CORPORATE P RA C TI C E NEWSWIRE - Norton … · P RA C TI C E N EWSWIRE M AY 2014 Lara Aryani +1 (212) 408-5243 [email protected] Ted P. Castell +1 (212) 408-1119 [email protected]

1 Structuring Earn-Outs: Recent Delaware Court Decisions Highlight Complexities

7 Regulation A+: A New Path to Accessing the Markets for Small Issuers?

12 Lost Profit Waivers: Beware of Unintended Consequences

15 Own 10% or More of a Foreign Business? — BEA Compliance Update

19 Drafting Tips for Purchase Price Adjustment Clauses: NYC Bar Association Weighs In

22 Private M&A Deal Trends: ABA Updates Market Study

26 Is Arbitration Right for Your Workforce? Recent Developments Make Now a Good Time to Consider (or Reconsider) Arbitration

CORPORATE PRACTICENEWSWIREMAY 2014

© 2014 CHADBOURNE & PARKE LLP, ALL RIGHTS RESERVED. THIS MATERIAL MAY CONSTITUTE ATTORNEY ADVERTISING IN SOME JURISDICTIONS. PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME.

IN THIS ISSUE

II CHADBOURNE & PARKE LLP CORPORATE PRACTICE NEWSWIRE MAY 2014

J. Allen Miller +1 (212) 408-5454 [email protected]

Kevin C. Smith +1 (212) 408-1092 [email protected]

EDITORS

TO OUR READERS Corporate Practice NewsWire is dedicated to in-depth analysis of current legal issues and trends affecting domestic and international business transactions. In this issue, our M&A lawyers take a look at certain issues, recent developments and other considerations that parties should bear in mind when drafting and structuring earn-out provisions, lost profit waivers and purchase price adjustment clauses. In addition, we highlight certain market trends identified from the ABA’s recently updated Private Target M&A Deal Points Study. In the area of capital markets and securities, we examine the SEC’s proposed rules, known as Regulation A+, that are intended to help smaller companies gain access to capital by expanding upon existing Regulation A. We also alert our readers to the potentially burdensome BEA reporting requirements of which US persons that own foreign businesses or are owned by foreign persons should be aware. Finally, our employment lawyers review recent developments affecting the enforceability of arbitration arrangements and address issues to focus on when considering workplace arbitration arrangements.

Corporate Practice NewsWire is published by Chadbourne & Parke LLP for general information purposes only. It does not constitute the legal advice of Chadbourne & Parke LLP, is not a substitute for fact-specific legal counsel and does not necessarily represent the views of the firm or its clients.

CORPORATE PRACTICENEWSWIRE

MAY 2014

Lara Aryani+1 (212) [email protected]

Ted P. Castell+1 (212) [email protected]

Amy E. D’Agostino+1 (212) [email protected]

David Gallai+1 (212) [email protected]

William Greason+1 (212) [email protected]

Rachel M. Kurth+1 (212) [email protected]

J. Patrick Narvaez+1 (212) [email protected]

Marc M. Rossell+1 (212) [email protected]

Nicholas Scannavino+1 (212) [email protected]

Edward P. Smith+1 (212) [email protected]

CONTRIBUTORS Kevin C. Smith +1 (212) 408-1092 [email protected]

Thomas H. Watson +1 (212) 408-5317 [email protected]

Tae Sang Yoo+1 (212) [email protected]

J. Patrick Narvaez, Associate Editor+1 (212) [email protected]

CHADBOURNE & PARKE LLP CORPORATE PRACTICE NEWSWIRE MAY 2014 1

An earn-out is a tool that buyers and sellers use from time to time in M&A transactions to defer the payment of a

portion of the purchase price until after the closing upon the achievement of certain performance targets or the

happening of certain defined events. Earn-outs can be a useful tool when buyers and sellers cannot agree on the

value of the business being sold or its future performance. Earn-outs offer the potential to bridge the valuation

gap between what a seller thinks the business is worth and how it will perform going forward and what the

buyer perceives the value of the business (and its future growth prospects) to be. Where the seller will remain

involved in the business after the closing, earn-outs can also be a useful tool to align the interests of the parties,

meaning that the prospect of a potential earn-out will incentivize the seller to continue growing the business

for the benefit of the buyer after the closing. However, because earn-outs are inherently conditional in nature

and dependent on a number of variables, some of which are outside the control of the parties, drafting and

negotiating earn-outs can be complex and become the source of disputes between the parties after the closing.

This article is intended to highlight (i) some of the potential advantages and disadvantages that earn-outs present for buyers and sellers, (ii) some notable structural issues and con-siderations that parties should bear in mind when formulat-ing an earn-out, and (iii) two recent Delaware court decisions that underline the importance of careful drafting of post-closing operating covenants relating to earn-out provisions in acquisition agreements.

Advantages and Disadvantages for Sellers and BuyersSeller PerspectiveFrom a seller’s point of view, an earn-out offers the possibil-ity of receiving a higher purchase price than a buyer would otherwise be willing to pay at the closing. An earn-out also provides a seller with the chance to participate in the future success of the business following the closing if certain defined performance targets are achieved. On the other hand, agree-ing to an earn-out may require a seller to remain involved or

invested in the business that it wants to sell, preventing a clean break from the business. A seller may also have to rely on the buyer to operate the business after the closing in a manner that results in the earn-out targets being achieved, thereby losing a measure of control over whether and to what extent the earn-out will be payable. As a result, a seller may attempt to include affirmative covenants in the acquisition agreement that require the buyer to operate the business in a certain manner after the closing or that restricts the buyer from making significant changes to the business after the closing. Even here, however, there are circumstances that a seller may not be able to predict and draft for or that arise after the closing that are outside of the control of even the buyer that may result in the earn-out not being achieved.

Buyer PerspectiveFor a buyer, an earn-out allows the buyer to defer payment of a part of the purchase price until after the closing and offers a buyer some protection against overpaying for a business.

STRUCTURING EARN-OUTS: RECENT DELAWARE COURT DECISIONS HIGHLIGHT COMPLEXITIESBy Ted P. Castell

2 CHADBOURNE & PARKE LLP CORPORATE PRACTICE NEWSWIRE MAY 2014

If the business is not as profitable after the closing as the seller and buyer think it will be or the business does not otherwise meet certain agreed performance targets follow-ing the closing, depending on how the earn-out provision is drafted, the buyer may not be required to pay the seller any of the earn-out amount or only a reduced portion of the earn-out amount. On the other hand, the presence of post-closing contractual covenants and restrictions in the acquisition agreement may limit the flexibility of the buyer to operate the business it just acquired in a manner it might otherwise in the absence of the earn-out provision. In some instances, the selling stockholder may stay on as part of the manage-ment team after the closing, which has the potential to create a conflict of interest between the selling stockholder and the buyer. For example, the selling stockholder may want to take certain actions in the near term that have the effect of maxi-mizing profits and increasing the earn-out payment, but the buyer may view such short term actions as not being in the best interests of the acquired business or its other businesses in the long term.

Structural Considerations Earn-out provisions are typically incorporated as part of the acquisition agreement and can vary considerably based on the business being sold and the commercial agreement reached by the parties as to the form and substance of an earn-out. There are many issues that need to be considered and ad-dressed when formulating an earn-out, including among others, the accounting and tax treatment of earn-outs, which are beyond the scope of this article. From a structural point of view, there are several key issues and considerations that buyers and sellers should always bear in mind when drafting any earn-out provision.

Earn-outs can be a useful tool when buyers and sellers cannot agree on the value of the business being sold or its future performance.

Defining the Earn-Out TargetEarn-out performance targets that give rise to the payment of the earn-out should be clearly defined and properly align the parties’ interests. Most performance targets are based on financial targets. Examples of common financial targets include performance targets based on revenue, net income or EBITDA. A seller and buyer may have different preferences when selecting financial performance targets. For example, a seller may prefer a target based on revenues because costs and expenses have less of an impact. On the other hand, a buyer may not like a target based on revenues because if the seller remains involved in the operation of the business after the closing, a revenue based target will not incentivize the seller to control its costs and expenses. Frequently, buyers and sellers will agree on an EBITDA-based target, particularly where the purchase price was based on a multiple of EBITDA, because EBITDA takes into account operational costs and ex-penses but excludes non-operational items such as interest, tax, depreciation and amortization. A seller may continue to have concerns with a buyer’s ability to manipulate earnings after the closing by making more expenditures in the short term during the earn-out period and thereby reducing earn-ings and ultimately the earn-out payment. This concern may be addressed by capping the amount of expenditures that the buyer makes during the earn-out period for purposes of the earn-out calculation or by drafting other specific post-closing operational covenants that address the manner in which the parties expect the business will be operated during the post-closing earn-out period.

In addition to financial-based performance targets, earn-outs may also be tied to non-financial performance targets or milestones. For example, the entry into a new contract or the renewal of certain key contracts, obtaining a minimum number of new customers, or the favorable resolution of a pending litigation matter may all result in increased earn-ings power and profitability for the business and trigger an earn-out payment. Operational performance targets are sometimes easier to structure and negotiate because they tend to be easier to define, in the common interest of each party and generally outside the direct control of the parties. Even here, however, the devil can be found in the details so the parties should think carefully about the parameters of such non-financial performance targets or milestones. For example, is the earn-out period long enough to allow suf-ficient time for the operational performance milestone to be achieved? Should the buyer be contractually obligated to


take any specific actions in connection with achieving the op-erational performance target? If the parties know that certain actions must be taken in order to achieve a performance target, a seller should negotiate for express language in the acquisition agreement to address the matter rather than rely on the buyer’s implied covenant of good faith and fair dealing, at least where the acquisition agreement is governed by Delaware law.

Calculation of the Earn-Out Target and Dispute ResolutionThe acquisition agreement should also clearly set forth how the parties will determine whether and to what extent the performance targets have been achieved and how disputes will be resolved. The mechanics for determining whether non-financial performance targets have been achieved tend to be somewhat simpler to document since generally speaking, it will usually just involve providing evidence that the specified non-financial performance target event has occurred. In con-trast, the mechanics for determining whether financial per-formance targets have been achieved tend to be more com-plicated since financial statements and calculations will need to be prepared in order to determine whether the financial targets giving rise to an earn-out payment have been met. A buyer will usually prepare the initial financial statements and calculations for an earn-out since it will be in control of the business following the closing. The earn-out should provide the seller with an opportunity to review and dispute the buyer’s financial statements and calculations. In this regard, it is important for both parties to carefully consider and specify what accounting principles will be used when preparing the financial statements and calculations in order to minimize future disputes when the calculations are made.

