So we are becoming a Benefit Corporation...

We have had a number of inquiries from clients and friends about becoming a benefit corporation or "B-Corp."  Can we do it?  Does it make any sense to convert?  Should we convert to benefit corporation or just try to get certified by B-Labs?

Our colleague Regina Robson is an expert in benefit corporation law and has published a number of articles on the subject.  But talk is cheap.  There is no better way to advise clients than to make ourselves the proverbial guinea pig and become a benefit corporation ourselves.

Becoming is benefit corporation is relatively simple as a legal matter but successfully integrating the sustainability and community value generating goals into an organization is a more holistic endeavor. Enter our friends at the Erivan K. Haub School of Business at Saint Joseph's University, in particular, friend of the firm and all around good guy Professor Ron Dufresne, Ph.D.  Dr. Dufresne focuses his teaching and research on applied sustainable leadership and has been generous enough to use our firm as the subject of his capstone Applied Leadership and Sustainability course.  As part of the course, a group SJU business students will evaluate the firm's practices and advise us on what we need to do to make the successful transition to B-Corporation land.

This will be the first in a series of posts mapping out the experience from beginning to end.  Our goal is to set out a soup to nuts road map for other small and mid-sized organizations to make the transition to a benefit corporation.

Do we really need a warning to "consider the environment before printing this email" in our signature lines to become a B-corp?  We will find out.

“You have no idea how expensive it is to look this cheap” – Pennsylvania Uniform Fraudulent Transfer Act

Everyone loves a bargain and businesses and individuals that deal in distressed assets really love cheap stuff.  But if it looks too good to be true, it might turn out to be very expensive.  If you are considering purchasing the assets of a distressed business, you need to consider the implications of the Pennsylvania Uniform Fraudulent Transfer Act.

The typical situation involves a business with significant debts.  Some creditors have initiated collection actions, others have threatened.  The owners have decided to throw in the towel and want to salvage what value they can by selling the assets at “fire sale” prices to third parties.  The purchaser completes the purchase only to be sued by creditors of the defunct company. The creditors claim that sale violated the Pennsylvania Uniform Fraudulent Transfer Act and want the purchaser to pay them the full value of the assets.

The Pennsylvania Uniform Fraudulent Transfer Act prohibits three types of transfers.  First, it prohibits debtor from transferring assets “with actual intent to hinder, delay or defraud any creditor of the debtor.”  In determining whether a debtor had such “actual intent,” courts look to a variety of factors and there is no bright line test for making such a determination.  The factors include: (1) whether the transfer was made to an insider; (2) whether the debtor retained possession or control of the possession property after the transfer; (3) whether the transfer was concealed; (4) whether the debtor had been sued or threatened with a lawsuit at the time the transfer was made; (5) whether the transfer was of substantially all of the debtors assets; (6) whether the debtor absconded; (7) whether the debtor removed or concealed assets; (8) whether the value received for the assets was reasonably equivalent to the value of the assets; (9) whether the debtor was insolvent; (10) whether the transfer occurred shortly before or after a substantial debt was incurred; and (11) whether the purchaser of the assets subsequently transferred the assets to an insider of the debtor.

Second, the act prohibits a debtor from transferring assets [when] “without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (1) was engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (2) intended to incur, or believed or reasonably should have believed the debtor would have incurred, debts beyond the debtors ability to pay as they became due.”  This provision, known as the “constructive fraud” prohibition, is somewhat better defined then the actual “actual intent” provision, in that receipt of “reasonably equivalent value” renders the debtor in compliance with the provision. 

Third, “a transfer made [] by a debtor is fraudulent to a creditor whose claim arose before the transfer was made [] if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer [] and the debtor was insolvent at the time or the debtor became insolvent as a result of the transfer.”

Notice that a purchaser need not know that the seller is insolvent or engaging in duplicitous behavior to be liable for the seller’s debts.  So what is a purchaser to do?  If a deal seems too good to be true, some due diligence is in order.  Why are the assets being sold? Do the public records indicate that the seller has judgments against it?  Are all or substantially all of the assets of a company for sale?  Are the assets encumbered by security interests?

If a transaction raises red flags, there are a number of strategies to reduce the risk but you cannot address unknown risk. 

What is "Discovery"?

After the initial stages of filing a lawsuit, the pleading stage, is complete, the parties will have an opportunity to obtain information to each other regarding factual and legal basis for their respective claims and defenses.  This is known as the discovery phase of litigation.  

What is the discovery phase?

During the discovery phase, each party has an opportunity to use the various discovery “tools” to obtain information regarding the other party’s claims or defenses.  The most common discovery tools are:

“Rule 26” Disclosures

In federal court, the parties are required to exchange “Rule 26” disclosures with one another.  These disclosures require that each party provide basic information on what discoverable information it possesses.  For example, “Rule 26” disclosures require that a party identify individuals that may have knowledge regarding the facts of a case and requires parties to identify relevant documents in their possession.  The purpose of the “Rule 26” disclosures is to streamline the discovery process for all parties involved.

There is no state court equivalent for “Rule 26” disclosures.  Instead, parties typically utilize other discovery tools to obtain the same information. 

Requests for Production of Documents and Things

A request for production of documents and things is precisely what the name implies.  Such a request is made in writing to an opposing party which must respond in the time period provided under the rules.  Requests for production now typically include request for electronic records, such as e-mails, text messages and information from social media.

Interrogatories

Interrogatories are written questions which are directed from one party to another.  The receiving party is required to respond with written answers within the period of time provided under the rules. Typically, counsel is heavily involved in providing the responses to interrogatories and rarely yields “smoking gun” information. 

Depositions

Depositions are the center piece of the discovery process and involve a real time interchange between individuals and counsel.  During a deposition, counsel asks a series of questions and the deponent provides a series of answers.

