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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August 26, 2013

When Commercial Landlord's File for Bankruptcy

In today's commercial real estate market, the possibility that your landlord will declare bankruptcy is very real making it important that tenants are aware of their rights. When a landlord declares bankruptcy under Chapter 11 of the Bankruptcy Code, the bankruptcy trustee (the person or entity placed in charge of the landlord's assets) is given the power to determine whether to accept or reject tenant leases.

1173761_the_coming_storm.jpgIf the bankruptcy trustee decides to accept a lease then the tenant must continue to satisfy its obligations thereunder as if the bankruptcy never happened. Both the landlord and tenant remain obligated to perform. Before the trustee can accept the lease, however, it must obtain permission from the bankruptcy court, cure any defaults that arose under the lease, compensate the tenant for any losses arising from the landlord's breach, and provide sufficient assurances that the landlord will be able to perform its obligations under the lease in the future.

In the event the trustee rejects an unexpired lease, the tenant may terminate the lease so long as the rejection amounts to a breach under the terms of the lease or under applicable bankruptcy law. Alternatively, the tenant may opt to retain its rights under the lease, including rights to continued possession of the premises, rental amounts, due dates, use rights, exclusivity, quiet enjoyment and assignment. Essentially, tenants retain rights that are in or appurtenant to the real property for the balance of the lease term and any enforceable renewal or extension periods. However, the trustee is relieved from lease obligations requiring future performance by the landlord such as the provision of utilities, repair and maintenance and janitorial services. Tenants who opt to retain their rights after the trustee has rejected the lease are entitled to offset damages caused by the rejection and resultant failure of landlord to perform its obligations under the lease against rent due under the lease. This becomes tenants' exclusive remedy for landlords' failure to perform.

Generally, the rejection of a lease by a bankruptcy trustee doesn't void the underlying lease but, rather, provides the tenant with a general unsecured claim against the estate. Consequently, such a claim should accrue to tenants who elect to treat an unexpired lease as terminated and vacate the premises after the trustee's rejection in bankruptcy. A tenant desirous of obtaining a security deposit is also an unsecured creditor and said obligation by the landlord may be discharged.

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August 19, 2013

Forming A Close Corporation In California

One of the most important decisions entrepreneurs face when starting a new business is how to organize the new venture.  Although the flexibility provided by a limited liability company (LLC) is enticing, California's gross receipts tax is distasteful to many business owners.  Moreover, the rigidity and formality of the standard corporate structure can prove cumbersome for young businesses.  California's statutory Close Corporate (meaning that the form of business entity was created and governed by statute) provides entrepreneurs a third option offering much of the same flexibility LLC's provide while simultaneously avoiding California's gross receipts tax.  Because the ultimate choice will vary from business to business, it's important to consult with a San Diego business attorney and a tax professional such as a C.P.A. before moving forward.  

corporate-955464-m.jpgA close corporation is one in which the shares of the corporation are not freely traded and are held by a limited number of individuals.  Significantly, the shareholders of a close corporation can authorize the elimination of the board of directors and run the corporation themselves, actively managing and operating the company's day-to-day affairs. Most states have statutes specifically limiting the number of shareholders (generally between 30 and 50),and requiring that certain transfer restrictions appear on the stock certificates.  California's Corporation Code Sec. 158(a) requires that a close corporation's Articles of Incorporation state, "This Corporation is a close corporation and that the number of shareholders shall not exceed 35."  In order to properly establish the corporation as closely held, the shareholders must prepare a written agreement (shareholder's agreement) outlining the method by which management decisions are to be made and determining what, if any, restrictions are applicable to the sale of the ownership shares.

Because the shareholders manage a close corporation, they owe greater fiduciary duties to each other, and the controlling shareholders owe minority owners the highest duty not to oppress them.  In the normal corporate structure, if a minority shareholder disagrees with the manner in which the company is conducting its business, typically his only recourse is to sell the stock (assuming the company's officers or directors are not violating the law or the corporation's bylaws).  In a close corporation, however, sale of the stock is generally not an option.  As such, the law allows minority shareholders to sue the majority shareholder(s) and seek court intervention in the management of the company

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August 12, 2013

The Business Judgment Rule Held Not Applicable To Corporate Officers in California

A 2011 decision by a federal court highlighted the applicability of a legal theory known as the business judgment rule to corporate officers in California.  Codified at section 309 of the Corporations Code, the business judgment rule establishes a presumption that a corporate director, in the performance of his or her duties, acts on an informed basis, in good faith, and in the honest belief that his or her actions are in the best interest of the corporation.

man-on-a-bridge-3-1427249-m.jpgIn Federal Deposit Insurance Corp. v. Perry (C.D. CA December 13, 2011) (Case No. CV 11-5561 ODW), the U.S. District Court for the Central District of California held that the business judgment rule is inapplicable to decisions made by corporate officers (as opposed to "directors") on behalf of the corporation.  In Perry, the Federal Deposit Insurance Commission ("FDIC") sued the defendant, Matthew Perry, in his capacity as CEO of Indymac Bank, alleging that Perry breached his fiduciary duties by negligently allowing the bank to generate over $10 billion in risky residential loans.

