Every day, small business owners make mistakes by failing to disclose issues when selling their businesses, risking potential legal entanglements.

“Selling a business is not unlike selling a house. In California, there is a duty to disclose. Although a broker representing the buyer or seller has fiduciary obligations, by law, the onus of disclosure falls on the seller,” says Gregory M. Gentile, a partner at Ropers Majeski Kohn & Bentley PC.

Smart Business spoke with Gentile about pitfalls owners should avoid when selling businesses.

What can a seller do to mitigate the risks of selling a business?

Finding the right broker and/or consultant to help sell or market your business is a crucial step to success. Many times, owners seeking to list their business select the first person they meet. This can cost time and money.

Within a few months, you may see no results and have to go on a search all over again. Take time to interview the broker and focus on a realistic outcome. A reputable broker can prepare a sound market analysis and aggressively list the property to attract willing buyers.

The seller can also expect a reputable broker to have a well-drafted representation agreement. It is important that the seller review the agreement carefully and understand his or her obligations.

What are the contractual responsibilities of the seller?

Using a broker to market the business does not relieve the seller from due diligence. The seller is required to disclose all material conditions that may affect the prospective buyer’s decision to purchase the business. The seller can expect the broker to set forth these obligations in the listing agreement. It is very important for the seller to carefully review the listing agreement to ensure his or her awareness of these obligations that the broker places, by contract, on the seller, and the potential downsides if the seller fails to abide by them. If any part of the agreement is questionable, it is important to ask questions; and if necessary, consult with an attorney.

What provisions in the listing agreement should a seller be most concerned about?

Many listing agreements have one or more provisions requiring that the seller affirmatively disclose. There may also be provisions that seek to relieve the broker of any liability if the seller fails to disclose. For the seller, this means to be complete and accurate with any information provided to both the broker and the prospective buyer. Any material fact that may reasonably influence a buyer’s decision to purchase the business must be disclosed.

The listing agreement may have indemnity provisions favoring the broker. For instance, if the agent or broker gets sued or is required to defend a claim brought by a buyer, the broker can seek indemnity (recovery of damages) against one or more of the parties to the transaction, and such damages include, by contract, any attorney’s fees and costs incurred by the broker’s attorney in defending any claim. This can be substantial and financially devastating.

Many agreements have arbitration provisions. Such a provision in a listing or purchase agreement will pre-empt a lawsuit in superior court, which means that the parties must go to judicial binding arbitration if there is a dispute. Arbitration has the potential of being expensive since arbitrators charge hourly for their time.

The agreement can also contain an attorney’s fee provision. If the seller fails to disclose, and the broker has been forced to hire an attorney and prevails against the seller, the seller will be required to pay the monetary damages, the broker’s attorney’s fees and costs, including expert fees (if any are incurred, and they usually are) and the arbitrator’s fees, which can be substantial.

Selling one’s business can be financially rewarding, but it is also a complex transaction with many pitfalls for the seller. It is important to do your homework and select a reputable business broker. Further, be sure to read and understand the contracts presented by the broker, ask questions and, if necessary, consult an attorney.

Gregory M. Gentile is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (408) 918-4554 or GGentile@rmkb.com.

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Published in Northern California
Investing some time and money when setting up a business can help you avoid more expensive problems down the line.

“Clients will want to form a corporation in Nevada because someone told them there’s no tax there. But if they’re doing business in California or elsewhere, generally they have to qualify as a foreign corporation and pay taxes and regulatory fees when they could have just incorporated in California,” says Tim M. Agajanian, a partner at Ropers, Majeski, Kohn & Bentley PC“It’s important to know what your personal and business goals are and where the best location is for your business.”

Smart Business spoke with Agajanian about steps owners can take when forming businesses that will reduce the potential for future problems.

How should an owner select the entity type for the business?

Sit down with your attorney and talk about the core of the business, your goals and the best locations for your business operations. An accounting firm should also be involved, preferably one with experience in your industry.

Together, you should determine 
what entity type to be, based on the kind of business performed; and the accounting, tax and legal issues that would serve as the basis of selecting a state for incorporation or other selected business entity (i.e., general partnership, limited liability company, limited partnership).

