Articles Posted in Small business

bookThe structure of a corporation establishes a division of rights and responsibilities among at least three groups. Ownership of the corporation is vested in the shareholders, while directors are charged with its overall management. Officers are responsible for the corporation’s day-to-day operations. A shareholder who is not also a director or officer may not have much of a role in the operation or management of a corporation, but they have rights to information about the corporation’s financial status. The Delaware Court of Chancery recently ruled in favor of a shareholder seeking access to a corporation’s books. Rodgers v. Cypress Semiconductor Corporation, No. 2017-0070-AGB, order (Del. Chanc. Ct., Apr. 17, 2017). The court’s order offers useful guidelines for shareholders seeking access to corporate information.

New Jersey law defines “shares” as “the units into which the proprietary interests in a corporation are divided,” and a “shareholder” as “a holder of record of shares in a corporation.” N.J. Rev. Stat. §§ 14A:1-2.1(l), (m). Any shareholder has the right to request financial documents, including balance sheets and profit and loss statements, from the corporation. Certain shareholders “have the right for any proper purpose to examine…[the corporation’s] minutes of the proceedings of its shareholders and record of shareholders.” Id. at § 14A:5-28(3).

Delaware law goes further, giving shareholders the right to inspect a wide range of corporate documents upon a “written demand under oath stating the purpose” of the shareholder’s request. 8 Del. Code § 220(b). If the corporation denies the shareholder’s demand, the shareholder can petition the Court of Chancery to compel production. A plaintiff in such a case must establish standing as a shareholder, compliance with the “form and manner of making a demand for inspection,” and a “proper purpose” for the inspection.” Id. at § 220(c).

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stormtroopersIn closely held businesses, minority shareholders—generally meaning shareholders with less than 50 percent of the company’s voting shares—can easily find themselves at a disadvantage in disputes with majority shareholders. New Jersey’s Oppressed Shareholder Statute (OSS), N.J. Rev. Stat. § 14A:12-7 et seq., provides shareholders with a means to assert their rights when they suffer from bad-faith actions by other shareholders. They do not necessarily have to be in the minority to qualify as oppressed shareholders under the OSS, according to New Jersey courts. A recent decision illustrates how shareholders can benefit from this statute. RP v. SP, No. UNN-C-108-13, mem. op. (N.J. Super. Ct. Chanc. Div., Dec. 22, 2016).

Avoiding conflicts that lead to litigation is obviously the goal of any business owner. Still, it is useful to know which options are available should a company’s operating agreement fail to provide an adequate means for dealing with conflict. The OSS authorizes courts to intervene in a business for various reasons, with remedies ranging from the appointment of a custodian or provisional director to the dissolution of the business entity. If a corporation has no more than 25 shareholders, the OSS allows court intervention if “the directors or those in control…have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees.” N.J. Rev. Stat. § 14A:12-7(1)(c).

“Control,” in this context, refers to control of the corporation’s voting stock. A “minority shareholder” can include not only a shareholder with a minority of shares but also one who “does not have control of the corporate shares with respect to voting rights.” Berger v. Berger, 249 N.J. Super. 305, 317 (1991). A minority shareholder, under this definition, can also be an “oppressed shareholder” under the OSS, regardless of whether they actually own a minority of shares. Balsamides v. Perle, 313 N.J. Super. 7, 16 (1998).

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penguinDigital technology enables businesses to store information electronically, without the need for expansive file cabinets and storage facilities, and to transmit data quickly and efficiently. It also exposes businesses to the risk of data breaches, which expose consumers to risks like identity theft. The Federal Trade Commission (FTC) recently issued guidelines regarding compliance with two major federal statutes that protect consumers and their privacy:  the Health Insurance Portability and Accountability Act (HIPAA) of 1996, Pub. L. 104-191, 110 Stat. 1936 (Aug. 21, 1996); and the Federal Trade Commission Act (FTC Act) of 1914, 15 U.S.C. § 41 et seq.

HIPAA is a comprehensive law dealing with various aspects of health insurance, but it is perhaps best known to the public for its provisions regarding medical information privacy. The statute directed the Department of Health and Human Services (HHS) to present “detailed recommendations on standards with respect to the privacy of individually identifiable health information” to several Congressional committees. Pub. L. 104-191 § 264, 110 Stat. 2033. HHS developed a set of standards and procedures from this, commonly known as the Privacy Rule, found at 45 C.F.R. Part 164.

