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CROWDFUNDING OR CROWDFOOLERY?

Written by Susan Maslow Friday, November 06 2015 16:27

Part 1 of 3 Part Series:

General Rules

After years of hand-wringing and speculation by entrepreneurs, re-occurring angels, venture capital firms, registered brokers and lawyer types involved with private placements, on October 30, 2015, the U.S. Securities and Exchange Commission (SEC) finally adopted equity crowdfunding rules pursuant to Title III of the Jumpstart Our Business Startup Act of 2012 (JOBS Act).  These rules, which rely on Section 4(a)(6) of the Securities Act, are scheduled to be issued in the Federal Register early in 2016 and will become effective 180 days after publication.

Assuming the issuer is not otherwise ineligible, the crowdfunding rules will permit the following:

• A company can raise a maximum aggregate of $1 million through crowdfunding offerings in a 12 month period.

• Individual investors can invest an aggregate sum, over a 12-month period, in any number of crowdfunded offerings, based on the following formulas:

1. If either the individual’s annual income or net worth is less than $100,000, s/he can invest the greater of $2,000 or 5% of the lesser of his/her annual income or net worth.

2. If both his/her annual income and net worth are equal to or more than $100,000, s/he can invest 10% of his/her annual income or net worth, provided that the total investment does not to exceed $100,000.

Not all companies can rely on crowdfunding under the final rules.  If the issuer is (i) not organized under the laws of a state or territory of the United States or the District of Columbia; (ii) subject to the Securities Exchange Act of 1934 reporting requirements; (iii) an investment company as defined in the Investment Company Act of 1940, or a company that is excluded from the definition of “investment company” under Section 3(b) or 3(c) of that act; (iv) has a “bad actor” in management or as a major equity holder;  (v) has sold securities in reliance on Section 4(a)(6) and failed to make the required ongoing reports within the two-year period before the proposed new offering; or (vi) is a development stage company that has no specific business plan or purpose or does not identify a proposed merger or acquisition target.

The new rules include detailed provisions relating to mandatory disclosures and other requirements, which will be discussed in subsequent posts on this blog.

Reprinted with permission from the September 28, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.

In a precedential opinion, the U.S. Court of Appeals for the Third Circuit affirmed an award of punitive damages awarded by a jury in a dispute between two businesses. Brand Marketing Group LLC v. Intertek Testing Services, No. 14-3010 (Sept. 10, 2015), addressed two issues of first or limited impression relating to punitive damages. First, the Third Circuit held that juries may award punitive damages in negligent misrepresentation claims. Second, the Third Circuit considered whether courts may consider harm to the public, rather than harm to the plaintiff only, in awarding punitive damages. As the dissent in Brand Marketing noted, the Third Circuit's decision creates some interesting risks and strategies for commercial disputes.

Brand Marketing Group LLC developed vent-free heaters known as Thermablasters. Brand contracted with a manufacturing company to manufacture the heaters, and a testing company, Intertek Testing Services N.A. Inc., to perform testing for the Thermablasters pursuant to American National Standards Institute (ANSI) standards. Brand entered into a contract with Ace Hardware Corp. to buy 3,980 Thermablasters for $467,000. Intertek then performed the testing on the heaters and found that they met the applicable ANSI standard. The heaters were delivered to Ace Hardware. Ace halted sales after discovering that the heaters, in fact, failed to meet the applicable ANSI standard. Ace sued Brand and obtained a judgment for $611,060. Brand then filed a claim against Intertek.

Brand prevailed on its negligent misrepresentation claim after a three-day trial. The jury awarded $725,000 in past compensatory damages, $320,000 in future compensatory damages, and $5 million in punitive damages. The jury found that Intertek negligently misrepresented it had the necessary expertise to test the heaters. Relevant to the issue of punitive damages, the jury found, after instruction by the court, that Intertek acted with reckless disregard for the safety of others.

The Third Circuit affirmed the trial court's denial of Intertek's post-trial motions, and thus the jury award of $5 million in punitive damages. In so doing, the Third Circuit predicted that the Pennsylvania Supreme Court would allow an award of punitive damages for negligent misrepresentation claims, noting there existed no precedent for treating negligent misrepresentation claims differently from general negligence claims for purposes of awarding punitive damages.

