drugs to secure preferential treatment or exclusionary access from pharmacy benefit managers for its non-blockbuster drugs.
Despite Amgen’s pre-litigation offer to commit that it would not bundle other products with Horizon’s orphan drugs, the FTC and six states filed a lawsuit claiming that the acquisition would give Amgen the ability and incentive to engage in cross-product bundling that would exclude Horizon’s rivals and maintain its monopolies, harming patients in the long run.
First and foremost, the settlement accepted by the FTC prohibits Amgen from engaging in any cross-product bundling or exclusionary rebating schemes involving Horizon’s monopoly orphan drugs. The consent order will also prohibit Amgen from entering into an agreement to acquire any pipeline and post-clinical trial products, commercialized products, or interests in any business engaged in the development, manufacturing, or sale of any such products, biosimilars, or therapeutic equivalents that treat either orphan illness, without prior approval. A monitor will be appointed to oversee Amgen’s compliance, and the monitor’s reports will be submitted to the Commission and to the states.
Black Knight
In late August, the FTC also announced the settlement of its challenge to the $13.1 billion acquisition of Black Knight, Inc. (“Black Knight”) by Intercontinental Exchange, Inc. (“ICE”). Black Knight and ICE are direct competitors with their loan origination system software (“LOS”) and a number of ancillary services, including product pricing and eligibility engines (“PPE”). PPE is software that allows a lender to identify potential loan rates for a borrower, determine the borrower’s eligibility for a given loan, and lock in the loan’s terms for the borrower.
According to the FTC, ICE offers the dominant LOS in the United States, processing nearly half of all residential mortgages originated each year, and Black Knight has the second-largest LOS in the United States. Black Knight’s PPE is the industry leader, serving lenders that originate as much as 40% of the residential mortgages in the U.S. each year. ICE’s PPE is currently available only to lenders who use ICE’s LOS. The FTC alleged that because of ICE’s dominant LOS market share and the dependency of PPEs and other ancillary service providers on LOS integration, ICE will have the ability to disadvantage existing and potential ancillary service competitors, including competing PPE providers, by foreclosing or impeding LOS access.
In an effort to resolve the FTC’s concerns, Black Knight proposed divesting its LOS and certain ancillary products but not its PPE. The divestiture buyer, Constellation Web Solutions, Inc. (“Constellation”), would also act as a reseller for certain ancillary services acquired by ICE from Black Knight. The FTC rejected the proposed remedy because it allegedly failed to provide Constellation with the ability, resources, and incentive to replace the intensity of the competition between ICE and Black Knight.
As part of the FTC settlement, Black Knight and Constellation agreed that Black Knight will finance a portion of Constellation’s purchase price of Black Knight’s PPE via a promissory note, but within ten days of a trustee’s appointment, the promissory note will be transferred to the trustee. The trustee will sell the note to a third party within six months of the divestiture.
The DOJ’s complaint alleged that Assa Abloy and Spectrum are two of the three largest producers of residential door hardware in an already concentrated US industry. The agency alleged that the proposed transaction would harm competition in two relevant markets: (1) premium mechanical door hardware and (2) smart locks. The DOJ rejected Assa Abloy’s pre-ligation offer to settle because the proposed divestiture package did not include sufficient smart lock assets and contemplated continuing entanglements between the company and potential divestiture buyer. Consistent with its past statements, the DOJ argued that only completely blocking the transaction would eliminate its risk to competition.
The settlement accepted by the DOJ included Assa Abloy’s EMTEK and Schaub premium mechanical door hardware businesses, its Yale and August residential smart lock businesses in the United States and Canada, and other assets for multifamily smart lock applications in the United States and Canada. The settlement also included expanded intellectual property and commercialization rights in smart locks, additional residential mechanical lock assets, and the ability for the DOJ to seek additional relief later under certain circumstances.
Conclusions
Amgen is the first FTC conduct remedy settlement under current leadership, and Assa Abloy is the first merger settlement under the DOJ’s current leadership. It is too early, however, to determine whether the recent settlements reflect a significant shift in either agency’s approach to merger enforcement.
In Amgen, the FTC explained that a settlement likely would not have been sufficient if the deal gave a company control over products or services that its rivals use to compete or increased the risk of information exchange. Because such conduct can be achieved through “subtle and varied” means that are “difficult to detect,” the FTC would have been more reluctant to accept a conduct remedy in lieu of blocking the transaction.
The Commissioners’ statement about the settlement noted that there are “features” specific to the Amgen matter that suggest that the settlement’s bundling prohibition was sufficient to effectively prevent it, making it unnecessary to block the transaction. The FTC seemed comforted by the fact that Amgen’s conduct would be monitored not only by a settlement monitor and agency but also by the states and that the prohibited bundling should be readily detectable by reviewing Amgen’s future agreements. Accordingly, the consent order will require Amgen to submit all contracts with payers related to the formulary and placement of Horizon’s orphan drugs within thirty days of entering into each contract, and the states will have the individual right to enforce the order.
The Black Knight and Assa Abloy settlements reflect the importance of addressing the potential lessening of competition in all the markets about which the agencies are concerned and, to the extent possible, the complete disentanglement of the divested business from the merging parties. In this and past administrations, the agencies would be very skeptical of a remedy that includes a resale agreement involving the products or services of the merged firm. Parties should be aware that the goal is for the divestiture buyer to compete vigorously against the post-merger company; this includes ensuring that the divestiture buyer has access to all the elements needed to compete and that the merged parties do not have the ready ability to interfere with that access.
As with the above matters and others, such as Microsoft/Activision and UnitedHealthcare/Change Healthcare, litigating the fix may be a successful strategy that allows the parties to shift some risk onto the agencies—they may either seriously consider accepting the parties’ proposed remedy in advance of litigation or be forced to shift their positions and accept a remedy package to avoid the risk of loss at trial and establishment of bad precedent. All reports suggest that the Assa Abloy judge was settlement-minded and that if the DOJ refused to consider any divestiture proposal, it was a risky tactic, and that if the merging parties refused to address the deficiencies the DOJ identified in the pre-trial proposed divestiture package, it was similarly risky. Accordingly, parties should not assume that the DOJ will significantly change its skepticism toward divestiture. Also, even if the DOJ accepts future settlements, it is likely that such settlements will, as the Assa Abloy settlement does, allow the agency to seek additional relief later if the divestiture fails to maintain the intensity of competition that existed before the merger in one or more areas or for one or more products.
September 17 is Constitution Day and Citizenship Day, and it is customary that the President of the United States proclaims the week of September 17 as Constitution Week.
The origins of Constitution Day and Citizenship Day are interesting because they illustrate how individuals or a small group of people can come up with and cause to be implemented ideas that contribute to strengthening the Rule of Law. This is worth noting because community commitment is an essential component of the Rule of Law.[1]
The origins of Citizenship Day date back to 1939, when William Randolph Hearst suggested creation of a holiday to celebrate American citizenship. As a result of his influence, in 1940 Congress designated the third Sunday in May as “I Am an American Day.” In 1952, a Louisville, Ohio, resident named Olga T. Weber petitioned the leaders of her municipality to change the day of the holiday to correspond with the anniversary of the signing of the United States Constitution in Philadelphia on September 17, 1787. They agreed. Weber then made the same request at the state level, and that too was approved. In 1953 Weber made a similar request to the United States Congress, and both the Senate and the House of Representatives approved the change. Consequently, President Dwight D. Eisenhower renamed the day “Citizenship Day” and moved it to September 17.
In 1997, Louise Leigh, a retired medical technologist from El Monte, California, founded a nonprofit organization called Constitution Day, Inc. with the goal of having a federally recognized Constitution Day. She had been inspired to do so after taking a course in Constitutional history sponsored by the National Center for Constitutional Studies. As a result of Leigh’s efforts, and with critical support from Senator Robert Byrd, Constitution Day became an official holiday in 2004, alongside Citizenship Day. (Senator Byrd added the “Constitution Day” amendment to an omnibus spending bill.)
You need not make any commitment of time and energy as significant as the efforts by Olga T. Weber and Louise Leigh in order to make a difference in terms of helping spread the word about Constitution Week. I have two suggestions for things you can do that would be “an easy lift.”
First, you can remind people that September 17 is Constitution Day and Citizenship Day and that the week following is Constitution Week. If they look at you and ask something along the lines of “So what?” you can share with them a few thoughts that were expressed in last year’s Presidential proclamation:
America is founded on the most powerful idea in history—that we are all created equal. That idea sparked our revolution, ignited a wave of change of across the world, and beats in the hearts of Americans today. It is central to our Constitution, and citizenship embodies a true faith and allegiance to give it full meaning in our everyday lives. . . .
When our Founding Fathers came together nearly 250 years ago, they set in motion an experiment that changed the world. They disagreed and debated but ultimately came together to forge a new system of self-government—a system balanced between a strong Federal Government and the States, held together by co-equal branches and a separation of powers. America would not be a land of kings or dictators; it would be a Nation of laws . . . .
As we have seen throughout our history, though, nothing about our democracy is guaranteed. America is an idea—one that requires constant stewardship.
A Proclamation on Constitution Day and Citizenship Day, and Constitution Week, 2022 (Sep. 16, 2022).[2]
Second, you can tell them about the annual “Civics Challenge” created by the Federal Judges Association (FJA). The FJA offers this annual challenge to high school students across the country as part of an effort to increase civic engagement, knowledge of United States history and government, and appreciation for our country’s citizenship process.
High school students, grades 9 through 12, can participate in this challenge if they have a teacher who is willing to participate. The students take the Civics Test that is given to individuals seeking United States citizenship. Any high school teacher can agree to administer and grade the Civics Test. The Civics Test must given, graded, and the results submitted by the participating high school teacher to the FJA by no later than December 31, 2023.
A student who achieves a perfect score on the Civics Test, as determined by the participating high school teacher, will receive an “Excellent Citizen” certificate, which will be mailed to the participating high school teacher. Such students will also have a potential opportunity to be invited to attend a federal court naturalization ceremony in their home judicial district presided over by a federal judge.
If you know a high school teacher, or know someone who knows a high school teacher, please mention this to that individual and let them know that they can contact the FJA coordinator, Susan DeCourcey, at the following email address: [email protected].
In case you are intrigued, the following is a sample of typical questions that appear on the Civics Test:
What does the Constitution do?
The idea of self-government is in the first three words of the Constitution. What are these words?
What are two rights in the Declaration of Independence?
What is the “rule of law”?
If both the President and the Vice President can no longer serve, who becomes President?
What does the judicial branch do?
Under the Constitution, some powers belong to the states. What is one power of the states?
What is one responsibility that is only for United States citizens?
The Federalist Papers supported the passage of the U.S. Constitution. Name one of the writers.
Name one American Indian tribe in the United States.
Name one U.S. territory.
Perhaps we should set up a testing booth at one of the American Bar Association Business Law Section meetings and see how we as a Section do?
