San Diego Business Lawyer Blog

February 28, 2013

Repair and Deduct by Commercial Tenants

It is common for commercial landlords and tenants to have disputes over needed repairs. Most commercial leases require tenants to make needed repairs to the leased premises while repair and maintenance to the structural elements of the commercial center and its common areas are left to the landlord. Moreover, even though the landlord maintains the structural elements of the center, those costs are most often passed on to the tenant as common area maintenance expenses (CAMs).

Problems arise where either the landlord or the tenant misconstrue respective responsibilities. When this happens, commercial tenants are tempted to make the needed repairs and simply deduct the cost from their monthly rent. Unfortunately, this commonly referred to “repair and deduct” remedy is not available to commercial tenants unless the remedy is specifically provided for in the lease. Even if the repair and deduct remedy is provided for under the lease, commercial tenants need to be careful about what repairs the landlord is legitimately responsible for under the terms of the lease. Commercial tenants that mistakenly withhold rent for repairs that weren’t the landlord’s responsibility or where the lease doesn’t specifically provide for the “repair and deduct” remedy risk being evicted (unlawful detainer).

Where a landlord clearly breaches the lease by failing to make repairs it is obligated to make under the express terms of the lease and there is no “repair and deduct” clause in the lease, commercial tenants are left with the unfortunate and expensive task of suing the landlord seeking declaratory relief (an order forcing the landlord to perform) or damages to compensate the commercial tenant for losses associated with the breach. See Realities of Pursuing Breach of Contract Actions. Ideally, San Diego business owners will negotiate with their landlords and look to resolve any outstanding issues amicably. Otherwise, the costs of battling a commercial landlord in court can be extensive.

February 8, 2013

The Virtual Office

by Donald Oder

Modern technology has revolutionized the way we do business. Digital copies of documents are emailed instantly, faxes are sent via on-line services, fillable digital forms make transferring information simple and efficient, mobile phones allow business people to field calls almost anywhere and a vast array of information is instantly accessible via the internet. These conveniences reduce the need for receptionists, secretaries and other staff, and as a result reduce the need for physical office space. Many San Diego business owners find it practical to work from home without the need for any office space, virtual or otherwise. However, some businesses necessarily require client contact and in such cases it is more important to have an actual office. Lawyers, accountants, architects, doctors and other professionals must consider the client’s first impression. Meeting at home might convey a host of negative impressions whether real or imagined. While the home office is becoming more and more accepted, there remains a stigma that professionals in new business ventures seek to avoid. Yet, the cost of leasing an office can be prohibitive especially for new and growing businesses.

The virtual office provides an economical alternative while simultaneously conveying a professional impression on clients. Moreover, in today’s business climate, customers and clients are developing a healthy respect for businesses that are able to keep overhead low. They recognize that a virtual office results in savings that are passed on to them. There is a variety of virtual office space available throughout San Diego offering diverse services including the use of offices and/or conference rooms, shared receptionists and secretarial support, phone and internet services and in some cases actual support staff.

Typically, young professionals are offered a fixed number of hours (say 30) for the reservation of an office or conference room. They pay a relatively low monthly rent and perform most of their work at a home office. The virtual office provider can answer the phone for them, take messages and/or transfer calls. Their mail and deliveries are sent to the virtual office. When the time comes to meet a client, the professional sets an appointment with the client and reserves an office or conference room through the virtual office provider. When the client appears for the meeting, he or she is greeted by a receptionist without ever really knowing that they are meeting at a virtual office. Coffee and other refreshments may be offered, and most of the virtual offices available in San Diego are at prime locations like downtown, Mission Valley or La Jolla. In short, clients are treated to maximum professionalism for a minimal cost. The level of service offered by the virtual office provider will depend on the rent agreed to but the rent is always affordable when compared to leasing permanent commercial space.

