Category: Financial Services Law

Is A Corporation’s Address A Trade Secret?

“Cryptocurrency” is a hybrid word form from the Greek adjective, κρυπτός, meaning hidden, and the Latin participle, currens, mean running or flowing.  The word “currency” is also derived from currens, perhaps based on the idea that money flows from one person to the next in an economy.  Literally, cryptocurrency, is secret money.  But there are secrets and there a secrets.

Recently, a cryptocurrency exchange sued one of its employees for violating the Defend Trade Secrets Act of 2016, 18 U.S.C. § 1831-39.  Among other things, the company alleged that the erstwhile employee had disclosed the “physical address” of the company in a complaint filed in a state court action.  Until now, I had never considered that a company’s physical address might be a secret.  The company argued that “keeping its physical address secret serves to protect it from ‘physical security threats,’ providing as an example of such threats ‘a recent spate of kidnappings’ of persons who work for cryptocurrency exchanges”.  Payward, Inc. v. Runyon, U.S. Dist.

Judge Maxine M. Chesney ruled for the defendant, finding that the plaintiff had failed to allege how its competitors would gain an economic advantage by knowing the company’s address.  Accordingly, Judge Chesney found that the plaintiff had not pled that the address met the definition of a trade secret under the DTSA.

I was somewhat nonplussed by the idea of an office address being a secret (trade or otherwise).  After all, the plaintiff, a Delaware corporation, had filed a Statement of Information with the California Secretary of State disclosing the address of its principal executive office (which is the same as its principal executive office in California).  That filing is a readily accessible public record.  It may be, however, that the address disclosed by the defendant was for another location not disclosed in the Statement of Information.

Etymologists use the term “hybrid word” to refer to a word that is formed by the combination of words from two different languages.  Greek-Latin hybrids are the most common form of hybrids in English.  English does have hybrids formed from other languages.  For example, “chocoholic” is a hybrid formed from New and Old World languages – Nahuatl, xocolatl, and Arabic, اَلْكُحُول (al-kuḥūl).  

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on corporate law, visit the National Law Review Corporate & Business Organizations section.

With Retail Bankruptcies on the Rise, Opportunities for Distressed M&A Increase

While there were already a number of high profile retail bankruptcies in 2019, current economic conditions and pandemic-related market challenges have exacerbated an already difficult retail environment, which has led to a significant increase in bankruptcies in 2020. Year to date, more than 30 major retail and restaurant chains have filed for bankruptcy, which is more than in all of 2019. Furthermore, 2020 is on track to have the highest number of retail bankruptcies in 10 years. Although the Q4 holiday season often provides the strongest quarterly financial performance for many retailers, which may slow the pace of bankruptcy filings, projected holiday sales numbers may be uncertain this year, and additional bankruptcies are still likely to follow by year end.

Despite these bleak statistics, distressed companies may present attractive targets for strategic and private equity buyers with available cash or access to financing on favorable terms. Distressed M&A transactions may offer certain advantages that can be attractive to buyers, such as the potential to purchase at a discounted price or the ability to complete a transaction on an accelerated timetable. Already, the retail market has begun to see the reemergence under new ownership of some shuttered companies that were the targets of liquidation sales and distressed M&A transactions within the past two years. Some of these retailers have relaunched with modified business strategies, such as a significantly reduced number of brick and mortar locations or an exclusively online presence. The distressed M&A transaction opportunities resulting from existing market conditions will likely play an increasingly important role in overall M&A deal activity and could lead to a reshaping of the retail landscape in the near future.

Copyright © 2020, Hunton Andrews Kurth LLP. All Rights Reserved.
For more articles on bankruptcy, visit the National Law Review Bankruptcy & Restructuring section.

SEC Adopts Expansion of “Accredited Investor” Definition

On August 26, 2020, the U.S. Securities & Exchange Commission (SEC) adopted amendments to Rule 501, Rule 144A and other related rules (the Amendments) to expand the definition of “accredited investor” under the Securities Act of 1933 (the Securities Act). The amendments were adopted largely as proposed and broaden the scope of natural persons and entities that may qualify to participate in private offerings of securities that are exempt from registration under the Securities Act.

In particular, the “accredited investor” designation will now include the following:

  • Natural persons holding certain professional certification and designations. The SEC will periodically issue orders designating those professional certificates, designations or credentials that, when held by a natural person, would qualify such person as an accredited investor. Contemporaneously with the Amendments, the SEC designated holders in good standing of the Series 7, Series 65 and Series 82 licenses as qualifying for accredited investor status. In evaluating additional professional designations for qualifying status, the SEC will consider a non-exhaustive list of attributes established by the Amendments.
  • “Knowledgeable Employees” of private funds as defined under the Investment Company Act, but only with respect to investment in such private fund. A Knowledgeable Employee’s spouse will also be considered an accredited investor with respect to joint investments in the private fund.
  • Certain enumerated entities, including:
    • federal- or state-registered investment advisers and exempt reporting advisers, regardless of the level of assets under management;
    • rural business investment companies (RBICs), as defined in Section 384A of the Consolidated Farm and Rural Development Act;
    • limited liability companies that have total assets in excess of $5 million and were not formed for the purpose of acquiring the securities offered1 ; and
    • any entity with at least $5 million in investments (as defined under the Investment Company Act of 1940) that has not been formed for the purpose of investing in the securities offered, in order to encompass entities such as Indian tribes, foreign entities and local government bodies that were not previously covered by Rule 501.
  • “Family offices” and their “family clients,” each as defined under the Advisers Act, provided the family office has at least $5 million in assets under management, was not formed for the purpose of acquiring the securities offered and was directed to make the investment by a person who has such knowledge and experience in financial and business matters such that the family office is capable of evaluating the merits and risks of the investments.

The Amendments would also clarify that spousal equivalents can pool finances when determining qualification as an accredited investor and update the definition of “qualified institutional buyer” under the Securities Act to conform with the new accredited investor definition.

The expansion of the accredited investor definition has many implications for asset managers, including updates to offering and subscription documents and questionnaires, consideration of expanded options for funding GP commitments via the expanded pool of knowledgeable employees and affiliated professionals and evaluation of fund-raising opportunities. Commissioners adopted the amendments on a 3-2 vote, with commenters disagreeing with the SEC’s decision not to index the wealth thresholds, which were initially adopted in 1982, for inflation.

