Articles Posted in General Business Issues

Continued from The Business Contract – Part Two.  

Integration Clauses:  The integration clause states that the written contract entered into by the parties is their entire agreement.  A typical clause reads: “This Agreement constitutes the entire agreement between the parties with respect to the subject matter of this Agreement and supersedes all prior agreements, oral and written, between the parties hereto with respect to the subject matter of this Agreement.”  The integration clause ensures that neither side will be able to later claim that there were additional terms agreed to in a side agreement, orally or otherwise.  All contracts should include an integration clause.  

1267744_time.jpgModification Clauses:  The modification clause is a simple but important clause that requires contract changes be set forth in writing and signed by all parties to be enforceable.  

Severability Clauses:  It is sometimes possible that a particular clause in a contract is unenforceable under California law for a myriad of reasons.  To avoid having such clauses invalidate the entire contract, parties routinely include severability clauses which state that in such cases the remainder of the agreement is valid and enforceable to the fullest extent permitted by law.  

Continued from Basic Business Contract Provisions – Part One.

Mediation/Arbitration Clauses: Mediation and arbitration are alternative methods of conflict resolution. ADR (“Alternative Dispute Resolution”) has grown in popularity of late especially with judges. For the most part, ADR relieves pressure on overcrowded courts, reduces litigation costs and results in faster resolution. It’s important that parties understand the consequences of mediation and arbitration clauses. Mediation, the tamer of the two, may require that the parties submit their case to a mediator (experienced attorney or retired judge) who will help the parties navigate through the realities of their respective positions. It often results in early resolution, but the mediator’s findings are not binding on the parties. Mediation is not cheap. The parties generally share the cost and if the mediation fails, the parties still face all of the additional costs of full scale litigation. Those with limited resources may want to consider forgoing mediation clauses in their contracts. The scenario with non-binding arbitration is similar to that of mediation except that the procedures differ.

1207444_courtroom_1.jpgBinding arbitration on the other hand has significant consequences, not the least of which is that the parties waive their right to a jury trial and, except in limited circumstances, waive their right to appeal. Foregoing these fundamental rights leaves parties at the mercy of arbitrators who are typically more business oriented and conservative than juries. It’s not surprising then that big business routinely includes arbitration clauses in their contracts. Nonetheless, resolving disputes without the significant costs associated with litigation is an appealing alternative to many businesses regardless of their size. Binding arbitration provides an affordable venue for dispute resolution that is otherwise unattainable for some due to the costly nature of full scale litigation.

It’s probably not too far of a reach to say that most San Diego business owners would prefer closing their deals over a hand shake rather than involve their attorneys in another contract negotiationAttorney fees alone are enough to convince even the most seasoned business owners to try and work out an agreement informally.  Yet, all San Diego business owners understand the importance of memorializing their agreements.  The business climate is dynamic requiring contract drafters to anticipate remote eventualities in order to provide the greatest protection to their clients.  While most business relationships are conflict free, business owners understand that they need a well written contract that sets forth the terms of their agreements in clear and concise terms should a dispute arise.

999926_petrona_towers_6.jpgA well written contract is enforceable (offer, acceptance, consideration, etc.), defines the rights and obligations of the parties (payment, services, warranties, indemnification, etc.), and accounts for contingencies (early termination, death of a party, natural disaster, disputes, etc.).  The principles of contract formation that determine enforceability, while certainly important, will be left to another article.  Specific contract terms unique to each contractual relationship are far too broad to cover in a single article.  The rights, obligations and contingencies outlined in an entertainment contract, a sales contract, a service contract, a franchise agreement, a buy-sell agreement or a commercial lease differ widely.  This article focuses on some common provisions found in most contracts.  It is not intended as a substitution for consultation with a contract attorney.  Rather, it is intended as a guide for businesses to better understand the contracts they enter into.

Attorney Fee Clauses:  Most people believe that as a matter of course attorneys’ fees are recoverable if they win a law suit.  Generally, however, this is not the case with contract disputes.  Under California law, the contract must include an attorneys’ fee provision in order for a party to recover attorney fees in a breach of contract action.  A good attorney fee clause provides for attorneys’ fees to be recovered by the prevailing party, provides that said fees are recoverable whether or not the case is tried to judgment, defines “prevailing party” and includes language for recovery of litigation costs (apart from legal fees).  Look for attorney fee clauses in all of your contracts.   In general, such clauses benefit all parties.

