Corporate Sustainability Obligations in the EU: France Urges the EU To Postpone the Application of Adopted EU Directives
On 20 January 2025, France published a memorandum urging the EU to modify the Corporate Sustainability Reporting Directive (Directive 2022/2464, “CSRD”), and to postpone the application of the Corporate Sustainability Due Diligence Directive (Directive 2024/1760, “CS3D”). France’s statements resonate with the series of Executive Orders aiming in the U.S. at various markets deregulations, although to a lesser degree.
The CSRD and the CS3D
Under EU law, a ‘directive’ (unlike a ‘regulation’) must be implemented by Member States into their own national legislation in order to be applicable. Member States should comply with the objectives of the directive, although they have the choice of the means to attain its objectives. Member States have a deadline to comply with this implementation obligation.
The CSRD
The CSRD entered into force on 5 January 2023 and the implementation deadline expired on 6 July 2024. France implemented it on time, but the European Commission opened infringement procedures before the Court of Justice of the European Union against 17 other Member States in September 2024. To date, the European Commission is still waiting for 8 Member States to implement the directive.
The CSRD requires EU large undertakings (“entreprises” in EU jargon), as well as EU and non-EU listed companies (excluding micro-undertakings) to report sustainability information at individual level.[1] The CSRD also provides for consolidated sustainability statements and corresponding exemptions at individual level. Moreover, non-EU undertakings with a net EU turnover above EUR 150 million are targeted if they have EU subsidiaries covered by the CSRD or branches with net EU turnover above EUR 40 million. In that case, it is up to the EU subsidiary or branch to make available the sustainability report, except if exemptions apply.
The sustainability statement is public and contains non-financial information on the social and environmental risks the company faces, and how its activities impact people and the environment. It is redacted according to the European Sustainability Reporting Standards (ESRS), and is supposed to improve the quality, consistency and comparability of sustainability information provided by companies.
The timeframe for applying the CSRD differs depending on the type of undertaking: FY 2024 for large undertakings which are public interest entities with more than 500 employees; FY 2025 for other large undertakings; FY 2026 for listed small and medium-sized undertakings (“SMEs”)[2]; and FY 2028 for non-EU undertakings with net EU turnover above EUR 150 million (through their subsidiary or branch).
For details please see our previous article here.
The CS3D
The CS3D entered into force on 25 July 2024 and the implementation deadline will expire on 26 July 2026. France has not implemented it yet.
The aim of the CS3D is to foster sustainable and responsible corporate behaviour in companies’ operations and across their global value chains. The CS3D establishes a corporate due diligence duty. The core elements of this duty are identifying and addressing potential and actual adverse human rights and environmental impacts in the company’s own operations, their subsidiaries and, where related to their value chain(s), those of their business partners.
The CS3D applies to EU limited liability companies and partnerships with more than 1,000 employees and a net worldwide turnover of more than EUR 450 million, as well as ultimate parent companies of a corporate group that meets the thresholds on a consolidated basis, and franchisors/licensors meeting certain conditions and thresholds. It also applies to non-EU undertakings of a legal form comparable to LLCs/partnerships with a net turnover of more than EUR 450 million generated in the EU, as well as ultimate parent companies of a corporate group that meets the threshold on a consolidated basis, and franchisors/licensors meeting certain conditions and thresholds.
The timeframe for applying the CS3D differs depending on the type of undertaking: July 2027 for EU companies with more than 5,000 employees and EUR 1,500 million worldwide turnover, as well as non-EU companies with more than EUR 1,500 million turnover generated in the EU; July 2028 for EU companies with more than 3,000 employees and EUR 900 million worldwide turnover, as well as non-EU companies with more than EUR 900 million turnover generated in the EU; and July 2029 for all other companies in scope.
France’s memorandum
France’s memorandum comes in the context of criticism of both directives. Member States like Italy or Germany, as well as stakeholders, recently alleged that they would hamper the competitiveness of the EU as compared to other regions. Even certain third countries have voiced concerns over the application of the CS3D, particularly if it resulted in fines. They claim that it imposes excessive compliance costs and creates unnecessary challenges for their companies, making them reconsider their involvement in the EU market.
France sees the need for action confirmed by Mario Draghi’s report[3] of 9 September 2024 on the future competitiveness of the EU and his diagnosis of loss of competitiveness vis-à-vis its main international competitors and in particular in the absence of a level playing field.
For the French authorities, the proportionality of the CSRD framework is no longer ensured in light of the very substantial competitive challenges that EU companies are facing. Therefore, they are in favour of the urgent adoption of several modifications including;
the reduction of the number of sustainability indicators and a narrowed focus on climate objectives;
the introduction in the Accounting Directive of the notion of “mid-caps”, i.e. intermediate-sized companies positioned above current SMEs and below large companies, to which SMEs ESRS would apply;
the introduction in the CSRD of a principle of capping reporting in the subcontracting chain of large companies;
the provision in the Accounting Directive for the inclusion of fees for auditing sustainability information in the annex to the company accounts.
As a subsidiary option, France is also open to a two-year postponement of the entry into force of the provisions of the CSRD.
