Treatment of inside salespeople under the Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) establishes minimum wage, overtime pay, recordkeeping and child labor standards affecting full-time and part-time workers in the private sector and in federal, state and local governments. Nearly all employees are covered by the FLSA unless they qualify for one of the exemptions.

Smart Business spoke with Michael B. Dubin, a member with Semanoff Ormsby Greenberg & Torchia, LLC, about the FLSA, why inside salespeople are commonly misclassified as exempt and the consequences of failing to pay overtime to non-exempt employees.

How are salespeople treated under FLSA?

Outside salespeople are exempt from the overtime requirements under the FLSA while inside salespeople are generally non-exempt and are required to be paid overtime for all hours worked over 40 in a workweek.

To qualify for the outside sales exemption:

  1. The employee’s primary duty must be making sales or obtaining orders or contracts for services, or for the use of facilities for which consideration will be paid by the client or customer; and
  2. The employee must be customarily and regularly engaged away from the employer’s place of business. Any fixed site, whether home or office, used by a salesperson as a headquarters or for telephone solicitation of sales is considered one of the employer’s places of business.

Inside salespeople are those generally attempting to make sales over the telephone, internet or by mail. These employees are typically non-exempt and are eligible for overtime pay. However, in certain limited circumstances, an inside salesperson may be exempt under the ‘retail or service establishment exemption.’ To qualify for this exemption, an employer must demonstrate that:

  1. The employee works for a retail or service establishment;
  2. The employee’s regular rate of pay is at least one-and-a-half times the minimum wage; and
  3. More than half of the employee’s earnings in a representative period (not less than one month and not more than one year) are derived from commissions on goods or services.

A retail or service establishment is a business where 75 percent of its annual dollar volume of sales of goods or services (or both) is not for resale and is recognized as retail sales or services in the particular industry.

Why do employers misclassify salespeople?

Many employers see no distinction between outside salespeople and inside salespeople since both positions are selling goods or services. As a result, many employers misclassify inside salespeople as exempt employees. When made aware of the misclassification, these employers often ask if they can direct the inside salespeople to go on the road a couple of days a month so they can be characterized as outside salespeople exempt from overtime. The answer is no, because an outside salesperson must be ‘customarily and regularly’ engaged away from the employer’s place of business, which means greater than occasional, but less than constant. Therefore, this attempt to avoid paying overtime will be unsuccessful if challenged.

What is the penalty for failing to pay overtime under the FLSA?

If an employer fails to pay overtime under the FLSA, the employee has a private right of action and can seek any unpaid overtime going back two years from the date of filing the action. If the employee can prove the employer acted willfully in violating the FLSA, they may be entitled to overtime going back three years. The employee may also be entitled to liquidated damages, which can be up to the amount of the back overtime (it doubles the amount owed to the employee), as well as the recovery of attorneys’ fees incurred in the action.

To keep abreast of FLSA requirements, it is prudent to have an attorney experienced in FLSA conduct a wage and hour audit every few years. This process will allow the attorney to review all job descriptions, the actual duties performed and the FLSA classification of each position to determine whether any employees or group of employees are misclassified and to rectify any such misclassification.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

It’s never too early to begin crafting your business succession plan

Succession planning can be a difficult task for business owners whose sole focus has always been the growth of the company, says Steven P. Larson, an attorney with McCarthy, Lebit, Crystal & Liffman. However, taking steps to secure your company’s future is the best way to protect yourself, your family and your employees following your departure.

“Every business transition strategy, even within the same industry, is going to follow a different path,” Larson says.

“Every approach is unique because it is based on what you want to accomplish and the legacy you wish to leave behind. There are always options, but the sooner you develop a plan, the more choices you will have. Ultimately, your efforts will provide a great deal of relief and guidance to your family and your employees, knowing that there is a plan in place.”

Smart Business spoke with Larson about how to initiate the succession planning process and the importance of starting early.

Where is a good place to begin your succession planning?
There are two primary areas of focus. The first step is to review your basic estate plan, which should include your will, revocable trust, financial power of attorney, health care power of attorney and living will.

