Posts by: leechen

Which State’s Law Applies in a Lawsuit?

February 14, 2017 Asset Protection, Business planning, Corporations, Law, Litigation, Real Estate, Small Business Comments Off on Which State’s Law Applies in a Lawsuit?

We frequently hear from clients who have been told by others that they should incorporate in Nevada (or other states outside of their home state) in order to take advantage of their favorable laws.   We have seen many individuals persuaded into incorporating in a state outside of their home, only to complain about the cost and complexity of the structure which ultimately had to be unwound.

This is not to say that incorporating an entity in Nevada or Wyoming should never be considered as part of an asset protection strategy. One primary reason for incorporating a Nevada or Wyoming entity is arguably due to their strong “charging order” protection.   The charging order is a concept protecting an LLC owner who is sued and held liable for something unrelated to and “outside” from the LLC from then being able go and take that LLC interest or the asset held by the LLC.   For example, if you’re cruising on the highway over the weekend and get into a major accident causing serious injuries, the charging order could prevent or hinder the injured plaintiff from seizing your assets held in your LLC.

However, the myth that we often hear from clients is that because states like Wyoming or Nevada have strong asset protection laws, they should take advantage by incorporating these entities into their structure even if they don’t own assets or do business there. What is often omitted from the conversation is whether Nevada or Wyoming law will actually be applied if there is no connection between the lawsuit and Nevada or Wyoming.

Since we are a union comprised of fifty states with different laws, there is an incentive to try and take advantage of states that have more favorable laws. Courts generally discourage this type of “forum shopping” where people try to use the favorable laws of one state even if they have no actual connection with that state.

One of the ways courts deal with these types of cases is by applying a set of rules called Conflicts of Laws. It is an area of the law that allows a state to determine which laws will apply to a case when the laws of multiple states could potentially apply.

For example, lets say a California resident is driving in Nevada on his way to Vegas and collides with a Colorado resident causing catastrophic injuries. Where should this type of lawsuit be filed and which of these three state’s laws should we apply? Because these types of circumstances can be so varied depending on the residency of the parties and the location where the events resulting in a lawsuit occur, it is sometimes difficult to predict where a lawsuit should be and what state’s laws should apply. This is further complicated by the fact that states have different Conflicts of Law rules.

Here are some general rules that courts will usually apply depending on the type of case. Examples include the following:

  1. Personal Injury or Fraud: Generally the law of the state where the wrongful act causing the injury or fraud occurred will be the law that should be applied. For example, if the accident or fraudulent conduct occurred in Nevada, that is an indicator that Nevada law should be applied;
  2. Personal Property (damage or theft): Where the personal property was located when the act causing the theft or damage occurred may determine which state’s laws should apply;
  3. Real estate: The state where the real estate is located will often determine which state’s laws will apply in a dispute relating to real estate;
  4. Contracts: Where the contract was entered or where the principal events necessary to form the contract occurs. Keep in mind that many contracts have provisions governing which state’s laws or courts will be used in the event of a dispute. These types of “forum selection” or “choice of law” clauses are often enforced by courts, unless there is no substantial or reasonable relationship with the chosen state. For example, if you are in California and you enter into a contract with someone else in California and all the activities relating to the contract occur in California, it is unlikely that a California court would enforce a provision that says Delaware law should apply even if you included such a provision in your contract.

These are just some very general guidelines as courts may consider additional factors in any given case. Hence, the outcome in any particular case is often difficult to predict with any consistency.

Therefore, before you decide to set up a structure that includes incorporating in a state which you have little or no connection with, make sure you understand not only the purposes for choosing that particular state, but perhaps even more importantly, its limitations.     Don’t assume that if you incorporate your entity in Nevada, that you will necessarily get the benefit of Nevada’s laws, especially if you do not live in Nevada.

Court Rules Against California Franchise Tax Board on Overreaching Franchise Tax

January 24, 2017 Business planning, Small Business, Tax Planning Comments Off on Court Rules Against California Franchise Tax Board on Overreaching Franchise Tax

On January 12, 2017, an appeals court in California ruled, in a closely watched case of Swart Enterprises, Inc. v. Franchise Tax Board (Appeals Case F070922), that a non-resident of CA was not “doing business in California” and therefore not liable for California Franchise Taxes merely because it owned a passive investment in California.   Although this ruling may not have much impact on California residents who own and direct investments from California, it does signify the Court’s willingness to impose some limitations on California’s ability to tax under its expansive definition of “doing business in” California.

California imposes a minimum franchise tax of $800 for every corporation (or LLC) “doing business within …this state.”   Revenue and Tax Code § 23101 defined doing business as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”

Beginning in 2011, the California Franchise Tax Board (“FTB”), adopted a policy whereby it would impose the minimum $800 franchise tax for any LLC or corporation outside of California if they were deemed to be “doing business in California.”  The policy was summarized in Publication 689 from the Franchise Tax Board, and used the example of a California resident (Paul), who formed a Nevada LLC owning property in Nevada, would nonetheless be subject to the annual LLC franchise tax because he could (from California) (1) hire and fire the Nevada management company, (2) have telephone conversations from California with the management company, and (3) was ultimately responsible for and oversees the management company from California.   The FTB need not consider the frequency or continuity of the California activities as a single activity tied to California could be sufficient to impose the Franchise Tax. This was considered by many experts to be an aggressive stance to tax out of state corporations and LLCs that had any connection with California.

