Articles Posted in Corporations

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A few years ago, I met with a new client here in San Jose about forming a corporation for his real estate management business. He wanted to use his name as the name of the corporation, e.g. John Smith, Inc., and he had no problems with using his name as the Agent for Service of Process, and having his home address as the business address on public record. Imagine my surprise when I went to the Secretary of State’s database to confirm that the name was available and found that the exact name was taken by the same client at the same address. The corporation had been formed back in 1989 and had been suspended for decades.

I discussed it with the client and discovered that he had spoken with another lawyer about forming a corporation many years ago, and although he thought it was just an informational meeting, the attorney actually formed the corporation and the client didn’t even know about it. If my client wanted to use the name of the suspended corporation, he would first have to revive it, in which case, he would have had to pay tens of thousands of dollars in back franchise taxes and interest. I counseled the client to walk away from the suspended corporation and simply start a new one under a different name. In this case, that was okay because he took no assets from the corporation and therefore could not be held personally liable for the corporation’s taxes. However, shareholders should not walk away from a corporation without carefully considering whether the same conclusion would apply to their situation, and whether they are willing to endure the annoying tax notices to the corporation in the meanwhile.

The landmark case in this area is the Appeal of Howard Zubkoff and Michael Potash, Assumers and/or Transferees of Ralite Lamp Corporation (April 30, 1990, 90-SBE-004). In that case, the Board of Equalization stated that the only way shareholders are liable for the corporation’s franchise taxes would be if the Franchise Tax Board proves that all of the following conditions were met:

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Although 2013 is well under way, taxpayers in San Jose may not be aware of changes to California laws that may affect them. Some of these changes include:

Proposition 30

With all the talk about federal income taxes going up this year, do not forget about the Proposition 30 retroactive increase in California taxes, effective as of January 1, 2012. For taxpayers with taxable income over $250,000, the California maximum rate is now 12.3%. On top of this, there is a 1% mental health surcharge for taxpayers with taxable income over $1,000,000. Together, these taxes give California the highest maximum state tax rate. If you fall under these tax brackets, you may not have paid enough taxes throughout the year, through either withholding or estimated tax payments, to avoid being under-withheld. However, there will be no penalty for the under-withholding so long as you pay the tax due in full by April 15, 2013. The ability to get out of penalties expires on April 15th. An extension to file doesn’t extend the payment deadline or the penalty exclusion. A late payment penalty of 5% plus 0.5% per month will be due if the full 2012 liability is not paid in full by April 15th.

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Having practiced corporate law in Silicon Valley for 15 years, I must say that there is nothing more frustrating for my clients, who are mostly closely held businesses in the San Jose area, than spending months or years training an employee only to have her leave and go on to compete with the company that trained her. In particular, I represent several staffing and consulting companies and have had to listen to their complaints of how unfair this is from the employer’s perspective. Often, I have to tell these hard working, small business owners that there is almost nothing they can do (except pursue a claim against the employee for misappropriation of trade secrets). In 2008, the California Supreme Court decided Edwards v. Arthur Andersen LLP, making it clear that employee post-employment non-compete agreements are unenforceable in California except in certain very limited circumstances, including in connection with the sale of a good business involving goodwill.

Now, a new California Court of Appeals case, Fillpoint, LLC v. Maas (August 24, 2012) further enforces California’s attitude towards fostering open competition and disfavoring restrictions on employees. In the Fillpoint case, a major shareholder and key employee signed both a three year non-compete agreement related to the sale of his stock, and a one year post-employment non-compete in his new employment agreement. The Court paid particular attention to whether the stock purchase agreement and the employment agreement should be read together as one document. The employment agreement alone would violate California’s view of post-employment non-compete agreements as against public policy. However, in connection with the sale of the business, it could be enforceable. In this case, the shareholder/employee worked for the acquired company until the three year non-compete ran out, but then terminated his employment and went to work for the competition. The company claimed that the one year non-compete covenant in the employee’s employment agreement should restrict him from such competing employment. The employment agreement non-compete provision specifically prohibited him from making sales contacts or actual sales to any customer or potential customer of the company, working for or owning any business that competes with the company, and employing or soliciting for employment any of the company’s employees or consultants.

The court found that the two agreements should be considered integrated because the covenants were executed in connection with the sale or disposition of stock in the acquired company. In particular, they noted the integration clause in the documents, which stated that if there were any conflicts between the two documents, the stock purchase agreement would control. The court went on to consider whether the non-compete and non-solicitation covenants should be void and unenforceable, and found that they were because they were overly broad. In particular, the court noted the over-broad restriction against selling to potential customers of the company.