However, this holding is not the most interesting part of the case. The Third Circuit next examined whether courts could consider harm to the public in general in awarding punitive damages, or whether the court must limit its analysis to damage to the plaintiff. In this case, Brand experienced financial harm only (Intertek did assert, without success, that the economic loss doctrine barred Brand's claim). No consumer experienced an accident or injury as a result of the testing failure. Intertek argued that an award of punitive damages violated the due process clause under these facts because the jury should not consider potential harm to consumers, and must only consider harm to Brand, in awarding punitive damages. The court found that this issue was "not settled by precedent." The Third Circuit analyzed the case law to conclude that courts may only consider instances of misconduct by the defendant in evaluating a punitive damages award where the conduct is of the same sort as the conduct that injured the plaintiff. The court rejected Intertek's argument that applicable law prohibited consideration of potential public harm in reviewing an award of punitive damages, and found that, in this case, potential public harm was "directly tied" to the harm to the plaintiff. The Third Circuit likewise found that the fact that no one was physically injured by the Thermablasters did not matter, stating that Intertek "should not be rewarded" for the fact the risk did not come to fruition. Thus, Brand stands for the proposition that a court may consider potential harm to the public in reviewing an award of punitive damages as long as the potential harm is directly tied to the injury to the plaintiff.

In his dissent, Judge D. Michael Fisher opined that if an "admission of imperfection" or a "lack of absolute uniformity" allows for an award of punitive damages whenever something goes wrong, "Pennsylvania companies may be in for a rude awakening." Indeed, as Fisher notes, the Brand decision will create new strategies and areas of risk for businesses involved in commercial disputes. Brand represents, at its most basic level, a commercial dispute—a dispute between businesses regarding a failure of one party to do what that entity contractually agreed to do. Interestingly, Brand did not assert that it was entitled to punitive damages as a result of intentional and outrageous conduct of Intertek, but instead proved to the jury that Intertek's "reckless disregard" for a known risk to safety justified punitive damages. Of course, the jury heard evidence that it concluded met the standard, but the application of the standard to a business dispute is an interesting one. Presumably, this standard would have relevance in any business tort case where a failure occurs in, for example, manufacturing or testing products.

Procedurally, Brand allows for the issue of punitive damages to go to the jury, and, arguably, expands the factors a jury may consider in awarding punitive damages in the context of a business tort, but Brand does not mean that a plaintiff will prevail on the issue. It goes without saying that the threat alone may be enough. Brand's strategy in asserting a claim for negligent misrepresentation (and not, for example, breach of contract) created the opportunity to plead and prove punitive damages. Brand was also fortunate to have sufficient facts to overcome the application of the economic loss doctrine. The Third Circuit's opinion in this case supports that strategy by allowing punitive damages in a negligent misrepresentation case and by allowing the consideration of potential (related) harm to the public. In this way, the Third Circuit has created another tool in the commercial litigation arsenal. It will be interesting to see whether courts in the future limit the application of this case to its facts, or if it marks a dramatic change in the available remedies for business torts. •

Google AdWords Trump Trademarks

Written by Bill MacMinn Thursday, September 10 2015 14:59

By Bill MacMinn

A client Googled the name of his own retail store. When he saw the results he was alarmed to learn that the result returned his store name with the name and telephone number of his biggest competitor, and a link to the competitor’s website, appeared in the top three search results and before the link to his own site. My client’s business name included a trademarked national brand. Surely, this must be unlawful?

Google searches return a natural or organic list of results produced by the keywords entered by the user. In addition, Google’s search engine also displays paid advertisements known as “Sponsored Links”. Google’s AdWords advertising platform permits a sponsor to purchase keywords that trigger the appearance of the sponsor’s advertisement and link when the keyword is entered as a search term. My client’s crafty competitor purchased the name of my client’s business as a “keyword” so that when a user searched on my client’s business name his competitor’s name was displayed as a “Sponsored Link” within the top three results and before the information and link to my client’s website. Google, which earns significant revenue from the AdWords platform, permits the use of trademarks as keywords.

