bargainAssessing the value of an ownership interest in a family business can be a tricky matter. If a person owns a minority interest in a family business, for example, the value of that interest is not necessarily the same as the pro rata share of the business’ value. This is due to disadvantages inherent in these types of ownership interests, which often make their real-world value less than what might appear on a balance sheet. The Internal Revenue Code (IRC) allows “valuation discounts” for certain types of ownership interests, under certain circumstances, for the purposes of gift and estate taxation. See 26 U.S.C. § 2704. A proposed regulation recently issued by the Internal Revenue Service (IRS), however, would make major changes to the valuation discount system. 81 Fed. Reg. 51413 (Aug. 4, 2016), 81 Fed. Reg. 68378 (Oct. 4, 2016). The agency is currently accepting public comments on the proposed rule change, which could take effect as early as January 1, 2017.

Minority interests in family businesses, particularly family limited partnerships (FLPs) and limited liability companies (LLCs), present multiple drawbacks. Owners of these types of interests are limited in their control and influence over the business, which affects the value of the interest. Additionally, when the rights associated with an ownership interest lapse, this creates valuation problems. In either case, the owner will have difficulty selling or otherwise transferring the interest for an amount equal or close to its value on paper—a 10 percent interest in an FLP with $1 million in assets is not really worth $100,000 because of these drawbacks. This is where valuation discounts come in.

Current rules regarding valuation discounts apply to controlling interests in family businesses—meaning 50 percent ownership or more—when voting or liquidation rights lapse. See 26 C.F.R. § 25.2704-1. The lapse is treated as a transfer of the ownership interest to the owner’s family. If the lapse is the result of the owner’s death, the transfer is subject to estate tax. Otherwise, it is considered a taxable gift. In general, the transfer is deemed to have occurred just before the lapse. The valuation discount uses the value after the lapse, i.e., when the value is diminished, as the value at the time of the transfer. This has the effect of reducing the taxable value and reducing the overall tax burden.

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Brooklyn BridgeOne of the greatest advantages of organizing a business as a corporation, along with certain other types of business entities, is that it shields the business’ owners from liability for business debts and other obligations. Corporations and other business entities exist separately from their owners as distinct legal entities. Creditors and other claimants can only recover from the business entity, except in certain rather extreme situations. A court rarely may “pierce the corporate veil” by allowing someone to assert a claim against, or collect a business debt from, the owners of a business. New York and New Jersey have similar rules regarding when a court may do this.

Types of Business Entities

Not all business entities protect owners from liability. An individual who operates a business with no formal legal structure is known as a sole proprietor. Two or more people operating a business in this manner are considered to be in a general partnership with each other. In both cases, the owners of the business may be held personally liable for business debts.

Organizing a business as a corporation requires filing paperwork with the state. Owners of a corporation are known as shareholders. Provided that they abide by the requirements set out by state law and by the business’ own bylaws, shareholders are shielded from liability.

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chess gameDebt collection is, unfortunately, an inevitable part of doing business for just about every business in New Jersey, the country, and probably the world. Whenever a business relies on customers or clients for revenue, it runs the risk of unpaid bills. Any business or individual engaging in debt collection should be aware of the time limit to bring a lawsuit, known as the statute of limitations (SOL). The New Jersey Appellate Division recently ruled in a case involving a dispute over retail store credit account debts. The parties disagreed over whether the six-year SOL for breach of contract claims should apply, or the four-year SOL for sales of goods. The court ruled that the four-year time limit applies. Midland Funding v. Thiel, et al., Nos. A-5797-13T2, A-0151-14T1, A-0152-14T1, slip op. (N.J. App., Aug. 29, 2016).

State and federal laws, such as the Fair Debt Collection Practices Act (FDCPA), 15 U.S.C. § 1692 et seq., regulate businesses that engage in debt collection activities on behalf of third parties. Creditors that attempt to collect their own debts are also subject to various laws and regulations. Prohibited conduct under the FDCPA includes excessive or harassing attempts to contact debtors. The law establishes a procedure for alleged debtors to dispute a debt and to receive documentation of the alleged debt from the debt collector. Violations of these provisions can result in civil liability to the debtor.

Most debt collection efforts do not lead to lawsuits, but a lawsuit offers the only legal means of compelling payment by a debtor. Under New Jersey law, a plaintiff alleging a breach of contract must bring suit within six years of the date of the alleged breach. N.J. Rev. Stat. § 2A:14-1. A four-year SOL, however, applies to “contract[s] for sale” in New Jersey. N.J. Rev. Stat. § 12A:2-725. State law defines a “contract for sale” as any contract for the “present sale of goods” and “to sell goods at a future time.” N.J. Rev. Stat. § 12A:2-106. Parties to a contract for sale may agree to reduce the SOL to a minimum of one year, but the law expressly states that they cannot extend it beyond four years.

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dollarsNew business ideas and practices spring up all the time. Some, but not all, find a niche that leads to success. Government officials at the city, state, and federal levels often keep a close eye on new or unconventional business practices to see how they fit into existing laws and regulations. If regulators determine that a particular business activity falls under their jurisdiction, they may attempt to rein in what they view as regulatory violations. The businesses, of course, might disagree with this assessment. Any new business should be aware of regulations that apply—or might potentially apply—to them. A lawsuit currently pending in a New Jersey federal court demonstrates this sort of dispute. RD Legal Capital, LLC v. U.S. Securities and Exchange Commission, No. 2:16-cv-05104, complaint (D.N.J., Aug. 22, 2016).

The plaintiff alleges that the Securities and Exchange Commission (SEC), a federal agency charged with enforcing securities laws, exceeded its authority under both federal law and the U.S. Constitution by initiating a regulatory action against it for alleged violations of the Investment Advisers Act (IAA) of 1940, 15 U.S.C. § 80b-1 et seq. While businesses in New Jersey and New York that do not provide financial services of any kind are not likely to find themselves subject to this specific statute, the case is illustrative of how the government can seek to impose an existing regulatory framework on a business, even if the business believes in good faith that it is not subject to that framework.

The statute at issue in RD Legal Capital defines an “investment adviser” in part as someone “in the business of advising others…as to the value of securities or as to the advisability of investing in, purchasing, or selling securities.” 15 U.S.C. § 80b-2(a)(11). Congress originally passed this law in the wake of important Great Depression-era statutes like the Securities Act of 1933 and the Securities Exchange Act of 1934. Each law uses a substantially similar definition of a “security,” id. at § 80b-2(a)(18), 77b(1), 78c(a)(10), and each has generated a considerable amount of regulatory opinions and caselaw regarding the scope of this definition.

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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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