World Justice Project, “What is the Rule of Law?,” https://worldjusticeproject.org/about-us/overview/what-rule-law (“The Rule of Law is ‘a durable system of laws, institutions, norms, and community commitment’ based on ‘four universal principles’: ‘just law’; ‘open government’; ‘accessible and impartial justice’; and ‘the government as well as private actors are accountable under the law.’”) (emphasis added) (last visited 9/7/23). ↑
The Governor of Delaware has signed into law amendments to the General Corporation Law of the State of Delaware (the “DGCL”) proposed by the Delaware State Bar Association and subsequently approved by the Delaware legislature. A number of provisions of the DGCL are affected, and the legislation addresses several significant topics, including simplifying the procedures required to ratify a defective corporate act because of a failure of authorization and simplifying the required contents of a certificate of validation under Section 204 of the DGCL; clarifying the record date for identifying which stockholders are entitled to notice of stockholder action via written consent; modifying the need for or reducing the minimum stockholder vote required for charter amendments effecting forward stock splits, reverse stock splits, and changes in the number of authorized shares of a class of stock; providing appraisal rights in connection with a transfer; continuance or domestication of a Delaware corporation to a non-U.S. entity; and creating a safe harbor in which stockholder approval would not be required for a mortgage or pledge of assets.
Authority to Sell Treasury Shares (Sections 152, 153, 157, and 160(b))
The amendments to Sections 152, 153, and 157 of the DGCL build on amendments adopted in August 2022 that expanded a board’s ability to delegate authority to an individual or entity to issue stock or options in the corporation, and also harmonized the procedures to authorize rights and options to purchase stock with existing procedural requirements to issue stock.
The amendments to Sections 152 and 153 of the DGCL, which govern the approval and issuance of stock, clarify that treasury shares may be sold for less than the minimum consideration required to issue stock, which is typically par value. In addition, Section 153 was amended to provide that (i) the consideration received for treasury shares may be greater than, less than, or equal to the par value of the shares, and (ii) the consideration a corporation may receive for treasury shares may consist of cash, any tangible or intangible property, or any benefit to the corporation, harmonizing Section 153 with language already contained in Section 152.
The amendments to Section 157 of the DGCL further modernize the statute by providing that, in addition to granting board authority to a person or body, including a committee of the board, to issue rights and options, the board may also delegate authority to determine the terms upon which shares may be acquired by the corporation upon the exercise of rights or options. As a practical matter, the amendments expand the delegation of authority permitted under Section 157 to include vesting terms, acceleration, and other typical features of equity awards.
In connection with the amendments to Section 152, 153, and 157, Section 160(b) of the DGCL was amended to clarify that a corporation may resell treasury shares resulting from the corporation’s redemption or repurchase of treasury shares out of surplus, in accordance with Section 153, so long as the shares have not been retired, and the corporation’s certificate of incorporation does not require the shares to be retired.
Ratification of Defective Corporate Acts (Section 204)
Section 204(c)(2) of the DGCL was amended to clarify that the determination as to whether any shares of valid stock are outstanding and entitled to vote on the ratification must be made at the time the board adopts the resolutions approving the defective corporate act. Similarly, Section 204(d) was amended to fix the board’s adoption of the resolutions ratifying a defective corporate act as the time for determining which shares constitute valid stock and which shares constitute putative stock entitled to vote on the adoption of the ratification of a defective corporate act, in circumstances requiring a vote of the holders of valid stock.
Streamlining the process to ratify a defective corporate act, a corporation is now required to file a certificate of validation only in circumstances where any section of the DGCL would have required the filing of a certificate in connection with the defective corporate act and such certificate was either (i) never filed or (ii) was filed, but to give effect to the underlying corporate act, the certificate must be amended. When a certificate of validation must be filed, Section 204(e), as amended, simplifies the required contents, including by eliminating the need to describe the underlying defective corporate acts and the nature of the failure of authorization relating to those acts.
Record Date for Stockholders Entitled to Notice of Stockholder Action by Written Consent (Section 228(e))
Section 228(e) of the DGCL has been amended to conform the determination of the record date to be used for purposes of identifying the stockholders entitled to notice of stockholder action taken by written consent with Section 213(b) of the DGCL. As amended, Section 228(e) now provides that the persons entitled to receive notice of action by written consent are persons who (i) were stockholders as of the record date for the action by written consent, (ii) would have been entitled to notice of the meeting if the action had been taken at a meeting and the record date for the notice of the meeting was the record date for the action by written consent, and (iii) have not consented to the action by written consent. The amendments further modernize the statute by permitting the notice required under Section 228(e) to be disseminated through a notice of internet availability of proxy materials, in accordance with current SEC rules.
Forward and Reverse Stock Splits (Section 242)
Amendments to Section 242 of the DGCL, which governs the requirements to amend the certificate of incorporation of a Delaware corporation, were implemented to address, in part, recent issues encountered by public corporations in securing the stockholder vote required to approve a reverse or forward stock split.
New Section 242(d)(1) of the DGCL provides that no stockholder approval is necessary for an amendment to the corporation’s certificate of incorporation for a forward stock split, provided that such class is the only class of such corporation’s capital stock then outstanding and is not divided into series. Further, the amendment may increase the number of authorized shares of such class of stock up to an amount proportionate to the subdivision.
The amendments to Section 242(d)(2) of the DGCL modify the voting requirement to a majority of votes cast rather than a majority of the shares outstanding for reverse stock splits and for amendments to certificates of incorporation to increase or decrease to the number of shares of a class of stock. The new voting standard applies if, (i) the shares are listed on a national exchange immediately before the amendment becomes effective and the corporation meets the listing requirements relating to the minimum number of holders immediately after the amendment becomes effective, and (ii) if the amendment increases or decreases the number of shares of a class of stock that has not opted out of the class vote pursuant to Section 242(b)(2), the votes cast for the amendment by the holders of such class exceed the votes cast against the amendment by the holders of such class. Abstentions have no effect on whether the required approval is obtained.
Section 242(d) of the DGCL continues to permit a corporation to opt in to the required stockholder votes under Section 242(b). Thus, a corporation must affirmatively opt out of the new Section 242(d). A general recitation of the vote generally required under Section 242(b) in the certification of incorporation will not be sufficient to opt out of Section 242(d).
Appraisal Rights (Section 262)
Subject to the “market out” exception, Section 262 of the DGCL has been amended to provide appraisal rights to stockholders in connection with a transfer, domestication, or continuance of the corporation in a foreign jurisdiction pursuant to Section 390 of the DGCL. In addition, appraisal rights have been eliminated for an entity that has converted to a Delaware corporation in connection with a merger, consolidation, conversion, transfer, or domestication authorized in accordance with Section 265 for an entity that has converted or domesticated into a Delaware corporation.
Section 262(k) of the DGCL was also amended to permit the withdrawal of an appraisal demand either within sixty days after the effective date of the transaction, or thereafter, if the withdrawal is approved by the corporation.
Conversions, Transfers, Domestications, and Continuances (Sections 265, 266, and 390)
Section 265 of the DGCL as amended adds subsection (k), which, in connection with a conversion pursuant to Section 265, permits the converting entity to adopt a plan of conversion setting forth the terms and conditions of the conversion. Newly added Section 265(c)(4) also requires the converting entity’s approval before the effective date of the conversion for any corporate action included in the plan of conversion. Similarly, the newly added Section 265(l) clarifies that any corporate actions included in the plan of conversion will be deemed to be authorized, adopted, and approved, as applicable, by the converted Delaware corporation, and do not require further action by the converted corporation’s board or stockholders.
Section 266(b) of the DGCL, governing the conversion of a Delaware corporation to another entity, has been amended to provide that a plan of conversion may be adopted setting forth: (i) the terms and conditions of the conversion; (ii) the terms of the instrument governing the internal affairs of the entity included as an attachment to the plan of conversion; (iii) the manner of exchanging or converting the shares of the converting corporation; (iv) any other provisions deemed desirable; and (v) such other provisions or facts as required by the laws applicable to the entity into which the entity is being converted. Section 390(b) of the DGCL was also amended to add a similar requirement pursuant to a transfer, domestication, or continuance to be adopted in accordance with Section 390(j) of the DGCL.
Section 390(b) of the DGCL was also amended to modify the voting requirement to approve a transfer, domestication, or continuance from all of the outstanding shares of stock of the corporation (voting or non-voting) to a majority of the voting power of the outstanding shares of stock of the corporation entitled to vote on the transfer, domestication, or continuance.
Safe Harbor—Mortgage or Pledge of Assets (Section 272)
Section 271 requires stockholder approval of a sale, lease, or exchange of all or substantially all of a corporation’s assets, subject to certain exceptions, while Section 272 of the DGCL governs the mortgage or pledge of the corporation’s assets. In response to Stream TV Networks, Inc. v. SeeCubic, Inc., 279 A.3d 323 (Del. 2022), new Section 272(b) of the DGCL provides a safe harbor clarifying that stockholder approval is not required under Section 271 with respect to the sale, lease, or exchange of property or assets securing a mortgage or pledged to a third party under certain circumstances. Importantly, the intent of the new Section 272(b) was not to preclude further development of the quantitative and qualitative analyses utilized by the Delaware courts to interpret Section 271.
Under Section 272(b), no stockholder approval is required if the secured party (i) exercises its rights to sell, exchange, or lease the property or assets without the corporation’s consent under applicable law, or (ii) in lieu of the secured party exercising its rights, the board of directors agrees to an alternative transaction and the value of the property or assets is less than or equal to the amount of the liability or obligation being reduced or eliminated as a result of the transaction (the “asset value test”). Section 272(b) provides further that the consideration paid to the corporation or its stockholders will not create a presumption that the value of such property or assets is greater than the total amount of such liability or obligation being reduced.
New Section 272(d) of the DGCL provides further that a corporation’s certificate of incorporation must expressly state that stockholder approval is required for a sale, lease, or exchange permitted by Section 272(b). Merely stating in the certificate of incorporation that stockholder approval is required for a sale, lease, or exchange of assets will not apply to such sale, lease, or exchange pursuant to Section 272(b). Section 272(d) only applies to certificate of incorporation provisions that first become effective after August 1, 2023.
Newly added Section 272(c) of the DGCL also provides that, following the consummation of a transaction, the transaction cannot be invalidated for failure to satisfy the asset value test above if the transferee provided appropriate value for the assets and acted in good faith.
The term “Artificial Intelligence” is not helpful to our public discourse. Artificial Intelligence (AI) is not intelligent. The term encompasses too much, is poorly defined, and therefore can’t be discussed precisely.
But it is important for policymakers to understand what they are encouraging or prohibiting. Passing a law to “restrict artificial intelligence” is a dangerous exercise under current definitions.
Different functions of artificial intelligence create different problems for law and society. Generative AI creates not only new text, code, audio, or video, but problems with deepfakes, plagiarism, and falsehoods presented as convincing facts. AI that predicts whether a prisoner is likely to commit future crimes raises issues of bias, fairness, and transparency. AI operating multi-ton vehicles on the road creates physical risks to human bodies. AI that masters the game of chess may not raise any societal issues at all. So why would politicians and courts treat them the same?
They shouldn’t, but if people don’t understand the distinctions between functional types of artificial intelligence, then they won’t be able to make sensible rules. Our language is holding us back. We need to think differently about AI before determining how to treat it.
There can be useful arguments for defining artificial intelligence by the process used to create it. Large language models or other models built by shoveling tons of data into the maw of a machine-learning algorithm may be the purest form of AI. Politicians don’t understand the distinction between these models and other functioning forms of code, however, and they shouldn’t need to. Politicians don’t care how to build an AI model; they only care what it does to (or for) their constituents.
Some of what we think of as AI is nothing more than complex versions of traditional computational algorithms. Standard big-data mining can seem miraculous, but no machine-learning modules are needed to elicit the desired results. And yet, when regulators discuss strapping restrictive rules onto AI, they would include standard algorithms.
Science fiction writer Ted Chiang has defined artificial intelligence as “a poor choice of words in 1954,” preferring instead to call our current technologies “applied statistics.” He also observed that humanized language for computer activities misleads our thinking about amazing, but deeply limited tools, like effective weather predictors and art generators. There is sorting, excluding, selecting, and predicting in these applied statistical processes, but not context, thinking, or intelligence in the human sense.
