Category: Business Organizations

The Confidentially Marketed Public Offering for the Smaller Reporting Company

What is it?

A Confidentially Marketed Public Offering (“CMPO”) is an offering of securities registered on a shelf registration statement on Form S-3 where securities are taken “off the shelf” and sold when favorable market opportunities arise, such as an increase in the issuer’s price and trading volume resulting from positive news pertaining to the issuer.  In a CMPO, an underwriter will confidentially contact a select group of institutional investors to gauge their interest in an offering by the issuer, without divulging the name of the issuer.  If an institutional investor indicates its firm interest in a potential offering and agrees not to trade in the issuer’s securities until either the CMPO is completed or abandoned, the institutional investor will be “brought over the wall” and informed on a confidential basis of the name of the issuer and provided with other offering materials.  The offering materials made available to investors are typically limited to the issuer’s public filings, and do not include material non-public information (“MNPI”).  By avoiding the disclosure of MNPI, the issuer mitigates the risk of being required to publicly disclose the MNPI in the event the offering is terminated.  Once brought over the wall, the issuer, underwriter and institutional investors will negotiate the terms of the offering, including the price (which is usually a discount to the market price) and size of the offering.  Once the offering terms are determined, the issuer turns the confidentially marketed offering into a public offering by filing a prospectus supplement with the Securities and Exchange Commission (“SEC”) and issuing a press release informing the public of the offering.  Typically, this occurs after the close of markets.  Once public, the underwriters then market the offering broadly to other investors, typically overnight, which is necessary for the offering to be a “public” offering as defined by NASDAQ and the NYSE (as discussed further below).  Customarily, before markets open on the next trading day, the issuer informs the market of the final terms of the offering, including the sale price of the securities to the public, the underwriting discount per share and the proceeds of the offering to the issuer, by issuing a press release and filing a prospectus supplement and Current Report on Form 8-K with the SEC.  The offering then closes and shares are delivered to investors and funds to the issuer, typically two or three trading days later.

What Type of Issuer Can Conduct a CMPO and How Much Can an Issuer Raise?

To be eligible to conduct a CMPO, an issuer needs to have an effective registration statement on Form S-3, and is therefore only available to companies that satisfy the criteria to use such form.  For issuers that have an aggregate market value of voting and non-voting common stock held by non-affiliates of the issuer (“public float”) of $75M or more, the issuer can offer the full amount of securities remaining available for issuance under the registration statement.  Issuers that have a public float of less than $75M will be subject to the “baby shelf rules”.   In a CMPO, issuers subject to the baby shelf rules can offer up to one-third of their public float, less amounts sold under the baby shelf rules in the trailing twelve month period prior to the offering.  To determine the public float, the issuer may look back sixty days from the date of the offering, and select the highest of the last sales prices or the average of the bid and ask prices on the exchange where the issuer’s stock is listed.  For an issuer subject to the baby shelf rules, the amount of capital that the issuer can raise will continually fluctuate based on the issuer’s trading price.

What Exchange Rules Does an Issuer Need to Consider?

The public offering period of a CMPO must be structured to satisfy the applicable NASDAQ or New York Stock Exchange criteria for a “public offering”.  In the event that the criteria are not satisfied, rules requiring advance shareholder approval for private placements where the offering could equal 20% or more of the pre-offering outstanding shares may be implicated.  Moreover, a sale of securities in a transaction other than a public offering at a discount to the market value of the stock to insiders of the issuer is considered a form of equity compensation and requires stockholder approval.  Nasdaq also requires issuers to file a “listing of additional shares” in connection with a CMPO.

Advantages and Disadvantages of CMPOs

There are a number of advantages of a CMPO compared to a traditional public offering, including the following:

  • A CMPO offers an issuer the ability to raise capital on an as needed basis as favorable market conditions arise through a process that is much faster than a traditional public offering.
  • The shares issued to investors in a CMPO are freely tradeable, resulting in more favorable pricing for the issuer.
  • In a CMPO, the issuer can determine the demand for its securities on a confidential basis without market knowledge.  If terms sought by investors are not agreeable to the issuer, the issuer can abandon the CMPO, generally without adverse consequences on its stock price.
  • If properly structured as a public offering, a CMPO will negate the requirement to obtain stockholder approval for the transaction under applicable Nasdaq and NYSE rules.

Disadvantages of conducting a CMPO include:

  • To conduct a CMPO, an issuer must be eligible to use Form S-3 and have an effective registration statement on file with the SEC.
  • Issuers subject to the baby shelf rules may be limited in the amount of capital they can raise in a CMPO.
  • In the event a CMPO is abandoned, investors that have been “brough over the wall” and received MNPI concerning the issuer may insist that the issuer publicly disclose such information to enable such investors to publicly trade the issuer’s securities.

This article is for general information only and may not be relied upon as legal advice.  Any company exploring the possibility of a CMPO should engage directly with legal counsel.

© Copyright 2021 Stubbs Alderton & Markiles, LLP
For more articles on the NASDAQ and NYSE, visit the NLR Financial, Securities & Banking section.

Denied Women’s Business Enterprise (WBE) Certification? How to Appeal a WBE Denial Through the Women’s Business Enterprise National Counsel

Women’s Business Enterprise (WBE) Certification could be a valuable tool to help your business access additional opportunities.  This blog post will cover the appeal process for WBE certifications through the Women’s Business Enterprise National Council (WBENC) and its Regional Partner Organizations (RPO).  According to WBENC, its RPOs are authorized to administer the WBENC certification, one of the most well-known WBE certifications, across the United States

In order to obtain WBENC certification, your business must show that it is at least 51 percent owned, controlled, operated, and managed by a woman or women.  The application process involves providing a lot of information and documentation about your business and its owners to the RPO, who will also conduct a site visit (virtually in times of COVID-19).

If your application for WBENC certification is denied, you can either reapply later, or appeal.  There are two levels of appeal.  The first is to the local RPO board.  If you are unsuccessful there, you can appeal to the WBENC Board of Directors.

Below we will outline the appeals process, according to the WBENC Standards and Procedures: see here.

Appeal to the Local RPO Board

The first step in appealing a denial of WBENC certification is to request a meeting with the RPO’s Executive Director or President to discuss the reasons for the denial.  This is for informational purposes only but may give your business an idea of the challenges you may face on appeal.

If you decide to pursue the appeal, you must make a request in writing to the RPO Board of Directors within 30 days of the date of your denial letter.

The RPO Board of Directors will then contact you to schedule an appeal date – if they deem it necessary.  Each RPO will have an Appeals Committee, made up of at least three trained members.  Their decision will be based upon the initial application materials, as well as any requested additional information.  Please note that the committee cannot consider changes in the ownership or control of the business that took place after you requested certification.  Within 30 days of your request, the Appeals Committee will review the file and make a recommendation to the RPO Board of Directors.  If there are new reasons for the denial, you will be notified and given 14 days to respond.

Within 15 days of the Appeal Committee’s recommendation, the RPO Board of Directors will either overturn the denial and grant certification or will uphold the denial.  You will be notified within seven days.