Depositions typically takes place in a law firm conference room but are sometimes held at a court house or other location.  The interchange between counsel and deponent is recorded verbatim by a stenographer who produces a written transcript that can be used at trial or in the context of a motion.

Because of the preparation time required to conduct a deposition or defend a client who is being deposed, a deposition is typically the most expensive discovery tool available.  Moreover, stenographers charge by the page and their rates range from four to ten dollars per page depending on the speed in which the transcript is needed.

Notwithstanding the costs, a deposition is often the most effective discovery tool as it requires the deponent to provide information without the softening effect of counsel.  The deposition also allows a preview of how a witness may behave at trial.

Subpoenas

A subpoena is a device used to compel information from individuals or entities that are not parties to litigation.  A subpoena is used in combination with some other discovery tool.  For example, you may send a subpoena to a third party in order to compel them to produce documents or appear for a deposition.

How long does the discovery phase last?

The length of the discovery phase depends primarily on the jurisdiction and venue where the case is being litigated.  The discovery phase in federal court is typically much shorter than in state court.  The discovery phase in federal court is typically less than one year. 

The discovery phase in state court can be extremely long as judges in state court do not set deadlines for propounding discovery.   Many parties use delays in discovery as a tactic to exhaust the opposing party.

Although state courts typically have long discovery phases, the Court of common pleas in Philadelphia has a sophisticated case management system that significantly reduces that time. The discovery phase of the majority of cases in Philadelphia is completed in less than eighteen months.

What will I need to disclose in discovery?

Although the specific documents and information that you will need to produce depend heavily on the particular circumstances of your case, the scope of discovery is generally quite broad.  A party may obtain discovery regarding any matter, that it not privileged, which is relevant to the subject matter in the pending litigation.  Moreover, even irrelevant information is subject to disclosure if the information appears reasonably calculated to lead to the discovery of “appears reasonably calculated to lead to the discovery of [admissible] evidence.”

Emergency Relief and Preliminary Injunctions

Some matters may require emergency action by a Court to prevent immediate harm. This is generally sought in the form of an injunction.   

What is a preliminary injunction?

A preliminary injunction is a court order to do or not do something issued at the outset of litigation to prevent irreparable harm.  It can take a number of forms and courts have broad discretion as to their scope.  A party that violates a preliminary injunction may be subject to contempt of court and subject to the criminal and civil penalties that go along with it.

How do we obtain a preliminary injunction?

A request for a preliminary injunction will only be granted to prevent immediate and irreparable harm to a party.  It is available when a party would be seriously harmed by waiting for the conclusion of litigation.  For example, a party seeking to stop a company from dumping toxic waste in a river, would be likely to receive a preliminary injunction ordering the company to stop discharging waste during the pendency of litigation.   If harm can be reversed by paying money, a preliminary injunction is not appropriate. 

Although the party seeking an injunction must show a probability of success that they will prevail on their claims, the purpose of a preliminary injunction is not to determine who will ultimately win.  It is meant to maintain the status quo during the pendency of litigation.

The party seeing an injunction is sometimes required to deposit money into the court or post a bond to cover any damage that may arise from the wrongful imposition of the injunction.

When can we get a preliminary injunction?

As the name suggests, a preliminary injunction can be obtained early in the litigation.  Depending upon the nature of the injunction, a motion for an injunction may be made simultaneously with the filing of the claim and the court will often hold a hearing within several days.  In some rare circumstances, a court may grant a preliminary injunction before the opposing party has any opportunity to respond.

Motions to Dismiss

During the course of litigation, you may have an opportunity to file a motion to dismiss.  You may also be forced to respond to such a motion from an opposing party.  

What is a motion to dismiss?

Preliminary objections and Rule 12-b motions ask the court to assume that everything in a pleading is true and that the party filing the pleading, nevertheless, has no legal basis for a claim.  Preliminary objections and a 12-b motions are very similar.  Preliminary objections are filed in Pennsylvania courts, whereas, “12b” motions are a feature of federal court procedure.   The term “Motion to Dismiss” is an informal way of describing either preliminary objections or a “12b” motion.

For example, if a plaintiff sued a defendant for telling plaintiff that he did not like the color of her shirt; the defendant would likely succeed on a preliminary objection or a “12b” motion.  Even if the court were to believe everything the plaintiff said—that defendant did not like the color of plaintiff’s shirt—there is no law that the defendant violated and plaintiff cannot recover.

Similarly, preliminary objections or a “12b” motion can be used to attack technical deficiencies in a pleading.   For example, if a plaintiff sues the defendant in an inappropriate venue, the defendant can challenge that venue using such a motion.

When do you file a motion to dismiss?

Preliminary objections or “12b” motions must be filed before answering a pleading.  In Pennsylvania courts, this means the preliminary objections must be filed within thirty days of service of pleading.  In federal court, a “12b” motion must be filed within 21 days of a pleading.  Objections that are not filed in time are waived.

Why would you file a motion to dismiss?

There are a number of reasons to file preliminary objections or “12b” motions.  Parties often file preliminary objections or “12b” motion to challenge technical deficiencies in a pleading, for example, venue or failure to attach exhibits.

Preliminary objections and “12b” motions can also be used to force an opposing party to clarify the basis of its claim.   Attorneys sometimes, whether as a tactical device or because of incompetence, inject or allow ambiguity and vagueness in their pleadings.  An opposing party may not wish to answer such a pleading as it may require them to disclose more information than they would otherwise or because it allows the filing party latitude to change or modify their claims later in the litigation.  

Preliminary objections and “12b” motions are used to dismiss frivolous claims.  Such motions can allow a party to avoid the need to answer frivolous allegations or conduct discovery. 

