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Business Entities: Beware of New Reporting Requirement for Change of Mailing Address, Business Location or Responsible Party

February 20, 2014,

If you are an employer in San Jose, you are most likely aware that on January 1, 2014, the minimum wage increased to $10.15 per hour for your business; California's minimum wage increase was to $9 per hour. In addition to new employment laws, there, there have been other new laws that affect businesses in 2014, such as the all new California limited liability company act. But one law actually applies to all business entities with an Employer Identification Number ("EIN"), including entities such as corporations, partnerships, limited liability companies, and even nonprofit organizations. As of January 1, 2014, any entity with an EIN must notify the IRS of a change of (1) a mailing address, (2) a business location or (3) the identity of a "responsible party." A change in a company's mailing address or business location is pretty clear, but the identity of a responsible party may not be so clear.

If you are not sure who the "responsible party" was initially, check the Form SS-4 application that was filed initially by the organization to obtain its EIN, and it will be the person or entity listed as responsible on that form. Then, look at the instructions to Form 8822-B to determine if your responsible party has changed. The instructions define a responsible party as "the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets." If the entity's original responsible party at the time of filing the Form SS-4 is no longer affiliated with the organization or no longer fits that definition, then the entity must use Form 8822-B to let the IRS know.

Form 8822-B must be filed within 60 days of the change. If such a change occurred before January 1, 2014, and the entity has not previously notified the IRS in some other manner, Form 8822-B must be filed before March 1, 2014. If you no longer have a copy of the SS-4 Application or remember who was named as the "responsible party," you may wish to file a Form 8822-B before March 1, 2014.

So, if you are a corporation or LLC making changes on your Statement of Information filing with the California Secretary of State, or if you are amending your LLC operating agreement or your corporate documents, keep in mind that you may also need to notify the IRS of the change. If you are not sure whether your company needs to notify the IRS or other agencies of changes, or if you have questions regarding the "responsible party" for your business, you may wish to consult with a business lawyer or accountant.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Founders' Equity: Repurchase of Unvested Stock by a Company

February 10, 2014,

I spend a lot of time talking to founders of Silicon Valley start-ups about the stock they will receive in exchange for their contributions to their new company, and then preparing restricted stock purchase agreements for the founders. In the last couple of blogs, I have discussed the issues surrounding how founders' stock could vest.

The concept of vesting is usually intertwined with the concept of repurchase rights. Simply put, for founders' stock, vesting is where the repurchase rights held by the company disappear or change. In a typical scenario, when a triggering event occurs, a company can repurchase unvested stock for its original purchase price. A company may not, however, repurchase any vested stock or may only repurchase vested stock at the stock's then fair market value.

What kind of triggering events might allow a company to purchase unvested stock? One common trigger is anything that results in the shareholder not working for the company. Most often, this means a termination of employment.

Termination occurs for a number of reasons. As a result, the number of shares the company can repurchase often changes depending on the reason for the termination. Put another way, vesting can accelerate as a result of certain events occurring. There is no law that dictates how vesting can change, if at all, on the occurrence of a particular triggering event. Founding groups design a variety of triggering events and repurchase rights to meet their goals.

Sometimes it is the company's decision, rather than the shareholder's decision, to end employment. Termination can occur for no particular reason, i.e., at-will, or where the company changes the employment relationship to such an extent that the shareholder terminates its employment, i.e., a termination for good reason. Where a termination occurs other than as a result of the shareholder's decision, it is not unusual for some of the vesting to accelerate. In these cases, the shareholder may receive an extra year of vesting. In cases where a shareholder decides to leave on his or her own, or the shareholder is fired for cause, no vesting acceleration will occur.

Stock purchase agreements will often describe what it means for an employee to be fired for cause, or for an employee to be allowed to leave for good reason. The more objective the description of cause or good reason, the less opportunity there will be for a dispute if a triggering event does occur.

Another common triggering event is an acquisition of the company. In this case, vesting may accelerate to such an extent that all of the shareholder's shares will be vested. Having shares of a founder, who may be critical to the success of a company, completely vest may scare off potential buyers who may want the founder to remain after the acquisition closes. For this reason, a double trigger is often used. In a double trigger, a shareholder's shares will vest if the company is acquired AND the acquirer later terminates the shareholder's employment for no reason. Before a newly formed company issues stock to its founders, it may wish to consult with a corporate or business attorney to be sure to take all of these considerations into account and make sure the founders discuss whether their shares should be issued subject to restrictions and, if so, how those restrictions should be structured.

Before I leave our discussion of vesting, there is one last critical point to mention. Purchasing stock that is subject to vesting can raise important tax consequences. If you receive any stock that must vest, it is critical that you consult your tax advisor BEFORE you sign any agreement purchasing unvested stock.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Founders' Equity - Stock Vesting Schedules

January 9, 2014,

Working with start-ups in San Jose, I have often had to counsel founders on the intricacies of business law as it relates to issuing stock. A large part of initial discussions with the founding group involves the funding needs of the new corporation, how shares will be divided, and the best way to provide equity incentives to founders, advisors, and new employees.

