Recent developments in Pennsylvania and New Jersey business law
Earlier this year, amendments to Pennsylvania’s statutes governing partnerships and limited liability companies (often referred to as unincorporated entities or alternative entities) went into effect. I recently blogged about the “transferable interest” concept adopted by the Act. Today, in Part 2 of this series, I highlight another significant change brought about by Act 170: the clarification of the fiduciary and other duties owed in the context of an unincorporated entity. In general, there are three basic duties:
• Duty of loyalty: generally, a duty to avoid self-dealing, competing and usurping company or partnership opportunities
• Duty of care: a duty to refrain from gross negligence and recklessness
• Duty of good faith and fair dealing: a duty to deal fairly and consistently with the terms of the parties’ agreement and the purpose of the entity
In a general partnership, each partner owes the above duties to each of the other partners and to the entity.
In a limited partnership: (a) the general partner owes each of these duties to the limited partners and to the partnership; and (b) the limited partners owe only a duty of good faith and fair dealing to each other.
In a manager-managed LLC: (a) the manager owes these duties to the members and to the entity; and (b) the members owe a duty of good faith and fair dealing to each other. In a member-managed LLC, the members owe these duties to each other and the company.
Some of these duties may be modified by agreement of the parties. In their operating or partnership agreement, the parties may modify, but not eliminate, the duty of loyalty and the duty of care, as long as the modification is not “manifestly unreasonable.” This standard is not defined and is left to the courts to interpret, but in general the agreement cannot convert the relationship into a strictly arm’s length relationship. The duty of good faith and fair dealing may not be modified or removed, but the owners’ agreement can identify the standards by which this duty will be measured.
The Pennsylvania General Assembly, with significant input from the Pennsylvania Bar Association’s Business Law Section, recently passed Act 170, which overhauls the statutes governing partnerships and limited liability companies (often referred to as unincorporated entities or alternative entities). This Act brings these statutes up to date with the uniform laws on which they are based and is now in effect for all new and all existing unincorporated entities. These comprehensive amendments provide default rules for governance and other matters that fill the gaps in the absence of an operating agreement or partnership agreement (or the absence of applicable provisions in those documents). Accordingly, it is important for owners of partnerships and LLCs to review their governing documents and be sure they have a clear understanding of how these new rules apply to them. Owners should work with counsel to draft provisions to vary these default rules if that is the desired outcome.
One significant change brought about by the Act is the recognition that equity interests in unincorporated entities are bifurcated into governance rights (including consent, management, and information rights) and economic rights (i.e., the right to receive distributions). The amendments adopt a concept called a “transferable interest”, which is an interest in the partnership or LLC that includes only economic rights. The holder of a transferable interest has no governance rights; he or she has only the right to receive distributions from the entity (but not the right to demand or sue for distributions). The transferable interest approach honors the “pick your partner” principle, which assures owners of a business entity that they will be able to choose the co-owners of the enterprise. Under the revised statute, the only interest that can be conveyed to a non-member is a transferable interest, unless the operating agreement provides otherwise or the other owners expressly agree. Thus, a creditor foreclosing on a member’s equity interest or a person seeking to attach a spouse’s equity interest in a divorce proceeding can take only a transferable interest. This limitation on the rights of non-members affords owners important protections from assertions of control by outsiders which may not be in the best interest of the entity or its members. The exception to this rule is that a creditor foreclosing on an equity interest in a single-member LLC will take the full membership interest (governance and economic rights). The rationale for this exception is that because there is only one member, the “pick your partner” rationale does not apply to limit the rights of the lender.
