Fox NewsCorporate directors and officers owe a fiduciary duty to the corporation and its shareholders to act in the corporation’s best interest. This is commonly known as the “duty of loyalty.” A breach of this duty may expose both the individual officer or director and the corporation itself to liability to the shareholders. Allegations against the former chairman and chief executive officer of a large New York City media company have led to a discussion of whether this individual might have breached the duty of loyalty in connection with an ongoing scandal. While it is important to note that these are only allegations, the ongoing story provides a useful demonstration of the duty of loyalty, as well as a possible defense to a claim of breach.

Under New York law, corporate officers, directors, and majority shareholders are considered “guardians of the corporate welfare.” Alpert v. 28 Williams Street Corp., 63 N.Y.2d 557, 568 (1984), quoting Leibert v. Clapp, 13 N.Y.2d 313, 317 (1963). Even if a particular action does not violate any specific law, it might violate the duty of loyalty if its purpose is “the aggrandizement or undue advantage of the fiduciary to the exclusion or detriment of the stockholders.” Alpert, 63 N.Y.2d at 569.

“Self-dealing” is a common example of a breach, such as when an officer or director has a significant financial interest in a corporate transaction and prioritizes their own interests over those of the corporation. An officer or director can avoid legal liability if they disclose the conflict of interest to the corporation ahead of time and receive approval from a majority of disinterested directors or shareholders. See N.Y. Bus. Corp. L. § 713.

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birdThe directors of a corporation owe a duty of loyalty to the corporation’s shareholders, which requires them to act only in the interest of the corporation and avoid self-dealing. Claims alleging a breach of this duty range from the relatively benign, such as a failure to disclose a conflict of interest, to overt acts of bad faith. A recent decision from the Delaware Court of Chancery addressed a claim of bad-faith breach, which the court noted is very difficult to prove. In re Chelsea Therapeutics Int’l Ltd. Stockholders Litig., No. 9640-VCG, mem. op. (Del. Ct. Chanc., May 20, 2016). A group of shareholders alleged that certain directors breached the duty of loyalty by disregarding higher financial projections before recommending the sale of the company. The court found that the plaintiffs had failed to establish that the defendants acted egregiously enough to meet the legal standard for bad faith. It described a situation that would constitute bad faith under the duty of loyalty as a rara avis, a “rare bird.”

Directors and officers are obligated to direct their efforts toward the interests of the corporation and its shareholders. The mere existence of a conflict of interest, however, does not automatically breach the duty of loyalty. A director with a conflict of interest, such as a personal financial stake in a board decision, must make a full disclosure to the other directors and the shareholders. Any related transaction requires majority approval from the disinterested directors or shareholders. A breach of the duty of loyalty could result in civil liability to the corporation, or to some or all shareholders.

Typically, it is in the corporation’s interest, and the interests of its shareholders, to maximize profits and minimize expenses, but this is not always the case. If a corporation is currently the subject of negotiations incident to a proposed merger or acquisition, for example, obtaining the best possible price is generally considered the top priority for the directors. This was the situation in the Chelsea case.

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phishingA vast array of cybersecurity threats costs businesses billions of dollars each year. In early 2016, the FBI issued a warning to American businesses about “business email compromise” (BEC) scams, also known as “CEO fraud.” It stated that the number of incidents involving this type of scam, along with the amount of associated losses, has quickly increased in the past few years. New York and New Jersey business owners should be aware of what this type of scam involves, and their potential liability should they be the victims of such a scam.

A typical BEC scam involves the use of a company’s own email network, or an email address made to look like an internal company email, to pose as the CEO or another high-level executive. The scammer, commonly known as the “imposter,” contacts a lower-level executive or employee and directs them to take certain actions, such as wiring money to an account that the imposter controls. By the time the company becomes aware of the scam, the imposter has usually withdrawn the money and closed the account. The BEC scam is similar to scams known as “phishing,” in which a scammer solicits personal information from people through emails made to look like they come from a bank or another legitimate entity.

A business could face various types of liability if it is the victim of a BEC scam, depending on the nature of the scam and the resulting loss. If the scam somehow compromises secure business information, such as customers’ payment information, the business could be liable to those customers for their damages from the identity theft and other misuse of that information. Guarding against BEC scams should be part of every company’s cybersecurity strategy.

