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As a business and M&A lawyer in San Jose, it is not uncommon for me to burn the midnight oil hammering out a deal for a Silicon Valley client. There is often a need to break from the perpetually connected life to recharge the lithium cells, so to speak. On a recent bike ride in Santa Clara on the local single track, it occurred to me that the life of a deal can be contained in a single mountain bike ride.

A ride starts with the first drop of a pedal. Any deal starts with the first realization that two people or groups can get together and construct a process that will create value for both of them. Whether it is a simple software license, or a complex strategic alliance and funding deal, it is that first pedal that moves everything forward.

Whether you are involved in a transaction deal or a single track mountain bike ride, you need the right tools to make it all work. For a lawyer, it is the years of learning that just begin after you leave law school. The late nights wrestling with creating a structure that will reduce risks and the time spent attending or teaching professional seminars all contribute to the base of knowledge that comes to bear in every transaction. Making sure your tires fit the trail and your derailleur is adjusted and chain oiled can make the difference between a ride and an ordeal.

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As a veteran M & A lawyer in San Jose, where deal making has never gone out of style, I have been though my share of mergers and acquisitions. For business counsel, the closing of a deal is one of the times I get to spike the ball in the end zone as I watch the cash flow to a happy (and relieved) seller. Needing only to put together a closing package, my work is done and I am off to popping the corks at the closing dinner. Or is it?

From sole proprietors and small businesses to large corporations, many business owners enter the sale process believing the closing of a deal is accompanied by a one-way ticket to paradise. They often find out, however, that the fun is just beginning. The first year after closing presents a number of challenges, all of which must be carefully managed to make sure the seller gets the full value of the business.

As I have discussed in prior blogs there are a number of adjustments, associated with audits and working capital, which occur within the first three to six months after closing, including the following:

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Some tax law changes recently went into effect that that will have an impact on both individuals and businesses in San Jose and throughout the State:

Yet Another Gas Tax Increase

On February 28th the Board of Equalization approved a 3.5 cent gas tax increase, effective July 1, 2013. This brings the gas tax rate to 39.5 cents for 2013-2014. This adjustment should produce revenue at the same rate as if Proposition 30 applied to gas sales. (Proposition 30 resulted in a 0.25% state sales tax increase which does not apply to gas sales.)

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In the wake of the California Supreme Court’s Riverisland ruling concerning lender liability, lenders in the San Francisco Bay Area and Silicon Valley may want to evaluate and consider modifying their current lending procedures. As a San Jose based attorney experienced in loan documentation, problem loans and loan workouts throughout California, I have followed the ebb and flow of lender liability law for many years. Although it is a bit early to assess the long term impact of the California Supreme Court’s Riverisland decision, it is not too early to consider precautionary steps, which generally have to be taken at the outset when the loan is being negotiated and documented, to minimize the chance of claims being asserted later.

The court in Riverisland said that a lender’s oral statements about loan terms, even if made before the documents were signed, can come into evidence in a lawsuit if the purpose is to show that the lender used fraud to induce the borrower to enter into the transaction. The facts of Riverisland are discussed below. Before Riverisland, if the borrower’s evidence of oral statements by the lender about the loan terms was inconsistent with the loan documents, the borrower’s evidence could not even come into the case. Now it can, if the purpose is to show fraudulent inducement by the lender. And the facts supporting the borrower’s claims can be taken from the borrower’s own testimony of his or her recollections. This shifts some bargaining strength toward the disgruntled borrower in problem loan negotiations, as it will be difficult after Riverisland to eliminate such fraud claims early in litigation, or perhaps even before a trial.

The immediate question for lenders is whether any changes in the loan-making and loan documentation process are needed to protect against the potential effect of the Riverisland ruling. Some ideas of possible changes are offered below.

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Having represented both buyers and sellers in mergers and acquisition transactions in Silicon Valley for more years than I care to admit, I have been through a number of closings. Some M&A closings that I have been involved in were smooth affairs, accomplished through an exchange of a single phone call with a confirming email, while others have stretched into all night marathons. Although it is often difficult to know whether your deal will allow you to finish at a reasonable time, there are a number of actions you can take to make sure your closing is as smooth and stress free as possible.