The Amendments will go effective 60 days after publication in the Federal Register.

_________________________________________________

1 While Rule 501 did not explicitly include LLCs meeting these requirements prior to the Amendments, the SEC historically has taken the position that such LLCs qualify as accredited investors.

© 2020 Vedder Price
ARTICLE BY Robert M. Crea, Joseph M. Mannon, and Adam S. Goldman of Vedder Price.
For more SEC news, visit the National Law Review Securities, SEC, & Financial Institution Law News section.

Supreme Court Decides to Rule on FTC’s Disgorgement Authority

As previously blogged about here, the Supreme Court recently upheld the SEC’s disgorgement authority but imposed certain limits, including consideration of net profits.  FTC defense practitioners immediately began to consider how the ruling might potentially impact FTC investigations and enforcement actions, including how it might bear upon other judicial challenges to whether Section 13(b) of the FTC Act authorizes the FTC to obtain equitable monetary relief.

On July 9, 2020, the Supreme Court granted certiorari in the AMG Capital Management and Credit Bureau Center matters that should now decide the issues of whether Section 13(b) permits courts to award disgorgement.

In AMG v. FTC, the Ninth Circuit held that courts’ equitable powers include awarding equitable monetary relief, including disgorgement.  In contrast, the Seventh Circuit in FTC v. Credit Bureau Center recently disregard years of precedent when it held that the express terms of Section 13(b) illustrate that Congress only authorized injunctive relief, not equitable monetary relief or disgorgement.

The two matters have been consolidated and with a total of one hour allotted for oral argument.   The importance of these matters cannot be overstated as they conclusively resolve splits of authority relating to whether or in what circumstances FTC lawyers are entitled to seek equitable monetary relief in the form of disgorgement.

© 2020 Hinch Newman LLP

Seila Law LLC v. Consumer Financial Protection Bureau: Has the Supreme Court Tamed or Empowered the CFPB?

On June 26, the Supreme Court issued its long-awaited opinion in Seila Law LLC v. Consumer Financial Protection Bureau,1 finally resolving the question that has dogged the new agency since its inception:  Is the leadership structure of the Consumer Financial Protection Bureau (CFPB) constitutional?  Writing for a 5-4 majority, Chief Justice John Roberts ruled that the CFPB structure—“an independent agency that wields significant executive power and is run by a single individual who cannot be removed by the President unless certain statutory criteria are met”—violates the Constitution’s separation of powers.2  

For financial services companies regulated by the CFPB, the most important aspect of Seila Law is not the headline constitutional defect, but the remedy.  Choosing “a scalpel rather than a bulldozer,”3 the Court did not invalidate the CFPB.  The Court held 7-2 that the Director’s constitutionally offensive removal protection could be severed from the CFPB’s other authorities, thus bringing the Director (and with her, the CFPB) under Presidential control, while leaving the CFPB’s other powers in place.4

While Seila Law  is an important case in the evolving doctrine of separation of powers as applied to independent agencies, the case has three immediate consequences for financial services companies.  First, the CFPB is here to stay, and its broad authorities and other controversial aspects (such as its insulation from Congressional appropriations) remain intact.  Second, the CFPB’s Director is now directly accountable to the President, significantly raising the stakes in the 2020 election for the agency’s regulatory and enforcement agenda.  Third, the Court left one important question unanswered:  it declined to address the effect of its ruling on prior CFPB rules and enforcement actions.  While we believe the agency will attempt to cure the constitutional defect, we expect continued litigation—and uncertainty—on this issue.

Background

In response to the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), creating the CFPB as an independent financial regulator within the Federal Reserve System.5  The CFPB has expansive authority to “implement and, where applicable, enforce Federal consumer financial law,” which includes 19 enumerated federal consumer-protection statutes and the Dodd-Frank Act’s broad prohibition on unfair, deceptive, and abusive acts and practices.6  The CFPB’s authority over consumer financial products and services includes rulemaking authority with respect to the enumerated statutes, the ability to issue orders, including orders prohibiting products and services which it concludes are “abusive” or substantively unfair, as well as the power to impose significant financial penalties on financial services companies.  The CFPB is funded through the Federal Reserve System, and thus is not subject to Congressional constraint through the appropriations process.  Although technically housed within the Federal Reserve System, the CFPB also is not subject to oversight or control by the Board of Governors of the Federal Reserve System.  As a result, the CFPB was created to be an independent agency, largely unconstrained by Congress or the Federal Reserve System.  The CFPB is headed by a single Director appointed by the President, by and with the advice and consent of the Senate, for a five-year term.7  The Director may be removed by the President only for “inefficiency, neglect of duty, or malfeasance in office.”8  

In 2017, the CFPB issued a civil investigative demand to Seila Law LLC, a California-based law firm that provides debt-related legal services to consumers.  Seila Law refused to comply, objecting that concentrating the CFPB’s authority in a single Director with for-cause removal protection violated the separation of powers doctrine.  The CFPB filed a petition to enforce its demand in federal district court.  The district court rejected Seila Law’s constitutional objection and ordered the law firm to comply with the demand.  The Court of Appeals for the Ninth Circuit affirmed.9

Case Analysis: Seila Law

The Supreme Court granted certiorari to address the constitutionality of the CFPB’s single-Director structure.  That decision was telling in and of itself, given that the Ninth Circuit’s ruling was in accord with PHH Corporation v. CFPB, the D.C. Circuit’s en banc opinion upholding the Director’s removal protection.10  As many had expected, the Supreme Court reversed the Ninth Circuit and held that Congress’s restriction on the President’s power to remove the CFPB’s Director violated the separation of powers doctrine. 