Avoiding Bad Press, Brand Impairment and Costly Litigation
Reprinted with permission from the February 28th edition of the The Legal Intelligencer © 2017 ALM Media Properties, LLC. All rights reserved.Further duplication without permission is prohibited
A significant amount of press surrounded the US Department of Justice (DOJ) one year trial pilot program on April 5, 2016 and the earlier September 29, 2015 “Yates Memo”, instructing companies to self-disclose possible violations of the Foreign Corrupt Practices Act (FCPA) and fully cooperate with the DOJ. What has not been as broadly made known is that, a few days later, the U.S. Customs and Border Protection (CBP) establish a Trade Enforcement Task Force within its Office of Trade to focus on issues related to enforcement of antidumping and countervailing duty laws and interdiction of imported products using forced labor.
Antidumping and countervailing duties are historic tariffs imposed on foreign imports priced below fair market value to ensure a level playing field for domestic producers. The interdiction of products using forced labor stems from The Trade Facilitation and Trade Enforcement Act of 2015(TFTEA), enacted in February 2016. TFTEA eliminates an earlier “consumptive demand” exemption, meaning that goods made with indentured, child, or other forced labor are no longer allowed in the US just to meet US demand. With this change, CBP will no longer be legally required to weigh demand considerations when processing information concerning forced labor. CBP will be updating its regulations to clarify the TFTEA amendment but, since March 10, 2016, CBP started training personnel and has executed several withhold/release orders related to goods made by convict or forced labor using a Department of Labor (DOL) list of foreign-made products for which the DOL “has a reasonable basis to believe might have been mined, produced or manufactured” by forced or indentured labor. The CBP has also established within its Office of Trade a Trade Remedy Law Enforcement Division and seems intent on taking action.
Reprinted by permission of the Lower Bucks Chamber of Commerce, Outlook Magazine, January 2017.
Lawyers are expensive. Most bill for their services by the hour, and there is no question, that can really add up. It is understandable to wonder if it is really worth spending money on legal representation on the purchase or sale of your home? Unfortunately, the answer sometimes comes at the end of the transaction, when it’s too late, the damage is done, and your options are limited.
The purchase of a home is usually the most expensive transaction one makes in a lifetime. It has also become much more complicated with mortgage financing, title issues, homeowners’ associations, etc. Often, the buyer or seller assumes that the form contract is standard and has protections “built in.” They may also rely solely on the real estate agent and title agent to look out for their best interest.
A lawyer who is well versed in real estate and contract law is the best equipped to focus entirely on protecting your interests. A lawyer does not have the pressure to make sure the deal closes; is independent from the pressure of sales and commissions; is able to read the Agreement of Sale, listing agreement, mortgage commitment, title searches and commitment and other related documents with an understanding of your interest and goals.
Unlike other states, including New Jersey, real estate contracts and closings in Pennsylvania are primarily done without the assistance of a lawyer. The real estate agent locates the perfect home, and buyer signs the contract, which is typically pre-printed As a seller, you finally decide to sell your house and you’ve selected the most successful agent in your area. You sign the pre-printed listing agreement. Usually, there is little time to read any of these documents in advance and, in my experience; they are seldom read unless a problem develops post-closing. Over the years, I have seen a number of these issues come back to haunt parties to these transactions, when it is too late to do anything to resolve them.
Some of the potential pitfalls are:
• Buyer may discover that a release is included in the Agreement of Sale which bars pursuit of claims that may develop later or limits remedies.
• Buyer did not realize this limiting language was included in the signed document
• Seller failed to realize that, per the listing agreement, the agent’s right to a commission may extend longer than seller intended or understood.
• Seller may not be able to timely change agents if seller thinks the home is not getting the attention it requires.
• Seller may not realize that a commission is due if the home is condemned and seller receives compensation.
• Seller may not realize that the Seller’s Disclosure Statement, as signed one night at the kitchen table, was not detailed enough and is being used against seller years later in litigation with the buyer that “loved” their home.
Unlike some states, there is no an attorney review clause in the standard Pennsylvania Agreement of Sale. Once you have signed it, it is binding and enforceable against you.
Unlike most commercial real estate purchases, there is no broad due diligence period in a residential real estate purchase. There are provisions for inspections and some contingencies, but they are time limited and tightly worded. Unlike a commercial transaction, you can’t terminate a residential real estate contract because you aren’t comfortable with an easement or local zoning restriction.