Preliminary objections and “12b” motions can be used to challenge novel legal theories.  It is not uncommon that a plaintiff seeks to recover from a defendant using a legal theory that has not been approved by an appellate court.  Preliminary objections and “12b” motions challenge the legal adequacy of such novel theories early in the litigation, thereby allowing the court to either approve a legal theory or reject it and allow the disappointed party to take an appeal. 

There are also dishonest reasons for filing a motion to dismiss.  Some attorneys and firms have a reputation for filing preliminary objections or “12b” motions as a tactical device aimed at delaying a proceeding, increasing their own billable hours and forcing their opponents to incur attorney’s fees to respond.  This practice is both unethical and a violation of the rules but it happens with some frequency, particularly in Pennsylvania courts. 

What happens if we win or lose a motion to dismiss?

Since preliminary objections and “12b” motions test the sufficiency of a pleading, a court is generally required to give a party the opportunity to correct these pleadings.  Thus, if preliminary objections are filed against you and you do not prevail, the court will generally allow an opportunity to amend the pleading.  A party can file an additional motion to dismiss to amended pleadings.

There may be instances where a party cannot “correct” their pleading.  For example, if the plaintiff is advancing a novel theory of law there is no way to add additional facts to a complaint that would validate that theory.  In such instance, the court’s order sustaining preliminary objections or granting a “12b” motion has the effect of dismissing one or more of a party’s claims.  If the order disposes of all claims in the litigation, the disappointed party is put out of court and has a right to appeal. 

If a court overrules preliminary objections or denies a “12b” motion, the party that filed it is required to answer to the pleading they objected to.  For example, if a party files a motion to dismiss to a complaint and the motion is denied, the party will be required to answer the complaint.

Motions for Summary Judgment

During the course of litigation, you may have the opportunity to file a motion for summary judgment.  You may also be forced to respond to a motion for summary judgment filed by another party.   

What is a motion for summary judgment?

To understand a motion for summary judgment, you must first understand the purpose of a trial.  A trial is meant to resolve factual disputes.  During a trial, the fact finder (either a jury or a judge sitting as a fact finder) has an opportunity to review testimony and evidence and weigh its credibility to decipher the truth.  For example, in a case where driver A strikes driver B in an intersection, whether the traffic light was green or red when driver A entered the intersection is factual issue.  If there is a dispute as to whether the light was red or green, a trial is required to resolve that dispute.  At the trial, driver A might testify that he believed that the light was green when he entered the intersection whereas driver B may testify that the light was red.  The fact finder would be required to evaluate the credibility of each witness and make a factual determination as to who is telling the truth. 

If there are no factual disputes in a particular matter, there is no reason to have a trial.  The purpose of a motion for summary judgment is to avoid unnecessary trials in matters where there are no factual disputes.  A motion for summary judgment presents evidence that was gathered in discovery to show that no factual disputes exist and asks the court to apply the law to the undisputed facts. 

Any party may file a motion for summary judgment. 

When is a motion for summary judgment filed?

Under the rules, motions for summary judgment can be filed at any time after the pleadings stage.  As a practical matter however, a motion for summary judgment is typically filed after the discovery phase has concluded and before the trial begins.  Many courts, for example the Court of Common Pleas in Philadelphia and federal court, set strict deadlines in which to file a motion for summary judgment.

What is involved in preparing or responding for a motion for summary judgment?

A motion for summary judgment is generally one of the most elaborate and time consuming motions to prepare.  Each fact set forth in the motion must be supported by evidence obtained during the discovery process.  Each item of discovery cited in the motion must be attached as an exhibit.

A motion for summary judgment or a response to one also contains an argument section that asks the judge to apply the law to the facts in a particular way.  Depending on the complexity or the novelty of a particular claim, this section is often quite detailed.  

What happens if I win or lose a motion for summary judgment?

If plaintiff files a motion for summary judgment and succeeds, the court will issue a judgment against the defendant and there will be no need to proceed to trial.  If a plaintiff files and loses, the matter will proceed to trial.

If defendant files a motion for summary judgment and succeeds, plaintiff’s claims are dismissed and plaintiff is put out of court.  If the same defendant loses, the case will proceed to trial.

These outcomes are sometimes more complicated when a party moves for partial summary judgment.   In a motion for partial summary judgment a party asks the court to grant summary judgment only on a particular issue or claim.  Even if the court grants a motion for partial summary judgment, a matter may still proceed to trial in order to resolve factual disputes associated with other claims. 

Avoid Common Pricing Structure Mistakes When Selling Your Business

 

Negotiating a purchase price for a business is more complicated than haggling for a new car. Most business sales have at least some portion of the price paid after closing.  This raises two questions for the seller - How much am I owed and can I collect it?  We see several common mistakes that business owners make when answering these questions.

 

Using Earn Outs Incorrectly.  

 

An "earn out" is a pricing structure where some or all of the purchase price is contingent upon the business hitting certain performance goals after closing.  A properly used earn out typically overcomes two roadblocks to reaching an agreement on purchase price.  Many disagreements over purchase price arise from disagreement over probability of certain outcomes.  For example, a seller may assert that the business is worth 10 million dollars because it will sell 50 widgets next year.  Buyer may say the business is worth only 8 million because it does believe the business will sell 50 widgets.  An earn out can bridge this gap by making the 2 million dollar difference in purchase price contingent on the business selling 50 widgets.

 

An earn out may also allow the seller to capture value from the acumen or resources of the acquirer.  If a target company has struggled because of lack of capital, market presence or other factors, acquisition by a larger company may increase profitability.  A earn out may allow a seller to capture this upside by providing an additional upside contingent on the business hitting performance metrics that exceed past performance.

