San Diego Business Lawyer Blog

October 17, 2011

Litigation Should Be Your Company’s Last Resort

Like any metropolis, San Diego has a diverse business climate requiring constant interaction amongst retailers, service providers, customers, guests, invitees, tenants and landlords, suppliers, manufacturers, contractors, government agencies, insurers, law firms, and accountants. This level of interaction naturally breeds conflict especially when multiplied by the large number of business, consumer and professional transactions occurring every day in San Diego County. Conflict resolution occurs routinely and the vast majority of conflicts are resolved amongst the parties without the need for lawyers. In fact most conflict is resolved before anyone recognizes that a conflict has even arisen. People naturally look to solve problems as quickly and efficiently as possible so that they can move on to more important matters. Whether a simple cashier error or a complex misunderstanding regarding the terms of a contract, most conflicts are resolved within the first few hours. Of those that are not resolved quickly, most are worked out informally by the parties in a reasonable timeframe and without the need of a San Diego litigation attorney.

Unfortunately, the law of averages guarantees that some business conflicts will not be resolved without resort to the legal system. When conflicts reach this level, business owners rely on the court system to provide them access to a just resolution. The problem of course is that access to a just resolution isn’t free and even in those circumstances where there seems little doubt about who is in the right, litigation outcomes are far from predictable. In fact, in most cases litigation is drawn out, expensive, emotionally draining and ultimately unsatisfying. This does not mean that access to justice is a myth. However, opting to resolve business disputes via litigation requires a cost benefit analysis similar to any other business decision. Even the most deserving cases may not be economical to pursue. Litigation costs and attorneys fees often exceed the value of the case to the litigants. In those cases, informal resolution becomes imperative. The alternative is to right off the loss rather than accept greater losses associated with long drawn out litigation.

Whatever the cost benefit analysis, resorting to litigation should be your last resort. Why? Because as stated above, litigation outcomes are unpredictable no matter how righteous a claim is. Assume for instance that a contractor is owed $225,000 for work completed on a construction project. There is little doubt from the contractor’s perspective that it is owed for the work completed. Nonetheless, the developer, a private individual, has questioned the quality of the workmanship and is refusing to pay until major repairs are completed. Assume further that the developer is being unreasonable. The contractor knows that the developer is out of money and is making excuses to avoid payment. The case is simple enough. The developer should pay for the work done. If the developer cannot afford to pay, a lien can be taken against the property to protect the contractor’s interest.

October 16, 2011

Why the California Limited Liability Company Is Right for Investment Properties

by Donald Oder

Ownership of investment property in San Diego can be a rewarding venture. However, as with all investments, a return is never guaranteed. It’s important to evaluate the property’s value up front factoring in: the property’s relative worth compared to alternatives; the market value of rental income in the geographic area for similar properties; the property’s potential for appreciation; management costs; and potential liability and tax implications. This article focuses on the choice of business entity that best protects investors from liability and negative tax implications. Whether or not you already own investment property or are considering purchasing investment property, choosing how to structure your ownership is crucial. Consultation with an experienced San Diego business lawyer and a real estate professional are the best ways to maximize your personal protection.

There is a reason the prevailing wisdom favors the Limited Liability Company (“LLC”) as the best form of ownership in California for investment properties. California LLCs are relatively flexible business entities that have proven particularly beneficial when it comes to ownership of investment properties. First, LLCs allow for pass through taxation avoiding the double taxation associated with C-Corporations (C-Corporations are taxed first on their profits and taxed again on the profits shareholders receive as dividends). Second, like most formal business entities, LLCs provide personal protection from the liabilities associated with an investment property. A member’s personal assets are protected from claims against the LLC. Personal ownership in an investment property or ownership as a partnership leaves the owners vulnerable to liability for accidents that occur on the property. Liabilities are often extensive and can exceed insurance policy limits, particularly where permanent injury or death is involved.

S-Corporations are a tempting alternative to the LLC, and in some business contexts the S-Corporation may make sense. In addition to liability protection, qualifying corporations that make an S-Corporation election with the Internal Revenue Service also benefit from pass-through taxation. However, S-Corporations lack the flexibility that LLCs offer. To maintain S-Corporation status, corporations must be domestic, have only one class of stock, distribute profits and losses in proportion to each shareholder’s ownership interest and cannot have more than 100 shareholders who are natural persons and U.S. citizens. LLCs, on the other hand, allow for unequal allocation of income, deductions and losses. Members can choose how profits are allocated regardless of each member’s contribution or level of management responsibility. This is especially convenient for family owned investment properties or where one owner will be more actively involved in the management of the property. Members of an LLC can also be a corporation or other LLC. In addition, if an S-Corporation transfers property to another entity or sells a property to another entity in exchange for another property, it immediately incurs a capital gains tax. These transactions, if done properly, can be tax free for LLCs.

