Business Law and Transactions Law Blog
Labor and Employment
Federal Court Denies ATS Tree Services' Bid to Delay FTC Rule Implementation
On July 23, 2024, U.S. District Judge Kelley Brisbon Hodge, serving the Eastern District of Pennsylvania, rejected ATS Tree Services LLC’s request to delay the Federal Trade Commission’s (FTC) final rule, set to take effect on September 4, 2024. ATS also sought a preliminary injunction against the rule. Still, Judge Hodge also denied this request, concluding that ATS had not shown that the rule would cause irreparable harm or that it could establish a likelihood of success on the merits. This decision followed shortly after U.S. District Judge Ada Brown of the Northern District of Texas issued a preliminary injunction blocking the FTC from enforcing the rule against Ryan, LLC, a tax preparation company, and certain intervenors. Judge Hodge’s denial of ATS's motion was based on a determination that ATS had failed to prove it would suffer irreparable harm because of the rule. The court found that ATS’s claims of irreparable harm—such as nonrecoverable compliance costs and the potential loss of contractual benefits— were based upon either a choice or a “speculative risk,” which did not rise to the level of irreparable and immediate harm required for an injunction. The court cited Third Circuit precedent, stating that nonrecoverable compliance costs, such as monetary losses or business expenses, do not constitute irreparable and immediate harm required for an injunction. Additionally, the court held that ATS offered no binding precedent to support its argument that the loss of contractual rights is an irreparable harm, reiterating that such determinations must be on a case-by-case basis. Even if ATS could establish irreparable harm, the court found that it had not demonstrated a likelihood of success on the merits. Judge Hodge’s opinion included a detailed analysis of the FTC’s authority to issue substantive rules regarding unfair methods of competition. The court confirmed that the FTC has such authority, noting that Section 6 of the FTC Act does not limit the FTC to procedural rules alone. The use of the term "prevent" in Section 5 of the Act supports the FTC's ability to make rules to prevent harm before it occurs rather than merely remedying it. The court also referenced prior circuit court decisions and Congressional actions, such as the Magnuson-Moss Act, which affirmed the FTC’s rulemaking authority. The court also addressed ATS’s other challenges to the rule. It upheld the FTC’s authority to broadly regulate non-compete clauses as unfair methods of competition, rejected claims that regulation of non-competes is solely a state matter, and found that the Major Questions Doctrine does not apply to the rule. Additionally, the court dismissed ATS’s nondelegation challenge, affirming that Congress had provided a clear guiding principle for the FTC’s rulemaking authority under the FTC Act. Given these findings, the court did not need to evaluate the balance of equities or public interest considerations. This ruling is significant for several reasons. It contrasts with the earlier decision in Ryan LLC v. Federal Trade Commission, where Judge Brown granted a preliminary injunction, suggesting the plaintiffs would likely succeed on the merits. The Texas court has indicated it will decide on the enforceability of the FTC rule by August 30, 2024. While Judge Hodge’s decision represents a victory for the FTC, it may be temporary. The Texas court’s preliminary injunction in Ryan LLC hinted at potential future invalidation of the rule based on arguments that the FTC lacked statutory authority or that the rule was arbitrary and capricious under the Administrative Procedure Act (APA). If the Texas court rules against the FTC, it might vacate the rule entirely or issue a permanent injunction, though the specifics are yet to be determined. In the meantime, businesses should continue to assess and document their use of non-competes and explore alternative protections like non-disclosure agreements, invention protection, non-solicits, training repayment programs, garden leaves, and non-competes related to business sales. The FTC’s guidance suggests that if properly structured, these alternatives should comply with the new rule. Additionally, state legislation and actions by other federal agencies, like the National Labor Relations Board (NLRB), may further influence the legal landscape regarding non-competes.
August 7, 2024
Business
Supreme Court Overturns Chevron Deference in Landmark Loper Bright Decision
On June 28, 2024, the Supreme Court issued its decision in Loper Bright v. Raimondo and Relentless v. Department of Commerce. As expected, following oral argument, the Court overruled the Chevron deference doctrine in a 6–3 decision written by Chief Justice John Roberts. The doctrine stems from a 1984 Supreme Court case, Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc, 467 U.S. 837 (1984), establishing a two-step analysis for judicial review of statutory interpretation. Under Chevron, if a court concluded that a statute was silent or ambiguous, it had to defer to an agency’s permissible construction of the statute. Now, under Loper Bright, courts must “exercise their independent judgment” and “may not defer to an agency interpretation of the law simply because a statute is ambiguous.” Supreme Court Review: Chevron Doctrine's Applicability to Cases Post-Loper Bright In Loper Bright, two sets of fishing companies challenged a rule issued by the National Marine Fisheries Service requiring vessels operating in the Atlantic herring market to pay for a government-certified observer during their fishing trips. Applying Chevron, the district court in each case rejected the companies’ challenge to the observer rule and granted summary judgment to the government. Panels of the U.S. Courts of Appeals for the D.C. Circuit and First Circuit affirmed these decisions. The U.S. Supreme Court granted certiorari in both cases on the limited question of whether Chevron should be overruled or clarified. Supreme Court's Interpretation of APA in Loper Bright The Loper Bright decision is premised on what the majority believes is a plain text reading of the Administrative Procedure Act (APA), which governs judicial challenges to agency actions. The Court specifically determined that the APA, which was not considered in Chevron, reflects the traditional understanding of the judiciary's role. This role requires courts to independently interpret the meaning of laws. The Court dismissed the notion of a “presumption” of agency expertise, explaining that resolving unclear laws falls within the court’s jurisdiction, not the agencies. Put another way, while courts may use an agency’s interpretation to help “inform their inquiry,” they cannot dictate how courts interpret the law. The Loper Bright Court also rejected the idea that Chevron promotes consistency, highlighting inconsistencies in its application. Furthermore, it concluded that adherence to Chevron is not mandated by stare decisis. Chevron had proven “unworkable” because determining whether a statute is ambiguous is an indeterminate exercise. Consequently, the Court vacated and remanded the lower court’s decisions. Supreme Court Opinion: Chief Justice Roberts and the Majority Chief Justice Roberts delivered the opinion of the Court, in which Justices Thomas, Alito, Gorsuch, Kavanaugh, and Barrett joined. Justices Thomas and Gorsuch each filed concurring opinions. Justice Kagan filed a dissenting opinion, in which Justices Sotomayor and Jackson joined.
July 12, 2024
Labor and Employment
Texas Court Blocks FTC Non-Compete Rule: What It Means for Businesses
On July 3, 2024, a federal district court in Texas took a significant step, temporarily blocking the Federal Trade Commission's (FTC) proposed rule banning non-competes. U.S. District Judge Ada Brown for the Northern District of Texas granted the motion for preliminary injunction filed by plaintiffs Ryan LLC and plaintiff-intervenors U.S. Chamber of Commerce, Business Roundtable, Texas Association of Business, and Longview Chamber of Commerce, effectively putting the FTC’s rule on hold for the named plaintiffs. Although the stay is temporary pending the court’s final decision on the merits of the case and applies only to the movants, it signals that a permanent and nationwide injunction is likely. Background on the FTC's Non-Compete Rule As a quick refresher, in April 2024, the FTC narrowly passed a rule along party lines intended to ban future non-compete agreements and nullify most existing ones. The FTC asserted its authority to enact this rule under Section 6(g) of the FTC Act, claiming it grants the power to establish substantive rules against unfair competition. Set to take effect on September 4, 2024, the rule would prohibit all new employment-related non-competes and invalidate nearly all existing ones. Ryan LLC and others immediately challenged the rule in court on various grounds. Judge Ada Brown's Ruling on the FTC Rule Judge Ada Brown, a former President Trump appointee, ruled in favor of the plaintiffs, determining that they successfully demonstrated all the necessary criteria for a preliminary injunction: (i) a strong likelihood of winning the case; (ii) a significant risk of irreparable harm if the injunction wasn't granted; and (iii) a favorable balance of the potential harms and benefits to both parties. Judge Brown’s opinion focused on two key points: The Scope of the FTC’s Authority: The court’s determination that the FTC lacked statutory authority to enact the rule is significant, particularly considering its alignment with the "major questions" doctrine. Historically, the FTC has disclaimed such power, but Congress has not expressly granted it. The court's reasoning aligns with the recent trend of limiting agencies' authority, echoing concerns in the "major questions" doctrine. Whether the Rule is Arbitrary and Capricious: Judge Brown ruled that the rule was arbitrary and capricious under the Administrative Procedure Act (APA) due to its overbroad nature and lack of supporting evidence. The opinion noted that no state has enacted a ban as broad as the one proposed by the FTC, and the FTC failed to justify its sweeping approach or consider less disruptive alternatives. Additionally, the court agreed that the rule would cause irreparable harm to the plaintiffs' businesses and that the balance of equities favored maintaining the status quo. Current Status and Potential Developments of the FTC Rule While the injunction only applies to Ryan LLC and the U.S. Chamber of Commerce (and not its members), no entities will be subject to enforcement before the rule's intended effective date of September 4, 2024. Additionally, Judge Brown indicated that she intends to issue a final ruling by August 30, 2024, which could invalidate or permanently enjoin the rule. In the interim, the parties will further brief the merits issues and the narrow scope of the court’s order, including whether the injunction should be expanded nationwide. A separate challenge brought by ATS Tree Services LLC is pending in Pennsylvania, with a hearing scheduled for July 10, 2024, potentially resulting in a nationwide injunction 1. This underscores the potential nationwide impact of the ongoing legal proceedings. Impact on FTC's Rulemaking Authority This ruling is a significant setback to the FTC's agenda to expand its rulemaking authority and regulate labor markets. It reflects a broader trend of constraining administrative agencies following the Supreme Court's recent decision (issued June 28, 2024) in Loper Bright Enterprises. In Loper Bright, the court overruled Chevron’s deference. It concluded that courts must interpret statutes de novo, and agency interpretations are not entitled to deference. The court found that even where a statute is “ambiguous,” there is a single “best reading” of the statute that courts, not agencies, are responsible for determining. Previously, courts often deferred to agencies under the Chevron doctrine if their interpretation of an ambiguous law was reasonable. However, Loper mandates that courts independently assess whether an agency acted within its authority, regardless of statutory ambiguity. This means the Ryan court's final decision will heavily depend on its own interpretation of the FTC's statutory power. Given this new precedent, it is plausible to expect the FTC's rule may be overturned, at least in part. The business community, which has strongly opposed the rule, likely sees this as a positive sign. However, state-level efforts to limit non-competes continue, and the National Labor Relations Board (NLRB) has taken the view that the proffer, maintenance, and enforcement of non-competes generally violate the National Labor Relations Act 2. Proactive Review of Non-Competes: Alternative Strategies Businesses are advised to proactively review their use of non-competes across their organization and explore alternative strategies to safeguard their interests. These alternatives include: Non-Disclosure Agreements (NDAs) Intellectual Property Protection Non-solicitation agreements Training Reimbursement Programs Garden Leave Clauses Non-Competes Linked to Business Sales The FTC has indicated that, when properly structured, these alternatives should not violate its proposed rule. _____________________________________________ 1 ATS Tree Services, LLC v. FTC, No. 2:24-cv-1743 (E.D. Pa. 2024). 2 On June 13, 2024, an administrative law judge for the NLRB held that certain non-compete and non-solicit covenants violated an employee’s labor rights under the NLRA. See J.O. Mory, Inc., 25-CA-309577, 25-CA-336995, JD-36-24 (2024).
July 10, 2024
Business
Compensation of Target Management Teams in Private Equity M&A
The typical private equity-sponsored buy-out includes the seller’s investment in the future growth of the target company’s valuation, a bargain for the participant’s active participation in the target company and buy-in for success. The customary approach for private equity buyers is to convey equity participation through equity-based incentive plans. There is a lot of appeal for both buyers and sellers to entertain deal structures with an equity-based compensation component to satisfy cash flow requirements, participant commitment and the creation of a common goal in the success of the target company. Both parties should be aware of the complexities associated with equity compensation which can present some disadvantages that are not discovered until after closing. Common forms of modern equity compensation include stock, stock options or warrants, profit participation and stock appreciation rights (and the limited liability company equivalents thereof). Each type of equity compensation has its own unique advantages to buyers and participants as well as potential negative consequences for both. Many of these structures are chosen over other structures for their total cost considerations and legal features that meet the operative requirements of the buyer. Both buyers and target management should factor these cost considerations and legal features in their offer and acceptance of this compensation. At a high level, here are a few of the considerations applicable to most all equity-based compensation schemes: With few exceptions, all equity-based compensation schemes have restrictions and conditions imposed on their receipt, retention, exercise and disposition. These limitations serve to align compensation with the long-term company performance requirements with the ability to mitigate against short-term behaviors. The most common restriction is a restriction on a participant’s resale of the equity-based compensation, making the opportunity unique only to the participant. A follow-on close-second restriction is the issuer’s right to ‘claw back’ or repurchase the equity compensation at the same or lesser value than its original valuation, a mechanism that aligns equity ownership with a participant’s active engagement. The common ‘management rights’ conveyed to institutional investors are commonly omitted in private equity-backed equity-compensation plans, including transactions for roll-over equity, to limit participant involvement and visibility of management discussions and information utilized by the company. Statutory rights are the minimum threshold and commonly the norm. Economic participation can come in the form of quarterly payments, annual payments, one-time payouts upon sale and the allocation of profit and loss. For private-equity sponsored plans, economic participation can have a minimum valuation threshold that the target must achieve and with exception to allocations, they are most-commonly limited until the target company’s liquidity event, which can be years later. Liquidity events include IPOs, sales and sometimes recapitalizations. Tax implications of equity-based incentives can vary between the types of equity-compensation conveyed. Synthetic forms of equity-compensation are typically taxed as income whereas traditional forms of equity ownership have capital gains treatment upon disposition. These tax consequences can occur at the time of conveyance, at vesting or disposition. For tax purposes, company and participant interests are not always aligned. Private equity buyers intend to provide value with the implementation of equity compensation plans. Each type of equity compensation has its own features, making it advantageous in some circumstances and not so in others. Firms frequently roll out an enterprise equity compensation plan that utilizes the same type of equity compensation plan throughout their portfolio to allow for a familiar and efficient form of management. Plans can vary greatly between different firms and participants can find distinctive and meaningful differences between plans although much of these distinctions remain unknown to would-be participants and are not discernable during the due diligence phase of a transaction.