Due to the volatility of the secondary market in which the loans were slated to be sold, Indymac was forced to absorb the loans into its own investment portfolio, resulting in losses of more than $600 million.  In July of 2008, Indymac Bank closed and the FDIC was appointed as receiver.  Perry moved to dismiss FDIC's complaint, claiming it had failed to allege facts upon which it could state a claim for recovery.  Specifically, Perry contended that the business judgment rule protected him from liability stemming from decisions he made as a corporate officer of the bank.  FDIC countered that the business judgment rule does not apply to corporate officers in California.

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August 8, 2013

What is Considered the "Sale Of A Security"?

A security is a financial instrument or a tradable asset of some type.  The Federal Securities Act defines a "security" as a laundry list of items which can be boiled down into three broad categories:
  • Debt securities (banknotes or bonds).
  • Equity securities (stocks or interests in partnerships or limited liability companies (LLCs)).
  • Derivative securities (futures or options).
man-made-world-4-167269-m.jpgFor the purposes of this discussion, the focus will be on whether ownership in a corporation or limited liability company constitutes a security, thereby requiring compliance with U.S. securities laws in its sale or purchase.  Usually, an offering of securities must be registered under the Securities Act of 1933, unless it falls under an exemption.  The standard as to whether stock is a security in any given circumstance was set forth nearly forty years ago in the U.S. Supreme Court cases of United Housing Foundation v. Forman, 421 U.S. 837 (1975) and Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985).

In Forman, the stock at issue was that of a non-profit corporation that allowed its holders to rent a dwelling within a housing cooperative.  The Court concluded that this stock was not a security because it did not have any of the traditional indicia of investment stock, specifically: (1) the right to receive dividends; (2) transferability; (3) voting rights; and (4) the capacity to appreciate in value.

In Landreth, the holders of stock in a corporation sold 100% of it to the buyers, thus giving control over the corporation to the purchasers.  Nevertheless, the Supreme Court applied the Forman test, ultimately deciding that, unless the sale of stock involves selling shares where there is no investment motive, the stock must be considered a security.

The holdings of Forman and Landreth and provisions of the Securities Act are of particular importance to owners of close corporations and limited liability companies that want to sell or transfer their interests while avoiding being subject to securities laws.  The sale or transfer of stock in close corporations are automatically exempt from securities law when the following requirements are met:
  • The transfer or sale is limited to ten or less people who are organizers of the company or who invested through direct solicitation.
  • The transfer or sale did not involve any use of the mails, telephones or the internet.
  • The transfer or sale was limited to one state.

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August 5, 2013

Tips On Negotiating A Commercial Lease For Restaurants

There are a number of provisions that can be written into a commercial lease that benefit either the lessor, lessee, or, in certain circumstances, both.  Although commercial lease terms are important to every business, they are of particular importance to restaurant owners where low profit margins require added attention to limiting operating costs.  Lease payments can directly impact the success or failure of a restaurant.   

483521_the_chef.jpgPrior to entering into lease negotiations, it's helpful to start with a feasibility study.  A feasibility study evaluates the potential of a restaurant concept taking into consideration the location and demographics.  Feasibility studies analyze the industry, relevant markets and marketing needs, capacity, traffic in the area, competition, costs structures and management requirements.  Obtaining a feasibility study prior to entering into a lease increases the likelihood that the restaurant concept will be successful.  

Although it's best to consult an experienced commercial lease lawyer prior to entering into any restaurant lease, there are some key issues and terms restaurant entrepreneurs should play particular attention to:

Consider the Space

Seating and aesthetics play an important role in the operation of a restaurant .  Seating capacity is dictated by the size and shape of the leased space.  In the restaurant business, any where from ten to twenty square feet per person is generally considered sufficient for seating purposes. However, the restaurant's theme, operation and aesthetics affect capacity.  It's important to ensure that the guests have enough space to dine comfortably and the staff have enough room to adequately serve the guests.   It's also important that adequate space is reserved for the kitchen, particularly when the location wasn't originally a restaurant.  Does the proposed location provide adequate square footage for the concept?      

Short Term Lease

Because the restaurant business is so unpredictable, it is difficult to say with any certainty whether a particular new venture will be successful.  A short term lease provides a prospective new restaurant owner with less long-term risk.  With a two or three year lease, the tenant is provided greater flexibility if the business starts to fail.  Landlords on the other hand generally prefer longer term leases and will most often seek a higher rent in exchange for a shorter term. A short term lease can also backfire.  Landlords may take advantage if the restaurant later proves a huge success demanding much higher rent and less favorable terms for a new lease.  To limit this risk, prospective tenants should seek an option or options to extend the term of the lease.  
Tenant Improvements

Building out (remodeling) a new location is perhaps the largest expense for any new restaurant.  A successful restaurant design is fresh and innovative and requires significant modification to the premises including the tearing down and erection of new walls, partitions, doors, windows, skylights and ceilings.  Creating an ideal atmosphere is critical to any restaurant concept.  It is often possible to negotiate for build-out costs in the form of a tenant improvement allowance.  Landlords are often willing to pay some or all of the costs associated with a build-out particularly where a long term lease is being negotiated.  Of course, as with any negotiation, there is a give and take with respect to other important terms.  Short term leases are often desirable for new businesses, making it necessarily more difficult to secure larger tenant improvement allowances.  


