February 2021 Update
In Securities Act Release No. 33–10824 (Aug. 26, 2020), the SEC amended the definition of “accredited investor” under Rule 501(a) (17 CFR §230.501(a)). The amendments add two new categories for natural-person accredited investors, as follows:
Those who hold certain professional certifications, designations or credentials, or other credentials issued by an accredited educational institution, which the SEC may designate from time to time by order (in connection with the adoption of the amendments, the SEC designated by order holders in good standing of the Series 7 (Licensed General Securities Representative), Series 65 (Licensed Investment Adviser Representative), and Series 82 (Licensed Private Securities Offerings Representative) licenses as qualifying natural persons); and
Those who are “knowledgeable employees” of a private fund and are investing in the private fund (the term “knowledgeable employee” is defined in Rule 3c–5(a)(4) under the Investment Company Act of 1940 and generally includes directors and senior executives of the manager and individuals who directly participate in the investment activities of the private fund).
The amendments also allow natural persons to include joint net worth from “spousal equivalents” (meaning a cohabitant occupying a relationship generally equivalent to that of a spouse) and add a note to Rule 501 clarifying that the calculation of joint net worth can be the aggregate net worth of an investor and his or her spousal equivalent and that the securities being purchased by an investor relying on the joint net worth test do not need to be purchased jointly. See §6.6.
The amendments also add the following new categories of entity accredited investors:
SEC- and state-registered investment advisers;
Rural business investment companies, as defined in §384A of the Consolidated Farm and Rural Development Act (7 USC §2009cc);
Family offices (as defined in Rule 202(a)(11)(G)–1 under the Investment Advisers Act of 1940) with at least $5 million in assets under management that were not formed for the specific purpose of acquiring the offered securities and whose prospective investment is directed by a person with such knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment; and
Family clients (as defined in Rule 202(a)(11)(G)–1 under the Investment Advisers Act of 1940) of a family office that qualifies as an accredited investor and whose prospective investment is directed by such family office by a person with such knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment.
In Securities Act Release No. 33–10763 (Mar. 4, 2020), the SEC has proposed new Rule 152 (17 CFR §230.152) dealing with the integration of offerings, which would replace current Rules 152 and 155. The integration provisions of Regulation D, Regulation A, Regulation Crowdfunding, and Rules 147 and 147A would be replaced by references to new Rule 152. See §6.12A.
In Securities Act Release No. 33–10763 (Mar. 4, 2020), the SEC has proposed amending the financial information requirements in Rule 502(b) (17 CFR §230.502(b)) for Regulation D offerings by nonreporting companies that include nonaccredited investors. See §6.13A.
The SEC has proposed new Rule 148 (17 CFR §230.148), which would provide that certain “demo day” communications would not be deemed to be general solicitations or general advertising. “Demo day” would mean a seminar or meeting held by, for example, a university or other institution of higher education, a local government, a nonprofit organization, an angel investor group, an incubator, or an accelerator. Among other things, the event sponsor would not be permitted to make investment recommendations or provide investment advice; engage in investment negotiations; charge fees to attendees (other than reasonable administrative fees); receive compensation for making introductions; or receive any other compensation with respect to the event that would require the sponsor to register as a broker, dealer, or investment adviser. Advertising for the event would not be permitted to refer to any specific offering of securities, and the information conveyed at the event regarding the offering of securities by the issuer would be limited to (1) notification that the issuer is in the process of offering or planning to offer securities; (2) the type and amount of securities being offered; and (3) the intended use of proceeds of the offering. Securities Act Release No. 33–10763 (Mar. 4, 2020). See §6.14.
The SEC has proposed new Rule 241 (17 CFR §230.241), which would allow an issuer to solicit indications of interest in an exempt offering orally or in writing before determining which exemption to utilize for the offering. A proposed amendment to the information requirements in Rule 502(b) would require an issuer selling securities under Rule 506(b) within 30 days of making a solicitation of interest to any nonaccredited purchaser, to provide such purchaser with any written communication used under proposed Rule 241. Securities Act Release No. 33–10763 (Mar. 4, 2020). See §6.14.
The SEC has proposed adding a new item to the nonexclusive list of Rule 506(c)’s accredited investor verification methods. Specifically, the proposed amendment would allow an issuer to establish that an investor for which the issuer previously took reasonable steps to verify as an accredited investor remains an accredited investor as of the time of a subsequent sale, if the investor provides a written representation to that effect and the issuer is not aware of contrary information. See Securities Act Release No. 33–10763 (Mar. 4, 2020). See §6.19C.
