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Valuation of Business Assets in Divorce

Sometimes estranged spouses can remain fair, rational and civil during divorce proceedings. But in other cases, a divorce can turn ugly. When the couple’s assets involve a business interest, the situation can be extremely complex.

Valuation of Business Assets in Divorce

Husbands and wives may become emotional and vindictive, hiding assets and withholding information. These behaviors can compromise the accuracy of asset appraisals and property allocations. But financial experts who specialize in divorce are accustomed to overcoming various roadblocks during discovery.

One Ohio Court of Appeals case illustrates some of the games people play in divorce court. In the end, neither spouse was satisfied with the trial court decision, so both made claims on appeal. Here are some of the valuation-related claims and how the expert witness managed to reliably value the business, despite having limited access to the company’s financial records, management and facilities.

Access Denied, Claim Denied

When Arun and Mona Chattree decided to call it quits after 48 years of marriage, their most significant marital asset was Arun’s 100 percent interest in Community Behavioral Health Center (CBHC), a mental health service company that was licensed in Ohio. During divorce proceedings, Arun refused to allow Mona’s expert to visit CBHC’s office or interview management.

The court ordered Arun to give Mona $5,000 to retain an appraisal expert to determine the value of CBHC, but he dragged his feet for six months. He also continuously delayed sending the expert court-ordered financial records, causing Mona’s expert to miss his original deposition date and submit his final report after the trial had begun.

One of Arun’s claims on appeal was that the court should exclude from evidence the appraisal testimony and report prepared by Mona’s expert. The appeals court denied this claim, because his failure to appear at deposition and untimely report resulted directly from Arun’s misconduct and repeated failures to comply with lower court orders.

Both spouses appealed the lower court ruling that CBHC was worth $1.5 million on December 31, 2008 on a controlling, nonmarketable basis. Arun argued the business had no value, given its liabilities and limited assets. Mona argued for her expert’s original appraisal setting the value at more than $1.9 million.

Mona’s expert used the capitalization of earnings method, relying solely on tax returns and audited financial statements from 2005 to 2008. His $1.9 million value included:

  • A 10 percent discount for lack of marketability
  • A normalizing adjustment for nonrecurring pension plan costs
  • A normalizing adjustment for the cash surrender value of officer life insurance policies, a nonoperating asset valued at approximately $600,000
  • A loan to its shareholder (Arun) for roughly $400,000 (see right-hand box on factoring in holder loans).

Consistent with Ohio legal precedent, no adjustment to the value of the business was made for goodwill. In Ohio, personal and enterprise goodwill in professional practice are generally marital property. Other states may handle goodwill differently, however.Arun claimed the valuator’s methodology was unreliable “due to his unfamiliarity with CBHC and its business structure.” Specifically, Arun contended that Mona’s expert didn’t understand Medicare and Medicaid regulations, the financing requirements for CBHC’s pension plan, and the transferability of the company’s license. (Chattree v. Chattree (2014-Ohio-489, 2/13/14)

Reliable Given the Limitations

Along these lines, the expert’s report contained the following disclosure:
Due to limited access to information and management, [my] analysis was not subject to the development or reporting standards set forth in the American Institute of Certified Public Accountants Statement of Standards for Valuation Services No. 1 (AICPA) nor the valuation standards as promulgated by the National Association of Certified Valuation Analysts (NACVA).
Additional information that could have impacted his conclusion — but Arun withheld from the expert — included:

  • Access to management or the opportunity to interview management
  • Details about certain balance sheet and income statement accounts
  • Corporate governance documents
  • An organizational chart
  • Budgets and forecasts
  • Other relevant information, such as significant contractual relationships and details of previous ownership transactions.

The valuator’s lack of knowledge about the day-to-day operations of CBHC stemmed primarily from Arun’s refusal to consent to a site visit or a management interview. The court refused to reward Arun for such conduct, so it ruled that the expert’s testimony and appraisal report, despite its limitations, were “reliable and based on application of his disciplines, practices, and knowledge of the facts of this case.” In the eyes of the court, the expert did the best he could with limited financial information.

In addition, the Ohio Court of Appeals reversed the lower court’s pension plan adjustment, which was based on an apparent misinterpretation of the expert’s original testimony. The appellate court ruled that the lower court erred in valuing the business at $1.5 million and remanded the case to the trial court to determine whether the appraised value of $1.9 million was appropriate.