Whether our problem is understandable-but-unfortunate humanization of these models, whether it is imprecise thinking about what types of technology constitute AI, or whether it is lumping together of disparate functionalities into a single unmanageable term, we are harming the discourse—and our ability to diagnose and treat dysfunction—by using the term “artificial intelligence” in the present manner.
If we wish to police AI, our society needs to define and discuss AI precisely.
In the explosion of commentary surrounding generative AI, hand-wringing about singularities devolved into an oft-expressed desire to regulate and otherwise “build guardrails” for AI. Society’s protectors, elected and otherwise, believe that we must stop AI before AI stops us, or at least before our use of AI foments foreseeable harm to populations of innocents.
What we casually call AI right now is a set of computerized and database-driven functionalities that should not be considered—and certainly should not be regulated—as a single unit with a single rule. AI consists of too many tools raising too many separate and unrelated societal problems. Instead, if we wish to effectively legislate AI, we should break the definition into functional categories that raise similar issues for the people affected by the technology in that category.
I propose a modest organizational scheme below to assist lawyers, judges, legislators, and regulators to 1) grasp the present state of AI and 2) design rules to regulate the functions of machine learning modules. Some of these lines blur, and certain technical or social problems are shared across classifications, but thinking of current AI solutions in legally significant functional categories will simplify effective rulemaking.
Each of these categories provides a unique set of problems. Legislators and regulators should be thinking of AI in the following functions.
Automating AI: Certain AI models automate processes within business or government without making decisions about the opportunities of specific people. Automating AI may streamline an accounting system, research the case law on burglary, or provide a system of forms for running a company. It can replace human workers in some tasks, and therefore has a social impact.
Generative AI: By predicting the output requested from a series of prompts, certain AI tools build a word-by-word or pixel-by-pixel product that can mimic (or copy) human-looking creations. This can lead to working software code and functioning websites, art in the vernacular of Jan van Eyck, papers discussing the use of symbolism in The Scarlet Letter, or legal arguments in a contract litigation. These products raise intellectual property and plagiarism questions, and they can be trained on improperly obtained material. This technology can produce deep-fakes that are indistinguishable from actionable proof. When Generative AI works poorly, it can generate absolute nonsense presented as true fact.
Physical Action AI: Driverless vehicles operate on the interplay between sensors and predictive algorithms, and so do many industrial and consumer technologies. These are systems that use AI to function in the physical world. This category of AI can include running a single machine, like a taxi, or managing traffic systems for millions of vehicles or Internet of Things devices. Legal concerns not only involve safe product design and manufacture, but tort law, insurance issues, and blame-shifting contracts that affect all activity where the laws of physics and moving bodies apply.
Strategizing AI: We all know about predictive machine-learning programs that mastered human strategy games like chess by playing millions of games. Strategizing AI makes predictions based on running simulations, and humans use it to choose effective strategies related to those simulations. Strategizing AI raises concerns regarding accuracy and reliability of the predictions.
Decisioning AI: This category is not defined by technology but by the technology’s effect on people. Algorithmic tools are used to limit or expand the options available to people. AI ranks resumes for human resource managers, highlights who should be interviewed for jobs, and evaluates the reactions of applicants in those interviews. For years algorithms have made prison parole recommendations, sorted loan applicants, and denied suspicious credit transactions. These decisions are subject to bias of various types, also raising issues of transparency, accuracy, and reliability. The EU and some US states have already regulated this category of AI. The Chinese government has elevated these tools into a societal scoring system that can affect every aspect of a citizen’s life and freedom.
Personal Identification AI: Also defined by its effects on humans, certain AI is being used to pick an individual out of a crowd and name them, to extrapolate whose fingerprint was pulled from a crime scene, or to identify a person carrying a specific phone over specific geography. Most Personal Identification AI uses biometric readings from face, voice, gait, or other traits tied to our bodies, but some is behavioral, including geolocation patterns, handwriting, and typing. This type of AI has been implicated in constitutional search and seizure issues, highlighted for findings that were biased against certain ethnic groups, and questioned for its trustworthiness.
Differentiating AI (Data Analytics): Some algorithms simply decide which items should be included or excluded from a specific group. While this sounds like a simple task, sheer numbers and/or complexity can make the work impossible for humans. Differentiating AI can spot a growing cancer from a shadow on an X-ray much more effectively than teams of trained radiologists. It can predict which cell in a storm may drop a tornado. It helps decide which picture shows a cat and which shows a dog. Both Decisioning AI and Personal Identification AI are legally significant subgroups of Differentiating AI, but I am proposing that this classification will not include tools designed to identify people or make subjective decisions about people, but instead be limited to those that suggest factual groupings that might lead to real-world consequences.
Military AI: An amalgam of each of the other functional types listed here, the military builds its own strategizing models, decisioning models, and physical action AI. These tools raise some of the same issues as civilian versions, but an overlay of special purposes and the law of war create a unique category of considerations for military AI. Like most military tools and strategy, the rules for military AI will appear in international treaties and informal agreements between nation-states. Civilian authorities are unlikely to develop effective limitations for the military’s utilization of AI and algorithmic tools.
AI exists in extensive forms and functionalities, so attempting to regulate the entire set of technologies would be overreaching and likely ineffective. The above categorizations provide a safer place to start if we wish to regulate a vast and shifting technology. By adopting this thinking, AI management becomes less daunting and more effective.
This article is excerpted from To a High Court: Five Bold Law Students Challenge Corporate Greed and Change the Law by Neil Thomas Proto (FriesenPress, 2023). Proto’s first-person account chronicles the efforts of a group of law students—chaired by Proto at the time—to challenge an increase granted by the Interstate Commerce Commission to railroad freight rates nationwide, suing the U.S. and the ICC for violating the National Environmental Policy Act. Their lawsuit culminated in the landmark 1973 decision on Article III standing United States v. Students Challenging Regulatory Agency Procedures (SCRAP).
The Supreme Court, February 28, 1973
The Chief Justice calls the first case: “TheAtchison, Topeka and Santa Fe Railroad Company versus the Wichita Board of Trade, Number 72214.” The Court is being asked to review an order of the Interstate Commerce Commission. The order permits particular railroads to increase their charge to grain shippers by 100 percent to stop the train in transit, inspect the grain, and determine its grade. The agrarians object. They are the railroads’ captives. It was the rough and quixotic abuse of this dependence that spurred the Granger movement and the presidential efforts of William Jennings Bryan. It also moved literary realists like Theodore Dreiser and Frank Norris— abhorred, angry, seeking to further awaken the nation to the railroads’ intimidating grip on the land. Norris said it: “[T]he symbol of a vast power … leaving blood and destruction in its path; the Leviathan, with tentacles of steel clutching into the soil, the soulless force, the iron-hearted power, the monster, the Colossus, the Octopus.” In 1887, Congress created a national institution to regulate the railroads and to protect the public interest: the Interstate Commerce Commission. That attempt had not worked. Montana’s Senator Mike Mansfield sought yearly to legislate the Commission’s abolition. He could not do it.
The Chief Justice thanks the participants in a pro forma but polite way. He settles back into his chair. The attorneys representing the next set of adversaries move into place. George places his hand firmly around my forearm. “We got here,” he whispers evenly. John looks at the two of us and smiles. It is one of his cunning grins. He sits back, prepared to listen. He will not miss a word. Neither will I.
“We will hear argument next in 72535 and 562, United States and ICC against Students,” says Warren Burger, “and Aberdeen and Rockfish Railroad against Students.” The Chief Justice pushes his hair back, seeming to bring recognition to its whiteness. He adjusts his posture—erect, framed, subtly moving his head downward so as to assure himself that the attorneys for each side are prepared to argue their case. He obviously has done this before.
The solicitor general of the United States, Erwin Griswold, has taken his seat at the counsel table directly in front of the Chief Justice and slightly to his left. It is Griswold’s responsibility to represent the United States and the Interstate Commerce Commission. He is the former dean of the Harvard Law School and is experienced in Supreme Court argument. He is wearing his morning coat. Seated next to him is Hugh B. Cox, senior partner at Covington & Burling, Washington’s most prestigious law firm. He is representing the nation’s railroads. Cox also is part of the tradition. He is familiar to this setting and knowledgeable about its culture. He, too, is wearing a morning coat.
Seated at the other end of the table is the attorney for the appellee, Students Challenging Regulatory Agency Procedures (SCRAP). Peter Harwood Meyers is twenty-six years old and a 1971 graduate from the George Washington University School of Law. This is the third oral argument he has ever presented. The first two were in the SCRAP case in the court below.
Meyers is sitting erect, hands folded on the table, nodding slightly when the Chief Justice looks downward. Meyers has trimmed his hair to a fashionable length and is wearing a white shirt. While he has no morning coat, he looks comparatively better without the lavender shirt he wore in the court below. Also at the table, to Peter’s left, is Professor John Banzhaf. “B as in Boy, AN, Z as in Zebra, HAF.” That is the way he spells it for the press, an institution he is acutely sensitive to and depends on for success. He, too, is without a morning coat. Despite the respectful appearance of the two, I know for a fact they have not done this before.
We had decided to file this lawsuit against the Interstate Commerce Commission in May 1972 because the Commission had failed to prepare a detailed statement on the environmental impact of a rate increase granted to all the nation’s railroads on all freight. This obligation, we contended repeatedly to the Commission since fall 1971, was imposed on the Commission by a new law, the National Environmental Policy Act (NEPA). The increased rates are discriminatory. They encourage the extraction of natural resources, including iron ore and timber, and they discourage industrial use of recyclable materials such as scrap iron and steel and textile and paper waste. They also impede the ability of the nation’s cities to move enormous amounts of solid waste. We urged the Commission to consider the environmental consequences nationwide, the same geographic reach of the railroads’ own rate increase.
The Commission and the railroads disagreed. It is their custom to do so. The 1970 report by Ralph Nader’s study group characterized the Commission as a place where “the men in … upper staff … share a protective attitude to ward the transportation industry. They are afraid of change.” This custom of insulation has a legal counterpart. The Supreme Court has regularly deferred to the Commission’s decisions. The Commissioners can do largely what they have always done: resist the public and protect the railroads. They knew that fact going into our lawsuit. So did we.
SCRAP is holding its own. In an opinion written in July 1972, a specially impaneled three-judge district court agreed with SCRAP’s position. “[SCRAP] alleges,” Judge J. Skelly Wright wrote, “that this price increase will discourage the environmentally desirable use of recyclable goods and that … under the terms of NEPA, cannot take effect before a ‘detailed statement on the environmental impact of the proposed action’ is prepared.” The court stopped the rates from going into effect. The railroads and the Commission are uneasy; their relationship has been penetrated, restricted by law, pronounced by a court of law—at the request of five law students. Since the lower court’s decision, the nation’s railroads have been stopped from collecting approximately $400,000 a month for one recyclable material alone: iron and steel scrap. We got their attention. The railroads, along with the United States and the Commission, immediately appealed to the Supreme Court. It is the first time the full Court will interpret the meaning of NEPA. The Chief Justice has already made his views known. He is for the Commission.