If you’ve thought 
about an exit strategy, that would affect your selected entity and where you would form that selected entity. Some companies are set up to go public eventually while others might be designed for sale to private equity firms or to remain in the family. If you’re not sure, your professional advisers can walk you through this process. It’s really about getting back to the fundamentals of your business and the related corporate and tax laws, regulations and estate issues.
What can happen if you chose the wrong entity type?

For example, if you are set up as a C corporation and should have been an S corporation, there are tax issues involved when it comes to sale and personal taxes. I have seen companies that were converted to S-corps to take advantage of more favorable tax structure, and owners had to delay a potential sale of their business while that conversion was effective. It can take years to fully convert from a C-Corp to an S-Corp. 

Right now, a limited liability company (LLC) is a popular setup because the administration is easy. But it’s not always the right vehicle. It works well for smaller operations such as family-owned businesses or ownership of certain types of real estate. But I’ve seen it become problematic with larger businesses that have issues regarding corporate governance.
If you’re a restaurant group with five locations, I’d look at a more formal corporate structure because there is more protection of shareholders. Another trend is to incorporate in a state like Nevada, which doesn’t have state income tax. But a business must have a legitimate reason to be there. I can’t tell you how often I’ve taken over representation and asked a client why they’re a Nevada corporation when they’re located in California. If you’re going to pay tax in California anyway, why aren’t you a California corporation or a LLC?

What do business owners need to consider before leasing space?

Look at where you need to be and get a good real estate broker who knows the area to represent you, particularly for professional service companies. The broker can determine what the market is and what landlords are willing to give, and also connect you with the best attorneys who have done multiple deals with that landlord. Some landlords require a personal guarantee from partners of a law firm, while others will treat it like a corporation, so there’s no recourse if they default on the note beyond the initial guarantee.

That’s nuanced protection you would not know about without local knowledge. Avoiding future problems with your business is really about attention to fundamentals, meeting with your attorney and making sure that person knows what is important to you so he or she can identify what issues need to be addressed from a legal and practical standpoint.
Tim M. Agajanian is a Partner with Ropers, Majeski, Kohn & Bentley PC. Reach him at (213) 312-2010 or tagajanian@rmkb.com
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Published in Los Angeles

Many businesses assume that employment at-will means the employer can terminate the relationship at any time. While the default assumption is that employment is at-will, some actions taken by employers can create an implied-in-fact contract.

“That’s where employers can often get into trouble with a disgruntled employee. At-will employment allows the employer to fire an employee at any time without having to show good cause, as long as it’s not for a discriminatory or punitive reason. But an employee, if they’re upset about getting fired, can claim they had an implied-in-fact contract and can only be dismissed for good cause,” says Stacy Monahan Tucker, a partner at Ropers Majeski Kohn & Bentley PC.

Smart Business spoke with Tucker about what at-will employment means and how businesses unknowingly create an implied-in-fact contract.

What types of interactions can be interpreted as an implied-in-fact contract?

Courts will look at the totality of an employer’s relationship with its employee when determining if an implied-in-fact contract exists. The key question is whether an employee had a reasonable expectation of an implied-in-fact employment contract. A court will consider many factors, including the written and verbal policies and procedures used by the company, the employment manuals, any employment-related agreements such as confidentiality agreements or noncompete agreements, and the interactions between the employer and the employee, as well as the employer and other employees. While many factors will not create an implied-in-fact contract alone, combined they can weigh heavily in favor of such a finding.

Factors considered by courts include the length of employment, the use of progressive discipline to make its termination decisions, statements made to an employee that he or she doesn’t have to worry about losing his job unless a mistake is made, and a requirement of signing a noncompete agreement or confidentiality agreement as part of the employment arrangement.

An employer might have written policies or employment documents in place that it thinks make it clear employment is at-will. Many handbooks state the employment arrangement is at-will. But frequently those handbooks also state that nothing in them is intended to create a contractual relationship. That can inadvertently invalidate all previous statements supporting the at-will relationship, as the document specifically states it does not define the contractual relationship. Moreover, the requirement that an employee sign a noncompete or confidentiality agreement can support the argument that the employee paid consideration by signing such an agreement and thus entered into an implied-in-fact contract. Many employers do not realize the importance of having employment documents reviewed for consistency.

