Lessons We All Should Learn from the Great Salt Lake Crisis

Those of us on the east coast have heard that the Great Salt Lake has receded to the verge of a public health crisis, including because toxins in the sediment that have been underwater for millennia may soon may soon be widely spread air pollutants.   Today I had the opportunity to visit the rapidly shrinking Great Salt Lake and hear from leading experts about what might be done about it.  Much of what I heard surprised me.  More importantly, some of the lessons learned in Utah are generally applicable to our still evolving response to our global climate emergency.

How much has the Great Salt Lake shrunk?   In the modern era it has lost 73 percent of its water and 60 percent of its area.  Of the 120 saline lakes on the planet, 100 are in decline and on average they have shrunk, on average, 60 percent.  That means that as bad as things are at the Great Salt Lake, there are many other places where things are worse.

Contrary to popular belief, while a warming climate is a contributing cause of this decline, it is not the main cause.  The main cause is that water has been diverted from the historic tributaries to the Great Salt Lake for other uses, primarily agriculture which is responsible for 72 percent of Utah’s water consumption.  Those diversions have been occurring since Brigham Young arrived in Utah in the 19th century.

Why does the shrinking of the lake matter?  Well, in addition to the public health threat posed to the southwestern United States by the toxins in the sediment, the increased water salinity that comes with the Great Salt Lake being smaller is toxic to the brine shrimp that are essential to the survival of the tens of millions of migratory birds that make the lake home for part of the year on their way to and from other places in North and South America.  The rapidly receding waters also pose a clear and present danger to other economically important activities including mineral extraction and tourism.  One example of the broad range of negative impacts of the shrinking lake — snow in the mountains has been proven to melt faster as a result of the deposition of dust from the lake, shortening Utah’s economically important ski season.

I was of the prior impression that people in Utah didn’t appreciate the magnitude of the crisis at hand.  I was wrong.  The fact is that the Utah Legislature has taken numerous actions in recent years to reverse more than a century of momentum in the wrong direction.  As a result of these actions there is cause for real optimism that the level of the Great Salt Lake will continue to rise though it will take decades to make lasting improvements.

And that brings me to the lessons of general applicability that I learned.   As one local water law expert said, there is no silver bullet to end the Great Salt Lake crisis but there is silver buckshot.   There is no one law that can be passed or one lawsuit that will be litigated that will immediately void the water rights that have resulted in Utah (and all of the other western states) using much more water than can sustainably be used.  What the people of Utah have learned is that many interventions are necessary, all at the same time.  And they’re implementing that lesson in real time.    We all might consider whether we’re acting with the same ingenuity and urgency respecting our environmental challenges.

And I heard another important thing for the second time in a week.  The biggest challenge in repairing the Great Salt Lake isn’t identifying what needs to be done.  It is getting people to own what it will take to get water into the Great Salt Lake and why that matters.   The necessary messaging is complicated because there is no one size fits all message and even if you’re doing it correctly, it isn’t immediately effective.  I heard The Nature Conservancy’s Chief Scientist, Dr. Katherine Hayhoe, say something similar about decarbonization and resilience when she was in Boston last week.

The Great Salt Lake crisis became too big for the people of Utah to ignore.  But their multifaceted approach to the crisis is impressive and left me wondering what we on the east coast might be able to do about our much different but equally serious environmental challenges, like the need to more quickly build renewable energy infrastructure and improve our resilience to GHG supercharged storm waters, if we acted with the same urgency.

For more articles on the environment, visit the NLR Environmental, Energy & Resources section.

Fed Issues FAQs Clarifying That Credit-Linked Notes Can Serve as Valid Capital Relief Tools for U.S. Banks

On September 28, the Federal Reserve Board (“FRB”) posted three new FAQs to its website regarding Regulation Q (Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks). The FAQ guidance provides additional clarity on the use of credit-linked notes (“CLNs”) to transfer credit risk and offer capital relief to U.S. banks. While in some respects the FAQs merely confirm positions that the FRB has already taken in regard to individual CLN transactions, these FAQs are nevertheless important inasmuch as they publicly memorialize the FRB’s view of these products as valid capital management tools.

The FAQs speak to two different formats of CLNs: those issued by special purpose vehicles (“SPV CLNs”) and those issued directly by banks (“Bank CLNs”). The FRB’s view of SPV CLNs is relatively straightforward: per the FAQs, the FRB recognizes that properly structured SPV CLNs constitute “synthetic securitizations” for purposes of Regulation Q and that the collateral for such SPV CLNs can serve as a credit risk mitigant that banks can use to reduce the risk-weighting of the relevant assets.

The FRB’s posture toward Bank CLNs, however, is more nuanced.  According to the FRB, unlike SPV CLNs, Bank CLNs do not technically satisfy all of the definitional elements and operational criteria applicable to “synthetic securitizations” under Regulation Q, such that banks that issue Bank CLNs would not be able to automatically recognize the capital benefits of such transactions (as would be the case with properly structured SPV CLNs). The reasons for this are twofold: first, Bank CLNs are not executed under standard industry credit derivative documentation; and second, the issuance proceeds from Bank CLNs generally are owned outright by the issuing bank (rather than held as collateral in which the issuing bank has a security interest). Nevertheless, the FRB recognized that Bank CLNs can effectively transfer credit risk; as such, the FRB is willing to exercise its “reservation of authority” to grant capital relief on a case-by-case basis for Bank CLNs where the only two features of the Bank CLNs that depart from the strictures of Regulation Q are those described above. In other words, Bank CLNs can offer capital relief, but only if the issuing bank specifically requests such relief from the FRB and the FRB decides to grant such relief under its reservation of authority powers.

In his statement dissenting on the issuance of the U.S. Basel III endgame proposed rules—our discussion of which is available here—Federal Deposit Insurance Corporation (“FDIC”) Director Jonathan McKernan argued for increased clarity on the FRB’s position with respect to CLNs in order to provide U.S. banks with better parity in relation to their European counterparts (which routinely issue CLNs in different formats). While these FAQs may not fully address FDIC Director McKernan’s concerns, they do begin to provide some clarity concerning the effective use by banks of CLNs as capital management tools.

For more articles on finance, visit the NLR Financial Institutions & Banking section.

EPA Ramps Up Climate Enforcement

Facilities operating across the country need to be prepared for increased climate-driven enforcement at all levels of federal government—especially at the U.S. Environmental Protection Agency (EPA). With EPA’s Climate Enforcement and Compliance Strategy announcement last week, the Agency has gone all-in on enforcement and compliance programs “to address climate change, wherever appropriate, in every matter within their jurisdiction.” This initiative is consistent with President Biden’s Executive Order 14008, which calls for a government-wide approach to tackling the climate crisis. The strategy also underscores the Agency’s announcement of its first-ever National Enforcement and Compliance Initiative (NECI) on climate change, which targets, among others, methane emissions at oil and gas facilities and landfills, as well as illegal importation of hydrofluorocarbons (HFCs). Companies with exposure to high-Greenhouse Gas (GHG) emissions and related climate risks, both in the Clean Air Act (CAA) and non-CAA context, should be on notice of increased scrutiny moving forward, including climate-focused auditing and inspections by the Agency and GHG-driven injunctive relief.