There is, however, a threshold legal question. It stems directly from the Constitution. In Article III, the framers created the Supreme Court and limited its jurisdiction to deciding only “cases … and … controversies.” Any party that attempts to invoke the Court’s jurisdiction has to show that it has, in fact, been injured by the government’s action. A party able to make that showing is said to have “standing to sue.” It is not done easily. The Constitution does not tell you what is required. The specific requirements are set by the Supreme Court speaking through its decisions. The requirement has changed over time. Without “standing to sue,” the Court must dismiss the lawsuit.
In the district court, the United States and the Commission challenged SCRAP’s “standing.” In its brief, the government made its case directly: “The plaintiff’s [SCRAP’s] lack of standing to maintain this action was settled by the recent decision of the Supreme Court in Sierra Club v. Morton,” rendered only a few weeks before our lawsuit was filed. According to the government, SCRAP has an even lesser claim: “The complainant in that case, Sierra Club, was a significant and respected organization, with a longstanding concern for the preservation of the environment…. S.C.R.A.P.’s purpose may be commendable, and the zeal of the five law students who comprise it perhaps should be encouraged. However, we respectfully submit that its concern for the public wellbeing does not give S.C.R.A.P. the requisite standing to maintain this action.”
The district court rejected the government’s argument. It concluded that SCRAP had “standing to sue.” But the question is not settled. The United States and the Commission, joined by the nation’s railroads, continue to raise it before the Supreme Court. If the members of SCRAP lack “standing to sue,” then the Commission’s failure to comply with NEPA cannot be reviewed by a court of law.
The solicitor general rises from the counsel table and steps with authoritative comfort to the podium directly in front of the Chief Justice. Solicitor General Griswold’s head moves slightly left to right, seeming to scan the bench as if acknowledging that everyone is present. Hugh Cox is seated to Griswold’s right. Cox is prepared, formidable in skill, and potent in the history and industrial force that buttress his position.
“I am representing the United States and the Interstate Commerce Commission,” the solicitor general states. “Mr. Cox is representing the appellant railroads in No. 72562. We have filed separate briefs, but there is no divergence between our positions.”
Finally, it is beginning. The line is drawn clearly. Now we will see whether it makes a difference that they have been here before and we have not.
The recent US Federal Trade Commission (“FTC”) proposal to ban employers from imposing non-competition clauses (“non-competes”) on their workers has sparked lively debate. Support comes from those who believe the proposed rule would encourage entrepreneurship and innovation and ultimately accelerate economic growth.[1] On the other hand, critics of the proposed rule argue that non-competes are necessary to protect confidential information, such as marketing strategies or pricing plans,[2] although much of the opposition is focused on whether the FTC has the legal authority to pass the rule.
It is difficult to predict whether the proposed rule will actually come to pass, but it received close to twenty-seven thousand public comments. It may be instructive to consider the treatment of non-competes in other common law jurisdictions like the United Kingdom (“UK”) and Singapore, where competing interests between the right of an employer to protect its confidential information, retain employees, and reduce competition are balanced against employees’ rights to market mobility, sometimes in slightly different ways and with different outcomes.
This article will attempt to briefly summarize the employment landscape in each jurisdiction with respect to non-compete agreements; highlight some differences between them; and in turn demonstrate the nuances between the jurisdictions, and their reputations as pro-employer or pro-employee jurisdictions.
I: Overview of New York’s Employment Landscape
In New York, restrictive covenants are “disfavored.”[3] However, they are generally enforceable if narrowly tailored to protect legitimate business interests such as trade secrets, confidential information, or customer goodwill and if they do not unreasonably restrict an employee’s right to earn a living. The duration and geographical scope of the non-compete must also be “reasonably limited.”
In the seminal case of BDO Seidman v. Hirshber, [4]the New York Court of Appeals held that a non-compete agreement that prevented an accountant from working for any client of his former employer for eighteen months, even if he had never worked on that client’s account, was overly broad and unenforceable. The court noted that such a restriction would effectively prevent the employee from working in his chosen profession, and was unnecessary to protect the employer’s legitimate interests.
The FTC proposal seeks to place a broad ban on non-competes, claiming that non-competes affect more than thirty million people in the private sector and if banned, would increase American workers’ earnings by $250 to $296 billion.
It is submitted that the new FTC rule would arguably produce limited practical changes in litigation outcomes in New York, whereas the potential practical impact of the rule in other arguably more pro-employer states like Maryland could be more significant.[5]
II: Overview of the UK’s Employment Landscape
Across the Atlantic, the enforceability of non-compete agreements is subject to common law principles and statutory regulations. Generally, non-compete clauses are enforceable only to the extent that they are reasonable and necessary to protect the employer’s legitimate business interests. The case of Tillman v Egon Zehnder Ltd[6] clarified the law on restrictive covenants and represents a good illustration of how the UK courts balance competing interests in this area. There, the Supreme Court held that the non-compete clause was unenforceable as it was too wide and prevented Tillman from holding even a minor shareholding in a competing business.
In Marathon Asset Management LLP v Seddon,[7]Seddon was sued for breaching his six-month non-compete clause. The Court of Appeal held that the non-compete clause was too wide and therefore unenforceable, as it prevented Seddon from working for any competing company, regardless of whether it was a direct competitor.
These cases demonstrate the UK’s increasingly strict approach to non-competes, where reasonableness and necessity are scrutinized and overly broad or restrictive clauses can be deemed unenforceable by the courts.
III: Overview of Singapore’s Employment Landscape
In Singapore, non-compete agreements are enforceable to the extent that they protect an employer’s legitimate business interests and are reasonable in scope, duration, and geographical coverage. Singapore is known as an employer-friendly jurisdiction, but its courts do strike down clauses that they deem overly restrictive or unreasonable. Indeed, in some respects, Singapore may be said to police the reasonableness of certain aspects of non-competes, for the benefit of employees, more strictly than New York.
For example, New York courts generally regard the use of non-competes to protect confidential information as legitimate. However, in Singapore, if the protection of confidential information is already addressed by another clause in the contract (e.g., a confidentiality clause), the Singapore courts have held that the employer must demonstrate that the non-compete clause covers a legitimate proprietary interest over and above the protection of confidential information or trade secrets, in order not to be regarded as an unenforceable restraint of trade.[8]
IV. Same but different
While the legal tests in each jurisdiction are very similar, their application to broadly similar facts can sometimes result in divergent outcomes, reflecting the public policy considerations of the respective jurisdictions. In the UK, courts have taken a relatively strict approach to the enforceability of non-compete clauses due to the country’s public policy of promoting competition and preventing the restriction of trade. As such, non-compete clauses must be narrowly tailored to protect the legitimate interests of the employer without unduly restricting the employee’s ability to work.
In Singapore, non-compete agreements are generally viewed as a legitimate means for businesses to protect their proprietary interests, within certain boundaries related to the duration, scope, and nature of the restrictions.
Given the substantial and often negative influence of large corporations on “labor market fluidity” in the US, with non-competes common even for fast-food workers, clerks, and low-level hospital employees, the FTC’s proposed rule should be welcomed by workers. Whether or not the rule is implemented, employers in the US would be well advised to start exploring alternative contractual, technological, and practical mechanisms to protect their confidential information, trade secrets, and goodwill.
This article originally appeared in International Law News, the quarterly magazine of the ABA International Law Section, in the Spring 2023 issue (Volume 50, Issue 3). Join the International Law Section to read the full issue and access other resources regarding international law.
Title 3 of Maryland’s Code Annotated for Labor and Employment, Section 3-716 only prohibits employers from requiring non-competes when the employee is earning equal to or less than $15 per hour. ↑
Today, some legal experts argue it’s time for Big Law to get more personal. Rather than prioritizing long work weeks and high salaries, firms need to focus on efficiently and carefully meeting their clients’ needs.
That’s where boutique law firms come in. These firms, typically consisting of fewer than thirty experienced lawyers, offer tailored services and have shorter, more intentional client lists.
In many ways, boutique law firms are disrupting the legal industry and paving the way for future innovations. Let’s dive deeper into their benefits and impact on the industry.
(1) Personalization
Boutique firms have a narrower focus and take on a smaller number of cases. This can allow them to deeply engage with each client and provide more custom attention to their needs.
According to research from Law Firm Marketing Club, 84% of clients expect same-day responses to queries. Another 65% expect to be able to speak to an attorney themselves, and 60% expect to have online chat options with their firm.
The bottom line: regardless of the legal subject matter, clients want to have a personal relationship with a responsive attorney—and boutique law firms have the opportunity to give that to them in a different way.
Bigger firms tend to have bigger deals, and with those come greater responsibility and more administrative staff. This can be a con in some situations, as mid-level or junior associates may take on more of the workload, resulting in less face-to-face time between clients and partners.
As with any small business, boutique firms have the opportunity to communicate more directly with clients. They are not bogged down by administrative demands of larger firms, which can result in quicker response times and more personal conversations.
(2) Expertise and Agility
Boutique law firms offer more dynamic representation for clients by leveraging knowledge and expertise in a particular area of law. When clients hire a smaller firm, they are usually opting for expertise over strength and size—and that can pay off.
Many attorneys choose to work at a boutique firm rather than a large firm because they’re passionate about a particular practice. A close-knit specialty environment allows lawyers to zero in on what they’re best at (and most interested in), resulting in more targeted services.
Boutique firms also tend to be agile and adaptable when responding to both client requests and industry regulations. Their small teams, coupled with their high degree of specialty and personal client attention, allow them to adjust to relevant legal changes and trends quickly.
(3) Operations
Finally, boutique law firms may offer effective, direct representation through streamlined operations that leave more room for client services.
Considering that most small firms boast a flatter organizational structure, there are fewer layers of management, reducing the risk of bureaucracy. At the same time, they benefit from having enough team members to get tasks done with urgency and precision.
This culture doesn’t just benefit the client – it can also have a significant impact on the attorneys’ work-life balance. These attorneys will likely get more hands-on experience and client-facing time, but they also tend to have more manageable caseloads and fewer 10+ hour work days.
Conclusion
As the world has become increasingly focused on personalization and speed, it’s time for the legal field to catch up. Boutique firms can help push the field in that direction.
Deciding between a boutique firm and a larger firm depends heavily on your preferences and case-specific needs. The bottom line is that you have options, and evaluating them is the first step in selecting the right partner.
The Ukraine conflict is the most recent event in a long history of strife between Russia and Ukraine that predates the current invasion by 250 years.[2] In relevant recent events, the Maidan Revolution in November 2013 was marked by mass protest against the Ukrainian government’s decision to cease negotiations with the European Union (E.U.) to enter into an association agreement, which was blamed on Russian influence.[3] After 77 protestors were killed in Kyiv, then-President Viktor Yanukovych was exiled to Russia while the Ukrainian opposition party took control of the government.[4] In March 2014, Russia annexed the Crimea, and in May 2014 pro-Western politician Petro Poroshenko won the Ukrainian presidential election.[5] In April 2019, Volodymyr Zelensky became president, unseating incumbent Poroshenko.[6] On February 21, 2022, Russia recognized two breakaway Ukrainian territories, Donetsk and Luhansk, which Russia had been supporting as independent states, and sent significantly more military support into the territories.[7] On February 24, 2022, Russia invaded Ukraine.[8]
The United States has had economic sanctions in place against Russia since 2014, when it invaded Crimea. However, the reaction to Russia’s wholesale military incursion in 2022 has taken the extent and degree of sanctions to a far higher level, creating the need for U.S. companies to establish much stronger diligence programs and in some cases deal with complex compliance issues.[9] The adoption of varying sanctions by numerous other countries and Russia’s recent moves to impose countersanctions and take steps against companies complying with international sanctions have made operating in the global marketplace a complicated and high-risk proposition.[10] Russian countersanctions have focused on indirect expropriation as leverage to punish or control foreign investment in its borders, using the countersanctions framework to extract assets and value from foreign investors. The current countersanctions regime is being implemented in a manner reminiscent of the Russian government’s long-standing use of bankruptcy and taxation law to punish corporations that fell out of favor or ran into conflict with the government.
