Reprinted with permission from the Spring 2018 Issue of the Pennsylvania CPA Journal

My partners and I were retained for a recent case that highlighted the value of tax and accounting expertise in litigation. We represented shareholders in a precious metals business who were embroiled in a difficult intrafamily dispute. The work illustrated a successful marriage of lawyers and accounting experts in a very complicated commercial case.

A platinum recycling company owned by three brothers – I’ll call them O, S, and K – acquired an interest in a company in Gibraltar and another company in the United Arab Emirates (UAE). Their creditor was a South African platinum company.

Trouble started in 2008. The company fell behind in payments to its South African creditor, and the brothers fought over their company’s future and strategies to repay their creditor. Litigation ensued.

Suits erupted in four different jurisdictions: in the London Court of International Arbitration (LCIA) in the High Court of Justice, Chancery Division (Chancery case), venued in London, England; in Bucks County, Pa.; in Burlington County, N.J.; and in federal court in the Eastern District of Pennsylvania.

Brother S and the company sued Brother K in New Jersey for failure to pay funds due under a loan from the company. The loan was to permit Brother K to purchase the UAE and Gibraltar companies, and then to transfer half of his interest to Brother S.

In the Chancery case, Brother S sued Brother K for K’s conduct in the transactions to purchase the UAE and Gibraltar companies.

Brother O sued Brothers S and K and the company in Bucks County for failure to make distributions to him, for mismanagement, and for self-dealing. Brother K, as an owner of the UAE and Gibraltar businesses, filed on behalf of those entities against the brothers’ company for failure to return metal or pay funds due.

In London, the South African company sued the brothers’ company for $200 million in loans owed to it. It filed the same action in the Eastern District of Pennsylvania.

The brothers eventually settled the Bucks County, London, and New Jersey actions, as well as one of the federal court actions. However, the dispute with the South African company in the LCIA went to trial. The South African company won a judgment for slightly more than $200 million.

The South African company then filed a new action in federal court, alleging that the earlier settlements amounted to fraudulent conveyances made to avoid the $200 million claim while the brothers’ company was insolvent and without fair value exchanged.

The dispute required forensic accounting experts on both sides to present on several issues, including maintaining the entity’s status as an S corporation, evaluating the solvency of the entity, providing insight into whether certain transactions amounted to fraudulent conveyances, and assisting counsel with cross-examination.

The accounting experts evaluated whether settling the Bucks County case to preserve an S election was a viable defense under the fraudulent conveyance statute, and provided advice, reports, and testimony to explain the S election, the steps the company could properly have taken to preserve the election, and the consequences of losing the election.

The parties sought expert opinions regarding the company’s insolvency, and the date it became insolvent. With a $200 million judgment looming, the issue of insolvency was a matter of “when,” rather than “whether.” The lawyers and accountants worked together to determine the date on which insolvency occurred and how to present that to the jury.

The most daunting issue in the case was the lack of professional recordkeeping by the brothers’ company. This issue is too common in family businesses, even among those that have been successful. Experts were required to recreate financial information from the reports generated related to the insolvency and tax issues. The forensic accountants provided support in cross-examination aimed at challenging those recreated reports.

The jury was called upon to answer the following question: Did the settlements amount to fraudulent conveyances? The jury answered “yes” with regard to the Bucks County settlement, but “no” to the settlement of the dispute with the UAE and Gibraltar entities. The jury found that the shareholders did not engage in actual fraud. It returned a verdict of $16 million in favor of the South African company.

The creditor portion of this case required extensive use of forensic accounting experts who expressed opinions on both sides of the Subchapter S and insolvency issues. They assisted in devising strategies to present highly technical topics to the jury. Accounting experts on both sides recreated financial records, and wrote reports addressing the issues. They assisted in devising strategies for cross-examination, and they testified. Together the lawyers and accounting experts were able to present very complicated evidence in a way that kept the jury engaged.

The Tax Cuts and Jobs Act includes a substantial change to the allowable amount of mortgage interest which is tax deductible.   For those who are contemplating purchasing expensive homes and taking out a mortgage with a principal balance of more than $750,000, the interest on the amount over $750,000 will not be tax deductible.  For mortgages issued prior to December 15, 2017, the mortgage interest is deductible for principal mortgage amounts of up to $1,000,000.  However, after December 15, 2017, that amount is reduced to principal amounts of up to  $750,000.  This only applies to properties purchased after December 15, 2017.  Absent any extension of this law, the amount reverts to $1,000,000 in 2026. 