In July 2014, the Franchise Tax Board doubled down on this policy and issued its Legal Ruling 2014-01 that if an LLC doing business in California was classified as a partnership for tax purposes, ALL of its members were also deemed to be doing business in California even if the individual LLC member never stepped foot into California or performed any transactions in California.  The rationale was that in an LLC taxed as a general partnership, each partner has the right to participate in the management of the partnership business, and it made no difference if the partner/member never actually participated in the management of the business.  In a general partnership, all partnership’s activities are attributable to each partner, and so if the partnership were doing business in California, then all the partners were also doing business in California.  Contrast that with the situation of a limited partner which the California Board of Equalization recognized in a 1996 decision of Amman & Schmid Finanz AG, did not have the right to manage or conduct the business of the limited partnership, and therefore, would not be considered doing business in California merely because of its limited partner interest in a California Limited Partnership.

The Swart Enterprises case was the test case for an out of state entity whose only connection to California was a passive investment in an LLC that happened to be taxed like a partnership.  Legal Ruling 2014-1 made clear that if an LLC doing business in California was owned in part by a corporation that had no independent presence or activities in California, the corporation would still need to register and pay the minimum annual $800 franchise tax fee (Situation 4 in Legal Ruling 2014-1).   Swart Enterprises was an Iowa corporation operating a farm in Kansas who had no physical connection to California except that it invested $50,000 for a .2% interest in Cypress LLC which was a California LLC.  Swart had no involvement in any of Cypress’ operations or management, and the Cypress LLC documents specified that the Cypress LLC was “manager managed,” and that no member could take part in the control, conduct or operation of the business, or bind the LLC or act on its behalf unless it was the “manager.”   Despite the fact that Swart had no independent business activities in California, the FTB concluded that that Swart owed the $800 minimum tax because the Cypress LLC elected to be taxed as a partnership, and all of its members would be considered doing business in California if the LLC itself was doing business in California.  In other words, the FTB applied its rationale in Situation 4 of Legal Ruling 2014-1 to conclude that Swart owed the $800 minimum franchise tax in California.

The Court of Appeals rejected the conclusion of the FTB and, focusing on the language in § 23101 requiring “actively engaging” in a transaction in California and following the rationale in Amman & Schmid, concluded that Swart’s purely passive investment did not meet the standard for doing business in California.  The Court concluded that an LLC electing to be taxed as a partnership does not make each LLC member a “general partner” for purposes of the franchise tax.  Among the other factors considered by the Court in favor of Swart included the following:

  1. Swart had no interest in any of the specific assets of Cypress LLC;
  2. Swart had no right to act, bind, or be liable for the obligations of the LLC, was specifically prohibited from management and control of the LLC which was reserved only for managers, and these limitations were specifically referenced in the LLC’s Articles and/or Operating Agreement;
  3. Cypress LLC was a “manager-managed” LLC, and under California law, a member who is not a manager in a “manager-managed” LLC has no authority to manage or conduct LLC activities; and
  4. There was no evidence that Swart actually conducted any management activities for the LLC.

Because Swart was deemed to be the “quintessential passive investor” akin to a limited partner who never performed any activities in California, the mere fact it was a member of an LLC in California did not result in imposition of California Franchise Taxes.

This case is most relevant for out of state entities seeking to invest in California.  Unfortunately, it does not provide any real assistance for California residents seeking to invest in entities outside of California.  Appellate decisions typically go to great lengths to limit the impact of rulings only to the specific facts of the case, and therefore, it is unknown if the outcome would be different if any of the factors 1-4 listed above were different.   In the opinion of this author reviewing the Court’s analysis in Swart, if the Court were presented with a situation similar to Paul from FTB Publication 689, the Court would likely agree with the Franchise Tax Board that Paul was “actively engaged in transactions” in California, and therefore, owes the minimum $800 Franchise Tax.  Nevertheless, Swart should settle the issue that merely passively investing in an entity in California will not, by itself, constitute “doing business in California.”

Hulk Hogan & Asset Protection Lessons from Bollea v. Clem

December 6, 2016 Asset Protection, Business planning Comments Off on Hulk Hogan & Asset Protection Lessons from Bollea v. Clem

In one of the more highly publicized cases of this year, in March 2016, a Florida jury in the case  Bollea v. Clem  awarded Hulk Hogan $115 Million in compensatory damages and $25M in punitive damages against the owners and operators of the Gawker website.  Gawker was a website founded by Nicholas Denton devoted to media news and gossip.   In the lawsuit, Gawker was accused of violating Hulk Hogan’s privacy by posting private videos of Hogan engaged in sex acts.

Several months after this jury award, both the LLC and corporation which allegedly ran the Gawker website, along with Nicholas Denton filed for bankruptcy.  The Gawker website which reportedly had over 23 million visitors per month in 2015 was permanently shut down in August 2016.   A review of the case along with Gawker’s structure as revealed in the bankruptcy documents illustrates some important asset protection principles to remember.