August 16, 2011

Why San Diego Tenants Should Seek Property Tax Protection in Commercial Leases

by Donald Oder

Most San Diego business owners know that commercial landlords typically pass on real estate taxes, including property taxes, to their tenants. Whether it’s a triple net lease requiring commercial tenants to pay their pro rata share of all property taxes due including property tax reassessments or a base year lease (common for office buildings) where tenants are responsible for property tax increases only, property tax reassessments can have a devastating effect on unsuspecting San Diego tenants. The problem stems from California’s Proposition 13 which limits property tax reassessments to 2% annually, but allows for full tax reassessments upon the transfer of ownership. Unwary prospective tenants may not realize that an attractive property has not been reassessed under Proposition 13 for years, if not decades. If the property is sold, or ownership is transferred in any number of ways, the property tax reassessment can be significant.

For example, consider a property that has not changed ownership in ten years (meaning it has not been reassessed for Proposition 13 purposes in ten years). In 1994, at the time the property last changed ownership, its value was assessed at $10,000.000.00. Assuming maximum Proposition 13 increases annually of 2%, in 2003 the Proposition 13 tax basis for the property would be $12,189,944. At a tax rate of 1.5%, the tax on the property in 2003 would be $182,849.00 (12,189,944 X .015). A new tenant in 2003 with a 10% pro rat share of property expenses under a triple net lease would owe $18,285 in taxes for 2003. Typically, these taxes are anticipated and paid by tenants as part their monthly Common Area Maintenance (CAM) expenses. However, in 2004, if the property is sold to an investor for $20,000,000.00, it triggers a Proposition 13 reassessment. The Proposition 13 reassessment is based on the new $20,000,000 price tag resulting in a property tax of $3,000,000.00 (20,000,000 X .15%). The new tenant’s pro rata share for 2004 is virtually doubled to $30,000.00. In most cases, the tenant will continue to pay the same monthly CAM payment for 2004 and will be billed for the difference upon reconciliation in early 2005 (approximately $11,350 assuming the 2004 CAM calculations accounted for an anticipated 2% Prop 13 tax increase). This can place a significant burden on a new or growing business especially when the business owners do not see it coming. In some cases, the amount owed can be staggering. This is a highly simplified example, but the outcomes are similar in just about any scenario so long as property values are appreciating faster than the 2% maximum allowed under Proposition 13. Of course, the problem is less common in San Diego’s current down market, but it is a climate where large appreciations can be expected in the future.

The simple solution for tenants is to seek Prop 13 protection (a clause in the lease that excludes from tenant’s expenses any increase in property taxes resulting from reassessments or at least those increases directly attributed to a transfer of ownership). This is not always a practical solution, especially for tenants with less leverage. Nonetheless, it should always be the subject of negotiation. The potential harm can devastate a business. If complete Proposition 13 protection is not possible, tenants should consider seeking a cap (say 5%) on annual property tax increases or an advance agreement to spread out the lump sum tax payment that would be due upon reconciliation. If these concessions prove impossible which is often the case, a new tenant needs to know when the property was last reassessed for Proposition 13 purposes, what its assessed value was at the time and what its assessed value is today in order to forecast the potential losses due to a transfer of ownership. The longer it’s been since the last reassessment, the greater the tenant’s exposure to extreme property tax increases.

July 22, 2011

The Commercial Lease and Your New San Diego Business

by Donald Oder

Continued from “Choosing the Right Business Entity for Your New Business“.

Now that you have a business plan and the capital to get started, the next step is to secure necessary raw materials, wholesale goods, manufacturing equipment, vendors, licensing, contracts and other necessary procurements all of which will be unique to your business. Securing a commercial lease on the other hand is common for virtually all businesses and, unless you plan to operate out of a home office, will have a critical impact a business’ success. First, by entering into negotiations for any commercial lease, you are making a fundamental choice about the location of the business. The location chosen can make or break any new venture. Second, the particular terms of the lease impact the bottom line. Rental payments, annual rental increases, inducements, common area maintenance expenses (CAMs), the term of the lease, options to renew and other rights and obligations set forth in the lease directly impact profits. Lowering monthly rents is obvious, but there are other less obvious costs that new tenants must concern themselves with many of which are intertwined with CAMs. For instance, most commercial leases require tenants to cover property taxes as part of the annual CAMs. Tenants are often shocked to learn later that the property was sold and a lump sum property tax was due sometimes tens of thousands of dollars or more per tenant.