There are ways for parties to a residential real estate sale to use the services of an experienced real estate attorney efficiently in such a manner as to minimize legal fees, while protecting themselves from potentially costly problems down the road . It is not necessary to hire a lawyer “soup to nuts”, instead, it is wise to narrow the services to those most critical to protecting your interests, such as:
• You should have a lawyer review all documents before you sign them. Important changes are usually allowed and you will know beforehand what you are signing.
• Your disclosure statement will be accurate and will not be used against you.
• Your title searches will be reviewed by someone who understands them and will point out a title defect or use restriction that may require that you walk away from the deal.
• At closing, your lawyer can be on call to handle any issues that develop at the closing table.
When you consider what is at stake, and the potential pitfalls associated with the purchase or sale of a home, there is no reason to take the chance that everything will work out and go smoothly, when you can retain a lawyer to be available when needed and as needed without incurring substantial fees.
Admittedly, insurance is an important part of any business plan. Protecting against a catastrophic loss occasioned from outside factors renders the premium cost a reasonable and justifiable expense. But it is important to understand that commercial general liability insurance is not a substitute for performance, nor will insurance provide any benefit with regard to a myriad of potential claims which commonly arise in the ordinary course of business. It is important to understand what protections are acquired and the scope of the coverage.
For example, commercial general liability insurance provides no coverage for any breach of contract claim. Generally, the insurance benefit applies only to an “occurrence”; which, under Pennsylvania law is defined as an “accident”. If your business fails to perform on a contract, or deliver on a promise, there has been no occurrence, and therefore no coverage will generally apply.
Further, most basic commercial general liability policies provide no coverage for “your work” meaning no coverage is provided with respect to the products you manufacture or the things you build. For example, if your business is engaged in the design and construction of a manufacturing line and that manufacturing line malfunctions causing damage only to itself, no coverage will apply. In contrast, if the manufacturing line were to malfunction causing damage to the property where it was installed, those damages may be covered. Similarly, if the manufacturing line were to malfunction causing a loss of product, those damages may likewise be covered.
As with any contract, the scope of commercial general liability coverage and exclusion is defined by the terms of the policy. Under Pennsylvania law, as the policies of insurance are drafted by the insurers and offered to policy holders without modification, the provisions of those policies are interpreted in a light most favorable to the insured. Traditional common law precedent relating to contract interpretation are also applicable.
Many particular risks which may be excluded from coverage under a basic commercial general liability policy may be subject to additional coverages available by endorsement. Although tedious, review of the often complicated and lengthy provisions of the policy of insurance with the issuing agent is the only way to gain even a rudimentary understanding of coverages. Even then, a professional review is often worth the investment. There is simply no substitute for an understanding of the relationship between the business risks and the provisions of the commercial general liability policy and an analysis of additional risk that may be insured by endorsement to the policy.
The Pennsylvania legislature recently enacted changes to the state sales tax code that affect computer software providers and their customers. These changes went into effect on August 1, 2016.
Under the Pennsylvania Tax Reform Code of 1971, a tax is imposed on the sale of “tangible personal property”, which is defined generally as “corporeal personal property” along with a non-exclusive list of various types of property. In 2010, the Pennsylvania Supreme Court held that the term “tangible personal property" includes canned computer software and that the licensing of such software is subject to the tax. In so holding, the Court rejected the argument made by the taxpayer (Philadelphia-based law firm Dechert LLP) that canned computer software consists of intangible intellectual property rights that are not subject to the tax. The Court noted, however, that fees paid by Dechert for software maintenance and support services did not represent the payment for the transfer of tangible personal property and were likely not taxable (though for whatever reason Dechert did not make the distinction and so it was not part of the Court’s holding).