If this appeal results in a denial, your options are to 1) reapply for certification within six months of the date of the original denial, or 2) appeal to the WBENC Board of Directors within 30 days from the date of the appeal letter upholding the initial denial.

Appeal to WBENC Board of Directors

Once WBENC receives your appeal, the President of WBENC will determine, on the basis of information provided by both the appellant business and the RPO, whether there is a reason to evaluate the appeal.  Again, changes subsequent to the initial application will not be considered.

If the President determines that there is insufficient evidence, the denial is upheld, and your appeal is over.

If the President determines that there is evidence for appeal, they will forward it to the Appeals Sub-Committee for review and obtain the original file from the RPO.

The Appeals Sub-Committee will review and make a recommendation to the WBENC Board of Directors within 120 days to either uphold the denial or certify the applicant.  This recommendation will be reviewed by the WBENC Board of Directors, and the President will notify the applicant of the final decision.

If the business is denied, there is no further avenue of appeal. However, the applicant may reapply within six months of the date of the original denial letter.

©2020 Strassburger McKenna Gutnick & Gefsky
For more, visit the NLR Corporate & Business Organizations section.

Seeking Haven in the Sunshine State

With the weather in Washington turning cool and miserable, we look to the Sunshine State of Florida, where we thought we saw signs of reopening. The US District Court for the Southern District of Florida is following the local school systems, announcing: “In light of the announced reopening of public schools in Miami-Dade, Broward, Palm Beach, St. Lucie and Monroe Counties, the United States District Courthouses in Miami, Fort Lauderdale, West Palm Beach, Fort Pierce and Key West, including Bankruptcy and Probation, will reopen on Tuesday, November 10, 2020.”

But, but, but…Chief Judge K. Michael Moore issued Administrative Order 2020-76, which provides, among other things: “All jury trials in the Southern District of Florida scheduled to begin on or after March 30, 2020, are continued until April 5, 2021. The Court may issue other Orders concerning future continuances as necessary and appropriate.”

The April 2021 date is significantly further in the future than most courts have gone. And notably, some judges in the district have not taken their upcoming trials off the calendar or relieved parties of their obligations to comply with pretrial deadlines.

© 2020 McDermott Will & Emery
For more articles on state reopening, visit the National Law Review Corporate & Business Organizations section.

Feuding Business Partners in Private Companies: Considering Arbitration to Resolve Partnership Disputes

It is common for private company co-owners to have disagreements while they operate their business, but they typically work through these disputes themselves.  In those rare instances where conflicts escalate and legal action is required, business partners have two options—filing a lawsuit or participating in an arbitration proceeding.  Arbitration is available, however, only if the parties agreed in advance to arbitrate their disputes.  Therefore, before business partners enter into a buy-sell contact or join other agreements with their co-owners, they will want to consider both the pros and the cons of arbitration.  This post offers input for private company owners and investors to help them decide whether litigation or arbitration provides them with the best forum in which to resolve future disputes with their business partners.

Arbitration is often touted as a faster and less expensive alternative to litigation with the additional benefit of resulting in a final award that is not subject to appeal.  These attributes may not be realized in arbitration, however, and there are other important factors involved, which also merit consideration.  At the outset, it is important to emphasize that arbitrations are created by contract, and parties can therefore custom design the arbitration to be conducted in a manner that meets their specific needs.  The critical factors to be considered are: (i) speed—how important is a quick resolution to the dispute, (ii) confidentiality—how desirable is privacy in resolving the claims, (iii) scope—how broad are the claims to be resolved, (iv) expense—how important is it to limit costs, and (v) finality—is securing a final result more desirable than preserving the right to appeal an adverse decision.

Speed—Prompt Resolution of Dispute

Arbitrations generally resolve claims more promptly than litigation, but that is not always the case as arbitration proceedings can drag on if the arbitration is not subject to any restriction on when the final hearing must take place.  One way to ensure that an arbitration will promptly resolve the dispute, however, is to require an end date in the arbitration agreement.  Specifically, the parties can state in their arbitration provision that the final arbitration hearing must take place within a set period of time, perhaps 60 or 90 days of the date the arbitration panel holds its first scheduling conference.  The arbitrators will then set a date for the final hearing that meets this contractual requirement.  Similarly, in the arbitration provision, the parties can also specify the length for the hearing (no more than 2-3 days), and they can also impose limits on the extent of discovery, including by restricting the number of depositions than can be taken.

If securing a prompt resolution of a dispute with a business partner is important, this result can be assured by requiring that all claims are arbitrated, particularly if the parties specify in the arbitration provision that the final hearing must take place on a fast track basis.

Confidentiality—Arbitration Conducted Privately

Litigation takes place in a public forum and, as a result, all pleadings the parties file, and with only rare exceptions, all testimony and other evidence presented at any hearings and at trial will be available to the public.  Therefore if a business partner wants to avoid having future partnership disputes subject to public scrutiny, arbitration provides this protection. But looking at this from another perspective, a minority investor may want to decline to arbitrate future claims against the majority owner if the owner is sensitive to adverse publicity.  The threat of claims being litigated in a public lawsuit may provide the investor with leverage in the negotiation and settlement of any future claims the investor has against the majority owner.

Scope of Dispute—How Much Discovery Required

Determining the scope of a future dispute with a business partner is difficult to do at the time that business partners enter into their contract when any future claims are unknown.  The downside arises in the arbitration context, because one of the parties may desire broad discovery of the type that is permitted in litigation, which may be necessary to defend against certain types of contentions, such as claims for fraud, personal injury and other types of business torts.  In an arbitration proceeding, discovery is typically more restricted, and it may further be limited by the arbitration provision, which caps the number of depositions and narrows the scope of document discovery.  Under these circumstances, the defending party (the respondent) may be hamstrung by these discovery limitations in defending against the claimant’s allegations in arbitration.

To avoid prejudice to the respondent from restrictions on discovery in arbitration, the parties may decide to agree that not all claims between them would be subject to arbitration.  For example, the parties could agree that all claims related in any way to the value and purchase of a departing partner’s interest in the business would be subject to arbitration, but that other claims of a personal nature (e.g., claims for discrimination, wrongful termination) would be litigated in court rather than arbitrated.  This splitting of claims in this manner may not be practical, but is something to be discussed by the parties when they enter into their agreement at the outset.

Expense of Dispute Resolution

As discussed above, business partners can limit the expense of resolving future claims between them by requiring a fast track arbitration hearing and also by limiting the scope and the extent of allowed discovery.  For example, if the parties require a final arbitration hearing to take place in 90 days after the initial scheduling conference, limit the hearing to two days and permit no more than three fact witness depositions per side.  They will have likely achieved a significant reduction of the cost of resolving their dispute.

The issue of cost requires additional analysis, however, because if the parties are not of equal bargaining power, the partner with more capital may not agree that arbitration is the best forum to resolve disputes with a less solvent partner.  The wealthier partner may believe that he or she would prevail over the less well-capitalized partner in a “war of attrition.” This factor may be so significant that it causes the wealthier partner to reject the arbitration of future disputes in favor of resolving of all future claims by or against the other partner through litigation.