 

There are a number of risks associated with an earn out for a seller.  It is often difficult to track whether a business has met its performance goals, particularly when the target business is integrated into an existing operating business.  "Creative accounting," in particular, overhead allocation, can make it appear as if a business is not performing or hitting its marks.  Detailed provisions addressing the purchaser's accounting practices help to reduce risk but such provision are fertile for disagreement and post-closing litigation  

 

Not Knowing Your Purchaser.  

 

If you are "taking back paper" - slang for accepting a promissory note in the place of a cash at closing - in a transaction, you are acting as a bank for your purchaser.  Just like a bank, a well-advised seller should conduct due diligence on the potential buyer to evaluate its ability to make good on its promise to pay.  This includes reviewing the purchaser's financial statements, cash flow, other debts and ability to obtain money from other sources.  A more generalized inquiry into the purchaser's business track record is also important.  How long has the purchaser been in business?  Has the purchaser ever declared bankruptcy or does it have judgment against it?  Is the purchaser highly leveraged?

 

Not Acting Like A Bank.  

 

A bank does not lend money without the borrower putting up collateral to back up its promise to pay; you shouldn't either.  The prudent seller treats the buyer as a bank would.  Without adequate collateral, a seller may have a successful lawsuit against a judgment-proof entity or individual.

 

Of course, not all collateral is created equal.  Clients who want to get the price they negotiated for their businesses like to see letters of credit, mortgages on real property and personal guarantees from the owners (and their spouses) of corporate buyers.  Relying solely unsecured promissory notes from recently formed entities or a security interest in the assets of the business just sold is a recipe for disaster. 

 

No transaction is without risk but thoughtful negotiation and good advice can help to minimize the chances of turning a happy time into a sore subject.

Better Options for Day Traders

The day trading business continues to grow.  As individuals who engage in day trading begin to realize that it can be a career rather than a rewarding hobby, they often begin to consider ways in which they can make the business more profitable.

 

The average individual who invests in the stock market is, from an IRS perspective, an “investor.”  There are strict limits on investors’ ability to deduct losses and the investment expenses they incur.  Since these individuals are merely investing rather than operating a business, they are limited in their ability to deduct losses against taxable income.  Further, investment-related expenses cannot be deducted against income unless those expenses are very high – in excess of 2% of the taxpayer’s adjusted gross income.  Even then, deductions for the expenses relating to the investments may be limited after calculating the taxpayers’ alternative minimum tax (AMT).

“Traders in securities,” on the other hand, have the opportunity to deduct greater amounts of losses and the expenses relating to trading.  The IRS sets a high bar for someone trying to qualify as a trader.  Traders engage primarily in frequent, speculative trading activity, seeking to profit from short-term price fluctuations in the securities traded rather than from dividends, interest or capital appreciation.  Their trading activities must be substantial and carried on continuously and regularly.  In short, a trader devotes a significant amount of time to trading activities and the activities should further the trader’s livelihood.

There is no requirement that traders operate as sole proprietors.  They can form business entities that may offer greater liability protection, provide salaries for themselves and other employees and take advantage of retirement planning opportunities.  Depending on the state where you reside, there may be additional advantages to establishing a business entity in a different state.  Coupling these benefits with the abilities to deduct greater amounts of losses and expenses can result in significant advantages for traders.

Navigating the tax and corporate rules that govern this area can be challenging but they rewards can be substantial.  It is advisable to seek guidance from experienced attorneys and tax professionals who can assist you with determining whether you can qualify as a trader and the appropriate way in which to establish your business venture.   

A “Playbook” for Difficult Negotiations

We routinely advise and prepare clients who are entering difficult or complicated negotiations.  Entering an important negotiation or one with an unfamiliar subject matter can be stressful.  We remind our clients that good negotiators are not born good negotiators; even the worst negotiators can improve with a few simple strategies.  Here are ten we have used successfully throughout the years.

1. Understand your Objectives – It is important to know your own bottom line.  Spend the time to do the financial analysis and talk to the stakeholders within your organization to see what they need to get from the agreement.  It can be easy to lose sight of these objections in the midst of negotiation.  Writing these goals down for your own reference can help to keep you focused.
2. Determine Whether the Negotiations are Recurring – The recognition that you will deal with your counterparty again, either in another negotiation or in the context of an ongoing working relationship, is important.  While this does not mean that you should soften your position, you should avoid a “last-dollar” mentality.  If you “win” too big in a deal, it may make ongoing relationships and future negotiations more difficult.
3. Look for Objective Standards – Attempt to find objective measures of value outside of the negotiation.  Ask yourself how a disinterested third-party might assess risks and assign value.  You might be able to gather objective values by talking to third-party suppliers or purchasers, market data or researching. 
4. Examine Your Starting Point – An extremely high or extremely low offer may offend the other side or may cause them to believe you are not serious.  Keep in mind that counterparty may be more inclined to walk away from negotiations early – before they have invested substantial time and money in the negotiation – if they feel your starting point is unreasonable.
5. Don’t Lie – Lying in negotiations has little chance of improving your position and has serious risks.  Maintaining your credibility is critical in negotiations; once lost, it is difficult to reclaim.  Trying to keep lies straight is mentally taxing and distracting.
6. Negotiation is Key – Some back and forth is desirable.  If an offer is accepted early and negotiations are settled very quickly, it may lead to questions about the success of the outcome.  Many people need negotiation to make them feel as if they have received a fair price.  Do not start a negotiation with your bottom line.  Allow the process to give the other side confidence they have found your bottom line.  On the other hand, avoid offers that increase your previous proposal by a miniscule amount.  They are a waste of everyone’s time.  Proposals should be substantial enough that it makes an impact on the opposing parties’ response.
7. Avoid Bidding Against Yourself – Never let the opposing party force you to bid against your proposal.  “Bidding against yourself” means changing your proposal before the other has even responded to it.  Negotiating against yourself only ends up changing your offer with no concessions from the other side.  Statements such as, “I have no authority to offer this but would you take $X dollars (which is lower than your last offer)” should not cause you to lower your number.  Make sure the opposing party offers a real proposal before you respond with a real proposal.
8. Explain your reasoning – Explaining your reasoning can help to enlist the other side in helping to reach your goals.  It can lead to a “win/win.”  It can also provide a viable impersonal focus for discussions.
9. Get Comfortable with “No” – Naturally, individuals want to say “yes” – it is socialized and hardwired into us.  Although saying “no” can be uncomfortable, it is liberating and gets easier over time.  Your ability to quickly and definitively say “no” depends on how well you know your own position.
10. Don’t Split the Difference – It is normal when a negotiation is coming to a close for someone to suggest splitting the gap between the two offers in order to settle the deal.  This is unwise since it reveals to the other side that you are willing to settle on a number between the current proposals.  A skilled negotiator will then try to move you from that amount, leaving you with less than half of the difference.