There have been a multitude of lawsuits alleging trademark infringement over this practice. Few result in published decisions and of these; nearly all were losses for the trademark owner. Typical of these is 1–800 CONTACTS, INC. vs. LENS.COM, INC., a 2013 case from the Tenth Circuit, involving two internet sellers of contact lenses and related merchandise. At the time the case was filed, 1–800 Contacts, Inc. was the world’s leading retailer of replacement contact lenses, selling them by telephone, by mail order, and over the Internet. It was the owner of the service mark “1800CONTACTS”.  Lens.com is one of 1–800’s competitors in the replacement-lens retail market, selling its products almost exclusively on line. Lens.com purchased the keyword 1800 CONTACTS which caused its “Sponsored Links” to appear when a Google user searched for that phrase. The Court ruled that Lens.com did not violate trademark laws. As with most such cases, the legal analysis turned on whether the alleged infringer’s use of the mark was likely to cause confusion to consumers. In ruling that such confusion was unlikely, the Court examined several factors, including the relatively few users who used the Lens.com link generated by the keyword “1800CONTACTS” to click through to the Lens.com site and the dissimilarity between the two companies websites which the Court concluded would minimize the likelihood of confusion. In other cases Courts have held that such factors as the sophistication of the Google users and the fact that the sponsored links generated by the keyword search appeared in boxes and were visually dissimilar from the organic links were sufficient to avoid user confusion.

Efforts to curtail this practice using state trademark common law and laws regulating unfair competition have also failed as these legal theories rely heavily on Federal trademark law requiring plaintiffs to meet the same likelihood of confusion requirement.

One commentator has observed that in many of the cases the sponsored links generated very few visits to the competitors’ site from users “clicking through” on keyword generated links. The economic value of those visits was small. For example, in the 1 800 Contacts case, the most optimistic estimate of damages was in the range of $40,000, much less than the cost of prosecuting the case.

Although the advice was counter-intuitive, I had to inform my client that any action based on his competitor’s use of his trademarked name as a keyword was not likely to succeed. The silver lining, if there is one, is that the strategy doesn’t appear to result in significant loss of revenue.

 

Scam Alert for Pennsylvania Business Owners

Written by Joanne Murray Wednesday, August 26 2015 12:54

Scammers targeting Pennsylvania businesses have been hard at work this summer. The Pennsylvania Department of State reports that three separate direct mail campaigns have sought to get unsuspecting Pennsylvania  business owners to pay unnecessary fees:

• A mailing from a company calling itself “Division of Corporate Services – Compliance Division” urges companies to complete a form with officer and director information and return the form with a $150 payment.

• A postcard from a company calling itself “Business Compliance Division” urges owners to call a toll-free number “to avoid potential fees and penalties.” When that number is called, the owner is instructed to pay $100 by credit card to obtain a “certificate of existence” in order to comply with state regulations. The address for this company is the same as the address for the “Division of Corporate Services – Compliance Division” above. According to the Pennsylvania Department of State, this is the address of a UPS store in Harrisburg.

• A letter from a company calling itself “Pennsylvania Council for Corporations” instructs business owners to complete a form with names of shareholders, directors and officers and return it with a $125 fee.

These solicitations include citations to Pennsylvania statutes and look official, but they are not: they were neither prepared nor authorized by the Commonwealth. Essentially, these notices represent a business-generating effort from the sender to prepare generic annual minutes for unwitting companies.

The Department of State cautions that any official notices sent to businesses by the Pennsylvania Department of State or the Secretary of the Commonwealth’s office will contain letterhead and/or contact information for the Bureau of Corporations and Charitable Organizations. If you receive one of these notices or a similar solicitation, contact the Bureau at 717-787-1057, or feel free to call Sue Maslow, Joanne Murray or Michael Mills at 215-230-7500.

