New York Small Business Law

One good Reason for a Shareholders Agreement........

....keeping control by restricting the transfer of shares.

You, your best friend Jane and Jane's cousin opened a store and online business selling luxury pet supplies under various brand names.  You run the business through a New York corporation.  Each of you has equal ownership in the corporation.  Everything goes well, your products get mentioned on Oprah and you grow beyond your wildest dreams.   One day,  Jane and her cousin can't take the every day stress of being entrepreneurs anymore and seek for an out.   They find a buyer for all of their shares and sell their stake in the venture to Betty Buyer.  Now you are in business with Betty Buyer whom you don't know and don't want to share ownership of a business with.  What is worse, Betty Buyer now has a majority of the shares in your business and can outvote you on every decision.  Obviously, this could be disastrous for you and your business.

An easy and painless way to prevent this scenario from unfolding is to adopt a shareholders agreement right at the beginning of your business venture.  A shareholders agreement can put limitations on the right of shareholders to transfer their shares.  Without such contractual restrictions, shareholders can just sell their shares to whomever they want. 

However, rather than completely prohibiting any transfer of shares, many owners of a corporation opt to provide for a so called "right of first refusal."

Essentially, a right of first refusal provides that if an owner wants to sell her shares to an outsider, she first has to offer the shares to the corporation and the remaining shareholders.  If the corporation and/or the shareholders do not want to buy the shares, she will be allowed to sell the shares to the outsider.

This simple idea can be customized further.  For example, does the corporation have to buy the shares for the same price that was offered to the shareholder who wants to sell, or is there a predetermined price notwithstanding the offer?  What is the predetermined price or how should it be determined?  Does the corporation have to pay for the shares in one lump sum or over time in installments?

Despite what many lawyers may tell you, a shareholders agreement does not have to be long and complicated, so there is no real reason to avoid getting one in place early on.

Don't get Roles mixed up when signing for a Business Entity (plus case in point)

When signing for a business entity, such as a corporation or limited liability company, an officer's signing capacities can get confusing.  Is she signing on behalf of the entity only, or in her personal capacity and on behalf of the entity?

Check the following points:

1.  When only the business entity is supposed to have obligations under the agreement, the signature block should look like this:

ACME INC.

By: _______________
       Name: Jane Smith

       Title:   CEO

2.  When both the entity and the officer are supposed to have obligations under the agreement, insist on two signature blocks and put all provisions that establish the officer's personal obligations before the signature blocks. Example:

ACME INC.                                                                        

By: _______________                                    
       Name: Jane Smith                                       

       Title:   CEO

JANE SMITH

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3.  If you are the officer signing for the entity, carefully read every agreement you sign, despite the fact that you are only signing on behalf of the entity.  Even if there is only one signature block for the entity, you may end up having to defend yourself against personal liability, because there were personal obligations hidden somewhere in the agreement. 

With respect to No. 3 above, it so happened to a CEO of a New York limited liability company (See Integrated Marketing and Promotional Solutions Inc. v. JEC Nutrition LLC, decided December 12, 2006; via the New York Law Journal, subscription required).

The CEO signed a seven page agreement on behalf of the LLC.  The first three pages of the agreement contained the main obligations between the LLC and the other party to the agreement. The fourth page contained the parties' signatures.  The CEO signed on behalf of the LLC only, i.e. only one signature block.   Three unsigned pages followed the signature page.  Page six of the agreement (unsigned) contained the following language:

The undersigned (that is the CEO) for the client (that is the LLC) personally guarantees the payment of client's debts.  In the event that agency is unable to secure payment from the client, the undersigned personally guarantees all liabilities, including interest, collection costs and attorney's fees.

The LLC didn't pay, so the LLC and the CEO got sued.  Should the CEO be personally liable under the guarantee provision above, despite only one signature, which was clearly on behalf of the entity?

The court wasn't in a position to decide this issue yet, but it stated the rules:

In order to determine whether the CEO's signature on the agreement was intended by the CEO to bind the LLC and herself personally, the court must look at five factors:  1. the length of the contract, 2. the location of the provisions that made the CEO personally liable in relation to the signature line, 3. the presence of the CEO's name in the agreement itself, 4. the nature of the negotiations leading to the contract, and 5. the CEO's role in the corporation.  In addition, the court stated that although two signatures are not required in order to impose personal liability on the CEO, the existence of only one signature weighs against imposition of personal liability. 

