Businesses are familiar with the notion that written employment contracts can be a source of rights and liabilities in the event of a split with an executive employee.

However, businesses 
are often not as familiar with other potential sources of employment liability in those situations, including the Wage Payment and Collections Act, sometimes called the Wage Payment Act.

Smart Business spoke with John Haarlow Jr., an attorney at Novack and Macey LLPto discuss the relationship between this statute and executive compensation.

What is the act and why is it important?

Generally speaking, the Wage Payment Act requires Illinois employers to pay the final compensation of separated employees. Employers need to be conscious of the act because it applies to all employees, from hourly wage earners to top executives. It also provides a range of powerful remedies for separated employees, including attorneys’ fees and potential personal liability. 

What are the elements of a claim?

To prevail on a Wage Payment Act claim, a separated employee must demonstrate that he or she has been denied final compensation in violation of an ‘agreement’ with an employer. Under the act, an agreement is broader and less formal than a traditional contract. For example, an agreement can arise from the pattern or practice between the employee and employer, such as payment of a fixed amount at regular intervals, or from a conversation between an employee and employer.

Claims 
under the act are brought, and sometimes won, solely based on an executive employee’s testimony that the employer promised a payment it later refused to make.

What types of compensation may an employee seek under the act?

Final compensation is essentially any payment due and owing pursuant to an agreement between the employee and employer, including salary, wages, commissions, bonuses, vacation pay, stock options, severance pay and pension contributions. In the event of mid-year separation, some of these payments must be made pro rata.

Calculating these payments 
can be complicated and expensive when dealing with executive separations that include substantial commissions, bonuses or golden parachute packages that vest at various times.

When is an employee entitled to receive a bonus under the act?

Whether executive employees are entitled to a bonus upon separation under the act has been heavily litigated. Generally, if an executive can show that the employer made an unequivocal promise to pay a bonus and that the conditions for payment have been met, a bonus may be awarded under the act. Such an award is still possible even though a bonus is within the employer’s discretion and is typically awarded at year’s end.

When may a separated employee recover attorneys’ fees?

A recent amendment to the act provides that employers are liable for the attorneys’ fees of any employee that brings a successful claim under the act. The relatively easy access to attorneys’ fees provides departing executives a key bargaining chip in connection with their claims and makes claims for smaller amounts feasible to bring.

Under what conditions is personal liability possible?

One of the most striking features of the act is that an employer’s officer or agent can be held personally liable for the departing employee’s damages and attorneys’ fees. For personal liability to attach, an officer must have knowledge of the compensation arrangement between the departing executive and the employer and knowingly permit the employer to violate the act. This can provide executives tremendous leverage by putting individual officers at personal risk in connection with a Wage Payment Act claim.

How can a business protect itself?

Every business is different, so there is no silver bullet to protecting against Wage Payment Act liability. However, broadly speaking, businesses should make clear what comprises an executive’s compensation package and when and how it will be paid. That way, there are less likely to be disputes about payment upon separation.
 
John Haarlow Jr. is an attorney with Novack and Macey LLP. Reach him at (312) 419-6900 or jhaarlow@novackmacey.com
 
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Published in Chicago
An expert witness is a person knowledgeable in a particular subject area who can assist a jury or judge in understanding specialized, technical or scientific evidence presented in a court case.

Experts are needed to explain 
what is reasonable in various industries, scientific or technical information, complicated financial data, and anything else that laypersons might have difficulty understanding on their own.

That’s why 
having a good expert witness is critical to litigants.

Smart Business spoke with Adam Waskowski, a partner at Novack and Macey LLP, about what to look for in an expert witness and what business owners can do to help their attorneys identify them.

What are the qualities of a good expert witness?

A good expert witness has two main qualities. First, the expert needs to actually have specialized knowledge. Second, the expert must be a ‘teacher’ who can explain technical information so a layperson can understand it.

How can business clients help identify expert witnesses?

Business clients are a good, underutilized resource for identifying potential expert witnesses in business disputes. Most trial lawyers have a database of professional expert witnesses for things like lost profit calculations, appraisals and other similar matters. These expert witnesses typically have a number of licenses or accreditations, and are extremely smooth and polished in court.

They tend to have 
a broad range of knowledge and meet the legal requirements to testify as experts, but they lack intense industry-specific knowledge and can be expensive. In some instances, you may be better off hiring an expert who actually works in your industry, even if that person has never been an expert witness before.

