Considerations when making generational ownership transitions

Some firms owned or dominated by family have achieved monumental success. Others have found the transition process difficult. Relentless competition, caused in part by the internet, and struggle for customer loyalty, combined with the thorny issues of family dynamics, are challenging.

Smart Business spoke with Howard N. Greenberg, managing member of Semanoff Ormsby Greenberg & Torchia, LLC, about making generational ownership changes in a family business.

How should owners prepare to transfer control of a family business?

The first step is making certain each potential successor is fully committed. Talk to them well in advance and explain the benefits and pitfalls of ownership and control. Evaluate their interest, qualifications and commitment. All three are required. Performance in college, grades and choice of major are important signs.

Prior to joining the family business, outside employment in a related field is extremely beneficial. Working for an accounting, finance or legal firm can provide the younger generation with confidence, stature and valuable knowledge. Performance on the outside likely will evidence future performance with the family business.

You shouldn’t, however, staff your business based on family. Staff it based on talent. Perhaps your family has talented managers, or people knowledgeable in finance. If not, you need to fill the gaps with non-family members. Similarly, if the third generation isn’t ready to take the reins, bring in interim managers as caretakers until the younger generation is ready.

How do generational mindsets affect success?

Typically, entrepreneurial founders do not have significant resources, but they do have lots of resourcefulness, drive and passion for the business, as well as talent and willingness to work very long hours with little pay. These characteristics and an intense drive to succeed help an entrepreneur create something that hopefully can be passed on to the next generation.

The second generation watched parents exert their efforts into their business venture, witnessed their passion and hopefully it rubbed off on them. They feel the responsibility to further the business and want to impress their parents. Though they might not have quite the same drive, they may have the privilege of greater resources and education. They are often successful at maintaining, growing and managing the business.

The next generation is where problems may arise and where outside help may often be required. The third generation usually has more resources, more education and more alternatives than the founding patriarch/matriarch had. But they may have other interests, lack the same drive and abilities, and there are usually more of them.

What should be done for non-participating family?

It may be better to provide the people not actively running the business with other assets from the founder’s or second-generation member’s estate. To reward long-term performance for successor generations running the business, it’s advised that the company recapitalize to lock in the current value with preferred interests. This provides the members of the next generation ceding control and those who choose a different career path with the value of their interests and provides the next generation who will run the business with the value of their future contributions. Include these provisions in wills, shareholder and operating agreements, as well as employment agreements and continuation plans.

It’s extremely difficult for the first or second generation to objectively evaluate the talents and value of their children and grandchildren. And if the second generation comprises more than one sibling, there will be arguments concerning rewarding the third generation and picking leaders. Trying to make things equal for everyone is a mistake. People are not equal. Their talents differ. Outside advisers and consultants can help make these decisions objectively. They can assist in preparing the comprehensive agreements that are carefully tailored to the particular family business. Doing this in advance of the generational transition is imperative.

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

Be prepared before buying property together

There are many issues for prospective property owners to consider before owning property with another party. From the form of ownership of the property, to agreements on use and cost sharing, the parties should make sure they have reached an agreement on all issues and that agreement has been memorialized in writing, as early as possible in the process of buying a property.

“The earlier the parties discuss the issues of joint ownership, the better,” says Catherine Marriott, a member of Semanoff Ormsby Greenberg & Torchia, LLC.

Smart Business spoke with Marriott about helping buyers make informed decisions about joint ownership of property to avoid major trouble down the road.

What are the main types of joint ownership of real property?

When there is more than one party who will be an owner of a property, the parties can own the property as tenants in common, joint tenants with a right of survivorship or tenants by the entirety. In a tenancy in common, each party owns an undivided interest in the whole of the property, either in equal ‘parts’ or as designated by a percentage in the deed. In the event of the death of a tenant in common, the decedent’s interest passes to the party or parties named in the decedent’s will. When property is owned as joint tenants with a right of survivorship, upon the death of one of the owners, the decedent’s interest passes by operation of law to the surviving owner or owners. Only married couples can own property as tenants by the entirety, which provides that the couple, together, owns an undivided interest in the entire property. Upon one spouse’s death, their interest passes by operation of law to the surviving spouse.

How do property owners decide which is the best form of ownership for them?