Effective January 1, 2021, the California Department of Business Oversight changed its name to become the California Department of Financial Protection and Innovation. The website address is https://dfpi.ca.gov. The former Department of Corporations is now the Division of Corporations under the Department of Financial Protection and Innovation. References in this chapter to the “commissioner” now refer to the Commissioner of Financial Protection and Innovation. See §6.32.
Although some borrowers may still try to assert the contrary, it is fairly well established in California that the relationship between a bank and its borrower is that of a normal lender-borrower. The bank/lender does not owe a fiduciary duty to its borrower absent the existence of unusual facts or circumstances that might create such a fiduciary duty or a special relationship. See Weimer v Nationstar Mortgage, LLC (2020) 47 CA5th 341. See §8.5.
In response to the COVID-19 pandemic, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub Law 116–136, 134 Stat 281) on March 27, 2020, which authorized multiple lending programs to assist small and medium-sized businesses during the pandemic. The most notable are the Paycheck Protection Program (PPP) and the Main Street Lending Program. Both loan programs are very detailed and complex and have experienced multiple revisions since the enactment of the CARES Act through implementation of the programs. The U.S. Small Business Administration (SBA) and the U.S. Treasury Department (Treasury) established the rules surrounding PPP loans. Unlike traditional SBA loans, PPP loans are not made by the SBA but by eligible PPP lenders, including depository institutions (i.e., banks and credit unions); nondepository institutions, such as community development financial institutions; small business lending companies licensed by the SBA; and some financial technology firms. One of the most significant features of PPP loans is that the entire principal amount and any accrued interest is eligible for forgiveness if applied toward forgiveness-eligible uses. Applying for loan foregiveness is also a detailed process, and borrowers will need to work closely with their lenders to ensure the required information and documents are provided to the SBA and Treasury. See §8.5A.
Under the Main Street Lending Program, there are five separate lending facilities, two of which are geared to nonprofit organizations. The Main Street Lending Program was established by the Federal Reserve and is operated by the Federal Reserve Bank of Boston (Boston Fed) and Treasury. The eligible lenders under the Main Street Lending Program are U.S. federally insured depository institutions (including banks, savings associations, and credit unions), U.S. bank holding companies, U.S. savings and loan holding companies, U.S. branches or agencies of foreign banks, and U.S. intermediate holding companies of foreign banking institutions. MS Facilities LLC, a special purpose vehicle operated by the Boston Fed, will purchase a 95 percent participation interest in each Main Street loan that meets all the eligibility requirements. All Main Street loans will have a 5-year maturity, principal will be deferred for 2 years, and interest will be deferred for 1 year. See §8.5A.
In bankruptcy, it is uncertain whether a prepayment premium will be enforceable unless expressly provided for. See In re Ultra Petroleum Corp. (5th Cir 2019) 943 F3d 758 (creditor’s right to make-whole payment on early repayment was in nature of unmatured interest (even though it might also be viewed as liquidated damages) and hence was disallowed to extent it arose postpetition; however, because debtor was solvent, bankruptcy court must determine whether solvent-debtor exception, which existed under pre-Code law, survived enactment of Bankr C §502(b)(2)); In re 1141 Realty Owner LLC (Bankr SD NY 2019) 598 BR 534 (make-whole premiums can be enforceable in bankruptcy post-default and post-acceleration if there is clear and unambiguous language to that effect in loan documents). See §8.18.
In In re 3MB, LLC (Bankr ED Cal 2019) 609 BR 841, the bankruptcy court held that a promissory note calling for interest after maturity at 4 percent more than the base rate of 6.27 percent was enforceable. The court found that an agreement for a higher interest rate after maturity is not, under California law, a liquidated damages clause that might be an unenforceable penalty. Instead, the higher interest rate provides for an alternative performance and compensates the bank for the lower value of the loan, since it no longer conforms to its expected duration. Even if the clause did provide for liquidated damages, it would still be enforceable because the increase in the interest rate is consistent with similar commercial loans and compensates for the increased risk of nonrecovery; determining actual damages would be difficult. See §8.18B.
When entering into a postdefault settlement agreement, lenders need to pay careful attention to how payments are structured to avoid having the payment terms ruled an unenforceable liquidated damages provision. In Red & White Distribution, LLC v Osteroid Enters., LLC (2019) 38 CA5th 582, the court found that an agreement that settled a dispute between a lender and a borrower and provided for payment by the borrower of $2.1 million through installments over a 1-year period, but also included a stipulation for entry of a $2.8 million judgment in the event of default, created an unenforceable penalty under CC §1671(b). Nothing in the settlement agreement indicated that the borrower owed $2.8 million; rather, it stated that the borrower was liable for $2.1 million. The court found that the additional $700,000 bore no reasonable relationship to the actual damages the parties could have anticipated from the breach of the settlement agreement. Had the parties intended to settle for $2.8 million, but apply a discount for timely payments, they could have done so expressly. See §8.18C.