July 3, 2024
Business
A Look at the U.S. Private Equity Middle-Market
There is some good news to report in the Private Equity (PE) world. PitchBook has released its US PE Middle Market Report, showing continued YoY growth for middle-market dealmaking in Q1 of this year. PitchBook cites recovery of deal multiples, an improvement in borrowing costs and a focus on selling the best assets as key features in publicized transactions. Here are some of the key findings from the report: Deal Values Are Up, Deal Count is Flat: PE middle-market dealmaking hit an all-time high in 2021 of $502.5 billion. It is no surprise that number was down last year by 36.8%, but PitchBook data shows a stabilization trend in recent quarters that started with the burst of activity we saw in Q4 2023 and continued into Q1 of this year. The Q1 numbers are not as strong as Q4, but they are ahead of Q1 2023 in terms of deal value. Deal count, however, remains flat. A Lack of Sellers: The report notes that a lack of PE sellers is impacting recovery in the volume of M&A transactions. PE sellers are focusing on bringing only their most attractive assets to the table and holding off on the rest. PitchBook notes that in order for dry powder to be deployed more quickly, the volume of sellers in the market needs to increase, especially in the middle-market. Decline in Buyouts: Overall, Pitchbook notes that buyouts were hit hard in 2023, but middle-market buyouts fared better, with only an 18.9% decline in deal value and a 4.0% increase in deal count. For Q1 2024, PitchBook notes that in Q1, buyouts across the board were relatively unchanged in value and slightly higher in volume YoY. Borrowing Costs Coming Down: PE borrowers are seeing some positive movement in terms of lending, with PitchBook pointing out competition between private credit lenders and bank-led syndicates as driving a decrease in borrowing costs. Their data shows that overall spreads were down by 54 basis points in Q1. Firming Trend on Multiples: Data also shows a “firming trend” for the middle market in terms of multiples. The report states, “The median EV/revenue multiple on middle-market PE deals for the TTM ending Q1 2024 rose to 2.2x, up from 2.0x as of Q4 2024. The median EV/EBITDA multiple recorded an even stronger bounce to 12.7x from 11.0x for the TTM ending Q1 2024 and Q4 2023, respectively.” These are just some of the key findings from this report, but they give us an overall idea of the health of the middle-market today. It will be interesting to see if an increase in sellers increases the deployment of dry powder. The report’s authors think this is the key to a rally in activity, so it is certainly something everyone will be watching closely.
June 26, 2024
Business
New Legislation to Override Judicial Precedents and Simplify Corporate Governance in M&A
Changes to the Delaware General Corporation Law (“DGCL”) were recently introduced to the Delaware General Assembly in response to several Delaware Chancery Court rulings affecting stockholder agreements, merger agreements and corporate governance requirements applicable to merger transactions. Introduced last month, SB313 imposes a legislative override over recent decisions to implement changes that allow for greater freedom of contract for stockholder and merger agreements and the elimination of technical, seemingly non-material governance requirements applicable to merger transactions. A new DGCL § 122(18) would permit corporations to convey the rights to consent and approval of corporate action to persons through stockholder agreements unless such conveyance is specifically prohibited by the corporation’s certificate of incorporation. This amendment nullifies the recent decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co. where the Court found a stockholder agreement requiring the majority stockholder’s approval for certain corporate actions “an impermissible internal governance restriction” in violation of DGCL § 141. Addressing the Court’s finding of a violation of DGCL § 251(b) when the board approved a draft version of the merger agreement in Sjunde Ap-Fonden v. Activision Blizzard, Inc., a new DGCL § 147, would eliminate the requirement for board approval of the ‘final form’ of agreement if, at the time of approval, all of the material terms are determinable through information and materials presented to or known by the board, and second, a new DGCL § 268(b) would clarify that disclosure schedules and the like are not required to be a part of the merger agreement for board approval pursuant to DGCL § 251(b). Doubling up on the results of Activision, in response to the Court’s finding of a violation of DGCL § 251(c) where the corporation had included a brief summary of the merger agreement in the proxy statement sent with a separate notice to the stockholders that did not include a brief summary of the merger agreement, a proposed DGCL § 232(g) would allow a corporation to satisfy the stockholder notice requirement for a merger agreement when such agreements and brief summaries are “enclosed with the stockholder notice or annexed or appended to the notice.” A third byproduct of the Activision decision, a proposed DGCL § 268(a) allows a board to approve and file a certificate of incorporation of the surviving corporation of a merger following the effectiveness of the merger if the surviving entity will be wholly-owned and controlled by the buyer and all of the shares of capital stock of the constituent corporation issued and outstanding immediately before the effective time of the merger are converted into or exchanged for cash, property, rights or securities (other than stock of the surviving corporation). In Crispo v. Musk, the Court denied a stockholder plaintiff’s claim for lack of standing where the plaintiff sued for ‘lost stockholder premium’ damages despite a provision in the merger agreement that specified that the buyer would be liable for ‘lost stockholder premium’ in the event buyer breached the merger agreement. A newly proposed DGCL § 261(a)(1) would specifically allow parties to a merger agreement to include provisions requiring the payment of penalties and ‘lost stockholder premiums’ in the event the merger is not consummated and allow parties to enforce these payment provisions. New DGCL § 261(a)(2) confirms that the stockholders of a constituent party to a merger agreement may irrevocably appoint one or more persons to serve as a representative of all stockholders and delegate to such person the exclusive authority to enforce the rights of all stockholders under such agreement, after consummation of the transaction as an agent of the stockholders of the constituent corporation whose shares are canceled and converted in the merger into the right to receive cash or other property, and to enter into a binding settlement on behalf of all shareholders, a principal of corporate law. Seemingly, this amendment codified stockholder representative authority articulated by the Court in Aveta Inc. v. Cavallieri, where the Court found that the stockholders were bound to the results of a post-closing adjustment and subsequent arbitration decision when the stockholders appointed a stockholder representative to represent the stockholders and the representative utilized facts ascertainable outside the merger agreement to derive post-closing adjustments on behalf of all stockholders using a calculation method clearly and expressly set forth in the merger agreement and subsequently pursued the final determination through the use of a neutral arbitrator. This Act requires the affirmative vote of two-thirds of the members elected to each house of the General Assembly. If passed, these changes will become effective on August 1, 2024, and retroactively applied except for any civil action completed or pending on or before such date.
June 20, 2024
Business
Managing Contract Liability in Ransomware Disruptions: A Case Study in the Logistics Sector
Recent litigation in the State of Washington highlights the need to address the evolving landscape of cyber liability and ransomware attacks. The lawsuit filed by POC USA, LLC ("POC") against Expeditors International of Washington, Inc. ("Expeditors") stems from a failure to fulfill third-party logistics services during a ransomware attack. The rising prevalence of ransomware is a concern that all businesses should address in their agreements. Because this litigation pertains directly to shipping fulfillment centers, we want to address how industry stakeholders can proactively address these cyber liability and ransomware issues in their service agreements. For context, POC manufactures and distributes protective gear for gravity sports such as skiing and mountain biking. Expeditors, on the other hand, is a third-party logistics ("3PL") provider. Expeditor contracted with POC and agreed to handle POC's shipping and distribution of protective gear. Expeditors suffered a ransomware attack that disrupted their ability to provide 3PL services for 90 days. Consequently, POC filed suit seeking the recovery of damages stemming from lost revenue resulting from the ransomware attack. POC’s complaint includes a claim for: Breach of Contract Breach of Implied Covenant of Good Faith and Fair Dealing Washington Consumer Protection Act Violations Unjust Enrichment Negligence and Gross Negligence In response, Expeditors filed a motion to dismiss, seeking a court order dismissing POC’s claims. On April 11, 2024, the court issued an opinion and order, dismissing the claims of negligence, gross negligence, and bailment. However, POC’s claims for breach of contract, breach of implied covenant of good faith and fair dealing, unjust enrichment, and Washington Consumer Protection Act violations were not dismissed remain subject to litigation. This pending litigation highlights the need to analyze and update commercial agreements to address current events that may cause service disruptions, such as ransomware. Failing to properly address these disruptions in your commercial agreements could leave your organization vulnerable to significant and unexpected claims. In today’s business environment, it is essential for almost every company to proactively review and update their agreements to address cyber liability and ransomware concerns effectively. The only exception would be a business run entirely on offline systems, a rarity today. Below are some of the relevant clauses to examine: Limitation of Liability: While many agreements limit liability to only the consideration paid under the agreement, the exact text of that clause matters. The language of that limitation of liability clause may not limit certain claims asserted for loss of services stemming from a ransomware attack. Based on the business operations, it may be prudent to ensure that your distribution services agreement does not limit liability solely to damages stemming from property damage (thereby allowing unlimited liability for claims other than property damage). At a minimum, the language should be updated to expressly limit liability for damages resulting from a loss of services due to uncontrollable events. This issue should also be addressed in your force majeure clause, as discussed in the following paragraph. By addressing this in the force majeure clause, cyber-attack liability can be effectively limited. This approach is preferred because, as illustrated in the case of POC v. Expeditors, where the amount paid under the agreement in prior years was $2.5-3 million, each company should endeavor to avoid any damages stemming from the malicious acts of a third party. Force Majeure: The force majeure clause is another critical clause that must be updated to address these issues. Relying on a contract’s limitation or disclaimer of liability clause is insufficient. The force majeure clause should expressly identify a force majeure event to include a loss of access or inability to perform services due to cyber-attacks, ransomware attacks, or other malicious third-party attacks on your cyber infrastructure, including hardware, on-premises, and cloud-based systems of any kind. Warranties and Representations: One of the factual averments set forth in the POC vs. Expeditors litigation focused on Expeditor’s representation that it used “up-to-date tools” that enabled Expeditors to move cargo “securely.” Arguably, Expeditors’ reference to “security” may mean physical security. Still, the lack of clarity opened Expeditors up to litigation based on this representation, including cyber security. A better approach to representations regarding cyber security should include a “commercially reasonable” qualifier. Companies should also audit their marketing material to ensure no marketing copy is overcommitting your organization to provide best-in-class cyber security, especially when that is not the case. Catch-All Disclaimers: Additional language expressly disclaiming the ability to perform services in the event of a cyber-security or ransomware attack is a widely accepted and prudent way to avoid claims from your customers. These clauses may be heavily negotiated but should be a baseline starting point for every 3PL service provider, providing a sense of industry-standard security. Cyber Insurance: Cyber liability insurance is another consideration to examine outside of the contract terms. Many service agreements now require that all parties maintain a cyber liability insurance policy; however, these policies are becoming increasingly expensive. The cost of insurance premiums also depends on the security measures your business puts in place, so engaging a cyber security professional is also a prudent method to mitigate cyber liability exposure and reduce insurance premiums. The above list is not exhaustive, and every organization will have scenarios that require bespoke contract language to address (and mitigate) potential customer claims. Engaging competent legal counsel capable of crafting the appropriate language within your agreements is crucial to ensuring comprehensive protection.