How should companies approach handbooks and policies?

Companies should have their employment documents drafted by an employment attorney rather than just a human resources person, who often has cobbled together information from previous handbooks without fully understanding the legal ramifications. An employment attorney can ensure that the documents are clear and work well together.

A best practice is to have a written employment agreement that every employee signs. It should clearly state that the arrangement is at-will employment and the agreement is integrated, which means that if a provision is found to be ambiguous or unenforceable, the rest remains in full force. That reduces the chance of an employer being able to invalidate the entire agreement.

Many of these employment issues can be avoided by careful review of internal policies and documents before problems arise. That’s why it’s important to develop an employment contract and a cohesive body of employment documents that work as a unit. Then you can cover issues you want to address and minimize any surprises down the line.

Stacy Monahan Tucker is a partner at Ropers Majeski Kohn & Bentley PC. Reach her at (650) 780-1719 or stucker@rmkb.com.

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Published in Northern California

Just as you would when buying a house, it’s important to conduct a thorough review when considering a commercial property purchase.

“Next time I buy a house, I’ll be walking around with the inspector to make sure that they’re doing a thorough job. I’m going to be turning on the faucets and flushing the toilets just in case the home inspector misses it,” says Todd J. Wenzel, a partner at Ropers Majeski Kohn & Bentley PC. “It’s a little different with commercial properties in that the concerns aren’t the same, particularly if it’s an investment property. But you have to do your due diligence.”

Smart Business spoke with Wenzel about problems commercial property owners need to watch for, whether they occupy the space or serve as landlords.

What due diligence should be conducted before completing a purchase?

It depends on the age and size of the building, but for the most part it’s not as involved as with residential properties. With owner-occupied properties, it’s more about checking for any structural problems with the building. However, if it’s an investment property, look at occupancy certificates and rent rolls. Ensure leases are up to date with no outstanding renewals or rental payments.

With commercial properties, it’s important to have full disclosure. It’s expected that parties on both ends are sophisticated, so the law does not provide the same protections that residential purchasers receive.

Should you check on tenants as well?

There should be a file on each tenant, complete with financial background checks to confirm that tenants have the wherewithal to continue making payments. Be sure to look at whether a tenant has a history of late payments or nonpayment of rent.

In a recent situation, there was no credit report run on tenants. The client that purchased the property received a good purchase price, but the tenant files were very thin. It turned out that some tenants were in immediate default after the purchase. Ultimately, one tenant breached his or her lease, left and litigation ensued. Obviously, a buyer wants to avoid that; if you see tenant information missing, run your own credit check as part of your due diligence.

Considering the moist climate in Northern California, how big of a problem is mold?

It can be a real problem. You typically see mold claims in residential settings, but it can happen in commercial ones, too. Tenants must notify a landlord as soon as they suspect mold, because it becomes problematic once spores are airborne. Commercial leases should contain specific notice provisions required of the tenant to notify the owner of the first signs of mold.

A commercial tenant client recently suffered property loss and business interruption when a roof leak caused water to drip into the office space and storage room walls for months (possibly longer). When they opened the wall, they found mushrooms growing. Mold in a commercial setting is not as serious of a health risk as in a residence because no one is sleeping there, but you still can have people working around it eight hours or more a day.

If the problem is hidden in the walls, landlords have some defenses if they had no notice or reason to know. But if it’s indicative of a persistent water leak, the owner may be charged with constructive knowledge. The legal exposure is worse if the landlord knows and acts slowly to address the situation.

What key items need to be looked at when considering facility expansion?

The main concern is structural integrity and the foundation, making sure the soil will support an addition. Get engineers to check piers and other foundational measures.

If you’re doing an extensive renovation on an older building, you may need to bring it up to current codes. This cost estimate should be part of a preconstruction checklist.

Ask architects and engineers if they can incorporate green-building elements into the project. It may cost a little more, but it’ll speed up the permit process and can help in terms of public relations.

Although it’s difficult to get contractors to guarantee a maximum price because costs are based on time and materials, it’s a good idea to include a cap when bidding projects — a $50,000 job cannot exceed $15,000 in change orders. Otherwise, some contractors submit low bids, hoping to make up the difference in change orders.