Often, entrepreneurs fall in love with a particular location and begin to negotiate for a lease from a weak position. If prospective tenants have no other options, they are typically willing to accept almost anything from the landlord so long as the rental payments seem reasonable. This is a mistake. The better approach is to choose among multiple locations all of which have positive features. Of course, there is almost always a “better” location for the entrepreneur, and there’s nothing inherently wrong with pursuing choice one first. However, knowing that other options exist better equips the entrepreneur to walk away from really bad deals. On the other hand, unrealistic expectations about lease terms can be just as detrimental to a new business. It remains important to understand relative bargaining power and make reasonable determinations about acceptable lease terms. Landlords also have other options, and are generally savvy real estate professionals. They understand what the market will bear and work from there. The negotiation requires tact and subtlety, and most importantly a hierarchy of priorities.

Because the commercial lease is of critical importance to any business, it is best to consult with an experienced San Diego Lease Lawyer before signing any lease. If hiring an attorney is not practical, take the time to review your proposed lease and diligently research all of the issues you are unclear about. There is a wealth of information available on the web.

Continued in “Starting a New Business In California – Hiring Employees“.

July 14, 2011

Recapture Clauses in Commercial Leases

by Donald Oder

Almost every San Diego business owner has had to negotiate a commercial lease at one time or another. Whether with the assistance of a San Diego lease lawyer or on their own, they are presented with a myriad of confusing terms and conditions. Business owners typically focus on the major terms of the commercial lease (rent, common area maintenance expenses, term of the lease and options to extend), and let their attorneys sort out the rest. While it is good practice to consult with an attorney before entering into any contract, business owners benefit from a basic understanding of the commercial lease as a whole and how its terms interrelate. This article takes a brief look at one common clause – the recapture clause.

A recapture clause allows a landlord to terminate the lease and take back possession of the premises upon the occurrence of certain conditions. It is usually associated with complex “assignment and subletting” clauses that allow tenants, upon landlord’s approval, to assign their lease or to sublet a part of the leased premises to a third party. Landlords like to include “recapture clauses” that are triggered by a tenant’s mere request for the approval of an assignment or subletting.

The “recapture clause” issue arises because landlords know that tenants’ desires to assign or sublet are usually motivated by profit. When the commercial real estate market is hot, tenants can assign their lease at rental rates above what they are currently paying or sublet a portion of the premises at exceptional rates. Recapture clauses allow landlords to step in and take the profits for themselves. In essence, landlords are able terminate the less profitable lease. Tenants then are better off without such clauses and existing tenants need to carefully review their leases before requesting approval of an assignment or sublease.

July 7, 2011

What is a California Close Corporation?

by Donald Oder

A California Close Corporation is a corporation designed to give its shareholders more control over the operation of their business. Instead of sitting back and letting others run the company, the owners of a Close Corporation typically act as the company’s managers. By complying with specific statutory requirements, Close Corporations can forego many of the corporate formalities other corporations are required to comply with. This in turn reduces the risk that others will be able to pierce the corporate veil and reach the owners’ personal assets. Section 300 of the California Corporations Code states: “The failure of a close corporation to observe corporate formalities relating to meetings of directors and shareholders in connection with the management of its affairs, pursuant to an agreement authorized by sudivision (b), shall not be considered a factor tending to establish that the shareholders have personal liability for corporate obligations”. However, shareholders who manage the Close Corporation are subject to the same fiduciary duties any director of officer of a corporation has.

The California Corporations Code imposes the following requirements for qualification as a Statutory Close Corporation:

1. The Corporation cannot have more than 35 shareholders. However, for the purposes of satisfying this requirement, spouses are considered to be a single shareholder as are corporations, trusts, partnerships or other business associations unless the primary purpose of the entity was to acquire the close corporation’s shares.

2. The Articles of Incorporation must include a provision that the corporation cannot have more than 35 shareholders and specifically state that the corporation is a close corporation.

3. The corporation’s share certificates must contain a conspicuous legend stating: “This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed 35. Any attempted voluntary inter vivos transfer which would violate this requirement is void. Refer to the articles, bylaws and any agreements on file with the secretary of the corporation for further restrictions.”