The Pennsylvania General Assembly apparently disagreed with the Court’s categorization of maintenance and support. While the amendment in question was ostensibly intended to just capture digital downloads of property already subject to the tax (e.g., games, apps, video streaming, canned software, etc.), the language adopted by the legislature arguably broadens the scope of the tax. The definition of “tangible personal property” was modified to include video, books, apps, music, games, canned software, and other items “whether electronically or digitally delivered, streamed or accessed, whether purchased singly, by subscription or in any other manner, including maintenance, updates and support”. The highlighted language contradicts the Supreme Court’s commentary in Dechert that software maintenance and support, as services, are not subject to the tax. Nevertheless, the General Assembly has spoken and prudent software vendors should collect sales tax not only on the price of the canned software package itself, but also on digitally or electronically delivered maintenance, update and support services, at least until the interpretation of this provision is clarified by the Department or through the courts.
The Pennsylvania Department of Revenue has published a summary of this and other changes that are part of the recent amendment to the Pennsylvania tax code: http://www.revenue.pa.gov/GeneralTaxInformation/TaxLawPoliciesBulletinsNotices/Documents/State%20Tax%20Summary/2016_tax_summary.pdf
To limit warranties or disclaim liability for products sold in online commerce or advertised online, most businesses create a Terms and Conditions or a Rules of Use page on their business website. A significant uptick in cases filed in New Jersey, however, cite these common broad warranty limitations and disclaimers posted on a business’ website as violations of the New Jersey Truth-in-Consumer Contract, Warranty and Notice Act (TCCWNA).
The TCCWNA gives standing to consumers who have suffered no financial loss or injury against sellers who, with no intent to mislead, have provided a consumer with, or even shown, a warranty, contract, sign or notice of any sort relating to personal, family or household merchandise that includes text that violates New Jersey (or federal) law. Using software to find Terms and Conditions or Rules of Use and other web-based advertising and social media campaigns that include the offensive text, the organized plaintiffs’ bar has increasingly relied on TCCWNA to bring class actions to generate huge fees for the attorneys and $100 to each consumer in the class under the statute’s automatic damages provision.
What is the TCCWNA ?
The TCCWNA can be found in N.J.S.A. 56:12-14, et seq. The law, which became effective over 30 years ago, is a broad consumer protection law that requires that a plaintiff/consumer only show:
1. the consumer or potential consumer was given or shown a warranty, notice, contract, or sign by the seller;
2. the product offered was consumer related – used primarily for personal, family, or households purposes; and
3. the document or notice included some language that breaches New Jersey or Federal law in some manner.
According to the TCCWNA, N.J.S.A. 56:12-15:
No seller, lessor, creditor, lender or bailee shall in the course of his business offer to any consumer or prospective consumer….or give or display any written consumer warranty, notice or sign…which includes any provision that violates any clearly established legal right of a consumer or responsibility of a seller, lessor ,creditor, lender or bailee as established by State or Federal law at the time the offer is made or the consumer contract is signed or the warranty, notice or sign is given or displayed.
Why are the TCCWNA lawsuits being brought?
TCCWNA lawsuits are being brought for a variety of reasons. The core reasons are:
• Most business websites include warranty waivers or indemnity provisions that try to limit a consumer’s legal right.
• The consumer does not have to show any specific injury or any loss.
• Good faith of the business is not a defense. The plaintiff does not need to prove an unconscionable act.
• There is no privity requirement; i.e., the plaintiff does not have to prove that he/she actually bought our used the product.
• Damages include attorney’s fees and court costs.
• There is an automatic $100 damages per plaintiff provision within TCCWNA so actual damages need not be proven. Just a thousand member class means $100,000 in damages.
How does TCCWNA affect a business website?
Business webpages are “notices” under the TCCWNA even if they are not intended by the business to mislead a consumer about the applicable law or to form a contract. This includes the Terms and Conditions, Menus, Disclaimers, and almost any page of the website. Any type of advertisement or print material may be considered a “notice” to consumers and the great variety of state laws and complexity of the Federal Magnuson-Moss Warranty Act make it easy to inadvertently include an impermissible warranty or disclaimer provision. Examples of text that can trigger problems include:
• disclaiming implied warranties (of merchantability or fitness for a particular purpose) on any consumer product if you offer a written warranty for that product or sell a service contract on it.