  1. Keep your Asset and Businesses Separate. In general, our approach to asset protection involves separating your assets from your business so that if your business gets hit with a big lawsuit, your assets are less likely to be at risk because they are held in entities separate from the business.   In this case, the Gawker website was operated by Gawker Media LLC.  Bankruptcy documents show that Gawker Media LLC was in turned owned 100% by Gawker Media Group, Inc.  Nicholas Denton owned approximately 30% of the shares of Gawker Media Group, Inc.   Certainly there could be other practical benefits from this hierarchical parent/subsidiary structure, but one of the risks of having everything owned in this linear structure is the possibility that a significant liability could cause the entire house of cards to fall.     Moreover, bankruptcy documents further show that the operator of the website, Gawker Media, LLC also owned substantial interests in real estate and intellectual property, all of which would be exposed to a significant liability from the website activities.   If you are running a website that posts negative information about rich and famous, does it make sense to also own valuable real estate and other assets in the same entity?  In the case of Gawker Media, LLC,  it also owned other websites and branding which were eventually sold to Univision through the bankruptcy process, but whenever you own significant assets, you should consider whether to segregate these assets into different entities to spread out the risk so that a liability coming from one direction does not infect the entire pool.
  1. Entities are not a License to Engage in Misconduct. One of the main reasons for using an entity like a corporation or LLC is to take advantage of the “corporate veil” which generally protects the owners from being personally responsible for debts incurred by the entity.  However, the corporate veil is not absolute.   In the Gawker case, despite the existence of a multi-entity structure, the jury specifically found that Nicholas Denton personally participated in the posting of the explicit videos that resulted in the lawsuit, in addition to allegations that he personally edited the video that ultimately appeared on the site, which contributed to a finding of personal liability.   Courts will generally disregard or “pierce the corporate veil” if the owners are using the entity to perpetrate fraud or engage in other wrongdoing, and so don’t think that the corporate veil will be there to protect you if you are committing fraud or other intentional misconduct.
  1. There is no 100% Guaranteed Asset Protection Strategy, but the Goal Should be a Multiple Barrier Approach.  As further discussed in Mark Kohler’s book “Lawyers are Liars,” there is no 100% guaranteed approach to asset protection.  Instead, the goals should be to implement as many barriers as you are willing to utilize depending on the cost, complexity and degree of protection afforded by the strategy.  Whether it is having the right insurance, ensuring your contracts are sound, stripping your assets of equity available to creditors, or multiple LLCs, the goal is to implement as many strategies as you can to make it as hard as possible for a creditor who would pursue you.

The Gawker case is a good illustration of the possibility that any asset protection strategy could be toppled if you have a motivated, resourceful litigant.   It was no secret that Hulk Hogan’s lawsuit is and was assisted by financing from billionaire venture capitalist Peter Thiel, who was also a previous target of Gawker’s posts, and was therefore motivated to financially assist Hulk Hogan and other litigants suing Gawker.  Denton has reportedly admitted that Thiel’s campaign against Gawker Media made the Gawker.com website too risky for Univision to purchase, and as a result, the website that had previously drawn the ire of Peter Thiel had to be shut down.

The outcome of litigation is often impacted by the financial resources of the parties, and having a well-designed multiple barrier asset protection strategy could make other adversaries (Peter Thiel excepted) think twice about how far they are willing to go.

The Gawker case, currently on appeal and in bankruptcy, is still pending and given the unpredictability of litigation, the ultimate outcome has yet to be decided.   Nevertheless, Denton has reportedly admitted that, even if the judgment is reversed on appeal, “Peter Thiel has already achieved many of his objectives.”     Therefore, the case is just another reminder that, regardless of whether you are an entrepreneur/executive worth hundreds of millions of dollars, or simply have a 401K and a rental, we all need to be cognizant of the potential legal consequences of our actions, and have a concrete strategy for protecting the fruits of our labor if and when an unexpected liability arises.

How to Negotiate a Solid Contract

November 15, 2016 Asset Protection, Business planning, Law, Small Business Comments Off on How to Negotiate a Solid Contract

Lets face it, we all have to deal with contracts, many of us on a daily basis, and it is the law of contracts which forms the very foundation for our civil and commercial society.  The main purpose of a contract is to memorialize and confirm the intentions and future performance of the parties to the contract, and our society would be fraught with chaos were it not for laws that bind parties to their contractual agreements.

In our practice, we see a lot of bad deals and lost investments that result from the failure to have the deal memorialized in a solid written agreement, or that the agreement that was signed did not have sufficient provisions to protect the party’s interests.  While it is true that oral agreements can be binding, the problem is how will you prove in court what the terms of the oral agreement were if the other side fails to perform?  If and when a dispute does arise from an oral agreement, be assured that the opposing party will likely have a different version of what was said, or at least their recollection will be foggy.  For that reason, we will always recommend that your deal or understanding should be confirmed in a comprehensive, written agreement.

While no article can address all of the issues that could arise in a given transaction, and certain types of transactions will call for varying type of contractual provisions, here are a few tips to help ensure that your contracts will adequately protect your interests in any given transaction.