January 28, 2013

Avoiding California’s $800.00 Minimum Franchise Tax for the Newly Formed LLCs that Haven’t Transacted Business

by Donald Oder

It is common for entrepreneurs to get excited about new business ventures. They often move forward with forming a formal business entity such as a California Limited Liability Company (“LLC”) believing that all of the elements of success are in place. They hire a San Diego business lawyer to set up their LLC and file Articles of Organization with the California Secretary of State. Sometimes, however, unanticipated changes or barriers stop the fledgling business in its tracks (partners back out, expected funding falls through or needed capital equipment becomes unavailable). Suddenly, the organizers of the LLC find themselves faced with the task of dissolving the company and aren’t sure what steps to take. Some will simply ignore the situation assuming that no steps are necessary given that the company hasn’t conducted any business – no income is generated so no taxes are due. This may or may not be true depending on the circumstances. California LLCs are subject to a minimum franchise tax of $800.00. This is true whether or not the LLC generates revenue. Presently, it does not appear that the California Franchise Tax Board is interested in pursuing individuals for an LLC’s taxes so the organizers are not held personally liable in most cases. Nonetheless, it makes sense to formally cancel or dissolve an LLC to ensure that any taxes due are paid and no outstanding obligations or liabilities come back to haunt organizers.

Newly formed LLCs may formally cancel the LLC and avoid California’s minimum franchise tax if the following requirements are met:

1. A Form LLC-4/8 Certificate of Cancellation is filed within 12 months from the date the Articles of Organization were filed with the California Secretary of State;

January 26, 2013

Realities of Pursuing Breach of Contract Actions

by Donald Oder

Contractual disputes are a regular part of doing business but this fact is rarely recognized by business owners. This is because the vast majority of disputes are resolved informally before attorney involvement becomes necessary. Every time discounts are offered because of delayed delivery or because a product is defective, every time a partner agrees to sell his interest in a business because the partners want to take the business in different directions or every time a commercial lease is renegotiated because of a problem between the landlord and tenant, contractual disputes are resolved. The list of examples is endless. The lesson is that most business owners are reasonable and seek efficient solutions to problems and in fact reach efficient solutions. This is because experienced business owners understand that litigation is time consuming, emotionally draining, risky and expensive. The purpose of this article is not to dissect the legal elements of a breach of contract cause of action. Rather, its purpose is to provide some guidance to business owners faced with a breach of contract while simultaneously conveying some of the pitfalls inherent to contract litigation.

It is common for business owners to call their attorneys abruptly with a passionate plea for justice relating in great detail just how badly they have been wronged. Attorneys listen of course because they know it’s good for their clients to vent. However, attorneys are internally sizing up the practical realities of the case. Attorneys ask themselves very simple questions. What are the damages (how much money is involved)? Playing devil’s advocate, what will the other side claim? Is this situation specifically addressed in the contract? How much will it cost my client to fight this battle? In fact some lawyers make it even simpler. They only want to know what the damages are. If the damages are small, then it is likely that their client will have to spend more money litigating the case than they can win – assuming they can and will win. Unfortunately, even the most practical business owners sometimes find themselves faced with a breach of contract that cannot be worked out despite significant efforts.

While every situation is different and consultation with a business litigation attorney is best, the following serves as a helpful guide in deciding how to proceed when a contractual dispute arises:

1. Determine how much money is involved. If it is less than $10,000, pursuing a small claims action in California is probably your best bet. However, even small claims actions require some commitment from the business owner. If the damages are a couple of hundred dollars, it’s probably better to send letters and continue to pursue the matter informally. The “I am not going away” tactic is often successful. If the amount is greater than $10,000 but below $25,000, consider consulting with a lawyer about an aggressive letter and phone call campaign. This can be done for a relatively low cost and is often successful. Depending on the circumstances, this tactic can be extended into filing a civil complaint for breach of contract. The purpose is to put pressure on the other side hoping that it brings them to the negotiating table. If it doesn’t, you can instruct your attorney to dismiss the case before it costs you more than $25,000 in attorney fees and litigation costs. Ultimately, the advice you receive will depend on the strength of your case.