May 16, 2024
Business
Shipment Success: The Importance of Pre-Contract Qualification in Fulfillment Centers
Shipping fulfillment centers play a pivotal role in the third-party logistics ecosystem. These businesses are uniquely positioned as both a warehouse to store products sold on e-commerce sites and a service provider responsible for packing and shipping such products once ordered. This dual role creates unique liabilities and responsibilities for each of these two functions. Appropriate customer and vendor screening is important to complete these functions. Warehouse Liability and Issues When a shipping fulfillment center receives customer products for storage and subsequent shipment, it is critical to understand what the products are, together with the creditworthiness of the fulfillment center’s customer. Product considerations may include: What products require a temperature-controlled environment? Do the products contain regulated materials that require special handling and storage? What is the packaging of these products when delivered to the fulfillment center warehouse? Additionally, assessing the customer’s creditworthiness upfront helps address accounts receivable issues and prevents scenarios where aging customer inventory occupies valuable rack space due to non-payment or bankruptcy. Each of these considerations is tied to some aspect of liability and whether the fulfillment center must take special steps to mitigate any such liability. This may include incorporating special charges for mitigation efforts into the service agreement with the customer. Packing and Shipping Concerns Similarly, the fulfillment center’s packing and shipping side must understand the customer’s desired packaging requests and shipping procedures. For example: Does the shipped product contain unique characteristics requiring special packaging materials? Are special freight charges likely to apply? Is the fulfillment center provided with the shipping materials, or is this item being sourced from a third party? Each of these factors will affect the workflow of the fulfillment center team. Pre-Contract Qualification of Customers With the above issues in mind, the fulfillment center must assess whether the customer is a good fit for their business or otherwise contract around any concerns or issues. This decision-making process (and subsequent contract negotiation) will help mitigate issues such as damage to other customer products, unforeseen expenses incurred to the fulfillment center’s detriment, delayed shipping issues, or rack space occupied by defunct customers. Implementing a comprehensive customer screening process will help drive better customer interactions and warehouse efficiency while ensuring that you engage with reliable and legitimate parties. Here is a structured approach that your warehouse can implement to evaluate potential customers: 1. Authorization to Do Business; Background Checks Documentation Check: Require potential customers to provide official business registration documents from the appropriate governmental body in their state (or, when dealing with international companies, their country of origin). This verifies their legal existence and is an easy way to confirm whether this customer sells legitimate products accepted by the market. Be cautious of any company unable to provide such documentation, as they may be either undercapitalized or operating as “fly-by-night” entities selling defective or non-compliant products until the market rejects them. Such companies are prone to leaving fulfillment centers with unpaid invoices and obsolete inventory occupying valuable fulfillment center rack space. Verification with Authorities: Cross-check the provided documents with relevant authorities or utilize online government databases specifically designed for business verification. Background Check: If the account is a significant size, consider a background check to ensure the company has a history of legitimate business operations and payment history. This can include checking for any legal issues or past bankruptcies. References: In addition to conducting background checks, consider requesting financial references from banks and other companies that have done business with the potential customer. This provides valuable insights into their financial integrity and payment track record. This is also an important step when negotiating contract terms because the fulfillment center can assert a security interest in the products being stored. Therefore, it is crucial to identify existing lienholders and assess whether they are considering legal action against the customer. 2. Proper Licensing Licensing Verification: Ask for copies of relevant licenses if the products use special materials that require specialized care. This same consideration should be given when hiring vendors to handle specialized products. This step is crucial for ensuring compliance with industry regulations and standards, as well as your applicable insurance policies. Compliance Checks: Conduct or request audits on compliance with industry-specific regulations and standards. This might include environmental, safety, and other operational standards relevant to the logistics sector. Implementing the Process Once you develop a screening and qualification process for customers, implementing that process into your daily workflows is essential. The best way to implement such screening is by creating a digital or paper-based checklist to be reviewed when accepting new customer inquiries. The process should also be continuous. Customers can change over time, so annual or bi-annual compliance and background checks can help proactively identify payment issues before they begin. Establish a structured procedure for periodic customer re-evaluation to ensure ongoing compliance with your standards. Lastly, be sure to maintain detailed records of all checks and verifications carried out. These records serve as vital documentation for audits, compliance checks, and resolving any potential disputes with the customer or third parties. Conclusion Implementing these measures will significantly reduce the risk associated with onboarding new customers. Warehouse space is critical for fulfillment center operations, and one of the quickest ways to endanger profits is to have this space occupied by delinquent customer accounts. Remember, the depth of the screening should be proportional to the potential risk and impact the customer might have on the fulfillment center’s business operations. For assistance implementing a customer screening process or addressing specific concerns in contracts, feel free to reach out to Mark Wendaur or Faith Miros.
April 2, 2024
Business
Is a Trust Better Protection Than a Prenup?
Business owners and families of wealth should know that a properly structured trust can be a very effective alternative to a pre-nuptial agreement. The Legal Intelligencer By Joe Armstrong Preparing for your child’s wedding should be a joyful experience, so it should come as no surprise when a family business owner avoids bringing up a prenuptial agreement. Business owners and families of wealth should know that a properly structured trust can be a very effective alternative to a prenuptial agreement. When one or more generations of a family have worked hard in business to accumulate substantial wealth, they will frequently ask their children to enter into prenuptial agreements to protect the family business and other assets in the event of a future divorce. For a first marriage of relatively young persons, the concept of a prenuptial agreement is frequently considered offensive and a topic to be avoided. Even the discussion between parent and child can be stressful and considered by the child to be undue pressure ahead of what they believe will be the happiest day of their lives. When met with these circumstances, counsel can help alleviate the family strife by suggesting the use of trusts to protect assets in the event of a divorce at least as effectively as an actual prenuptial agreement signed by those about to be married. This article discusses some of the many ways that a trust can be a very effective alternative to a prenuptial agreement. Each state has its own laws and customs regarding the division of property between divorcing spouses. These state laws can vary significantly (e.g., equitable distribution v. community property states), but they all will look at the extent to which a spouse owns or controls an asset and the right to receive income from that asset. It is the ownership or control of an asset by a spouse that will bring the asset within reach of a divorce court. This core concept of ownership or control is what allows a trust to be such an effective alternative to a prenuptial agreement. As a general proposition, if a divorcing spouse does not own or control a particular asset or the right to income from that asset, a divorce court will not attempt to award that asset to the other spouse. Just because a trust is established for someone’s benefit does not mean that the beneficiary automatically has ownership or control of the assets in the trust, or even the right to income generated by those assets. The key is structuring the trust in a way that does not give the spouse ownership or control over the assets in the trust while still giving the trustee broad discretion in how to utilize the assets for the benefit of the spouse. Revocable Living Trusts One of the most commonly used trusts is a revocable living trust or “RLT.” As suggested by its name, an RLT is fully revocable by the settlor and is typically used in conjunction with a simple will that leaves the assets of the testator to the RLT. Since an RLT does not provide savings on death taxes that can be achieved with a more complicated irrevocable trust, those without exposure to the federal estate tax often prefer an RLT as a cost-effective method to minimize the burden of the probate process and provide asset protection to the heirs. An RLT does not complete a transfer of assets during the lifetime of the settlor since by nature an RLT may be revoked at any time. An RLT can work well for the generation owning the family business or otherwise having substantial wealth with the intent to hold on to their assets until death. Irrevocable Trusts An RLT immediately becomes an irrevocable trust upon the death of the settlor since the trust can no longer be revoked. An irrevocable trust upon formation transfers assets of the settlor to the trust during the lifetime of the settlor (an inter vivos transfer). The use of an irrevocable trust allows for more complex tax planning to minimize the burden of estate, gift and generation skipping taxes on the beneficiaries and future generations. For those fortunate enough to have wealth beyond the amount of the lifetime federal estate and gift tax exemption ($13.61 million for an individual and $27.22 million for a married couple in 2024), an irrevocable trust with tax planning provisions will be the preferred form of trust to use in lieu of a prenuptial agreement. So How Does It Work? Whether using an RLT or one of the many varieties of irrevocable trusts, it all comes down to making sure the language of the trust document cannot be fairly construed to give the spouse, as beneficiary, ownership or control of the assets in the trust. The following are some of the key points to address when drafting a trust to have the same impact as a prenuptial agreement but without the angst that goes along with putting one in place. A Trustee You Can Trust Selecting a trustee that you can readily trust (for lack of a better word) to act in the best interest of the spouse as the beneficiary is critical. The more independent the trustee is from influence by the beneficiary, the better for protecting the assets from a divorcing spouse. A corporate trust company will be viewed as highly independent while a sibling of the beneficiary spouse may be considered more susceptible to influence by the beneficiary. Identifying the trustee is often the most challenging task for the family. When in doubt, select a corporate fiduciary with a long history of serving as a trustee for multiple generations of families of substantial wealth. No Absolute Right to Income or Principal Distributions Clients are often tempted to provide terms in their trust that will give their child as a beneficiary the right to withdraw some or all of the principal in the trust at certain ages or other milestones. Providing beneficiaries with the absolute right to income from the trust or the ability to withdraw principle from the trust can significantly weaken the asset protection characteristics of the trust and its effectiveness as a substitute for a prenuptial agreement. Giving withdrawal rights or the absolute right to income to beneficiaries of a trust indirectly gives them a degree of ownership or control over the assets of the trust that springs into existence when the stated age or milestone is reached. In a divorce court setting, one can expect a special master or judge to consider a spouse to own or control some or all of the assets in the trust. Once ownership or control is established, one must assume that the divorce court will look to find a way to include the value of the assets in the trust as being subject to some form of distribution to the other spouse in the divorce. In the end, a carefully crafted trust can be even better than a prenuptial agreement when seeking to protect assets in the event of a divorce. Reprinted with permission from the February 15, 2024, edition of The Legal Intelligencer © 2024 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or asset-and-logo-licensing@alm.com.
March 7, 2024
Business
The Corporate Transparency Act and FinCEN Reporting
As you may already know, the Corporate Transparency Act (“CTA”) goes into effect on January 1, 2024. Under the CTA, many privately held companies will be required to file beneficial ownership information (“BOI”) reports online with the Financial Crimes Enforcement Network of the U.S. Treasury (FinCEN). For more information, see an overview linked below. We will continue to monitor updates to this process in the new year.
December 27, 2023
Business
Newly Enacted Requirements for Disclosure of Beneficial Ownership of US Business Entities
Originally posted on 02/21/2021, content updated 11/08/23. Congress has passed legislation over the veto of former President Trump to require the disclosure of the direct or indirect beneficial ownership of US business entities at the time of formation. This legislation was included as part of the annual National Defense Appropriations Act, which took effect on January 1, 2021. Under this Act, upon the issuance by the Department of Treasury of regulations providing more detail on the specific requirements of the Act, all corporations, limited liability companies and other types of business entities will be required to disclose the details of their direct and indirect beneficial owners at the time the business is formed unless the business falls within a group of exempt industries. These exempt industries include banking, insurance, and other financial institutions, where the disclosure of beneficial ownership of such businesses is generally already required. In addition, within 2 years of the issuance of the regulations, the same disclosure requirements will apply to all existing non-exempt industry business entities, except those which are publicly traded or have more than 20 full-time employees, have annual revenues of more than $5 million, and have an operating presence at a physical office within the United States. The Treasury regulations must be published within one year of the effective date of the Act or by January 1, 2022, but are expected to be published sooner. The Act requires such reporting companies to submit the disclosure information to the Department of Treasury, which is required to create a beneficial ownership registry within its Financial Crimes Enforcement Network (FinCEN). The purpose of the registry is to “crack down on anonymous shell companies, which have long been the vehicle of choice for money launderers, terrorists and criminals.” The information will not be made available to the public in general but will be available to US federal law enforcement agencies and, with the consent of the reporting company, financial institutions in order to meet their customer due diligence requirements. The Act defines a beneficial owner as an individual who owns a 25% equity interest in or exercises “substantial control” over the reporting company. The definition of substantial control is not stated in the Act, and there are many other questions regarding the scope of the disclosure requirements, including how to measure a 25% equity stake in a tiered group of entities or in an entity which has shifting percentage interests of its members. Presumably, these and other issues arising under the Act will be clarified in the regulations. The information that must be reported to the registry includes the following with respect to any beneficial owner, as well as any “applicant” for the entity (which includes incorporators and other formation agents): (i) full legal name, (ii) date of birth, (iii) residential or business street address, and (iv) a unique identifying number from an acceptable identification document, including a driver’s license, US passport, or other US state-issued identification document. Further, any changes to the beneficial ownership of a business entity or any change to any of the foregoing information must be reported to the registry within one year of the change. The Act imposes penalties on companies that fail to report the required information or submit a report containing false or fraudulent beneficial ownership information of $500 per day up to a maximum of $10,000 and imprisonment of up to 2 years. The Act represents a sea change in the US requirements for beneficial ownership disclosure of business entities. Similar or even more restrictive ownership disclosure requirements have been in place for several years in Europe and other developed nations throughout the world. We will be monitoring the issuance of the Treasury regulations and other developments in this area. Please feel free to contact us with any questions. Final regulations under the Corporate Transparency Act were issued on September 30, 2022, which provide for the implementation of the Act commencing January 1, 2024. See separate blog post – “FinCEN Issues Final Rule for Beneficial Ownership Reporting under the Corporate Transparency Act.”
November 8, 2023
Business
Choice of US Entity for Foreign Companies
Originally posted on 02/12/2019, content updated on 10/09/2023 Foreign companies (“FC”) wishing to establish a U.S. entity to expand their business activities in the U.S. will need to consider whether to form a corporation (Inc.) or a limited liability company (LLC). Likewise, an FC which wants to invest in an Inc. or an LLC will need to be familiar with certain tax and non-tax aspects of an Inc. and an LLC. Professional services, such as architecture and engineering, may require a special professional services entity (which will not be addressed in this article). An Inc. and an LLC are similar in that they both offer limited liability to their owners (shareholders of an Inc. or members of an LLC). In general (with some exceptions), an FC is not liable for the obligations of an Inc. or LLC. Following are some of the main differences between both entities: Taxation: An Inc. is subject to U.S. federal, state and local corporate income tax. An LLC is not subject to federal or state income tax (but may be subject to local tax, such as the New York City unincorporated business tax). Profits of an LLC are allocated or “passed-through” to its owners, who are subject to U.S. income tax on those profits, whether or not distributed, and who will need to file U.S. income tax returns for their share of the LLC’s profits. An FC which owns an LLC will need to obtain a U.S. federal taxpayer identification number and will need to appoint a person whom the IRS can contact for any tax matters of the LLC (so-called “partnership representative”). That person does not need to be a U.S. citizen or resident. Professional investors, such as venture capitalists, often do not want to invest in LLCs because of their flow-through tax treatment. In order to avoid pass-through tax treatment to the FC, an LLC can file an election with the IRS to be taxed as a corporation. Alternatively, the FC could establish a so-called “blocker” corporation which will own or invest in the LLC. Dividends from an Inc. to the FC are generally subject to a U.S. withholding tax or a reduced income tax treaty rate, if applicable. After-tax profits of an LLC are generally subject to a U.S. “branch profits” tax (or a reduced income tax treaty rate, if applicable) when distributed or deemed distributed to the FC. In contrast, net profits distributed to an owner in the U.S. are not taxed again. Management: An Inc. is managed by directors and officers. The directors are responsible for overall management of the Inc. Although they make certain management decisions, such as approving a major contract, they generally do not sign contracts on behalf of the Inc. Directors are elected and removed by the shareholders. The officers are responsible for day-to-day management and sign contracts and other documents on behalf of the Inc. The officers include a President/CEO, Secretary and a Treasurer. They are elected and removed by the directors. The directors and officers must be individuals. They do not need to be U.S. citizens or residents. All director and officer functions can be combined in one person. An LLC is managed by one or more managers or by the owners of the LLC. A manager can be either an individual or a corporate entity and does not need to be a U.S. citizen or resident. Formation costs: Although the costs of formation of an Inc. and an LLC are comparable, an LLC which will register in New York will need to publish its formation in two newspapers in New York. Publication costs can make the formation or registration of an LLC in New York more expensive than that of an Inc. Corporate Organizational Documents. Both an Inc. and an LLC are formed by filing a formation document with the secretary of state of the state in which the entity will be formed. An Inc. will also need to have several additional organizational documents, including a statement of "incorporator" for the election of the first director(s), a written consent of the first director(s) electing the first officer(s), bylaws, issuance of the first shares to the FC and a shareholders’ agreement if more than one shareholder. An LLC will only need an operating agreement between the LLC and its owner(s) providing for, among other things, the management of the company and the allocation and distribution of profits and losses. Sharing of Profits and Losses. Shareholders of an Inc. share in the profits in proportion to their ownership percentages. Owners of an LLC share in the profits and losses as agreed to between the owners in the operating agreement. If an FC invests in a joint venture company and wishes to allocate profits and losses to the joint venture partners in a ratio which is different from the ownership percentages, the FC should consider forming the JV entity as an LLC. All in all, generally, unless there is a need for pass-through tax treatment, management by a corporate entity, or a flexible joint venture entity, an FC will probably prefer to establish or invest in an Inc. instead of an LLC.
