Articles Posted in Buying and Selling Businesses

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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295128_6656.jpgA business may decide to sell all or a substantial amount of its business assets to another individual or company for a variety of reasons. These types of transactions are known as “bulk sales” if they are not part of ordinary business activities. Both New York and New Jersey require businesses that collect sales tax to disclose a planned bulk sale to state tax authorities. This disclosure is the purchaser’s obligation, since the purpose is to allow the state to determine the seller’s tax liability. If the purchaser does not make the required disclosures, it could become liable for the seller’s outstanding tax debt to the state. The disclosure process is not terribly complicated, but it appears to be one that many businesses forget in the course of purchasing another business’ assets.

What Is a “Bulk Sale”?

Any sale of business assets that is not part of the normal course of business could qualify as a bulk sale under state law. A bulk sale may occur if a company is going out of business, upgrading its equipment, or making significant changes in its business activities. Bulk sales may also occur in mergers or acquisitions, or if a business is converting from a sole proprietorship to a corporation or other business entity.

“Business assets” include any assets used in the course of business, including:
– Personal property, such as computers, office furniture, and inventory;
– Intellectual property, including patents, trademarks, and trade secrets;
– Certain types of real property; and – Intangible assets, like business goodwill.
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Fondos_archivo.jpgA business entity created under the laws of New Jersey or another U.S. state is, at the most basic level, a collection of legal rights and obligations aimed at specific business activities, usually with the goal of making a profit. Those rights and obligations depend on a substantial number of agreements that should be reduced to writing and stored where a business owner can easily find them.

The following list includes 15 types of documents you should keep with your business records. You might need any of them if you have a disagreement with a business partner, co-owner, contractor, or employee, if you want to do business with a government agency, if you are looking for venture capital or other new investors, if you are trying to wind the business down, or simply in preparation for the unexpected. A few ounces of paper might be worth many pounds of future regret.

1. Formation Documents

Forming a business entity requires filing documents with the state and paying a fee. In New Jersey, the Department of the Treasury’s Division of Revenue and Enterprise Services handles business formation. A document forming a corporation is often known as a Certificate of Incorporation, while one creating a limited liability company (LLC) is known as a Certificate of Organization.
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I_Like_a_Little_Competition.jpgA hospital system’s purchase of a physician group violates state and federal antitrust law, according to a federal court’s ruling in two combined cases, Saint Alphonsus Medical Center, et al v. St. Luke’s Health System, Ltd., No. 1:12-cv-00560, and Federal Trade Commission, et al v. St. Luke’s Health System, Ltd., et al, No. 1:13-cv-00116, findings of fact (D. Id., Jan. 24, 2014). State and federal regulators, as well as several competing medical groups, filed suit against the hospital system for alleged anticompetitive practices. The plaintiffs claimed that the acquisition of the physician group gave the hospital substantial dominance over a relatively small market, which was likely to drive up prices for consumers. The court agreed and entered a permanent injunction barring the merger.

St. Luke’s, which operates a statewide system of hospitals in Idaho, began purchasing independent medical practices in order to “assemble a team committed to practicing integrated medicine.” Id. at 2. The court actually praised St. Luke’s for its efforts to create a model of healthcare based on patient outcomes, rather than one that focuses on increasing revenue through expensive medical procedures. St. Luke’s purchased Saltzer Medical Group, a physician group located in Nampa, Idaho. After the merger, St. Luke’s employed approximately eighty percent of the primary care physicians in Nampa, a town of approximately 83,000 people.

Several other medical groups, the Federal Trade Commission (FTC), and the state of Idaho filed suit against St. Luke’s under federal and state antitrust law. They alleged that the market dominance enjoyed by St. Luke’s after the merger would give it enough leverage to negotiate higher rates of reimbursement with health insurance plans and to set higher rates for ancillary medical services, such as x-rays. These costs would eventually be passed on to consumers, raising the cost of healthcare for everyone in the Nampa market. After a bench trial, the court agreed with the plaintiffs and ruled in their favor.
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US_Wireline_Broadband_31Dec2012.tiff.jpgThe proposal by Comcast, generally considered to be one of the world’s largest mass-media companies, to purchase Time Warner Cable has generated a considerable amount of controversy. The offer is, on the most basic level, not that different from any other proposed merger or acquisition, but given the size and influence of the two companies, the deal involves far more issues and far more complications. Comcast must show that the deal will not hurt competition in the market and will be in the public’s interest. While most small businesses will probably never have to contend with this many issues, the Comcast/Time Warner deal demonstrates that combining two or more businesses can involve much more than just buying up stock and assuming leases.