2. Forget about Punitive Damages and Contingency Fee Agreements. It is only in extraordinary cases where independent torts exist (fraud, physical harm, etc) that punitive damages are awarded. If the actual damages are high and the case involves egregious actions you will certainly want to discuss the potential for punitive damages with an attorney. If litigation is pursued in high damage cases, attorneys will plead numerous causes of action seeking all potential relief. However, most business disputes do not rise to this level and even if punitive damages are sought, they are rarely awarded in disputes between businesses. It might be different of course if you were harmed by Microsoft and can show egregious action but this is not the typical scenario that is the subject of this article. The same is true regarding contingency cases. Attorneys will rarely handle business disputes on a contingency basis. If they do, it’s because the case is extremely valuable and the facts are so one-sided that they have high confidence in winning and collecting. It cannot be stressed enough that these types of scenarios are rare. It doesn’t hurt to consult with several lawyers, but it is better not to expect that a lawyer or law firm will assume the risk for you.

January 14, 2013

Tenant’s Options After Landlord Breach of Commercial Lease

by Donald Oder

Under California law, a commercial tenant’s options when a landlord fails to perform under a lease are generally limited by the terms of the commercial lease. San Diego businesses often find themselves without a practical legal remedy because the terms they originally agreed to prevent them from withholding rent or terminating the lease. Tenant’s are forced in these circumstances to seek a remedy through litigation which is of course costly and time consuming.

Those tenants that entered into leases without review or who were unable to negotiate better terms often find themselves dealing with landlord breaches. Some withhold rent immediately not realizing that they might be held in breach of contract. Others just abandon the premises and end up getting sued afterward. Whether or not a commercial tenant can do these things for the most part depends upon the actual terms of the lease. Is it silent as to landlord’s defaults? Does it allow the tenant to make needed repairs and then deduct the cost from rent (repair and deduct)? Or does it have specific language limiting the tenant’s remedies to court action. For instance, a lease clause might state, “in no event shall the tenant have the right to terminate this lease as a result of landlord’s default and tenant’s remedy shall be limited to damages and/or an injunction.”

The best way to avoid this peril is to negotiate better terms in the first place. However, negotiating better terms is dependent on a party’s bargaining power. In most cases, San Diego businesses have little bargaining power because they are new or unknown entities. In addition, competing businesses are willing to enter into a lease with the landlord under any terms, leaving the more savvy entrepreneurs a difficult tight rope to walk. Many landlords approach lease negotiation from a “take it or leave it” perspective. This does not mean that San Diego businesses have absolutely no bargaining power, but landlords typically stand strong when it comes to limiting a tenant’s remedies. Nonetheless, a prospective tenant should never shy away from negotiation better lease terms no matter how limited their bargaining power. Every landlord is different, and the issues that are important to one landlord may not be as important to another.

Ideally, those tenants currently facing landlord defaults which cannot be resolved through informal discussions will consult a commercial lease lawyer. Of course, paying for an attorney is not always practical. In such cases, the first step is to review the operative lease and its amendments carefully. Look for language that limits, or relates to in any way, tenant’s remedies upon landlord breaches including language limiting the tenant’s ability to terminate the lease, seek consequential damages, seek declaratory relief, withhold rent or any other limitations on tenant’s remedies. Once the tenant has gained a basic understanding of its limitations, it can determine whether seeking legal assistance is necessary. If there are limitations, consulting a commercial lease lawyer is highly recommended.
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August 16, 2012

California Limited Liability Company versus the S-Corporation

by Donald Oder

As with most business decisions, the decision regarding which legal entity is best suited for your San Diego business depends on a variety of important factors. Most San Diego business owners interested in the benefits of a formal business organization without the burden of the double taxation that accompanies the C Corporation, turn to either the California Limited Liability Company (LLC) or the S Corporation. Both offer owners protection from unlimited liability and both offer pass through taxation (no double taxation). The question then becomes which is better, the S Corporation or the LLC. The decision is best made with the guidance of a San Diego business entity lawyer and a tax professional. However, with fewer restrictions on the allocation of ownership and profit interests and greater management flexibility, the LLC seems to be the better option although this doesn’t mean it is the better option for every business.