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New York CityThe people in charge of a business entity, such as the directors of a corporation or the managers of a limited liability company (LLC), owe multiple fiduciary duties to the owners of the business. In a dispute between corporate shareholders and a corporation’s directors, the extent of scrutiny that a court will give to the directors’ decisions depends on the circumstances. A recent decision by the New York Court of Appeals considered whether to apply the “business judgment rule” (BJR) or the stricter “entire fairness standard” (EFS) in a shareholder lawsuit. The lawsuit involved a proposed “going-private merger,” in which a majority shareholder sought to buy all of its outstanding shares. The court chose the BJR, citing a Delaware Supreme Court decision that applied the BJR under similar circumstances. In re Kenneth Cole Prods., Inc., 2016 NY Slip Op 03545 (May 5, 2016); Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). The court also noted, however, that the Delaware decision establishes multiple safeguards for minority shareholders that must be in place before the BJR may apply.

Under the BJR, courts defer to the judgment of a corporation’s directors, provided that the directors acted reasonably and rationally, and without conflicts of interest. The court’s decision in Kenneth Cole states that the directors must “exercise unbiased judgment in determining that certain actions will promote the corporation’s interests.” Kenneth Cole, slip op. at 6. The plaintiff has the burden of proving that one or more directors acted in bad faith, had an undisclosed conflict of interest, or otherwise behaved fraudulently or with gross negligence in order to overcome the deference afforded by the BJR.

The EFS sets a far stricter standard. It views a transaction in its entirety. Rather than requiring evidence of misconduct or negligence as a prerequisite for second-guessing directors’ decisions, the EFS essentially requires the directors to prove that they handled the subject of the dispute fairly. They must show that both the process of the transaction and the final price were fair, especially with regard “to independent directors and shareholders.” Id. at 8.

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baseballBusinesses that engage in new types of business activity, particularly those on the internet, often face scrutiny from regulators. The New Jersey Legislature is considering at least two bills that would regulate daily fantasy sports (DFS). “Fantasy sports” refer to games in which participants create imaginary sports teams based on real players and earn points based on those players’ actual performance. DFS games typically take place on a more accelerated basis online and involve cash awards to whomever has the most points. Multiple state regulators have concluded that this violates laws prohibiting sports betting and online gambling. The two New Jersey bills are under consideration at a time when the state is also challenging the constitutionality of a federal law that bans sports betting.

Two federal statutes could apply to DFS. The Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006, 31 U.S.C. § 5361 et seq., essentially prohibits many forms of online gambling by prohibiting online gambling companies from accepting transfers of money from anyone they know to be making a “bet or wager” via the internet. 31 U.S.C. § 5362(10). The law had a devastating impact on some online gambling companies. It also led to a complaint against the United States by Antigua and Barbuda before the World Trade Organization (WTO), which built on a previous complaint regarding online gambling laws. DFS companies have argued that they are not subject to this statute because DFS is a “game of skill” rather than a “game of chance.”

The Professional and Amateur Sports Protection Act (PASPA) of 1992, 28 U.S.C. § 3701 et seq., created a rather uneven national standard for the legality of sports betting. It generally prohibits sports betting but exempts states that established sports lotteries during a specified time period. At the time of the law’s passage, this included Delaware, Montana, Nevada, and Oregon.

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Open APISA jury recently issued a significant verdict in a legal fight between two major technology companies, although it might not resolve some questions brought up by the litigation. The two companies are fighting over protocols used in a wide range of software applications, known as application programming interfaces (APIs). The plaintiff sued for copyright infringement, alleging that the defendant unlawfully appropriated its APIs for use in its mobile device operating system. Oracle America, Inc. v. Google, Inc., No. 3:10-cv-03561, complaint (N.D. Cal., Aug. 12, 2010). APIs are essential tools for countless digital technologies, so the outcome of this case ought to be of great interest to anyone who regularly uses the web. A federal judge ruled in 2012 that APIs are not subject to copyright infringement, but an appellate court reversed that ruling. On remand, a jury found that Google breached Oracle’s copyright, but the breach was excused under the Fair Use Doctrine.