Independent Contractors and “Works for Made Hire”

Use of independent contractors for tasks traditionally performed by employees has become an increasingly popular business model.  Many businesses use independent contractors to produce original works such as software code, marketing materials, websites, CAD drawings, blueprints and designs.  Although a viable business strategy, using independent contractors to create these materials can result in disputes over ownership.

Many businesses assume that, since they paid for the work, they own it.  The United States Copyright Act, however, provides a potentially counter-intuitive answer.

Authors Usually Own What They Produce

As a general proposition, the author of a creative work automatically owns the work without the need for any additional action.  This is true for independent contractors.  For example, if a business were to hire a contractor to produce a sequence of computer code for use in one of the business’s products, the contractor would own the code and be able to use it in any matter the contractor wishes, including selling it to competitors.

Independent Contractors and “Work Made for Hire”

The “work made for hire” doctrine contained in the Copyright Act provides an exception to this rule.  If a creative work is a “work made for hire” the business commissioning the work, and not its creator, owns the work.  In order for a contractor’s work to be considered a “work made for hire,” it must satisfy several conditions: (1) it must be “specially ordered or commissioned” by the business; (2) must fit into one of nine enumerated categories identified in the Copyright Law; and (3) must be produced pursuant to a written agreement that specifically identifies the material as a “work made for hire.”

The first and the third requirements are typically satisfied together.  A well-drafted written agreement that “specifically orders or commissions” a work should also include language identifying the work as a “work made for hire.”  This written agreement will often take the form of an “independent contract agreement” or an “agreement for services.”  Indeed, businesses should already employ independent contractor agreements to cover important issues like compensation, quality of work, delivery schedule and indemnification.

Copyright law further restricts the scope of “works made for hire” to material used: (1) as a contribution to a collective work; (2) as a part of a motion picture or other audiovisual work; (3) as a translation; (4) as a supplementary work; (5) as a compilation; (6) as an instructional text; (7) as a test; (8) as answer material for a test; or (9) as an atlas.  These categories limit the usefulness of the “work made for hire” doctrine for many businesses.

A well-drafted independent contractor agreement can typically overcome these limitations with language assigning ownership of a work from the independent contractor to the business that retained it.  In the event that a work is deemed not to be a “work made for hire,” the agreement would automatically convey ownership of the work to the business.

Conclusions

Well-drafted independent contractor agreements can minimize the risk of ownership disputes over the creative works developed by independent contractors.  Businesses should also consider adding “work made for hire” and assignment language to any form agreements they use with such contractors.

Alternatively, the Copyright Act is much more liberal for works created by employees in the scope of their employment.  Such works are automatically considered “works made for hire” and are not limited to nine categories mentioned above.  Depending on a business’s need for certain creative materials, using employees rather than independent contractors may make sense.

Owner Exclusion from Title VII

A recent case from the Third Circuit, the federal appellate court covering Pennsylvania, clarifies the limitations of employment laws for owners of closely-held corporations.

Mariotti v. Mariotti Building Products, Inc., No. 11-3148, 2013 WL 1789440 (3d Cir. April 29, 2013).

Plaintiff, Robert Mariotti, was an officer, shareholder, and director of Mariotti Building Products, Inc. (MBP) which was a closely held family business started by Plaintiff’s father, Louis Mariotti.  The Plaintiff served as both vice-president and secretary to the company.  Plaintiff and his brothers were employed in the business pursuant to an agreement which provided for termination “only for cause.”  In 1995, Plaintiff had a “spiritual awakening” which he claimed resulted in “systematic antagonism” from the company’s officers, directors, and some employees. 

In early 2009, after the death of Plaintiff’s father, Eugene Mariotti, Plaintiff’s brother, derided Plaintiff and his faith.  At the funeral, Plaintiff gave a eulogy, which included comments about his faith, which upset some family members.  Two days later, the shareholders of MBP convened without the Plaintiff and voted unanimously to terminate his employment.  On January 10, 2009, the Plaintiff received notice of his termination in a letter that explained that certain benefits would cease, including health insurance and access to company credit cards.  The letter further indicated that Plaintiff would continue to receive a draw from the corporation.

After his termination, Plaintiff remained a member of MBP’s board of directors until August 2009 when the shareholders did not reelect him as a director.  The Plaintiff then filed a charge of religious discrimination and hostile work environment in violation of Title VII of the Civil Rights Act of 1964 against MBP.  MBP moved to dismiss the claim, arguing that the Plaintiff was not an employee under Title VII and therefore could not invoke its protections.  The District Court granted the motion and Plaintiff appealed.

