The National Law Forum

On Friday, the British Cabinet met in Chequers, the Prime Minister’s country retreat, to agree among itself, a position to propose to the EU27 on its intended future relationship with the EU after Brexit. A mere two years after the referendum. Key points involved agreeing to maintain a “common rulebook” for all goods and agricultural products and the establishment of a “combined customs territory”, under which the UK would apply its own, possibly lower, tariffs and policies for goods for the domestic market, and EU tariffs and policies for goods entering the EU. These, the Cabinet considered, would go some way to enabling the UK to maintain a frictionless, or close to frictionless, border in Ireland and mainland Europe, while giving it an independent trade policy, particularly in relation to services. On jurisdiction, the UK would pay “due regard” to EU case law in respect of the common rulebook, but would not technically be bound by its decisions, nor would the ECJ resolve disputes between the UK and the EU. Free movement would end and be replaced with a “mobility framework”.

A Government White Paper is expected to be published on Thursday, with considerably more detail than the three-pager that was published at the start of the weekend. In its current form, the proposal may not fly in Brussels. It looks like the fabled “cherry picking” of the UK requesting the benefits of EU membership without fully signing up to the Four Freedoms, and the fear in Brussels is that it would give the UK a competitive advantage that other members states do not have. But it is at least the first document emerging from the UK government that explicitly accepts trade-offs will need to be made.

Brexiteer Conservative MPs were not impressed, taking the view (not unreasonably) that the government’s position, which is likely to be watered down further by the EU, leaves the UK in a position where it remains subject in effect to EU rules while not being able to influence them, and unable to enter into bold new trade deals (a free trade agreement with the US would likely be hard to conclude if the UK was bound by European standards on goods and agricultural produce). Speculation that a UK Cabinet Minister might resign rather than sign up the government’s position came to nought, as none did. Michael Gove, one of the most prominent Cabinet Brexiteers was reported to have argued enthusiastically in favour of the Prime Minister’s position, and certainly was on the Sunday political shows.

Until late last night. David Davies, the Brexit Secretary, having reflected over the weekend, decided he could no longer remain in his post, particularly given the Prime Minister has told her Cabinet Minister that she will no longer tolerate any public dissent on the government’s agreed position. He stated publicly that he could not continue as a “reluctant conscript” in a “weak negotiating position”. It should be noted that Davies has largely been away from the centre of the negotiations, with the Prime Minister having taken back control and entrusted a senior civil servant, rather than the Brexit Secretary, to lead on them.

He has been replaced in the post by Dominic Raab, an ambitious Brexiteer who has not previously been in the Cabinet. It is not clear whether any powers will be repatriated back to DExEU and to what extent the replacement of Davies, a “big picture” man by the more studious Raab, will impact on either the government position or its engagement with the EU27.

And as I write, the Foreign Secretary Boris Johnson, has also resigned. This would appear to increase the chances of Theresa May facing a confidence vote, but it remains unclear to what extent she is at risk of losing it. She needs 48 MPs to trigger a no-confidence motion. A vote is then put to the entire body of Conservative MPs. If Mrs May loses that vote, there is then a leadership contest, in which she could stand (but, in practice, probably wouldn’t). What happens then is anyone’s guess. The membership of the entire Conservative Party will vote on the new leader, on a list of two voted on by Conservative MPs. They may or may not both be “leavers”.

Even if there is a new Prime Minister, and that Prime Minister is a “leaver”, the Parliamentary arithmetic does not immediately change. Meanwhile, the clock keeps ticking and the currently immoveable deadline of 29 March 2019 draws ever nearer at which point, in the absence of an agreed deal, the UK will leave without one.

This blog has always advised that all businesses, whether small, medium-sized, large or global need to ensure that they are well prepared for a range of possible outcomes. The rapidly evolving events since Friday and particularly today show that a “no deal” Brexit remains a significant risk and the chances of that have increased today. A soft or softish Brexit should not be taken for granted, even if it appears to be the preferred outcome for Theresa May, whose future is not looking rosy right now.