Play by the Rules: In divorce cases that involve private business interests, it may be tempting for controlling shareholders to downplay assets, income, strengths and growth opportunities — and play up expenses, liabilities, weaknesses and threats — to alter the appraised value of the company. But as the case described above demonstrates, many valuation-related issues are left to the court’s discretion, and judges don’t look favorably upon spouses who hide assets, withhold information or otherwise defy court orders.

It’s best to consult with an attorney with questions about your situation.

Advocacy vs. Neutrality: Overcoming the Expert’s Dilemma

Scenario: An expert forensic accountant is hired by the plaintiff’s counsel to determine economic damages in a financial dispute. The expert meets with the attorneys and the clients to discuss the key elements of the case. They talk about what is expected, as well as the expert’s background, credentials and any potential conflicts of interest. Information about the case is provided, along with documents, time frames and other administrative requirements.

Expert Advocacy vs Neutrality
In the above scenario, it is important that the team (attorneys/clients/expert) communicate in an open forum on key positions, facts, damage theories, etc. All viewpoints should be respected and evaluated. By doing so early on, the expert is better able to maintain a sense of independent objectivity. This leads to more effective testimony and less vulnerability to attack from the opposing counsel, who will likely try to impeach the objectivity and independence of the expert.

Expert Witness Maintaining Neutrality

Here are some frequently asked questions about the importance of an expert witness maintaining neutrality:

Q. What is the difference between being an advocate and being neutral?
A. Advocacy is defined as the act of pleading for, supporting, or recommending.

So, if an expert testifies about the credibility of the damage claims put forth by the plaintiff, is the expert an advocate? Ideally, the expert should reach a professional comfort level after pre-trial sessions of discussion and debate as well as his or her independent analysis of data.

Neutrality means not being aligned with or supporting any side or position in a controversy. This can be challenging when an expert is hired by one party in a dispute. Obviously, it is more easily accomplished when the expert is appointed by a court or jointly retained by all parties in a dispute to evaluate the data and reach conclusions. In these cases, experts present both sides in order to foster a settlement or to help a judge in rendering decisions.

However, in litigation, neutrality shouldn’t depend on which party retained the expert — it should be more of a mindset. It involves the expert maintaining a professional distance from the emotional aspects of the client’s case and the desire of counsel to win. Of course, this does not mean the expert becomes belligerent or difficult, but he or she should insist on airing out alternate views to uncover provable facts and irrefutable documentary evidence. In this capacity, the expert provides an invaluable service by thinking through the complex details. Attorneys and clients are best served when an expert is passionate about his or her testimony and written reports and does not feel pressured.

Q. When are the lines of advocacy and neutrality blurred?

A. The expert in litigation is often asked to assist counsel in preparing for a deposition of a witness on the other side. In this role, the expert reviews the case information and composes draft questions. This work can lead to a planning meeting with the attorney and perhaps the client. At the meeting, the expert becomes exposed to the thoughts and strategies of the attorneys and the concerns of the client. At this point, it is incumbent on the expert to point out any flaws in the logic surrounding these views. An open exchange should be encouraged at this critical juncture, when the role of the expert becomes evident.

Q. What happens if the expert disagrees with the counsel or the client?

A. Sometimes, disagreements arise between members of the litigation team. They can stem from disputes over strategy or the completeness of data.

For example, an expert may not feel that the evidence overwhelmingly supports the client’s position. It is essential that the expert explain the basis for his or her position and allow time for discussion and debate. Perhaps more documentation can be located to buttress an argument.

However, after a period of time, if the expert still disagrees with the client’s position, the attorney may decide not to call the individual as a witness. In some cases, this can mean that the client’s case is weak or based on circumstantial evidence.

The unwillingness of an expert to testify can be a signal to counsel that settlement is in the best interest of the client.

Expert Independence and Objectivity

An expert witness has a unique independence within the legal system. Unlike lawyers, experts owe no specific allegiance to clients. “While a lawyer is an advocate for his client, an expert witness is supposed to be a source of knowledge and opinions that will aid the Trier of fact,” according to an article in the Missouri Law Review.

Therefore, slanted opinions that are not based on empirical data and sound theory are subject to vicious attack on cross-examination and, potentially, dismissal of the expert by the court. Sometimes an expert is rejected prior to trial through a Daubert challenge. In such a challenge, the specific background of the individual in every intended area of testimony becomes subject to argument — making it much more difficult to proffer experts.