These documents provide baseline protection to ensure that upon your death or incapacitation, a trusted individual is ready to step in and manage your affairs. Along those lines, it’s a good time to consider what protective measures you have in place, such as life insurance and disability insurance to cover you in the event of death or incapacity.

The other area of focus is to develop your ideal business succession plan. Here, the options are vast and highly customizable. While some business owners choose to transfer control of the business to a family member, others may elect to remain with the company in a reduced capacity.

Further options include selling the company to a third party or arranging for a management buy-out, either immediately or over a period of time. Typically, this is a lengthy process that can take years to fully develop and implement from beginning to end. It is never too early to begin thinking about the future of your business and what you want your legacy to be.

How does insurance tie in with both estate planning and business succession planning?
Insurance is important for any business owner, but it becomes particularly significant if you own a business that is highly dependent on your presence to succeed or a service business, such as an architectural firm, law firm or medical practice.

These types of businesses cannot function without you. Thus, you need to formulate a plan that clearly spells out what should take place in the event that you are unable to continue due to your incapacity or death. If you wait until this worst-case scenario occurs, it will be too late to get the insurance coverage needed to protect your business and any stakeholders.

Life insurance is utilized frequently during the estate planning process, particularly for business owners. It may be used to fund a buy-sell agreement, pay estate taxes or provide liquidity to your family.

How prepared are most business owners to deal with succession planning?
It’s one area of the business that is often put off for another day.

Succession planning involves asking and answering difficult questions, including when you should step away, if there is someone in the family or business who has what it takes to lead the company, if you have the time to transfer your knowledge to that person, and ultimately, what is your legacy.

Often business owners have a general idea of what they envision the transition looking like, but it takes work to craft the final version of their succession plan.

Business owners, especially those who built the company from scratch, have a deep knowledge of their business. They also recognize the value of the company, but they may not know what it takes to monetize that worth.

It can be eye-opening to go through a business valuation and determine what needs to be accomplished in order to find the right buyer, if that’s the chosen path. It is important to engage the right team of advisers and give yourself time to complete the process to ensure you achieve your end goals.

Insights Legal Affairs is brought to you by McCarthy, Lebit, Crystal & Liffman

HIPPA and business agreements: what service providers need to know

Anyone who has been to a doctor’s office knows that the Health Insurance Portability Act (HIPAA) protects the confidentiality and security of identifiable patient health information (PHI). Yet, many businesses newly marketing services to the health care industry are not aware of the impact of HIPAA on their business.

“The relationship between health care providers and their service providers who handle PHI requires a written business associate agreement (BAA),” says Jules S. Henshell, Of Counsel at Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Henshell about what to consider when signing a HIPAA business associate agreement.

Who is a business associate?

A business associate is any individual or entity that creates, receives, maintains or transmits PHI in the course of performing services on behalf of a HIPAA-covered entity. The HIPAA Omnibus Rule makes business associates of HIPAA-covered entities directly liable for violations of HIPAA and the Health Information Technology Act (HITECH).

What is a business associate agreement?

A business associate agreement is a written agreement, required by HIPAA, between a covered entity and a business associate that describes the rights and responsibilities of each party with respect to the handling of PHI, compliance with HIPAA and implementing regulations known as the HIPAA Omnibus Rule.

How can a company evaluate whether or not a proposed BAA is acceptable?

Certain elements of every BAA are required by law. Other terms are not expressly required. The latter are potentially negotiable. For example, HIPAA does not require that a business associate agree to indemnify a covered entity in the event of breach of PHI, but a covered entity may want such protection. Similarly, HIPAA requires that a business associate agree that the Secretary of Health and Human Services will have access to its books and records. HIPAA does not require that a BAA include such access by a covered entity, but a health care provider may want to audit HIPAA compliance by the business associate.