For example, 
many of my small business clients are small to midsize manufacturers with five to 10 serious competitors in the world. Only a small number of people can testify about those industries without first undertaking significant research.

While such true 
industry experts are not as polished in court, they may be as good or better than professional expert witnesses, and much cheaper.

Do you have an example of a time that a client helped identify an expert?

One case concerned the value of a rare, classic sports car. The client recommended a colleague to give an opinion on its value. The guy had never testified in court as an expert witness and was not a professional appraiser. However, he collected rare sports cars and held leadership roles in various organizations devoted to the sports car at issue. By contrast, the other side’s expert was a certified appraiser and a professional expert witness.

At trial, our expert performed brilliantly. At one point, the opposing lawyer tried to trip up our expert by asking him if the car at issue appeared in a famous movie from the 1960s. The expert said, ‘no,’ but then rattled off the make, model and year of the car in the movie. After that, it was pretty clear to everyone in the courtroom that this guy knew his stuff, and the court adopted our expert’s valuation. We probably would not have found this expert but for the client.

How can experts help before trial? 
 
Many cases settle before trial, often on the strength of expert reports. For instance, I once represented an alcoholic beverage manufacturer in a case concerning whether a competitor abandoned one of its brands. The client recommended a colleague to evaluate the competitor’s business. The expert quickly determined that the competitor’s order history and regulatory actions showed that the competitor dropped the brand.  
 
Even better, he reached these conclusions and prepared a report in a matter of hours, which led to a settlement. As a result, he helped bring the case to a prompt and inexpensive resolution. 

Business clients are often reluctant to micromanage lawyers, but it’s important for business owners to understand that if you can suggest a good expert witness, do not hesitate to suggest that person to your lawyer.
 
Adam Waskowski is a Partner with Novack and Macey LLP. Reach him at (312) 419-6900 or awaskowski@novackmacey.com
 
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Published in Chicago
The cost of business litigation is inherently uncertain because of unforeseen maneuvers by your opponent and unexpected rulings by the court. However, there are things that you — as the client — can do to reduce your litigation costs, including your attorneys’ fees. “Experienced clients know how to efficiently use their litigators,” says Monte L. Mann, a partner at Novack and Macey LLP.
 
Smart Business spoke with Mann about how to reduce your business litigation expenses.

How can you be sure your attorney has a clear understanding of your case?

Introduce your litigator to your case efficiently. Before your first substantive meeting with counsel, prepare a written narrative that:
Provides general background on your industry and your business.
Explains all of the material facts of the dispute in chronological order.
References and attaches all important documents — such as key contracts and correspondence.
In other words, ‘tie it up in a bow.’ No doubt this will require substantial time and effort, but it is the most efficient way to convey the information to your counsel, and it will be an excellent reference point for you and your counsel throughout the entire case.

What can be done to better understand the costs you might incur?

Your first meeting with counsel should include a discussion of your goals for the lawsuit. What outcomes, short of a trial, are acceptable to your business?

What 
are the essential terms that you would require as part of any settlement? Communicate your goals and ask your counsel whether he or she believes your expectations are realistic. Insist that your counsel formulate a strategy to achieve your goals and estimate the time frame, legal fees and costs to execute the strategy to secure those goals. You may be surprised by the plan and the estimates, and this, in turn, may change your perspective about acceptable outcomes.
 
How are the expenses of discovery best managed?

The discovery phase in litigation requires that each side disclose all relevant facts, produce all relevant documents and present all relevant witnesses for depositions. The proliferation of computers has greatly increased the costs of producing all relevant documents because it is expensive to search computer servers for files, emails, voice mails and texts. 

Have your counsel try to negotiate with the other side to reduce these costs by agreeing to limit the searches for relevant documents by date ranges and particular employees, and by limiting the number of depositions each side will take. In addition, when you produce your own documents to your attorney, it is helpful, and saves money, if you identify the source of the documents — i.e., Employee John Doe’s files — and provide a general index of the documents, for example, ‘correspondence with vendors,’ ‘financial projections,’ ‘Employee Jane Doe’s personnel file,’ etc.
 
Are there different ways to handle billing?

