Because of the inherent risk of fraudulent activity, the sale of stock is a highly regulated transaction by both state and federal authorities. Unfortunately, many corporate shareholders erroneously believe that privately held corporations do not have to worry about securities regulations because of the limited number of people involved and the relatively limited share worth. They often sell shares of stock either via oral contracts or hastily thrown together written agreements without consulting a corporate attorney. While it is true that smaller privately held corporations benefit from a number of exemptions to securities registrations, the directors, officers and shareholders of these corporations must still comply with numerous state and federal regulations when it comes to selling shares of stock. In fact, it can be argued that in the smaller more intimate setting of a closely held private corporation, the risk of fraudulent activity is particularly troubling. For more on exemptions to registration requirements, see "Exemptions to Registering Federal Securities with the SEC". Given the inherent risk and associated governmental requirements, it is important that corporate officers consult with an experienced corporate attorney before issuing shares of stock.
A well drafted stock purchase agreement not only protects both the seller and purchaser of stock, it ensures that the corporation is in compliance with securities regulations. It should evidence a transparent transaction. Full disclosure (offering complete access to corporate transactional and financial records) is the key to complying with securities regulations. The idea of course is to ensure that the purchaser is fully informed as to the risk associated with the investment. The stock purchase agreement will also set forth the price per share, the number of shares, whose shares are being sold, the class of shares being sold, the effective date of the transfer and other terms and conditions governing the sale. The stock purchase agreement should clearly define each party's rights and obligations going forward.
One of the most misunderstood concepts in litigation is the concept of proof. San Diego business owners know when someone or some other business has committed a wrong. They know if a business partner has stolen from them, when a deal has been broken or when someone fraudulently induced them into a bad deal. Because of this confidence, business owners often walk into an attorney's office expecting an unqualified validation of their claims. In some rare cases, it may be true that a party has a virtually guaranteed win. Unfortunately, in most cases, prospective litigants face numerous hurdles involving significant litigation fees and costs, legal hurdles (including defenses), damages and amassing admissible evidence (proof) all of which vary the risk of loss. This article provides a brief summary of issues of proof in California litigation.
It's the attorney's job to evaluate the case and give the client a frank assessment of what lies ahead. A good attorney will be careful to qualify her assessment pointing out various problems that may lie ahead including potential problems with proof. The client tells his story and while the attorney is listening, she is picturing how admissible evidence will be gathered and presented at trial. This often creates a disconnect between attorney and client leaving the client feeling flat. However the business owner might feel, it is important that he accept his attorney's frank assessment especially when he has talked with several attorneys who are all providing similar evaluations. In fact, an attorney giving different advice might be blowing smoke to do whatever it takes to engage the client. It's extremely important for prospective litigants to understand that what they personally know and what they can actually prove with admissible evidence are not always the same. Accepting these realities is often complicated because of the client's personal and emotional connection to the dispute.
There are two key types of evidence presented at trial: witness testimony and documentary evidence. Both types of evidence come with a host of evidentiary and foundational requirements that in their entirety are beyond the scope of this article. However, there are some important evidentiary issues that assist the lay person in better understanding what their attorneys are trying to accomplish:
It may seem obvious that damages are important to litigation but it's surprising how misunderstood the concept is amongst business owners and the general public. The misconception is understandable of course given the natural inclination to focus on wrong doing. Nonetheless, without damages (significant damages in most cases) the cost of litigation can be prohibitive even where the most egregious conduct exists. There are two very important practical reasons damages are a critical consideration in deciding whether or not to sue: 1) the costs of winning may exceed the value of the case; and 2) even if you win an amount greater than your costs, the chances of collection may be minimal.
If the damages are less than what it will cost to litigate the case, there is very little benefit in suing. Aside from the moral vindication, risking $50,000.00 to fight a court battle where the damages are $50,000.00 is effectively a useless exercise no matter how low the risk of losing is. Moreover, it's difficult to place a value on the emotional cost that comes with litigation. The battle itself takes a toll. Determining whether the damages are outweighed by the costs requires careful evaluation of numerous factors including the risk of losing and whether or not attorney fees are recoverable. The risk of losing is not always clear. The first step in analyzing risk is analyzing the merits of the case, something that should be analyzed with the assistance of an experienced litigator.