In the wake of EPA’s announcement of this new enforcement and compliance strategy, watch for the following developments:

  • EPA will increasingly prioritize enforcement and compliance actions to mitigate climate change, including further scrutiny of high-GHG emitters through information requests, inspections, and formal enforcement. Oil and gas facilities and landfills have been specifically targeted, but any facility with high GHG emissions should expect greater enforcement scrutiny.
  • Enforcement demands will likely include higher penalties, compared to other non-GHG-driven cases, more GHG-related injunctive relief, as well as more climate adaptation and resilience requirements. This relief could include more fence-line monitoring or flare gas reductions or recovery, among other priorities.
  • Climate-focused injunctive relief measures will not be limited to CAA. Expect a renewed emphasis on green remediation technologies at Superfund and Resource Conservation and Recovery Act corrective action sites, as well as a push for green infrastructure, resiliency planning, and stormwater management enhancements in Clean Water Act settlements.
  • Plan for EPA to scrutinize GHG emissions reports more closely. Carefully evaluate these submissions to ensure consistency with reporting regulations.
  • EPA will be interested in Supplemental Environmental Projects that reduce GHGs.  Consider clean and renewable energy projects or other GHG mitigation projects as part of any strategy to resolve an enforcement case, particularly if the penalty demand is large.

Facilities located in Environmental Justice (EJ) communities should particularly expect additional climate-related scrutiny, as EPA has indicated that “[t]hese efforts are particularly necessary in overburdened and marginalized communities that are on the frontlines of the climate crisis.” Facilities will need to engage in more extensive consultation with local communities to evaluate remedy selection, including any climate adaptation efforts, as well as more protracted enforcement negotiations to evaluate community-focused injunctive relief (i.e., climate risk reporting, additional community engagement, etc.).

Finally, be prepared to respond to these issues quickly, including the Biden Administration’s broader EPA enforcement agenda, which is expected to increase enforcement dramatically over the coming months and years. Apart from EPA, broader scrutiny of corporate climate reporting will become more common as the Securities and Exchange Commission looks to finalize its proposed Climate Risk Disclosure Rule, requiring public companies to disclose climate-related risks and emissions data, among other requirements. Facilities should review publicly available information and emissions reporting for consistency and accuracy.

For more articles on the EPA, visit the NLR Environmental, Energy and Resources section.

Using AI to Replicate or Replace Human Creativity May Violate Intellectual Property Law

As artificial intelligence (AI) becomes better and more prevalent, people will increasingly use its computing power to supplement or replace human creativity. Film director Gareth Edwards attempted to do just that  in his new movie, The Creator, about artificial intelligence. Edwards used an AI algorithm to attempt to replicate the musical style of composer Hans Zimmer.  Ultimately, Edwards abandoned this effort and hired Zimmer to compose the score because although the AI-generated track was convincing, Edwards believed it still felt short of human Zimmer’s work.

Because AI generates new content through a database of existing content, the model’s output can convincingly replicate existing artists. However, the AI-generated content may be simplistic and lack a human’s creativity. In an interview with the MIT Technology Review, Edwards stated his belief that generative AI should be embraced like Photoshop and treated like a tool for improving the creative process.

Although there may be similar creative benefits between generative AI and Photoshop, using AI to replicate or replace human creativity may violate intellectual property laws. Writers, including Game of Thrones author George R.R. Martin, are currently suing OpenAI alleging that the company violated the authors’ copyrights by using their collective works to train its model. The results of this case and similar cases may determine the future viability of generative AI as a creative tool for mass consumer entertainment.

For more articles on AI, visit the NLR Communications, Media & Internet section.

Employer Student Loan Debt Benefits Following SECURE 2.0

In December 2022, Congress enacted groundbreaking legislation as part of the SECURE 2.0 Act (SECURE 2.0) codifying an opportunity for employers to provide matching contributions within a tax-qualified retirement plan based on their employees’ qualified student loan payments outside the plan. The SECURE 2.0 student loan payment match is the latest vehicle for employers to aid employees to help relieve the financial burden of student loan debt.

This On the Subject discusses the SECURE 2.0 student loan benefit and other employer options for providing tax-advantaged benefits to employees based on student loan payments. It also examines the open questions and current implementation challenges for sponsors of 401(k) and 403(b) plans hoping to implement the student loan benefit.

IN DEPTH


THE STUDENT LOAN DEBT PROBLEM AND EMPLOYER RESPONSE

Over the last two decades, the amount of outstanding student loan debt in the United States has grown exponentially. Studies suggest there are currently around 43 million Americans with student loan debt of more than $1.6 trillion. Paying off student loan debt has become a hot-button political issue, including with presidential candidates and members of Congress. Earlier this summer, the US Supreme Court’s decision in Biden v. Nebraska rejected the Biden administration’s plans for student loan debt relief. The Supreme Court held that the Higher Education Relief Opportunities for Students Act of 2003 did not authorize the secretary of education to cancel approximately $430 billion in federal student loan principal. This decision comes as the statutory pause on student loan repayments ended on September 1, 2023, a moratorium enacted in response to the COVID-19 pandemic and lasting over three years.

Managing student loan debt has become an increasingly significant issue for many workers. As a result, student loan debt presents a significant opportunity for employers. Student loan repayment programs can be a key factor in attracting and retaining talent. In a 2019 survey conducted by Gradifi, a student loan benefits provider, 70% of employees said they were likely to stay at their current jobs because a student loan paydown plan was available. Ninety-seven percent of employees reported being happier in their place of employment because of a student loan repayment program. Ninety-two percent of employees reported feeling an improvement in their stress because of their employer’s student loan repayment program. As a result, many employers are investigating new options to stay competitive and help their employees tackle student loan debt.

OPTIONS FOR EMPLOYERS TO PROVIDE TAX-ADVANTAGED STUDENT LOAN DEBT BENEFITS

Unfortunately, there are limited ways for employers to structure a program to provide student loan debt assistance that is not subject to immediate income tax. The current vehicles for providing student loan debt benefits on a tax-advantaged basis are:

Educational Assistance Programs

As part of the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act), Congress amended Section 127 of the Internal Revenue Code (Code) to permit employers to pay up to $5,250 per year to employees for student loan repayments as part of an educational assistance program. Many employers utilize such plans to provide tuition reimbursement for college or advanced degrees. Under the CARES Act, employers may also utilize these plans to provide student loan debt assistance.

To do so, employers must comply with the requirements of Section 127 of the Code, including:

  • The employer must have a written plan document that lays out the terms of the program;
  • The program must benefit employees or certain former employees who qualify under rules set up so that the program does not favor highly compensated employees;
  • The program must not provide more than 5% of its benefits during any year for shareholders or owners (or their spouses or dependents) who own more than 5% of the stock or of the capital or profits interest of the business;
  • The program must not allow employees to choose to receive cash or other benefits that would be included in gross income instead of educational assistance; and
  • Eligible employees must be given reasonable notice of the program.

An educational assistance program provides a direct ability to pay off student loan debt through a basic but effective tax structure. Employers can make payments either to employees or directly to lenders. Many employers who offer student loan repayment benefits work with a third-party vendor because the employer does not want to be in the position of asking employees for sensitive financial information regarding student loan debt. Vendors often work with lenders either to pay off student loan debt directly or, if the employer provides direct payment to employees, to track or verify student loan debt payments so that the employer can be certain the payments are being used to pay off student loan debt.

The $5,250 limit is the combined limit for all educational assistance, including both expenses related to tuition reimbursement and student loan debt payments. Under current law, the ability for employers to pay up to $5,250 per year to employees for student loan debt payments as part of an educational assistance program expires on December 31, 2025. However, it is often the case that employee benefit options enacted through the Code which are originally scheduled to sunset are extended indefinitely or made permanent. There is no guarantee, but it would not be surprising if the student loan debt payment benefit is extended or made permanent, particularly in the current environment where student loan debt receives significant media attention.