The Court began its analysis from the premise that Article II of the Constitution gives the entire executive power to the President alone, “who must ‘take care that the Laws be faithfully executed.’”11  Lesser officers who aid the President in his or her duties “must remain accountable to the President, whose authority they wield.”12  The President’s power to remove these lesser officers at will is foundational to the President’s executive function and “has long been confirmed by history and precedent.”13  The Court held that “[w]hile we have previously upheld limits on the President’s removal authority in certain contexts, we decline to do so when it comes to principal officers who, acting alone, wield significant executive power.”14  The Court found that the CFPB’s Director fit that bill.  In creating the CFPB, Congress “vest[ed] significant governmental power in the hands of a single individual accountable to no one.”15  Such an agency “has no basis in history and no place in our constitutional structure.”16 

Next, the Court turned to the remedy.  Seila Law argued that the Director’s unconstitutional removal protection rendered the “entire agency … unconstitutional and powerless to act.”17  The Court disagreed.  Relying on the Dodd-Frank Act’s severability clause, the Court’s severability precedent, and the proposition that “Congress would have preferred a dependent CFPB to no agency at all,” the Court ruled that the Director’s removal protection is severable from the CFPB’s other statutory authorities.18  “The agency may therefore continue to operate, but its Director, in light of our decision, must be removable by the President at will.”19  

Finally, the Court expressly declined to address how its holding affects prior CFPB regulatory and enforcement actions.  The government had argued that the Court need not reach the constitutional question because the CFPB’s demand to Seila Law had since been ratified by an Acting Director accountable to the President.20  The Court remanded the question of ratification to the lower courts, noting that it “turns on case-specific factual and legal questions not addressed below and not briefed here.”21

Implications

Seila Law is an important case for the canons of administrative law and the separation of powers doctrine.  But for financial services companies regulated by the CFPB, it has meaningful (and immediate) practical consequences.

First, the CFPB has escaped Supreme Court review with its authorities basically untouched.  Absent Congressional action, the CFPB will (i) continue to be run by a single Director, (ii) continue to wield expansive rulemaking, supervisory, and enforcement authority over the multi-trillion dollar market for consumer financial products and services, and (iii) continue to be insulated from Congressional control via the appropriations process.

Second, the CFPB’s Director is now directly accountable to the President—whoever that person may be.  Typically, financial regulators have a measure of insulation from the political process to provide consistency and certainty to financial markets.  With this decision, the election of the next President—and the prospect of a Democratic administration—could result in significant and immediate changes to the CFPB’s regulatory and enforcement agenda.

Third, while Seila Law secured the CFPB’s future, the Court left in place significant uncertainty as to its past.  This past includes major enforcement actions and rulemakings that have reshaped the market for consumer financial products and services over the last nine years.  Of course, it remains to be seen what appetite financial services companies have to challenge the CFPB’s prior rules and enforcement orders.  And, we expect the CFPB will attempt to remedy the constitutional defect by ratifying the agency’s past actions or perhaps invoking the de facto officer doctrine.22  Yet, the availability of either remedy is an open question.  Ratification in particular is a live dispute in both Seila Law and a pending en banc appeal before the Fifth Circuit, Consumer Financial Protection Bureau v. All American Check Cashing.23  Ratification of prior agency actions was also left unresolved in another thread of the Supreme Court’s recent separation of powers jurisprudence.  In Lucia v. SEC, the Court found that the SEC hired administrative law judges (ALJs) in violation of the Appointments Clause, but offered limited remedial guidance aside from instructions that Lucia was entitled to a “new hearing before a properly appointed” ALJ.24  While litigating Lucia’s challenge, the SEC issued an order purporting to ratify its past ALJ appointments by approval of the Commission itself.  The Court acknowledged that order, but declined to address its validity.25

1   Seila Law v. Consumer Financial Protection Bureau, 591 U.S. ____ (2020) (June 26, 2020).

2   Id., Slip Op. at 2–3.

3   Id., at 35.

4   Id.,  at 3. 

5   Title X of the Dodd-Frank Act, 12 U.S.C. § 5301 et seq., created the CFPB and defines its authorities. 

6   12 U.S.C. § 5511 (defining CFPB’s purpose); 12 U.S.C. § 5481(14) (defining “Federal consumer financial law”). 

7   Id. § 5491(b)(2), (c).

8   Id. § 5491(c)(3).  For a detailed discussion of the CFPB and its powers, see our Clients & Friends Memo, The Consumer Financial Protection Bureau: The New, Powerful Regulator of Financial Products and Services (March 06, 2012).

9   Seila Law, Slip Op. at 6–8 (discussing procedural history).

10 PHH Corp. v. CFPB, 881 F. 3d 75 (D.C. Cir. 2019) (en banc).  Tellingly, then-Judge Kavanaugh wrote the D.C. Circuit panel decision holding that the CFPB’s structure violated the separation of powers doctrine.  839 F.3d 1 (D.C. Cir. 2016). The en banc court vacated that decision, but now-Justice Kavanaugh joined the majority in Seila, reiterating his separation of powers analysis from the D.C. Circuit.    For further analysis of the PHH decision, see our Client & Friends Memo Federal Appeals Court Rules That CFPB Structure is Constitutional  (Jan. 31, 2018) (discussing the en banc decision); D.C. Circuit Brings CFPB under Presidential Control  (Oct. 13, 2016) (discussing the initial panel decision of the D.C. Circuit).

11 Seila Law, Slip Op. at 11 (quoting U.S. Const., Art. II, § 1).

12 Id. at 12.

13 Id.

14 Id. at 36.  Specifically, the Court wrote that it has recognized two limited exceptions to the President’s unrestricted removal power.  Seila Law, Slip Op. at 15–16.  First, in Humphrey’s Executor, 295 U.S. 602 (1935), the Court upheld removal restrictions for Commissioners of the Federal Trade Commission, which Roberts characterized as “a multimember body of experts, balanced along partisan lines, that performed legislative and judicial functions and was said not to exercise any executive power.”  Seila Law, Slip Op. at 15.  Second, in United States v. Perkins, 116 U.S. 483 (1886), and Morrison v. Olson, 487 U.S. 654 (1988), the Court permitted removal protections for certain inferior officers with narrow duties, such as an independent counsel appointed to investigate and prosecute specific crimes.