Continued from Part Two.

Paragraph 6 – Security Deposit: From the landlord perspective, it is a good idea to include lease language wherein the tenant waives its rights under Civil Code §1950.7 allowing the landlord to apply security deposits toward future rent.

Paragraph 7.4(b) – Removal and Surrender: Under the AIR lease, landlords may require tenants to remove alterations and utility installations by providing notice between 30 and 90 days before the end of the lease term. To avoid unanticipated costs, tenants should seek language requiring landlords to provide notice of landlord’s requirement of removal before the alterations or utility installations are made. This way, tenants can calculate the costs of removal in deciding whether the improvements are economically feasible.

Continued from Part One.

Paragraph 4.2 – Common Area Operating Expenses: The AIR lease includes a comprehensive list of common area operating expenses which tenants are responsible for. The list includes property management fees. While property management fees are common in commercial leases, the AIR lease does not set any limits on the amount landlords can expense or define how such fees are assessed. Tenants should seek a limit on management fees and seek clarification of how administrative and management fees are calculated. See Understanding Your Lease – Common Area Expenses. Administrative and management fees should not be a source of additional income for landlords. The AIR list of common area operating expenses also includes reserves set aside for property maintenance. If the lessor is unwilling to remove this language, at least ask that the procedures for determining the reserves and the amounts reserved are set forth in the lease and/or an addendum to the lease.

453592_2_ladies.jpgParagraph 4.2(a)(ix) passes on the costs of capital improvements to the tenants. This is also common in commercial leases. The AIR lease calls for the costs to be amortized over 12 years reducing the tenants’ monthly burden. However, this burden may still be significant depending on the size of the commercial property and the particular premises leased. This can be especially problematic for smaller businesses leasing space in a smaller commercial property. If the business leases 25% of the space from a 50,000 square foot strip mall and the lessor decides to completely remodel the property at a cost of $500,000.00 , the business’ monthly obligation increases an additional $868.00 not including any additional property tax passed on to tenants. This can be disastrous for new or growing small business. This clause essentially passes on the costs of discretionary capital improvements to tenants. Capital improvements ultimately benefit both the landlord and its tenants. As such, passing on a portion of the cost is reasonable. However, tenants need to be acutely aware of this potential expense. Ideally, tenants will negotiate for the elimination of this clause. Alternatively, tenants should seek a cap on the capital improvement costs that may be passed on to the tenant during the term of the lease. From the landlord perspective, agreeing to a cap might be a reasonable compromise, but the landlord should clarify that the cap only applies to discretionary capital improvements. Compliance with applicable laws is dealt with comprehensibly by the AIR standard lease and California law.

In the San Diego commercial real estate market, these days it is relatively common for landlords to ask prospective tenants to enter into a standard AIR (American Industrial Real Estate) commercial lease.  The AIR standard lease was drafted by the AIR Commercial Real Estate Association with the intention of balancing the interests of commercial landlords and tenants in an effort to expedite the negotiation process.  While the standard lease provides a framework for landlords and tenants to work from in negotiating lease terms, it’s important that they avoid arbitrary acceptance.  Every lessor/lessee relationship is different and it is important that individual landlords and tenants examine the AIR lease with an eye towards their particular circumstance.  Consultation with an experienced commercial lease attorney is the best way to ensure that a business’ interests are protected.  This article examines some general issues with specific attention directed to the Standard Industrial/Commercial Multi-Tenant Lease – Net:
77428_carson_building.jpgIn general:  The parties to a commercial lease should always be acutely aware of important terms and definitions such as Premises, Common Areas, Common Area Operating Expenses, Commencement Date, Parking, Use, Warranties, Rent, Maintenance, Utilities, Trade Fixtures, Alterations, Insurance, Property Taxes and Renovations.  This list is not exhaustive, but it is a good representation of lease language that requires specific attention by both the lessor and lessee.  The ultimate terms will depend on the tenant’s business and the layout of and landlord’s vision for the property.  The standard AIR lease language is typical for commercial net leases.  Landlord’s who repeatedly use the AIR lease have practical experience relying on its terms, and aren’t necessarily concerned with changing the status quo.  However, finding and keeping good tenants provides a significant benefit to landlords, and working with new tenants to achieve lease terms that are practical and economically feasible for new tenants is a good long term business practice.  New tenants have much to learn about the “triple net” lease and common area operating expenses.  It’s important that they understand clearly what their rights and obligations will be under the new lease regardless of whether they are able to negotiate more favorable terms. 