October 9, 2023
Business
U.S. Inbound M&A and Investment Transactions May Be Subject to CFIUS Review
Originally posted on 03/26/2020, content updated on 10/06/2023 Foreign companies and investors who are acquiring or investing in a U.S. company should consider whether their U.S. inbound transaction will be subject to review by the Committee on Foreign Investment in the United States (CFIUS). On February 13, 2020, regulations (31 CFR §§800, 802) (the “Final Regulations”) issued by the U.S. Department of the Treasury went into effect, which expanded and clarified CFIUS’ jurisdiction over certain foreign investments in U.S. companies or real estate. CFIUS is an interagency committee chaired by the Secretary of the Treasury that is authorized to review certain transactions involving foreign investment into the U.S. to determine the effect of such transactions on national security. If a transaction could pose a risk to U.S. national security, the U.S. President may suspend or prohibit the transaction, or impose conditions on it. Before August 2018, CFIUS’s jurisdiction was limited to transactions in which a foreign investor acquired control of a U.S. business (which involves certain blocking rights). CFIUS’s jurisdiction was expanded in August 2018, when President Trump signed the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) into law. The Final Regulations implement FIRRMA. FIRRMA covers not only certain controlling/majority investments but also certain non-controlling/minority investments and certain investments in real estate located near sensitive government sites (including airports, harbors, and military sites). This article will focus on non-controlling investments in U.S. companies. A non-controlling investment is subject to CFIUS’ jurisdiction if it (i) is an investment in a U.S. business involved in certain critical technologies, critical infrastructure, or sensitive personal data of U.S. nationals (referred to as “TID” businesses), and (ii) grants the foreign investor any of the following: (a) access to any material non-public technical information of the U.S. company, (b) membership or observer rights on the board of directors or equivalent governing body of the U.S. company or the right to nominate an individual to a position on the board of directors or equivalent governing body, (c) any involvement, other than through voting of shares, in substantive decision-making of the US company. Critical technologies are defined as items on certain U.S. export regulations (such as the U.S. Munitions List and the Commerce Control List) and other regulatory regimes and include certain emerging and foundational technologies controlled under the Export Control Reform Act of 2018 (“ECRA”). The Bureau of Industry and Security (BIS) is working on proposed rules to define “emerging and foundational technologies” that will be subject to future export controls. BIS is considering technologies such as (a) artificial intelligence and machine learning technology; (b) logistics technology; (c) robotics; and (d) advanced surveillance technologies, such as faceprint and voiceprint technologies. Critical infrastructure is generally defined as systems and assets, whether physical or virtual, so vital to the U.S. that the incapacity or destruction of such systems or assets would have a debilitating impact on national security. Critical infrastructure includes certain IP networks, telecommunications services, interstate oil pipelines, crude oil storage facilities, rail lines, public water systems, and electric power generation, storage, or transmission facilities. A list of types of critical infrastructure can be found in Appendix A to Part 800 of the Final Rules. Sensitive personal data include the following categories: financial, consumer report data, geolocational, health data, non-public electronic communications (including emails and chats), Federal ID card data, U.S. government personnel security clearance data, and genetic testing data. The categories are covered under FIRRMA only if the U.S. business: (a) targets or tailors its products or services to sensitive U.S. Government personnel or contractors, (b) maintains or collects such data on greater than one million individuals, or (c) has a demonstrated business objective to maintain or collect such data on greater than one million individuals and such data is an integrated part of the U.S. business’s primary products or services. Genetic testing data from databases maintained by the U.S. government and routinely provided to private parties for research are exempted, so as not to capture U.S. businesses using common datasets for research purposes. Examples of transactions that were blocked by CFIUS involved a dating app for LGBT individuals (Grinder LLC) and an online patient forum (PatientsLikeMe). Under the Final Regulations, non-controlling investments by certain investors from Canada, the UK and Australia are exempted. Furthermore, investments in TID businesses by U.S. investment funds with foreign limited partners will not be subject to CFIUS review if (i) the fund is managed exclusively by a U.S. general partner (or equivalent), (ii) the firm's advisory board on which the foreign limited partner sits does not have the ability to control in any way the investment decisions of the investment fund, (iii) the foreign limited partner does not have the ability to control the fund, including through investment decisions, ability to approve or disapprove decisions made by the managing partner, or unilaterally determine the compensation of the general partner, and (iv) the limited partner does not have access to material, nonpublic technical information. Filings with CFIUS are voluntary, except for the following investments which require a prior filing with CFIUS: (i) investments in critical technology businesses operated within one of twenty-seven specific industries, as defined by the North American Industry Classification System (NAICS) codes, listed in Appendix B to Part 800 of the Final Rules, as well as (iii) investments by foreign persons in which a foreign government (other than Canada, the UK, or Australia) owns a substantial stake. Filings related to investments in critical technology businesses were made mandatory in October 2018 when FIRMA instituted a “Pilot Program”. CFIUS stated, however, that it expects to replace the Pilot Program system based on NAICS codes with a system based on export control licensing requirements. Even if a prior filing with CFIUS is not required, the parties should consider filing on a voluntary basis in order to avoid a possible rejection or modification of the transaction after closing. Filings with CFIUS may require a filing fee not to exceed $300,000. Voluntary and mandatory CFIUS filings can be done by a short declaration or longer notice. Mandatory declarations must be filed 45 days before the close of a transaction. CFIUS has 30 days to render a decision on a mandatory declaration but may at that time require a full notice, which may delay the transaction substantially. CFIUS has 130 days to decide on a notice. Failure to submit a mandatory filing may result in a penalty of up to the greater of $250,000 or the value of the transaction. If you have any questions or would like to discuss any of these issues, please contact me at 212-545-1900 or mbloemsma@offitkurman.com.
October 6, 2023
Business
Healthy Businesses Lead to Successful Sales: Business Ownership Maintenance is Key
What does getting your car its annual safety inspection and selling a business have in common? More than seems obvious. Many states require annual safety inspections for vehicles. Maryland is one of the states that does NOT have this annual safety inspection. In Maryland, your vehicle does not need to be safety inspected until you seek to transfer the title. Thus, in practice, there are many cars in Maryland on the road for years that have not been safety inspected. Hence, numerous vehicles are driving around that may have “issues” that the owners are not aware of. My personal experience has shown that when you transfer a vehicle in Maryland and have the car inspected, you are suddenly faced with numerous vehicle “defects” that must be fixed to pass inspection and transfer title. Fast forward to selling a business. In my experience, I have not come across a single business that was without “defects” in the sale process. Like the running car, these businesses are operating and making money. However, when the business goes to sell, the buyer and its advisors will conduct a thorough inspection. Too often, many defects rise to the surface, requiring remedy before the sale can proceed. In this series of articles, I will be discussing the best ways to start, grow, and maintain a healthy business by reflecting on top issues when selling a business and what can be done to set up a business for a successful sale. This series will include annual “inspections” by the owner in the areas of legal, operation and financial to better prepare the business for sale. Frequently defect areas often include tax planning, employment and key employees, intellectual property, ownership issues/operating agreements, cap tables, and corporate governance issues.
September 21, 2023
Business
M&A Nugget: Dissenters’ Rights
In Maryland, and other states, a stockholder who does not believe that the purchase price to be paid by an acquirer is fair value has the right to object to the sale and receive payment for the fair value of the stock. The basic procedure for a stockholder to invoke that right is to object to the proposed transaction in writing, not vote in favor of the transaction and make a demand for payment of the stock. The target may then notify the stockholder of the price the target is willing to pay for the stock. If that price is not satisfactory to the owner, or the target does not notify the owner, then the owner may ask a court to obtain an appraisal to determine the fair value of the stock. If the court accepts the appraisal or, not accepting the appraisal, determines the fair value of the stock itself, the amount determined shall be entered as a judgment against the target. Although the use of these dissent and appraisal rights is rare, both parties to a sale transaction need to be aware of them, especially if the acquirer intends to purchase 100% of the target’s stock.
September 11, 2023
Business
M & A Nuggets: The “KEIP”
The Key Employee Incentive Plan (“KEIP”), has become common as a way to incentivize key employees. The KEIP usually allows key employees to participate in an exit transaction through the grant of a percentage of the net proceeds from the sale of the business. Many transactions are structured with potential post-closing payments through earnouts or other mechanisms. Acquirers do not want or accept responsibility for KEIPs and, therefore, require that the seller maintain responsibility for the KEIP post-closing. During the negotiation process, a significant amount of time is devoted to the KEIP. Instead of leaving it to the acquirer to react to and dictate how the KEIP will be handled, owners of target companies should have a plan developed. The plan will have as its objective achieving the same end result that the acquirer will eventually insist on. Here are the two most common ways KEIPs are dealt with: Termination of the KEIP, with the only surviving provision being the payment of amounts that may be owed to the key employees in the future reducing the seller’s share of net proceeds, and The transfer of any future responsibility under the KEIP to the selling owners. When first developing a KEIP, it is important that the agreements that will memorialize the KEIP allow flexibility to achieve one of the results described above. By proactively dealing with the KEIP and having a plan in place, a target can lessen an acquirer’s concern about the KEIP and save both sides time and resources.
September 7, 2023
Business
M&A Nugget: Licenses – Odds and Ends
When acquiring a business, it is important to understand the licenses needed to operate that business. Some licenses, such as professional and contractor’s licenses, are obvious. There are many business activities that do not shout out as requiring a license, but for which the license is integral to operate the business. Here are a few examples: Locksmithing License Well Drillers License Salvage Yard Permit Bottled Water License Fire Sprinkler Contractors License Taxidermy License Licenses are either required to be held in the company’s name, a designated individual’s name, or both. There may be different levels for a particular license, such as master, associate or apprentice. Usually, even with a license in the company’s name, an individual who has gone through training and licensing, must be listed. For the purchaser entering into a new business, it can take weeks or even months to obtain the necessary licenses. It is therefore often crucial that the licensed individual agrees to allow the purchaser to continue to use the license and to provide services to the purchaser post-closing. The bottom line is that the purchaser and seller must plan for the purchaser to be able to operate with the requisite licenses on the closing date.
August 30, 2023
Business
M&A Nugget: Related Party Transactions
It is important that the purchaser investigate related party transactions when conducting due diligence. A related party transaction is a transaction or a contract between the target and another company controlled by, or related to, the owners of the target. An example of a related party transaction that is often encountered is a real estate lease between the owner of the target and the target. Another example is a key supplier agreement between the target and a relative of the target’s owner. Related party transactions must be examined to determine whether they are priced at fair market value. Often these arrangements are priced at higher than fair market value to benefit the related party. Another factor to consider is whether the related party will continue doing business with the purchaser post-closing, especially if the related party is a key supplier of goods or even a sole source provider. I have encountered situations where the key supplier was the target owner’s relative, and while more than happy to do business with the target on generous terms, would not commit to continuing those terms with the purchaser. So, as part of the purchaser’s due diligence, related party arrangements must be asked about and investigated.
August 28, 2023
Business
M&A Nugget: Cyber Insurance – The Tail
As data breaches have become larger (think Equifax, Target, and Yahoo) and more frequent, buyers and sellers should pay more attention to cyber insurance. Cyber insurance provides coverage for risks that arise out of the use of devices that maintain data, including computers and mobile phones. The insurance has existed for years, and generally covers losses incurred by the insured and claims of third parties seeking to be compensated for a data breach. One issue that arises with cyber insurance is that it is usually issued on a “claims-made” basis, which means that, for a loss to be covered, the claim must occur while the insurance policy was in place or within a specified period after the policy lapses. The problem with this is that cyber incidents may not be uncovered until well after the coverage period lapses. This is where tail insurance comes in. The inclusion of a tail provision extends the time during which a claim can be reported and therefore covered. Another way for a buyer to close the gap in coverage that exists with claims-made policies is to purchase cyber insurance with a retroactive coverage date, that will cover cyber incidents that occur before closing. The bottom line here is that with the increase in cyber security breaches, the buyer and seller need to ensure seamless coverage for incidents that occur before closing.
