New York Small Business Law

Should we incorporate our Small Business in Delaware?

More often than not, a small business operating out of New York is well advised to incorporate in the Empire State.

While you could theoretically incorporate in any of the 50 states (including Delaware), incorporating in another state such as Delaware adds additional costs and almost no benefits to the small business corporation.

Let's look at the usual statements offered in favor of Delaware:

You don't pay income taxes in Delaware

That may be true, but you will pay taxes in New York if you do business in New York regardless of your place of incorporation.  All corporations doing business in New York are subject to New York's so called "franchise taxes, " (see Section 209 New York Tax Law).

More than 50% of all corporations listed at the New York Stock exchange are incorporated in Delaware

True; but just because big company does it, small company doesn't have to do it.   If you have no plans of going public any time soon or attracting big shot investors who might want to take the corporation public at one point, there is no benefit gained here.  Even if you do want to go public, being a Delaware corporation is not a prerequisite.

Delaware is the most sophisticated jurisdiction when it comes to corporations

Granted, Delaware  and its laws are known to be very business friendly.  According to Delaware's Department of State, Division of Corporations website:

The Delaware General Corporation Law is the most advanced  and flexible business formation statute in the nation.  The Delaware Court of Chancery is a unique 210 year old  business court that has written most of the  modern U.S. corporation case law. Delaware's State Government is business-friendly and accessible.  Our Division of Corporation is a model state-of-the-art efficiency and our staff provides prompt, friendly and professional service to clients,  attorneys, registered agents and others. These factors have all contributed to making Delaware a premier legal home to companies around the world.

Sounds all very nice and dandy, but a small business corporation doing business in New York is unlikely to encounter situations where the differences in New York law and legal system to Delaware law and legal system really matter.

It saves you money to incorporate in Delaware

May be the actual fees for incorporation are cheaper in Delaware than in New York (I didn't check), but that is where that argument ends.  If you incorporate in Delaware, but do business in New York, you face additional expenses not due from a domestic New York corporation:

1.  A foreign corporation has to get authorization to do business in New York (Section 1304 Business Corporation Law).  The fee is $225.

2. A foreign corporation has to pay a license fee to do business in New York (Section 181 (1) New York Tax Law).  The one time fee depends on the number of issued shares (par value or non par value).

3. A foreign corporation has to pay an annual maintenance fee of $300 (Section 181 (2) New York Tax Law).

4. A Delaware corporation has to appoint a registered agent in Delaware who is responsible for receiving governmental and legal papers for the corporation.

****Legal Information is not Legal Advice****

How to Execute a Contract - Good Practice Checklist

You put it in writing, you aced the negotiations, and you are ready to execute the contract.  Don't let down your guard at the last minute!  The following points are worth noting when executing a contract in New York.  While neglecting to follow the below points may not result in an invalid or unenforceable contract per se,  following below "good practice" can help to avoid problems later on.  Remember, spending a little extra time to get it right the first time - a minor expense;  staying out of court - priceless.

1.  Don't let technology (or anybody else) fool you

If the contract has gone through several rounds of negotiation and revisions, don't assume that the last circulated "execution copy" is what you think it is.  Before you sign, be one hundred percent sure that you know exactly what you are signing (you'd be surprised how many people neglect this one).

Under New York law, you are generally bound by a contract which you signed even if you have no knowledge of its content.   Unless  fraud or other  wrongdoing is involved, you are presumed to know the contents of the contract. 

2. Date the Contract

While a contract need not be dated to be valid and enforceable, it is kind of foolish to not date a contract.  Dating helps to identify a contract years later and puts the contract into chronological context.

FYI, you can predate a contract under New York law.  If you provide that your contract is entered into "as of" a date earlier than the date of execution, the agreement is effective retroactively "as of" such date.

3.  Both parties should sign the contract

It might come as a surprise to you, but in New York , unless a signature is required by statute, you don't necessarily have to sign an agreement for it to be valid.  If you and the other party in some other way indicate consent to the contract, you are both bound.

However, nothing beats a solid signature from both parties when it comes to proving that a contract was entered into by the parties with an intent to be bound thereby.  Better yet, put a provision into the contract that provides that the contract is not binding unless signed by both parties.

The signatures of each party to the contract do not necessarily have to appear on the same page of the contract, as long as you both agree that only the signature pages together constitute a complete executed agreement.  To that end, parties to a contract sometimes include a provision that states "the parties may execute this contract in counterparts, each of which is deemed an original and all of which constitute only one agreement."

4. Initial last minute hand written changes to the contract

Any last minute change to a contract that is done by hand should be initialed by the parties to the contract.   Better though, insist on a revised contract reflecting the change.

