The U.S. Supreme Court finally rendered its decision in U.S. v. Quality Stores, Inc., 572 U.S. ____ (2014), on March 25, 2014, in a closely watched tax case.  The Supreme Court reversed the Sixth Circuit Court of Appeals, and found that severance pay is to be considered wages, and therefore subject to Federal Insurance Contribution Act (“FICA”) taxes. 

This holding dashed the expectations created by the Sixth Circuit’s holding that severance pay was not subject to FICA taxes.  Many businesses had already filed refund claims based on the Sixth Circuit decision, and many more were in the process.  Those refund claims are now most likely going to be denied.

The taxpayer, Quality Stores, Inc., paid severance to hundreds of employees while undergoing Chapter 11 bankruptcy reorganization.  In its originally filed payroll tax returns, the taxpayer paid roughly $1 million of FICA tax on those severance payments.  It later sought a refund of those payments while in bankruptcy, which then placed jurisdiction with the U.S Bankruptcy Court, rather than the U.S. Tax Court.   That jurisdictional position seemed to work in the taxpayer’s favor, as the Bankruptcy Court found in favor of the taxpayer, as did the Michigan District Court on review of the decision. 

Commercial lenders were left shuddering in the wake of a September 6, 2013 Pennsylvania Superior Court decision that affirmed a $3.6 million Bucks County jury verdict in favor of a local developer against an area bank. In County Line/New Britain Realty, LP v. Harleysville National Bank and Trust Company, the developer successfully argued that the term sheet provided to it by Harleysville was in fact a binding contract notwithstanding evidence of the parties’ intent to execute subsequent, more detailed agreements. The court also upheld the lower court ruling that Harleysville’s decision not to fund the loan described in the term sheet constituted a breach of contract. The court dismissed Harleysville’s claim that the term sheet did not contain the essential terms of a loan agreement (such as the closing date, how interest would be calculated, a repayment schedule, representations and warranties, and defaults and remedies) and therefore was not enforceable. The court held that the term sheet contained sufficient terms to create a binding contract, such as the identities of the borrower and lender, the principal amount of the loan, interest rates, the term, the manner of repayment, the names of the guarantors, and an identification of the collateral. The court acknowledged that the evidence showed that the parties intended to execute subsequent agreements but nevertheless held the term sheet to be binding.

Harleysville also argued that the developer did not meet all the loan conditions specified in the term sheet, so Harleysville was not required to fund the loan. Specifically, Harleysville asserted that two conditions were not met: (i) a satisfactory review by the lender of an “environmental assessment” of the parcels, and (ii) a satisfactory review by the lender of all specifications, engineer reports and government approvals. It argued that the trial court impermissibly allowed the jury to consider evidence regarding industry custom and practice, the course of dealing between the parties, and evidence of Harleysville’s motives in evaluating whether these loan conditions had been met. The Superior Court found that the term sheet did not articulate these conditions in sufficient detail and that it was appropriate for the jury to consider additional evidence in order to interpret the parties’ intent. This extrinsic evidence was particularly damning to Harleysville because it showed that Harleysville lost interest in making the loan shortly after the term sheet was issued, due in part to its desire to reduce the amount of commercial real estate loans in its portfolio and its precarious position as a result of the recent bankruptcy filing of its largest customer.

By Thomas P. Donnelly, Esquire, Reprinted with permission from the March 27, 2014 issue of The Legal Intelligencer. (c)
2014 ALM Media Properties. Further duplication without permission is prohibited.

It happens all the time.  A potential or existing client calls and advises they have been stiffed by a customer on a commercial contract.  Often times, your client has provided goods or services to a client business only to be advised their client, the other named party to agreements in place, has ceased business operations.  [As filing under Chapter 7 of the Bankruptcy Code does not result in a discharge of corporate obligations, a bankruptcy filing is generally not forthcoming.]  There is no event which gives the client finality as to their loss.  The client is left with only their suspicions that operations have commenced under a new corporate umbrella and whatever assets remained have simply been transferred out of the client’s reach.   

While certainly not in an advantageous position, your client’s claims may not be dead.  Under the right factual circumstance, recovery may still be had.  Claims against successors, affiliated business entities, and corporate principals are fact specific and often necessitate pre complaint development through available public information or, potentially, through the issuance of a writ of summons.  If sufficient information can be mined, causes of action for violation of the Uniform Fraudulent Transfers Act, successor liability under the de facto merger doctrine, unjust enrichment, and claims for piercing the corporate veil may have merit and be successfully pursued.