Todd J. Wenzel is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (415) 972-6316 or twenzel@rmkb.com.

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Published in Northern California

It’s easy to forget about costs when you’re embroiled in a lawsuit, but you could end up winning the trial and losing the fiscal war if you let the litigation tab spiral out of control.

“Business owners can be bamboozled by a litigation attorney when they’re in the heat of battle,” says Kim Karelis, a partner and expert witness with Ropers Majeski Kohn & Bentley PC. “Avoid disputes by negotiating a reasonable fee schedule in advance.”

Smart Business spoke with Karelis about the best ways to avoid and resolve a legal fee dispute.  

What is a legal fee dispute?

Attorneys usually charge a flat fee for routine tasks like reviewing a contract or setting up an LLC, so novice executives may experience sticker shock when they receive a bill from a litigation attorney if they don’t perform adequate due diligence. The lack of a formal fee schedule can sometimes lead to a dispute and additional litigation if the two parties can’t resolve the issue.

What should business owners know about hiring a litigation attorney?

Refuse block billing and question vague descriptions for services when negotiating a retainer agreement so you can compare and determine whether an attorney’s fees are reasonable and customary. Only the senior partner should bill for in-house strategy meetings involving several staff members and you shouldn’t pay bloated fees for photocopies, phone calls and secretary time.

Consider the cost for expert witnesses, court filling fees and depositions, and estimate your true ROI by comparing the total tab to what you may gain or lose by going to trial.

Finally, be wary of an attorney who seems unreasonable or wants to bill for every single second. Lawyers should be willing to negotiate, especially in this market.

What else can business owners do to prevent legal fee disputes?

Hiring a referral from a trusted colleague is probably your best bet, but you still need to get everything in writing and seek an outside opinion before signing an agreement if you’re unfamiliar with litigation costs.

Establish a budget and a goal for the action and consult several attorneys to see if they’re reasonable and attainable.

Lastly, nip potential problems in the bud by reviewing invoices and questioning any unreasonable charges you find in a timely basis.

What happens if a dispute arises?

Clients have the right to seek arbitration by a panel consisting of neutral attorneys and a layperson who will decide the appropriate amount of attorney’s fees through an informal, low-cost proceeding administered by the local bar association. The losing party has the right to pursue a court trial. However, they must act quickly and file the paperwork within 30 days of the loss.

What are the legal standards that apply to legal fee disputes?

A signed retainer agreement takes precedent when a fee dispute arises. If none exists, the court will attempt to determine a fair charge for the attorney’s services, in part by assessing whether the attorney’s fees are unreasonable or unconscionable.
While the courts tend to side with clients, especially when the attorney’s charges are vague, there’s little sense in taking chances when the problem is avoidable.

How are legal fee disputes usually resolved?

Most executives and attorneys don’t want to air their dirty laundry in public, so they try to resolve their disputes through informal, private discussions and by consulting an outside expert.

While few disputes end up going to trial, the chances increase when emotions run high and business owners don’t do their homework.

Kim Karelis is a partner and expert witness at Ropers Majeski Kohn & Bentley PC. Reach him at (213) 312-2012 or kkarelis@rmkb.com

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Published in Los Angeles

Some companies can’t afford or simply don’t perceive the need for in-house legal counsel. However, many are seeing the benefits of using outside legal help regularly, rather than when a problem is at hand, says Enrique Marinez, a partner at Ropers Majeski Kohn & Bentley PC.

“Smaller and midsize businesses need to be proactive and preventative in addressing issues that could lead to litigation problems. The role of general counsel should be one of collaboration and proactive planning to address some of those eventualities before they become problems,” Marinez says.

Smart Business spoke with Marinez about how to best utilize outside counsel to provide a level of service that replicates having in-house expertise.

Why has the role of outside counsel changed?

There’s been a proliferation of the use of electronic media and technology, which brings additional challenges that not all companies have kept up with. One problem that’s prevalent now concerns the handling  of electronic media — how to store backup tapes and how often backups should be run. Companies need to have polices and procedures in place to put holds on emails and electronic information when a claim or other circumstance arises.