Finality of Arbitration Awards

There is no right of an appeal in arbitration and the grounds for attacking an arbitration award in a court proceeding after the arbitration concludes are narrow and rarely successful.  This finality element may thus be an important factor in selecting arbitration as the forum for resolving partnership disputes with the goal of ending the dispute without having it linger on.

There is another concern here, however, that also bears considering.   The conventional wisdom among trial lawyers is that arbitrators are prone to “split the baby” by not providing a strict construction of the written contract or the controlling statute at issue.  Instead, the belief is that arbitrators are inclined to include something for both sides in the final award in an attempt to be as fair as possible, which results in mixed bag outcome.   That has not been my personal experience, but it is true that if the arbitration award is not fully consistent with the contract or a governing statute, there is no right to appeal the decision.  The bottom line is that, at the end of the arbitration, the parties will have to live with the result, and there is no available path to challenge an unfavorable/undesired outcome.

Conclusion

The takeaway is that arbitration is not a panacea.  It can be structured to take place faster and more cost-effectively than a lawsuit, and it will also be held in private and not be subject to public scrutiny.  But, business partners also need to consider other factors in arbitration, such as specific limits on discovery that may be problematic and the finality of the arbitrators’ decision, which may not be viewed as fully consistent with the partners’ contract or in strict accordance with the applicable law.   To the extent that business partners do opt for arbitration, they should craft the arbitration provision to make sure its terms closely align with their business goals.

© 2020 Winstead PC.

ARTICLE BY Ladd Hirsch at Winstead.
For more on business conflict resolution, see the National Law Review Corporate & Business Organizations law section.

Renewed Shutdowns/Restrictions Present Interesting Issues Regarding COVID-19 Business Interruption Claims

In recent weeks we have published multiple pieces on issues related to the calculation of damages under business interruption policies for losses associated with COVID-19 shutdowns/restrictions.  Unlike more conventional business interruption claims, such as losses associated with a hurricane, COVID-19 claims are likely to be more complicated regarding the end date for loss calculations, especially in instances where the policyholder was permitted to resume operations in a limited capacity, such as restaurants that initially were ordered closed but then were allowed to transition to a take-out/delivery model, outdoor seating only, or to operate at restricted capacities.

As many jurisdictions now face a resurgence in COVID-19 cases, another complicating issue is likely to arise.  In these jurisdictions that previously imposed restrictions on operations but lifted such restrictions, many policyholders have already submitted COVID-19-related business interruption claims to their insurance carriers.  Having thought that they had weathered the storm and were on the path to recovery, they now face the potential of new shutdowns/restrictions.

If renewed shutdowns/restrictions are imposed, a question is likely to arise as to whether these policyholders have one claim applicable to both sets of shutdowns/restrictions or two separate claims.  Does the policyholder need to provide additional notice related to the second set of shutdowns/restrictions?  Is it more beneficial for the policyholder to have one or multiple coverage triggering events (i.e., occurrences)?  What is the impact on available limits or deductibles/retentions?

These are just a few of the insurance issues potentially presented by the prospect of renewed shutdowns/restrictions.  Policyholders should review the terms of their policies carefully to understand their rights and their best path forward.

© 2020 Gilbert LLP

For more on business interruption, see the National Law Review Insurance, Reinsurance & Surety law section.

One-Two Punch: Businesses Must Fight the Virus and Possible Liability Claims

After several weeks in lockdown and thousands of business closures in an attempt to control the spread of the novel coronavirus, businesses are finally reopening their doors. Given the high transmission of COVID-19, businesses should consider their risks of legal liability to visitors on their property – customers, employees and others – in the event of COVID-19 exposure at their premises.  But the fear of civil liability remains a hindering problem. These claims will most commonly be pursued under the legal theory of negligence and plaintiffs may seeking financial compensation for their injuries and medical treatment related to COVID-19. Plaintiff’s lawyers in these cases will focus on the operations and procedures in place during the reopening. Some businesses are taking extraordinary measures to protect customers, while others are doing the bare minimum. Businesses need to know how to be in compliance with best safety practices to prevent and defend against claims related to an alleged failure to protect customers from COVID-19 exposures.

Immunity for Businesses for COVID-19 Exposure?

A large number of states, including Massachusetts, have enacted laws to shield health care workers, health care facilities and volunteer organizations treating COVID-19 patients from negligence claims subject to certain exceptions. However, the immunity does not extend to cover damages caused by gross negligence or recklessness. It is important to note that these states have not provided similar immunity to other businesses, nor have they limited liability in cases involving gross negligence for COVID-19 related claims. There have been discussions of additional legislation to protect businesses in these cases, but this has yet to happen.

Tort Claims and Premises Liability Law in Massachusetts

Personal injury claims typically stem from negligent acts, where a party had a duty of care, failed to reasonably care for that individual, and that failure to care caused the individual harm or injury. A ”duty of care” exists when its reasonably foreseeable that some act or omission would cause some type of knowable harm, and thus taking reasonable action to ensure safety. The breach of that duty is the act or omission that causes the harm. The breach of duty must cause some damages. Damages are monetary compensation for the victim’s injuries and losses if liability is found.

Premises liability law, a subset of personal injury law, similarly holds that property owners owe a duty of reasonable care to visitors on their premises in Massachusetts, so as to not create or allow unsafe or hazardous conditions to exist on their premises that could cause injury or harm to patrons and guests. If a hazardous condition exists that could reasonably cause harm, and the property owner fails to remove it or warn of it, this could ultimately result in liability.

The duty of care is stricter for business owners, as they invite persons onto their property to purchase goods or services. The level of care owed depends upon the type of visitor on the property. Massachusetts has two types of lawfully present visitors: 1) licensees- individuals presenting financial gain for the property owner like patrons, diners, shoppers; and 2) invitees- those who are not providing any financial gain to the property owner like guests and friends at a social gathering. The property owner owes its visitors a duty of care, that is to keep the property reasonably safe. In this context, the property owner is well aware of the risks associated with COVID-19, the nature of the disease and how it is transmitted. If it did not take reasonable steps to prevent the transmission of the virus to its licensees and invitees, and the claimant can prove the business’ failure to exercise reasonable care was a “substantial contributing factor” in causing the claimant’s injury, they may be entitled to damages, which can include among other things, medical expenses, economic damages, and even emotional distress.

Breach of Duty

There is an abundance of guidance available to businesses on the virus, transmission, preventative measures. Whether a business “breached” their duty of care will focus on what the business did to determine if taking action (or taking no action) was reasonable or not, given the state of knowledge on the virus. Thus, claimants would need to point to what steps the businesses took to protect its licensees and invitees, and whether there were additional procedures that could have been implemented to prevent the transmission, and whether those additional actions were reasonable in light of what was known about the virus. Intentional ignorance is not a defense – property owners have a duty to investigate known or potential hazards, including COVID-19.

Causation

Claimants in tort claims have the burden of proving causation. This usually means proving that the breach of duty was a “substantial contributing factor” in causing the claimant’s injury. In COVID-19 cases, the claimant will ultimately need to prove that the virus was contracted at that business as opposed to another source, which may be extremely difficult to do. Asymptomatic spread of COVID-19 is one of many challenges to proving the initial source of exposure. While some claimants will rely on contact tracing, that alone does not rule out alternative sources of COVID-19 exposure – any other place the person visited (markets, homes, their workplace), and exposure to family members and friends.

