Tuesday, December 28, 2010

Doing Business in Russia

I was recently browsing through discussions and postings on LinkedIn groups and found an interesting article that I would like to share with you. It was posted on FizzLaw group’s bulletin, a group dedicated to providing small businesses with access to small business lawyers. Originally being from Russia, I have always been interested in understanding how business is done there. This article was written by Daniel J. Alexander II, an attorney and a member of FizzLaw group. The full text can be found on his blog at http://www.outhousegeneralcounsel.com/2010/10/establishing-legal-presence-in-russia.html


The article presents a well researched summary of current Russian laws relevant to business formation. Just one more note: I have not personally verified the research and, knowing the constantly changing nature of Russian laws and regulations, I believe it would be wise to check the information below before relying on it to open a business in Russia. I also had to make minor formatting changes to be able to repost here.

“A foreign investor may act through one of several legal forms:

►As a representative or branch office of foreign legal entity;
►As a Russian legal entity; and
►As a foreign investor.

The procedures for establishing a company in Russia are quite well-developed and are regulated by the RF Civil Code and by additional RF laws.

Russian Legal Entities

In accordance with the Civil Code, the following are some of the most important types of legal entities:

►Joint stock companies (JSC);
►Limited liability companies (LLC);
►Additional liability companies;
►General partnerships; and
►Limited partnerships.

Joint stock and limited liability companies are forms that are most frequently used by foreign investors to enter the Russian market and are reviewed below.

Limited Liability Company

The limited liability company (hereinafter LLC) is recognized as a company established by one or more persons, whose authorized capital is divided into participation interests, the size of which is stipulated by founding documents. Participants of the LLC do not bear liability by its obligations but bear the risk of losses connected with the company's activity within the cost of the contributions they have made. An LLC can be founded by either a person or group of people, or a Russian or foreign company. The number of participants in an LLC cannot exceed 50. If the number of exceeds 50, then the LLC is subject to reorganization into a JSC within a year. On the expiry of this term, if the number of participants has not been reduced, it shall be liquidated under the court decision. The minimum authorized capital may not be less than RUR 10,000 (approximately $370) and at least 50 percent of the capital must be paid in prior to the company’s registration. Contributions can be made in cash or in-kind.

The founding documents of an LLC are known as Articles of Incorporation signed by its founders, and the Charter, which is approved by them. If the company is set up by a single person, its foundation document is the Charter.

An LLC has a three-tier management structure which consists of:

►General participants meeting, the highest governing body which has exclusive rights to amend the Charter, approve annual financial reports, etc;
►Board of Directors, which supervises the general company’s activity; and
►Executive body, which may be an individual (usually the general director) and a collegial body. The primary function of the executive body is the daily management of a company.

Joint Stock Company

A joint stock company (JSC) is a company, whose authorized capital is divided into a definite number of shares; the owners of the JSC (the shareholders) do not bear liability for its obligations, but do accept the risks involved with losses connected to the JSC’s activity within the value of their shares.

There are two types of JSCs:

►Closed joint stock companies (CJSC); and
►Open joint stock companies. (OJSC)

The distinctions between the two above mentioned forms are as follows:

Open Joint Stock Company

►Minimum authorized capital is RUR 10 000 (approximately $370)
►Unlimited number of shareholders
►Shares may be freely sold to third parties

Closed Joint Stock Company

►Minimum authorized capital is RUR 100,000 (approximately $3,700)
►Limited number of shareholders, which cannot exceed 50. Otherwise, the company is subject to reorganization into Open Joint Stock Company within one year

►Shares may not be freely sold. Share transfers are subject to preemptive rights of other shareholders

The management structure of a JSC is similar to the management structure of an LLC. Both open and closed JSCs are obliged to have two governing bodies: the General Shareholders’ Meeting and the Executive Body. The OJSC with over 50 shareholders must have a Board of Directors or Supervisory Council. Furthermore, a JSC must annually undergo a professional outside audit for control and approval of its annual financial reports.

Branch and Representative Offices

Branch and representative offices of foreign legal entities are not considered to be Russian legal entities, but bodies representing the interests of foreign legal entity with headquarters in another country.

Representative Office

►A representative office is subdivision of a foreign legal entity which represents the company’s (headquarters) interests in Russia and cannot undertake commercial activity. The main purpose of establishing a representative office is marketing research for the Russian market and promotion of commercial relations between the head company and Russian companies.
►The term for which a representative office can be set up is a maximum of three years, with the right of extension.

Branch

►A branch is a subdivision of a foreign legal entity which may undertake commercial activity.
►The term for which a branch can be set up is up to five years, with the right of extension.

The management structure of a representative or a branch office is represented by the executive body in the person of the head of the branch or representative office. The head of the subdivision of a foreign legal entity acts on the basis of a Power of Attorney issued by the parent company.

Registration

Once a form of a legal presence is chosen, the procedure for state registration must be started. In accordance with the Federal Law “On State Registration of Legal Entities,” registration is performed by tax authorities which file documents with the Unified State Register within five days.

Afterwards, the following procedures must be completed:

►Registration with the State Statistics Committee
►Registration with non-budgetary funds (the Pension Fund, Obligatory Medical Insurance Fund and Social Security Fund)
►Opening of bank accounts
►Notification of tax authorities about the opening of bank accounts
►Production and registration of a company’s seal
►In case of establishing a JSC, the securities issue must be registered with the Federal Service for Financial Markets of the Russian Federation.

Branches and representative offices must also be accredited with state bodies authorized to grant such accreditation. Usually, these authorities include the State Registration Chamber at the Ministry of Justice of the Russian Federation, the Chamber of Commerce and Industry and various Ministries of Russia. For example, if the company is engaged in educational activity, a representative or branch office may be accredited with Ministry of Education.

To establish a company, a foreign investor has to prepare a comprehensive list of documents required by Russian law. All documents from the home country of a foreign legal entity must be notarized and apostilled and a notarized translation into Russian must be provided.”

Friday, December 17, 2010

12-Month Extension on the 100% Capital Gain Exclusion for Investments into Small Businesses

Today, President Obama signed the “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010” (the “Act”).  Among other features, the Act extends for an additional year the 100% exclusion from federal capital gains tax for sales of qualified small business stock (QSBS) purchased during 2011.  As I wrote in my earlier post from November 15, 2010, this benefit previously applied only with respect of stock purchased through the end of 2010.  This extension provides a continued incentive for investment in small businesses.  Note that the QSBS must be held for 5 years in order to qualify for the tax exclusion.

Trade Name vs Trade Mark

Is a trade name the same as a trade mark? What is the difference between the two terms? Should I trademark my business name? These are the commonly asked questions that today’s post aims to answer.


Trade name is the official legal name of your business entity. This name appears on the incorporation papers and you can find it if you search the Department of State business registry. You use this name to open bank accounts, obtain business credit cards, and this name is the one you use to pursue or defend a claim in courts. Trademark, on the other hand, is any word, design, slogan, sound or symbol that serves to identify the source of goods or services (service mark).

Not every trade name (or business name) may be trademarked. You should trademark your trade name only if you use it in commerce to advertise, promote or identify the source of goods or services your company produces. For example, Google is both a trade name (there is a Delaware corporation called “Google”) and a trademark (because Google puts its name on its products and services to identify the source). On the other hand, TJ Maxx is a trademark for retail department store services, but is not a trade name. The actual name of the company is TJX Operating Companies, Inc., which is a trade name that consumers would not typically identify with what TJ Maxx does.

Just having the name registered with the New York Department of State as a name of your business does not afford you protection against someone using the same name as a trademark. For example, person A started marketing his handbags under the name “Handy Bandy” in New York in 2000 without forming a legal entity. Person B could form a legal entity “Handy Bandy” and register it with the New York State in 2004. This is possible because in the NY Department of State registry the name is still available. However, person B would not be able to use this name as a trademark to identify the source of handbags because person A already uses this name for this purpose and has a common law trademark. The reverse may also be true. If person A registered his business in New York State under the name “Handy Bandy” in 2000, there may be an argument made that if person A does not use this name as a trademark, then the name may be available to person B wishing to use it as a trademark to advertise and sell handbags. This would be a difficult but not an impossible argument to make.

In conclusion, business owners may want to consider whether they use their trade names as trademarks, and if they do, to register them with the U.S. Patent and Trademark Office.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Sunday, December 12, 2010

Virtual World: Get Ready to Meet COICA (Combating Online Infringements and Counterfeits Act)

On November 18, 2010, the Senate Judiciary Committee unanimously approved COICA, a legislation that, if passed by the full Congress and signed by the President, would allow the Attorney General to commence a legal action to obtain injunction against the domain name of any website suspected of infringing copyrights or trademarks. It would also allow Attorney General to ban credit card companies from processing US payments to the website and forbid online ad networks from working with the website.