Intent of ownership upon the death of an owner is a major consideration in the form of ownership. Another major consideration is access to a party’s interest in the property by the owners’ creditors. Depending on the form of ownership, creditors may have more or less success in attaching to a party’s interest in the real estate, or forcing the sale of the property, when seeking to collect a judgment. Most married couples own property as tenants by the entirety. There are reasons beyond the scope of this article why a married couple may not want to own property as tenants by the entirety. Similarly, most unrelated parties choose to own property as tenants in common, which is the presumed form of ownership for unmarried individuals if no form of ownership is designated in the deed.

What else should be discussed?

One of the biggest issues that the parties will need to figure out is how the costs of acquisition and ownership will be shared. How much will each party contribute in order to buy the property? If the purchase will be financed, will both parties be personally liable? Will the parties set up a bank account and each put money into the account on a regular basis? What if a party doesn’t pay? How will the parties determine if improvements and repairs are needed? What if they don’t agree? The list goes on and on.
The parties also need to determine who can use the property and when, especially in the case of a vacation home. Will the property be rented? Can the parties have guests and how will that work?

Another major consideration involves a party’s desire to sell his or her interest in the property. Most agreements restrict the ability of a party to sell to a third party or require an offer to sell to the other owner or owners, and many agreements include a formula for determining the purchase price. The same consideration should be given to what happens when a co-owner dies. The agreement should address if the surviving owner can or must purchase the interest and on what terms.

There are many issues that parties need to work through before buying property together. Once buyers locate a property, there will be a flurry of activity — the parties will negotiate the terms of an agreement of sale, apply for financing, complete inspections and prepare for closing. Timetables will vary. The more prepared buyers are up front, the smoother things will go as closing approaches.

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

How recent changes to unemployment benefits affect employers

The Commonwealth of Pennsylvania has made adjustments to the unemployment compensation requirements that employers need to know, including compelling employers to provide newly laid-off employees with information regarding unemployment benefits.

At the same time, the federal government has incentivized employers to retain employees through the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act with Paycheck Protection Program (PPP) loans, which includes a provision that grants employers repayment forgiveness if they meet certain criteria, including maintaining a high percentage of their workforce.

Smart Business spoke with Joseph Wendell Fluehr, an attorney at Semanoff Ormsby Greenberg & Torchia, LLC, about what employers need to know about these laws and programs to stay in compliance.

How has eligibility for unemployment benefits in Pennsylvania changed?

The recent federal laws, including the CARES Act, have expanded Pennsylvania citizens’ access to benefits, including gig workers like Uber and Lyft drivers, independent contractors and self-employed individuals. Employers who are making the difficult decision to reduce employees’ hours or even layoff or furlough employees, whether or not caused by COVID-19, can recommend to their employees to apply for unemployment benefits with the Pennsylvania Office of Unemployment Compensation.

What responsibilities do employers have?

Governor Wolf recently enacted Act 9, which provides that each employer, whether or not the employer is liable for the payment of unemployment benefits, must provide notice to employees of the availability of unemployment compensation. The Office of Unemployment Compensation has created form UC-1609 for employers to use to satisfy this notification requirement. The form provides employees with information in the event they decide to apply for unemployment benefits.

What if an employer is able to offer reemployment?

If an employer submits a bona fide written return to work offer for employees laid off or furloughed due to COVID-19 and the employee refuses to return to work, the employer may, but is not required, to submit Form UC-1921W – Refusal of Suitable Work available to the Office of Unemployment Compensation to avoid an employer’s unemployment compensation contribution from increasing. Pennsylvania is currently not increasing contribution rates for employers based on an increase in employees requesting unemployment compensation due to COVID-19. Before filling out and sending Form UC-1921W, it is important for the employer to consider any refusal based on its given set of facts. A former employee may rightfully refuse reemployment, or accept a position but not return to work, and be protected by federal and/or state laws, including the Families First Coronavirus Response Act. Further, former or current employees may require a reasonable accommodation based on a medical need or need to care for family members before returning to work. In these scenarios, employers should work with employees to determine if the work or job duties can be reasonably altered to accommodate an employee’s needs.

How might a borrower’s PPP loan forgiveness amount be affected?