In addition to review of the terms proposed by the covered entity, the acceptability of a proposed BAA may turn on the following considerations:

  1. Determine if you are a business associate — Will you be creating, receiving or transmitting PHI in the course of performing services? If the services agreement does not entail handling PHI, there is no reason to sign a BAA.
  2. Consider your ability to comply with the BAA commitments — Do you have policies, procedures and safeguards for protecting privacy and security of PHI?
  3. Consider your bargaining power to negotiate — Is the covered entity willing to entertain discussion of the terms of the BAA not required by HIPAA? Contracting officers for large health systems may resist negotiation, but allow for direct discussion between their legal counsel and your lawyer.
  4. Consider whether you will be using a subcontractor to perform — Do you have a subcontractor agreement to ensure that your subcontractor complies with HIPAA? Does it include timeframes that enable you to meet breach notification deadlines in the proposed BAA?
  5. Consider your risk in the event of security breach of PHI.

What is at risk if a business associate violates HIPAA rules?

There are substantial civil monetary penalties for each HIPAA violation. Civil monetary payments totaling $22,855,300 were made to the Department of Health and Human Service’s Office of Civil Rights (OCR) to resolve HIPAA violations last year. In 2016, OCR also announced its first enforcement action directly against a business associate, Catholic Health Care Services of the Archdiocese of Philadelphia. The resolution agreement imposed a $650,000 monetary payment and a corrective action plan, signaling new focus on enforcement against business associates.

Such focus is likely to continue as OCR identifies business associates through ongoing audits of covered entities.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Understanding the role lawyers play in a turnaround situation

A lawyer is an integral part of a turnaround team, uncovering legal issues in a way that allows the financial and business advisers to find the best path to turn the company around.

“It’s not the lawyer who is responsible for finding a turnaround solution, but rather he or she serves as a translator between the financial and business professionals, and someone who can assemble and lead the team that ultimately puts together the turnaround strategy,” says Gary Philip Nelson, a shareholder at Sherrard, German & Kelly, P.C.

Smart Business spoke with Nelson about company turnarounds, and what and who should be involved.

What are the first steps in a turnaround?

A key aspect of working with a troubled company is understanding what the lender is trying to accomplish and how it views the borrower; is it just an asset to be managed or is the loan part of an ongoing business relationship between the two?

A lawyer will consider relevant documents pertaining to loans and will do a lien search to see who, if anyone, has judgments or security interests in the debtor. Then the lawyer will assemble and analyze those loan documents, looking for leverage to negotiate more favorable results. A company that owes money and does not have much equity or personal resources will often take whatever it can get from a lender. A company with leverage can have a more even exchange because a vulnerable lender will recognize its vulnerability and try to contain its exposure by giving something up to fix the problem.

With the nature of the relationship understood, a lawyer can help the company find the right set of professionals to identify the problems and lead the turnaround.

When is bankruptcy a more viable option?

Because the cost of Chapter 11 is now very high, the tendency is to attempt a non-bankruptcy court solution through a forbearance agreement, a state court receivership, or other non-bankruptcy solutions that are now more popular because they might be faster and less expensive. These alternatives give companies more control than going through court where creditors have a say or can band together in a lawsuit. They also allow banks and management to focus on the core problem and have a fighting chance to solve it.

A Chapter 11 proceeding can come into play, however, if the company gets into a situation in which it would be profitable if it were not buried in litigation or facing a large volume of personal injury or product liability lawsuits. Going into bankruptcy in these instances could result in the creation of personal injury settlement trusts for the benefit of tort victims, which offer protection to the post-bankruptcy company from mass tort plaintiffs.

What are the unique skills lawyers bring to turnaround situations?

When there are competing liens against a company’s assets, the lawyer can weigh in on who has the first priority so that everyone involved can focus the turnaround discussions on the right parties. If there are liens that exceed the value of the collateral, the company may need bankruptcy to wipe them out because whoever holds them won’t voluntarily give up a lien position, even if there is no value.