Obtain Third Party Consents:

The most important task for both the seller and acquirer is to plan ahead. Everything you will need, to accomplish the closing, will take longer than you think. One item which often delays a closing is getting the necessary consents to the transaction required from third parties. Certain third parties, often parties to major relationships that the acquired company, post-closing, requires for its operations, have rights under their contracts to consent to any change in control. Many of these contracts create significant value for the acquired company and their continued existence are often a key incentive for the buyer proceeding with the deal. It is best to identify these material agreements early on and plan a strategy for securing the necessary consents. Other areas where third party consents might be required are when a party, often a strategic investor, has a right of first refusal that is triggered by the transaction.

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A few years ago, I met with a new client here in San Jose about forming a corporation for his real estate management business. He wanted to use his name as the name of the corporation, e.g. John Smith, Inc., and he had no problems with using his name as the Agent for Service of Process, and having his home address as the business address on public record. Imagine my surprise when I went to the Secretary of State’s database to confirm that the name was available and found that the exact name was taken by the same client at the same address. The corporation had been formed back in 1989 and had been suspended for decades.

I discussed it with the client and discovered that he had spoken with another lawyer about forming a corporation many years ago, and although he thought it was just an informational meeting, the attorney actually formed the corporation and the client didn’t even know about it. If my client wanted to use the name of the suspended corporation, he would first have to revive it, in which case, he would have had to pay tens of thousands of dollars in back franchise taxes and interest. I counseled the client to walk away from the suspended corporation and simply start a new one under a different name. In this case, that was okay because he took no assets from the corporation and therefore could not be held personally liable for the corporation’s taxes. However, shareholders should not walk away from a corporation without carefully considering whether the same conclusion would apply to their situation, and whether they are willing to endure the annoying tax notices to the corporation in the meanwhile.

The landmark case in this area is the Appeal of Howard Zubkoff and Michael Potash, Assumers and/or Transferees of Ralite Lamp Corporation (April 30, 1990, 90-SBE-004). In that case, the Board of Equalization stated that the only way shareholders are liable for the corporation’s franchise taxes would be if the Franchise Tax Board proves that all of the following conditions were met:

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Those of us involved in real estate loans, debt financing, and problem loans or loan workouts have sometimes wondered whether a deed of trust can be valid if no trustee is identified. I am often asked this question and, surprisingly, the issue was never been directly addressed by California courts until the end of 2012! In a decision handed down a few months ago, a California Court of Appeals ruled that the omission of a named trustee on a deed of trust at the time it is executed and recorded does not preclude enforcement of the deed of trust through a foreclosure sale of the secured property.

The facts of the case are straightforward. A real estate loan was made and secured by a deed of trust on the property being purchased. The lender designated Mortgage Electronic Registration Systems, Inc., or MERS, as the beneficiary and simply omitted naming a trustee. Later, the borrowers defaulted on the loan and MERS then recorded a substitution of trustee naming ReconTrust Company, N.A. (ReconTrust) as trustee, and assigned its beneficial interest under the deed of trust to a loan servicer who further assigned the beneficiary’s rights to Arch Bay Holdings, LLC – Series 2010B (Arch Bay). As newly appointed trustee, ReconTrust filed the required notice of default and notice of sale, and eventually conducted a trustee’s sale at which Arch Bay purchased the property. After the sale, the borrowers filed a lawsuit asserting, among other things, that the failure to designate a trustee in the original deed of trust was a fatal flaw and precluded any trustee’s sale under the power of sale in the deed of trust. See, Shuster v. BAC Home Loans Servicing, LP, et al. 211 Cal.App.4th 505 (2012).

The court first noted that this issue had never been addressed in prior California rulings. After wading through some technical arguments, the court ruled in favor of the lender or creditor and against the borrower, stating that the essential validity of the deed of trust is not affected because a trustee is omitted in the original deed of trust, as long as a trustee is named prior to a foreclosure. The court reasoned that the very limited powers granted to a trustee under a deed of trust – to convey the property at an out of court sale – are insufficient incidents of ownership or control to make the actual naming of a trustee critical to the validity of the document.