With respect to the CS3D, France submits that the new CS3D obligations entail a number of potential risks identified by companies and likely to affect their competitiveness, including in relation to non-EU companies not subject to these same standards. Therefore, the French authorities are in favour of an indefinite postponement of the entry into force of the CS3D, to allow the incorporation of several adjustments, among which;
the limitation of the personal scope to EU companies with more than 5,000 employees and EUR 1,500 million worldwide turnover, as well as non-EU companies with more than EUR 1,500 million turnover generated in the EU;
the application of due diligence at group level instead of subsidiary level;
the creation of a single EU supervisory authority, which would be explicitly endowed with a support and mediation role;
the deletion of additional requirements for regulated financial companies, in order to treat the latter similarly to companies in other sectors.
France’s proposal goes well beyond the two above Directives and suggests comprehensive changes to other regulatory instruments including in relation to AI, Taxonomy, Environmental Data Reporting, Banking Sector Standards, State Aid Procedures, Agricultural Aid, Securitisation Market, REACH Regulation, Biomass Installations, Waste Classification Harmonisation, Agricultural Sector Simplifications.
Conclusion
France also seems to be adopting a position of reducing, or at least simplifying, regulation (to a lesser extent than the United States), in order to enable its companies to remain competitive. This approach is not limited to the issue of sustainability, but also covers areas such as agriculture and AI, which are crucial for the coming years.
To what extent France will succeed with its initiative is open. Ultimately, the proposal requires a comprehensive regulatory simplification agenda with a broad scope to enhance EU competitiveness and alleviate administrative burdens, particularly for SMEs and mid-sized companies.
While postponement might be easily achieved, substantive changes will require EU institutions to reopen the dialogue which is feared to postpone the implementation of the directives indefinitely. On the other hand, the burdensome rules have been widely criticised and de-regulation is the buzz-word of the moment. It is not unlikely that more countries will jump on the bandwagon which would give France’s initiative further momentum.
Companies are well advised to monitor this development carefully. Until an EU level consensus is reached, national laws in France and across the EU will continue to apply. Independent initiatives by EU Member States to postpone or amend their rules could be in breach of their obligations of the Directive, which will make a national solo-action less likely.
FOOTNOTES
[1] Under the EU Accounting Directive 2013/34, micro-undertakings do not exceed the limits of at least two of the three following criteria: total balance sheet total of EUR 450,000; net turnover of EUR 900,000; or average number of 10 employees during the financial year. Large undertakings exceed at least two of the three following criteria: total balance sheet of EUR 25,000,000; net turnover of EUR 50,000,000; or average number of 250 employees during the financial year.
[2] Under the EU Accounting Directive 2013/34, small undertakings do not exceed the limits of at least two of the three following criteria: total balance sheet total of EUR 5,000,000; net turnover of EUR 10,000,000; or average number of 50 employees during the financial year of; medium-sized undertakings do not exceed the limits of at least two of the three following criteria: total balance sheet total of EUR 25,000,000; net turnover of EUR 50,000,000; or average number of 250 employees during the financial year.
[3] Mr. Draghi was the President of the European Central Bank and a former Italian Prime Minister; he was mandated by the European Commission to draft a report on the future competitiveness of the EU.
President Trump’s Recent Executive Orders and Their Potential Impact on Social Initiatives
President Trump started his second term by signing executive orders that covered a number of environmental, social, and governance (ESG)-related issues, such as eliminating diversity, equity, and inclusion (DEI) programs in departments and agencies in the executive branch, repealing DEI directives from the Biden administration, requiring enhanced vetting and screening processes for individuals seeking U.S. citizenship, limiting the enforcement of federal civil rights law and labor law, among others. The effects of President Trump’s executive orders have already begun as an United States Office of Personnel Management (OPM) memo placed DEI officers on immediate leave and set a January 31, 2025, deadline for agencies to submit plans to dismiss the employees that were put on leave.
This article focuses on executive order Ending Illegal Discrimination and Restoring Merit-Based Opportunity, as it is the order most likely to have a significant impact on the private sector’s human capital management initiatives. That executive order noted that major companies, as well as other entities, are engaging in “race- and sex-based preferences under the guise of” DEI programs that may be in violation of federal civil rights laws. The order further encouraged federal agencies and the Attorney General to take the necessary steps to promote “individual initiative, excellence, and hard work.” The order also tasked the Attorney General and Director of the Office of Management and Budget to prepare a report that outlines (a) ways to leverage federal laws and “other appropriate measures to encourage the private sector to end illegal discrimination and preferences, including DEI,” (b) key areas of concern, (c) “[t]he most egregious and discriminatory DEI practitioners in each” area of concern, (d) plans and strategies “to deter DEI programs or principles . . . that constitute illegal discrimination or preferences,” and (e) litigation and potential regulatory action that can be taken. Of note, the order instructs executive departments and agencies to identify at least nine civil investigations that may be taken of public companies, “large non-profit corporations, . . . foundations with” more than 500 million in assets, medication associations, and other entities.
With respect to the federal government, the order, among other things, requires “executive departments and agencies” to cease “discriminatory and illegal” initiatives and enforcement proceedings and mandates that these departments and agencies “combat illegal private-sector DEI preferences, mandates, policies, programs, and activities.” There were also a host of items in the order directed to federal contractors or grant recipients, including a requirement to certify that they do not have DEI programs in violation of federal law.
