January 27, 2015

Negotiating Option Clauses in Commercial Leases

The terms of commercial leases vary significantly depending on the type of commercial property being leased and the specific business goals of both landlords and tenants. "Option clauses," also known as "renewal terms," are provisions in a commercial lease agreement that allow a tenant to extend the term of the lease for an additional term after the initial term has expired. Tenants prefer option clauses because they reduce the risk of having to relocate an established business after the expiration of the initial term.

nightshopping-130418-m.jpgWhile option clauses are prevalent in commercial leasing, most landlords would probably prefer not to have to deal with them. This is especially so where the rental rate during the option period is fixed. Option clauses prevent landlords from leasing the premises on the open market and ultimately obtaining the highest possible rent. Options give tenants a choice which necessarily reduces a landlord's flexibility. Once a tenant exercises its right to the option term, the terms of the option clause govern regardless of how good the market is at the time. That is why most landlords prefer that the rental rate during the option period be determined by the actual market rate for the premises at the time the option is exercised. This is generally a fair approach for both landlords and tenants because each side is equally exposed to the vagaries of the market.

A market rate would benefit tenants if the leasing market is especially soft when it comes time to exercise the tenant's option. Moreover, in soft markets, tenants may be tempted to explore better options leaving landlords with empty space. To hedge against this uncertainty and in exchange for including an option clause, landlords will usually require that there be a floor to the new rental rate during the option period (usually no less than a 3% increase over the rental rate immediately preceding the option period). This provides landlords with the best of both worlds - a minimum increase in rent even if the leasing market is dismal or an increase in rent equal to the higher market rate should the market be strong. In such circumstances, tenants are better off with predetermined fixed increases in rent usually consistent with the annual increases in rent during the initial term of the lease. Either way, option clauses are inherently valuable to tenants and how the rental rate is determined during any option period under the terms of the lease will depend on the tenant's bargaining power during commercial lease negotiations.

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January 20, 2015

Derivative Lawsuits and the Closely Held Corporation

In general, shareholders are not permitted to sue corporations on their own behalf seeking damages for themselves. Instead, they are required to bring an action against wrongdoers (usually the officers and/or directors of the corporation) on behalf of the corporation in what is termed a "derivative" lawsuit. Where the corporation has a legal claim that the officers and/or directors refuse to prosecute on behalf of the corporation, the shareholders may do so derivatively. The damages recovered from a derivative lawsuit go to the corporation which in theory results in increasing share value. The idea of a derivative lawsuit may seem an oddity or even absurd to the average investor, especially shareholders in small closely held corporations where it's officers or directors are stealing from the company.

944870_oak_tree.jpgThe public policy behind derivative actions is to protect corporations (especially publicly traded corporations) from the whims of fickle shareholders unhappy with share values. Even though it may be difficult for these fickle shareholders to win, the ability to bring actions without limitation can create significant waste. In essence, the goal is to reduce the number of frivolous suits and to encourage informal resolution, and there is a plethora of corporate law dictating the procedures necessary for bringing derivative actions. In general, derivative law requires shareholders to make a written demand on the corporate officers requesting that action be taken to investigate and if necessary file a lawsuit on the corporation's behalf seeking to remedy the wrongs. This gives the corporation the opportunity to address the shareholders' concerns in an effort to avoid costly litigation. The problem, especially for shareholders in smaller corporations, is that making written demands and allowing reasonable time for the corporation to act wastes important time especially if the officers and directors are all part of the problem. Nonetheless, where a derivative action is required, the demand is mandatory (except where the shareholders can show that due to the dominant control of the corporation by its officers, such demand would be futile). Pleading futility however requires more than simply naming all of the officers. The shareholders must be more specific. There are also potential bond requirements in derivative actions. If the corporation can show that there is no reasonable possibility that the lawsuit will benefit the corporation or its shareholders, the court may require the shareholders to post a bond up to $50,000. This can be prohibitory for many litigants. Moreover, because derivative actions are equitable actions, they are heard by judges and not juries. On the other hand, shareholders do benefit from derivative actions because they are able to recover attorney fees if they are ultimately found to be the prevailing party.

Derivative law for the most part isn't necessarily ideal for small non-publicly traded or closely held corporations. This does not mean that shareholders in smaller corporations are without options. A shareholder may bring a direct action against an officer or director who committed fraud against the shareholder specifically - for instance, intentionally lying to the shareholder to induce him into purchasing shares knowing that the lies misled the purchaser regarding the true value of the company. Similarly, a shareholder may bring any other direct action against the corporation or its officers and directors where the injury is to the shareholder personally and not to the corporation. Stealing from the corporation, breaching fiduciary duties to the corporate shareholders and mismanaging corporate assets are all generally considered injuries to the corporation requiring a derivative action. As explained above, this matters because of the additional procedural hurdles required to pursue derivative actions.

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January 13, 2015

Indemnification Clauses in Commercial Leasing

Indemnity clauses in general are designed to shift liability for claims asserted by third parties from one party to another. In the commercial lease context, tenants typically agree to both indemnify landlords and to defend and hold them harmless for all claims arising out of tenant's operation of business on the leased premises, tenant's maintenance of the premises and the negligence and/or misconduct of the tenant or its representatives, employees, agents and contractors (and sometimes even the tenant's customers). In essence, the tenant agrees to defend the landlord for specified damages or claims. While it may seem absurd to a prospective tenant, commercial leases sometimes contain language requiring tenants to indemnify landlords for claims for liabilities arising out of occurrences in the common areas controlled by landlords and even for those liabilities arising out of the landlord's own negligence.

outlet-center1-52397-m.jpgMost importantly, under California law, these types or indemnification clauses are generally enforceable, at least in the commercial lease context. Of course, there are public policy considerations even where commercial leases are concerned. For instance, landlords cannot contract against future claims for their own intentional misconduct or gross negligence. It is advisable, given this limitation, for tenants to seek reciprocal indemnification language for any intentional conduct or gross negligence by landlords. Moreover, depending on the parties' relative bargaining power, some landlords may be willing to indemnify tenants for their own negligence and even the negligence of those under their control where the damages arise from occurrences in the common areas.

