June 30, 2014

Is Your Business Being Sued?

Being served with a lawsuit can be one of the worst things that can happen to any business.  The specter of long drawn out litigation causes immediate anxiety and young and inexperienced owners worry that their business may collapse.  In short, panic sets in and panic is the worst response.  There are two very good reasons not to overreact to being sued.  First, most businesses are insured to protect against the risk of litigation.  In such cases, the insurance company (with some exceptions) will step in and defend the action.  Second, overreacting leads to bad decision making especially for those that are not insured or perhaps under insured.  Whatever the scenario, there is little doubt that the most prudent step any business owner can take after being sued is an immediate consultation with an experienced business litigator.  The second most prudent step is to act fast.  It is important that business owners are aware of the deadline to respond to the complaint.  They have thirty days from service to do so and need to be acutely aware of the deadline.  Otherwise, on-the-ball attorneys on the other side will promptly move for default which at worst will result in a judgment and at best require significant additional attorney time to cure.  If more time is needed to gather insurance documentation and/or obtain counsel, it is best to at least contact the opposing party or attorney and ask for an extension to "respond" to the complaint and confirm so in writing.  Using the word "respond" instead of "answer" will allow you to respond to the complaint in any manner available under the law.  Most attorneys will agree to this at least once.  

time-to-do-business-924991-m.jpgMost people would be surprised at the number of business owners (in San Diego alone) that choose to ignore lawsuits only to find out later that judgment has been entered against them for tens of thousands of dollars or even hundreds of thousands of dollars.  The existence of the judgment is often discovered only after bank accounts are attached or a Sheriff shows up one day to conduct a till tap (collecting money from the cash register at the end of the day to satisfy the judgment).  Others will rush to resolve the matter without the assistance of an experienced business litigator hoping that they can avoid the problem by agreeing to resolve the dispute informally.  While informal resolution is certainly preferable, signing agreements without legal representation is extremely risky.  The attorney representing the other side is armed with tools to maximize the benefit to their clients.  The harm to business owners under this scenario can be incalculable.  Usually, unrepresented business owners have no idea of the true extent of what they are agreeing to.  For instance, a business owner who agrees to pay off a debt in twenty-four monthly payments may unknowingly stipulate to forfeiting all of her shares in a corporation (a disastrous outcome) if she is late even one time on her payments.  An experienced business lawyer will build a cushion regarding late payments into any agreement settling the matter.  

After "not panicking", the first thing any business owner should do upon being served with a lawsuit is to retrieve all insurance policies (including personal umbrella policies) that might in any way cover the business.  In fact, any experienced lawyer would first ask about insurance policies.  It would be malpractice to do otherwise.  Moreover, attorneys aren't interested in spending time on lengthy consultation and evaluation if a case is eventually going to be turned over to an insurance company who retain their own attorneys to handle litigation.  Businesses pay considerable premiums to protect themselves from risk.  When sued, they shouldn't hesitate to tender their claims to insurers.

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June 9, 2014

Negotiating Tenant Improvement Allowances

A Tenant Improvement Allowance (TIA) is a landlord incentive designed to assist new tenants with the build-out of their space. Build-outs are improvements to leased space to make the space usable for a particular tenant's needs. Whether or not a landlord will offer a TIA and how much the landlord will offer depends on a variety of factors including the relative bargaining power of prospective tenants, the current market for commercial space, the current condition of the premises, the extent to which the current condition suits a prospective tenant's needs, the tenant's desirability, the base rent and other key terms being negotiated. Often, new business owners are surprised when a TIA is offered and may over estimate its significance. While TIAs are important landlord incentives, landlords are careful to minimize the true costs. In most cases, tenant improvements are capital improvements that provide a long term benefit to the property. Even where the improvements are specific to a tenant's needs, landlords most often build the cost of TIAs into the base rent. However one looks at it, TIAs are an important factor in commercial lease negotiation. If a tenant improvement allowance is being offered, the associated lease language is critical for both landlords and tenants. When negotiating TIAs and associated lease terms, it is important that the parties have a clear understanding of the improvements needed and their likely cost.

old-bulilding-2-147832-m.jpgTwo Common Approaches - The Stated Dollar Amount Approach and the Turn-Key Approach:

With a stated dollar amount, the landlord offers a fixed sum to the tenant for the build-out. The tenant must absorb any additional costs that exceed the fixed sum. In some cases, landlords will require any excess monies be returned after completion of the job. Where landlords do not require the return of excess funds, they are more likely to allow soft costs such as architectural and engineering fees. Again, ensuring that these issues are clearly addressed in the lease avoids any potential future conflict. The stated dollar amount method is fairly straight forward. The landlord knows the precise amount it will be responsible for and tenants (who typically oversee the build-out) retain control of the process. It is also possible for landlords to offer a fixed sum while retaining control of the build-out process.