August 24, 2023
Business
Over 50 Years of Law Practice Tips
Originally posted on 08/12/2020, content updated on 07/27/2023 Having been fortunate to serve clients on every continent other than Antarctica in transactions of every size and in every kind of business and having been privileged to have mentored many newer lawyers, over 50 years of experience as an international and domestic business lawyer has taught me many things. I have compiled a list of many of the lessons I have passed on to others over 50 years, and this article sets out the latest iteration of my tips for others to consider. If something does not make sense, it usually does not make sense for a reason. Finding that reason is not always easy. Ask questions and continue to ask questions, just like peeling back the layers of an onion. Make statements in the form of a question. Focus your thinking by diagraming the deal or what happened or was supposed to have happened. Understand the underlying economics of a particular matter. Learn financial statements and how each statement impacts the other statements. Do your own income tax return at least once to understand the schematic of the Internal Revenue Code. Research the income tax regulations on a specific matter at least once in your career. Framing a question properly will often suggest the answer or options. Ask if anyone in the firm has a file or precedent for your legal issue. Whatever you say in writing, whether in an email, fax, letter, or otherwise, can and will be used against you and will be distorted. Re-read calmly whatever you write before sending it and ask yourself if you really want to say whatever you wrote. Ask how it would look if whatever you write appears on the front page of your favorite newspaper. It may be best to use bcc’s and not cc’ s to clients on letters or emails to opposing lawyers, or better yet, forward what you send to avoid a bcc recipient from replying to people who do not know who was bcc’d and to preclude a waiver of the attorney-client privilege. No typo’s or typos — clients and adversaries will find them! Use spellcheck. Proofread all documents even after using spellcheck. Spellcheck is not a substitute for proofreading. Know the differences between:effect-affect principal-principle your- you’ re its-it’s lose-loose No split infinitives. Avoid the passive voice. The ultimate reader of your email, fax or document is a judge or arbitrator. Listen to the client or other side and ask questions. Hear and process what is said, and what is not said. Ask questions! It’s best if all questions have a purpose. Silence your cell phone and other devices before a meeting starts; preferably, put the device away and help cause everyone in the meeting to focus on the agenda. Have an agenda for each meeting and stick to it. Start meetings on time. Those who miss the start will learn not to do that again, especially if you bar them from attending the meeting if they are late. Do not multitask during a meeting or call. If you do, you cannot be listening, and you are being rude to the person you are talking to. Better to end the call or meeting or not have it. There is no such thing as ” boilerplate.” Pay attention to the so-called “boilerplate” provisions in contracts that generally appear in a “General” or “Miscellaneous” final section of a contract. The other side often (1) may consider those clauses to be “boilerplate” and in drafting or reading them often pay less attention to them and (2) may be tired or bored by the time they get to read those provisions if the other side reads a draft starting with page 1 straight through to its conclusion. The agreement you are using as a model is the end product of negotiation in another deal. Do not copy someone else’s mistakes. Start with the basics of legal principles and definitions, including looking at Black Law’s Dictionary or other sources of definitions because those precedents may give you words and concepts that will aid in your drafting or mark-up. Check to see if there is a statute on whatever the issue is, including statutes providing for statutory construction, definitions of terms, rules of construction for contracts, and other statutes that may use or define a particular term that can offer some guidance. Is there a Federal issue lurking somewhere, including any Constitutional question? Is there a public policy matter underlying the legal rule in issue, and are your facts distinguishable so that the public policy underlying the legal rule may or may not be violated depending on the result? Excluding Constitutional, criminal and tort cases, most reported court decisions usually result from (1) a client not seeking or getting good legal advice before the particular matter eventuated into a litigation, (2) a lawyer not giving particularly good legal advice either in the underlying matter or in the litigation itself, (3) the client did not use a lawyer and made a mistake, or (4) there was a serious miscommunication in the underlying matter. If a trial or intermediate appellate courts made no errors, the quantity of reported judicial decisions would be reduced materially. An appeal, therefore, and planning for that appeal, may be an appropriate part of litigation strategy because error at the trial court or intermediate appellate court level is very possible, either on a procedural or substantive matter. It may not make sense to rely solely on online research and not consult books. Check findlaw.com or cornell.edu for free legal research links before using Westlaw or Lexis. Consider not using the word “should” in communications with clients if its use could be deemed to create a standard of conduct for the client or for our firm. Have multiple original copies of a power of attorney signed and where appropriate, acknowledged, because you never know who will want to keep an original. Have only one original copy of a promissory note signed. Ask the client to obtain the original signed promissory note when it is paid off. Do not allow what you do to fall to or be viewed as the lowest common denominator. Shortcuts often result in mistakes or less than comprehensive documents. Document client instructions in confirmatory emails and do that in a nurturing and not accusatory way. Price and cost are two different things. Negotiating and bargaining are two different things. Generally, it takes 3 hours of preparation time for every 1 hour of a meeting or negotiation. Try to be elegant in whatever you do, for yourself, and for appearances with others. There are excuses, but there is no such thing as a good excuse. We recruit for skills. We hire for attitude. We promote for both. Under-promise and over-deliver. The best interests of our entire firm are paramount to the self-interest of any one person or group of persons in our firm. Understand the client’s goal and think as if you were the client and your money or business is involved, bringing to that thought process all your skills and experience as a trusted legal advisor. Document everything. Undocumented anything often results in ambiguity. Strategy and tactics are two different things. What is your unique selling proposition? As a glassblower-artist for 31 of those 47 years, sometimes the old tried and true ways are just as good or better than the new ways. No matter what you know, there is always more to learn, whether from others or from your own mistakes. The remaining number of years in your life may not include as many years as your current age may suggest. Hope is not a strategy. All business is personal. I welcome comments from others and am always happy to discuss the story behind each of these tips.
July 27, 2023
Business
Paycheck Protection Program (PPP) Loan Forgiveness Primer
This blog post may contain information that was accurate at the time of publication but could become outdated over time. We strive to provide relevant and timely content, but circumstances, facts, and data can change. Users are encouraged to verify the current status of any information presented and seek updated guidance where necessary. Originally posted on 6/9/2020, no content changes. You applied for and obtained a Paycheck Protection Program loan. Now it is time to ask for the loan to be forgiven. Listen and watch here for a 30 minute presentation from the Offit Kurman CV-19 Business Response Team on the what, when and how to that apply to the loan forgiveness process, along with keen insights into that process. This presentation was recorded on June 5, 2020. For any updates to the loan forgiveness rules since then, please contact us.
June 9, 2023
Business
UPDATE: Did Your Business Need a PPP Loan? Borrowers May Return Funds by May 14 Without Fear of Civil or Criminal Enforcement
This blog post may contain information that was accurate at the time of publication but could become outdated over time. We strive to provide relevant and timely content, but circumstances, facts, and data can change. Users are encouraged to verify the current status of any information presented and seek updated guidance where necessary. Originally posted on 5/6/2020, no content changes. UPDATE: On May 6 the SBA extended the safe harbor deadline to return PPP funds from May 7 to May 14 in FAQ #43. FAQ #43 also noted this is an automatic extension of the safe harbor and that borrowers do not need to apply for the extension. The safe harbor applies to any borrower who applied for a PPP loan prior to April 24, 2020 and repays it in full by May 14, 2020. As the SBA has provided little guidance on what it means to “need” a PPP loan, the SBA has promised to provide additional guidance on this issue prior to May 14, 2020. *All May 7th deadlines have been extended to May 14th In response to adverse publicity, a number of high-profile entities, including listed companies, that had received loans in recent weeks under the Paycheck Protection Program (PPP), announced that they were returning the money. The decision by these entities was prompted in part by the SBA’s publication on April 23, 2020 of FAQ 31, emphasizing that loan applicants should think carefully before certifying, as required, that the loan was really necessary to support ongoing operations considering the uncertainty of economic conditions. The stakes were raised even further on April 28, 2020, when Treasury Secretary Steven Mnuchin announced that all companies receiving more than $2 million of PPP money, and other loans as appropriate, would be audited and could face criminal prosecution if their certification of “need” was false and they did not return the money by May 14th*. Predictably this sudden scrutiny of “need” by businesses that received loans has created uncertainty and anxiety among business owners who had applied in good faith, had been able to check all the qualification boxes on the application, and felt fortunate to have received the quick infusion of capital. However, the same business owners who a few weeks ago asked their attorneys and accountants for help in applying, are now asking these same advisors, with trepidation, should they keep the money? The problem of course is that the CARES Act legislation, and supporting regulations, were hastily drafted and did not provide clarity, especially with respect to “need”. Facing a hard May 14th* deadline, what should a business owner do now if he has any concerns regarding entitlement to the loan? Certainly, this requires a case-by-case analysis, beginning with making certain that the proceeds of the loan will be put to use as Congress intended: putting workers back on the payroll promptly, i.e., within the first eight weeks of receiving the loan. If a business is in an industry that cannot function during the lockdown, e.g., hospitality, the need for PPP money is difficult to justify. Second, businesses that have access to other sources of capital through, the public securities markets, private equity or hedge funds, should take a closer look at their “need”. On a more subjective basis, any company that would consider the scrutiny of a federal audit to be bad optics, e.g., a defense contractor, should carefully consider the consequences of not being able to support the need for the money. These special circumstances aside, what should the owners of a business that received a significant PPP loan be thinking about, and doing, in the next few days before the May 14th* deadline? If a borrower decides to retain the PPP Funds, affirmative steps must be taken now, if they have not been taken already, to document in writing the need for the loan. Put differently, in the event of audit by the SBA, the borrower must demonstrate that it had a good faith belief that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” While the Treasury and SBA have provided very little guidance on the interpretation of this borrower certification, documentation to establish a good faith belief should examine all issues the borrower faces as to economic uncertainty and necessity of the funds. Projections of revenue and cash flow under various scenarios should be made, with the margin of solvency resulting from each scenario closely analyzed. Further, the borrower should focus on issues specific to its business and also in the industry/region in which the borrower operates. Specifically, the borrower should review and document, among other items: Financial stability - budgets and projections, including payroll shortfall projections; Liquidity - cash on hand and alternative sources of funds; Geographic Location – will the area and region in which the borrower operates open first or last; Risks – is the borrower a favored “mom and pop” business; Employee Availability – cost to train, find and replace staff; Materiality of the Loan Amount – will the business be able to operate without the loan and for how long; Sensitivity to Public Scrutiny – what is the impact of an audit on prospective business opportunities; and Projected Uses of the Funds – when and how. Although the absence of clarity in the PPP legislation and rules makes good faith compliance challenging and uncertain for all, business owners should address these issues with a team of advisors including their attorneys and accountants.