New restaurants want as little competition as necessary.  Determining where the nearest competing businesses are is an important factor in selecting the right location.  The worst thing that can happen after opening for business is to have a competing restaurant move next door or in the same center.  There's not much that can be done about properties that aren't under the control of your landlord.  However, Landlords will often agree to exclusivity within the property they control, as long as the exclusivity language is not too broad.  Language that restricts the landlord from renting to any other Italian restaurants during the term of the lease is reasonable.  It's always a good idea to negotiate for exclusivity. 

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July 29, 2013

What California Business Owners Need To Know About Oral Contracts

The best advice an attorney can give a client regarding any type of a business agreement is to "get it in writing".  Too often, inexperienced business owners rely upon "hand-shake" verbal agreements to accomplish commercial transactions. See "Why Oral Partnerships Are a Bad Idea."
83672_oil_purchase.jpgIn California, oral contracts are legally binding.  However, in the event a dispute arises between the parties, the existence and terms of oral contracts are much more difficult to prove than with traditional written contracts.  As such, it is important for business owners to be cognizant of the issues that can arise when attempting to establish and enforce an oral agreement under California law.     
Non-Enforceable Oral Contracts
While oral agreements are generally valid and enforceable under California law, there are important exceptions:
  • Verbal agreements that are illegal in nature or violate federal, state, or local law are void and unenforceable. For instance, an oral agreement to sell/purchase a stolen car would be invalid. 
  • A verbal agreement is invalid if the parties to it misunderstood a material term or terms of the contract.  To have a valid contract, the parties must have a "meeting of the minds", meaning they both understood what they were agreeing to.
  • A verbal agreement that is too vague or non-specific as to its terms is unenforceable because it does not technically exist.  For example, a verbal contract to purchase a car at some undefined date in the future would be unenforceable because it does not specify enough of the material terms of the agreement such as purchase price or the date of the transaction.
  • Pursuant to California Civil Code ยง1624, referred to as the Statute of Frauds, certain contracts are required to be in writing.  The following transactions are invalid unless supported by a written agreement:
  •  An agreement that is not to be fully performed within a year from its making.
  • A promise to answer for the debt, default, or miscarriage of another person (except in certain circumstances).
  • 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.

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July 22, 2013

Starting a New Business In California - Hiring Employees

Continued from "The Commercial Lease and Your New San Diego Business".

Perhaps one of the most important aspects of starting a new business is the hiring of employees.  Employees are often both the face and backbone of any company and their hiring comes with a host of legal obligations, liabilities, and expenses.  Some estimates place the cost of finding, interviewing, hiring, and training a new employee at nearly $4,000.  In addition to each employee's salary, employers need to add approximately 18% to employment costs for withholdings, payroll taxes, worker's compensation, and compliance with labor laws and this is exclusive of employee benefits. 

Employees8.jpgThe first step in successfully completing the hiring process is to determine whether your company is, in fact, in need of an employee or employees.  For new businesses, knowledge and experience in the company's industry helps to guide the decision.  If you are opening a retail clothing outlet in a busy shopping mall, you will almost certainly have to hire employees.  The decision for existing businesses is more complex.  Although every business is different, there are several key warning signs: missing deadlines; making mistakes due to excessive workload; or being so overwhelmed with miscellaneous tasks that it becomes difficult to focus on key aspects of the business.  Whether starting a new business or considering the hiring of employees for the first time, it's important that the business has the resources to follow through. 

Once a business has decided that employees are necessary to its continued growth and success, there are a series of important steps that the business needs to take to ensure it complies with local, state and federal laws. 

Obtain an Employer Identification Number

Employer identification numbers (EIN) are tax identification numbers issued by the Internal Revenue Service ("IRS") which are necessary to report taxes and submit other tax documentation.  An EIN number can be obtained at the IRS website by completing a short application process.
Establish A System To Withhold And Record Employment Taxes
The IRScrequires that all employers withhold employment taxes and keep records of such withholdings for at least four years.  Further, employers must submit W-4s (forms that state how much will be withheld from each employee's paycheck) to the IRS and report annually how much they've paid in wages and withheld in taxes on their W-2s. In addition to being necessary for compliance with IRS and state tax regulations, the maintenance of tax records allows a company to monitor its growth, track expenses, and prepare tax returns.  For many small businesses, outsourcing payroll is an cost effective way of complying with employment and tax laws.

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