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As a Silicon Valley corporate attorney, I work with a lot of Internet law and cyberspace law issues and am often asked by businesses to make sure their websites keep them free from trouble. Whether you are a large, multi-national corporation, a mid-size company, or a small business owner, chances are you run and operate a commercial website. One way to minimize the risk that comes from operating a commercial website is to create the conditions, sometimes called Terms of Use, that govern a visitor’s use of the site. A court decision in September, however, found that website terms could be invalid and therefore fail to provide any protection to website operators. Because the court is located in the federal district that includes California, it is a critical decision that affects California website operators.

The case, In re Zappos.com Inc., Customer Data Security Breach Litigation, 2012 WL 4466660 (D. Nev. Sept. 27, 2012) arises out of Zappos’ customer data security breach in January of this year. As is typical in a data breach situation, Zappos notified all persons whose personally identified information may have been compromised. When the inevitable lawsuit was filed, Zappos attempted to enforce an arbitration clause in the Terms of Use found on its website. A federal court in Nevada said “not so fast”.

Some background is helpful. Terms of Use are often created with little thought, and can often be changed at any time by the website operator. They typically are submitted as a “browse-wrap” agreement, which, unlike a “click-wrap” agreement, does not require the user to click on a box to confirm the user’s consent to the agreement. Browse-wrap agreements are usually referenced with an inconspicuous link at the bottom of a home page.

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Whether an acquisition is in San Jose, Cupertino, San Francisco, or anywhere else in California or the United States, any corporate lawyer will tell you that a buyer will not close a deal unless certain conditions are satisfied. Fortunately, closing conditions contained in mergers and acquisitions documentation have become standardized. Exceptions, however, always arise based on the unique attributes of the transaction, and standard does not always mean simple.

Some merger or acquisition closing conditions are standard and rarely require negotiation. For example, one of the standard closing conditions is that there is no injunction, law, or court order that prevents the transaction from proceeding. Outside of an actual known threat to a transaction, these clauses are rarely negotiated in a private company acquisition transaction.

Another standard closing condition is that the requisite corporate approvals will be secured. Because the respective Board of Directors of the each company will have approved the acquisition agreement, this is usually a noncontroversial item.

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In the past couple of years, corporations and limited liability companies that were formed or registered in California have had to deal with long delays from the Secretary of State in getting their documents processed. Whether the document that is being filed is a Statement of Information, Certificate of Dissolution or Cancellation, or Articles of Incorporation or Organization, the Secretary of State is taking weeks or even months to process a filing. As a business lawyer in San Jose, I have seen a multitude of problems resulting from such delays.

Statements of Information are experiencing the greatest delays, as the Secretary of State is taking several months to process a filing. This has actually created problems for some businesses that pay the filing fee with a check that contains an expiration or “void-by” date. If the check expires before the Secretary of State is able to process the Statement of Information, the Secretary of State will either reject the Statement or treat the payment as a dishonored payment.

Since many of my San Jose clients are newly formed LLCs, I frequently see these delays cause another type of problem. Very often, my client’s bank will require a copy of the LLC’s filed Statement of Information before opening a bank account or approving a loan. Because of the significant amount of time that it is taking for the State to process Statements, I often have to work with my client to take advantage of a relationship with the bank and ask the bank to accept a copy of the Statement that the LLC has submitted for filing.

I can avoid this situation in several ways if I am aware of the need to provide a filed copy of a Statement of Information by a certain date.

For a corporation, we can file the Statement of Information online with the Secretary of State and then request a copy of the record (this option is currently not available to LLCs). This avoids the usual queue. In addition, most regional state offices offer the opportunity for a corporation or LLC to pay an expedited service fee for filing a Statement of Information in person at the Secretary of State’s Sacramento office. We can email the document to our agent in Sacramento who actually walks it into the Secretary of State and files it on an expedited basis over the counter. The benefit to using the expedited service is that we can receive a filing confirmation or response within a guaranteed time frame (usually 24 hours).

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Every corporation, limited liability company and limited partnership, that either forms in California or registers to do business in California must pay an annual minimum franchise tax of $800. However, I just read an article in Spidell’s California Taxletter that really annoyed me (Volume 34.7, July 1, 2012, pages 75-76). The article, entitled “Midyear switch from S to C corporation means an extra $800” says that when a corporation files two short year returns for one calendar year, each return is subject to the $800 minimum tax even though the corporation is the same entity for civil law purposes. Because it is changing its tax status, it is two different entities for tax purposes and therefore must pay the minimum tax twice in one year. As a corporate and business attorney, I am sensitive to this issue since many of my clients are small businesses or partnerships in San Jose, Santa Clara and other parts of Silicon Valley, and every dollar counts when you are running a small business.

