Articles Posted in Corporations

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In fiercely competitive Silicon Valley, businesses of all sizes must be on guard to prevent unfair competition. Unfair competition consists of business piracy, theft of trade secrets, and other dishonest or fraudulent acts in the course of business. As a business litigation lawyer in San Jose, I have seen companies initiate lawsuits against offending parties when unfair competition occurs. This blog focuses on unfair competition by competitors.

While corporate espionage and spying are known to occur, most businesses encounter unfair competition through less clandestine means, and from more familiar sources, such as prior business owners and trusted partners. For example, unfair competition can occur if the owner of a Thai restaurant sells his or her business with a non-compete clause, but then sets up a new competing restaurant across the street.

The key to successfully winning a lawsuit in each of these examples begins with a well-drafted non-compete agreement (or a “covenant not to compete”). So businesses should consult with a business lawyer to help them draft such an agreement. California generally disfavors agreements not to compete, and views restraints on engaging in a lawful profession, trade, or business as harmful to the state’s economy and the personal freedoms of its citizens. However, some agreements not to compete are recognized as valid under California law, including those relating to the sale of a business and the withdrawal of a partner.

In these instances, the key factors used to determine the validity of the non-compete agreement are its geography and duration. A business purchase agreement may include a clause stating that the seller agrees to refrain from operating a similar business within the specific geographic area that the purchased business operates. The duration of this agreement is usually limited to a number of years. The non-compete agreement protects the value of the purchased business – and serves to prevent the seller from selling his or her business today and then setting up shop next door tomorrow!

Similar rules apply to agreements not to compete as they relate to partnerships, and the courts have enforced agreements among partners in various professions, including physicians, accountants, and attorneys. In the case of professionals, non-compete agreements are typically enforced by requiring the competing partner to compensate his or her former partners to some extent at least for the business taken from them.

One of the benefits of a well-drafted non-compete agreement is that, if it is abided by the parties, it can prevent potentially costly litigation. If, however, litigation becomes necessary to enforce a non-compete agreement, the results of winning the subsequent unfair competition lawsuit can be twofold. First, the plaintiff may receive restitution for the money lost due to the defendant’s unfair competition activities, and may also be awarded any of the defendant’s ill-gotten gains. Second, if the plaintiff provides evidence showing a probability that the defendant will commit future violations of the unfair competition laws, an injunction may be issued ordering the defendant to curtail its unfair activities.

The injunction remedy stands in recognition of the fact that sometimes a defendant’s unlawful conduct will continually harm the plaintiff unless the defendant is stopped. Rather than require the plaintiff to file lawsuit after lawsuit in an exhausting effort to seek money damages, the injunction empowers the plaintiff to put a stop to the defendant’s unlawful activities once and for all.

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As a merger and acquisition lawyer in Silicon Valley, I have been involved in numerous business transactions, from small startups transferring their technologies after getting acquired by other companies, to medium-sized and larger technology and pharmaceutical companies going public. With Facebook’s impending IPO, many companies in San Jose, Sunnyvale, Santa Clara and Mountain View are expecting another technology boom. A company hoping to take advantage of the imminent dot-com boom and sell its business should make sure its books are in order and hire a good M&A attorney to prepare an acquisition agreement.

As discussed in my last blog, a seller will often make a number of commitments to a buyer concerning the seller’s business. These commitments, known as representations and warranties, allocate between the buyer and seller many of the risks existing in the seller’s business.

One of the most important documents accompanying the representations and warranties is a schedule that describes certain items requested to be disclosed, and any exceptions to the content of the representations and warranties. This document, which goes by “Schedule of Exceptions” or “Disclosure Schedule,” is really a description of the main documents and key agreements of the seller, and disclosures of material facts concerning the buyer and its operations. It can often take as much time to prepare and negotiate as the acquisition agreement itself. There are a number of things the seller can do to help expedite the preparation of this document.