15 Seila Law, Slip Op. at 23.

16 Id. at 18.

17 Id. at 31.

18 Id. at 32–36 (emphasis in original).

19 Id. at 3.

20 Id. at 30.

21 Id. at 31. Justice Thomas viewed this theory as irrelevant, since the Acting Director could not have ratified the continuance of the action by Director Kraninger. Justice Kagan did not address this theory specifically.

22 See Ryder v. United States, 515 U.S. 177 (1995) (the de facto officer doctrine “confers validity upon acts performed by a person acting under the color of official title even though it is later discovered that the legality of that person’s appointment or election to office is deficient.”).

23 No. 18-60302 (5th Cir.).

24 Lucia v. S.E.C., 138 S. Ct. 2044, 2055 (2018).

25 Id. at 2055 n.6.

© Copyright 2020 Cadwalader, Wickersham & Taft LLP

ARTICLE BY Rachel Rodman and Scott A. Cammarn and Nihal S. Patel at Cadwalader, Wickersham & Taft LLP.

For more on the CPFB, see the National Law Review Consumer Protection law section.

Confusion in Bankruptcy Courts Regarding Debtor Eligibility for PPP Loans

The Small Business Administration’s (SBA) rules and regulations concerning the eligibility of businesses for Paycheck Protection Program (PPP) loans when the business is involved in bankruptcy have recently been a source of substantial uncertainty, with the nationwide split of authority in bankruptcy courts. While these cases deal with a very small minority of PPP recipients and are a relative novelty in that regard, these decisions could foretell future issues for companies who have received PPP loans but are later forced to file Chapter 11, specifically regarding their eligibility for loan forgiveness.

The SBA is enabled with emergency rulemaking authority to adopt rules and regulations to manage application and qualifications for PPP loans under the CARES Act. Pursuant to this authority, the SBA publishes Interim Final Rules (IFR). The SBA’s April 28, 2020 IFR expressly disqualified applicants who are debtors in a bankruptcy proceeding at any time between the date of application and when the loan is disbursed.[1] Several companies in bankruptcy proceedings, whose loans have been denied, have challenged the SBA’s rulemaking authority in this regard, leading to a nationwide split on this issue in bankruptcy courts.

Specifically, these courts have rendered opinions to decide whether the SBA can impose a policy disqualifying a business in bankruptcy proceedings from participating in the PPP and whether the SBA violates other laws for doing so.[2] More than a dozen cases have been decided in the last two months, with the recent decisions highlighting the confusion that bankruptcy courts face in discerning the intent of Congress and the purpose of the CARES Act.

In decisions amounting to a majority of court decisions to date, bankruptcy courts have ruled in favor of the debtor on the merits or a request for injunctive relief.[3] One decision in favor of the debtor, with detailed analysis, has been rendered in the In re Gateway Radiology Consultants, P.A. bankruptcy case. In that case, the bankruptcy court concluded that excluding Chapter 11 debtors conflicts with the intent of Congress and the purpose of the CARES Act. The bankruptcy court determined that collectability was not a criterion for a qualification which Congress intended to focus on and rejected the SBA’s argument that debtors had a higher risk of misusing PPP funds for non-covered expenses.[4]

On the other hand, in a minority stance are bankruptcy courts that have found that the IFR is not in violation of the CARES Act, and that the SBA has not exceeded its statutory authority under the APA. Some of these courts point to the extreme urgency with which the CARES Act was enacted, which they say necessitated clarifying rulemaking, as well as the historical broad authority granted by Congress to the SBA which allows for such rulemaking in areas where the CARES Act is silent.[5]

Given the large number of PPP recipients and the potential for a dramatic increase in the number of companies forced to file for bankruptcy protection in the near future, the ultimate resolution of this issue may have significant implications for the future. Varnum will continue to follow the current case split, as well as their possible implications for other debtors that may have received a PPP loan pre-filing and will seek to have the loans forgiven as part of the Chapter 11 process.

[1] See Interim Final Rule, 13 C.F.R. Parts 120-21, Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility (RIN 3245-AH37), at p. 8-9.
[2] The laws invoked are under the Administrative Procedures Act (the “APA”) 5 U.S.C. § 706(2)(C), APA 5 U.S.C. § 706(2)(A), and under the Bankruptcy Code’s antidiscrimination provision, 11 U.S.C. § 525.
[3] In re Skefos, No. 19-29718-L, 2020 WL 2893413 (Bankr. W.D. Tenn. June 2, 2020) (order granting the Debtor’s motion for PI); In re Gateway Radiology Consultants, P.A., No. 8:19-BK-04971-MGW, 2020 WL 3048197 (Bankr. M.D. Fla. June 8, 2020) (enjoining the SBA from disqualifying the Debtor and finding that the decision-making of the SBA was not reasoned); Diocese of Rochester v U.S. Small Bus. Admin., No. 6:20-CV-06243 EAW, 2020 WL 3071603 (W.D.N.Y. June 10, 2020).
[4] In re Gateway Radiology Consultants, P.A., No. 8:19-BK-04971-MGW, 2020 WL 3048197, at *15-17.
[5] Schuessler v United States Small Bus. Admin., No. AP 20-02065-BHL, 2020 WL 2621186 (Bankr. E.D. Wis. May 22, 2020) (denying declaratory and injunctive relief and dismissing the complaints in three consolidated Chapter 12 cases); In re iThrive Health, LLC, Adv. Pro. No. 20-00151 (Bankr. D. Md. June 8, 2020) (finding Debtor would not prevail on the merits and denying preliminary injunction; but granting Debtor’s motion to dismiss the bankruptcy without disclosing if Debtor intends to move to reinstate the bankruptcy after PPP funding is approved as contemplated by Debtors in Arizona and S.D. Florida); In re Henry Anesthesia Assoc., 2020 WL 3002124 (Bankr. N.D. Ga. June 4, 2020).

© 2020 Varnum LLP
For more on the topic, see the National Law Review Bankruptcy & Restructuring law section.

LIBOR Benchmark Replacement – “It’s Time to Get Off the SOFR” – An Overview of the Impact of LIBOR Transition on Aircraft Financing and Leasing Transactions

It’s time to face up to the fact that financial market participants will soon no longer be able to rely on LIBOR.