In particular, the Act would allow the Attorney General to seek a temporary restraining order, preliminary or permanent injunction against a domain name used by a website if the domain name is used by the website “dedicated to infringing activities”, i.e., if the website is “primarily designed, has no demonstrable commercially significant purpose or use other than, or is marketed by its operator, or by a person acting in concert with the operator, to" infringe copyrights or trademarks and such infringing activities, if taken together, are "central to the activity” of the website. The definition is extremely broad and is met if the website includes "a link or aggregated links to other sites or Internet resources for obtaining access to” infringing products or services.

The injunctive relief can be obtained against the domain name registrar where the website is registered, the domain name registry which maintains the database of names for the target website’s domain, and any of the service provides or operators of network linked to the Internet. If the injunctive relief is obtained, the domain registrar, registry or service operator must suspend operation of the domain name, but can petition the court for relief from such order.

When initiating a legal action, the Attorney General must notify the domain registrant of the alleged violation and its intent to obtain injunction, as well as publish a notice of the action once the injunction is obtained.

The Act also gives the Attorney General the right to keep a list of websites that meet the definition of “dedicated to infringing activities” but which have not been the subject of suspension. A website owner would have to bring an action against the Attorney General in federal court to be considered for removal from such list.

The Act has been subject to a lot of criticism. One such criticism is that the Act violates the freedom of speech protected by the First Amendment. (See Law Professors’ Letter in Opposition to S.3804, signed by 51 law professors, available at http://www.eff.org/files). Another important criticism raised by the Letter is that domain registrars, registries or service providers will have “no information whatsoever concerning the allegations regarding the presence of infringing content at the target websites because they have no relationship to the operators of those websites; they are therefore in no position, and they have no conceivable incentive, to contest those allegations. The Act contains no provisions designed to ensure that the persons actually responsible for the allegedly infringing content – the operators of the target websites – are even aware of the proceedings against them, let alone have been afforded any meaningful opportunity to contest the allegations in a true, adversarial proceeding.” Additional objections have been raised in a Letter from NetCoalition.com (which represents Amazon, Bloomberg, eBay, Google, IAC, Yahoo!, Wikipedia and others), dated November 15, 2010, available also at http://www.eff.org/files.

According to Wired.com, “COICA is the latest effort by Hollywood, the recording industry and the big media companies to stem the tidal wave of internet file sharing that has upended those industries and, they claim, cost them tens of billions of dollars over the last decade. The content companies have tried suing college students. They’ve tried suing internet startups. Now they want the federal government to act as their private security agents, policing the internet for suspected pirates before making them walk the digital plank.” (http://www.wired.com/epicenter/2010/11/coica-web-censorship-bill).

In conclusion, the Act, if passed, may not pass judicial scrutiny given constitutional concerns. Also, financial burden resulting from business interruption and legal fees for some (especially smaller or lesser known) websites could be astronomical. Finally, there are already civil and criminal remedies set in place by current trademark or copyright laws, - is there really a need for such radical measures?

Sunday, November 21, 2010

What is branding and how to protect it?

Key to business success often lies in creation of a powerful brand. A brand defines the source of goods and services. The goal is to get customers shopping for a certain type of goods or services to look for your particular brand because they came to identify it with a certain look, feel, quality or another attribute that they prefer. For example, I am currently shopping for a new laptop. I know that I only want to buy a Dell laptop as, in my experience, Dell laptops are the best in terms of durability and quality. Of course, feel free to disagree. The point that I am trying to make is that a powerful brand is what sets you apart from the competition and allows you to establish recognition in this competitive environment.


Creating a brand can be expensive. It is important to first thoroughly research the market to know the competition and determine if someone else is already using the same or similar brand. A brand can include a name and a logo or design, which can be used together or separately. Sometimes, a brand can include a color (like orange for Home Depot) or a slogan.

Protecting the brand is of utmost importance. I recommend that business owners take the following actions to protect it: file federal trademark applications with the US PTO office and enter into non-disclosure agreements (NDAs) with potential investors, partners, licensees, manufacturers, etc. I already discussed the advantages of federal trademark registration in my previous posts (see my posts under Intellectual Property tab). I now want to spend a few minutes discussing the NDAs.

It is important to enter into NDAs to protect the brand name while the brand is being developed. Once the brand is released, NDAs are typically entered into when parties are considering doing business together, either as a collaboration, joint venture, or project outsourcing, - projects that would involve disclosing proprietary information. Proprietary information is defined broadly and is not limited to the brand name (that, once released, is already known to the public at large). It can include information about how you run your business and what makes it successful, such as business plans, financial projects, patents, patent applications, agreements with third parties, trade secrets, designs, licenses, drawings, hardware configurations, technology, research, product plans, products, services, suppliers, customers, prices and costs, etc. The receiving party in an NDA agrees to use such proprietary information only for the purposes specified in the agreement and not disclose it to anyone else (other than employees on an as needed basis). However, there are exceptions to the definition of proprietary information, which include information that is or becomes publicly available without the breach of the agreement; that the receiving party has already known; that the receiving party has already received from someone else or has developed independently; and finally, that the receiving party must disclose to government authorities. Like with trademarks, it is up to the disclosing party to enforce the NDAs. One common method is issuance of an injunction or a restraining order against the receiving party.

A powerful brand must not only be created but also be continuously protected through the use of NDAs, trademark registrations and ongoing vigilance with respect to potential infringements and violations of confidentiality clauses.

Monday, November 15, 2010

Small Business Jobs Act of 2010: Zero Tax Investments

A part of the Small Business Jobs Act that President Obama signed recently relates to investments made between September 27 and December 31, 2010.  Gains on such investments, if they qualify, will not be taxed at the federal level.  This law is meant to serve as an incentive for private investments into small businesses, and may apply to investments made by angels and other investors.  One caveat: such investment must be kept for more than five years, which may be in conflict with the exit strategy of some investors.

A blog describing this new law is found here:

http://angelsoft.net/blog/2010/10/08/new-federal-law-zero-taxes-on-gains-on-small-business-investments/

Wednesday, November 10, 2010

Seed Round of Raising Capital: What Terms are Customary?

I am certain that any business owner looking to raise capital by issuing equity securities to investors wants to have a good idea of what terms/privileges would the investors be looking for in exchange for investing in the company. How can a business owner who has never accessed capital markets before know what is reasonable and expected and whether there is room to negotiate? The answer is: the Internet, where much has been written about private placements.  Another answer is, of course, consult a knowledgeable securities lawyer.


In particular, I would like to bring to your attention several sets of investment documents suitable for seed rounds I found on the internet. The seed round is usually $750,000 or less, so the terms are somewhat simplified (as compared to the later rounds when venture capital firms get involved). Typically, one would see the following legal documents as part of the transaction (apart from the disclosure documents): (a) a term sheet summarizing the key investment terms (not binding); (b) restated articles of incorporation or charter, revised to include the terms of the new securities, this document gets filed with the state of incorporation; (c) a shareholders agreement, revised to include the new investors; (d) bylaws that may or may not change; and (e) a subscription or stock purchase agreement, a contract between the company and each of the new investors containing customary representations and warranties by both parties.

The first set of documents was developed by Cooley Godward LLP and can be found here: http://www.techstars.org/2009/02/07/techstars-model-seed-funding-documents/. The second set of documents was developed by Y Incubator and Wilson Sonsini Goodrich & Rosati, and can be found here: http://ycombinator.com/seriesaa.html. The third set of documents was developed by attorneys at Fenwick & West and is found here: http://www.seriesseed.com/posts/2010/02/series-seed-financing-documents.html.

The three models offer some variations but the key terms are as follows. Investors get voting preferred stock that can be converted into common stock at any time at agreed upon conversion rate, subject to adjustment. Upon liquidation, investors get to receive their money first, before the common stock owners. Once investors are paid back, the rest of the money is distributed among the common stock holders. Investors get to vote separately as a class on the main decisions by the company, such as its sale. Investors get rights of first offer in future rounds of financings and if any future financings offer better rights, investors get them too. Investors receive annual and quarterly financial statements of the company. And last but not least, investors get a board seat.

These models are good tools for business owners to get a better idea of what to expect from a seed round of equity financing. All documents have to be reviewed by counsel and negotiated. These are simplified forms generally suitable for early rounds of financing, so some provisions are missing. Again, please consult an experienced securities attorney before engaging in raising capital.

Friday, November 5, 2010

Business Consultants and Finders: Are They Brokers?

This post is not written for the business owners, but rather for the consultants who connect companies that are looking to raise capital with potential investors, whether angels or VCs. I was recently reviewing the broker-dealer definitions in the Securities Exchange Act of 1934, and decided to highlight a part of a definition of a broker that may not be well known or understood by some.