  1. Make sure the contract addresses all of your expectations for the transaction. The whole reason for having contracts is to confirm who will do what, when, where, and how.   We have seen our share of overly simplistic agreements that the parties “thought” were adequate, but failed to contain sufficient specificity as to all of the expectations of the parties.  For example, I had a case where the parties signed a written agreement that they would start a business and be 50-50 owners.   Nothing else was mentioned regarding who would do what, who was responsible for what, and what would happen to the business if they split or disagreed.  The subsequent result was years of litigation and tens of thousands of dollars in legal fees even though technically they did have a written contract.   A contract should be very specific and detailed as to each and every expectation you have of the other side.  Anything you expect the other side to do, not do, or any rights, protections or contingencies you want to preserve should be confirmed in detail in the contract.   Don’t assume that if the other side told you something verbally, in an email or text, that it necessary be enforced.  If a particular issue, term, or detail has any importance to you, put it in the final written agreement.
  2. Make sure terms are objectively clear and comprehensive.  Terms in a contract should be objectively clear and understandable.  I often see agreements that contain references that would only be understood by those in the industry, or worse, only by those individuals who were parties to the agreement.  Keep in mind that if the other party defaults and you need to have the agreement enforced, it will likely be a lawyer, judge, or jury that decides your case.  Therefore, the terms in your contract should be written as if it were to be interpreted by someone who has no experience or knowledge with your particular transaction, since realistically they will likely be the ones to interpret or enforce the agreement in court.    Many contracts written by attorneys will begin with a summary of the facts and circumstances giving rise to the agreement itself which helps provide context to third parties for the provisions that follow.
  3. Make sure you properly address foreseeable contingencies or breakdowns. Similar to No. 1, many laypersons inexperienced in negotiating agreements frequently fail to consider all the possible ways their agreement could fail.  One of the most important aspects of a solid contract is to fully address all the “what ifs” in a given transaction.  Indeed one of the best ways to protect your rights in a transaction is to fully address each and every way the transaction could go wrong (i.e. events of breach or default), and what will be the rights of the parties if or when those events occur (i.e. remedies or enforcement upon default).  Some may feel they are disrespecting or offending the other side by bringing up these concerns, but the best time to address these types of issues is BEFORE they occur.    Similarly, many inexperienced with contracts or the process that is involved to enforce a contract in court fail to even consider the possibility that a dispute could arise, and that they may end up having to pay attorneys’ and other fees to enforce their rights.  The general rule in America is that unless you specifically provide for attorney’s fees in the contract, each party will pay their own attorney’s fees if court intervention becomes necessary.  Therefore, I generally recommend dispute resolution provisions and attorney’s fees clauses in every contract.

These tips are not intended to be a substitute for consulting with your attorney or other professionals who have experience in your particular type of transactions, and can advise you on terms and issues that could likely arise that should be included in the contract.   Given the proliferation of contracts in today’s society, it would be unrealistic to expect that you would apply this level of scrutiny to every contract you see.  However, if you have important rights at stake in a given transaction, these tips along with consulting your attorney will help ensure that, for THIS contract, your interests are adequately protected in the deal.

What are My Options if I Disagree with the IRS?

October 25, 2016 Business planning, Law, Small Business, Tax Planning Comments Off on What are My Options if I Disagree with the IRS?

Many view the IRS as an agency shrouded in mystery and the IRS is generally perceived as the omnipotent “big brother” that we should all fear. It is true that the IRS does have the ability to unilaterally garnish wages or levy on assets, whereas almost every other creditor would only have these rights only after filing a lawsuit and successfully getting a judgment from the courts.

However, that does not mean you do not have rights if you disagree with the IRS, and the IRS does have administrative procedures available when a taxpayer disagrees with an IRS determination.

In general, disputes with the IRS from individual taxpayers will usually fall into several categories which include:

  1. Deficiency determinations: Taxpayer disagrees with a determination of income or certain other taxes or penalties assessed by the IRS after an examination (audit). Typically, when the IRS assesses additional taxes after an examination, they will send a letter stating what changes were made which could be on a Letter 915 or “30 day letter.” If there was no examination but the IRS believes additional taxes are due, they may send a “balance due” notice instead. Typically, if you disagree with the determination by the IRS, you should file a “Protest” with the office issuing the letter within thirty (30) days. The notice you receive from the IRS usually includes a summary explanation of your rights or options if you disagree, and so read those notices carefully, and especially any time limitations stated in the letter.   For additional information on preparing Protests, see IRS Publication 5.
  2. Collection Actions: Taxpayer disagrees with actions the IRS intends to take to collect on taxes owed, or is planning to deny or revoke a proposal for tax resolution such as an installment agreement or offer in compromise. The issue in these types of cases is not whether the tax liability is valid or not, but whether the proposed collection action by the IRS is reasonable and/or whether the IRS followed the required procedures. For example, the IRS filed a federal tax lien, or purports to seize assets from the Taxpayer without complying with the notice requirements in 26 U.S.C. §6331(d). In these circumstances, you may have the right to a Collection Due Process Hearing (CDP) with the Office of Appeals or an appeal under the Collection Appeals Program (CAP).   There are differences in which types of actions can be appealed as a CDP or as a CAP, and there is no right to judicial review of CAP decisions, and so you must familiarize yourself with the rules for these procedures which you can find under IRS Publication 1660 and in the Internal Revenue Manual Section 5.1.9. This should also be done within 30 days of the date of the notice or according to the date stated in the notice.
  3. Disallowing Refund Claims: The IRS disallows all or part of a refund claim filed by the taxpayer. The deadlines for filing Refund Claims is generally 3 years from the return due date or 2 years from the date the tax was paid.   IRS Form 843 is generally used for this purpose.   If you disagree with the determination of the IRS with respect to a refund claim, the procedures for disputing the IRS determination and requesting an Appeals conference can be similar to deficiency procedures and more information can be found in IRS Publication 556.
  4. Penalty Abatement: If you disagree with a penalty proposed by the IRS, it is important that you respond timely to the deadline stated in your notice and usually to the office that proposed the penalty. You may be able to obtain relief under the provisions for “First Time Penalty Abatement, ”the “Reasonable Cause Exception,” or other basis for relief.  Details on the factors for meeting these exceptions can be found in the Internal Revenue Manual from the IRS.

In any written dispute to the IRS, you should always include copies of all documents and any legal authorities supporting your dispute. This may include documents previously sent or received from the IRS including, the legal notice you received, IRS tax transcripts, receipts, affidavits or sworn statements from third parties in support of your dispute, and send your dispute certified mail with return receipt.