Another problem area is dealing with employee complaints. You need to have policies to address complaints about the workplace environment — someone claims they’ve been sexually harassed or discriminated against because of age or race. There should be a procedure for how to investigate claims.

Other employment issues can range from  someone not being paid proper overtime, providing for proper meal and rest breaks or items like smartphones. If you send employees work-related texts, should you be paying for the phone?

If you have policies and procedures to guide you through these issues, you can follow those when a problem arises rather than responding in the heat of the moment.

Can’t these policy needs be determined by meeting with counsel on a regular basis?

Exactly. Risk management should be part of every company’s business plan. Part of that is meeting with a legal professional who can guide them so they’ll be better positioned when a problem arises. That should be on the agenda at meetings.

Often, counsel attends board meetings or company leaders visit to address issues such as policies and procedures for handling complaints and other employment issues. Believe it or not, there are a lot of companies that do not have employee handbooks.

Meet with counsel on a quarterly basis to make sure risk management procedures are in place and to ensure you have proper liability insurance, including directors and officers, and employment liability coverage. Make it part of the business plan to discuss preventative measures, so you’re better able to address situations as opposed to being reactive.

Do companies just not think about using outside counsel that way, or is it that they don’t want the expense?

It’s a little of both. Some people think that you use a lawyer only when you have a problem. But much of the problem can be ameliorated on the back end when there are preventive measures taken upfront. And, yes, there is a cost, but it’s often much less than waiting until a problem requires litigation. For example, if you don’t change your car’s oil, then the engine blows out and you’re paying $3,000. That type of analogy fits exactly for the use of outside counsel.

Plus, establishing an ongoing relationship with a law firm provides additional benefits. Counsel has experience dealing with other companies and exposure to how they have addressed employment issues. For example, a multiservice firm deals in many different disciplines and can help with insurance issues, obligations in real estate contracts and things of that nature.

Outside counsel should be viewed as an extension of your company that can provide assistance similar to in-house. It’s unfortunate that many companies don’t have a dedicated attorney to work with them and only seek legal assistance when there is a problem. When you reactively act on the defensive, things do not go as well as they could. Address issues head-on before they become the subject of litigation.

Enrique Marinez is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (650) 780-1679 or emarinez@rmkb.com.

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Published in Northern California

Civil courts, trying to manage busy caseloads with reduced staffs, are pushing litigants to seek alternative means of resolving their differences.

“Alternative dispute resolution (ADR) is the debt that all civil litigants pay. One way or another, everyone has to pass through some form of ADR during the life cycle of his or her litigation,” says Brock R. Lyle, a partner at Ropers Majeski Kohn & Bentley PC. “Everyone has the right to a trial by a jury of their peers, but most cases can be resolved without one. Courts cannot force you to resolve your case through mediation or some other alternative means of resolution, but they can, and will, strongly encourage you by placing settlement stops and incentives along your path to trial.”

Smart Business spoke with Lyle about the various trial alternative methods available.

Do you need to attempt mediation or some form of ADR before a case can go to trial?

There are several nets in place to catch cases before trial. The first is often mediation, a formal negotiation assisted by a neutral professional. At the initial case management conference, the court will inquire whether the parties are willing to go to mediation. If so, the court will set a completion date and follow-up hearing. If one party refuses, the matter is generally set for trial.

There are instances where parties are willing to enter into mediation even before a case is filed, a good way to save money on legal fees. But you run the risk of resolving a case before the parties fully understand it. The parties can conduct as many mediations as they believe would be helpful. Some mediators keep working with the parties after the formal session ends. Certain courts also offer no-cost mediation for simpler cases.

In place of, or sometimes in addition to, mediation, the parties can submit to an early neutral evaluation or an early settlement conference, both of which involve an impartial lawyer or judge evaluating the case and pushing both sides toward a resolution.

The final net is a mandatory settlement conference, where the judge meets with both parties separately to remind them of the costs and uncertainties inherent in trial, and to push them once again to settle. Depending on the type and size of the case, settlement through ADR can help avoid tens of thousands or even hundreds of thousands of dollars in attorney fees.

What other ADR options are available?