As I discussed in my last blog, one of the key issues involved in issuing stock to founders is how to incentivize them to stay with the new corporation. One mechanism discussed is reverse vesting, where the corporation can repurchase a founder's shares of company stock at their original purchase price when certain events specified in a contract occur.

A typical reverse vesting structure is to allow the corporation to purchase a declining number of a founder's shares at their original purchase price as time goes on. Typically the number of shares the corporation can repurchase will reduce on a straight-line basis over the course of three or four years.

Time may not be the only factor, however, to contribute to the growth of a company. The success of a new venture may be measured by its ability to develop something new and different, or to access markets others have failed to access. Accomplishing this often requires a number of milestones to be met, with many intermediate steps along the way. Because of this, some companies have adopted vesting schedules that allow shares to vest only when the corporation satisfies a particular goal.

As with anything, there are advantages and disadvantages to this approach. One disadvantage is that the milestones that the corporation believes are important at the outset become less critical, especially if the corporation has had to pivot its product or service offerings. Amending stock purchase agreements may not be easy down the line due to founder resistance, among other things. Recognizing this, valuable talent may not be disposed toward accepting stock with this kind of structure and may seek greener pastures. Another disadvantage is that the growth path for the venture may be so uncertain that it is very difficult to define the critical tasks that allow the stock to vest. This is especially true here in Silicon Valley where technology advances and competition often require shifts in start-up strategies. This may result in stock becoming vested on an event that does nothing for the corporation.

There are some important advantages to vesting by milestone. The first is that it could prevent a founder, who contributed little to the corporation's growth, from having a large interest just because he or she stuck around. In those cases where a founder has since left the corporation but still maintains a sizeable interest, management may not have the flexibility to increase the corporation's stock option pool because investors may believe that they have already suffered too much dilution. The solution may be for the remaining founders to reduce their interest, at least on a relative scale, to be able to have a meaningful stock option plan. A well thought out milestone vesting structure can help prevent this from happening.

A second advantage to vesting by milestone is that it forces the founders to really think through their business plan, and to set up a milestone schedule that is objective and attainable. Investors can be comforted by this approach because it shows that the founders have a plan over which success can be measured. This may prevent investors from increasing the time for shares to vest as a condition of their investment.

A third advantage to using milestones rather than time for stock to vest is that it assists in keeping founders focused on the particular goal because of the strong reward provided in reaching that goal.

So what is the bottom line here? Basically, if you have a start-up where technology and market development can be objectively defined, and there is a little risk of a pivot, then milestone-based vesting may be the way to go. Otherwise, you are probably best to use a time-based vesting and staying on top of each founder's efforts to make sure an adequate contribution is made to the venture.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

The Vesting of Stock - Founders' Equity

December 9, 2013,

Practicing business law in Silicon Valley over the past year, I have seen start-up activity pick up. We are in that part of the cycle where the survivors of the not so great recession have decided that they are better off on their own and have decided to make their dreams come true by forming their own companies.

Because many of these companies hope to become a welcome opportunity for outside investors, their choice of entity is the corporation. From the legal end, the process of incorporation is fairly straightforward and can be accomplished relatively quickly. Founders have a number of decisions to make, such as how much they want to each contribute to the new venture, and who will have which role.

Where a group of founders is involved, one of the most difficult issues, relatively speaking, is the issuance of stock. The first issue involves what percentage of the corporation each of the founders should receive. There are few, if any, rules of thumb as to whom should get what, and the decision is typically made by the founders assessing each of their respective strengths and weaknesses, and their contribution to the new venture, and deciding on a split. If the new corporation never expects to issue any new stock, and each founder will be actively involved in the business with profits being split at the end of each year, there may be little more to do with the stock other than to create a suitable buy-sell relationship.

For those corporations on the start-up path, where technology will need to be developed at the expense of salaries, and where outside funding may be required, additional mechanisms are often designed. The mechanisms, known as vesting, repurchase rights, and transfer restrictions, each have a number of complications and purposes, and this next series of blogs will explore the basic issues that founders should consider when determining whether to apply these mechanisms to their stock.

Let's start with vesting. Simply put, when something vests, you have the right to it. For example, when an option vests, you have the right to exercise it and receive stock.

How do you apply this concept to already issued shares, particularly those shares that are issued to founders when the corporation is formed? In this case, you adjust the vesting concept so that the shares can be repurchased by the corporation under certain events. This mechanism often referred to as "reverse vesting". The number of shares that can be purchased, however, is reduced over time or on the occurrence of certain events. Shares that can't be repurchased are deemed to be vested.

So, why do this? Start with the proposition that vesting only works with shareholders who are actively involved in the business. Vesting encourages the shareholder to stick around and continue to work with the corporation for a period of time so that all of the shareholders get the full benefit of their shares. This helps bind the founders together, because they are doing more than promising that they will work to make the new corporation a success. They now have an economic reason to do so.

Another reason is to make sure that if a founder does not work out, or cannot contribute for reasons of death or disability, their interest will be reduced appropriately. The shares that are repurchased can then be used as incentives for the founder's replacement.