Russian Bankruptcy Laws
Russian insolvency matters are governed by Federal Law No. 127-FZ On Insolvency (Bankruptcy) (the “Russian Bankruptcy Law”), which has been amended repeatedly since its introduction on October 26, 2002.[11] In late December 2008, further reforms were enacted, including provisions on bankruptcy administrators, payment priorities, secured creditors’ rights, foreclosure on security during bankruptcies, and settlement of taxes.[12] The impact of the Russian Bankruptcy Law and its subsequent amendments has evolved over time; after a few years, it created concern among businesses operating in Russia that the laws would be politically misused because politicians had too much of a role in the process.[13] The implementation and execution of the Russian Bankruptcy Law by the Russian government has drawn criticism; such criticism and concern has become acute and renewed in light of the Ukraine conflict.
Perhaps the most significant development in Russian insolvency law prior to the enactment in 2002 of the Russian Bankruptcy Law occurred with the 1998 legislation, which replaced the 1992 bankruptcy law. The 1992 law was itself a new legal regime instituted in the wake of the fall of the former Soviet Union.[14]
The 1998 amendments were a keen source of interest for both the media and legal scholars because they were heralded as a fundamental reform of bankruptcy laws that had allowed debtors, prior to the amendments, to run up insurmountable debt, which left very little to distribute to creditors or important constituencies like the Russian government and workers.[15] The prior laws were criticized as being too debtor friendly, allowing weaker companies to continue to finance their struggling operations by not paying creditors.[16] Many Russian economic and insolvency experts argued that the bankruptcy laws facilitated heavy payment defaults that Russian debtors were being allowed to accumulate before they were declared bankrupt.[17] The 1998 amendments’ hallmark, and the topic of much of the discussion, was one of hope for a new economic pragmatism towards bankruptcy law that would help modernize the Russian economy.[18] At the time, a payment default rate in Russia existed that threatened the viability of the economy, and those in support of the reforms felt that the bankruptcy laws were too lenient on defaulting debtors.[19]
In April 2009, further amendments were made that included provisions on vicarious, third-party liability in a bankruptcy; lower voluntary bankruptcy filing thresholds; rules regarding conflicts by business entities; and provisions regarding bankruptcy litigation tools such as avoidance actions used to bring assets back into a bankruptcy estate (preference actions or fraudulent conveyances, for example).[20] On July 30, 2017, significant changes were made to the Russian Bankruptcy Law regarding vicarious liability of controlling persons.[21] These and other successive amendments to the Russian Bankruptcy Law were designed to perfect practical application of its provisions and to prevent perceived abuse by shareholders.[22] Because of the prevalence of personal guarantees in Russia, it is also important to note that in 2015, the Russian insolvency laws introduced a personal bankruptcy act.[23]
Russian “Rule of Law”
Though structural improvements have been progressively better through each amendment of the Russian Bankruptcy Law, there are strong opinions over whether or not the laws matter if such laws are not “honestly enforced.”[24]
Legal scholars, journalists, and courts outside of Russia have been consistent in expressing doubts over the legitimacy of the actions of Russian bankruptcy trustees, also known as bankruptcy administrators. For example, the 1998 bankruptcy law amendments were supposed to create a way for creditors to enforce claims, but they have been criticized as instead being used as a new mechanism for insiders to siphon off funds from minority shareholders and creditors; there have been allegations that the fiscal malfeasance has been facilitated by bribes to judges and bankruptcy trustees.[25]
President Boris Yeltsin’s announcement in late 1999 that he would step down as president at the end of 1999 and designate Vladimir Putin as his successor was a surprise to many.[26] President Yeltsin’s regime was tied closely to the rise of oligarchs who had profited from the large-scale privatization of Soviet Union’s economy.[27] Some hoped that this surprise successor would bring a new direction for economic policy focused on further modernization.[28]
The Demise of Yukos
The fate of the Yukos corporation is cited as the definitive indication of how the Putin regime would handle the economy and was lamented as a failure to address the cronyism of the Yeltsin regime.[29] The chairman/CEO of Yukos at the time, Mikhail Khodorkovsky, was a Russian oligarch who attempted to enter into a merger with a Western oil company. The prospective merger was favorably received by the markets with a $43 billion valuation, though the good news came shortly before Khodorkovsky was arrested by the Russian authorities.[30]
The Russian government did not formally privatize Yukos; instead it used the tax laws to orchestrate a takeover that not only jailed Russian nationals, but also rendered foreign and domestic investment worthless through enforcement of the Russian tax code. In April 2001, the Russian government imposed a total assessment of $3.4 billion in taxes owed and sought court enforcement against Yukos, which resulted in an order freezing company assets and forbidding the company from alienating or encumbering its property.[31] The government then engaged in a series of actions that crippled both the company’s finances and its ability to pay any outstanding taxes.[32] A judge who ruled against the government and tried to lift the freeze order was removed from the case and then fired, while a judge who ruled for the government was promoted.[33] The courts also allowed procedural deadlines to be instituted that did not allow for time or access to review documents or evidence.[34] Yukos’s legal department, in turmoil due to the arrests of Yukos personnel, was given exceptionally short deadlines to respond to the government’s case and no effective opportunity to review the government’s evidence.[35] The government also argued that due to the asset freeze, Yukos could not liquidate any assets to pay the fine.[36]
It soon became evident that the true objective of the government was to render the company insolvent and begin taking its assets; this was not done directly, but instead by proxies. In July 2004 the government announced the sale of a Yukos affiliate, YNG, which owned the majority of the Yukos production operations, by selling off the YNG stock owned by Yukos.[37] The government increased the tax liabilities up to $24 billion, and then the sale only yielded $9.35 billion, despite YNG’s stock being valued at between $15 and $20 billion. A state-owned oil company, Rosneft Oil Company, purchased YNG.[38] Yukos filed for bankruptcy protection in 2006; the courts, Rosneft, and the tax authority rejected its restructuring plan, and it liquidated in 2007, with Rosneft taking most of the assets.[39] Promnefstroy, a former Rosneft subsidiary, was given the rights to Yukos’s Dutch subsidiary Yukos Finance B.V.[40]
In March 2022, Russia’s ruling party, United Russia, announced a draft law that provides for the involuntary bankruptcy sale of assets left behind by departing companies from “unfriendly countries.”[41] The proposed law would have placed entities that were 25% or more owned by foreigners from “unfriendly states” into bankruptcy unless they divested their holdings to a Russian entity.[42] While the Russian government placed this draft legislation and similar, more direct, measures aside at that time, a new “Yukos” strategy has emerged out of the battling sanctions and countersanctions that have been implemented because of the Ukraine conflict, and recent countersanctions have involved seizures of foreign companies, which have been justified by the Kremlin as retaliation for seizure of Russian funds.
Russian Countersanctions, Indirect Expropriation
The Russian government has imposed significant “countersanctions” against “unfriendly countries” and controversial third-party sanctions against companies complying with the Western sanctions regimes against Russia and Belarus. This product of the Ukraine conflict was an anticipated, but no less disruptive, byproduct of the U.S., U.K., and E.U. sanctions regimes. The Russian countersanctions have complicated and stymied global efforts by corporations to comply with all applicable laws in the markets in which they operate and has exacerbated the exodus of companies from Russia. The hallmark of these government efforts by the Kremlin and the Russian legislature is a revitalization of the tactic of expropriation—especially indirect expropriation—which harkens back to familiar tactics utilized by the Soviet Union, but adapted to modern global economic and political norms.
Expropriation
Expropriation, the seizure of property of another country’s nationals by a sovereign, is a recognized right of sovereign states (“States”) under certain conditions. For expropriation to be lawful (i.e., where the State does not incur international liability), the taking must be for a State obligation, cannot discriminate against foreigners, must respect due process, and must entail prompt and adequate compensation.[43] If expropriation is legal, compensation may limited “to the value of the company at the time of dispossession, plus interest to the date of payment.”[44] Unlawful expropriation can allow for further damages, including lost profits.[45]
Direct expropriation is a legal transfer of title or the physical seizure of property that benefits the State—or a State-selected third party—accomplished through formal law, decree, or physical act.[46] Large-scale nationalizations are direct expropriation and are rare.[47] Indirect expropriation is the complete or partial deprivation of a property right without a formal transfer of title or seizure.[48] There are many terms for the variants of indirect expropriation, including de facto, creeping, constructive, disguised, consequential, regulatory, or virtual expropriation.[49] Creeping expropriation is worth further examination. Creeping expropriation “encapsulates the situation whereby a series of acts attributable to the State over a period of time culminate in the expropriatory taking of such property.”[50] The State can utilize regulatory, legislative, and judicial processes to interfere with property rights over time to dilute foreign nationals’ rights without transferring title or taking control of the asset.[51]
Modern expropriations typically result from legislative, executive, and administrative acts, which include new legislation; resolutions; decrees; and revocation, cancellation, or denial of government concessions, permits, licenses, or authorizations that are necessary for the operation of a business.[52] Judicial intervention is more rare.[53] Investors have challenged confiscatory tax policy; the prohibition of distribution of dividends; labor regulations or other interference in staffing and operations; judicial decisions; financial regulations; and licensing regimes as expropriation.[54]
Russian Response to Ukraine Conflict
The Russian commission on legislative activities has drafted proposed legislation nationalizing property of foreign organizations leaving the Russian market. It was first announced that the issue would be reviewed by a government commission in March 2022, but the law has not yet been passed.[55] The proposed law on external administration for the management of a company would apply to companies with (1) over 25% shareholding (directly or indirectly) “connected” to “unfriendly” States (including place of registration and place of primary economic activity); and (2) a book value of over one billion rubles (around USD 12 million as of early April 2022) and/or over 100 employees. If passed, this law could have retroactive effect from February 24, 2022.[56]
The proposed legislation would be direct expropriation that would arguably require compensation under international law. Since the Yukos takeover was so successful and was accomplished without payment from the Russian treasury, legislation has typically been geared towards indirect expropriation, which is harder to prove than a direct expropriation and easier to defend against in later lawsuits over compensation.