Another option is arbitration, which is like a private trial. It can only occur by agreement of the parties or a prior written agreement, because it involves a waiver of the right to a jury trial. Arbitrations can be binding or nonbinding, though the latter is often more informational because one or both parties can disagree with the ruling and disregard it.

At arbitration, a retired judge hears evidence from both sides with exhibits, witnesses and many elements of trial. The arbitrator then issues an award that the prevailing party has confirmed by the court.
Of course, either attorney or party can always discuss settling the case and try for an informal resolution over coffee or lunch.

How do you know what ADR method is best?

In many cases, the contract or agreement at the center of the case will require mediation, arbitration or both. For example, most real estate contracts include mediation provisions. As an added ‘incentive,’ California case law cuts off a party’s entitlement to have attorney fees reimbursed if the party is unwilling to mediate, or starts a case without first offering to mediate. If no ADR process is spelled out in a written agreement, the posture and progress of a case often dictates the best fit.

What are some pitfalls to avoid with ADR?

One concern is going through an ADR process before the case is ready. If essential information needs to come forward in written discovery, depositions or expert testimony, an early mediation may be a waste of time and money.

The ADR process also creates pressure to settle that can force a disadvantageous position. After investing time, money and energy in preparing for and attending the ADR session, parties often feel they should settle. There is no shame in walking away.

Finally, parties can abuse ADR by going through the motions without any intent to settle, delaying the matter and racking up attorney fees. It is useful to see if the other party is ‘in the ballpark’ before the cost and effort of preparing for an ADR session.

Brock R. Lyle is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (650) 780-1647 or blyle@rmkb.com. Find out more about Brock R. Lyle.

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Published in Northern California

Saving money on insurance sounds good to any business, particularly one that may be struggling. But going with a policy that includes a self-insurance retention (SIR) can be risky, especially if you become involved in a lawsuit.

“Companies that are struggling to stay in business and accept a larger SIR than they probably should can be put in a very bad position because they may be without insurance protection if they are not able to satisfy the SIR,” says Michael T. Ohira, a partner at Ropers Majeski Kohn & Bentley PC.

Smart Business spoke with Ohira, whose practice includes advising insurers in construction defect lawsuits, about how SIRs work and when they make sense for businesses.

What are the key differences between SIRs and deductibles?

The differences are pretty profound. SIRs and deductibles are both forms of risk assumption by the policyholder and are traditionally for a set amount, generally referred to as the retained limit. The policyholder basically agrees to be responsible for paying losses or claims within the retained limit, although there are differences regarding when the insurance company’s duties begin.

With an SIR, the insurance company essentially has no duties unless and until the retained limit is paid. Many times SIR endorsements provide that only the insured can satisfy the SIR, and the payment obligation is not excused by the insured’s insolvency or bankruptcy. So an insured is at its peril — if it cannot satisfy the condition of paying the SIR, it is not entitled to the benefits provided under the insurance policy.

SIRs are common in construction. Many insurers have left the market because of the proliferation and cost of defending construction defect lawsuits. Subcontractors can be in a difficult situation because general contractors require their subcontractors to have liability insurance and to add the general contractors as additional insureds under the subcontractor’s liability policy.

Typically, the reasons to have an SIR are about cost and the availability of insurance. A large corporation that is financially strong can reduce its insurance costs by electing to purchase a policy with an SIR, which commands a lower premium.

What are the benefits of deductibles over SIRs?

The biggest benefit of a deductible is that, unlike an SIR, the deductible does not need to be paid upfront and is not a condition to receiving insurance benefits. That’s important when you have a liability policy, get sued and need a lawyer. With a deductible, the insurance company will provide a lawyer and provide a defense immediately, as opposed to requiring the insured to pay its own attorneys’ fees until the amount of the retained limit is satisfied.

Where do companies make mistakes in deciding which route to go?

Some companies will assume an imprudently large SIR. If the business is in decline and gets hit with a liability claim, then paying for a defense lawyer on top of normal operating expenses can push the company into a precarious financial condition. I’ve seen retained limits as high as $250,000. Businesses that assume a large SIR, that they cannot later pay, can find themselves without insurance coverage.