Contributions to Tax-Qualified Retirement Plans

In 2018, the Internal Revenue Service (IRS) released a groundbreaking private letter ruling (PLR) that helped to clear the way for employers to begin providing student loan repayment benefits as part of their 401(k) plans. The PLR confirmed that, under certain circumstances, 401(k) plan sponsors may link the amount of employer contributions made on an employee’s behalf to the amount of student loan debt payments made by the employee outside the plan. However, the PLR only applied to the specific plan sponsor requesting the ruling and did not address the effect on many other plan qualification requirements, such as the Code Section 401(a)(4) nondiscrimination requirement.

SECURE 2.0 codified the ability for certain defined contribution plan sponsors to provide employer-matching contributions based on employee payment of student loan debt. Effective for plan years after December 31, 2023, 401(k) and 403(b) plan sponsors can provide employer-matching contributions based on an employee’s “qualified student loan payments” made outside of the plan. A qualified student loan payment includes any payment made by an employee in repayment of a qualified higher education loan. The loan must be for the cost of attendance at an eligible educational institution.

SECURE 2.0 provided a helpful statutory framework for plan sponsors to provide matching contributions on student loan payments. Some of the most significant features are:

  • “Qualified student loan payments” can include payments made by an employee for student loans made on behalf of the employee, the employee’s spouse or dependent;
  • Plan sponsors are permitted to rely on an employee’s self-certification of qualified student loan payments, which certification must be made on an annual basis;
  • Matching contributions on student loan payments must be treated the same as matching contributions made on elective deferrals concerning the match percentage, eligibility and the same vesting rules (though match frequency can differ);
  • Plan sponsors may make the student loan match more frequently than annually (e.g., on a payroll period basis), but employees must have at least three months after the close of the plan year to claim the match;
  • Qualified student loan payments are treated as available to all participants for purposes of the Code Section 401(a)(4) nondiscrimination testing requirements;
  • Student loan payments can be treated as elective deferrals for safe harbor plan rules; and
  • For purposes of the Actual Deferral Percentage (ADP) test, plan sponsors may separately test participants who receive matching contributions on account of qualified student loan payments.

OUTSTANDING QUESTIONS REGARDING SECURE 2.0 STUDENT LOAN EMPLOYER MATCHING CONTRIBUTIONS

While SECURE 2.0 provided the framework for the implementation of the student loan match, many open questions remain, and the US Department of the Treasury (Treasury) and IRS need to provide more guidance to fully implement this feature. Some specific areas where guidance would be helpful include:

  • More guidance on what constitutes a qualified student loan payment. It seems clear that payment made by an employee toward a loan taken by an employee, employee’s spouse or dependent qualifies, but when is this determined? What if the employee’s spouse or dependent was a spouse or dependent when the loan was taken, but not when the loan payments are made (or vice versa)?
  • What is required for a plan sponsor to establish reasonable procedures regarding annual self-certification? Separately, are there any limits on how much substantiation a plan sponsor can require if it wants to?
  • If the match is allocated after the end of the year, can it be limited to active employees? Would this apply to safe harbor plans (which generally are not permitted to require service as of the last day of the plan year for employees to receive contributions) as well?
  • How does the ability of employees to claim the match within three months after the end of the plan year affect the general requirement for non-safe harbor plans to correct ADP and Actual Contribution Percentage testing failures within two-and-a-half months after the end of a plan year to avoid an excise tax?
  • How do the vesting requirements work? The student loan match must vest “in the same manner” as a regular match. How does this work if the plan has a fully vested safe harbor match plus a discretionary match subject to a vesting schedule?

SECURE 2.0 directs the Treasury to issue regulations to address these and other questions and establish reasonable procedures and deadlines for employees to take advantage of the student loan match benefit.

PLAN SPONSOR CHALLENGES IMPLEMENTING SECURE 2.0 STUDENT LOAN DEBT BENEFITS

In addition to the open legal questions, numerous other challenges exist for plan sponsors seeking to implement the SECURE 2.0 student loan matching contribution. Most significantly, plan sponsors need to assess their ability to implement a student loan benefit within the context of their existing 401(k) or 403(b) plan platform. The plan’s recordkeeper and third-party administrator must have systems set up to administer the student loan debt benefit. Due in part to the ongoing questions and lack of guidance, many recordkeepers have delayed the development of the systems set up to administer student loan debt benefits on a large scale beginning in 2024. Some have set up pilot programs to test the option for a handful of plans. Many recordkeepers and administrators are just starting to “pilot” their process and systems for 2024 before making the offering available more widely, which may be in 2025 or 2026.

Employers pondering a SECURE 2.0 student loan benefit should consider the following:

  • Is the benefit right for your employee population? For some employers the answer is obvious: They either have a significant number of employees with college or advanced degrees for whom this issue is a high priority, or they do not. For others, it can be useful to assess the employee demographics to estimate the proportion of employees who may be interested in a student loan match. Some 401(k) recordkeepers are developing data and programs to help their clients make this determination. Some employers have utilized polls or surveys to try to determine employee interest.
  • What is the potential cost? Employers can model cost projections based on expected participation rates. Some recordkeepers are developing data and programs to help their clients make this determination.
  • Are there other, more effective ways to provide student loan debt benefits? For example, the CARES Act educational assistance program benefit discussed above is a relatively straightforward way to provide direct student loan debt benefits.

Although challenges remain, plan sponsors should keep in mind that plan design features are constantly evolving, and implementation issues always take time. Many retirement plan practitioners believe that it is only a matter of time before the student loan employer matching contribution becomes a commonplace feature within most employers’ 401(k) or 403(b) retirement plans.

Article by Jeffrey M. Holdvogt , Brian J. Tiemann , Teal N. Trujillo of McDermott Will & Emery

For more news on education, visit the NLR Public Education and Services page.

The Complex Reality of Immigration Detention Centers in the Biden Era

n 2020, President Joseph “Joe” Biden pledged to end for-profit immigration detention, emphasizing the moral imperative that “no business should profit from the suffering of desperate people fleeing violence.” However, as the Biden administration embarked on this mission, it encountered numerous challenges.

As of July 2023, 90 percent of the 30,000 individuals in ICE detention were housed in privately operated facilities. Private corporations have seen their revenues from immigrant detention increase exponentially. As the ACLU has stated, it is evident that the federal government’s immigration detention system leans heavily on private prison corporations. Notable entities in this sector, including the GEO Group, CoreCivic, LaSalle Corrections, and the Management Training Corporation, have amassed billions from ICE detention contracts over the past two decades.

A recent internal review of detention centers brought into focus the intricate issues surrounding immigration detention and how it currently affects communities, detainees, and the interests of private prison companies.

The Promise of Change & Findings

During his campaign, Biden pledged to end the use of private prison companies for immigration detention. In 2021, he declared “no private prisons, period,” when responding to protesters advocating for an end to immigration detention. However, Biden’s statement noticeably omitted ICE detention from this pledge despite issuing an executive order in Jan. 2021 instructing the Department of Justice to gradually terminate its contracts with private prison companies. Consequently, the number of immigrants detained by ICE has continued to rise, leading to increased revenues for private prison companies.

In May 2021, shortly after Biden took office, senior immigration officials launched an internal review of detention centers, aiming to assess which facilities should be scaled back, reformed, or closed. During this period, private prison companies experienced a notable surge in revenue from ICE contracts, prompting concerns among advocates who questioned whether private facilities met the required standards of care for detainees, including concerns about poor medical care, unsanitary conditions, limited access to legal representation, sexual assault, and detainee deaths. The internal review highlighted advancements achieved within detention centers as well as persistent challenges. At the Moshannon Valley Processing Center, noticeable changes included the removal of razor wire from the fences and the absence of deadly weapons among staff. Detainees are now referred to as “residents,” and guards are designated “resident advisers.” However, accounts from inmates reveal instances of unjust solitary confinement and mistreatment by guards, underscoring the ongoing issues within these facilities.