How does this mechanism work? Here are some examples of time-based vesting. In Silicon Valley, a common vesting structure (although not necessarily for founders) is a four-year vest with a first year cliff. This means that all of the shares will vest in four years so long as the founder is employed by the corporation for those four years. This is the four-year part. For any of the shares to vest, however, the founder needs to be employed for at least one year, at which time 25% of the shares will vest. Thereafter, shares will typically vest evenly on a monthly basis.

Another example, sometimes used with founders, is to allow vesting over a three-year period, with no cliff. This means that so long as the founder stays with the corporation, his or her shares continue to vest on a monthly basis. If the founder is with the corporation for three years, all of his or her shares are vested.

Vesting schedules based on time are by far the most common form of vesting used. Vesting schedules based on time may also be the least effective. My next blog will tell you why.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Tax Planning Reminders for Businesses Before Year-End

November 7, 2013,

It is that time of year again. Every year in the fourth quarter, businesses in San Jose and all over the United States are looking at the quickly approaching year-end and trying to figure out what they can do now before it is too late to save on taxes for 2013. This is especially true for small businesses, where every dollar of deduction is important because it hits the owner(s) directly in the pocketbook. My law firm is an LLP, so all items of profit and loss flow through to the partners. Therefore, this is the time of year that I look very carefully at how much money is available and what my law firm is going to need or want to buy in the next few months. Do we need a new copier? Do we want to upgrade our software? If so, let's do it in December rather than January and get the deduction this year. With this in mind, here are a few things for business owners to consider before 2013 is over.

Purchase Equipment for Your Business
Make your equipment purchases before year-end. In 2013, up to $500,000 of both new and used assets purchased and actually put in use by December 31st can be expensed. This means you get a dollar for dollar deduction this year, without having to depreciate the asset over its useful life. This is really helpful for partners that want a deduction for every dollar spent so that they do not have taxable profits without available cash for distribution. But this benefit is limited. If you purchase and put in place more than $2,000,000 of assets during 2013, the $500,000 expense is phased out on a dollar for dollar basis. These limits will likely be even lower next year, so take advantage of them now.

Make Tenant Improvements on Your Commercial Property
Another tax break set to expire after his year is the 50% bonus depreciation, which allows companies to write off half the cost of new assets with useful lives of 20 years or less, in the first year. This includes interior leasehold improvements for commercial real estate. The remaining 50% is depreciated as usual. So, if you are planning some nice tenant improvements in your office, do them before year-end, just in case Congress does not get around to extending this tax break.

Purchase an SUV for Your Business
Have you been thinking about a new Sport Utility Vehicle? You can deduct most of the cost of new SUVs that are used 100% for business and weigh over 6,000 pounds, in the year of purchase. First, there is the special $25,000 deduction for new SUVs, add to that the 50% bonus depreciation, plus normal depreciation on top of that, and you end up with approximately $46,000 of a $60,000 heavy SUV being deductible this year.

So whether you are a partner in a law firm like me, or a partner in any type of business partnership, or a shareholder in a corporation, do not wait until tax time to look at what deductions are available to you. Start planning now for tax savings later.

Source: The Kiplinger Tax Letter, Vol. 88, No. 18, Aug. 30, 2013

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Crowdfunding Made Easy? Not So Much

October 1, 2013,

I have always known that Silicon Valley is home to many innovative companies and has a lot of entrepreneurial talent, but I was still amazed to read that start-ups in Palo Alto, Mountain View, Redwood City, Sunnyvale and San Jose received a combined $980+ million in funding in Q2'13. [Source: Silicon Valley Business Journal, July 16, 2013]. As a business lawyer in San Jose, I have seen a number of attempts to make fundraising for start-up companies easier. Recently, a new technique has come into favor.

The new buzz word for start-ups looking for funding is crowdfunding (sometimes known as crowdsourcing). In this type of deal, a group or entrepreneur will receive contributions from a large number of people for a project. The process started with artists raising money for their projects. Their success led for-profit companies to look at crowdfunding to raise money. Websites like kickstarter.com and indiegogo.com are just a few that provide crowdfunding opportunities.

To encourage crowdfunding, Congress passed the JOBS Act a year ago last September. In response, the Securities and Exchange Commission (SEC) released new regulations intended to encourage crowdfunding. One of the new regulations relaxes the public solicitation limitations that had been imposed for certain types of private financing deals.

A little background may be helpful at this point. Because start-up fundraising involves selling stock, start-ups have to comply with federal securities laws. To avoid the formal and expensive registration process, companies comply by using an exemption, known as Regulation D. To be eligible to use Regulation D, you could not publicly solicit your stock. Here is where the SEC relaxed its requirements. For issuances involving only financially sophisticated persons who are accredited (meaning, rich) investors, you can publicly solicit your stock. Life is good!

Well, not so fast. The SEC said if you publicly solicit, you need to be sure the investor is actually accredited. So, what do you have to do?

In the past, most stock purchase documents merely have the purchaser state they are accredited. Under this new rule, that will not be enough. Instead, the issuer has to take "reasonable steps to verify that such purchasers are accredited investors." The SEC did not want to dictate what has to be reviewed to verify accredited status, but did make some suggestions. For example, if you are using income as a basis for accredited status, you can look at tax returns. If you are looking at net worth as a basis, you can look at bank statement, brokerage statements, and a consumer report as to liabilities from a nationwide consumer reporting agency. You can also accept a written statement from a registered broker-dealer, registered investment advisor, or attorney.