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Last November, I was working closely with one of our clients and their real estate lender to purchase a large property in the San Francisco Bay Area. I formed two California limited liability companies for the transaction. One LLC was the investment entity that was going to own the property, and the other was the management entity that was going to hold the sponsor interests in the deal. Both entities had to be properly and fully formed so that we could obtain good standing certificates from the Secretary of State and be in position to issue legal opinions for the lender. During the due diligence period, our client discovered something about the property that was not what had been represented to them by the seller of the property. As a result of this information, the purchase fell through.

Fortunately, despite all of the other costs expended on pursuing this property, the client had not yet paid the $800 franchise taxes for each of the two LLCs we formed. In California, if an LLC meets certain requirements it may cancel its Articles of Organization within 12 months of the filing by filing a Short Form Certificate of Cancellation with the Secretary of State, and avoid paying the first year’s franchise taxes. These requirements include:

– The California LLC has no debts or other liabilities (other than tax liability);
– The assets, if any, have been distributed to the persons entitled to them;
– The final tax return has been or will be filed with the Franchise Tax Board;
– The California LLC has not conducted any business since filing the Articles of Organization;
– A majority of managers or members, of if there are no managers or members, then the person who signed the Articles of Organization, voted to dissolve the LLC and

– If the LLC has received any payments from investors for LLC interests, those payments have been returned to the investors.

Source: Spidell’s California Taxletter, Vol 34.11, Nov. 1, 2012.

Because our client met all of these requirements, we were able to cancel the LLCs without paying the $1600 ($800 x 2) in California franchise taxes. If, on the other hand, the client had already paid the taxes, we would not have been entitled to a refund. With this in mind, sometimes when forming an LLC it may be better to wait until the last minute before the franchise taxes are due before paying them to make sure the business is going forward, as long as you either pay them before late fees would be imposed, or you are willing to incur late fees in the event your LLC does not qualify for the short form cancellation.

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Although 2013 is well under way, taxpayers in San Jose may not be aware of changes to California laws that may affect them. Some of these changes include:

Proposition 30

With all the talk about federal income taxes going up this year, do not forget about the Proposition 30 retroactive increase in California taxes, effective as of January 1, 2012. For taxpayers with taxable income over $250,000, the California maximum rate is now 12.3%. On top of this, there is a 1% mental health surcharge for taxpayers with taxable income over $1,000,000. Together, these taxes give California the highest maximum state tax rate. If you fall under these tax brackets, you may not have paid enough taxes throughout the year, through either withholding or estimated tax payments, to avoid being under-withheld. However, there will be no penalty for the under-withholding so long as you pay the tax due in full by April 15, 2013. The ability to get out of penalties expires on April 15th. An extension to file doesn’t extend the payment deadline or the penalty exclusion. A late payment penalty of 5% plus 0.5% per month will be due if the full 2012 liability is not paid in full by April 15th.

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The pace of merger and acquisition activity in Silicon Valley continues unabated, and the satisfaction of conditions to make sure both parties conclude a deal with all loose ends tied up becomes critical to a final closing. In my last blog, I discussed certain standard closing conditions contained in merger and acquisition documentation, particularly the requirement of stockholder approval and the use and impact of dissenters’ rights. In this blog, I will cover some of the other commonly used conditions in acquisitions of privately held companies.

Being a technology transfer lawyer, many of my clients’ deals focus on the need to retain key employees after the company is sold. For that reason, a key closing condition included in most acquisition agreements requires that certain employees with the acquired company agree to continue working with the company for a period of time after the closing. Often this obligation is structured by requiring the employees to sign employment agreements or consulting agreements with the buyer. Managing this process can be tricky, because employees will want to agree to terms they find preferable (e.g., receiving additional options and higher salary) and some key employees may be reticent to work with a buyer they do not know. In addition, negotiations occur between the key employee and an acquirer before a deal is closed, which is sometimes an awkward process.

Covenants Not to Compete

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