Attorney fees for litigating a case through trial can easily reach $100,000.00. In more complicated cases, the fees can be far higher. Even in the most simplest cases with extraordinarily efficient litigation counsel, attorney fees through trial can exceed $50,000.00. This all of course presumes that attorney fees are recoverable in the first place either pursuant to a contract or some statute. Moreover, it's possible that if you are awarded $5,000.00 in damages where you originally sought damages of $50,000.00, the court may not consider you a prevailing party for the purposes of awarding attorney fees. In such cases, your attorney fees will not be recoverable (you will have spent $50,000.00 in attorney fees plus costs while only recovering $5,000.00). In addition to attorney fees, actual costs are incurred. Copying fees, court filing fees, service of process fees, court reporter and transcript fees for depositions and trial and expert fees are just some of the actual costs incurred during litigation. These fees can double the cost of litigation. While most of these actual costs are recoverable to the prevailing party, the determination of who is the prevailing party is often unpredictable. In the worst case, your opponent may be determined to be the prevailing party in which case you will have to pay their costs and attorney fees along with your own (while collecting nothing in damages).
Triggering events include the death, incapacitation, bankruptcy, divorce or retirement of a partner or the desire of a partner to sell his ownership interest. A good buy-sell agreement will clearly define precisely what happens upon the occurrence of any of these triggering events. It may call for the immediate purchase of a deceased, incapacitated or bankrupt partner's ownership interest by the company itself (Redemption Agreements), or it may grant the remaining partners a right of first refusal before the company itself is required to purchase the interest. It might also call for the remaining owners to purchase the ownership interest (Cross Purchase Agreements). In cases of divorce, the buy-sell agreement might require that any claimed interest of the non-partner spouse automatically transfer to the partner (the non-partner spouse will have signed a spousal consent when the buy-sell agreement was originally executed). When one partner wishes to sell his interest in the company, the buy-sell language will usually require that the remaining partners approve of the sale or at least maintain a first right of refusal in which case the buy-sell agreement will detail the mechanism by which this right will be exercised.
Because federal bankruptcy law preempts California landlord/tenant law, it's important that commercial landlords and tenants alike understand the process when a tenant has filed for (or is considering filing for) bankruptcy. The timing of a tenant's bankruptcy is critical because once a tenant files for bankruptcy an automatic stay immediately stops any state court action against the tenant including pending unlawful detainer actions (evictions). Once the bankruptcy stay is in force, the tenant can maintain possession of the premises for up to seven months so long as it pays rent post bankruptcy filing. Landlords' recourse depends entirely on the timing of the landlord's pre-bankruptcy actions. If a judgment is obtained prior to the bankruptcy filing, the landlord will be able to recover possession. If an unlawful detainer action is filed but a judgment is not yet obtained, the landlord can file a motion with the bankruptcy court seeking to lift the stay so that the landlord can proceed with the unlawful detainer action. This can be accomplished in relative short order. If the bankruptcy action is filed before the landlord filed an unlawful detainer action, then the landlord is bound by the bankruptcy procedures which give tenants 120 days time to consider their options (90 days longer with a court approved extension).
Due to the bankruptcy risk, it's advisable for landlords to move quickly where they suspect a tenant is heading for bankruptcy and is behind in rent. Of course, there is a cost (especially for large retail centers) to serving three day notices and filing unlawful detainers on the drop of a hat. Long time tenants with proven track records are known entities. There is a benefit to working with these known entities to see if the problem is a short term one or, if not, whether a compromise can be reached. Either way, open lines of communication allow landlords to get a better sense of the tenant's current position while simultaneously letting the tenant know that the landlord is willing to talk. However, if there is any hint that bankruptcy is on the horizon, the sound business decision is to file an unlawful detainer action as soon as possible (after a three day notice to pay rent or quit is served) and to pursue the action to judgment as quickly as possible.
The decision for tenants on the verge of bankruptcy on the other hand is much simpler. They want to file for bankruptcy as soon as possible. However, it's important that they are not filing bankruptcy for the sole purpose of avoiding eviction. First, at best the eviction proceedings are merely delayed (and rent for the post bankruptcy filing will still be due). Second, there are consequences to filing frivolous bankruptcies. For a tenant that truly qualifies, bankruptcy is certainly worth considering and back due rental obligations should be a factor in that decision. Because of the negative consequences attached to bankruptcy, it's important to consult with a bankruptcy attorney to fully understand whether it is right for your business.
Whether or not to sell shares in a privately held corporation is often hotly debated among shareholders. In most cases, the shareholders are seeking a necessary cash infusion either because initial funding has run out before the company could reach its full potential or because the shareholders desire expansion. The shareholders, however, are simultaneously reluctant to share equity, profit and control. After investing significant personal time and resources in development, they feel as though they have poured their heart and soul into the company. With so much invested and so much at stake, it's not surprising that shareholders have disagreements about funding and expansion. Funding and expansion aren't the only reasons shareholders may want to issue new stock. In smaller closely held corporations, it may be that the shareholders (typically fewer in number) desire to issue new stock to someone with a particular expertise even if that person has no money to invest. In other cases, issuing new stock is a way to ease into a full transfer of ownership over time so that tax liabilities are spread out.
