5 areas where corporate penalties are increasingly influenced by ability to pay

While historically we have seen ability to pay (ATP) analyses used most frequently in the bribery and corruption space (i.e. FCPA, UK Bribery Act), the changing regulatory landscape coupled with wider economic uncertainty are driving an expansion of ATP use, in the interest of preserving economic activity.  

An intense debate centers on the policy implications of escalating fines, as excessively high penalties can distort markets. More businesses and organizations may benefit from considering ATP arguments when facing consequential penalties. Industry insights, coupled with our experience in this field, continue to suggest an increasing recognition among regulators of a company's financial standing and the potential broader market repercussions of substantial penalties (read our earlier article Penalties don’t have to bankrupt).

We have identified five sectors of interest where ATP analysis may play a strategic role in future agreements between companies and regulators

1. US False Claims Act  
2. Competition Law  
3. Litigation and Insolvency  
4. Export Administration Regulations & International Traffic in Arms Regulations
5. US Environmental Protection Agency

^{Watch our recent webinar featuring FRA forensic accountants Carolyn McDonnell, Ash Klass and Toby Duthie, who have worked with corporations and counsel on headline regulatory settlements around the world.}

1. US False Claims Act: increased DOJ scrutiny means high-stake potential fines

The False Claims Act (FCA) stands out as an area witnessing a notable increase in ATP analysis applications. The Department of Justice (DOJ) has heightened its attention on FCA cases, leading to settlements and judgments exceeding $2.68 billion in 2023 from a record-breaking 543 cases, a substantial 50% increase from the previous year.

Fines under the FCA are calculated on a "per count" basis. Individuals and entities found liable for knowingly submitting false claims face three times the government's damages plus a penalty linked to inflation for each offense. This cumulative approach can swiftly escalate into multimillion or billion-dollar penalties. It is noteworthy that around 64% of FCA cases are associated with Medicaid and the medical sector. Additionally, a substantial portion of the recent surge in cases arose from pandemic relief packages, such as the Inflation Reduction Act.

Moreover, the risk of "piling on" emerges when import-export activities span multiple jurisdictions, potentially subjecting a company to dual penalties for the same misconduct. While FCA penalties carry significant consequences, regulators keep the methodology for determining final penalty amounts somewhat opaque, which can open the door for ATP analyses to be considered by regulators on a case-by-case basis.

2. Competition law: avoiding further disruptions

In the realm of competition, fines from regulatory bodies, including the European Commission, can rise to a maximum of 10% of annual turnover, which could put companies into immediate economic hardship. An ATP analysis is a strategic tool that should be implemented. The ongoing debate revolves around the policy aspect of the escalating fines: an excessive burden may drastically destabilize market equilibrium. Such distortions may arise as companies, burdened by hefty fines, alter their market strategies, potentially leading to reduced competition or skewed market dynamics.

The use of ATP is exemplified in past cases like the International Removal Services cartel case, where fines imposed by the European Commission were slashed by 70% based on the company's specific circumstances and demonstrated inability to sustainably pay more. Beyond financial fragility, another argument resonates with regulators: large anti-trust penalties may not be in the best interest of a fair market if a competitor is driven out of business.

3. Litigation & insolvency cases: protecting both creditors and debtors.
   

The surge in insolvency litigation, observed prominently in European countries like France, Germany, and Spain, is anticipated to continue (source: Insolvency Litigation).

Class actions are arriving to the old continent. Europe and the UK have continued to see record-high numbers of class actions, with 121 claims filed in 2022, up from 55 in 2018 according to the CMS report. Moreover, the 2023 Collective Redress Directive in the EU will set uniform standards for class action in the EU, effectively imposing the need for collective action in all 27 member states’ legal systems. This has led to a boom in the industry: third party litigation companies like class action funders and US plaintiffs firms have raised their presence in Europe, with over 100 litigation companies already operating in this space. Simultaneously, litigation volumes in the United States have consistently increased.  

Similar to the justifications in competition cases, ATP may prove useful in defense of litigation cases. Driving a defendant into bankruptcy may not be in the best interest of the claimant, who is unlikely to be a preferred creditor as part of the liquidation process. Thus, ATP may be raised to find an agreement that both protects creditor rights and preserves the debtor’s estate.

4. Export Administration Regulations (EAR) & International Traffic in Arms Regulations (ITAR): increasing regulatory risks due to heightened tensions

In a climate of heightened international tensions, EAR & ITAR play a crucial role in regulating exports to maintain national security. Compliance becomes paramount, with violations potentially incurring criminal fines of up to $1 million and administrative penalties reaching $300,000 per violation or twice the transaction value. The recent Seagate case, where the US Bureau of Industry and Security imposed a record $300 million civil penalty for selling hard disks to Huawei, highlights the substantial financial repercussions for non-compliance. Similar fine rates apply to ITAR violations, as prosecutions towards relatively small businesses have been on the rise (source: Miller & Chevalier).

In this stringent regulatory landscape, a strategic application of ATP analysis emerges as a valuable tool for both regulatory adherence and financial sustainability. It may also be used to protect critical companies in defense, technology, and other nationally strategic sectors against risks from excessive punishment from foreign authorities.

5. Environmental Protection Agency (EPA): taking the lead in ATP implementation.
   

Finally, another growing sector open to ATP implementation in legal proceedings is US environmental law. Under the leadership of the EPA, ability-to-pay guidelines have been published with the latest guidelines being issued in 2015. In a sector where maximum penalties range from $58k to $67k per day for each violation, (source: Crowell) burden to prove inability to pay rests on the defendant if responsible parties claim they do not have the financial resources to pay their portion of the cleanup costs or damages. Clear instructions and checklists for necessary supporting documentation are available to the responsible parties. These provide a blueprint for possible ATP arguments in both environmental and non-environmental matters.

Conclusion:  

Ability to pay analyses emerge as a vital tool to prevent severe economic impacts caused by exorbitant fines. By assessing a company's financial capacity, fines are more likely to be more proportionate than punitive. They may prevent potential job losses, disruption in services or goods to customers and reduce the impact of challenging market conditions for fragile sectors. Additionally, ability to pay analysis can counter the reluctance to self-disclose, fostering more transparency and cooperation with regulators. Integrating such analyses into agreement negotiations may prove valuable for both a company’s legal strategy and its larger economic environment.