By William T. MacMinn, Esquire Reprinted with permission from the January 25, 2014 issue of The Legal Intelligencer. (c)
2014 ALM Media Properties. Further duplication without permission is prohibited.

Of all the steps involved in litigating an action, one of the most important is correctly identifying the opposing party. While this step may seem to be the most obvious part of the process, misidentifying the defendant can prove fatal to the underlying cause of action—and this particularly is true where the defendant, unbeknownst to a lawyer and his or her client, dies before legal proceedings begin.  Even though the Pennsylvania Rules of Civil Procedure permit a party “at any time [to] change the form of action, correct the name of a party or amend his pleading,” the door to this liberal right to amend  slams closed once the statute of limitations on the underlying claim expires.

These principals create a trap for the unwary in situations where the opposing party dies before a plaintiff could, or should have, filed the original cause of action.  The Supreme Court of Pennsylvania long has held that “the death of an individual renders suit against him or her impossible where an action is not commenced prior to death.” Myers v. Estate of Wilks, 655 A.2d 176, 178 (Pa. Super. 1995) (citing Erhardt v. Costello, 264 A.2d 620, 623 (Pa. 1970)). Practically speaking, then, any complaint filed against someone after that person has died is a legal nullity rendering any attempt to amend such a pleading void.

Plan B:  Litigating Non-Solicitation Provisions

By Patricia C. Collins, Esquire
Reprinted with permission from December 12, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Propeties. Further duplication without permission is prohibited.

Increasingly, employers and their attorneys meet resistance when seeking to enforce covenants not to compete.  States such as Georgia and California continue to refuse to honor those restrictions. Even in states that recognize the validity of such agreements, Courts can restrict the geographic or temporal scope of the agreement, refuse to find sufficient irreparable harm to permit the entry of a temporary or preliminary injunction, or find other equitable grounds to refuse to enforce the covenant not to compete.  Employers do have a back-up plan, however.  Recent cases illustrate that the court will enforce agreements not to solicit customers and clients after termination.  These cases also illustrate that courts will look to the nature of the contacts with clients or employees to determine if there is a breach of a non-solicitation provision.

In Corporate Technologies Inc. v. Harnett, the United States Court of Appeals for the First Circuit affirmed the district court’s grant of a preliminary injunction against a former employee of Corporate Technologies Inc. and his new employer.  The preliminary injunction restricted the employee from doing business with certain customers of Corporate Technologies with whom he worked during his employment, and required the new employer to withdraw bids which the employee prepared during his employment with the new employer.  The First Circuit court noted that the district court was specifically applying the non-solicitation and not the non-compete provisions of the agreement.  Accordingly, both courts engaged in a discussion of the applicable requirements for the entry of a preliminary injunction (which are the same under Massachusetts and Pennsylvania law).  Notably, the First Circuit did not engage in a discussion of the reasonableness of the geographic or temporal scope of the agreement, or whether the employer had a “protectable interest” served by the non-solicitation provision.  The district court found that the employee breached the non-solicitation provisions of the agreement, and the First Circuit affirmed the grant of the preliminary injunction.

By Thomas P. Donnelly, Esquire, Reprinted with permission from October 11, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.

Senior Judge Anita Brody of the United States District Court for the Eastern District of Pennsylvania recently presided over a non- jury trial in the matter of Lehman Brothers Holdings, Inc. v. Gateway Funding Diversified Mortgage Services, L.P. Judge Brody is expected to render a decision in the coming weeks.  Lehman Brothers represents the first occasion for the District Court to consider the legal principal of de facto merger under Pennsylvania law following the Pennsylvania Supreme Court’s landmark decision in Fizzano Brothers Concrete Products, Inc. v. XLN, Inc., 42 A.3d 951 (Pa. 2012).  In Fizzano Brothers, the Supreme Court substantially modified the application of the de facto merger doctrine allowing trial courts far greater flexibility in the application of the doctrine to a broader set of facts.

