If you operate a business, someday you will find yourself in a dispute, or even embroiled in litigation. Whether you receive a complaint from a disgruntled former employee or you find yourself looking for the best way to recover money that your business is owed, you need another player on your team.

“Many business people believe that the litigator, unlike the transactional adviser, is a lawyer to be avoided until the last possible minute, in order to save money,” says Anne Owings Ford, a member with McDonald Hopkins LLC. “My experience tells me that a different model is better.”

Smart Business spoke with Ford about how litigation attorneys can support business owners and improve the business’s bottom line.

Doesn’t a litigator deal with cases that are going to court, to arbitration or to mediation — in other words, disputes that already exist? Why should I talk with a litigator in the absence of a dispute?

Certainly, an experienced litigator should be familiar with and very comfortable in all of those arenas. But a broader view of the role of a litigator is most beneficial to the business owner, both in terms of peace of mind and cost savings.

For example, several years ago, I had a business client that was keeping me busy defending it in small controversies across the country arising out of its form sales contracts. I handled dozens of these matters, some just at the letter-writing stage, and others in full-blown litigation. My client contact called me one day and said, ‘We’d like you to look at this contract and see what we need to do to improve it, so that we can avoid these issues, rather than having to keep fighting them.’

I spent a few hours reviewing and reworking the contract, with an eye toward the provisions that had generated the most claims. I consulted with a transactional colleague to get her view of the contract.  Then I returned the revised contract to my client, and they began using it right away.  The claims dried up and I turned to other matters.

That was a powerful lesson: Consider whether you can save major attorney fees by spending a few dollars up front to identify problems before they end up in court.

Are there other reasons to talk to my litigation attorney outside the courtroom?

Your litigation attorney can help you deal with some of the least pleasant aspects of your business life.  Consider the following:

* If your business receives a claim letter, your litigation attorney can help gather information, plan a response strategy, interview employees, run interference with your board and communicate with your insurer.

* If your business needs to advance a claim against a competitor, supplier or customer, your litigation attorney can help you frame the claim properly, to take into account not only the value of the claim but also the nature of the relationship and other competing factors. Your litigation attorney also can work with you on the proper approach, from a strongly worded letter on law firm letterhead to a complaint filed in federal court. Different disputes call for different approaches to resolve them.

* If your business is experiencing a high volume of a particular kind of claims, your litigation attorney can help you investigate whether there is a way to change your process to limit future claims.

* If you are experiencing pushback from within your organization regarding a dispute you feel needs to be addressed, your litigation attorney can help air the issues and offer constructive advice to get all players on the same page.

What should I expect from my litigator, in or out of a lawsuit?

You should have high, although realistic, expectations of your litigation attorney. You should expect not only prompt responses to your questions but also periodic updates, even if it’s only a quick email to let you know that the court has not yet issued a ruling. Your litigator knows that you have people looking to you for answers; it is the litigator’s job to provide them.

You should expect your litigator to be available to you when you need help. The kinds of issues that litigators address don’t always arise at convenient times. (Think an explosion at a plant or a confrontation in the office.)  Litigators work hard to be readily available and you should expect to be able to reach them.

You should also expect your litigation attorney to explain to you — and to help you explain to your managers, your board and your insurer — your company’s options, as well as the litigation and dispute resolution process.  The landscape can change quickly when you’re dealing with a litigation issue, and you should expect to be able to ask questions whenever you have them.

Finally, you should expect your litigation attorney to care, not just about a single crisis but about your business and its issues. Your litigator needs to know what’s going on in your world, because he or she can’t know whether one issue is related to another without knowing what they are.

Why can’t the attorney who provides my transactional advice do these things for me?

Your relationship with that attorney is an important part of your business, and no litigator is looking to  interfere with it. That said, the litigator’s focus is different. Your business adviser is looking at the big picture, working to help you maximize your bottom-line profit and minimize costs of doing business. On the other hand, your litigation attorney can help you evaluate whether a specific issue is likely to blow up into multiple, high-dollar-value claims, or if the right approach may help snuff it out.

Litigators are geared toward identifying claims and lawsuits, so that if you talk with that attorney sooner rather than later, you may be able to advance a proper claim in a cost-effective manner, or address a bogus claim with a minimum of fuss. Ultimately, good litigators want to help you address claims — yours or anybody else’s — efficiently.  If you call them, they can do exactly that.

Anne Owings Ford is a member with McDonald Hopkins LLC. Reach her at aoford@mcdonaldhopkins.com or (216) 430-2001.

Insights Legal Affairs is brought to you by McDonald Hopkins LLC.

Published in Cleveland

One of the more interesting times of the year to be an executive compensation attorney -— proxy season -— is about to begin. That is when publicly traded companies issue their annual proxies containing a substantial amount of information regarding how they compensate their executives.

“This information not only contains a comprehensive analysis of the issues and factors that are taken into consideration in designing and implementing the compensation strategy, it contains detailed descriptions of the amounts paid to such executives,” says John M. Wirtshafter, a member with McDonald Hopkins. “In addition to simply being interesting reading, private companies can learn a lot from how public companies compensate their key employees.”

Smart Business spoke with Wirtshafter and Michael G. Riley with McDonald Hopkins about four lessons private companies can learn from public companies about executive compensation.