The most significant benefit of the S Corporation is the ability to limit self employment taxes (social security and Medicare taxes). The benefit is available to stockholder/employees who minimize their salary (subject to self employment taxes) and then distribute excess profits as dividends (not subject to self employment taxes). In certain circumstances, this can be a valuable tool. For example, assume an S Corporation is owned entirely by two stockholder/employees (each owning 50% of the stock). The corporation’s profits for the last taxable year were $200,000 of which each salaried stockholder received $50,000 in wages. Each owner would pay self-employment taxes on $50,000 and each would receive a dividend for $50,000 free from self-employment taxes. Based on the current social security and Medicare rates, each owner would save $7,650. However, this benefit is limited by two important factors. First, the IRS requires that salaries paid to owner/employees of corporations be reasonable. There is no guarantee that the IRS will accept the $50,000 incomes in this example, and it has recently become more aggressive in ensuring that stockholder/employee salaries are not too low. It may instead consider the dividend distributions to be wages subject to self-employment taxes. Second, most of the self employment tax is the social security portion which is currently capped when wages reach $106,000. This means that stockholder/employees who earn an annual salary above $106,000 only save 2.9% percent (the Medicare portion) for all dividends paid above their salary.

California LLCs are also subject to a gross receipts tax. The tax is relatively small when compared to the revenues that trigger the tax. The gross receipts tax is $900 for gross receipts between $250,000 and $499,999, $6,000 on for gross receipts above $1,000,000, and $11,790 for gross receipts in excess of $5 million. Profitable businesses will barely notice this tax. For unprofitable businesses or for businesses with a very low profit margin, the gross receipts tax can be problematic since the tax is on gross revenue and not on profits.

For the stockholders in the above example, the tax savings seem to make sense. In fact, tax savings no matter how small always make sense. Nonetheless, the S Corporation suffers from several statutory limitations and lack many of the benefits LLCs offer. First, the S Corporation cannot be owned by another corporation or LLC; it cannot be owned by a foreign person; it cannot have more than 100 shareholders; it cannot issue different classes of stock; and it must distribute profits in equal proportion to ownership interests. While one owner in the example above could pay himself a higher salary for taking on greater responsibility, he would still have to take 50% of the dividends distributed. All distributions must be made simultaneously and on a pro rata basis. If one of the owners above preferred to purchase his interest in the S-Corporation directly from his existing LLC, he couldn’t. The LLC suffers from none of these limitations. The LLC members are free to allocate profits however they like, make contributions however they like and are able manage the company with the greatest flexibility.

July 12, 2012

Protecting Trade Secrets In California

by Donald Oder

Protecting proprietary information and processes is important to San Diego business owners. Trademarks, Patents and Copyrights provide companies protection for inventions, artistic works, symbols, names, images, and designs which are made public. As the name implies, “trade secret” law provides businesses protection for secret information. A trade secret is a process, formula, practice, design or compilation of information including customer lists which is/are not generally known or reasonably ascertainable and from which a business obtains economic advantage over competitors. Tension between public policies favoring protection of trade secrets and public policies promoting competition have left California businesses in a tenuous position when it comes to protecting their trade secrets. It is often difficult to distinguish between an employee who has stolen a trade secret from one that has merely used his experience and personal knowledge to obtain new employment. In addition to consulting a San Diego business lawyer, there are important steps business owners can take to reduce the risk of theft.

California’s Uniform Trade Secrets Act prohibits misappropriation of trade secrets. “Misappropriation” is defined as “(1) Acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means; or (2) Disclosure or use of a trade secret of another without express or implied consent by a person who: (A) Used improper means to acquire knowledge of the trade secret; or (B) At the time of disclosure or use, knew or had reason to know that his or her knowledge of the trade secret was: (i) Derived from or through a person who had utilized improper means to acquire it; (ii) Acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or (iii) Derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or (C) Before a material change of his or her position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake.” “Improper means” is defined to include “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means”.

