Welcome to the AMM Law Blog, a tool to help you keep up to date on current legal developments over the broad spectrum of our practice areas. We welcome your comments and suggestions to create a dynamic forum that will be of interest to readers and participants.
Restrictions against competition are frequently included in employment agreements and agreements for the sale of business assets or stock. The restriction against competition is designed to secure a time period for the employer or buyer of business assets, as the case may be, during which the employer/buyer is free from competition for a departed employee or seller so as to facilitate the transition and better protect their own business assets and customer relationships. If properly drafted and implemented, restrictions against competition are enforceable under Pennsylvania law.
The primary method of enforcement in the event of breach is a preliminary injunction in equity. In order to prevail on a petition for preliminary injunction, a petitioner must demonstrate several factors including (1) the need to prevent irreparable harm which cannot be compensated by money damages, (2) that more harm will result from the denial of the preliminary injunction than from granting same, (3) that the injunction will restore the parties to the status quo, (4) the likelihood of success on the merits, (5) that the injunction is designed to abate the offending activity, and (6) that the injunction will not negatively impact public policy. In most cases the issues of likelihood of success on the merits and irreparable harm incapable of compensation with money damages represent the contested issues.
In Bucks County, the petition for preliminary injunction must be accompanied by a verified complaint and an order for hearing. The petition is often, though not always, heard by the initial pre-trial judge assigned to the case at the time of filing. Court administration reviews all petitions for preliminary injunction and assigns the presiding judge, courtroom and date for evidence to be taken. The order for hearing is an essential aspect of the petition; without it, no hearing will be scheduled.
The petitioner in any injunction matter bears a heavy burden. Adequate evidence as to the need for enforcement of the covenant, the potential irreparable harm and right to relief must be presented. Because the entry of injunctive relief is an extraordinary remedy, the evidence must be clear and persuasive. In employment and business asset transfer cases, the language of the restriction in the applicable agreements must be constrained to those aspects of competition which are reasonably necessary for the protection of the employer/buyer. For example, a covenant which is overbroad in terms of geography, time or scope will not be enforced.
Preliminary injunctive relief may be acquired in the Bucks County Court of Common Pleas if supported by the underlying agreement and if properly perfected under the practices and procedures employed in the County.
Just when minority owners of Delaware LLCs thought that the Delaware Limited Liability Company Act (the “Act”) protected them from overreaching managers, along comes the Delaware Supreme Court to say “better get it in writing.” It appears that practitioners longing for certainty will have to wait until the Delaware legislature steps in and revises the statute.
The Delaware Supreme Court recently published an opinion in a case involving a Delaware LLC (Gatz Properties, LLC) that was the manager of another LLC (Peconic Bay, LLC). Gatz Properties is managed and controlled by William Gatz, and the Gatz family and their affiliates owned controlling equity interests in Peconic Bay. They also owned real estate that was leased to Peconic Bay, which in turn subleased the property to a national golf course operator. The golf course proved to be unprofitable because it was poorly managed, and Mr. Katz anticipated that the sublease would be terminated. He decided to acquire the sublease and Peconic Bay’s other assets for himself. Consequently, he foiled the efforts of a third party to buy the sublease rights. He then engaged a valuation expert to appraise the property but did not provide the expert with information about the prior third party offers or tell the expert that the golf course’s unattractive financials were the result of its being mismanaged. Not surprisingly, the resulting appraisal showed that Peconic Bay had no net positive value. Next, Mr. Katz hired an auctioneer with no experience in the golf course industry to sell the golf course business. After lackluster advertising for the auction, Mr. Katz was the sole bidder and acquired the property for $50,000 plus the assumption of debt. Peconic Bay’s minority members brought suit in the Delaware Court of Chancery, alleging that Mr. Katz had breached his fiduciary duties to them. The Court of Chancery held that Gatz had breached both his contractual and statutory duties to the minority members, and Gatz appealed to the Delaware Supreme Court.
The Delaware Supreme Court agreed with the Court of Chancery that the LLC agreement’s clear language prohibited self-dealing without the consent of 2/3 of the minority owners, and Mr. Gatz testified on several occasions that he understood that Gatz Properties owned fiduciary duties to the minority members. The Court also upheld the lower court’s finding that Gatz breached this duty.