Copyright law protects “original works of authorship fixed in any tangible medium of expression.” 17 U.S.C. § 102(a). This includes books and other written works, musical recordings, video or film recordings, and software code. It does not, however, include “any idea, procedure, process, system, [or] method of operation.” Id. at § 102(b). A copyright can be a very valuable asset for a business, and copyright owners must take affirmative steps to protect their copyright interests. The Fair Use Doctrine holds that unauthorized use of a copyrighted work is not infringement under certain circumstances, including “criticism, comment, news reporting, teaching…, scholarship, or research,” provided that the use is “transformative.” Id. at § 107; Campbell v. Acuff-Rose Music, 510 U.S. 569, 579 (1994).

The Oracle case presented the question of whether APIs are subject to copyright protection, or whether they are non-copyrightable procedures or processes. An API, simply stated, allows one software application to communicate or interface with another application, acting as a sort of translator between different pieces of software. APIs are essential parts of many common digital technologies, allowing mobile devices to run a wide range of applications and allowing websites to interface with social media services like Facebook and Twitter, to name just two examples.

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Coca ColaThe protection of trade secrets is a critical component of building a competitive business. Companies must safeguard proprietary information against misappropriation by employees and others, typically through nondisclosure agreements. State law provides remedies through the court system, both to enjoin potential disclosures of trade secrets and to obtain damages for theft or misappropriation. Most states have enacted the Uniform Trade Secrets Act (UTSA) in some form, but the enforcement of these laws across state lines can be difficult. In May 2016, the U.S. Congress passed the Defend Trade Secrets Act (DTSA) of 2016, Pub. L. 114-153 (May 11, 2016), which gives the federal court system jurisdiction over claims of trade secret theft that affect interstate and international commerce. This gives trade secrets federal legal protection that is comparable in many ways to copyrights, trademarks, and patents.

The precise definition of a “trade secret” may vary from one jurisdiction to another, but every definition has common features. The UTSA, drafted by the National Conference of Commissioner on Uniform State Laws, and approved by the American Bar Association in 1986, ascribes two key elements to a trade secret. First, it must have “independent economic value” that derives from the fact that it is not known to others who might derive economic benefit from it, nor is it something they could easily figure out on their own. Second, reasonable efforts must have been made to keep it secret. The “secret recipe” for Coca-Cola is perhaps the most famous example of a trade secret.

Unlike other forms of intellectual property, such as copyrights, trademarks, and patents, no government agency registers or directly regulates trade secrets. This makes sense, considering that the whole point of a trade secret is to keep it out of the public eye. It also means, however, that the owners of trade secrets have the sole responsibility to protect and enforce their rights, using a patchwork of state laws. All but three states have enacted the UTSA. See, e.g., N.J. Rev. Stat. § 56:15-1 et seq. New York is one of the three states that has not enacted it, relying instead on common law trade secret protections. A bill is currently pending that would add the UTSA to the New York General Business Law.

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PakpongICCH444 (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia CommonsOne of the key features of capitalism, as the concept is generally understood in our society, is competition. Consumers benefit from a competitive marketplace, and they suffer when businesses use anticompetitive practices. Congress began enacting laws to curb monopolistic and other anticompetitive practices, known as antitrust laws, in the late nineteenth century. Having a monopoly is not, by itself, necessarily a violation of antitrust law. Antitrust law deals with actions or practices that prevent competition. The Federal Trade Commission (FTC) brought a case against a company that was first to market with a new medical product, alleging that it used exclusive contract terms to prevent competitors from entering the market for that product. The company agreed to cease these practices in a recently announced settlement. In the Matter of Victrex plc, et al., No. 141-0042, consent order (FTC, Apr. 27, 2016).

In an ideally competitive market, consumers may choose among competing companies for a particular good or service, leading to the success of the companies that provide the “best” experience for consumers. In this context, the “best” is really just whatever consumers en masse—i.e., the “market”—want. When one company dominates a market, however, it no longer has to compete for customers, so it arguably lacks the incentive to give consumers what they want. This can result in higher prices, diminished quality, and other problems.