A group of 21 state attorneys general have sent a letter to the Senate majority and minority leaders as well as to the chairman and ranking member of the Senate Banking Committee urging them to reject H.R. 3299 (“Protecting Consumers’ Access to Credit Act of 2017”) and H.R. 4439 (“Modernizing Credit Opportunities Act”).

H.R. 3299, known as the “Madden fix” bill, was passed by the House in February 2018.  It attempts to address the uncertainty created by the Second Circuit’s decision in Madden v. Midland Funding.  In that decision, the Second Circuit held that a nonbank that purchases loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act (NBA) allows the national bank to charge.  The bill would amend Section 85, as well as the provisions in the Home Owners’ Loan Act (HOLA), the Federal Credit Union Act, and the Federal Deposit Insurance Act (FDIA) that provide rate exportation authority to, respectively, federal savings associations, federal credit unions, and state-chartered banks, to provide that a loan that is made at a valid interest rate remains valid with respect to such rate when the loan is subsequently transferred to a third party and can be enforced by such third party even if the rate would not be permitted under state law.

H.R. 4439 was referred to the House Financial Services Committee in November 2017.  It is intended to address a second source of uncertainty for some loans that are made by banks with substantial origination, marketing and/or servicing assistance from nonbank third parties and then sold shortly after origination.  These loans have been challenged by regulators and others on the theory that the nonbank agent is the “true lender,” and therefore the loan is subject to state licensing and usury laws.

The bill would amend the Bank Service Company Act to add language providing that the geographic location of a service provider for an insured depository institution “or the existence of an economic relationship between an insured depository institution and another person shall not affect the determination of the location of such institution under other applicable law.”  The bill would amend the HOLA to add similar language regarding service providers to and persons having economic relationships with federal savings associations.

It would also amend Section 85 of the NBA to add language providing that a loan or other debt is made by a national bank and subject to the bank’s rate exportation authority where the national bank “is the party to which the debt is owed according to the terms of the [loan or other debt], regardless of any later assignment.  The existence of a service or economic relationship between a [national bank] and another person shall not affect the application of [the national bank’s rate exportation authority] to the rate of interest rate upon the [loan, note or other evidence of debt] or the identity of the [national bank] as the lender under the agreement.”  The bill would add similar language to the provisions in the HOLA and FDIA that provide rate exportation authority to, respectively, federal savings associations and state-chartered banks.

The state AGs assert in their letter that the bills “would legitimize the efforts of some non-bank lenders to circumvent state usury law” and “would constitute a substantial expansion of the existing preemption of state usury laws.”  As support for their argument that Congress did not intend to allow nonbank entities to use NBA preemption, they cite to the OCC’s recent bulletin on small dollar lending in which the OCC stated that it “views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).”

While the context for the OCC’s statement was “specific to short-term, small-dollar installment lending,” we have expressed concern as to its implications for all banks that partner with third parties to make loans under Section 85.  As we noted, the statement also seems at odd with the broad view of federal preemption enunciated by the OCC with respect to the Madden decision.

While the enactment of legislation reaffirming the valid-when-made doctrine and addressing the “true lender” issue would be helpful, we have advocated for the OCC’s adoption of a rule providing that (1) loans funded by a bank in its own name as creditor are fully subject to Section 85 and other provisions of the NBA for their entire term; and (2) emphasizing that banks that make loans are expected to manage and supervise the lending process in accordance with OCC guidance and will be subject to regulatory consequences if and to the extent that loan programs are unsafe or unsound or fail to comply with applicable law.  In other words, it is the origination of the loan by a national bank (and the attendant legal consequences if the loans are improperly originated), and not whether the bank retains the predominant economic interest in the loan, that should govern the regulatory treatment of the loan under federal law.

In two enforcement actions pending in Colorado state court, the Administrator of the Uniform Consumer Credit Code for the State of Colorado is employing the “true lender” theory and the Second Circuit’s Madden decision to challenge two bank-model lending programs.