Impact on the Private Sector
Before the recent executive orders, several Fortune 500 companies ended or reduced their DEI initiatives. The recent executive orders, particularly the order on Ending Illegal Discrimination and Restoring Merit-Based Opportunity, will likely drive more companies to pare back their DEI programming (or expedite their prior plans to reduce those initiatives). That said, as was the case before the executive orders, there will continue to be some companies that maintain their DEI initiatives until a court decision or law compels a different approach. Further clarity on the scope of what may be considered illegal discrimination beyond existing case law may be elucidated by the Attorney General’s report, which need not be submitted until May 21st. During the time that the report is being prepared, government officials will be identifying candidates for potential investigations. Further, we expect litigation to test the bounds of what constitutes illegal discrimination.
Adding to the complexity of the situation, on the state level, attorney generals are taking action in the DEI arena. For example, after Costco rejected a shareholder proposal to analyze the risks of its DEI policies, 19 Republican attorney generals demanded that within 30 days the company announce that it has repealed its DEI policies or explain why not. Conversely, a group of 13 attorneys general publicly noted their concerns with attempts to paint DEI initiatives as illegal. That group of attorneys general cited to a statement from the Equal Employment Opportunity Commission that confirmed that DEI programs remain legal. Put simply, companies may find themselves pulled in opposite directions by federal and state regulators while simultaneously confronting litigation in this area from private actors. Public companies may also see increased shareholder action with respect to DEI initiatives.
Next Steps
The DEI-related executive orders are poised to have a significant impact on the private sector at this time (and in the foreseeable future) as companies grapple with identifying the contours of what is permitted and safe from legal challenge (or at least defensible in the event of a lawsuit or governmental inquiry). In this rapidly evolving DEI landscape (which will almost certainly evolve yet again once the Attorney General’s report is issued), it is important that companies evaluate their contracts, internal and external policies and procedures, and messaging. Companies should also train their personnel on any changes to their DEI initiatives. Because this area is rapidly developing, it will also be crucial for companies to ensure they have reliable methods to track developments in the sector.
Requirements For Professional Engineers Practicing in Connecticut
Many out-of-state professional engineering companies practice engineering in Connecticut and may not be aware of all the requirements to do so. Connecticut has certain requirements for corporations and limited liability companies (LLCs) engaging in the practice of engineering. The applicable law, General Statutes §§ 20-306a and 20-306b, requires that (1) the personnel who act as engineers on behalf of the company must be either licensed in Connecticut or exempt from Connecticut’s license requirements, and (2) the company must have been issued a certificate of registration by the State Board of Examiners for Professional Engineers and Land Surveyors (State Board). Professional engineering firms must be registered with the Secretary of State as a domestic or foreign firm prior to applying for registration from the State Board. In addition, no less than two-thirds of the individual members of an LLC or owners of a professional corporation must be individually licensed as professional engineers in Connecticut. The Connecticut Department of Consumer Protection maintains a list of all professional engineers licensed in Connecticut and all State Board registrations.
Caselaw interpreting these requirements is sparse. Strict compliance with the State Board registration requirement is not always required. In Rowley Engineering & Associates, P.C. v. Cuomo, 1991 WL 27286 (Conn. Super. Jan. 2, 1991), the defendant alleged that the plaintiff professional corporation was not entitled to its design fees because it had not been issued a certificate of registration and thus did not comply with Conn. Gen. Stat. § 20-306a. The Rowley Court rejected this argument, reasoning that the statute was established for administrative purposes to allow professional engineers to practice in a corporate form and not safeguarding life, health, or property. The Court found substantial compliance with the statute, reasoning that all of the design professionals in Rowley were, in fact, licensed to practice in Connecticut. Thus, the purpose of licensure—to protect the public—was essentially satisfied. However, strict compliance with Connecticut’s professional engineer license requirement is required. In Anmahian Winton Architects v. J. Elliot Smith Holdings, LLC, 2010 WL 1544418 (Conn. Super. Mar. 16, 2010), the Court confirmed that a professional engineer or architect license in Connecticut is required to practice in Connecticut and it does not matter that such professional is licensed in any other state. The failure to be licensed in Connecticut precludes professional engineers from enforcing their right to payment for work performed.
Professional engineering companies practicing in Connecticut should be familiar with all state requirements. The failure to do so could result in being terminated from a project and not getting paid for work otherwise properly performed. Even if the company substantially complies with the State Board registration requirement, it could be difficult to explain this to an inquiring owner.
United States: SEC Issues New Guidance on Schedule 13G Eligibility
The SEC’s Division of Corporation Finance recently issued new guidance regarding when shareholders can file beneficial ownership reports on Schedule 13G. While the 11 February 2025 Compliance and Disclosure Interpretation (C&DI) maintains the same fundamental principles as before, it adopts a more nuanced approach to what constitutes “changing or influencing control of the issuer.”