Another big change relates to home equity lines of credit on your residence.  In the past, the mortgage and home equity line of credit could be lumped together, and the interest on both deducted up to the maximum allowed loan amount.  That is no longer the case.  It does not matter if the home equity line of credit was taken out before or after the change in tax law.  In general, the interest on home equity lines of credit is no longer deductible.  There are some limited exceptions to this where the funds are used to substantially improve the residence, but even this exception requires very specific requirements to be met.  This tax change could have a large impact on those who intentionally took out a home equity line of credit rather than refinance their mortgage to a larger amount. Without this deduction, taxable income will be higher.

Reprinted with permission from the February 26th, 2018 issue of The Legal Intelligencer. (c) 2018 ALM Media Properties. Further duplication without permission is prohibited.

At the end of 2017, legislators in Pennsylvania proposed legislation to ban noncompete agreements.  The proposal is consistent with a legislative trend in other states.  In New Jersey, the Senate proposed a bill (Senate Bill 3518) that would place limits on the ability to impose noncompetes (there is a similar Assembly Bill, A5261).  Both of these bills reflect already existing challenges in drafting and enforcing restrictive covenants. 

Pennsylvania’s House Bill 1938 was referred to the Labor and Industry Committee on November 27, 2017.  The Bill recites a declaration of policy that reads like a defendant’s brief in a preliminary injunction case.  It states, summarizing, that the Commonwealth has an interest in the following:  allowing businesses to hire the employees of their choosing; lowering the unemployment rate; allowing employees to make a living wage; allowing employees to “maximize their talents” to provide for their families; promoting increased wages and benefits; promoting innovation and entrepreneurship; promoting unrestricted trade and mobility of employees; allowing highly skilled employees to increase their income; attracting high-tech companies; disfavoring staying in jobs that are not suited to qualifications; and disfavoring the practice of leaving the Commonwealth to seek better opportunities. 

The Bill defines a “covenant not to compete” broadly as an agreement between an employer and employee that is designed to impede the ability of the employee to seek employment with another employer.  Interestingly, the Bill does not seem to distinguish between a non-solicitation restriction and non-competition restriction.  The Bill prohibits all “covenants not to compete,” and does not allow a court to rewrite the covenant not to compete to make it enforceable. 

There are exceptions:  “reasonable” covenants not to compete that relate to an owner of a business; covenants not to compete involving a dissolution or disassociation of a partnership or a limited liability company; and “reasonable” covenants not to compete that were in place prior to the effective date of the statute.  One presumes that previous case law regarding what constitutes a “reasonable” restriction on competition will apply. The Bill would allow an employee to recover attorneys’ fees and damages upon prevailing in a suit brought by the employer related to the enforcement of a covenant not to compete.

The historical reluctance of courts to enforce restrictive covenants as written has certainly impacted how and when employers use such documents.  Employers (with their attorneys) have attempted to draft documents that a court will enforce, and given careful thought to filing suit in the event of a breach.  This Bill, however, would change that calculus dramatically; not just because of the outright ban on arguably both noncompete and nonsolicitation agreements, but also because of the attorneys’ fees provision.  Employers who get it wrong will pay attorneys’ fees and damages, including punitive damages, to the employee.  It may no longer be wise to file preliminary injunctions as a deterrent or a means to a resolution.  If passed, this Bill would require employers to focus on two important concepts going forward, one legal, and one not legal:  retention of key employees and protection of trade secrets. 

The Bill remains with the House Labor and Industry Committee and does not, at this time, appear on that committee’s schedule. 

The New Jersey Bill would also impact the legal and economic strategy of using and enforcing restrictive covenants.   Introduced on November 7, 2017, the Bill recites public policy goals with regard to covenants not to compete similar to those recited in the Pennsylvania Bill.  The Bill defines a restrictive covenant more narrowly than the Pennsylvania Bill:  agreements under which the employee agrees not to engage in certain specified activities competitive with the employer after the employment relationship has ended.   The New Jersey Bill does not ban covenants not to compete, but instead imposes a series of restrictions that would seriously impact how noncompetes were enforced and drafted, and would have required employers to pay employees for the period of the restriction.  The New Jersey Bill died in committee. 

Both Bills reflect the historical judicial reluctance to enforce noncompetes, and change the economics and legal issues related to those agreements dramatically.  They are in line with restrictions in other states like California, North Dakota and Oklahoma.  Most importantly for practitioners, they reflect that reliance on a well-drafted choice of law provision may not save the day.  Case and statutory laws on this particular topic are not really predictable in the usual way.  Just by way of example, Massachusetts has eight outstanding bills related to the topic, all of which were the subject of hearing on October 31, 2017, and both Vermont and New Hampshire proposed outright bans earlier this year.   Even the results of upcoming elections could change the statutes in any particular state.

These bills proposed late in 2017 reflect current challenges in drafting and enforcing agreements that are enforceable and highlight the importance of considering each decision carefully.  Drafters must consider carefully the specific interest an employer is attempting to protect, but even the most careful drafting may not survive new legislation.   It will be interesting to see whether, and in what form, legislatures may codify some of these challenges in the future. 

Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on employment, commercial litigation, and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com

As everyone has heard by now, the 2017 Tax Cuts and Jobs Act was signed on December 22, 2017, and is now law.  While the name may be confusing, what it means for taxpayers is that many tax laws are changing.  Attorneys and accountants are still figuring out what the impact of the Act  will be, and more direction will be provided by the IRS in the coming months and years.  This is the first in a series of blogs designed to demystify the new tax laws that may impact those who are divorced or currently in the process of getting divorced.

Alimony has long been tax deductible to the payor (person paying alimony) and added to taxable income to the recipient (the person receiving alimony), as long as specific requirements set forth by the IRS are followed.  The result has been an income shift from the party that pays a higher tax rate to the party that pays a lower tax rate.  In the end, both parties under this scenario end up with more money than if alimony were not taxable or deductible.  This treatment has applied to spousal support, alimony pendente lite and alimony.

With the passage of the Tax Cuts and Jobs Act, such treatment of alimony will change, but not right away.   As of now, the change is only for tax years 2019 through 2025, and specifically will only apply to agreements signed after December 31, 2018.  It remains to be seen what will happen after 2025, or possibly before if there are additional changes to the tax code.  There is an exception made, however, for those who have already entered into an agreement on or before December 31, 2018.  The law changes for all agreements entered after December 31, 2018, so that the alimony will no longer be deductible for the payor, or count as income to the recipient.  It remains to be seen if there are any changes to how the amount of spousal support, alimony pendente lite or alimony are calculated given the change in the tax law.  If there are no changes to the calculations, the result will be a loss of tax advantage for the party paying support, while the party receiving support will receive the benefit.  If there are changes to the support calculations, I would anticipate that we will know by the end of this year.  Stay tuned.

The words “I’m calling my lawyer” as famously spoken on the big screen are intended to inspire fear and trepidation.  They often do; particularly where one side in litigation has a disproportionally strong legal position on a critical issue.  The threat of litigation is certainly a motivating factor in pre-suit settlement discussion.  Even before lawyers get involved in a dispute, the parties have often drawn their respective battle lines and prepared for the standoff.     

Sometimes litigation is absolutely necessary.  Where one party to a dispute unreasonably believes a legal position is infallible or is deluded by the grandeur of potential recovery, a third party, arbitrator, judge or jury may be necessary to convince that party otherwise.  An inability to assess risk often results in a failure to completely evaluate ramifications. In such cases, litigation is inevitable and the best available alternative.      

Under any circumstances, the parties must consider the impact of litigation.  In business, that impact is not only the expenditure associated with legal fees, but also the distraction litigation brings to the business.  Instead of pursuing the next lead, deal or development, the business can be dedicated to the completion of discovery, attendance at deposition or preparation for trial. 

A couple of practical considerations:

First, involvement in litigation invites intrusion into a business’s management, internal affairs and financial information.  Selecting appropriate individuals within your company who will be involved on a day to day basis and who have knowledge of the facts of the dispute can be a massive undertaking in and of itself, as the demands of producing needed information, data and research will inevitably interfere with that person or persons performing their normal duties and responsibilities for the business.   More importantly, in some cases, litigation results in exposure or threatened exposure of otherwise secret information.  Customer relationships can be impacted, particularly if those customers are forced to respond to subpoenas.  It is critical under such circumstances that business owners and managers make sure a plan is in place to manage internal and external communication.  

Other sensitive information may also be revealed.  In a classic case of “I did not realize that was important”, clients often omit material facts which may not bear directly on their claim but which may be implicitly revealed.  Tax issues are a prime example of such material facts.  Any time money changes hands, the manner in which such proceeds are recorded will be addressed in litigation and to the extent either party has sought an unsupportable tax advantage, that act or omission will be revealed.    

Undoubtedly, the party sued will seek retaliation and file counterclaims.  For example, a contractor performs work for a homeowner which the homeowner fails to pay for.  Contractor sues, only to have the homeowner raise counterclaims based on the Unfair Trade Practices and Consumer Protection law which provides for triple damages and attorney fees which can potentially dwarf the original claim. Now the contractor spends more defending the claim for treble damages than in pursuit of the recovery.    

Finally, there is the issue of cost.  Litigation is expensive.  At the end of the day, the parties must consider the cost of a particular course of action and whether the potential for recovery is simply outweighed by that cost. 

So before embarking down the road of litigation, be certain it is a path you wish to follow.  Be sure to consider the impacts, both intended and incidental, to ongoing business operations.  Be sure your house is in order and that the skeletons in the closets are not subject to reanimation.  Finally, be confident in the analysis that money spent in litigation is a good investment. 