The court applied the factors and found that factor 1, factor 3 and factor 5 weighed against the CEO.   The contract was only 7 pages long, the CEO's name was mentioned in the agreement, and the CEO had a position of "prominence and control" in the LLC.  Factor 2 weighed in favor of the CEO; the provision that established liability against the CEO was located after the signature block.

Still, it will take further court proceedings and additional convincing evidence to show that the CEO did not intend to be bound by the agreement.

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Related Post:  How to execute a Contract - Good Practice Checklist

CORI K-Base Contract Research Expands

In one of my previous posts I mentioned  Cori K-Base, the resource for free contract forms and research sponsored by the University of Missouri.  I just received an e-mail from them informing me that they have made some major improvements:

"First, we have partnered with QL2 Software, Inc., to enhance our ability to acquire and incorporate contracts from EDGAR and other on-line sources. Expect an explosion in the number of documents you will be able to access using our full-text search functionality! The new system will also increase the utility of Company Name searches to include all contract parties, not just the filing company'€™s name.

Second, we have created an opportunity for individual firms or for groups of firms and trade associations to maintain secured, on-line collections and archives for their firm'€™s or association members' exclusive use. Participating members can search and retrieve contracts exclusively within their private collection or expand their search to include the public collection in order to compare private and public documents. This is an excellent opportunity for smaller companies to create a central, electronic repository of their contract agreements, or for groups of firms and trade associations to add value to their group members by creating a pool of contract resources unique to their group's members. As an additional value added, CORI can conduct periodic analysis of contract forms and identify trends in new contract designs and prepare white papers reports those results to group members. For more information on how CORI can provide a solution for your organization, please contact us!

These are exciting milestones in the development of the CORI K-Base.  But we need your assistance to keep the K-Base available and to support continued improvements.  Please consider a tax-deductible, year-end donation to support CORI'€™s continued efforts to reduce the transaction costs of contracting and of doing research on contracts. You can even give online through the University of Missouri's online donation! s site: http://donatetomu.missouri.edu.*  For more ideas on how you can support CORI, see the Support CORI page on our website.

Thank you for your support. We look forward to a new year of working with you to make CORI your first destination when researching contracts."

I think this is a great service.  If you have the money to spent, why not donate some towards the greater good of contract research.

   

Resources for low cost or free Form Business Contracts

I've posted on web resources for form contracts before; however, this is supposed to be a comprehensive list.

First the Disclaimers:

There is no assurance that any agreement that was not drafted for you and your individual circumstances is worth more than the paper it was written upon.

An agreement develops through negotiation.  You must be aware of the legal consequences of each and every change to your original form.  There may be major consequences to minor changes.

There is no assurance that any agreement form is of any quality, even if your circumstances exactly mirror the circumstances of the parties it was originally drafted for.  There is a lot of junk in cyberspace.

The law that shapes and governs agreements is mostly state law.  An agreement drafted for a Florida transaction may have different legal consequences for a New York transaction.

The forms you are likely to find on the internet are often taken from public filings with the Securities and Exchange Commission.  This means they have been drafted for rather large companies and may have a lot of "overkill" provisions that are inappropriate, or even harmful, for a small business.

But now, without further ado, my resources for low cost or free form business contracts (in no particular order):

1.   Findlaw

2.   Onecle

3.   Digital Contracts Library of the University of Missouri (free registration required)

4.   Creative Google Searches: do an Advanced Search for "_______ agreement" and, under file format, limit the search to word documents or pdf documents.  This will result in more relevant hits than a plain search.

5.    RealDealDocs (starting at $9.95 per day): I've kind of praised this one before, but it seems you can get similar results from the above free resources.

6.   The NVCA Model Venture Capital Financing Documents:  For venture capital transactions only.

As I find more resources, I will add to this list and make you aware of the update.  If you know of another resource, let me know, and I will add it with a "tip of the hat" to you.

If you are interested in my firm's services relating to business contracts, click here.

 

Seal of Approval for Forfeiture for Competition Agreements

You may know that non-compete agreements between an employer and an employee are problematic since there is always the real possibility that a court may find that the restrictions put on the employee in the agreement are unreasonable.  There are even websites trying to help employees break their non-competes.  Nonetheless, businesses would like to be protected from an employee leaving the job and competing with them or joining a competitor.  Thanks to a recent case* decided by the New York Court of Appeals, employers can be even more confident than before that a certain type of non-compete agreement will hold up in New York courts.  (For the scholarly article on this see Friday's New York Law Journal, "Noncompetes With No Reasonableness Hurdles" by Fagie Hartman, subscription required).