The U.S. Department of Treasury guidance requires employers to document the written offer of rehire and the employee’s rejection of such an offer. Submitting Form UC-1921W will assist employers in abiding by the documentation requirements to exclude such employees from the PPP loan forgiveness calculations. Some of the new laws enacted to help employers and employees during the pandemic are set to expire by the end of 2020. Employers should be sure to act reasonably in these times in both operating their business and assisting employees who seek benefits. That being said, the laws and guidance are regularly being updated as the pandemic continues. Employers can contact their attorney with any questions or concerns related to operating or reopening during COVID-19, including maximizing forgiveness on PPP loans.

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

Keep proprietary information safe with remote employees

When the economy started shutting down in March as a result of COVID-19 and employees began working remotely, keeping intellectual property and proprietary information safe didn’t top the list of companies’ concerns.

“Some businesses didn’t put procedures in place or have appropriate training classes because no one really thought the pandemic would extend as long as it has,” says Carl Ronald, shareholder at Babst Calland. “They didn’t instruct employees on how to identify important confidential information or safeguard certain proprietary documents when working from home.”

Smart Business spoke with Ronald about how to keep your company’s proprietary information safe when employees are working outside the office.

What approach should employers take to protect proprietary information?

There are different levels of confidentiality with different information, so I like to begin by identifying the information you have and classifying it accordingly. Some things are sensitive and you’d prefer them not to be disclosed, such as manufacturing schedules, production forecasts, or discounts for specific customers. But while those are things you don’t want your competitors to know, it isn’t going to be disastrous to the company if they are inadvertently disclosed.

Other information, such as a trade secret or the development of a new process that gives you a competitive advantage can devastate your business if it gets out. So, the first step is to identify the information you have and label it appropriately.

Second, businesses should train employees on the different categories of information and make sure they are treating each properly. Make sure everyone understands the importance of keeping information safe and reiterate basic steps to create barriers to access, such as not sharing passwords and using privacy screens when laptops are used in public.Third, identify employees who have access to confidential information and make sure they are bound by confidentiality agreements. While those may not ultimately prevent someone from disclosing, it makes it easier to claw back information that was improperly disclosed and it does strengthen your defense to allegations that you didn’t properly safeguard your trade secrets.

How does having employees working remotely change the equation?

Leadership should consider where employees are working and who may have access to proprietary information of the company. If an employee shares a computer at home with a child — whether a work-issued device or an employee-owned device — it is possible the child could accidentally install a key logger or some other malware that could compromise the security of the company’s infrastructure and information. Employees should use a dedicated work computer and family members should not use it without adequate safeguards.

For example, if an engineer is working from home and developing new technology on behalf of the company, who has access to that workspace? If the product may be patentable, it’s vital to keep that work from being disclosed, because disclosure could jeopardize a potential patent. It’s harder when employees are working remotely to monitor them, and you need to ensure information is treated appropriately.

It’s important to consistently remind employees to protect information and reinforce basics such as being cautious about printing documents, not leaving screens open and ensuring sensitive information isn’t shared on unsecured networks.

What other steps can companies take to protect IP?

Have a VPN connection to a secure server maintained by the company. If employees are working in a public place, have them use their phones to create hotspots that no one else can access. Involve your IT staff in talking about device use. And designate a point person for employees if they have questions about how a document should be treated.

Good information hygiene requires diligence on the part of both management and employees. It’s really important to consistently identify information you want to protect, determine how it should be protected and communicate that to employees, both through written guidance and virtual training.

Insights Legal Affairs is brought to you by Babst Calland

Challenging your Notice of Valuation to decrease your tax burden

The Philadelphia Office of Property Assessment determines the fair market values of properties throughout Philadelphia. These values are the basis of real estate taxes for such properties. When assessments are changed, the changes are reflected in Notices of Valuation, which inform property owners of the changes to the values of their properties and, therefore, the new assessment on which their taxes will be based.

“It’s not a bill,” says Jeffrey G. DiAmico, a member at Semanoff Ormsby Greenberg & Torchia, LLC. “It doesn’t tell the property owner how much their taxes are changing. It tells the property owner the change in the assessed value of their property, which is most likely an increase.”

Unfortunately, he says, property owners commonly disregard the Notices. This disregard leads to fewer options for the property owner, and dwindling time to challenge the assessment, which would potentially lower their annual tax bill.

Smart Business spoke with DiAmico about Notices of Valuation, what they mean and how property owners in Philadelphia can challenge them to reduce property taxes.

When property owners receive their Notice of Valuation, what should they do?