5.  Sign in your correct capacity

If you are signing for an entity, make sure that the signature block properly identifies you.  For example, if you are signing as president of a corporation, the signature block should read substantially like this:

ABC Corporation

By: _________________
Name: Joe Smith
Title: President

Signing correctly on behalf of a corporation prevents later claims that you are personally liable under the agreement.

6. Check the other party's authority to sign

For example, if the other party to the contract is a corporation, you want to be sure that the corporation is in existence, that the person signing on behalf of the corporation is authorized to do so, and, particularly in larger transactions, that the corporation approved the contract by consent of its shareholders or directors.

7. Get an original executed copy of the contract for your files

Each party should have an original executed copy of the contract for their files.  In other words, if there are two parties to the contract, you have to execute two identical contracts.  One copy goes to you, one copy goes to the other party.  Each copy constitutes an original contract.

If you need help on "How to Execute a Contract - Good Practice Checklist", contact a small business attorney in your area.

Off Topic: Shocking New York Times Article

Today's  "most e-mailed article" in the New York Times reports on abuses of law and power in tiny New York village and town courts.  A  shocking must read.

Thankfully, not all town and village courts seem to be that bad.  Nicole Black remembers:

"During my first few years as an Assistant Public Defender, I was assigned to nearly half of the Town and Village Courts in Monroe County and found that, by and large, most Village and Town Court judges were extremely competent, although there were a few exceptions.  And, a law degree was not necessarily indicative of competence on the bench."

Read her full post and her own bad experience in one  court here.

Keeping your Employees' Personal Information Safe- the Security Breach and Notification Act

Picture this:  Your accountant has access to all of your employees' records which she keeps on her computer system.  One day, against better judgment, she leaves the laptop in her car.  The laptop gets stolen.  Next thing you know, your employees are victims of identity theft. (Accountants loosing laptops seems to be a common occurrence.  See here, here and here).  What to do?

Don't try to sweep these kinds of accidents under the rug.   New York has a new law that tells you exactly what businesses must do under these circumstances.  The new law requires employers to notify employees of a misappropriation of employees' personal information immediately.

The law is called Security Breach and Notification Act and the part applicable to businesses can be found in  Section 899-aa of New York's General Business Law (sorry, can't link to it directly, go here  ▶  "Laws of New York" ▶ GBS  General Business  ▶ Article 39-F ▶ 899 AA)

If you do business in New York, you must disclose to a New York resident when their private   information was, or is reasonably believed to have been, acquired by a person without valid authorization.

An employee's social security number, driver's license number, account number, credit card number and similar information are all considered personal information.

If any of this information is stolen or anything else happens that makes it likely that unauthorized persons have access to it, you must - in the most expedient time possible without unreasonable delay - inform the affected employees in the manner provided by the law.

It seems to be a no-brainer to keep that sort of information safe in the first place in order to avoid security breaches and prevent employee law suits based on negligent handling of their information.  In any event,  good advice would be to:

• keep employee information secure by putting in place appropriate security measures for inhouse recording and archiving and requiring similar standards from outside consultants who have access to the information (leaving a laptop in the car should definitely not be allowed!);

• limit the number of employees and outside consultants who have access to the information;

• educate employees about consequences of unauthorized access and disclosure of personal information.

For more information see New York's Office of Cyber Security & Critical Infrastructure Coordination.

****Legal Information is not Legal Advice****

How to choose New York Law and New York Courts in your Business Contracts when you have no connection to New York

I don't need to tell you that New York lies at the center of the universe.  But did you know that you can be a part of it by choosing New York law to govern your business contracts and New York courts to decide upon any conflicts arising from your business contracts, even if the transaction, you, or the other party to the contract have no relation to New York?

Choosing New York law and New York courts may be desirable, because

• you and the other contract party are from different states or countries and you wish to agree on a neutral law and a neutral place for dispute resolution; or
• you wish to take advantage of New York law and New York courts which are known to address the most complex financial and commercial transactions.

You can choose New York law to govern your contract - whether or not the contract has any relation to New York - if your contract provides for consideration of at least $250,000.  (General Obligations Law Section 5 1401).

How do you choose New York law to govern your contract?  You agree to it with your contract partner by including a provision in your contract similar to this one:

This Contract shall be governed by and construed in accordance with the laws of the State of New York.

Now, in order to ensure that your choice of law provision will be enforced when you find yourself in court over the contract, you are well advised to choose New York courts in addition to New York law.  If you have chosen New York law in your contract and your contract relates to an obligation of at least one million dollars, you can have New York courts to decide upon your contract disputes.  New York General Obligations Law Section 5 1402 provides that you can sue a foreign corporation or non-resident where the dispute arises out of a contract for which a choice of New York law has been made and which is a contract with consideration covering at least one million dollars. 

