Posts in: February

Boilerplate Contract Clauses Every Business Owner and Investor Should Know

February 16, 2016 Asset Protection, Business planning, Law, Small Business, Uncategorized Comments Off on Boilerplate Contract Clauses Every Business Owner and Investor Should Know

I know you’ve read a contract and “glossed” over sections with headings like “Indemnification” and “Severability”. Although these clauses are often overlooked, these clauses are often included in most contracts for investments, equipment, services, and other business needs. This article outlines some of those key terms and explains why you should seek to have these ‘boilerplate” terms in your contracts.

1. Indemnification. You’ve seen this clause and you’ve maybe even read the language and thought, what does this cover? Let’s take a contract between a Buyer and Seller in a business sale. In that contract the indemnification clause may read something like this, “Buyer agrees to indemnify Seller from all causes of action, losses, damages, and claims made against Seller that are a result of Buyer’s actions.” In other words, if the Seller is sued by a third party for something that the Buyer did then the Seller has a contractual claim to bring against Buyer to make the Buyer responsible for the damages or claims they caused. This is an important contractual term between service providers, customers, joint venture partners, and buyer’s and seller’s of investments or assets, and it essentially shifts the burden from the innocent party to the party responsible for creating the liability. Now, in the example outlined above the clause is between Buyer and Seller but the clause as written only protects Seller from Buyer’s actions. What about the Buyer? Are they protected from Seller’s actions. When reviewing contracts make sure that the indemnification clause provides protection for you and your business and not just for the other guy. Often times the indemnification clause will only provide the indemnification protection to one party and leaves the other party to fend for themselves. This can be remedied by creating a similar clause in favor of the other party.

2. Severability. This clause usually says something like, “If a Court holds that there is an invalid or illegal term in the contract that specific provision shall be severed from the contract but the rest of the contract’s terms shall have full effect.” Generally, if a contract has an invalid or illegal term it typically makes the entire contract invalid, unless the contract contains a severability clause as explained above. For example, lets say you loan money to someone and your promissory note to the borrower contains an interest rate that is too high and is usurious under law. If that happens, the contract would be ineffective entirely, however, with a properly drafted severability clause, the contract can survive and the usurious rate itself would be reduced to the maximum rate allowed by law.

3. Attorney’s Fees. Many investors and business owners who win cases in Court are often disappointed with the legal process because even though they’ve won their case they are typically left with a large legal bill that they end up having to pay. However, if the lawsuit is regarding a contract and if the contract contains a provision for attorney’s fees then the party who wins in court not only wins the case but can also get their attorney’s fees paid by the other party.

Understanding your contracts is vitally important and having clauses that protect your interests will limit your liability and will allow you to more fully recover your losses. Remember, in cases between parties in a contract, the terms of the contract are the law. You might as well write them in your favor.

The Perils of On-Line Do-It-Yourself Legal Services

February 16, 2016 Asset Protection, Business planning, Small Business Comments Off on The Perils of On-Line Do-It-Yourself Legal Services

With explosion of the internet and e-commerce in the past twenty years, the internet has become the primary source for consumers for obtaining information and conducting business.  The fact that we can now have access to the world with just a click of the button 24 hours a day, 7 days a week from the comforts of our bedroom is certainly alluring to consumers seeking a convenient and expedient way to get things done at the lowest possible price.

The furnishing of legal services is no exception.  The proliferation of Online Document Production Services (“ODPS”) like Legalzoom offer consumers legal documents and contracts traditionally prepared by lawyers by merely answering a few questions online, and thereby reducing (as consumers are led to believe) the complexity and cost of traditional legal services. This has certainly been an attractive alternative for consumers.  While their marketing is certainly adept at portraying the services as a win-win for the consumer, are the interests of consumers truly served when important legal documents that affect  your rights and responsibilities are prepared by a computer, and ultimately your money is at stake?

At KKOS, we frequently see the consequences that may result when consumers sacrifice the knowledge and expertise that an attorney can provide in favor of convenience.  In fact, our office has a specific service called a “clean-up” where we fix entities that have been set-up on-line or through a state filing system. We get about 100 clean-ups a year and many of them have to be shut-down and entirely scrapped and then we have to start over with a new entity. Some entities can be kept and fixed but it always costs the business owner more in time and money to fix an entity than it does to set one up right the first time.