This is where an attorney who is experienced in such tax issues who can research your specific issue and present your legal arguments in an organized and logical manner setting forth the facts, the law, and legal analysis applying the facts to the law can be helpful. Above all, always make sure the IRS has a current address for you and do not ignore IRS Notices as failure to take advantage of these dispute procedures will effectively waive your rights.

If you are not satisfied with the administrative remedies with the IRS, you may have an option to litigate the matter in tax court. The procedures and rules are similar to litigation in court. For more information on your rights and options with the IRS, refer to the Taxpayer’s Bill of Rights.

How to Properly Use Credit Reports to Screen Tenants

September 27, 2016 Asset Protection, Litigation, Real Estate, Small Business Comments Off on How to Properly Use Credit Reports to Screen Tenants

Experienced landlords and property managers understand the importance of carefully screening prospective tenants and anyone who has had to go through the process of evicting a tenant knows how cumbersome the eviction process could be.  The ability to screen tenants based on their credit report and/or score is an important tool for landlords to better understand the character of the individual or individuals you intend to rent to, and to assist in identifying potential risks of doing so.

Moreover, information from credit reports can be used to verify or confirm information provided by the prospective tenant in their rental application.  For these reasons, I recommend running credit checks on all prospective tenants, but keep in mind that there are rules imposed by Federal (and possibly state) law that must be followed when a decision is being made based on credit history, which includes the following requirements under federal law:

  1. Landlord must obtain the prospective tenants written consent to obtain a credit report or credit score.
  2. If the Landlord intends to take adverse action based in any part on information in a prospective tenant’s credit report or credit score, the landlord should provide a notice of adverse action to the tenant in writing. Examples of potential adverse actions that would require an adverse action notice if based on credit history or score include:
    • Requiring a larger security deposit;
    • Requiring a co-signer or guarantor;
    • Requiring advance payment of rent; or
    • Rejecting a prospective tenant.

If the adverse action is not based in any way on information on a credit report or credit score, then no adverse action notice is required.

  1. An Adverse Action Notice, under federal law, must contain the following information:
    • A statement that the landlord’s decision was based in whole or in part on information contained in a consumer credit report;
    • The name, address and telephone number of the consumer credit reporting agency which furnished the report to the landlord;
    • A statement that the prospective tenant has a right to obtain, within sixty days, a free copy of the applicant’s report from the credit reporting agency identified in the notice; and
    • A statement that the applicant has the right to dispute the accuracy or completeness of any information contained in the report from the credit agency.
  1. If the adverse action is based on a credit score, the notice must contain the following:
    • The numerical credit score used to make the decision;
    • The range of possible scores used by the ratings agency;
    • Up to four key factors that adversely affected the credit score;
    • The date when the credit score was created; and
    • The name of the person or entity that created or provided the credit score.

States may have additional or more stringent requirements than the above.   For example, in California, if a prospective tenant paid a “application screening fee,” they are entitled to a copy of the credit report upon request.

Under federal law, a landlord that willfully fails to comply with these requirements could be liable for actual damages sustained by the prospective tenant, or statutory damages between $100 to $1000 in addition to possible punitive damages, legal costs and attorneys’ fees (15 U.S.C. § 1681n).  Moreover, federal law also gives the Federal Trade Commission and/or state attorney general authority to enforce compliance with the law.  Additional information about landlords using credit reports can be obtained from the Federal Trade Commission website at www. ftc.gov.

Having a uniform set of guidelines, standards and procedures during the tenant screening process, and properly using credit reports and scores as a tool to evaluate prospective tenants are important steps to choosing the most qualified and stable tenant for your rental.

The ‘ABCs’ of Buy-Sell Agreements

August 30, 2016 Asset Protection, Business planning, Law, Small Business Comments Off on The ‘ABCs’ of Buy-Sell Agreements

Most of us know that in business it is crucial to choose your partners carefully as the success of your business (and perhaps your livelihood) depends on it. We also encourage our business owners to have frank discussions with their partners regarding the details of the partnership and all the “what ifs” that could happen, and to confirm these agreements in a written partnership agreement at the outset of the partnership.

In addition, to ensure stability and certainty in the partnership, we usually want the partners we select to abide by certain limitations on the partners ability to sell or dispose of the interest, such as requiring partners to first following agreed upon procedures, or a require “right of first refusal” in favor of the existing partners.

A frequently overlooked detail, especially for long term partnerships, is what would happen if a life changing event happened to the partner? For example, if your partner experiences a sudden death, does that mean you now have new partners that you never agreed upon (such as the spouse or children of your deceased partner)? In most cases, if an existing partner passes away without any written plan in place, the deceased partner’s interest would pass to his/her heirs (e.g. the departing partner’s spouse or children).

The departing partner’s surviving spouse or heirs will usually have no experience or interest in operating the partnership and so planning is necessary to ensure that a departing partner’s family is adequately compensated without unduly interfering with the operations of the partnership.

Without any concrete written succession plan, you may find that your new partner or the outcome resulting from a departing partner may be determined by a civil, probate or family law court which could be expensive, and even result in the dissolution of the partnership. Most partners in a business or investment want the ability to choose who their partners will be, and would not want such unpredictability, delay, and risk in the partnership.

A buy sell agreement is an agreement among partners (or shareholders) which specifies what happens to the partner’s interest in the event of a life changing event. In most cases, these agreements cover the “four D’s” being death, disability, divorce, or departure. However, it can cover any potential situation where a partner may depart including retirement, resignation, expulsion, or sale to a third party.