The acquisition agreement should address how disputes will be resolved. In the case of an earn-out based on financial targets, it is usually heard by an independent accountant se-lected by the parties and may be similar in nature to dispute resolution procedures that are frequently incorporated into acquisition agreements for resolving post-closing purchase price adjustments based on working capital or other financial metrics. Common considerations in drafting a dispute resolu-tion provision include, among others, (i) how the independent accountant will be selected; (ii) the scope of the independent accountant’s authority (e.g., can the accountant apply a dif-ferent methodology from the one used by the parties; can the accountant decide on issues not raised by the parties; can the accountant decide on its own figure or must it choose

between the figures proposed by the parties); (iii) the alloca-tion of the independent accountant’s costs and expenses; and (iv) the timing for payment of any amounts not in dispute. The Length of the Earn-Out PeriodThe length of the post-closing earn-out period will vary de-pending on the performance target chosen and can be a point on which a seller and buyer have competing interests.

Earn-out periods may range from one year or less follow-ing the closing to several years after the closing. For sellers, depending on the performance target and its outlook, they may prefer a short earn-out period so that they can receive their earn-out payment as quickly as possible. This will reduce the amount of time that a seller is effectively providing the buyer with interest free financing for the purchase of the busi-ness and also mitigate against the risk that intervening events occur after the closing that adversely affect the creditworthi-ness of the buyer. On the other hand, some sellers may prefer a longer earn-out period to ensure that they have sufficient time to achieve the earn-out target and maximize the earn-out payment.

A buyer may also have conflicting interests to consider when evaluating the duration of the earn-out period. On the one hand, a buyer may prefer a shorter earn-out period so that it is not indefinitely subject to a contingent payment obligation and related post-closing operating restrictions that limit its flexibility to operate the business. On the other hand, some buyers may prefer a longer earn-out period to make sure that the performance of the business is not fleeting but rather sustainable over the longer term. Where the seller stays on to manage the business post-closing, a buyer may prefer a longer earn-out period to ensure that strong perfor-mance in the first year following closing is not an aberration manufactured by the seller taking short term actions that will negatively impact the business in the long run.

The Nature of the Earn-Out PaymentThe nature of the earn-out payment itself may range from a flat specified amount, a multiple of the amount by which the business exceeds the earn-out target, another agreed formula or even payment in the form of buyer’s stock. If a formula is used to determine the earn-out payment, a buyer will likely want to cap the earn-out amount and a seller will likely want to set a minimum floor amount that it will receive. A seller should also consider whether a creditworthy guaranty should be provided in order to secure the buyer’s contingent


Because earn-outs are inherently conditional in nature and dependent on a number of variables, some of which are outside the control of the parties, drafting and negotiating earn-outs can be complex and become the source of disputes between the parties after the closing.

obligation to pay the earn-out, particularly where the buyer acquired the seller’s business through a leveraged buyout resulting in the pledge of the assets of the business to the lenders that financed the purchase price.

The Timing of Earn-Out PaymentsWhere the earn-out period is shorter (e.g., one year or less), there may just be one payment at the end of the earn-out period. In other instances where earn-out periods extend for a number of years, multiple earn-out payments may be contemplated and measured, for example, on an annual basis during the earn-out period. With earn-out periods that extend over a number of years, a buyer may negotiate for a claw back right where an earn-out payment is earned in one year by the seller but there is a shortfall in a subsequent year or years during the earn-out period. To facilitate a claw back, a buyer may even seek to deposit any earn-out payments that are achieved during one year of an earn-out period with an independent escrow agent in order to secure against the pos-sibility of shortfalls during subsequent time periods during the earn-out period. Conversely, a seller may negotiate for the right to receive all or a portion of the earn-out payment where, for example, there is a shortfall in the financial performance target during one year, but the financial performance target is exceeded during other years of the earn-out period. The timing of earn-out payments may also depend on whether the parties negotiate for buy-out options, acceleration provi-sions or setoff rights. A buyer may seek a buyout option for itself, which gives it the flexibility to pay a specified amount to satisfy the earn-out obligation early, in order to free itself from restrictive covenants or any rights the seller may have to consent to certain actions (e.g., a sale of the business by the buyer). Similarly, a seller should consider whether the timing for earn-out payments should be accelerated where certain events occur after the closing (e.g., sale of the business; breach of post-closing buyer covenants; buyer insolvency). Another consideration for a buyer that may impact its view of the timing of the earn-out obligation is whether the buyer will attempt to make the earn-out obligation subject to offset on account of indemnification claims that may arise after the closing against the seller.

Recent Delaware Court Decisions Two recent Delaware court decisions highlight the impor-tance of considering the inclusion of express post-closing operating covenants related to earn-outs in acquisition agree-ments governed by Delaware law.

In Winshall v. Viacom International Inc., 76 A.3d 808 (Del. 2013), the Delaware Supreme Court upheld the dismissal by the Court of Chancery of a complaint over the payment of an earn-out in which Walter Winshall, as a representative of the selling shareholders, argued that after the acquisition of Harmonix Music Systems, Inc. (“Harmonix”) by Viacom International, Inc. (“Viacom”) pursuant to a merger agree-ment, Viacom breached its implied obligation of good faith and fair dealing under the merger agreement by intention-ally not taking advantage of an opportunity to negotiate lower distributions fees under a distribution agreement with Electronic Arts, Inc. (“EA”), which would have resulted in an increased earn-out payment to the selling shareholders.

Under the merger agreement, the selling shareholders were entitled to a contingent right to receive incremental uncapped earn-out payments based on Harmonix’s financial performance during the two years after the merger (i.e., 2007 and 2008). The selling shareholders’ earn-out payments were equal to 3.5 times the amount by which Harmonix’s gross profit exceeded $32 million in 2007 and $45 million in 2008. The distribution fees payable by Harmonix to EA under the dis-tribution agreement had the effect of reducing gross profits for purposes of the earn-out formula. Notably, the merger agreement did not require Viacom or Harmonix to conduct their businesses following the merger so as to ensure or maxi-mize the earn-out payments. During a renegotiation of the distribution agreement with EA after the merger, EA offered to reduce the 2008 distribution fees in exchange for other benefits, but ultimately Viacom did not accept that proposal and instead left the 2008 distribution fee level unchanged


and reduced the distributions fees for years beginning in 2009 in exchange for certain other benefits. While it is true that the selling shareholders’ earn-out payment may have increased had the 2008 distribution fees been reduced as part of the renegotiations between Viacom and EA, the court explained that “none of those amendments [that Viacom entered into with EA in respect of the distribution agreement] affected in any way the Selling Shareholders’ earn-out payment for 2008: the amount of that payment remained exactly what it would have been under the Original EA Agreement.”

Plaintiff argued that when the opportunity to increase the amount of the selling shareholders’ 2008 earn-out pay-ments was presented, Harmonix had an obligation implied under the merger agreement to take that opportunity, but the court rejected the plaintiff’s argument and explained that “[t]he implied covenant of good faith and fair dealing cannot properly be applied to give the plaintiffs contractual protec-tions that ‘they failed to secure for themselves at the bargain-ing table.’” The court in Winshall concluded that Winshall’s claim rested on a fundamental misconception of the limited scope and function of the implied covenant of good faith and fair dealing in Delaware contract jurisprudence. In affirming the decision of the Court of Chancery, the court in Winshall cited several passages from the Court of Chancery’s decision that are instructive:

[T]he implied covenant is not a license to rewrite contractual language just because the plaintiff failed to negotiate for protections that, in hind-sight, would have made the contract a better deal. Rather, a party may only invoke the protec-tions of the covenant when it is clear from the underlying contract that “the contracting parties would have agreed to proscribe the act later complained of … had they thought to negotiate with respect to that matter.

[T]here is a critical difference between Viacom and Harmonix’s actions here and the actions of an acquirer who promises earn-out payments to the sellers of the target business and then pur-posefully pushes revenues out of the earn-out period. It is true that when a contract confers discretion on one party, the implied covenant of good faith and fair dealing requires that the discretion — such as Viacom’s discretion

in controlling Harmonix after the Merger and during the earn-out period — be used reasonably and in good faith. Thus … if Viacom and Harmonix had agreed to pay double EA’s ask in distribution fees in 2008 in return for paying no distribution fees in 2009, such an agreement would argu-ably be a breach of the implied covenant. In that case, Viacom and Harmonix would be depriv-ing the Selling Stockholders of their reasonable expectations under the Merger Agreement by actively shifting costs into the earn-out period that had no place there…. Winshall would have me hold that [Viacom’s] discretion over the Harmonix business … was subject to an implied covenant of good faith that encompassed not only a duty not to harm the Harmonix business so as to reduce Gross Profit for purposes of cal-culating the earn-outs, but also to do everything it could to increase the earn-out payments. As Viacom and Harmonix point out, “on [Winshall’s] logic, Defendants would have been obligated to negotiate the distribution fees down to zero for 2008 to maximize the impact on the [earn-out payment for 2008] and make up the shortfall with higher payments thereafter—a commer-cially absurd outcome.” This is not a tenable ap-plication of the limited implied covenant of good faith and fair dealing.

More recently, in American Capital Acquisition Partners, LLC v. LPL Holdings, Inc., 2014 WL 354496 (Del. Ch. Feb. 3, 2014), the Delaware Court of Chancery heard a dispute over an earn-out provision in a stock purchase agreement in which the plaintiff seller argued that the buyer was obligated under the implied covenant of good faith and fair dealing to make certain tech-nical adaptations that would have resulted in the satisfaction of certain “gross margin” thresholds necessary for triggering the payment of a contingent earn-out. The parties anticipat-ed and discussed the need for certain technical adaptations to be made to the buyer’s computer-based systems prior to signing the stock purchase agreement, but the stock purchase agreement did not include any express language obligating the buyer to make, or even use any efforts to make, any such technical adaptations to allow the acquired business to meet the contingent purchase price earn-out targets. The plaintiff seller argued that notwithstanding the absence of express


language requiring such technical adaptations, the existence of the contingent earn-out itself in the stock purchase agree-ment imposed an obligation on the buyer under the implied covenant of good faith and fair dealing to make the techni-cal adaptations because the parties recognized that, absent those adaptations, there would be insufficient revenue to achieve the contingent purchase price earn-out targets.

The defendant buyer argued that the implied covenant of good faith and fair dealing only serves a gap-filling function that is implicated when an issue arises after the stock pur-chase agreement is signed that was not anticipated when the parties negotiated and signed the stock purchase agreement. If the issue, which in this case centered around the need for certain technical adaptations, was known and the parties chose not to draft for it in the stock purchase agreement, the implied covenant should not be used to impose a new obliga-tion on the buyer that could have been negotiated for and in-cluded in the stock purchase agreement but was not included.

The court in American Capital Acquisition Partners agreed with the buyer’s interpretation of the implied covenant of good faith and fair dealing. The court concluded that the tech-nical adaptations that the plaintiff seller wanted the buyer to make were understood by the parties to be necessary before the stock purchase agreement was signed, but the parties did not draft any language into the stock purchase agreement to obligate the buyer to make such adaptations. As a result, the implied covenant’s gap-filling function could not make up for that omission.