Testimony and written reports offer opinions and projections that should be as free of bias as possible. Soundly written reports should include references to published materials from authoritative sources. Novel opinions are difficult to introduce unless the expert possesses such lofty credentials that he or she recognized as an undisputed authority. Even then, is essential to explain why more traditional theories are not as good as the novel argument. Since both sides may retain their own experts, a battle could take place during trial.

Conclusion

The posture of an expert witness should be one of professionalism and balance. Experts who testify as a predominant part of their practices can be cast as “hired guns.” The jury may dislike medical doctors, for example, who no longer practice medicine, but spend all of their time testifying in legal cases. Of course, this creates a challenge for skilled experts. They want to build their reputations within the legal community for being experts in certain fields to garner more business, but if they testify too many times, there can be a challenge that they were “bought.” For this reason, experts must guard their personal reputations for independence and objectivity, even if it means walking away from some cases.

Finding the right expert witness can make or break a case — it can make the difference between winning and losing, or settling favorably versus settling poorly. Experts must be seen as credible and knowledgeable, but must not seem strongly biased or slanted without strong evidence to support their views.  If you find yourself in a dispute that is in litigation or could result in litigation, as part of our services, we will help you find the right expert to help your case the most.

Issues to Consider when Drafting a Franchise Agreement

Have you ever thought of owning a franchise?

Or are you in a business where you hope to have franchisees?

Many businesses are set up as a franchisor/franchisee relationship. In these situations, it’s important to draft agreements not only to cover the immediate terms of the franchise relationship — but also to incorporate a potential future change in ownership of the franchisor.

Franchise Agreement

The reason: Many times, franchise owners would like to reap the benefits of their success and sell or merge with other businesses. While this is a potential growth opportunity, it can also lead to growing pains. A solid franchise agreement can limit conflicts that can occur with future changes in ownership.

Franchise Agreement Issues

Example: Let’s say Franchisor #1 acquires or merges with Franchisor #2. Along with this acquisition or merger, the successor Franchisor may want the newly merged or acquired franchisees to assume new products, a new marketing strategy, a new territory, or even a new trade name. The issue is whether a new franchisor is legally capable of doing so. And if so, whether there is a way to formulate a franchise agreement to allow for such a scenario in the future. Anticipation of certain issues is important because of the potential lawsuits which can arise, based on, for example:

  • Wrongful termination
  • Forced sale
  • Forced changes

An attorney can help draft the agreement to minimize potential conflicts at a later date.

Merger & Acquisition Factors to Consider

When deciding to merge or acquire a franchise, the parties must determine whether there is:

1. Adherence to the explicit terms of the agreement;
2. Permissible modification to the agreement;
3. Sufficient notification;
4. An explicit right to renew;
5. Discriminatory action; and
6. Constructive termination.

Just Cause Requirement and Covenant of Good Faith

Many states have statutes that require just cause to alter a contract. This may include a just cause requirement for both terminations and non-renewals. Courts interpret just cause differently. Some states interpret just cause broadly (for example, basing it on a franchisor’s legitimate business reasons) while other states interpret it narrowly (for example, holding that a business justification argument is meaningless because a franchisor could always claim a plausible business reason for termination).

Courts in some jurisdictions will also determine whether a covenant of good faith and fair dealing is applicable. Courts generally use a measure of the justifiable expectations of the parties. As a result, where one party acts arbitrarily, capriciously, or unreasonably, the court may decide to compensate the second party for its damages, or excuse it from performance.

Terms and Provisions of an Agreement

Next, consider what terms you need to put into the agreement that are pertinent to a potential future merger or acquisition including the right to:

  • Add or delete products;
  • Add new franchisees to geographical areas;
  • Alter or change the trademark;
  • Advertise new products or services;
  • Terminate a business or product line due to a merger or acquisition; and;
  • Request a remodeling or redecoration.

When drafting a franchise agreement, you must decide what can potentially happen in a merger. Each of the above terms should be accounted for in the agreement. Further, consider whether there is a statute in your state requiring a just cause basis for a merger, acquisition or termination, or whether there is an implied covenant of good faith in your jurisdiction. These are complicated issues. Consult with your attorney about them before entering into a franchise agreement.

Twelve Ways to Lessen Employee Legal Risks

12 Ways to Lessen Employee Legal Risk
Your business or organization can reduce tensions from and conflicts with employees… and help lessen the risks of employee-initiated legal actions by focusing on at least 12 areas.