Section 3(a)(4)(A) of the Exchange Act defined “broker” very broadly as “any person engaged in the business of effecting transactions in securities for the account of others.” Depending on various factors, some of which I discuss below, the definition includes (among others) business brokers or finders, who find investors (venture capital, angel) for companies issuing securities, even if in “consultant” category; find buyers or sellers of businesses; act as investment advisers and financial consultants or act as “placement agents” for private placements of securities.

In order to determine whether you are a broker, the Securities and Exchange Commission (SEC) recommends looking at these factors (if answer is “yes” to any of the questions below, then it is likely that you are a broker):

• Do you participate in important parts of a securities transaction, including solicitation, negotiation, or execution of the transaction?

• Does your compensation for participation in the transaction depend upon, or is it related to, the outcome or size of the transaction or deal? Do you receive trailing commissions, such as 12b-1 fees? Do you receive any other transaction-related compensation?

• Are you otherwise engaged in the business of effecting or facilitating securities transactions?

• Do you handle the securities or funds of others in connection with securities transactions?

For example, the SEC recently denied no-action relief to a law firm that intended to help its client raise funds by introducing it to potential investors.  The law firm was to be compensated based on a percentage of the gross amount the client raised as a result of the law firm’s introductions. See Brumberg, Mackey & Wall, PLC, May 2010. The SEC staff stated in its response that “a person’s receipt of transaction-based compensation in connection with these activities is a hallmark of broker-dealer activity.”

If you think that you may be a broker, you should consult with a private counsel or the SEC to determine whether you need to register. You cannot engage in the securities business until the registration is complete. A broker typically needs to register with the SEC. There is a number of exceptions to this rule, one of which is if the broker conducts all of his business in one state (then, registration with the state authorities is in order). However, since a lot of information is posted on the internet and is accessible to persons from any state, a broker may need to register federally as well.

Federal registration process involves filing form BD with the SEC, becoming a member of a self-regulatory organization (such as FINRA or a registered national securities exchange), becoming a member of the Securities Investor Protection Corporation and complying with all applicable state requirements. States require separate registrations.

Certain brokers may also need to register as investment advisers under the Investment Advisers Act. An investment adviser is a person who receives compensation for providing advice about securities as part of a regular business. Registration as an investment adviser involves filing a form ADV (check the recent amendments adopted in October 2010!) with the SEC or the state authorities depending on the amount of capital under management and the number of clients in a state.

In conclusion, it is important to reiterate that none of this should be considered as legal advice. I wrote this blog for information purposes only, as a reference for business consultants who may or may not be required to register as brokers in their states or federally.

Wednesday, November 3, 2010

How to find a unique name for your business, product or service?

I decided to write a blog about how a business owner should go about choosing a name for his or her business, product or service. Branding is very important, and a successful business is one that has a brand that is easily recognizable and unique. I am not an expert in marketing or branding, so I will approach this task from the legal point of view. I will look at trademarks (trade names and service marks) to see which name would be easily protectable by the US Patent and Trademark Office.

Choosing a name for me is a two-step process. First, you think of a name using the criteria I list below. Second, you conduct a thorough search on the USPTO database (www.uspto.gov) and on the internet to make sure that no one is using this name or a name that could be confusingly similar (including misspelled words, synonyms, foreign word translations). If someone has already claimed it, then go back to step one and start over.

So, step one involves identifying potential names. To do that, think of what are the essential characteristics, purposes or attributes of your business. What needs would the product or business serve? Who are the customers who will use or buy it? What images do you associate with this product or service? With this in mind, look at the five word categories below.

Category 1 consists of fanciful or coined (made up) words, i.e., words that do not exist in the dictionary. For example, Kodak, Aveeno or Neutragena are made up words that came to identify with very successful companies and products. These are the best names to have, as they are distinctive and will not be easily confused with any other name. As you think of your company, product or service, think of a play on words or sounds to make up a unique name that may also carry a hidden message describing what your business does. It may not be as difficult as it sounds.

Category 2 consists of arbitrary words, which are real dictionary words but are used to describe something other than their traditional meaning. For example, “Camel” brand is being used for cigarettes, “Apple” – for computers. These are also good names to trademark, as the use of the word is likely to be unique.

As we go down the category list, the words become more difficult to trademark. Category 3 consists of suggestive words, which can be indirectly used to describe the product or service that they are protecting or that invoke an image that can be associated with the product or service. For example, the word “caress” is a suggestive trademark for beauty soap bars or the word “obsession” is a suggestive trademark for a perfume. Some words can have a double meaning (for example, “Pea in the Pod” maternity clothes line). Here, one needs to be careful not to slip into the next category of descriptive words, which is generally not protectable.

Category 4 consists of descriptive words, i.e., words that describe the underlying product or service. Trademark protection is very unlikely for these words, as they are not distinct. Ordinary words used in an ordinary way do not warrant the protection of trademark law, as there may be many other business owners who would want to use the same words to describe their own businesses or products. For example, Reliable Pet Care would not work for a pet care service, as other pet care services would also like to advertise themselves as reliable.

The final category 5 consists of generic words. The rule here is that the USPTO will not register trademarks that are the generic names of the goods or services they seek to protect.

In conclusion, my advice is as follows: take your time selecting the name that is unique, falls under the first three categories, and is legally available. You would not want to spend much time and money only to find out later that the name is already being used by somebody else. Be creative in choosing your name: try new combinations of words, foreign words, words with double meaning or combinations of word and design that make the overall impression unique. The world of business is very competitive and having a unique brand is one way to distinguish your company and gain competitive advantage.

Sunday, October 24, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation. Conclusion - Part V

This posting concludes my comparion of Delaware, Nevada and Wyoming business-related legislation.  In this posting I draw conclusions about where one should actually consider registering the business.  Generally, a company has to register in every state where it conducts business in order to enjoy limited liability in that state. This also means that the company would have to pay taxes in every state where it registers and be subject to local reporting obligations. If a company does business in one state only, then it is preferable to incorporate in that home state, thus saving on taxes, registered agent fees and registration paperwork elsewhere. However, if a company plans to conduct business in several states, then such company should carefully choose which state would be most suitable for its needs.

Large companies with complex structures or those companies that plan to go public should consider Delaware as the state of incorporation. It is almost expected that a company going public be a Delaware corporation. In the 1990s, for example, the share of Delaware companies’ IPOs registered on the New York Stock Exchange increased to 73-77%.  After all, Delaware’s corporate laws are the most flexible, its Chancery Court is the oldest in the country, and the abundance of business law precedent is clear. However, costs of incorporation and ongoing tax obligations in Delaware may be substantial.

Smaller companies and start-ups may consider choosing a state that provides a cheaper alternative. Wyoming appears to be the least expensive state in terms of incorporation, annual taxes and filings fees, as compared to Nevada or Delaware. However, it is unclear whether litigating there would be the best option for a start-up, given the geographic location and absence of a court system specifically dedicated to resolving business disputes. Wyoming and Delaware afford businesses the most privacy, as compared to Nevada. Wyoming and Nevada, on the other hand, are the most management-friendly in terms of antitakeover protections included in their statutes.

This article has discussed only several of the many considerations that should go into deciding in which state to incorporate. Each company is unique, and legal advice relating to the state of incorporation should be carefully tailored to each particular company. In addition, the choice of where to incorporate is an important one but does not necessarily have to be a permanent one, as it is always possible to re-incorporate in a different state, as the companies grow and their business needs and priorities change.

Thursday, October 21, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation. Part IV.

Below is Part IV of my article comparing certain aspects of Delaware, Nevada and Wyoming business-related legislation. As I said earlier, I wrote this in April of 2010, so the information here may have become outdated. Information contained is this article is for informational purposes only, so please check each state’s laws before making any legal or other decisions with respect to your business. In this Part I discuss two issues that are of interest to business owners: managerial liability and antitakeover provisions.


Managerial Liability

The following discussion pertains to corporations only. Section 102(b)(7) of Delaware General Corporate Law allows shareholders to include a provision in the corporation’s certificate of incorporation exculpating a director for breach of fiduciary duty, except if the director breached duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, or if a director derived an improper personal benefit. This provision does not extend to officers. However, recently the Supreme Court of Delaware held in Gantler v. Stephens29 that corporate officers owe the same fiduciary duties as corporate directors. The Court suggested in footnote 37 that in this case corporations should have the ability to exculpate officers as they are allowed to do in the case of directors. It remains to be seen whether legislature will extend Section 102(b)(7) to corporate officers.

While Delaware’s Section 102(b)(7) does not itself limit personal liability of directors but allows shareholders to do so in the charter, Nevada’s Private Corporations Law uses the opposite approach and provides that a director or officer is not individually liable to the corporation, its stockholders or creditors unless there is a breach of fiduciary duties, fraud, intentional misconduct or a knowing violation of law, and unless the articles of incorporation provide for a greater personal liability.30  Unlike Delaware’s law, Nevada’s law covers officers.

