New Jersey Lawyer & Attorney : Stark & Stark Law Firm : New Jersey Law Blog

Before purchasing a business, the proposed buyer of company should request and review extensive documents about the target company’s ownership, function, income, assets, obligations and liabilities.  That process, called “due diligence” affords the buyer the last real chance understand exactly what he or she is buying. 

The importance of conducting due diligence in an organized and exhaustive way cannot be overstated.  Failure to do so could lead the buyer to unknowingly purchase a company that is not viable under new ownership, or a company that is facing serious legal or financial issues. Therefore, to ensure the benefit of the bargain, the shrewd buyer should take full advantage of due diligence.

Having represented clients in both local business and multinational corporate acquisitions, I’ve realized that the due diligence process for each is surprisingly similar. That is because no matter the size of the target company, buyers have universal concerns about the target company remaining profitable under new ownership. 
 
Depending upon the nature of the transaction, such as in the case of a small business owner who does not want to upset the employees, the sale purchase agreement may require the buyer to conduct due diligence discreetly by, for example, visiting the business off-hours or by only contacting a designated individual for follow-up.  Due diligence may also require a personal visit to the target company, or even the seller opening all of its files for review in a designated place (usually a conference room or online on a secure website).

Ideally, a trusted professional should issue the due diligence requests, and then review all of the responsive documentation. An experienced attorney can be invaluable in that respect by knowing exactly what documents to seek, by helping the buyer to identify irregularities in the responses, and by drawing  the buyer’s attention to the important risks of the deal.  It may also be beneficial to have an accountant review the financial documents provided in due diligence to advise the buyer as to the target company’s financial health.

In order to capture the complete picture of target business for the buyer, the due diligence requests and documentary responses should at least address the following aspects:

Corporate Documents
The buyer should review and understand the implications of all of the governing documents for the target company along with minutes of the board of directors or shareholders, Certificates of Good Standing; stock certificates and stock ledgers.  That way, the buyer can understand how the company has operated and how it should continue to operate under new ownership.

Intellectual Property
Name recognition is always an issue.  Therefore, the buyer should review evidence of any trademarks, trade names, service marks, patents or copyrights that may be registered, pending, rejected, searched, or even contemplated by the target company.  The buyer should also seek a list of all know-how, trade secrets and technical information material to the target company’s business to make sure that the buyer will be able to continue to operate the business after the acquisition.

Furthermore, the buyer should analyze the way the target company has protected the intellectual property, and should review all contracts or documents relating to the protection of proprietary information such as agreements with independent contractors, confidential information policies and non-disclosure agreements.  Otherwise, the intellectual property may not be worth very much if it has been or may easily be disclosed to the public.

Material Contracts and Agreements
The buyer needs to know if the target company is contractually obligated or restricted from taking action after the acquisition, and whether or not the target company may assign all of its business contracts to the buyer as the new owner. For example, if most of the target company’s revenue stems from a service contract with a local government, the buyer should ensure that the target company will be able to continue providing services under that contract even after the buyer becomes the new owner.

It is therefore imperative for the buyer to review all of the contracts that affect the target company’s performance.  Some examples include the target company’s credit agreements, mortgage agreements, financial or performance guaranties, notes, indemnifications, sales & service agreements, non-solicitation agreements, non-compete and marketing agreements.

Litigation
Thorough due diligence includes a search to determine if the target company is subject to or even threatened by litigation that may be extremely expensive to defend.  While the claims facing the target company may be of little substance, the buyer should at least know what to expect, and to make sure that he or she is properly indemnified against the cost of pre-existing claims or litigation in the sale purchase agreement. 

Employees
The buyer should be able to identify at least the key employees to understand how each one contributes toward the target company’s daily operations, in addition to understanding how the employees are (and may continue to be) compensated. In that respect, the buyer should review all: employee lists, employment agreements, benefits policies, retirement plan policies and compensation schedules.

Financial Information
It is often advisable for the buyer to have an accountant review the target corporation’s income tax returns and financial statements to evaluate the target company’s financial health, to determine if there are any tax issues, and perhaps to advise if the purchase price is fair under those circumstances.

Property
Because the target company’s real and personal property may be the most expensive aspect of the deal, the buyer needs to know all of the details surrounding such property.  Buyers therefore often seek bills of sale, deeds, appraisals, depreciation schedules or restrictions on that property.

Insurance
The buyer or the buyer’s attorney should review all material insurance policies affecting the target company, and should ensure that the policies are appropriate and up-to-date.

Governmental Regulations
Finally, all target companies answer to a higher authority . . . the government.  Therefore, the buyer may request OSHA, EPA, IRS, EEO, or other governmental agency inquiries, as well as copies of all permits and licenses necessary to conduct the company's business.