As Biden gears up for potential re-election in 2024, immigration continues to be a controversial topic. While the Biden administration has not yet addressed concerns regarding the closing or improving some of the most heavily criticized detention centers, a White House spokesperson reiterated the administration’s dedication to reducing the use of private detention facilities.

Ongoing immigration detention reform is a journey fraught with challenges, including competing economic interests, political pressures, and the need to work toward the humane treatment of detainees. The Biden administration has made some strides, but the debate surrounding immigration detention remains complex and divisive.

Read more immigration news on the National Law Review.

Mo Money, Mo Problems? No Biggie for a Homeowner’s Association, Right?

Was your community association lucky enough to come in under budget last year?

On the surface, this might appear to be a bonus, but if not handled properly, it can quickly turn into an unexpected tax burden.

Taxation of Community Associations

 

Almost all community associations in North Carolina are formed as non-profit corporations, which are taxed as corporations. This means community associations should file an IRS Form 1120 (“U.S. Corporate Income Tax Return”) at the federal level. However, a community association may elect to be taxed as a “homeowners association” under Section 528 of the Internal Revenue Code of 1986, as amended (“Code”), and file a Form 1120-H (“U.S. Income Tax Return for Homeowners Associations”).  Oftentimes, a community association’s articles of incorporation, bylaws, or declaration will require that the association make this election.  If your community association chooses to file a Form 1120-H, it will be taxed at a 30% federal income tax rate on its “homeowners association income.” In addition, the election means that the association is not eligible to avoid tax on excess income.  However, the good news is that “homeowner association income” does not include membership dues, fees, and assessments.

Taxation as a Regular Corporation

 

A community association that does not elect to be taxed as a Code Section 528 homeowners association (and file a Form 1120-H) is taxed as a regular corporation subject to standard federal and state income taxes.  Under these standard tax rules, taxable gross income includes “all income from whatever source derived.”  Code Section 61.  But in the case of membership funds paid to community associations, the funds are viewed not necessarily as income but as monies held by an agent (the community association) to pay expenses for its principal (the members or owners of the community association).  For example, Revenue Ruling 75-370 found that condominium owner assessments are not treated as taxable income to the condominium association “since the funds are received by the community association for the unit owners to be used solely for the benefit of the unit owners.”

Handling Excess Assessments

 

Where a community association has received assessments from its members during the year in excess of its budgeted expenses, the Internal Revenue Service (“IRS”) determined, in Revenue Ruling 70-604, that the excess amounts are not taxable income to the association itself where the members vote at the end of the year either to: (1) apply excess assessments to their future assessments; or (2) rebate the excess amounts back to the members.  The IRS made this key ruling with respect to excess assessments received by a condominium management corporation. In its ruling, the IRS noted that the stockholder-owners of the condominium association held a meeting each year at which they decided what to do with any excess assessments not actually used for association expenses.  Your community association’s membership will need to do the same to take advantage of this tax exemption—take a vote (either in person or by written ballot) before the association files its Form 1120.

After issuing this ruling, the IRS clarified, in several informational letters, that the ruling did not mean that condominium and homeowners associations could retain excess assessments from year to year in a working capital reserve without recognizing the amounts as taxable income.  Accordingly, your community association may not apply excess assessments to its reserve account.  It must either: (1) return the excess assessments to the membership or (2) apply the excess assessments to the next fiscal year, thereby reducing the subsequent year’s annual assessment.

Authority of the Community Association Board of Directors

 

Under the North Carolina Planned Community Act and the North Carolina Condominium Act, the board of directors has the authority, not the members, to decide if excess funds will be returned to the members, used for reserves, or used to offset assessments for the following year.  If the board of directors does decide the funds will be used to offset future assessments the, the members should vote to take advantage of the exemption.

Thus, both federal and state law authorizes a community association to avoid excess assessments by returning such excess to its members or by applying such excess to the subsequent year’s budget.  However, both of these Acts vest the financial affairs of a community association in the association’s board of directors, not the members.  Accordingly, if your community association comes in under budget for any tax year, we recommend that your community association’s board of directors include with its annual membership minutes an action item for the members to vote upon adopting Revenue Ruling 70-604 to avoid paying taxes on any excess assessments.

Summary of Steps to Avoid Federal Income Tax

To sum things up, your community association can avoid federal income tax on any excess assessments it has at the end of the fiscal year if:

  • it files a regular IRS Form 1120;
  • its members take a vote each year to apply the excess towards next year’s operating budget;
  • the vote is either in person or via written ballot at the annual membership meeting before the community association’s tax return is filed.

 

Read more real estate news on the National Law Review.

Renewable Energy Tax Credit Transfer Guidance Provides Both Clarity And Pitfalls

Highlights

The renewable tax credit transfer market will accelerate with new government guidance; public hearing and comments deadlines are scheduled for August

Risk allocation puts the usual premium on sponsors with a balance sheet and/or recapture insurance coverage

While the guidelines provide clear rules and examples, many foot faults are present

On June 14, 2023, the Treasury Department and Internal Revenue Service issued long-awaited guidance on the transferability of certain renewable energy-related federal tax credits. The guidance takes the form of a notice of proposed rulemaking, proposed regulations, and an online Q&A, with a public hearing to follow in August.

Under new Code Section 6418, eligible taxpayers can elect to transfer all or any specified portion of eligible tax credits to one or more unrelated buyers for cash consideration. While the tax credits can be sold to more than one buyer, subsequent transfers by the buyer are prohibited.

This alert highlights several practical issues raised by the guidance, which should allow participants waiting for more clarity to proceed.

Individual Buyers Left Out

  • The guidance applies the Code Section 49 at risk rules and Section 50(b) tax-exempt use rules, generally restricting sellers in calculating the amount of tax credits for sale, and Code Section 469 passive activity rules, generally restricting buyer’s use of such tax credits, in various contexts. On the buyer side, these rules appear to be more restrictive than the limitations that would apply to identical tax credits in an allocation, rather than sale, context. Suffice to say, this will prohibit individuals from taking part in the transfer market for practical purposes outside of fact patterns of very limited application.
  • While this result may not be surprising since such rules currently severely restrict individuals from participating in traditional federal tax credit equity structures, there was some hope for a different outcome due to the stated policy goal of increasing renewable energy investment (not to mention the Inflation Reduction Act’s general departure from decades of case law precedent and IRS enforcement action prohibiting sales of federal tax credits with the enactment of Section 6418).

Lessees Cannot Sell the Tax Credits

  • A lessee cannot transfer the credit. With the prevalence of the master lease (inverted lease) structure in tax equity transactions, this prohibition created an unexpected roadblock for deal participants who have been structuring tax equity transactions with backstop type sale provisions for almost a year now. This presents developers, at least in the inverted lease context, with a choice of utilizing a traditional tax equity structure for the purpose of obtaining a tax-free step up in basis to fair market value, or forgoing the step up for less financing but also less structure complexity. The standard partnership flip project sale into a tax equity type of holding company structure could still remain a viable alternative.
  • As the transfer is generally made on a property-by-property basis by election, creative structuring, in theory, could allow for a lessor to retain certain property and sell the related tax credits (e.g., on portfolios with more than one solar installation/project, or even with large projects that go online on a block-by-block basis assuming the “energy project” election is not made – a term that future guidance will need to provide more clarity on).
  • However, this seems to be an ivory tower conclusion currently, and the practical reality is that too many unknown issues could be raised by such out of the box structuring, including the fact that conservative institutional investors may refuse to participate in such a structure until clear objective guidance is published addressing the same.