Historically, a Notice of Valuation has been issued from the Office of Property Assessment with respect to a property after a new structure is built or when assessable improvements have recently been completed; assessable improvements being enough of an improvement in the property that a change in the assessed value of the property is required. New construction of any kind was generally the triggering event for a new assessment on a property. More recently however, Philadelphia has been reevaluating market values and issuing Notices of Valuation for all properties in Philadelphia, not just new construction and those with recent improvements.

Property owners who receive a Notice of Valuation have a limited amount of time to appeal the updated value. When property owners receive the assessment change, they should review it and immediately contact their tax advisers or attorney to see if the value is accurate based upon the current market value of the property.

What options exist for property owners who believe the valuation is incorrect?

Those who want to challenge the valuation can seek an appeal. In Philadelphia, there is a First Level Review allowing a property owner to informally appeal a Notice of Valuation within a certain number of days of receipt, typically 45 days. If a property owner did not submit a First Level Review; was unsuccessful at the First Level Review; or did not receive a timely decision, such owner can file a formal appeal of the real estate market value of the property by filing an application with the Board of Revision of Taxes, typically no later than the first Monday of October of the year preceding the tax year for which the revision is requested. Unfortunately, the First Level Review decision is rarely provided before the annual appeal deadline, so quite often the property owner will also have to file the appeal application with the Board of Revision of Taxes to preserve their right to an appeal.

Following a determination by the Board of Revision of Taxes after a formal hearing, if the property owner doesn’t agree with the ultimate decision, an appeal can be filed with the Philadelphia Court of Common Pleas.

Why should a property owner work with a lawyer to address an incorrect valuation?

Property owners should work with an attorney to make any legal arguments on their behalf either as part of the application process or at the formal hearing. Only specific people may appear before the Board of Revision of Taxes on a property owner’s behalf: the property owner or an attorney representing the property owner. A property owner cannot just send an appraiser or a realtor to testify on their behalf.

Real estate values generally lag behind changes in the overall financial markets. Although property values may not have adjusted just yet, there may be forthcoming revisions to property values over the next six to 18 months because of the current COVID-19 pandemic. Accordingly, property owners should take a look at their current assessment to see if it warrants an appeal this year for reduction of their taxes next year.

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

Pittsburgh’s space industry is thriving

As Pittsburgh and the surrounding region continue to attract and grow companies that support the space industry, a space collaborative is gaining ground to bring stakeholders together.

“If we do things right, Pittsburgh is well-positioned to be recognized as a center for research and commercialization of space-related technologies and innovation,” says Justine Kasznica, an attorney at Babst Calland.

Smart Business spoke with Kasznica about the growing number of local companies and regional stakeholders supporting space exploration.

How did the space collaborative begin?

In 2019, Astrobotic Technology Inc., a Pittsburgh-based space robotics company building lunar delivery capabilities, made national news when it was awarded an $80 million NASA grant for a mission to develop a lunar lander to deliver payload to the lunar surface. This year, Astrobotic was awarded an additional $200 million NASA grant for an historic mission to deliver a NASA rover to drill for water ice on the South Pole of the Moon. A group of individuals representing industry, academia, local and state government, as well as regional economic development organizations — all passionate about space — saw this as a unique opportunity to coalesce a broader network of existing regional assets to establish a space industry group in Pittsburgh.

What role have other institutions played in bringing Pittsburgh to the forefront of space-related industries?

Pittsburgh has been involved in space history since the Apollo era, having manufactured much of the steel and glass hardware, as well as communications technology, for the Apollo 11 mission. Today, the region’s advanced manufacturing capabilities and world-class expertise in artificial intelligence, robotics, and space transport and logistics can propel Pittsburgh to an even more dominant seat at the table.

Local universities, in partnership with industry and the federal government, are actively engaged in planetary science research, space navigation, mobility and robotics programs. Life science companies are researching how tissue reacts, grows and interacts with other factors in a zero-gravity environment.

Other stakeholders are working on advanced technologies that are optimized for an extreme space environment and are developing experiments to send to the International Space Station and beyond. Still others are building business, legal and policy capabilities designed to support a growing global space industry.

What is the collaborative’s goal?

The goal is to become a space economic development organization committed to supporting the emerging global commercial space industry by attracting and growing the next generation of space industry businesses and workforce talent in Pittsburgh and the region.

What is the space collaborative currently doing?

The group is engaging in four distinct ways.