No one can claim that this comes as a surprise. In 2014, in response to concerns about the reliability and robustness of the interest rate benchmarks that are considered to play the most fundamental role in the global financial system, namely LIBOR, global authorities called for the development of alternative “risk free” interest rate benchmarks supported by liquid, observable markets. Notably, in July 2017, the Chief Executive of the UK Financial Conduct Authority (FCA), the authority which regulates LIBOR, made a seminal speech about the future of LIBOR, indicating that market participants should not rely on LIBOR remaining available after 2021. To emphasize the point in the United States, the President and Chief Executive Officer of the New York Federal Reserve famously quipped during a speech in 2019, “some say only two things in life are guaranteed: death and taxes. But I say there are actually three: death, taxes and the end of LIBOR.”

Even the enormous pressures heaped on market participants by COVID-19 have not changed the picture. As the impacts of COVID-19 continue to evolve, there is speculation as to whether the pandemic will delay the projected LIBOR cessation timeline. At the end of March 2020, the FCA confirmed that no such delay was forthcoming, remarking, “The central assumption that firms cannot rely on LIBOR being published after the end of 2021 has not changed and should remain the target date for all firms to meet.”

More recently, the Alternative Reference Rates Committee (ARRC), the working group convened by authorities in the United States, has announced a set of “best practices” for completing the transition from LIBOR. Of particular note is the ARRC’s recommendation that hard-wired fallbacks should be incorporated into loan documentation from as early as 30 June 2020, and the target date for ceasing to write new LIBOR deals should be 30 June 2021.

This article explores the steps already taken by the Loan Market Association (LMA), the ARRC and the International Swaps and Derivatives Association (ISDA), the likely impact of LIBOR benchmark replacement on loan and lease documentation and some of the uncertainties which still fall to be resolved.

LIBOR

LIBOR (the London Inter-Bank Offered Rate) is a rate of interest, ostensibly used in lending between banks in the London interbank market. The LIBOR rate is calculated for various currencies and various terms. In the aviation financing market, 1-month or 3-month USD LIBOR is most commonly used. Note that these rates are forward-looking, are calculated based on repayment at the end of a specified term and represent a rate of interest for unsecured lending.

In aircraft transactions, LIBOR:

  • can form part of the interest (and default interest) calculation in loan agreements;
  • can represent the rate against which floating rate payments under interest rate swap agreements are calculated; and
  • can form part of the default interest calculation in aircraft lease agreements (and, where lease rental calculations are made on a floating rate basis, the determination of rent).

SOFR

A number of alternative benchmarks were considered as suitable replacements for USD LIBOR. The emerging winner, and the ARRC’s recommended alternative, is the Secured Overnight Financing Rate (SOFR). SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.

Unlike term LIBOR rates, SOFR is an overnight, secured rate.

Aircraft loan and interest rate swap repayments are not typically made on an overnight basis, so how would we apply an overnight rate to a loan which provides for accrued interest to be paid monthly or quarterly?

In time, it is anticipated that forward-looking term SOFR rates will emerge – this is the stated preference of the ARRC – but this has not happened yet and it is not certain that satisfactory term SOFR rates will be available ahead of LIBOR discontinuation. Therefore, the ARRC does not recommend that financial market participants wait until forward-looking term SOFR rates exist to begin using SOFR in their loans. Instead, a simple average or compounded average of overnight SOFR rates for an interest period might be made to apply in lieu of a term rate.

A further complication with an overnight rate arises because, unlike term LIBOR rates, the amount of interest payable on a loan interest repayment date cannot be calculated until the last day of the applicable loan interest period. This makes loan administration (for banks) and payment processing (for borrowers) complicated. Various alternative calculation conventions remain under discussion. Selecting a final methodology is proving challenging in light of the lack of market convention and the operational challenges faced with making such a calculation.

Credit Adjustment Spreads

Because SOFR is an overnight, secured rate it does not include any term liquidity premium or any bank credit risk element, unlike a term LIBOR rate, where interest is paid at the end of a specified term and which represents an unsecured rate. As a result, SOFR prices lower than LIBOR.

Bankers therefore intend to apply a “credit adjustment spread” on top of SOFR, in order to account for the differences in which LIBOR and SOFR are determined, and in order to limit any transfer of economic value as a result of the transition between benchmark rates. The basis on which a credit adjustment spread is calculated is also the subject of continuing discussion. A further complicating factor for determining the spread adjustment is that the spread between LIBOR and SOFR fluctuates in rather meaningful ways over time. This fluctuation is, in part, due to the fact that Treasuries yields may be pushed down during times of crisis where there is a flight to quality.

LMA and ARRC Slot-in Provisions dealing with LIBOR Transition

The LMA and ARRC have both been working on slot-in drafting for various financial instruments in anticipation of transitioning away from LIBOR.

On 21 December 2018, the LMA issued “The Recommended Revised Form of Replacement Screen Rate Clause and Users Guide”.

On 25 April 2019, the ARRC recommended two sets of fallback language, also for syndicated loan documentation – the “Amendment Approach” fallback language and the “Hardwired Approach” fallback language.

Note that the ARRC has also prepared recommended fallback language for floating rate notes and securitization transactions.

LMA and ARRC Amendment Approach – creating a framework for future agreement

The LMA and ARRC Amendment Approaches (the Amendment Approaches) do not set out the replacement benchmark or credit adjustment spread which should apply, or set out the detailed basis on which interest should accrue or be calculated. Instead, a framework is set out in order to facilitate future agreement and related amendments to the loan documentation.

The LMA Amendment Approach does this by reducing the threshold for lender consent that might otherwise apply to relevant amendments.

The ARRC Amendment Approach provides that the borrower and the loan agent may identify a replacement rate (and spread adjustment), and the required lenders (typically 51%) have five days to object. If the required lenders reject the proposal, the loan goes to a prime-based rate until a successful amendment goes through.

ARRC Hardwired Approach

The alternative, the ARRC “Hardwired Approach”, provides that, when LIBOR ceases, the benchmark rate converts to a specified version of SOFR plus a credit adjustment spread. Failing this, a rate agreed between the parties would apply. Unlike the ARRC Amendment Approach, the Hardwired Approach is also “future-proofed”, to cover further benchmark replacement to the extent this occurs.