What Hasn’t Changed
The basic framework remains intact: shareholders can still file on Schedule 13G if their securities weren’t acquired or held with the purpose of changing or influencing issuer control. The guidance continues to prohibit using Schedule 13G when advocating for clear “control” transactions, such as:
Sale of the issuer
Sale of significant assets
Restructuring
Contested director elections
What Has Changed
The new guidance takes a more detailed look at how shareholders engage with management. While simply discussing views or voting decisions remains acceptable, the C&DI now explicitly addresses pressure tactics. Specifically, shareholders might lose Schedule 13G eligibility if they:
Exert pressure on management to implement specific measures
Condition their support for director nominees on the adoption of particular policies
Link their voting decisions to management’s acceptance of their recommendations
Practical Impact
This interpretation represents more of a tone shift than a substantive change in policy. However, it may cause institutional investors to think twice about their engagement strategies. Those who currently file on Schedule 13G might become more cautious about how they communicate their voting policies, particularly if those policies include withholding support from directors at companies with inconsistent practices.
The guidance suggests that while engagement remains acceptable, the manner and context of that engagement matter more than previously emphasized. Shareholders will need to carefully consider how they frame their discussions with management to maintain their Schedule 13G eligibility.
Streamlining Sustainable Finance: Simplification of the EU Taxonomy
On 5 February 2025, the EU Platform on Sustainable Finance (the ‘‘Platform’’) published a report with recommendations on how to simplify the EU Taxonomy (the ‘‘Report’’). The EU Taxonomy is the EU’s classification system for sustainable activities. The Report sets out key areas of improvement and simplification of taxonomy reporting by making the EU Taxonomy more efficient with the overall aim of enhancing sustainable finance.
The Report sets out five key recommendations to the European Commission for simplification of the EU Taxonomy. The Platform anticipates that its proposals could reduce the burden of reporting on non-financial companies by over a third. The Platform further believes that a materiality approach to EU Taxonomy reporting would increase the efficiency in reporting for both financial and non-financial companies. The Report also emphasises the importance of greater interoperability between the EU Taxonomy and taxonomies being introduced in other jurisdictions.
The Platform’s Proposals:
We set out some of the key proposals below.
1: Refine the‘‘Do No Significant Harm”(‘‘DNSH’’) assessment and reporting obligations through:
a review of all DNSH criteria in the delegated acts with a focus on increasing their usability for financial and non-financial companies. Until a comprehensive review of the DNSH criteria is complete, a temporary ‘‘comply or explain’’ approach should be introduced for DNSH assessment of the Turnover key performance indicator (‘‘KPI’’);
adoption of a lighter compliance assessment process; and
support international applicability by converting references to European legislation into alternative requirements, such as on quantitative or process-focused requirements based on international standards. This would be a welcome development and has been a real hurdle for EU Taxonomy alignment with non-EU assets.
2: Reducing the corporate reporting burden by more than a third by:
introducing a materiality threshold for calculating KPIs in non-financial company reporting and the combined KPIs of financial undertakings;
making the operational expenditure KPI a mandatory disclosure only for research and development costs;
enhancing alignment of materiality thresholds with existing financial reporting regulations; and
simplifying templates and reducing data points to limit reporting to only the information relevant to making business decisions.
3: Simplifying the Green Asset Ratio (‘‘GAR’’) that encourages green and transition lending by:
excluding assets in the numerator and denominator that cannot be measured against the EU Taxonomy;
simplifying retail exposure reporting and focusing on substantial contribution; and
allowing estimates and proxies to be used in reporting along with measures to protect against greenwashing allegations.
4: Defining clear guidelines for the use of estimates in reporting:
where estimates are used, methods of estimation must be consistently applied to the substantial contribution and DNSH criteria; and
companies must adopt estimation methods with sufficient governance, traceability, transparency, input coverage and input quality in place.
5: Supporting small and medium-sized enterprises (‘‘SMEs’’) in accessing sustainable finance by:
introducing a simplified approach to the EU Taxonomy for listed SMEs; and
adopting a voluntary approach for banks and investors’ exposures to unlisted SMEs.
While the European Commission is not formally bound by the Platform’s recommendations, the proposals set out in the Report have the potential to significantly streamline reporting burdens under the EU Taxonomy and therefore enhance access to sustainable finance.
Nevada Bill Would Bestow Personal Jurisdiction On Business Entities Who Simply Register
Earlier this month, Nevada Assemblymember Erica Roth introduced a bill, A.B. 158, to authorize Nevada courts to exercise general personal jurisdiction over entities on the sole basis that the entity:
is organized, registered or qualified to do business pursuant to the laws of this State;
expressly consents to the jurisdiction; or
has sufficient contact with Nevada such that the exercise of general personal jurisdiction does not offend traditional notions of fair play and substantial justice.
The following entities would be covered by the statute: corporations, miscellaneous organizations described in chapter 81 of NRS, limited-liability companies, limited-liability partnerships, limited partnerships, limited-liability limited partnerships, business trusts or municipal corporations created and existing under the laws of this State, any other state, territory or foreign government or the Government of the United States
The last basis is generally consistent with traditional constitutional jurisprudence. See Int’l Shoe Co. v. Washington, 326 U.S. 310, 316 (1945) quoting Milliken v. Meyer, 311 U. S. 457, 463 (1940). California has codified this principle in Section 410.10 of the Code of Civil Procedure (“A court of this state may exercise jurisdiction on any basis not inconsistent with the Constitution of this state or of the United States.”).