Occasionally people attempt to solve the succession uncertainty by setting forth provisions in their estate plan for handling or distributing their interests in a partnership. This is not recommended because (1) including these provisions in individual estate plans do not require the input of the other partners, and therefore, one of the primary goals of promoting harmony and a mutual agreement among partners is lacking, and (2) most estate plans can be amended at any time prior to death, thereby frustrating the need of the partners for absolute certainty regarding the transition of partnership interests.

A typical buy sell agreement will contain provisions whereby if one partner experiences a death, disability, divorce, or departure from the partnership, the other partners will have an automatic right to purchase their interest at agreed upon terms and price.   Oftentimes, in order to avoid liquidity issues, partners can get life and/or disability insurance on each of the partners that would fund the buyout of the departing partner’s interest. Alternatively, a buy sell agreement could specify payment of the departing partner’s interest in installments over time at an agreed upon terms, but usually that is not preferred in the case of a death or disability where the family of the departing partner may be in need of an immediate lump sum.

Since the value of the business can change over time, it is recommended the buy sell agreement set forth procedures for determining the value of the business on an ongoing basis for purposes of an unexpected buyout. Agreed upon appraisers may be used for this purpose, but it can be costly and time consuming in actual application. Instead, we generally recommend that the partners meet periodically (e.g. annually) to review the agreement and update the company valuation. This helps the partners to achieve the primary goals of a buy sell agreement, to promote certainty and the orderly transition of a departing partner’s interest, while making sure that the departing partner’s family and/or next of kin are adequately compensated.

Similar to an estate plan or marital property agreement, a buy sell agreement can be as flexible and specific as the partners wish. Many partnership agreements or operating agreements include provision governing transfers of partner’s interests, but make sure that those provisions are suitable for your situation and are comprehensive enough to apply to each of the different scenarios in which the departure of a partner could cause instability, uncertainty, or interfere with the management or business of the partnership.

A well conceived buy sell agreement should assure all the partners so that they know exactly who their partners would be in the event a triggering event, but also assure the partner’s next of kin that they will be adequately compensated for their interest in the event of a tragedy. If these provisions don’t exist in your current documents, a separate buy sell agreement that supersedes contrary provisions in your existing agreements may be recommended so that the partnership operations will not be adversely affected by a life changing event from one of the partners.

How to Reduce Your Liability as a Landlord

August 9, 2016 Asset Protection, Business planning, Law, Litigation, Real Estate Comments Off on How to Reduce Your Liability as a Landlord

Premises liability is an area of the law that addresses the responsibility of land owners to individuals who come on the land.  This is basically the liability a Landlord faces when owning property.

Perhaps the most common form of premises liability which most people hear of is the “slip and fall,” but it could also include liability against property owners for any injury on the property, even those from mass shootings such as the shooting in Virginia Tech in 2007 that resulted in an $11 million settlement.

For most of us, potential liability for personal injuries is the greatest and most likely source of liability we commonly face, and this is especially true for landlords owning rentals.  Therefore, taking steps to reduce your chances of premises liability for properties that you own should be a part of everyone’s asset protection plan.

The specific standards for evaluating a premises liability case is determined by the laws of the state where the property is located.  However, the factors courts most often look towards is the foreseeability of the harm balanced by the measures that the landowner could have taken to prevent the harm.   In general, the more likely it is that an injury could occur on the property, the more steps the landowner should take to mitigate that risk.   Therefore, the question in many of these cases is whether the landlord had any reason to be aware of a particular risk that resulted in an injury.

For example, in Virginia Tech case, there was evidence the school had some knowledge of the perpetrator’s disturbing behavior prior to the shooting, that they knew there was a gunman was on campus before the attack occurred, and that school officials had locked down their own building on campus, but failed to issue an all-campus notification for more than two hours thereafter.  By contrast, in the 2012 Aurora Colorado shooting at the Cinemark movie theater, the plaintiffs alleged that the movie theater failed to employ security officers and place alarms on the doors, but the Court dismissed the case holding that the movie theater could not have foreseen the premeditated and intentional actions of the shooter.

In general, if the landlord is aware that an unreasonable risk of harm exists, appropriate steps should be taken to mitigate that risk.  Of course, insurance is a key component for risk management but here are some additional tips that could reduce the chances for premises liability:

  1. Landlords should periodically inspect the property and assess what if any dangers pose a threat to persons on the property, document those findings, and take appropriate action to remedy those risks.  Courts will generally balance the likelihood or severity of the risk with the burden on the landlord to take corrective measures, and weigh those factors based on the totality of circumstances.    If the risk was highly probable and/or could result in severe consequences, those factors could tip the balance in favor of liability against the landlord.  On the other hand, if the cost for corrective measures is excessively high, that could tip the balance in the landlord’s favor.
  2. Be proactive in seeking and requiring tenants to report potentially dangerous conditions, and do not ignore complaints from tenants regarding conditions on the property. Once you have been informed of an issue, you are on “notice” which may give rise to a duty to take corrective action to protect the tenants from further harm.  Don’t let ticking bombs fester.
  3. Familiarize yourself with laws or customs that affect the condition of the property such as lead based paint, asbestos, mold, smoke or CO detectors, etc., as failure to comply with these established laws or standards could make the landlord an easy target.   Make sure all the systems on the property are updated and conform to code requirements.
  4. If you become aware of incidents that cause injury or damage, you should be proactive in taking steps to prevent such incidents in the future.  This is known as the “prior similar incidents” rule.  For example, if you discover that there has been a rash of burglaries in the area, you may have a responsibility to take reasonable precautions such as installing locks, screen doors, or cameras.
  5. Require appropriate insurance for potentially dangerous activities or conditions. This could apply to tenants who want, for example, to keep pets, above ground pools, trampolines, playgrounds, etc.   Of course, knowing your tenants and regulating any illegal or risky activities they may engage in is a must.  This is where a solid lease agreement could be your strongest ally.