Notably, a large number of states are enacting legislation applicable to workers compensation claims related to COVID-19. This legislation establishes a rebuttable presumption that an employee who tests positive for COVID-19 contracted it in the course of employment, although some are limited to essential workers. A “rebuttable presumption” means that the burden of disproving causation is thrust upon the employer. While there are no similar rebuttable presumptions for personal injury and premise liability claimants at this time, it is an open question as to whether these presumptions can be used affirmatively in tort lawsuits, particularly in a situation where a worker brings COVID-19 into the home and sickens a family member or housemate.

Mitigating Liability

If businesses can show that safety protocols were followed, this evidence can be used to defend these types of claims. The Centers for Disease Control and Prevention (CDC) has set guidelines that should be followed as best practices to avoid COVID-19 liability claims. There is an abundance of state and local guidance on social distancing, use of masks and other measures to prevent the spread of the virus. With the vast amount of information available to the public on the risks of the virus and preventative measures, claimants will argue that businesses have enough information to safely operate Crafty plaintiff’s lawyers will likely seek out and find guidance that specifically supports their clients case. Business owners are advised to do the same for their respective industries, whether it be restaurants, offices or youth sports leagues.

Defenses to Consider in Defending COVID 19 Liability Claims

Statute of Limitations

The statute of limitations for in Massachusetts governing personal injury and premises liability cases places a time limit of three years within the date of the incident for filing the lawsuit. Lawsuits filed after the statute of limitations period may be dismissed as “time-barred.” Other states have similar statutes, although the specific timeframe may vary.

Modified Comparative Negligence Law

Some states, including Massachusetts, use a modified comparative negligence rule in personal injury cases, allowing plaintiffs to recover only if the defendant’s share of the blame was equal to or greater than their own. There are only a few exceptions allowing plaintiffs to recover if they were more than 51% at fault. Another important factor of this rule to consider is that if plaintiffs are found to be at fault, their damages are reduced by their allocated share of the blame. Did the visitor where a mask? Did they stay 6 feet apart from other individuals? Did they wash their hands and sanitize frequently? Were they placing their hands on their mouth and nose? These facts and circumstances are critical factors to consider when shifting the blame to the claimant.

Assumption of Risk Abolished in Massachusetts

Some jurisdictions allow a defendant in a personal injury action to raise an affirmative defense of assumption of risk, but that is abolished in Massachusetts as a defense in personal injury cases. In jurisdictions where this defense is allowed, instead of denying the allegations, defendants can assert that a plaintiff was aware of the risk when engaging in the activity or conduct, fully had knowledge of the consequences and willingly disregarded the risks or assumed the risks. Therefore, the defendant cannot be at fault for negligence and this serves as a complete bar to recovery.

Liability Waivers

Did a plaintiff sign a written liability waiver acknowledging and accepting risks? Enforceability of liability waivers as well as the exceptions to the enforceability of releases vary from state to state. While this only shows licensees and invitees were made aware of the risk, using such waivers in these COVID 19 claims is not a slam dunk defense.

Conclusion

We encourage businesses to consider these liability risks when resuming operations and to follow comprehensive procedures and CDC guidelines to mitigate the risks and protect licensees and invitees from the spread of the virus at these establishments. Our office can help businesses develop a plan specific to their business to mitigate the risks of liability from emerging claims related to COVID 19 and provide guidance and advocacy for defending such claims.

©2020 CMBG3 Law, LLC. All rights reserved.

ARTICLE BY Seta Accaoui at CMBG3 Law.
For more on business COVID-19 liability, see the National Law Review Coronavirus News section.

10 Reasons Why FCPA Compliance Is Critically Important for Businesses

  • The Foreign Corrupt Practices Act (“FCPA”) prohibits companies from bribing foreign officials in an effort to obtain or retain business, and it requires that companies maintain adequate books, records, and internal controls to prevent unlawful payments.
  • The FCPA was passed in response to an increase in global corruption costs.
  • Implementing an effective FCPA compliance program can benefit companies financially and socially, and it can help companies seize opportunities for business expansion.
  • In drafted and implemented appropriately, an FCPA compliance program will: serve as an invaluable tool against corruption, promote ethical conduct within the company, reduce the societal costs of corruption, and foster business expansion domestically and globally.
  • Company leaders should consider hiring experienced legal counsel to provide advice and representation regarding FCPA compliance.

What is the Foreign Corrupt Practices Act?

Enacted in 1977, the Foreign Corrupt Practices Act (“FCPA”) is a federal law that prohibits bribery of foreign officials in an effort to obtain or retain business. It also requires companies to maintain adequate books, records, and internal controls in their accounting practices to prevent and detect unlawful transactions.

Congress passed the FCPA in response to growing concerns about corruption in the global economy. The FCPA includes provisions for both civil and criminal enforcement; and, over the past several decades, FCPA enforcement proceedings have resulted in billions of dollars in penalties, disgorgement orders, and other sanctions issued against companies accused of engaging in corrupt transactions with government entities.

What are the Risks of FCPA Non-Compliance?

The U.S. Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”) are the primary agencies tasked with enforcing the FCPA. These agencies take allegations of FCPA violations very seriously, motivated in large part by the damage that bribery and corruption of foreign officials can cause to the interests of the United States. Prosecutions under the FCPA have increased in recent years, with both companies and individuals being targeted.

Due to the risk of federal prosecution, companies that do business with foreign entities must implement compliance programs that are specifically designed to prevent, detect and allow for appropriate response to transactions that may run afoul of the FCPA. In addition to helping to prevent and remedy FCPA violations, adopting a robust compliance program also demonstrates intent to follow the law and can create a positive view of your company in the eyes of federal authorities.

“Implementing an effective FCPA compliance program serves a number of important purposes. Not only can companies mitigate the risk of their employees engaging in corrupt practices, but they can also discourage corrupt conduct by other entities and demonstrate to federal authorities that they are committed to complying with the law.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

If your company is targeted by the DOJ or SEC for a suspected FCPA violation, it will be important to engage federal defense counsel promptly. Having counsel available to represent your company during an FCPA investigation is crucial for protecting your company and its owners, executives, and personal against civil or criminal prosecution.

Why Should Companies Implement FCPA Compliance Programs?