The Hardwired Approach sets out a “waterfall” of replacement benchmarks which are to apply – firstly, a term SOFR rate or, failing which, the next available term SOFR rate; secondly, a compounded SOFR rate; and thirdly, an alternative rate selected by the loan agent and the borrower which has given due consideration to any selection or recommendation made by a “Relevant Governmental Body”, or market convention. The credit adjustment spread is added to the applicable replacement benchmark in each case.

The Hardwired Approach also sets out a waterfall of options to calculate the credit adjustment spread – firstly, the adjustment selected or recommended by a Relevant Governmental Body; secondly, the adjustment that would apply to the fallback rate for a derivative transaction referencing the ISDA Definitions to be effective upon an index cessation event with respect to USD LIBOR for a period equal to the relevant loan interest period; and thirdly, an adjustment agreed between the loan agent and the borrower giving due consideration to the factors which apply to determining a replacement rate of interest and set out above.

So, which approach is the aviation industry using? For the time being, we are seeing the Amendment Approaches (or negotiated variations of those approaches) applying, but as noted in the ARRC “best practices” recommendations, this is something which must develop quickly.

The ARRC noted that many respondents to their consultations who prefer the use of the ARRC Amendment Approach at the current time generally believe that eventually some version of the Hardwired Approach will be more appropriate. The Amendment Approaches set out a more streamlined procedure for LIBOR transition, but they leave many of the difficult questions unanswered and provide for additional amendments to be made further down the road. Banks and counterparties will need to consider whether it is feasible to amend thousands of loan documents in short order, and the related disruption this could cause.

ARRC Hedged Loan Approach

Outside of the syndicated loan market, the ARRC recommends a third set of fallback language – the “Hedged Loan Approach”, to be considered for bilateral USD LIBOR loans which benefit from interest rate hedging.

The “Hedged Loan Approach” is the alternative approach for those who want to ensure that the fallback language in their loan agreement is consistent with the fallback language in any corresponding hedge they enter into with respect to their credit facilities. There is no reason that the language cannot be amended to accommodate syndicated loan transactions.

Interest rate swaps are commonly used in aircraft lessor financings in order to mitigate basis risk between operating lease payments (typically calculated on a fixed rate basis) and scheduled interest rate payments under the related loan agreement (typically calculated on a floating-rate basis).

The Hedged Loan Approach aligns the trigger events, replacement rate, and any spread adjustments under a subject loan with those as determined in accordance with the soon-to-be finalized revisions to the ISDA Definitions.

Trigger Events for LIBOR Transition

There is some variation between the trigger events for LIBOR transition between the LMA and ARRC approaches. As you would expect, both cover events relating to an immediate or upcoming LIBOR cessation. Both also include an early opt-in election which may be made by the parties. The ARRC Hedged Loan Approach trigger events are tied to those that will apply under any relevant ISDA documentation.

The LMA has also included a “material change” event, such that a trigger event can apply if the methodology, formula or other means of determining the LIBOR screen rate has materially changed. The LMA offers both objective and subjective language (in the opinion of the Majority Lenders and, where selected, the Obligors) for making the material change determination.

The ARRC includes as an additional event an announcement from the supervisor of a benchmark administrator that the applicable benchmark is no longer representative. This is intended to reflect the requirements of, and the procedures which apply under, the EU Benchmarks Regulation (the BMR). Where such a determination is made, it is possible that the loan parties would want to accelerate LIBOR transition, and EU-supervised entities could be prohibited from referencing LIBOR in new derivatives and securities. U.K. and U.S. authorities have also stated that it might be prudent for market participants to include this pre-cessation trigger in their loan documentation.

The early election triggers that apply under the ARRC Amendment and Hardwired Approaches are also drafted differently. Note that a term SOFR rate only can apply if an early election trigger applies under the Hardwired Approach.

ISDA Benchmarks Supplement

ISDA published its Benchmarks Supplement in 2018 primarily to facilitate compliance with the requirements of Article 28(2) of the BMR, but it has been drafted so that market participants can use it to incorporate fallbacks for reference rates into derivative transactions, whether or not they or the transactions are subject to BMR. The Supplement includes a number of trigger events relating to benchmarks and fallbacks which apply upon the occurrence of one of those triggers. Currently, ISDA has provided for benchmark replacement in two scenarios: (i) a permanent cessation of the then applicable benchmark; or (ii) if applying an applicable benchmark would breach applicable law. These broadly align with the corresponding trigger events in the ARRC documentation, but there are some important variations, discussed below.

Ultimately, ISDA intends to update the ISDA Definitions to include fallbacks to selected alternative interest rate benchmarks, and work on this is ongoing, but in the meantime incorporation of the Supplement into transactions referencing LIBOR could form part of a wider strategy for the transition away from LIBOR, even if it is not required by BMR.

Tensions between the Loan and Derivatives Markets?

As described above, aircraft lessor financings will very often be hedged pursuant to an ISDA Agreement in order to avoid basis risk.

But what if the approach taken by loan markets in relation to the timing for LIBOR transition and the calculation of floating rate interest differs from the approach taken by derivatives markets under swap agreements? Payments are no longer fully hedged and basis risk is re-introduced.

The major issue goes to the rate itself – the ARRC is hoping for term SOFR rates to emerge which will be used to calculate floating rate loan interest payments, but it is almost certain that ISDA will not apply term SOFR rates to floating rate payments under derivatives transactions and a version of compounded SOFR will instead apply.

Trigger events for benchmark replacement also vary between the two markets, but work is ongoing to converge differing approaches.

Under the ISDA Benchmarks Supplement, no early opt-in election applies. This would tend to make it less likely that early opt-in elections for hedged loans would in fact be exercised.

Note also that no pre-cessation trigger event currently applies under the Supplement – so “material changes” to the benchmark calculation (as contemplated by the LMA Amendment Approach), and the non-representativeness test included in the ARRC provisions, are not included as trigger events, albeit that ISDA has consulted on the latter and an amendment to the Supplement to include the non-representativeness test is expected to be published in July.