The penultimate basis is consistent with and might even be categorized as a subset of the last. How is fair play and substantial justice offended if an entity has consented?
The first basis hearkens to the U.S. Supreme Court’s decision in Mallory v. Norfolk Southern Ry. Co., 600 US 122 (2023). In the case, the Supreme Court in a 5-4 decision held that a Pennsylvania statute did not offend the Due Process clause of the United States Constitution. The Pennsylvania statute provided that a company’s registration as a foreign corporation” is deemed “a sufficient basis of jurisdiction to enable the tribunals of this Commonwealth to exercise general personal jurisdiction over” the corporation. 42 Pa. Cons. Stat. § 5301(a)(2)(i).
If A.B. 158 becomes law, the doors of Nevada’s courts will be thrown open to lawsuits against foreign entities that have registered to do business suits. These lawsuits may be brought even when the plaintiff, the defendant and the dispute occurred outside of Nevada. The case may be a boon to Nevada’s lawyers (Assemblymember Roth is a lawyer), but may have the unintended consequence of discouraging business in Nevada or encouraging creative business structures.
Bipartisan Support For A CTA Pause And Livy Explains The Inequity Of Student Loan Forgiveness
As the courts wrestle with various challenges to the Corporate Transparency Act, Congress is also taking an interest. Last week, the House of Representatives passed H.R. 736 which would allowcompanies formed or registered before January 1, 2024, to submit beneficial ownership information to FinCEN by January 1, 2026, instead of by January 1, 2025, as required under the current statute. The bill passed the House with overwhelming bipartisan support by a vote of 408 to zero. The next day, Senator Tim Scott introduced a companion bill in the Senate, S. 505.
A Two Thousand Year Old Explanation For Why Student Loan Forgiveness Is Inequitable
I have just finished reading books 1-5 of Ab Urbe Condita (From the Founding of the City) by the Roman historian Titus Livius (aka Livy) who lived and wrote in the first century B.C.E. This famous retells the history of Rome from its founding until 9 B.C.E. in 142 books, only a portion of which survive completely. One of the great pleasures of reading the ancients is the realization that as Qoheleth observed long ago “The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun”. Ecclesiastes 1:9.
In the early days of the Roman republic, citizens were expected to serve in the military at their own expense. In 406 B.C.E., however, the Roman Senate decided to curry the favor of plebeians by paying soldiers out of the public treasury:
decerneret senatus, ut stipendium miles de publico acciperet, cum ante id tempus de suo quisque functus eo munere esset (the senate resolved that a soldier should receive a stipend from the public treasury, when before that time whoever served did so at his own expense).
Many of plebeians thought this a great boon since, according to Livy, their property would not be diminished whilst they served in Rome’s numerous wars. Their elected Tribunes, however, discerned otherwise. First, they asked:
unde enim eam pecuniam confici posse nisi tributo populo indicto? (where will the state be able to get the money except by levy on the people (i.e., taxes)?
Thus, it was understood, at least by some, two thousand years ago that the governments do not create wealth. Rather, governments take wealth from the many and redistribute to a chosen few.
But redistribution was not the only problem. The proposal was fundamentally inequitable:
neque id, etiamsi ceteri ferant, passuros eos, quibus iam emerita stipendia essent, meliore condicione alios militare, quam ipsi militassent, et eosdem in sua stipendia inpensas fecisse et in aliorum facere (Even if others should suffer it, those who had earned their discharge by service would not endure that others should serve on better terms than themselves – to have paid their own expenses and to pay the expenses of others).
In other words, some citizens were being forced to pay twice – once for themselves and then again for others.
Nevada Bill Introduced to Expand General Jurisdiction Over Businesses
Nevada’s 2025 legislative session has commenced, and at least one bill is already raising concerns. Assembly Bill 158 would expand general jurisdiction in Nevada to an entity that “is organized, registered or qualified to do business pursuant to the laws of this State.” Simply stated, merely registering to do business in Nevada would create general jurisdiction over that entity. This could expose entities to lawsuits in Nevada that have nothing to do with the state. It could also lead to extreme forum shopping because of the potential to sue entities anywhere.
AB 158 appears motivated by the United States Supreme Court’s 2023 decision in Mallory v. Norfolk Southern Railway Co., 600 U.S. ___ (2023). Mallory concluded that a Pennsylvania statute requiring a foreign corporation to consent to general jurisdiction in Pennsylvania as a condition of doing business there did not violate due process. However, Mallory leaves at least one question unanswered. Justice Alito noted in his concurrence that although the statute might not violate due process, it might be unconstitutional under the Commerce Clause. That issue, though, was not before the court in Mallory. Whether a statute such as AB 158, as proposed, is constitutional remains unknown.