• requiring a purchaser of a warranted product to buy an item or service from a particular company to use with the warranted product in order to be eligible to receive a remedy under the warranty.
• requiring customers to return a registration card when stating that the business is providing a “full” warranty.
• offering a warranty that appears to provide coverage but in fact provides none (like a warranty covering only moving parts on an electronic product that has no moving parts).
• excluding or imposing limitations on incidental or consequential damages or on how long an implied warranty last in some states.
• including a provision that requires customers to try to resolve warranty disputes by means of an informal dispute resolution mechanism before going to court that does not meet the requirements stated in the FTC’s Rule on Informal Dispute Settlement Procedures.
You should always have a lawyer review the Terms and Conditions and Rules of Use pages (and perhaps all the pages) of your website before you publish to see what clauses or statements may be in violation of New Jersey or Federal law. Prohibited limitations on the legal rights of a consumer under implied or express warranties should be edited or deleted. No business that is acting in good faith should face huge litigation costs and a stiff statutory penalty in a class action lawsuit brought by plaintiffs who suffer no actual harm.
The issuer is permitted to communicate with potential crowdfunding investors if the communications occur through the platform but, in spite of the use of the platform or a website link, the final rules limit the ability of the issuer, as well as the ability of others acting on the issuer’s behalf, to advertise. Pursuant to Rule 204, the issuer-company is permitted to advertise the Section 4(a)(6) exempt offering by releasing an offering notice (similar to tombstone ads permitted under Securities Act Rule 134) that contains only the following information:
• a statement that the issuer is conducting an offering;
• the name of the intermediary and a link to the intermediary’s offering page;
• the amount of securities offered (target and maximum);
• the nature of the securities;
• the price of the securities;
• the closing date for the offering;
• the name, address, phone number and website of the issuer;
• the email address of a representative of the issuer; and
• a brief factual description of the issuer’s business.
Will compliance with all of these crowdfunding rules be easier than the traditional Regulation D private placement (without general solicitation)? Certainly the hope was that the crowdfunding rules would allow smaller issuers (and smaller investors) greater opportunities to access capital markets. But the procedural and informational requirements justifiably deemed necessary to protect investors and reduce the risk of fraud make crowdfunding far less accessible than hoped. Only the passage of time will determine which of the recent SEC initiatives prove most popular and affordable to small issuers with limited budgets.
The crowdfunding offering must be conducted through a registered broker-dealer or a funding portal with a “platform”. A “platform” is defined as “a program or application accessible via the Internet or other similar electronic communication medium through which a registered broker or a registered funding portal acts as an intermediary.…” No more than one intermediary can be used for an offering, and the issuer-company is required to make certain disclosures to the SEC, investors and the intermediary facilitating the offering, including:
• A discussion about the size and scope of the offering.
• The specific use or range of possible uses for the offering proceeds, as well as the factors impacting the selection by the issuer of each such use.
• Information about the securities being sold to the public.
• A description of the company’s business operations.
• Information about the company’s officers and directors during the prior three years, including how long they have held those positions and their respective business experience.
• Information about the holders of 20% or more of the company’s outstanding voting securities, as well as a description of the capital structure and any special voting rights or investor rights.
• Identification of Rule 501 and any issuer-company imposed transfer restrictions on the securities offered.
• A discussion of risks associated with an investment in the securities and with participation in a crowdfunded offering.
• A discussion of the financial condition and financial statements of the company, tiered in accordance with the size of the offering such that:
1. Offerings of $100,000 or less require financial statements certified by the company’s principal financial officer.
2. Offerings of more than $100,000 but less than $500,001 require audited financial statements if available or, if a first time crowdfunding exemption user, financial statements reviewed by an outside auditor.