Generally, officers and directors owe fiduciary duties to a narrow range of stakeholders. But, in certain jurisdictions, when a company is insolvent, the stakeholder group might expand to include creditors and employees, and result in an expansion of the fiduciary duties of managers and directors to include more constituents. Knowing this, and depending on who is the engaging client, experienced insolvency counsel can help managers or directors take appropriate actions to make a workout successful.

One of the more intricate areas in which a lawyer can help is with employment relationships, such as understanding the company’s responsibilities in collective bargaining agreements, whether it can lay off workers without notice, and what sorts of severance arrangements exist under current employment contracts.

A lawyer equipped with the necessary skills in this field can quarterback a turnaround situation, recruiting the help of service professionals and assigning them tasks while advising a company on whether an out-of-court or in-court solution is the best path. They are a vital part of the process.

Insights Legal Affairs is brought to you by Sherrard, German & Kelly, P.C.

Proper planning is a critical piece to a successful business sale

Owners looking to sell their business should begin planning as soon as they can, says Michael D. Makofsky, Principal at McCarthy, Lebit, Crystal & Liffman.

“The sale of a business is one of the most significant events in an owner’s life. An owner is understandably eager to close the deal, monetize and move on to the next chapter,” Makofsky says. “It is not very realistic, however, for an owner to suddenly decide to sell a business, try to do so quickly on one’s own and expect an optimal result.”

Smart Business spoke with Makofsky about steps an owner can take to make the process run more smoothly.

What are the key first steps when you’re looking to sell your business?
You need to know the value of your business before trying to sell it. That goes beyond income, revenue, debts and expenses — it is an understanding of what your company is worth on the open market. You may overestimate the value of your company, only to be disappointed with lower offers from potential buyers.

A valuation can provide a clearer view of the state of the business. With that frame of reference, you are more equipped to handle offers.

A potential buyer will conduct due diligence. Proper preparation can help you as the owner more readily identify information buyers are interested in. Consider the questions a potential buyer might ask. This enhances your credibility and minimizes potential surprises that could lead a buyer to try to renegotiate a deal or walk away altogether.

How can advisers help you get a better deal for your business?
Owners often try to sell their business by themselves. After all, you know your company better than anyone. However, you may not understand how to fairly value your company, how to market it, how to negotiate legal documents, tax implications or how to manage the proceeds.

There are many complexities in mergers and acquisitions that, if not handled properly, can lead to unfortunate results. Assemble a team of professionals who can guide you through the process. Experienced investment bankers, accountants, M&A attorneys and financial advisers can help navigate the transaction.

When you have a strong team of advisers, they can interact with potential buyers and present the best picture of your company. They can also work through issues and mitigate risks, all of which can lead to a successful transaction closing.

When owners contemplate a business sale, many envision selling their entire interest to a third party. This traditional type of sale, however, may not always be possible or in your best interest. Advisers can help develop alternatives that provide flexibility to better meet your needs.

What are some common concerns that come up in a negotiation?
In a purchase agreement, an owner makes representations and warranties regarding various facets of the business. Representations often include statements regarding financial information, payment of taxes, conditions of assets, intellectual property and status of contracts.

You must be able to confirm the veracity of all representations before signing a definitive agreement. With respect to intellectual property, for example, does the company really own what it purports to?

Companies routinely require employees to sign invention, confidentiality and non-compete agreements that assign ownership of intellectual property created by the employee to the company and ensure that employees cannot “set up shop” down the street. Not having effective agreements in place beforehand creates intellectual property risks for a prospective purchaser.

Another example is customer and/or vendor contracts. Are there written contracts in place and are they valid?

Many contracts also require consent from the counterparty prior to assignment, or contain provisions allowing a party to cancel or terminate in the event of a change in control of the business of the other party. To avoid altering these relationships, the process of obtaining consents or waivers of the change in control provisions needs to be managed carefully.

While there are many situations that can disrupt a transaction, advisers can help identify issues like these in enough time to rectify the situation and facilitate a smooth closing.