In addition, there are important practical considerations not the least of which is whether or not those wishing to sell corporate stock have the authority to do so under the corporate by-laws. If the by-laws require a unanimous decision of the shareholders for the issuance of new stock, then even a one-percent owner with little involvement in the company's operations can veto the sale. If the total authorized shares under the Articles of Incorporation are already outstanding, then either the Articles need amending or the shareholders will have to relinquish some of their existing shares.
Finding Investors: Once the corporation's directors decide to issue new corporate stock, the first step becomes the difficult task of finding an investor. In some cases, the call for issuing new stock in the corporation arises because the board of directors has already found (or been approached by) a prospective investor. In such cases, the investor has already been vetted and the directors go straight to a vote. In other cases, the directors consult with the shareholders about the need for investment and after satisfying themselves that the shareholders are on board, seek out investors.
Commercial tenants are often perplexed when they realize that under the terms of their lease, they are responsible for damages that occur on the leased premises even if caused by the landlord's own negligence. In most cases, the landlord's liability for just about any scenario is limited to gross negligence and willful misconduct. Landlords typically insist that all liability shift to tenants because tenants have control over the leased premises. Tenants are then required to adequately insure against all liabilities whether or not it's the landlord's fault. The idea that tenants should be responsible for a landlord's negligence seems counter intuitive. Landlord's simply argue that they do not want to get caught up in battles over who may or may not be negligent. In their view, the simpler solution is for tenant's to indemnify landlords for all liabilities while maintaining adequate insurance coverage (including insurance covering the landlord's negligence). Whether or not one buys into the argument, the practical reality is that most landlords in California will insist on indemnification clauses requiring tenants to defend, indemnify and hold landlords harmless except in cases of the landlord's gross negligence or willful misconduct. As a practical matter, excepting gross negligence and willful misconduct from indemnification clauses is not problematic for landlords because under California law they are already unable to contractually shift liability for their own gross negligence or willful misconduct. Willful misconduct is intentional misconduct. But what is "gross negligence"?
In layman's terms, negligence is often referred to as carelessness. In legal terms it refers to the failure to meet an accepted standard of conduct. For example, a surgeon that accidentally leaves a sponge in a patient would clearly be careless thereby breaching the "standard of care" expected from surgeons generally. Gross negligence refers to a level of negligence that is greater than standard negligence but falls short of an intentional act to harm. Leaving the sponge in the patient on purpose because the surgeon didn't like the patient's constant complaining would be an intentional act. In California, gross negligence is defined as misconduct that demonstrates either a want of even scant care or an extreme departure from the ordinary standard of conduct. Gross negligence falls somewhere between a careless accident and an intentional act. Perhaps a nurse reminded the surgeon twice that the sponge was still in the patient but the surgeon decided to respond to a text message. Being warned about the sponge and texting while operating reflects a more careless act and in this case arguably rises to the level of gross negligence. Defining the contours of what is and what isn't gross negligence however is easier said than done. Proving gross negligence then, at least in California, depends on making a factual determination as to what is scant care and/or an extreme departure. This is a highly subjective standard. The finder of fact (the jury in most cases) is tasked with determining what the standard of care is and then what level beyond this standard rises to gross negligence. In short, proving gross negligence is difficult in almost any circumstance.
To learn more about landlord liability and indemnification clauses, contact a San Diego commercial lease lawyer today.
Although California law does not require a written partnership agreement, there are significant risks associated with informal oral agreements to form partnerships. If after careful consideration, the prospective partners opt to go with the partnership, there is little doubt that a written partnership agreement should be entered into. A written agreement of some sort is an essential part of any good business venture. A well drafted written partnership agreement helps insure that there will be no future misunderstandings regarding each partner's intent. Often, partners rely on the default provisions governing partnerships under California law without realizing that many of these default provisions are inapposite to the partners' expectations. Or in some cases, the partners will merely rely on oral agreements to deal with key provisions. However, enforcing oral agreements comes with a host of problems that can result in significant future conflict. See "Why Oral Partnerships Are a Bad Idea". California's Revised Uniform Partnership Act (RUPA) sets forth the default rules that govern oral partnerships.
Important Provisions in Partnership Agreements
A complete analysis of every possible provision in a partnership agreement is beyond the scope of this article. However, there are key issues that prospective partners should pay particular attention to:
- Limitations on Outside Pursuits: It is common for partners to commit varying amounts of time towards the operation of the business. Some maintain full time employment while committing resources and after hour time towards operation of the partnership. Others maintain partnership interests in other business ventures. A well-written partnership agreement will address whether these options are permissible. Whatever the case, the partnership agreement needs to clearly delineate each partners obligations and limitations with respect to time and resources towards business operations.
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.
While 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.
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.
The 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.
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.
Most 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.
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.
What 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.