TLD's General Counsel Blog

Keep Your LLC Current!!

Are you the manager or the managing member of a California limited liability company? If so, you should be aware of a new program to be implemented beginning in early 2009.

The Franchise Tax Board, working with the California Secretary of State, is currently implementing a suspension/forfeiture process for Limited Liability Companies (LLC's). The FTB will begin to suspend/forfeit the rights, powers, and privileges of LLC's for nonpayment of taxes, penalties, or interest, and/or failure to file a return.

The effect of this program is to quickly alert the Secretary of State to LLC's that are not paying their taxes, penalties and interest to the Franchise Tax Board. These LLC's will more quickly be placed into "Suspended" or "Forfeited" status by the Secretary of State.

The consequence of having an LLC in suspended or forfeited status is costly. Any other party contracting with an LLC in suspended status can have that contract declared VOID and unenforceable! See California Revenue & Taxation Code 17654, 23301.5, 23304.1 and 23305.5.

To check the status of your LLC, go the California Secretary of State's website and type in the name of your LLC here:

http://kepler.sos.ca.gov/list.html

If your LLC is in suspended status, we can help you get it active and avoiding possible legal exposure.

Article Submitted by: Attorney Brooke Pollard

Business Divorces

There was recently an article in the Daily Journal about "Business Divorces." The main argument in the article was that when a business partnership turns sour, it is as difficult as a divorce to get out. TLD frequently prepares clients for these situations.

A buy-sell agreement is a way for two partners beginning a business to decide when, how and at what price their "business divorce" will play out. We recently drafted a buy-sell agreement for a group of individuals beginning a cellular accessories distribution business. The three individuals were equal shareholders, all were on the Board of Directors, and all three were employees of the corporation.

One of the shareholders decided he could get a better business opportunity by taking business leads from the company and diverting them to himself for his own personal gain. The other partners found out about what was going on and wanted this partner out of the corporation. Without a buy-sell agreement in place, this partner could be fired as an employee, but the re-purchase of that individual's shares is generally not possible. The law does not provide for a requirement of non-employee shareholders to sell their shares either to the corporation or to the other partners.

With the Buy-Sell Agreement in place, these shareholders were able to compel the repurchase of the shares, give a price for the re-purchased shares, and gave them a significant bargaining power.

The best time to draft and sign a buy-sell agreement is when the business is started. However, any time before there is a dispute amongst the shareholders a buy-sell agreement should be drafted and signed by all shareholders. Please contact TLD if you would like a buy-sell agreement drafted to protect yourself and your business.

Article Submitted By: Attorney Brooke Pollard

The “joint client” exception

The original article was written by:

Alexander Y. “Sandy” Thomas and Matthew R. Sheldon,
of The Law Firm of ReedSmith
September 9 2008

Courts are increasingly faced with claims that the “joint client” exception bars application of the attorney-client privilege. The joint client exception may come into play when an individual litigant, who was an officer or director of the business to which he is adverse in litigation, demands production of privileged material that he reviewed or had access to while affiliated with the company. The exception is based on the theory that a corporation is, in fact, one collective client that includes the corporation and each individual member of the board of directors and each officer of the company. As evidenced by the three decisions described below, courts are surprisingly receptive to application of the joint client exception. The practical implication of greater acceptance of the exception is the need for businesses and in-house lawyers to be particularly careful to limit access to privileged information only to those with a true need to know the information.

a. Montgomery v. eTreppid Technologies, LLC, 2008 U.S. Dist. LEXIS 35561

In this action, the individual plaintiff was a member and former manager of the defendant LLC, eTreppid. The plaintiff demanded production of relevant, but privileged, communications created during the time he was a manager and member of the LLC. The LLC argued that the client for purposes of determining who had authority to claim or waive the privilege was solely the LLC. The plaintiff countered that he, too, was the client, having been a member and a manager of the LLC, and claimed that eTreppid could therefore not assert the privilege against him.