1. Ensure managers and supervisors are qualified to coach and lead.

Studies of the root causes of employee turnover and employee legal actions often trace those underlying causes to unqualified or dysfunctional managers and supervisors. So the single, best way to protect against employee-caused problems is to fill supervisory and leadership positions with individuals who have the temperament and personality traits best suited for coaching and leading others.

2. Train managers and supervisors.

The managers and supervisors who work directly with employees on a day-to-day basis may cause difficulties with employees… or they will avert most of the problems and actually promote harmonious and productive behavior. One key to which results the managers and supervisors get is in the knowledge and training they receive in several areas. These areas include:

The organization’s policies and procedures and their role in applying them and enforcing them;
The myriad of laws and regulations that protect employees and how not to violate them;
How to avoid harassment and abusive interactions with others; and
How to skillfully coach employees.

3. Replace Dictatorial Discipline with Coaching Correction.

The typical, traditional way managers and supervisors went about attempting to correct employee misbehavior and poor performance has been the arbitrary, “dictator,” discipline approach: Tell the employee what they’ve done wrong, discipline them, and threaten them with termination in the future.

There’s a better way, coaching employees to correct behaviors. This approach involves:

Identifying — with the employee — the unacceptable behavior or performance.
Agreement with the employee on the required behavior or performance.
Setting a time/date-certain when the employee will behave or perform as required.
Explaining the consequences to the employee if the behavior or performance does not change.
Agreeing on any additional coaching, training, or education the employee may need to reach the required behavior or performance goal.

4. Hold performance achievement meetings.

Think of the performance achievement meeting as a replacement for the traditional performance review or performance appraisal. In many workplaces, the performance review is never done or is rarely done. In other workplaces, it’s done on schedule once a year. And when it’s done, it typically involves perfunctorily telling the employee what he or she has done right — and especially, wrong — in the previous year. Generally, it also involves giving the employees some kind of rating and telling them whether or not they qualify for a raise.

A performance achievement meeting is different. The focus is on what the employee has done, and is doing, right… and on what the employee can do in the future to do even better. The “agenda” for the meeting is something like this:

These are your (the employee’s) achievements since we talked last about your performance, these are achievement goals for you in the near future and longer-term, and these are the ways that we (the organization), I (the supervisor) and you (the employee) will work together to assure that you’ll reach these achievements.

5. Terminating employees when necessary.

One mistake many organizations and their managers and supervisors make is to avoid the disagreeable act of terminating employees who deserve termination. There are many reasons why some employees, from time to time, don’t belong in a workplace. Some just aren’t qualified and never should have been hired. Some become diehard troublemakers. Some become known under-performers. The other employees quickly learn who these employees are. And the longer management tolerates their presence in the workplace, the more their presence lowers the morale of the other employees.

What to do? Identify these employees. Treat them fairly. But when the “coaching correction” approach doesn’t work, make the decision to terminate. And stick with the decision.

6. Put the right people in the right jobs.

One cause of frustration for an employee is to get stuck working in the wrong job. The employee’s performance suffers and this has a negative impact on the organization’s results. Make it one of a manager’s and a supervisor’s responsibilities to identify employees who are better qualified for other positions. Develop systems in your organization that will channel these employees into new positions where they can excel.

7. Improve the hiring process.

The best way to avoid terminating deserving employees is to not hire undeserving applicants in the first place. So put more time and effort into recruiting and hiring the individuals who are the best fit for the jobs you have open. This means:

identifying the essential tasks and the essential qualifications for each position,
screening resumes to focus on interviewing only those individuals who appear to have the essential qualifications,
testing these applicants to identify those who actually have the qualifications, behavior style, and attitudes necessary for success in your workplace, and
checking on the background and work history of finalists.

8. Empower employees as much as possible.

Empowerment in the workplace means giving employees the opportunity and the responsibility to use their knowledge and talents to achieve the best possible results in their jobs. To see empowerment happen, employees have to know their expanded boundaries for making decisions. They have to know they have the right to make these decisions. And they have to know they’ll not be disciplined for making decisions that go wrong. (One of the manager’s and supervisor’s responsibilities, in turn, is to help employees learn from the experience when their decision doesn’t work out.)

9. Set up an ongoing employee idea program.

Call it a suggestion program if you like, but don’t limit it to the old suggestion box type program in which employees submit suggestions… and never hear from management. Go beyond that. Commit to responding quickly to all employee ideas. And empower the employee who submits the suggestion to implement it, or to have a part in implementing it, whenever possible.