A single, monopolistic company might engage in anticompetitive practices that prevent other companies from entering the market, such as contracts with exclusivity clauses that prohibit a company’s customers or vendors from doing business with its competitors. Multiple companies might act together to limit competition, such as by fixing prices or by dividing geographic areas between themselves. The federal Sherman Antitrust Act of 1890, 15 U.S.C. § 1 et seq., prohibits a wide range of anticompetitive practices. The FTC Act, 15 U.S.C. § 41 et seq., prohibits “unfair methods of competition,” which can overlap with antitrust law.

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Boris Dzhingarov [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrTax treatment is one of the key factors a business owner must consider when choosing a business form. Business partnerships can exist in several multiple forms, differing mainly in the extent of liability protection offered to the owners. As a general rule, partnerships are not directly subject to federal income tax. Individual partners are instead liable for tax on a pro rata share of partnership income, commonly known as “pass-through taxation.” 26 U.S.C. § 701. Congress passed the Bipartisan Budget Act (BBA) of 2015, Pub. L. 114-74 (Nov. 2, 2015), 129 Stat. 584, which amends the rules for partnership tax audits and could make partnerships themselves subject to income tax. The new rules do not go into effect until 2018.

A general partnership consists of any two or more people engaged in business together. It does not offer its owners, known as partners, any protection against personal liability for business debts. State laws allow the formation of partnerships that offer liability protection, including limited liability partnerships and limited partnerships. See, e.g. N.J. Rev. Stat. §§ 42:1A-47, 42:2A-1 et seq. The business form known as the limited liability company, see N.J. Rev. Stat. § 42:2C-1 et seq., is normally subject to pass-through taxation like a partnership, but it gives owners the option to elect taxation as a corporation. 26 C.F.R. § 301.7701-3(a).

The current rules regarding partnership tax audits originated with the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, Pub. L. 97-248 (Sep. 3, 1982), 96 Stat. 324. TEFRA created a process for partnership-level audits, instead of audits of each individual partner. Partnerships that are subject to these audit rules are known as TEFRA partnerships. A “small partnership exception” applies to many partnerships with 10 or fewer partners. 26 U.S.C. § 6231(a)(1)(B). Partnerships with 100 or more partners may make a “large partnership election,” which allows for different procedures. 26 U.S.C. §§ 771 et seq., 6240 et seq.

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Captain Albert E. Theberge, NOAA Corps (ret.) [Public domain], via Wikimedia CommonsMaritime commerce constitutes a major part of the economies of New York City and Northern New Jersey. Any type of business transaction involves a complex web of legal obligations and risks, and transactions involving interstate and international shipping can be the most complex of all. Legal claims arising from maritime disputes can be particularly difficult. The debtor/defendant might be based in a different jurisdiction—possibly a different country—from the creditor/plaintiff, and any assets might be located in yet another jurisdiction. The Supplemental Rules for Admiralty or Maritime Claims and Asset Forfeiture Action (the “Supplemental Rules”), part of the Federal Rules of Civil Procedure, provide methods for asserting claims over otherwise highly mobile assets in maritime disputes. This should be a last resort, of course, since carefully drafted contracts with dispute-resolution provisions often yield more satisfactory results in a shorter span of time.

Rule B of the Supplemental Rules enables plaintiffs to attach a defendant’s assets in an ex parte proceeding, provided they cannot locate the defendant in the same jurisdiction as the asset. The plaintiff files a quasi in rem lawsuit in the jurisdiction where the asset is located. Lawsuits typically proceed in personam, against a particular person, business, or organization; or in rem, against a particular item of property. A quasi in rem lawsuit combines elements of both types of suit, with a plaintiff asserting a claim over a piece of property in connection with a claim against its owner.

In maritime transactions, parties often do business using multiple corporate shells to protect assets and other interests. As a result, the record owner of an asset that could be subject to attachment under Rule B might not be the same as the business entity against which the plaintiff has a claim. Rule B allows a plaintiff to attach an asset owned by a different business entity if they can establish that the entity functions as an “alter ego” of the defendant. A New York court recently addressed this issue in a Rule B claim in D’Amico Dry Ltd. v. Primera Maritime (Hellas) Ltd., et al., No. 1:09-cv-07840, order (S.D.N.Y., Jul. 30, 2015).

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