In May 2021, Russian Prime Minister Mikhail Mishustin signed a decree accompanied by a list of “unfriendly states” that “have carried out unfriendly actions” against Russia, Russian nationals, or Russian entities, primarily by restricting diplomatic relations with Russia.[57] The original designation only included the U.S. and the Czech Republic and was made in response to separate denunciations by the U.S. and the Czech Republic for interference by Russia within the borders of each respective country.[58] The list has been expanded multiple times, and its original purpose has been expanded by the Russian government as a response to sanctions imposed against Russia for its invasion of Ukraine.[59]
On March 5, 2022, the Russian government approved the most recent list of “unfriendly countries,” which included Albania, Andorra, Australia, Canada, members of the European Union, Iceland, Japan, Liechtenstein, Micronesia, Monaco, Montenegro, New Zealand, North Macedonia, Norway, Singapore, San Marino, South Korea, Switzerland, Taiwan (the Republic of China), Ukraine, the United Kingdom (including Jersey, Anguilla, British Virgin Islands, and Gibraltar), and the United States.[60]
Russia also instituted countersanctions by presidential decree on March 3, 2022, including a ban on trade, financial transactions, and the honoring of any contract with any party that is a foreign national of an “unfriendly country,” which is the legal designation for any country that has joined in the sanctions against Russia.[61] The Russian government also passed a resolution that all transactions and operations between Russian companies and nationals from “unfriendly countries” must be approved by the Government Commission on Monitoring Foreign Investment.[62]
Currency Restrictions
The Russian government has also imposed currency restrictions on Russian banks so that their clients cannot withdraw more than the equivalent of $10,000 in U.S. dollars.[63] Otherwise, currency can only be withdrawn in rubles at a rate set by the central bank.[64] Any money deposited since March 9, 2022 cannot be withdrawn. The Russian central bank originally stated these restrictions would remain in place until at least March 9, 2023.[65] The restrictions were recently extended to September 30, 2023.[66]
Patent Licensing
Foreign nationals from “unfriendly countries” are subject to a compulsory license of their patents for a 0% royalty.[67] Owners of Russian patents will receive no compensation for infringement in Russia for as long as the countries remain on the “unfriendly country” list, which is populated with countries that have imposed sanctions on Russia and Russian nationals for Russia’s invasion of Ukraine, as described above.[68] The same type of legislation was extended to trademark and copyright infringement.[69] Hasbro Inc. subsidiary Entertainment One UK, which owns the animated children’s television character “Peppa Pig,” brought a trademark and copyright infringement claim against a Russian citizen in the Russian Arbitration Court for the Kirov Region in 2021.[70] On March 3, 2022 (after sanctions were imposed), the court overturned an award it had given to Entertainment One UK and held that the Russian citizen could continue to use the trademarks without payment or permission.[71] The court ruled that a plaintiff domiciled in an “unfriendly country” cannot claim IP infringement against Russian defendants.[72]
Energy Sector
The most serious restrictions have been in the energy sector, where the government measures have been directly tied to the status of the foreign national’s country on the “unfriendly country” list. For example, there was a ban in 2022 on foreign investment in the energy sector. The law banned foreign investors from unfriendly territories and states from restructuring or selling their interests in Russian strategic enterprises, banks, energy companies, and mining companies until December 31, 2022.[73] In practice this means the government can control the terms under which an investor can restructure/sell its assets and effectively can appropriate the assets indirectly. This law has been applied several times, where foreign businesses were essentially forced to sell or lose their businesses in Russia. The government is able to set the rates centrally under this decree.[74]
In March 2023, Russian countersanctions were expanded.[75] Businesses from “unfriendly countries” are now required to make a voluntary contribution to the Russian state budget, and failure to pay will subject the business to a government-appointed receiver.[76] Shortly after, in April 2023, President Putin authorized expropriation of foreign-owned assets in response to the seizure of Russian assets.[77] The first victims of these policies were, not surprisingly, in the very lucrative energy sector.
In late April, the Kremlin seized the shares of Finland’s Fortum (FORTUM.HE) and Germany’s Uniper (UN01.DE), which operate energy plants in Russia, and placed the shares in the custody of temporary control of Rosimushchestvo, the federal government property agency.[78] Rosneft seized operations and remains in control of the facilities.[79] The Russian government justified the seizures as direct retaliation for seizures of its assets by unfriendly countries.[80]
Consequences for “Unfriendly Countries”
On October 7, 2022, the Russian government moved forward through presidential decree to disenfranchise the owners of the Sakhalin-1 energy project, including the foreign nationals of several countries that the Russian government has designated as “unfriendly countries.” ExxonMobil, a significant owner, operator, and partner in the project, had had difficulty with the Russian authorities since late summer 2022 and initiated a prerequisite to arbitration by sending a “note of difference” to the Russian government after President Putin issued a decree in August 2022 that blocked a sale of its 30% stake in the Sakhalin-1 project.[81] The sale would have effectuated the exit ExxonMobil announced in February 2022 after the invasion of the Ukraine.[82] While not naming a buyer in its SEC quarterly filing, it was reported that Exxon would be selling its stake to existing partner ONGC Videsh of India, which wanted to increase its existing 20% stake.[83] Significantly, India has not joined in Russian sanctions and increased its purchases of Russian oil by 33 times since the invasion of the Ukraine.[84] In April 2022, ExxonMobil disclosed a $3.4 billion write-down on the Russia exit and signaled a third-quarter $600 million impairment charge for unidentified assets.[85] ExxonMobil had valued its Russia holdings at more than $4 billion.
ExxonMobil has denounced the decrees as an expropriation, stating: “With two decrees, the Russian government has unilaterally terminated our interests in Sakhalin-1, and the project has been transferred to a Russian operator.”[86]
Through the October decree, President Putin seized ExxonMobil shares in the oil production joint venture and transferred them to a government-controlled company it established, managed by Rosneft subsidiary Sakhalinmorneftegaz-shelf. Foreign partners will have one month after the new company is created to ask the Russian government for shares in the new entity pursuant to the decree. In addition to ExxonMobil and ONGC Videsh, a foreign-owned entity affiliated with Japan’s SODECO also holds a stake in the project.[87] The decree gives the Russian government authority to decide whether these foreign owners can retain stakes in the project.[88]
President Putin used a similar strategy in a July 2022 decree to seize full control of Sakhalin-2, another gas and oil project in the Russian Far East, with Shell and Japanese companies Mitsui & Co and Mitsubishi as partners.[89] On July 1, 2022, it was reported that Shell had lost its 27.5% stake in the Sakhalin-2 project after the Russian government transferred the project to a new holding company.[90] Japan’s Mitsui & Co and Mitsubishi agreed to take shares in the new holding company, retaining their minority stakes in Sakhalin-2.[91]
Remedies
Multinational corporations have largely been driven out of Russia and suffered a similar fate as Russian citizens who were targeted by the Russian government in the recent past. The Russian government has used regulatory and tax regimes to soften companies, even jail the management, and then seize the assets through the bankruptcy system. The Ukraine conflict has created a sanctions war between the West and Russia where both sanctions regimes have placed corporations in the precarious position of having to navigate between them and risk penalties from lack of compliance within the borders of each regime by compliance in the other.
Another unwelcome product of the conflict and related sanctions regimes is the adaptation of these same takeover techniques to accelerate the exit of foreign companies from Russia and disguise expropriation by using regulatory and legal justifications to seize foreign company assets within Russia. So what recourse is there for foreign companies who have lost millions in their investment and assets in Russia during the Ukraine conflict?
Lessons from the Yukos Bankruptcy
The litigation that followed the dissolution of Yukos provides a useful history regarding the legal issues, opportunities for recovery, and potential liability for those seeking to exercise their creditor’s rights against the Russian government. The Russian government did not stop with the dissolution of Yukos; it pursued employees and management of Yukos who left for fear of criminal prosecution. Extradition requests and subpoenas for records of third-party corporations were denied because the applicable domestic courts outside of Russia had serious reservations about the Russian judicial process, including the criminal and tax proceedings in Russia.[92] The Russian bankruptcy administrator sold Yukos Finance B.V. in the Netherlands and Yukos CIS in Armenia to Rosneft and Promneftstroy, a former Rosneft subsidiary.[93] In assigning the Dutch assets to a locally controlled Dutch trust, the Dutch court held that it was primarily motivated to put the assets in trust by the lack of integrity in the Russian proceedings, which failed almost every possible standard for a proper adjudication of the issues.[94]
U.S. Courts
Bankruptcy courts in the United States are likely to have limited success in untangling insolvency matters in Russia, especially those that are a result of countersanctions. Chapter 15 was added to the U.S. Bankruptcy Code to facilitate cross-border cooperation between U.S. and foreign courts where assets in multijurisdictional disputes are a common challenge.[95] Typical of many treaties, there is a public policy exception in chapter 15, which allows a U.S. bankruptcy court to refuse to cooperate in a cross-border dispute, if cooperation is “manifestly contrary to the public policy of the United States.”[96] The entirety of the current U.S. sanctions regime is based upon the isolation of Russia from the global financial system, and no U.S. bankruptcy court would likely facilitate any payment that would proceed through Russian financial institutions. Section 1503 also prohibits any action that conflicts with a treaty or “other agreement” with other countries.[97] The U.S. currently is acting in cooperation with its allies and partners to impose both export controls and a wide range of sanctions.[98]
Prior to the 2022 invasion of Ukraine, and outside of the current U.S. and E.U. sanctions, a U.S. bankruptcy court granted recognition of a Russian insolvency proceeding as a foreign main proceeding in the In re Vneshprombank case.[99] The U.S. Bankruptcy Court of the Southern District of New York allowed a Russian trustee to take discovery in order to trace and recover a failed Russian bank’s allegedly stolen funds, which were taken by two New York LLCs and deposited within the U.S.[100] Two prior Chapter 15 cases were less successful: one where the Russian foreign representative dropped the matter,[101] and another where provisional relief was granted but the case was dismissed before recognition.[102]
In 2004, embattled Yukos tried to file a U.S. bankruptcy to stop Russian tax authorities from auctioning off its Siberian oil-pumping subsidiary Yuganskneftegaz to collect on the $27.5 billion back tax bill that had been assessed by the Russian government.[103] The U.S. Bankruptcy Court for the Southern District of Texas initially granted a temporary restraining order and preliminary injunction to stop the sale, holding that the evidence presented “support[ed] a finding that it is substantially likely that the assessments and manner of enforcement regarding Plaintiff’s taxes were not conducted in accordance with Russian law.”[104]
The court later granted a motion to dismiss the case brought by Deutsche Bank AG, rejecting arguments made regarding lack of jurisdiction, forum non conveniens, comity, and the act of state doctrine.[105] The court instead dismissed the case based upon a review of 11 U.S.C § 1112(b), holding that a variety of factors warranted dismissal. It held that it was impractical to expect that the Russian government would cooperate with the case (and the court deemed such cooperation essential to the bankruptcy), that funds that were transferred to the U.S. were done so immediately before filing and to create jurisdiction in the U.S., and there were multiple other forums in which Yukos had filed seeking relief which the court felt were as capable as, if not more capable than, the U.S. Bankruptcy Court in determining matters under foreign law.[106]
Multilateral and Bilateral Forums
The U.S. suspended bilateral engagement with the Russian government on most economic issues in response to Russia’s ongoing violations of Ukraine’s sovereignty and territorial integrity.[107] Russia is a party to 60 bilateral investment treaties,[108] including many with countries that are now listed as “unfriendly” under Russian sanctions law.[109] There have been several arbitral awards against Russia related to the annexation of Crimea in 2014 that have had to be enforced against Russian assets outside of Russia.[110] The various measures taken by the Russian government against “unfriendly countries” are in violation of these bilateral investment treaties (and many multilateral treaties).[111] Investment treaties incorporate the basic principles of legal expropriation, which require the taking to have a public purpose, be nondiscriminatory towards foreign nationals, and be subject to due process. Investment treaties also regularly prohibit restrictions on transfers of funds.[112]
Under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”), an award against Russia, which is a party to the treaty, can be enforced in the 169 jurisdictions that are also parties to the treaty.[113] There are over 300 billion USD of Russian assets from Russia’s central bank that have been frozen by the U.S. and its allies,[114] though it will take further authority from Congress to attach the assets that have been seized or frozen.[115]
Russia is also a party to the World Trade Organization (WTO), and its measures against the intellectual property of nationals of “unfriendly countries” also could violate the extensive multilateral protections for intellectual property under that umbrella. However, Article XXI of the General Agreement on Tariffs and Trade (GATT) is a “national security exception,” which allows WTO members to breach their WTO obligations for purposes of national security.[116] Article XXI of the GATT was invoked by Russia in a WTO panel dispute between itself and Ukraine over trade restrictive measures taken by Russia, and the Article XXI claim was upheld by a WTO panel on April 5, 2019.[117]
Domestic courts have been largely unsuccessful in suits against the Russian government for lack of jurisdiction.[118] International tribunals also have limited jurisdictional reach. Although Russia was not a party to or had not ratified certain signed treaties, claims have been brought under European Convention of Human Rights in the Strasbourg, though that court has limited remedies available to it.[119]
Between the bilateral tribunals and the Strasbourg Court, litigants against Russia in the Yukos matter fared better under arbitrators.[120] The Russian Chamber of Commerce’s International Commercial Court awarded $425 million to the Dutch trust pursuant to an arbitration provision in the loan documents based on a loan default to which Roseneft became a successor when it took over Yukos assets.[121]
A Spanish arbitrator, pursuant to a bilateral investment treaty, found that unlike the Strasbourg Court, it did not have to analyze whether or not Russia violated its own laws or international norms; instead it had to determine whether nor not Russia engaged in expropriation and acted inconsistently within the expected and normal exercise of regulatory powers to enforce a tax regime.[122] The arbitrator was particularly critical of both the Russian government and the Strasbourg decision under an expropriation analysis.[123] The panel found that Russia had engaged in expropriation, which required compensation.[124]
Conclusion
The accumulating volume and complexity of U.S. sanctions create serious risks for U.S. businesses with respect to both their own vulnerability to sanctions violations and concerns over retaliation from governments involved in the conflict. Proper redress at a later stage for losses incurred due to direct or indirect expropriation will depend on preservation of evidence and strategic planning in anticipation of which forums will be used to recover value from the consequences of the Ukraine conflict.