How do you choose New York courts?  You agree to it with your contract partner by including a provision in your contract similar to this one:

Each of the parties to this Contract hereby irrevocably consents and agrees that any legal action, suit or proceeding with respect to this Contract may* be brought in a federal or state court located in [_______, New York], and each of them hereby irrevocably accepts and submits to the jurisdiction of such courts with respect to any such action, suit or proceeding.

*Note that this provision makes the selection of New York courts optional.  You could also agree that the selection of New York courts is mandatory.

If both parties are not present in New York, it is advisable to agree in advance what constitutes service for the purpose of starting a law suit in New York courts.  For this reason, you could agree to a provision similar to this one:

Each of the parties to the Contract hereby irrevocably designates, appoints and empowers [insert name and address of an agent in New York], as its authorized agent to receive for and on its behalf service of summons or other legal process in any action, suit or proceeding in the State of New York.  Each of the parties to the Contract further irrevocably consents to the service of process out of any New York court by mailing copies thereof by registered United States air mail postage prepaid to each of the parties of the Contract at its address specified in this Contract.

FYI, this post has been submitted to Problogger.net's writing contest.

****Legal Information is not Legal Advice****

Picture courtesy of Absolutewade protected under Creative Commons License Attribution 2.0

Update to "Conflict Resolution"

My post on September 14 talked about conflict resolution and the resources available at the American Arbitration Association. 

In the meantime, I discovered another great resource for domestic and international arbitration issues:  Lovell's International Arbitration Guide.  This site offers extensive information about arbitration, even  a drafting engine that automatically drafts an arbitration provision for you!

The site is free, but you have to register.  Hey, there is nothing wrong with using Big Firm resources without hiring them.

A Google Search Asks: Can an LLC pay its Members a Salary?

Courtesy of Mybloglog, I can actually see what people were searching for when they  clicked on my blog.  One of the  google searches that caught my attention was:  "Can an LLC pay its members a salary?"

Lonely internet surfer at 4:32 a.m on a recent Monday, this belated answer is for you:

Not really.

Absent a special election, a limited liability company (LLC) is treated as a partnership for federal tax purposes.  That means that payments by the LLC to its members cannot be considered wages paid to an employee, but distributions of the LLC to its members.  While there is considerable uncertainty regarding the question whether some payments to a member can – under certain circumstances – be treated as wages, most payments can clearly not be considered wages.

What is the difference?

An employer can deduct taxes from the employee’s paycheck and pay such taxes directly to the government.  Employer and Employee are liable one-half each for social security tax and Medicare (FICA). FICA is due at a rate of 12.4% of the first $94,200 (2006) of wages paid to the employee and Medicare is 2.9% of all wages.  The employee is not required to do any paperwork with respect to FICA, rather the employer files and collects the employee’s 50% share by withholding from wages. 

In contrast, members of an LLC generally have to pay self-employment tax (SECA) on the distributions received from the LLC. The rate of SECA is the same as FICA, but the LLC does not have an obligation to pay half of that amount.  The member is obligated to file for self-employment tax and generally includes the self-employment tax in his or her quarterly estimated tax payments.  However, the member can deduct 50% of the self-employment tax from his or her taxable income.

As I mentioned, there is no clear answer to whether some payments to a member of an LLC could be treated as wages.  In addition, there is also considerable uncertainty as to whether some payments to members of an LLC should not be subject to SECA (for example, payments to passive members of the LLC, i.e. members who do nothing in respect of services for the LLC or management of the LLC).

Despite these uncertainties, there is no shortage of possible structures to avoid the LLC salary and SECA issues.  All of these structures try to accomplish that the (working) member holds his interest in the LLC through a separate entity, i.e. separate from the LLC that is receiving the services provided by the member.

If you are in the mood for a heavy dose of tax law and in-depth answers to these questions, check out "Taxation of Partner Compensation:  FICA, SECA or Nothing" by James B. Sowell of Deloitte Tax LLP (also available through PLI).

James B. Sowell comments:

….one still sees a great number of situations in practice where an employee of a partnership has received an interest in the partnership and continues to be treated as an employee. One reason for this situation is simply the failure by many advisers to recognize the importance of this issue. Others believe that as long as withholding taxes are being paid to the government, nobody is harmed, so the Service should not have any stake in challenging the classification.

****Legal Information is not Legal Advice****

Conflict Resolution

As a business owner you will encounter conflicts; particularly with your fellow business partners.   As in any relationship, it helps to deal with these conflicts rationally.  Easier said than done, I know.