Delaware Supreme Court Clarifies “Related” Claim D&O Analysis in Delaware
Analysis of “relatedness” in directors and officers liability insurance claims has shifted over time in Delaware. In last week’s decision in Alexion Pharmaceuticals, Inc. Insurance Appeals, Case Nos. 154, 2024 and 157, 2024 (Del. Feb. 4, 2025), the Delaware Supreme Court adopted a “meaningful linkage” standard for relatedness analysis in overturning the trial court’s holding on relatedness. Related claims is an inherently unpredictable and fact-specific issue, and the Alexion decision provides further guidance to Delaware policyholders on how to navigate those disputes in the future.
Background
In Alexion, a pharmaceutical company sought coverage under its D&O liability insurance policies. The company had a 2014-2015 D&O policy program, which consisted of a primary policy and a series of excess policies. The company also had a 2015-2017 D&O policy program, which consisted of a primary policy and a series of excess policies. The primary insurers were the same for both policy programs, and the line of excess insurers were nearly identical.
The 2014-2015 D&O policy program included a related claim provision which stated that “any Claim which arises out of such Wrongful Act shall be deemed to have been first made at the time such written notice was received by the Insurer.” The related claim provision in the 2015-2017 D&O policy program used similar language to the earlier policy program, such as “alleging,” “based upon,” “arising out of,” and “attributable.”
The company first contacted the primary insurer in June 2015 to report, via a notice of circumstances, an SEC subpoena served on the insured in 2015. At that time, the primary insurer did not consider the company’s communication to be a claim and stated it needed additional information. The company later provided notice in January 2017 of a securities class action filed against the company in 2016.
The primary insurer ultimately decided that the SEC subpoena and the securities class action were related, and thus took the position that “the Securities Action, among other actions, was a single ‘Claim’ first made in the 2014-2015 policy period.” But one of the excess insurers under the 2014-2015 D&O policy program took a contrary position that the securities class action was not covered under the program because the SEC subpoena and the securities class action did not sufficiently overlap. And the second level, third-level, and ninth-level excess insurers under the 2015-2017 D&O policy program denied coverage for the securities class action under the program based on their position that the SEC subpoena and the securities class action were related and were, therefore, deemed to have been first made during the early 2014-2015 policy period before the excess insurers’ policies incepted.
The company then filed suit and the issue before both the trial court and the appellate court in Alexion was whether the SEC subpoena and the securities class action were related claims.
The Appellate Decision
In the appeal of the earlier Alexion decision, the insurers argued that the trial court erred by treating the 2015 notice of the SEC subpoena from the company to the insurers as a claim rather than a disclosure of facts or circumstances that may give rise to a future claim. The trial court erred, the insurers asserted, by analyzing whether the SEC subpoena and securities class action were meaningfully linked, instead of analyzing whether the securities class action arose from any wrongful act, fact, or circumstance that was the subject of the notice. In contrast, the company argued that the trial court correctly held that the SEC subpoena and the securities class action were not related because they had different focuses.
The Delaware Supreme Court agreed with the insurers. It first considered the language of the related claims provisions in the policies. Because terms used in those provisions were undefined, and there was no other textual evidence of the parties’ intent about those terms, the court interpreted the “arises out of” language in the related claim provisions as requiring a “meaningful linkage” between two conditions for them to be related. The linkage must be meaningful and not merely tangential.
The court then clarified that the appropriate “objects of comparison” in assessing meaningful linkage is whether the securities class action is materially linked to any alleged wrongful acts that were disclosed in the notice of the SEC subpoena. Based on this analysis, the court held that the SEC subpoena and the securities class action were related claims because they involved the same underlying wrongful acts. The common underlying wrongful acts were the company’s alleged improper sales tactics worldwide, including its grantmaking activities.
If claims are related, an exclusion may be triggered that limits or bars coverage under a later policy. Because the appellate court held that an SEC subpoena and a later-filed securities class action at issue in Alexion were related, the insurance coverage for both was limited to the earlier of two D&O policy programs, and the company could recover only up to the one policy limit.
Takeaways
There are several aspects of the Alexion ruling that bear on future related-claim disputes in Delaware.
First, related claims analysis is inherently unpredictable because policy language concerning related claims is often broad and indefinite, and the related claims analysis used by courts is fact-specific. This case-by-case inquiry is compounded by the fact that insurers and policyholders can usually find support both for and against relatedness in any given dispute; and because the analysis is fact-specific, small changes in circumstances can materially impact the result in terms of whether claims are related.
Second, despite unpredictability in related claims analysis, the Delaware Supreme Court confirmed that “meaningful linkage” is the appropriate related-claim standard, at least where insurance policies include the same “arises out of” causation language. The court also provided guidance on what must be compared to determine whether there is a meaningful linkage.
Third, even though the Delaware Supreme Court previously ruled that Delaware law applies to D&O coverage disputes involving Delaware corporations, policyholders should not assume that Delaware law controls in all case. That is because some policies include choice-of-law provisions stating that another state’s laws governs interpretation of the policy. And those variations in applicable law can result in different outcomes based on how other states have interpreted related-claim provisions. In the recent related-claim dispute in Benefytt Tech., Inc. v. Capitol Specialty Ins. Corp., Case No. N21C-02-143 PRW CCLD (Del. Super. Ct. Jan. 2, 2025), for example, the Delaware Superior Court applied New York law to a Delaware dispute because that’s what the policy required. Choice of law provisions matter and can depart from what the venue court would otherwise do.