Therefore, before you decide to click that button to have a legal document prepared for you by an automated service, please consider the following:

  1. An Online Document Preparation Service (ODPS) May Not Provide the Correct Structure for Your Specific Situation Because It is Incapable of Analyzing Your Specific Needs and Goals. An ODPS is used most frequently in the context of business formations or other form contracts.  However, there are infinite number of reasons, purposes or goals in a business or other legal relationship, and different purposes may warrant different types of structures or considerations.  For example, will the entity be running an operational business that creates a need for savings on self-employment tax?  Will it be an entity that holds investments warranting more asset protection?  Is the entity owned by only one person or are there partners involved?  The answer to these questions may result in very different types of entity structures, and contrary to the suggestions of some ODPS Companies, an LLC may not be the appropriate entity for every type of business.   Moreover, if the business is a partnership, an ODPS is ill equipped to be able to reconcile the varying and potential competing rights, duties, responsibilities and interests of the various partners.   In our office, we often called upon the handle or even litigate partnership disputes and often times, resolution of these disputes could have been much more efficient or even avoided had they sought to prepare a partnership specifically catered to their needs and goals.
  2. No one is Available to Counsel and Advise You Through the Process nor Answer Your Questions. While some ODPS Companies do offer the opportunity to speak with a lawyer, in most cases you do not have the opportunity until after you have already paid them to prepare the document, which is like asking you how cold is the water after you’ve already been thrown in. Choosing an appropriate legal structure or preparing legal documents that adequately protect your rights necessarily entails that you have an advisor there understand the situation, and to explain your rights, options, and the legal consequences of any actions you propose to take.     In our experience, many who use ODPS Companies do not have the training and sophistication in the area they are requesting services, and thus do not know the risks or pitfalls involved.   What you don’t know can certainly hurt you, and there are few better examples than when you are dealing with your legal rights or protecting your money.
  3. You Have No Recourse If They Set You Up Incorrectly. Our office has seen many instances where clients were harmed by relying on an ODPS.  For example, clients setting up their entities may have set up with the wrong entity or in the wrong state requiring our services to completely unwind the structure and start over.  Another Client using an ODPS was not told about annual tax filing requirements and was shocked when the taxing authority came after them for back taxes and filing penalties over $10,000.  Still another Client set up a trust, but wasn’t told to transfer real estate into the trust, and now the beneficiary is facing probate.  Some ODPS services tout the fact that they are not a law firm and therefore can pass the savings on to you, but what that really means is they have no license, no accountability, and that you have no recourse if the decisions you make using their services are wrong.
  4. They’re Actually Just as Expensive As a Small Law Firm.  While many ODPS services market a $99 price, when you go through the process you end up paying around $650-700 plus state filing fees for a complete entity set-up. For example, take Legalzoom, you may be able to file articles with the state through them for $99 but if you want an EIN, an operating agreement or bylaws, minutes, membership/share certificates, a corporate book and seal and the rest of the items that are part of a complete entity set-up you will end up having to add all of those items on and that brings you to between $600 and $700. Filing articles through an ODPS for $99 is like going to McDonalds and buying a burger where you only get the burger. Maybe that’s all you really want but most people are at least expecting a bun, some lettuce, and ketchup. That’s just like an entity. Make sure you get what you need and don’t get lured in buy the low price of $99. Our full attorney set-up is only $800 plus state filing fees and that’s only $100 more than a complete entity set-up on Legalzoom.

The internet is a fantastic resource for information and commerce, and can be a valuable tool for individuals seeking information on their rights and the law, and ODPS definitely plays a role in providing access to legal resources to some who would otherwise do nothing.  However, it is important to understand that, in the delivery of legal services, there are limits to what technology can do and to carefully consider what could be at stake when using the services of an ODPS.