First, keep good corporate records. As I discussed in my blog on due diligence, organizing the seller’s major documents, and making sure they are readily available, will considerably reduce the time to close the transaction.

Second, appoint someone who has intimate knowledge of the seller and its operations to assist in gathering requested documentation and answer the inevitable questions. Typically, the company’s chief financial officer or controller will fill this role.

Third, get all of the documents to the company’s attorney as soon as possible. The lawyers will need to review the documents and decide what types of schedules and disclosures will be required. This is a very time consuming process.

Fourth, discuss early on any areas where the company thinks a buyer might be concerned. This is not a time to sweep difficult issues under the rug, but a time to get them out in the open. There is nothing worse than being blind-sided at the last minute with the proverbial skeleton in the closet. Worse, failing to disclose difficult issues known to management can lead to a fraud claim, a claim for which the seller’s liability is never limited. Areas that raise concerns include any transactions between the seller and any of its insiders, litigation and threats of litigation, and accounting irregularities.

Fifth, start preparing the Disclosure Schedule as soon as possible. Attorneys that are experienced in acquisition transactions are aware of the likely representations that will be requested, and can start organizing and preparing the substance of the Disclosure Schedule even before the acquisition agreement is distributed. Delivering a completed Disclosure Schedule to buyer’s counsel sooner rather than later will surface any issues so they can be resolved in a timely manner.

Sixth, review the Disclosure Schedule with your attorney to determine if any issues exist that will delay closing. There are two major areas that need to be reviewed. The first is the approval that is required for the transaction to proceed. Almost always, this will involve approval by the board of directors and the shareholders of the Company. It may require preparation and delivery of a separate disclosure document to the shareholders to assist them in determining whether to approve the transaction. The second is the existence of any material agreements, desired by the buyer to operate the business, that require approval of the other party in order to close the transaction.

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Has your business been misclassifying workers as independent contractors? If so, you should pay special attention to a recent IRS announcement of its new program giving a break to employers who voluntarily correct such misclassifications. With Silicon Valley being a technology hub, there are thousands of computer programmers and engineers working as independent contractors in San Jose, Sunnyvale, and Mountain View. High-tech companies and start-ups that employ these individuals should carefully review their HR files to see if they have misclassified any employee. If a company discovers that it has wrongly classified an employee, it should then evaluate the IRS program to determine if the company should participate in the program.

In an earlier blog, I wrote about the importance of companies classifying their workers correctly in order to avoid substantial penalties and taxes. If your company may have misclassified workers, the new IRS program will let you voluntarily correct your errors and just pay a low penalty equal to 1.068% of compensation paid to those workers last year. IRS Announcement 2011-64 provides the details. To qualify for the IRS program, your company must not be under audit, and must have consistently treated the workers as contractors for the past three years. No reasonable basis for the previous misclassification is necessary. Going forward, you must treat the workers correctly as employees. The minimal penalty may be a good idea if you consider that the Labor Department and the IRS are beginning to share leads on misclassified workers. [Kiplinger Tax Letter September 30, 2011, Vol. 86, No. 20.]

However, there are some potential downsides in addition to having to pay the penalty. So, think twice before you come clean with the IRS. First, you will lose IRS Safe Harbor protection on those workers and they will always be treated as employees going forward. Second, as part of the deal, the IRS requires you to agree to extend the statute of limitations for an extra three years, meaning you can be audited for employment taxes and misclassifications for six years. Third, the California Employment Development Department (“EDD”) is not participating in the program, so it is not bound by the rules and will likely assess your identified workers for the full three year statutory period. And the EDD is likely to find out about your deal with the IRS because of their agreement with the IRS to share information, and because they will see your employer credit for paying unemployment taxes and it will not reconcile with your quarterly wage reporting, triggering an audit. [Spidell California Taxletter, vol. 33.11, November 1, 2011, pages 124-125.] California has some new misclassification penalties which are significant.