With the turn-key approach, the landlord allowance covers certain specified work which the landlord typically oversees (i.e. build out of a new kitchen or bathroom, erection of interior walls and partitions, installation of new doors and windows, new flooring and ceilings, etc.). Any additional work would be considered extra work to be absorbed by the tenant. Some new business owners may prefer the turn-key approach so that they may remain focused on other important aspects of forming their new business. Overseeing construction while simultaneously focusing on licensing, trademarks, dbas, incorporation, employees, inventory, insurance and other business responsibilities can be daunting. However, it's important that new business owners understand the downside to landlord control of build-outs. When landlords control the process, they are motivated to limit expenses. They may not have the same quality goals and may take short cuts the tenant wouldn't be willing to take. Tenants will want to ensure that they get the most work possible with the allowance provided, that the landlord warranty the work, that the work be completed by a specified date and that the tenant have a reasonable opportunity to inspect the work to be sure the work was done properly including retaining the ability to submit a punch-list of things that need to be completed after taking possession. In addition, it's helpful to ask landlords to undergo a competitive bidding process where sealed bids are opened in the tenant's presence.

In some cases, landlords will allow tenants to control the build-out process choosing their own architects and contractors (subject to landlord approval). However, the tenant's expenses would be limited by the allowance. If the tenant goes over budget, the tenant would be responsible for the excess costs.

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May 26, 2014

The Pros and Cons of Guerrilla Discovery

Litigation can be divided into three relatively distinct phases: the pleading phase , the discovery phase and trial. While the distinction can sometimes be blurred, there is no doubt about these three significant areas of litigation. The average San Diegan has little understanding of the pleading phase. It involves the filing of a complaint followed by answers, cross-complaints and/or attacks on the pleadings (demurs, motions to strike and motions to quash) most of which require a response by the plaintiff and ultimately a hearing before the trial judge. This phase can be remarkably drawn out and complicated, and it is a topic for another article. Trial is, well, trial. It is of course the most well known phase in litigation. The discovery phase is no more or less important. A properly discovered case provides attorneys with the necessary tools to prove a litigant's case at trial.

stone-judge-778488-m.jpgThere is a school of thought in both the legal and non-legal communities that discovery can also be used as an effective bulldozing tool (often referred to as "guerrilla discovery"), and the sad truth is that this is indeed true. The idea is to propound so much discovery (whether via written requests or deposition testimony) and to provide as much resistance to discovery propounded on you that the other side cowers in response to the onslaught. Between attorney fees, court reporter fees, transcript costs and expert fees, the total cost for the discovery phase alone can be astronomical. Even in a relatively simple case between two San Diego business owners, an attorney can propound hundreds and hundreds of interrogatories, requests for production of documents and requests for admissions (a discovery tool that allows parties to ask the other side to admit certain important facts in the litigation). If the propounding party feels that the discovery responses are inadequate for any reason a round of negotiation and motions to compel follow. By the time all of this is accomplished, the opposing party's attorney may spend fifty to one hundred hours dealing with this written discovery alone. Even the most affordable litigator whose fees are in the low $200.00 per hour range, fifty to one hundred hours for a single battle over written discovery adds up fast. In addition, a guerrilla campaign will include taking the depositions of every possible witness resulting in significant additional cost. It is not uncommon for a party to notice the depositions of twenty or more witnesses. Some of these depositions are of business owners or managers and can last for days. The above scenario is an example of what can occur even with the simplest of cases. In more complex cases like patent litigation, attorney fees can be hundreds of thousands of dollars (for the discovery phase alone). As one might imagine, this type of onslaught can be daunting to the opposing party.

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May 22, 2014

Capital Expenditures in California Commercial Leasing

Most commercial leases in California are triple net leases. With a triple net lease, tenants contribute to the payment of the landlord's operating expenses, such as building insurance, taxes, repairs, maintenance, and utilities in addition to base rent. Typically, these expenses are referred to as Common Area Maintenance Expenses (CAMs). As one might imagine, what should and shouldn't be included as an operating expense is an important part of lease negotiation. Depending on the parties' relative bargaining positions, tenants are often able to negotiate for a list of CAM exclusions.

420973_planning_for_construction.jpgUnder Generally Accepted Accounting Practices, capital expenditures are defined as the costs of obtaining items that last beyond the current accounting period and increase the value or the life of an asset. Capital expenditures include things like additions, improvements, renovations, repairs and upgrades to existing facilities, and can be thought of as investments that are intended to yield long-term benefits. Commercial leases deal with capital expenditures in a variety of ways. Many, but not all, commercial leases contain a general capital expenditure exclusion that excuses tenants from having to contribute to the costs of such expenditures with two major exceptions: expenditures necessary to comply with new laws and improvements that reduce operating expenses. In some cases, these lease exclusions will also exempt those capital expenditures when the costs of replacing equipment (an HVAC system for instance) would be greater than the replacement cost of the equipment.

