Category: Administrative & Regulatory

Top Five Traps for the Unwary in Spin-Offs

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A wave of corporate breakups has swept through the United States over the last few years as investors have taken notice of the fact that smaller companies focused on a single business tend to outperform their more diversified peers.  A primary vehicle for these breakups has been the spin-off transaction, in which a publicly traded parent company distributes the shares of the spin-off company (spinco) to its own shareholders, creating a new, independent publicly traded entity.  The New York Times, citing Dealogic, reported that there were 93 spin-off transactions worth $128 billion in 2011, and that 2012 kept pace with 85 spin-off transactions worth $109 billion.  The rationale for a spin-off often is to unlock the value in a business or division that is trapped in a larger corporate bureaucracy.  Conglomerates tend to spread capital across all of their divisions rather than focusing on the individual opportunities within each business that are the most promising.  Holding company structures also can make decision-making more cumbersome and equity incentives less incentivizing for division management who feel as though their hard work is being diluted by the underperformance of other divisions or businesses.

Spin-offs, however, are complicated transactions that require a great deal of advance planning.  In many cases, an announcement that a parent company is considering the spin-off of one of its businesses is actually the start of a “dual-track” process wherein the parent company considers and plans for a spin-off while also remaining open to potential bids from third parties to acquire the business.  In even more complicated cases, a parent company agrees to sell a business to an acquirer in connection with a spin-off transaction.

The vast majority of spin-off transactions are designed to qualify under the rules of the Internal Revenue Code as “tax free” to the parent company and the shareholders who receive the spinco stock.

With this in mind, any company considering spinning off a division or business should keep in mind the following five potential traps.

1.  Tax-Free Qualification – Legitimate Business Purpose 

The spin-off must satisfy a legitimate business purpose in order to qualify under both the tax-free rules of the Internal Revenue Code and the Securities Act of 1933.  The tax authorities require that the spin-off be motivated in whole or in substantial part by one or more legitimate corporate business purposes in order to ensure that the purpose of the transaction is not simply “tax avoidance.”  The business purpose requirement is one of many requirements under the tax laws to qualify for a tax-free spin-off.  Because the costs of triggering tax in a spin-off transaction often are very high, most parent companies obtain a legal opinion from outside counsel and obtain a ruling from the Internal Revenue Service as a condition to completing a spin-off transaction.  As discussed in relation to trap number five below, a legitimate business purpose for the spin-off also is required under the securities laws in order for the distribution of the spinco stock to not be treated as a “sale” of securities by the parent company or the spinco requiring Securities Act of 1933 registration and the strict liability standard of care that comes with such a registration.  See the article entitled, “Five Key Tax Considerations for Spin-Off Transactions” for a more in depth discussion of tax issues raised in spin-offs.

2.  Separation of Assets and Liabilities

Before a business or a division can be spun off, both its assets and its liabilities must be separated.  Large companies with long operating histories often find that the process of separating out the spinco business is not straightforward, because the legal entities that house the business might also house other businesses and divisions that share assets, services, products, employees, vendors and customers with the spinco business.  The pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial agreements, financing agreements, intellectual property licensing agreements, collective bargaining agreements, employment contracts, benefit plans, etc.  Often the spinco and the parent company or another legacy business must enter into complex sharing or licensing agreements or joint ventures relating to valuable intellectual property, such as trade names, trademarks or patents, as well as employee matters.  See the article entitled “Trademark, Domain Name and Other IP Considerations for Spin-Offs” for a more in depth discussion of IP issues raised in spin-offs and see the article entitled, “Employee Benefit Issues in a Spin-Off” for a more in depth discussion of employee benefit issues raised in spin-offs.

The sharing of liabilities is often the most complicated endeavour because of the slew of legal obligations that are triggered.  In allocating liabilities to the spinco, the parent company must evaluate the impact such allocation will have on the solvency of the parent and the spinco.  Parent company directors can face personal liability under state corporate law for making an unlawful dividend because the company lacked sufficient capital to make such a dividend or for rendering the parent company insolvent by distributing out the spinco business, and the parent company itself can face claims of constructive fraudulent conveyance—i.e., the parent company received less than equivalent value, and either the parent or spinco was rendered insolvent (assets do not exceed liabilities), the parent and/or spinco was left with unreasonably small capital to run its respective business, or the parent or spinco was left with debts that exceed its respective ability to pay those debts as they become due.  Parent company directors can rely on legal experts and financial advisors to assist them in satisfying their duty of care.  A solvency opinion from a nationally recognized provider of such opinions is often a condition to the consummation of a spin-off transaction.  Such an opinion may be helpful to the directors of the parent company and spinco for a variety of reasons: (i) it can help to show that the directors properly exercised their duty of care in determining to enter into the spin-off transaction; (ii) it can assist in rebutting a fraudulent conveyance claim; and (iii) it can assist in rebutting a claim that the company had insufficient capital to make such a dividend.

3.  Transition Services

While one of the key rationales for spinning off a business or division is to allow the enterprise to operate independently, the reality in most cases is that, at least during the first year or so post-spin, a spinco must rely on its former parent company to provide many key administrative and operational services during the spinco’s transition period to a self-sufficient, independent public company.  During the pre-spin planning period, companies should consider, among other things, which transition services will be required, how they will be provided, for how long and under what pricing terms.  Typical transition services include legal, internal auditing, logistics, procurement, quality assurance, distribution and marketing.  These arrangements often have durations that last between six and 24 months.  Many parent companies agree to provide such transition services purely on a cost basis, while others will use a “cost plus” or “market” rate.