The court of appeal in Weimer v Nationstar Mortgage, LLC (2020) 47 CA5th 341 held that loan servicers and the loan owner owed a duty of care to a mortgagor with regard to processing of the mortgagor’s loan modification application because a special relationship existed between the mortgagor, the loan servicers, and loan owner that would allow an exception to the general rule of no tort duty for economic losses. See §8.80.
In In re Davis (Bankr CD Cal 2019) 595 BR 818, the court held that an individual debtor who had been determined to be the alter ego of a corporation, and therefore liable for the corporation’s debts, was entitled to recover attorney fees incurred in successfully defending against a creditor’s challenge to the individual’s bankruptcy discharge and the dischargeability of his obligations to the creditor. All contract issues had been litigated previously, and therefore the action was not “on the contract,” so CC §1717 did not apply. Yet the individual was entitled to attorney fees in accordance with the attorney fee clause in the contract because the clause covered “any … proceeding or court action arising out of this Agreement or the enforcement or breach thereof.” But see Menco Pac., Inc. v International Fid. Ins. Co. (CD Cal, Feb. 15, 2019, No. LA CV17-07830 JAK) 2019 US Dist Lexis 25391 (bankruptcy debtor who successfully defended against motion for relief from automatic stay was not entitled to award of attorney fees under CC §1717 because motion was not an “action on a contract”). See §8.84.
In Handoush v Lease Fin. Group, LLC (2019) 41 CA5th 729, the court found that the trial court erred in enforcing a New York choice-of-forum clause in an equipment lease. The clause also selected New York as the governing law and included a predispute jury trial waiver. The court held that enforcement would diminish the plaintiff’s substantive rights and violate a fundamental public policy of California, which prohibits predispute jury trial waivers. See §8.86.
The California Supreme Court has held that California’s rule that late notice does not bar coverage unless the insurer is prejudiced is an important California public policy. See Pitzer College v Indian Harbor Ins. Co. (2019) 8 C5th 93 (“California’s notice-prejudice rule is designed ‘to protect insurers from prejudice, … not … to shield them from their contractual obligations through a technical escape-hatch’”). See §11.17.
While many courts have held that an insurer need not show it was prejudiced to avoid coverage under the voluntary payments clause, this is not the case with first-party insurance policies under California law. See Pitzer College v Indian Harbor Ins. Co. (2019) 8 C5th 93 (“the notice-prejudice rule is a fundamental public policy of our state … that applies to consent provisions in first party insurance policies”). See §11.21.
Since the outbreak of the COVID-19 pandemic, hundreds of lawsuits have been filed around the United States and the world seeking coverage for losses associated with the pandemic and the orders of civil authorities closing so-called nonessential businesses and directing the public to stay at home. Typically, coverage is sought under the business interruption and civil authority coverages in property insurance policies. There are two main issues: (1) whether the presence of SARS-CoV-2 is “direct physical loss or damage” under the policy terms, and (2) the applicability of a common exclusion for losses arising from viruses. See §11.60.
Property insurance policies typically apply when there has been “direct physical loss or damage” to property. Insureds usually contend that the presence of SARS-CoV-2 on surfaces or in the airspace of a building satisfies this requirement. Insureds also argue that, in any event, because the virus and the various orders of civil authorities impair the use or function of property, this requirement is satisfied. Insurers argue in response that there must be a structural change to property, that no such structural change exists, and that even if the presence of SARS-CoV-2 were sufficient, insureds cannot show that the presence of the virus caused their closures or that the virus was permanently present. Court decisions to date are split. Compare Studio 417, Inc. v Cincinnati Ins. Co. (WD Mo, Aug. 12, 2020, Case 6:20-cv-03127-SRB) 2020 US Dist Lexis 147600 (denying insurer’s motion to dismiss) with DieselBarbershop, LLC v State Farm Lloyds (WD Tex, Aug. 13, 2020, No. 5:20–CV–461–DAE) 2020 US Dist Lexis 147276. See §11.60.