1. You don’t need to go it alone. Typically, public companies use independent compensation committees and outside consultants and attorneys to design, implement and administer the compensation programs for executives of the company. We are not suggesting that private companies should all create compensation committees on their board of directors or independent groups to review and set their compensation. However, most private companies could benefit from impartial advice and counsel. It is easy to lose perspective when you are so closely involved. It makes sense to periodically step back and make sure that your compensation programs are appropriate and strategic. After all, we can all use a sounding board from time to time.

2. Know where you stand. Publicly traded companies have access to all sorts of public information about the compensation paid to executives of their competitors. So do their investors and executives. They rely on this information to ensure they are paying a market rate of compensation and in order to attract, motivate and retain their executives. The same information is equally important to privately held companies. While the information available from proxies may not be all that applicable for most smaller and middle market privately held companies, there are a number of resources that could provide helpful information. If nothing else, it is important that you understand how your total compensation packages compare to others. Otherwise, your best executives may have better opportunities elsewhere and take them.

3. Get on the ‘pay for performance’ bandwagon. Perhaps the most-used terminology in executive compensation in the publicly traded world is ‘pay for performance.’ It has been the mantra of compensation specialists for years. Shareholders of public companies demand that the compensation strategies for executives align the executive’s interests with their interests. This is usually best accomplished by a combination of short-term and long-term bonus and incentive plans that are tied to the actual economic performance of the company. For executives to really succeed in such programs, they need to build long-term shareholder value. For instance, practically every Fortune 500 company awards substantial amounts of stock options and/or restricted stock to their executives. As the value of the benefit is directly tied to the performance of the company’s stock, this closely aligns the executives’ interests with the shareholders’ interests. Many privately held companies also share stock options and restricted stock with their executives. Companies that are unwilling to use actual stock can provide a similar benefit through phantom stock or other long-term strategies that are based upon the net worth of the company. For limited liability companies or partnerships that do not have stock, there are other methods, such as profits interests, limited partnership interests and restricted units that can potentially be used to accomplish a similar incentive. Each method has its own distinct tax, accounting and cash-flow issues. Furthermore, as there is not a market for the stock, these programs must be designed so that the tax and cash obligations of the company and the executive are considered. It is important to fully understand your objectives and alternatives before settling on a strategy. This is clearly a case where one size does not fit all.

4. Ensure your compensation programs align risk with the reward. Perhaps the most recent concern relating to pay for performance in executive compensation is to ensure that the compensation programs are designed, both qualitatively and quantitatively, to align pay with actual performance of the company. Investors often object when large compensation payments go to executives when the company’s stock is failing. It is also critical that pay plans not encourage executives to expose the company to unacceptable risks in the pursuit of performance targets.

One way publicly traded companies protect themselves from this risk is through the use of ‘claw-backs.’ Claw-backs are where the company is entitled to a refund of the bonus or stock gains received by an executive if the company’s financial statements upon which the bonus or profits were based are later restated or if the executive breaches an employment agreement covenant or a company policy. These provisions penalize bad behavior, ensure that the executive does not receive an undeserved windfall, and protect the company from unnecessary risk.

Other ways to address these concerns include using performance-based metrics for vesting rather than simply basing vesting on the passage of time; requiring severance or certain payments to be approved by the board of directors; ensuring bonus criteria are strategic; and implementing programs based, in part, on the company’s performance relative to the performance of its competitors. These same issues are important for privately held companies.

John M. Wirtshafter and Michael G. Riley are members with McDonald Hopkins LLC. Reach Riley at (216) 348-5454 or mriley@mcdonaldhopkins.com. Reach Wirtshafter at (216) 348-5833 or jwirtshafter@mcdonaldhopkins.com.

Published in Cleveland

If you serve on the board of a non-profit organization, you may be familiar with this scenario: revenue is down, donations are smaller and more tightly restricted, government assistance has become all but non-existent, and costs have continued to rise. While the near panic of 2008 and early 2009 is in the rear view mirror, the economy is far from fully recovered, and non-profit organizations are no better off than their for-profit brethren.

Shawn Riley and Sean Malloy of McDonald Hopkins’ Business Restructuring Services Department sat down with Smart Business to talk about what a troubled non-profit organization can do to help face the challenges posed in these troubled times.

Why are so many non-profit organizations struggling?

Riley: A number of reasons. Non-profits face many of the same business challenges as for-profit companies. Money is tight everywhere, so growing top line revenue or even keeping it steady can be difficult. Many non-profits also rely on charitable donations for a large portion of their revenue. While there are different estimates about the overall level of charitable giving, most data show that it dropped in 2008 and 2009, and recovery in that sector, like the economy generally, has been slow.

What should the board of a distressed non-profit be doing to face challenges?

Malloy: The minute a board starts to see financial trouble on the horizon, it has to take active steps toward solving the problem. It is easy for non-profit boards to let inertia take over instead of actively managing. The leaders of a nonprofit are usually on the board out of a desire to give back to a community or a goal, but it is important to think about it as a business, especially when signs of trouble begin to appear. The board needs to make sure there is solid financial reporting and metrics by which to measure success. Most importantly, the board’s members need to admit they have a problem and not put off dealing with financial distress until the next quarterly meeting or when it turns into a true crisis.

Riley: It is also critically important for a board to understand where its duties lie. In a for-profit company, fiduciary duties are owed to shareholders. This is not the case for a non-profit. The board of a non-profit owes its primary duty to the entity’s mission. So the first thing the board should do is make sure that it is aware of the mission — it can then evaluate the ‘going forward’ strategy in that context. Sometimes a real focus on the mission has been lost as the entity has struggled. Looking deeply at the mission and how best to continue to accomplish it can help a board reorder priorities and make key decisions.