May 8, 2023
Business
In Delaware – Is Your Business “Essential” or Not? A Deep Dive With Our Guidance
This blog post may contain information that was accurate at the time of publication but could become outdated over time. We strive to provide relevant and timely content, but circumstances, facts, and data can change. Users are encouraged to verify the current status of any information presented and seek updated guidance where necessary. Originally posted on 3/30/2020, no content changes Practice Group: Business Law & Transactions In response to the Coronavirus pandemic, most of us know that governments have ordered certain businesses to close. Delaware Governor John C. Carney declared a State of Emergency starting on March 13, 2020 and has since updated it multiple times, most recently on March 22. On March 22, the Governor ordered Non-Essential Businesses to close at 8:00 a.m. on Tuesday, March 24. The March 22 Order also requires that employers operating “Essential Businesses” maximize telecommuting. Moreover, the Order is a “stay at home” order that requires everyone to stay home, except essential personnel. The Order also puts in place a travel ban except for certain circumstances. The purpose of the Order is to control and direct within the State of Delaware the operation of certain businesses, organizations, and enterprises necessary to maintain life, health, property, or public peace during the State of Emergency. Above all else, we as a firm want everyone to remain healthy and make it through this emergency unscathed. This article provides a general overview. As always, please contact us for specific guidance for your business as the March 22 Order creates a few murky areas for the unwary business. For example, while the Order allows individuals to leave their house to perform “Essential Activities,” which seems to allow for work in the office, the section on “Essential Travel” does not seem to authorize leaving the house to go to the office. Another example is that the Order appears to require employers to exclude workers over 60 years old from the worksite. However, this provision may run afoul of the Americans with Disabilities Act. Another issue presented is what to do about situations in which employees cannot be kept six feet apart, as will happen in many situations. We are here to help. THE MARCH 22 ORDER. In essence, the March 22 Order states that all physical locations of Non-Essential Businesses within the State of Delaware are closed until after May 15, 2020, or after the public health threat of COVID-19 has been eliminated, except that Non-Essential Businesses may continue to offer goods and services over the internet. Here is a link to the 18-page March 22 Order relating to Essential and Non-Essential Businesses. https://governor.delaware.gov/wp-content/uploads/sites/24/2020/03/Fourth-Modification-to-State-of-Emergency-03222020.pdf WHO CAN WORK? Essential Businesses are certain businesses that employ or utilize the following workers: (a) healthcare and public health; (b) law enforcement, public safety and first responders; (c) food and agriculture; (d) certain energy-related industries (electricity, petroleum, natural and propane gas); (e) water and wastewater; (f) transportation and logistics; (g) public works; (h) certain communications and information technology businesses; (i) certain community-based government operations and essential function; (j) manufacturing; (k) hazardous materials; (l) financial services and insurance; (m) chemical; (n) defense industrial base; (o) construction; (p) necessary products retailers; (q) necessary retail and service establishments; and (r) open air recreational facilities. Non-Essential Businesses are certain businesses that employ or utilize the following workers: (a) hospitality and recreational facilities; (b) concert halls and venues; (c) theaters and performing arts venues; (d) sporting event facilities and venues; (e) golf courses and shooting ranges; (f) realtors; (g) business support services, including customer service call centers and telemarketing operations; (h) shopping malls; and (i) retail stores. It is important to note that the above list of Essential Business and Non-Essential Businesses contains many exceptions and clarifications. The list found at the link above also contains the relevant 4-digit North American Industry Classification System (NAICS) code. All businesses should have a NAICS code or codes on their unemployment insurance forms or on their most recent tax return to aid in determining whether a business is Essential or Non-Essential. If you are unsure as to whether your business is Essential or Non-Essential, you can email covid19faq@delaware.gov or call 302-577-8477 between the hours of 9:00 am and 4:00 pm with any additional questions. Again, Offit Kurman is also here to help you navigate your business through these troubled waters. CAN YOU APPEAL YOUR BUSINESS CLASSIFICATION AS NON-ESSENTIAL? Yes, but there is not a guarantee that a petition will be successful. A petition must be requested in writing via electronic mail to covid19faq@delaware.gov for consideration. We understand that you can expect to receive a decision within one week of your submission. If you have questions or need assistance with the preparation of your petition, please contact us at the phone number or e-mail address listed below. ENFORCEMENT. The March 22 Order has the force and effect of law. Any failure to comply with the provisions contained in a Declaration of a State of Emergency or any modification to a Declaration of the State of Emergency constitutes a criminal offense. State and local law enforcement agencies are authorized to enforce the provisions of any Declaration of a State of Emergency. OTHER RESOURCES. Delawareans with questions about COVID-19 or their exposure risk can call the Division of Public Health’s Coronavirus Call Center at 1-866-408-1899, or 711 for people who are hearing impaired, from 8:30 a.m. to 8:00 p.m. Monday through Friday, and 10 a.m. to 4 p.m. Saturday and Sunday, or email DPHCall@delaware.gov For more information go to https://dhss.delaware.gov/dhss/dph/epi/2019novelcoronavirus.html The Delaware Department of Health & Social Services website offers a response to COVID-19, including information on testing, community resources and what you can do to avoid spreading COVID-19. For more information go to https://coronavirus.delaware.gov/ FURTHER GUIDANCE AND CLARIFICATION. As noted above, Governor Carney has modified the Declaration of a State of Emergency on six occasions and we anticipate that such modifications will continue, seemingly on a daily basis. For example, on March 24, the Governor issued an order, effective March 25 at 8:00 a.m. that delayed elections, evictions, foreclosures, termination of utility service, and termination of insurance coverage. Here is a link to the March 24 order as to these issues. https://media1.dsba.org/public/pdfs/GOVR%20Sixth-Modification-to-State-of-Emergency-03242020.pdf Please contact us if you have any questions regarding the Declaration of a State of Emergency generally, the classification, or appeal of a classification, as an Essential or Non-Essential Business, insurance coverage questions, employment law questions, or the most recent order concerning delayed elections, evictions, foreclosures, termination of utility service, and termination of insurance coverage. Stay tuned for more. Charles “Max” McCauley III contributed to this Article.
March 31, 2023
Business
Crisis Management – Lessons from the Law, Aviation and Real Life
Originally posted on 03/04/2020, content updated on 03/04/2023 Crises are often self-inflicted, such as the Boeing 737 Max crisis in which Boeing’s executives apparently ignored the very people inside Boeing who knew of the Max’s problems – the pilots. “After the crash, Boeing issued a bulletin disclosing that this line of planes, known as the 737 Max 8, was equipped with a new type of software as part of the plane’s automated functions. Some pilots were furious that they were not told about the new software when the plane was unveiled.”[1] “Boeing Pilot Complained of ‘Egregious’ Issue With 737 Max in 2016” was a headline in the New York Times.[2] Too often a crisis in the cockpit is so urgent that time does not allow for taking out the paper or electronic flight manual to help analyze and solve the problem. Student pilots are taught the “4 C’s” -- when faced with difficulty, “Climb, Communicate, Confess and Comply with instructions.”[3] In addition to learning what’s in the flight manual for the aircraft being flown, the 4 C’s are part of every pilot’s proficiency check ride. “A pilot goes through four stages of proficiency when learning a new airplane, a new set of skills, or working in a new environment. Those stages are Cautious, Compliant (or Current), Confident and Complacent. The last of these can kill you.”[4] Boeing as an institution seems to have gotten “complacent” when it came to Max’s safety because, it appears, those in the C-suite knew better than the pilots in the trenches. Once a self-inflicted crisis due to whatever cause, such as complacency, escalates, the 4 C’s come into play – Climb to safety, Communicate the problem, Confess what you did and what the problem is, and Comply with instructions from the higher authority of air traffic control. Boeing did what the Iranians did in the crash of a Ukrainian Boeing 737-800 (not a Max). The Iranians denied there was a problem and blamed someone else. Boeing blamed pilot error and the Iranians blamed mechanical failure. The two Boeing Max crashes occurred when foreign pilots were in control of new Boeing Max jets maintained and operated by foreign airlines. The Iranians did what some say they do best – invoke the big lie. The Iranians had no access to the black box or to cockpit information; there was no distress call; and in lying the Iranians were effectively faulting Ukraine’s pilots, mechanics, and pilot training even though Ukraine has one of the best safety records in terms of aircraft maintenance and pilot training. Only days later did the Iranians admit their military “unintentionally” shot down the Ukrainian airliner.[5] Even when “confessing,” the Iranians continued to lie – the missile was fired intentionally at an ascending aircraft, not at a descending incoming anything, and the Iranian’s Russian missile homed in on the airliner’s transponder which is what those missiles are supposed to do to hit their targets. The “unintentional” word was intended to excuse the incompetence and stupidity of the Iranian missile defense personnel. Bill Clinton in the Monica Lewinsky affair invoked only part of the 4 C’s -- he Climbed by telling America he had to get back to work as President of the United States, and he certainly Communicated that position. He also did the big lie when he denied he had had “sex with that woman.” In telling America, “It depends on what the meaning of ‘is’ is,”[6] President Clinton made every American parent of a daughter cringe. Boeing, Iran and President Clinton created these crises, and all mismanaged them. While it would seem axiomatic that a self-inflicted crisis can be managed more easily than an unexpected crisis, that unfortunately appears not to be the case. In unexpected crises, these rules of aviation also apply. The obituary of one of America’s foremost crisis management experts, Harold Burson, said: “Mr. Burson advised corporate C.E.O.s to get bad news out quickly and fully, making it a one-day story rather than letting it drag out. He urged them to be candid, and refused to take clients who could not be. He held staff seminars to promote Burson-Marsteller’s ‘vision and values.’ He was less interested in hiring reporters with contacts than he was in finding good writers who could capture the essence of a client. As business and financial news reporting improved in the 1970s and ’80s, he sought writers adept at detailed analysis, not the old puffery about chief executives and companies.”[7] [Emphasis added] Boeing, Iran and President Clinton could have used and heeded this advice which looks similar to the 4 C’s As a lawyer for over 50 years, I have had the privilege of having clients trust my judgment when a crisis occurs. Sometimes those have been “bet-the-company” crises. Boeing’s Max crisis was potentially a “bet-the-company” crisis. The Iranian shoot-down of a passenger plane and killing all 176 aboard was nothing more than a seeming “public relations” crisis to the Iranian regime.[8] And the Clinton crisis was a “Bet-the-Presidency” crisis that turned on a 50-50 Senate vote. “Over the years, I learned that the traditional advice of a lawyer to avoid public comment during a legal crisis had become outdated, especially with the impact of the Internet at the turn of the twenty-first century. . . . It was no longer viable for a lawyer to tell a client, ‘We’ll win it in the courtroom—we won’t litigate this in the media.’ There were too many ways for the judge and the jury to be influenced by public opinion, consciously or unconsciously; too many ways for prosecutors and regulators to be persuaded by adverse media coverage to launch an investigation or to bring a case, as broadcast news, once a day, became 24/7 cable, and then within just a few years, the Internet led to websites and then some blogs and then the blogosphere and then Google, Twitter, YouTube, WiFi, and social networks. Everything that follows ineffective crisis management – developing a simple message, rapid response to correct misinformation that could hurt a client’s reputation, share values or outcome in the courtroom – and, in the long-term, repairing the damage begins with the need to get the facts, all the facts, good and bad – not just those that attorneys are ready to tell a non-attorney crisis manager or public relations, consultant. And that means getting access to all the facts, first with the protection of attorney-client privilege.”[9] While the author of that advice was one of President Clinton’s advisers in the Paula Jones and Monica Lewinsky matters, his words of today, which may be ironic given what happened some 25 years ago, are valuable: “The first rule of Crisis Management is to get all the facts.”[10] Some law firms have created crisis management practices, sometimes within their government investigations practices. One firm “advocates a multifront approach to crisis management. Whether the situation stems from internal problems or external events, we enable our clients to maintain focus on their business objectives while managing a crisis to its best outcome.”[11] In aviation terms, this law firm is telling clients to continue to fly the airplane – continue to run their businesses, which is the “Climb” mandate of the 4 C’s, and the lawyers will gather the facts and engage other professionals such as public relations or crisis management firms, under the umbrella of the attorney-client privilege, and then advise the client on potential courses of action. An Above-the-Law article explains the critical importance of learning the facts: A hospital manager’s lost laptop with protected patient information on it meant the focus had to be not first on what the potential damage for a HIPAA violation could be, but first on making sure the “fact” the laptop was lost was accurate. “[T]he only ‘wise’ decision I made that day was to turn over the reins of our response to my colleague who suggested we first ask the manager to retrace her steps over the previous day. And as luck would have it, her laptop turned up in a rarely used conference room a few minutes later. Safe and sound, and most importantly, no violation of HIPAA or our patients’ information.”[12] There is no substitute for learning the facts as quickly and as accurately as possible. Another aviation crisis management lesson taught to all student pilots and repeated at all phases of pilot training is to “Aviate, Navigate, Communicate.”[13] The “Aviate and Navigate” part of this mandate is the “Climb” part of the 4 C’s. The “Communicate” element is shorthand for the “Communicate, Confess and Comply with instructions” part of the 4 C’s. The client must always Aviate and Climb – run the business. The Confess part is usually where things get dicey in terms of whether the client will come clean with the lawyers. Boeing apparently did not. The global media were the lawyers in the case of the Iranian shoot-down of the Ukrainian aircraft. And we do not know whether President Clinton Confessed to his advisers at the time all of the facts regarding Paula Jones, Monica Lewinsky and other women accusers. I chose the aviation analogy to crisis management for business because as a licensed pilot for more than 40 years and having owned my own single engine aircraft for more than 38 years, I have had my share of difficult situations just as every plot does. Having a landing light blow out on approach to an unfamiliar non-tower controlled airport after a multi-hour night cross country to work on an acquisition in Maine; having a very large Seagull dive towards my windscreen and hit my right wing over the New Jersey Turnpike at 500 feet on approach to my home airport; and getting lost when encountering an unexpected snow squall in Western Pennsylvania, many occurring in my aircraft’s pre-GPS days, were all manageable because of my recurrent pilot training to prepare for those potential crises. While the possible crises in aviation are seemingly endless, especially the more complicated the aircraft, training and more training proves the adage that “practice makes perfect.” There are some crises that cannot be practiced in an aircraft and need to be practiced in a simulator, especially when flying more complicated aircraft. An airplane is a machine with parts, systems, passengers and crew that can malfunction. What we do as student pilots and then as pilots is train for contingencies. Training for a crisis in business is not as easy as training for a crisis in aviation because training for crises is usually not part of a business’s agenda. Contingency planning can be urged by insurers, and some companies’ management will have risk managers who do engage in contingency planning. Unenlightened management will often view costly contingency planning as an expense without a quantifiable immediate benefit. How often do we roll our eyes at fire drills in high rise office buildings? This is contingency planning and practice, or recurrent training, no different from what we do as pilots. “If you see fire or smoke, follow the four ACES of high rise building fire safety: 1. ACTIVATE the fire alarm immediately by pulling the nearest Fire Alarm Box . . . . If you cannot pull the Fire Alarm, call 911. 2. COMMUNICATE with the Fire Warden Team and other colleagues on your floor. 3. EVACUATE by using the stairs . . . . DO NOT USE THE ELEVATORS. Members of the Fire Warden team will lead the evacuation down two or more floors for re-entry (or if there is the need to evacuate the building completely . . .). 4. SELF-ESCAPE Stay calm, don’t panic. Stay low in smoke conditions, and close doors to confine fire and smoke. Feel doors before opening them; if they’re hot, don’t open!”