Cam Newton’s Terrible, Horrible, No Good, Very Bad (Tax) Day

February 9, 2016 Small Business, Tax Planning Comments Off on Cam Newton’s Terrible, Horrible, No Good, Very Bad (Tax) Day

Von Miller, DeMarcus Ware, and the rest of the Denver Broncos’ historically devastating defense harassed, hammered and battered 2015 NFL MVP Cam Newton into his worst performance of the season during the Broncos’ 24-10 victory in last weekend’s Super Bowl at Levi’s Stadium in Santa Clara, California. Newton didn’t do much to improve the situation when he sulked his way through his mandatory post-game press conference before abruptly leaving the podium after only a handful of questions. Unfortunately, the loss will do more than hurt Newton’s pride. Thanks to the California Franchise Tax Board, his three turnover performance will literally cost him money. Here’s how:

California is one of several states that tax a percentage of visiting athletes’ income based on how many “duty days” they spend in the state during a given year. The state’s “Sports Program” (detailed at: https://www.ftb.ca.gov/individuals/wsc/sports.shtml) defines a duty day as “any day services are performed under the contract from the beginning of an official preseason activity until the last game played. The duty days in California are then divided by the total duty days to create a ratio. This ratio is then multiplied by the total compensation. This then is deemed to be the California source income.”

It is estimated that Newton will have a total of 206 “duty days” in 2016. He spent seven duty days in California for the Super Bowl, and will spend four more duty days in the state because the Panthers are slated to visit both the Oakland Raiders and Los Angeles Rams in the 2016 NFL regular season. Therefore, 11 of 206 (or roughly 5.3%) of Newton’s duty days will be spent in California this year. Between base salary, signing bonuses and playoff bonuses, Newton should make about $23 million in 2016. 5.3% of $23 million is about $1.228 million. California’s top income tax rate is 13.3%, which means that Newton will pay roughly $150,000 in California income taxes in 2016.

So, how exactly did playing in the Super Bowl cost Newton money? Well, his bonus from the NFL for playing in, and losing, the Super Bowl was $51,000 (if Carolina had won, it would have been $102,000). If Carolina had lost the NFC Championship to the Arizona Cardinals, then Newton would only have four duty days in California out of 199 this year (instead of 11 out of 206). This would make his 2016 California income taxes roughly $55,000, instead of $150,000. Therefore, the Panthers’ seven day trip to Cali earned Newton $51,000 in income (not to mention a bruised body and a bruised ego), but will cost him an additional $95,000 in California state taxes. This makes Newton’s effective California state tax rate on his $51,000 Super Bowl bonus about 186% – and you thought Sweden had an oppressively high tax rate!

So, how does this apply to those of us whose glory days in sports took place on the Little League diamond or the church basketball court? Well, if you live in one state and earn income in another or moved from one state to another during the year, then you will need to determine how much tax is owed to each state and how credits for payments to one state or the other should be applied. The consequences usually aren’t as dire as a 186% income tax rate, but getting it right can save you money and will give you peace of mind in the event of an IRS audit. Because of this, it makes sense to get advice from a licensed tax professional if you have questions.

Jarom Bergeson is an associate attorney with Kyler Kohler Ostermiller, and Sorensen, LLP (“KKOS Lawyers”) in its Cedar City, Utah office and has extensive experience in helping client register their trademark and protecting their brand identity. He can be reached at jarom@kkoslawyers.com or by phone at (888) 801-0010.

If Friends and Family Invest in My Business, That’s Not a Security, Right?

February 2, 2016 Business planning, Small Business Comments Off on If Friends and Family Invest in My Business, That’s Not a Security, Right?

One of the most important aspects of business ownership is raising capital for your business.  A threshold question is often asked whether a particular transaction for raising capital is going to be considered a security and whether securities law is implicated.  The Jumpstart Our Business Startups (“JOBS”) Act has brought many changes to the landscape of securities law – for example, the advent of equity crowdfunding (see my blog article on federal equity crowdfunding here.)  However, many aspects of securities law remain the same.

We’ve frequently seen clients incorrectly assume that the securities laws do not apply when their friends of family invest in their business. This is incorrect.  Securities law will apply when someone invests their capital in a common enterprise with the expectation of profits solely through the efforts of others.  SEC v. W.J. Howey Co., 328 U.S 293 (1946).  For example, if friends and family invested their capital into your business with the expectation of profit solely through your efforts, then securities are being issued and the Securities Exchange Commission (SEC) will be very interested to ensure that securities laws are being followed.  Although there can exist a sense of security (no pun intended) that friends and family are not going to complain to the SEC if you lose their money, the fact that friends and family are involved, does not in and of itself not make it a security.  