Significantly, California’s trade secret act defines a trade secret as “information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (1) 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 (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” In order for a San Diego business to ensure that its information will be considered a trade secret under California law, it needs to take reasonable steps to keep it secret. Secrecy is critical. First, the information must have some independent economic value, and second, there must be some effort to maintain secrecy. If a San Diego business doesn’t consider the information important enough to maintain secrecy, neither will California courts.

There are several relatively simple measures businesses can take to maintain adequate levels of security. Physical security is the most obvious measure. Keeping secret information under lock and key with limited access to employees and marking documents “Confidential” serve as a constant reminder that the information within is intended to be kept secret. Similar physical measures can be taken with electronic information. Computer files should be password protected as well as marked confidential, and the passwords provided only to necessary personnel. The more limited the access, the better.

May 29, 2012

How to Avoid Double Taxation for Small Corporations

by Donald Oder

One of the first decisions new San Diego business owners make is whether or not to incorporate or form some other formal business entity. The decision often seems daunting and turning to a San Diego Business Lawyer and tax professional are important first steps. If the business owner opts for a limited liability company (“LLC”) or an S-Corporation (which is taxed like a partnership as opposed to the C-Corporation subject to double taxation), double taxation is not an issue. Thus, the first way to avoid double taxation is to choose a business entity that is not double taxed. This includes forming a California Corporation and then electing S-Corporation status with the IRS. Many small business owners have nonetheless formed corporations without electing S-Corporation status. This may be because a tax professional recommended it or because the business owner simply didn’t consider the various business entities available when forming the corporation. Whatever the reason, the choice of a C-Corporation for small businesses isn’t inherently a bad one. It does, however, become imperative that these C-Corporations take steps to avoid or at least limit double taxation.

The easiest way to avoid double taxation is to elect to be taxed as an S-Corporation with the Internal Revenue Service. However, to qualify for S-Corporation status the IRS requires that your corporation be a domestic corporation, issue only one class of stock, distribute profits and losses in proportion to shareholder interests and have no more than 100 shareholders who are natural persons and U.S. citizens. Another corporation or LLC cannot own stock in an S-Corporation nor can foreign nationals. If opting for S-Corporation taxation, it is important to timely file Form 2553 with the IRS – no later than the 15th day of the third month following the date of incorporation. If a business is already incorporated, it can still opt for S-Corporation taxation the following year by filing Form 2553 by December 31st. However, it’s important to consult with a tax professional before doing so especially where the company was initially advised not to elect S-Corporation status.

If you are a small corporation and do not elect S-Corporation status, the following is a short list of legitimate ways to minimize double taxation:

Accumulate Earnings: Leaving profits in the corporation avoids double taxation since there are no dividends to tax. Saving is advantageous so long as the money is eventually re-invested toward growth. It is a good short term plan. However, if too much profit is retained, the corporation can face an additional Accumulated Earnings Tax (a substantial penalty in addition to the regular corporate tax). The goal is to prevent corporations from accumulating profits for the sole purpose of avoiding income tax. The IRS looks to see if the corporation is accumulating earnings and profits beyond the reasonable needs of the business. Generally, accumulated earnings up to $250,000 ($150,000 for some personal service corporations) are considered reasonable. For earnings in excess of this amount, corporations may still show the IRS that the retained earnings are reasonable based on the needs of the business. If you choose to retain earnings, consult with your tax professional.

May 18, 2012

Office Leases and the Base Year

by Donald Oder

At first glance, the differences between triple net leases (NNN), gross leases and modified gross leases seem complicated. Many of the definitions found on the internet are convoluted and even experienced real estate professionals have trouble figuring out what some bloggers are trying to say. The differences, however, are not that complicated. In the simplest terms, commercial leases can be separated into two major categories: those where the tenants pay all of the property’s expenses (NNN leases) and those where the landlords pay all of the property’s expenses (gross leases). A base year lease, or modified gross lease, calls for existing expenses to be paid by the landlord, but any annual increases in expenses to be assumed by tenants. A base year lease is somewhere in between the NNN lease and the gross lease.