4.  Spinco Management and Board of Directors

Again, while independence from the former parent company is a key benefit for most spincos, having corporate managers with institutional knowledge and history with the enterprise is an important factor in assisting the spinco to successfully transition to independence.  Many spinco management teams include members who have served as executives at the former parent company.  In many cases, these are managers who served as division leaders who reported to the parent company CEO or CFO and are now ready to step into executive roles on their own.  It is also common for between one and three members of the parent company board to agree to take seats on the spinco board to provide the new public company board with a source of the company’s history and culture to ensure a smooth transition.  However, because of the competing fiduciary duties that these directors will face if they hold seats on both the parent and spinco boards, it is important for the spinco board to also have a majority of truly independent directors.  Spinco directors who are former executive officers of the parent also must be aware that the stock exchanges and influential shareholder services firms such as Institutional Shareholder Services will not view them as being truly independent from a corporate governance standpoint for some time after the completion of the spin-off.  This will inhibit their ability to serve on key board committees of the spinco.

5.  Preparation of the Disclosure 

Under the U.S. Securities and Exchange Commission’s rules, a spin-off of the shares of a subsidiary to a parent company’s shareholders does not involve the sale of securities by either the parent company or the subsidiary as long as the following conditions are met: (i) the parent company does not provide consideration for the spun-off shares; (ii) the spin-off is pro rata to the parent company shareholders; (iii) the parent company provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; and (iv) the parent has a valid business purpose for the spin-off.

To meet the adequate public information requirement, parent companies are required to prepare and disseminate detailed “information statements” that effectively look like initial public offering registration statements for the spinco.  These information statements are filed with the spinco’s Form 10 registration statement, which is required in order to register the spinco’s shares under the Securities Exchange Act of 1934 and to permit listing of such shares on a national securities exchange.  The preparation of the spinco information statement can take up to three or four months and requires a great deal of effort and cooperation among the lawyers, the business leaders, the finance department, the human resources/employee benefits department and the auditors.  In addition, under New York law, a spin-off of all or substantially all of a company’s assets may require a vote of such company’s shareholders, while under Delaware law, such a requirement is much less likely.

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Pregnancy and Disability Discrimination the Focus of EEOC Enforcement Activity

Poyner SpruillSince Congress’ enactment of amendments to the Americans with Disabilities Act (ADA) in 2008, making it easier to establish disability status under that law, the EEOC has directed more of its attention to claims of pregnancy and disability discrimination and accommodation of pregnancy-related limitations. In its 2012 Strategic Enforcement Plan, the Commission identified the investigation and pursuit of this type of claim as a national priority.  This enforcement initiative was recently demonstrated in a lawsuit filed by the EEOC against an employer which allegedly denied accommodations to an employee who suffered from complications arising from her pregnancy. The suit, EEOC v. Engineering Documentation Systems, Inc.,settled for $70,000 before a judgment on the merits was reached. However, the case serves as a reminder to employers that the issue of pregnancy-related disability is now being targeted by the EEOC.

Title VII of the Civil Rights Act of 1964, as amended by the Pregnancy Discrimination Act (PDA), prohibits discrimination against employees or job applicants on the basis of pregnancy, childbirth or related medical conditions. The EEOC takes the position that Title VII and the PDA require employers to treat pregnant employees in the same manner as other employees with temporary medical conditions. For example, according to the EEOC, if an employer provides leaves of absence or light duty to employees with short-term medical conditions which render those employees unable to work, then an employee unable to work due to her pregnancy must also be afforded the same treatment.1   But Title VII is not the only potentially applicable law in this circumstance. The ADA requires employers to provide “reasonable accommodation” to an employee with an actual (or record of) disability. This raises the question whether a pregnant employee has a “disability” within the meaning of the ADA.

Under the ADA, a disability is defined in part as a physical or mental impairment which substantially limits a major life activity. Prior to the amendments to the ADA, temporary medical conditions generally were not found by the courts to constitute disabilities, on the grounds that short-term impairments were not “substantially limiting.” However, the ADA Amendments Act (ADAAA) has led to a more expansive interpretation of the term “disability.” Specifically, the EEOC’s regulations implementing the ADAAA state that an impairment may be substantially limiting of a major life activity, and thus a disability, even if it is of a duration of less than six months. While the EEOC still considers pregnancy itself not to constitute a disability (See EEOC’s “Questions and Answers on the Final Rule Implementing the ADA Amendments Act of 2008”), it recognizes that certain impairments resulting from pregnancy may be disabilities if they substantially limit a major life activity. As stated on the EEOC’s webpage regarding pregnancy discrimination, this could include short term complications of pregnancy such as gestational diabetes or preeclampsia.

With the possibility that more medical conditions and complications arising from pregnancy will now fall within the definition of disability under the ADAAA, employers must be more cognizant of when an obligation to consider and provide reasonable accommodation to employees with a pregnancy-related disability arises. Such accommodations might include leaves of absence, job reassignment, light duty, or job modifications, unless such accommodations would result in an undue hardship to the employer. It is also imperative that employers engage in the “interactive process” with such employees to identify reasonable accommodation. The failure to take such proactive measures can result in liability for an employer, particularly given that the EEOC is now focused on this area of enforcement.

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“Actually, Someone Knows You are a Dog”– the Chinese Regulation Efforts on Private Data Protection

Sheppard Mullin 2012

Do you have privacy in the era of information?

“On the Internet, nobody knows you’re a dog.” First published in The New Yorker on July 5, 1993, this widely known and recognized saying has been quoted many times to describe the anonymous feature of Internet. However, now this description has been drifting from the truth.