Insights Legal Affairs is brought to you by McCarthy, Lebit, Crystal & Liffman

Lessons from sports team deals that can be applied to buying a business

Buying a sports team, in many ways, is similar to the purchase of any other business: Buyer and seller negotiate the price, lawyers do the due diligence and prepare the acquisition agreement.

“The difference, especially with major league teams, is that there is a limited supply — they don’t often come on the market,” says David Lowe, shareholder and director at Sherrard, German & Kelly P.C., who has worked on both major and minor League sports team acquisitions that include the Florida Panthers, Texas Rangers, Buffalo Sabres and Buffalo Bills. “And when they do, there can be fierce competition for them. That competition can result in prices that don’t seem to make any sense if you apply the traditional valuation metrics used in most other acquisitions.”

Smart Business spoke with Lowe to get a behind-the-scenes look at the unique process of buying a sports team and lessons that can apply to other business purchases.

What are some of the unique conditions that apply to the purchase of a sports team?

One primary difference between buying a business and buying a sports team is that buyers of sports teams are applying to be members of an exclusive club. League owners must approve any potential new team owners, and buyers can be surprised by the league rules. For instance, most leagues have limitations on the amount of debt an owner can have on its books. That can limit the ability of a buyer to finance the purchase with a bank deal because it requires that more equity be put into the purchase than might be typical in other industries.

Sometimes it’s a group of owners that want to buy a team, which is not uncommon since the prices are so high. However, all owners must go through the vetting process, which includes extensive background checks and review of assets and liabilities. If approved, there are restrictions put on the owners’ ability to transfer ownership of the team. Every time there’s a transfer, there’s a vetting process.

Many leagues require owners to sign a guarantee that they will, in addition to their equity, put in additional money to pay the team’s bills, creditors, or otherwise keep the team operational. Some of the leagues have more ability to control individual teams than others. The NHL requires all owners to grant the league a proxy on their ownership interest in the team, which allows the league to take control of a team under certain circumstances.

What are potential buyers looking for in sports team deals?

Sports team acquisitions tend to focus on stadium or arena lease terms and what rights the team owner has to control events at that location to generate revenue. Sponsorship contracts, suite and ticket sales and concession vendor contracts are important and are key areas of focus in the due diligence process. New team owners also examine player contracts for guaranteed money obligations.

Media contracts are also important in leagues in which local media contracts are negotiated by individual teams. NHL, MLB and NBA teams can generate significant income from media contracts or by setting up regional sports networks to broadcast their games locally. In the NFL, conversely, the league negotiates most of the media deals.

Buyers of sports teams, as opposed to other types of businesses, are not necessarily looking for year-over-year generation of net profit return. While that’s a consideration, the real upside is in the increase in valuation of the team over time. There currently doesn’t seem to be any abatement in the increase in value of sports teams, especially in the NFL, MLB and NBA where there recently have been high prices paid for teams. Owners can expect, after seven or 10 years, to make quite a bit of return in a sale.

What lessons from buying sports teams can be applied to buying a business?

With the acquisition or purchase of any business, hire lawyers and advisers who are familiar with the industry of the entity being bought. They’ll bring an understanding of the unique features of the business and the industry. They can more easily steer buyers through the process and identify the key business and legal issues more readily than generalists.

Insights Legal Affairs is brought to you by Sherrard, German & Kelly, P.C.

How to protect your business against wage and hour lawsuits

A worrisome trend for businesses is the explosive growth of wage and hour lawsuits. The Department of Labor reports that it receives nearly 25,000 wage and hour related complaints per year, and the number of lawsuits brought against companies under the Fair Labor Standards Act (FLSA) continues to soar — wage and hour lawsuits against companies for violations of the FLSA have increased 456 percent since 1995. These lawsuits can be expensive to defend, extremely disruptive and often result in the payment of significant settlements.

“The popularity of these lawsuits is explained by the potential for recovery,” says Stephen C. Goldblum, a member at Semanoff Ormsby Greenberg & Torchia LLC. “Even a small wage and hour violation can result in large damages when the claim is brought on behalf of all similarly situated employees.”