Negotiation in this area is important to both landlords and tenants because capital expenditures can be significant. The issue is often a point of heated dispute. Tenants contend that their contribution towards the capital expenditures unfairly confers a permanent benefit on the landlord. Landlords argue that tenants benefit from adequately maintained facilities, repairs to existing equipment and additions that make the property more attractive. For the most part, capital expenditures benefit the property overall. As such, it is generally accepted in the commercial leasing community that such costs should be built into base rents.

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May 13, 2014

Arbitration Clauses and Class Action Waivers Under California Law

When a large group of individuals are injured by the actions of a person or company, the class action lawsuit allows them to pursue their legal claims even where the damages personal to each individual may be small.  Because attorneys' fees are recoverable in class action suits, litigation attorneys are generally willing to take such cases on a contingency basis.  Often, large corporations with potential exposure to class action claims incorporate arbitration clauses and class action waivers requiring any claimant to seek relief via arbitration and foreclosing the class action option.  Arbitration clauses are attractive to defendants, and sometimes plaintiffs, because it is faster, cheaper and more flexible than litigation.

u-s--supreme-court-2-1038828-m.jpgWhere individual damages are small, the class action waiver most often acts as a bar to relief.  From the corporate perspective, the class action waiver protects companies from frivolous suits brought by unscrupulous lawyers.  Currently, the enforceability of a class action waiver under California law is unclear.  One side is concerned with the protection of consumers who have little choice in most cases but to enter into whatever agreement they are presented (i.e. signing a contract with a cell phone provider).  The other side is concerned with protecting the strong policy goal of encourage arbitration and reducing the pressure on overwhelmed courts.  

Historically, California courts have been loathe to enforce arbitration agreements that limit or waive a plaintiff's ability to pursue a class action. Following the U.S. Supreme Court's recent decision in AT&T Mobility LLC v. Concepcion, 131 S.Ct. 1740 (2011), however, the California Supreme Court has had to reconsider its previous attitude towards such waivers, at least to some extent.  In Concepcion, the U.S. Supreme Court held that the Federal Arbitration Act ("FAA") preempted state laws restricting the right of parties to agree to arbitration.  The Concepcion Court noted the efficiency and cost advantages of arbitration over class litigation and arbitration.  Significantly, the Court emphasized that contract law governs and that "the FAA requires courts to honor parties' expectations".   Thus, the enforceability of arbitration clauses and class action waivers falls squarely within the boundaries of contract law.

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May 12, 2014

California's Statutes of Limitation

In order to discourage unreasonable delay in bringing civil lawsuits, all states have established certain time limits within which a legal action must be brought, more commonly known as the "statute of limitations." Some states, including California, have also adopted what are known as statutes of repose which act as an absolute bar to certain legal causes of action. Statutes of limitations and repose are intended to protect potential defendants from being subjected to stale legal claims where witnesses and/or evidence become unavailable thereby impeding the defendant's ability to defend against the claims. If an action is not brought within the specified period, subject to certain exceptions, a court is barred from hearing the case.

1137812_old_time.jpgThe first step in determining when a statute of limitations begins to run is to ascertain when the cause of action "arose" or when it "accrued." A cause of action arises when the conduct upon which the claim is based occurs. A cause of action accrues when the right to take legal action arises. Generally, the statute of limitations begins to run from the time a cause of action accrues.

For example, assume that John underwent surgery in 2000. During the procedure, unbeknownst to John, the surgeon negligently left an instrument inside him. Years later, in 2014, John began experiencing pain as a result of the instrument and later learned of the surgeon's negligent mistake. John's claim for medical malpractice arose in 2000, at the time the surgeon committed the negligent conduct. However, John's cause of action didn't accrue until 2014, when he discovered the surgeon's negligence. Under the California Code of Civil Procedure, the statute of limitations for malpractice is the lesser of three years after the date of injury or one year after the plaintiff discovers, or through the use of reasonable diligence should have discovered, the injury.