The truth is that, some people using the Internet may know you better than yourself. When you log on Amazon, not only will the site greet you by name, the homepage will also suggest certain purchases. Surprisingly, you will be interested in at least one third of them. Your addresses have been recorded and Amazon will automatically calculate the delivery period. Besides those online shopping sites, getting visitors’ information is the common practice of online service and/or information providers. Youku and Netflix suggest videos to watch. Weibo and Facebook suggest friends to follow. Douban and IMDB suggest movie tickets to buy and parties to attend.

On one hand, these recommendations might give you convenience in your life and entertainment; while on the other hand, this can be really intruding and make you anxious by knowing you so much. For example, you just bought an apartment and even did not get the keys. However, decoration companies and contractors give you calls telling you the decoration designs for the new apartment have been done. You just submitted some resumes for a job. Even before the interview, insurance companies and training companies give you calls and emails to make sales. Have you wondered how strangers know your private, personal information?

Every time you log on a website, make a call or buy a ticket by showing ID card, computer systems will track you down, and record everything you have clicked and purchased. Data analyzing systems will collect, characterize, store your information, and take further actions based on the information. Some entities even purchase and resell personal data for profit. The reason why personal data become commodities is because direct marketing based on private data is profitable. Marketing communications are only classified as “direct marketing” where they are addressed to a specific person by name or where a phone call is made to a specific person, and the use of private data is the foundation of direct marketing. The newly issued Hong Kong Personal Data (Privacy) Amendment Ordinance contains a number of new provisions regulating the use of personal data in connection with direct marketing activities in Hong Kong, which has come into force since April 1, 2013. Apart from Hong Kong, there are over fifty countries and regions which have laws and regulations protecting personal data.

What is the new trend in China to protect personal data?

In order to safeguard the legitimate rights and interests of Chinese citizens concerning private data protection, the Ministry of Industry and Information Technology of China (“MIIT”) announced the Provisions on the Protection of Personal Information of Telecommunication and Internet Users (Draft for Comments) (“PPI Rules”) and the Provisions on the Registration of True Identity Information of Telephone Users (Draft for Comments) (“RTII Rules”) and sought for public comments. The deadline for submitting comments is May 15, 2013.

The PPI Rules and RTII Rules are a breakthrough with respect to legislation of personal information protection. Although these two rules are not officially a personal information protection law, they are a good beginning and call for a complete set of rules.

The PPI Rules and RTII Rules are designed to protect personal information from two perspectives. While the PPI Rules regulates the collection and utilization of users’ private information, the RTII Rules requests “real-name registration” of telephone users for the prohibition of direct or indirect marketing using no-name telephone numbers. Specifically, the PPI Rules requires that telecommunication service providers and Internet information service providers (“Service Providers”) shall not collect or use the users’ personal information without their consent. Service Providers shall also clearly notify the users of the purpose, method and scope of collection and utilization of the users’ personal information, retention period of such information, ways to access and modify such information, and consequences of refusal to provide such information.

Meanwhile, the “real-name registration” required by RTII Rules is a double-edged sword. Not only are telephone users required to supply their true identity information, some Internet services, for example, the Chinese Twitter Weibo, also require users’ true identity information. On one hand, it will reduce the risk of private information abuse by no-name telephones and Weibo bloggers. One the other hand, the “real-name registration” regime means it is legitimate for telephone and some Internet service providers to collect their users’ information. Although RTII Rules prohibits the sales and illegal provision of users’ information, it doesn’t mean those providers will not utilize the users’ information to make profits and provide such information to government or other compulsive entities. This “real-name registration” may limit the health development of Internet and even harm users’ right to free speech. Is “real-name registration” the only way to protect personal information? This is a controversial topic.

What can enterprises do to avoid violations of personal data protection rules in China?

Putting the controversial topic aside, let’s talk about what the enterprises doing business in China can do regarding new rules to protect personal information. Those enterprises may not be limited to Internet/telecommunication service providers, because the regime may expand in the future to regulate more entities that may get access to citizens’ personal data.

First, the concerned enterprises can log on MITT official websites and submit comments if any. They can make their voice heard since the rules are in the “draft for comments” period.

Second, thorough study of the new rules and other anticipated rules in this area is needed. The concerned enterprises need to provide proper training to their employees regarding the users’ information protection, since this is not only required by the new rules, but the enterprises might also have joint and several obligations with the employees who abuse the users’ information.

Third, proper drafts of disclaimer/declaration/agreement are needed when the enterprises want to collect and utilize the users’ private information. The enterprises need to make sure that they have obtained the users’ consents concerning the information collection and utilization. Proper preparations are needed to avoid future risks.

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Natural Gas Companies Settle Antitrust Suit Stemming from Joint Bidding

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On Monday, April 22, 2013, after rejecting the initial settlement agreement, Judge Richard Matsch (D. Colo.) approved a revised settlement of a suit brought by the U.S. Department of Justice (DOJ) against two energy companies for conspiring not to compete for mineral rights leases.  Gunnison Energy Corp. (GEC) and SG Interests I Ltd. and SG Interests VII Ltd. (collectively “SGI”) will each pay a fine of $275,000 to the DOJ to settle allegations of agreeing not to bid against each other in violation of antitrust law for natural gas leases on government land in western Colorado.  These fines are in addition to those related to alleged False Claims Act violations, for which SGI and GEC paid government fines of $206,250 and $245,000 respectively.  The new settlement is twice the amount of the fines in the original settlement.