Another set of regulations that is required under the JOBS Act governs the operation of funding portals, essentially companies that will enable investors to invest in start-up companies. The only problem with these regulations is that they do not yet exist. We are all waiting for these new regulations, and the latest rumors are that we should see something in the last quarter of this year.

What this all means is that if you want to use crowdfunding to sell stock, you will need to be a lot more invasive in investigating the financial status of your investors. Investors may not be comfortable releasing this information. As a result, this newest revision from the SEC may not open the floodgates of capital to start-ups. In addition, if you want to use a funding portal, you need to wait a little longer for the SEC to get its regulations together. Still, it all adds up to a new way of raising funds, and may prove to be useful in the right situation.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Asset Purchases May Come With Hidden Liabilities

September 11, 2013,

One of my clients is a medium sized manufacturing plant here in San Jose. Although not a high-tech business, they have extensive capital assets and specialized skills. The business is being run by the second generation of family members, and the third generation is now being trained to take the reins someday. The family has recognized that many of their competitors are still being run by the first generation of owners, and it does not look like those businesses are likely to transition to other family members. As the owners of the competitive businesses age and want to retire, they will be looking to sell their manufacturing plants. My client wants to buy them. We recently sat down and discussed acquisition strategies. I explained that there are two common ways to buy a business - either you buy the stock, or you buy the assets. What most people do not realize, is that even when you are only buying the assets, you could be liable for up to three times the purchase price in state taxes that should have been paid by the seller.

Most people know that when you buy the stock of a corporation (or membership interests in an LLC), you get all of the assets as well as all of the liabilities in that company. As a result, many of my clients want to buy only the assets of a company as a strategy to avoid the liabilities (known and unknown) that come with a business with history behind it. To accomplish this, we draft an asset purchase agreement that includes lists of which assets we are buying, which liabilities we are buying, and which liabilities we are not taking on. For example, when you buy the stock of a company, you get all of its employees including their accrued and unpaid vacation time. When you buy the assets of a company, we ask the selling business to terminate all of its employees so that we can start over by hiring them in the acquiring company as new employees, without any potential claims for what came before. However, many people do not realize that certain tax liabilities may follow the business of the company rather than the company itself. So, if you buy enough of the assets to be considered as having purchased the company, you could be buying tax liabilities... even if they are on your list of items excluded from the sale.

Each of the Franchise Tax Board (state franchise and income taxes), the Board of Equalization (sales taxes) and the Employer Development Department (employment taxes) has the right to come after the buyer of a business for unpaid taxes in an amount up to the entire purchase price. So, if you pay $100,000 for the assets of a company, you could be liable for unpaid taxes of up to $100,000 to each of those three government entities. Your $100,000 purchase price just became $400,000!

Most asset purchase agreements deal with this concern in two ways: First, they request a representation and warranty from the seller that there are no unpaid taxes. Second, the agreement includes an indemnification provision whereby the seller has to indemnify the buyer if any claim for unpaid taxes is made against the buyer for the time period before the company's assets were purchased. However, an indemnification provision is not enough protection. All it does is provide a contractual claim against the seller. The buyer still has to sue the seller and get a judgment and then collect that judgment.

A much better way to protect yourself as a buyer of a business is not to rush into things. In only 60 days, you can get tax clearance certificates from all three entities showing you exactly how much unpaid taxes, if any, are outstanding. Each agency has its own requirements for submitting such a request. If the agency does not return a tax clearance certificate within 60 days (30 days for the EDD), then the buyer may not be held liable for outstanding taxes of the seller's business. So, take your time, open an escrow, and get tax clearance certificates prior to closing escrow on the purchase. And of course, consult with an attorney if you need help with an acquisition. Otherwise that $100,000 business may cost you $400,000 in the end.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

A Checklist for Closing Down a Business

August 7, 2013,

Small businesses dominate the U.S. economy. According to the U.S. Small Business Administration (SBA), 99% of all independent companies in the U.S. have less than 500 employees. As a small business attorney in San Jose, most of the time I am working with clients to form new businesses. However, as we all know, not all businesses succeed. Recently I was counseling a client with regard to the sale of her retail store. She had worked hard building the store into a business that could support her needs, but it was time to retire. Rather than going through the hassle of selling the business as a whole, she decided to simply sell the inventory to a competitor and shut the doors. However, shutting down a company can still be a hassle, and if you forget to do one thing it could result in a big liability later.

So, what does it take to shut down a small company? Here is just a short to-do list of the basic items common to most small businesses. This list does not take into account the added complexities of a business with multiple owners.

1. Talk to your accountant, attorney, financial advisor and any other professionals that may be able to assist you in a smooth closure of your business.