Keep in mind that, in general, you would not be liable for an injury that you had no reason to know would occur, and there must be some degree of fault that must be proven for the landlord to be liable.   Incidents do happen even for the most conscientious of landlords, but being proactive and taking appropriate action as soon as you become aware of potential risks will go a long way in keeping you out of court.

Tips on Purchasing Homeowner’s Insurance

June 27, 2016 Asset Protection, Real Estate Comments Off on Tips on Purchasing Homeowner’s Insurance

People who have read Mark Kohler’s Lawyers are Liars know that our philosophy with respect to asset protection is the “multiple barrier approach” to put as many barriers as you can between you and someone who would sue you.  For owners of real estate, one of primary asset protection barriers is your homeowner’s insurance policy.

No insurance policy will cover all risks under any circumstance, and so it is important for owners of real estate to request, understand and procure the right policy for their situation.   Unfortunately, getting the right policy tailored your situation may not as easy as just calling your insurance agent and getting whatever they recommend, but requires a careful understanding and analysis of risks that can be protected by insurance, but most importantly making sure your policy actually covers those risks.  Your insurance agent should assist you in deciding on appropriate coverage, but remember that you, not the agent, knows this property the best and so it is your job to communicate the risks and perils on the property to the agent.   Some guidelines that can help maximize coverage include the following:

  1. Make sure you are Dealing with a Licensed Insurance Company or Agent. Both Insurance Companies and Agents are generally licensed by the state and their information can be found online at the insurance department for the state.   Most state insurance departments have resources online to assist you in purchasing the right insurance, and make sure that the person or company you are dealing with specializes in that specific area of insurance
  1. Understand What Type of Risks and Coverage You Need. Every property is different and may entail different risks.  A typical homeowner’s policy will generally classify coverage for (1) Dwellings or other structures, (2) Damage to Personal Property, and (3) Liability coverage.   Knowing what you are specifically looking for in the form of coverage BEFORE you shop for insurance will help ensure that the actual coverage you buy matches your expectation.   For example, for Dwellings, you want to know, from as reliable a source as possible, the estimated cost to repair or replace the structure with like kind and materials.  Make sure you understand terms used by your insurance company such as the difference between “Actual Cash Value” versus “Replacement Cost” or “Guaranteed Replacement Cost,” with the understanding that insurance companies may define these differently.  For Personal Property, you want to make sure that important items of personal property are covered, how much they are actually worth, and create an inventory or snapshot of your personal property.  For Liability Coverage, you need to be very precise as to what your expectations in terms of what are the most horrible things that could cause significant injuries on the property what the appropriate amount of coverage would be.    Create a list of all the risks and perils that are important for the property so that you can address these with the insurance agent.   Also understand or ask how the deductible amount or other discounts such as alarms or other safety features will impact the premiums.  Look online for tips from state insurance departments websites such as insurance.ca.gov, or consumer oriented websites like www.insuranceconsumers.com   for issues and topics that can help you understand what risks and perils you should be aware.
  1. Keep Detailed Notes of Your Communications with Insurance Representatives and Confirm, Confirm, Confirm. Although the nature of the relationship between the insurance agent and insured could vary depending on laws of the state and whether they are working for the insurance company or an insurance “broker,” you want to be very clear with your insurance representative as to what coverage is important to you, and any specific requests or expectations of coverage should be made or confirmed in writing to the insurance representative.  Ask and confirm with the agent in writing any specific exclusions from the policy.  In other words, if the agent makes a representation of coverage to you that is important, send a confirmation of that representation in writing (e.g. email, fax, etc.) so that a record exists confirming your expectations.  Better yet, ask the agent for a copy of the policy beforehand.  Most agents won’t volunteer this but any agent that has been doing this for any amount of time should have this handy.   Keep copies of everything, including advertisements and marketing as that information could be relevant in a coverage dispute.   If you’re not sure about the type or amount of coverage you need, ask the insurance agent for their opinion and confirm this opinion in writing.  An insurance agent who makes a representation to you concerning coverage could be bound by that representation even if it doesn’t appear in the policy so it is important to document all communications with the agent to hold them accountable for what they say.
  1. Read Your Policy. I’m not talking about the 1-2 page “Declarations Page” that is only designed to show proof of coverage, but 20-30 page insurance “Binder” or “Policy” that contains the details of the actual coverage and exclusions.  No one really enjoys reading insurance policies and don’t be surprised or embarrassed if you don’t understand what you are reading.  It is a well known fact that insurance companies intentionally make their policy language difficult so as to create ambiguities as to their coverage responsibility.    Nevertheless, don’t let the first time you read the policy to be when you need to file claim.   Get ahead of it beforehand which will give you the perfect opportunity to ask questions and to clarify coverage with the insurance agent before a claim arises (See #3 above).   Be assured that if a claim is ever made, the adjusters and defense attorneys will be combing through the policy language with a fine toothed comb to try and evade responsibility.   If you do ask questions about the policy language, don’t be surprised if the insurance agent initially doesn’t understand what the policy says either as that is quite often the case, but make sure you get an answer to your questions in writing.
  1. Coverage for an LLC. For those of you who own rental property in an LLC, check with your insurance agent as to what they would require to add the LLC as an additional insured.  Some companies will simply add the LLC as an additional insured in addition to the owners.  If your insurance agent tries to sell you a different policy such as a commercial policy, consider getting a second opinion, and again, do not rely merely on the verbal assurances of your agent, but confirm it in writing.   If you have a mortgage, be aware that some lenders may periodically ask for proof of coverage, and so there are possible due on sale implications  for adding an LLC as additional insured.