Bonus Credits Cannot Be Sold Separately

  • Bonus credits cannot be sold separately from the underlying base credit. This is more problematic for certain adders – for example, the energy community adder rules are now out and amount to simply checking a location on a website. Others (e.g., the low-income community or domestic content adder) require more extensive and subjective application and qualification procedures which makes when and how such adders can be transferred difficult to ascertain. Projects hoping to transfer such credits may need to be creative in compensating buyers for such uncertainty and qualification risk. Tax equity transactions that closed prior to the guidance’s issuance may also need to be revisited, as provisions in such transaction documents commonly attempted to bifurcate the bonus credit away from the base credit in order to allow the sponsor to separately sell such adders.

Buyers Bear Recapture Risk and Due Diligence Emphasis

  • While the Joint Committee on Taxation Bluebook indicated the buyer is responsible for recapture, industry participants were still hoping such risk would remain with the seller. Outside of the limited situation of indirect partnership dispositions (which still results in a recapture event to the transferring partner if triggered), the recapture risk is borne by the buyer, using the rationale that the buyer is the “taxpayer” for purposes of the transferred tax credits. While this is familiar territory for tax equity investors, whose allocated tax credits would be reduced in a recapture scenario, tax credit purchase transactions are now burdened with what amounts to the standard tax equity type of due diligence, including negotiation of transaction documents outside of a basic purchase agreement.
  • The guidance provides that indemnity protections between the seller and buyer are permitted. Tax equity transactions historically have had robust indemnification provisions, which should remain the case even more so in purchase/sale transactions. Tax equity investors traditionally bear “structure risk” dealing with whether the investor is a partner for tax purposes – such risk is eliminated in the purchase scenario as the purchasing investor no longer needs to be a partner (subject to the caveat of a buyer partnership discussed below).
  • If the buyer claims a larger credit amount than the seller could have, such “excessive credit transfer” will subject the buyer to a 20 percent penalty on the excess amount (in addition to the regular tax owed). All buyers are aggregated and treated as one for this purpose – if the seller retains any tax credits, the disallowance is first applied to the seller’s retained tax credits. A facts and circumstances reasonable cause exception to avoid this penalty is provided, further emphasizing the need for robust due diligence.
  • Specific non-exclusive examples that may demonstrate reasonable cause include reviewing the seller’s records with respect to determining the tax credit amount, and reasonable reliance on third-party expert reports and representations from the seller. While not unique to this new tax credit transfer regime, the subjective and circular nature of such a standard is complex – for example, when is it not “reasonable” for buyers or other professionals to rely on other board certified and licensed professionals, such as an appraiser or independent engineer with specialized knowledge?
  • Buyers thus need to remain vigilant about potential recapture causing events. For example, tax equity investors will not generally allow project level debt on investment tax credit transactions without some sort of lender forbearance agreement that provides that the lender will not cause a tax credit recapture event (such as foreclosing and taking direct ownership of the project). Buyers remain responsible for such a direct project level recapture event, which again aligns the tax credit transfer regime with tax equity due diligence and third-party negotiation requirements. The guidance is more lenient for the common back-leverage debt scenario.
  • While similar interparty agreements between back leverage lenders and the tax equity investor are required for non-project level debt facilities to address tax credit recapture among other issues, the guidance provides that a partner disposing of its indirect interest in the project (e.g., the lender foreclosing and taking ownership of a partner’s partnership interest) will remain subject to the recapture liability rather than the buyer provided that other tax-exempt use rules are not otherwise implicated. However, the need to negotiate such lender related agreements is still implicated as not all recapture risk in even this scenario was eliminated to the buyer.
  • While the recapture risk could place a premium on production tax credit deals (that are technically not subject to recapture or subjective basis risk), the burdensome process of needing to buy such tax credits on a yearly basis in line with sales of output may make such transactions more tedious.
  • The insurance industry already has products in place to alleviate buyer concerns, but this is just another transaction cost in what may be a tight pricing market. Not unlike tax equity transactions, sponsor sellers with a balance sheet to backstop indemnities may be able to demand a pricing premium; other sponsors may need to compensate buyers with lower credit pricing to reward such risk and or/to allow the purchase of recapture insurance. While this seems logical, the guidance also includes anti-abuse type rules whereby low credit pricing could be questioned in terms of whether some sort of impermissible transfer by way of other than cash occurred (e.g., a barter for some sort of other service). What the IRS subjectively views as “below market” pricing could trigger some sort of audit review based on this factor alone which further stresses the importance of appropriate due diligence.

Partnerships and Syndications

  • The guidance provides very clear rules with helpful examples, which should allow partnership sellers and buyers to proceed with very objective parameters. For example, the rules allow a partnership seller to specify which partner’s otherwise allocable share of tax credits is being sold and how to then allocate the tax-exempt income generated. The cash generated from sales can be used or distributed however the partnership chooses.
  • Similar objective rules and examples are provided for a buyer partnership. Subsequent direct and indirect allocations of a purchased tax credit do not violate the one-time transfer prohibition. Purchased tax credits are treated as “extraordinary items” that must be allocated among the partners of the buyer partnership as of the time of the transfer, which is generally deemed to occur on the first date a cash payment is made. Thus, all partners need to be in the partnership on such date to avoid an issue. Purchased tax credits are then allocated to the partners in accordance with their share of the nondeductible expenditures used to fund the purchase price.
  • What level of end-user comfort is needed in such a syndicated buyer partnership is an open question. While the rules provide objective guidelines in terms of when and how such purchased credits are allocated, subjective questions that are present in (and focused on) traditional tax equity partnerships are implicated. For example, could a syndication partnership set up for the business purpose of what amounts to selling the tax credits somehow run afoul of the subjective business purpose and disguised sale rules in tax credit case precedent, such as the Virginia Historic Tax Credit Fund state tax credit line of precedent? Will the market require a robust tax opinion in such scenario, thereby driving up transaction costs?
  • An example in the proposed regulations speaks to this sort of partnership formed for the specific purpose of buying tax credits, but leaves out of the fact pattern a syndicator partner. The example itself should go a long way towards blessing such arrangements, but the IRS taking a contrary position when dealing with such issues would not be a new situation. For example, the IRS challenged allocations of federal historic tax credits as prohibited sales of federal tax credits to the point of freezing the entire tax equity market with its positions in Historic Boardwalk Hall, which was only rectified with the release of a subsequent safe harbor revenue procedure.
  • Moreover, the guidance provides that tax credit brokers are allowed to participate in the market so long as the tax credits are not transferred to such brokers as an initial first step in the transfer process (as the subsequent transfer to an end user would violate the one-time transfer rule). Specifically, at no point can the federal “income tax ownership” be transferred to a broker. It is an open question if further distinction will be made at where this ownership line should be drawn. For example, can a third party enter into a purchase agreement with a seller and then transfer such rights prior to the transfer election being made? Does it matter under such analysis if 1) purchase price installments have been paid (which implicates rules in the buyer partnership context as noted above) and/or 2) the tax credit generating eligible property has been placed in service (which is when the investment tax credit vests for an allocated tax credit analysis; a production tax credit generally arises as electricity or the applicable source is sold)?
  • Indirectly implicated is what effect the new transfer rules will have on established case law precedent and IRS enforcement action in traditional tax equity structures. The Inflation Reduction Act and guidance dances around certain of these issues by creating a fiction where the buyer is treated as the “taxpayer” – this avoids the issue of turning a federal tax credit into “property” that can be sold similar to a certificated state tax credit. This also provides a more logical explanation as to why the buyer of these federal tax credits does not need to report any price discount as income when utilized, unlike the well-established federal tax treatment of certificated state tax credits that provides the exact opposite (e.g., a buyer of a certificated state tax credit at $0.90 has to report $0.10 of income on use of such tax credit).