Moving on to whether Gatz breached a statutory duty under the Act, the Court noted that it was “improvident and unnecessary” for the Court of Chancery to decide that the Act imposed “default” fiduciary duties on managers where the LLC agreement is silent because, in the case at bar, the issue could be decided by interpreting the text of the LLC agreement. Additionally, no litigant asked that the lower court resolve the issue by interpreting the Act. Another concern for the Court was the lower court’s suggestion that its statutory interpretation should withstand scrutiny because practitioners rely on its rulings. The Court remarked that, as the highest court in Delaware, it was not bound to follow the lower court’s decisions. The Court rebuked the lower court for using the case at hand as a “platform to propagate [its] world views on issues not presented.” The Court concluded its reprimand by stating that because the issue of whether the Act imposes default fiduciary duties is one on which reasonable minds can differ, the matter should be left to the legislature to clarify.
Following the decision in Gatz Properties, equity holders in Delaware manager-managed LLCs would be prudent to clearly identify in the LLC agreement which fiduciary duties are intended to apply to their managers. Given the Court’s position that the issue is a matter for the legislature (not the courts) to decide, practitioners will be monitoring the activities of the legislature to see if it takes up the gauntlet.
As the calendar year comes to a close, all corporate entities, profit and nonprofit, look to their books and make end of year decisions to best avoid the pitfalls of the clear and concise (NOT!) Internal Revenue Code (the “Code”). Private foundations have a unique challenge in their efforts to avoid excise taxes which are imposed on them, as well as their managers, in accordance with Section 4944(a)(1) of the Code if it is found that such foundations made investments that jeopardize the private foundation’s exempt purposes. Such “jeopardizing investments” generally occur when foundation managers fail to exercise ordinary business care and prudence, under the facts and circumstances prevailing at the time of making the investment, in providing for the long and short term financial needs of the private foundation.
On May 21, 2012 the Service published proposed regulations that provide nine new examples of types of private foundation investments that qualify as Program Related Investments (“PRIs”). PRIs are not classified as investments which jeopardize the carrying out of exempt purposes of a private foundation because they possess the following characteristics:
a. have as the primary purpose the accomplishment of one or more charitable or educational purposes defined by Section 170(c)(2)(B) of the Code;
b. do not have as a significant purpose the production of income or the appreciation of property; and
c. do not further one or more of the purposes described in Section 170(c)(2)(D) of the Code (relating to prohibited political activities and lobbying).
To be certain both the foundation and the recipient of the PRI are on the same page (and to also prove the foundation is exercising “expenditure responsibility” to the Internal Revenue Service), a private foundation must secure a written commitment from the recipient of the PRI which specifies the purpose of the investment and contains an agreement by the organization:
a. to use all amounts received only for the purposes of the investment and to repay any amount not used for these purposes back to the foundation, provided that, for equity investments, the repayment is within the limitations concerning distributions to holders of equity;
b. to submit, at least once a year, a full and complete financial report together with a statement that it has complied with the terms of the investment;
c. to keep adequate books and records and to make them available to the private foundation; and
d. not to use any of the funds to carry on propaganda, influence legislation, influence the outcome of any public elections, carry on voter registration drives or make grants that do not comply with the requirements regarding individual grants or expenditure responsibility.
Examples of acceptable PRIs in the proposed new regulations are based on published guidance and on financial structures that had previously been approved in private letter rulings. The regulations do not modify the existing regulation but illustrate certain principles and current investment practices. Where the examples in the older regulations focused on domestic situations principally involving economically disadvantaged individuals in deteriorated urban areas, the new examples include a broader range of opportunities that might be presented to a private foundation.
The new examples demonstrate that a PRI may accomplish a variety of charitable purposes, such as advancing science, combating environmental deterioration and promoting the arts. Several examples also demonstrate that an investment that funds activities in one or more foreign countries, including investments that alleviate the impact of a natural disaster or that fund educational programs for individuals in poverty, may further the accomplishment of charitable purposes and qualify as a PRI. One example specifically illustrates that the existence of a high potential rate of return on an investment does not, by itself, prevent the investment from qualifying as a PRI. Another illustrates that a private foundation’s acquisition of an equity position in conjunction with making a loan does not necessarily prevent the investment from qualifying as a PRI and two examples illustrate that the private foundation’s provision of credit enhancement (such as a deposit agreement or a guarantee) can qualify as a PRI.
As a result of the new examples, the Service has made it clear that the recipients of PRIs do not need to be within a charitable class if they are the instruments for furthering a charitable purpose.
Thus, an investment in a for-profit that develops new drugs may qualify as a PRI if the for-profit business agrees to use the investment to develop a vaccine distributed to impoverished individuals at an affordable cost. Similarly, the purchase of equity in a benefit corporation or L3C that engages in the collection of recyclable solid waste or a below market rate loan to allow a social welfare organization formed to promote the arts purchase a large exhibition space may each also qualify for a PRI from the right foundation.