There are many alternatives to the conventional fee arrangement, which is hourly rate billing. Examples include: contingent fees; reverse contingent fees, where compensation is based on avoiding liability; blended rates, which blend the lower rates of junior lawyers and higher rates of senior lawyers into one blended rate for all; fixed or flat fees, where the law firm charges one price for the engagement regardless of how many hours it requires; and combined approaches, such as a low blended hourly rate, plus a contingency. Explore the alternatives with your counsel. 

Are attorney’s fees tax deductible?

Tax deductions will not actually lower your legal fees, but they can reduce your taxable income. Remember that legal fees for securing tax advice and business legal fees are often tax deductible.
 
Monte L. Mann is a Partner with Novack and Macey LLP. Reach him at (312) 419-6900 or mmann@novackmacey.com
 
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Published in Chicago

Everyone makes mistakes, including lawyers and businesspeople drafting contracts. Usually, a simple typographical or grammatical mistake will not change the meaning of the agreement in a significant way — but what if it does? 

“While Illinois courts protect the sanctity of the written word, they also recognize that people make mistakes, and they are willing to reform or rewrite the contract to conform to the parties’ agreement in certain circumstances,” says Rebekah Parker, an associate at Novack and Macey LLP.

Smart Business spoke with Parker about what to do when writing fails to reflect the parties’ agreement.

What is contract reformation?

Contract reformation is an equitable remedy that changes the language of a contract so that it conforms to the agreement actually reached by the parties but not accurately reduced to writing because of a mistake. Contract reformation cannot be used to change the terms of the deal; rather, it merely fixes a mistake so that the writing better expresses the bargain the parties reached.

Can any mistake be reformed?

No. Reformation is most appropriate for scrivener’s or drafting errors, such as erroneous numerical figures, incorrect dates or errant commas that change the meaning of a sentence.

 If all contracting parties agree that a mistake has been made, they may — but do not have to — seek court intervention to reform their agreement. Or, they can voluntarily reform the contract themselves. This can be accomplished by, among other things, correcting the language on the original contract and having each party initial the revision; executing a rider to the agreement that identifies and corrects the mistake; or executing a new version of the contract that clearly states that it is intended to reform the parties’ prior agreement.

Courts encourage voluntary reformation and will usually enforce the reformed agreement should a dispute later arise.

What if the parties disagree about whether a mistake was made?  

If a mistake advantages one party and disadvantages the other, it is not unusual for them to disagree as to whether a mistake was made. The disadvantaged party may need to bring a legal action for reformation, which can be combined with a claim for breach of contract — even if the breach of contract claim depends upon the contract being reformed. It is important that such a claim be brought as soon as possible after the mistake is discovered, because laches — unreasonable delay accompanied by prejudice — is a common defense to reformation.  

The party seeking reformation bears the burden of proof, and it is a heavy one. In Illinois, there is a presumption that a written instrument reflects the true intention of the parties. Overcoming that presumption generally requires ‘clear and convincing evidence’ — a higher burden than the usual preponderance of the evidence standard.

Even if the party seeking to reform a contract fails to meet its heavy burden, it can still succeed on its breach of contract claim if the court finds the agreement to be ambiguous. In that case, the parties can introduce extrinsic evidence of their actual intent, and the court will interpret, rather than reform, the contract following ordinary canons of contract interpretation and applying ordinary standards of proof.

 

Do you have any advice for avoiding drafting errors in the first place? 

Given the difficulty in reforming written contracts, it is vital to ensure that important contracts are mistake-free. Most drafting errors can be avoided by following these three tips: First, be cautious when creating a new contract from an old template. Sometimes stock language conflicts with a term agreed to by the parties. 

Second, always have someone review the final draft, such as an outside counsel or businessperson, especially one who was involved in negotiating the deal or whose area of business is impacted by it. 

Third, beware of grammar. Several headline-grabbing contract disasters involve something as simple as a misplaced comma. Most people do not know how to use commas properly, so keep sentence structure simple, and avoiding modifying clauses as much as possible.

Rebekah Parker is an associate at Novack and Macey LLP. Reach her at (312) 419-6900 or rparker@novackmacey.com.

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Published in Chicago

The purpose of an arbitration clause is to resolve disputes by means of a private proceeding that is generally perceived as quicker and less expensive than the court system. Yet many contracting parties do not fully analyze the arbitration clauses in their contracts, and so do not draft such provisions in a comprehensive and precise manner. These lapses can lead to costly and time-consuming disputes.