10. Help employees feel needed and important.

This desire to feel needed and important is one of the basic desires of nearly all employees. Employees who feel they are needed at work and that what they do is important to the company’s or organization’s success are more likely to feel positively about their employer. And they are less likely to see grievances where there are none.

So gather supervisors and management staff together and brainstorm ideas to help employees feel needed and important. Design a plan to carry out which is intended to increase employees’ feelings that they are needed in their jobs, that their jobs are important, and that what they do is appreciated.

11. Use caution before disciplining or terminating an employee.

Before disciplining or terminating an employee, review the individual’s work history carefully. In addition to the negatives about the employee, consider also the positives. Review the positive qualifications that influenced the hiring of the employee and ask, What have I overlooked? Are the positive qualifications still present? Can this person still contribute positively? What commitments will we make, and what commitments will we ask the employee to make, to continue employment with us? What are the penalties for failing to improve?

Also, before disciplining or terminating an employee, consider the individual’s age, sex, race, and any other legally protected trait or qualification the employee may have. Ask this question: Will a jury or human rights hearing officer believe our actual intent was to “target” or “get rid of” a person in a protected class?

Important: Document discipline actions in writing. Describe the employee’s conduct or performance and why it is unsatisfactory. Also describe any steps you have given the employee to improve and any deadlines for improvement.

In all dealings with your employees, be courteous and respectful. For example, when terminating an employee give as much advance notice as possible. Also, when communicating with employees, do not speak aggressively, do not belittle them and do not use disrespectful or insulting words.

[NOTE: Information and guidance in this story is intended to provide accurate and helpful information on the subjects covered. It is not intended to provide a legal service for readers’ individual needs. For legal guidance in your specific situations, always consult with an attorney who is familiar with employment law and labor issues.]

Choosing the Right Legal Form for Your Business

Choosing the appropriate legal form for a business is one of the first issues most entrepreneurs face. It is an important decision at the formation stage and also as a business grows. Sole proprietorships are generally the easiest. Corporations offer some different advantages, but often with additional complexity.
3

Legal Structure Considerations

This article addresses some of the pros and cons of different types of legal structures for businesses. Even if your enterprise has been in existence for a while, it may be time to review your options. There can be many complexities in determining the best legal structure and a qualified attorney may be of value when evaluating your choices.
At a minimum, consider the following issues when evaluating the business structure decision:

    • Number of owners
    • Personal liability of owners
    • Tax treatment
    • Control and management
    • Capital contributions

Business Structure Alternatives

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It is always important to consider the costs and benefits, advantages and disadvantages from legal and tax/accounting perspectives. Thus you should talk with your attorney AND your accountant to discuss your unique situation, possible future scenarios, and other considerations before rushing into formation without proper advice.

Why Business Owners Don’t Plan for Succession … and Why it’s Critical

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www.civil-law.com

Many business owners procrastinate putting a well-conceived succession plan in place. The reasons are understandable. It can be difficult to plan for your replacement and deal with your mortality.
Here are five of the top reasons why business owners don’t have an exit strategy, along with the reasons why it’s best to make a proactive plan.

Reason Number 1: No Time

Business owners are busy with the day-to-day tasks involved in running their companies. There are deadlines to meet and deals to be made. Succession planning can be done … later.
Why this thinking is wrong: Waiting too long can cause the outcome to be less beneficial to the owner and his family. If a rushed decision is made, the owner may get a low price or pay more in taxes than he or she would if adequate planning was done. And in a worst case scenario, “later” may never come. An unexpected death or disability might result in succession occurring sooner than expected and without a solid plan, the future of the business can be placed in jeopardy.

Reason Number 2: Loss of Control

In some cases, business owners may not want to stop working for the companies they spent years building. Giving up control is difficult. Owners may worry they will be bored in retirement or their companies will no longer flourish if they are not in charge. So they hang on.
Why letting go is a better approach: The most successful exit strategy takes months or even years to complete. With proper planning, you may be able to secure a position after the sale as a consultant. If you want to pass on the business to your children or grandchildren, you can be involved in training them to help them achieve success. In other words, a proactive approach brings more control over the end result.