The new regulations should provide private foundation boards and managers in the second half of 2012 with the additional assurance they needed to make PRIs not only to traditional non-profits but to for-profit, benefit corporations and L3Cs with an articulated social enterprise consistent with the foundation’s exempt activities. Rejecting traditional boundaries between nonprofit and for-profit sectors, the PRI regulations can help encourage the most creative business minds achieve ‘double bottom line’ (financial and social) and sometimes ‘triple bottom line’ (financial, social and environmental) results. By expanding the base for PRIs, we move beyond traditional conception of society as divided neatly into three sectors (business, nonprofit and government) help develop a new forth sector that encompasses elements of both business and nonprofit sectors.
Often, in the business context, agreements contain representations and warranties of the parties to the agreement. The representations and warranties can range from general items such as business forms and the payment of taxes, to more specific items, such as the accuracy and reliability of financial information. While such representations and warranties are commonplace in business agreements, their importance should not be overlooked.
Under Pennsylvania law, when performance of a duty under contract is due, any non-performance is a breach. If a breach constitutes a material failure of performance, the non-breaching party is discharged from its duties under the contract. A party who has materially breached a contract may not complain if the other party refuses to perform. In other words, a material breach of contract may excuse performance by the non-performing party.
In the context of representations and warranties contained in a business agreement, should the representations and warranties contained in the agreement prove to be false, the party to whom the representations and warranties were made may raise the falsity of the representations and warranties to excuse further performance of any contractual obligations under the agreement. Such a circumstance could spell disaster in the business context – particularly in a case where the payment of money is due at some time after closing.
Pennsylvania courts impose an element of materiality to the breach of a representation or warranty. The elements of materiality under Pennsylvania law include the extent to which an injured party will be deprived of the benefit which he reasonably expected, the extent to which the injured party may be adequately compensated for that part of the benefit of which he will be deprived, the likelihood that the party failing to perform or offer to perform will cure, and the extent to which the party failing to perform comports with the standards of good faith and fair dealing.
Accordingly, representations and warranties contained in an agreement should not be taken lightly, but should be made with any eye toward the potential ramifications in the event of breach.
Actually, this blog post is not really about binders full of women – the title is pure, unadulterated pandering. But it is about the conversation that generated that Tweet-worthy sound bite. In case your computer, smartphone, television and ears were down this week, let’s recap. At the October 16, 2012 town hall Presidential Debate, an undecided voter asked how the candidates would address pay inequality for women. President Obama answered by referencing his support of the Lilly Ledbetter Act. Governor Romney answered with a story about binders full of women searching for female candidates, and providing flexibility for female employees. An employment lawyer drooled. Please note that this is not a political discussion, but a legal one, and the analysis that follows is about whether the law would permit the approaches recommended by the candidates.
President Obama had the easy path. The Lilly Ledbetter Act is now the law. Under the civil rights laws, employees have 180 days from the alleged discriminatory act to file a complaint with state or federal equal employment commissions. If the employee fails to file the claim in the time required, the employee’s claim is forever barred. Poor Ms. Ledbetter discovered, too late, that she was paid less than a male employee for the same work. The court dismissed her claim because she filed it more than 180 days after the first discriminatory paycheck. The Lilly Ledbetter Act states that the statute of limitations for an equal pay claim resets with each paycheck. It was the first statute that President Obama signed into law.
Governor Romney’s answer invites employment lawyer criticism. To be clear, this is not political criticism, but legal criticism. The answer essentially had two parts: first, his search for female candidates and second, his willingness to provide flexibility to female employers who needed to get home to make dinner. Let’s start with the search for female candidates. The civil rights laws prohibit discrimination on the basis of gender. It was not clear from Governor Romney’s answer whether or not he was referring to an affirmative action program, or whether there was a written diversity plan at issue. But, certainly, the goal of employing an underrepresented group in the office of the governor is a laudable one.
Nevertheless, an employment lawyer worries. Imagine two candidates, both with comparable education and experience, both interviewed well, and, in all respects were both qualified candidates. One is male, one is female. Could the governor decide to hire the female candidate solely because she was female? Put another way, would it be discrimination on the basis of gender for an employer to deny employment to the equally qualified male candidate solely on the basis of his gender? The legal answer is yes. An interesting defense to such a claim is that the governor had made a policy decision that his cabinet must reflect the views of qualified women. Employers should always base their decisions on qualifications for the job. Where an employer has decided that gender, for example, is part of the qualifications for the job, they must also articulate a legitimate business reason for such a qualification.
Governor Romney also talked about the need for flexibility for female employees. Tsk tsk, Governor Romney, tsk tsk. The law requires that Governor Romney provide the same level of flexibly for all of his employees, regardless of gender. The law also requires that Governor Romney avoid making employment decisions based on gender stereotypes (i.e., the woman needs to get home to make dinner). An employment lawyer loses a few hours of sleep.