As we reported here, record-keepers for large 401(k) plans have thus far been successful in defending ERISA fiduciary-breach litigation over investment advice powered by Financial Engines.  These lawsuits generally claim that fees collected by record-keepers for investment advice were unreasonably high because the fees exceeded the amount actually paid to Financial Engines.  Plaintiffs in Chendes v. Xerox HR Solutions, LLC were given a second chance to plead their claims, this time alleging that the defendant record-keeper was a fiduciary because it “used its influence” as the plan’s record-keeper to force the plan sponsor to engage Financial Engines—primarily by refusing to use any other investment adviser—and therefore exercised de facto control over the plan’s retention of Financial Engines.  The court rejected the argument that constraining the plan’s service provider choices amounted to de facto control since the plan had other alternatives to choose from (such as not using an investment adviser or changing record-keepers) and dismissed the claim without leave to amend, ending the case at the district court.  The case is Chendes v. Xerox HR Solutions, LLC., Case No. 2:16-cv-1398, ECF No. 63 (E.D. Mich., June 25, 2018).

The Texas Supreme Court unanimously ruled on June 22, 2018, that a state law on solid waste disposal pre-empts local ordinances banning single-use bags. The ruling strikes down the City of Laredo’s Plastic Bag Ordinance that bans single-use plastic and paper bags. (An amendment to the Ordinance included single-use paper bags in the definition of “checkout bag.”)

The Laredo Merchants Association initially sued the city in March 2015 claiming that the Laredo plastic bag ban was illegal because it is pre-empted by Texas Health & Safety Code Section 361.0961, which bans local ordinances that: 1) prohibit or restrict the sale or use of a “package” or “container”; 2) have “solid waste management purposes”; and 3) are not otherwise authorized by state law. The 341st Judicial District Court in Webb County sided with the city; however, on August, 16, 2016, the Court of Appeals ruled 2-1 to overturn the lower Court’s ruling.

In City of Laredo v. Laredo Merchants Association (case number 16-0748), the City maintained that its ordinance to reduce litter from single-use bags was designed to beautify the city and reduce clogs in storm drains, not to manage solid waste. In the July 22, 2018 ruling, Judge Nathan Hecht wrote, “The Ordinance’s stated purposes are to reduce litter and eliminate trash—in sum, to manage solid waste, which the Act preempts. The Ordinance cannot fairly be read any other way.”

The Texas Supreme Court accepted this case, in part, because several Texas municipalities have enacted ordinances banning single-use bags. Responding to the Court’s decision, Texas Attorney General Ken Paxton issued a release in which he stated:

“I commend the Texas Supreme Court for upholding the principle that no one is exempted from the rule of law…Municipalities violate the law when they unlawfully pass the burden of solid waste management to citizens and retailers through illegal bag bans. I hope that Laredo, Austin, and any other jurisdictions that have enacted illegal bag bans will take note and voluntarily bring their ordinances into compliance with state law…”

On June 22, 2018, the U.S. Department of the Treasury (“Treasury”) issued Notice 2018-59 (the “Notice”), which deals with the “begin construction” test that is applicable to solar projects. More specifically, the newly issued guidance clarifies the eligibility requirements applicable to the Investment Tax Credit (“ITC”) claimed in connection with solar projects, closely following the “begin construction” guidance Treasury has previously issued for wind developers in order to determine eligibility for the production tax credit (“PTC”).

The Notice provides solar developers with long-awaited guidance on what constitutes the “begin construction” test in order for a solar project to qualify for the ITC equal to 30 percent. Similar to PTC guidance, the Notice provides two methods for determining when construction begins on solar projects: (1) the Physical Work Test and (2) the Five Percent Safe Harbor Test. Under the Physical Work Test, solar developers must show that physical work of a significant nature has begun. Under the Five Percent Safe Harbor Test, solar developers must show that at least 5 percent of the total cost of energy property has been paid or incurred. The Physical Work Test requires that a solar developer maintains a continuous program of construction, and the Five Percent Safe Harbor Test requires that the solar developer maintains continuous efforts toward completion of the solar project (collectively, the “Continuity Requirement”).