If you still feel that participating in the IRS program is a good idea and will help you sleep better at night because you have been misclassifying workers, think carefully about which workers do and do not need to be reported and re-classified. It may be that only some of your workers are misclassified, but once you claim them as employees under the new IRS program, you are stuck with that classification.

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Those endless representations and warranties in your acquisition agreement aren’t just for your merger and acquisition lawyer. Ignore them at your own risk.

Mergers and acquisitions in San Jose and elsewhere are a lot more complex than those of the past when deals were closed with a handshake. As acquisition documentation becomes more extensive, companies frequently turn to mergers and acquisitions attorneys to assist them with their transactions. One issue on which an attorney will focus deals with the representations and warranties of a seller.

A seller’s representations and warranties, which are the commitments that a seller will make to a buyer concerning the state of the seller’s business, make up one of the more extensive sections of an acquisition agreement and serve a number of functions. This is because they allocate between the buyer and seller many of the risks existing in the buyer’s business.

Representations allocate risk in a fairly straightforward manner. The seller will make a statement of fact regarding its business. If the seller’s statement is wrong, and the buyer is damaged as a result, the seller will compensate the buyer for any damages the buyer incurs.

An example helps illustrate the point. Let’s say that the seller states that it has paid all of its taxes, a very common representation. After the closing, the business that was sold gets hit with a sales tax audit, and is found to have underpaid its sales taxes. Because the seller’s representation was wrong (i.e., it hadn’t paid all of its taxes), the buyer, all other things being equal, can look to the seller for reimbursement for the amount of the additional sales tax liability.

The situation above describes the simplest form of risk allocation in an acquisition agreement. In this form, the seller bears the risk whether the seller knew there was a problem or not.

Some types of risk allocation shift risk only if the seller knew there was a problem. These representations, sometimes referred to as knowledge-qualified representations, allow a seller to escape liability in a representation if the seller did not know a problem existed.

In our sales tax example above, let’s say that the representation stated that the seller did not know of any nonpayment of taxes. Let’s also say that the seller’s officers were completely unaware that they had failed to pay any sales taxes. In that situation, the seller would not be liable for the sales tax liability.

Because acquisition agreements are prepared by lawyers, the concept of knowledge can mean different things. For example, does knowledge mean the subjective knowledge of the seller’s CEO, or the subjective knowledge of all of the seller’s employees? Does knowledge mean just what is in employees’ memories, or should employees be required to look through their files? If employees are required to look through files, should they also be required to look through other documentation, such as public records and other resources? For these reasons, it is critical that the concept of knowledge be defined so that the seller knows what they have to do to satisfy the representation, and both parties know how the risk is to be allocated.

What if the seller wants to allocate the risk of an item back to the buyer? When a seller makes a representation that he or she knows may not be entirely correct, the seller will disclose an “exception.” The seller provides this disclosure in a schedule commonly attached to acquisition agreements, known as a “disclosure schedule,” or a “schedule of exceptions.” Unless the agreement specifies otherwise, a buyer cannot recover for damages for an item that has been disclosed.

Going back to our sales tax example, if the seller knew there was a problem, the seller would describe the problem in a disclosure schedule. The seller would say something like “Seller underpaid its sales tax liability for the periods 2008 through 2010, which liability seller believes to be between $50,000 and $75,000.” The buyer could not thereafter bring a claim for reimbursement for the later assessed tax liability as a result of the seller’s disclosed exception.

As I mentioned above, representations and warranties, and their accompanying disclosures, are heavily negotiated. One point of contention is whether the risk of an item, even when disclosed, should be allocated to the buyer. Buyers with sufficient leverage will force the seller to remove the disclosed item, or affirmatively accept the risk associated with the item. Another point of contention is what the concept of knowledge means, and whether knowledge can qualify a particular representation. For these reasons, it is critical to spend a lot of time understanding the representations and warranties of any acquisition agreement so that you can understand the risks that may exist for you in a deal.