Interestingly, this is the place where the candidates intersect. The law requires equal pay for equal work, and the Lilly Ledbetter Act keeps that claim alive with each new paycheck. But employees, male and female, do ask for flexible work schedules, and many employers are happy to oblige to keep good candidates. Our advice: don’t be like Governor Romney! Make sure flexibility is available to all employees, and that the pay is commensurate with the work provided.
The candidates’ discussion does highlight the challenges for employers: sometimes, an employer’s good intentions, the realities of the workplace, and the requirements of the law seem at odds with one another. Even presidential candidates struggle with these competing concerns. It is our experience that employers can work through these complex issues and strike a balance with good legal and human resources advice.
With less than 5 months remaining in 2012, we have had many clients take advantage of the current $5,120,000 exemption from federal estate taxes by engaging in some form of lifetime gifting. We have helped clients to establish Family Limited Partnerships (FLPs), Grantor Retained Annuity Trusts (GRATs), and Intentionally Defective Grantor Trusts (IDGTs). In many cases, multiple strategies have been combined to provide the client with additional planning benefits, including the potential for even greater estate tax savings.
Although the above strategies are excellent ways to take advantage of the current planning opportunity, we have also been encouraging our clients to consider using Qualified Personal Residence Trusts (QPRTs). For those not familiar with a QPRT, it is simply the transfer of a personal residence to a trust, wherein the donor retains a right to reside and use the residence for a term of years. At the expiration of the term, the real estate passes to the trust beneficiaries or is held in further trust for them. The QPRT provides for an initial discount on the gift because of the donor’s retained right to live there and it also allows any appreciation in the value of the property to move out of the donor’s estate tax free. However, when discussing the QPRT strategy with fellow estate planners, CPAs, financial advisors, and in some cases, even the clients themselves, the strategy is often dismissed out of hand, on account of the low interest rate environment we are in. The stock response I usually get is… “QPRTs work better in high interest rate environments.” In many ways, the low interest rates have caused the QPRT to be forgotten. But it should not be.
While it is true that low interest rates decrease the value of the retained interest (right to live in the property for a term of years), which increases the value of the gift, there are a few factors currently in play which mitigate the higher gift value assigned to the transfer. The primary factor is the depressed real estate values. Most of our clients’ primary residences are located in Bucks and Montgomery counties, the Philadelphia suburbs, Princeton, New Jersey, and the Saucon and Center Valley areas to the north. Their vacation residences are often located in Florida or at the Jersey Shore. These locations are very desirable places to live and vacation, yet such properties are being appraised at 25%-50% below market values from just a few years ago. While we do not have a crystal ball, we feel such properties have the potential to increase in value, with such appreciation outside of the Donor’s estate. This would likely make up for the smaller discount attributable to the current low rates.
Another major factor in favor of using a QPRT, even in this low interest rate environment, is the current $5,120,000 lifetime exemption from federal estate tax. This unprecedented exemption makes the smaller discount on the gift less problematic than in prior years when the exemption was substantially lower. In my experience, the donor often does not feel as compelled to drive down the value of the gift given the larger exemption the donor currently has to work with.
Finally, gifts of fractional interests in real property allow for discounting of the gifts to the QPRT. Assuming clients don’t mind the added complication and cost associated with gifting fractional interests to two separate QPRTs, the transfer of fractional interests adds value to the trust.
Similar to a GRAT, a donor who transfers real property to a QPRT must survive the QPRT term for the strategy to work. However, like a GRAT, a QPRT is as close as you can get to a no lose proposition in that, if the donor does not survive the term, the donor is in no worse position than if the donor had done nothing, except of course for the legal fees incurred to implement the strategy.
One advantage the QPRT has over the GRAT or the FLP is that the strategy has not been under attack in recent years, and if done properly will be a safe harbor. Additionally, some clients feel more comfortable gifting an asset that is not generating income, which is the case with most personal residences. The retained right to live at and use the residence for a number of years also provides a measure of security not found with outright gifts. Finally, upon the end of the term, the QPRT will usually provide that the donor may lease the residence from the QPRT or the trust remainder beneficiaries. This provides another mechanism to move additional assets out of the donor’s estate (via rent) without using any gift tax exemption.
These are exciting times for estate planning, but the current opportunities may not be available on Jan 1, 2013. Some have even described the situation as the perfect storm, and in many respect it certainly is. So please carefully consider the use of GRATs, FLPs, and IDGTs, before year end, but don’t forget the QPRT.