Here are 10 of the most important reasons why companies that do business with foreign entities need to adopt comprehensive and custom-tailored FCPA compliance programs:

  1. The FCPA is an invaluable tool in the federal government’s fight against foreign corruption.
    • The FCPA is a massive piece of legislation that is designed to allow the DOJ and SEC to effectively combat corruption and bribery involving foreign officials. Ultimately, enforcement of the FCPA is intended to eliminate the costs of foreign corruption to the United States.
    • An effective and robust FCPA compliance program promotes these objectives while also protecting companies and individuals against civil liability and criminal prosecution.
  2. Anti-corruption laws like the FCPA promote ethical conduct.
    • Companies that have comprehensive policies against bribery and corruption send a strong message to other companies and foreign officials that they are committed to aiding in the federal government’s fight against corruption.
    • Foreign officials are less likely to ask for bribes from companies that promote an anti-corruption corporate environment through their compliance policies and procedures.
    • Compliance with anti-corruption laws promotes positive morale among company personnel who feel the pride of working for a company that is committed to transparency and ethical conduct.
  3. The FCPA allows companies to develop strong internal controls and avoid a slippery slope toward an unethical culture.
    • Companies that regularly utilize bribes in their business operations are likely to eventually encounter multiple problems, both in the U.S. and abroad.
    • Once a foreign official knows that a company is willing to pay bribes, that foreign official will request larger bribe amounts. In order to continue business operations in the relevant jurisdiction, company personnel may continue to accept the foreign official’s terms and pay larger bribes.
    • If left unchecked, corrupt practices can become so prevalent that they create enormous liability exposure for the company.
    • Maintaining a focus on FCPA compliance allows companies to develop effective internal controls that promote efficiency in their business operations.
  4. The FCPA reduces the societal costs of corruption.
    • Corruption increases costs to society. This includes political, social, economic, and governmental costs resulting from unethical business conduct.
    • By adopting and enforcing strong FCPA compliance programs, companies can help reduce these costs.
  5. The FCPA reduces the internal business costs of corruption.
    • Corporate success depends on certainty, predictability, and accountability. An environment where corruption is rampant costs companies time and money, and it can lead to disruptions in the continuity of their business operations.
    • FCPA compliance instills predictability in investments, business transactions, and dealings with foreign officials.
  6. Corruption and bribery create an unfair business environment.
    • Companies are more likely to be successful in an environment that emphasizes fair competition, and in which all competitors sell their products and services based on differentiation, pricing, and efficiency.
    • Corruption and bribery allow for unfair results in the marketplace. For instance, companies that utilize bribes can achieve increased sales and increased market share despite offering an inferior product at an uncompetitive price.
  7. The penalties under the FCPA encourage compliance and accurate reporting.
    • The penalties imposed under the FCPA incentivize the disclosure and reporting of statutory violations. These penalties include fines, imprisonment, disgorgement, restitution, and debarment.
    • Whistleblowers can receive between 10% and 30% of amounts the federal government recovers in FCPA enforcement litigation, and this provides a strong incentive to report violations as well.
    • The risk of significant penalties is an important factor for companies to consider when deciding how much time, effort, and money to invest in constructing an FCPA compliance program.
  8. Anti-corruption laws foster business expansion and stability both domestically and globally.
    • For companies that plan to expand domestically or internationally, success depends on the existence of a competitive environment in which companies compete fairly based on product differentiation, price, and other market factors.
    • Fair competition and growth opportunities are hampered when competitors can simply bribe their way to success. Therefore, FCPA enforcement is essential to maintaining fair competition.
    • DOJ and SEC investigations can severely disrupt efforts to maintain stability and predictability, and they can lead to significant financial and reputational harm.
  9. Corruption leads to human rights abuses.
    • Companies that regularly utilize corruption and bribery to achieve their business goals often resort to other illegal practices as well. This includes forced labor and child labor.
    • These types of human rights abuses are commonplace in countries where corruption and bribery are widespread.
    • To reduce the risk of these human rights abuses, it is crucial for company personnel to be educated on the potentially disastrous consequences of corruption and bribery.
    • Developing a robust compliance policy is the best way to educate personnel, reduce the risks of corruption and bribery, and eliminate the human rights abuses associated with these risks.
  10. The FCPA encourages open communication between companies and their legal counsel.
    • With regard to FCPA compliance, it is a legal counsel’s job to represent the best interests of the company and help the company foster an environment of ethical conduct. Achieving these objectives requires open and honest communication between the company and legal counsel.
    • Due to the severe sanctions imposed under the FCPA, companies are incentivized to hire counsel to advise them with regard to compliance and to adopt and implement effective FCPA compliance programs.

Effective FCPA Compliance Programs Help Companies Avoid Costs, Loss of Business Opportunities, and Federal Liability

Working with legal counsel to develop robust FCPA compliance policies and procedures can help prevent company personnel from offering bribes and engaging in other corrupt practices while also encouraging the internal disclosure of suspected violations. Failing to maintain adequate internal controls and foster a culture of compliance can be detrimental to a company’s operations, and FCPA violations can lead to civil or criminal prosecution at the federal level. As a result, all companies that do business with foreign entities would be well-advised to work with legal counsel to develop comprehensive FCPA compliance policies and procedures.

Oberheiden P.C. © 2020

For more on the Foreign Corrupt Practices Act see the National Law Review Criminal Law & Business Crimes section.

Keeping Eyes Wide Open When New Members Join the Pack: A Cautious Approach to the Addition of New Business Partners

There are many reasons for business owners to consider adding new partners, including to secure additional capital, to add needed expertise to help grow the company, to bring family members or close friends to join in building the business and to put a succession plan in place. Adding new partners can, therefore, provide a boost to the company’s revenues, lighten the load carried by the founder, and put the business on course for long-term success.  But this decision is not without risk because the new business partners may create conflicts, disrupt the business and insist on making changes that put the company’s existence in peril.

If after carefully weighing the pros and cons, business owners decide to move forward in adding new partners, this post reviews important steps they can take to protect themselves and the business from the decisions and actions of these new stakeholders in the company.

Equity Ownership Can Be Conditional or Subject to Cancellation

One protective step business owners can take when adding a new partner is to make the addition of a new partner’s conditional or subject to cancellation. This approach permits the owner to wait to grant the ownership interest in the company to the new partner until he or she has met specified business goals by a certain date or to cancel the grant of equity to the new partner if the specific goals have not been achieved by the agreed date.

The addition of a new business partner is conditional when the partner does not receive equity in the business until the prescribed business goals are met. For example, if a new partner is tasked with generating new investments or growing sales for the business, the partner will not receive any equity in the company unless these business targets are met by the stated date. This conditional arrangement prevents a potential new partner from becoming an owner if he or she has failed to deliver on important goals right from the outset.

Under a cancellation arrangement, the new partner may receive equity in the company initially, but the grant of this ownership stake is subject to being cancelled if the set goals are not met. Using the example above, if the new business partner is tasked with raising funds or with increasing sales for the company and cannot meet these goals by a specific date, the equity grant will be cancelled automatically or it can be made subject to cancellation. In the latter case, the business owner has discretion to extend the time for the new partner to meet the specified goals.

The use of a conditional or “cancelable” approach to adding a new business partner gives the business owner an “out clause.” These are contract rights that authorize the business owner to avoid adding a new partner who has failed to meet clear and defined expectations.

Securing a Buy-Sell Agreement Is Essential

We have written frequently about the importance of a Buy-Sell Agreement, which gives the business owner the right to redeem the ownership interest of a new partner.  This is a key provision to permit the majority owner to exercise rights to remove an investor as an owner of the business who has become disruptive or even adversarial.  Absent a Buy-Sell Agreement, a business owner may be “stuck” with a minority investor who cannot be removed, and who is demanding access to financial records and who may also assert claims against the owner for alleged breaches of fiduciary duty.