A welcome safe harbor for satisfying the Continuity Requirement is provided by the Notice. If the solar project is placed in service by the end of the calendar year that is no more than four calendar years after the calendar year in which construction begins, the Continuity Requirement will be deemed to have been met. If this safe harbor is not met, a solar developer can still satisfy the Continuity Requirement (via the Physical Work Test or the Fiver Percent Safe Harbor Test) through facts and circumstances.

Similar to PTC guidance, the Physical Work Test described in the Notice provides that whether physical work of a significant nature has begun depends on the relevant facts and circumstances and may include work performed by the taxpayer, work performed for the taxpayer by another person under a binding written contract, and work that occurs both on-site and off-site. As provided in the Notice, examples of on-site work that would qualify include:

• Solar – installation of racks or other structures to affix photovoltaic panels, collectors, or solar cells to a site;

• Geothermal – physical activities that are undertaken at a project site after a valid discovery such as the installation of piping, turbines, generators, flash tanks, or heat exchangers; and

• Small wind energy – installation of the foundation, tower, wiring, or grounding systems.

For off-site work, physical work of a significant nature includes the manufacture of components, mounting equipment support structures such as racks and rails, inverters, transformers, and other power conditioning equipment. Similar to PTC guidance, physical work of a significant nature does not include the manufacturing of components that are in existing inventory or normally held in the inventory of a vendor.

The Notice also provides guidance on the types of activities that will not be taken into account for purposes of the “begin construction” test. For instance, physical work of a significant nature is limited to property that is considered integral to the production of electricity and does not include:

• Property used for transmission;

• Roads used to access the site or that are primarily used for employee or visitor vehicles;

• Buildings that are not functionally an item of equipment or do not house energy equipment and are expected to be removed when the energy property they house is removed; and

• Fencing.

In addition, preliminary activities such as planning or designing, securing financing, obtaining permits and licenses, or clearing a site, do not count for purposes of the “begin construction” test.

If a solar project that starts construction in 2018 or 2019 meets (A) either the Physical Work Test or the Five Percent Safe Harbor Test (as summarized above), and (B) the Continuity Requirement (as summarized above), and (C) the project is placed in service by December 31, 2023, then the project will qualify for the full ITC of 30 percent. The amount of the ITC that can be claimed decreases to 26 percent for projects that otherwise qualify and start construction in 2020 and 22 percent for projects that otherwise qualify and start construction in 2021.

Finally, similar to PTC guidance, the Notice clarifies that the taxpayer may transfer property after construction begins without jeopardizing eligibility for the ITC. Specifically, a solar developer can contribute a Physical Work or Five Percent Safe Harbor Test project to a tax equity partnership, a tax equity investor can acquire a membership interest in that partnership, and the partnership can claim the ITC based on the developer’s prior ITC qualification when the project is placed in service. In addition, a purchaser of a partially developed solar project may tack on the developer’s costs or work for purposes of the Physical Work or Five Percent Safe Harbor Test.

Despite this good news, unanswered questions remain. Namely, Treasury has yet to issue specific guidance regarding whether solar-plus-storage projects are eligible for the ITC. Although a series of published Private Letter Rulings have strongly suggested that storage projects that are part of a solar facility are eligible for the ITC, Treasury has yet to release any definitive guidance on this topic. It remains to be seen whether Treasury might include such guidance in any future revisions of the ITC Treasury Regulations or whether Congress might address the issue through legislation.

The Department of Defense (DoD) has once again emphasized its willingness to engage with commercial companies and other non-traditional contractors to try to expedite and simplify its procurement of innovative technologies. In particular, the Defense Information Systems Agency (DISA) indicated that it plans to enter directly into Other Transaction Authority (OTA) agreements, and DoD issued a class deviation for a commercial solutions opening (CSO) pilot program.

These developments, in connection with the continued promotion of OTA agreements by DoD’s Defense Innovation Unit Experimental organization (DIUx), provide commercial companies with additional incentives to enter into creative collaborations with the U.S. Government.