The type of non-compete agreement is a so called "Forfeiture for Competition Agreement."  The gist of these agreements is "we'll pay you a chunk of money and benefits to be vested at a later time, but if you leave your job with us and go to the competition, we'll pay you nothing."  New York courts have found these agreements to be valid without going into the tedious question whether they are reasonable or not in each individual case, because they figured it was the employee's choice whether to compete and forfeit the benefits, or take the benefits and refrain from competing.  However, this was only legitimate, if the employee left on his own devices and was not fired.

The  New York Court of Appeals cemented this favorable legal rule for employers by holding that post-employment forfeiture for competition agreements will be enforced without regard to reasonableness.  But the employee in question claimed he was as good as fired, because he was demoted and thus the employer "fired" him from the job that he was doing before and wanted to keep.  He had no choice other than to leave and that is why the non-compete agreement should be invalid.  The court disagreed.  With respect to what constitutes leaving a job voluntarily versus leaving a job involuntarily (i.e. being fired), the court said that an employee only leaves a job involuntarily if the working conditions at the time of his resignation were so intolerable that a reasonable person would have been forced to leave the job.  Whether the employee was asked to do a job that was not comparable to his earlier job responsibilities was irrelevant. 

*Morris v. Schroder Capital Management, 2006 N.Y. Slip. Op. 08638 (N.Y.Nov 21, 2006)

Confidentiality Agreements between a Business and an Employee

A confidentiality agreement (also known as a Non-Disclosure Agreement) is meant to protect a business from misappropriation of valuable proprietary information by employees.  Often it is a good idea to have one in place with your employees.

When drafting or reviewing such a confidentiality agreement, check the following points (and consult with your attorney):

1.    Use the proper form of Confidentiality Agreement

Make sure that the form of the confidentiality agreement that was used to draft your agreement is appropriate for the business-employee situation.  Confidentiality Agreements designed for a business to business transaction where both parties disclose confidential information won’t do.

2.    Define Confidential Information

There must be a definition of what constitutes confidential information.  Be specific, but also include a more general “catch-all” provision.  Do not make confidential information depended on whether it was expressly marked as such.  Exclude information that is public or already in the lawful possession of the employee.

3.    State the Confidentiality Obligations

No disclosure of confidential information, unless to authorized other employees or compelled by court order (but we will have right to defend against court order before disclosure);

No removing of confidential information from business’ premises;

No poking around in confidential information to learn more than we disclosed (i.e. reverse engineer any data, software and so forth);

No reproduction of confidential information from memory;

Use of confidential information only for job purposes;

Obligation to notify business immediately upon learning that confidential information was disclosed or used inappropriately;

Upon notice by business, return of any confidential information in employee's possession.

4.    State your Remedies

Money damages are often not sufficient to make whole for a business’ loss caused by disclosure of its confidential information.  A business must also be able to stop an employee in his or her tracks when disclosure is imminent.  To make courts give those remedies, it is advisable to state that in the agreement. In legalese, these provisions might be called  “Equitable Relief” or “Injunctive Relief.”

5.    Make the employee pay for the consequences of his or her breaches of confidentiality

In legalese, these provisions might be called “Indemnity.”  Make sure the indemnification clause includes “including reasonable legal fees incurred by the businesss.”

6.    State the Term of the Agreement

Usually as long as the confidential information remains confidential.

7.    Remember the limits of a Confidentiality Agreement

Confidentiality Agreements only offer so much protection.  Don’t neglect very practical protective measures:

Limit access to “as needed”;

Clearly identify confidential information (if verbal, say so), but don’t make that a prerequisite for your definition of confidential information (see above);

Monitor dissemination of confidential information by any appropriate means;

Continuously remind employees of confidential nature, i.e. verbally, in work manuals and so forth);

Implement security measures.

Have I forgotten any important point?  Feel free to comment.

The Art of Using Recycled Agreements and where to find them

In a recent article on Legal Technology,  Justin Hectus writes that much of an attorney's work consists of the "recycling of documents and information that has proven successful in the past."

So why, you ask, do attorneys get paid the big bucks for recycling work product?

Justin states:

"I believe that the value provided by the attorneys at my firm (and, for that matter, at any firm of merit) comes in the nuanced interpretation and execution of the matter at hand. We'd be doing our clients a tremendous disservice if we tried to reinvent the wheel each time we had to create a new agreement, instead of leveraging previously successful work product and adding the artful interpretations and additions relevant to the current situation. By starting with a foundation of proven work product and further, by learning as much as we can about our competition, we're able to focus our efforts on delivering real value to our clients."