“Any party entering into an arbitration agreement, therefore, would be wise to carefully analyze the arbitration clause thoroughly, with a view to ensuring that it will accomplish all of the party’s goals,” says Courtney D. Tedrowe, a commercial litigation partner at Novack and Macey LLP.

Smart Business spoke with Tedrowe about what it takes to draft an effective arbitration clause.

What are the key considerations in drafting an arbitration clause?

Broadly speaking, there are two categories of issues to consider when drafting an arbitration clause. The first of these concerns the extent to which the court will be involved in pre-arbitration and post-arbitration issues. The second category concerns the parameters and procedures of the arbitration proceeding.

Why consider the court’s involvement in pre- and post-arbitration proceedings?

Just because you have an arbitration clause doesn’t mean that you will avoid court proceedings. Not infrequently, a party will oppose the arbitration demand on the grounds that it does not fall within the scope of the arbitration clause. Under the Federal Arbitration Act, courts are required to ensure that the claim is arbitrable. However, the arbitration clause can specify that the arbitrator decides such substantive ‘arbitrability’ issues, effectively limiting the court’s role from the very outset.

The parties may also restrict the court’s involvement in post-arbitration proceedings. Some post-arbitration judicial action is inevitable, since courts, not arbitrators, have the power to reduce the arbitration award to an enforceable judgment and to decide any challenges to the award. Here, the parties can use the arbitration clause to limit the grounds of appeal, further reducing the chances that the award is vacated, and minimizing the risk of lengthy appeals.

How should the arbitration clause be drafted to provide for procedural matters?

Parties can agree to pretty much whatever they want when it come to procedures. Typically, agreements simply select an organization’s rules, such as the American Arbitration Association, JAMS or ADR Systems.

There are two big pitfalls here. First, most organizations have more than one set of rules with sometimes very different deadlines, discovery options and evidentiary rules. When drafting the clause, be sure that you select not just the organization, but the specific set of rules most favorable to the particular situation.

Second, organizations change their rules regularly, meaning parties will likely be bound to use the rules in effect at the time of the dispute, which may have changed.

Can parties modify the applicable rules?

Yes. For example, although the rules of evidence do not typically apply in arbitration, parties may specify that they will apply, or that only certain rules of evidence apply. Parties also have the ability to craft the discovery process to their particular situation. The arbitration clause can set forth, among other things: whether parties may take depositions and, if so, how many; whether documents requests and interrogatories will be allowed and, if so, how many; and the parameters of any other discovery method.

The clause may also deal with the hearing location; pre- and post-arbitration motions, such as motions to dismiss; and the arbitrator’s power to fashion specific remedies.

How much freedom do the parties have to control the arbitrator selection process?

Parties have complete control over who arbitrates their dispute. The specific arbitrator could be identified in the clause, or the clause can set forth the rules by which an arbitrator is selected, either expressly or by selection of a particular organization’s rules.

Courtney D. Tedrowe is a commercial litigation partner at Novack and Macey LLP. Reach him at (312) 419-6900 or cdt@novackmacey.com.

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Published in Chicago

Although commercial leasing and rental rates are coming back in Chicago, new tenants are still able to negotiate certain benefits from their landlords. Among these benefits are exclusivity provisions, which limit a landlord’s ability to lease space to a tenant’s competitors.

Smart Business spoke with Andrew D. Campbell, a partner at Novack and Macey LLP, about exclusivity provisions.

What is an exclusivity provision?

An exclusivity provision in a lease protects a tenant by prohibiting a landlord from leasing space to others engaged in the same line of business as the tenant. These provisions are especially common in leases for retail tenants, but they can be applied in many contexts.

There are two basic ways to create an exclusivity provision:

1. Expressly identifying the types of businesses to be excluded, or the types of goods that may not be sold in the landlord’s other spaces.

2. Creating an implied exclusivity provision.

An implied exclusivity provision arises when a lease provides that a tenant will have ‘exclusive’ rights — for example, ‘tenant shall have the exclusive right to operate a restaurant with a liquor license.’

Exclusivity provisions restrain trade — are they enforceable?

Yes, exclusivity provisions restrain trade, but this does not render them unenforceable. Courts enforce exclusivity provisions where they do not unreasonably restrain trade. If an exclusivity provision is reasonably necessary for the tenant, reasonable in duration and territorial scope, and does not unduly prejudice the interests of the public, they are generally enforceable.