Since the FCA has already announced the expected procedures that would apply if it were to make a determination that LIBOR was no longer representative and how such a determination would be communicated to the markets, it seems that the ARRC approach towards trigger events would be the preferred approach for hedged loan documentation.

It is also possible that the basis on which credit adjustment spreads are calculated will vary between the two markets but, on this point, it has been the ARRC’s turn to re-consult on the proposal made by ISDA; i.e. that the same spread adjustment value is used across all of the different fallback rates. It is hoped that a consistent credit adjustment spread can be made to apply between loan and derivative markets, although given that there is a range of methodologies for calculating pre-cessation credit adjustment spreads that could apply in loan markets, this might be more difficult to achieve where an early opt-in election is exercised and might make the actual exercise of early opt-in elections less likely for hedged loans.

Where Does That Leave Us?

Thus far, most borrowers/lessees within the aviation finance market have favoured some version of the LMA or ARRC

“Amendment Approach” fallback language in their loan or lease documentation – the advantage being that it does offer flexibility.

Parties have entered into a number of variants but the underlying principle behind the Amendment Approaches appears to be adhered to – it serves as a placeholder to the issue and aims to bring the commercial parties back to the table once the loan market has broadly accepted a replacement standard for LIBOR. Key reasons for this are the absence of a term SOFR rate and an absence of consensus as to the basis on which alternative SOFR rates and credit adjustment spreads might be calculated. People are not yet ready to commit to SOFR or a Hardwired Approach since at the moment no one knows exactly what they might be getting.

Notwithstanding the above, the “Hedged Loan Approach” should not be discounted for bilateral (or syndicated) aircraft lessor financings which are hedged by way of an interest rate swap. Lenders/borrowers that are concerned with “basis risk” upon LIBOR cessation may prefer this approach since it is designed to eliminate any basis risk between the loan and the related hedge. However, it remains to be seen whether loan markets will be able to accommodate a departure from whatever becomes settled loan markets convention, commercially and operationally.

If the floating rate under the swap and the floating rate under the loan are aligned, then the change from LIBOR to a different benchmark should theoretically be cost neutral for that borrower, except where a swap premium is payable as a result of transition to a replacement benchmark rate. The requirement to pay a swap premium may be considered more likely if a swap is required to pay a floating rate that reflects a term SOFR rate or another loan market convention where the same is at odds with the default position in the derivatives market. Commercial parties will follow this issue with particular interest.

Note also that on 6 March 2020, the ARRC released a proposal for New York State Legislation for USD LIBOR contracts, which would operate to replace LIBOR by the recommended alternative benchmark included in the legislation and other related matters.

Operating Leases

Lessors and lessees will need to consider how LIBOR transition is achieved under their operating leases.

Most operating leases do not make provision for LIBOR transition, nor do they provide for a fallback rate in the event of LIBOR cessation beyond requesting reference bank rates (which is not itself an effective fallback, since a shrinking number of reference banks are prepared to quote a rate even now).

At this stage, where LIBOR is referenced in operating leases, it would be prudent for leasing companies to take a similar approach in their operating leases to that taken in the Amendment Approaches referred to above. This will ensure that LIBOR transition triggers are broadly consistent between operating leases and any related financing and hedging arrangements; it will also ensure that appropriate interest calculation methodologies and market approaches can be introduced into operating leases by amendment at the appropriate time.

Where fixed rate operating lease rentals are payable, the parties might also consider an alternative basis on which to calculate default interest under the lease which avoids SOFR and credit adjustment spreads altogether, but this would require careful thought, particularly regarding the way in which this interacts with any upstream financing.

Leasing parties will need to consider an appropriate costs allocation for amendments of existing leases.

Another point to note is that fixed rate operating lease rental calculations are usually constructed from a swap screen rate for an agreed term (taken an agreed number of business days ahead of the rent calculation date), and lease rentals cannot be adjusted after the event.

The swap screen rate will itself have been constructed from an interest rate exchange which assumed that 1-month LIBOR rates would remain available for the duration of the swap period, which means that such correlation as previously existed for leasing companies between outgoings (funding costs) and income (lease rental) is lost. Whether this creates a windfall or a loss for leasing companies will depend on what happens to SOFR rates in the future.

So, some real food for thought and some important decisions lie ahead. Discussions should start now and action should be taken soon in order to ensure an orderly transition.

© 2020 Vedder Price

For more on LIBOR/SOFR see the National Law Review Financial Institutions & Banking law section.

Guide to Federal Reserve Main Street Loan Facilities and Primary Market Corporate Credit Facility

The Federal Reserve has created a number of programs to provide loans and other credit facilities to support the economy in response to COVID-19.  Several of these programs provide for new extensions of credit for small, medium and large businesses, including the Main Street Lending Program and the Primary Market Corporate Credit Facility.  The Main Street Lending Program creates three separate facilities (“MSLFs”):  (1) the Main Street New Loan Facility, (2) the Main Street Expanded Loan Facility and (3) the Main Street Priority Loan Facility.  Each of these facilities contemplates banks and other financial institutions making “new money” loans to eligible borrowers, and in turn selling participation interests in the loans to a Fed / Treasury special purpose vehicle.  The Primary Market Corporate Credit Facility (“PMCCF”) i contemplates a Fed / Treasury special purpose vehicle that will make new money extensions of credit to eligible borrowers by directly purchasing bonds issued by them, or by making loans to such eligible borrowers, whether as a direct lender or by purchasing loans to such borrowers under syndicated loan facilities.

The Federal Reserve released and then updated term sheets for the MSLFs and PMCCF in March and April 2020 and circulated an FAQ for the MSLFs in April 2020, and the Federal Reserve Bank of New York released and circulated FAQs for the PMCCF in April and May 2020.  The term sheets and FAQs provide a number of material terms and conditions for the facilities, but many questions and issues remain in terms of structuring and implementing these facilities generally and for agents, lenders, trustees, borrowers, issuers and other parties satisfying eligibility requirements for and participating in transactions under these facilities.

The MSLFs and PMCCF, which collectively represent hundreds of billions of dollars of new money financing for borrowers and issuers, are expected to launch by the end of May 2020.