After conducting due diligence, the buyer should have a full understanding of the target company and its relative value as a going concern.  If the buyer chooses not to conduct extensive due diligence, well, caveat emptor.

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I am often asked by clients whether prejudgment interest can be obtained from debtors on unpaid claims. Prejudgment interest is usually awarded by the courts in New Jersey only when a written contract exists between the creditor and the debtor which includes a provision for the assessment of interest if payment is not received by the creditor in a timely manner. The written contract can be a simple as a purchase order or an invoice. However, some counties will not award prejudgment interest unless the contract is actually signed by the debtor.
 
Prejudgment interest may run on contract claims not as a matter of right but rather in accordance with equitable principles. Absent, however, unusual circumstances the prejudgment rate should be the same as that provided for by the rule governing post-judgment interest. The current post-judgment rate of interest for 2008 is 5.5%. This rate is adjusted on a yearly basis. Equitable principles do not apply to the same extent where the parties have obligated themselves to a certain interest rate by contract. See Pressler, Current N.J. Court Rules, Comment R. 4:42-11, (Gain).
 
Creditors should seek to protect themselves from debtors who fail to pay their obligations in a timely manner, and additionally should commit their agreements to writing with an appropriate interest provision whenever possible. Creditors should insist that their clients execute such agreements so that misunderstandings are avoided and creditors are protected in the event invoices are not paid in accordance with the agreement between the parties.   

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Virtually all small closely held businesses should have an up-to-date Buy-Sell Agreement. A Buy-Sell Agreement should accomplish a number of important objectives for closely held company, including: (1) providing mechanism for the orderly transfer of the business; (2) establishing a valuation mechanism which avoids disputes between owners as well as possible disputes with the Internal Revenue Service; (3) reducing possible disputes between owners, an owner’s heirs, and possible unwanted business partners to whom an ownership interest in the company may otherwise be transferred; and (4) providing financial security to a deceased or disabled owner’s family.

It is important that company’s Buy-Sell Agreement be reviewed periodically to make certain that it is properly customized to the needs of the specific company and its owners, as well as to make certain the agreement meets the requirements of current tax laws. Two of the most important areas of periodic review are the valuation provisions in the Buy-Sell Agreement and the funding of the buy-sell arrangement set forth in the Buy-Sell Agreement.. Valuation formulas based upon earnings can become obsolete and should be updated periodically based upon changes in a company’s accounting and compensation practices. Funding of the buy-sell arrangement should also be periodically updated to avoid a situation where there is a gap between the value of the company and the available funding.

Another aspect of the Buy-Sell Agreement that should be reviewed periodically is the agreement’s structure. Typically, Buy-Sell Agreements are structured as either a redemption agreement, a cross-purchase agreement, or hybrid agreement. It is important to review the structure of a Buy-Sell Agreement to determine if a different structure would be more beneficial in light of the corporate alternative minimum tax on life insurance proceeds. In addition there are also basis considerations to take into account when reviewing the structure of a Buy-Sell Agreement, in order to avoid serious income tax consequences.

Lastly, a periodic review of a Buy-Sell Agreement should include a careful review of the triggering events which either allow or require a transfer of ownership. While most Buy-Sell Agreements adequately deal with the death of an owner, it is equally as important to make sure that the Buy-Sell Agreement adequately covers other triggering events such as disability, voluntary termination of employment, involuntary termination of employment, bankruptcy of an owner, and the divorce of an owner.

When reviewing a Buy-Sell Agreement, it is important to take into account the unique needs of each company, the existing relationships between owners, as well as the individual functions of each owner. It is also important to do an analysis of the underlying economics of the company when considering an update of Buy-Sell Agreement.

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In light of yesterday's bankruptcy filing by Rockaway Bedding, suppliers to the retail chain need to be aware of how to proceed in protecting themselves for the goods they have shipped but not yet been paid for.

Section 503(b) of the Bankruptcy Code allows administrative-expense status to all claims for "the value of any goods" received in the ordinary course of business by a debtor within 20 days before the bankruptcy filing. The supplier must request administrative-expense status. By doing this, the supplier is in a better position than unsecured creditors to be paid, since a Chapter 11 plan of reorganization cannot be confirmed unless administrative claims are paid in cash on the effective date of the plan. Unsecured creditors typically receive only a fraction of their claims.