McDermott Will & Emery wrote an article in February 2012 analyzing the DOJ’s initial complaint against the parties, and the competitive implications of joint bidding.  At the time, the parties had agreed to pay a total of $550,000 in fines.  The court rejected the settlement in December 2012 finding that it was not in the public interest.  “There is no basis for saying that the approval of these settlements would act as a deterrence to these defendants and others in the industry, particularly as GEC considers ‘joint bidding’ to be common in the industry.”  Further, the settlement amount was “nothing more than the nuisance value of [the] litigation.”  Additionally, as reflected in the newly approved deal, the court wanted the alleged Sherman Act violations and False Claims Act violations settled separately, with a payment for the Sherman Act claims separate from, and in addition to, any amount due under the False Claims Act.  At heart, it appears Judge Matsch wanted any settlement he approved to be meaningful enough to have a deterrent effect on future agreements.

This was the DOJ’s first challenge to an anti-competitive bidding agreement for mineral rights leases, but it is just one of the recent cases in which joint bidding activities have become the focus of antitrust scrutiny.  In Summer 2012, the DOJ opened an investigation into Chesapeake Energy’s acquisition of oil and gas properties in Michigan and the possibility that Chesapeake conspired with Encana Corp. to allocate bids on those properties.  In 2006, the DOJ began investigating the joint bidding practices of private equity firms in connection with leveraged buyouts.  That investigation led to class action suits against private equity firms.  One of those suits survived a motion for summary judgment last month.

It is important to note that the DOJ is paying attention to joint bidding practices and taking action.  As noted in the SGI/GEC matter, while joint bidding may in fact be common practice in the energy field, it is not necessarily lawful.  Each arrangement should be evaluated for potential anticompetitive effects.

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Obama Administration Aims to Restrict Physician Self-Referrals for Certain In-Office Services in Proposed Budget

Barnes & Thornburg

In its recently unveiled budget proposal for fiscal year 2014, the Obama administration has proposed saving billions in federal expenditures by tightening restrictions on certain services for which physicians can self-refer patients and receive government payment.

Under current federal law, a physician cannot make a referral to an entity for the furnishing of “designated health services” payable by government-funded health programs, such as Medicare, if the physician has a financial relationship with the entity. Correspondingly, this law—the “Stark Law”—also prohibits the entity receiving the referral from submitting a claim for payment for such services. Several exceptions, however, punctuate these prohibitions, including the “in-office ancillary services” exception, which shields referrals within physician practice groups for designated health services that meet specified criteria regarding the individual who furnishes the services, the location where the individual furnishes the services, and the party that bills for the services.

In an overview of the President’s 2014 budget plan for health care spending, the U.S. Department of Health and Human Services (HHS) notes that there are “many appropriate uses” for the in-office ancillary services exception, which the agency describes as designed to allow physicians to “self-refer quick turnaround services.” But, the agency cautions, some physicians have relied on the exception for certain services, such as advanced imaging and outpatient therapy that “are rarely performed on the same day as the related office visit.” Additionally, HHS claims, evidence suggests that the exception may have spurred “overutilization and rapid growth” of these services.

In light of these findings, the Obama administration has recommended excluding radiation therapy, therapy services (such as physical therapy and occupational therapy), and advanced imaging (such as CT scans and MRIs) from the in-office ancillary exception to encourage “more appropriate use of select services,” as HHS explains in the health spending overview. Notably, however, the administration would not extend this exclusion to “cases where a practice meets certain accountability standards,” which the HHS Secretary would have the authority to define, presumably before the exclusion would take effect in calendar year 2015 as the administration intends. Amending the Stark Law exception in this fashion would yield $6.1 billion in federal savings over 10 years, according to the administration.

Providers of the in-office services identified by the Obama administration should follow closely to see if the administration’s suggested change to the Stark Law makes it into the final budget and, if so, how the HHS Secretary ultimately defines the “accountability standards” that could make the difference between staying within the boundaries of the law and falling outside of them.

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Watt’s New? Michigan Energy News

Varnum LLP

Community Solar Success

Cherryland Electric Cooperative has installed 48 solar panels on a site adjacent to its offices in Grawn.  Individual customers have signed up to lease each panel for 25 years for a one-time fee of $470 per solar panel. A rebate of up to $150 will be given the customer to account for energy optimization credits. The customer will also receive a monthly billing credit for the electricity produced by the solar panel, which is expected to be at least 25 kWh per month. As many as 360 panels will be installed on the racking at the site, depending on customer support.

Energy Innovation with Nanoparticles

Grid Logic Incorporated of Lapeer is developing a low-cost superconducting wire for electric utility application. Using a new manufacturing technique, it will embed very fine particles into metals to induce superconductivity. This will reduce the cost of transmission lines, motors, wind turbines, and other electric devices. At Michigan Technological University in Houghton research on growing manganese dioxide nanorods may lead to new high performance electric capacitors. By minimizing internal resistance, such material will store more energy, allow extraction of energy more quickly, and operate longer between recharging. University of Michigan labs in Ann Arbor have added silver nanoparticles to increase solar cell efficiency by 8 percent. The nanoparticles also allow for thinner silicon layers, which means lower costs (ten times less silicon used) and flexible substrates for solar panels.

Annual Meeting of Energy Group

The Michigan Energy Innovation Business Council held its Annual Meeting on April 17 in Lansing and elected new Board members. The meeting featured a solar industry panel discussion and a keynote address on the Department of Energy’s New Clean Energy Manufacturing Initiative. The new Board is composed of top officials from Astraeus Wind Energy, Growth Capital Network, Novi Energy, Ecotelligent Homes, Dowding Industries, Advanced Energy Group, Dow Chemical Company, TOGGLED, Sakti 3, First Energy Finance, Wind Resource LLC, and Ventower Industries. These are companies already engaged in wind, solar, bioenergy, geothermal, energy storage, and energy efficiency businesses. Committees on policy and advocacy, membership and marketing, and market and business development were also formed. The group participated in all seven energy forums held around Michigan in February, March, and April.