4. The Shareholders must enter into a written agreement setting forth the matters upon which the shareholders, rather than the board, will exercise control. The shareholders’ agreement must be lodged with the Secretary of the Corporation and available for inspection by prospective purchasers. It is common for Shareholders’ agreements to include buy-sell provisions limiting transferability of shares providing existing shareholders with a right of first refusal. Moreover, close corporations may provide for greater control by minority shareholders and disproportionate distributions of profit.

In addition to these statutory requirements, Close Corporations cannot go public.
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June 20, 2011

How to Fire an Employee

by Donald Oder

Firing an employee is never a pleasant task. Yet it is a normal part of any business’ operations whether a national corporation or a small San Diego business. Learning the best way to fire an employee begins with an understanding of the employment relationship. Most San Diego business owners understand that employment in California is presumed to be “at-will” (employees may be terminated for any reason or for no reason at all, also termed “without cause”). If a business can fire any employee it wants any time for any reason, then why bother writing an article on how to fire employees? It sounds easy enough. Putting aside the moral hesitation associated with depriving someone of their livelihood, many business owners remain reluctant to fire an employee without first consulting with a business attorney for fear of being sued for wrongful termination. Although employers are permitted to fire at-will employees without any stated reason, there are legitimate concerns employers should consider before doing so.

First, laws against discrimination and retaliation subject employers to considerable risk. Even an at-will employee cannot be fired because if his age, gender, race, sexual orientation, physical limitations, marital status or religion. To do so is illegal. It is also illegal to fire an employee, at-will or otherwise, in retaliation for seeking redress. The risks of these types of claims are significant. Employers that follow consistent termination procedures and provide reasons for termination, whether for cause or for other business reasons, reduce their risk that discrimination claims will be successful.

Second, an employer may be wrong about the employee’s at-will status. In some cases, the answer is obvious. The employee has a written contract. However, in cases where employee manuals and historical procedures are in place that evidence a good cause requirement for termination, courts may infer that an employee is not at-will (that an implied contract exists). In essence, the employee is permitted to rely on the employer’s written policies and historical practices. Offer letters, employment applications and employee manuals that emphasize at-will status reduces uncertainty in this area. Nonetheless, a consistent termination policy is recommended. In addition to reducing the risk of successful wrongful termination claims, a consistent termination policy signifies to other employees that they can expect to be treated fairly.

A termination policy typically includes procedures for progressive discipline and documentation of employee actions. Consistent and progressive disciplinary procedures require open lines of communication and provide employees with an opportunity to correct their ways. The procedures themselves show fairness and document the employer’s reasons for termination. With a consistent termination policy and a basic understanding of at-will employment, the employer is better equipped to handle the ultimate task of firing an employee.

So back to the original question: how do you fire an employee? The steps are relatively simple (assuming there have been no violations of labor laws).

June 10, 2011

Landlord Management of Common Area Maintenance (CAM) Expenses

by Donald Oder

Triple net leases dominate today’s San Diego commercial lease market and virtually every landlord is faced with the annual burden of reconciling common area maintenance expenses (CAM expenses). Challenges to CAM expenses often spiral out of control. Tenants, ever weary of the unseen profit center, want to ensure that they are being billed correctly and are willing to share their frustration with other tenants. The management of CAM expenses begins with the initial lease negotiation which in the ideal results in lease terms that clearly set forth each CAM expense and how each expense will be calculated and apportioned. Experienced commercial managers and lease lawyers understand the need for clarity and comprehensiveness and strive for consistency among tenants while simultaneously negotiating the best possible terms. Unfortunately, the result is most often imperfect. National chains and anchor tenants’ demands are given greater weight in negotiation and smaller tenants are finding themselves with increased bargaining power due to the current downturn. Regardless of the economic climate, landlords can and should take care in managing and accounting for CAM expenses. The goal is to reduce tenant frustration and avoid future problems and associated costs.

The best first step towards improved management of CAM expenses is for property managers to simply pay attention. Supervision of maintenance operations ensures that waste is kept to a minimum. If or when a tenant does question a specific expense, the landlord will be prepared to produce relevant invoices and explain why the expenses were necessary. This is especially important for anchor tenants who typically have the resources to challenge landlords’ accountings. Too often property managers ignore potential problems hoping that the tenant will either forget about it or accept an evasive answer for fear of creating conflict. What property managers tend to overlook is that tenants have long memories. If later problems arise or if business starts to decline (for whatever reason), tenants inevitably latch onto the older seemingly innocuous issues and the landlord/tenant relationship can deteriorate rapidly. Regardless of the tenant’s size, experienced property managers know the headaches this can create.