This delayed accrual of the statue of limitations in medical malpractice cases is similar to the common-law "delayed discovery rule". The doctrine tolls the statute of limitations until the injured party discovers or has reason to discover the cause of action. Generally, the delayed discovery rule applies because it would be "manifestly unjust" to deprive a plaintiff of his or her cause of action before he or she is aware of the injury. For example, assume Bill buys a used car from a shady auto dealer. Unknown to Bill, the dealer covered up the fact that the car had a salvage title because it had been involved in a serious accident. Bill buys the car thinking it has a clean title but begins having trouble with it after four years of use. After taking it to a mechanic, Bill finds out about the car's history. Bill wants to file a claim against the car dealer for defrauding him, but, under California law, the statute of limitations for fraud is three years. However, pursuant to California's statutory discovery rule (which provides that a cause of action for fraud is "not deemed to have accrued until the discovery, by the aggrieved party, of the facts constituting the fraud or mistake"), the statute of limitations didn't begin to run until Bill found out about the true car history.

The following are the statute of limitations for some common civil causes of action recognized in California: Fraud: 3 Years; Libel/Slander/Defamation: 1 Year; Personal Injury: 2 Years; Medical Malpractice: 3 Years from injury/1 Year from discovery; Breach of Written Contract: 4 Years; and Breach of Oral Contract: 2 Years. 

Statute of limitations can involve complex issues and the above list is meant only as a general guide. If you have questions regarding California's statutes of limitations, consult an experienced San Diego litigation attorney as soon as possible to ensure that you preserve your right to compensation.

May 10, 2014

The Legal Check-Up For Your Business

Continued from "Starting a New Business In California - Hiring Employees".

To conclude our series on starting your own California business, we turn to examining the legal health of your company as it moves forward. In essence, a legal check-up is a business risk assessment. New and growing businesses may be reluctant to seek legal advice for broad issues fearing excessive fees. They worry that attorneys will exaggerate their legal needs or at least nitpick to such a degree that the business will feel compelled to comply with all recommendations. However, burying ones head in the sand is not the answer. In fact, many San Diego business attorneys will provide a legal check up for a reasonable fee. Of course, the size of the business matters. A legal check up for an international corporation for instance would require much greater analysis than the typical San Diego business. For most new and growing businesses, a basic legal check can cost less than $1,000.00.

businessman-walking-592542-m.jpgMost importantly, the fact that a business is made aware of additional legal risk doesn't necessarily mean that it must immediately remove all risk. Rather, the legal check up will assist entrepreneurs in prioritizing risk. For instance, if a business learns that its workers' compensation insurance has lapsed (for whatever reason), that the term of its commercial lease expires in one year, that several of its hand-shake agreements should probably be memorialized in a written contract and that its name and goodwill are vulnerable because it doesn't own a trademark, the business can react accordingly. Clearly, the workers' compensation issue would need to be resolved immediately at whatever cost. The remaining issues can be dealt with one at a time. There is a year to think about a new commercial lease, the handshake agreements are at least in the short term working out and the trademark issue can be carefully considered over the coming months.

The following is a summary of the issues your attorney will examine.

Existing Concerns: Often owners will have immediate concerns they need advice on. These concerns are typically addressed first and may include plans for expanding the business.

The Type of Business Entity: If the business is operating as a formal business entity such as a corporation or limited liability company (LLC), it is important that the corporate books are in order. Are annual meetings being held pursuant to California law and/or the company's bylaws or organizational minutes? Are corporate minutes maintained? Are the company's officers and managers complying with other corporate requirements under California law and the company's bylaws or organizational minutes? Are statements of information being filed with the California Secretary of State when required? Is the company complying with securities regulations? Corporate entities that fail to comply with corporate formalities (including LLCs) put themselves at risk. The owners of the business may find themselves personally liable for the debts of the corporation. Litigants may be able to pierce the corporate veil.

Operating as a formal business entity is advisable for most businesses. If your company has not yet done so, the attorney will analyze your business structure and desired goals and discuss the various options available. See "California Limited Liability Company versus the S-Corporation" and "Choosing the Right Business Entity - Sole Proprietorship May Still Be the Right Choice" for some insight.

The attorney will also analyze agreements between partners, including shareholders' agreements, buy/sell agreements and written partnership agreements regarding transferability of ownership interests. A written partnership agreement is always advisable. See "Why Oral Partnerships Are a Bad Idea".

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April 15, 2014

Hiring Employees

Now that you've committed to starting your new business, developed a solid business plan, obtained necessary financing, decided on a business entity and entered into a commercial lease, it's time to consider the hiring of employees. Whether or not to hire employees is a critical decision all new San Diego business owners must make. Depending on the type of business, some entrepreneurs may decide that they are able to move forward without the need for employees with the understanding they will revisit the issue in the future. If after careful consideration, you decide that you need to hire an employee or employees, the following is a summary of important steps to take. There are a number of state and federal regulations to navigate making it important for all businesses to carefully evaluate their legal responsibilities. See "New and Growing San Diego Businesses - Hiring Employees", Parts One through Three for a additional analysis.

