The Corporate Transparency Act of 2020 took effect on January 1, 2024, adding new filing requirements for many companies that may find themselves involved in mergers and acquisitions. Given the breadth of standard representations and warranties insurance (“RWI”) policies, carriers and underwriters should be aware of these new requirements and their impact on RWI policies issued in 2024 and beyond. In the below legal update, the Seyfarth RWI Underwriting Counsel team describes the new filing requirements and provides practical guidance to carriers and underwriters on due diligence considerations and risk mitigation strategies.
What is the Corporate Transparency Act of 2020?
As you may know, in 2021, Congress passed the Corporate Transparency Act of 2020 (the “CTA”). The stated purpose of the CTA is to “protect the U.S. financial system from illicit use and impeding malign actors from abusing legal entities, like shell companies, to conceal proceeds of corrupt and criminal acts.” In other words, the CTA seeks the disclosure of corporate ownership and the prevention of money laundering. The CTA took effect as of January 1, 2024.
CTA Filing Requirements
Small corporations, limited liability companies, limited partnerships, statutory trusts and any other entity created in or registered to do business in the United States will be required to report beneficial ownership information (“BOI”) to the Financial Crimes Enforcement Network (“FinCEN”) as to the ultimate beneficial owners of the entity, unless an exemption applies.
Exemptions include tax-exempt nonprofit entities, tax-exempt trusts, and certain entities already subject to regulatory oversight such as public companies, registered investment companies, and registered investment advisors. The regulations also exempt “Large Operating Companies,” which are companies with more than 20 full-time employees in the US, an operating presence at a physical office within the US, and more than $5 million in gross receipts or sales from sources inside the United States on its prior year federal tax return. Wholly owned subsidiaries of exempt entities may also be exempt.
If an exemption is unavailable, an entity (“Reporting Company”) must disclose specific information about the Reporting Company itself, as well as the BOI on beneficial owners. Read Seyfarth’s CTA Guidance here for more information on the information as to who is a “beneficial owner” and the types of information that must be reported.
Key Deadlines
The deadline for an initial filing depends on when a Reporting Company is initially created or registered:
If a previously exempt Reporting Company loses its exemption status (e.g., a Large Operating Company no longer has 20 full-time employees), then the initial filing is due within 30 calendar days of the date on which the Reporting Company stops qualifying for the exemption.
There are additional deadlines to the extent a Report Company needs to file a corrected and/or updated filing.
Penalties
Failures to comply with the CTA may result in the following: (i) civil penalties of $500 per day (up to a maximum of $10,000) for a failure to timely report; and (ii) criminal penalties of up to two years imprisonment if the failure to report is willful (or if a report knowingly includes erroneous information). As a related matter, the CTA also imposes increased penalties for violations of anti-money laundering and counter-terrorism financing.
Key RWI Considerations
Underwriting Risks:
FinCEN is regularly issuing new guidance and FAQs; however, as with any new major law change, there are a number of uncertainties and potential challenges facing a Reporting Company in these early stages of implementation, as well as enforcement. For example, the disclosure form that must be filed with FinCEN was just recently released. As such, t Reporting Companies have had a limited opportunity to collect information for easy reporting. Third party service providers have had limited time to develop offerings to assist a Reporting Company with their filing requirements, which in turn may result in the Reporting Company completing these forms in-house or using other outside vendors who may not be as familiar with the CTA.
Also, some smaller entities may face challenges in (i) collecting, retaining and reporting the necessary information, and/or (ii) demonstrating that it is in fact eligible for an exemption, like the Large Operating Employer exemption which is based on Affordable Care Act standards that may not otherwise apply to a small employer.
Potential Impacts on Transaction Agreements:
We expect that buyers will include CTA-specific reps and warranties (“R&Ws”) in transaction agreements. Such R&Ws may also include that organizational documents include covenants requiring investors/owners to comply and cooperate with the company in its CTA obligations.
Even if buyers do not include CTA-specific R&Ws in the agreement, RWI underwriters should be aware that such CTA compliance would likely be covered by the general compliance with laws, or even, the anti-money laundering, R&Ws that are typically included in transaction agreements.
Due Diligence Considerations:
CTA compliance is currently not yet considered a material issue for a non-exempt Reporting Company created or registered before January 1, 2024, because a Reporting Company generally has until January 1, 2025, to make an initial required filing. However, for Reporting Companies created or registered after January 1, 2024, or for a previously exempt Reporting Company that loses its exemption status, CTA compliance could be a material issue. Going forward, we expect a buyer would conduct due diligence on CTA filings (confirming that they have been timely filed, were complete/accurate, confirming that an exemption was available, comparing information against current director, officer and shareholder information that is collected in standard diligence), and confirming that there have been no disputes or challenges by employees or owners in providing such information.
Further, because the CTA requires in certain circumstances disclosure of company applicants, which could include lawyers at law firms who assist in the creation of entities, we understand that some law firms will no longer create entities for their clients. It is yet to be seen whether this position will change, but to the extent some firms refuse to create the entities, less experienced advisors or individuals may be tasked with this formation, which may lead to concerns about correct and accurate entity formations and filings.
RWI Risk Mitigation Strategies:
RWI underwriters should consider including confirmatory questions regarding the scope of the CTA due diligence conducted by buyer and its advisors, and whether any in-scope entities are subject to the CTA reporting. To the extent a Reporting Company has not filed the required forms, RWI underwriters may wish to consider an adjustment to coverage.
Next Steps for RWI Carriers and Underwriters
As the CTA is still in flux, exactly how it will be addressed in the transactional context and from a diligence perspective is still fluid.