In contrast, the court in American Capital Acquisition Partners did find an inference that the defendant buyer had breached its implied covenant of good faith and fair dealing in connection with certain other affirmative actions that the buyer took in order to minimize its earn-out payments to the seller. For example, the seller argued, and the court agreed, that the buyer had breached the implied covenant of good faith and fair dealing by intentionally shifting sales and re-sources (e.g., customers and employees) away from the target company to a separate wholly owned subsidiary of the buyer in order to depress revenues and avoid paying the additional contingent purchase price. With respect to these affirmative actions that the buyer took, the court concluded that those actions had not been anticipated by the parties at the time of signing the stock purchase agreement and therefore the implied covenant of good faith and fair dealing could be used as a basis to claim that the buyer’s taking of those affirmative

actions constituted a breach of its implied covenant of good faith and fair dealing.

Key Takeaways There are several key points that sellers and buyers may take away from these recent Delaware court decisions when con-sidering whether to include, and how to draft, post-closing earn-out covenants in acquisition agreements:

While the recent Delaware court decisions may be read to hold in relevant part that the implied covenant of good faith and fair dealing may bar a buyer from taking affir-mative actions to reduce or avoid a contingent earn-out payment, the implied covenant of good faith and fair dealing does not require a buyer to maximize a contingent earn-out payment.

As the implied covenant of good faith and fair dealing, at least in Delaware, only provides a limited measure of pro-tection for sellers in the context of earn-outs, whenever possible, sellers should try not to leave the issue of post-closing earn-out covenants entirely silent. Possible formula-tions may include a requirement that the buyer act in good faith and avoid taking any actions intended to prevent or inhibit the achievement of the earn-out payment or an af-firmative covenant that the buyer will use some level of effort (e.g., commercially reasonable efforts) to achieve the earn-out targets.

If there are any particular actions that the parties have dis-cussed or anticipate will need to be taken in connection with achieving an earn-out, sellers should negotiate for express post-closing covenants to address any such antici-pated actions rather than rely on the implied covenant of good faith and fair dealing. At least in Delaware, the implied covenant of good faith and fair dealing cannot be used to create new obligations where the issue in question was known by the parties and they chose not to draft for it.

If the chosen governing law of the acquisition agreement is not Delaware, the parties and their counsel should con-sider whether the chosen governing law jurisdiction has addressed this issue and taken a view that is similar to or different from Delaware. �


The U.S. Securities and Exchange Commission (the “Commission”) has proposed new rules implementing Section

3(b)(2) of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to the mandate under Title IV

of the Jumpstart Our Business Startups (“JOBS”) Act. Also known as Regulation A+, the proposed rules intend to

help smaller companies get better access to capital by expanding upon the existing Regulation A.

Proposed RulesUnder the existing Regulation A, eligible non-reporting U.S. and Canadian companies can conduct offerings of securi-ties up to $5 million in a 12-month period through a limited “mini-registration” process that exempts them from the more onerous registration requirements under the Securities Act and the post-offering reporting requirements under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In addition, Regulation A offerings are considered to be public offerings and securities sold pursuant to Regulation A have the benefit of being freely transferable in contrast to securities sold in private offerings under Regulation 4(a)(2) or Regulation D under the Securities Act. However, Regulation A offerings have never been widely used for a number of reasons, including the $5 million offering size limit and the re-quirement to comply with state securities (“Blue Sky”) laws.

The proposed rules seek to reform the limitations on Regulation A by building on the existing structure. Specifically, the proposed rules create two tiers of offerings: Tier 1 and Tier 2. Tier 1 offerings would largely preserve the existing Regulation A framework and allow eligible non-reporting U.S. and Canadian companies to conduct offerings of securities up to $5 million in a 12-month period, including up to $1.5 million for secondary sales. Tier 2 offerings would expand the offer-ing limit to $50 million in a 12-month period, with up to $15 million for secondary sales.

Under the proposed rules, Tier 1 and Tier 2 offerings would generally be subject to the same basic requirements with regard to eligibility, manner of offering and provisions

regarding solicitation of interests (what is widely referred to as “testing the waters”). However, Tier 1 and Tier 2 offerings would differ in certain key respects. In general, Tier 2 offerings (given their greater offering amount limit) would be subject to stricter requirements than Tier 1 offerings with regard to ongoing reporting, limitations on investment amounts by each individual investor and auditing standards, as sum-marized in the table below. More significantly, however, the proposed rules would preempt Blue Sky laws for Tier 2 of-ferings and thus allow offering participants to streamline their offering process.

Review of the Comment LettersThe Commission received over 80 comment letters from the public during the 60-day comment period that ended on March 24, 2014. The comment letters discussed various issues relating to the proposed rules, and the following offers a short summary of some of the key issues and arguments that may impact the usefulness of the proposed Regulation A amendments for issuers.

Comments Regarding Preemption of Blue Sky LawsOn the same day as the proposed rules were released, William F. Galvin, the Secretary of the Commonwealth of Massachusetts, submitted a comment letter indicating that he was “dismayed and shocked” that the Commission sought to preempt Blue Sky laws, and he labeled the pro-posed rules to be “anti-investor.” Similar comment letters strongly objecting to the preemption of the Blue Sky laws

REGULATION A+: A NEW PATH TO ACCESSING THE MARKETS FOR SMALL ISSUERS?By Marc M. Rossell and Tae Sang Yoo


were submitted from various state securities regulators, secretaries of state and the North American Securities Administrators Association (“NASAA”).

The various comment letters objecting to the preemption of the Blue Sky laws were primarily based on two arguments: a policy argument regarding protection of investors and a legal argument challenging the authority of the Commission to preempt Blue Sky laws. Under the policy argument, various state securities regulators and officials indicated that state oversight of Regulation A offerings is crucial given their “pre-dominantly local and regional character” and pointed out that the Commission has been unable to effectively protect investors in connection with Rule 506 offerings. Furthermore, many also argued that the preemption of Blue Sky laws is unnecessary given the development of a “new coordinated, multi-state review program” within NASAA’s framework. In

particular, NAASA indicated that this new system would ease the regulatory burden of issuers by facilitating state reviews through a one-stop electronic filing process.

The state securities regulators and officials also chal-lenged the Commission’s statutory authority to preempt Blue Sky laws for Regulation A offerings. Congress had permitted securities sold pursuant to offerings limited to “qualified pur-chasers” to be preempted from Blue Sky laws under Section 18 of the Securities Act while leaving the task of defining such term to the Commission. Under the proposed rules, the Commission has defined “qualified purchasers” to include (1) all offerees in any Regulation A offering (including Tier 1 offerees) so that issuers may test the waters and conduct post-filing communications with potential investors without being submitted to state requirements and (2) all purchasers in any Tier 2 offering. The comment letters objected to the

TOPIC TIER 1 TIER 2

Subject to State “Blue Sky” Regulation Yes No

Ongoing Reporting Requirements Post-Offering

None; New Form 1-Z exit report Various periodic and special reports on Forms 1-K, 1-SA and 1-U

Maximum Investment Amount per Investor

None 10% of the greater of the investor’s:

Audited Financial Statements in Offering Statement

Audit only required to the extent audited financial statements are otherwise available

Audit required

Audit Standard for Financial Statements

U.S. generally accepted auditing standards (“U.S. GAAS”); or Public Company Oversight Board (“PCAOB”) standards

PCAOB standards

Liability for Disclosures General antifraud liability under Rule 10b-5 of the Exchange ActSection 12(a)(2) liability for material mis-statements or omissions in the offering statement or any oral communication

Section 12(a)(2) liability for material mis-statements or omissions in the offering statement or any oral communication

General antifraud liability under Rule 10b-5 of the Exchange Act


Commission’s definition of “qualified purchasers” by arguing that the intention of Congress was to define qualified inves-tors based on the “investors’ characteristics,” such as “inves-tor sophistication, high financial resources, or any other indi-cator of risk bearing ability” rather than by type of transaction being conducted.

On the other hand, numerous commenters strongly sup-ported the Commission’s approach. One commenter argued that the Commission should in fact “include any offeree or purchaser of any security issued under Regulation A” in the definition of “qualified purchasers” and thereby preempt Blue Sky laws for all Regulation A offerings in order to protect issuers seeking to raise smaller amounts of capital. Others also supported the Commission’s approach by indicating that adopting a definition of “qualified purchasers” that is equiva-lent to “accredited investors” would make the preemption of Blue Sky laws for an offering be premised on sales only to ac-credited investors, as in the case of Rule 506 offerings. Given the various disclosure requirements under Regulation A, such a definition would make Regulation A offerings less attractive compared to Rule 506 offerings. In the alternative, a few com-menters also raised questions as to whether NASAA’s coordi-nated review program would indeed be able to reduce time and expenses as intended.

Comments Regarding EligibilityWhile the comment letters have largely been dominated by the issue regarding preemption of Blue Sky laws, other issues have been brought up as well. In particular, several com-menters argued for the expansion of eligibility. One com-menter urged the Commission to also allow all shell com-panies, blank check companies, special purposes acquisition companies and foreign private issuers to utilize Regulation A offerings. Specifically, the commenter indicated that al-lowing shell and blank check companies to make Regulation A offerings, subject to certain additional requirements, “would help create new public vehicles with cash to provide a speedier and less costly process for a company to go public and raise capital.” The commenter also argued that there is no reason why foreign private issuers should not be able to utilize Regulation A offerings given that they “already can go public with reduced disclosure as a foreign private issuer, with no dollar limit on offerings or investment limit for investors.” Other commenters also supported expanding the eligibility to foreign private issuers and shell companies as well as non-re-porting business development companies. In addition, a few

commenters also proposed that public micro-cap companies with a non-affiliate float less than $250 million should be eli-gible to use Regulation A offerings.

Comments Regarding Offering and Investment Limits and Secondary SalesA number of letters also commented on the issue of offering and investment limits. For example, one commenter recom-mended increasing the offering limit for Tier 2 offerings to $100 million per year or $50 million without the 12-month time limit and removing all investment limits for accredited investors. Other commenters proposed adjusting the method of calculating the offering limit so that the aggregate offering price of the underlying security should only be included in the $50 million limitation during the 12-month period in which such security is first convertible, exercisable or exchangeable. Several focused more on modifying the limitations on sec-ondary sales for Tier 2 offerings by arguing that “potential in-vestors will be more likely to invest in privately held emerging companies if they have a reasonable range of post-offering li-quidity opportunities,” while a few recommended eliminating the secondary sale limitations for Tier 2 offerings altogether. The underlying thought in all of these comment letters was that relaxing or eliminating the restrictions on secondary sales would improve liquidity and thereby incentivize poten-tial investors to invest in smaller emerging companies. Comments Regarding Disclosure RequirementsMost commenters generally reacted positively to the pro-posed disclosure requirements, with many arguing for the reduction or scaling back of disclosure requirements for both the offering statement and, in the case of Tier 2 offerings, ongoing reporting obligations. A few commenters provided specific comments on improving the disclosure process, such as eliminating Model B and using a scaled back version of Form S-1 for the purposes of the offering statement, given

Relaxing or eliminating the restrictions on secondary sales would improve liquidity and thereby incentivize potential investors to invest in smaller emerging companies.


that many advisers engaged by the offerees would be familiar with Form S-1 and the related Regulation S-K disclosure rules.