The Third Circuit upheld the District Court’s dismissal, holding that the Supreme Court’s test in Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440 (2003) applies to business entities that are not professional corporations.  The Third Circuit, applying Clackamas, looked to the following six factors from the Equal Employment Opportunity Commission (EEOC) to determine whether Plaintiff was an employee for purposes of Title VII:

[1.] Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work

[2.] Whether and, if so, to what extent the organization supervises the individual's work

[3.] Whether the individual reports to someone higher in the organization

[4.] Whether and, if so, to what extent the individual is able to influence the organization

[5.] Whether the parties intended that the individual be an employee, as expressed in written agreements or contracts

[6.] Whether the individual shares in the profits, losses, and liabilities of the organization.

The Third Circuit concluded that the Plaintiff was not an employee for purposes of Title VII.  The court noted that the analysis focused on the amount of control and the source of the individual’s authority.  After reviewing the Plaintiff’s complaint, the Third Circuit found that his status as a shareholder, director, and corporate officer gave him significant control and authority at MBP.  As a director and corporate officer, Plaintiff had the ability to participate in fundamental decisions of the business. In addition, the Plaintiff continued to serve on the board of directors after his termination until August 2009. The court further noted that the termination letter did not cease Plaintiff’s salary.  The Third Circuit therefore concluded that the Plaintiff was not an employee for purposes of Title VII.

Take Away

Business owners do not receive all of the legal protection of employees.  The Clackamas / Mariotti line makes clear that business owners do not receive the protections of the Americans with Disabilities Act (“ADA”) or Title VII.  Similarly, a business owner is not entitled to collect unemployment compensation upon termination.  Whether a person is a “business owner” for these purposes depends on the level of control they can exert over the business and ownership alone is not dispositive.

The business owner need not be at the mercy of a group of fellow shareholders however.  There are contractual ways for an owner to protect him or herself.  Shareholder agreements that require other shareholders to purchase the shares of a terminated shareholder is one such alternative.  Employment agreements that incorporate the ADA and Title VII by reference may also create a breach of contract claim that is co-extensive with the statutory rights that the business owner would otherwise be ineligible.

Assets or Stock: The Form of Purchase DOES Make a Difference

Purchasing or selling a business can be accomplished in a number of ways. While the objective of the transaction is always the same – transfer of ownership from a seller to a buyer – the form of the transaction does make a difference. When it comes to the purchase or sale of a business, the form of the sale has significant implications, not only at the time of sale but with regard to operations going forward.

The purchase or sale of a  business is generally accomplished by either a stock sale or a sale of substantially all of the assets of the company. The form of the transaction has important implications for both buyers and sellers in several key areas:

Liability

Purchasers of stock essentially “step into the shoes” of the seller. This means that the purchaser assumes all of the liabilities of the acquired business – whether known or unknown, whether past or future. Such liabilities may be extensive and include liability for debt or purchases; losses arising from injuries caused by products or services provided by the purchased entity; claims of trademark or patent infringement; and liabilities based on employment discrimination, wrongful termination or violation of wage and hour laws.

Constructing the transaction as a purchase of assets of the company may enable a purchaser to avoid some potential liabilities inherent in a stock transaction. Yet, even asset purchases carry some risk of assumption of unknown liabilities. Asset purchasers may be responsible for undisclosed liabilities if it appears that they have implicitly accepted liabilities, or where there is sufficient continuity of enterprise that the transaction can be considered a de facto merger.

Scope of Purchase

One of the advantages of an asset purchase agreement is the opportunity it affords the buyer to “pick and choose” the assets that the buyer deems most desirable for the business. Obsolete inventory or redundant equipment can remain with the seller, in contrast to a stock purchase that transfers every and all assets owned by the business. Asset buyers, however, must be careful to ensure that the asset purchase agreement has a complete and comprehensive description of all of the assets necessary to operate the business or they will face some unwelcome surprises at closing.

Taxes

Tax and accounting treatment for asset purchases vary significantly from that afforded stock transactions. Purchasers of stock continue to carry assets on the books on the same basis as the seller. Stock sellers recognize a gain to the extent the sale price for the stock exceeds their basis.  In contrast, an asset sale requires the buyer to adjust the basis of the assets that are acquired based on the fair market value. This may result in an increase or decrease in the book value and depreciation for such assets.

What is clear is that no form of transaction – stock purchase or asset purchase – is inherently “good” or “bad.”  Each form has advantages and disadvantages for buyers and sellers and the decision of which form to adopt can be difficult – especially since what advantages one party may be disadvantageous to the other. In many cases, other elements of the transaction can be used to reduce risk and to satisfy the core objectives. 

Five New Year’s Resolutions For Family Business

January is over and we have already stopped going to the gym, started eating ice cream and gave up on organizing our sock drawers.  Now is a perfect time to set some more realistic business resolutions for the upcoming year.  Most family businesses set sales or profitability goals but sometimes overlook the more mundane items that come back to bite them.  We propose five simple, specific and achievable goals for 2015:

Plan Your Exit (Or Your Escape) – Many of our family business clients have never seriously considered what will happen to the business if key family members involved in the business were unable to continue because of retirement, death or disability.  Many more of our family business clients have never seriously considered what would happen to the business if family members begin feuding.  Perhaps it is not surprising that some of the nastiest shareholder disputes arise between family members. 

Failure to plan for these contingencies can result in significant and avoidable taxes when transferring ownership of a business to the next generation.  It can deprive a disabled family member or their heirs from being able to capture any value of a business they helped develop.  It can destroy the value of a business with fighting between family members who cannot stand to work together and have no fiscally viable exit.