Once these priorities are evaluated, how should the non-profit execute on its goals?

Malloy: Our best and first advice is usually to get experienced help from a financial professional. Non-profit boards are made up of smart, accomplished and caring people. But the reality is that they were probably chosen for the board based on connections in the community, experience or interest in the industry and fundraising ability. While that is great in good times, it does not  provide the expertise  necessary  to deal with a financial crisis.

Riley: In many ways, once the priorities and goals are set, restructuring a non-profit is similar to doing the same thing for a for-profit company. We often recommend hiring a financial adviser with turnaround experience. They can usually suggest ways to cut costs and  grow  revenue  in ways that  are  not obvious  to the current  management  and board.

What if things get really bad? Is bankruptcy an option for non-profits?

Riley: Yes, it is. Having said that, bankruptcy is an expensive process and we try to help our clients restructure their finances without filing a bankruptcy case. Banks and other creditor groups have become more and more sophisticated and can be willing to work with companies to provide relief and avoid bankruptcy. The good news for non-profits is that there is a section of the U.S. Bankruptcy Code which provides that creditors cannot force a non-profit into involuntary bankruptcy. So a bankruptcy case is usually only filed when the board makes an informed decision that the protection of the Bankruptcy Code is the best structure under which to restructure the organization.

Malloy: There are some situations when bankruptcy is the best option for a non-profit. One example might be a non-profit hospital where revenue is not matching operating costs and pre-bankruptcy attempts to turn around operations have not been able to close the gap. In a case like that, filing a bankruptcy can stop creditor collection efforts and give the hospital the cash flow needed to ensure that patient care is maintained at a high level while negotiations with creditors occur. Every factual situation is different.

Are there other unique aspects of non-profit restructuring?

Malloy: One unique issue is donated funds. The board and management should be careful to continue to manage donated funds appropriately, even in an insolvency situation. Donations that are made for a restricted, specific purpose cannot be used for general operating expenses or turned over to the non-profit’s creditors.

Riley: Despite the unique issues for troubled non-profit organizations, the board needs to remember that creditors who are owed money will assert their rights. They will not just go away because the organization has a non-profit mission rather than an economic goal. As a result, the board should make sure there is current and sufficient directors and officers insurance in place. And as we said before, the most important thing is to be active — and not wait too long when trouble starts to brew.

Shawn Riley and Sean Malloy are members of the Business Restructuring Services Department of McDonald Hopkins LLC. Reach

Riley at (216) 348-5773 or sriley@mcdonaldhopkins.com. Reach Malloy at (216) 348-5436 or smalloy@mcdonaldhopkins.com.

Published in Cleveland

Interest rates are at historic lows. Market values of many assets are lower than they were a few years ago. This juxtaposition creates potentially significant wealth transfer opportunities.

“The interest rates for loans to family members and related party transactions are lower than they have been in several decades,” says Brian J. Jereb, a member with McDonald Hopkins LLC. “These rates set the valuation rate used to determine the value of property transferred in certain types of gift strategies.”

In the valuation process, this is the assumed rate for valuing the taxable gift component. This rate is often referred to as the “hurdle-rate” in terms of the rate of return required for the strategy to perform as well as the valuation projection for tax purposes.

“While relative investment rates of return are low, the assumed rate is fixed at the time of the transfer, so when rates of return increase to more normal levels and market values increase as a result, the chance for success of these strategies should be greater than under normal circumstances,” Jereb says.

This juxtaposition also occurs at a time when the lifetime gift tax exemption is at an all time high of $5 million, which allows for larger taxable gifts while still having enough left to cover estate taxes or gift tax.

There are recent rumors that the so-called “Super Committee” could include in its plan a decrease in the gift tax exemption from $5 million to $1 million. “These rumors appear to be based on sheer speculation by various commentators about what the Super Committee may include in its plan if its members are ever able to reach an agreement,” Jereb adds. “By the time this article is published, we may have some indication concerning the possible future of the gift exemption should the committee agree to a plan.”

Smart Business asked Jereb how business professionals can take advantage of these opportunities now, as pending tax reform discussions loom on the horizon.

What is the simplest approach to capture this ‘double-barreled’ opportunity?

The simplest approach is a low interest loan to a family member. The borrower is not burdened by high interest charges and could use the loaned money for his or her desired purposes. If the lender dies, the loan is an asset, but will not disappear. If the borrower is a beneficiary of the lender’s estate plan, the loan balance can be distributed to the borrower or be offset against the inheritance.

What about trusts?

The Installment Sale to a Grantor Trust, sometimes referred to as an ‘Intentionally Defective Grantor Trust,’ or ‘IDGT,’ allows a senior generation member to sell an asset to a trust for the benefit of family members. An IDGT is designed so that the assets therein are treated as being owned by the trust’s creator for income tax purposes under the applicable federal income tax laws. While the assets are treated as owned by the trust’s creator for federal income tax purposes, they are owned by the IDGT and not the creator for federal estate tax purposes. The creator can sell assets to the IDGT without generating income tax; assets sold to the IDGT and appreciation are excluded from the creator’s taxable estate for estate tax purposes.