Similarly, Wyoming Business Corporation Act provides that officers and directors are not personally liable to the corporation or its shareholders absent certain factors (different standards apply to officers and directors).31

Comparing the three approaches to the statutory limitations on directors’ and officers’ personal liability, it is clear that Nevada’s is the broadest, as it applies to both groups and exculpates directors and officers from personal liability to the corporation, shareholders as well as creditors.

Antitakeover Provisions

This section also focuses on corporations. An issue which primarily concerns companies with many shareholders32 is the state’s stance on antitakeover provisions. Shareholder rights plans or “poison pills” are generally legally vulnerable because they discriminate against specific shareholders. Although these may not be immediate concerns for a start-up company, choosing a state with strong antitakeover laws may save the company costs of reincorporating in a different state down the road.

Nevada and Wyoming have very strong antitakeover laws because, unlike Delaware, they do not impose enhanced fiduciary duties on directors in takeover situations. Instead, they apply the business judgment rule to the use of antitakeover tactics. Nevada does not restrict directors from issuing defenses in response to hostile takeover threats even if they “deny rights, privileges, power or authority to a holder of a specified number of shares or percentage of share ownership or voting power.”33  Although, given the powers granted to directors by Section 78.138.4 of the Nevada Private Corporations law, a “poison pill” may not be necessary to enact at all, since the directors are free to reject a hostile bid in the interests, for example, of the State economy or society:34

Directors and officers, in exercising their respective powers with a view to the interests of the corporation, may consider:
(a) The interests of the corporation’s employees, suppliers, creditors and customers;

(b) The economy of the State and Nation;

(c) The interests of the community and of society; and

(d) The long-term as well as short-term interests of the corporation and its stockholders, including the possibility that these interests may be best served by the continued independence of the corporation.
This is an extremely management-friendly provision that allows directors to consider the interests of shareholders as just one factor among others. Wyoming’s legislature offers an almost identical management-friendly language in Section 17-16-830 of its Wyoming Business Corporation Act.

Delaware, on the other hand, requires heightened fiduciary duties from their directors, as elaborated in the Unocal and Revlon35 decisions. Delaware courts apply the Unocal standard to ensure that the directors’ defensive actions are reasonable in relation to their belief regarding the danger of the takeover to the corporate policies and proportionate to the magnitude of the perceived threat to the corporate policies.36  Therefore, it may be more difficult for Delaware directors to resist a takeover attempt. In response to the concerns with the heightened fiduciary duties of directors, as per the Unocal and Revlon decisions (decided in 1985 and 1986, respectively), in 1988 Delaware’s legislature adopted an antitakeover law (Section 203 of the Delaware General Corporation Law). This section prevents buyers of more than 15% of a target company’s stock from completing its acquisition for three years. A takeover could be completed if (i) the buyer purchased over 85% of the stock, (ii) the target’s board approved it prior to the transaction or (iii) the target’s board and the holders of two-thirds of outstanding shares (excluding shares held by the buyer) approve the takeover at or after the transaction. However, in January 2010, the constitutionality of Section 203 was challenged by the Harvard Professor Guhan Subramanian et al. in his paper “Is Delaware’s Antitakeover Statute Unconstitutional? Evidence from 1988-2008.”37 The debate continues, and the future of this antitakeover provision remains to be seen.

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29  See Gantler v. Stephens, No. 132, 2009 Del. LEXIS 33 (Del. Supr. Jan. 27, 2009) (unpublished decision).


30  See NEV. REV. STAT. § 78.138.7 (2001).

31  See WYO. STAT. ANN. § 17-16-842(d) and 831.

32  Bishop, supra note 3 at 4. In closely held firms, there is often little or no separation of capital and management, therefore there is less likelihood of the interest of the owners and managers to diverge.

33  NEV. REV. STAT. § 78.195.5.

34  NEV. REV. STAT. § 78.138.4.


35  Revlon duties come into play when the sale of the company is inevitable. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A. 2d 173 (Del. 1986).

36  See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (1985), Moore Corp. v Wallace Computer Services, 907 F. Supp. 1545, 1556 (D. Del. 1995).

37  Available at http://www.law.upenn.edu/academics/institutes/ile/PNYUPapers/2010/Subramanian_Is%20Delaware's%20Takeover.pdf.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Saturday, October 16, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation. Part III

In this Part III I will focus on the costs of incorporation and annual fees and taxes to determine which state out of three is the least expensive. I will take a look at the privacy laws of the three states, since privacy is a major concern for business owners. Just a reminder: all the information here is as of April 2010, and may have since become outdated.

Incorporation Fees

The fee for incorporating a corporation in Delaware is a minimum of $89, but is increased incrementally if the amount of authorized capital exceeds $75,000. The fee to file a document of formation is $90 for an LLC and $200 for LP, LLP (per partner) and statutory trust.

Wyoming charges a flat fee of $100 to form any of its business entities.

Nevada charges a flat fee of $75 to form an LLC, an LP or an LLP, and $100 - an LLLP. For corporations, Nevada bases the amount of fees on the value of authorized share capital (fees start at $75 for the capital of $75,000 or less and gradually increase to $375 for capital valued at less than $1 million, with incremental increases to a maximum fee of $35,000).  There is also a requirement to file an initial officer and director/member and manager/general partner list with an accompanying fee of $125.

These price differentiations among the three states indicate that (1) it is relatively inexpensive to form an LLC in either state; (2) Nevada and Delaware are more expensive places of incorporation for big corporations as they calculate the filing fees based on the amount of capital stock; and (3) Delaware has generally higher fees to form an LP, LLP, LLLP and trusts than do Nevada and Wyoming.

Annual Fees and Taxes

A look at the state’s annual fees and taxes shows that Wyoming is the least expensive incorporation state as compared to Nevada or Delaware. Wyoming’s annual license tax is based solely on the value of all assets located and employed within Wyoming. The minimum fee is $50 and it increases based on the amount of assets within the state.21  Additionally, Wyoming has no corporate income tax, personal income tax, inventory tax, tax on intanglible assets such as stocks or bonds, and there is no legislative plan to implement these types of taxes.22

Nevada, on the other hand, charges a yearly $125 ($175 for some LLLPs) officer and director filing fee and imposes an additional business license fee of $200 per year on corporations, LLCs, LP, LLPs and LLLPs (last increased on July 1, 2009).23 There is also a requirement that domestic and foreign corporations (including close and professional corporations) pay an annual list fee calculated based on the amount of authorized stock, with a minimum fee of $125 and a maximum fee of $11,100. Like Wyoming, Nevada does not at this time charge a corporate income tax, franchise tax, personal income tax, inventory tax or tax on corporate shares.

In Delaware, all corporations have to file an annual report and pay a filing fee of $50. In addition, all corporations have to pay franchise tax for the privilege of incorporating in Delaware, calculated based on the number of authorized shares or assumed no par capital (minimum tax is $75 and a maximum tax is $180,000).  GPs, LPs, and LLCs do not file an annual report but pay an annual fee of $250, and LLPs and LLLPs have to file an annual report and pay $200 per partner. 24  Delaware also levies a corporate income tax on domestic corporations (those corporations that do not conduct business in the state, although are incorporated there, do not have to file a tax return).25  Delaware does not impose a state or local sales tax, but does impose a gross receipts tax on the seller of goods (tangible or otherwise) or provider of services in the state.

Privacy

Concerns about privacy may be the deciding factor for some businesses if asset protection issues are involved. Nevada requires that all business entities file annual lists with the state, which contain the name and resident or business address of partners, officers, directors, managers or managing members of business entities incorporated in Nevada. It is possible to search the state website for business-related information not only by the name of the business but also by officer’s name. In Nevada, shareholders can vote by proxy, valid only for 6 months, unless the appointment document provides a different length of time, not to exceed seven years. 26

Wyoming’s annual update reports do not require disclosing the names of business owners except for the person signing the report. Wyoming also allows nominee shareholders (designated persons to appear on public record instead of the actual persons involved) as well as action by lifetime proxy. 27

Similarly to Wyoming, Delaware does not require disclosure of the names of business owners, directors or officers of business entities in its filings, allows nominee shareholders and provides for lifetime proxy.28 Therefore, it appears that Wyoming and Delaware laws offer greater privacy protection to the business owners of the entities formed in their states than Nevada.
 
______________________________
21 Wyoming requires its business entities to file an annual report on or before the first day of the anniversary month of the company’s incorporation and pay a license tax (except for statutory trusts). The cost is $50 or two-tenths of one million on the dollar ($.0002), whichever is greater, on the portion of the corporate assets located and employed in Wyoming. See Wyoming Secretary of State, Frequently Asked Questions, available at http://soswy.state.wy.us/FAQ.aspx (last visited Mar. 25, 2010).


22 See Wyoming Department of Revenue, Income Tax, available at http://revenue.state.wy.us/ (last visited Mar. 25, 2010).

23 See Nevada Secretary of State, Forms and Fees, available at http://nvsos.gov/index.aspx?page=127 (last visited Mar. 25, 2010).

