New York & New Jersey Business Lawyer Blog

By Peosoldier photographer [Public domain], via Wikimedia CommonsEvery business may begin with an idea, but without money, a business cannot operate and grow. Most aspiring business owners fund their businesses from their own savings, or from credit cards or bank loans. A wide range of investment sources are available for businesses that can demonstrate a solid product or service, and the potential for growth and scalability, and profitability.

Stages of Business Financing

New businesses often follow several stages in obtaining financing:

– Seed stage:  The business solely consists of an idea or a product.
– Startup financing:  The business is ready to launch its product or service. In venture capital financing, this is sometimes known as the “Series A” financing round.
– Second-stage financing:  The business has demonstrated its viability and needs additional capital. This is sometimes called “Series B” financing.
– Line of credit, additional financing:  The business is nearing profitability and secures a line of credit from a commercial bank for “working capital.” It may also seek additional rounds of financing, beginning with “Series C” and continuing through the alphabet.
– Acquisition or IPO:  The business is acquired by another business or makes an initial public offering (IPO), which makes its shares available for purchase and sale on one or more stock exchanges.

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By Employeeperformance (Own work) [Public domain], via Wikimedia CommonsBuilding a team is a critical step in the process of growing a small business, but it brings unique issues and challenges. Employment laws at the federal, state, and local levels affect almost every aspect of the employer/employee relationship. Here is a brief overview of some laws that New Jersey small business owners should know, with a focus on laws at the state level.

Minimum Wage

The New Jersey Wage and Hour Law (WHL), N.J. Rev. Stat. § 34:11-56a et seq., governs wage rates throughout the state. As of January 1, 2015, the minimum wage for employers in the State of New Jersey is $8.38 per hour. The federal minimum wage has been $7.15 per hour since 2010. 29 U.S.C. § 206(a)(1)(C).

The minimum wage for employees, such as food servers, who receive gratuities or tips from customers is $2.13 per hour. This is the same as the federal rate. If an employee’s tip income is less than $6.25 per hour for a pay period, however, the employer must make up the difference to bring their wage up to $8.38 per hour.

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Identify the image source as Compliance and Safety LLC and include a working hyperlink to http://complianceandsafety.com on the same page that uses this image. [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsCybersecurity, the process of protecting a company’s digital assets from theft and other harm, is an important issue for every business, regardless of size or complexity. Almost every business now relies on computers to some extent, and criminals are constantly developing ways to access business computer systems to steal customer information or company financial information, or even just to cause damage. Hackers may be able to penetrate a company’s computer security remotely, but many high-profile data breaches are accomplished by stealing laptop computers, hard drives, and other hardware. A company’s legal liability for a data breach is still a developing area of law, and few answers are certain in that area. Avoiding legal liability, however, is far from the only reason to take precautions against data breaches.

Recent data breaches have led to lawsuits against the affected companies by customers and shareholders, and a data breach could also result in administrative fines or penalties in some circumstances. Few statutes directly address a company’s liabilities with regard to cybersecurity, but numerous legal claims are possible:

– Negligence:  One or more customers whose personal information was compromised in a data breach could claim that the company breached a duty of care to safeguard that information, and that this caused them financial damage.

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By Pictofigo (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsGreat business successes often begin with a single idea, or so we often hear from people who have succeeded in business. It is certainly true that an idea can mark the beginning of a process that, hopefully, results in “success” by whatever metric a business owner wants to measure it. That process has many steps, and it requires the assistance and involvement of many other people, businesses, and organizations. How does a business owner or entrepreneur embark on this path while keeping others from stealing their idea? Intellectual property laws are not much help for something that is still in the “idea” phase, but New Jersey’s trade secrets law may provide some protection. Caution is still a good strategy, however, and no business venture is free of this sort of risk.

The first question to address, of course, is what we mean by a “business idea.” In order to qualify for legal protection, a business idea cannot be too general or vague. New Jersey law states that a “trade secret” must be kept secret, must have “actual or potential” economic value, and must not be something that a competitor could easily figure out on their own. N.J. Rev. Stat. § 56:15-2. New Jersey law allows a person to obtain injunctions and recover damages, including actual damages and unjust enrichment, for misappropriation of trade secrets.

If an idea must be kept secret in order to have protection under the trade secrets law, how does anyone ever work with other people on their business ideas? This is the part that involves some inherent risks. A person may ask other people, prior to meeting to discuss the idea, to sign a non-disclosure agreement (NDA). This can be effective, since it is enforceable both under the trade secrets law and breach of contract law. Some larger companies, however, may refuse to sign NDAs, often on the grounds that they do not want to risk exposure to a legal claim if they reject the idea, but then later develop a similar idea entirely on their own.