A comprehensive summary of the MSLFs and PMCCF based on the term sheets and FAQs issued to date, market reconnaissance and strategic planning and considerations around these facilities can be accessed here.  We will periodically update and supplement the MSLF/PMCCF summary and separately provide additional alerts and guidance regarding these facilities generally and the parties qualifying for and participating in transactions under these facilities.

© 2020 Bracewell LLP

For more on Federal Reserve Main Street Loans, see the National Law Review Financial Institutions and Banking law section.

TransUnion to Seek Supreme Court Review After Ninth Circuit Finds Class Members Had Standing and Partially Upholds Punitive Damages Award

A hotly contested ruling in a Fair Credit Reporting Act (“FCRA”) class action case will soon be appealed to the Supreme Court of the United States.  The Ninth Circuit in Ramirez v. TransUnion LLC, Case No. 17-17244, recently granted the parties’ Joint Motion to Stay the Mandate, seeking to stay the Ninth Circuit’s mandate pending TransUnion’s filing of a petition for writ of certiorari in the Supreme Court.  The Motion to Stay comes soon after the court denied TransUnion’s Petition for Rehearing or Rehearing En Banc regarding the Ninth Circuit’s decision in Ramirez v. TransUnion LLC, 951 F.3d 1008 (9th Cir. 2020).

In Ramirez, the Ninth Circuit held for the first time that every class member in a class action lawsuit needs “standing” to recover damages at the final judgment stage.  The 8,185 member class alleged that TransUnion, knowing that its practice was unlawful, violated the FCRA by incorrectly placing terrorist alerts on the front page of consumers’ credit reports and later sending the consumers misleading and incomplete disclosures about the alerts and how to remove them.  The court held that each class member was required to, and did, have standing, even though the credit reports of over 75% of the class were not actually disclosed to a third party because TransUnion’s alleged violation of the consumers’ statutory rights under the FCRA, by itself, constituted a concrete injury.  The Ninth Circuit also found that the jury’s punitive damages award of 6.45 times the statutory damages award was unconstitutional, and reduced it to 4 times the statutory damages award.  The Ramirez decision is discussed in more detail here.

In its Petition for Rehearing, TransUnion claimed that the dissent had the correct view, and the majority’s decision “not only conflicts with Supreme Court teachings, but puts the Ninth Circuit on the wrong side of a lopsided circuit split.”  TransUnion argued that the class of consumers did not have standing for their FCRA claims unless their credit reports were disclosed to a third party.  TransUnion further alleged that the class should have been decertified because Ramirez, the named plaintiff, “was radically atypical of the class he purported to represent” since there was no evidence that any other class member’s credit report was disseminated.  Finally, TransUnion disputed the court’s punitive damages award because a reduction to 4 times the statutory damages award was not enough.  According to TransUnion, the Supreme Court requires, at a maximum, a punitive damages award “equal to compensatory damages . . . when compensatory damages are substantial.”

TransUnion concluded its Petition for Rehearing by stating:

It is no exaggeration to say that, for many class members, the first indication that they were injured at all will be when they receive a $4,925.10 check in the mail. That absurd result is the product of ignoring basic requirements of Article III, Rule 23, and due process.

As of the date this article is published, TransUnion has not yet filed its petition for writ of certiorari in the Supreme Court, but we will continue to monitor the case for updates.

Copyright © 2020, Hunton Andrews Kurth LLP. All Rights Reserved.

For more on the Fair Credit Reporting Act, see the National Law Review Financial Institutions & Banking law page.

Israeli Bank to Pay $30 Million for FIFA Money Laundering Violations

In 2015, the world was shocked by well-documented revelations of widespread corruption and bribery within the Fédération Internationale de Football Association (“FIFA”). At the time, the full extent of the FIFA money laundering scandal was unknown. This month, that 2015 revelation and the subsequent investigation has led to Bank Hapoalim (“BHBM”), an Israeli subsidiary of Swiss bank Hapoalim Ltd. (“HBS”), to pay $30 million of forfeiture and criminal fines.

In an April 30, 2020 press release, Assistant Director in Charge William F. Sweeney of the FBI’s New York Field Office described the difficulty in interrupting and identifying large scale sophisticated financial crimes. “This announcement illustrates another aspect in the spider web of bribery, corruption and backroom deals going on behind the scenes as soccer games were played on the field,” Sweeney said. He further explained that “Bank Hapoalim admits executives looked the other way and allowed illicit activity to continue even when employees discovered the scheme and reported it.”

Chuck Blazer, an “insider” and a former top FIFA official, provided vital evidence relied upon by the United States in securing the indictments that served as a basis for allegations against BHBM. The key to unlocking the FIFA money laundering scandal is the long reach of U.S. anti-bribery and corruption laws, which allow any person, whether a U.S. person or not, to report international financial misconduct. Yesterday, the Department of Justice reported that Bank Hapoalim would forfeit over $20 million and pay nearly $10 million in fines as a penalty for almost five years of financial misconduct.

In 2015, the full extent of the fraud within the inner workings and financial institutions like BHBM and BHS that knowingly enabled these corrupt activities within FIFA remained undisclosed. BHBM’s admission that it conspired to launder money and did facilitate bribes to corrupt FIFA officials, and the resulting $30 million to be paid as a consequence, reinforces the value of whistleblower contributions in concrete terms. This case serves as ample evidence that backroom dealings around the world can be brought to light by brave individuals who are willing to share what they know with authorities.

Whistleblower laws are potent tools available to individuals regardless of nationality or citizenship. They also provide substantial monetary rewards. When information leads to a recovery, the whistleblower is entitled to a financial award of 10%-30% of the total recovery. Another critical component of the U.S. anti-fraud program is that whistleblowers can anonymously provide information and still recover the reward. In this case, a whistleblower could have a claim for almost $10 million of the funds paid by BHBM. Due to the strict rules regarding anonymity, the world may never know whether such a claim is paid. However, the possibility of such a significant award serves as an effective incentive to other potential insiders contemplating blowing the whistle on misconduct.

Copyright Kohn, Kohn & Colapinto, LLP 2020. All Rights Reserved.

For more on similar topics, see the National Law Review Criminal Law & Business Crimes section.