24 See Delaware Division of Corporations, How to Form a New Business Entity, available at http://corp.delaware.gov/howtoform.shtml (last visited Mar. 25, 2010).


25 Delaware Division of Revenue, Filing Corporate Income Tax, available at http://revenue.delaware.gov/services/Business_Tax/FilingCIT.shtml (last visited Mar. 25, 2010).

26 See NEV. REV. STAT. § 78.355 (1991).

27 Effectively, it is possible to appoint lifetime proxies, as Wyoming Business Corporation Act provides for the appointment of proxies for an 11-month period unless a longer period is expressly provided for in the form of appointment. See Wyo. Stat. Ann. § 17-16-722(c).

28 DEL. CODE. ANN. Tit. 8, § 212(b) (providing that a proxy is for a period of three years, unless the proxy provides for a longer period).

Thursday, October 14, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation. Part II

In this part I am discussing the ability of Delaware, Nevada and Wyoming courts to handle corporate law cases.

State Court System

Delaware has been praised for its court system.12  Delaware has a separate Court of Chancery, dating back to 1792, which is a business law court where judges are appointed on merit, not elected. This Court has no juries, and decisions are issued in a form of written opinions. Delaware business case law is abundant and there is much precedent for corporations to refer to when considering what actions they can and cannot take. Delaware business law (statutes and precedents) has come to be considered as the “national corporation law” since all lawyers are well familiar with it, having studied it in law school, and the most well-known business-related decisions have come out of Delaware courts.13

However, there is also some criticism about the effectiveness of the Delaware courts and unclear standards they set. It has been said that "the [Delaware] law governing the responsibilities of directors has become so muddled that, incredibly, one can't get a consistent answer to the most basic corporate law question of how many fiduciary duties directors have - if you ask Delaware lawyers, the answer can range anywhere from two to five!"14  Uncertainty about case law is exacerbated by the high reversal rate for decisions from the Court of Chancery of approximately 25%.15  Also, the length of litigation of cases has been extensive: for example, certain cases involving “fairness” considerations took an average of 8.7 years to resolve.16  Frequency of litigation is also alarming: in 1999 and 2000, there were 1,280 complaints filed, of which 78% were related to breaches of the fiduciary duties.17

Nevada created a business court system in 2006 based on the Delaware, Maryland, Pennsylvania and North Carolina models. The business court system was created specifically for the purpose of attracting new businesses by minimizing the time, cost and risks of commercial litigation.18  It exists within the district courts of Washoe and Clark counties, where several judges are selected to primarily handle business cases, even though they also handle criminal and civil cases. Judges are selected based on their experience in business litigation. As per Nevada Secretary of State’s website, the court system offers “early, comprehensive case management, active judicial participation in settlement, priority for hearing settings to avoid business disruption, and predictability of legal decisions in commercial matters.”19  However, no written precedent exists as the court rules do not allow the publishing of opinions. A creation of a separate chancery court like the one in Delaware would require a constitutional amendment. 20

Wyoming does not appear to have a court or judges exclusively dedicated to business litigation, although it is probable that Wyoming has sufficient precedent relating to LLCs, given that Wyoming was the first state to adopt an LLC statute in 1977. Therefore, given the criticisms of the Delaware courts, lack of published written opinions in Nevada business court system and the fact that Wyoming does not appear to have a court specifically dedicated to business-related matters, it remains uncertain which of the three states should be preferred in terms of litigating business disputes.
 
_____________________________________
 
12  See Lewis S. Black, Jr., Why Corporations Choose Delaware, (2007), available at http://corp.delaware.gov/ (last visited Mar. 25, 2010).
 
13  See id.

14  William J. Carney and George B. Shepherd, The Mystery of the Success of Delaware Law: the Mystery of Delaware Law's Continuing Success, 2009 U. Ill. L. Rev. 1 (2009) (quoting Paul T. Schnell, From the Editor - M&A at Year-End, M&A Law, Glasser LegalWorks, N.Y., Jan. 2005, at 3-4).

15  See id. (referring to Norman Veasey et al., The Role of Corporate Litigation in the Twenty-First Century, 25 Del. J. Corp.L. 131, 135 (2000)).

16  See id. (referring to Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110 (Del. 1994) (nine years); Rabkin v. Philip A. Hunt Chem. Corp., 498 A.2d 1099 (Del. 1985) (6.5 years); Rosenblatt v. Getty Oil Co., 493 A.2d 929 (Del. 1985) (8.3 years); Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) (eleven years)).

17  See id. (quoting Robert Thompson & Randall Thomas, The Public and Private Faces of Derivative Lawsuits, 57 Vand. L. Rev. 1747, 1761 (2004)).

18  Nevada Secretary of State, Why Incorporate in Nevada, available at http://nvsos.gov/index.aspx?page=152 (last visited Mar. 25, 2010).

19  Id.

20  See Arnold M. Knightly, New Business Court Called Unnecessary, reviewjournal.com (Jan. 30, 2009), available at http://www.lvrj.com/news/38688889.html.

Monday, October 11, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation: Part I

Part I


I am publishing here my article that I wrote back in April 2010 (with assistance from Leia Glasso, a law school student at Cardozo Law School) regarding where to incorporate a business. I decided to compare Delaware, Nevada and Woyming legislation since I have been receiving many inquiries as to how these three states compare in terms of their business legislation.  I would like to warn, however, that none of the information below contains any legal advice and that I wrote this piece five months ago, so the laws of these states may have changed since then.  That said, I hope you will still find the information below useful!

Introduction

It has become increasingly popular for companies to choose to abandon their home state and decide to incorporate out of state. However, not in all cases incorporating elsewhere represents the best decision for the business. This article discusses some advantages and disadvantages of incorporating in a state other than the home state, specifically focusing on the states of Nevada, Wyoming and Delaware.

Some lawyers are likely to believe that there is less risk of error or surprises when they recommend for their client to incorporate in the home state. This is due to two facts: first, they know the law and the accompanying case law already, and secondly, they are concerned about the cost and inconvenience of litigation in another jurisdiction.1  So when businesses do look out of state, what do they look for? In addition to the types of entities, availability of precedent and reliable court system, incorporation costs, annual fees and taxes, they also check to see how particular states deal with the issues of privacy, managerial liability and antitakeover provisions. This article aims to compare legislation in Delaware, Nevada and Wyoming in each of these areas.

It is commonly known that incorporating in Delaware has numerous advantages (as explained below). However, in recent years, other states have “waged aggressive and successful campaigns to attract corporate charters.”2  Among these states are Nevada and Wyoming. Small Business and Entrepreneurship Council ranked Nevada, Wyoming and Delaware as numbers 2, 3 and 34, respectively, in its Small Business Survival Index 2008, with lower rankings representing the most business-friendly states.3  So, how do these states really compare from the point of view of an entrepreneur?

Types of Entities

More than 882,000 companies are incorporated in Delaware, including approximately 64% of Fortune 500 companies and more than 50% of all public companies.4  In Delaware, one can incorporate a corporation, a close corporation (limited to 30 shareholders), a limited partnership (LP), a limited liability company (LLC), a limited liability partnership (LLP), a limited-liability limited partnership (LLLP)5 and a statutory trust. It is also possible to form a series LLC, where limited liability protection is provided across several “series”, each of which is insulated from the other (like a corporation with subsidiaries).6  Of 121,628 new entities formed in Delaware in 2008, 67% were LLCs, 24% were corporations, 6% were LPs/LLPs and 2% - statutory trusts.7

In recent years the number of companies incorporating in Nevada has skyrocketed: in 1994, 22,704 new companies incorporated in Nevada, whereas in 2006, a total of 84,207 companies incorporated there.8 In Nevada, one can register a corporation, a close corporation (limited to 30 shareholders), an LLC (including a series LLC) 9, an LP, an LLP, an LLLP and a business trust. Out of 84,207 new companies in 2006, 49% were LLCs, 47% were corporations, 3% were limited partnerships and the remaining 1% - limited liability partnerships and business trusts.

In Wyoming, one can form a corporation, a close corporation, an LLC, a close LLC, an LP, a registered limited liability partnership (a general partnership that registers in a limited liability form), an LLLP10 and a statutory trust. Wyoming was the first state to adopt an LLC statute in 1977. Close corporations and close LLCs were created for small or family-owned businesses and, similarly to close corporations, close LLCs include restrictions on interest transfer and withdrawal of capital contributions. 11

In addition to the more traditional entity choices, all three states allow for the creation of LLLPs, and Delaware and Nevada (but not Wyoming) allow creation of series LLCs. Like Nevada and Delaware, Wyoming provides for a formation of close corporations and, singularly, close LLCs, to best protect the interests of small and family-owned businesses.