But because exclusivity provisions restrain trade, some courts construe these provisions strictly.  So, if an exclusivity provision is susceptible to two reasonable interpretations, courts often will choose the interpretation that imposes the least restraint on trade.

What should an exclusivity provision say?

To avoid disputes, exclusivity provisions should be as clear and specific as possible. For instance, suppose a McDonald’s restaurant is leasing space in a mall and it wants an exclusivity provision. A provision that excludes all other ‘fast-food restaurants that sell hamburgers’ would probably be too vague. It leaves questions unanswered such as to what constitutes ‘fast food’ and what it means to ‘sell hamburgers.’

A better limitation would be to specifically describe the types of businesses to be excluded — for example, excluding ‘restaurants that do not have table service and that derive 30 percent or more of their gross sales from the sale of hamburgers.’

An even better limitation would give specific examples of restaurants to be excluded — Burger King, Wendy’s, Five Guys, etc. A catchall provision at the end of this list, such as, ‘all other similar restaurants,’ may also be useful in case a relevant competitor was inadvertently omitted from the list. Although catchall provisions lack specificity, courts generally will apply them, but only to the extent the ‘other’ restaurant is similar to those listed.

What are a tenant’s remedies if a landlord violates an exclusivity provision?

While remedies will vary based on the specific terms in the lease, and the governing state law, tenants’ remedies for violation of an exclusivity provision can include repudiating the lease — that is, walking away from any remaining lease obligations — or suing the landlord for injunctive relief and/or damages. So, a tenant may file a lawsuit seeking to preclude a competitor from opening in the landlord’s space and/or the tenant may seek monetary damages that may have resulted from the opening of the competing store.

To minimize this risk, landlords should be sure to check the exclusivity provisions in other tenants’ leases before signing a new tenant.

Andrew D. Campbell is a partner at Novack and Macey LLP. Reach him at (312) 419-6900 or acampbell@novackmacey.com.

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When people consider intellectual property (IP) they most often think patent or copyright, which can be very valuable to a business. But, in fact, one form that’s often overlooked is trade secrets.

What constitutes a protectable trade secret varies from state to state, but the gist of what trade-secret law protects is similar in almost every state. A trade secret is any sufficiently valuable, secret information that can be used in the operation of a business to afford an actual or potential economic advantage.

“Given this broad definition, it should come as no surprise that a wide variety of things have been found to constitute trade secrets, including product formulas, data compilations, customer or client lists developed through hard work, manufacturing techniques and some forms of business know-how,” says P. Andrew Fleming, a partner at Novack and Macey LLP. “The point is that many things could be protectable trade secrets if a business took the time to identify and properly protect them. All too often, however, businesses do not do a good job at either.”

Smart Business spoke with Fleming about how your company should be protecting your trade secrets.

How might a company’s trade secrets be vulnerable?

It is hard for a business to protect something unless it knows what it is — a business has to identify its trade secrets before it can protect them. A little common sense goes a long way. Business owners should start by asking a simple question: ‘What does my business do better than the competition that my competition does not know about, and that I do not want them to know about?’

What policies should a company put in place to protect its trade secrets?

The next step is protecting that trade secret. This can be tricky because, as the name implies, a trade secret loses protection when it is no longer secret. Moreover, the law does not protect a trade secret unless its owner takes reasonable steps to keep it secret. Although there is no hard and fast rule, a business should consider:

  • Password-protecting computers containing its secrets.

  • Limiting access to secrets on a ‘need-to-know’ basis.

  • Keeping hard copies of documents containing or describing its secrets under ‘lock and key.’

  • Entering into contracts with its employees that requires those employees to maintain secrecy during employment and after their employment ends.

A business also might consider using reasonable non-compete agreements with employees who know trade secrets to keep them from going to the competition. After all, if a former employee cannot work for a competitor, he or she has little incentive to reveal secrets once employment ends.

How has social media affected a company’s ability to protect its trade secrets?