The district court first determined that the LLC should be treated as a corporation, as opposed to a partnership, for purposes of the privilege. It then noted the split of authority regarding acceptance of the joint client exception and determined that the more persuasive view was that directors and officers are not joint clients with the corporation such that the plaintiff could discover privileged information merely on the basis that it was accessible to him when he was affiliated with the defendant LLC. The court observed: “It makes sense that the corporation is the sole client. While the corporation can only communicate with its attorneys through human representatives, those representatives are communicating on behalf of the corporation, not on behalf of themselves as corporate managers or directors.” Because the plaintiff brought suit to benefit himself individually, he was not entitled to discover the LLC’s privileged information. His prior access to such information took place as a consequence of his capacity as a member in the entity, not in an individual capacity.

eTreppid squarely adopts the “sole client,” as opposed to the joint client, approach to control over the attorney-client privilege.

b. Barr v. Harrah’s Entertainment, Inc., 2008 U.S. Dist. LEXIS 26018

Similar to eTreppid, the New Jersey district court in Barr faced a demand for access to privileged information by a plaintiff who previously served as CEO and board member of the defendant’s predecessor. The plaintiff, serving as the named representative in this class action suit, sought application of the joint client exception and discovery of communications between the defendant and its in-house and outside counsel during the time the plaintiff served as CEO.

The defendant argued that application of the joint client exception was inappropriate in the class action context. It maintained that disclosure of the privileged information to the plaintiff/class representative would inevitably result in disclosure of the privileged documents to the remaining class members, the majority of whom had never been officers or directors of the defendant and could not be said to be in a joint client relationship with the defendant.

Applying Delaware law and the substantial authority supporting application of the joint client exception, the court keyed its holding to the contemplated use of the privileged materials sought by the former director seeking application of the joint client exception. Unlike the Delaware cases that allow individual former officers and directors access to privileged information, the Barr court reasoned that the plaintiff/class representative actually asserted a right to discover the defendant’s privileged communications on behalf of a class of individuals who would not otherwise have access to the privileged information under Delaware law. Indeed, the plaintiff/class representative owed a fiduciary duty to the class he represented. Thus, the court acknowledged the vitality of the joint client exception, but simply declined to apply it in the class action setting.

c. Rush v. Sunrise Senior Living, 2008 Va. Cir. LEXIS 12

Again, in Rush, a court was confronted with the claim by a former officer of the defendant that he should have access in discovery to privileged information to which he was privy while employed by the defendant. The plaintiff claimed that his termination as CFO of defendant was retaliatory because of his disclosure of certain of defendant’s alleged accounting practices to the SEC. The defendant claimed the former CFO was terminated because of violation of company policies. The plaintiff sought disclosure of privileged information based on the joint client exception.

Rather than directly evaluating the merits of the joint client exception, the Virginia court applied a rigorous and narrow standard to the defendant’s threshold burden in claiming privilege over the disputed communications. The court determined that “the public policy of furthering [defendant’s] ‘full and frank communication’” with its counsel was outweighed by the plaintiff’s right of access to the privileged documents to which he was privy while employed with the defendant. The court simply declined to apply the attorney-client privilege to the withheld communications between client and counsel, and did so on the basis that the disputed communications had not been “kept confidential in relation to [the plaintiff].”

The Rush court’s ruling amounts to a pragmatic acceptance of the joint client exception. The court ordered production of privileged material to which the plaintiff had access while in the defendant’s employ, based on the fact that such materials had not been kept confidential from the plaintiff. The court did not address the question of the capacity (individual, corporate, or both) in which the plaintiff had, or was given, access to the privileged materials at the time of disclosure. Thus, under Rush, the attorney-client privilege may in some circumstances simply not be applicable when privileged communications are made to an officer or director in that person’s capacity as such, and are later sought in discovery when the individual and corporation are adversaries.

What Are the Tax Consequences of a Settlement to the Recipient of a Non-Personal Injury Action?

In litigation, any settlements should take into consideration the tax consequences to the client recipient of settlement proceeds. As a litigator, this is something very important to consider for the benefit of the client because the settlement can put the client in a tax bracket over and above what he/she is at, thereby increasing the percentage of tax the client has to pay. Here are the nuts and bolts of the taxability of non-personal injury settlements: all damages/settlements received are taxable as gross income with the exception of damages for emotional distress that are used specifically to pay medical expenses. This article does not address the taxability of personal injury settlements which is treated differently under the Internal Revenue Code ("IRC").