Many property insurance policies have a virus exclusion based on a standard form introduced in 2006. Insurers argue that the exclusion bars coverage for all losses involving the virus. Insureds argue that while SARS-CoV-2 may be a cause of the loss, it is not the “efficient proximate cause” of the loss and therefore coverage is still afforded. This argument is based on Garvey v State Farm Fire & Cas. Co. (1989) 48 C3d 395, 402 (“[C]overage would not exist if the covered risk was simply a remote cause of the loss, or if an excluded risk was the efficient proximate (meaning predominant) cause of the loss. On the other hand, the fact that an excluded risk contributed to the loss would not preclude coverage if such a risk was a remote cause of the loss”). See §11.60.
Laws of nature, natural phenomena, and theoretical concepts such as algorithms, mathematical principles, or formulae are not patentable; however, algorithms and mathematical formulae that yield useful, tangible results are patentable if they satisfy the process patent requirements. Likewise, if an invention is directed to a law of nature, the invention must do more than invoke that law of nature to achieve a result. The invention must limit its reach to particular inventive applications of the law. American Axle & Mfg., Inc. v Neapco Holdings LLC (Fed Cir 2020) 966 F3d 1347. See §12.5.
“Originality remains the sine qua non of copyright; accordingly, copyright protection may extend only to those components of a work that are original to the author.” Feist Publications, Inc. v Rural Tel. Serv. Co. (1991) 499 US 340, 348, 111 S Ct 1282. An original work may include or incorporate elements taken from prior works or works from the public domain, but those borrowed elements are not considered original parts and are not protected by copyright. Skidmore v Led Zeppelin (9th Cir 2020) 952 F3d 1051, 1071. See §12.17.
Trademark registration may also be denied when the use of the goods or services in interstate commerce is illegal. See In re PharmaCann LLC (TTAB 2017) 123 USPQ2d 1122. For example, trademark registration for a food product was properly denied when the applicant’s goods contained cannabidiol (CBD), an extract of the cannabis plant, that is regulated by the Food and Drug Administration (FDA) as a drug. In re Stanley Bros. Soc. Enters. LLC, Serial No. 86568478 (TTAB, June 16, 2020). See §12.36.
If an otherwise generic term is not perceived by consumers to be generic and has acquired secondary meaning, it may be protectable as a registered trademark. This is also true even if a generic term is combined with a .com domain name. Whether any given “generic.com” term is generic depends on whether consumers in fact perceive that term as the name of a class or, instead, as a term capable of distinguishing among members of the class. See U.S. Patent & Trademark Office v Booking.com B.V. (2020) ___ US ___, 140 S Ct 2298 (Supreme Court rejected USPTO’s blanket rule that when generic term was combined with generic top-level domain like “.com,” resulting combination was generic). See §12.52.
In some circumstances, color trademarks can be inherently distinctive and bypass a requirement of showing secondary meaning if consumers would be predisposed to equate the character of the color feature with the source. See In re Forney Indus., Inc. (Fed Cir 2020) 955 F3d 940. See §12.58.
The California Consumer Privacy Act of 2018 (CCPA) (CC §§1798.100–1798.199) requires the California Attorney General to adopt regulations that further the purposes of the CCPA. Those regulations were finalized in August 2020. See 11 Cal Code Regs §§999.300–999.341. Practitioners are advised to stay abreast of developments related to the CCPA by reference to the following website: https://oag.ca.gov/privacy/ccpa. The Attorney General may bring enforcement actions after July 1, 2020. See §13.13.
A bonus first-year depreciation allowance applies to “qualified property.” The allowance is claimed in the first year that the property is placed in service by the taxpayer for use in its trade or business or for the production of income. The first-year bonus depreciation allowance is mandatory. However, taxpayers may elect out of the bonus depreciation for the taxable year the property is placed in service, and such election applies to all “qualified property” that is in the same class of property and placed in service by the taxpayer in the same taxable year. Prop Treas Reg §1.168(k)–2(e)(1)(ii); IRS Form 4562 (2019); IRS Additional First Year Depreciation Deduction (Bonus) — FAQ, at Q&A # 2, available at https://www.irs.gov/newsroom/additional-first-year-depreciation-deduction-bonus-faq. See §15.12.
On May 20, 2020, the SEC amended the requirements for financial statements relating to acquisitions and dispositions of businesses. Under Rule 3–05 of Regulation S-X (17 CFR §210.3–05), acquiring companies must provide separate audited annual and unaudited interim pre-acquisition financial statements of a “significant” acquired business, with the number of years required determined on the basis of the relative significance of the acquisition. Article 11 of Regulation S-X (17 CFR §210.11) requires the company to file unaudited pro forma financial information with regard to the acquisition or disposition, including adjustments that show how the acquisition or disposition might have affected the historic financial statements. The amendments modify the rules for determining whether an acquisition or disposition is significant and require the financial statements of acquired businesses for only up to the 2 most recent fiscal years, instead of the previously required 3 fiscal years. Securities Act Release No. 33–10786 (May 20, 2020). See §§17.5, 20.13.
