On October 8, 2019, the US Department of Justice (DOJ or Justice Department) issued new guidance on evaluating inability-to-pay arguments in a memorandum to the Criminal Division. The memorandum provides considerably more detail than existing guidance on evaluating assertions of an inability to pay. Although directed at Criminal Division personnel, the memorandum is likely to inform how other divisions evaluate such claims. The memorandum confirms that even when companies observe corporate formalities, the DOJ will look beyond the financial condition of the entity at issue to examine its relationship with corporate parents and affiliates.

The memorandum and the accompanying Inability-to-Pay Questionnaire “provide guidance and an analytical framework for Criminal Division attorneys to assess assertions by a business organization that is unable to pay an otherwise appropriate criminal fine or monetary penalty.”

Process

The memorandum makes clear that the process will require time and resources. “[T]he parties must first reach an agreement” as to the form of the criminal resolution and the monetary penalty before the Justice Department will consider inability to pay. The company then has the burden to demonstrate its inability to pay. In addition to completing the Inability-to-Pay Questionnaire, the company must “cooperate fully” in responding to requests for information or access to personnel. “In most cases,” the memorandum adds, “prosecutors also will need to consult an accounting expert to examine the financial condition of the business.”

The Inability-to-Pay Questionnaire remains the primary set of questions that will be asked regarding a company’s inability to pay, with questions focused on the company’s current assets, liabilities, and cash flows, and required documentation, including financial statements and tax returns. The updated Questionnaire, however, includes additional forward-looking questions regarding projections and proposed changes to financing, capital, and corporate structure, including restructuring plans.

Legal Considerations and Additional Factors

The memorandum provides as context the factors to consider under federal criminal statutes and the federal Sentencing Guidelines. It proceeds to provide additional relevant factors to consider, including additional questions regarding the company’s current financial condition, alternative sources of capital, and collateral consequences.

When considering the company’s current financial condition, the memorandum instructs that attorneys “should assess what gave rise to the organization’s current financial condition,” and ask questions such as:

  • Did ownership or management take capital out of the organization in the form of dividends, distributions, loans or other compensation?
  • Has the organization recently made investments in the form of facilities’ expansion, capital improvements, or an acquisition?
  • Has the organization engaged in related-party transactions?

Regarding alternative sources of capital, the memorandum suggests consideration of “the organization’s ability to raise capital through existing or new credit facilities or via a sale of assets or equity,” insurance or indemnification agreements, booked reserves, plans for the acquisition or divestment of assets, and the details from any company forecasts. Relevant collateral consequences include the ability to fund pension obligations or comply with laws or regulations and a likelihood that the penalty would cause layoffs, product shortages, or disruptions to competition. Not generally considered are consequences to growth and opportunities, executive compensation, or future hiring or retention.

Potential Adjustments

Once the Justice Department finds an inability to pay, the adjustment will be limited to the amount “necessary to avoid . . . threatening the continued viability of the organization.” Merely asserting such a threat will likely be insufficient. The memorandum suggests that attorneys should consider how the company “has addressed going concern issues with its outside auditor prior to asserting an inability to pay claim,” and suggests that attorneys consult applicable accounting standards. The adjustment may be a reduction in the fine or penalty or an installment plan “over a reasonable period of time.” Any adjustment must be approved by the chief of the relevant section, and a proposed reduction of more than 25 percent will require approval from the assistant attorney general for the Criminal Division or a designee.

Implications for Corporate Families

The memorandum suggests that companies that follow corporate formalities will not be insulated from fines or penalties even when the entity at issue lacks considerable assets. Related-party transactions, including intercompany loans and services agreements, are likely to be scrutinized.