Lost Earnings and Lost Wages

Compensatory Damages received in non-personal injury lawsuits whether pursuant to judgment or settlement are taxable as ordinary income if they compensate the recipient for lost earnings. Estate of Carter v. Commissioner (8^th Cir.1962) 298 F.2d 192. Recoveries in employment contract disputes are generally characterized as ordinary income, just as the compensation would have been characterized under the contract. Stocks v. Commissioner (1992) 98 T.C. 1; Byrne v. Commissioner (1988) 90 T.C. 1000; Glynn v. Commissioner (1981) 76 T.C. 116. Since back pay is a quintessentially contractual measure of damages, any recovery of back wages is taxable, even if paid along with tort-like injuries. Commissioner v. Schleier (1995) 515 U.S.323; United States v. Burke (1992) 504 U.S. 299.

Reimbursement of Legal Fees and Deduction of Legal Fees

Judgment or settlement amounts intended to reimburse a taxpayer for legal fees in non-personal injury cases are generally considered income to the taxpayer. Baylin v.United States (Fed. Cir. 1995) 43 F.3d 1451; Bagley v. Commissioner (1995) 105 T.C. 396; Estate of Gadlow v. Commissioner (1968) 50 T.C. 975; Rev. Rul. 60-14, 1960-1 C.B. 16. Where an attorney is paid under a contingent fee arrangement, the client must include in gross income as a contingent fee. Commissioner v. Bank (S.Ct. Jan. 24, 2005) NO. 03-892 . Under the anticipatory assignment of income doctrine, a taxpayer may not avoid taxation by assigning income to another party. Id.

Legal fees may be deducted as ordinary and necessary business expenses. Whether litigation expenses are deductible business expenses depends on the origin and character of the claim for which the expense incurred and whether the claim bears a sufficient nexus to the taxpayer’s business. US v. Gilmore (1963) 372 US 39. Ordinary and necessary litigation costs generally are deductible when the matter giving rise to the costs is proximately related to a business activity. Woodward v. Commissioner (1970) 397U.S. 572. If indeed the legal fees are qualified as business expense, the effectiveness of the deduction may be substantially limited by the 2 percent floor on miscellaneous itemized deductions under IRC §67 and the alternative minimum tax, under which miscellaneous itemized deductions are completely disallowed.

Emotional Distress Damages in Employment Discrimination/Wrongful Termination Case

Only damages that result from personal injury actions are excluded from gross income. IRC Section 104(a)(2). The exclusion from gross income does not apply to damages received through employment discrimination or defamation actions accompanied by a claim for emotional distress. However, taxpayers can exclude damages received for medical expenses associated with emotional illness (this does not include amounts compensating for emotional distress beyond the medical expenses). IRC § 104(a); Treas. Reg. 1.213-1(g).

Punitive Damages

IRC §104(a)(2) expressly provides that punitive damages are not excluded from income, even though such damages may accompany the award of other damages that are excluded from income.

Article Submitted By: Attorney Pamela Tahim

Beware of the Contractual Arbitration Clause

Many contracts include mandatory or optional arbitration clauses which either bind the parties of the contract to an arbitration process or give the parties the option of attending an arbitration in the event of a dispute. However, not all arbitration clauses are created equally and all should be carefully reviewed and screened. Easily overlooked provisions such as whether the arbitration is binding or non-binding, a required venue or location in which the arbitration is to take place, the number of arbitrators, and what rules will govern the arbitration proceeding, will all dramatically effect the cost of an arbitration. For instance, a requirement that the arbitration take place at or under the rules of the American Arbitration Association or at some other professional arbitration company may subject the participants to the management and facility fees of the companies. In addition, even though the California Code of Civil Procedure provides for its own rules of procedure in an arbitration proceeding, such rules will be preempted by any rules agreed to in the arbitration clause. Arbitration clauses must also be carefully reviewed to determine what penalties there may be if you fail to abide by the terms of the arbitration clause. So whether you are in the process of drafting a contract, negotiating a contract, or are involved in a contractual dispute which contains an arbitration clause, the details of the arbitration clause should be carefully reviewed by an attorney to fully protect your present and future interests.

Article Submitted By: Attorney Jennifer Lumsdaine

Contract Disputes Are On The Rise

Contract disputes are on the rise.  I always encourage small business owners to include attorney's fee provisions in all contracts to be able to recoup the expenses of collection or enforcement of agreements.  The precise language, however, must be carefully considered.  In the event the term "reasonable attorney's fees" is used, then the court fixes the fees, thereby leaving open the possibility that the prevailing party will not recoup all of the amount spent.  By contrast, if the term "actual attorney's fees" is used, then the prevailing party can recover the actual amount spent on attorneys.