On September 30, 2020, AB 979 was signed into law by Governor Newsom. The bill amends Corp C §301.3 and adds Corp C §§301.4 and 2115.6, to require each publicly held corporation that is incorporated in California or has its principal executive offices in California to include at least one person from an “underrepresented community” on its board by the end of 2021, and two or three, depending on the size of the board, by the end of 2022. The bill defines a member of an underrepresented community as anyone “who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender.” By the end of 2022, corporate boards with more than four members must include two members from underrepresented communities, and corporations with more than nine members must include a minimum of three members from underrepresented communities. See §§17.26, 18.42.
Effective March 20, 2020, the SEC approved the first comprehensive revision of FINRA Rule 5110 since 2004. See Exchange Act Release No. 34–37855 (Dec. 23, 2019) (Order Approving SR-FINRA-2019-012). The amendment, among other things, modifies the rule’s general filing requirements, available exemptions, definition of underwriting compensation, venture capital exceptions, treatment of nonconvertible or non-exchangeable debt securities and derivatives, lock-up restrictions, and prohibited terms and arrangements. For a description of the amendment, see FINRA Regulatory Notice 20–10 (Mar. 20, 2020). See §18.11.
On March 4, 2020, the SEC announced proposed amendments to harmonize and simplify the exempt offering framework, including Regulation A, Regulation Crowdfunding, and Rule 504. See Securities Act Release No. 33–10763 (Mar. 4, 2020). See §19.4.
In September 2019, the SEC extended to all issuers the “test-the-waters” accommodation, available to emerging growth companies (EGCs). See Securities Act Rule 163B (17 CFR §230.163B). The new rule allows any issuer to engage in oral or written communications with potential investors that are, or are reasonably believed to be, qualified institutional buyers or institutional accredited investors, either before or after the filing of a registration statement, to determine whether those investors might have an interest in the offering. The rule is nonexclusive, and an issuer may rely on other Securities Act rules or exemptions when determining how, when, and what to communicate about a contemplated offering. Under the rule, (1) there are no filing or legend requirements, (2) the communications are deemed to be “offers,” and (3) issuers subject to Regulation FD will need to consider whether any information in a test-the-waters communication would trigger disclosure obligations under Regulation FD. Securities Act Release No. 33–10699 (Sept. 25, 2019). See §20.17.
FINRA Rules 5130 and 5131 promote fairness in the allocation of a “new issue” of equity securities in an IPO. Rule 5130 prevents broker-dealers and portfolio managers from receiving shares in a new issue. Rule 5131 prevents broker-dealers from allocating shares in a new issue to individuals who have the authority or ability to direct their company’s investment banking business to the broker-dealer making the allocation. In January 2020, FINRA amended Rules 5130 and 5131 to clarify and liberalize their exclusions and exemptions, including excluding from the definition of “new issue” special purpose acquisition companies (SPACs) and offerings made under Regulation S (17 CFR §§230.901–230.905) (and not concurrently offered in the United States). See FINRA Regulatory Notice 19–37 (Nov. 26, 2019), available at https://www.finra.org/rules-guidance/notices/19-37. See §20.37.
On November 2, 2020, the SEC announced its approval of amendments to a number of the rules governing exempt offerings under the Securities Act. The new rules are intended to simplify, harmonize, and improve certain aspects of the exempt offering framework to promote capital formation while preserving or enhancing important investor protections. The amendments generally (1) establish more clearly, in one broadly applicable rule, the ability of issuers to move from one exemption to another; (2) increase the offering limits for Regulation A (17 CFR §§230.251–230.263), Regulation Crowdfunding (17 CFR §§227.100–227.503), and Rule 504 (17 CFR §230.504) offerings, and revise certain individual investment limits; (3) set clear and consistent rules governing certain offering communications, including permitting certain “test-the-waters” and “demo day” activities; and (4) harmonize certain disclosure and eligibility requirements and bad actor disqualification provisions. This title does not yet fully reflect this comprehensive SEC action. Readers are therefore advised to review the SEC’s press release, SEC Harmonizes and Improves “Patchwork” Exempt Offering Framework (SEC, Nov. 2, 2020), available at https://www.sec.gov/news/press-release/2020-273, and SEC Release Nos. 33–10884, 34–90300 (Nov. 2, 2020), available at https://www.sec.gov/rules/final/2020/33-10844.pdf, for detailed information on the amendments. The amendments are estimated to become effective as of a date in January or early February 2021 (60 days after publication in the Federal Register).