The IDGT generally benefits the creator’s family members. When the creator sells assets to the IDGT, the trust pays most of the purchase price with a promissory note at the current low interest rates. Because the creator and the IDGT are treated as the same taxpayer for federal income tax purposes, the interest paid on the note is not taxable to the trust’s creator. However, because the creator is deemed to own the assets in the IDGT for income tax purposes, he or she continues to be taxed on the ordinary income and capital gains realized by the IDGT’s assets. The payment of the income tax allows the assets in the IDGT to appreciate without reduction for income tax, and the payment of income tax is not a gift to the beneficiaries because the trust’s creator is merely paying his or her legal income tax liability.

With the low current market valuations, it is more likely than normal that the assets sold to the IDGT will increase in value from their depressed current values, and the current low interest rates make such a sale an efficient planning technique.

Another strategy is the Grantor Retained Annuity Trust (GRAT). Here, the senior generation contributes property to a trust in return for an annuity payment during the term of the trust. The term and the annuity rate determine the amount of the gift to the trust’s remainder beneficiaries. There are two limitations: (1) if the creator of the trust dies during the term, some or all of the trust assets will be part of the creator’s taxable estate and (2) the property transferred could be used up by the annuity payments, leaving no value for the remainder beneficiaries.

How can family-owned businesses benefit?

In the family business context, the low market valuations and the large gift tax exemption make it a good time to recapitalize C corporations with preferred and common shares and in the process make significant gifts to family members. Both C corporations and S corporations can be recapitalized into voting and non-voting shares. The non-voting shares can then be sold to family members or to an IDGT via a low interest rate note back to the senior generation. The current low tax and interest rates also currently provide an ideal opportunity for the business to borrow money to either pay a dividend or redeem shares owned by the senior generation.

How can charitable giving best be structured?

A related strategy with a charitable advantage is a Charitable Lead Annuity Trust (CLAT). In this strategy, the trust pays an annuity to selected charities over a term of years. At the end of the term, if the investment rate of return exceeds the valuation rate, the remainder that is available to the family beneficiaries will be greater than the amount projected using the IRS valuation rate. A CLAT is often used as a vehicle to fund ongoing annual gifts or to establish and fund an endowment gift through the annuity payments.

BRIAN J. JEREB is a member with McDonald Hopkins LLC. Reach him at (216) 348-5810 or bjereb@mcdonaldhopkins.com.

Published in Cleveland

If your company exports products or provides certain services abroad, you may be able to achieve significant tax savings by establishing an Interest Charge Domestic International Sales Corporation (IC-DISC).

“Despite the name, this tax saving technique is fairly straightforward,” says Mark D. Klimek, chair of the Tax Practice Group at McDonald Hopkins. “It is not aggressive from a tax standpoint or overly complicated from a legal or accounting standpoint. In fact, it’s not very complicated at all. An IC-DISC can be set up for a relatively low cost, which can easily be recovered in the first year of tax savings alone.”

Determining whether an IC-DISC makes sense for your company is as simple as looking at your export sales and profits on them and then comparing the tax savings versus the set-up costs. As for companies that already have an IC-DISC in place, Klimek says there are probably opportunities to achieve even greater tax savings.

Smart Business asked Klimek for more details on this tax saving opportunity.

How is an IC-DISC structured?

An IC-DISC is simply a separate corporation that is formed by the owners of an existing company (the ‘manufacturer’). The new corporation’s shareholders, which can be individuals or other types of business entities, make an election to treat the corporation as an IC-DISC. The IC-DISC is paid a commission on foreign sales by the manufacturer, and the manufacturer can take a deduction for the commission payment. This deduction normally generates a tax benefit of 35 percent to the manufacturer. The IC-DISC itself is a tax exempt entity; tax is paid only by the IC-DISC shareholders on dividends received from the IC-DISC. Currently, these dividends are taxed at the favorable 15 percent rate. Therefore, the tax savings occur because the commission arrangement between the IC-DISC and the manufacturer provides a corporate deduction (usually worth 35 percent) in exchange for the tax cost of a dividend to the IC-DISC shareholders (taxed at only 15 percent), generating a net tax benefit of 20 percent on the allowable commissions paid.

Is the commission limited?

Yes, the commission is limited under the IRS rules to a maximum of the greater of 4 percent of total export sales or 50 percent of profits from export sales. However, this is a very basic analysis and is really the minimum commission. A consultant can study a company’s product lines and gross sales figures and come up with very sophisticated ways to maximize the commission.

What are some of the requirements that must be met in order to qualify as an IC-DISC?

The company has to be a C corporation and can only have one class of stock. There must be an initial capitalization of at least $2,500. There is an election form to be signed by all shareholders and filed with the IRS. The IC-DISC should follow the normal corporate requirements of any other corporation There needs to be a commission agreement between the manufacturer and the IC-DISC.  This commission agreement is normally flexible in terms of stating how the commission is to be calculated.

Please provide some estimates of the potential tax savings.

The tax savings depend on the profitability of the company’s export sales. A company taking the 4 percent commission on $5 million in gross export sales would save at least $40,000 of federal income taxes, assuming the tax rates are as discussed earlier. If the same company had $5 million in gross export sales and $1 million in profits and was able to deduct the 50 percent commission, the tax savings would be at least $100,000. Again, these savings are minimums; various techniques exist for increasing the effective commission by, for instance, applying the commission limitation to different product lines.

What types of related planning opportunities are associated with this technique?