Moreover, Civil Code section 1717 provides for reciprocity.  In other words, if a contract permits one party to recover attorney's fees, then the provision allows the other party to recover reasonable attorney's fees if it is the prevailing party.  Again, the language of the contract becomes key in the event there are other claims brought not related to the contract, or peripherally related to the contract.  If the provision is broadly written, it is possible for a prevailing party to recover attorney's fees even on non-contractual, tort claims such as negligence.  On the other hand, if the provision is narrowly drawn such as limiting recovery of attorney's fees to actions "to enforce the contract," then the prevailing party will only be able to recover the fees incurred on the contractual claims.   

We can help if you have concerns about the language in your contracts, or if you have a claim in which a contract is involved and would like to know your rights to recovery.

Article submitted by: Attorney Min N. Thai

Restraining Orders

Restraining orders are powerful tools that we have used to protect our clients in a variety of situations. Restraining orders can limit both physical interactions and communications by telephone, email, or mail. In addition, certain restraining orders can grant monetary damages and even affect long term child custody. While common in domestic violence cases, restraining orders also are not limited to family or romantic relationships. They may also be appropriate in business or real estate disputes where there have been threats of violence or physical altercations. Restraining orders may also be appropriate where there has not been any physical threats or abuse. For example, elder abuse restraining orders may be granted to protect an elder or dependent adult from family, neighbors, caretakers, or any other person who may have engaged in financial abuse or otherwise acted to jeopardize the elder or dependent adult’s physical or financial well-being.

Article Submitted By: Attorney Jennifer Lumsdaine

Cal/OSHA - Tips for Helping Employees Work Safely, Minimize Heat Stress

What can I do to protect my employees from the effects of working in high temperatures?

When employees work in hot conditions, employers must take special precautions in order to prevent heat illness. Heat illness can progress to heat stroke and be fatal, especially when emergency treatment is delayed. Operations involving high air temperatures, radiant heat sources, high humidity, direct physical contact with hot objects, or  strenuous physical activities have a high potential for inducing heat stress in employees engaged in such operations. During the summer, workers employed in outside jobs such as construction and agriculture are subjected to many of these conditions and, for those who ignore the signs and symptoms, can become victims of a heat stress incident. According to Cal/OSHA, heat illness contributed to 12 work-related deaths in 2005 and eight in 2006. It has been well publicized that Cal/OSHA has adopted regulations for outdoor workers to address the employer’s responsibility to ensure that employees are provided means to counter the effects of working in high temperatures. These requirements, Heat Illness Prevention in Outdoor Places of Employment, are contained in Section 3395 of the General Industry Safety Orders.

Injury/Illness Prevention Plan

Employers are required to put their heat illness prevention procedures, including employee training, in writing. It is recommended this document be incorporated into the employer’s injury and illness prevention plan (IIPP). Training, at a minimum should include: l why it is important to prevent heat illness; l procedures for acclimatization; l the need to drink water frequently; l the need to take breaks out of the heat; l how to recognize the symptoms of heat illness; l how to contact emergency services and how to effectively report the work location to 911; l the importance of choosing water instead of soda or other caffeinated beverages and avoiding alcoholic beverages all together during high heat.

Signs to Recognize

There are several “causal factors” that may affect a person’s sensitivity to heat. Age, weight, degree of physical fitness, degree of acclimatization, metabolism, use of alcohol or drugs, and a variety of medical conditions such as hypertension, all affect a person’s sensitivity to heat. Even the type of clothing worn must be considered. Prior heat injury predisposes an individual to additional injury. Four conditions must be recognized by supervisors of employees potentially exposed to heat stress: Heat rash or prickly heat, heat cramps, heat exhaustion, and heat stroke. The Cal/OSHA website, HRCalifornia and CalChamber booklets contain detailed descriptions and symptoms of heat stress-related illnesses with intervention treatments. Specific measures that can be adopted to lessen the likelihood of a heat stress illness include: l administrative controls, such as work rotation, starting work early in the morning or in the evening; l providing plenty of fluids to drink, especially water; and l providing personal protective equipment in the form of cooling vests and light-colored or reflective clothing and/or shade.