Other Administrative and Foot-Fault Issues

  • The purchase price can only be paid in cash during the period commencing with the beginning of the seller’s tax year during which the applicable tax credit is generated and ending on the due date for filing the seller’s tax return with extensions. Thus, such period could be as long as 21.5 months or more (e.g., a calendar year partnership seller extending its return to Sept. 15). Tax equity transactions generally have pricing timing adjusters for failure to meet placement in service deadlines. Such mechanism will not work if advanced payments were made and then the project’s projected placement in service year changes. Tax credit purchase agreements executed prior to the June 14 guidance may require amendments or complete unwinds to line up with the rules to avoid foot faults (e.g., purchase agreements executed in 2022 where a portion of the purchase price was paid in 2022 for anticipated 2023 tax credits would not fall within the “paid in cash” safe harbor period). Advanced commitments, so long as cash is not transferred outside of the period outlined above, are permitted.
  • The typical solar equity contribution schedule of 20 percent at a project’s mechanical completion makes purchase price schedules approximating the same a reasonable adjustment for most investment tax credit energy deals in terms of the timing of financing. In addition, the advance commitment blessing of the guidance will give lender parties the comfort necessary similar to having executed tax equity documents in place. Thus, typical project construction financing mechanisms should be similar in the tax equity versus purchase agreement scenario, with projects that allow for a more delayed funding mechanism possibly obtaining a tax credit pricing premium. Production tax credit deals, for which tax credits can only be paid for on a yearly basis within the cash paid safe harbor timing window, may have more significant project financing hurdles without further tax credit transfer rule modifications.
  • Sellers can only make the transfer election on an original return, which includes extensions. Buyers, by contrast, may claim the purchased tax credit on an amended return.
  • Buyers need to be aware that usage of the purchased tax credits is tied to the tax year of the seller. For example, a fiscal year seller could cause the tax credits to be available a year later than an uninformed buyer anticipated, regardless of when the tax credit was generated using a traditional placement in service analysis. For example, a solar project placed in service during November 2023 by an August fiscal year seller would generate credits first able to be used in a calendar year buyer’s 2024, instead of 2023, tax year. A buyer can use the tax credits it intends to purchase against its estimated tax liability.
  • The pre-registration requirements, which are expansive and open-ended, are also tied to the taxable year the tax credits are generated and generally must be made on a property-by-property basis. For example, 50 rooftop installations could require 50 separate registration numbers outside of the “energy project” election. When such registration information needs updated is also not entirely clear – for example, a project is often sold into a tax equity partnership syndication structure on or before mechanical completion. Needing to update registration information could delay transactions and implicates unknown audit risk.

While these rules provide much-needed clarity, failure to adhere may be catastrophic and will require sellers and buyers to put proper administrative procedures in place to avoid foot faults. The new transfer regime will expand the market to new buyers who may have viewed tax equity as either too complex or had other reasons to avoid these transactions, such as the accounting treatment of energy tax credit structures. However, it would be prudent for such buyers to approach such transactions with eyes wide open.

© 2023 BARNES & THORNBURG LLP

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How The U.S. Supreme Court’s Ruling On College Affirmative Action Programs May Impact Private Employers

The U.S. Supreme Court in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College decided that the race-based admissions programs at Harvard College and the University of North Carolina (the “Schools”) violated the Equal Protection Clause of the Fourteenth Amendment. While the Court answered the question for publicly funded schools, it is an open question whether, and how, the Court’s decision will impact affirmative action and diversity programs for private employers, as discussed in more detail below.

Overview

The Fourteenth Amendment states, in relevant part, that no State shall “deny to any person . . . the equal protection of the laws.” Among other things, the clause protects people regardless of their race. A limited exception that permits race-based action by the government is permissible if such action can survive a rigorous standard known as “strict scrutiny.” Under that standard, race-based conduct is permissible only if the government can establish a “compelling government interest” and the race-based action is “narrowly tailored” to achieve that established interest.

The Supreme Court concluded that the Schools’ race-based admissions programs failed strict scrutiny. In support of their race-based admissions programs, the Schools asserted the following educational goals as their compelling interests:

  • Training future leaders in the public and private sectors/preparing engaged and productive citizens and leaders.
  • Preparing graduates to adapt to an increasingly pluralistic society/broadening and refining understanding.
  • Better educating students through diversity/enhancing appreciation, respect, and empathy, cross-racial understanding, and breaking down stereotypes/promoting the robust exchange of ideas.
  • Producing new knowledge stemming from diverse outlooks/fostering innovating and problem solving.
  • Preparing engaged and productive citizens and leaders.

The Court noted that although these goals were laudable, they were too amorphous to pass muster under the strict scrutiny standard. The Court recognized that a court would have no way to know whether leaders have been adequately trained; whether the exchange of ideas is sufficiently robust, or whether, and in what quantity, racial diversity leads to the development of new knowledge. In other words, the Court took issue with the fact that the asserted interests could not be measured in any meaningful, quantifiable way.

In addition, the Court found there was no meaningful connection between the Schools’ use of race in the admissions process and the claimed benefits. For example, the Court noted that while diversity may further the asserted interests, the Schools failed to establish that racial diversity would. The Court took particular issue with what it viewed as the overbroad and arbitrary nature of the Schools’ race considerations as they were underinclusive (for example, failing to distinguish between South Asians or East Asians, or define what Hispanic means, or account at all for Middle Eastern applicants). The Court reasoned that the overbroad, arbitrary, and underinclusive racial distinctions employed by the Schools undermine the Schools’ asserted interests—essentially noting that the Schools’ race-based admissions programs sought to “check the diversity box” rather than obtain a truly diverse (racially or otherwise) student body.

In addition to the School’s programs’ failure to survive strict scrutiny, the Court also recognized that the Schools’ race-based admissions processes promoted stereotyping, negatively impacted nonminority applicants, and, contrary to Court precedent, did not have a durational limit or any cognizable way in which to adopt a durational limit.

Supreme Court Precedent

The Court’s decision rested largely on two prior cases addressing race-based admission programs in higher education: Regents Univ. of Cal. v. Bakke, 438 U.S. 265 (1978) and Grutter v. Bollinger, 539 U.S. 306 (2003). As a guiding principle, the Court noted that the Equal Protection Clause of the Fourteenth Amendment bars admissions programs that use race as a stereotype or a negative.

In Bakke, while rejecting other asserted interests, the Court explained that obtaining the educational benefits associated with having a racially diverse student body was “a constitutionally permissible goal for an institution of higher education,” provided that certain guardrails were in place. This is despite the Court’s recognition that racial preferences cause serious problems of justice. The Court said that race only could operate as “a ‘plus’ in a particular applicant’s file” and the weight afforded to race must be “flexible enough to consider all pertinent elements of diversity in light of the particular qualifications of each applicant.”

In Grutter, the Court decided “student body diversity is a compelling state interest that can justify the use of race in university admissions,” provided that sufficient limitations were in place—notably, that under no circumstances would race-based admissions decisions continue indefinitely. The Court cautioned that, because the use of race was a deviation from the norm of equal treatment, race-based admissions programs must not result in “illegitimate . . . stereotyping,” must not “unduly harm nonminority applicants,” and must be “limited in time.”