2. Check your leases and terminate them. If they cannot be terminated, try to negotiate with your landlord. For example, if your real property lease still has a number of years left to run, advanced notice to the landlord may allow time for the landlord to re-rent the space. Or, the landlord may take a lump sum payment of a portion of the total liability to let you out of the lease now. Do not forget smaller leases like your postage machine lease or copier lease. If you have a car lease, talk to the dealer about assigning the lease to you individually.

3. Check your contracts for rights to terminate and any personal liability. If allowed, provide notice of termination. Try to complete contracts if possible. If not, return any unused deposits or payments.

4. Try to sell off as much inventory as possible. Use a liquidator, have a 'going out of business' sale, and contact competitors to see if they want to buy what is left at a discount. Publish a bulk sales notice if required.

5. Liquidate other business assets - furniture, equipment, etc.

6. Collect as much of the accounts receivable as possible - after others hear you are going out of business it may be harder to collect.

7. Notify anyone that may be affected by the closure - especially creditors. Pay or settle your debts as much as possible. Ask each creditor for a confirmation that they have been paid in full, or settled in full satisfaction. Note that there are specific bulk sales requirements for notifying creditors if you sold your inventory. If you cannot satisfy your creditors, contact a bankruptcy or insolvency attorney to help assess your options. A bankruptcy or an assignment for the benefit of creditors may affect your rights to take actions on this list.

8. Tell your employees and give them as much notice as you can. Be ready to pay them their final paychecks, including all accrued and unpaid vacation, on the date of their termination. Notify your payroll company that these are the final paychecks so they can notify the Employment Development Department (EDD), or if they do not notify the EDD, file a DE-24 form yourself.

9. Submit final sales taxes and employment taxes.

10. File all final federal, state and local tax returns.

11. Cancel any business permits or licenses, including sales tax resale permit. File a Notice of Closeout for Seller's Permit (form BOE-65) with the California Board of Equalization,.

12. Close your bank accounts, cancel any line of credit and outstanding credit cards, and shred business checks.

13. Turn off utilities.

14. Forward mail and email accounts.

15. Shut down websites (or post a notice) and turn off any e-commerce accounts.

16. If you have a fictitious business name, file a statement of abandonment with the county.

17. Distribute remaining assets to yourself (the owner), but only after creditors have all been satisfied. It is important to transfer any assets that are currently titled in the name of the business, before the business entity is dissolved.

18. Dissolve your business entity with the Secretary of State.

Businesses with more complex ownership structures may wish to consult with an attorney or tax professional to guide them through the shutting-down process.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

UCC-1 Financing Statements: Easy to Make A Whopper of a Mistake

July 25, 2013,

In this digital age, the courts increasingly have zero tolerance for errors on a UCC-1 financing statement intended to perfect a lender's security interest in collateral as part of a loan transaction. Most recently, a federal court in Rushton v. Standard Industries, Inc., et al. (In re C.W. Mining Company), 488 B.R. 715 (D. Utah, 2013) ruled that a UCC financing statement that omitted two periods from the debtor's name was materially misleading, and the "secured party" was therefore not perfected. A lender who thought it was properly secured on a $3 million obligation suddenly found itself entirely unsecured because of this seemingly trivial mistake!

The debtor in this matter was C.W. Mining Company, whose fortunes had slipped, leading to a bankruptcy. Well before the bankruptcy petition was filed a creditor with a security interest in coal owned by the debtor (C.W. Mining Company was a coal producer) filed a UCC-1 financing statement naming the debtor as "CW Mining Company." The bankruptcy trustee (usually the bad guy in these situations, from the secured creditor's point of view) brought an action to, among other things, avoid the lien because of this mistake, arguing that the creditor was not properly perfected.

The Bankruptcy Court and the Federal District Court, on appeal, agreed with the trustee. They held that the manner in which the creditor set forth the debtor's name on the UCC-1 financing statement was seriously misleading, as it omitted the two periods. Of major importance was the fact that the search algorithm used by the state - Utah in this instance - did not pick up the filing in its data base when the debtor's proper name was entered.

This recent case is in line with the harsh holdings for creditors by other courts on this issue. So what is the take-away lesson? If you intend to be a secured creditor, treat the debtor's name as you would a new email address or a phone number. If you are off by one character or digit, the communication fails. This means getting the debtor's registered name (when the debtor is a corporation, limited liability company or LLC, or limited partnership) correct from the beginning by searching the Secretary of State's business entity information and/or obtaining copies of articles. Don't rely on the name put down on a letterhead, logo or business card, which may simply be a trade name. Also, when filling out a UCC-1 financing statement, be sure the information inserted on the form is carefully checked and the process supervised, not delegated to an inexperienced person and forgotten.

There is a UCC Safety Net but it has Many Holes!

If you discover that a financing statement has a mistake in the debtor's name, you of course should take steps to correct it, but even without doing so a possibility exists that the security interest will nevertheless be perfected and enforceable. The Uniform Commercial Code provides that if a search of the records in a state's filing office under the correct debtor name using "the filing office's standard search logic" would disclose the creditor's financing statement, the error in the debtor's name is not seriously misleading. (This is found in Section 9506 of the California Commercial Code.) The more sophisticated the particular state's UCC search algorithm, the more likely it is that errors or inconsistencies will be recognized and the financing statement nevertheless captured and displayed in a search, providing a small measure of safety for the secured creditor. The obvious problem is that it is difficult or impossible to know in advance whether a seemingly minor mistake on the financing statement will be fatal or not. Therefore, the only safe approach is to get the debtor's registered name right on the UCC-1 financing statement, character-by-character.