Reason Number 3: Ignoring Tax Issues Because They are Complex

There are obviously a number of ways to structure a succession transaction. The most tax-efficient way depends on the company, the parties involved and when you sell (federal tax capital gains rates may increase in the future). The tax implications of a sale or transfer can be extremely complex.
Why it’s best to get professional tax advice: You have to make several decisions that will affect the tax bill, such as whether to sell assets or stock. Your company may wind up with unknown, costly liabilities if the transaction isn’t structured properly. Handling the sale in a tax-wise manner can save you a fortune in the long run — not only with income and capital gains taxes but also with estate and gift taxes. Consult with your tax adviser well in advance of the actual sale.

Reason Number 4: Not Sure Who Is Going to Take Over

For many owners, there is not a clear-cut successor. Are there partners? Should you sell to employees via an Employee Stock Ownership Plan (ESOP)? Sell to a third party?
In the case of a family business, there are even more questions. What if some children are active in the company and others are not? Which child is going to run the company? Does the “heir to the throne” have the business skills to succeed? Will a formal succession plan cause family conflict?

Without all the answers, a business owner may do nothing.

Why this is a mistake: Without a solid plan, the company you spent years building could cease to exist. There are many options for ownership transfer. You can sell outright, sell to your children, gift interests to family members at a low tax cost — and more. But if you don’t explore the possibilities, you leave the outcome to chance.

Reason Number 5: Not Enough Retirement Savings

While building their businesses, many owners put off making adequate contributions to retirement plans. The result may be insufficient savings. Where is income going to come from during retirement — especially if the owner wants to pass the company onto family members? Often, there is a conflict between wanting comfortable golden years and wanting to transfer the company to heirs as part of an estate plan. So the owner just keeps working.
Why continuing to work without a succession plan is a mistake: By planning ahead, you can take care of your retirement and your heirs. With certain financial strategies, you may be able to retire comfortably and plan for the eventual sale or transfer of the company.

These are just some of the reasons business owners procrastinate and why they need to have proactive exit strategies. Start well in advance. Assemble an advisory team that includes your accountant, estate adviser, corporate attorney, and possibly other professionals.

And if you transfer your business to your children, urge the next generation to start thinking about their succession plans.

Starting a New Company in the New Year? Corporation vs. LLC? Find the Right Entity Form!

Business Entity Formation

Business entities can take many different forms – sole proprietorships, partnerships, limited liability companies (LLC), and corporations are the most common ones. Although they are simple and have the most flexibility and least regulation, sole proprietorships and partnerships fail to protect the company’s assets and the owners’ assets, and they fail to take advantage of many of the tax advantages of other types of entities. Additionally, entities such as LLC’s and corporations tend to present a more professional image and allow for greater future growth.

Corporations

There are a few different types of corporations: non-profit corporations, C corporations, and S corporations. Non-profit corporations must qualify as such under the restrictions of Federal law as stated in the Internal Revenue Code, one of the most important of which is that they must be formed for a charitable purpose as defined there. When incorporating a for-profit company, the default form is a C corporation. Companies must elect to be treated as an S (small business) corporation by the IRS, should they wish to do so, and if they meet certain criteria, such as having no more than 100 shareholders, not having shareholders that are partnerships, corporations or non-resident aliens, and having only one class of stock. C corporations are taxed on their profits, and the shareholders are taxed on the dividends they earn (if declared and distributed), which can result in “double taxation.” S corporations have their income or loss pass through to the shareholders, who report that on their personal tax returns and pay tax at their individual income tax rates.

LLCs

3LLCs are similar to corporations in that they provide a shield to personal liability, and they also enjoy the benefits of pass through taxation. Some have even argued that they provide an even better shield to personal liability than corporations. Additionally, when compared to S corporations, LLCs have fewer restrictions relating to the number and types of owners, and in Texas and many other states, there are less administrative requirements. Also, the form and structure of LLC management is more flexible when compared to corporations.

Comparisons and Considerations

Corporations and LLCs create a legal “person,” (separate entity with rights like a person) that insulate owners’ legal liability for the debts and actions of the company. In Texas, and in most other states, both corporations and LLCs can be owned and managed by just one person. Importantly, however, in order to ensure the limitation of personal liability, all must follow certain financial, accounting, recordkeeping and operational formalities.

It is always important to consider the costs and benefits, advantages and disadvantages from legal and tax/accounting perspectives. Thus you should talk with your attorney AND your accountant to discuss your unique situation, possible future scenarios, and other considerations before rushing into formation without proper advice.