You can use the IC-DISC to provide shares to family members or to employees. If it’s a family business, you can give family members shares in the IC-DISC, which will provide them with income every year, but not ownership rights in the primary business. If you’re transitioning a business to the next generation by selling shares to that generation, perhaps you’re wondering how your children will get the money to pay you for the business. You can pay them a higher salary to generate this cash, and the company can take a 35 percent deduction on that payment, but the children have to pay tax on this income at ordinary income rates so there is not much tax efficiency. If you or the children own shares in an IC-DISC, the company still gets to take the 35 percent deduction for the commission, but now your children only have to pay tax on the dividends at 15 percent (versus having to pay the ordinary income rates). You can also use an IC-DISC to provide an equity type of incentive to employees, which can serve as a motivation tool to improve productivity and increase export sales.

Does a company have to be making a certain level of sales for the IC-DISC to make sense?

Again, this depends on a company’s profitability. A company doing $1 million in export sales could save at least $8,000 per year under the 4 percent commission scenario. However, if this same company has $200,000 in profits, the tax savings would be $20,000 — still making the IC-DISC an attractive option. Anything less than $100,000 in profits on $1 million in sales would require a closer look at some of the commission-maximizing strategies to see if the IC-DISC makes sense.

MARK D. KLIMEK is chair of McDonald Hopkins’ Tax Practice Group and is a member of the firm’s mergers and acquisitions practice group. Reach him at (216) 348-5453 or mklimek@mcdonaldhopkins.com.

Published in Cleveland

The America Invents Act, passed on Sept. 16, 2011, will significantly impact the way companies do business in the United States, says David Cupar, member, McDonald Hopkins LLC.

“The act helps standardize U.S. rules with those that the rest of the world adheres to regarding patents,” says Cupar. “It will create consistency both for U.S. companies doing business internationally and for international companies and individuals seeking to do business in the U.S.”

Smart Business spoke with Cupar about how the rules have changed and what that means for U.S. companies protecting their technologies through patents.

How will the act change the way rightful patent owners are determined?

The act addresses one of the biggest discrepancies between U.S. patent law and that in other industrialized countries. The U.S. has always had a first-to-invent system: if you invent first, then you would be entitled to patent protection even if someone who invents second files a patent application before you. This is different from the law in the rest of the world where the first to file a patent application becomes the rightful patent owner.

The new act changes the U.S. rules from a first-to-invent to a first-to-file system like the rest of the world. From a business perspective, this will help remove unwanted inconsistency. For example, in the past, if a Dutch company invented second but first filed a patent application in Europe and in the U.S., a U.S. company that invented first could argue that it is entitled to the U.S. patent. That puts the Dutch company in the anomalous position of owning the patent right in Europe but not in the U.S. based on the different rule.

How will this change the way U.S. businesses operate?

Companies will need to become more dedicated to filing patent applications as quickly as possible to minimize the chance of a competitor filing first on a similar invention.

Determining who invented something first is time-consuming and costly. The first-to-file system has a date of application and a government document, so there is no ambiguity.

Does this system give an advantage to bigger companies?

Inventors argue that the first-to-file system gives big companies an advantage because they understand the patent system and how to protect their inventions. However, patents are so prevalent in business, it is almost impossible to imagine why individuals and smaller companies would be at a disadvantage.

How will patent infringement disputes change?

The act will change patent litigation strategies significantly. If a party is concerned it might be accused of infringing, it will have more tools to oppose an issued patent outside of the classic federal district court litigation model. In the past, if you believed that my product infringed your patent, you would sue me, and I would assert a defense and counterclaim of invalidity against your patent in federal court. The downside of this approach is the length of time, cost and uncertainty in the process. For example, it can cost $2 million to $3 million to defend yourself in federal court.

To help reduce litigation costs and timing, the act introduces a post-grant review and inter partes review of patents. With a post-grant review, a party can file a petition with the U.S. Patent and Trademark Office to reopen the patent to determine whether the subject matter is patentable. If the USPTO determines it is not, or requires the patent owner to narrow the patent scope, the accused infringer can obtain favorable dispute resolution in this manner. Also, nine months after the patent is issued, an accused infringer can request an inter partes review, challenging whether the patent should have been granted in the first place. Thus, inter partes and post-grant reviews will provide a mechanism for accused infringers to have claims heard regarding the validity of a patent without being involved in full-blown federal district court litigation.

Another advantage in seeking a post-grant review or inter partes review of the patent is that you can request the district court in which you were sued to stay that suit until the USPTO review is completed. If you have a strong basis to seek invalidation of the patent and you prevail, the lawsuit goes away, and that $2 million price might only be $200,000.

How will the act change (1) joinder and (2) false patent marking claims?

Previously, ‘patent trolls’ — nonpracticing entities that own patents — could sue a number of companies, or an entire industry, for infringement in one lawsuit. The act makes the joinder of multiple defendants in a patent suit more difficult. Under the new act, a patent owner can join two or more parties to accuse them of infringement in the same suit only if those defendants are involved in the same transaction. This new rule will stop the practice of the patent trolls suing a number of companies in a related industry in one suit because those companies typically are not involved in the same transaction (e.g., GM and Ford sell different cars in different transactions). Now, patent trolls must sue each company individually in separate lawsuits, making it more difficult to sue an entire industry.

The act also changes the way parties may litigate false patent marking claims. The prior false patent marking statute prohibited parties from falsely marking products with expired patents or patents that did not cover that product with the intent to deceive the public. The problem with the statute was that anyone could sue anyone else. People would set up LLCs for the sole purpose of filing false patent marking suits against large companies to force them to settle out of court for substantial amounts of money. These LLCs did not suffer any competitive injury but still sued under the statute to earn settlement money.