Comcast provides residential and commercial cable television and internet service in at least forty U.S. states, while Time Warner is in twenty-nine U.S. states. Both companies provide service in New York and New Jersey. Comcast announced in mid-February 2014 that it had reached an agreement to purchase Time Warner for $45.2 billion in stock, with Time Warner’s shareholders receiving 2.875 Comcast shares for each Time Warner share. Comcast previously purchased the media company NBCUniversal, which owns the NBC television networks, the Universal Pictures film studio, and other properties, in 2011, so it has recent experience with the regulatory processes involved in a large acquisition. The deal with Time Warner would make it, beyond a doubt, the largest media company in the world.

The federal government must approve the deal before it can move forward under federal antitrust laws, which prevent monopolies and anti-competitive practices, and communications regulations that protect the public’s interest in public airwaves and other infrastructure. The Department of Justice (DOJ) has jurisdiction over antitrust issues, and has quite recently pursued Comcast for alleged anti-competitive practices. It filed suit against the company during the merger with NBCUniversal, accusing it of using unlawful practices to limit competition by online video providers like Netflix and Hulu. The company entered into an agreement with the DOJ requiring it to provide services that allow other companies to compete in the online video market. The DOJ may conduct a similar review regarding the impact of the proposed Time Warner deal.
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Collaboration_logo_V2.svg.pngA new year often provides an opportunity for business owners to review their goals and their progress towards those goals, to consider whether those goals remain the same, and to make adjustments to the business based on changed circumstances in the market or in their own lives. Small businesses, especially closely-held and family companies, often depend on the hard work and dedication of their owners. It can be difficult for owners to step back from the business, even when necessary. Succession planning, which allows a business to continue operations in the event that the owner or owners cannot continue in their previous role for whatever reason, is a critical responsibility of a business owner. The arrival of a new year may be the perfect time, if an owner has not thought about succession planning yet, to start thinking about it. Here are four steps in succession planning to help small business owners on their way.

Identify the Organization’s Needs. Every business is unique, obviously, so each one will have its own unique needs for a smooth transition in leadership. Some small business owners may designate someone to take over for them, but all succession plans should have clearly-defined procedures for identifying a successor and moving them into a leadership position. If running the company requires a high level of expertise in a particular field, or even professional credentials like a law or medical license, a succession plan should include a process for keeping the business in the hands of qualified individuals. If such individuals are not already part of the organization, the plan should include a way to locate and recruit someone.

Identify Personal Needs. Small businesses often depend on leaders working together, and discord is frequently the cause of a small business’ failure. A succession plan must consider the personalities and relationships of the people who currently comprise the business and, to the greatest extent possible, plan for the continuation of the business with minimal feather-ruffling. It should also consider personal issues like income and estate tax.
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file2581243266765.jpgA business owner may have violated the Uniform Fraudulent Transfer Act (UFTA), N.J.S.A. 25:2-20 et seq., when he closed his wholly-owned corporation and began working for another company in the same field, according to a New Jersey appellate court. Del Mastro v. Grimado, et al, No. A-1433-11T4, per curiam (Sup. Ct. N.J. App. Div., Sep. 5, 2013). The plaintiff, who had obtained a judgment against the defendant in a separate matter, claimed that the defendant fraudulently transferred business assets in order to prevent her from collecting the judgment. The appellate court ruled that the client list of the defendant’s corporation was an asset for the purposes of the UFTA. The ruling could be important for any New Jersey small business that seeks to reorganize, dissolve, or merge with another company while certain debts remain outstanding.

The defendant was the sole shareholder of Internal Concepts, Inc. (ICI), an S-corporation that brokered electric motors used in medical equipment for about fifty clients. According to the court, the business had gross sales of $1.3 million in 2003 and $1.7 million in 2004. In August 2005, the plaintiff obtained a judgment against the defendant in a separate suit for invasion of privacy and intentional infliction of emotional distress. The court awarded her $531,000 in compensatory and punitive damages, based on an evaluation of the defendant’s assets, including ICI. The defendant closed ICI shortly before the 2005 trial began. He testified that the closure of the business was completed in July 2005. The defendant went to work for Precisions Devices Associates, Inc. (PDA), a company that had worked alongside ICI, and which began to perform many of the services ICI had performed once he joined as an employee.