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Cut the cost of your old unpaid traffic tickets in half! If one of your new year’s resolutions involves clearing out that old traffic ticket that you either failed to show up in court for, or just didn’t pay on time, a new Santa Clara County amnesty program may be right for you. From January 1, 2012 through June 30, 2012 you may be able to get rid of an outstanding traffic case that was due in full before January 1, 2009 by paying 50% of the fine. The case must have been within Santa Clara County, which includes the cities of Santa Clara, San Jose, Sunnyvale, Cupertino, Milpitas, Monte Sereno, Palo Alto, Mountain View, Los Altos, Los Altos Hills, Saratoga, Campbell, Los Gatos, Morgan Hill, and Gilroy.

To determine whether you are eligible for to participate in the amnesty program or to find out more information, you may go to the Santa Clara County Court’s website .

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With the new year comes new laws, and businesses in the San Jose area should be aware of the new California employment laws that are on the books in 2012. Ensuring compliance with these new laws is good for the bottom-line, as it will make for happy employees, who will in turn make for satisfied customers. Making sure that your business complies with the new laws put on the books each January 1st may help your company avoid employment-related litigation.
Hiring Practices
Starting in 2012, employers may no longer obtain consumer credit reports about employees and job applicants. There are exceptions to this law, particularly for positions requiring access to bank or credit card information and other personal information, positions that include access to $10,000 or more during the daily course of business, positions involving signatory authority, and management positions.
Also, at the time of hire, employers must now provide notice to new nonexempt employees of the following information: pay rate; overtime rate; form of pay (hourly, salary, commission, other); a list of allowances that are included as part of the minimum wage; name, principal address, and telephone number of the employer; and the regular pay day designated by the employer. The employer must provide written notice to employees within seven days of any changes to this information.
Finally, the penalty for willfully misclassifying employees as independent contractors is now between $5,000 and $25,000. This five-fold penalty increase underscores the importance of properly classifying new hires.
Employee Leave
All employers with five or more employees must maintain and pay for a group health plan for any eligible female employee who takes Pregnancy Disability Leave for up to a maximum of four months during a 12 month time period. These benefits must remain at the same level as though the employee had been working during the leave. These requirements extend beyond those of the federal Family and Medical Leave Act.
The law regarding organ and bone marrow donor leave has also been clarified for 2012. During a one year period, employees are allowed 30 days of leave for organ donation and 5 days of leave for bone marrow donation, with the law now stating that the leave days are to be calculated as business days.
Discrimination Law
The California Fair Employment and Housing Act (FEHA) has been amended to prohibit employers from discriminating against employees based on genetic information, including genetic tests of an employee or his or her family members, and the existence of a disease or disorder in family members of the employee. FEHA differs from a similar federal law in that FEHA applies to employers with five or more employees, while the federal law covers employers with 15 or more employees.
FEHA has also been updated to clarify that discrimination on the basis of gender identity or gender expression is prohibited. Previously, only the term gender identity was used. Gender expression is defined as, “a person’s gender-related appearance and behavior whether or not stereotypically associated with the person’s assigned sex at birth.” Employee dress codes must allow employees to dress in a manner consistent with both the employee’s gender identity and gender expression.
Additionally, health care service plans and health insurance policies issued to California residents must provide equal coverage to domestic partners as that provided to spouses. While this has been the standing policy in California, the new law ensures that employers located outside California and with a majority of employees located outside of California must comply with California law as it pertains to California residents.
Wage and Hour Laws
Employees alleging violations of the minimum wage may now recover liquidated damages as a result of a complaint heard before the Labor Commissioner. Liquidated damages, which serve to punish the employer, are permitted in an amount equal to the unpaid wages owed to the employee. Put simply, for every dollar an employee is awarded in unpaid wages, the Labor Commissioner is authorized to award an additional dollar in penalties. Previously, employees could receive liquidated damages only after filing a complaint in civil court.
In the prevailing wage arena, which applies to specified state or federal public works contracts, the minimum penalty for wage violations has been raised from $10 to $40 per day for each worker paid less than the prevailing wage, and the maximum has been raised from $50 to $200.