To avoid this situation, business owners should secure a Buy-Sell Agreement with all of their new partners at the time they become owners in the company.  The specific terms and the issues associated with Buy-Sell Agreements have been discussed in previous posts [here] and [here].

Consider Confidentiality Provisions and Restrictive Covenants

New business partners may not be employed by the company, but they will likely receive access to the company’s trade secrets and other business sensitive information. For this reason, all new business partners should be requested to sign confidentiality agreements to protect all of the company’s confidential information. This confidentiality agreement should be in force, of course, while partners have an ownership stake, as well as for at least some period of time after they no longer hold any interest in the business.  A majority owner will not want to be forced to compete with former business partners who are using the company’s confidential information immediately after they sever ties with the company.

For this reason—avoiding competition with former business partners—majority owners may want to require their new business partners to also agree to non-competition and non-solicitation agreements as a condition of becoming new owners of the company. These may not be multi-year agreements, but it is not unreasonable for a majority owner to require former partners not to engage in competition for a period of 12-18 months after departing as owners of the company. A non-compete agreement may not be warranted if the new partner will be holding only a small stake of less than 10% of the company. But for partners who receive a substantial ownership stake in the business, the majority owner will want to consider requesting some type of non-compete and non-solicitation agreement with these partners.

Allow Competition by Owners

As a final note, Texas law permits the duty of care to be eliminated as fiduciary duty by officers, directors and managers and that duty should therefore be removed from the company’s governance documents.  Texas law does not permit company owners, however, to eliminate the fiduciary duty of loyalty owed by governing persons, but the owners can agree that each of them are permitted to engage in competition with the business and they can agree that certain officers or managers are not required to devote full-time efforts to the business. Therefore, if a business owner wants the freedom not to work full-time for the company and/or the owner is engaging in activities that may be seen as competitive by other company owners, the company’s governance documents should expressly provide for the majority owner to have this type of flexibility.

Conclusion

A majority owner’s decision to add new business partners to the company can rejuvenate the business by providing financial capital, critical new vision, and helpful support. But these new business partners may also challenge the owner and create disruptive conflicts that harm the company and its prospects.  Business owners should therefore be cautious when they decide to add new partners, and the addition of these new owners should be structured in ways that will ensure that the business remains successful.  If things do not work out, as a last resort, the Buy-Sell Agreement that the majority owner should obtain from all new partners will enable the owner to exercise redemption rights to remove these new partners from the business when their presence threatens the company’s continued existence.

© 2020 Winstead PC.

For more on business partner considerations, see the National Law Review Corporate and Business Organizations law section.

SBA Rulemaking and Guidance Challenged in Federal Lawsuits in Connection with PPP Loan Guidance

The Coronavirus, Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law by the President on March 27, 2020. Title I of the CARES Act, named “Keeping American Workers Employed and Paid” by Congress, appropriated $659 billion for loans guaranteed by the Small Business Administration (“SBA”) under the Paycheck Protection Program (“PPP”).

Section 1114 of the CARES Act instructs the SBA to issue regulations “to carry out this title and the amendments made by this title” within fifteen days and without regard to the usual notice requirements, which the SBA did in the form of Frequently Asked Questions (the “FAQs”). 15 U.S.C. §§ 9001(1), 9012.

While ostensibly intended to clarify uncertainty in the CARES Act, two recent federal lawsuits challenge certain rulemaking and guidance promulgated by the SBA. The question before the courts is whether such rulemaking and guidance is a lawful interpretation of the CARES Act or, as the plaintiffs argue, amounts to illegal rulemaking.

Agencies are prohibited by the Administrative Procedures Act from taking action “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right.” 5 U.S.C. § 706(2)(C). The validity of an agency’s interpretation of a statute is reviewed by a court using the two-step framework outlined in the landmark case, Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984). The first question reviewed in the Chevron analysis is, “whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842–43.

The plaintiffs argue that certain elements of the SBA guidance did not give effect to the unambiguously expressed intent of Congress and, as a result, are unlawful and unenforceable.

DV Diamond Club of Flint v. SBA

DV Diamond Club of Flint LLC (“DV Diamond”) is a strip club in Flint, Michigan, which feared that it would be denied a PPP loan by lenders as a result of guidance from the SBA that is not consistent with the CARES Act. DV Diamond’s initial complaint, dated April 8, 2020, was amended on April 17, 2020 to add forty-one new co-plaintiffs (collectively with DV Diamond, the “Plaintiffs”), each of which claims to operate a legal sexual oriented business which meets the eligibility requirements under the CARES Act. The Plaintiffs argue that the CARES Act is unambiguous as to what businesses are eligible for PPP loans and the SBA, therefore, has no right to assert additional eligibility requirements or disqualifiers. See DV Diamond Club of Flint, LLC v. U.S. SBA, 20-cv-10899, 2020 U.S. Dist. LEXIS 82213, at *27 (E.D. Mich. May 11, 2020).

The U.S. District Court for the Eastern District of Michigan (the “District Court”) issued an injunction in favor of the Plaintiffs, noting that Congress unambiguously stated that the SBA may not exclude from eligibility for a PPP loan guarantee a business that met the CARES Act’s size standard for eligibility. Id. at *27.

The District Court agreed with the Plaintiffs that, “under step one of Chevron that the PPP Ineligibility Rule conflicts with the PPP and is therefore invalid.” Id. at *42.

“Congress provided temporary paycheck support to all Americans employed by all small businesses that satisfied the two eligibility requirements—even businesses that may have been disfavored during normal times.” Id. at *4-5.

The Sixth Circuit Court of Appeals denied the SBA’s motion for a stay of the injunction, holding that the relevant factors, including the Plaintiff’s likelihood success, weighed in favor of the Plaintiff. DV Diamond Club of Flint, LLC v. SBA, No. 20-1437, 2020 U.S. App. LEXIS 15822, at *8 (6th Cir. May 15, 2020).

Zumasys, Inc. v. SBA

Zumasys and two affiliated companies (collectively, “Zumasys”) received PPP loans but are concerned that they may subsequently be deemed ineligible as a result of “improper, and legally impermissible, underground regulation” promulgated by the SBA. (Zumasys, Inc. v. U.S. SBA et al., Dkt. No. 20-cv-008511, Dkt. 1 (the Zumasys Complaint) ¶ 58.)

Zumasys claims to have acted in reliance on the CARES Act by obtaining—and spending—what they expected to be forgivable PPP funds under the terms of the CARES Act rather than furloughing or terminating their employees. Subsequently, guidance set forth in questions 31 and 37 of the SBA’s Frequently Asked Questions, according to Zumasys, might require their loans to be repaid. Zumasys claims that being forced to repay their loans will place them in a worse financial position than had it never sought the PPP funds.

The SBA’s “credit elsewhere” test, which requires a borrower to demonstrate that the needed financing is not otherwise available on reasonable terms from non-governmental sources, was expressly excluded as an eligibility requirement to obtain a PPP loan by Congress. Zumasys alleges, however, that the FAQs “purport to re-impose the “credit elsewhere” requirement in contravention of” the CARES Act. (Id. ¶ 66.)