Getting the right insurance coverage should be one of your front line defenses in your overall asset protection strategy.  Doing your homework beforehand, exercising proper due diligence during the process, and making sure there is a paper trail of your dealings with the insurance company will help ensure that there will be coverage in the event of a loss.

5 Important Reasons to Avoid Probate

May 31, 2016 Estate Planning, Law Comments Off on 5 Important Reasons to Avoid Probate

Anyone with a basic understanding of estate planning knows that one of the primary benefits of having a living trust is to avoid probate. Nevertheless, unless you are an attorney or have been personally involved in a probate proceeding in the past, few people have an understanding of what probate really is and why it is not recommended for most estates.

Probate is a court supervised process for administering and (hopefully) distributing a person’s estate after their death. When a person dies leaving property (especially real estate) in their name, the only way to transfer ownership from the deceased owner’s name to the name of their heirs is for a court to order the transfer through the probate process. In other words, since a deceased owner of property is no longer around to execute deeds, only a court can effectuate the transfer of real property after the owner dies, and probate is the legal process by which this would occur.

Many people have the misconception that having a will alone avoids the probate process. A will merely informs the world where you want your property to go, but probate is still needed to carry out the wishes expressed in the will (since even with a will, property stays in the name of decedent). Only a trust can avoid probate because once you have a trust, all of your assets are then transferred to the trust during your lifetime thereby avoiding the need for a court to do so.

There are plenty of stories of heirs for high profile individuals who have had to suffer through the probate process, from Jimi Hendrix to Heath Ledger, and now most recently Prince. For some estates, probate might be a good alternative, but consider these five reasons why you would want to avoid having your estate pass through probate:

  1. Probate is a public proceeding. As with any court proceeding, the court hearings and documents in probate are completely open to the public. For example, anyone who is curious about James Gandolfini’s (aka Tony Soprano) will can easily find this online, which contains detailed information on his finances, property, and his family members. In fact, probate courts typically require filing an inventory and accounting of the entire estate with the court. Anyone can simply visit the probate court and view or copy probate records, and some courts even make this information available online. If you have any interest in keeping your finances, property or family members secret upon your death, you want to avoid the probate process.
  1. The personal representative has to formally notify all your creditors of your death. One of the primary purposes of probate is to afford creditors the opportunity to have their debts with the decedent settled through the probate process. In fact, one of the first steps in the probate process is to specifically notify all known or reasonably ascertainable creditors that decedent has died, and therefore, if they want anything, they need to act now. Once a creditor has been notified, they merely need to file a claim with the probate court within the time allowed and will be entitled to payment from the probate estate (assuming it is not contested and there are assets are available to pay).
  1. Probate is a court supervised process. In many cases in probate, court approval is required at every step in the process, from appointing the initial personal representative for the estate, proving the will (if any), confirming dispositions of property, approving the inventory and accounting of the estate, settling disputes between creditors or beneficiaries of the estate, and final distributions of the estate. The process is fraught with rules and procedures that must be followed in order to obtain court approval. For example, selling real estate through the probate process may entail securing formal appraisals, offering the property for sale through a court bidding process, and ultimately obtaining court approval for the final sale. By contrast, since a trust is usually administered without any involvement of a court, the makers of the trust can be very flexible in how their property will be distributed without the need for a lot of formalities that a court would require.
  1. Probate involves time and delay in administering and distributing the estate. Given all the court procedures and requirements of administering a probate estate, even the most simple and uncontested probate proceedings can take many months to a year. If there are claims, disputes, or other complications in the proceedings, the process can take much longer. As an example, it was reported that probate estate for country singer John Denver lasted over six (6) years, meaning that his heirs had to experience years of delay before they were able to receive what was their rightful inheritance. As courts continue to report reduced funding and large caseloads, increasing delays will likely continue to be part of the probate process.
  1. Probate usually involve significant attorney’s fees. Although parties certainly have the option to represent themselves in probate, due to all the procedural requirements in probate, which is usually quite different from the procedures in a typical lawsuit, attorneys are usually recommended in all but the most simple of probate estates. Attorney’s fees are usually paid from the estate based on a percentage of the value of the estate. For example, in California, the fees to administer an estate with a single property valued at $300,000 would be approximately $9,000. If there are complications in the estate administration that requires extraordinary services, the fees would be even more. Compare this with our typical estate planning services whereby we can usually set up the entire estate plan for around $1,500 and avoid these unnecessary attorneys’ fees for a probate.

This is not to say that probate is undesirable in every case. Indeed, since probate is a court process, it might be a good idea in some cases especially if the estate wishes to have the finality that a court order provides.   For example, if an estate wishes to reduce the timeline for which creditors can pursue the estate, a probate may be advantageous since creditors have only a limited time window to file their claims. If heirs having an interest in the estate fear the possibility of ongoing disputes over assets in the estate, a probate could be the ideal forum for having those disputes decided once and for all by a binding court decision. However, in most cases, the time, expense, complexity, delay and emotions from having to deal with attorneys and courts is not the type of legacy that we would like to impose on our family members who are still mourning the loss of a loved one, and one just needs to google all the celebrity estates that had to go through probate as testament to why probate court is not where you would want your loved ones to have to go after you die.