In addition, several commenters proposed a further scaled back disclosure approach for both the offering statement and ongoing reports that is contingent on the issuer’s size and so-phistication and/or the size of the offering. These commenters argued that such an approach would motivate issuers to turn to Tier 2 offerings as an alternative to a fully registered IPO. Many commenters also requested that the Commission sim-plify the transition process from a Regulation A issuer to full reporting status under the Exchange Act by using Form 8-A instead of Form 10, as they viewed the current requirement to file a full Form 10 as being duplicative and overly burdensome.

Comments on Section 12(g) ThresholdsA few commenters also objected to the fact that the pro-posed rules would not exempt Regulation A offerings from the “holder of record” threshold under Section 12(g) of the Exchange Act. These commenters pointed out that a Tier 2 of-fering, coupled with the restrictions on maximum investment amount, is by design likely to result in many non-accredited investors holding the securities of the issuer. Furthermore, issuers that often do not have adequate resources would be faced with the difficult task of monitoring and limiting the number of holders of securities in order to maintain an exemption from the reporting requirements under Section 12(g). In order to address the potential chilling effect that this may cause, some commenters proposed partial exemptions for Tier 2 offerings depending on the issuer’s non-affiliate

market capitalization or compliance with ongoing reporting requirements and also suggested adopting transition periods for issuers that have crossed the Section 12(g) threshold.

Looking AheadWhile much depends on what comments the Commission decides to incorporate into its final rules, Regulation A under the current proposed rules may nevertheless be useful for small emerging companies that require access to capital for growth but are not yet prepared to conduct a full-scale IPO. Companies that may have otherwise sought to conduct a Regulation D private offering may now want to conduct a Regulation A offering given that the securities offered under Regulation A are unrestricted and have the potential to attract a larger number of investors. It is also possible that Regulation A may become a cost-effective initial step for a smaller company that is seeking to be listed on a national securities exchange as a fully reporting public company, especially if the Commission amends the proposed rules to further facilitate the transition as requested in some of the comment letters.

On the other hand, however, Regulation A offerings under the current proposed rules may not be as attractive to issuers that are either very small or sufficiently mature and sophisti-cated to conduct a full IPO. Issuers seeking to raise less than $5 million a year under Tier 1 would not, as is currently the case under the existing rules for Regulation A, be exempt from Blue Sky laws. In the alternative, smaller issuers seeking to conduct a Tier 2 offering may find the various disclosure requirements to be overly burdensome. For instance, the offering state-ment on Form 1-A requires disclosures similar to Form S-1 as well as audited financial statements under PCAOB standards. While the issuer does have a choice between using a narrative disclosure or providing the information required on Part I of Form S-1 and may limit the Form S-1 disclosure as it is appli-cable to smaller reporting companies (“SRCs”) if it qualifies as an SRC, the issuer is likely to require additional assistance from outside legal counsel and auditors. The continuing periodic disclosure obligations, which are largely scaled back versions of the Exchange Act reporting requirements, may also be too costly for an issuer, especially if the issuer is seeking to raise over $5 million but significantly less than $50 million.

For an issuer that deems itself to be sufficiently experi-enced and is considering eventually listing on a national se-curities exchange, conducting a fully registered IPO may be a more attractive option, especially if it seeks to raise amounts closer to the $50 million limit. Such issuers would have to take

Companies that may have otherwise sought to conduct a Regulation D private offering, may now want to conduct a Regulation A offering given that the securities offered under Regulation A are unrestricted.


into consideration the already significant requirements for conducting Tier 2 offerings and the fact that it would have to largely duplicate its work by filing a Form 10 when it makes its decision to become a full reporting company. Issuers may view the incremental costs of conducting a fully registered IPO as a reasonable price for avoiding the various restrictions under Regulation A and the possibility of incurring additional costs at a later date.

In the end, a well-designed Tier 2 offering framework, if adopted, may allow many small to mid-sized companies to obtain better access to the public markets and act as a pos-sible stepping stone to eventually list on a national securities exchange. In a recent speech, SEC Commissioner Luis Aguilar noted that a goal of the SEC is to have a “form of Regulation A that is utilized more frequently than its predecessor because it provides an effective way for small companies to raise capital and because, importantly, it provides appropriate investor protection.” In order for such potential to be realized, however, the rules would have to maximize the benefits of a Tier 2 of-fering over private offerings while reducing costs compared to a fully registered IPO. As noted in the numerous comment letters, this might involve, among other things, making the

A well-designed Tier 2 offering framework, if adopted, may allow many small to mid-sized companies to obtain better access to the public markets and act as a possible stepping stone to eventually list on a national securities exchange.

securities offered under Tier 2 more liquid by modifying the limits governing secondary sales and investment, maintain-ing the preemption of Blue Sky laws, and reducing costs by adopting an appropriate disclosure framework that addresses investor protection concerns without being overly burden-some. How the Commission will respond to the comment letters remains to be seen, but hopefully it will take some of these comments into account in the final rules release. �


Many acquisition agreements contain boilerplate excluding recovery for punitive, special and consequential

damages. The clause may also include “lost profits” as an example of “consequential damages” or sometimes as

a separate item that is excluded from recovery. The parties should pay attention to this boilerplate to avoid the

unintended result that lost profits are not recoverable even if such lost profits are a direct result of the transaction

contemplated by the acquisition agreement.

The boilerplate clause emanates from the English case of Hadley v. Baxendale, 9 Exch. 341 (1854), which established the general rule that recoverable losses for a breach of contract are limited to those directly arising from the breach or arising from special circumstances of which the breaching party had knowledge when the contract was made. A party damaged by a breach may, however, contractually waive these damages.

The exclusion of lost profits from recoverable damages is often provided for in the acquisition agreement as an example (or subset) of consequential damages. Consequential damages are one of the more common types of damages that are explicitly excluded from recovery in acquisition agree-ments. According to the 2013 Private Target M&A Deal Points Study published by the Mergers & Acquisitions Committee of the American Bar Association, more than half of the acquisi-tion agreements surveyed contained a provision expressly excluding consequential damages as a recoverable damage. While the survey did not include lost profits as a separate type of damage or indicate whether the agreements that excluded consequential damages may have included lost profits as an example of consequential damages, care must be given to any waiver of lost profits.

For acquisition agreements governed by New York law, New York courts have respected the parties’ ability to limit potential liabilities in a contract and have enforced provi-sions that expressly exclude lost profits. For example, in Great Earth International Franchising Corp. v. Milks Development, 311 F.Supp.2d 419 (S.D.N.Y. 2004), the court found that a clause limiting liability for lost profits or for consequential

damages precluded the buyer from all claims of lost profits, even though the lost profit damages at issue may have been considered “general damages” directly resulting from the transaction.

The boilerplate waiver may take several forms. Lost profits may be included as an example of consequential damages. For example, the provision might state “in no event shall any indemnifying party be liable to any indemnified party for any consequential damages, including loss of future revenue or income.” In this first formulation, lost profits are a subset of consequential damages. In the following second formula-tion, “in no event shall any indemnifying party be liable to any indemnified party for any consequential damages or loss of future revenue or income,” lost profits are a separate class of damages in addition to consequential damages and not merely just a subset of consequential damages.

Although there may only be minor language differences, widely different, and at times unintended, consequences may result from either formulation. For the first formulation where lost profits are a subset of consequential damages, courts would likely find that lost profits should be waived only if the lost profits are found to be consequential damages and not general damages. In the case of the second formula-tion where lost profits are a separate class of damages, courts would likely disallow recovery for lost profits in any situation. Where the provision is silent on lost profits, lost profits would presumably only be disallowed if found to be consequential damages and not general damages.

LOST PROFIT WAIVERS: BEWARE OF UNINTENDED CONSEQUENCESBy Edward P. Smith and J. Patrick Narvaez


The first formulation may not effect the parties’ intent if they actually desire to exclude recovery for lost profits in any situation. While lost profits are generally considered conse-quential damages, this is not always the case. There are times when lost profits may be considered “general” or “direct” damages. While consequential damages have not been pre-cisely defined with respect to acquisition agreements, courts have analyzed in other contexts when lost profits might be general damages and not consequential damages. For example, the court in Tractebel Energy Marketing, Inc. v. AEP Power Marketing, Inc., 487 F.3d 89 (2d Cir. 2007) (holding that the lost profits claimed were general damages and not con-sequential damages as the lower court had concluded)1 de-scribed the distinction between lost profits as consequential damages and lost profits as general damages as follows:

Lost profits are consequential damages when, as a result of the breach, the non-breaching party suffers loss of profits on collateral business ar-rangements. In the typical case, the ability of the non-breaching party to operate his business, and thereby generate profits on collateral transac-tions, is contingent on the performance of the primary contract. When the breaching party does not perform, the non-breaching party’s business is in some way hindered, and the profits from potential collateral exchanges are “lost.”…

By contrast, when the non-breaching party seeks only to recover money that the breaching party agreed to pay under the contract, the damages sought are general damages. The damages may still be characterized as lost profits since, had the contract been performed, the non-breaching party would have profited to the extent that his cost of performance was less than the total value of the breaching party’s promised payments. But, in this case, the lost profits are the direct and probable consequence of the breach. The profits are precisely what the non-breaching party bar-gained for, and only an award of damages equal to lost profits will put the non-breaching party in the same position he would have occupied had the contract been performed.

Whether lost profits are considered consequen-tial damages or general damages is thus signifi-cant since, if using the first formulation of the waiver described above, such lost profits would likely be recoverable as general damages. This would be the case even though the parties may have intended to exclude recovery for all lost profits, no matter the situation.

Unintended consequences may also arise from the second formulation of the lost profits waiver provision described above. Where lost profits are waived as a separate class of damages, courts will likely disallow recovery for lost profits in any situation, even in cases where the lost profits are consid-ered general damages directly relating to the transaction con-templated by the acquisition agreement. For example, a seller may represent and warrant in the acquisition agreement that a particularly lucrative contract of the target company is valid and enforceable. If the seller has breached this representa-tion and the contract is in fact terminated or otherwise un-enforceable, the buyer may be surprised to find that the lost profits stemming from the unenforceable contract (which contract may have formed the primary basis of the buyer for consummating the transaction) is not recoverable since all lost profits have been waived. This potential outcome may result even though the lost profits may be found to be general damages directly related to the acquisition agreement which the buyer had specifically bargained for. Due to the language

Where lost profits are waived as a separate class of damages, courts will likely disallow recovery for lost profits in any situation, even in cases where the lost profits are considered general damages directly relating to the transaction contemplated by the acquisition agreement.

1 Tractebel involved an action claiming lost profits to be received under a contract for the sale of power.


of the provision, the buyer may be precluded from any claim for lost profits.