The explosion of information on the Internet has made it more difficult for businesses to argue information or know-how is sufficiently secret to constitute a trade secret. It is now far easier to find descriptions of techniques, know-how and even customer lists — a point underscored in Sasqua Group, Inc. v. Courtney. There, the defendant allegedly took secret and valuable customer information to her new job, and the plaintiff argued the information was a trade secret. The court acknowledged that the customer information could in the early days, i.e. pre-Internet and pre-social media, have been sufficiently secret, but since virtually all of the allegedly protected information could be found on the Internet, including through social media sites, it no longer qualified.

It is not difficult to imagine other scenarios in which a business could lose trade secrets via the Internet or social media. For example, a disgruntled employee could intentionally post secrets so the otherwise secret information loses its protection. Even a happy employee unwittingly could disclose secrets through careless posting, such as establishing links to all customers on a social media page.

There are no easy answers to such problems, but businesses must remain on guard, take care when creating or posting to social media sites, and educate employees about the pitfalls of using social media.

P. Andrew Fleming is a partner at Novack and Macey LLP. Reach him at (312) 419-6900 or andrewf@novackmacey.com.

 

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Most businesses have ‘comprehensive’ insurance policies that cover damage to the company’s physical assets and protect against third-party bodily injury or tangible property damage claims against the company. But this traditional coverage generally does not fully protect against losses related to intangible assets, like computer-stored data and intellectual property.

“Businesses need to be aware of this exposure and consider specific coverage designed for their individual business needs and risks,” says Steven J. Ciszewski, a partner at Novack and Macey LLP.

Smart Business spoke with Ciszewski about where comprehensive polices might fall short and how to plug the holes with additional coverage for your business’s needs.

What types of coverage are available for computer-stored data and other cyber risks?

Some aspects of computer- or data-related losses might be protected by commercial crime coverage that applies when a third party or employee commits a crime or fraud directed at your business. This coverage can be an add-on to a general commercial policy or a stand-alone policy. Beyond that, many insurers offer both first-party and third-party coverage dedicated to computer and cyber risks. First-party coverage typically pays for costs incurred if your computer network or data systems suffer a catastrophic failure. The coverage might pay for costs incurred to restore your network and data, and/or the lost profits suffered because your business lost the use of its network and data. Third-party coverage protects against liability claims arising out of computer or cyber risks — for example, claims arising out of a breach of your network security. In the event of a breach, confidential customer information could be exposed or stolen. Third-party coverage would cover those claims and pay damages suffered by customers, pay for customer notification, and fund a credit-monitoring program for the affected customers.

What coverage is available for intellectual property?

Increasingly, courts have found that trying to secure coverage for intellectual property (IP) risks under a general liability policy is like trying to jam a square peg into a round hole. As a result, businesses with IP assets or exposure are wise to consider dedicated IP coverage. Again, this coverage generally falls into two broad categories: Defense coverage, which pays for the cost to defend and satisfy any judgment arising out of a claim that your business infringed another’s copyright, trademark, patent or other IP; and abatement coverage, which fronts the cost of pursuing a claim against another for infringing on your IP. For abatement coverage, even if your claim fails, the insurer typically covers all or most of the cost. If the claim succeeds and you recover, the insurer may be entitled to some of the recovery to offset the costs it fronted. For businesses with critical IP, both types of coverage are important just to pay for litigation costs, since IP litigation can often become prohibitively expensive.

Are there any other emerging areas where businesses may be unknowingly exposed?

Just like IP claims, many employment-related claims, such as discrimination — race, age, gender, etc. — sexual harassment or wrongful termination, are not covered by most general liability policies. Accordingly, businesses should consider employment practices liability (EPL) coverage. EPL policies pay for defense costs and for judgments arising out of these types of claims against your business by prospective, current or former employees. Again, coverage for defense costs is particularly important since it can be expensive to defeat even a frivolous claim brought by a disgruntled employee.

Steven J. Ciszewski is a partner at Novack and Macey LLP. Reach him at (312) 419-6900 or stevec@novackmacey.com.

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It is widely understood that organizing a business as a corporation or a limited liability company insulates its owners from personal liability for the debts of the company. What is less well appreciated is that, under certain circumstances, such protection can be lost.

“When a creditor of a corporation or limited liability company is unable to collect from the company itself, it is not unusual for it to try to circumvent the corporate shield and recover the amount owed from the individual, or parent company, which owns the debtor entity,” says Michael A. Weinberg, a partner with the business litigation specialty firm Novack and Macey LLP. “Such attempts to ‘pierce the corporate veil’ face steep legal hurdles, but nonetheless can, under certain circumstances, pose real threats to owners of corporations and LLCs. Accordingly, it is imperative not only that owners understand why such piercing attempts sometimes succeed and how they can avoid such a fate, but that creditors understand when pursuit of a veil-piercing remedy is warranted.”