Part II will compare the states’ court systems.
_________________________________
1  Keith Paul Bishop, There are Many Benefits to Incorporating in Nevada, But Tax Avoidance Is not One of Them, LA Lawyer (Nov. 2008).


2  Bishop, supra note 1.

3  Small Business and Entrepreneurship Council, Small Business Survival Index 2008 (13th edition), available at http://www.sbecouncil.org/uploads/sbsi%202008[1].pdf (last visited Mar. 25, 2010).

4  Delaware Division of Corporations 2008 Annual Report (June 29, 2009), available at http://corp.delaware.gov/2008AR.pdf (last visited Mar. 25, 2010).

5  An LLLP is a relatively recent form of entity (currently only 18 states have adopted LLLP statutes), where general partners can also enjoy limited liability for debts and obligations of the limited partnership. In a traditional limited partnership, only the limited partners have limited liability and are not responsible for the debts and obligations of the partnership beyond their capital contributions while the general partners are jointly and severally liable.


6  Each LLC may hold its separate assets, have different purposes, incur liabilities, have different members and managers and enjoy limited liability protection, while the series LLC pays one filing fee and files one yearly income tax return. Delaware was the first state to approve a series LLCs, since joined by eight other states. However, the federal tax treatment of a series LLC has not been fully resolved and there are questions as to the treatment of series LLCs in other states that do not statutorily provide for such entity.

7  See Delaware Division of Corporations 2008 Annual Report, supra note 6.

8  Nevada Secretary of State, Filing Statistics, available at http://nvsos.gov/index.aspx?page=147 (last visited Mar. 25, 2010).

9  See NEV. REV. STAT. § 86.1255, Nev. Rev. Stat. § 86.161(1)(e) (2005).

10  See WYO. STAT. ANN. § 17-14-202, 301, 503(c) (1971).

11  The main characteristics of a Wyoming close corporation include: no more than 35 shareholders, limitations on share transfers, buy-out provisions in case of deceased shareholders, and relaxed corporate governance standards (no need for a board of directors or annual meetings). See “Choice is Yours” available at http://soswy.state.wy.us/Forms/Publications/ChoiceIsYours.pdf (Apr. 2009) (last visited Mar. 25, 2010).

Sunday, October 10, 2010

Work-for-Hire: what’s the big deal about it?

A lot has been said and written about why businesses need to have work-for-hire agreements with their freelancers. Yet I find that some of my clients and business owners I meet at networking receptions have no idea what I am talking about and why anyone would need this additional piece of paperwork. I agree, the reason for having work-for-hire agreements is somewhat counterintuitive and it has to do with copyright law. The U.S. Constitution grants the initial copyright in a work to its creator. As usual, there is an exception that applies to work made for hire: (1) if an employee creates the work as part of his or her job, then the copyright vests in the employer, and (2) if the parties expressly agree that the work is work made for hire and it falls within one of nine categories, then the copyright vests in the person/entity that commissioned the work.


So, let’s imagine a scenario where a business owner hires an independent contractor to create website content for his business and pays him for this one-time project. It would be natural to assume that the business owner owns the copyright to the end result since he paid for it. However, this is not automatically the case because the independent contractor has a constitutionally protected copyright to the content that he has created. He is also not an employee, so the first exception does not apply. The only thing that would protect the business owner is a work-for-hire agreement that he has (hopefully) entered into with the independent contractor, in which the independent contractor (the original creator) transferred his intellectual property rights to the business owner. I hope now you see the importance of these agreements.

The U.S. Copyright Act of 1976 defines work made for hire as “(1) a work prepared by an employee within the scope of his or her employment; or (2) a work specially ordered or commissioned . . . . . , if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire.”

One further limitation: a work for hire must come within one of the nine categories listed below: (1) a contribution to a collective work, (2) a part of a motion picture or other audiovisual work, (3) a translation, (4) a supplementary work, (5) a compilation, (6) an instructional text, (7) a test, (8) an answer material for a test, or (9) an atlas.

In all other circumstances, there needs to be an additional assignment or licensing provision to make the assignment effective. There is room for negotiation, of course, as licenses can be made exclusive or nonexclusive, worldwide or limited to a certain geographic location, granted in perpetuity or limited to a certain amount of time, royalty-free or otherwise...

An additional question may arise as to whether the person who created the work was in fact an employee or an independent contractor. But this is a topic for another blog.

Tuesday, October 5, 2010

Proposed IRS Regulations on Series LLC

What is a series LLC?

A series LLC is a relatively new entity form that provides for the creation of multiple LLCs under the umbrella of one organization, like a corporation with multiple subsidiaries. This entity form was first enacted in Delaware in 1996, and is sometimes known as Delaware LLC. Creating a series LLC allows for limited liability protection across all “series” or “cells”, thus protecting each cell from the liability that may arise in another cell. It is commonly used in real estate, where each property can be held in a separate LLC cell, whereas the owner owns just one company. So far, nine states (Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, Utah, Wisconsin) and Puerto Rico have adopted legislature providing for the creation of series LLC. Although all these states provide for a significant degree of separateness for individual cells (each cell can own its distinct business purpose, assets, liabilities, different managers and members), most do not provide for all attributes of a separate entity. Therefore, cells are ordinarily treated as a single entity for state law purposes (typically, a series LLC would pay just one filing fee).

What do proposed regulations say?

On September 13, 2010, the IRS released proposed regulations governing the federal tax treatment of cells within a series LLCs. The main question that the IRS aimed to clarify was whether for Federal tax purposes each cell of a series LLC should be treated as a separate entity or whether the series LLC (including all its cells) should be treated as a single entity (like under state law).

The proposal is to treat each cell as a separate entity formed under local law, regardless of whether or not the state law treats such cell as a separate legal entity. The tax treatment of each cell will be determined by check-the-box regulations. So, for example, if a series LLC has two cells, one with two partners and the second one with one partner, the first cell will be treated as a partnership for the federal tax purposes, whereas the second cell will be treated as a disregarded entity.

IRS proposed regulations can be found here: http://www.journalofaccountancy.com/Web/20103328.htm.

How will the proposed regulations affect series LLC as the entity choice going forward?

Once adopted, the regulations will provide much needed guidance and clarity for the tax payers. At the same time, the regulations add additional complexity for LLC series owners since each cell will be required to file its separate tax returns and annual information statements with the IRS. However, it seems that despite this added complexity, the series LLC will remain an attractive option for those business owners who want to form multiple limited liability companies while paying only one filing fee.

Tuesday, September 28, 2010

Small Business Jobs Act of 2010

On September 27, 2010, President Obama signed into effect a new law directed at helping small businesses survive and grow in this economy.  The most useful provisions of the Act, in my opinion, are those directed at making it easier for small businesses to obtain bank financing.  Businesses borrow money when they want to grow, which in turn leads to job creation.  Therefore, lending to small businesses can have a positive impact on lowering the unemployment rate.  In particular, the Act:


- provides $30 billion in cheap capital to community banks for use in making loans to small businesses;
- temporarily raises the government guarantee on certain Small Business Administration’s loans to 90% and waives fees on 7(a) and 504 loans;
- increases the size limits on various SBA loans (for example, a maximum $5 million 7(a) loan instead of a $2 million one); and
- allows temporary refinancing of unfavorable terms on commercial real estate loans through the SBA’s 504 program.


A link to the full text of the Act is below:
http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h5297enr.txt.pdf

However, the Act also has its critics. See yesterday’s article posted by Barbara Weltman (link below). Ms. Weltman makes some valid observations about whether small businesses will actually be able to use all of the resources now available to them. My favorite point made by Ms. Weltman is that the most effective way to help small businesses is by actually listening to their problems (such as high regulatory compliance costs) and then creating regulation directed at solving those precise problems.

http://www.openforum.com/idea-hub/topics/innovation/article/small-business-jobs-act-of-2010-does-little-for-small-business-barbara-weltman



What are corporate formalities and why are they important to observe?

One of the main reasons why a business owner decides to incorporate is to limit his or her own personal liability for business debts. However, simply incorporating is not enough to enjoy protection of limited liability. One also needs to observe corporate formalities. Otherwise, the courts may decide to “pierce the corporate veil” of the business entity and hold the owner liable for the company debts. So, what does a business owner need to do to properly observe corporate formalities?

First, I want to point out that observing corporate formalities is important even for one-person corporations. Second, regardless of what anyone says, even LLC owners need to do it, not just owners of corporations (please keep reading, I’ll discuss LLCs a bit later).