In a recent case that may expand the circumstances when lost profits are considered general damages, Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 2014 WL 1237514 (N.Y. March 27, 2014), the New York Court of Appeals, in a split decision, reversed the lower court and held that the lost profits at issue were general, and not consequential, damages and were thus not barred by the consequential damages waiver in the con-tract, despite the fact that the claimed lost profits related to the resale of the defendant’s product by the plaintiff to third parties. The court noted that prior decisions on whether lost profits were consequential or general damages focused on the distinction between “whether the lost profits flowed di-rectly from the contract itself or were, instead, the result of a separate agreement with a nonparty.” However, the court stated that “[t]his distinction does not mean that lost resale profits can never be general damages simply because they involve a third party transaction. Such a bright line rule vio-lates the case-specific approach we have used to distinguish general damages from consequential damages.” In analyzing the facts, the court noted that the contract used the plain-tiff’s resale price as a benchmark for the price to be paid to the defendant and although not specifically identified in the agreement, the lost profits from resale can be seen to flow directly from the pricing formula. Thus, the court held that “any lost profits resulting from a breach would be the ‘natural and probable consequence’ of that breach.” In New York, courts will thus take a careful look at the underlying agreement and facts and circumstances surrounding the transaction in determining whether lost profits are general or consequential damages.

The parties to an acquisition agreement should carefully consider the implications of including any boilerplate “lost profits” waiver. If lost profits directly result from the trans-action and represent the “benefit of the bargain,” New York courts may find such lost profits to be general damages and not consequential damages. If the provision only excludes lost profits as a subset of consequential damages, such lost profits may thus be recoverable as general damages. Conversely, if the lost profits waiver provision specifically excludes lost profits as a separate class of damages, then the provision may have the effect of precluding damages that are directly related to the transaction. In both cases, the outcome may be unintended. Upon careful consideration, the parties may even determine that a lost profits waiver is not needed as the seller’s concerns may be alternatively addressed through other means, such as through indemnity caps or deductibles. �

If the provision only excludes lost profits as a subset of consequential damages, such lost profits may thus be recoverable as general damages.


I received a large stack of Express mail over a foot deep last month from the Bureau of Economic Analysis (the

“BEA”), which has statutory authority to collect vast amounts of data on certain international investments both

in the U.S. and abroad. The envelopes waiting for me in my in-box included BEA annual surveys (BE-11 forms)

due May 31, 2014, with an estimated public reporting burden per reporter and form of approximately 86 hours.

Thankfully, I have spent the past few years handling compliance with this little-known reporting obligation and

have advised clients how to significantly reduce the public burden related to BEA compliance including the BE-11

forms. Unfortunately, this fact does not change the reporting duty.

The girth of the envelopes highlighted the need for a compli-ance update regarding the statute, especially since the poten-tial penalties for non-compliance include financial penalties (up to $25,000 per reporter and form unfiled, subject to infla-tionary adjustments) and potential jail time for officers, direc-tors, employees or agents engaging in willful non-compliance.

The purpose of this article is to outline current BEA re-porting burdens for U.S. individuals and legal entities (“U.S. Persons”) who own 10% or more of a foreign business abroad and for U.S. Persons that are owned 10% or more by foreign individuals and legal entities (“Foreign Persons”), and to sum-marize efforts made by the BEA in 2013 which may impact persons currently complying with the reporting requirements.

As one of the most highly regarded statistical organi-zations in the world, the BEA analyzes data and releases reports on some of the most important economic indicators for the U.S. economy. Government, business and financial leaders in the White House, Congress, the Federal Reserve, and Wall Street rely on BEA data daily. This data includes the GDP growth rate, personal income and expenditures, international trade balance and the current account deficit, along with regional GDP estimates by state across multiple industries. The White House and Congress use BEA data and analysis to prepare budget estimates and projections. The Federal Reserve Banks use BEA data to set monetary policy, and trade policy officials use BEA data to negotiate international trade agreements.

The BEA is authorized through the International Investment and Trade in Services Survey Act (the “Act”) and Part 806 of the Code of Federal Regulations to obtain data on international investments made by U.S. Persons abroad and Foreign Persons in the United States.

In 2013, the BEA made significant changes to public re-porting obligations under the Act. Prior to 2013, completion of all BEA surveys was mandatory, regardless of whether the BEA solicited a response. The BEA made attempts to change the mandatory reporting requirement in 2013 by issuing notices in the Federal Register with respect to required quar-terly and annual surveys. The 2013 notices stated that any reporter required to file certain annual and quarterly surveys under the statute only had a duty to report if the reporter had been contacted directly by the BEA.

Unfortunately, this change did not apply to the BEA bench-mark surveys (BE-12 forms) that were due on May 31, 2013. The BE-12 Report is required from all U.S. Persons who are owned 10% or more by a Foreign Person. The BEA is still collecting data related to the benchmark surveys through May 31, 2015. This survey is mandatory and is the most comprehensive and time consuming survey a reporter has a duty to complete -- estimated at approximately 96 hours per reporter/response and the maximum response time estimated at 633 hours. Furthermore, it is reasonable to expect that those who have a duty to report a benchmark survey will likely be contacted by the BEA and asked to complete the required quarterly and

OWN 10% OR MORE OF A FOREIGN BUSINESS? – BEA COMPLIANCE UPDATEBy Amy E. D’Agostino


annual surveys going forward. The BEA has advised that it will continue to use discretion to evaluate quarterly and annual reporting requirements for all U.S. Persons owned 10% or more by Foreign Persons and all Foreign Persons owned 10% or more by U.S. Persons.

There Are Two Sides to Every SurveySimply put, there are two circumstances when surveys must be filed by a U.S. Person: (i) when that U.S. Person owns 10% or more of a foreign entity, and (ii) when that U.S. Person is owned 10% or more by a Foreign Person. The Act deals sepa-rately with U.S. direct investment abroad and foreign direct investment in the United States and establishes multiple reporting requirements for each. The Act defines “direct in-vestment” as the ownership or control of 10% or more of the voting securities of an incorporated business. The term “voting securities” is not independently defined in the Act or in the Code of Federal Regulations; however, the term is used interchangeably with “voting interest”. “Voting inter-est” is defined as the percentage of ownership in the voting equity of the relevant entity. Essentially, ownership of 10% of a foreign entity that establishes a capacity to vote and influ-ence corporate action appears to be the defining feature of what constitutes a foreign direct investment abroad. On the flip side, ownership of 10% of a U.S. entity by a Foreign Person that establishes a capacity to vote and influence corporate action appears to be the defining feature of what constitutes a foreign direct investment in the United States.

Reporting U.S. Direct Investment AbroadA U.S. Person with direct investment in a foreign business (“U.S. Reporter”) bears the dual obligation of reporting its own operations and its operations with respect to each of its “Foreign Affiliates” (an entity outside the United States in which the U.S. Person has a direct investment). However, a U.S. Reporter is exempt from reporting with respect to its Foreign Affiliate when (1) total assets, (2) net sales or gross operating revenues (excluding taxes), or (3) net income (loss) after foreign income taxes fall below certain financial thresh-olds for that affiliate. Certain real estate holdings must also be reported with an exception for real estate held or owned for personal use.

Below is a description of the forms, reporting criteria and exemptions for each required survey of U.S. direct investment abroad required by the Act. It should be noted that this article identifies the exemption levels (lowest level financial thresh-olds) and related forms in an effort to point out the absolute financial cut offs. Higher level thresholds exist and would require a reporter to fill out additional and different forms.

Annual Survey of U.S. Direct Investment Abroad – Form BE-11At present it is estimated that over 50,000 U.S. Reporters are currently reporting direct investment abroad activities under the statutory scheme. U.S. Reporters that are contacted by the BEA (including those contacted by the BEA following receipt of the required benchmark surveys) must annually file a Form BE-11A regarding their own operations, and a Form BE-11B, Form BE-11C and/or Form BE-11D for each of their Foreign Affiliates exceeding the exemption threshold of $60 million (positive or negative) in (i) total assets, (ii) net sales or gross operating revenues (excluding taxes), or (iii) net income (loss) after foreign income taxes in the year, unless a Foreign Affiliate was in its first year of operation, or established or acquired in the reporting year, in which case the threshold is $25 million. One exemption to filing in this category would be if the affiliate is less than 20% owned by all U.S. Reporters of the affiliate combined. The due date for the BE-11 survey is May 31, 2014.

The potential penalties for non-compliance include financial penalties (up to $25,000 per reporter and form unfiled, subject to inflationary adjustments) and potential jail time for officers, directors, employees or agents engaging in willful non-compliance.


Quarterly Survey of U.S. Direct Investment Abroad – Form BE-577A quarterly Form BE-577 must be filed by a reporter contacted by the BEA (including those contacted by the BEA following receipt of the required benchmark surveys) for each directly-owned Foreign Affiliate exceeding or expected to exceed an exemption level of $60 million (positive or negative) in (1) total assets, (2) annual sales or gross operating revenues (exclud-ing taxes), or (3) annual net income (loss) after provision for foreign income taxes at any time during the reporting period. The U.S. Reporter must also report indirectly-owned Foreign Affiliates that meet the $60 million threshold with an inter-company debt balance with the U.S. Reporter that exceeds $1,000,000. Form BE-577 is due 30 days after the close of each calendar year or fiscal quarter or 45 days if the report is for the final quarter of the financial reporting year.

At the close of fiscal year 2014 the BEA will be conducting another five year benchmark survey for all U.S. Persons who own 10% or more of a Foreign Person. This 2014 Benchmark Survey of U.S. Direct Investment Abroad has not yet been re-leased by the BEA, but the filing deadline is May 31, 2015, with reporting burdens similar to those outlined below.

Reporting Foreign Direct Investment in the United StatesThere are a number of reporting requirements for a U.S. entity in which a Foreign Person has a direct investment (“U.S. Affiliate”).

Annual Survey of Foreign Direct Investment in the United States – Form BE-15A Form BE-15 must be completed within five months from the last day of each calendar year by each U.S. Affiliate con-tacted by the BEA (including those contacted by the BEA fol-lowing receipt of the required benchmark surveys) exceeding an exemption level of $40 million (positive or negative) in (1) total assets, (2) net sales or gross operating revenues (exclud-ing taxes), or (3) net income (loss) after foreign income taxes (real estate transactions to be analyzed similarly). Additional BE-15 forms are necessary for reporters who meet higher fi-nancial thresholds set by the government.

A Form BE-15 Claim for Exemption is required if foreign ownership in a U.S. Affiliate falls below 10 percent, the U.S. Affiliate is fully consolidated or merged into another U.S. Affiliate, or if all of the following three items for the U.S.

Affiliate are $40 million or less (positive or negative): (1) total assets, (2) annual sales or gross operating revenues, and (3) annual net income (loss) after provision for U.S. income taxes. Exempt U.S. Affiliates should file a BE-15 Claim for Exemption. Provided the U.S. Affiliate continues to meet the exemp-tion criteria, it is not necessary to file again. Form BE-15 is due on May 31, 2014.

