Posted on Leave a comment

Business Basics 104

Part 2 – How to Form a Business, Corporations

You don’t have to be a big business to form a corporation. A corporation, sometimes known as a C corp., is chartered with the secretary of state, and is a unique “person” with separate liability from its owners, known as stockholders. The biggest advantage of forming a corporation is that it limits the stockholders’ liability to the amount they’ve invested; they do not have personal liability for the debts or other problems of the company. A corporation also allows multiple people to share in the ownership, and hopefully the profits, of a business without the necessity of working there or other commitments to the company. Corporations choose whether to offer ownership to outside investors or to remain proviately held.

As previously stated, a corporation offers limited liability for its owners. Additional advantages include the ability to sell stock to raise money from investors; to borrow money from banks or investors; perpetual life, i.e. the company does not terminate with the death of its owner(s); ease of ownership change; ability to offer stock options to attract valuable employees; and to raise money separate from getting investors involved in management of the business.

The corporate heirarchy, from the top down, begins with the owners/stockholders who elect the board of directors, the board hires officers, the officers set the corporate objectives and hire management, the managers supervise the employees, and the employees perform the functions of the business. Thus the owners help dictate who runs the company, but not its day to day operations.

There are also disadvantages to corporate entities, including the initial set up costs; paperwork, both initially and ongoing; double taxation – first the corporation pays tax on its income before any is distributed to stockholders as dividends, then the stockholders pay income taxes on the dividends they receive; two tax returns, a corporate return and individual return; once started a corporation is hard to end; and finally the potential for conflict between directors and management.

While we are all aware of many large corporations, IBM, AT&T, Apple, many corporations are small business owners who typically do not issue stock to outsiders, focusing more on limited liability and possible tax benefits.

An S corp. is a regular corporation that elects to be taxed like a partnership, thus avoiding double taxation. Profits of an S corp. are taxed only as the personal income of the shareholders. In order to qualify to make this election, the company cannot have more than 100 shareholders, must have shareholders that are individuals or estates, and who are citizens or permanent residents of the United States, must have only one class of stock, and must derive no more than 25% of its income from passive sources. If an S corp. loses its status as such, it must wait five years to make another S election.

Finally, there’s an interesting hybrid known as a limited liability company. This entity does not have the formal requirements of a C corp. and has the tax advantages of an S corp. It offers limited liability to its members; is taxed as a partnership, though it can choose to be taxed as a corporation; does not have the same ownership restrictions as an S corp.; has flexible distribution of profits and losses, which do not have to be distributed in proportion to the money each person invests, but is by agreement of the members; anddoes not have to comply with the ongoing operating requirements of a corporation, such as annual meetings, minutes and written resolutions, though an operating agreement is a good document to put in place.

LLCs have disadvantages as well, including limitations on transferabiity of membership interests; a limited life span, which could be triggered by the death of a member; inability to deduct fringe benefits, thus few incentives available for employees; although less paperwork than a corporation, more than a sole proprietorship; and members must pay self employment taxes on their profits.

Determining the appropriate form for your business typically involves input from both a lawyer and an accountant to ensure you create the best opportunity for you and your company.

Posted on Leave a comment

Force Majeure Contract Clauses

COVID-19 has caused us to take a deeper look at many of our business practices, including the physical workplace, business plans, and emergency contingency plans. Business contracts are another area that need review.

Business agreements routinely include boiler plate language, such as a force majeure clause. This language protects the parties in the event of an unlikely circumstance that would significantly impair either or both parties’ ability to perform, such as fire, war, flooding, earthquake and the like. While these clauses have rarely been relevant, the pandemic requires us to take another look.

One of the benefits of force majeure clauses is that they protect a party that is unable to perform from claims of breach of contract and related damages resulting from non-performance. The events listed in force majeure clauses differ from a breach of contract scenario because the party did not choose to not perform, rather circumstances beyond its control caused its inability and thus failure to perform.

If your business cannot perform under a contract due to COVID-19, either because of the virus itself or the government’s response to it (shelter in place orders, quarantine or other governmental restraints), look at your existing contracts to determine whether each has a force majeure clause and, if so, whether it is broad enough to include the current pandemic, and how the parties agreed to proceed in the event the clause is triggered. If there is no force majeure clause, or if it is not broad enough to cover COVID-19, there are other legal defenses that can help you, such as frustration of purpose and impracticability.

And while force majeure clauses and other defenses may be available, the best first strategy is to communicate with the other party to the agreement. Using common sense, issues related to non-performance or inability to perfom can hopefully be resolved without resorting to legal action.