In a very general sense, the Privacy Rule only applies to health care providers, insurers, and related businesses, described as “covered entities.” 45 C.F.R. 160.103. The Rule also applies, however, to “business associates,” defined to include any “subcontractor that creates, receives, maintains, or transmits” PHI. Id. This definition can apply to many types of businesses besides medical professionals and health care providers.

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meetingThe owners of a corporation, typically known as shareholders or stockholders, are shielded from individual liability for corporate debts. This is one of the main purposes of organizing a business venture as a corporation. Protection from liability is not absolute, however, and courts can “pierce the corporate veil” to hold shareholders individually liable for a variety of reasons under both statutes and common law. New York’s Business Corporations Law includes a provision that allows courts to hold the “10 largest shareholders” of a corporation liable for unpaid wages owed to the corporation’s employees. N.Y. Bus. Corp. L. § 630. The New York Legislature amended the law in 2016 to ensure that it applies equally to domestic and foreign corporations.

Shareholders, as a matter of general legal principle, may not be held individually liable for the corporation’s debts as long as any actions by the shareholders are reasonable and directed toward the benefit of the corporation. Self-dealing by a shareholder, the use of a corporation by a shareholder as an “alter ego,” or acts that are illegal or grossly negligent may result in individual liability. A wide array of court decisions have identified circumstances in which courts may pierce the corporate veil. Certain situations also allow courts to hold all shareholders or a distinct group of shareholders strictly liable for corporate debts.

Section 630 effectively imposes a strict liability standard on a group of corporate shareholders. An employer with a claim for unpaid wages must serve written notice on a shareholder, either within 180 days of being terminated or 60 days after reviewing the corporation’s shareholder records. The statute identifies the 10 largest shareholders based on “the fair value of their beneficial interest as of the beginning of the period during which the unpaid services…are performed.” N.Y. Bus. Corp. L. § 630(a). These shareholders are jointly and severally liable for the amount of unpaid wages.

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highway signsThe Commerce Clause of the U.S. Constitution gives Congress the power “to regulate Commerce…among the several States.” U.S. Const. art. I, § 8, cl. 3. Federal laws can therefore regulate business activities if they affect interstate commerce. This authority has led courts to identify a converse legal principle, known as the “dormant” Commerce Clause, which holds that state laws may not discriminate against out-of-state businesses in a way that impedes interstate commerce. A petition for certiorari currently before the U.S. Supreme Court could lead to changes in how states may regulate interstate commerce. Texas Package Stores Assoc., Inc. v. Fine Wine and Spirits of North Texas, LLC, No. 16-242, pet. for cert. (Sup. Ct., Aug. 19, 2016). The petitioner is asking for clarification about the scope of the dormant Commerce Clause in relation to the rarely-discussed Twenty-First Amendment, which ended Prohibition and gave broad authority to the states to regulate alcohol.

The U.S. Supreme Court has given Congress very wide authority under the Commerce Clause. The dormant Commerce Clause is essentially the negative converse of this authority. If Congress can regulate interstate commerce, the states cannot unreasonably impede it, nor can they discriminate against out-of-state businesses in favor of in-state businesses. For example, the Supreme Court found that a Massachusetts law imposing a tax on milk produced out of state, while providing a subsidy for in-state milk producers, violated the dormant Commerce Clause. West Lynn Creamery, Inc. v. Healy, 512 U.S. 186 (1994).

The Twenty-First Amendment ended the period of American history known as Prohibition, when alcohol was banned nationwide, in 1933. The Eighteenth Amendment, ratified in 1919, had started Prohibition. Section 1 of the Twenty-First Amendment officially repealed the Eighteenth Amendment. Section 2 states that transporting, importing, or possessing alcohol in any U.S. state or territory is prohibited if it is done “in violation of the laws thereof.” This has generally been construed to mean that the states have broad authority to regulate alcohol within their own jurisdictions. Courts have had to address the apparent conflict between § 2 and the dormant Commerce Clause on several occasions.

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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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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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