Paragraph 3.3 – Delay In Possession:  The lessor is required to use its best commercially reasonable efforts to deliver possession of the premises by the “commencement date”, and lessees have little recourse against the landlord for delayed delivery.  Under Paragraph 3.3, lessors are not liable in any way for delayed delivery.  At best lessees may terminate the lease if possession isn’t delivered by the 60th day.   If delivery is delayed beyond six months, the lease automatically terminates under Paragraph 3.3.  Termination of the lease is an untenable option for most new tenants who have made commitments to lenders, contractors, suppliers, franchisors and/or customers.  As such, lessees are at the mercy of the lessors’ “commercially reasonable efforts” without legal recourse for the damages delayed delivery cause.  This does not mean that landlords are out looking to take advantage of new tenants.  However, tenants should ask their attorneys to try and negotiate better terms with respect to delayed possession to increase the landlord’s incentive to be diligent and efficient, including a provision for damages for delayed possession. 

Continued in Part Two.

Continued from Due Diligence When Purchasing a Business – Part One.

It’s also important to be certain about the extent of the company’s additional obligations.  Is there a lease?  What is the rent?  Are there common area maintenance expenses?  What is the term of the lease and are there options to renew?  Must the landlord consent to an assignment?  Be sure to review all existing leases including any addendums and amendments.  Confirm with the landlord that the rent is up to date.  Equipment leases should get the same scrutiny.  Ask the seller whether there are pending or threatened lawsuits or governmental proceedings against the company.  You’ll want the seller to retain such liabilities where possible.  A business attorney can assist with negotiations and ensure that the purchase agreement reflects the seller’s retention of liabilities.  

469994_antique_store.jpgAn important operational component of any business is the existing staff.  Talk to key personnel such as officers, managers and supervisors to get a sense of their commitment and to get a feel for the employees’ level of productivity.  Is there a risk of mass exodus with the departure of the current ownership?  Do the employees seem content in their positions?  Or does there appear to be a widespread discontent with working conditions and pay?  If there is an employee manual, review it carefully.  Does the company appear to follow its own policies?  Does it comply with Federal and State employment laws?  

The process of investigating a business for sale is commonly referred to as “due diligence”.  In layman’s terms, “due diligence” is essentially the exercise of common sense, and it is the difference between the beginning of a successful venture and a complete disaster.  Proper due diligence requires a thorough evaluation of the company’s business, its history and its finances, and it is best conducted with the assistance of a team of professionals including a lender (or lenders), an appraiser, an accountant (preferably a CPA) and a lawyer.  

81261_modecore.jpg“Due diligence” starts with an understanding of the industry.  It’s important to learn as much as possible about the industry’s fundamentals including operations, manufacturing processes, suppliers, current and historical markets, customer preferences, local and national competitors, marketing methods and anything else relevant to the industry.  Wise purchasers look for businesses where they have an aligned interest or expertise.  Once you have a clear picture of the industry you can better evaluate the specifics of the prospective purchase.  

The next step is to examine the business for sale, starting with its financials.  This is best done with the assistance of an accountant.  The review should include an in depth analysis of the company’s records including but not limited to its current balance sheets, profit and loss statements, financial audits, accounts payable and receivable, debts (secured and unsecured) and information pertaining to any liens on debt, and the company’s tax returns for the past five years.  Check, or have your attorney check, with the County Recorder’s office for undisclosed liens and UCC-1 filings (filings made by creditors with loans secured by the company’s assets).  Ask the following important questions:  What does the revenue stream look like?  How has it changed over time?  How about expenses?   