[14] Isn’t this really a tenant’s variant on “Climb, Communicate, Confess and Comply with instructions?” “I have written before about the necessity of contingency plans, but what if there is simply no time to pull out the book and turn to page 63? You are in a state of emergency, your stomach is in a knot, and the CEO is asking you some very difficult questions. Grab the canoe. Take a breath and do your best.”[15] The canoe is the business or the aviate and navigate/fly the plane part of dealing with an aviation crisis. “First, you must ‘grab the canoe’ and get back to floating; only then can you assess what else might be wrong (missing possessions, food, wet socks, etc.). Things are going to go screwy during your tenure as an attorney — they just will. You cannot possibly plan for everything, but you can remember the mantra of ‘grab the canoe.’ The canoe is a metaphor for the stasis that usually surrounds your job. You are first and foremost representing an entity. . . . The entity is what keeps you and the other employees afloat. During a crisis, all of the happenings within the entity are to be worried about after first taking care to right your primary client, the business. Some things that occur in an emergency, or a quickly moving negotiation, can be left behind, such as obsolete contractual language. Other issues are absolutely necessary in a publicly-traded company — reporting requirements, for instance. And in the time it takes to read this column, some of these issues can overturn your company’s sense of balance, and leave you drifting.”[16] “Of course we are not saving lives, or curing dread disease. We practice law. The key is in the word “practice.” As you practice, answers become ingrained, and your expertise begins to grow. After years of “practice,” you enable yourself to right tipped canoes, and assist stressed CEOs quickly, efficiently, and appropriately. But in the recesses of your mind, you must always be aware of the possibilities for crisis. Remember that in the moment you will rely on what you know and keep the primary focus on staying afloat. You can allow yourself to let the what-ifs creep in once you are past the crisis and are happily ensconced at the third seat at the bar, with a martini safely in hand.”[17] Crises can be big or small. And they can sometimes involve saving lives. It is not often we as lawyers are called upon to help clients deal with “Bet-the-Company” or life-and-death crises. Our “practice” for these crisis events usually comes on the job and our performance often turns on the judgment we have developed from experience, from observing more experienced lawyers, from reading as much as we can about as much as possible, and most of all from thinking and analyzing what we read, see and hear and all the what-if’s that never cease in our daily law practices. In my law practice, I have had a few “Bet-the-Company” crises to help clients through. Fortunately, all turned out fine. One involved consumer product tampering and the other involved a brother-in-law’s attempt to misappropriate my client’s business. The Product Tampering Crisis: The CEO of my branded consumer product client called in a panic, telling me a supermarket executive notified the client and FBI that one of its stores had received a call from someone claiming to have put poison in a container of the client's product. The client asked whether he should issue a product recall. I have used this example in interviewing job applicants. I ascertained the facts by speaking with the client’s CEO, COO and plant manager and by liaising with the FBI. I learned that wiretaps had been placed on the supermarket's telephone lines and that the FBI agent’s experience was more often than not these were hoaxes. My advice to the client was to wait, not rush to issue a product recall, and instead to withdraw the product just from the stores in the local area, to test the withdrawn product, and to replace the product with new product produced at a different plant. That was done and testing proved negative. We waited. This was in the days before computer real-time inventory could tell us how much product had been purchased at each location. If no poisoned product was out there and the client issued a recall, the company and its brand would have been severely and possibly irreparably damaged. If a poisoned container was already out there in commerce to an unsuspecting consumer, the company would be severely damaged, and a recall would necessarily follow. The FBI agent and I thought the odds of a just-purchased container being consumed and harming or killing someone were fairly low. The supermarket received a second call from the same caller a few hours later. The FBI wiretap led to an arrest that day of a disgruntled teenage supermarket employee who confessed to the hoax. A public product recall was avoided, and no one was hurt. The Brother-In-Law Crisis: A prospective client was referred to me to discuss estate planning and his desire to leave his hotel business to his adult child who had joined the business and opened an on-premises restaurant. The client believed this hotel was “his,” as the client ran this hotel and his brother-in-law ran two other hotels that all four in-laws owned. I needed to know what the client owned, not what the client told me he owned. After reading the relevant documents, I learned that the client did not own or control the business he thought he did, and he would not be able to leave the business to his heir. The client owned 26% of a limited partnership that owned the business, and he was one of two general partners, the other being his brother-in-law, a very controlling and domineering person. The brother-in-law conditioned his okay for the client’s adult child to open the restaurant on the restaurant providing, at its expense, free breakfasts to the hotel’s guests. The client's then-lawyer and then-accountant were among the dozen or so family and friends limited partners. The partnership's term was contractually scheduled to expire some years earlier, but the brother-in-law, attorney and accountant had advised the client to extend the partnership's term because if the business was sold, they would all have to pay taxes. It was not a coincidence that each limited partner's original investment was yielding an annual 700% cash return, all while the assets of the business had appreciated significantly. Because the client was the nicest person I had ever met and was the kind of man one would choose as your father if that was a matter of choice, the client was not confrontational and did not want to sue despite what I thought were good claims against some of the actors here. I devised a non-litigation strategy that included the partnership not distributing cash to its partners so the partnership could use its cash for acquisitions and other business matters. That resulted in the partners having taxable income without cash being distributed to them. The client offered to buy out the limited partners who rejected the offer, commenced arbitration, and sued for an injunction to compel cash distributions. Although the client would not sue, he would defend himself quite vigorously. The injunction was denied. The case proceeded to pre-arbitration mediation. Relying on their own "expertise," the former lawyer and former accountant chose not to obtain an appraisal and agreed on behalf of the limited partners to a buy-out at a particular partnership valuation. I arranged for a bank client to make a loan to the partnership in an amount greater than the buy-out value of the limited partners’ 48%. The bank's appraised value of the business turned out to be about 50% greater than the buy-out value. After some intra-family transactions, this crisis was resolved with my client owning 100% of his business and having the ability to leave his very valuable asset to his heir. The client said that the decision to make me his attorney was the most significant business decision of his life. It is critical to ascertain the facts in any crisis situation, both for the lawyer and the client, and the lawyer must be able to communicate those facts clearly to the client and ultimately to others involved in the crisis. “’We are advocates,’ Mr. Burson told The New York Times in 1984. ‘We are being paid to tell our clients’ side of the story. We are in the business of changing and molding attitudes, and we aren’t successful unless we move the needle, get people to do something. But we are also a client’s conscience, and we have to do what is in the public interest.”[18] While we are advocates to the world outside the client, we need to be truth-tellers to and questioners of the client. “When cyanide-laced capsules of Tylenol, the pain medication, killed seven people in the Chicago area in 1982, its manufacturer, Johnson & Johnson, made the best of a bad situation. After consulting Mr. Burson, the company’s chief, James E. Burke, announced a recall, ordered new tamper-resistant caplets and packaging seals, and mounted a campaign that acknowledged the facts, stressed safety measures and eventually restored his company’s credibility. ‘Basically, I served to help him think through problems and reinforce his own instincts,’ Mr. Burson said of Mr. Burke. It was not modesty. P.R. people have always tried to keep their hands invisible, allowing clients to take credit and blame, and the Tylenol case is often cited as a textbook model of corporate responsibility in a crisis. No one was ever prosecuted for the tampering, or for an isolated 1986 recurrence.”[19] (Coincidentally, I advised a pharmaceutical packaging company client at that time that repackaged Tylenol in tamper-evident packaging following that crisis.) Sometimes, identifying and articulating the facts suggests a solution. In my examples, each business needed to continue to be operated while these crisis situations played out and resolved. “Climb, Communicate, Confess and Comply with instructions” is the client’s job in a crisis. Our role as lawyers is to focus the client on running the business and ascertaining the facts as rapidly and as accurately as possible, evaluate options with the client, and then together arrive at the solution that makes the most sense for the client and the client’s constituencies. "Never let a good crisis go to waste" has been attributed to Winston Churchill[20] and to others.[21] No matter the outcome of a crisis, there is always a lesson to be learned. [1] https://www.washingtonpost.com/business/economy/new-software-in-boeing-737-max-planes-under-scrutinty-after-second-crash/2019/03/13/06716fda-45c7-11e9-90f0-0ccfeec87a61_story.html[2] https://www.nytimes.com/2019/10/18/business/boeing-flight-simulator-text-message.html [3] https://airfactsjournal.com/2018/09/the-other-4-cs-of-aviation/ [4] https://airfactsjournal.com/2018/09/the-other-4-cs-of-aviation/ [5] https://www.nbcnews.com/news/world/iranian-military-says-it-unintentionally-shot-down-ukrainian-plane-n1113996 [6] https://en.wikipedia.org/wiki/Impeachment_of_Bill_Clinton [7] Harold Burson, a Giant in Public Relations, Dies at 98 https://www.nytimes.com/2020/01/10/business/media/harold-burson-dead.html [8] https://en.wikipedia.org/wiki/Ukraine_International_Airlines_Flight_752 [9] Lanny J. Davis, Why Lawyers Are Best At Crisis Management http://www.lannyjdavis.com/why-lawyers-are-best-at-crisis-management/ [10] http://www.lannyjdavis.com/why-lawyers-are-best-at-crisis-management/ [11] https://www.steptoe.com/en/services/practices/criminal-defense-investigations/crisis-management.html [12] https://abovethelaw.com/2017/05/counseling-through-an-in-house-crisis/ [13] For much more on this topic, see https://idea.library.drexel.edu › idea:6094 › datastream › OBJ › download). [14] https://finance.columbia.edu/content/building-evacuation-procedures [15] https://abovethelaw.com/2013/07/grabbing-the-canoe-or-reflections-on-crisis-management/ [16] https://abovethelaw.com/2013/07/grabbing-the-canoe-or-reflections-on-crisis-management/?rf=1 [17] https://abovethelaw.com/2013/07/grabbing-the-canoe-or-reflections-on-crisis-management/?rf=1 [18] https://www.nytimes.com/2020/01/10/business/media/harold-burson-dead.html [19] https://www.nytimes.com/2020/01/10/business/media/harold-burson-dead.html [20] https://realbusiness.co.uk/as-said-by-winston-churchill-never-waste-a-good-crisis/ [21] http://freakonomics.com/2009/08/13/quotes-uncovered-who-said-no-crisis-should-go-to-waste/
March 4, 2023
Business
FTC Seeks to Ban Non-compete Clauses: What This Really Means for Your Business
Today we will cover how the FTC seeks to ban non-compete clauses and what this means for your business. On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a new rule banning employers from imposing non-competes on their workers. The rule is undoubtedly politically motivated as it was issued in response to President Biden’s Executive Order that encouraged the FTC to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” The FTC believes a non-compete is a “widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” By stopping this practice, the FTC erroneously estimates wages would increase by nearly $300 billion per year, and it would expand career opportunities for 30 million Americans. By stopping this practice, the FTC erroneously estimates wages would increase by nearly $300 billion per year, and it would expand career opportunities for 30 million Americans. Scope of Proposed Rule to Ban Non-compete Clauses The FTC’s proposed rule would prohibit employers from using non-compete clauses – i.e., any contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, within a specific geographic area and period of time after the conclusion of the worker’s employment with the employer. It would make it illegal for an employer to: enter into or attempt to enter into a non-compete with a worker; maintain a non-compete with a worker; or represent to a worker, under certain circumstances, that the worker is subject to a non-compete. The proposed rule would apply to “workers,” broadly defined by the FTC to include employees, individuals classified as independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a client or customer. The rule also includes a “functional test” for determining what constitutes a “de facto” non-compete clause that has the same effect as an express non-compete clause – the same test employed by courts in states that already have express prohibitions on non-compete clauses. Effective Date of Proposed Rule Importantly, this is a proposed rule that is not in effect. The proposed rule is in a comment period until March 20, 2023. We do not believe it will go into effect, if at all, until after a lengthy court battle ending with a ruling from the United State Supreme Court. Then, even if the proposed ban becomes law, employers will have 180 days to revise their agreements to conform with the law. Moreover, there are a variety of tools, such as reasonably tailored non-disclosure agreements and confidentiality provisions, employers can use to accomplish their goals without violating the proposed ban. The proposed rule is the first step in a long process that will take years to complete. We expect the FTC will receive thousands or hundreds of thousands of comments to consider. Based on the comments, the rule will be revised. It could take the FTC until late 2023 or even the end of 2024 to issue a final rule. After the final rule is set forth, it will be subject to a legal challenge (or challenges); this will undoubtedly delay the effective date into 2025 or later, assuming the final rule survives any legal hurdles it faces. During this challenging period, a presidential election will occur, and the political winds will likely change, potentially further reversing the course of the FTC. Criticism of the Proposed Rule The U.S. Chamber of Commerce has opined that the FTC lacks the authority to issue the rule and ignores the benefits of non-competes. A senior vice president for the U.S. Chamber of Commerce has stated: “Attempting to ban non-compete clauses in all employment circumstances overturns well-established state laws which had long governed their use and ignores the fact that, when appropriately used, non-compete agreements are an important tool in fostering innovation and preserving competition.” An FTC Commissioner issued a dissenting statement when the proposed ban was announced. The dissenting statement outlined potential legal challenges noting the FTC lacks the legal authority to issue the ban, and the rule is barred by a recent United Supreme Court decision. Even if the FTC has authority, it is an impermissible delegation of that authority. The proposed rule must overcome extensive case law upholding the use of non-compete clauses that are determined to be reasonable unless they are unreasonable as to time or geographic scope. Even if the FTC has authority, it is an impermissible delegation of that authority. Exemptions to Proposed Rule to Ban Non-compete Clauses The proposed rule would exempt non-compete agreements that a person entered in connection with the sale of a business, but only if that person owned 25% or more of that business. The FTC is also seeking comments as to whether: non-compete clauses between employers and senior executives should be subject to a different standard; the rule should apply uniformly to all workers; and the rule should impose a categorical ban on non-compete clauses. Alternatives to Non-compete Clauses Employers are not without options. The FTC’s proposed rule’s definition of a non-compete clause does not include other types of covenants. Accordingly, employers should begin analyzing their confidentiality clauses, non-solicitation, and non-disclosure provisions. Carefully drafted provisions can ensure that employers are able to protect confidential information and customer relationships, as well as the poaching of current employees by former employees. Employers should also use this as an opportunity to strengthen trade secret protection plans. Employers should also use this as an opportunity to strengthen trade secret protection plans. What Should I Do as an Employer? There is no need to panic. The proposed rule will not go into law in its final form, if at all. However, now is the time to implement proper planning techniques into agreements with employees. As noted previously, with proper legal counsel, non-compete, non-solicitation (vertically and horizontally), confidentiality, non-disclosure, and other restrictive covenants can be used to accomplish the goals of employers, most of which are not within the scope of the current version of the proposed rule. With proper legal counsel, non-compete, non-solicitation, confidentiality, non-disclosure, and other restrictive covenants can be used to accomplish the goals of employers. Conclusion Thank you for reading our blog on how the FTC seeks to ban non-compete clauses and what this means for your business. Please contact us immediately so that we can assist you in your planning and contract drafting process to properly implement such restrictions to protect your business. Charles McCauley can be reached at cmccauley@offitkurman.com or 484-531-1712, and Sarah Goodman can be reached at sarah.goodman@offitkurman.com or 267-338-1319.