Quarterly Survey of Foreign Direct Investment in the United States – Form BE-605

In most cases quarterly reports must be submitted on a Form BE-605 within 30 days of the close of each quarter by every U.S. Affiliate contacted by the BEA (including those con-tacted by the BEA following receipt of the required bench-mark surveys) for all U.S. Affiliates in which one of the fol-lowing exceeds an exemption level of $60 million (positive or negative): (1) total assets, (2) annual sales or gross operating revenues (excluding taxes), or (3) annual income (loss) after foreign income taxes (real estate transactions to be analyzed similarly). If the foreign ownership is indirect (through another U.S. Affiliate) and the U.S. Affiliate has no relationship with its Foreign Affiliate, then the U.S. Affiliate can discharge its re-porting obligation by completing item C and the “Person to Consult” portion of Form BE-605 Certificate of Exemption — a requirement that is not derived from the Act or the regu-lations, but is specified only on the form itself. Form BE-605 is due 30 days after the close of each calendar year or fiscal quarter end or 45 days if the report is for the final quarter of the financial reporting year.

Benchmark Survey of Foreign Direct Investment in the United States – Form BE-12

Form BE-12A is required for all U.S. Persons who are ma-jority-owned by a Foreign Person and have total assets, sales or gross operating revenues, or net income greater than $300 million (positive or negative). Form BE-12B is required for (i) all U.S. Persons who are majority owned by a Foreign Person and have total assets, sales or gross operating revenues, or net income greater than $60 million (positive or negative), but not greater than $300 million (positive or negative), and (ii) all U.S. Persons who are minority-owned (at least 10%) by a foreign business and have total assets, sales or gross operating rev-enues, or net income greater than $60 million. Form BE-12C is required for all U.S. Persons who are owned (at least 10%) by a Foreign Person and have total assets, sales or gross operating


revenues, or net income less than or equal to $60 million (positive or negative). Form BE-12 (Claim for Not Filing) may be used for U.S. Persons who ceased to be owned by a Foreign Person within the timeframe of the survey, or for U.S. Persons that are not required to report on any of forms BE-12A, BE-12B and BE-12C and have been contacted by the BEA to do so.

Privacy Concerns?Information collected under the Act is confidential and may not be published or made available in any manner such that the person to whom the information relates can be specifical-ly identified. The exchange of collected information between government agencies is permitted in order to carry out the purposes of the Act, but the information may only be used for analytical or statistical purposes or for a proceeding under the penalty provisions. It cannot be used for taxation, investiga-tion, or regulatory purposes, and copies retained by any U.S. Reporter are given extra protections from legal process.

Practical AdviceThe first step towards compliance with this little-known statute is to understand the ever-changing reporting require-ments and corresponding forms. The next step is to properly educate clients, legal counsel and financial advisors who are

Simply put, there are two circumstances when surveys must be filed by a U.S. Person: (i) when that U.S. Person owns 10% or more of a foreign entity, and (ii) when that U.S. Person is owned 10% or more by a Foreign Person.

best situated to access information needed to complete the forms. Lastly, it is necessary to set up a process for determin-ing financial thresholds by calendar quarter and a system for compliance. The BEA is now accepting internet filings, which speeds the process considerably. Advisors may also review the BEA’s website for additional reporting requirements and forms for certain international service transactions at http://www.bea.gov/international/index.htm#surveys. �


The New York City Bar Association recently presented a program titled “Why Purchase Price Adjustment Clauses

Fail and How to Fix Them.” The program presented the findings of the Committee on International Commercial

Disputes on purchase price adjustment clauses in private M&A transactions. The Committee’s report found that

case law has exposed fundamental flaws in the structure of purchase price adjustment clauses and substantial

disagreement about the applicable legal standards for such clauses. The NYCBA panel distilled some of the main

issues addressed in the Committee report, and we summarize and discuss some of these issues below.

Purchase Price Adjustment Clauses GenerallyPurchase agreements in private M&A transactions often include a provision (commonly referred to as the “purchase price adjustment clause”) that sets forth a mechanism to confirm the value of the target business as of closing and for an adjustment to the purchase price for any changes to the target’s value during the period between signing the pur-chase agreement and closing the transaction. The purchase price offered by the buyer is typically determined, at least in part, based on the target company’s most recently prepared financial statements (usually the most recent fiscal quarter or year end). Purchase price adjustments are typically based on changes to specific financial metrics of the target company, and most commonly on changes to the target company’s working capital.

Dispute Resolution in Purchase Price Adjustment ClausesPurchase price adjustment clauses commonly contain their own dispute resolution mechanism whereby the parties agree to submit any disputes regarding the adjustment to an independent accounting firm for a final and binding de-termination. The Committee’s report found that there has been significant confusion as to how to classify these dispute resolution mechanisms from a legal standpoint. They are often assumed to be arbitration provisions, and thus to be governed by the legal rules governing arbitration with the

independent accountants acting as the arbitrators. However, the Committee’s report suggests that there is another viable option, called “appraisement” or “expert determination” that is less commonly known in the United States, but that has a developed legal history, especially in New York. The legal classification is important because it will determine how the parties can challenge and enforce the accounting firm’s de-termination, so parties should carefully consider the available options when drafting purchase price adjustment clauses.

Arbitration vs. Expert DeterminationThe case law suggests that the best way to determine if the parties intend for a dispute resolution mechanism to be treated as an arbitration or an expert determination is to look at the type and scope of the authority granted to the decision maker. In an arbitration, the parties delegate broad author-ity to the decision maker to decide all legal and factual issues necessary to resolve a dispute (analogous to the authority of a judge to resolve a dispute). In an expert determination, the authority granted is limited to deciding a specific factual dispute, normally concerning a matter within the special ex-pertise of the decision maker.

While expert determination is less well known in the United States than in other jurisdictions, New York actu-ally has a statute (CPLR 7601) that explicitly recognizes this dispute resolution mechanism and provides that parties to an agreement providing for an expert determination of a dispute

DRAFTING TIPS FOR PURCHASE PRICE ADJUSTMENT CLAUSES: NYC BAR ASSOCIATION WEIGHS INBy William Greason, Lara Aryani and Thomas H. Watson


may seek a special proceeding to specifically enforce such a determination (similar to how a party would enforce an ar-bitration clause in New York). New York courts recognize the distinction between arbitration and expert determination and will specifically enforce expert determinations and, in ap-propriate cases, will provide judicial confirmation and entry of judgment with respect to expert determinations, pursuant to the power granted them by CPLR 7601.

Standard of Review for Expert DeterminationThe distinction between arbitration and expert determina-tion is also significant because of the way that disputes re-garding the arbitration award or expert determination are handled by the courts. It is important for the parties to cor-rectly identify whether they prefer an arbitration or expert determination because the two proceedings may be subject to different standards of review by a court.

The review of an arbitration award is set by the applicable rules of arbitration and cannot be contractually modified. Conversely, the review of expert determinations are gov-erned by state law and in New York, for example, an expert determination is binding in the absence of “fraud, bad faith or palpable mistake.” The Committee notes that while this standard may be difficult to meet, it may still give the court greater discretion than the parties intended by allowing the expert determination to be invalidated upon a finding that the expert lacked a “reasonable basis” for his determination, failed to follow customary practice or procedure or used a method deemed by the court to be unreliable.

Unlike the arbitrator’s role, which is to determine issues of both fact and law, an accounting firm’s role in reaching an

expert determination is to determine factual issues relating strictly to the closing financial statements. The Committee advises against giving courts the discretion to second-guess and therefore “re-arbitrate” the expert determination and recommends that the parties narrow the court’s review and provide that the expert determination will be final and binding absent “fraud or manifest error.”

Committee RecommendationThe Committee noted that parties usually do not clearly distinguish whether they intend the accounting firm’s pur-chase price adjustment resolution to constitute an arbitra-tion award or expert determination. In some cases, parties may even use terms such as “arbitration” or “arbitrator” but describe a proceeding that shows their intent to provide for an expert determination. The Committee recommends that the parties expressly provide for either an arbitration or an expert determination. When providing for an arbitration, the Committee suggests (1) using the terms “arbitration,” “arbi-trator” or “arbitration award,” (2) designating the applicable arbitration rules and (3) providing that judgment on the “ar-bitration award” may be entered in any court of competent jurisdiction. When providing for an expert determination, the parties should state that (1) the accounting firm is “acting as an expert and not as an arbitrator,” (2) the purchase price ad-justment clause is not an arbitration provision and should be governed by the law of expert determination and appraisal, (3) the accounting firm’s authority is limited to resolving dis-puted issues of fact and not law, and (4) the expert determina-tion will be final and binding absent “fraud or manifest error.”

Reconciling a General Arbitration Clause with a Purchase Price Adjustment ClauseA few issues arise when a contract has both a general arbitra-tion clause and a purchase price adjustment clause. First, will a dispute related to the purchase price adjustment clause be decided by the designated accounting firm or by an arbitra-tor under the general arbitration clause? Second, what is the relationship and hierarchy between the purchase price adjust-ment clause and the general arbitration clause? For example, if a party seeks an injunction in connection with, or to enforce or set aside a decision made by, an expert acting under a pur-chase price adjustment clause, should that party go to court or file a claim with an arbitrator under the contract’s general arbitration clause?

The sparse case law on these issues has generally found that disputes relating to the expert determination fall outside

It is important for the parties to correctly identify whether they prefer an arbitration or expert determination because the two proceedings may be subject to different standards of review by a court.


the scope of the agreement’s general arbitration provision unless expressly included. Under this theory, only a court will have jurisdiction to mediate any disputes regarding the expert determination. The logic behind these rulings may be that an expert determination is treated as an alternative or specific carve out to the general arbitration clause. On the other hand, courts have also found that the opposite is true, particularly in disputes involving cross-border transactions where generally parties intend to avoid the national courts of the other party. To avoid potentially unexpected results in the event of such a dispute, the Committee recommends that the parties ex-pressly carve out or include the expert determination within the scope of the general arbitration provision.

Procedural Problems in Purchase Price Adjustment Clauses: Access to Books and RecordsPurchase agreements often grant one party the right to access the books, records and personnel of the party that has pre-pared the closing financial statements. Access to this finan-cial information is usually necessary for a party to be able to fully understand the closing financial statements and prepare its required objections with the “reasonable detail” often re-quired by the agreement. Denial of access to the preparing party’s books, records and personnel may have significant consequences for the objecting party. Failure to identify a spe-cific issue or otherwise comply with the “reasonable detail”

requirement in the objection notice may result in a waiver or invalidation of a party’s objection to the closing statements.

As most purchase price adjustment clauses are currently structured, the independent accounting firm is retained only after a dispute has arisen and the parties have failed to ne-gotiate a resolution. Typically, first the closing financial state-ments are prepared by one party, then the other party is given a limited period of time to prepare its objections, and then the parties attempt to negotiate a resolution to the dispute. It is only if the parties cannot reach a resolution that an account-ing firm is retained and even then, the accounting firm’s role is limited to resolving only the disputed items (even if undis-puted items are later found to be incorrect).