My favorite blog about blogging (Problogger by Darren Rowse)  has a post about "10 steps to conflict resolution."   Darren recommends:

    1.  Set a time and place for discussion;
    2.  Define the problem or issue of disagreement;
    3.  How do you each contribute to the problem?
    4.  List past attempts to resolve the issue that were not successful;
    5.  Brainstorm. List all possible solutions;
    6.  Discuss and evaluate these possible solutions;
    7.  Agree on one solution to try;
    8.  Agree on how each individual will work toward this solution;
    9.  Set up another meeting.  Discuss your progress;
    10.  Reward each other as you each contribute toward the solution;

All good advice when it comes to conflicts with your business partners.  I would like to add one piece of advice:  Contemplate the cost of the conflict.  What are you giving up by focusing your energy on winning the conflict?  How much would you gain by resolving the conflict as soon as possible? You will be surprised how much energy and money can be wasted on inefficient conflict resolution.

In the legal arena it also helps tremendously if you agree on a method of conflict resolution BEFORE any conflict arises.   Rather than bringing the conflict to court which can be extremely costly and time consuming, you may want to agree to mediation or arbitration of any future conflicts.

Mediation is a process in which a mediator helps the parties to reach a solution to their conflict.  The mediator does not have the power to decide the conflict. Think couples therapist without the couch.

Arbitration is a process where an arbitrator comes to a final decision (an award) that is binding on the parties.  Think judges without the court house, bureaucracy and robes.

The agreement to arbitrate or mediate could be in your partnership agreement, shareholder agreement, operating agreement or any other agreement that deals with the relationship between you and the other business owners.

Example of a Mediation Provision

If a dispute arises out of or relates to this contract or the breach thereof and if the dispute cannot be settled through negotiation, the parties agree first to try in good faith to settle the dispute by mediation administered by the American Arbitration Association under its Commercial Mediation Procedures before resorting to arbitration, litigation, or some other dispute resolution procedure.

Example of an Arbitration Provision

Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.

The above provisions are just examples and you could agree to more details of your dispute resolution.  For example, you could agree on the number of arbitrators to be appointed, how they are to be appointed and by whom, and where the arbitration is to take place.   You do not have to use the American Arbitration Association; however, many businesses do, since they have offices all over the country and are (in their own words)  "the world's leading provider of conflict management and dispute resolution services." 

For further information consult this very helpful guide to arbitration and mediation published by the American Arbitration Association:  A Guide to Mediation and Arbitration For Business People.

Finally, for the legal eagles, you can find New York law dealing with arbitration in Sections 7501 through 7514 of the New York Civil Practice Law and Rules.

****Legal Information in not Legal Advice****

Picture courtesy of  entr'acte's protected under creative commons license  attribution - noncommercial  - share alike 2.0

       

 

You may be a Partnership without knowing it!

The scenario is all too common.  You and one or more of your friends "go into business together."  You start spending money on the business, take in some first profits, and share everything equally.    Since you are all friends, there are no lawyers and no paperwork to hold you back.   For reasons discussed in an earlier post, this is risky business. 

But what kind of business entity are you,  if you choose to proceed like this?  A partnership.

What does that mean practically speaking (under New York law)?

• You are personally liable for all liabilities of the partnership, i.e. you can loose your personal assets to creditors of the partnership.

• Your friends (business partners) can bind the partnership without your knowledge, i.e. they can purchase  things in the name of the partnership or enter into any kind of agreement in the name of the partnership.

• You are personally liable for ALL of the partnership's debts, i.e. creditors can collect the entire debt of the partnership from you alone.

New York's partnership law can be found here; or (likely more up to date) at the New York State legislature.

If you need help on the topic of "You may be a Partnership without knowing it", contact a small business attorney in your area.

Your Employee's Right to Party!

Did you know that your employees have a right to pretty much do whatever pleases them outside of work?   New York law (New York labor law Section 201-d 1.b.) prohibits employers from firing employees for "engaging in legal recreational activities outside work hours."  "Recreational activities" are "...any lawful, leisure-time activity, for which the employee receives no compensation and which is generally engaged in for recreational purposes including but not limited to sports games, hobbies, exercise, reading and the viewing of television, movies and similar material."

In an interesting article in the New York Law Journal ("An Employer's Latest Internet Quandary: The Blog" subscription required), the authors (Wanda L. Ellert and Judson L. Hand) discuss the statute's applicability to a blogging employee.  They conclude that the statute may indeed protect a blogging employee to some extent.  However, an employee who discloses company secrets is not protected.