Corporate formalities for corporations consist of the following (this may not be an all inclusive list, but I believe is a good start):

1. Bylaws. Every corporation must have bylaws, a set of internal rules governing how the corporation is run.

2. BOD Meetings. The board of directors of the corporation (needless to say that every corporation must have a board of directors, although these individuals can also serve as officers, subject to some exceptions) has to meet regularly. The secretary of the corporation should record minutes of the meetings, reflecting resolutions and discussions that the directors had at that meeting. The minutes would then need to be adopted by the board at the next meeting and put into a minutes book. All major decisions of the corporation should be adopted in a board resolution pursuant to the procedure set forth in the bylaws (such as mergers, stock issuances, major financial decisions such as loans, dividends, guarantees, hiring of consultants and legal or other experts, transactions with insiders, executive officer compensation, etc.).

3. Shareholders Meetings. Shareholders of the corporation should also have regular meetings (at least annually to elect directors), the secretary of the corporation should take minutes of the meeting and add them to the minutes book.

4. Stock Ledger. There needs to be a stock ledger reflecting the stock ownership of the corporation and the names and addresses of the shareholders.

5. Bank Account. The corporation has to have a separate bank account, and there should be no commingling of personal and business funds.

6. Business Name. All business of the corporation with third parties needs to be conducted in the name of the corporation so that it is clear that the directors and officers are acting on behalf of the corporation and not in their individual capacity.

7. Filings, Taxes. The corporation should file all appropriate federal, state and local tax returns and pay taxes when due, as well as obtain all necessary permits and licenses.

8. Assets. The corporation must have adequate capitalization and maintain proper operating capital.

9. Debt Guarantees. Shareholders should be careful not to personally guarantee and pay the debts of the corporation (at least not on the recurrent basis). Otherwise, the courts may decide that the owners act as alter egos of the corporation and the corporation has lost its separate entity status. Board resolutions should be adopted allowing guarantees for specified purposes only.

LLCs generally require less corporate formalities to preserve limited liability of their members. However, it is still important to do the following:

1. Have an operating agreement that defines member roles, outlines distribution guidelines and specifies operational and taxation rules.

2. Hold regular member meetings (some states like New York require at least annual meetings), adopt resolutions, record minutes, keep a minutes book.

3. Follow guidelines #4-9 above.

Following corporate formalities should become a part of doing business for both corporation and LLC owners. Board, shareholder or member meetings should take place on ongoing basis, and minutes of such meetings should be kept regularly. After all, it may be difficult if not impossible to recreate corporate formalities retroactively if the limited liability protection has been challenged.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, September 24, 2010

NYSE Commission Announces Core Corporate Governance Principles

On Thursday, September 23rd, the New York Stock Exchange-sponsored commission on corporate governance issued a report that contained 10 core corporate governance principles. Even though these principles apply to public companies, private companies should also be aware of them and try to apply them on an ongoing basis. Apart from the principles themselves, the commission noted that:


- the objectives of a board of directors should be directed at long-term growth, and any measures by the management aimed at short-term stock price increases are inconsistent with the corporate governance principles of the company;

- it is not just the board’s responsibility to make sure that the company has sound corporate governance practices, but importantly it is the management’s responsibility to create an environment where these principles are created, respected and fostered;

- a board of directors should be comprised of a mix of independent directors and those who are not independent, so that all points of view can be presented and considered; and

- best corporate governance principles are those that are created by the market itself (ie, other companies), not those that are dictated from above by a rule-making authority.

I am copying below the 10 core principles from the NYSE news release:

• The Board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation;

• Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior;

• Good corporate governance should be integrated with the company’s business strategy and not viewed as simply a compliance obligation;

• Shareholders have a responsibility and long-term economic interest to vote their shares in a reasoned and responsible manner, and should engage in a dialogue with companies thoughtful manner;

• While legislation and agency rule-making are important to establish the basic tenets of corporate governance, corporate governance issues are generally best solved through collaboration and market-based reforms;

• A critical component of good governance is transparency, as well governed companies should ensure that they have appropriate disclosure policies and practices and investors should also be held to appropriate levels of transparency, including disclosure of derivative or other security ownership on a timely basis;

• The Commission supports the NYSE’s listing requirements generally providing for a majority of independent directors, but also believes that companies can have additional non-independent directors so that there is an appropriate range and mix of expertise, diversity and knowledge on the board;

• The Commission recognizes the influence that proxy advisory firms have on the markets, and believes that it is important that such firms be held to appropriate standards of transparency and accountability;

• The SEC should work with exchanges to ease the burden of proxy voting while encouraging greater participation by individual investors in the proxy voting process;

• The SEC and/or the NYSE should periodically assess the impact of major governance reforms to determine if these reforms are achieving their goals, and in light of the many reforms adopted over the last decade the SEC should consider the expanded use of “pilot” programs, including the use of “sunset provisions” to help identify any implementation problems before a program is fully rolled out.

Here is a link to the press release: http://www.nyse.com/press/1285236224629.html

Here is a link to the full commission report: http://www.nyse.com/pdfs/CCGReport.pdf

Tuesday, September 21, 2010

What is a trade dress?

This is not just about any dress. A trade dress is actually a form of a trademark. It protects the “touch and feel” of a product, its total presentation, total experience. Examples inlcude The Hard Rock CafĂ© and the shape of Absolut vodka. The concept of a trade dress is based on distinctiveness and customer recognition and can include unique size, shape, feel, look, design, graphics, color combinations, etc.


The same rules apply to trade dress as to trade marks or service marks. The feature for which you seek protection has to be distinct. Distinctiveness can be either inherent or acquired. Some features can be inherently distinct, on the basis of the feature itself. Fashion designs, for example, are not inherently distinct. The Supreme Court held in Wal-Mart Stores, Inc. v. Samara Brothers, Inc., 120 S.Ct. 1339 (2000) that product designs such as the appearance of a line of children’s clothing are not considered to be inherently distinctive and can only be protected if they acquire distinctiveness through sales or advertising. Accordingly, acquired or secondary distinctiveness comes from the public’s growing association of this image with one particular source. This can be proven by showing the owner’s advertising, promotions and sales.

Another rule relevant to trade dress is that the feature for which you seek protection cannot have a functional purpose. This may be difficult as even the most unique packaging, for example, has a functional purpose of protecting the product. However, the rule remains, - design or feature has to be nonfunctional and be used only to identify the source.

Similarly to other types of trade marks or service marks, infringement of a trade dress happens when there is a likelihood of confusion by customers between similar goods/services and their sources. These are just the “nuts and bolts” of trade dress law. Trade dress protection can get quite complicated, and assistance of an experienced attorney may be required to obtain it.

Thursday, September 16, 2010

Why you should federally register your trademark ASAP?

Trademarks identify and distinguish your products or services from other similar products and services in the marketplace. Trademarks are essential when creating a brand. According to Wikipedia, trademarks were first used in the Roman Empire where the blacksmiths would stamp the swords they made to show the source of origin. Other early uses included Lowenbrau beer (since 1383) and Stella Artois (since 1366). Now, trademarks are used as a marketing tool to build a brand and to allow consumers to rely on and expect certain quality and experience associated with that particular brand.


Trademark is created the moment you start using it. You do not have to register it to have it. However, this so called “common law” trademark protects your goods or services only in the territory of use (not nationally). Also remember, - trademark law is all about who was the first to use that particular mark.

In short, federal registration (registration with the US Patent and Trademark Office) gives you the following advantages:

1. Exclusive nationwide ownership of the mark.

2. Official notice to other potential users that the mark is not available (can put an ® after it).

3. Right to sue in federal courts (where it is more likely to win an infringement lawsuit and get larger damages, including attorney fees).

4. Presumption that the trademark owner is the rightful owner of the mark (although this presumption can be rebutted with proof of prior use by another party).

5. An option for the owner to file an “intent to use” application (instead of traditional actual use). This still gives the owner priority of use provided the owner filed the application before another party used the mark and the owner later puts the mark to actual use.

I believe that, taken together, these benefits outweigh the costs ($275 to $325 if filing electronically and $375 if filing a paper application, plus attorney fees). I know, the costs may seem high, but are they really that high if you compare them to the costs of spending a year developing your brand just to find out later that the name was not available?

Wednesday, September 15, 2010

NY State Provides Tax Benefits for Companies in BioTech, HighTech, CleanTech, GreenTech and certain other industries

Now NY small businesses in certain industries can get significant tax benefits if they qualify and participate in the new Excelsior Program. This is an important step taken by the government in an effort to encourage these businesses to develop and stay in New York State despite the hard economic times. I have personally noticed a lot of enthusiasm around the City with respect to creation of new high-tech or clean energy start-ups, and it seems that the government is backing up these efforts.