When it comes to new year’s business resolutions, some cannot fall by the wayside. Resolving to make sure that your business is in compliance with the new California employment laws for 2012 is an easy resolution to keep, and one that will help keep your employees happy and avoid costly litigation.

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Mileage Rate:

Keeping up to date with the standard mileage rate is important for me as a business lawyer because I often drive to meetings, as well as for my small business clients in San Jose and all over Silicon Valley who will be using that rate to figure out their tax deduction for miles driven in the operation of their businesses. In addition, it is also usually the rate at which businesses agree to reimburse their employees for miles driven while on the job. The IRS has confirmed that the standard mileage rate for the use of business vehicles in 2012 will remain the same as it was for the final six months of 2011, at 55.5 cents per mile (which was higher than the previous 51 cents in early 2011). The mileage rate for medical and moving expenses actually goes down by half a cent to 23 cents per mile, but the mileage rate used when driving for charity is still unchanged at 14 cents per mile.

401(k) Contribution Amount:

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Many profit-driven companies in California interested in providing a positive social and environmental impact experienced the problem of maintaining a fiduciary duty to their shareholders and being charitable and green at the same time. Effective January 1, 2012, this should be less of a problem as the state has adopted two different types of corporations – the “flexible benefit corporation” and the “benefit corporation” – offering businesses in Silicon Valley and elsewhere in California, the opportunity to operate with a view toward both increasing shareholder value and fulfilling socially beneficial goals.

The primary differences between the two corporations, often called “B corporations“, lies in the purpose flexibility allowed, and the extent of disclosure required. Greater flexibility means greater disclosure.

Purpose

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During the past few months, we have seen an increase in hiring from small startups and larger corporations here in San Jose and other parts of Silicon Valley. At this time of year, when companies are about to review Forms W-2 and 1099 for their workers, it is a good time for a reminder about California worker reporting requirements. In California, when a company hires a new employee, it is required to report this to the Employment Development Department (the “EDD”) within 20 days of hire, regardless of whether the employee is full-time or part-time, or the amount of compensation.

If a business hires an independent contractor and pays the contractor more than $600, or enters into a contract with that individual for $600 or more, within a calendar year, the business is required to report the hiring to the EDD within 20 days of making a payment. Although the hiring of a new employee need only be reported once, the hiring of an independent contractor must be reported every year. However, if a company contracts with another business that provides a tax identification number rather than a social security number, the company hiring that business does not need to report to the EDD.

It is wise for a company to report to the EDD contractors it expects to pay in January of each year (e.g. continuing contracts) when the company prepares and reviews 1099s for the prior year. There is no penalty if a company reports a contractor and then the contractor does not actually perform services in the new year. However, the EDD could assess a penalty against a business for each failure to report a contractor within the required time frames. Source: Spidells California Taxletter Vol. 33.10.

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Starting in April, 2012, the EDD will calculate an ex-employee’s unemployment claim differently than it does now. Currently, the EDD calculates the unemployment claim based on a lookback period of one year ending two quarters prior to the termination of employment. In April, 2012, the EDD will calculate the claim based on a lookback period of one year but ending one quarter prior to the termination of employment. This is a good reason to convert to online filing if you haven’t already. For online filers, the EDD will already have this information and the change will be seamless to your business. However, if you do not file online, the EDD may not yet have your wages report for the prior quarter, or may simply not have processed it yet. In that case, you will receive a request for wage verification, and the employee will receive a request for proof of wages claimed. As the employer, you will have 10 days to complete the form and mail it back.

Source: Spidells California Taxletter Vol. 33.11, November 1, 2011, pages 130-131.