Under the new rules, only the government or a party who has suffered a competitive injury may sue for false marking. Moreover, expired patents marked on products no longer constitute false marking.

David Cupar is a member and co-chair, Intellectual Property practice with McDonald Hopkins LLC. Reach him at (216) 430-2036 or dcupar@mcdonaldhopkins.com.

Published in Cleveland
Wednesday, 05 October 2011 17:13

Check your multistate tax liabilities

Governments are looking to find new sources of revenue to hold their heads above water during troubling economic times or just to generate more income, and they are becoming more active in tracking down multistate and even multilocal tax liabilities.

“The states are becoming more and more active in making certain that the taxes they can charge are indeed charging,” says Chuck Zellmer, attorney for McDonald Hopkins LLC.

“They are becoming very active assessing and collecting taxes, contacting clients on a regular basis. I think what you'll see is even going down to the municipalities because some of them have different tax rates, they’re collecting the tax or not, and businesses just don’t think that way right now. Businesses are cognizant that they've got to collect sales taxes but not necessarily on a multistate level.

“Then you have the whole issue of are my people in the state regularly enough that I not only have to pay taxes for the sales in the state, but do I have to pay income taxes, do I have a franchise tax, and all the other taxes that go with having an employee in the state,” Zellmer says.

In the past, businesses have conducted themselves by having independent contractors in other states instead of employees. However, the government is looking at that very hard. Zellmer recommends conferring with your attorney since even some of the more sophisticated clients ? because they think they have sophisticated independent contractor agreements ? aren’t necessarily going to meet the standards the government is pushing these days.

“The independent contractor question is one that is going to be on the front burner for a while until the government settles some questions ? the trend seems to be pushing toward making it the exception when there is an independent contractor relationship,” he says.

Chuck Zellmer is manager of the Business Law Department for McDonald Hopkins LLC. Based in Cleveland, he focuses his practice on business counseling, real estate and succession planning for business clients in a variety of industries on personnel, contract and other issues encountered in daily operations, transactions and strategic planning.

Published in Cleveland

It was announced recently that the Utica Shale formation in Ohio is not only a source of natural gas, but oil as well. New technological advancements — especially in horizontal drilling techniques and the hydraulic fracturing of the shale (“fracking”) — along with the fact that the oil appears to be of high quality, is bringing drilling to Ohio a lot faster than originally thought.

“Drilling has been taking place in the Marcellus Shale in Pennsylvania and West Virginia for a while now,” says Jeffrey R. Huntsberger, a member of the Business Department and the Real Estate Practice Group at McDonald Hopkins LLC. “Geologists knew there was natural gas in Ohio’s Marcellus formations, but figured Ohio wouldn’t be as rich a source as Pennsylvania. All of that has changed now with the discoveries in the deeper Utica Shale formation. For example, the CEO of Chesapeake Energy Corp. recently said that his company expects to invest $10 billion per year in Ohio for the next couple of decades.”

Smart Business asked Huntsberger what Utica Shale drilling means for Ohio.

Why does the Utica Shale hold so much promise for Ohio?

The Utica Shale formation appears to hold significant amounts of ‘wet’ gas and oil. The wet gas has elements in it that are sought after by gas companies, including propane, ethane, butane, and other large molecule hydrocarbons and, in addition, there’s oil, which appears to be of high quality.  Companies like Chesapeake Energy and others are excited about the wet gas and oil in Ohio.

How will drilling impact Ohio businesses?

Drilling in the Utica Shale is a game changing industrial event taking place right in our own back yard. Drilling is already taking place in southeastern and mideastern Ohio counties and promises to spread northward through the entire eastern part of Ohio. Manufacturers of tubular steel, pumps, valves, and fittings are already seeing substantial demand for their products as a result of drilling. If everything works out, we’ll have a cheap source of energy on our doorstep, which will give us an advantage in manufacturing. In addition, the byproducts of oil can be used for hundreds of industrial applications, and having a source of those byproducts right here in Ohio will be beneficial for a variety of industries. In the long-term, the drilling should stir growth.

What are the potential environmental impacts?

The major issue is water. Rural areas rely on well water (drawn from about 50 to 250 ft. deep). The shale layers are found at 5,000 feet and deeper below the surface but, in order to get there, the wells must be drilled through the water table. If the well is not drilled and cased properly, there’s a good chance that someone’s well water will be contaminated.

Fracking itself requires up to three million gallons of water per well. The crew has to drill down vertically several thousand feet and then sideways for as much as a mile.  The fracking fluid, which is then inserted into the well and forced into the shale layers, is 98 percent water and sand with the remaining two percent made up of ‘nasty stuff’ — chemicals intended to help ease the hydrocarbons out of the shale. Huge pressure is created to break the shale, release the gas, and bring it back up. What comes up is contaminated with the chemicals as well as other environmentally damaging materials from the ground, such as heavy metals, which must be dealt with properly.

What kind of regulatory oversight is in place?

Almost all regulation in Ohio is through the Ohio Department of Natural Resources (ODNR). A number of years ago, the legislature took away the rights of local communities to regulate drilling. A new law (Senate Bill 165), enacted about a year ago, adds to the ODNR’s power to regulate the industry. Included in the many new provisions are restrictions on how close companies can drill to occupied dwellings and property lines; increased liability insurance required for drillers; tighter construction standards; and the requirement that fracking must not be done in a manner that creates any danger to the water or the environment.