Until now, virus, pandemic, quarantine and the like have not typically been listed in force majeure clauses. Many businesses are taking the time now to update their contracts to include such circumstances as a hedge against future unknowns.

Posted on Leave a comment

Hiring 101, Evaluating the Candidate

Good employees can be the most important ingredients in a successful business.  But finding and hiring good employees can be among the most challenging aspects of running a small or growing company.

Numerous federal and state laws govern the various processes of soliciting employees, including advertising, interviewing and hiring.  If you don’t follow the rules, you may find yourself as the defendant in a lawsuit over your hiring (or non-hiring) practices.  Or, you may end up being stuck with a very costly and unproductive employee who you have trouble firing.

Employers are subject to many laws requiring equal employment opportunity and prohibiting discrimination in employment, which can include Title VII of the Civil Rights Act of 1964, the Equal Pay Act, the Age Discrimination in Employment Act, the Civil Rights Act of 1966, the Immigration Reform and Control Act, the American with Disabilities Act and numerous other federal and state laws.

You probably have many questions that you would like to ask a prospective employee.  But certain questions can only get you in trouble (yes, you can trip over many laws in an interview).  The following are examples of questions you should NOT ask:

How old are you?
Do you have any disabilities?
Are you pregnant?
Are you married with kids?
Have you ever been arrested?
What is your religious affiliation?
What is your sexual orientation?

Focus on questions relating to the skill and experience of the candidates and the qualifications needed to perform the job.

Once you find the “perfect” candidate for the job, you should perform a background and reference check before extending an offer.  Ideally the prospective employee will sign your “background check permission form” which allows you to get reference information from prior employers and even do a credit check.  Before formally requesting information in writing from a prior employer, make sure the prospective employee gives you permission to do so.  However, you may find that previous employers are relucant to give much information, often confirming only the employment, position and maybe salary.  (And yes, your company should have a similar policy with respect to your departing employees.)

From a fact checking perspective, think about checking out school experience (some people embellish their degrees or where they went to school); talk to the candidate’s former supervisor(s), if possible, who may provide more meaningful information than the company’s HR department; for sensitive jobs, check for felony convictions; and verify past employment (ensure the candidate actually worked at each of the companies listed, in the position listed, and check dates of employment).

Part 2 of this blog will offer helping hints for your hiring tool kit.

Posted on Leave a comment

Audit Thyself

Audit Thyself

By Alex Gertsburg
The Gertsburg Law Firm Co., LPA
(Reprinted with permission)