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geralt [Public domain, CC0 1.0 (http://creativecommons.org/publicdomain/zero/1.0/deed.en)], via PixabayThe attorney-client privilege, which safeguards communications between an attorney and a client, is a cornerstone of our legal system. Attorneys must maintain a high standard of confidentiality, and the attorney-client privilege builds on this by stating that a lawyer may not be compelled to testify about communications with a client, or to disclose such information in response to a subpoena or other demand. The privilege can apply to almost any sort of legal matter, not just communications related to litigation. Business clients face complicating factors that may not be present for individuals. For example, an employee of a business must be authorized to speak on behalf of the business in a conversation with the business’ attorney for the conversation to be privileged. A New York federal court issued a ruling earlier this year addressing whether documents transmitted by a business to its attorney constituted a privileged attorney-client communication. It held that the documents, which were not prepared by legal counsel for the business, were not privileged. Wultz v. Bank of China Ltd., No. 1:11-cv-01266, opinion and order (S.D.N.Y., Jan. 21, 2015).

The lawsuit’s claims arise from a suicide bombing in Tel Aviv, Israel in 2006. The plaintiffs, whose son died in the bombing, allege that the person responsible was a Bank of China (BOC) customer, and that BOC facilitated the attack by executing millions of dollars in wire transfers for the person. The documents at issue in the court’s recent order reportedly describe an internal investigation by BOC into the lawsuit’s allegations. The plaintiffs’ counsel sent a letter to BOC’s New York branch (BOC-NY) in January 2008, stating an intention to file suit in connection with the bombing and inviting BOC to enter into settlement negotiations. BOC-NY sent the letter to BOC’s head office (BOC-HO) in Beijing. The General Manager of the bank’s Legal Compliance Department in Beijing instructed the Chief Compliance Officer to investigate the plaintiffs’ allegations. According to the court, neither of these individuals were attorneys.

While BOC-HO was conducting an investigation, the Chief Compliance Officer at BOC-NY, who was also not an attorney, was conducting a parallel investigation. The two offices exchanged information and preliminary findings, and the executive at BOC-HO directed the New York office to continue investigating. The bank branch in Guangdong, China (BOC-GD) also conducted an investigation. At some point between January and March 2008, BOC executives discussed retaining outside counsel, but they did not formally do so until the end of March. No one involved in the investigation up to that point was an attorney, nor was any inside counsel for BOC involved in the investigation.

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QWERTY_keyboard.jpgA lawsuit against a New Jersey insurance company sought damages for a November 2013 data breach that reportedly resulted in the theft of personal information of hundreds of thousands of policyholders. The plaintiffs sought to certify the suit as a class action on behalf of other policyholders whose information was compromised. They asserted causes of action for breach of contract, negligence, and violations of the Fair Credit Reporting Act (FCRA), 15 U.S.C. § 1681 et seq., and the New Jersey Consumer Fraud Act (CFA), N.J. Rev. Stat. § 56:8-1 et seq. In March 2015, however, the district court dismissed the lawsuit, holding that the plaintiffs lacked standing to sue under the FCRA. In re Horizon Healthcare Services Inc. Data Breach Litigation, No. 2:13-cv-07418, opinion (D.N.J., Mar. 31, 2015).

The defendant is a New Jersey-based health insurance company that provides services to about 3.7 million individuals. At some point over the weekend of November 1-3, 2013, an unknown individual stole two laptop computers from the defendant’s office in Newark. The laptops, which were protected by passwords, contained the personal information of over 839,000 policyholders, including names, dates of birth, member numbers, and addresses. The computers also contained Social Security numbers and clinical information for some policyholders.

The defendant issued a press release several days after the theft describing the extent of the data breach. It stated that it was not clear if the thief or thieves would be able to break the password protection to access the information on the laptops. It individually notified the policyholders whose information was contained on the laptops, and it offered free identity theft protection and credit monitoring services to policyholders whose Social Security numbers might have been compromised.
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10939979096_cab7741637_z.jpgTitle III of the Americans with Disabilities Act (ADA) of 1990, 42 U.S.C. § 12181 et seq., prohibits businesses classified as “public accommodations” from discriminating against individuals with disabilities, and it may require them to make modifications to their facilities and services to allow reasonable access. The definition of “public accommodation” has been a matter of dispute for all 25 years of the law’s existence. Several recent court cases have addressed whether businesses that provide services exclusively via the internet may be considered “public accommodations” within the meaning of Title III. Federal courts have reached different conclusions, so the dispute is likely to continue.

“Public accommodation” is broadly defined by Title III to include hotels, restaurants, theaters, public meeting spaces, retail stores, service establishments, train and bus stations, museums, parks, and schools, to name but a few. 42 U.S.C. § 12181(7). A common Title III claim might involve the alleged inaccessibility of a business’ physical location, such as due to a lack of wheelchair ramps. What about businesses that provide all their services online, with no physical facilities for customers? Claims against this type of business have included claims that video-streaming services do not accommodate deaf customers, and that websites do not accommodate blind customers.