Smart Business spoke with Goldblum about wage and hour violations and how companies can steer clear of them.

What types of claims are brought in wage and hour suits?

Although failure to pay overtime wages accounts for nearly 40 percent of wage and hour class action lawsuits, these suits can include a variety of other claims including: misclassification of employees, failure to pay for off-the-clock time, failure to pay for meal breaks, and failure to pay compensable time before and after a work shift. A burgeoning area of concern is the failure to pay employees for the use of email and mobile devices outside of working hours.

How can companies decrease the chance of a wage and hour suit?

An internal audit of wage and hour practices by expert outside counsel can identify and help prevent most violations of the law, thereby helping to avoid a lawsuit. The cost for such a review is substantially less than the fees to defend a single claim.

An effective wage and hour audit will include a thorough review of the company’s policies and practices, including a review of employee classifications, independent contractor relationships, timekeeping and payroll practices, employment policies, overtime calculations, and whether and to what extent managers are properly trained with respect to these issues. If violations are found, counsel can offer strategies to correct them and deal with any potential back pay obligations in ways that reduce the likelihood of litigation. After an effective audit, a company will know and understand any existing risks and can take steps to bring the company into compliance.

How important is it to review and revise wage and hour policies?

One of the most vital things a business can do is to periodically have its wage and hour policies reviewed by an attorney well-versed in this area of the law. For example, handbook policies that notify employees of the company’s expectations regarding off-the-clock work and meal and rest periods are a vital tool in defending wage and hour claims. Moreover, a clear policy that states smartphone use during off hours is only permitted with supervisory approval and must be recorded and reported immediately (i.e., within 72 hours) is recommended, as is a statement that ‘off-the clock work is prohibited.’ Employers should additionally ensure that time cards and electronic recording programs contain language that require employees to confirm that they have recorded all time worked. Finally, clearly articulated meal and rest period policies are now a necessity in employee handbooks.

How can companies implement effective time-keeping measures?

Employees and former employees often assert in class action lawsuits that the hours paid were not accurate because the hours were under-reported or not reported by the employee. To prevent this type of claim, ensure that time-keeping practices are well documented and that the reported time is verified by the employee. Best practices for accomplishing this include using a standard system to record all time, either electronically or with an actual punch-clock; having each nonexempt employee record, review and sign off on their time each pay period; implement a signed verification that the hours reported accurately include all time worked for the period; and training supervisors to monitor and review employees’ time records.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Pennsylvania adopts comprehensive laws governing limited liability companies

On Nov. 21, 2016, Pennsylvania Governor Tom Wolf signed Act 2016-170 into law, enacting sweeping reforms to the state’s statutory law pertaining to limited liability partnerships, general partnerships, limited partnerships and limited liability companies. The changes to the law as it relates to LLCs should be of particular interest to many business owners throughout the Commonwealth, as the LLC is the most popular corporate form, and the most suitable for many businesses.

“Generally speaking, the effect of the law is to streamline and harmonize Pennsylvania corporate law as it applies to different types of entities, thus eliminating some of the confusion that had previously existed among the different statutory sections that had previously governed entities in Pennsylvania,” says John M. Hickey, an attorney with Semanoff Ormsby Greenberg & Torchia LLC.

Smart Business spoke with Hickey about what this law change could mean for businesses.

When do the changes become effective as they pertain to LLCs?

The act is fully effective against all LLCs on April 1, 2017. Prior to that date, the law applies to:

  • LLCs formed on or after Feb. 21, 2017.
  • LLCs that elect to have the law apply sooner.

Why is the LLC designation desirable for most business owners?

In three words: protection with simplicity. The LLC affords its members the same protections of the corporate form without the added baggage of corporate formalities and corporate double taxation. Consider that one of the primary reasons business owners incorporate is to protect themselves from personal liability, and the LLC does just that —LLCs offer the same protection from personal liability that a corporation offers. Also of importance is the tax structure of the LLC. An LLC is considered a ‘pass through entity,’ which means that the members of an LLC are only subject to a single layer of taxation, much like any individual paying personal income tax. Further, an LLC is inherently flexible. It can either be managed by its members, or managed by a manager appointed by the members. There is no need for any periodic meeting of the members.