DISA OTAs

On June 29, DISA issued a News Release on its website to highlight the agency’s commitment to using its recently granted Other Transaction Authority to drive innovation and solutions to the warfighter. DISA recognized that the traditional procurement rules encompassed by the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS) can discourage potential partners and thus slow or prevent access to goods and services that would benefit our nation’s defense. As a potential solution for concerns associated with traditional procurement contracts, DISA explained that OTA agreements can provide more flexibility, which in turn permits the agency to “approach acquisitions in a commercial-like manner with some restrictions.”

As noted in an earlier post, there are many benefits for contractors that proceed with an OTA agreement in lieu of a traditional procurement contract. In addition to generally providing the benefit of a more rapid acquisition process, a significant advantage of an OTA agreement is that the FAR, DFARS, and many of their accompanying compliance obligations do not apply. For example, although DoD may want to include cost requirements in an OTA agreement, neither the cost principles in FAR Part 31 nor the Truth in Negotiations Act are applicable by law. DoD also retains flexibility to negotiate intellectual property rights that may deviate from default rights established under the Bayh-Dole Act, Part 27 of the FAR, and Part 227 of the DFARS.

The lack of set rules, however, may prove challenging for established contractors that have structured internal business systems based on FAR-based contract requirements and may not know where to begin in negotiating an OTA agreement. At the same time, entities that are not familiar with the FAR may have difficulty negotiating with DoD contracting officers who may try to impose the same forms and clauses that would otherwise apply under traditional procurement contracts. Small entities in particular may not have the resources to fully assess the consequences of agreeing, for example, that all costs incurred under an OTA agreement comply with FAR Part 31. Accordingly, both private and government negotiators need to understand that an OTA agreement is meant to be “commercial like” and can and should be drafted to meet the parties’ needs with or without reference to traditional contracting frameworks.

Although DISA has to date relied on other agencies to support its OTA agreements, it plans to enter into OTA agreements directly in the future using a CSO process that is similar to a process initially developed by DIUx. Only time will tell whether DISA will be able to retain sufficient flexibility in negotiations to maximize the benefits of OTA agreements while also addressing their challenges.

CSO Pilot Program

On June 26, three days before the DISA News Release, DoD issued a class deviation for a pilot program that allows contracting officers to use a simplified CSO process for standard procurement contracts to acquire “innovative commercial items, technologies or services.” The deviation permits DOD components to award traditional procurement contracts through a peer-reviewed process that will be deemed competitive without head-to-head competition between proposals. The pilot program implements Section 879 of the National Defense Authorization Act for Fiscal Year 2017, which represents another congressional push for DoD to use non-traditional processes to pursue cutting-edge technologies.

Much like the CSO process initially applied by DIUx and adopted by DISA for OTA agreements, the pilot program allows DoD contracting officers to select proposals received in response to a general solicitation that is similar to a broad agency announcement without being limited to basic or applied research projects. Instead, eligible projects only need to be “innovative,” covering completely new technologies, processes, or methods—including research and development—in addition to new applications of technologies, processes, or methods that are already in existence.

Specific limitations and requirements that traditionally apply to prototype projects and circumstances involving limited competition will not apply to the pilot program’s CSO process. However, awards valued at more than $100 million will be subject to prior approval and congressional reporting requirements. In addition, unlike OTA agreements, awards will need to be issued under the pilot program on a fixed-price basis.

Contracting officers will be required to post a notice of availability of a pilot program CSO at least annually and, in limited situations, may advertise a CSO in scientific, technical, or engineering periodicals. Proposals submitted in response to a CSO will not be evaluated against each other because they will not be submitted in response to a common performance work statement or statement of work. Thus, like awards resulting from the CSO process used by DIUx and DISA, as well as broad agency announcements generally, there can be more than one awardee working on similar projects.

Following DISA’s approach, contracting officers implementing the pilot program may ultimately reference CSO evaluation procedures that have already been established and tested by DIUx. Importantly, the pilot program’s concept of “innovative” development is based on criteria initially established by DIUx, and contracts awarded under the pilot program likely will support many of the same goals as OTA agreements.

The authority to enter into a contract under the pilot program is scheduled to expire on September 30, 2022, although existing pilot contracts in effect at that time will be permitted to continue performance until completed.