97150_more_lessons_on_the_laptop__1.jpgObtain an Employer Identification Number (EIN No.): Often, new businesses obtain an EIN No. without thinking much about it. When forming a formal business entity such as a corporation or limited liability company or when opening a back account after obtaining a DBA, it is common for business owners to obtain an EIN No. for use in opening a bank account under the business' name. If one hasn't been obtained for whatever reason, then you will need to get an EIN No. (Employer Tax ID) from the IRS. It is a simple process and can be completed on-line using IRS Form SS-4.

Set Up a Payroll System for Withholding Taxes: Employers are required to withhold taxes from employee income as well as Social Security and Medicare taxes. These withholdings are then paid to the IRS. There may also be requirements for State tax withholdings (check with your state tax agency - in California it's the California Franchise Tax Board at California Tax Service Center). You will need to obtain a completed Form W-4 from each employee prior to start of employment. This form which requests employee withholding information (number of dependents claimed, etc.) is then provided to the IRS. At the end of each year, employers then report employee income and withholdings using Form W-2 (wage and tax statement). This form should be provided to employees by the end of January and sent to the IRS by the end of February the following year. Employment records need to be kept for at least four years.

Setting up a payroll system provides employers with the tools necessary to calculate employee incomes and withholdings, make tax payments to the IRS, prepare financial statements and prepare tax returns. The payroll system thus becomes part of the business' accounting system. For some businesses, it may make sense to outsource payroll to companies that already have efficient systems in place to manage payroll for companies. Review the IRS's Employer's Tax Guide for a more detailed explanation of federal tax filing requirements.

Register With the California Labor Department: In addition to tax withholdings, employers are required to pay state unemployment compensation taxes.

Verify Employee Eligibility: The U.S. Citizenship and Immigration Services (USCIS) requires all employers to verify each employee's eligibility to work in the United States. Verification starts with Form I-9 which can be found online at www.uscis.gov. The form is to be filled out by the employer within three days of the hire date and kept by the employer for three years from the hire date or one year from termination, whichever is later. However, it does not have to be filed with USCIS or the IRS. Rather, the employer is required to maintain all From I-9s in a separate file making them available for inspection upon request.

Form I-9 lists acceptable documents employers may rely upon in determining eligibility. Employers may only ask for the documents identified. Employers then use the information provided obtained to electronically verify (E-Verify) eligibility. by registering with E-Verify.

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April 14, 2014

When Is a California Commercial Property Considered Abandoned?

It is more common than one might imagine for a commercial tenant to pack up and leave the premises rather than negotiate with its landlord for lease termination. This is most often because the business owner/tenant is far behind in rent and doesn't believe that there are any other options available. It is also most likely that, for whatever reason (whether a past history of conflict, landlord bureaucracy or tenant complacency), a lack of communication between landlord and tenant has contributed greatly to the problem. Whatever the reason, landlords and tenants should be careful about how they approach lease termination and abandonment.

rusted-neon-green-and-white-cafe-sign-1337952-m.jpgThe best way to avoid dealing with abandonment is to maintain open lines of communication. Business owners who better understand available alternatives are more likely to consider agreeing to a payment plan with respect to past due rent and/or voluntarily turning over possession of the premises to the landlord on some fixed date. Landlords are in turn better able to gauge the tenant's position and ultimately to avoid costly litigation. Depending on the circumstances, landlords will often find that it makes more economic sense to agree to a lesser amount owed and to release the tenant from future obligations. It is surprising how often simple communication (even with lawyers involved) leads to a peaceful and voluntary turnover of possession. Better yet, in some cases, the parties are able to work out an arrangement that results in a continued tenancy.

While it seems sometimes lost on landlords, there is a significant benefit to retaining long time tenants with a proven track record. This is usually due to bureaucracy in this writer's view. There are systems in place, and managers tend to let the systems control. For example, it is not uncommon for corporate landlord's to serve three-day notices demanding rent and then to ignore tenant inquiries regarding the problem whether or not they actually intend to pursue eviction. The result is to encourage abandonment. This is not necessarily problematic for landlords. If the circumstances clearly warrant eviction as soon as possible, the cost of abandonment isn't so great. However, even in the worst of scenarios, communication tends to reduce friction.

When Is a Property Considered Abandoned?

So when is a commercial property considered abandoned? This is an important question for landlords. First, the tenant must be at least 14 days behind in rent. Second, the landlord must have a reasonable belief that the tenant has abandoned the property. It may seem obvious in most cases: the tenant is closed for business; hasn't been seen on the premises for more than a month and has stopped paying rent and communicating in any way. While intuitively this seems like clear abandonment, the law is a bit more complicated. There must be a demonstrated intent to abandon the premises taking all circumstances into account . The standard is one of a reasonable belief - such that a reasonable landlord would believe that there was an intent to abandon. In the above example, the property may not be considered abandoned if for instance after investigation, the landlord discovers that all of the tenant's property remains and/or that utility bills are still being paid. Some facts that tend to show abandonment include accumulating mail and newspapers, disconnected utilities, no one answering the door, out of business signs and premises empty of personal property. In more obvious cases, a tenant might actually tell the landlord he is abandoning the premises.