Wind Buoy Goes Back into Lake Michigan

The Grand Valley State University Wind Sentinel research buoy, one of only three in the world, will be returned to Lake Michigan this month. It will be placed about seven miles offshore, northwest of the Muskegon Channel, for its third research season. The project is running short of funding, and its future activities beyond this year are uncertain. Project partners include researchers from: Michigan Technological University, who are studying wind turbulence; Michigan Natural Features Inventory, a component of the Michigan State University Extension program, who are studying bird and bat activity (and who confirmed for the first time ever last summer that bats do fly over the Great Lakes); and the University of Michigan, who are conducting research on large data sets.

DOE Renews MSU Biofuels Funding

The U.S. Department of Energy has awarded $25 million per year for another five years to fund the Great Lakes Bioenergy Research Center. Michigan State University is a partner in the Center which is physically based at the University of Wisconsin-Madison. The Center supports nearly 400 researchers, students and staff working in disciplines ranging from microbiology to economics to plant biology to engineering aimed at advanced cellulosic biofuels technologies.

Courts to Rule on Wind Issues

Seventeen neighbors of the Consumers Energy Lake Wind Energy Park have filed a complaint in Mason County claiming the wind farm has negatively impacted property values and caused sleep disruption, headaches, ringing ears, dizziness, stress, extreme fatigue, nausea, and other physical and mental problems. A cease and desist order is being sought, together with damage awards, in a jury trial. In Clinton County, Forest Hill Energy-Fowler Farms LLC is suing Essex, Dallas, and Bengal townships for adopting ordinances that effectively block its wind farm development. The county had previously granted a special land use permit to Forest Hill Energy for its $120 million wind project, and the townships have moved to override that permit.

Energy Forums Concluded

With the conclusion of the last of the seven energy forums ordered by Governor Snyder in November, the next stage of fact-finding is underway. The schedule describes the May-June period as the time when the two forum chairs will be “outlining reports in each program and laying out plan for development of information that is not yet available.” The following three months is reserved for “compilation/development of information.” October-November will see the release of draft reports for public feedback. Final reports will be released in the November-December timeframe. Governor Snyder will be “making his comprehensive recommendations regarding Michigan’s energy future in December of 2013.”

Orisol Energy US, Inc. of Ann Arbor is one of the companies selected to bid on leases for submerged land in the Atlantic Ocean for offshore wind developments in the coastal waters of Virginia Midwest Independent System Operator (MISO) reported that on November 23 more than a quarter of its total generation came from wind turbines at 10,012 MW  The Michigan Public Service Commission has approved a special rate contract between Cloverland Electric Cooperative and the Manistique paper mill of MPI Acquisition LLC  State Senator Hoon-Yung Hopgood has introduced a bill to increase Michigan’s renewable energy standard to 22 percent by 2022  Mascoma, cellulosic ethanol maker with plans for commercial operations in the U.P., has withdrawn its $100 million initial public offering citing market conditions

Exporting Pure Michigan

Two years ago President Obama challenged the nation to increase its exports. American exports are up 34 percent since that time, with 70 percent of total exports being manufactured goods. “Made in America” still has a huge cache around the world. “Made in Michigan” can and should have significance overseas as well. Now is the time for Michigan’s alternative energy supply chain and manufacturers to look abroad for new markets, niche and otherwise. The demand for electricity is exploding in emerging markets of developing and less developed countries. The Kyoto Treaty and other international efforts are aimed at satisfying this demand with renewable resources rather than fossil fuels. With its technology, engineering, and lean manufacturing prowess, Michigan could be on the leading edge of this effort. The export market is wide open. Let’s go to work on exporting “Pure Michigan.

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SEC Announces First Non-Prosecution Agreement Involving Foreign Corrupt Practices Act (FCPA) Violations

DrinkerBiddle

On April 22, 2013, the Securities and Exchange Commission (SEC) announced it had entered into a Non-Prosecution Agreement (NPA) with Ralph Lauren Corporation under which the company agreed to disgorge approximately $700,000 in connection with certain unlawful payments made by a foreign subsidiary to government officials in Argentina from 2005 to 2009.  This is the first time the SEC has used a NPA for violations of the Foreign Corrupt Practices Act (FCPA).

According to the NPA, Ralph Lauren Corporation’s Argentine subsidiary paid “bribes,” i.e., payments in violation of the FCPA, to government and customs officials to improperly secure the importation of Ralph Lauren Corporation’s products in Argentina.  The purpose of the unlawful payments, made through a “customs broker,” was to obtain entry of Ralph Lauren Corporation’s products into the country without certain paperwork and to avoid certain inspections by customs officials.  The unlawful payments to Argentine officials totaled $593,000 during a four-year period.

The NPA further notes that the unlawful payments occurred during a period when Ralph Lauren Corporation lacked meaningful anti-corruption compliance and control mechanisms over its Argentine subsidiary.  The company discovered the misconduct in 2010 as a result of measures it adopted to improve its worldwide internal controls and compliance efforts, including implementation of a FCPA compliance training program in Argentina.  The NPA notes that the SEC determined not to charge Ralph Lauren Corporation with violations of the (FCPA) in light of several factors including:  (1) the company’s prompt reporting of the violations on its own initiative, (2) the completeness of the information it provided, and (3) the company’s extensive, thorough, and real-time cooperation with the SEC’s investigation.  According to the SEC, Ralph Lauren Corporation’s cooperation saved the Commission “substantial time and resources.”