Reprinted with permission from the January 18, 2018 issue of The Legal Intelligencer. (c) 2018 ALM Media Properties. Further duplication without permission is prohibited.

In a recent decision, the Pennsylvania Superior Court complicated the already tricky business of paying nonexempt employees on an hourly basis for Pennsylvania employers.  In Chevalier v. Hiller, the Court found that a “fluctuating workweek” overtime calculation method, approved by federal regulation, violates Pennsylvania’s Minimum Wage Act, 43 P.S. §333.101  et seq. (“PMWA”).  The Superior Court reversed the trial court’s grant of summary judgment in favor of the employees, in a comprehensive opinion that requires Pennsylvania employers to review carefully their overtime calculation methods.

The employees in this case were managers at various levels for GNC.  GNC calculated their overtime pay using the “fluctuating work week method.”  Under this method, in an example provided by the Superior Court, overtime was calculated as follows:  employees were paid $1000 a week regardless of the number of hours worked in a week.  In one week, the example goes, the employee worked 50 hours.  GNC thus calculated the employees “regular rate” at $20 an hour.  GNC then paid the employee an additional $10 an hour for the ten hours over 40, resulting in $1100 in wages for the 50 hour week.

The employees argued that this method was improper under the PMWA, and the trial court agreed.  The trial court opined that the rate instead should have been calculated using the “forty hour” method.   Under this method, the regular rate is determined by dividing the weekly salary of $1000 by forty hours, to produce a rate of $25 an hour.  Then, the additional ten hours over forty worked should have been paid at time and a half for an additional $375, resulting in $1375 in wages for the 50 hour week. Notably, had the Superior Court agreed with the trial court, the cost of paying nonexempt employees on a salary basis would have increased exponentially. 

Instead, the Superior Court disagreed with the trial court and found that the regular rate was properly calculated using the “fluctuating workweek method,” that is, that the employer’s calculation of the regular rate by dividing the employee’s salary in a given week by the number of hours the employee actually worked did not violate the PMWA. 

However, the Superior Court found that GNC’s method of paying for the overtime hours violated the PMWA.  The Superior Court found that PMWA required the payment of an overtime premium of 1 and ½ times the employee’s regular rate for all hours in excess of forty in a work week.  Accordingly, using  the fifty hour example set forth above, that employee should have received $200 in overtime. 

The Superior Court began its analysis by noting the purpose of the PMWA, which mirrors the language of the FLSA, “to protect employees who do not have real bargaining power.”  The Court noted that no Pennsylvania appellate court had evaluated the propriety of the fluctuating workweek method under the PMWA, but that some federal courts had addressed the PMWA’s overtime requirements.  In those cases, the federal courts agreed with the conclusion of the Superior Court regarding the premium due, but did not address the appropriate method for calculating the regular rate. 

The Superior  Court’s holding imposes a different requirement than the federal Fair Labor Standards Act.  Under the FLSA, and cases interpreting it, an employer is free to use the fluctuating work week method, and to pay a premium of one-half the hourly rate for hours over forty in a workweek, on the theory that the regular rate for those hours is captured in the salary.  While the Superior Court found that the PMWA permitted a calculation of the regular rate, consistent with the FLSA, using the fluctuating workweek method, the Superior Court found that Pennsylvania law would not permit a premium of only ½ that regular rate.

Instead, the Superior Court found that the applicable regulations required the payment of one and one-half times the regular rate for hours over forty in a workweek. The applicable regulations require that “each employee shall be paid for overtime not less than 1-1/2 times the employee’s regular rate of pay for all hours in excess of 40 hours in a work week.”  24 Pa. Code § 231.41.    The regulations do permit the payment of half the regular rate only for employees who are paid a flat sum for a day’s work.  34 Pa. Code § 231.43(b).  Finally, another regulation permits employer and employee to come to an agreement as to the “basis rate” for payment of work in excess of the maximum workweek, but only if the employer uses a multiplier of one and one-half.  In other words, the Superior Court found, in all instances where the regulations address the appropriate multiplier, the regulations required the payment of one and one-half times the regular rate.  The Court pointed out that the Department of Labor did not adopt the federal regulation that expressly permits the payment of half the regular rate as the overtime premium, although it could have done so.  The Court found the decision not to adopt that federal regulation was a deliberate reflection of the purpose to protect employees.   

The Superior Court’s decision creates a dilemma for Pennsylvania employers using the fluctuating workweek method.  Pennsylvania employers currently paying an overtime premium of half the hourly rate for hours over forty in a workweek to nonexempt, salaried employees, are complying with federal, but not Pennsylvania law.  Employers will need to evaluate their overtime calculation policies and review whether paying nonexempt employees on a salary basis continues to make economic sense. 

Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on employment, commercial litigation, and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com