  • Sponsorship and partnership opportunities. The collaborative is looking for and identifying sponsors and partners to support regional programs and events and to identify research and funding opportunities for the region that align with the collaborative’s mission.
  • Ecosystem mapping. The collaborative is building a regional map of key participants in the space industry and identifying relevant cross-disciplinary skills in the region that can be leveraged by the space industry, as well as skills gaps that need to be further developed to enable a robust space ecosystem.
  • Government relations/policy. The collaborative is committed to securing strong partnerships with local, state and federal governments, with the goal of driving the development of policies and laws to support the rapid development of a commercial space industry, on and off-Earth, within the existing Outer Space Treaty framework.
  • Education. The collaborative will develop educational materials, networking opportunities, industry events and speaker series to introduce the public to the regional space ecosystem and drive broad cross-sector collaboration.

Insights Legal Affairs is brought to you by Babst Calland

Squatters’ rights? Discerning fact from fiction in “adverse possession” horror stories

A little legal knowledge can sometimes become a very frightening thing.

Many laypersons have heard accounts, for instance, of “squatters” acquiring legal title to real property, through a doctrine known as “adverse possession,” simply because no one objected to the squatters’ presence for decades. Those stories settle placidly in a hearer’s long-term memory, but they can roar back if she obtains a boundary survey and realizes that she actually owns a swath of land that an adjoining landowner has for decades fenced off, mowed, tended, and otherwise treated as his own.

Has the adjoining owner acquired the area in dispute by “adverse possession?”

Smart Business spoke with William Maffucci, a real-estate litigator with Semanoff Ormsby Greenberg & Torchia, LLC, to find out.

Can someone really obtain title to a property just by occupying it or continuously?

Not exactly. The possession of property for a prescribed (or ‘prescription’) period, often about 21 years, is just one of several requirements to acquire title through adverse possession. The use must also be continuous, conspicuous, and exclusive. And it must be hostile, which means the party in possession is acting as if he were the owner, not a tenant or someone who is occupying the property with the owner’s permission.

However, a party claiming adverse possession need not reside on the property. A party’s continuous use of a property, even without the party frequently occupying it, can sometimes constitute the ‘possession’ required by the doctrine.

Can a claimant acquire only part of a property by adverse possession?

Theoretically, yes, if the claimant is the archetypical ‘squatter.’ But when the area in dispute is along a boundary, the claimant is rarely a squatter. He’s usually just the adjoining owner.

In most states boundary disputes must be resolved through ‘boundary retracement’ principles as applied by professional land surveyors. In Pennsylvania, boundary disputes can sometimes be resolved in a different way: by proving that the adjoining owners have, through their continuous actions, jointly recognized a specific boundary for a sufficient period of time. The boundary so recognized, called a ‘consentable line,’ can become the legal boundary even if it conflicts with the boundary described in the parties’ deeds.

Why don’t the land descriptions in the deeds always control?

When the doctrines of adverse possession and consentable line were developed, many deeds were not recorded. And surveying equipment and conveyancing conventions were crude, so conflicts between two surveys were common. Resort to the doctrines was often necessary to resolve those conflicts.

Although most deeds nowadays are recorded, few of them use boundary descriptions based on new surveys. Instead they incorporate the legal descriptions that appeared in the previous deed or deeds, sometimes extending back a century or more.

Is it necessary for a property owner to file a lawsuit to prevent a claim of adverse possession?

There is another option for an owner who knows that the occupancy or use has not yet continued for the prescriptive period: delivering a written notice that the owner is aware of the occupancy or use, that the owner claims ownership of the area at issue, but that the owner grants ‘permission’ for the occupancy or use. Such ‘permission’ contradicts the claim that the use is ‘adverse,’ and it prevents the user from claiming that the parties’ recognition of a specify boundary was ‘consensual.’

But there’s a risk to this approach. The recipient of the notice might respond that he doesn’t need ‘permission’ because he owns (or so he claims) the property in dispute. Upon receiving such a response, the first party should assume that the ‘permission’ notice was ineffective. To prevent the adjoining owner from acquiring title by adverse possession, she should sue him, before the prescriptive period is complete, to regain possession of the property in dispute.

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

Information security for the 21st century business

When the in-person operations of many companies were mandated to close to slow the spread of COVID-19, businesses got creative. The most popular approach was to implement telework or remote work arrangements, a change expected to stay once businesses resume normal operations. However, if remote work programs continue, it is imperative employers are aware of the privacy and data protection risks they will encounter.