In addition to supervising maintenance operations, it’s best to know what allowable CAM expenses are for each tenant. That is of course why consistency in tenant leases is so important. Knowing that all of the tenants are billed the same way for all expenses makes for simpler calculations. Because perfect consistency is virtually impossible, it is particularly important that property managers know where the differences lay. Misunderstandings can be costly. It may seem that a parking lot improvement is simple enough. Putting aside that the anchor tenant may not be required to share in the expense (reverting a large share of the cost back to the landlord), it may be that another tenant previously negotiated for the specific use of some of the parking spaces being torn out.

May 24, 2011

How to Respond to a Cease and Desist Letter Claiming Trademark Infringement?

by Donald Oder

Cease and desist letters claiming trademark infringement have an intimidating effect on their recipients. Most San Diego business owners are bewildered and have no idea how to respond. They have been in business for months if not years, and have constructed signs, circulated business cards, advertising and other promotional materials, published websites, formed a corporation and built goodwill and customer loyalty all under their existing name. Now some company they have never heard of is telling them they need to abandon their identity and start all over, a costly endeavor. Ideally, businesses will conduct a trademark search before deciding on the use of a name and logo and then file their own trademark registration, but this is of course hindsight. There are two very important things to keep in mind upon receipt of a cease and desist letter claiming trademark infringement: don’t panic and don’t ignore it.

Don’t panic because in many cases the issues can be resolved without having to abandon your business’ identity. Your mark may not actually infringe on the claimant’s mark, you may have a common law trademark giving you the right to use the mark in your geographical area, or the claimant may be willing to license use of the mark, place some limited restrictions on use or request some reasonable modifications to the mark. Remember that pursuing trademark infringement claims is an expensive endeavor and it is often economical for the claimant to work out an agreement with alleged infringers. Usually, a San Diego trademark attorney can assist in resolving the dispute for a reasonable cost. Of course, in some circumstances the claimant will not walk away so easily. It depends on the size of the claimant’s business, the strength and recognition of the claimant’s mark and the geographical scope of the claimant’s customer base. A business won’t get very far opening a hamburger joint called McDonald’s and utilizing a big yellow “M” at the forefront of its logo’s design. McDonald’s will pursue a trademark infringement claim no matter the expense.

Don’t ignore it because some companies will pursue their claims even if they are not as big as McDonald’s. Once a trademark infringement claim is filed in Federal court, you lose significant bargaining power. Even if you capitulate and agree to change your business’ name, the claimant will almost certainly want to be recuperated for bringing the action including attorney’s fees and other costs associated with filing suit. With or without an attorney, open the lines of communication.

May 23, 2011

How to File for a Federal Trademark?

by Donald Oder

Few doubt the importance of protecting a business’ name and logo with a federal trademark. Yet, many business owners focused on more immediate problems and concerned about the cost and time associated with applying for a trademark put the task aside. Some local businesses that have had a name and logo in continuous use prior to other trademark registrations will benefit from common law trademarks. However, if those businesses begin marketing themselves on line (even if only locally), they may run up against trademark infringement claims. In addition, the common law trademark will only protect a business’ name within a limited geographic area where the business is located. While there is no need for all business owners to fall victim to the “you can’t afford not to trademark” doomsday threat, it is important to evaluate your risk. Consider consulting a trademark attorney for guidance.

If you do need a federal trademark, the process is relatively straight forward but can be challenging for the lay person. The first step is to be sure that someone else hasn’t already trademarked the name. This does not necessarily mean that your trademark cannot include the same words as other trademarks. The question is whether your trademark is similar enough to an existing trademark for a similar product or service such that it creates a likelihood of confusion to the consumer. Registering a trademark without an attorney requires some research to better understand this concept and evaluate your trademark against existing registrations. The actual search for existing trademarks is simple enough and can be conducted on the United States Patent and Trademark Office (USPTO) website using the Trademark Electronic Search System (TESS). If there is a potentially conflicting Trademark, be sure to check its status. It may be that the trademark registration was canceled. Finally, qualifying for a federal trademark requires that the mark at issue be in use in interstate commerce. A restaurant that serves customers from other states does business in interstate commerce as does just about any internet business.

The next step is to draft a description. This includes a description of the mark and the goods and/or services the mark will be used with. Refer to the USPTO’s manual Acceptable Identification of Goods & Services for valuable assistance in preparing your description. You will also need to select a classification. The classification options are listed on the USPTO website. The trademark application also requires an actual representation of the mark. The mark can consist of the words only in standard letter format or can be a designed logo.