The Court’s Additional Considerations

Of critical importance to the Court’s ruling was the fact that neither School’s race-based admissions program had an articulable end point. The Court noted that the Schools’ arguments to overcome the lack of a definite end point were, essentially, “trust us, we’ll know when we’re there.” Yet such arguments, the Court held, were insufficiently persuasive to offset the pernicious nature of racial classifications. Justices Thomas and Gorsuch, who joined the majority opinion, took additional issue with the Schools’ “trust us” arguments in separate concurrences, noting (1) their view of the Schools’ histories of harmful racial discrimination, and (2) that courts are not to defer to the morality of alleged discriminators.

Additionally, the Court took issue with the logical necessity that, in any instance when a limited number of positions are available, a race-based “plus factor” for applicants of a certain race is a negative for applicants who do not belong to the favored race. “How else but ‘negative’ can race be described if, in its absence, members of some racial groups would be admitted in greater numbers than they otherwise would have been?” In this, the Court recognized that equal protection is not achieved through the imposition of inequalities.

Impact on Private Employers

The Supreme Court’s recent decisions have no direct legal impact on private employers. The Court based its decision on the Equal Protection Clause of the Fourteenth Amendment, applicable to the Schools under Title VI, which does not intrinsically apply to private companies; it is Title VII and analogous state and local laws that apply to private employers (not Title VI) and prohibit private employers from discriminating against employees and applicants on the basis of race (and other protected characteristics). In employment, the law has always prohibited any consideration of race in decision-making, such as who to hire or who to promote, except in extremely narrow and limited situations but, even then, quotas and set-asides are strictly prohibited.

While not directly applicable, it is highly likely that the Court’s decision will spawn new challenges to private employer diversity and inclusion programs, and the Court’s rationale will be referenced as an indicator of how the Court will view such programs under Title VII. Even before the Court’s decision, the legal landscape around an employer’s use of affirmative action plans to aid in making employment decisions was murky. Generally a private employer’s affirmative action plan is permissible under Title VII in two scenarios: (1) if the plan is needed to remedy an employer’s past discrimination, and (2) if the plan is needed to prevent an employer from being found liable under Title VII’s disparate impact prohibitions (which operate to prohibit facially neutral policies that nevertheless disproportionately disadvantage certain groups).

Regarding the latter scenario, it is unlikely the Court’s ruling will have much if any impact. For an affirmative action plan to survive scrutiny on this basis, an employer must first prove a disparate impact case against itself: it must identify a specific policy, prove that such policy has a disparate impact on a certain group, and either show that the policy is not justified by business necessity or show that there is a viable alternative that both (a) accounts for the employer’s business necessity, and (b) has less of a disparate impact on the affected group. Then, the employer must prove how its affirmative action steps offset the disparate impact. There is nothing in the Court’s opinion that suggests an employer’s effort to remedy an ongoing Title VII violation would itself be a violation of Title VII.

However, there is language in the Court’s opinion that suggests an affirmative action plan implemented in the former scenario could be problematic, especially if it is not designed carefully. Indeed, a number of lower court decisions even before the Supreme Court’s recent ruling have struck down employer affirmative action programs. Permissible affirmative action programs are typically implemented to remedy past racial imbalances in an employer’s workforce overall, and are not tied to past discrimination against an identifiable employee or applicant. At the close of the Supreme Court’s recent opinion, it admonished Justice Sotomayor’s dissent wherein she proposed a world where schools consider race indirectly, through, for example, essays submitted alongside applications. The Court noted that such would nevertheless violate the Constitution, and clarified that admission decisions can rely on the content of application essays, but that such decisions must be based on an individual applicant’s character or experiences, and not based on the applicant’s race. Similarly, Justice Thomas, in his concurring opinion, recognized that “[w]hatever their skin color, today’s youth simply are not responsible for instituting the segregation of the 20th century, and they do not shoulder the moral debts of their ancestors.” Accordingly, challenges to affirmative action plans that attempt to remedy past discrimination generally, by using race in its decision-making may find purchase in the Court’s closing sentiments and Justice Thomas’s concurrence. Although a standard less exacting then “strict scrutiny” is used to evaluate discrimination claims under Title VII, the sentiment expressed by Members of the Court could make the judiciary increasingly skeptical of affirmative action programs that resemble those used by the Schools. In any event, the possibility of being able to continue to use affirmative action plans in the strict sense to increase diversity in an employer’s workforce is likely little comfort to private employers, as few will want to prove a discrimination case against themselves to justify a diversity program.

Additionally, employers’ diversity, equity, and inclusion (DEI) programs may be the subject of challenges based on the Supreme Court’s skepticism of the benefits of “racial” diversity, as opposed to diversity on less-pernicious characteristics. For example, DEI programs that seek to increase racial diversity based on broad racial definitions may be subject to challenges because of their overbreadth or purportedly arbitrary nature. And DEI programs that highlight racial diversity, rather than, for example, diversity based on socio-economic, ideological, or experiential characteristics may suffer challenges to their legitimacy in reliance on the Supreme Court’s implication that there may be no identifiable tether between “racial” diversity and the purported benefits of diversity as a concept.

Of course, to the extent private employers with affirmative action plans have contracts with government entities and/or receive government funding, affirmative action plans under the Office of Federal Contract Compliance Programs (“OFCCP”), require targeted diversity recruiting efforts, aimed at increasing the diversity of applicant pools, although this also does not permit race (or other protected traits) to be used in decision-making.

Practical Tips For Employers

The Court’s decision applies to affirmative action programs in the college setting and applies an analysis under the Equal Protection Clause that does not directly apply to private employers. The decision also deals with very different scenarios where colleges and universities directly used race as a criteria for admissions. As noted, this has generally never been permitted in the employment context and, as a result, the rules of the road for implementing DEI programs have not changed, although they may evolve through future legal challenges in light of the Supreme Court’s recent decisions. There are still countless ways that private employers can design and implement lawful DEI programs. Below are just a few examples employers may consider:

  • Reiterate D&I as a priority in meetings, conferences, and other communications.
  • Implement recruiting programs to diversify your talent pool.
  • Incentivize employees to refer diverse candidates for openings.
  • Support employee resource groups, mentoring programs, and leadership training.
  • Educate your managers and supervisors on unconscious bias.
  • Encourage diversity in suppliers and business partners.
  • Tie D&I efforts (not results) to managerial performance evaluations.
  • Under the privilege of working with counsel, monitor changes in workforce demographics and conduct pay audits.
  • Consider modifying the goal of DEI programs to seek diversity based on broader characteristics that do not involved protected classes, such as experiences, economic background, or worldview.

Conclusion

The Court’s decision is a landmark ruling that will alter the landscape of college and university admissions. And it will almost certainly spawn new challenges beyond the classroom and into the workplace.

However, the decision does not legally require private employers to make changes to their existing DEI programs if such practices comply with already-existing employment laws. Employers can still implement diversity and inclusion programs and promote diversity within their workplaces but, as has always been the case, employers should tread carefully in designing and implementing these programs. Employers would do well to engage counsel to review such programs and initiatives for possible concerns in light of the Court’s decision, as well as existing precedent in the employment context.

Copyright © 2023, Hunton Andrews Kurth LLP. All Rights Reserved.