On July 1, 2015, the Pennsylvania Association Transactions Act (also known as the Entity Transactions Act) (the “Act”) went into effect. The primary purpose of the Act is to simplify the architecture of Title 15 of the Pennsylvania Consolidated Statutes by moving the provisions applicable to names, fundamental transactions and registration of foreign entities into a new Chapter 3. Presently, those provisions are spread out in numerous subsections applicable to each entity type (e.g., corporations, limited liability companies, etc.). The thinking was that since identical or nearly identical provisions already applied to most or all entity types, they should be moved to a new chapter to streamline the statute and hopefully simplify the process for undertaking fundamental changes. The Act adopts new terms to refer to various entity concepts, so practitioners will have to learn a new vocabulary. For example:

  •  Association: a corporation for profit or corporation not-for-profit, partnership, limited liability company, statutory or business trust, or an entity or two or more persons associated in a common enterprise.
  • Governor: a person by or under whose authority the powers of an association are exercised and under whose direction the activities and affairs of the association are managed (e.g., a corporate director, the general partner of a limited partnership, a partner of a general partnership, a manager of a manager-managed LLC, etc.).
  • Interest holder: a direct or record holder of an interest (e.g., a shareholder, member, general or limited partner).

    While much of the Act is simply a reorganization of the statute, some changes are substantive. For example, the Act expands the use of conversions. In a conversion transaction, one Pennsylvania entity type converts to another Pennsylvania entity type. Until now, this result could be accomplished by using a 2-step process: forming a new entity of the desired type and merging the old entity into it. Alternatively, a business seeking to change its form would have to wind down its business and dissolve, then start again by forming a new entity type. Both approaches were cumbersome and can involve significant transaction fees and delays so the new one-step process is welcomed. But even the simplified conversions can have tax consequences, so a tax advisor should be consulted.

    At the opposite end of the transaction spectrum is the division transaction. Prior to the Act, an entity could only divide into like entity types. The Act permits an entity to divide into different entity types (e.g., a corporation can now divide into a corporation and a limited liability company). Once again, care should be taken to avoid unintended tax consequences.

    Another significant change is a new provision that allows for contractual dissenters rights where such rights would not otherwise be available under the statute. Additionally, the existing concept of share exchanges is expanded to include other association types and bundled into a new subchapter called “Interest Exchanges.”

    All of the transactions included in new Chapter 3 require a plan approved by the interest holders of the constituent associations, although the approval process and plan contents vary depending on the type of association. Many of these transactions have tax consequences for the entity and/or the interest holders, so the advice of tax counsel is critical.

    The Act is based on the Model Entity Transactions Act (known as META). The Pennsylvania Bar Association’s Section on Business Law, which drafted the Act, continues its work to modernize the remainder of Pennsylvania’s association statutes to make them consistent with the uniform laws passed in other states.

Indemnification Fee Advancement

Written by Susan Maslow Thursday, August 06 2015 20:54

No one (not even us legal corporate types) would ever suggest that bylaws are interesting. But recent Third Circuit and Delaware Court of Chancery decisions have highlighted the complexity of issues regarding a company’s fee advancement bylaws and policies. Some corporate indemnification provisions are mandated and other provisions are simply permitted under Delaware state law. In practice, adopted corporate bylaws refer to the right (or absence of a right) of officers and directors of a company to be reimbursed by the company for losses, including legal fees, incurred in legal proceedings that name individual officers or directors if those proceedings relate to their employment or activities on behalf of that company.   Mandated indemnification obligations under Delaware statutory requirements attach only to an “officer or director” but many companies nevertheless have bylaws and policies that permit indemnification to “any person” (including officers, directors, employees and agents) who act in good faith and in a manner they reasonably believed to not be opposed to the best interests of the entity. The Third Circuit, however, recently held that the definition of “officer” was ambiguous; an executive title like “Vice President” alone does not automatically prove eligibility for indemnification. And the Court of Chancery held that officers and directors need not prove that they will be indemnified to obtain fee advancement where bylaws tie fee advancement to indemnification. In other words, entitlement to advancement of fees under corporate bylaws is to be considered independently of indemnification entitlement. Examining the requirement that the conduct in question of any person seeking indemnification must be “by reason of the fact” of his or her officer/employment status, the same court determined that bylaws may not exclude entire categories of alleged wrongdoing for the purpose of fee advancement denial. If the alleged wrongdoing relates to an officer’s duties owed to the company (such as breaches of fiduciary duty), fee advancement may be required (even where the same bylaws require a clawback if the officer is ultimately found to have engaged in such wrongdoing).

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    Joanne concentrates her practice in the areas of Business Law, Business Transactions,…
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    Lisa Bothwell counsels corporate/business clients on the formation, operation, acquisition, and sale…
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