Finally, while the Alexion court reversed and ruled in favor of the insurers, the ruling does not uniformly inure to the benefit of D&O insurers because they may take contrary positions against relatedness depending on the circumstances. Stated differently, related claims analysis is not an issue where policyholders or insurers uniformly argue in favor or against relatedness. For example, a policyholder may argue in favor or relatedness to avoid multiple retentions across multiple policy years, while in another case the policyholder may argue against relatedness to recover under greater policy limits across multiple policy years. The specific facts of the case are important when determining whether to argue in favor or against relatedness, and the analysis on how to proceed can be complicated.
Does The Stock Market Believe That California’s Board Diversity Mandates Enhance Firm Value?
In 2018 and 2020, California enacted laws mandating that publicly held corporations (as defined) having their principal executive offices in California have specified minimum numbers of directors who are female and from “underrepresented communities”. Supporters of these mandates contended that these mandates would improve firm value, but what did the stock market think?
University of Pennsylvania School of Law Professor Jonathan Klick tackled this question in a recent paper. He focused on the dates when these laws were found to be unconstitutional by the courts – April 1 2022 (underrepresented communities mandate) and May 13, 2022 (female mandate). Professor Klick’s conclusion?
When California judges found AB 979 and SB 826 to be in conflict with the equal protection clause of the state’s constitution, firms headquartered in California appreciated in value, with non-compliant firms gaining more than compliant firms. Because the court decisions arguably had no repercussions for other changes in corporate law and regulation in the state, which cannot be said with as much confidence for the original adoption of these mandates, these results improve confidence in the conclusion that board diversity mandates do not improve firm value and, perhaps, they even lead investors to lower their valuations.
While Professor Klick’s study tells us how the market reacted, he is careful to note that the study does why the market reacted in the way that it did.
CLOs and Material Nonpublic Information: Key Takeaways from the SEC’s Settlement with Sound Point
In this alert, we present the key lessons to be learned from the U.S. Securities and Exchange Commission’s (the SEC) settlement with Sound Point Capital Management, LP (Sound Point), and discuss whether a similar enforcement action would be possible under the EU and UK market abuse regimes. Fund managers trading in collateralized loan obligations (CLOs) should take note of the SEC’s decision, review their material nonpublic information (MNPI) policies, and closely monitor the SEC’s increased focus on transparency in private credit markets.
Settlement
On August 26, 2024, the SEC announced settled charges against a New York-based investment adviser, Sound Point, for failing to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI concerning its trading in CLOs. The settlement follows a similar enforcement action brought by the SEC against another investment adviser in 2020.
CLOs and Sound Point
CLOs are securities that typically consist of a series of bonds collateralized by a pool of corporate loans, loan participations, or credit default swaps tied to corporate liabilities. The bonds differ in terms of subordination or, in other words, the priority for receiving cash flow distributions from the underlying loans. The most junior tranche (also called the equity tranche) is subordinate to the remaining tranches and, as a result, is the first to absorb losses if any of the loans default.
Sound Point is an SEC-registered investment adviser that manages its own CLOs and CLOs issued by third parties. In addition, Sound Point often participates in ad hoc lender groups or creditors’ committees, where it explores potential debt restructuring opportunities with companies on the edge of bankruptcy filings or restructuring.
Sound Point and MNPI about Company A
According to the SEC, in June 2019, as a member of such an ad hoc group of lenders, Sound Point became aware of the likely need for rescue financing of a media services company (Company A) – information which constituted MNPI about that company. Given that Sound Point owned and managed CLOs collateralized by loans issued to Company A, it began to explore the possibility of reducing its exposure to such CLOs. Sound Point decided to sell portions of its equity tranches several weeks later, and its compliance department approved the sale despite being aware of MNPI about Company A.
When MNPI concerning Company A became public the day following the sale, the prices of loans issued to Company A immediately dropped by more than 50%, with the value of the tranches sold by Sound Point declining by approximately 11%, or $685,000.
SEC’s Charges
Although Sound Point had in place a general MNPI policy, it did not require Sound Point’s compliance personnel to consider the impact of MNPI relating to a corporate borrower on the value of a CLO tranche containing a loan to that borrower, when evaluating a proposed sale of that tranche.
In the SEC’s view, this gap constituted a violation of Sections 204A and 206(4) of the Investment Advisers Act of 1940 (the Advisers Act) and Rule 206(4)-7 promulgated thereunder, which require investment advisers to, among other things, “establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser’s business, to prevent […] the misuse of material, nonpublic information” and have “policies and procedures reasonably designed to prevent” violations of the Advisers Act.
After accounting for the subsequent reviews and investigations conducted by Sound Point, as well as the implementation of the revised MNPI policies in 2022 and 2024, the SEC accepted Sound Point’s offer to settle for $1.8 million in a civil penalty. (Sound Point neither admitted nor denied the SEC’s findings.) The SEC did not, however, charge Sound Point with violating SEC Rule 10b-5 relating to trading in securities based on MNPI.
Lessons for Fund Managers
The Sound Point enforcement action demonstrates the SEC’s increased focus on the activities of fund managers in the context of insider trading and the specificity of written policies and procedures.