As a result, in an argument similar to that made by DV Diamond and its co-plaintiffs, Zumasys asserts that the FAQs “are not in accordance with the law and exceed Defendants’ authority under the CARES Act,” and asks that the SBA should be enjoined from enforcing them by the court. (Id.)

Subsequent to the filing of the Zumasys lawsuit, on May 13, 2020, the SBA issued guidance in question 46 in the FAQs that any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.

While this development, on its face, would seem to alleviate the concerns of Zumasys, a great deal of uncertainty remains for borrowers in connection with the guidance that has been released by the SBA since the passing of the CARES Act into law. Furthermore, there is no guarantee that subsequent guidance from the SBA will not contradict the guidance currently being relied upon, and in FAQ 39 the SBA noted that it will review all loans in excess of $2 million and in subsequent rulemaking it noted that with respect to a PPP Loan of any size, the “SBA may undertake a review at any time in [the] SBA’s discretion.”

Conclusion

The challenges by DV Diamond, Zumasys and other plaintiffs will hinge on whether or not the applicable courts determine that the guidance issued by the SBA is inconsistent with the unambiguously expressed intent of Congress.

To the extent that borrowers and applicants continue to believe that problematic discrepancies exist between the law and guidance being delivered by the SBA, and the SBA subsequently determines that a borrower is ineligible for a PPP loan or forgiveness of such loan, the courts may in the future be called upon again to apply the Chevron analysis to the SBA’s actions in connection with the PPP.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of Sills Cummis & Gross P.C.

© Copyright 2020 Sills Cummis & Gross P.C.
For more on SBA’s PPP loans, see the National Law Review Coronavirus News section.

Federal Courts Side With Strip Clubs in Opposing the SBA’s Ineligibility Rules for the Paycheck Protection Program, Possibly Signaling a Broader Trend

Recent rulings from federal courts enjoined the US Small Business Administration (SBA) from applying its April 2, 2020 Interim Final Rule (April 2 IFR) to limit the types of businesses that can participate in the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Some of these rulings are expressly limited to the named plaintiffs that had been denied PPP loans and do not directly impact any other businesses that have or might apply for a PPP loan. Irrespective of any limitations in these cases, such decisions may signal a broader trend. In increasing numbers, federal courts are agreeing with arguments made by small businesses facing COVID-19-related challenges that the SBA’s PPP business eligibility limitations are inconsistent with Congress’ intention to help “any business concern” during this unprecedented time.

Financial services businesses that are deemed ineligible under the April 2 IFR need to pay close attention to cases that challenge the SBA’s incorporation of its existing list of “prohibited businesses” into eligibility requirements for a PPP loan. Even without court rulings, it also is possible (although not likely) that Congress or the SBA could suspend or revise the April 2 IFR to broaden PPP eligibility to include some or all of the currently designated “prohibited businesses.”

This advisory will explore:

  • the SBA’s April 2 IFR restricted eligibility in the PPP to certain financial services businesses that were ineligible for SBA-guaranteed loans under existing federal programs;

  • a recent Sixth Circuit ruling challenging the April 2 IFR as well as other federal court cases may signal a trend by federal courts to adhere to the text of the CARES Act; and

  • whether other federal courts will follow the Sixth Circuit’s view, or whether Congress or the SBA will suspend or revise the April 2 IFR to broaden PPP eligibility.

The April 2 IFR and Subsequent SBA Rules and Guidance

The PPP was one of several measures enacted by Congress under the CARES Act to provide small businesses with support to cover payroll and certain other expenses for an eight-week period due to the economic effects of the COVID-19 pandemic. As noted in a prior Katten Financial Markets and Funds advisory, the SBA published the April 2 IFR on the evening before lenders could accept PPP applications, determining that various businesses, including some financial services business, were ineligible to apply for PPP loans under the CARES Act.1

The April 2 IFR limited the types of businesses eligible for the PPP by specifically incorporating an existing SBA regulation and guidance document that lists the types of businesses that are ineligible from applying for Section 7(a) SBA loans. In particular, the April 2 IFR provides, in part, that: “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2.”2

Some of the ineligible financial services businesses listed in the SBA’s Standard Operating Procedure 50 10 (SOP) include, without limitation:

  • banks;
  • life insurance companies (but not independent agents);
  • finance companies;
  • investment companies;
  • certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
  • speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

With respect to last category in this list, the SBA provided further clarity regarding certain investment businesses and speculative businesses that were applying for PPP loans. In an April 24, 2020 Interim Final Rule (April 24 IFR), the SBA expressly clarified that hedge funds and private equity firms are investment and speculative businesses and, therefore, are ineligible to receive PPP loans.3 However, the April 24 IFR created an exception for portfolio companies of private equity firms, which were deemed eligible for PPP loans if the entities met the requirements for affiliated borrowers under the April 2 IFR.4

Recent Sixth Circuit Case

As noted above, the SBA’s SOP did not only deem financial services businesses ineligible to receive PPP loans. Other types of businesses, including without limitation, legal gambling businesses, lobbying firms, businesses promoting religion and businesses providing “prurient sexual material” also were deemed ineligible. Believing that these limitations were inconsistent with a plain reading of the text of the CARES Act, some of these businesses have challenged the SBA’s restrictions imposed pursuant to the April 2 IFR.

On May 11, 2020, the US District Court for the Eastern District of Michigan preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude sexually oriented businesses from PPP loans under the CARES Act.5 Plaintiffs were primarily businesses that provided lawful “clothed, semi-nude, and/or nude performance entertainment,” which were considered ineligible businesses for the PPP under the April 2 IFR due to their “prurient” nature.6 The district court found that the CARES Act specifically broadened the class of businesses that are PPP eligible,7 determining that it was clear from the text of the statute that Congress provided “support to all Americans employed by all small businesses.”8 The district court, however, limited the injunction to the plaintiffs and intervenors in the case, noting that it was “not a ‘nationwide injunction’ and did not restrict any future action the SBA may take in connection with applications for PPP loans.”9 The SBA appealed to the US Court of Appeals for the Sixth Circuit and requested a stay of the injunction.10

The Sixth Circuit ultimately denied the SBA’s stay, and agreed with the district court’s interpretation of the CARES Act’s eligibility requirements.11 Specifically, the Sixth Circuit held on May 15 that the CARES Act conferred eligibility to “any business concern,” which aligned with Congress’s intent to provide support to as many displaced American workers as possible. The SBA pointed out that the CARES Act explicitly listed “nonprofit organizations” as eligible for PPP loans, even though “they are ineligible for ordinary SBA loans.”12 The SBA argued that if Congress wanted to include previously ineligible businesses for PPP loans, like sexually oriented businesses, the CARES Act would have listed such entities.13 The Sixth Circuit stated that it was “necessary to specify non-profits because they are not businesses,” which further supported the district court’s expansive interpretation of the CARES Act.14

The Sixth Circuit’s opinion only requires the SBA to issue loans to the businesses that were a party to the underlying lawsuit. The ruling does not require the SBA to make PPP loans to any other businesses that are defined as ineligible in its April 2 IFR. However, as a practical matter, this opinion could be used to support a small business located in Ohio, Pennsylvania or Michigan (i.e., the states within the jurisdictional reach of the Sixth Circuit) in a federal court proceeding initiated prior to the submission of a PPP application requiring the SBA to defend its eligibility criteria in connection with such small business’s specific facts. (Note that an application should not be made without first obtaining a similar legal result as the small business applicant would not otherwise be able to make the certifications necessary to apply for a PPP loan.)