In short, the Program is run by the Empire State Development (ESD) and provides tax credits to the qualifying businesses to be used over a five-year term. The Program offers four new fully refundable tax credits:

1. the Excelsior Jobs Tax Credit (a refundable tax credit of up to $5,000 per new job, available to all certified firms);

2. the Excelsior Investment Tax Credit (a refundable credit equal to 2% of the cost of qualified investments, available to all certified firms). Generally, a qualified investment is depreciable property with a useful life of four or more years located in New York and placed in service on or after the date ESD issues an eligibility certificate to the taxpayer;

3. the Excelsior Research and Development Credit (a refundable tax credit equal to 10% of new investments based on the Federal Research and Development Credit, available to all certified firms); and

4. the Excelsior Real Property Tax Credit - this refundable 5 year tax credit is available only to businesses located in designated distressed areas of the state and to businesses in targeted industries that meet higher employment and investment thresholds. The credit is equal to 50% of the property taxes assessed and paid in the year prior to a taxpayer’s application to the Excelsior Program. The credit decreases by 10% each year following thereafter.

The credits are capped at $250 million annually and businesses will be granted the credits only after they have met the annual program requirements. Eligibility is based upon projected long term growth, job creation and expansion in New York.

For more information, click here: http://www.empire.state.ny.us/BusinessPrograms/Data/Excelsior/Excelsior_ProgramOverviewedit.pdf.

Sunday, September 12, 2010

L3C – a Welcome Hybrid for Social Entrepreneurs

Please meet a new business entity form that is quickly attracting attention of businesses with social message, investors and entrepreneurs all around the country. L3C, a low-profit limited liability company, is a hybrid legal entity form that has a flexible structure of an LLC but a well defined purpose of a nonprofit. Five states have already adopted L3C as a legal entity form, and many more states have L3C legislation pending. New York is about to adopt (in my opinion) an L3C act (Senate passed the bill S6726 on June 29, 2010 and it is now in front of the Assembly).


L3C is an exciting business form that is designed to tap into a wealth of tax-exempt funds while still attracting regular capital, all for a social good. At least in theory, L3Cs have the capability of channeling numerous funds into the nonprofit or social enterprise sector and making a difference where our taxes fail to work. But in practice, it is not certain that L3Cs will achieve their objective. Here is why.

Purpose:

An L3C is a regular business and can be profitable. The primary purpose of an L3C cannot be to make a profit, but rather to further a social purpose. In particular, an L3C must significantly further the accomplishment of one or more charitable or educational purposes; it would not be formed except to further such purpose(s); it cannot make the production of income or appreciation of property as its primary purpose; and it cannot be created for any political or legislative purpose.

Taxation:

L3C is not exempt from federal or state tax and contributions to L3C are not tax deductible. L3C can be classified as a “pass through” entity, which means that the entity itself does not pay federal tax, but rather the tax is passed through to its members and is allocated proportionally to their ownership. L3C profits are also subject to taxation.

Good things:

L3Cs are not subject to nonprofit regulation, which can be quite complex. L3Cs are designed to attract funding from both nonprofit and for-profit sectors: program-related investments (PRIs) from private foundations, as well as private investments from individuals and businesses. Private foundations can become part owners or lenders to an L3C. In fact, since L3C has no limitation on ownership, all entities (foundations, trusts, pension funds, for-profit businesses, etc) and individuals can be members of an L3C.

Problems:

Mainly, L3C structure is created to attract PRIs from private foundations, which are seen as a great underutilized source of funding (in 2006 and 2007, less than 1% of all foundation funding was PRI). And here lies the main challenge of L3Cs: foundations are still reluctant to invest PRI money into L3Cs for reasons I explain below.

PRI investments are quite rare and risky because when the foundation is filing its tax returns, IRS can refuse to recognize PRIs if the investment is not made in furtherance of the foundation’s charitable purpose. This can result in high excise taxes, both on the foundation and the foundation’s manager. Foundations can request an advance ruling from the IRS, but such requests may be expensive and time consuming. Additionally, even a qualified PRI may be subject to expenditure excise tax unless the foundation monitors that the L3C uses the funds in furtherance of the charitable purpose. This requires expenditure approval by the foundation and a detailed report by L3C. The foundation may even lose its tax-exempt status if the PRI confers a benefit on a third party (if the terms of the investment are unfavorable).

The foundations’ involvement with the L3Cs is also complicated by the proposed tranche investment scheme. Investments by the foundations would be in a tranche with high risk and low return, so as to attract private capital to be invested in a separate tranche with low risk and high return. A flexible LLC structure allows for uneven distribution of returns, but may create problems for the foundations unless the investment is in line with the foundation’s charitable mission and is therefore a PRI.

The IRS is still silent regarding whether investments into L3Cs by private foundations can automatically be considered PRIs. Until the IRS adopts this position, PRI investments by the foundations remain risky and the most promising funding option for L3Cs remains uncertain. Even if IRS adopts this position, foundations may be discouraged by the amount of policing and monitoring they’ll have to do to ensure that L3Cs use their PRI money in furtherance of the right purpose.

Conclusion:

The idea of having L3Cs is very appealing. The ability of using private capital together with tax-exempt capital for social purposes while still generating profits seems perfect from all angles. However, to make L3Cs a success, L3Cs would need to be carefully regulated and monitored to ensure that their social purpose remains primary at all times and the IRS will need to qualify investments into L3Cs as PRIs.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, September 10, 2010

About Tweets – is it OK to collect them?

I want to share with you an interesting article I found about the legality of use of Tweets for marketing and research purposes. The article suggests that it is legal, given that Tweets are not designated private. However, privacy concerns still exist, and in the future the answer to this question may be different.


I am reprinting the article below:


Harvesting Tweets for Research and Profit - Is it Legal?

Harvesting tweets is on the rise. Researchers and marketers alike are now capturing and downloading Tweets from Twitter's database. Privacy activists argue privacy concerns. Researchers, marketers, and Twitter users all want to know - is Twitter harvesting legal?

How and Why

Every day, users of the Twitter social media publishing platform send out millions of Tweets -- short electronic messages of 140 characters or less -- to their readers and followers.

Most Twitter users are not aware that it's relatively easy for anyone with a skilled programmer to harvest and download their Tweets. All a programmer has to do is to gain access to Twitter's Application Programming Interface (API), and then to write code that requests data from Twitter's servers through the API. The code contains search criteria, usually in the form of key words and phrases of interest.

One prime example of why Tweets are harvested is the harvesting of Tweets by news organizations Tweets during the riots that followed the Iranian presidential election of 2009. The results provided an excellent source of real time information from a closed society as events unfolded, and afterwards, a fascinating historical record of how the protesters worked together under difficult conditions.

Advertisers have also joined the Tweet harvesting process. For example, suppose you're going to lunch in an urban office setting, and you tweet a collection of co-workers suggesting a specific restaurant. A savvy marketer harvests your Tweet, and then emails to your smart phone a coupon for a hefty discount at another restaurant nearby. Pretty nifty for the savvy marketer, and perhaps a welcome suggestion for a discounted lunch, but is it legal?

The Electronic Communications Privacy Act

In 1968, the Wiretap Act was passed to impose rules for obtaining wiretap orders. In 1986, the Wiretap Act was amended by The Electronic Communications Privacy Act to extend coverage of the Wiretap Act to electronic communications.

Generally, the Wiretap Act as amended prohibits the intentional interception, use, or disclosure of wire and electronic communications, unless a statutory exception applies. This means that all persons (including governments) are prohibited from wiretapping phones and intercepting electronic communications over the Web, unless a statutory exception (safe harbor) applies.

How does this apply to Tweets? A specific statutory exception applies to electronic communications that are publicly accessible. This is the exact language of the statutory exception: "It shall not be unlawful... for any person... to intercept or access an electronic communication made through an electronic communication system that is configured so that such electronic communication is readily accessible to the general public".

Readily accessible to the general public is defined by the statute as follows: "... with respect to a radio communication, that such communication is not... scrambled or encrypted".

It would appear that any Tweet that is not designated by the Twitter user as "private" would clearly fall within the statutory exception because the Tweet is not scrambled or encrypted. So, Tweet harvesters appear to have a strong argument that they're protected by the publicly accessible safe harbor.

The Google Litigation

Google is now involved in litigation involving its collection of WiFi data. It seems that Google's Street View cars have engaged in the now-ended practice of collecting bits of private wireless data while cruising neighborhoods for data used in its Google Maps online service.

Although Google ceased this type of electronic data collection and stated that it was not intentional, a class action suit has been filed against Google.

Conclusion

The harvesting of Tweets that are not designated as private would appear to be protected by the publicly accessible safe harbor.

It's interesting that Google's collection of WiFi data is very similar to Tweet harvesting. It would seem that publicly accessible safe harbor would also protect Google in this litigation, but we'll have to wait and see how this case is resolved.

Copyright © 2010 Chip Cooper

This article is provided for educational and informative purposes only. This information does not constitute legal advice, and should not be construed as such.

Leading Internet, IP and software lawyer Chip Cooper has automated the process of drafting Website Legal Forms. Use his free online tool - Website Documents Determinator -- to determine which documents your website really needs for FTC website forms and website legal compliance. Discover how quick, easy, and cost-effective it is to draft your website contracts at http://www.digicontracts.com/.