The plaintiff filed suit against the defendant, as well as ICI, PDA, and PDA’s owner in July 2009, claiming that the closure of ICI and transfer of the client list to PDA hindered her efforts to collect on her judgment, and therefore violated the UFTA. The trial court dismissed the complaint in October 2011, finding in part that the plaintiff had not provided clear and convincing evidence of fraud.
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The_Bosses_of_the_Senate_by_Joseph_Keppler.jpgAs a small business grows, it may seek to purchase or acquire another business. The business it is acquiring could be a competitor, a supplier, or a means of entry into an entirely new market. Two or more businesses may decide to join together in what is commonly known as a “merger,” with one of the companies taking over all of the shares, assets, and liabilities, and emerging as a new company. These types of transactions require careful negotiation and planning, with consideration given to the rights and interests of the shareholders, management, employees, and creditors of all of the companies involved. State and federal antitrust laws must also factor into planning a merger or acquisition transaction. An experienced business lawyer can advise New York and New Jersey businesses that wish to pursue a merger or acquisition.

Mergers

Two or more companies may decide to merge and form a new, larger company that takes on the assets and liabilities of all the participating businesses. One company, known as the “surviving company,” acquires all of the assets of the other companies and assumes all of their liabilities. For corporations, shares of stock in the other companies are converted into shares of the surviving company, and all shareholders become shareholders of the surviving company. The same may apply to membership interests in merging limited liability companies (LLCs), and partnership interests in merging partnerships. The surviving company emerges from the merger, and may change its name to reflect a new identity.
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1185795_59504811.jpgFor some aspiring entrepreneurs, buying an existing business may be preferable to starting a new business from the ground up. Buying a business offers the advantage of an established brand and customer base, an existing income stream, and the opportunity to jump directly into business operations. It can be a risky process, though, so an understanding of the risks and potential pitfalls of buying a business is essential. Our experience as business attorneys has shown us many important issues for a prospective buyer to consider. Here are three of them:

Determining a Sales Price

A business’ sales price is based on a wide array of factors that are unique to each business. In simple accounting terms, the value of a business’ total assets, minus its total liabilities, is its net worth. Assets like equipment and accounts receivable are usually offset by liabilities such as outstanding debt on a capital asset. Every business should maintain an accounting of its assets and liabilities to establish net worth, but a sales price may also reflect intangible factors like business goodwill and intellectual property.

Annual profits play a major role in establishing a sales price, as well as expected profitability. A business may have liabilities peculiar to its market or location, or it may have particular legal obligations based on environmental or other types of regulations. A seller must disclose any unusual liabilities, as they can significantly impact the value, and even the viability, of a business.
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369109_6448.jpgA decision from the New York Tax Appeals Tribunal illustrates the importance of clearly and carefully documenting business transactions, even when those transactions are between family members. The case, Matter of Ultimat Security, Inc., involved an attempt by the New York Division of Taxation (DOT) to hold a company liable for sales tax owed by the company whose assets it acquired. The original business and its successor were owned by a son and his mother, respectively, and they contended that the asset transfer was not a “bulk sale” subject to tax liability. The courts disagreed and held the successor business liable for the full tax bill.

From November 2000 to May 2007, Tim Butler owned and operated Ultimate Security, Inc., a Hempstead-based provider of residential and commercial security guard services. The company employed Butler’s mother, Vera Drayton, as an office administrator. Drayton reportedly wanted to start her own business, and Butler approached her about taking over his company. Drayton created a new business entity, Ultimat Security, Inc. During May 2007, Ultimate Security transferred its business assets, which consisted of a customer list, office equipment, equipment for security guards, and other personal property, to Ultimat Security. Neither the two companies nor Butler and Drayton signed a sales contract, nor did any consideration change hands.

New York state law requires the purchaser in a “bulk sale” of assets to file a notification with the DOT, which Ultimat did not do. The DOT requested information about the bulk sale from Ultimat in December 2007, and received a reply denying that the transfer of asset constituted a bulk sale. In January 2008, the DOT notified Ultimat of a possible claim for sales taxes owed by Ultimate. The DOT concluded that the transfer was a bulk sale because of, among other factors, the relationship between Butler and Drayton, the commonality of the companies’ customer and employee lists, the similarity of the company names, and the lack of documentation filed by Ultimat upon the commencement of its business operations. The agency issued a Notice of Determination that February holding Ultimat liable for tax assessments against Ultimate, totaling almost $350,000.
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