From the landlord's perspective, the idea is to shift liability to the tenants who conduct business on the premises daily. This reallocation of risk is guided by the parties respective insurance coverage. From a practical standpoint, the shift in responsibility is a shift in insurance obligations. If the lease shifts liability for "any and all" claims arising out of anything to tenant, it becomes incumbent upon the tenant to insure against "any and all" claims. In fact, most commercial leases specifically require suitable coverage. As such, allocation and the actual procurement of adequate insurance coverage is essential for both landlords and tenants.

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August 11, 2014

Tenant Estoppel Certificates in Commercial Leasing

Landlords routinely request estoppel certificates from their tenants. Tenant estoppel certificates are signed statements requested by third parties (typically lenders or prospective purchasers of commercial real estate) in order to verify certain terms between the current tenant and landlord of the commercial real estate property, things that cannot be ascertained by simply reading the commercial lease agreement.. The estoppel certificate confirms that a valid lease exists, that the lease remains in full force and effect, that neither the landlord nor tenant are in default and that the rent is paid up. This allows for instance a prospective buyer of a shopping center to better evaluate the shopping center's performance. Once a tenant verifies these details in the estoppel certificate, they cannot be later disputed. Potential purchasers of the commercial property rely on the certificates to evaluate the risks associated with purchasing the property and to determine an appropriate offering price.

golden-pen-469098-m.jpgWhat Information is Included in a Tenant Estoppel Certificate?

Typically, an estoppel certificate will ask a tenant to verify the following:

  • The date of the commencement of the lease;
  • That the lease has been unmodified and is in full force and effect or that it has been modified;
  • The most current date in which rent is paid through; and
  • That there are no defaults by the tenant or the landlord.

Other information that may be requested in an estoppel certificate includes the financial health of a tenant, the amount of any security deposit paid, the tenant's ownership structure, or whether there is any ongoing litigation related to the tenant. Most of the time, but not always, landlords will attach a form of the estoppel certificate as an exhibit to the actual lease agreement to help avoid disputes that may arise in the future regarding what information should be provided by the tenant. It is in a tenant's best interest to negotiate which information should be included in the estoppel certificate prior to entering into the lease. For example, information that can be determined by reading the lease or statements that modify the lease agreement in any way should be avoided.

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August 1, 2014

Exemptions to Registering Federal Securities with the SEC

When forming a California limited liability company (LLC) or corporation, it is important that the owners determine whether any of the ownership interests in the company will be treated as a security.  Under federal and state law, if one or more co-owners of a corporation (shareholders) or an LLC (members) seek to invest in the company for profit only, and do not wish to actually work for the company or take an active role in its management, the ownership interest will be treated as a security.  Essentially, a security interest is an ownership interest that is passive in nature (like investing in the stock market).  An ownership interest is not a security if all shareholders or LLC members actively participate in the company's operations.  In such cases, there is no need for the owners to worry about qualifying for an exemption.  

courtroom-1-1207444-m.jpgRegistering with the SEC vs. Qualifying for an Exemption

LLCs and corporations with security interests are subject to securities laws governed by the Securities Act of 1923 and regulated by the Securities Exchange Commission (SEC). Registering securities can be a complex process requiring that the company provide investors various documents such as financial statements, documentation and other information designed to ensure that potential investors are able to make informed decisions prior to investing.  However, the SEC and state regulators have promulgated a number of exemptions allowing LLCs and corporations to avoid the complex process of registering securities. Once the owners of a company determine that the interest being sold is indeed a security, it must next determine whether the sale qualifies for an exemption.  State and federal exemptions are not identical but typically sales of securities that qualify for a federal exemption also qualify for state exemptions.  If the sale qualifies for an exemption, the next step is to apply for the exemption with the appropriate federal and state securities agencies.  This process is far less complicated than registering securities with the SEC.  

Summary of Commonly Used Federal Exemptions

The following is a brief summary of the most common exemptions to the federal registration requirement found in the Securities Act:

  • Government Securities: Any government treasuries or municipal bonds.
  • Non-Public Offering Exemption: Where the sale of the security is to "sophisticated investors" who have the financial means and have sufficient knowledge in business and investments.  The investor must have full access to information and agree not to redistribute the securities to the public.
  • Single State Offerings: Intrastate companies qualify for a federal exemption to the registration requirement.   An intrastate company is a company that does all of its business in a single state.  To qualify as an intrastate company, an LLC or corporation must:
    • Be incorporated or organized in the state the security is being offered or sold in; 
    • Have its principal place of business in such state; 
    • Be owned entirely by investors who are bona fide residents of such state; 
    • Maintain at least 80 percent of the company's assets in such state;
    • Derive at least 80 percent of its gross revenues from such state; and
    • Use at least 80 percent of its net proceeds within such state.

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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".

Continue reading "The Legal Check-Up For Your Business" »

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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