Most retail leases are triple net leases and the common area maintenance expenses (CAM expenses) that the tenants pay for include just about every imaginable cost for the operation of the property including in most cases property taxes, utilities, maintenance, insurance and management fees. Each tenant is responsible for its pro rata share of the CAM expenses. The actual terms in NNN leases vary widely from lease to lease and how favorable the terms are to the tenant depend on the tenant’s negotiating power. Gross leases are less common but still used today. This is largely because landlords are reluctant to take on the risk of increased costs over time. A base year lease or modified gross lease eliminates this problem by transferring the risk of increased costs to the tenants. The base year lease provides landlords security by passing on increased costs to tenants.

Most office leases are some variant of a base year lease. In a base year lease, a base year is selected (usually the first year of the lease). The landlord agrees to pay the property’s expenses for the base year. The landlord continues to pay the property expenses at the base year level and the tenant agrees to pay its pro rata share of any increases in property expenses. If the property expenses for the base year (say 2010) are $40,000 and the expenses increase to $50,000 for the year 2011, a tenant with 20% of the square footage would pay $2,000 (20% of the $10,000 increase) in 2011 in addition to the tenant’s base rent (with a NNN lease, the tenant would pay its pro rata share of the entire $50,000 in 2011 or $10,000 in addition to the base rent). Each year thereafter, the tenant pays its pro rata share of the property’s expenses but only to the extent that those expenses exceed the $40,000 established in the base year. In most cases, the annual increase in expenses is estimated at the start of each year and tenants pay monthly to spread out the cost over the year. In the above example, if at the beginning of 2011 the landlord over estimated the increase in property expenses at $12,000, the tenant would pay monthly payments of $200 (20% of 12,000 divided by 12 months) totaling $2,400. The tenant thus overpays $400. At the end of 2011, the landlord would perform an expense reconciliation resulting in the extra $400 being credited back to the tenant.

April 23, 2012

What is Double Taxation?

by Donald Oder

Most people are generally familiar with the concept of double taxation. Corporate attorneys and accountants regularly raise the issue when asked by entrepreneurs about choosing the right business entity for a new company (or for an existing company looking to grow and insulate its owners from personal liability). Moreover, double taxation remains a hot button political issue. Whatever political side one falls on, double taxation is real and new and existing business owners need to be informed as they make critical business decisions regarding incorporation or the creation of some other formal entity.

The concept of double taxation itself is simple enough – the Internal Revenue Service (IRS) and state taxing authorities tax corporations based on their profits. In addition, when those profits are distributed to the corporate shareholders in the form of dividends, the individual shareholders are taxed again creating a significantly higher actual tax rate on the corporate profits. Say a corporation generated profits of $100,000 in a given tax year. The federal corporate tax rate on profits of $100,000 is currently 34% so the corporation owes a tax of $34,000. If you and a co-owner each own 50% of the stock in the corporation and issue yourselves each a $50,000 dividend, you will each add the $50,000 to your income for the tax year. Assuming you both end up in the 35% tax bracket, each of you will both pay an additional $17,500 in taxes. In effect, the $100,000 in corporate profits is hit with a total tax bill of $69,000 or an actual tax rate of 69%. While this picture is much more complicated for most corporations, the concept remains the same – corporate profits are taxed twice.

The most common reason business owners incorporate is to insulate themselves from the liabilities of the business. This goal can be accomplished in ways that avoid double taxation, including the formation of a Limited Liability Company (LLC) or, if a corporation meets certain qualifications, by electing to be taxed as an S-Corporation. S-Corporations are taxed the same as partnerships (pass-through taxation). The profits are divided amongst the individual shareholders who are then taxed as individuals. The Corporation’s profits are not taxed separately. If an S-Corporation election is not made, then the entity is considered a C-Corporation and is taxed accordingly (double taxation).