3. Offerings of more than $500,000 up to the $1,000,000 limit require audited financial statements
The offering materials must also include a description of the offering or subscription process and a disclosure of the investor’s right to cancel his/her investment up to 48 hours prior to the deadline identified in the offering materials.
The issuer must complete Form C, which includes details of the initial disclosure about the offering. The completed Form C must be filed with the SEC and either posted by the intermediary on its platform or viewable by investors through a link. The issuer-company must report material changes on Form C-A, periodic updates on Form C-U and ongoing annual filings on From C-AR until the filing obligation is terminated on Form C-TR.
The new rules allow the issuer to engage in limited advertisement of the offering, but there are traps for the unwary. These rules are discussed in the next installment of this blog.
In Socko v. Mid-Atlantic Systems of CPA, Inc., the Pennsylvania Supreme Court held that the Uniform Written Obligations Act (“UWOA”) could not render a restrictive covenant not supported by adequate consideration enforceable nonetheless. In so doing, the Court emphasized that such restrictive covenants – agreements that restrict an employee’s ability to compete against an employer after termination - are disfavored restraints on trade. As the dissent noted, the opinion does appear contrary to the plain language of the UWOA, but this dissonance highlights the disfavored nature of restrictive covenants.
As part of his employment with Mid-Atlantic, Socko signed three restrictive covenants: one upon the beginning of his employment, a second upon return to Mid-Atlantic after terminating his employment, and a third, more restrictive, agreement signed during his employment. Along with the third restrictive covenant, Socko did not receive a bonus, promotion or other consideration. The document recited the magic words of the UWOA that “the parties intended to be legally bound.” Socko resigned from Mid-Atlantic and went to work for a competitor, and Mid-Atlantic filed suit for breach of the restrictive covenant.
Pennsylvania law requires that restrictive covenants must be accompanied by adequate consideration. To meet this requirement, the employee must sign the agreement at the commencement of employment, or the employer must supply new consideration for restrictive covenants signed after the commencement of employment. “New consideration” includes a benefit to the employee or a beneficial change to the employee’s status. Socko did not receive any new consideration for the new restrictive covenant that Mid-Atlantic sought to enforce. Importantly, the new restrictive covenant also included language superseding all previous restrictive covenants, thus rendering the second restrictive covenant, which was supported by sufficient consideration, ineffective.
To address this problem, Mid-Atlantic argued that Socko was barred from challenging the restrictive covenant on the basis that it was not supported by new consideration because it contained the UWOA language. Mid-Atlantic asserted that the “magic words” foreclosed the usual analysis of consideration for restrictive covenants signed after the commencement of employment. The Supreme Court, affirming the Superior Court’s holding, held that the UWOA language does not foreclose such an analysis as it relates to restrictive covenants. In so doing, the Supreme Court rejected Mid-Atlantic’s framing of the issue. The issue was not, as Mid-Atlantic asserted, that the UWOA foreclosed Socko from challenging the validity of the agreement based on a lack of consideration. Instead, the Supreme Court stated that the issue was whether the UWOA acted as a substitute for consideration.
The Supreme Court relied on principles of statutory construction and the body of case law holding that restrictive covenants are disfavored restraints of trade to find that the UWOA language would not act as a substitute for consideration to support a restrictive covenant. The Supreme Court noted that the unique treatment of restrictive covenants in the law, including rigorous judicial scrutiny, required this outcome.
While this holding will not shock employment lawyers, as it is consistent with the court’s jaundiced approach to restrictive covenants, it does highlight important considerations for the use of such documents. Employers strive to foster their entry level employees into valuable positions, and such a practice benefits employer and employee. Employers must consider when and whether to require those employees to execute restrictive covenants, the consideration they will provide for new restrictions, and whether there are other, more productive, ways to retain a valuable employee and protect the business. The Supreme Court’s decision does not change the analysis, but it does clarify that no mere technicality will encourage a court to set aside the rigorous scrutiny of restrictive covenants required by the case law.
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