That can be an issue for general contractors. If a subcontractor has an SIR that allows only the subcontractor to pay the SIR, then the general contractor would be without coverage as an additional insured under that subcontractor’s policy, if the subcontractor fails or is unable to pay the SIR. This is because the insurance company’s obligations are not triggered until the subcontractor pays. So, general contractors and developers need to carefully review the insurance policies of the subcontractors they hire to ensure that the subcontractor either doesn’t have an SIR or that the policy allows the developer or general contractor to pay the retention if the subcontractor is unable.

When deciding whether to have an SIR, take a hard look at your financial situation. Do you have the financial wherewithal to comfortably absorb that initial share of risk? It’s a business decision — weigh the cost savings against the benefit of being able to get insurance benefits more immediately, and from dollar one.

Michael T. Ohira is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (213) 312-2000 or mohira@rmkb.com. Find out more about Michael T. Ohira.

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Published in Los Angeles

California Business and Professions code section 7159 comprises eight pages of small type covering home improvement contracts, which makes it difficult for contractors to always follow the letter of the law.

“There are so many very technical requirements in 7159, including type size and placement of various provisions within the contract document, that even a conscientious contractor might miss them,” says Kevin P. Cody, a partner at Ropers Majeski Kohn & Bentley PC.

Smart Business spoke with Cody about construction contracts and how companies can avoid problems that void agreements.

When do contract problems arise?

Obviously, if construction goes well, the contract typically isn’t brought up. But when there is a problem, the homeowner or his or her attorney will search the contract for defenses. For example, the entire contract can be voidable or unenforceable if the contractor hasn’t complied with all of the requirements of section 7159, which are numerous and pretty detailed.

California law gives particular protection for home renovation projects because it’s frequently a one-on-one relationship between an inexperienced homeowner and a contractor. Prior to enactment of 7159, a homeowner might find himself or herself in a position where substantial upfront payments had been made, the contractor would only be partway through with work, and all of a sudden the homeowner couldn’t find the contractor. In a commercial setting, where you’re dealing with people who are quite sophisticated and savvy, they do not require the same degree of protection.

However, strict compliance with 7159 will not always work as a defense for the homeowner. A landscape designer/contractor client didn’t strictly comply with all code provisions, and a homeowner, because he was dissatisfied with a few things, hired an attorney and decided not to pay. The homeowner filed a lawsuit, claiming the contractor’s failure to strictly comply with 7159 justified nonpayment. In spite of the landscape designer/contractor’s failure to strictly comply, the court sided with the designer/contractor and awarded it all of the money the homeowner had withheld.

How detailed are the code provisions?

A window company wanted contracts prepared for installations it was going to be doing. On the first page of the contract, you have to mention the date the buyer signed, there has to be a notice of cancellation and a heading that says ‘home improvement’ in at least 10-point, bold face type — that comes straight from the statute. There are a lot of other very detailed requirements.

What should you do to draft contracts that are compliant?

Most contractors already have contracts that comply in certain areas, but in many instances they haven’t updated them. An attorney can go through and make recommendations. In addition to compliance with the technical requirements of 7159, there are other statutes with provisions that the contractor may not appreciate fully, e.g., those dealing with attorney’s fees, or with provisions that have changed in the last few years, e.g., indemnity.

For example, Civil Code section 1717 states that if a contract provision allows one party to recover attorney’s fees, it will be reciprocal to the other party. Without knowing about 1717, the contractor may want an attorney’s fees clause in the contract that only allows the contractor to recover fees if it has to sue to collect payment. But what happens if there is litigation and the other party can recover attorney fees, even if it isn’t mentioned? It becomes an issue of whether the contractor really wants the clause because it might engender litigation.

Similarly, while the law with respect to what general contractors can be indemnified for recently changed to limit indemnity rights, there still are ways to improve the situation. Though a general contractor cannot be indemnified for its active negligence, it typically has leverage over subcontractors to request that the general contractor is named as an additional insured on the subcontractor’s insurance.

It’s a good idea to update your contracts every two or three years with an attorney who specializes in construction contracts. The cost will be relatively modest in the long run, especially considering the benefits of that review.

Kevin P. Cody is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (408) 918-4557 or kcody@rmkb.com. To learn more about Kevin Cody.

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Published in Northern California