A Legal Note Concerning UCC Financing Statements and Perfecting a Security Interest in Collateral

To have an enforceable security interest in most types of business assets, a UCC-1 financing statement must be filed in the filing office of the state where a debtor is registered - assuming the debtor is a business entity such as a corporation, limited liability company or limited partnership. In California and most other states, the filing office is run by the Secretary of State. Most lenders and borrowers are very familiar with this process. The UCC-1, once filed, becomes part of the searchable data base in the state where it is filed. In lawyer-speak, filing the UCC-1 financing statement "perfects" the security interest, which is an essential requirement to making it generally enforceable. The UCC-1 filing also gives the lien priority over any lien described in a later filed UCC-1 financing statement, as well as certain other types of filings. If a person wants to learn whether anyone has a lien encumbering assets of a particular debtor, a search can be conducted under the debtor's name and all generally enforceable encumbrances on the business assets of the debtor will show up - so long as the correct debtor name is entered.

A UCC-1 filing will not perfect a security interest in certain types of collateral. To perfect a security interest in real estate in California and most other states (as is well known by most lenders and borrowers), a deed of trust or mortgage must be recorded in the real property records of the county in which the real property is located. Other types of specialized collateral, such as copyrights, aircraft and motor vehicles, have unique filing offices and requirements for perfection of security interests. A security interest in some other types of collateral, such as bank accounts, stocks and securities, may be perfected by possession or control.

You probably can guess the last point to be made here. Perfection of security interests can be a confusing matter, so if you have any questions, consult your attorney!

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

New Corporate and LLC Startups May Find Relief with the Passage of a New Bill in California

July 15, 2013,

In Silicon Valley, home to many large technology corporations and thousands of innovative startups, businesses need to move quickly to stay ahead of the competition. As a small business attorney in San Jose, I have formed countless of limited liability companies (LLCs), partnerships and corporations with the Delaware and California Secretaries of State over the years. And one of the first questions my eager small business clients ask me in our initial meetings is almost always, "How long will it take to form my company?"

For many years my answer was that we could have the filed Articles of Incorporation (for a Corporation), Articles of Organization (for an LLC), or Certificate of Partnership within about a week. When the California Secretary of State slowed down a few years ago, I had to tell clients that it could take as much as several weeks. However, in the last year or so the delays crept up to three months or more for the California Secretary of State to process and return a business filing.

Of course, California does provide a 24-hour expedited filing option, for an additional $350 over the usual filing fees. In my more cynical moments I have had to wonder whether it was the California budget crisis that was causing filing times to slow down because of lack of resources, or if the Secretary of State was purposefully taking longer to return routine filings in order to force virtually everyone to pay the "rush" fees.

Now it seems my cynicism may have been misplaced. Governor Brown just signed a bill (AB 113) which will provide $1.6 million in funding to the California Secretary of State to be used to eliminate the backlog of over 100,000 filings and speed up the business filing process. The stated goal is to reduce waiting times for a business filing to be processed and returned from three months to between 5 and 10 days by November, 2013. [Source: Spidell's California Taxletter, Vol 35.6, June 1, 2013, p.71]

Although I applaud the Governor for trying to do something, I think we need to go a lot further than this. As the home of Silicon Valley, California should be setting the standard for the use of technology in business. Never mind that we can form corporations and LLCs usually the same day by email in Delaware (with no extra fees). I want to be able to form entities immediately on-line, without extra State charges, and without the need to pay extra fees to filing agents in Sacramento to walk my client's filings into the Secretary of State's office to be at the front of the line (processing times for filings by mail are much slower).

If our business owners and inventors can start their business in California faster and less expensively (with no rush fees), this will benefit everyone. The State will collect more franchise taxes and will likely start collecting more payroll taxes and sales taxes from new businesses sooner. With this in mind, I hope the Secretary of State is seriously considering significant investments in technology both as part of the $1.6 million and in addition to the AB 113 funds.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Upcoming Nationwide Changes in UCC Financing Statements

June 28, 2013,

Head's up!! UCC financing statements are changing as of July 1, 2013. Lenders and borrowers need to take extra care to ensure that they have correctly prepared UCC financing statements and, of course, consult with an attorney as necessary. UCC filings are of critical importance in any secured loan transaction, whether it involves asset based loans, technology lending, construction financing, equipment financing, and even real estate lending where fixture filings may be an integral part of the transaction or personal property may be included in the collateral pool. Accordingly, changes in UCC forms affect every lender, secured party and borrower. In a problem loan, loan workout or bankruptcy situation, the validity of the lender's security interest becomes of paramount importance.

For lenders, the basic rule for perfecting a lien or security interest in most types of assets is to file a UCC-1 Financing Statement with the Secretary of State where the debtor or borrower is registered. If the borrowing company happens to be in San Jose or Palo Alto, California, for example, and is registered as a California corporation, the UCC-1 is filed with the Secretary of State in California. As of July 1, a revised form of UCC-1 is to be used in most states, including California and Delaware.