This could be an issue in many midyear circumstances, including:
• When an S corporation loses its S election
• When an LLC switches from single member to multiple member
• When an LLC switches from multiple member to single member
• When a limited partnership changes into a limited liability company
• When 50% of the ownership of a limited partnership or limited liability company changes hands
• When an LLC elects to be taxed as a corporation, or revokes such an election
• If an entity changes accounting periods resulting in two short-period returns

Although this may look reasonable on the surface of one tax return independently, when you look at both returns together this looks like double-dipping to me. If one entity has to file two tax returns for one calendar year, I think the entity should get credit in the second tax return for any minimum tax already paid for that entity for that year. However, with California’s ongoing budget crisis, I know this argument will fall on deaf ears. Therefore, I applaud Spidell’s California Taxletter for informing tax practitioners of this tax trap. I’m hoping California business owners, as well as out of state owners with businesses registered in California, will read this blog and avoid inadvertently paying double minimum taxes. As a California business lawyer, I will do what I can to structure deals for my clients to avoid this double tax.

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San Jose and Santa Clara are such vibrant places to do business that many foreign companies want to relocate to Silicon Valley. As a corporate lawyer working with start-up companies, I have helped a number of ventures enter the U.S. market, and have worked with companies from Australia, Canada, China, Denmark Finland, India, and Israel, among others.

In past blogs, I have discussed some of the threshold considerations faced by companies leaving their home countries and relocating in the U.S. I have also discussed some of the entity forms that companies can adopt when deciding to access the U.S. market merely to sell their products or services.

Companies that decide that they want to access the private equity markets and managerial and technical talent resident in Silicon Valley often relocate their headquarters here in the U.S. For these companies, a “flip-up” will allow them to grow their company in the U.S. by being in a position to access local capital and hire a sophisticated workforce.

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As a business lawyer representing many closely held corporations, I often see shareholders elect board members without much thought, either because they are family members or employees of the business. The board of directors serves a very important management role for a corporation and the decision of who you put on the board should not be taken lightly. If an elected board member is no longer a good fit for your company, do not wait too long to replace him/her or you could be missing an opportunity to find a board member who will add value to your company.

Electing a Director

In most corporations, the bylaws provide that directors will be elected at each annual shareholders’ meeting and will hold office until the next annual shareholder meeting and until their successors are elected and qualified, unless they are removed from the board before that time. Each year when it is time to renew your board, make sure you stop to consider whether the same directors should continue serving the company, or if it is time for some new blood. It is much easier to not re-elect a director, than it is to remove one during his/her term.

Removing a Director

Directors can be removed for cause, which means the director being removed did something wrong. The board can declare a director’s seat to be vacant if that director is convicted of a felony or declared incompetent. A director can also be removed for cause by a court order, but the court will require at least 10% of the outstanding shares to petition for removal, and a showing of fraudulent or dishonest acts or gross abuse of authority by the director to be removed.

Shareholders may remove directors without cause if the removal is approved by a majority of the outstanding shares entitled to vote for the election of directors. However, no individual director can be removed over an objection by one or more shareholders who, collectively, have enough votes to elect that director under cumulative voting.

Filling a Vacancy on the Board

Generally, the shareholders are supposed to elect the board of directors. However, depending on how the seat was vacated, either the board itself, or the shareholders, can fill a vacant board seat. If a director dies, is incapacitated, or resigns, the remaining directors can usually appoint a replacement director (unless the corporate documents say otherwise). If a director is removed, the vacancy must be filled by the shareholders unless the corporate documents authorize the board to fill such a vacancy. In the event that a majority of the directors have been appointed by the board, there is a safeguard to make sure the shareholders have the ultimate authority. Holders of 5% or more of the outstanding shares may call a special meeting of the shareholders and elect an entirely new board.

Whether or not your entire board is in place, in order to maintain your corporate liability shield, the corporation must follow the statutory rules regarding regular and special board meetings for the board to make decisions on behalf of the company. The rules for board meetings will be covered in another blog.

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In my last blog concerning market entry into Silicon Valley by foreign companies, I discussed some of the basic issues and tasks surrounding the effort. As an attorney practicing corporate law and representing technology startup companies, I am often asked to assist in designing and implementing the legal structures that enable a foreign-owned company to access the US market.

There are a number of factors that guide a company’s decision to enter the US market. First, what is it trying to sell? Second, does the company hope to generate its return on investment through a cash-flow from sales, or by building value and ultimately selling the company or taking it public? Third, does it need funding from US private investors? Let’s look at how each of these factors guide entity form.

The first factor focuses on the best method for product distribution. If the company is trying to sell simple, commodity type products using an established distribution network, it may be able to get by with no entity at all. In other words, it can sell its products directly into the US through a distributor or independent sales representative. Even if the product is complex, but does not require a sophisticated domestic marketing, sales, or support organization, an independent sales representative could be used.

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