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April 2, 2014

Profit Interests in California Limited Liability Companies

A limited liability company is a type of legal entity that possesses many of the same characteristics as a standard corporation. A limited liability company, or LLC, is attractive to many business owners because it combines the limited liability feature of a corporation with the flexibility of a partnership. A key component of the flexibility offered by an LLC is related to how it is taxed. The members of an LLC may elect to have it taxed like a partnership, thereby allowing for pass-through taxation. Although these unique characteristics offer a clear benefit, they can also make compensating LLC members for their equity in the company more complicated.

90376_accounting_calculator_tax_return.jpgOne common way that LLCs motivate their employees or service providers to grow and improve the business is to give them an equitable interest in the company. There are two basic forms of equity compensation in an LLC: the profit interest and the capital interest. A profit interest allows the holder to share in the profits and residual value of the LLC, while a capital interest is an ownership in both the LLC's future profits and its current and future assets upon liquidation.

The recipient of a profit interest receives distributions of future profits of the LLC and an equity interest based on the increased value of the company after the grant of the profit interest. For example, ABC, LLC grants a 5% profit interest to an employee on January 1, 2014 at which time the value of ABC, LLC is $10,000,000. At the time ABC, LLC is sold, it is valued at $15,000,000. The employee's interest at the time of sale is equal to 5% of $5,000,000 (the increase in the value of the company since the grant date) or $250,000.

Issuing profit interests to employees or service providers of an LLC is similar to a corporation issuing stock options. Like a stock option, a profit interest has little worth unless the LLC increases in value after the date the interest is granted. Usually, a profit interest will be conferred through a written agreement establishing the specific terms of the interest including in most cases a vesting schedule. Further, a profit interest will generally be subject to a repurchase right or right of first refusal by the LLC should the holder cut ties with the LLC or attempt to transfer or sell the interest.

Tax Implications Of Profit Interests

As mentioned above, the grant of a profit interest can create some complex tax issues. Because each member of an LLC is treated as a direct owner of the company's assets, liabilities and operations, each member is subject to tax on the LLC's operations. Accordingly, each member must individually report their respective shares of the LLC's profits and losses. A holder of a profit interest will be a member of the LLC to the extent of their interest and will therefore receive a share of any pass-through items of income, loss and deductions from the company. This also means that the profit interest holder may, for tax purposes, be considered self-employed and subject to the self-employment tax.

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January 31, 2014

Sublet and Assignment Clauses In California Commercial Leases

There are a myriad of provisions in commercial leases that benefit either the lessor, lessee, or, in certain circumstances, both.  As the provisions contained in a commercial lease can drastically impact the rights and obligations of the parties, it is of particular importance that each party effectively negotiate its position in order to obtain the most favorable terms possible.  Sublet and assignment clauses are important provisions that should be considered carefully by both landlords and tenants when negotiating the terms of a commercial lease.
 
1270509_beach_playa_13.jpgSubleases Versus Assignments
 
Sublease and assignment clauses accomplish similar results.  They allow tenants to transfer their lease obligations to another individual or entity.  However, each clause operates in a different way.  With a sublease, a tenant transfers part of the leased property to another tenant while remaining on the premises, or transfers the entire property to another tenant for a period of time during the term of the lease.  An assignment occurs when a tenant transfers all of its rights and obligations under the term of the lease to another individual or entity for the entire remaining term of the lease.  Essentially, the new tenant takes the place of the old tenant and releases the old tenant of its obligations to the landlord.  The extent of the obligations released depends on the terms of the assignment clause.  
 
Assignment and Subletting Clauses
 
Consent Conditions:  Most assignment and subletting clauses in commercial leases require landlord consent.  Generally, landlord's will insist on a consent requirement in order to retain the ability to properly "vet" a sublessor or assignee.  When negotiating these provisions, the landlord and tenant should be careful to clarify under what circumstances the landlord may withhold consent.   Often, landlords will be willing to include language indicating that the landlord "will not unreasonably withhold consent".  
 
Cost of Sublet/Assignment:  Some clauses impose an application fee on tenants in order for the landlord to review a sublease or assignment request.  The clause may also require that the tenant pay any attorney fees or other costs associated with the preparation of a sublease/assignment agreement.  In some cases, the clause may allow the landlord to increase the rental rate upon sublease or assignment.  Such clauses tend to discourage potential sublessors and assignees.     
 