The pattern that has emerged from Russian countersanctions of using indirect expropriation though taxation, bankruptcy, intellectual property, currency restrictions, and investment controls should be carefully monitored and examined in formulating a strategic approach to the pursuit of recoveries. Equally important is whether assets seized as part of the Western sanctions regime will actually be available to satisfy the losses of these companies once they have found an appropriate forum willing to take jurisdiction over a commercial dispute stemming from a sanctions-induced loss.
The Russian approach to the Western sanctions regime is a direct extension of its recent history of using taxation and regulatory powers to attack real and perceived enemies within its borders, weakening them and then using the bankruptcy laws to take their assets. The countersanction regime justifies the adaptation of this use of government power against foreign companies, who have invested time, technology, and funds in Russia, by conveniently equating them and aligning them with their home countries, and then completely divesting their assets in the process under the color of law. This tactic, disguised as a legitimate exercise of government power, particularly within its borders, was questioned by some, and was criticized early on. The most recent manifestation of this policy, it appears, has no one fooled.
Rafael X. Zahralddin-Aravena, Partner, Lewis Brisbois Bisgaard & Smith LLP, (“LBBS”), Wilmington, Delaware. Opinions, if any, expressed in this article are his and not the opinion of LBBS. ↑
The most recent amendments instituted a ban against filing bankruptcy against certain classes of debtors to act as a stabilizing feature for the domestic economy during the COVID outbreak. Federal Law No. 98-FZ dated April 1, 2020, “On Amending Certain Legislative Acts of the Russian Federation Regarding Prevention and Liquidation of Emergencies.” Bankruptcy is also governed by the Civil Code of the Russian Federation (the “Russian Civil Code”); the Commercial Procedure Code; and the Law on Enforcement Proceedings. The participation of state authorities in bankruptcy proceedings is also regulated by Resolution No. 257 of the Russian Federation Government dated May 29, 2004, “On Protecting the Interests of the Russian Federation as a Creditor in Bankruptcy Cases and in Bankruptcy Proceedings.” ↑
3 Collier International Business Insolvency Guide P 38.05 (2022). ↑
Sabrina Tavernise, “Using Bankruptcy As a Takeover Tool; Russian Law Puts Healthy Companies at Risk,” New York Times, October 7, 2000, at 1; “Russian Bankruptcy Law Updated,” ABI Journal, September 1999. “Under the Bankruptcy Law, 5,300 bankruptcy cases were filed between March 1, 1998 and December 25, 1998, whereas only 4,200 cases were under the courts’ consideration before March. Furthermore, bankruptcy procedures of the Bankruptcy Law were applied to more than 900 cases opened before March.” ↑
Federal Law of the Russian Federation, No. 6-FZ, “On Insolvency (Bankruptcy),” January 8, 1998. See Sobr. Zakonod., RF, 1998, No. 2, Art. 222. The prior statute was the Law of the Russian Federation “On Insolvency (Bankruptcy) of Enterprises” No. 3929-1, November 19, 1992. See Vedomosti, Verkh, Soveta RF, 1993, No. 1, Art. 6. ↑
See, e.g., Tavernise, at 1; William P. Kratzke, Russia’s Intactable Economic Problems and the Next Steps in Legal Reform: Bankruptcy and the Depoliticization of Business, 21 Nw. J. Int’l L. & Bus. 1, 2 (2000) (“[T]he most important legal reforms for Russia are those that eliminate the reward system that encourages economic activity that can be highly inefficient. These legal reforms are an effective bankruptcy law and the de-politicization of business. The two go hand-in-hand. It is the politicization of business that renders Russia’s bankruptcy laws ineffective by making non-viable business entities appear to be solvent. These two reforms, were they adequately implemented, would eliminate rewards for inefficiency.”). ↑
See, e.g., Kratzke at 30–39; Vassily V. Vitryansky, “Insolvency and Bankruptcy Law Reform in the Russian Federation,” 44 McGill L.J. 409 (August 1999) (Deputy Chairman of the Higher Court of Arbitration of the Russian Federation discussing the necessity for bankruptcy reform and the process of drafting and features of the new insolvency law). ↑
3 Collier International Business Insolvency Guide P 38.05 (2022). ↑
Id. There were also amendments regarding residential property developers and credit institutions (specifically incorporating banks and credit institutions into the Russian Bankruptcy Laws, with certain provisions specific to financial institutions not applicable to other business entities, but a repeal of the prior Federal Law No. 40-FZ on Bankruptcy of Credit Organizations). ↑
Federal Law of the Russian Federation No. 154-FZ, “On the Regulation of the Particulars of Insolvency (Bankruptcy) Within the Territory of the Republic of Crimea and the Federal City of Sevastopol and on the Introduction of Amendments to Certain Legislative Acts of the Russian Federation,” arts. 2–4, 6–14, Ros. Gaz. (July 3, 2015). ↑
Bernard S. Black and Anna S. Tarassova, Institutional Reform in Transition: A Case Study of Russia, 10 S. Ct. Econ. Rev. 211, 253 (“Laws that aren’t honestly enforced are little better, and can sometimes be worse, as those without scruples manipulate the laws for personal gain.”). ↑
Paul B. Stephan, Taxation and Expropriation—The Destruction of the Yukos Oil Empire, 35 Hous. J. Int’l L. 1, 16 (2013) (citing to Allen C. Lynch, Vladimir Putin and Russian Statecraft 58–61 (2011)). ↑
Id. at 2 (citing to various sources which have examined the Yukos saga, the law review literature includes Paul M. Blyschak, Yukos Universal v. Russia: Shell Companies and Treaty Shopping in International Energy Disputes, 10 Rich. J. Global L. & Bus. 179 (2011); Sara C. Carey, What Do the Recent Events Involving Yukos Oil Company Tell Us About Legal Institutions for Transition Economies?, 18 Transnat’l L. 5 (2004); Dmitry Gololobov, The Yukos Tax Case or Ramsay Adventures in Russia, 7 Fla St. U. Bus. Rev. 165 (2008); Dmitry Gololobov, The Yukos Money Laundering Case: A Never-Ending Story, 28 Mich. J. Int’l L. 711 (2007); Matteo M. Winkler, Arbitration Without Privity and Russian Oil: The Yukos Case Before the Houston Court, 27 U. Pa. J. Int’l Econ. L. 115 (2006); Brenden Marino Carbonell, Comment, Cornering the Kremlin: Defending Yukos and TNK-BP from Strategic Expropriation by the Russian State, 12 U. Pa. J. Bus. L. 257 (2009); Peter C. Laidlaw, Comment, Provisional Application of the Energy Charter as Seen in the Yukos Dispute, 52 Santa Clara L. Rev. 655 (2012); Alex M. Niebruegge, Comment, Provisional Application of the Energy Charter Treaty: The Yukos Arbitration and the Future Place of Provisional Application in International Law, 8 Chi. J. Int’l L. 355 (2007)). ↑
See Amoco v. Iran, Award, July 14, 1987, para. 192. (“[A] clear distinction must be made between lawful and unlawful expropriations, since the rules applicable to the compensation to be paid by the expropriating State differ according to the legal characterization of the taking.”). ↑
7 The Chorzów Factory Case (Germany/Poland), September 13, 1928, Series A, No. 17 (substantive issue) at 2. ↑
See Starrett Housing v. Iran, Interlocutory Award No. ITL 32-24-1, December 19, 1983, 4 Iran-United States Claims Tribunal Reports 122, 154 (stating “…it is recognized under international law that measures taken by a State can interfere with property rights to such an extent that these rights are rendered so useless that they must be deemed to have been expropriated, even though the State does not purport to have expropriated them and the legal title to the property formally remains with the original owner.”); The Factory at Chorzów (Claim for Indemnity) (The Merits), Germany v. Poland, Permanent Court of International Justice, Judgment, September 13, 1928, 1928 P.C.I.J. (ser. A) No. 17, at 47; and Norwegian Shipowners’ Claims, Norway v. the United States, Permanent Court of Arbitration, Award, October 13, 1922. ↑
Expropriation UNCTAD Series on Issues in International Investment Agreements II (2012) at 11. ↑
Generation Ukraine v. Ukraine, Award, September 16, 2003, para. 20.22. 6. ↑
Suez et al. v. Argentina, Decision on Liability, July 30, 2010, para. 121. ↑
Expropriation UNCTAD Series on Issues in International Investment Agreements II (2012) at 15. ↑
Id. The Iran-United States Claims Tribunal found expropriation where the Iranian Government appointed temporary managers in the subsidiaries of United States companies and the acts of the government appointees. ↑
“Правкомиссия одобрила проект по национализации имущества ушедших из РФ западных компаний” [“Government commission approved a project to nationalize the property of Western companies that left the Russian Federation”], Russian News Agency TASS, March 9, 2022, https://tass.ru/ekonomika/14012987. ↑
Decree of the President of the Russian Federation dated March 5, 2022, No. 252, “On the application of retaliatory special economic measures in connection with unfriendly actions of certain foreign states and international organizations,” http://actual.pravo.gov.ru/text.html#pnum=0001202205030001. ↑
GOR, Resolution No. 295,431-p of March 6, 2022, “Government approves rules for transactions with foreign companies from unfriendly countries and territories,” March 7, 2022; see also 2022 ITA Unpub LEXIS 343. ↑
Decree of the Government of the Russian Federation dated March 6, 2022, No. 299: “On Amending Paragraph 2 of the Methodology for Determining the Amount of Compensation Paid to the Patentee when Deciding to Use an Invention, Utility Model or Industrial Design without His Consent, and the Procedure for Its Payment,” http://actual.pravo.gov.ru/text.html#pnum=0001202203070005. ↑
On March 30, 2022, Russian Prime Minister Mikhail Mishustin announced and signed a law that made it legal to import grey market goods without proving the legitimacy of the products or obtaining the authorization of the trademark owner (which previously was required). Meeting of the Presidium of the Government Commission to Increase the Sustainability of the Russian Economy under the Sanctions, March 30, 2022, http://government.ru/en/news/44982/. The Russian Ministry of Industry and Trade will be issuing a list of products allowed into Russia, regardless of trademark protections. Id. ↑
See e.g. SwissInfo, “Court rules against Russia over Yukos affair,” August 23, 2007, https://www.swissinfo.ch/eng/court-rules-against-russia-over-yukos-affair/6068860 (noting that the Swiss Federal Court would not allow bank records to be sent to Russia because “Russia’s judicial standards fell short of the international norms needed to comply with the request.”); see also Paul B. Stephan, Taxation and Expropriation—The Destruction of the Yukos Oil Empire, 35 Hous. J. Int’l L. 1, 29–30 (2013) (citing to extradition cases Government of the Russian Federation v. Maruev and Chernysheva, Bow Street Magistrates Court, March 18, 2005; Government of the Russian Federation v. Temerko, Bow Street Magistrates Court, December 23, 2005; Regarding Law on Extraction of Fugitives 95/70, Application No. 2/07, District Court of Nicosia, April 10, 2008; and cases that refused to allow the seizure of corporate records Khodorkovsky v. Office of the Attorney General, Federal Supreme Court, Case 1A29/2007, August 23, 2007; Decision of February 6, 2006, Princely Court of Justice of Principality of Liechtenstein). ↑