Heat Risks

There is no absolute cut-off below which work in heat is not a risk. With heavy work at high relative humidity or if workers are wearing protective clothing, even work at 70 degrees Fahrenheit can present a risk. In the relative humidity levels (20 percent to 40 percent) often found in hot areas of California, employers need to take some actions to effectively reduce heat illness risk when temperatures approach 80 degrees Fahrenheit. It is especially important to be vigilant during periods of abnormally high heat. Even though Section 3395 is specific to outdoor workers, the requirements can be useful to all employers who have employees subject to working in/at a work site where the temperature/humidity can result in heat illness — for example, poorly ventilated warehouses, work processes exposing employees to high temperatures and/or humidity such as foundries or glass bottle manufactures, construction sites, etc. Heat illness is a foreseeable hazard as defined and enforced by Cal/OSHA.

Using Section 3395, employers can address the conditions within a building or permanent work site and prevent the occurrence of heat illness. As stated previously, the steps taken should be included in the company’s IIPP.

More Information

Cal/OSHA has published informational documents at www.dir.ca.gov. Click on “Heat Illness Prevention” under “What’s new.” CalChamber members can find information on heat illness by searching on “heat illness” at www.hrcalifornia.com. In addition, the CalChamber has developed a mini-book, Heat Illness Prevention in California. It is written in both English and Spanish and has readily understood illustrations of the outward symptoms of heat illness. For information on obtaining this booklet, call (800) 331-8877 or visit www.calbizcentral.com.

Article Provided by: volume 34, number 18 ● June 6, 2008 of the CalChamber Alert Newsletter. And written by Mel Davis - Cal/OSHA Consultant

Asset Protection and Limited Liability Companies

I have had quite a few questions recently about "Asset Protection" and limited liability companies.  Many clients transfer a rental property into a California limited liability company, an "LLC", for asset protection purposes, without fully understanding what "asset protection" is and why an LLC can provide it.

The concept is simple.  Imagine you own a rental property in the name of yourself and your wife, as joint tenants.  You rent this property to a couple with one child.  You have a written rental agreement (good for you!) and collect rent on a monthly basis.  You retain a general homeowners insurance policy for the value of the home. One day, a guest of the renters' falls off the roof and suffers a tragic death (it is dramatic to make the point easier to comprehend). 

As the owner of the property, you and your wife will most likely be named in any litigation for recovery by the guest's widow.  If the widow is able to obtain a judgment against you greater than the amount of your homeowners insurance policy, she will be able to enforce this judgment not only against the rental property, but also your personal assets including your residence, bank accounts, etc.

If you had transferred the rental property into an LLC, the LLC would be named as a defendant in that lawsuit, as opposed to you and your wife.  If the widow was able to obtain a judgment, it would be against the LLC, which does not include your personal assets such as your residence, bank accounts, etc.  The widow will not be able to enforce the judgment against all of your personal assets. 

This is one way to limit the risk inherent in owning rental property, and to "protect your personal assets."  Remember, in order for the LLC to be considered a separate legal entity and upheld by a court of law, the formation, implementation and ongoing maintenance of the LLC must be correct.  There are also many property tax pitfalls with transferring property from an individual to an LLC.  If you would like more information about asset protection or LLC's and their formation, please call us.

Article Submitted By: Attorney Brooke Pollard

ARC Walk - ARC of Southeast Los Angeles County

A rowdy gang of 34 TL&D supporters showed- up to the ARC Walk on Saturday, April 5, 2008 to show our great support for ARC of Southeast Los Angeles County. TL&D also donated $2,500 to become a diamond sponsor of this special event.

Arc of Southeast Los Angeles County is committed to providing for people with mental retardation and other developmental disabilities the ability to form and work towards goals through training and education, based on their individual abilities. Arc of Southeast Los Angeles County is further committed to helping to reduce and limit the incidence and consequences of mental retardation through education research, advocacy and the support of families, friends and community.

Tredway, Lumsdaine & Doyle has supported ARC for many years through special events such as this, and by hiring people with developmental disabilities as support for the law firm. “Community service is important for any business, but its particularly important for lawyers,” said Joe Lumsdaine, senior partner for the firm, “Lawyers serve in a privileged position. They should be willing to support the community in return.”