Before Fizzano Brothers, Pennsylvania courts were constrained to a mechanical application of four elements: (1) continuation of the enterprise of the seller corporation; (2) continuity of shareholders; (3) cessation of ordinary business operations on the part of the selling entity; and  (4) assumption of those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations.  In practical application, the “continuity of shareholders” requirement was nearly impossible to satisfy where sophisticated business people with legal representation structured the transaction as a sale of assets to a new entity.  Consequently, mechanical application of the continuity of shareholders element was the stumbling block in the de facto merger analysis.

The Fizzano Brothers court substantially modified the analysis by discarding the mechanical application of continuity of shareholders.  Citing public policy and recognizing the sophistication of business transactions in the current climate, the court ruled that “where the underlying cause of action is rooted in a cause of action that invokes important public policy goals, the continuity of ownership prong may be relaxed.”  Fizzano Brothers, 42 A.3d at 966.  The question of successor liability should first be viewed in light of “whether, for all intents and purposes, a merger has or has not occurred between two or more corporations, although not accomplished under the statutory procedure.”  Id. at 969.

The Supreme Court went on to hold that the shareholders of the predecessor company were no longer required to become shareholders of the successor to meet the requirements of de facto merger. The court concluded such a holding would be “incongruous” with provisions of the Pennsylvania Business Corporation Law stating; “because a de facto merger analysis tasks a court with determining whether, for all intents and purposes, a merger or consolidation of corporations has occurred, even though the statutory procedure had not been used, the continuity of ownership prong of the de facto merger analysis certainly may not be more restrictive than the relevant elements of a statutory merger as contemplated by our legislature.”  Id. at 968.

The court then adopted a more flexible approach. After Fizzano Brothers, cases rooted in breach of contract and express warranty no longer require strict transfer of ownership.  Rather, the de facto merger doctrine now requires “’some sort of’ proof of continuity of ownership or stockholder interest. . . . However, such proof is not restricted to mere evidence of an exchange of assets from one corporation for shares in a successor corporation.” Id. at 969 (internal citations omitted).

The Fizzano Brothers factors are at issue in Lehman Brothers Holdings, Inc. v. Gateway Funding where Lehman Brothers raised claims of successor liability relating to indemnification agreements with Gateway’s alleged predecessor.  At trial, evidence was admitted indicating that  Gateway had specifically and intentionally purchased all assets that were necessary to the continuation of the mortgage origination business formerly conducted by the predecessor.  Such evidence included direct testimony on the part of Gateway’s management team that the acquisition was designed to acquire not only the current “pipeline” of loans in progress, but also the potential for continued loan origination.  Contemporaneously, Gateway also undertook to acquire debt obligations owed by the predecessor which were necessary to loan origination including securing warehouse lines of credit utilized to temporarily fund mortgage loans until sold on the secondary market.  Finally, documents related to the transaction reflected the intention that the business operations of the predecessor entity were to be “wound down”.  In that regard, restrictions against competition imposed upon the former principals of the predecessor, now Gateway employees, were permitted to “compete” only for the purpose of effectuating that wind-down.

While evidence was admitted as to each element of the de facto merger doctrine, continuity of ownership was specifically contested.  The transaction at issue was characterized by the buyer and seller as an asset transaction with no stock transfers. However, the four shareholders of the predecessor entity were provided compensation in a variety of ways which Lehman Brothers argued were illustrative of ownership.  The four shareholders received employment agreements with Gateway which included substantial severance benefits, a right to share in the profits of the same operations as had been conducted by the predecessor, and cash considerations.  One former shareholder indicated the cash component was paid, at least in part, as a result of his equity position in the predecessor.

In contrast, Gateway argued that the four shareholders were valuable and experienced revenue generating employees with corresponding compensation arrangements following the acquisition.  Objectively, the four shareholders of the predecessor were not granted stock in the acquiring entity.  Further, although certain of the agreements between the four shareholders and Gateway referenced the shareholder’s equity stake in the predecessor, no provision for consideration set forth in the language of the agreements was expressly tied to that equity position. 

The Lehman Brothers trial is the first test of the new more relaxed application of the continuity of ownership prong of the de facto merger analysis.  Judge Brody’s decision will provide guidance to both transactional practitioners in structuring transactions where liabilities may remain post-closing, and to litigators when faced with claims against a defunct entity where assets were transferred leaving a hollow shell.

The author served as local trial counsel to Lehman Brothers Holdings, Inc.