In parallel criminal proceedings, the Justice Department also entered into a Non-Prosecution Agreement with Ralph Lauren Corporation under which the company will pay an $882,000 penalty.[1]

NPAs are part of the Enforcement Division’s Cooperation Initiative announced in 2010.  Prior to 2010, the SEC did not have the ability to enter into NPAs or Deferred Prosecution Agreements (DPAs).  The purpose of the Cooperation Initiative was to give the Commission the flexibility to incentivize and reward cooperation while at the same time ensuring that cooperators are held accountable for their misconduct.  Since 2010 and prior to this instance, the Commission has entered into three NPAs[2] and two DPAs[3]  It is likely that the SEC will continue to use DPAs and NPAs particularly in connection with FCPA matters given the factual complexity of the cases and the difficulty in discovering violations, which almost always occur outside the U.S.

The Ralph Lauren NPA provides useful guidance as to what the SEC will consider in assessing corporate cooperation by detailing the significant actions that Ralph Lauren Cooperation took in connection with the parallel investigations.  According to the NPA, Ralph Lauren Corporation:

  • reported preliminary findings of its internal investigation to the staff within two weeks of discovering the illegal payments and gifts:
  • voluntarily and expeditiously produced documents;
  • provided English language translations of documents to the staff;
  • summarized witness interviews that the company’s investigators conducted overseas; and
  • made overseas witnesses available for staff interviews in the U.S.

The NPA also notes that Ralph Lauren Corporation entered into tolling agreements during the staff’s investigation.  The statute of limitations with respect to the 2005 conduct, the earliest conduct charged, would have likely run in 2010, just as the company reported the violations to the SEC.

The Ralph Lauren NPA provides several other takeaways.  First, the Ralph Lauren Corporation agreed to enter into the NPA “without admitting or denying liability.”  While the NPA also contains the standard provision prohibiting the Ralph Lauren Corporation from “denying, directly or indirectly, the factual basis of any aspect of the” NPA, the inclusion of the “without admitting or denying language” seems to run counter to the policy announced by the Enforcement Division in January 2012 to eliminate the use of “neither admit nor deny” language from settlement documents involving parallel (i) criminal convictions or (ii) NPAs or DPAs[4]  This may suggest that the “without admitting or denying liability” language remains negotiable.

Second, under the agreement, the Company must seek the staff’s prior approval of the contents of any press release concerning the NPA.  Third, while the SEC emphasizes the Ralph Lauren Corporation’s enhanced compliance program and successful implementation of the enhancements, it also highlights that the Ralph Lauren Corporation has ceased retail operations in Argentina and is in the process of winding down all operations there.  It is possible Ralph Lauren Corporation’s decision to close operations in Argentina was a significant factor in the SEC’s decision to use a NPA in this circumstance.  Fourth, notably, the NPA does not require the Ralph Lauren Corporation to retain an independent consultant to review its policies and procedures and to prepare a report to the staff regarding any findings.  The financial burden of independent consultant “reviews” is often significant.  The staff’s willingness to forego such an undertaking demonstrates the value of taking quick and full remedial action during an investigation.

Fifth, the NPA also refers to “gifts” such as perfume, dresses and handbags valued at between $400 and $14,000, which were provided to three different government officials during the relevant time.  This underscores the importance of having policies and procedures that extend beyond prohibiting monetary payments to government officials.  Finally, the NPA requires that the Ralph Lauren Corporation “to pay disgorgement obtained or retained as a result of the violations discovered during the investigation.”  In its press release, the SEC notes that Ralph Lauren Corporation will “disgorge” $700,000 in illicit profits and interest.  The disgorgement, however, appears to be the total amount of unlawful payments plus interest made rather than any profit earned as a result of the unlawful payments.  Disgorgement is frequently difficult to calculate, especially in FCPA cases.  It appears that rather than tracing the unlawful payments to profits, the SEC was satisfied to use the amount of unlawful payments as a proxy for disgorgement.  Moreover, the low monetary value of the unlawful payments may have also contributed to the SEC’s decision to enter into a NPA in this instance.

[1]  The agreement with the Justice Department stands as yet another example of DOJ’s position that senior management be intricately involved in anti-corruption compliance efforts.  More specifically, the agreement requires that Ralph Lauren’s “directors and senior management provide strong, explicit, and visible support and commitment to its corporate policy against violations of the anti-corruption laws and its compliance code.”  Further, the agreement requires that the company “assign responsibility to one or more senior corporate executives of the Company for the implementation and oversight of the Company’s anti-corruption compliance code, policies and procedures.” 

[2]  In December 2010, the SEC entered into a NPA with Carters Inc. in connection with a financial fraud perpetrated by a former Executive Vice President of Carters.  The NPA focused on the isolated nature of the misconduct, Carters’ prompt self-reporting, extensive cooperation and remedial actions.  In December 2011, the SEC entered into DPAs with Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) in connection with certain misleading statements claiming that the companies had minimal holdings of higher-risk mortgage loans including subprime loans.  The NPA focused on Freddie Mac’s and Fannie’s Mae’s cooperation in connection with the SEC’s litigation against former senior executives.