New Year Special!!! Discounted Pricing for Business Formation

From now until January 31, 2016, I will offer anyone who mentions this blog post a special price for my legal services related to forming a business entity. During that time, I will take 25% ($300) off the normal price of forming a corporation or LLC, making the price only $900, plus the filing fee owed to the Texas Secretary of State. Included for this price is the drafting and filing of the Certificate of Formation, as well as the drafting of bylaws (corporation), company agreement (LLC), organizational minutes, and templates for future years annual minutes. Additionally, we include a company records binder, company seal, and pre-printed stock (corp) or membership (LLC) certificates. If you prefer a different entity, I am also offering special pricing on partnerships (general, limited, and LLP). I look forward to hearing from you!

May you have very happy holidays and a healthy and prosperous new year!

“You’ve been served!” on Social Media

Recently, I saw a story that ran on a KEYE-TV (ch. 42, in Austin) newscast about a bill that has been proposed in the Texas legislature by Representative Jeff Leach (R) from Plano. That bill, HB 1989, is proposing to allow people to be served subpoenas through social media.  When I first saw KEYE’s story, I must admit I thought this proposal was one of the worst ideas to be proposed in our Texas Legislature in recent memory.

Opponents of the concept argue that most people (myself included) miss posts and messages sent through social media all the time, there’s no way to confirm receipt by the actual person, and it is hard to confirm that a particular account is actually created, monitored and maintained by the particular individual sought to be served. They also say that serving someone in this manner is inappropriate because it would make the fact that the individual was being sued more public than it should be. While it is true that most court cases are public record, they are passively so–one has to go to the courthouse or to an online site to specifically look for the case. It is not like when someone files a lawsuit, it makes the front page of the paper, except in rare high-profile cases of public interest, and most lawsuits don’t fit that category.

But after reading the article on KEYE’s website (http://www.keyetv.com/news/features/top-stories/stories/texas-bill-would-allow-serving-subpoenas-through-social-media-7193.shtml?wap=0) and reviewing the actual text of the bill (http://www.capitol.state.tx.us/tlodocs/83R/billtext/html/HB01989I.htm), I realized it was not emphasized in the story that the same base criteria that have been in place for “substituted service” or alternative service plus additional safeguards/restrictions applicable only to social media under this bill, would be applied to these situations. Currently, under Rule 106 of the Texas Rules of Civil Procedure, which has been in place over 70 years,

(a) Unless the citation or an order of the court otherwise directs, the citation shall be served by any person authorized by Rule 103 by

(1) delivering to the defendant, in person, a true copy of the citation with the date of delivery endorsed thereon with a copy of the petition attached thereto, or

(2) mailing to the defendant by registered or certified mail, return receipt requested, a true copy of the citation with a copy of the petition attached thereto.

(b) Upon motion supported by affidavit stating the location of the defendant’s usual place of business or usual place of abode or other place where the defendant can probably be found and stating specifically the facts showing that service has been attempted under either (a)(1) or (a)(2) at the location named in such affidavit but has not been successful, the court may authorize service

(1) by leaving a true copy of the citation, with a copy of the petition attached, with anyone over sixteen years of age at the location specified in such affidavit, or

(2) in any other manner that the affidavit or other evidence before the court shows will be reasonably effective to give the defendant notice of the suit

Citation by publication, or serving someone through a newspaper or other published media, has also been provided for in our court procedural rules for over 70 years, and it provides,

When a party to a suit, his agent or attorney, shall make oath that the residence of any party defendant is unknown to affiant, and to such party when the affidavit is made by his agent or attorney, or that such defendant is a transient person, and that after due diligence such party and the affiant have been unable to locate the whereabouts of such defendant, or that such defendant is absent from or is a nonresident of the State, and that the party applying for the citation has attempted to obtain personal service of nonresident notice as provided for in Rule 108, but has been unable to do so, the clerk shall issue citation for such defendant for service by publication.

It is not being proposed that social media be allowed as the primary or first option for serving someone, only when under the rules that already exist here in Texas (and similarly in most states and under Federal court rules also) it would be okay to serve someone by a substitute or alternate method to personal service by a constable or authorized private process server. If a litigant can show a court that service in person or by certified mail as authorized has been unsuccessful and can show that the criteria for obtaining substitute service or citation by publication have been met, under under the procedural rules the court may allow service by such alternate means.

In addition, as described in HB1989, additional procedures and safeguards must be followed.

If substituted service of citation is authorized under the Texas Rules of Civil Procedure, the court may prescribe as a method of service under those rules an electronic communication sent to the defendant through a social media website if the court finds that:

(1)  the defendant maintains a social media page on that website;

(2)  the profile on the social media page is the profile of the defendant;

(3)  the defendant regularly accesses the social media page account; and

(4)  the defendant could reasonably be expected to receive actual notice if the electronic communication were sent to the defendant’s account.