Judgment of the District Court of Amsterdam in Case No. 355622/HA ZA 06-3612 of October 31, 2007. On appeal, the Amsterdam Gerechtshof (Court of Appeals) (confirming that Dutch law would not recognize any interest in Yukos Finance that Promneftstroy was granted in the Russian proceeding) and Judgment in Cases No. 200.002.097/01 and 200.002.104/01 of October 19, 2010. ↑
See 11 U.S.C. § 1500, et seq. Enacted in 2005, Chapter 15 governs cross-border bankruptcy and insolvency proceedings and was enacted pursuant to the 1997 UNCITRAL Model Law on Cross-Border Insolvency (“Model Law”) that has been enacted by more than 50 countries. ↑
In re Vneshprombank, Case No. 16-13534 (MG), Bank Foreign Main Proceeding Order, ECF Doc. #24. ↑
In re Vneshprombank, Case No 16-13534 (MKV) (Bankr. S.D.N.Y.). Section 1521(a)(4) allows for discovery by a foreign representative who is recognized by the Court. Section 1521(a)(5) “enables a Foreign Representative to take broad discovery concerning the property and affairs of a [foreign] debtor.” In re Foreign Econ. Indus. Bank Ltd., 607 B.R. 160, 170 (Bankr. S.D.N.Y. 2019) (quoting In re Millennium Glob. Emerging Credit Master Fund Ltd., 471 B.R. 342, 346 (Bankr. S.D.N.Y. 2012)). ↑
In re CJSC Automated Services, Case No. 09-16064 (JMP) (Bankr. S.D.N.Y. Nov. 23, 2009) (recognition granted for claims investigation but foreign representative failed to move forward). ↑
In re Rebgun (Yukos Oil Co.), Case No. 06-10775 (RDD) (Bankr. S.D.N.Y. Feb. 28, 2008) [ECF #145] (Chapter 15 case dismissed after provisional relief was granted but before recognition). ↑
In re Yukos Oil Company, 320 B.R. 130, 136 (Bankr. S.D. Tex. 2004). ↑
United States Department of State, U.S. Relations with Russia, Bilateral Relations Fact Sheet, Bureau of European and Eurasian Affairs, September 3, 2021, https://www.state.gov/u-s-relations-with-russia/. Russia and the United States signed an investment treaty in 1992 that was never enacted. Id. ↑
See, e.g. Agreement Between the Government of the Republic of Singapore and the Government of the Russian Federation on the Promotion and Reciprocal Protection of Investments, September 27, 2010. ↑
Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958) Commission On International Trade Law. ↑
Seizures by REPO are authorized under the International Emergency Economic Powers Act (IEEPA). 50 U.S.C. §§1701–1707. However, the IEEPA does not allow the U.S. government to take ownership over the assets as it is not a “vesting” statute, unless the U.S. is “engaged in armed hostilities or has been attacked by a foreign country or foreign nationals,” which is not the current state of the conflict in Ukraine. See 50 U.S.C. §1702(c) (the Patriot Act amended the IEEPA). ↑
General Agreement on Tariffs and Trade, October 30, 1947, 61 Stat. A-11, 55 U.N.T.S. 194 (“GATT 1947”). ↑
Terence P. Stewart and Shahrzad Noorbaloochi, “The WTO Panel Report on Article XXI and its Impact on Section 232 Actions,” Washington International Trade Association, April 11, 2019, https://www.wita.org/atp-research/the-wto-panel-report/. ↑
In re Yukos Oil Co., 321 B. R. 396 (Bankr. S.D. Tex. 2005), and Allen v. Russian Fed’n, 522 F. Supp. 2d 167, 171 (D.C. Cir. 2007). ↑
See Paul B. Stephan, Taxation and Expropriation—The Destruction of the Yukos Oil Empire, 35 Hous. J. Int’l L. 1, 36–45 (2013) (excellent discussion of the various available tribunals and the litigants’ approach in each, with the Strasbourg Court and the arbitration available through bilateral investment treaties being most amenable to hearing cases and finding jurisdiction). ↑
Id. (discussing that the Strasbourg Court held on several points in favor of the Russian taxing authority while arbitration panels disagreed with those decisions). ↑
Yukos Capital S.A.R.L. v. OAO Rosneft, Case No. 200.005.269/01, Decision (April 28, 2009) (Amsterdam Gerechtshof). ↑
Stephan at 41. In summary, “[i]t did not have to determine that Russia violated its own laws, much less any of the specific human rights obligations found in the European Convention. Rather, it had to determine whether Russia’s actions, in their entirety, constituted a compensable expropriation. To do so, it only had to determine that the government’s behavior was inconsistent with ‘routine regulatory powers,’ that is normal tax assessment and enforcement.” See also Quasar de Valores S.I.C.A. v. Russian Fed’n, I.I.C. 557 at P 227 (Arb. Inst. Stockholm Chamber of Commerce 2012). ↑
A new rule (12 CFR Part 1002, the “Rule”) issued in final form by the Consumer Financial Protection Bureau (the “CFPB”) earlier this year, though subject to legal challenges and delay, will impose a host of data collection and reporting obligations on lenders to small businesses. This article provides a high-level overview of key considerations for lenders in light of such enhanced future obligations.
A. Statutory Background:
The Rule, issued on March 30, 2023, implements Section 1071 (“Section 1071”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 1071, which amended the Equal Credit Opportunity Act, requires lenders who receive applications for small business loans to obtain, maintain, and periodically report to the CFPB certain information about applicants. Further, Section 1071 contemplates that the CFPB will make public the information it receives.
B. The Rule:
Application: The Rule’s reporting requirements apply to any financial institution with at least one hundred “covered originations” in each of the two previous calendar years. “Financial institution” is defined broadly to cover a range of entities engaging in “any financial activity”— i.e., this definition, and by extension, the Rule, could apply to both “traditional” bank lenders and alternative or direct lenders or private credit funds. Covered originations are certain types of credit extensions to “small businesses” (defined as businesses with gross revenues of no more than $5 million in the fiscal year preceding the time of determination).
Requirements: Lenders must report to the CFPB three types of data in connection with each consumer request (importantly, whether written or oral) for a covered credit transaction, including any refinancing of existing debt:
data generated by lenders (e.g., method of credit application and actions taken regarding such application);
data collected from applicants or third parties (e.g., credit purpose, amount requested, and details about the applicants’ business); and
demographic data collected from applicants, including minority-owned business status and information about principal owners.
Additionally, lenders must maintain certain policies and procedures, including:
Procedures reasonably designed to obtain a response to each request for applicant-provided demographic and other data.
Methods to recognize and address “indicia of potential discouragement”—i.e., practices that might cause applicants to decline to provide requested information. Note the CFPB issued a statement that it will “use its enforcement and supervisory authorities to focus on covered lenders’ compliance with” this requirement.
A “firewall” so that, with certain exceptions, persons making credit and other relevant determinations regarding a covered application by a small business do not have access to sensitive information provided by applicants pursuant to the Rule.
Unintentional errors occurring despite maintenance of appropriate procedures will not result in violations of the Rule. There is a presumption that unintentional errors below a numerical threshold are bona fide in nature. Safe harbors for certain types of inaccuracies in reported data also apply.
C. Compliance Considerations:
Smaller lenders will have more time to prepare for compliance than larger lenders. Compliance requirements will be phased in, starting in October 2024 for lenders with at least 2,500 covered originations in the aggregate for both 2022 and 2023. This timing may be affected by litigation for some lenders as described below.
Among other things, lenders must:
Analyze potentially covered credit transactions to determine whether the Rule applies and, if so, collect and provide accurate required data. In addition to developing effective routines to ensure careful and timely reporting, this process involves accurately identifying relevant data for each covered transaction, such as:
the purpose and type of credit;
the application method for such credit;
the reportable amounts (applied for and approved amounts);
pricing information; and
as applicable, reasons for approval or denial of such credit.
Collect and accurately analyze information about applicants, including by identifying relevant demographic and other characteristics.
Maintain procedures to “identify and respond to indicia of potential discouragement” in the credit and lending process.
Develop practices to ensure proper maintenance of the above-mentioned “firewall.” This would involve accurately identifying which persons are (or are not) involved in determining whether to extend credit to a given applicant.
D. Concluding Observations:
The Bureau’s Rule implementing Section 1071 has been the subject of considerable controversy. The rulemaking followed a lawsuit filed by community groups seeking to compel the Bureau to promulgate the Rule, and the process generated voluminous comments, many critical of the new burdens the Rule will impose on lenders. Currently, litigation is pending in federal district court in Texas in which the American Bankers Association and the Texas Bankers Association contend the Rule must be set aside. On July 31, 2023, the court in that case preliminarily enjoined the Bureau from enforcing the Rule against ABA and TBA members pending a decision in CFPB v. Community Financial Services Association, in which the Supreme Court will review the decision of the Fifth Circuit that the CFPB’s funding structure is unconstitutional. Since then, multiple other trade groups representing community banks, credit unions, and others have intervened in the Texas case and requested that implementation of the Rule be enjoined as to their members as well. The Kentucky Bankers Association has also filed a new separate lawsuit together with a group of Kentucky-based lenders similarly contending the Rule must be set aside.
As a practical matter, however, small business lenders would be wise to ensure they can meet future compliance obligations under the Rule. As sketched above, the Rule imposes substantial new administrative burdens, and compliance could prove costly and challenging, especially for community and local institutions. The Rule also seems likely to present challenges for larger institutions, whose existing frameworks for collecting demographic and other consumer information (for example, as required by federal fair lending laws) may not map easily onto the Rule’s distinct requirements. Notably, the Rule is part of a growing trend towards greater regulatory scrutiny over commercial lending, with a particular emphasis on small business transactions—in recent years, state regulators in jurisdictions such as California, Utah, New York, and Virginia have enacted laws mandating broad disclosures by commercial lenders. Considering the Rule’s broad applicability, the numerous new requirements it imposes, and the Bureau’s stated intention to make the Rule’s provisions concerning “discouragement” an enforcement priority, industry participants that engage in small business lending should work with counsel to prepare for compliance.
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