Keep An Eye On The Money – If you are a passive owner (i.e. not engaged in the operations) of a family business, you have a statutory right to look at the book and records of the company.  You should do that once and a while.  Books and records (or the lack of them) can provide a wealth of information about how the business is being run and whether you are getting the income that is owed to you.  It also helps to keep operating family members honest.

Clean Up That Corporate Binder – Our family business clients tend to take two approaches to corporate record keeping – the overstuffed corporate binder where some, but not all, of the three hole punched paper holes have torn through such that five pages hinge out when you hold it up or the “what are you talking about” corporate binder that never existed in the first place.

If you are a corporation, you need to make at least one entry into your corporate record book each year.  Major business events should also trigger minute entries in your books, for example, the sale or purchase of significant assets.  If you are an LLC, the annual administrative record keeping requirements are more relaxed but major business events should be reflected in the corporate minutes. 

Fresh Faces, Fresh Ideas, Reduced Liability – Consider inviting non-family members to become involved in your family’s board of directors or advisory board.  As a matter of good corporate governance, non-family members tend to bring less baggage and can offer a fresh perspective than family members.  The existence of “disinterested” board members (i.e. ones who have no personal interest in the particular matter before the board) allows a family business to proceed with less risk of shareholder litigation from family member owners disenchanted with a particular action of the board
 
Sharpen Your “Bread and Butter” Contracts – Almost every business uses and reuses “bread and butter” form agreements to buy things, sell things, license things, employ people or mitigate risk.  When was the last time a C-level person or the company’s general counsel reviewed them?  Have any of the form agreements been tested with litigation and, if so, are there any modifications that could have prevented the litigation in the first instance.

Get your former boss to sue you in three easy steps

 

We spend a good deal of time advising clients on how to stay out of court.  Some clients, however, find this approach too conservative, stodgy or dull and would prefer to be involved in otherwise avoidable litigation.  They often complain "things are just going too well for me" or "I need some drama in my life."  Since we do not want to alienate any client or potential client with practical, financially sound legal solutions, we are offering some tips on how to end up in court, lose money and dismantle that which you worked hard to build.  Of course, if you are like most of our clients, we strongly suggest that you disregard everything that follows.

 

You have been with your current employer for some time and you are good at what you do.  It's time to leave the nest to start your own company.  You like to challenge yourself, so rather than focusing solely on your new endeavor, you want to leave your current employer in such a way that you can be sure they will initiate distracting, time-consuming and expensive litigation against you.  Here are a few suggestions to assure this result:

 

Steal things.  Nothing makes your former employer happier than when you steal things before you leave.  Staplers and mouse pads are a nuisance but customer lists, proposals to clients, pricing information, form documents or product specifications should get you into court quickly.  Since most of these items are stored electronically, downloading them to a thumb drive or emailing them to your personal Gmail account should leave an easy trail for your employer's IT department to track. 

 

If you are clever enough to steal these items, you should expect your employer to seek a preliminary injunction - an order from a court to do or not do something - prohibiting you from working.  Because of the emergency situation you have created for your employer, you should expect to incur significant legal fees quickly to prepare for significant court events early in the litigation.

 

Breach your non-compete.  Restrictive covenants that limit a person's ability to make a living are enforceable under Pennsylvania law but are disfavored and courts look closely at them to determine whether they are really necessary to achieve an employer's legitimate business interests.  In light of the opaque legal standard and the desire the avoid litigation, a negotiation between the former employer, employee and new employer regarding the scope of the employee's employment is often a reasonable solution.  The strength of the restrictive covenant, the employee's role in the company and the job responsibilities at the new company would all inform this negotiation.  But what's the fun in that?

 

The adventurer leaves his employment by providing no notice to the former employer.  He immediately begins work with the direct competitor located just down the street doing the same job he did with the former employer. 

 

"Soften" your transition by diverting opportunities.  Even absent any employment agreement, Pennsylvania law imposes a duty on employees to be loyal to their employers.  This means that diverting customers, projects or opportunities that come to you because of your job may be a problem if you want to stay out of court.  Although an employee may make plans and take steps to start a new venture while still employed, they may not do it on the employer's time or using the employer's resources.

 

The buccaneer business person will tell their customer contacts and subordinates that they are leaving months before they alert their employer.  Since the departing employee wants to make sure she has the best employees for her new venture, she makes employment offers to all her subordinates.  She will quietly promote her new venture at trade shows and other events that she is attending on behalf of the employer.

 

Take Away

 

If you are considering leaving your employment, engaging in this type of behavior carries a significant risk of litigation.  The law is generally reluctant to restrain the free movement of labor but there are limits.  

 

GROWING THROUGH ACQUISITION: NOT JUST FOR THE “BIG GUYS” ANY MORE

“Entrepreneurship” is frequently defined as “starting” or “developing” a business venture or idea.  While many entrepreneurs do start a business from “scratch,” others purchase a going concern or selectively buy assets that can enhance their own opportunities to grow.  Growing through acquisition – which frequently makes financial headlines – is not just for publically traded, high profile companies. Medium and small firms can use acquisitions to implement strategic objectives and build their business. Acquisitions may make strategic sense

·         to jump start entry into a new product line

·         to access or expand a customer base or distribution channels

·         to acquire technology or expertise

·         to facilitate entry into a new geography

·         to increase sales or reduce costs

The recent economic downturn has had the effect of making many respected and well run firms take a look at core competencies and shed assets or divisions that no longer “make sense” for their business model. Such divestitures create opportunities for entrepreneurs willing to devote the time and attention necessary to maximize value. Even in the best of times, business founders frequently look for opportunities to “cash out.”  Acquiring businesses from the folks who built them – frequently with the opportunity to tap the experience and talent of the founders as part of a well planned transition – gives entrepreneurs a competitive and strategic advantage in the market. Moreover, increased access to both private and government funding allows even small and mid-size firms to take advantage of growing through acquisition.