Continuing Obligations: Most assignment clauses also require that the old tenant remain liable to the landlord in the event that the sublessor or assignee default for any reason.  This means that, should the sublessor or assignee fail to pay rent or default for any reason, the assignor (prior tenant) becomes liable for the breach.  From a landlord's perspective, the original lease is entered into after significant scrutiny.   As such, landlords typically want to retain as much control as possible.  By insisting on a tenant's continuing liability, they afford themselves an additional layer of protection.  However, in cases where tenants anticipate selling their business prior to the end of the lease term, it is advisable to negotiate with landlords for more liberal assignment language.  Depending on the parties relative bargaining positions, landlords may be willing to include a novation provision wherein the assigning tenant will be absolved from any obligations under the lease.  More likely, however, tenants will have a better chance seeking novation after presenting landlord with a viable assignee at the time an assignment is requested. 

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January 3, 2014

Fiduciary Duties of Officers and Directors in a California Corporation

Generally, corporate officers and directors have a fiduciary obligation to the corporation and its shareholders that requires them to act in good faith, use their best judgment, and do their best to promote the corporation's interests. Collectively, this set of obligations is known as an officer or director's fiduciary duty and arises from the legal relationship between the individual and the corporation or shareholder.

a-business-mans-path-313281-m.jpgAn officer or director's fiduciary obligations under California law can generally be distilled into two duties: the duty of loyalty and the duty of care. With regard to corporate directors, both of these duties have been codified in California Corporations Code section 309(a) which provides:

"A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances."

Generally, officers have the same fiduciary duties as directors.

The Duty of Loyalty

The duty of loyalty requires a corporate officer or director to always act in the corporation's best interest, and forbids the officer or director from engaging in "self-dealing." Self-dealing is conduct by a corporate officer or director that involves taking advantage of his or her position in the corporation to benefit his or her own interests rather than those of the corporation or shareholders.

For example, assume John is the CEO of a major computer corporation, ABC, Inc. ABC needs to buy a considerable amount of computer chips to install in its computers, so it begins shopping for a manufacturer. John happens to own a large amount of stock in XYZ, Corp., a manufacturer of computer chips.

John, without notifying anyone of his personal interest in XYZ, uses his authority as CEO to ensure that ABC hires XYZ to produce the necessary computer chips, giving XYZ's share price a significant bump and, in the process, earning John a nice return on his investment in XYZ.

The type of transaction will not always necessarily amount to self-dealing. Had John disclosed to the board of directors that he held an interest in XYZ, and the board elected to contract with XYZ anyway, John would not have violated any fiduciary duty to ABC or its shareholders. However, because John failed to disclose his personal interest in XYZ, his conduct constituted a breach of his duty of loyalty.

The Duty of Care

The duty of care requires a corporate officer or director to carry out his duties as would any ordinarily prudent person in similar circumstances. For example, a corporate officer or director might violate his duty of care by contracting to buy a company without first conducting due diligence to find out if it is an economically sound decision.

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December 27, 2013

Subordination, Nondisturbance and Attornment Provisions In California Commercial Leases

Commercial lease clauses can significantly impact the rights and obligations of landlords and tenants.  Subordination, non-disturbance and attornment ("SNDA") provisions are standard in commercial leasing and they have a substantial affect on the nature of the relationship between the landlord's current and future tenants.  As such, consideration of such clauses is essential in the negotiation of any commercial lease.

Leasing Opportunities4.jpgGenerally speaking, SNDA's are covenants between the tenant and landlord that outline the rights of the parties, and certain non-parties, to the lease where third party lenders are involved.  The three key elements - subordination, non-disturbance, and attornment are closely related.  Subordination to a third party lender is problematic for tenants without the inclusion of non-disturbance language.  

The Subordination Clause

A subordination clause is a lease provision whereby the tenant subordinates its possessory interest in the leased premises to a third-party lender, usually a bank (the rights of the tenant are thus subject to the rights of the lender).  The purpose of this provision is to allow a landlord seeking financing for the purchase of a commercial property additional flexibility in dealing with lenders. Most lenders are unwilling to finance (or refinance) commercial loans where the tenants' leases do not contain subordination clauses.  Before they will extend financing, lenders require that all tenants subordinate their possessory interest in the premises to the lender's mortgage interest.  This is so that the lender has the ability to terminate the tenant's lease (absent a non-disturbance clause) and initiate foreclosure proceedings should the landlord default on the mortgage.

Usually tenants lack the bargaining power necessary to refuse the inclusion of a subordination clause in a commercial lease.  That's why it is important that tenants always request the addition of a  non-disturbance provision.  