Whenever I go to court, I have the same stupid thought: is that judge wearing a real shirt and tie under that robe or is it a dickey?  It’s sophomoric and immature but I can’t get rid of that image of Judge Harry Stone in Night Court wearing that half-shirt in those countless 80’s childhood nights in front of the tube. That and Arnie Becker from LA Law made me want to be a lawyer.  Night Court, that is, not the idea of wearing a dickey.
That’s my Wizard of Oz behind-the-green-curtain question today.  If anyone knows the answer, or if any judges out there are bold enough to fess up, let me know.  Anonymity is guaranteed on pain of a contempt order.
Here’s another one:  what do in-house corporate counsel do all day?  I used to think they split their time between golf courses and suites at the Q.  Wish I did more of that.  I can’t speak for all of them but I can tell you what I did much of the time during my ten years as general counsel for Broadvox.  It all fell into two buckets:  proactive and reactive.  You want it to be a lot more of the former and a lot less of the latter.  More planning for disasters and avoiding them equals less time, less energy, less stress and less money spent reacting to them, and to the government agencies, plaintiffs and plaintiffs’ lawyers that start investigations when a disgruntled employee or customer, or a curious investigator, files a complaint.  It seems obvious because it is obvious.
The way to be proactive is to conduct a good old-fashioned internal audit.  You have to take it seriously and you have to pretend to be someone else.  It’s tough, it’s time-consuming, but it’s worth it.
And here’s the thing:  you don’t need to have an in-house GC in your office to do that for you.  In fact, you really don’t even need an outside attorney to do that for you, though relying on one will be much more helpful, for reasons I’ll mention in a minute.  Like a lot of things in my world, if you study up and plan well enough, then doing an audit with a good lawyer is better than doing one with a bad lawyer, doing one with a lawyer is usually better than doing one without one, but doing one without one can be better than not doing one at all, and that’s what most companies do — or don’t do.  Most companies don’t audit themselves.  That keeps their lawyers much busier later on, when they’re reacting and responding to subpoenas, lawsuits and investigations.
Here’s how you do it:
Step 1:     Create a written plan.  I used a gantt chart.  I love gantt charts.  If you don’t know what a gantt chart is, go google gantt charts.  Every good project needs one.  It’s a chart that shows you a visual, calendar-style depiction of who’s doing what and when.  (Another little nugget you pick up in-house, along with how to read financial statements and how to use excel for things other than shopping lists.)  Business people have outpaced lawyers in this area for years.
Your plan or gantt chart will specify all the tasks in audit, name the person responsible for each task, and state how long that task will go from a start date to an end date.  Go ahead, google it and you’ll see what it looks like.  In fact, google some combination of “internal audit gantt chart” and you’ll see what other folks have done.
Step 2:     Identify the universe of legal exposure areas that your company is likely to have.  One way of thinking about this is picturing your company as a leaky bucket and trying to figure out what’s likely to cause those leaks.  Another image I like to use is something Tony Robbins uses.  It’s a car or bike wheel divided into pie-pieces radiating outwards from the center, with each pie only going out as far as the company is compliant in that area.  When one pie piece is shorter than the other ones (because, for example, hiring practices are 60% compliant while most of the other areas are 90% compliant), your car or bike is going to have a bumpy ride.
Usually, the exposure areas (or pie pieces) fall into these categories:  employment, tax, corporate, contracts, government regulation, real estate and information technology / security.  You want your wheel to be relatively smooth and well-rounded, your bucket devoid of major leaks.
Step 3:     Next, get specific.  Drill down in those leaky areas to the ones specific to your business.  Here, talking to a lawyer helps.
Let’s do an aside here.  Here are a couple of reasons why talking to an attorney at this stage is helpful.  The first is issue-spotting.  For example, on the employment piece of your bucket / wheel, your business lawyer will ask you if you have independent contractors.  If you do, one of the drill-down areas will be proper classification of contractors and employees.  (For more info on this topic, check out our earlier blog post, here.  Another issue your business lawyer will spot is proper exemption classification.  A misclassification of a true employee as a disguised contractor, or of a non-exempt employee as an exempt employee, is a major leak, a major bump in the wheel that is your business.  Don’t get that wrong.  But it’s hard to spot those issues if you’re not a lawyer.  So that’s one reason why it helps to talk to one.
Another really good reason to have an attorney run your audit is that she’s more likely to be objective.  Business owners are like parents of small children, or writers of crappy novels.  They think their creations are better, or smarter, or more interesting than they actually are.  I can’t tell you how many times I’ve had to wake clients up from the sweet slumber of blissful ignorance, simply because they had fallen madly in love with the exceptional analytical skills they’d gleaned from that one semester of business law at Cleveland State (no offense to Cleveland State).
One of the best reasons to have a lawyer conduct your audit though is the attorney client privilege.  With few exceptions, you can protect your compliance audit and all the nasty cobwebs it uncovers with a confidentiality that may be far stronger than any non-disclosure agreement you’ve signed with your employees, assuming you’ve signed one (something a good audit would uncover and a good lawyer would issue-spot).  Lawyers don’t need such agreements.  Confidentiality is an ethical obligation for us and we can lose our ticket if we don’t comply with it.  If your lawyer is guiding your audit, and stamping your plan and your findings with a “performed at the direction of counsel” label, and you don’t waive the privilege by (for example) posting it online or sharing it with your girlfriend, your audit should be protected from later subpoenas.
But I digress…
We’re drilling down.
If your lawyer is involved, he’s creating more specific compliance areas based on the type of business you run and the facts and circumstances inside your business.  If you’re a manufacturer or a car dealership, one specific area within the government regulation pie may be OSHA compliance or environmental compliance.  If you’re a retailer, one specific area under government compliance may be FTC (Federal Trade Commission) or CSPA (Consumer Sales Practices Act) compliance.