How Do I Properly Raise Capital From Friends and Family?

Option #1: Not a Security.  The primary option is to structure the capital raise so that it is not considered a security.  The key factor to make a particular transaction not subject to securities law is to give cash partners voting rights and participation in the key decision-making functions of the business, e.g., decisions on incurring additional debt, management compensation, and buying and selling company assets.  A guiding principle in all of this is that typically there is a sliding scale where the more control you have over other people’s money, the more likely securities law is implicated. Giving yourself unlimited control can be a fatal mistake that will subject the transaction to securities law.  To avoid that, you may need to put language in the LLC operating agreement that allows for your removal as manager by majority vote and that key decisions must be approved by the investors/owners including regular meetings while the day-to-day operations can be handled by you as the LLC manager.  Mat Sorensen wrote an article that discusses this in more detail here.

For example, if you wanted to raise $250,000 for your business and you had five family members willing to invest $50,000 each, if you give them the right to participate in the decision-making of the business, then this would not be a security.  This is probably the least expensive and most common option for receiving capital from friends and family without becoming subject to SEC scrutiny.

However, remember that doing business with friends and family can sometimes come with a price it usually changes the nature of the relationships you may have with your best-friend or favorite cousin. Now that the SEC allows for general solicitation of investors under equity crowdfunding offerings and Rule 506(c) offerings, you may not need or want Cousin Eddie’s money to infuse your business with capital, given the other options and the complications that can arise when accepting funds from friends and family.  

Option #2: Exempt from Public Security Registration.  In the event you were reluctant to give such voting rights to your friends and family investors just for the sake of not implicating securities law, one option would be to meet the requirements of a private security offering, i.e., exemption from public registration.  There are numerous exemptions but the most common relied upon exemptions are found in what is known as Regulation D or “Reg D”, either through a Rule 506(b) or 506(c) offering.  Some of the exemptions put a dollar limit on the amount of capital you can raise in a 12 month period.  Other exemptions allow only “accredited investors”, which is basically those whose net worth exceed $1M or have annual earned income of greater than $200,000.  Most all of the more established exemptions prohibit general solicitation of investors (which is why historically friends and family are asked to invest). Still, as securities law continues to evolve, other exemptions now allow for general solicitation of investors, e.g., 506(c) and equity crowdfunding.  Note: There is sometimes a misunderstanding in how the word “exemption” is used in this context.  It is not meant to indicate a transaction is exempt from being a security – rather, it is meant to indicate a transaction or capital raise is exempt from public registration of the security.  

Although structuring the capital raise to comply with one of the exemptions from public registration can be more costly than allowing your investors to participate in the decision-making of the business, the benefit of doing it this way is you can retain the control and decision-making of the business to yourself, which in the end, can be less costly. If you’re raising more than $500,000 for your business then you should consider this option as the legal fees become more reasonable given the capital being invested. However, if you were only trying to secure $100,000 from family and friends, the legal fees for a Regulation D offering would be too costly to justify this option.  Plan on $20,000 to $25,000 in legal fees for a Regulation D offering. They can fluctuate below and above this is a good average range to consider when analyzing the cost and benefit of a Regulation D offering.

Option #3: Secured Loan.  This article has thus far has centered on receiving capital in exchange for ownership in your company.  Another way to receive funds from friends and family without implicating securities law is to structure the investment as a loan that is adequately secured or collateralized.   Be careful though in assuming that a loan is never considered a security – it still might be unless it is secured or collateralized.

In sum, in order to receive funds from friends and family for your business without becoming subject to SEC scrutiny, you should:  a) let them participate in the business through sufficient voting rights and participation; b) structure the capital raise to fit within one of the numerous exemptions from public registration, or c) structure the transaction as a secured loan. Please contact our office to set up a consultation regarding these matters.

Kevin Kennedy is an associate attorney with Kyler Kohler Ostermiller, and Sorensen, LLP (“KKOS Lawyers”) in its Phoenix, Arizona office and has extensive experience in helping client register their trademark and protecting their brand identity. He can be reached at kevin@kkoslawyers.com or by phone at (888) 801-0010.