February 24, 2023
Business
FinCEN Issues Final Rule for Beneficial Ownership Reporting under Corporate Transparency Act
On September 30, 2022, the Financial Crimes Enforcement Network (FinCEN) within the U.S. Department of Treasury issued final regulations under the Corporate Transparency Act (CTA) that will require most small domestic and foreign business entities which are registered to do business in the United States to disclose the identity of their beneficial owners. The rule will take effect on January 1, 2024. These regulations, which finalized proposed regulations issued under the CTA in December 2021, resulted from years of debate in Congress over the best measures to develop a database of beneficial owners of business entities in order to combat terrorism, money laundering and other financial crimes. With the adoption of these regulations, the United States joins many other developed countries throughout the world in providing a means for the federal government, as well as state and local law enforcement agencies, to ascertain the identity of individuals who possess ultimate control over so-called “shell companies” that heretofore were not required to disclose their owners and therefore be better equipped to combat illicit activities conducted through such entities. The regulations require all “reporting companies,” as discussed below, to report identifying information concerning itself and any individual who either (i) exercises “substantial control,” as discussed below, over the reporting company or (ii) owns or controls at least 25% of the ownership interests of the reporting company. In addition, all reporting companies formed after January 1, 2024, must disclose the identity of the individual or individuals who directly filed the document that creates the entity, or in the case of a foreign reporting company, the document that first registers the entity to do business in the United States, and the individual who is primarily responsible for directing or controlling the filing of the relevant document by another (including attorneys, corporate service companies, etc.)(each such individual referred to as a “company applicant”). Reporting Company A reporting company is any entity (i) that is formed under the laws of any state or Indian tribe in the United States or any entity that is formed under the laws of any foreign jurisdiction that has qualified (registered) to do business in any jurisdiction in the United States, and which is formed or qualified by the filing of a document with the secretary of state or equivalent filing office in the jurisdiction of formation or qualification, and (ii) is not one of 23 specified categories of exempt entities that are already subject to beneficial ownership reporting requirements to FinCEN. Accordingly, all corporations, limited liability companies, limited partnerships and business trusts, among other entities, fall within the definition of a reporting company, while general partnerships, sole proprietorships and other trusts do not. Exempt entities include, among others, (i) most regulated financial institutions, including banks, credit unions, insurance companies, and broker-dealers, (ii) companies required to file reports under the Securities and Exchange Act of 1934, (iii) tax-exempt entities, (iv) subsidiaries of exempt entities, and (v) “large operating companies”. This latter category of an exempted entity consists of any entity that has a physical presence in the United States, employs more than 20 full-time equivalent employees and has annual gross receipts in excess of $5 million. Beneficial Owners The regulations require each reporting company to report to FinCEN certain information with respect to each individual that qualifies as a direct or indirect beneficial owner of such reporting company, as described below. The determination of who constitutes a beneficial owner derives from either of two independent tests, a substantial control test or an ownership test. The regulations define “substantial control” over the entity to mean any of the following: (i) service as a senior officer; (ii) possessing authority to remove or appoint any senior officer or majority of the board of directors or equivalent body; (iii) having the ability to direct, determine or have substantial influence over important decisions to be made by the reporting company; or (iv) having some other form of substantial control over the reporting company. Substantial control can be exercised in a number of ways, including through a position held with the reporting company, through a position held with the parent or other controlling entity of the reporting company, through contractual or other arrangements, through nominee relationships, or through other financial relationships with the reporting company. The ownership test requires that the individual own, directly or indirectly, at least 25% of the ownership interests of the reporting company. Such ownership may be obtained through direct or indirect ownership of equity interests in the company, through a profits interest, or through convertible instruments such as options, warrants or convertible debt instruments, as well as through trusts or other contractual arrangements. In calculating the percentage of ownership, the regulations require that the number of ownership interests owned by such individual be compared to the total outstanding ownership interests of the company and that any convertible, or exercisable interests in securities owned by the individual be considered to be fully converted or exercised on a per share basis. The regulations make it clear that there can be more than one beneficial owner of each reporting company. Information to be Reported and Filing Deadline Each reporting company formed on or after January 1, 2024, must file an initial report with FinCEN within 30 days of receipt of official notice of formation or qualification from the applicable jurisdiction of formation or qualification. Each reporting company in existence or qualified prior to January 1, 2024, must file an initial report no later than January 1, 2025. The initial report must contain the following information: Legal name of the entity and any d/b/a names Full business address Jurisdiction of formation or qualification for foreign entities Tax Identification Number Beneficial Owner information, including for each individual:Full legal name of the individual Residence address of the individual Unique identifying number for the individual as provided by a governmental agency, such as a driver’s license number, passport number or other identification card number, in each case together with an image of the document where such number exists. In addition, reporting companies must file an updated report with FinCEN containing revised information within 30 days of (i) any changes to the information or (ii) the company becoming aware or having reason to know of any incorrect information previously reported. For entities formed on or after January 1, 2024, the initial report must also include information for each company applicant similar to that required of beneficial owners, although a business address may be reported in place of a residence address for such individuals. While a reporting company must file a report to show any corrected information for any company applicant named in the initial report, it is not required to report updated information with respect to company applicants. When a reporting company files an initial report, it may apply for a FinCEN identifying number that it may use for filing any updating reports. In the future, FinCEN will be releasing FAQs that detail questions and answers regarding specific situations as they arise and the forms for the initial and updated reports. In addition, FinCEN will be subsequently releasing separate sets of regulations dealing with what parties will have access to the database of beneficial ownership information and revisions to the existing Customer Due Diligence regulations for financial institutions to better harmonize the existing requirements with those under the final Beneficial Ownership Reporting regulations. Offit Kurman has a team of attorneys who are familiar with the CTA and the final regulations. We will continue to monitor the roll-out of the additional regulations and other FinCEN guidance and will be happy to answer any questions that you may have in this regard.
November 3, 2022
Business
Executive Playbook: The Challenges of Hiring and Recruiting
On this month’s episode of the Executive Playbook, Mike Cammarata and Russell Berger discuss the practical challenges of making strategic hires and recruiting. Mike and Russell focus on the different leading indicators that should prompt business owners to move forward with a hire and then, once that decision is made, where to recruit and how best to interview. Listen in to learn more.
October 27, 2022
Business
Executive Playbook: Maryland Saves Program
On this month’s episode of the Executive Playbook, Mike Cammarata and Russell Berger discuss the new Maryland Saves program. Under this program, almost all employers in Maryland are required to either offer a retirement plan of their own or to provide their employees with access to the Maryland Saves program. While this program should not cost employers any out-of-pocket funds, it is an opportunity for employers to ensure that they are taking strategic steps to not only comply with the law but to provide meaningful benefits to employees. Listen in to learn more about the financial and legal opportunities Maryland Saves presents for business owners.
September 29, 2022
Tax
Virtual Currency and Virtual Transactions – Real Tax Issues in Real Dollars
Recently the IRS released a draft form of Form 1040 for the upcoming tax year. The biggest change is a more detailed question about virtual currency transactions. The new draft form asks, “At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset),” followed by a “Yes” or “No” box. You can see a copy of the draft form here. Although not as bad as some expected (Line A-How much did you make last year? Line B-How much do you have left? Line C-Send Line B.), this change shows the Service is increasing its scrutiny of virtual currency transactions and, not coincidentally, subjecting taxpayers to false statement penalties if they are not truthful in their answer. Although the question asking about virtual currency did not appear on the 1040 until 2020, as seen here, the Service began issuing guidance on virtual currency and transactions as early as 2014, as seen in Notice 2014-21. Five years later, in Rev. Rul. 2019-24, the Service issued further guidance to address “hard forks” and “airdrops.” So, what are the rules? First, despite the moniker, virtual currency or cryptocurrency, the Service considers virtual currency (Bitcoin, Dogecoin, Ethereum, as well as all other cryptocurrencies) to be personal property, not currency. Setting aside currency arbitrage transactions, the basis of currency is the face value of the currency. If I receive a $100.00 bill, my basis in that Benjamin is always $100.00 (I can’t depreciate it), and when I dispose of it (use it to buy, say $100.00 of Dogecoin), I have no gain or loss on the disposition of that bill. Now, because Dogecoin is treated as property and not currency if my $100.00 of Dogecoin grows to $300.00 and I use it to buy something else for $300.00, I have taxable gain, in this case, $200.00. Because my Dogecoin is considered property, not currency, the gain will be taxed either as ordinary income or as a capital gain. Whether the gain is taxed as a capital gain depends on whether the Dogecoin is a capital asset in my hands. See Q &A No. 7, Notice 2014-21. If I do not hold the Dogecoin in inventory for sale to others but hold it as an investment, much like stocks, bonds, and other investments, it should be treated as a capital asset and taxed at capital gains rates. If I satisfy the long-term capital holding period (more than one year, i.e., a year and a day), then I get the favorable long-term capital gain rates, which generally are lower than short-term capital gain rates. Let’s take the flip side. What if someone pays me in virtual currency? What is my basis in the virtual currency with which I was paid? My basis is the fair market value of the virtual currency on the date of receipt. See Q & A No. 4, Notice 2014-21. Transactions using virtual currency must be reported in U.S. dollars for U.S. tax purposes. If the virtual currency is traded on an exchange, the value can be determined simply by looking at the exchange rate on the date of receipt or payment. Where the virtual currency is not traded on an exchange, the taxpayer still must determine the fair market value based on all the facts and circumstances. What if I receive virtual currency in payment for services? If I am an independent contractor (I receive a 1099), the receipt of virtual currency is considered self-employment income, which means it is subject to self-employment tax. This also means that payment to an independent contractor using a virtual currency is subject to information reporting, i.e., reporting to the IRS payments of $600 or more in the same tax year to the same person, and the attendant penalties for not filing information returns. If I am an employee (I receive a W-2 from my employer), the payment of wages in virtual currency is subject to federal income tax withholding and, if I am the employer, to the employer’s share of employment taxes. If I am an employer, I must pay the taxes withheld and the employer’s share of employment taxes in U.S. currency, not Dogecoin or any other virtual currency. What if I “mine” virtual currency? If I mine virtual currency, the fair market value of the virtual currency as of the date of my receipt of it is included in gross income. What if I “mine” virtual currency as a trade or business? If I mine virtual currency for my own trade or business or as an independent contractor, the net earnings from that activity constitute self-employment income, but I am entitled to deduct my ordinary and necessary business expenses in determining my net income. You said something about hard forks and airdrops; tell me more. (For those unfamiliar with soft forks and hard forks, click here to read an Investopedia article containing a brief explanation). Typically, and grossly general terms, a hard fork results in the creation of a new cryptocurrency. After a hard fork, transactions involving the new cryptocurrency are recorded on a new distributed ledger, while transactions involving the old or legacy virtual currency continue to be recorded on the old legacy ledger. An airdrop is a way of distributing units of virtual currency to the distributed ledger addresses of multiple taxpayers. Hard forks are often, but not always, followed by airdrops. Generally, a virtual currency is received from an airdrop on and at the date and time it is recorded on the distributed ledger. For U.S. tax purposes, whether the taxpayer received the virtual currency on and at that date and time is determined by the dominion and control test. If the taxpayer has dominion and control over the virtual currency on the date and at the time it was airdropped, then the taxpayer, if on the cash basis of accounting, has gross income under IRC § 61(a)(3) on and at the date and time of receipt. On the other hand, if the hard-forked virtual currency is airdropped into a wallet managed by an exchange that does not support the newly created (hard forked) virtual currency, which means the taxpayer cannot transfer, sell, exchange, or otherwise dispose of it, then the taxpayer does not have dominion and control over the new hard fork airdropped virtual currency, and it would not be included in the taxpayer’s gross income unless and until the taxpayer later acquired dominion and control over it. The use of virtual currencies and transactions using virtual currencies can create real tax issues. If these tax issues result in federal tax liability, those liabilities must be paid with the U.S., not virtual, currency. If in doubt regarding the tax consequences of buying, selling, using, or mining virtual currency, taxpayers should consult their tax advisor regarding the implications of buying, selling, and using virtual currencies. Offit/Kurman PA counsels clients on intellectual property matters such as virtual currency and NFTs, including the tax aspects and effects of those matters. The views expressed herein are solely those of the author, are not intended as, and do not constitute, legal or tax advice.
August 24, 2022
Business
Executive Playbook: Alternative Solutions for Recruiting and Retention
Recruiting and retention continues to be a challenge for employers. While employers could always pay employees more, that is not a particularly attractive solution and, in many cases, is not a solution at all. In this episode of the Executive Playbook, Mike and Russell discuss strategies that employers can implement to attract new employees and retain existing employees.
July 28, 2022