The Sound Point enforcement action is not the first action brought by the SEC against a fund manager in relation to MNPI. In 2020, the SEC settled charges with another private equity adviser for the lack of sufficient policies and procedures to prevent the misuse of MNPI obtained through employees who had been appointed to the boards of portfolio companies. Although the firm had a general MNPI policy, the SEC concluded that the policy was not specific enough to account for the types of MNPI obtained in the context of the firm’s unique business lines.
Both settlements clearly signal the need for fund managers to review their MNPI policies and update them accordingly. When managers deal with complex derivative products, they should consider whether their policies accurately reflect the MNPI risks related to these products, including loans behind them. Generally restricting trades on the basis of MNPI may not be sufficient, and fund managers should holistically address exposure of their business operations to MNPI, and actively maintain and enforce their policies.
BROADER CONTEXT
Could a similar action be brought on the other side of the Atlantic? The European MNPI regime is based on EU Regulation 596/2014 on market abuse (MAR) that applies directly in every EU Member State. The UK decided to retain the provisions of MAR following Brexit with very limited amendments.
Competent authorities of the EU Member States and, in the UK, the Financial Conduct Authority (the FCA) have broad powers to investigate infringements of MAR, including infringements of its Article 16(2), which requires any person professionally arranging or executing transactions to “establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions” involving insider dealing and market manipulation.
To date, the FCA has published three enforcement actions for violations of this provision (see here, here, and here). The last enforcement, published in August 2022, imposed a financial penalty of £12,533,800 on an international broker-dealer, part of one of the world’s largest banks, for failures in control systems resulting in a number of erroneous orders being executed across various European exchanges.
However, unlike the SEC, the FCA has not published the results of any investigation into MAR policies of fund managers operating in the UK, nor has it announced any specific focus on this type of enforcement action.
Global M&A Trends: Spotlight on Japan
According to a recent KPMG report, the global M&A landscape in 2024 signals a rebound despite challenges like geopolitical tensions, high interest rates, and persistent inflation for much of the year. The dealmaking environment gained momentum in part due to inflation and interest rate pressures starting to ease towards the end of the year, the return of major lenders to acquisition finance markets, and technology advancements, particularly artificial intelligence (AI).
Although 2024 marked a turnaround for global M&A markets, performance was mixed. The KPMG report states that while deal volumes declined by approximately 17%, the total deal value rose, driven by 89 megadeals totaling an impressive $1.034 trillion. However, smaller deals (valued under $500 million) experienced a dip in both value and volume.
Private equity (PE) firms faced hurdles in closing new funds, reflecting challenges in the broader dealmaking environment. However, last September, a pivotal moment arrived when the US Federal Reserve initiated a rate cut. This infused a cautious optimism into the market.
Stable interest rates, cooling inflation, and abundant dry powder sparked a renewed interest in PE markets. Valuation gaps started to narrow, and lenders, both traditional and private credit funds, started offering more favorable financing terms.
Spotlight on Japan
While the Americas attracted around half of the total deal value in 2024, the biggest gains were seen in Japan. Last year was a busy year for Japan-related mergers, thanks in part to private equity funds snapping up businesses being shed by companies that have become increasingly focused on capital efficiency.
According to a JP Morgan report, after three decades of deflation and stagnant growth, recent government and market reforms designed to improve corporate governance and capital management have encouraged corporates to embrace a more transparent, pro-growth agenda. This has led to a wave of dealmaking in Japan.
The volume of mergers and acquisitions linked to Japan was up around 20% in the first half of the year compared to 2023 and was followed by a strong performance in the second half of 2024. Japan-related deals accounted for over 20% of Asia’s entire transaction volumes for 2023, the highest in four years, MARR data showed. Much of this has been driven by increases in shareholder activism and PE activity.
Japan’s recent reforms and renewed focus on growth create opportunities for US companies to expand in a potentially undervalued but stable market, particularly when the yen is hovering at multi-decade lows.
Japan’s M&A activity towards the US is being influenced by economic conditions, currency, and the regulatory environment. While the weak yen makes overseas investments more expensive for Japanese acquirers, a strong US economy compared to Japan’s stagnant growth encourages Japanese companies to pursue acquisitions in the US as a growth strategy.
2025 Outlook: Optimism on the Horizon
Recent coverage in Bloomberg indicates that Japan’s dealmakers are expecting a busier 2025 after more than $230 billion in mergers and acquisitions last year. In 2024, the value of M&A deals that involved a Japanese company rose 44% to more than $230 billion, according to data compiled by Bloomberg. That’s the fastest growth since 2018 and compares with a 38% rise in M&A activity across the Asia-Pacific region.
Much of this increase was due to a jump in foreign PE firms looking for undervalued companies in Japan. According to Pitchbook, PE deals in Japan with foreign PE participation reached an all-time high in 2024, a pace that seems to be continuing. Bain Capital recently announced the acquisition of 300-year-old Tanabe Pharma for $3.4b, which was the largest PE deal ever announced in the Japanese healthcare sector.
While the forecast is positive, dealmaking activity remains susceptible to unexpected disruptions. That said, if current trends remain steady, 2025 could solidify itself as a year of robust growth in M&A markets.