The changes to the form are driven by privacy concerns and primarily involve eliminating entries for a company's registration number and an individual's social security number. Such identifying information has not been required - in fact, social security numbers have automatically been redacted or made unreadable - for a while now in California. One thing the change highlights, however, is the ever-increasing importance of getting the debtor's name correct on the UCC form, character by character, as other references to a borrower or debtor no longer appear.

California says that it will continue to accept the "old" form of UCC-1 for the present, but that may change with the old forms entirely eliminated in the future once new forms are widely circulated. Other states have announced that the period for accepting old forms will be phased out just 30 days after July 1, after which time only new forms will be accepted for all UCC filings.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Closing a Business Transaction is A Lot Like Riding a Mountain Bike

June 10, 2013,

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

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

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

Both deals and rides can vary in how they start. Sometimes, you are thrown right into the negotiations, having just met the client minutes before, like the ride that starts with a pounding incline over gravel and sharp rock. Other times, there are in depth discussions over goals and approaches, like the trail that starts level and smooth through redwood shade.

Then, there is the slog. I ride in the mountains, and it is very typical for rides to start uphill, and end downhill. Cranking slowly up a ponderous grade is not glamorous, but is critical to getting to your goal. Even a business deal built on insightful strategy needs implementation, and it is the late nights and weekends, slogging through reams of documentation and often mind-numbing minutiae that lead to success. It is sweaty ponderous work, but somebody has got to do it.

The home stretch is where things can get, shall we say, interesting. In mountain biking, the downhill is where skill is required to keep bike and body together. Any mountain biker will tell you about their last "endo," so named because your body has just gone "end over" the handle bars. Road rash and cracked ribs are the usual result. In deals, it is the same. At some point, some new fact or number is looked at just a little bit differently, or a recalcitrant stockholder will not cooperate, or a delayed negotiation on a major issue leads to stalemate, or a lawsuit from left field hits, and you have received the legal equivalent of a body slam. Although the first few minutes may feel like it is the end of the world, most times you pick yourself up, assess the damage, figure out the fix (time to replace the rear derailleur drop out or buy out that difficult stockholder) and continue on your way. In rare circumstances (like you just snapped your collar bone or the Federal Trade Commission will not approve your deal), you lick your wounds and try again another way on another day. But this is rare.

There is an old lyric that goes "... you better watch your speed, trouble ahead trouble behind, don't you know that notion just crossed my mind". All parties to a deal want it done yesterday, and the business case for doing so can be convincing. Going too fast on a mountain bike, however, can lead to the dreaded endo, and a whole other parade of orthopedic and epidermal horribles. In a business deal, it can be worse. The Time Warner AOL acquisition was rumored to have been negotiated and signed under a very compressed time schedule, and is taught in business schools as one of the worst mergers in American history. Go fast, but be deliberate and do it right.

Everyone will tell you that deals are not a sprint. In any ride, you need to make sure your energy stays fueled, or you will "bonk", hit the wall, run out of gas, or hit countless other metaphors that mean you've just come to a full and complete stop. In a transaction, we call it deal fatigue. Bringing up countless new issues as a deal gets closer to close, experiencing unexpected delays, or a thousand other things, can kill a deal as fast as any bonk. The cure: deal with it upfront. Before a ride I slam a peanut butter sandwich (whole grain bread, thank you very much). Before a deal, the more I know about the parties, their business, motivation, experience and interests, and the more I know about getting done the type of deal in which I am involved, the less chance my transaction will bonk.

I could go on, but the last conference call just ended, the next turn of the agreement went out the door, and it is time to go spin the local single track.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

I Gave It All To You, So Why Don't You Like Me: Post-Closing Disputes in Mergers and Acquisitions

May 22, 2013,

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

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

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

Post-Closing Audit
The first concerns the post-closing audit. Typically, a selling company's books will close on the actual closing date, and funds will be held back to deal with any adjustments exposed by the audit. Hopefully, the buyer and seller will have agreed in advance to the accounting procedures which must be used, i.e., how generally accepted accounting principles will be interpreted. Otherwise, the first fight will be over whose interpretation should control. This is particularly difficult, because each side may be constrained to using accounting procedures that differ from each other. Key issues in accounting procedures that can lead to disputes revolve around revenue recognition (a favorite for software companies), collectability of receivables, and valuation of hard assets.

Adjustment of Working Capital
The second concerns the working capital adjustment. This follows closely behind the audit, because it is the audit that establishes whether the working capital adjustment established in the acquisition agreement has been satisfied. I have talked before about the working capital adjustment, and like any post-closing adjustment, it is critical to ensure that the parties establish agreed upon accounting procedures to make sure they are not comparing apples to oranges.