In a corporation, shareholders are subject to ‘double taxation’ — once when the corporation receives revenue, and again when that revenue is distributed to the shareholders. Further, corporations must hold meetings of the shareholders and periodically elect directors to carry out the functions of the corporation.

What are some of the changes made by the act to the law governing LLCs in Pennsylvania?

By adopting the act, Pennsylvania becomes one of the first states to have adopted the latest version of the Uniform Limited Liability Company Act. These uniform acts are developed by scholars and professionals as model acts for states to adopt and employ, and are meant to encourage consistency and quality in the law between states. The effect of the act is essentially two-fold, in that it both clarifies existing principles of law and establishes new rules applicable to LLCs and their members. With regard to an LLC, the act sets forth specifics on formation and governance, duties owed by members and managers to each other and persons dealing with the LLC, authority and liability of members, the treatment of interests in the LLC, and dissolution. Another big change includes a clarification regarding the duties owed between members of an LLC in the context of a member-managed LLC. Now, members owe one another a fiduciary duty, duty of care, and a duty of good faith and fair dealing.

What is the expected impact of the act?

The act should make Pennsylvania a more favorable place to be incorporated. The law benefits from consistency and clarity, as it is ambiguity and inconsistency that give life to litigation. Remember that, in the world of law, the LLC is still a relatively new creation. Before the act, it was not always clear that certain aspects of corporation law would apply to LLCs, despite the fact that numerous court decisions have held that wherever possible, the governing law should be consistent between an LLC and a corporation.

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

Settle disputes before they happen by drafting effective governing documents

There are misconceptions that people have at the outset of a business relationship that, over time, can present difficulties for the entity they create.

“People enter into a business partnership believing that the relationship is premised upon and strengthened by their personal friendship, and that their personal friendship will steer them through tough times,” says Christopher Passodelis, Jr., a shareholder and co-chair of the Litigation Services Group at Sherrard, German & Kelly, P.C. “Unfortunately, personal friendships deteriorate rapidly when disputes arise as to the direction of the company. That often leads to hostility that pollutes and corrupts. The reliance on friendship is misplaced and needs to be taken out of the equation.”

When entering a business relationship, he encourages partners to create governing documents that set the rules that guide the actions of a company from the start.

Smart Business spoke with Passodelis about governing documents, why they are important and what they should include.

What documents should shareholders prepare at the outset of a relationship?

Operating, Partnership and Shareholder Agreements set the rules that guide how a company will be run, creating, in essence, a roadmap to follow as partners navigate through various circumstances. These foundational documents are otherwise important because they force potential partners to consider and discuss major issues before entering into a formal business relationship. This can help determine if the two potential partners share similar goals. If not, it is better to forgo a partnership before money and time are wasted.

Governing documents dictate the ways in which the company will manage day-to-day affairs and long-term planning, how the company would approach a sale event, and how partners leave and new partners enter the business, among other issues.

They can also set the rules for appointing a board to oversee the business. It is best if the board has an odd number of members who are not closely affiliated with one partner or the other so they can dispassionately help resolve conflicts with minimal bias.

The process of dispute resolution among shareholders must be addressed. The risk of business failure is highest when partners are focused on disputes among themselves rather than minding the underlying business.

What options do shareholders have when it comes to dispute resolution?

To address disputes, build in a resolution process that starts with each side presenting their position at a special meeting with the board to seek their guidance, relying on their independence to decide what is in the best interest of the company. That is akin to an informal mediation.

The next step would be to retain an independent mediator to guide the partners to a resolution. Mediators are professionally trained to help find common ground.

If that fails, some form of litigation is next. Regardless of the approach — arbitration or court — the struggles associated with this last step are rarely worth the effort because it is such a caustic process.