Smart Business spoke with Weinberg about the factors that Illinois courts consider when determining whether corporate veils should be pierced in debtor-creditor disputes, how business owners can minimize the risk of exposure to personal liability for company debt and when creditors should think about seeking a veil-piercing remedy.

What is veil-piercing, and when might it come into play as a means of collection?

As a general rule, corporations are entities distinct from their shareholders and LLCs are entities distinct from their members. Accordingly, those owners are not liable for the entities’ debts. The doctrine of veil-piercing recognizes that situations may arise when the legal separation between entity and ownership should be stripped away. In those instances, corporate shareholders or LLC members can be held personally liable for company debts and liabilities. Piercing the veil is an extraordinary remedy and creditors should not view it as a routine tactic whenever a corporation or LLC defaults on a debt or obligation. The purpose of veil-piercing is to prevent fraud or grave injustice, and where such conditions are absent, piercing efforts are likely to fail.

In cases arising out of commercial relationships, and not torts where different considerations may apply, Illinois courts frequently apply a two-part test to decide whether veil-piercing is appropriate. Part one is whether the corporation or LLC is operating as a mere ‘alter ego’ for the owner, and part two is whether adherence to the fiction of separate corporate existence facilitates fraud or inequitable consequences. That a business fails, and cannot meet its obligations, does not ordinarily implicate fraud or injustice, and indeed, that is seldom the case.  However, occasionally, the way in which a corporation or LLC is run demonstrates that it was operated as a mere instrumentality of its owner, so that it would be unfair to allow the owner to escape personal liability for the company’s obligations. In those circumstances, a creditor may appropriately consider pursuit of a veil-piercing remedy.

What factors do courts consider when deciding if veil-piercing is justified?

Courts have identified a number of factors that help determine if and when a veil should be pierced in cases arising out of commercial transactions. Those factors include, among other things, inadequate capitalization; failure to issue stock; non-observance of corporate formalities, such as maintaining corporate record books, holding directors or shareholders meetings, etc.; failure to pay dividends or make distributions; insolvency; no real role or duties performed by non-owner officers; absence of corporate records; commingling of funds; diversion of company funds by or to a shareholder or other recipient to the detriment of creditors; lack of arms-length relationships among related entities; and whether the corporation is merely a façade for the operations of the dominant shareholders. No ‘magic number’ of factors need be present for veil-piercing to be justified, but it is equally clear that fewer than all of the factors can be sufficient to support application of the remedy.

What should business owners do to minimize the risk of veil-piercing?

It’s simple: Avoid any of the 11 things I just mentioned. Too many business owners assume that, once they have organized their enterprise as a corporation or LLC, their worries are over. That leads to sloppy practices and opens the door to veil-piercing.  Maintaining proper records and paperwork, holding required meetings, providing reasonable start-up capital, segregating assets from those of related entities and not taking company resources for personal benefit when business circumstances do not justify such transfers will go a long way toward preserving the limited liability protection that the corporate or LLC forms of an organization were intended to provide.

From a creditor’s perspective, when should veil-piercing be considered as a possible remedy?

Start by asking whether a fraud or injustice occurred. There has to be something fundamentally unfair about how and why a creditor did not get paid if piercing is to come into play. Just because a business goes belly-up does not mean it was being operated as an alter ego of its owners. Millions of companies fail, but only a tiny fraction of those businesses will have functioned in such a way as to justify a veil-piercing claim. If a creditor feels something about the debtor’s operation does not pass the smell test, or better yet, if some of the 11 factors referred to earlier are known to be present, then further inquiry as to whether veil-piercing should be pursued is warranted. Where the minimum required support for a veil-piercing claim can be mustered in support of a complaint, discovery will often turn up further facts, which strengthen the claim. However, Illinois courts do not favor veil-piercing, so the odds of success are remote.

Michael A. Weinberg is a partner with the business litigation specialty firm Novack and Macey LLP. Reach him at (312) 419-6900 or maw@novackmacey.com.