At the federal level, the U.S. EPA is looking into the fracking process and studying the potential impact on the environment. The EPA expects that it will be well into 2012 before any preliminary comments are made, and then another two years for any regulations to be put in place.  As a side note, as of September 30th, Ohio House Bill 133 authorized drilling in Ohio’s state parks.

How can landowners maximize their benefits if approached about leasing rights?

Some of the simple things you can negotiate with the companies leasing your land include the size and timing of the bonus payment; the amount of the royalty (the standard is usually around 12.5 percent of what gets produced from the well; however, this can often be negotiated to 15 or 18 percent, or even higher); and the time period for the company to hold the lease until drilling takes place. More complex negotiations involve placing restrictions on unitization (the right of the lessee to combine your property with that of other land owner lessors); prohibiting the storage of gas or the permanent disposal of toxic liquids on the property; obtaining mutual agreement on the placement of roads, wells and pipelines; and having the ground water tested before and after drilling.

Educate yourself through easily accessible materials such as those found on the Ohio Department of Natural Resources’ website. Hire an attorney who really knows this area. Don’t be quick to sign a standard lease presented to you, because these companies will negotiate.

JEFFREY R. HUNTSBERGER is a member of the Business Department and Real Estate Practice Group at McDonald Hopkins LLC. He focuses on real estate, business counseling and energy. Reach him at (216) 348-5405 or jhuntsberger@mcdonaldhopkins.com.

Published in Cleveland
Wednesday, 31 August 2011 20:01

How to select, protect and enforce trademarks

Trademarks help consumers identify and distinguish your products and services in the marketplace. If you don’t protect your trademarks, your rights can be weakened, which may allow for competitive products/services using similar markings, ultimately diminishing the value of your trademarks.

“If you’re a new business or are launching a new product — especially one that’s innovative — it’s important to choose your trademarks wisely,” says Jim Dimitrijevs, a member at McDonald Hopkins LLC, whose practice focuses on Intellectual Property.

“It’s important to consider the inherent strength of a proposed trademark,” adds Grant Monachino, also a member specializing in Intellectual Property at McDonald Hopkins LLC. “It’s equally important that you enforce your trademark rights as the years go by, or you risk losing them.”

Smart Business asked Dimitrijevs and Monachino how companies can best select and protect trademarks.

How does a company go about selecting a trademark?

First you need to consider the product or service itself, as well as its life expectancy. If it’s going to be long lived, an inherently strong trademark will likely be more beneficial over the life of the product or service. If it’s going to be a fleeting fad and you want to ensure quick catch-on, you might select a more basic descriptive name that fits that purpose, but is not necessarily an inherently strong trademark. You also need to consider whether the product is going to be sold outside of the U.S. If so, you’ll need to assess 1) how those markets will perceive the trademark, and 2) whether the trademark is available for use in all the jurisdictions you’re considering.

How can you evaluate the inherent strength of a trademark?

In the initial marketing phases for a new product, it can be beneficial to use a basic, descriptive term, but it won’t be as easy to protect. It is easier to protect words and marks that are more distinctive when used in association with the company’s product or service.

When selecting a trademark, we look at the ‘spectrum of distinctiveness’ in the context in which a proposed trademark will be used. On the weakest end, we have generic terms that are essentially the common name for the product or service (e.g., ‘DVD’ for digital video/versatile discs). Next we have descriptive terms (e.g., Web Analytics Experts for services regarding the analysis of Internet-based statistics), followed by suggestive terms (e.g., Sure for a deodorant). At the stronger end, we have arbitrary terms (e.g., Apple for a computer) and fanciful (invented) terms (e.g., Kodak for film).

In practice, most trademarks are somewhere in the middle range between descriptive and suggestive. However, there can be a lot of long-term benefit in selecting an arbitrary or fanciful mark if you’re introducing something completely new to the market and/or the product/service being introduced will have a long shelf life.

What happens after the company agrees on a proposed trademark?

You check on availability and assess risk. Counsel will evaluate the marks you want to use and consider them against the goods and services you want to link them to, and then have a trademark search conducted. The search will uncover whether any other companies or individuals are already using the same or similar marks for similar goods and services. Counsel will analyze the search results to determine if there are conflicts that could cause consumer confusion, and prepare a legal assessment of risk.

How can a company protect its trademark?

In the U.S., trademark rights accrue with use (i.e., ‘common-law’ rights). You will obtain your best rights, however, by registering your trademark at the federal level. In the U.S., this gives you protection in all 50 states (among other benefits). In most jurisdictions outside the U.S., trademark rights are only protected if a registration is obtained. Thus, you should register your trademarks not only where you sell, but also where you manufacture, especially if you sell or manufacture products abroad.

Trademark rights are somewhat unique in that you need to police them. Although theoretically, you can maintain a trademark registration and the related rights for as long as you use the mark, if you let others use your trademark or something similar without trying to stop them or enforce your rights, you allow your rights to be eroded.

How do you proceed if you think another company is infringing upon your rights?

First, conduct sufficient due diligence to confirm you have superior rights, as well as the nature and scope of your rights.

Once sufficient due diligence has been conducted, consider who the infringer is in crafting your approach to try to resolve the issue.  One typical approach is sending a cease and desist letter. Another is filing a court action (in lieu of or in connection with a C&D letter). While sending a letter may achieve a quicker, less expensive result, it may also give the infringer the opportunity to select the forum where the dispute will be resolved (i.e., by filing a declaratory judgment action in a jurisdiction more favorable or convenient to the infringer).