If your lawyer is not involved, you may be able to get close by googling (is that a real word now?) “Ohio employment compliance areas” or “[your state] safety compliance” or “[your industry] government regulations”.  Spend a lot of time on this and try to create a hierarchy of compliance areas as best as you can.
Step 4:     Create a compliance checklist for each area.  Again, there’s a lawyer and a non-lawyer answer here.  Lawyers will pull checklists from Lexis or Westlaw or Practical Law or some other research database for each compliance area specific to your business from Step 3.  If you’re not a lawyer, you may still be able to buy access to one of these databases, or you can google that too.  Creating good checklists is really important.
Another aside:  whether you do or do not use a lawyer, don’t expect a perfect checklist or a perfect audit.  The goal is to plug big leaks, the ones that either draw the most attention from plaintiffs’ lawyers and government agencies, the ones that have the highest rates of investigation, the ones that have the highest exposure points, the ones that will cost you the most if you get it wrong.  Again, employee classification tends to be a big-ticket item.  Same with IT security and customer contracts.  If you’re in a regulated industry, agency activity among your peers tends to be well known and easy to research.  Your particular business will also have its own priorities.
I start with Pareto’s Principle:  what are the 20% of compliance issues that tend to be responsible for 80% of the exposure?  I then expand that to 30% or 40%, until I can account for 90%-95% of the exposure points in terms of liability and expense.  This is probably more art than science, but you’re unlikely to create a 100% compliant company without making the audit process more of a pain than it’s worth.
One way to do this is to prioritize your drill-down areas and your checklist items into high-, medium- and low risk items, and note them as such on the checklist.  Later, when you create a report card, you’ll use weighted values to create a sliding scale of scores based on the risk level of each item.
Step 5:   Create your team.  Choose them wisely, assign tasks and then meet with them to explain.  Employee communications should be on a need to know basis.  Let employees not involved in the audit go about their business and their lives without worrying about what an audit might mean.  When we do one for our clients, we do an introductory call or meeting with managers at various tiers of the company who will be involved in the audit.  Managing communications is important to avoid panic or anxiety.  We tell managers that this is intended to help the company keep more of its money and stay out of trouble, nothing more.  We tell them it’s not intended to embarrass or punish anyone, just identify and fix legal issues.  They tend to be receptive to this message.
We also talk about confidentiality, candor and integrity of the process.  This is important and should be carefully scripted.
Step 6:     Document requests and spot checking.
Here we/you will send a document request to the people in your company most likely to have relevant documents.  If you get any pushback, you’re probably on to something.   Review the documents closely against the checklist items specific to documents.  If you’re in a regulated industry, there are probably disclosure obligations or magic language about privacy or warranties or something similar.  They often need to match the regs verbatim.
Many of your document requests will involve spot checking.  Sometimes you’ll want to send someone trustworthy to file locations to pull their own documents.  For checklist items that don’t involve documents (for example, is there a proper eye washing station in your garage bay, if one is required; are fire extinguishers located where they’re supposed to be, etc.), you or your lawyer or your designee will physically go to the department to observe compliance or non-compliance.
Step 7:    Conduct interviews.  This is necessary to learn about processes and practices that are difficult to read in a document or observe when spot checking.  I use the “funnel technique”, where you start with open-ended questions and then drill down to the compliance checklist items, veering off when you hear something worthy of a detour.  If you’re delegating to managers, coach them on how to conduct proper interviews.
Step 8:     Make written findings.  At this point, you’re going to generate a report.  Ideally, your checklist was specific enough to tell you what was necessary to comply or not comply.  Your finding should reference those items.
Step 9:     Create a report card.  Here, you’ll grade your compliance and non-compliance.  We use grades like my kids use.  People seem to like that.  It’s easy to administer, and gives businesses goals to strive for in the next go-round.  Remember that not all compliance areas are equal, and not all checklist items within those compliance areas are equal.  Having an employee handbook with strict anti-discrimination policies, and having the right labor law posters on the wall, may be more important than ensuring that your vacation policy has been properly communicated to that one remote employee you have in Alaska.
Step 10:     Create a fix-it report.  Once you’ve identifies your leaks, create a new checklist to plug them.  This is often a copy/paste job from your report card.  Start with the high dollar / high-risk items and work your way down, flagging any show-stoppers (or as one of my friends calls them, door-closers).  Assign each fix to a particular manager and create a new gantt chart that says who is doing what and when.
Step 11:     Follow up.  You’re almost there.  Don’t waste all that effort.  You need to follow up on the fixes to make sure they’re getting done, and then you need to do a periodic follow up on the entire audit to make sure no one’s sloughing off and that your car is still running on a smooth wheel.  I recommend revisiting your audit at least every six months, at the very least on the high-dollar items.  You also want to revisit your checklists once a year to ensure that new regulations haven’t created new compliance areas or new individual checklist items.
So, okay, I know that seems like a lot.  If you’ve read this far, though, then you’re either my mother or a business-person who’s interested in operating free of legal problems in our business.  Take my word for it — or don’t, you know this already:  be proactive, be a boy scout, be prepared.  You know I’m right.
And now you know what in-house counsel do for their clients, and what former in-house counsel do for their clients when they start a law firm.
Now, who can tell me if judges wear dickeys under their robes?