Suppliers of goods have another method to be paid ahead of unsecured creditors. They may seek reclamation of goods sold to a debtor in the ordinary course of business under Section 546(c) of the Bankruptcy Code. A supplier must demand in writing reclamation of such goods not later than 45 days after delivery. Suppliers must move quickly or their right to reclaim will be lost. If the 45-day period has not expired as of the filing of a bankruptcy case, a supplier will have an additional 20 days after the filing of the case to demand reclamation of the goods sold. A reclamation demand is "subject to the prior rights" of a holder of a security interest in the goods sold.

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Businesses and individuals often engage in negotiations with regard to any number of issues through the forum of e-mail.  Such negotiations pose a variety of risks because of the fact that the negotiations are in writing and could be used for purposes that the sender did not intend.  For instance, the sender of an e-mail should exercise caution during preliminary discussions to transfer or share rights in a copyright.  Even though the Copyright Act requires that any such agreement must be signed, there is a high probability that the Third Circuit would find that an e-mail satisfied such a requirement.  
   
The Copyright Act, at 17 U.S.C. 204(a), provides:

• A transfer of copyright ownership, other than by operation of law, is not valid unless an instrument of conveyance, or a note or memorandum of the transfer, is in writing and signed by the owner of the rights conveyed or such owner's duly authorized agent.

17 U.S.C. 204(a).  No cases specifically address e-mail signatures with regard to this statute.  However, federal courts have applied the statute of frauds, and the decisions interpreting it, to this section of the Copyright Act.  See Pamfiloff v. Giant Records, Inc., 794 F.Supp. 933 (N.D.Cal. 1992).  The statute of frauds case law generally supports the enforceability of an e-mail contract.  For example, in Bazak Intern. Corp. v. Tarrant Apparel Group, the Southern District of New York found that including a typed “signature” at the bottom of an e-mail satisfied the signature requirement in the statute of frauds contained in the Uniform Commercial Code.  378 F.Supp.2d 377, 386-387 (S.D.N.Y. 2005); see also Shattuck v. Klotzbach, 14 Mass.L.Rptr. 360, 2001 WL 1839720 (Mass.Super. 2001).  
   
Though there are no cases in the Third Circuit directly supporting this principle, it seems likely that the Third Circuit would make the same findings.  That court, applying the Pennsylvania Uniform Commercial Code’s statute of frauds has stated, “Any mark or symbol-including a typewritten name-will be deemed to constitute a signature for the purposes of the statute if it is used with the declared or apparent intent to authenticate the memorandum.”  Flight Systems, Inc. v. Electronic Data Systems Corp., 112 F.3d 124, 129 (3d Cir. 1997) (citing Hessenthaler v. Farzin, 388 Pa.Super. 37, 564 A.2d 990, 993 (Pa.Super.1989)); First Valley Leasing, Inc. v. Goushy, 795 F.Supp. 693, 696 (D.N.J. 1992)(finding that a company’s letterhead on an invoice was sufficient to satisfy the statute of frauds’ signature requirement).  It seems likely, especially considering the findings of other jurisdictions cited above, that these principles would also apply to e-mail signatures.  
   
Therefore, if the content of an exchange of e-mails would otherwise satisfy the requirements for contract formation, the signature requirement of the Copyright Act would most likely not protect a party from the enforcement of the terms of such e-mails.  As a result, parties should exercise caution in composing e-mails containing negotiations for the transfer of rights to a copyright. 

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The growth and development of a business is generally dependent upon the efforts and dedication of its key employees. Such key employees can greatly contribute to the success of a business. Conversely, upon the termination of their employment, these same employees have the potential to negatively impact the company. Depending on his or her relationships with clients, a former employee can convince your company’s clients to leave the company and be serviced by the former employee’s new employer or company. The former employee can also solicit or encourage other key employees to leave the company. 

To minimize disruption to the company’s operations and client relationships, a company can be proactive and have the key employee sign an agreement agreeing to certain restrictive covenants: 

Confidentiality Agreements. While an employee of your company, the employee will likely become familiar with confidential and proprietary information about the company, including its customer base, marketing strategies, supplier information and pricing of products. Confidentiality agreements require the employee to keep the business practices and operations of the company confidential both during and after the term of his or her employment. The confidentiality agreement should also require that the employee return and not remove from the company’s office, any confidential books, records, documents, lists, computer programs and other proprietary information. 

Non-Compete Agreements. This covenant restricts the employee from competing against the company for a certain time period, after the employee’s employment with the company is terminated.

Non-Solicitation of Clients. This covenant prohibits the employee from soliciting any person or business who was a current or prospective client during the employee’s term of his employment with the company. 

Non-Solicitation of Company Employees. This covenant prohibits the employee from soliciting any full or part-time employees of the company for purposes of inducing them to leave the employ or association with the company. In the event the departing employee intends to compete against the company, it will limit his or her ability to solicit other company employees to come work with the terminate employee. 