Acquiring a business is an important decision.  Not only does the purchaser risk losing his investment, undisclosed and unanticipated liabilities might affect the bottom line for years to come. However, with planning and counsel, purchasers can avoid many of the pitfalls associated with an acquisition. Some important steps to consider:

Assemble A Team

Business acquisition is not a “do-it-yourself” venture.  Even an experienced manager may need qualified experts to help make a strategic decision about the value of the business and whether it meets his needs.

A fundamental understanding of the financial infrastructure of the business being purchased is critical. An accountant can be instrumental in helping to understand the financial health of the business and in navigating the tax implications of the transaction.

Transactional attorneys skilled in the purchase and sale of businesses of comparable size can assist in identifying and reducing risks.  Attorneys can assist in negotiating the purchase; identifying and evaluating critical issues; and drafting the operative documents.  In transactions with post-closing obligations – such as subsequent payments to the seller or non-competition agreements – knowledgeable counsel can assist in assuring that the buyer realizes the value in his purchase.
When financing an acquisition through debt, early contact with the lender is important to understand the availability of funds and the terms and conditions that will apply. Careful review of loan and financing agreements will eliminate the risks of hidden fees and provide a clear understanding of any other financial obligations.

Retaining a business broker or consultant may also be of great assistance when valuing a possible acquisition target.  Valuing a business can depend on a number of factors including sale prices of comparable businesses; the industry in which the business operates; and estimated growth.  Access to a broker or consultant – particularly during the process of valuing the business – can avoid “buyer’s remorse” if you believe you have overpaid.

Depending on the type of business, other expertise may be beneficial.  For example, if the business has trademarks, service marks or patents, intellectual property counsel is advisable. If real estate is part of the transaction, the team may include inspectors and environmental engineers.

Decide On Assets or Stock

One of the early decisions in the acquisition process is the decision whether to purchase the equity of the business or the assets. The decision on how to structure the transaction has a significant impact on how the transaction is taxed; what liabilities are assumed; and whether the contracts of the business continue in effect after the transaction.  While purchasers frequently prefer an asset sale where they can select the specific assets they wish to acquire, the decision on the form of the transaction should be made with an understanding of the business as a whole, including the potential reaction on suppliers and customers.

Decide On Your Purchase Price

The final price that is paid for a business is usually result of a negotiation process. Nonetheless, buyers should have a good sense of how to value the business and how much they are willing to spend to acquire it.

The price of a business usually consists of a base price and a number of “adjustments” that are made to reflect the changes to the base price.

There are a number of ways of determining the base price. One of the most common is a price equal to a multiple of sales or income. For example, a business whose annual in income is $3 million dollars might carry a multiple of 5 in one industry for a total sale price of $15 million, but carry a multiple 8 in another industry, with a resulting sale price of $24 million. In some industries, sale price is a function not of income but of other parameters – such as customer acquisition or profit. Multiples are also dependent on economic conditions – both in general and in specific industry. Whatever the process, a consideration of recent multiples used in valuing comparable businesses provides an external validation that the business being acquired has as much value to the market as to the individual purchaser.

Engage in “Due Diligence”

Due diligence is the investigation undertaken by the buyer prior to purchasing a business. Frequently buyers will not be allowed to engage in due diligence until they have executed a Non-Disclosure Agreement. The Non-Disclosure Agreement (NDA) obligates the buyer to maintain the confidentiality of any information that he receives from the seller as part of the due diligence process. Due diligence provides the buyer with an opportunity to better understand – and appraise – the business that is being purchased. The scope of due diligence varies widely and is sometimes the subject of negotiation between the buyer and seller. Some important areas of inquiry include:

·         Identification of key assets and assessment of their condition

·         Review of financial statements for current and preceding years, with particular emphasis on bad debt and other expenses

·         Identification of key employees and employment agreements

·         Review of any past or pending litigation and any notice of claims that might lead to litigation

·         Assessment of environmental liabilities associated with products or real estate

·         Review of employee benefits and outstanding liabilities

·         Review of customer contracts, licensing agreements and supplier agreement

·         Identification of key suppliers

·         Identification of future capital needs

·         Interviews with customers, suppliers and key employees

·         Evaluation of insurance coverage

While a comprehensive due diligence process will not eliminate all risks for the buyer, it does offer an opportunity for the buyer to assess such risks, and if warranted, seek an adjustment in purchase price.

Document The Transaction

“Papering over” a transaction – drafting the legal documents that describe the transaction and transfer the business – may occur at different stages of the transaction. Parties sometimes execute a “Letter of Intent” indicating their intent to proceed to a final Purchase and Sale Agreement, subject only to certain identified conditions. Letters of Intent can present legal challenges. Parties sometimes sign such agreements, believing that they are not undertaking any legal obligations. Despite language that sometimes implies that such agreements are without legal effect, letters of intent have been the basis of damage awards.

Once the contours of a transaction have been agreed on, counsel prepares a Purchase and Sale Agreement that identifies all of the details of the transaction, including but not limited to the sale price and the basis for any adjustments; a description of the assets and/or stock being purchased; disclosures of liabilities and potential liabilities by the seller; and any post-closing obligations of either party. The provisions of the Purchase and Sale Agreement must take into account the risks and conditions specific to the business that is being sold. A well-drafted document ensures that neither buyer nor seller will be “surprised” during the transaction and provides a framework for cooperation in the period after the sale takes place.

Buying a business can be stressful and risky. One size does not fit all. The most successful transactions are those that recognize the unique risks and rewards in a particular acquisition and uses the law to accommodate the needs of the parties.  With proper counsel, even small to mid-size firms can reap the benefits of growing through acquisition.