The result is that there is no practical ability for a party to seek the early intervention of an accounting firm to force a party to provide information the other party needs to prepare its objection notice. Without such a clause, a party seeking to require the other party to comply with its obligation to provide access to books, records and personnel has no option but to turn to the court. Compounding this problem are the very short time limits — typically 30 to 45 days — imposed on a party to prepare its notice of objections.

Committee RecommendationThe Committee recommends that parties modify their pur-chase price adjustment clauses so that a party may seek the early intervention of the designated accounting firm to resolve disputes about access to books, records and person-nel. The Committee also recommends that the accounting firm be given the authority to stay and extend any relevant deadlines, and, if a party demonstrates that it has been preju-diced by a denial of access to information, then also to allow the party the opportunity to amend its notice of objections and any other applicable documents. �

The Committee advises against giving courts the discretion to second-guess and therefore “re-arbitrate” the expert determination.


The M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of the American Bar

Association’s Business Law Section (ABA) earlier this year released its 2013 Private Target M&A Deal Points Study,

which analyzes a number of commonly negotiated deal points in publicly available acquisition agreements

involving the acquisition of private target companies by public companies. The ABA last published its Private

Target M&A Deal Points Study in 2011. The ABA deal points studies are often used by deal practitioners as a

resource for market trends when negotiating acquisition agreements. This article focuses on select deal points

analyzed by the 2013 and 2011 studies and provides comparative results highlighting notable changes in market

trends between the 2013 and 2011 studies (note that this article does not address all deal points analyzed by

the studies).

Deal OverviewThe 2013 Study covers more deals than the previous study and reflects an increase in the average size of deals, with the tech-nology and health care industries continuing to generate the largest percentage of deals.

Financial ProvisionsThe use of purchase price adjustments, as well as the metrics used to adjust the purchase price, continued to increase, with adjustments based on working capital continuing to represent the most common adjustment metric. Notably, the use and average length of earnouts decreased, indicating a return to pre-recession levels.

Representations and Warranties (Target)The 2013 Study indicates that (1) almost all deals included a “fair presentation” representation with respect to the target company’s financial statements, reflecting an increase from the previous study, (2) more deals covered all liabilities (as opposed to only GAAP liabilities) in the “no undisclosed liabili-ties” representation, reflecting a more buyer-friendly position, and (3) fewer deals covered both present and past compli-ance in the “compliance with law” representation, reflecting a more seller-friendly position.

PRIVATE M&A DEAL TRENDS: ABA UPDATES MARKET STUDYBy Kevin C. Smith and Nicholas Scannavino


DEAL POINTS 2013 STUDY(transactions completed in 2012)

2011 STUDY(transactions completed in 2010)

Number of Deals Analyzed 136 100Deal Size $17.2M - $4.7B $25M - $960MAverage Deal Size(excluding uncapped earnouts and assumption of debt)

$305M $175.99M

Most Common Industries Technology (26%)Health Care (20%)Industrial Goods & Services (11%) Oil & Gas (10%) Telecom (7%)

Technology (29%)Health Care (16%)Industrial Goods & Services (10%)Personal & Household Goods (8%)Telecom (7%)



Includes Purchase Price Adjustment 85% 82%Purchase Price Adjustment Based on Working Capital(if includes purchase price adjustment)

91% 79%

Purchase Price Adjustment Based on Debt (if includes purchase price adjustment)

44% 28%

Purchase Price Adjustment Based on Cash(if includes purchase price adjustment)

35% 23%

Purchase Price Adjustment Based on More Than One Metric(if includes purchase price adjustment)

59.5% 42%

Includes Earnout 25% 38%Most Common Earnout Period (if includes earnout)

12 months (32%) 36 months (24%)

Deal Overview

Financial Provisions



Includes “Fair Presentation” Rep with Respect to Financial Statements

99% 77%

Includes “No Undisclosed Liabilities” Rep 94% 96%“No Undisclosed Liabilities” Rep Covers All Liabilities (not just GAAP Liabilities)

78% 61%

Includes “Compliance with Law” Rep 99% 99%“Compliance with Law” Rep Covers Present and Past Compliance

33% 73%

Representations and Warranties (Target)




Target’s Reps Must Be Accurate at Signing and Closing

57% 59%

Includes Stand-Alone “No Material Adverse Effect” Condition

23% 23%

Includes Legal Opinion (non-tax) of Target’s Counsel

19% 27%



Disclosure Schedule Updates Permitted or Required

31% 37%

Includes No Shop / No Talk Provisions 85% 83%

Closing Conditions

Covenants (Target)

Covenants (Target)The results of the 2013 Study related to the target company’s covenants generally remained consistent with the results of the previous study, including with respect to disclosure sched-ule updates (most deals do not expressly permit or require disclosure schedule updates) and no shop / no talk provisions (most deals include no shop / no talk provisions).

IndemnificationThe 2013 Study suggests that (1) the inclusion of pro-sand-bagging provisions remained more common than the inclu-sion of anti-sandbagging provisions, with approximately half of all deals continuing to remain silent on the matter, (2) the most common length of the general survival period with respect to breaches of representations remained the same at 18 months, (3) indemnity baskets continued to be most com-monly structured as a deductible, although the size of indem-nity baskets (as a percentage of transaction value) decreased, (4) the use of a “mini-basket” (or “de minimis threshold”) in-creased1, (5) the inclusion of a “materiality scrape” provision decreased, (6) the size of indemnity caps generally remained

1 See, however, our November 2013 article titled “Materiality Scrapes Trending Upward in Private M&A Deals”, indicating an increase in the use of materiality scrape provisions based on an indepen-dent study of deals signed in the first half of 2013 with a signing value of at least $25 million involving the acquisition of private US companies.

Closing ConditionsThe results of the 2013 Study related to the conditions to the obligations of the parties to close the transaction also gen-erally remained consistent with the results of the previous study, including with respect to the bring down of represen-tations and the stand-alone “no MAE” condition. Notably, however, the 2013 Study reflects a continued move away from requiring the target company’s counsel to deliver a legal opinion (non-tax).

the same, (7) the size of indemnity escrows / holdbacks (as a percentage of transaction value) generally decreased, and (8) more deals required the buyer to mitigate losses.

Dispute ResolutionThe use of general Alternative Dispute Resolution provi-sions continued to be uncommon. However, where included, Alternative Dispute Resolution provisions tended to require that arbitration expenses be shared equally by the parties, re-flecting a move away from the loser bearing such expenses. �




Includes Pro-Sandbagging Provision 41% 41%Silent with Respect to Sandbagging 49% 54%Most Common General Survival Period 18 months (44%) 18 months (34%)Indemnity Basket Structured as Deductible 59% 59%Most Common Size of Indemnity Basket(as a percentage of transaction value)

0.5% or less (56%)> 0.5% - 1% (32%)> 1% - 2% (11%)> 2% (1%)

> 0.5% - 1% (47%)0.5% or less (41%)> 1% - 2% (12%)> 2% (0%)

Average Size of Indemnity Basket(as a percentage of transaction value)

0.58% 0.65%

Includes Mini-Basket / De Minimis Threshold

30% 17%

Includes Materiality Scrape 28% 49%Materiality Scrape Limited to Calculation of Losses Only

41% 66%

Most Common Size of Indemnity Cap (as a percentage of transaction value)

< 10% (48%)> 10% - 15% (29%)10% (12%)> 15% - 25% (4%)

< 10% (43%)> 10% - 15% (17%)10% (14%)> 15% - 25% (14%)

Average Size of Indemnity Cap(as a percentage of transaction value)

16.6% 18.88%

Includes Indemnity Escrow / Holdback 89% 86%Most Common Size of Indemnity Escrow / Holdback(as a percentage of transaction value)

> 7% - < 10% (24%)> 3% - < 5% (22%)> 10% - 15% (18%)> 5% - 7% (13%)

> 7% - < 10% (24%)> 10% - 15% (24%)> 5% - 7% (16%)10% (10%)

Average Size of Indemnity Escrow / Holdback(as a percentage of transaction value)

7.83% 9.30%

Buyer Required to Mitigate Losses 44% 28%



Includes Alternative Dispute Resolution (ADR) Provision

15% 18%

Arbitration Expenses Shared Equally(if includes ADR Provision)

40% 28%

Arbitration Expenses Borne by Loser(if includes ADR Provision)

15% 38%

Indemnification

Dispute Resolution


Over the past year, there has been much discussion within the employment law community about

workplace arbitration arrangements, and in particular, about recent case law generally upholding contractual

requirements that arbitration proceed on an individual basis and not on a class or collective basis. Given the

rising tide of class actions (e.g., discrimination claims, state wage-and-hour claims) and collective actions (e.g.,

claims for overtime under the Fair Labor Standards Act, age discrimination claims under federal law) being

filed against businesses, employers are beginning to re-examine whether arbitration makes sense for them.

Those employers who have existing arbitration arrangements are examining whether and how they can add

to or improve on their arrangements.

This article begins by briefly addressing the recent develop-ments affecting class and collective action waivers in arbitra-tion arrangements. It then goes on to discuss other issues that employers should focus on when considering (or reconsider-ing) the value and enforceability of their workplace arbitration arrangements.

Enforceability of Class and Collective Action Waivers in ArbitrationThis past summer, in American Express Co. v. Italian Colors Restaurant, the U.S. Supreme Court held that an arbitration provision containing a class action waiver is enforceable even where the cost of pursuing the claim on an individual basis is not economically feasible because the costs of proving the individual claim exceed the potential recovery. While this case did not involve the employer-employee relationship (it was an antitrust claim brought by businesses against American Express), the decision contains favorable language for em-ployers, language that multiple courts, including the Second Circuit Court of Appeals, are now citing to enforce class and collective action waivers against employees.

At the same time, the National Labor Relations Board (NLRB) has been attacking the enforceability of class and col-lective action waivers on the ground that such waivers violate employees’ “Section 7 rights” under the National Labor Relations Act (“Section 7 rights” allow employees to engage in “concerted activities” for their “mutual aid and protection”). The NLRB first set forth its position in its January 2012 deci-sion in the D.R. Horton case. However, the NLRB’s D.R. Horton decision was reversed by the Fifth Circuit Court of Appeals in December 2013 and no other Court of Appeals has followed the NLRB’s D.R. Horton decision as of the date of writing of this article. Nonetheless, the NLRB has continued to main-tain its position that class and collective action waivers are unenforceable, and the NLRB recently filed a petition asking the Fifth Circuit to rehear and reverse its decision in the D.R. Horton case. On April 16, 2014, the Fifth Circuit denied this petition and declined to rehear the D.R. Horton case. Nonetheless, it is likely that the NLRB will continue to main-tain its position until a sufficient number of Courts of Appeals follow the Fifth Circuit’s decision or the U.S. Supreme Court overturns the NLRB.