Earnouts
The mother of all battles, however, usually occurs around earnouts. I have spoken about earnouts before. Earnout disputes are so pervasive in merger and acquisition deals that litigation attorneys have another word for them: inventory. This is also where the seller must be the most involved. Earnouts depend on business performance, and as much as the seller wants to start their new life, their presence and operation of the company post-closing can make a large difference in the amount ultimately received for their business. Changing business operations, sales approaches, and collection procedures are all matters the former owner needs to watch carefully. One of the biggest issues comes in the form of administrative overhead allocations, with the earnout payment being reduced due to a reduction in net earnings as a result of over allocation of administrative overhead.

Breach of Fiduciary Duty
Another fruitful area for litigation is where a representation or warranty may be breached. We discussed these in past blogs, and noted that, in most deals, funds are held back to satisfy buyer damages arising out of a breach of a representation or warranty. A seller that remains on the shop floor, so to speak, often has the institutional knowledge and relationships to prevent or minimize the acts or omissions that lead to a breach, and thereby reduce the ultimate hit against the holdback that might otherwise occur.

Resolving post-closing disputes is not easy. Most acquisition agreements will require disputes to be resolved through arbitration, which is usually faster than waiting for a court (especially here in California with our impacted court system). Arbitration, however, is not simple, fast or inexpensive. Where post-closing adjustments are involved, many of the issues revolve around accounting concepts, requiring accounting experts to be retained. These experts are not cheap. Where a seller's representation has been breached, complex indemnification provisions are often triggered, which can muddy ultimate resolution. It is not unusual for post-closing disputes to add a year or more to ultimate payout to a seller.

For this reason, sellers should expect that their full payout from the sale of their business may require continued involvement for a year or two after the closing. Sellers may find, however, that the additional involvement is a small price to pay.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Recent California Tax Law Changes

May 13, 2013,

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

Yet Another Gas Tax Increase
On February 28th the Board of Equalization approved a 3.5 cent gas tax increase, effective July 1, 2013. This brings the gas tax rate to 39.5 cents for 2013-2014. This adjustment should produce revenue at the same rate as if Proposition 30 applied to gas sales. (Proposition 30 resulted in a 0.25% state sales tax increase which does not apply to gas sales.)
Source: Spidell's California Taxletter, Vol. 35.4, April 1, 2013.

Payroll Tax Reporting Changes
The Employment Development Department has announced two changes:

First, employers must use "business days," not "banking days" to determine payroll tax deposit due dates.

Second, an employee is considered a rehire if she returns to work for an employer after a separation of at least 60 consecutive days. Employers must report all new and rehired employees to the New Employee Registry within 20 days of starting work.
Source: Spidell's California Taxletter, Vol. 35.4, April 1, 2013.

For Real Estate Professionals
A real estate professional that spends over half of his or her working hours and at least 750 hours per year materially involved in real estate is exempt from the passive loss rules. These tests are difficult to meet if you also have a job, and the IRS knows it. Since 2007 the IRS has been specifically pulling returns for audit of individuals that claim they are real estate professionals but also have significant W-2 wage income. Be reasonable -- records of time spent on real estate must be contemporaneous and believable.
Source: Kiplinger Tax Letter Vol. 88 No. 8, April 12, 2013.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Closing the Deal: Boring is Best

March 27, 2013,

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

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

Obtain Stockholder Approval:
Stockholder approval, especially where large numbers of stockholders exist, can often be a gating item. As with third party consents, it is critical that the parties design a strategy early on for soliciting approvals from the stockholders, and, if necessary, investigate and resolve any securities compliance issues that might exist. This may require significant advance planning and document creation, particularly for securities compliance purposes.

Complete Agreements and Disclosure Schedules Before Closing:
Part of planning ahead is to front load all of the work that needs to be accomplished for the closing. For those transactions in which a closing follows sometime after the contract signing, agreements and schedules required for the closing, such as key employment agreements and disclosure schedules, should be completed and attached to the contract as part of signing. The temptation to put these types of schedules and agreements off until the closing can prove costly, as these types of documents, particularly a disclosure schedule, can raise issues which may require significant time to resolve.

Remove Contingencies:
As a closing approaches, it is critical to make sure all contingencies pertaining to the closing are removed or waived. One way to ensure this is to make sure, during contract negotiation, that contingencies are based on standards that are objective and easy to determine. One area that can be problematic is a contingency based on the occurrence of a material adverse effect. Because these tend to be very broadly and qualitatively designed, it is best to objectify them as much as possible. This can be accomplished by tying the effect to financial or other measures, or limiting it to known risk issues.

Have a Pre-Closing Review:
Expectations during this period need to be rational. If there is any deal term or contingency that is open, the transaction simply is not ready to close. For this reason, it is always a good idea for the deal team to conduct a pre-closing a few days before the planned closing date, to make sure all remaining issues and contingencies are resolved and that the documentation is sufficiently in order to close.

Be Closely Involved:
The most important task for the business executive is to understand that his or her job at this point in time is not necessarily to run the business, but to get the deal done. The executive needs to be closely involved with the transaction, and should not merely rely on his or her advisors. There is no substitute for carefully reviewing all of the documents involved in the transaction. In addition, the executive needs to ensure that the entire deal team be available for the inevitable last minute decisions.

Like many things in life, closings benefit from advanced planning and hard work early on. Save the surprises for birthdays and holidays. When it comes to closings, boring is best.


The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.