Whether a web-based business meets the definition of a “public accommodation” is still a matter of dispute in the federal court system. The Third Circuit Court of Appeals, which has jurisdiction over New Jersey, has ruled that Title III only applies to physical locations. Ford v. Schering-Plough Corp., 145 F.3d 601, 613 (3rd Cir. 1998). That case involved loss of access to insurance benefits, not services offered by a web-based company, but the decision could apply to that sort of business. The court based its ruling on the definition of “public accommodation” found in Title II of the Civil Rights Act of 1964, which is limited to “places.” Id., citing 42 U.S.C. § 2000a(a).
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S&P500_(1950-12).jpgA superior court in New Jersey denied a motion by the credit rating agency Standard & Poor’s Financial Services (“S&P”) to dismiss a lawsuit brought under the New Jersey Consumer Fraud Act (CFA), N.J. Rev. Stat. § 56:8-1 et. seq. Hoffman, et al v. McGraw Hill Financial, Inc., et al, No. ESX-C-216-13, opinion (PDF file) (N.J. Super. Ct., Essex Co., Dec. 31, 2014). The New Jersey Attorney General is alleging financial and advertising fraud involving mortgage-backed securities, which were a major factor in the 2008 financial crisis. The case, which should be of interest to New Jersey small businesses and consumers alike, has traveled to federal court, to a multidistrict litigation (MDL) matter, and back to state court.

S&P publishes research and analysis of stocks and bonds, maintains indices like the S&P 500, and issues credit ratings for private companies and government entities. The New Jersey Attorney General alleges that, from at least 2001 to 2008, S&P based its ratings of various mortgage-backed securities on its own financial interests, and gave favorable ratings to companies that were paying clients, even if they did not merit such a rating. Numerous other states and the federal government have sued S&P over the same general allegations.

The New Jersey lawsuit (PDF file), originally filed on October 9, 2013, asserts three causes of action against S&P and its parent company: (1) Misrepresentations and knowing omissions of material fact under the CFA, N.J. Rev. Stat. § 56:8-2; (2) unconscionable commercial practices under the CFA, id.; and (3) misrepresentation and knowing omissions of material fact in violation of the Advertising Regulations, N.J. Admin. Code § 13:45A-9.2(a)(9).
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4517840289_e6558e6f0a_z.jpgA little-known federal agency within the Department of Commerce, the Bureau of Economic Analysis (BEA), revived a reporting requirement last year for U.S. companies receiving foreign investments. It also expanded the reporting requirements for U.S. companies that directly invest in foreign businesses. Prior to the recent amendments to these rules, the reporting requirements only applied to companies directly contacted by the BEA. Now they apply to any U.S. company that meets the benchmarks for reporting.

The International Investment and Trade in Services Survey Act authorizes the Executive Branch “to collect information on international investment and United States foreign trade.” 22 U.S.C. § 3101(b). The BEA is charged with carrying out this purpose. It revived Form BE-13, the “Survey of New Foreign Direct Investment in the United States,” in a final rule published in August 2014, after having discontinued the survey in 2009. 79 Fed. Reg. 47573, 15 C.F.R. § 801.7. Another final rule, published in November 2014, changed the requirements for Form BE-10/11, the “Benchmark Survey of U.S. Direct Investment Abroad.” 79 Fed. Reg. 69041, 15 C.F.R. § 801.8.

Information provided in the surveys may only be used “for analytical or statistical purposes” by the federal government, to enforce reporting requirements, and for “augmenting and improving the quality of data collected by the Bureau of the Census.” 22 U.S.C. §§ 3104(c), (d). Failure to file reports as required can result in civil penalties of $2,500 to $25,000, as well as criminal penalties of up to one year’s imprisonment and a fine of up to $10,000. 22 U.S.C. § 3105.
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345829246_a7434a76dc_z.jpgElecting “subchapter S” status has many benefits for a corporation and its shareholders, although it is subject to certain limitations on the number and type of shareholders. If a corporation’s S status is revoked, it may be able to make the election again at a later date, but that raises the question of whether tax benefits available to shareholders during the original subchapter S election are still available. The Office of Chief Counsel for the Internal Revenue Service (IRS) recently issued a memorandum on this question with regard to corporate earnings for which shareholders paid income tax, but that they did not receive as dividends. IRS regulations assign a special account for these funds and allow shareholders to withdraw them tax-free in later tax years. The account does not, however, survive the revocation of subchapter S status, meaning that shareholders lose tax-free access to those funds.

Shareholders of S corporations pay taxes on corporate income, similar to partnership taxation. They are responsible for paying income tax on their pro rata share of corporate income even if they do not receive dividends during that tax year. The IRS allows S corporation shareholders to withdraw dividends for previous tax years without incurring additional tax liability, since that money was already taxed. IRS regulations define an “accumulated adjustments account” (AAA) as containing the amount of corporate earnings taxed to shareholders but not yet paid out to them. 26 U.S.C. §§ 1366(a)(1), 1368(e)(1); 26 C.F.R. § 1.1368-2. The account is not apportioned among the shareholders.

The question presented to the IRS was whether an S corporation’s AAA survived “beyond the post-termination transition period into a subsequent S period.” In Memorandum No. 201446021 (PDF file) (“IRS Memo”), issued on November 14, 2014, the IRS concluded that the AAA does not survive this transition.
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