Insights Legal Affairs is brought to you by Novack and Macey LLP

Published in Chicago
Wednesday, 31 October 2012 21:13

How you can settle your lawsuit quickly

Business litigation is an expensive process. Indeed, it is now common for parties to spend years producing documents, attending depositions and arguing motions, all of which happens before reaching a trial. As a result, experienced executives and in-house counsel often want to know how they can promptly settle a dispute on favorable terms.

Smart Business spoke with Richard L. Miller II, a partner at Novack and Macey LLP, about settling a lawsuit on the best terms possible.

What is the secret to settling a case?

In a word, information. In order to settle a complicated case, it’s important for an executive to know four things. First, he or she needs to know the facts. What do the key documents say and what will the players actually testify to? Parties are commonly surprised by such things as: a third party’s recollection of what happened; a damaging email that they did not know existed; or the meaning of an overlooked contract provision.

Second, it’s critical to know the law. The law will tell you what claims, counterclaims and/or defenses you have. But there are two sides to the majority of business disputes that make it to a courthouse. In order to make sound settlement decisions, you will need straight advice from a seasoned litigator about the likelihood of prevailing on each claim or defense.

Third, it’s vital to understand the motivation of the other side. Many times, people think that business litigation is purely about dollars. This is usually not the case. For instance, is the opposing entity in dire financial straits such that it simply cannot pay the amount? Or, does the opposing party fear having its conduct or practices publicized in the course of litigation? All too often, parties incorrectly assume that they know what is driving the opposition’s decisions.

Fourth, have a clear and realistic sense of your tolerance for risk and uncertainty. It commonly takes two to four years from the time a case is filed until a jury renders a verdict. After that, the loser may appeal. The appeal could result in a second trial or yet another appeal to a higher court. This process can be a roller-coaster ride — particularly if a judge makes a bad ruling, new evidence is discovered or key witnesses become unavailable.

What are a few common mistakes you see when parties are trying to settle?

One common mistake is rushing the process. It’s natural for busy executives to desire a fast resolution. However, at the same time, most decision-makers are loath to take a ‘first offer.’ Consequently, several counteroffers are often necessary. This back-and-forth usually takes at least a few days and, more likely, a few weeks. If your opposition senses that you need a quick settlement, it will attempt to use that information to its advantage.

Another mistake is overreaching. At the outset of a dispute, less experienced negotiators sometimes make an outrageous demand. This can stiffen the resolve of the recipient. Then, the overreaching party finds it difficult to make a reasonable offer without losing all credibility. Consequently, the parties proceed with litigation. This problem can be avoided by making demands and offers within the realm of reason.

A third mistake that’s frequently made is not understanding damages. In order to obtain a monetary award, you must have a legal theory that entitles you to relief. For example, if a former employee steals a customer list, you probably will not be able to obtain a money judgment if you cannot prove that the employee used the list, or shared the list, in a way that caused you to actually lose a sale or customer.

Are settlement conferences with judges effective?

It depends. If the parties and their attorneys are reasonable and experienced, a judge rarely tells them something that they do not already know. However, this is frequently not the case. In such instances, the right judge can be of tremendous assistance.

If the plaintiff is behaving outrageously, the judge can tell that person that his or her case has serious weaknesses and that his or her settlement position should be adjusted accordingly. Likewise, if one of the attorneys is not giving his or her client good advice, a judge can offer a fresh perspective.

Because judges are impartial and imbued with authority, litigants will often accept advice or arguments from them in a way that they will not from either opposing counsel or even their own lawyer. Still, some judges excel at resolving cases, while others do not.

In order to truly add value, a judge must become familiar enough with the evidence to be able to express opinions on the parties’ legal theories and settlement positions. Merely giving a canned speech about the costs and uncertainties of litigation rarely adds value.

Are written settlement agreements worth the time and expense of preparing them?

Yes. If a case was worth litigating, it is surely worth sewing-up with a written settlement agreement. Remember, the attorney who handled your case is already familiar with your business, your adversary and your concerns. Now that he or she has that knowledge, spending a bit more to protect your rights is a sound investment. Moreover, the best person to protect you against future litigation is someone who litigates for a living — we know all of the tricks of the trade.

Richard L. Miller II is a partner with the business litigation firm Novack and Macey LLP. Reach him at (312) 419-6900.

Insights Legal Affairs is brought to you by Novack and Macey LLP

Published in Chicago
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