IS ARBITRATION RIGHT FOR YOUR WORKFORCE? RECENT DEVELOPMENTS MAKE NOW A GOOD TIME TO CONSIDER (OR RECONSIDER) ARBITRATIONBy David Gallai and Rachel M. Kurth


As a result of these recent developments, employers should feel more comfortable including class and collective action waivers in their arbitration arrangements. Such waivers will not only reduce the risks and costs associated with em-ployment class and collective actions, but are also likely to result in a reduction in the number of significant claims filed against employers, as it may not be economically feasible for employees to pursue certain claims on an individual basis.

Considerations for Employers and Their Workplace Arbitration ArrangementsThere are a number of reasons why employers may find it beneficial to bind their employees to arbitration, besides the prospect of limiting employee class and collective actions that could be initiated against them by current and former em-ployees (note, however, that government agencies, who are not parties to the arbitration arrangement, would still be free to litigate claims in court). Other advantages of arbitration, as compared to litigation in court, can include lower costs, a confidential setting with more privacy, a speedier resolution, and a more efficient and flexible process likely to result in a lesser time commitment for the employer’s key personnel and its counsel. Appeal costs are also generally lower, as judicial review of arbitration awards is limited (which can work for or against either party).

In order to create a workplace arbitration arrangement that is in the best position to withstand a challenge to its en-forceability, there are a number of issues that employers will want to focus on, ten of the most important of which are ad-dressed briefly below. Please note that these issues are gener-ally matters governed by state law, so in considering how best to structure a workplace arbitration arrangement, employers must also focus on the applicable law of the state(s) in which they operate. (1) Class and Collective Action Waivers Should Be Drafted CarefullyA class and collective action waiver should be explicit, clearly worded, and conspicuous. It should make clear that the arbi-trator does not have the authority to hear class or collective action claims. Employers should consider whether it makes sense to include a provision alerting the employee that he or she is free to challenge (acting individually or concertedly with others) the class and collective action waiver in any forum, although the employer remains free to seek to enforce the waiver and compel arbitration on an individual basis.

(2) Arbitration Should Not Prevent Employees from Filing Administrative ClaimsWhile the Fifth Circuit Court of Appeals reversed the NLRB’s decision in D.R. Horton with respect to the enforceability of the class action waiver, it upheld the NLRB’s decision that the employer was required to revise its arbitration provision to clarify that the provision did not eliminate employees’ rights to pursue claims of unfair labor practices with the NLRB. An arbitration arrangement will violate the NLRA if it prohibits employees from filing unfair labor practice claims with the NLRB. The same likely holds true for arrangements that pro-hibit employees from filing claims with other government agencies. Arbitration arrangements should include a state-ment that a waiver of class and collective actions is not in-tended to limit or interfere with any rights that employees may have to file administrative claims (for example, with the NLRB, EEOC, or DOL). We also recommend specifically carving out employees’ rights to file workers’ compensation and un-employment insurance claims, and rights to bring claims that by law may not be subject to a pre-dispute mandatory arbitra-tion arrangement.

(3) The Arbitration Arrangement Must Be Supported by Valid ConsiderationIn order to be an enforceable contract, an arbitration arrange-ment must be supported by valid consideration. In some ju-risdictions, including New York, at-will employment or con-tinued employment is generally sufficient consideration for an agreement to arbitrate. However, in some jurisdictions, additional consideration may be necessary. Arbitration ar-rangements often bind both the employer and the employee, and this mutual forbearance of the right to litigate in court

There are a number of reasons why employers may find it beneficial to bind their employees to arbitration, besides the prospect of limiting employee class and collective actions that could be initiated against them by current and former employees.


generally can serve as valid consideration (and, in some juris-dictions, is required). Employers will want to consider what claims they may want to exclude from their arbitration obli-gations (e.g., claims for injunctive relief enforcing restrictive covenants and/or claims for benefits under employee benefit plans) and to what extent such exclusions would weaken the enforceability of their arbitration arrangements.

(4) The Arbitration Arrangement Must Not Be UnconscionableWhile employers may be able to use arbitration to change some of the rules that would normally apply in litigation (e.g., reduced motion practice and limited discovery), they should not do so to the point where the arrangement could be invali-dated on grounds of “unconscionability.” In most cases, a de-termination of “unconscionability” revolves around whether the arrangement’s terms are grossly unreasonable or unrea-sonably favorable to one party. For example, if an arbitration arrangement requires employees to pay unaffordable arbitra-tion costs or arbitration costs unreasonably in excess of the costs of litigation, alters the right of the parties to collect certain types of damages, or places extreme limits on the dis-covery process, these factors could cause a court to invalidate an arbitration arrangement on the grounds of unconsciona-bility. While beyond the scope of this article, in light of recent U.S. Supreme Court decisions, some requirements imposed by states on arbitration arrangements in order to avoid a finding of unconscionability are being struck down as preempted by the Federal Arbitration Act.

One point that is clear is that employers should carefully consider what portion of the arbitration’s costs employees

will be required to bear. Multiple U.S. Supreme Court decisions caution that an arbitration arrangement could be invalidated under the “effective vindication” doctrine if filing and admin-istrative fees attached to arbitration are so high as to make arbitrating impracticable.

(5) Consider What Fairness Safeguards Are Needed Some jurisdictions, such as California, require that certain “fairness” safeguards be contained in an arbitration ar-rangement before certain statutory rights can be waived. For example, state law may require that the arbitration ar-rangement provide for the selection of a neutral arbitrator, a written arbitral award, and the availability of all of the types of relief that would otherwise be available in court. As noted above, there is an open question as to whether these types of state law requirements are preempted by federal law in light of recent U.S. Supreme Court decisions.

(6) The Arbitration Commitment Should Not Be Illusory Employers should consider limits on their right to modify, amend, or revoke the arbitration arrangement for all claims at any time. Broadly reserving such rights could make the ar-rangement vulnerable to attack on the grounds that it is il-lusory (because only the employee is actually bound by the arrangement) and therefore unenforceable. Instead, we rec-ommend that employers place limits on their right to modify, amend, or revoke the arrangement, such as by including a sufficient notice period that is required before implementing changes to the arrangement and/or a prohibition on retroac-tive changes that apply to claims that have already accrued.

(7) Consider Whether and How Employees Expressly Agree to the Arbitration ArrangementArbitration arrangements can take many forms. For the great-est likelihood of enforceability in all jurisdictions, a written agreement addressing the arbitration arrangement should be signed by both parties. This can be done within an indi-vidual agreement (such as an employment agreement or a counter-signed offer letter) or via a stand-alone policy. However, a written signature is not always required to create a binding contract. While some jurisdictions, such as New York, will enforce an arbitration provision set forth in an em-ployee handbook even if the employee has not signed an acknowledgement of receipt and/or agreement, we do not recommend that such provisions be contained in employee

Since arbitration is in many ways simply a matter of contract between parties, employers should think of creative approaches to making arbitration a more efficient and economical dispute resolution mechanism for their workforce.


handbooks (because employee handbooks generally contain language that would undermine the argument that the ar-bitration arrangement is a binding and mutual contract between the parties).

Employers should consider how to obtain each employee’s agreement to the arbitration arrangement. In some cases, a written signature from every employee is not always feasible. Other considerations may dictate against such an approach. In those cases, some employers distribute an arbitration policy and expressly put employees on notice of it, relying on an employee’s employment or continued employment after receipt of such notice as his or her agreement to be bound by the policy (such practices are generally enforceable in New York). Other employers distribute an arbitration policy with an “opt-out” provision, offering employees a procedure by which they can affirmatively opt out of the arbitration ar-rangement within a certain period of time, or else be bound by it. Each of these approaches has its pros and cons, and one approach that may work well for one employer may not work well for another.

(8) Consider Using Arbitration to Shorten Statutes of Limitations For some claims, parties may agree to shorten the otherwise applicable statute of limitations period by contract, provided that the shortened period is reasonable. In examining rea-sonableness, courts have historically looked at factors such as unequal bargaining power, whether the shortened statu-tory period would preclude recovery under law, and whether or not there is or can be mutuality. However, some states, such as Florida, have passed statutes explicitly voiding any contract provision attempting to shorten an applicable statute of limitations, and courts in other jurisdictions, such as California, have held that shortened limitations periods in arbitration provisions are unconscionable. In the Heimeshoff v. Hartford Insurance case, the U.S. Supreme Court held that, absent a controlling statute to the contrary, ERISA does not prohibit employee benefit plans from shortening the

otherwise applicable statute of limitations, provided that the shortened statute of limitations period is reasonable. This holding may ultimately have implications for employers beyond the ERISA context.

(9) The Arbitration Arrangement Should Seek to Resolve Disputes Efficiently Since arbitration is in many ways simply a matter of con-tract between parties, employers should think of creative approaches to making arbitration a more efficient and eco-nomical dispute resolution mechanism for their workforce. For example, one arbitration provision discussed in a federal court decision provided that, while the employee had the right to be represented by an attorney at the arbitration, if the employee declined attorney representation, the employer agreed that it would also forego having an attorney present at the arbitration.

(10) Consider Including a Specific Severability ClauseWe recommend including a severability clause in any arbi-tration arrangement, so that if a court finds that certain el-ements of the arrangement are unenforceable, the court is authorized to sever the offending elements and enforce the remainder of the arrangement as written. One caveat in-volves a finding that the class and collective action waiver is unenforceable (for example, if the NLRB’s D.R. Horton deci-sion gains traction and is upheld). Employers should consider including a provision that, in such event, the class and collec-tive action can only proceed in court rather than arbitration (as it is generally thought that employers are in a better posi-tion to defend themselves in court against class or collective action claims).

Bottom LineCreating a workplace arbitration arrangement encompasses many business as well as legal considerations. Employers should involve experienced employment law counsel in that process. �

www.chadbourne.com

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WarsawWłodzimierz Radzikowski +48 (22) 520-5000 [email protected] & Parke Radzikowski, Szubielska i Wspólnicy sp.k. ul. Emilii Plater 53 00-113 Warsaw, Poland Telephone: +48 (22) 520-5000 Facsimile: +48 (22) 520-5001

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IstanbulAyșe Yüksel +90 (212) 386-1310 [email protected] & ParkeBüyükdere Cad. No:191Apa Giz Plaza, Kat:1734330 Levent, Istanbul, TurkeyTelephone: +90 (212) 386-1300Facsimile: +90 (212) 269-4075

DubaiDaniel J. Greenwald +971 (4) 422-7088 [email protected] & Parke LLC Boulevard Plaza Tower 1, Level 20Burj Khalifa DistrictP.O. Box 23927Dubai, United Arab Emirates Telephone: +971 (4) 422-7088 Facsimile: +971 (4) 422-7089

Beijing Hong Li +86 (10) 6530-8843 [email protected] Representative Office Room 902, Tower A Beijing Fortune Centre 7 Dongsanhuan Zhonglu, Chaoyang District Beijing 100020, China Telephone: +86 (10) 6530-8846 Facsimile: +86 (10) 6530-8849

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CORPORATE P RA C TI C E NEWSWIRE - Norton … · P RA C TI C E N EWSWIRE M AY 2014 Lara Aryani +1 (212) 408-5243 [email protected] Ted P. Castell +1 (212) 408-1119 [email protected]