Smart Business spoke with Megan E. Stamm, an attorney at Semanoff Ormsby Greenberg & Torchia, LLC, about how businesses can better protect their information as more employees work outside the office.

How does working remotely create privacy and security issues?

When employees access business information from multiple locations, the information is being retrieved by various servers and networks that may not be secure. In order for business information to be safe from unauthorized users, each employee’s home network needs to be secure.

If a company stores personal information on an unsecure network, a third person can access that personal information and steal an employee’s or customer’s identity, drain bank accounts, sell this personal information to other individuals, and generally cause chaos.

Personal information is not the only valuable information stored on business networks. Customer or client lists can be valuable assets to steal.

What are the legal consequences of a breach?

Some states have implemented privacy laws that protect the use of personal information. These privacy laws hold companies liable if their systems are breached and result in consumer information being accessed.

Pennsylvania’s Breach of Personal Information Notification Act requires entities to notify any affected residents of a security breach involving personal information. Although, the Pennsylvania act does not penalize an entity for the breach (unlike California), notifying each affected resident can be costly to the business. The amount of liability in each circumstance will depend on the business’ safeguards and security measures, how the business remedied and mitigated the damage, and whether affected individuals were notified.

How can businesses better protect their information?

To better protect information from data breaches, businesses should provide employees with company computers/devices to use at home. Although expensive, this will ensure the device is automatically updated and protected with proper firewalls, anti-virus software and encryption technology. If this is not possible, require all employee devices to be updated and installed with proper software or meet with IT to verify the devices are protected.

Businesses can also utilize virtual machine software to only allow employees access to particularly sensitive data from within this virtual setting, allowing the data to be stored only on the company’s systems.

Two-factor authentication should be required for email and other logins. This adds an extra layer of security by utilizing two login credentials that fall into three categories: something you know, such as a password or PIN; something you have, such as a phone number, or key fob; and something you are, such as biometric data.

There should also be procedures put in place to mitigate security breaches. Install features that can remotely render business data unreadable — through encryption software, for instance — and automatically backup or upload saved information to the cloud so that if a device goes missing, saved files can still be accessed.

Also, require employees to only use secured Wi-Fi networks. Unsecured networks, such as public Wi-Fi, are risky because it’s unclear who is using it or who has the ability to access a device from the shared Wi-Fi.

Companies should also distribute privacy policies and train employees on safe searching practices so they don’t fall for phishing scams, download viruses, or inadvertently disclose sensitive or confidential information. This training can benefit employees personally, as information security is just as important for the individual as it is for the company.

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

New rules mean foreign investments in U.S. real estate fall under government review

The rules of international investment in U.S. real estate have changed, and failure to understand these new rules — issued by the Committee on Foreign Investments in the United States (CFIUS) in February — could cause huge headaches.

“If you’re not aware of or don’t understand the rules, that could cause a real estate deal to be undone by CFIUS, potentially resulting in financial harm or making a business liable to a foreign entity,” says Boyd A. Stephenson, an attorney at Babst Calland.

The president has the authority to reverse certain business transactions involving a foreign entity if it is determined they pose a national security risk. CFIUS advises the president on when to do that. In February 2020, that authority was extended to real estate ownership.

Smart Business spoke with Stephenson about the impact of the new rules.

What is CFIUS, and how does it work?

CFIUS is an interagency committee of the federal government that advises the president about mergers and acquisitions, financings, and real estate transactions that involve foreign actors. If a foreign entity wants to invest in or buy a cardboard box manufacturer, it’s generally not a concern. But if it wants to invest in a U.S. startup that’s developing technology with better AI, such an investment would result in a review from CFIUS to determine whether the deal should be cancelled based on national security concerns. This authority is retroactive, so if your deal consummates on April 15 and the transaction is reversed on May 1, you lose that equity stake.

How does the new rule extend into real estate transactions?

The new rule applies to real estate acquisitions that are a certain distance from an airport or seaport, or, for a military installation, up to being within the same county. You need to be aware of the rules, because if you are selling property to a foreign entity, you want to make sure that transaction can be completed. The last thing you want is to go through the negotiating process and have a transaction called back because of a ruling by CFIUS.