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FTC and DOJ Propose Significant Changes to US Merger Review Process

On 27 June 2023, the Federal Trade Commission (FTC) and the Department of Justice–Antitrust Division (DOJ) (collectively, the Agencies) announced sweeping proposed changes to the US-premerger notification filing process. The proposed changes mark the first significant overhaul of the federal premerger notification form since its original release in 1978 and would require parties to report

On 27 June 2023, the Federal Trade Commission (FTC) and the Department of Justice–Antitrust Division (DOJ) (collectively, the Agencies) announced sweeping proposed changes to the US-premerger notification filing process. The proposed changes mark the first significant overhaul of the federal premerger notification form since its original release in 1978 and would require parties to reportable transactions to collect and submit significantly more information and documentation as part of the premerger review process. If finalized, the proposed rule changes would likely delay deal timelines by months, requiring significantly more time and effort by the parties and their counsel in advance of submitting the required notification form.

In this alert, we:

  • Provide an overview of the current merger review process in the United States;
  • Describe the proposed new rules announced by the Agencies;
  • Explain the Agencies’ rationale for the new proposed rules;
  • Predict how the proposed new rules could impact parties’ premerger filing obligations, including deal timelines; and
  • Explain what companies should expect over the next several months.

BACKGROUND ON THE HSR MERGER REVIEW PROCESS

The Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the HSR Act or “HSR”) requires certain persons making acquisitions of assets, voting securities, and non-corporate interests (i.e., interests in partnerships and limited liability companies) to:

(a)    File premerger notifications with the FTC and DOJ; and

(b)    Wait until the expiration or termination of a waiting period (usually 30 days) before consummating the acquisition.

Most mergers and acquisitions valued in excess of USD$111.4 million fall under the HSR Act subject to size-of-party thresholds in certain cases. Additionally, there are several exemptions that may apply to an otherwise reportable transaction.

The FTC or the DOJ reviews the parties’ HSR filings during the waiting period to determine whether the transaction may substantially lessen competition in violation of the antitrust laws. If, at the end of the waiting period any concerns have not been placated, the reviewing agency may issue a Request for Additional Documents and Information (commonly referred to as a Second Request), a very broad subpoena-like document seeking documents, data, and interrogatory responses from the filers. This tolls the waiting period until both parties substantially comply with the Second Request. The reviewing agency then has an additional 30-day period to decide whether to challenge the transaction in court.

WHAT ARE THE PROPOSED CHANGES?

On 27 June 2023, the FTC and DOJ announced a number of significant changes to the HSR notification form and filing process, the first such overhaul in almost 45 years. The Agencies released the proposed changes and rationale for the same in a 133-page Notice of Proposed Rulemaking (Notice) that will be published in the Federal Register later this week. While antitrust practitioners are still digesting the full extent of all of the proposed changes, it is clear that they would require parties to submit significantly more information and documentation to the Agencies as part of their HSR notification form. The most notable additional information and documentation includes:

  • Submission of additional deal documents, including draft agreements or term sheets (as opposed to just the preliminary agreement), where a definitive transaction agreement has not yet been executed; draft versions of all deal documents (as opposed to just the final versions); documents created by or for the deal team lead(s) (as opposed to just officers and directors); and verbatim translations of all foreign language documents.
  • Details about acquisitions during the previous 10 years.
  • Identification of and information about all officers, directors, and board observers of all entities within the acquiring person, including the identification of other entities these individuals currently serve, or within the two years prior to filing had served, as an officer, director, or board observer.
  • Identification of and information about all creditors and entities that hold non-voting securities, options, or warrants totaling 10% or more.
  • Disclosure of subsidies (e.g., grants and loans), by certain foreign governments, including North Korea, China, Russia, and Iran.
  • Narrative description of the strategic rationale for the transaction (including projected revenue streams), a diagram of the deal structure, and a timeline and narrative of the conditions for closing.
  • Identification and narrative describing horizontal overlaps, both current and planned.
  • Identification and narrative describing supply agreements/relationships.
  • Identification and narrative describing labor markets, as well as submission of certain data on the firms’ workforce, including workforce categories, geographic information on employees, and details on labor and workplace safety violations.
  • Identification of certain defense or intelligence contracts.
  • Identification of foreign jurisdictions reviewing the deal.

WHY ARE THESE CHANGES BEING PROPOSED?

In its press release announcing the proposed new rules, the FTC stated that “[t]he proposed changes to the HSR Form and instructions would enable the Agencies to more effectively and efficiently screen transactions for potential competition issues within the initial waiting period, which is typically 30 days.”The FTC further explained:

Over the past several decades, transactions (subject to HSR filing requirements) have become increasingly complex, with the rise of new investment vehicles and changes in corporate acquisition strategies, along with increasing concerns that antitrust review has not sufficiently addressed concerns about transactions between firms that compete in non-horizontal ways, the impact of corporate consolidation on American workers, and growth in the technology and digital platform economies. When the Agencies experienced a surge in HSR filings that more than doubled filings from 2020 to 2021, it became impossible to ignore the changes to the transaction landscape and how much more complicated it has become for agency staff to conduct an initial review of a transaction’s competitive impact. The volume of filings at that time also highlighted the significant limitations of the current HSR Form in understanding a transaction’s competitive impact.2

Finally, the FTC also cited certain Congressional concerns and the Merger Fee Filing Modernization Act of 2022, stating that the “proposed changes also address Congressional concerns that subsidies from foreign entities of concern can distort the competitive process or otherwise change the business strategies of a subsidized firm in ways that undermine competition following an acquisition. Under the Merger Filing Fee Modernization Act of 2022, the agencies are required to collect information on subsidies received from certain foreign governments or entities that are strategic or economic threats to the United States.”

HOW WILL THESE CHANGES POTENTIALLY IMPACT PARTIES’ HSR FILINGS?

The proposed changes, as currently drafted, would require significantly more time and effort by the parties and their counsel to prepare the parties’ respective HSR notification forms. For example, the proposed new rules require the identification, collection, and submission of more deal documents and strategic documents; significantly more information about the parties, their officers, directors and board observers, minority investments, and financial interests; and narrative analyses and descriptions of horizontal and non-horizontal relationships, markets, and competition. Gathering, analyzing, and synthesizing this information into narrative form will require significantly more time and resources from both the parties and their counsel to comply.

Under the current filing rules, it typically takes the merging parties about seven to ten days to collect the information needed for and to complete the HSR notification form. Under the proposed new rules, the time to gather such information and complete an HSR notification form could be expanded by multiple months.

WHAT IS NEXT?

The Notice will be published in the Federal Register later this week. The public will then have 60 days from the date of publication to submit comments. Following the comment period, the Agencies will review and consider the comments and then publish a final version of the new rules. The new rules will not go into effect until after the Agencies publish the final version of the new rules. This process will likely take several months to complete, and the new rules–or some variation of them–will not come into effect until that time.

While the final form of the proposed rules are not likely to take effect for several months, the Agencies’ sweeping proposed changes to the notification form and filing process are in line with the type of information that the Agencies have been increasingly requesting from parties during the merger review process. Accordingly, parties required to submit HSR filings over the next several months should be prepared to receive similar requests from the Agencies, either on a voluntary basis (e.g., during the initial 30-day waiting period) or through issuance of a Second Request, and they should build into their deal timeline (either pre- or post-signing) sufficient time to comply with these requests.

 

“FTC and DOJ Propose Changes to HSR Form for More Effective, Efficient Merger Review,” FTC Press Release, June 27, 2023, available at FTC and DOJ Propose Changes to HSR Form for More Effective, Efficient Merger Review | Federal Trade Commission.  

“Q and A on the Notice of Proposed Rulemaking for the HSR Filing Process,” FTC Proposed Text of Federal Register Publication, available at 16 CFR Parts 801 and 803: Premerger Notification; Reporting and Waiting Period Requirements | Federal Trade Commission (ftc.gov).

Copyright 2023 K & L Gates