In this writer’s experience, the most common cause of business failure is the lack of a written agreement between partners. No one ever enters into business with a friend or trusted associate thinking that the deal will collapse around them. Yet, business relationships routinely run into difficulties, and without a written contract defining the contours of the relationship, the difficulties are often destructive. Even minor disputes result in financial ruin for unwary partners who had vastly different expectations regarding the minutia of the business relationship. Moreover, partners expose themselves to substantial liability for the debts incurred by their partners on behalf of the partnership and for the conduct of their partners.

807851_friends_in_business.jpgPartnerships are complex and demand serious commitment much like any business relationship, whether a corporation, limited liability company or other formal business entity. Along with the financial resources necessary to start up the partnership, partners invest their time and energy. In most cases, they make a personal and emotional commitment to the venture hoping for significant financial reward. This personal investment makes it all the more difficult to deal with the inevitable conflicts. The key to success is planning and this starts with a well drafted partnership agreement.

People often start out in business together with nothing more than a hand shake, but they rarely anticipate the number and variety of decisions they will have to make moving forward. It is common for young partners to exhibit flexibility in the beginning but as businesses grow or struggle, the decisions become more complex and more important and partner flexibility starts to wane. If the partners cannot agree on key decisions, the partnership falls apart. See “Ending Bad Partnerships“. Without a well drafted written agreement, the partners have no mechanism for operational continuity or for winding up the company’s affairs. Will one partner be bought out? If so, for how much? How should the business be valued? If both partners wish to continue, who will retain the company’s assets, including the company’s name, website, location and customer lists? If both partners have personally guaranteed a lease, how will the exiting partner be relieved of his obligations? What other continuing debt obligations will the exiting partner retain? If the partners decide to dissolve the partnership, how will the company’s debt be paid? How will the remaining assets be divided? Who will be responsible for winding up the company’s affairs? What if one partner abandons a failing business entirely and disappears? What recourse does the remaining partner have to recover losses? A well drafted partnership agreement will set forth mechanisms to deal with such contingencies.

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San Diego businesses typically invest significant resources in the development of customer lists, but often fail to adequately protect them.  Companies may believe that such lists are automatically protected “trade secrets”.  However, without affirmative steps designed to ensure that confidential lists fit within the definition of a trade secret, customer lists are at risk.  In California, customer lists are considered trade secrets if the lists are valuable because they are kept secret (information that “derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use”), and if the business takes reasonable steps to protect the lists.  The greatest risk comes from the company’s employees.  In order to maximize protections, companies should take the following affirmative steps:  

856856_post_boxes.jpgMaintain physical security:  Customer lists should be isolated from other company information and clearly labeled “Confidential”.  Computer files containing customer lists should be password protected and each file marked “Confidential”.  When computer lists are accessed, the computer should flash the user a confidentiality reminder.  Hard copies should be kept under lock and key with the cabinet and individual files clearly labeled “Confidential”.  In addition, employee access should be limited to those employees that actually need it.  These physical security measures serve as a constant reminder to employees and others that the company’s customer lists are indeed confidential.  

Require non-disclosure (confidentiality), non-compete and non-solicitation agreements:  Require employees to sign non-disclosure, non-compete and non-solicitation agreements.  Requiring employees to sign non-disclosure agreements puts them on further notice that the company’s customer lists are confidential.  It’s important that the non-disclosure language specify the company materials intended to be confidential.  Courts are inclined to strike contract language that is too broadly worded.  Non-compete clauses limit an ex-employee’s ability to hire on with competitors.  Such clauses are generally unenforceable in California.  This is because courts are reluctant to place restrictions on an individual’s ability to seek new employment.  However, their inclusion in employment agreements can affect how departing employees behave.  Where enforceable, non-compete clauses are typically limited in time and geographic scope.  Non-solicitation agreements are less burdensome than non-compete agreements and therefore are more readily accepted by courts.  In non-solicitation agreements, employees agree not to solicit a company’s existing customers or prospective customers.  Whichever state your company resides, it is important to have your attorney carefully draft non-disclosure, non-compete and non-solicitation language to ensure enforceability.

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