Two recent developments reinforce my expectation that the Supreme Court will need to clarify the scope of its 2005 Granholm v. Heald decision within the next few years.

Granholm struck down state restrictions on the interstate sale and shipment of wine by wineries, where the state permitted in-state wineries to engage in such direct-to-consumer sales activities but withheld that privilege from out-of-state wineries. According to that decision, such facially-discriminatory laws are virtually per se unconstitutional under the so-called “dormant” Commerce Clause, and are not saved by the additional power that states have over alcohol sales under the 21st Amendment. The Granholm court also referred to the three-tier system as “unquestionably legitimate.”

In the years since Granholm, lower federal courts have wrestled with the question of whether or not the Commerce Clause’s non-discrimination principle is limited to state laws imposing different rules on in-state versus out-of-state producers and products. Decisions by several Circuit Courts of Appeal, including the US Court of Appeals for the Second Circuit (Arnold’s Wines, 2009) and the Eighth Circuit (Southern Wine, 2013), have concluded that only those state laws discriminating against out-of-state producers or products face the high level of scrutiny mandated by Granholm. Others, including the Fifth Circuit (Cooper II, 2016) and the Sixth Circuit (Byrd, 2018), have concluded that state laws regulating the wholesale- and retail-tiers remain subject to vigorous Commerce Clause scrutiny. Notably, however, the Fifth and Sixth Circuit opinions also suggest that the outcome of a challenge to a state law regulating the wholesale- or retail-tier may depend on the type of law challenged, and both involved residency requirements for licensees, not laws directly regulating the sale and shipment of alcohol.

Developments in the past month add incremental pressure on the federal judiciary to provide clarity on these issues.

First, on June 14, 2018 Orion Wine Imports filed a complaint alleging that the California laws prohibiting out-of-state wine importers and wholesalers from selling directly to California retailers violate the dormant Commerce Clause, as in-state importers and wholesalers can (of course) make such sales. (As in most Commerce Clause cases, the complaint also includes a count arising under the Privileges and Immunities Clause, but such claims almost invariably rise or fall with the outcome of the Commerce Clause claim.) Among the counsel for Orion Wine Imports are Robert Epstein and James Tanford, two Indiana-based attorneys who have been at the forefront of direct wine shipping litigation for almost two decades. Notably, California falls within the Ninth Circuit, and that court has yet to issue an opinion taking a position on the application of Granholm to laws regulating the wholesale- or retail-tiers.

Second, on June 15 the US District Court for the Eastern District of Missouri handed down an opinion in Sarasota Wine Market v. Parson, E.D. Mo. No. 4:17CV2792 HEA. The opinion grants the state defendants’ motion to dismiss a case brought by a Florida wine retailer and a Missouri resident seeking to purchase wine from out-of-state retailers. Because Missouri sits within the Eighth Circuit, it was not surprising at all that the district court found the plaintiffs’ claims under the Commerce Clause and Privileges and Immunities Clause foreclosed by the Eighth Circuit’s 2013 decision in Southern Wine and Spirits v. Division of Alc. & Tobacco Control. Much more surprising was the district court’s conclusion that the plaintiffs lacked standing to sue. An appeal seems likely.

With another post-Granholm case filed and another case decided and likely headed to an appeal, these developments add incrementally to the pressure for the US Supreme Court to hear a case involving the application of the dormant Commerce Clause to a state alcohol beverage law regulating the wholesale- or retail-tier. Which particular case and particular issue eventually becomes the subject of Supreme Court review is anyone’s guess. But the stakes are high for both sides: A limitation of the non-discrimination principles arising from the Commerce Clause to state alcohol laws regulating only producers or products would remove an important tool that various plaintiffs have used to challenge the alcohol market’s status quo in the past decade. Conversely, the broad application of non-discrimination principles to state alcohol laws regulating wholesale and retail sales would forcefully push the United States towards a single national alcohol beverage market.

It remains possible that the Supreme Court does not address these questions for decades. But the existing circuit split and escalating litigation activity illustrated by last month’s developments all point to a Granholm sequel at the Supreme Court—what I call the “Son of Granholm”—sooner rather than later.