Well put. 

Where can you find agreements drafted by other attorneys?  As the article reports, by using a new service offered by REalDealDocs.  Through their interface one can perform very targeted searches in SEC documents to reveal business agreements of almost any kind.  While all SEC documents are publicly available, it used to be very difficult to find what you were looking for.  RealDealDocs makes it possible for a relatively low fee.

Another source for SEC documents is a website called onecle.com.  Their offering is not as big as that of RealDealDocs; but it is free.

Another Limitation of "Limited Liability": Personal Guarantees

If your LLC or corporation is getting any kind of loan financing, it is very likely that the lenders will ask you and your fellow business owners for personal guarantees.   Even if your business offers decent collateral, lenders like to see that you put some of your own skin in the game.

Thus, even though you, as a busines owner, are not liable for the debt obligations of the LLC or corporation under the law (limited liability shield), you will become liable under the personal guaranty if the business defaults under the loan.   If the business goes under and can't repay the loan, your assets are on the line.  What is even worse, if the other business owners can't pay under their personal guarantees, you may be on the line for the entire amount of the loan, despite the fact that you may only own part of the business.

CCH offers this really good summary of personal guarantees in the loan context, including possible avenues of negotiation in order to minimize or avoid personal guarantees when executing loan documents.  Remember:  Everything is negotiable!

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Related Post:  Limited Liability Protection of LLC not absolute

International Sales Contracts - Don't overlook the United Nations Convention on Contracts for the International Sale of Goods

Gone are the times when small businesses had only local dealings.  Many small businesses sell or purchase goods internationally.

When drafting an agreement for an international sale of goods, you must be aware of the potential applicability of the United Nations Convention on Contracts for the International Sale of Goods (CISG). 

The CISG applies to:

international transactions, i.e. the buyer and the seller are from different countries and such countries are a party to the CISG.  For example, a seller in the United States and a buyer in Germany would make a transaction an international transaction;

regarding commercial goods, i.e. not goods for personal, family, or household use, not partially to be manufactured goods, not goods sold by auction, not securities or other financial instruments, and so forth (See Article 2 and Article 3 CISG);

where the agreement expressly states that CISG applies to the transaction or,

(and this is what many people, including attorneys,  overlook)

where the agreement has a gap with respect to a particular issue or there is a conflict between the UCC and the CISG,  the CISG may act as the default law, even if the contracting parties had no intention of applying the CISG or didn't even know of its existence.

To avoid the default application of the CISG, parties can choose to waive its applicability (see Article 6 CISG) by including language into the sales agreement similar to this:

This agreement is governed by the Uniform Commercial Code as in effect in the State of New York, and is not governed by the United Nations Convention for the International Sale of Goods.

Should you opt out of the CISG?  It depends.  The CISG differs in numerous aspects from the UCC.

At minimum, your counsel should be aware of the CISG, compare its rules to the UCC and make a decision based on such differences and the particular circumstances of your transaction.  One benefit of the UCC:  people are more familiar with it. 

The LLC Operating Agreement - Keep it Simple

Here is a little known secret about limited liability company (LLC) operating agreements:  They are often more complex than necessary.  Pick up any "standard" operating agreement from the internet or elsewhere and you will see a lot of provisions incomprehensible to a mere mortal.  Most of these provisions deal with so called "special allocations" among members of the LLC.   "Special allocations" describes a scenario where members of an LLC share profits and losses of the LLC in percentages different from the percentage of ownership in the LLC.  When members of an LLC opt for special allocations, the corresponding operating agreement has to incorporate certain tax rules in order to pass muster with the IRS.

Example:  A and B each contribute $500 to the LLC and agree to share profits and losses of the LLC equally.  Result:  No special allocations.

A and B each contribute $500 to the LLC and agree that for the first two years A is to receive 70% of the profits and losses of the LLC and B only 30% of the LLC's profits and losses.  Result:  Special Allocations.

If you and your fellow members  share profits and losses of the LLC in proportion to your membership interests (i.e no special allocations), you don't need any complicated provisions dealing with  special allocations. 

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 Related Posts:

All you Need to Know About:  The LLC Operating Agreement

Management Provisions in an LLC Operating Agreement

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

LLC Member Obligations in an LLC Operating Agreement

Buy Sell Provisions in an LLC Operating Agreement

**This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**