To offer a way out for two partners who cannot get along, an effective solution is to include a ‘shotgun clause’ in the agreement. This gives either party the option to make an offer, to the other, to purchase his or her shares, and the party receiving the offer then has the opportunity to either accept the offer or buy the other partner out for the same amount. It can be a hard decision, but the value that you preserve is higher than the value that you lose in litigation.

When should legal counsel get involved? Does each partner need a lawyer?

The most effective approach is to have the company hire a lawyer who works to reach an agreement that favors the company over any other partner. Individual partners should be represented by their own independent counsel to ensure that they understand the effect of the agreement. Working with unbiased legal counsel in the formative stages can ensure that the terms and conditions in the governing documents are clear and fairly applied to both parties.

Forming an enterprise is serious and should be considered from every perspective from the outset. Separate emotion from the process and rely on governing documents as the guide. When times get difficult, this document will offer a logical way to resolve problems.

Insights Legal Affairs is brought to you by Sherrard, German & Kelly, P.C.

Mediation can be a useful tool for companies locked in conflict

When your business is entangled in a legal dispute, mediation offers a way to resolve the conflict that can save both time and money. But, you must enter into the process with the right frame of mind, says David A. Schaefer, an attorney at McCarthy, Lebit, Crystal & Liffman.

“Some companies use mediation to learn more about the other side’s case or position,” Schaefer says. “They view it as ‘cheap discovery’ or in other words, a means to prepare for their eventual day in court. As a mediator, I think the ultimate goal of mediation should always be resolution.”

If you don’t know enough about the other side’s position, there’s a better way to get informed, according to Schaefer.

“Start a conversation with your adversary and run through your questions,” he says. “Go into the process with a sense of urgency to understand, but also a spirt of compromise and intent to resolve the conflict.”

Smart Business spoke with Schaefer about mediation and the benefits it provides to businesses when used in place of traditional litigation.

What are the origins of mediation as a tool to resolve legal disputes for businesses?
In 1990, Congress passed a statute known at the time as the Civil Justice Reform Act. It was pushed by the American business and insurance communities in response to concern that civil litigation had become too expensive and was affecting the ability of U.S. businesses to remain competitive. Cleveland was one of 12 cities designated as a pilot city to see if mediation would work for commercial disputes.

Once this door was opened for cases that were already in the court system, people began to ask why they had to wait for their case to be sent to mediation by a judge. Today, most mediation cases begin as lawsuits, but it’s not uncommon for a dispute to skip the courts and go straight to mediation.

What enables mediation to be effective?
A mediator has nothing to gain by the outcome of your dispute. His or her role is to gather facts, hear from both sides and use that knowledge to drive the process toward a settlement that is acceptable to both parties. It may be helpful for the mediator to offer an opinion at some point, but it’s always done in a neutral way and from the perspective of an outsider who is examining the case for the first time.

Written mediation statements are an important part of the process. They provide an opportunity to explain in writing what has happened and what led to the dispute. The more complicated the case, the more important the mediation statements become. They give the mediator an opportunity to prepare notes and questions in advance of the mediation session.

These questions can be used to gain understanding about aspects of the case or to make one side think about a particular point, typically a weakness in that side’s case. It’s important through this writing process to pull together the points of the dispute that favor your side and at least privately compile the points that favor the other side. You want to be as informed as possible going into mediation.

What about the cost of mediation?
Mediation eliminates the need for depositions, the filing of motions and, of course, a trial. A typical mediator in Northeast Ohio will charge about $300-$400 per hour and the average mediation is eight hours.

When all is said and done, factoring in the cost of a mediator, attorneys on both sides and the preparation to get ready for the case, mediation will cost a company around $5,000. If it resolves the case, it’s always cheaper than what it would cost to go to court.

If you find yourself in a legal dispute, give your attorney clear direction as to what you’re willing to accept to resolve it. Be upfront about what you’re willing to pay if you’re the defendant or what you’re willing to accept if you’re the plaintiff. Consider the scope of the case and what’s at stake to ensure these figures make sense, so your attorney can properly represent you.

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