Claims available may include one or more of the following: federal trademark infringement, state trademark infringement, federal or state unfair competition, and/or an action in court or the Trademark Office to challenge the trademark application or registration of the infringer.

If both parties have viable rights, or want to avoid the cost and unpredictability of an action in court or in the Trademark Office, they may decide to resolve the dispute by a coexistence agreement that allows both parties to use their marks in ways that avoid consumer confusion.

JIM DIMITRIJEVS and GRANT MONACHINO are members at McDonald Hopkins LLC, both specializing in Intellectual Property. Reach Dimitrijevs at (216) 348-5774. Reach Monachino at (216) 430-2003.

Published in Cleveland

Serving as a director or officer on a board can be complicated, especially if the business is floundering.

Directors have certain duties to the company they are serving, but when the business is financially distressed, the beneficiaries of those duties switches to the creditors, according to Shawn Riley, the Managing Member of the Cleveland office of McDonald Hopkins LLC and co-chair of its Business Restructuring Services Department.

“In normal situations, those duties exist for the benefit of the owners,” says Riley. “However, when a business starts to experience financial distress, the obligations shift. Two questions arise: ‘When do they shift? And, how do they shift — in other words, who are beneficiaries of those duties?’”

Smart Business spoke with Riley about shifting fiduciary responsibilities and how recent court rulings are changing the rules of the game.

How are directors’ and officers’ fiduciary responsibilities defined?

The fiduciary responsibilities that directors and officers owe a business, particularly a distressed business, have been evolving. Recent court decisions suggest that the responsibilities are not as stringent as people thought they were just a few years ago.

Generally speaking, directors and officers owe their fiduciary duties to the company itself, for the benefit of the owners. To meet their fiduciary duties, directors and officers are required to fulfill two primary obligations — the duty of care and the duty of loyalty. The duty of care means they must be well informed and must reach well-reasoned decisions with respect to the company and its assets. The duty of loyalty requires that directors and officers act without conflict of interest, without benefiting themselves to the detriment of the business.

When do those duties shift?

When a company is in financial distress, case law has suggested that directors and officers have to ignore the interests of the owners and instead focus exclusively on the interests of the creditors. They must think about how to maximize the value of the business so as to pay creditors. That is a pretty significant adjustment in thinking, because directors and officers up to that point will have been running the business for the benefit of the owners.

So when, exactly, do those duties shift? Some argue that it is at the first sign of trouble. Others argue that it is only at the time of filing a bankruptcy proceeding. For others, it is the period when the business is insolvent, whether or not it is in bankruptcy. Until recently, the uncertainty over questions such as these has caused directors and officers to tread carefully.

The uncertainty in the law has diminished recently as courts over the past couple of years have introduced a dose of reason to the process. The courts have begun to suggest that the shift of duties does not occur as early as people were arguing, but rather when there is very clear evidence of insolvency, when the business simply cannot pay its debts. At that point, directors have to start thinking about the interests of creditors.

How do those duties shift?

While it seemed the rule was that directors had to completely ignore the interest of the owners, others argued that creditors’ interests and shareholders’ interest should be given equal weight.

Again, recent case law indicates that directors, even in an insolvency situation, should not ignore the interests of the owners but rather should make their primary concern the interest of creditors, at least until the point where they can demonstrate that the business is solvent again.

The continuing issue for directors and officers, however, is that this is usually judged after the fact, with the benefit of 20/20 hindsight. It is not as if, in the middle of its efforts to right itself, a business can call a timeout and ask a judge what it or its board should do. If the board is unsuccessful in turning the business around, its actions will likely be second-guessed by creditors.

Who can sue directors and officers for breach of fiduciary duties?

It is the company itself that is supposed to sue those directors and officers that it believes have breached their fiduciary duties. But it would be pretty remarkable if those directors who run the business authorize counsel to file suit against them.

Courts allow shareholders (and creditors) to assert derivative standing, in which a group of shareholders — or a creditors’ committee in a bankruptcy — sue on behalf of the company in a situation in which it would be futile to ask the company to sue. Anything that is recovered against the directors’ and officers’ insurance policies would then be distributed to the shareholders or creditors. However, the courts have started to impose tighter restrictions on the circumstances under which a creditors committee in a bankruptcy can file derivative actions. In a recent case involving a limited liability company in Delaware, the court ruled that only owners or members of the LLC could sue derivatively, meaning that creditors are not authorized to pursue directors and officers. Even if creditors could demonstrate that directors and officers clearly did something wrong that resulted in damage to creditor interests, they have no standing to pursue claims.

This may reflect a recognition that perhaps the pendulum had swung too far in one direction, authorizing aggressive lawsuits by creditors against directors and officers for marginal claims under otherwise reasonable decision points for directors. The pendulum is swinging back and the courts are limiting not only the time period claims can cover, but also the types of claims and who can file them.

This ruling may make people more willing to serve on boards, as they can join a board less worried about the potential for being sued. It should also reduce the cost of directors’ and officers’ insurance.

Shawn Riley is the Managing Member of the Cleveland office of McDonald Hopkins LLC and co-chair of its Business Restructuring Services Department. Reach him at (216) 348-5773 or sriley@mcdonaldhopkins.com.

Published in Cleveland
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