[3]  In May 2011, the SEC entered into a DPA with Tenaris S.A. in connection with FCPA violations.  The DPA required Tenaris to disgorge approximately $5.4 million.  The DPA focused on Tenaris’ early self-reporting, extensive cooperation and remedial actions.  InJuly 2012, the SEC entered into a DPA with Amish Helping Fund in connection with certain misrepresentations and omissions in offering documents.  Again, the DPA focused on Amish Helping Fund’s immediate and complete cooperation, its willingness to offer investors a right of rescission and its remedial efforts. 

[4]  The Amish Helping Fund DPA entered into on July 18, 2012, does not contain the “without admitting or denying” or “neither admitting nor denying” language.

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Progressive Casualty Litigation Stayed Pending Outcome of Liberty Mutual Covered Business Method Patents

Schwegman Lundberg Woessner

Progressive Casualty Insurance Co. sued different insurance companies for patent infringement of 5 of its patents in 2010-2012 in the Northern District of Ohio.  (Cases 1:10CV01370 and 1:11CV00082 against Safeco; Case 1:12CV01068 against State Farm; and Case 1:12CV01070 against Hartford.)  One of the defendants is Safeco Insurance Company, which has Liberty Mutual as its parent.  In 2012 and 2013 Liberty Mutual filed ten covered business method patent review (CBM) petitions (two CBM petitions were filed per patent).  Eight of these ten petitions were instituted for trial and two petitions were denied, but each of the five patents has at least one CBM where trial was instituted by the PTAB.

Liberty Mutual and the remaining defendants moved to stay the litigation based on the CBMs instituted.  Progressive opposed the motion to stay.  The District Court heard oral arguments on April 11, 2013, and granted the motion stay on April 17, 2013.

The court used a four-factor test set forth in the AIA section pertaining to CBMs (AIA § 18(b)(1), P.L. 112-29, 125 Stat. 284, 331):

  • (1) whether a stay, or the denial thereof, will simplify the issues in question and streamline the trial;
  • (2) whether discovery is complete and whether a trial date has been set;
  • (3) whether a stay, or the denial thereof, would unduly prejudice the nonmoving party or present a clear tactical advantage for the moving party; and
  • (4) whether a stay, or the denial thereof, will reduce the burden of litigation on the parties and on the court.

It is interesting that the Liberty Mutual litigation was previously stayed pending the outcome of ex parte reexaminations, yet the Court found the benefits of inter partes covered business method review compelling enough to order another stay pending the outcome of the PTAB trials.  Some of these benefits observed by the Court include:

  • CBM proceedings are inter partes rather than ex parte, which allows Liberty mutual “a better platform to advocate its interests.”
  • CBM proceedings are “presided over by a panel of three administrative judges whom are required to have ‘competent legal knowledge and scientific ability,’ 35 U.S.C. § 6(a), as opposed to a single patent examiner.”
  • To institute CBM review, the petitioner must show the claims are likely invalid, 35 U.S.C. § 324(a), which is more onerous than meeting the “substantial new question of patentability” standard required to initiate ex parte reexaminations.
  • The Court also found the short timeline of the CBM proceedings (to be completed within 18 months of institution of trial), to be attractive and likely to decide issues before the Court.

For further information the order for stay provides the details of the Court’s findings and has a detailed table attached at the last page showing the different CBMs and their status.

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Supreme Court Hears Oral Arguments Regarding Limits on Class Arbitration Waivers in Federal Cases

Womble Carlyle

Recently, the United States Supreme Court heard oral argument in American Express Co. v. Italian Colors Restaurant, a case that will have a substantial impact on the enforceability of arbitration agreements that contain class action waivers.  Italian Colors picks up where the Supreme Court left off in AT&T Mobility, LLC v. Concepción when a sharply divided Supreme Court held that a state law purporting to invalidate class action waivers in arbitration agreements was preempted by the Federal Arbitration Act.

Here, the Supreme Court is confronting the question of whether, as the Second Circuit Court of Appeals put it, the “federal substantive law of arbitrability” can invalidate class action waivers in arbitration agreements when the underlying claims are based on federal law.  The Second Circuit Court of Appeals determined that federal law requiredthe invalidation of the class action waiver because the cost of litigation compared to the relatively minimal amount of potential damages would effectively prohibit plaintiffs from pursuing their federal claims.  Concepción did not compel a different result, according to the Second Circuit, because in that case there was no showing that ”the practical effect of the enforcement would be to preclude [the plaintiff class’s] ability to vindicate their statutory rights.”

The Supreme Court’s decision in this case will have a substantial impact on the viability of class action waivers contained in arbitration clauses.  If the Second Circuit’s ruling is upheld, it will provide plaintiffs with a way around the limitations of Concepción if they are able to show that litigating a matter on an individual basis would be prohibitively expensive.  A decision reversing the Second Circuit would give business owners a greater ability to avoid complex and expensive class action litigation through carefully worded arbitration agreements.

The Supreme Court is expected to decide the case before the end of June 2013.

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A Reminder About Pollution Legal Liability Coverage

GT Law

A recent decision from the federal district court in Pittsburgh highlights the importance of carrying environmental insurance, especially in connection with properties or facilities with an increased potential for environmental legacy liabilities. Many property owners believe that comprehensive general liability (CGL) policies adequately protect against environmental liabilities. However, standard CGL policies will typically only cover certain, very limited environmental liabilities and are by no means an effective tool for comprehensive environmental protection. Pollution legal liability (PLL) policies, designed to respond to contamination found on properties, are a far more useful and comprehensive mechanism to mitigate potential liability stemming from current or past ownership of environmentally sensitive properties.

Wiseman Oil v. TIG Insurance, 2013 U.S. Dist. LEXIS 14747 (W.D. Pa. Jan. 22, 2013), report and recommendation adopted, 2013 U.S. Dist. LEXIS 37501 (W.D. Pa. Mar. 19, 2013), involved a claim by Wiseman for coverage and for defense under Wiseman’s CGL policy for underlying claims against Wiseman under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).