The Non-Disturbance Clause

The non-disturbance clause affords tenants that are not in default the right to continue occupying the leased premises.  The effect of the non-disturbance clause is to protect the tenant in the event a subordination clause is triggered.  A typical non-disturbance clause states that the lease shall not be subordinate to any mortgage arising after the date of the lease unless and until the landlord provides tenant with an agreement from the mortgagee (lender) stating that so long as the tenant is not in default, the landlord's and the tenant's rights and obligations under the lease shall remain in force and tenant's right to possession shall be upheld. Without the protection afforded by a non-disturbance clause, a commercial tenant, through no fault of its own, could easily find itself evicted from a property due to the delinquent loan obligations of the landlord. Maintaining the possessory interest in leased premises is especially important in the commercial leasing context because tenants are usually businesses that would suffer substantial losses if forced to move locations.

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November 19, 2013

What is the Statute of Frauds?

Under California law, oral contracts (verbal agreements) are generally valid and enforceable.  However, due to the uncertainty inherent in oral agreements, in some circumstances, a written record of the contract is required to make it legally binding.

1045239_butterfly_2.jpgCalifornia has statutory provisions, codified in Cal. Civ. Code. section 1624 and commonly referred to as the Statute of Frauds, that enumerate specific situations under which an oral contract is unenforceable.  The Statute of Frauds is designed to reduce the likelihood of fraudulent conduct by requiring a written record of the terms agreed-upon by the parties to a contract.
 
California's Statute of Frauds.
 
Under California's law, the following transactions are invalid unless supported by a written agreement:
  • An agreement that by its terms cannot be performed within a year from its making.
  • A promise to answer for the debt, default, or miscarriage of another person.
  • A lease lasting longer than one year, or a contract for the sale of real property.
  • An agreement authorizing an agent to purchase or sell real estate, or to lease real estate for a longer period than one year.
  • An agreement that is not to be performed during the lifetime of the promisor (the person promising to undertake some action).An agreement by a purchaser of real property to pay an indebtedness secured by a mortgage.
  • An agreement to loan money or extend credit in an amount greater than one hundred thousand dollars ($100,000) made by a person engaged in the business of lending money or extending credit.
  • An agreement for the sale of goods in excess of $500.00 in value. 
  • An agreement for the sale of personal property in excess of $5000.00 in value.
Requirements of the Statute of Frauds.
 
In order to comply with the requirements of the Statute of Frauds, a written agreement must:
  • Be in writing.
  • Identify the subject matter of the contract.
  • State the material terms of the agreement (contracts for the sale of goods must state the quantity and price of goods to be sold).
  • Be signed by both parties (under the Uniform Commercial Code, contracts for the sale of goods need only be signed by the party against whom enforcement of the contract is being sought).

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November 5, 2013

Forming A Professional Corporation In California

The professional corporation or the professional limited liability company are similar to their traditional counterparts, but are organized for the purpose of providing professional services, such as medical, legal, or accounting services. Unlike other states however, California does not provide for the formation of a "professional limited liability company". California only provides for the formation of a "professional corporation". A "professional corporation" is a service corporation that is licensed by the State of California. With an ever increasing prevalence of professionals in California, the professional corporation is becoming more and more prevalent. This article is specifically directed at the California Professional Corporation.

1270499_beach_playa_6.jpgA professional corporation is formed, just as a traditional corporation, by the filing of articles of incorporation with the California Secretary of State. However, unlike traditional corporations, a professional corporation generally has to comply with the rules and regulations of the appropriate licensing body. For instance, a professional corporation for medical doctors must register with the Medical Board of California. Moreover, there are specific requirements regarding who may own shares and who may hold title as an officer and/or director of a professional corporation. Typically, only licensed professionals of like professions may share in the ownership and serve as officers and/or directors.

Shareholder Limitations On Professional Corporations

In California, shares of stock in a professional corporation can only be issued to individuals that hold a license in the professional service which the business provides. Further, a shareholder of a professional corporation is prohibited from entering into a voting trust, proxy, or any other arrangement that would permit a non-shareholder to vote his or her shares of stock. In the event a shareholder is disqualified from rendering professional services or dies, the professional corporation must acquire all of his shares.

Choosing A Name For The Professional Corporation

In California, the name of a professional corporation must end with specific designations such as "a Professional Corporation" or the abbreviation "PC." The name requirements vary from profession to profession. In addition, the name cannot be the same as, or "deceptively similar" to, that of any other professional corporation licensed in California. The California Secretary of State maintains a database of current business names that may be checked to see if the name chosen is available. If a name is available, it can be reserved for up to sixty days by filing a reservation request with the office of the California Secretary of State. It's important to review the particular state licensing board for the requirements of any given profession to ensure compliance.

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