The enforceability of restrictive covenants generally depend on the geographical scope and duration of the provision.  In general, courts will only enforce restrictive covenants if they are reasonable in nature. Any restrictions on the terminated employee should be limited to only what is necessary to protect the company. For example, if the company’s clients and operations are limited to New Jersey, a court would likely scrutinize an agreement which contained prohibitions for any geographical areas outside of New Jersey, where the company does not operate. 

In addition, the enforceability of the agreement will likely depend on the jurisdiction in which the agreement is being enforced.  In certain states, restrictive covenants are generally unenforceable.   Even when they are enforceable, they are generally disfavored by courts because they interfere with a person’s ability to earn a livelihood. In some states, if a court finds that the restrictive covenant is overly broad, some courts may modify (“blue pencil”) the agreement to make it more reasonable (e.g., reducing the term of the non-compete from three years to one year).  

Provided that they are reasonable in nature, restrictive covenant agreements can be a useful tool to minimize the impact an employee can have on the company after his or her employment is terminated.

Technorati Tags: New Jersey : Restrictive Covenants

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Thomas Lewis, Chair of the Employment Litigation group, was quoted in Wal-Mart Mea Culpa Saves Company Legal Costs down the Road in Workforce Management magazine.

Lewis commented on the settlement between WalMart and the Department of Labor concerning improper overtime compensation for thousands of workers.

You can read the article here.

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For individuals starting a business, the form their business takes is important and hinges on their desire to protect their investment (limited liability), enjoy flexibility in management and administration, and the ability to maximize profit by paying taxes on earnings directly, rather than at the entity level and again individually on distribution. Before 1994, New Jersey businesses wanting limited liability without double taxation used “S’ corporations. After 1994, business owners could chose primarily between “S” corporations and the limited liability company (“LLC”).

Before 1994, “S” corporations were preferred because of limited liability and flow-through taxation. For an “S” corporation to pay taxes through the shareholders directly, certain requirements are necessary. “S” corporations may only issue one class of common stock, other business entities and non-U.S. persons cannot be shareholders, and “S” corporations can have no more than 75 shareholders. Additionally, an “S” corporation is required to abide by sometimes rigid corporate practices to preserve limited liability, such as conducting meetings of shareholders and directors, maintaining minutes and making annual corporate filings. Also, shareholders of an “S” corporation can sell or transfer shares absent a shareholder agreement otherwise (subject to securities laws restrictions).

LLC’s combine the best features of a corporation (limited liability) with the best features of a partnership (flow-through taxation), while offering greater flexibility in management and ownership structure. An LLC is automatically taxed at the owner level without the need for corporate tax filings, unless the LLC elects to be taxed as a corporation. LLC’s may also have any number of members and those members may be other businesses or non-U.S. persons. The structure of the management of an LLC is more flexible, does not require duplication of paperwork and individuals playing multiple roles (shareholder and director), and is done with substantially less confusion.

Several LLC limitations have resulted in the continued viability of the “S” corporation. In an “S” corporation, a shareholder-employee pays self-employment tax on money received as compensation for services, but not on profits that pass through as a shareholder. Thus an owner can still be paid a salary, and only pay additional self-employment tax on the “reasonable compensation” portion of total distributions. The entire distribution drawn by an LLC’s member-employee is treated as a “guaranteed payment” meaning all payouts are subject to self-employment tax. The second factor is that if it is expected that the business will require institutional investment, most institutional investors will require that the business be a “C” corporation (versus an LLC or “S” corporation). An “S” corporation need only “unelect” their flow-through status to be treated as a “C” corporation to raise institutional investment, while an LLC would have to undergo a cumbersome conversion process.

Sorting through the characteristics of these business forms can be daunting for business owners, and making changes once a business is established can be difficult and costly. As such, individuals forming businesses should consult with legal counsel and accountants to review the characteristics of each entity important to their businesses.

Technorati Tags: New Jersey : Corporations

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Adam Siegelheim, a member of the Franchise group, was quoted in One Chain's Groundwork for Growth in the January 8 Philadelphia Inquirer, which discussed the expansion of the New Jersey-based Saladworks franchise.

You can read the story here.

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This week's New Jersey Legal Update podcast will discuss the use of objective standards in hiring practices. This podcast will also discuss the impact objective standards can have on a sexual discrimination case.

This week's New Jersey Legal Update is presented by Jason Storipan, member of Stark & Stark’s Employment Group.

You can download the New Jersey Legal Update Podcast # 55 here. (4.75 MB)

Technorati Tags: New Jersey : Podcast :  Employment

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