For most transactions, companies can submit a five-page declaration with the government, identifying who they are and who the foreign investor is and describing terms of the deal. CFIUS will either say it’s good to go, or it’s not happening, or initiate a notice process, which is a significantly longer filing for transactions that attract scrutiny. Transactions that involve an entity from Canada, Australia or the United Kingdom are exempted from this rule.

What are the dangers of being unaware of the new rule?

The worst-case scenario would be to close a sale of real estate to a foreign entity, only to find out later that the transaction fell within the scope of the rules and should have been reviewed, then have the government force you, as the seller, to undo the transaction. The risks and potential liability to the seller, both from having to walk back the sale and potential claims by the foreign investor buyer, are substantial.

From the perspective of the seller, it can be dangerous to sell to a foreign entity without a thorough review of the CFIUS rules to determine if they apply, and if there is any question, a review and recommendation by the committee. It is a good idea to address the potential outcomes of a CFIUS ruling in your real estate sales agreement to protect both parties.

How do you know if your transaction with a foreign entity requires review?

At a minimum, any transaction involving a foreign investor should include an analysis by legal counsel of the risks and applicability of the rules. For CFIUS review, even an American buyer with a minor stake held by a foreign entity could be treated as a foreign entity. The good news is that the transactions likely to attract scrutiny are pretty common sense. If you are a box company, it’s probably not an issue, unless you are located next to a military installation. But if you are a cutting-edge data processing firm, doing AI, lasers or technology, you should be aware of the rules. If not, this is an area where ignorance could really come back and bite you.

Insights Legal Affairs is brought to you by Babst Calland

Rewarding key employees with phantom equity

Business owners often use a phantom equity plan to incentivize senior management by giving selected employees certain benefits of equity ownership without transferring stock or other equity interests to the employees. A phantom equity plan is a type of employee benefit plan in which the value of the phantom ownership increases and decreases over time in parallel with the company’s value.

“Phantom equity plans and stock appreciation rights plans (plans) are a useful tool to reward key employees,” says Jill M. Bellak, Esquire, a member of Semanoff Ormsby Greenberg & Torchia, LLC. The plan is intended to provide deferred compensation to the employee through appreciation in the value of the business as if the employee owned equity in the company.

Smart Business spoke to Bellak about the basics for implementing a plan and the tax treatment to both the employee and the employer.

How is the phantom interest valued?

The initial fair market value of the company at the time the plan is adopted is typically performed by an independent third party business appraiser. Later, upon a payout event under the plan, fair market value of the company is determined either through an arms-length transaction with an unrelated third party or by an independent business appraiser or accounting firm.

What documents are needed to implement a plan?

The documents typically used to implement a plan consist of the plan itself, board of director and shareholder resolutions approving adoption of the plan and typically appointing a plan committee to administer the plan. Documentation also includes the award agreements, beneficiary designations and often a restrictive covenant agreement containing non-solicitation and non-compete provisions made by the employee in favor of the employer. The plan committee identifies the key employees to be granted awards, the percentage of equity granted and the vesting schedule.

The award agreement can provide for either 100 percent vesting upon the date of grant or incremental vesting over time. A change in control of ownership, a sale of substantially all of the assets of the business and similar fundamental transactions typically accelerate the vesting and payout of awards to key employees. The award agreement also specifies certain events that result in termination of the award, including termination of employment for cause or resignation by the employee. An award does not entitle the employee to dividends or voting.

What is the tax treatment of a plan?

Employees are taxed at the time the benefit is realized, calculated on the value of the award less the consideration, if any, paid by the employee. All payments made to employees under the plan are treated as deferred compensation and taxed as ordinary income to the employee when received and deductible by the company when paid to the employee. As a deferred compensation plan, the plan must be compliant with Section 409A of the Internal Revenue Code. Section 409A applies whenever there is a deferral of compensation. There are various exceptions including certain stock option plans, stock appreciation or phantom equity plans, 401(k) plans and short term deferrals in which payments are made within 2.5 months of the year in which the deferral is no longer subject to a substantial risk of forfeiture.

Are there any Employee Retirement Income Security Act (ERISA) filing requirements?

A ‘top hat’ filing is required with the U.S. Department of Labor in order to elect out of certain ERISA filing provisions. The top hat filing must be made within 120 days of adoption of the plan and can be accomplished by submitting a letter to the DOL identifying certain information relating to the plan.

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