Cases in Other Circuits

In addition to the Sixth Circuit, several other federal courts have struck down the SBA’s imposition of its ineligibility criteria on PPP applicants engaged in sexually oriented businesses. For example, the US District Court for the Eastern District of Wisconsin on May 1 preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude “erotic dance entertainment” companies from obtaining a PPP loan.15 The SBA argued that because Congress removed some conditions that would ordinarily apply to Section 7(a) SBA loans (such as the PPP eligibility for non-profits), “it must have intended for the SBA to enforce all other conditions.”16 Similar to the Sixth Circuit, the district court found the SBA’s interpretation “highly unlikely” given “Congress’s clear intent to extend PPP loans to all small businesses affected by the pandemic.”17 Additionally, the SBA failed to identify any purpose of either the CARES Act or Section 7(a) that is furthered by the SBA’s exclusion of sexually oriented businesses.18 The SBA appealed to the US Court of Appeals for the Seventh Circuit and requested a stay of the injunction pending appeal. The Seventh Circuit denied the request for a stay on May 20, 2020, but has yet to rule on the merits of the appeal.19

Implications

As of May 21, 2020, roughly $100 billion PPP funds are still available.20 In its recent statutory amendments to the PPP, Congress decided not to address PPP eligibility issues.21 Notwithstanding Congress’s decision not to take action on these issues more recently, financial services businesses deemed ineligible under SBA regulations for PPP loans under the CARES Act should still pay close attention to these cases and whether federal court rulings influence Congress or the SBA to revisit the April 2 IFR.22

1 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program, 85 Fed. Reg. 20811, (Apr. 15, 2020).

2 See Interim Final Rule at 8, citing 13 C.F.R. § 120.110 and Small Business Administration Standard Operating Procedure 50 10 Subpart B, Chapter 2.

3 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility, __ Fed. Reg.___, available.

4 According to the April 24 interim final rule, the affiliation requirements are waived if “the borrower receives financial assistance from an SBA-licensed Small Business Investment Company (SBIC) in any amount. This includes any type of financing listed in 13 CFR 107.50, such as loans, debt with equity features, equity, and guarantees. Affiliation is waived even if the borrower has investment from other non-SBIC investors.” Id.

5 DV Diamond Club of Flint, LLC, et al. v. SBA, et al., No. 20-1437 (6th Cir. Apr. 15, 2020).

6 Id. at 2.

7 DV Diamond Club of Flint LLC v. SBA, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2. The district court stated that 15 U.S.C. § 636(a)(36)(D) of the CARES Act specifically “broadened the class of businesses that are eligible to receive SBA financial assistance.” Id. at 9. This section provides, in relevant part, that “‘[d]uring the covered period, in addition to small business concerns, any business concern . . . shall be eligible to receive a covered [i.e., SBA-guaranteed] loan’ if the business employs less than 500 employees or if the business employs less than the size standard in number of employees for the industry,” which is established by the SBA. Id. See also 15 U.S.C. §§ 636(a)(36)(D)(i)(I)-(II).

8 DV Diamond Club, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2.

9 Id. at 45.

10 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 1.

11 Id. at 4. The Sixth Circuit interpreted the CARES Act under the Supreme Court’s ruling in Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984). Id. In Chevron, the Supreme Court stated that if a federal statute can be facially interpreted, “the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842–43.

12 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 5.

13 Id.

14 Id. US Circuit Judge Eugene E. Siler Jr. dissented, stating that the CARES Act was ambiguous and the district court’s injunction should be stayed to give time to decide on the merits. Id. at 6. He noted that the CARES Act requires “PPP loans to be administered ‘under the same terms, conditions and processes’” as the SBA’s section 7(a) loans, which would exclude sexually oriented businesses from PPP eligibility. Id. See also 15 U.S.C. § 636(a)(36)(B).

15 Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-C-061 (E.D. Wis. May 1, 2020), at 27-28. A similar case, filed early May 2020, is currently pending in the US District Court for the Northern District of Illinois. See Admiral Theatre Inc. v. SBA et al., No. 1:20-cv-02807 (N.D. Ill May 8, 2020).

16 Camelot Banquet Rooms, No. 20-C-061 (E.D. Wis. May 1, 2010), at 15.

17 Id. at 16. In contrast to the Eastern District of Michigan, the Wisconsin federal court did not explicitly limit its injunction to the parties. In light of the potentially serious penalties for ineligible applicants, businesses that are ineligible for the PPP under the April 2 IFR should be cautious about applying for a PPP loan without exploring all options and consequences with counsel.

18 Id.

19Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-1729 (7th Cir. May 20, 2020). In contrast to the Sixth and Seventh Circuit rulings, the US District Court for the District of Columbia denied an injunction to enjoin the SBA from making an eligibility determination for the PPP under the CARES Act. Am. Ass’n of Political Consultants v. SBA, No. 20-970 (D.D.C. April 21, 2020). Plaintiffs, a trade association of political consultants and lobbyists, argued that the denial of PPP loans under the SBA’s April 2 IFR due to the political nature of their businesses violated plaintiffs’ First Amendment rights. Id. at 1-2. The district court ruled that it was constitutionally valid for the SBA to decide “what industries to stimulate” with PPP loans. Id. at 11. The plaintiffs filed a notice of appeal on April 22, 2020. Am. Ass’n of Political Consultants, Notice of Appeal, ECF No. 22 (D.D.C. April 22, 2020).

20 Kate Rogers, More than half of small businesses are looking to have PPP funds forgiven, survey says, CNBC News (May 21, 2020), available at https://www.cnbc.com/2020/05/21/more-than-half-of-small-businesses-are-looking-for-ppp-forgiveness.html.

21 On June 3, 2020, Congress passed the Paycheck Protection Program Flexibility Act (“PPP Flexibility Act”), which modified certain provisions of the PPP. H.R. 7010, 116th Cong. (2020), available at https://www.congress.gov/bill/116th-congress/house-bill/7010/text?r=12&s=1. At a high level, the PPP Flexibility Act: 1) extends the PPP to December 31, 2020; 2) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 3) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 4) increases the current limit on non-payroll expenses from 25% to 40%; 5) extends the maturity date on the portion of a PPP loan that is not forgiven from 2 years to 5 years; and 6) defers payroll taxes for businesses that take PPP loans.

22 IFRs are subject to public comment under the Administrative Procedures Act. The particular comment period of the April 2 IFR expired on May 15, 2020.

©2020 Katten Muchin Rosenman LLP

For more on business’ PPP loan eligibility, see the National Law Review Coronavirus News section.