The CERCLA claims against Wiseman arose out of environmental contamination at property formerly owned by Wiseman. TIG asserted that it owed no such defense or coverage-related duties to Wiseman. Among other arguments, TIG asserted that the CGL policy contained an exclusion for bodily injury orproperty damage claims arising out of the release of hazardous materials “into or upon land.” However, the exclusion contained an exception to releases that were considered “sudden and accidental.” “Sudden and accidental” was not defined under the policy. TIG asserted that the CERCLA claims brought against Wiseman did not allege any sudden or accidental event and thus it had no duty to defend or otherwise provide coverage.

The case was assigned to Chief Magistrate Judge Lisa Pupo Lenihan for a report and recommendation. She clarified that TIG’s duty to defend did not hinge on whether the underlying complaint “expressly alleges specific factual predicates clearly within the applicable policy terms.” Rather, the duty to defend arose when a fair reading of the underlying complaint did not “expressly rule out the possibility of insurance coverage under the applicable policy terms.” Pupo Lenihan stated further that TIG could not reasonably conclude from the face of the underlying complaint that the allegations “precluded or negated any potential applicability” of the “sudden and accidental” qualifiers.

Based on the foregoing, Pupo Lenihan held that the language of the underlying complaint was a sufficient basis to deny TIG’s asserted grounds for summary judgment and to grant Wiseman’s motion for partial summary judgment on the question of TIG’s duty to defend.

Last month, U.S. District Judge Joy Flowers Conti of the Western District of Pennsylvania adopted Pupo Lenihan’s report and recommendation. (See 2013 U.S. Dist. LEXIS 37501 (W.D. Pa. Mar. 19, 2013).)

Although in this case Wiseman succeeded in thwarting its insurer’s summary judgment motion on the dutyto defend, in order for Wiseman ultimately to obtain coverage for its claim it will face a significant burden in demonstrating that the “sudden and accidental” exception to the policy exclusion applies. Given that the property was likely contaminated over a long period of time rather than in a single abrupt, catastrophic event, actually obtaining coverage under the policy will require a factually intensive showing that the gradual contamination was sufficiently like the abrupt event to qualify as “sudden and accidental.” In short, the case highlights the difficulty of obtaining coverage for environmental liabilities under a CGL policy.

That controversy could have been avoided if the plaintiffs had considered other insurance products that are better suited to cover this type of pollution-related risk. This is especially true of properties on which manufacturing or other environmentally sensitive operations may have occurred.

Generally speaking, PLL insurance policies can help landowners mitigate known and unknown risks associated with the acquisition and divesture of real property, and offer more robust protections for environmental risks than the CGL policy that the plaintiffs sought to rely on in the Wiseman case. In situations comparable to the facts at issue in Wiseman, a PLL policy would have been a more appropriate coverage and likely would have negated the need to bring a lawsuit to enforce the policy.

PLL coverage is the most common type of insurance to address potential environmental liabilities associated with real property.

It is generally used to address cleanup costs for environmental contamination, third-party claims for bodily injury or property damage arising from environmental contamination (both pre-existing or first occurring during the policy term), and business interruption losses resulting from a covered environmental condition or claim.

Among other things, PLL policies can also provide for protection against natural resource damages, risk stemming from non-owned disposal sites, and legal defense costs associated with all of the foregoing. PLL policies cover unknown pre-existing contamination discovered after the policy inception, as well as new conditions that occur after the inception date.

Known conditions are included under most PLL policies unless they are specifically scheduled and excluded from coverage under the policy. Capital improvement exclusions are quite common and would exclude costs of remediating known conditions, such as urban fill material, in connection with redevelopment of a property.

However, costs arising in connection with government claims stemming from known conditions can still be covered under a typical PLL policy. CGL policies will typically exclude coverage for underground storage tanks, fuel or chemical storage, waste storage and business interruption, which can be included under a PLL policy. It is also important to note that off-site disposal sites or landfills (often called “non-owned disposal sites” in PLL policies) can be scheduled onto policies. If liability arises at the disposal facility and liability attaches to your client as a generator, the PLL policy would kick in.

PLL policies also can cover re-opener type situations. In many states, parties that have received no-furtheraction determinations after cleaning up a contaminated property may be audited, and the cleanup decision re-opened to require further investigation or remediation. This is likely to occur in situations where the remediation standards governing a particular contaminant are revised, or where new data become available at a later date suggesting that remediation was not properly completed. With a PLL policy in place, costs associated with a re-opener become less of an uncertainty. PLL policies also entitle the policyholder to legal defense of any of the above situations.

PLL policies are claims-made-and-reported policies, meaning that claims must be made during the term of the policy. So, for example, Wiseman would have had to have an existing PLL policy covering the property to avail itself of that policy’s protections when the underlying CERCLA claim arose. It would not have been enough to have had the policy during ownership of the property.

Underwriting on PLL policies is typically conducted using readily available environmental documents, including Phase I and Phase II environmental site assessments, as well as other environmental reports, and agreement documents.

Wiseman offers an important lesson, especially to those that own or operate properties that have current or former facilities with environmentally sensitive operations: CGL policies are not an effective tool to manage environmental liability risks. Although not perfect, PLL policies are a more appropriate type of coverage to mitigate unknown risks associated with present and legacy property ownership. PLL policies can offer particular value to address the residual risk after a cleanup.

Kyle R. Johnson also contributed to this article.

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