Bradley Shear, a Washington DC area social media lawyer, stated in an ABC News story last year, “Authentication [of the social media user who is sought to be served through such social media] is a major issue since you must be sure that the person with whom you are trying to serve online is the same person offline. You don’t want to have someone’s due process rights infringed upon due to not being properly notified.” This principle is addressed by the first two criteria, as long as the courts hold the attorneys and litigants hoping to use this method to strict and high burden of proof to show that the online person is actually the same person in “real life” who is sought to be served..

So, given the advancement of technology, and the reality that it is possible that it could even be MORE likely in some situations that someone might see the subpoena or other legal process if served through the social media source than by some other means currently becoming less used (i.e., newspaper), if implemented right, I believe that service of process through social media could actually be a better and more appropriate method than certain currently allowed alternative methods.

Service by social media has been allowed  in New York, Minnessota, Nevada (Federal appeals court – 9th Circuit), Australia, New Zealand, Canada, and the United Kingdom, and other jurisdictions are being added all the time.

We will have to wait and see if the Texas Legislature passes HB 1989 to know whether service through social media officially becomes a permissible means to serve someone in a case.

Starting a New Company in the New Year? Corporation vs. LLC? Find the Right Entity Form for You!

Business Entity Formation

Business entities can take many different forms – sole proprietorships, partnerships, limited liability companies (LLC), and corporations are the most common ones. Although they are simple and have the most flexibility and least regulation, sole proprietorships and partnerships fail to protect the company’s assets and the owners’ assets, and they fail to take advantage of many of the tax advantages of other types of entities. Additionally, entities such as LLC’s and corporations tend to present a more professional image and allow for greater future growth.

Corporations

There are a few different types of corporations: non-profit corporations, C corporations, and S corporations. Non-profit corporations must qualify as such under the restrictions of Federal law as stated in the Internal Revenue Code, one of the most important of which is that they must be formed for a charitable purpose as defined there. When incorporating a for-profit company, the default form is a C corporation. Companies must elect to be treated as an S (small business) corporation by the IRS, should they wish to do so, and if they meet certain criteria, such as having no more than 100 shareholders, not having shareholders that are partnerships, corporations or non-resident aliens, and having only one class of stock. C corporations are taxed on their profits, and the shareholders are taxed on the dividends they earn (if declared and distributed), which can result in “double taxation.” S corporations have their income or loss pass through to the shareholders, who report that on their personal tax returns and pay tax at their individual income tax rates.

LLCs

LLCs are similar to corporations in that they provide a shield to personal liability, and they also enjoy the benefits of pass through taxation. Some have even argued that they provide an even better shield to personal liability than corporations. Additionally, when compared to S corporations, LLCs have fewer restrictions relating to the number and types of owners, and in Texas and many other states, there are less administrative requirements. Also, the form and structure of LLC management is more flexible when compared to corporations.

Comparisons and Considerations

Corporations and LLCs create a legal “person,” (separate entity with rights like a person) that insulate owners’ legal liability for the debts and actions of the company. In Texas, and in most other states, both corporations and LLCs can be owned and managed by just one person. Importantly, however, in order to ensure the limitation of personal liability, all must follow certain financial, accounting, recordkeeping and operational formalities.

It is always important to consider the costs and benefits, advantages and disadvantages from legal and tax/accounting perspectives. Thus you should talk with your attorney AND your accountant to discuss your unique situation, possible future scenarios, and other considerations before rushing into formation without proper advice.

New Year Special!!!  Discounted Pricing for Business Formation

From now until January 31, 2011, I will offer anyone who mentions this blog post a special price for my legal services related to forming a business entity. During that time, I will take 25% ($300) off the normal price of forming a corporation or LLC, making the price only $900, plus the filing fee owed to the Texas Secretary of State. Included for this price is the drafting and filing of the Certificate of Formation, as well as the drafting of bylaws (corporation), company agreement (LLC), organizational minutes, and templates for future years annual minutes. Additionally, we include a company records binder, company seal, and pre-printed stock (corp) or membership (LLC) certificates. If you prefer a different entity, I am also offering special pricing on partnerships (general, limited, and LLP). I look forward to hearing from you!

May you have very happy holidays and a healthy and prosperous new year!