Publicly held companies generally receive greater media attention about scrutiny from shareholders and government regulators than private companies, but that doesn’t mean that private companies are immune to lawsuits regarding management activities that can disrupt operations and create a financial burden for the business.
“People think that privately held businesses and nonprofits do not have much exposure. The reality is that there are many lawsuits that are brought by shareholders, employees, regulatory agencies, competitors and customers that are not covered by general liability insurance. Only a directors and officers policy can provide coverage for an actual or alleged wrongful act, breach of duty or mismanagement,” says Peter Bern, CEO of Leverity Insurance Group.
Smart Business spoke with Bern about the risks private companies face and how directors and officers insurance (D&O) can help limit exposure.
What are some potential D&O claims for private companies?
Regardless of your company’s size, the legal cost to defend a director, officer, or employee is substantial, as are the potential penalties that can be personally incurred. Because of the personal liability risk, which is not covered under a personal insurance policy, protecting these key individuals and the entity itself is critical.
Private companies have investors, shareholders, creditors and employees that can bring lawsuits alleging wrongful acts, mismanagement, breach of duty or neglect. Regulatory agencies, suppliers, competitors and customers can also be plaintiffs.
Types of lawsuits include the following:
- Breach of fiduciary duty, including self-dealing and conflicts of interest.
- General business mismanagement and bankruptcy.
- Failure to deliver services.
- Failure to disclose information.
- Disclosing materially false or misleading information.
- Regulatory agency actions and investigations.
- Merger and acquisition complications and objections.
- Shareholder derivative actions suits.
- Freeze-out mergers forcing minority shareholders to sell stock below fair market value.
How can companies determine what coverage they need?
Because there is no standardized policy, it makes it difficult to comparison shop. There are special endorsements or enhancements that can be placed on these policies. It’s a matter of analyzing needs and selecting the necessary limits and coverages accordingly.
Underwriting factors for D&O insurance include company characteristics such as:
- Age: Companies with less experience and shorter history of effective management are riskier.
- Industry: Investment banking and securities expose executive management to more risk than those experienced by board members of a small nonprofit.
- Financial stability: If a company’s finances are unstable, there is a greater chance of becoming insolvent during a lawsuit.
- Litigation history: Insurers will analyze a company’s history of previous lawsuits and any adverse business developments.
Is D&O coverage becoming more commonplace?
It’s been around for a long time, but it had been very cost prohibitive. Also, directors and officers thought it wasn’t necessary to purchase coverage if the company wasn’t publicly traded. But even nonprofits have exposure. They have volunteers donating time, making decisions and moving money; D&O covers them if there is mismanagement.
Still, many companies are not aware D&O insurance is available. Without D&O coverage, executives are not protected personally — business pursuits are excluded from homeowners insurance.
Whether you’re a privately held, nonprofit or a public company, it is likely that your business can benefit from a D&O liability policy. Since there is no such thing as a ‘standard’ policy, a professional insurance agent is invaluable when purchasing D&O coverage. He or she will understand your organization and can help design a policy that will meet the needs of the directors and officers, shareholders and the entity itself.
Peter Bern is the CEO of Leverity Insurance Group. Reach him at (216) 861-2727 or firstname.lastname@example.org.
Insights Business Insurance is brought to you by Leverity Insurance Group
Many people begin exercising with a fixation on some sort of external goal, which usually means getting better at various activities. They’re chasing after a target when their primary objective is usually to improve their body composition and functional ability through exercise.
“Often people set out to achieve a goal and hope this goal will provoke change to their body,” says Joshua Trentine, president of Overload Fitness. “In reality, their training is designed to make them as efficient as possible at achieving the external goal rather than being as efficient as possible at stimulating the body’s adaptive mechanisms.”
Smart Business spoke with Trentine about catering a workout program to meet your true objectives.
What is an external goal?
An external goal can be considered an ‘assumed objective,’ i.e., one might set a goal such as walk a mile, run a marathon, do 1,000 sit-ups, lift as much weight for as many reps as possible or swim across a lake. While all of these activities produce an ‘exercise effect,’ they will not produce the best possible results with regard to body composition and overall functional ability because they lack the most exacting stimuli; the training addresses the activity rather than the body. If your goal is to simply achieve a task, the body will always find the path of least resistance. The goal should be to stimulate the muscles, in other words find the path of greatest resistance.
What is a better exercise objective?
There are qualitative measures that can be taken to incorporate the most efficient, safe, intense and sustainable exercise stimuli. Rather than trying to add more activity to your already busy life, focus instead on quality over quantity.
Let’s call these qualitative measures ‘the real exercise objective,’ which is to momentarily weaken the musculature in order to set forth a cascade of biological events that encourage all of the muscles and their supportive sub-systems — cardiovascular, hormonal, bone, etc. — to adapt to the stress.
The real exercise objective is best accomplished through quality exercise stress. The body can easily adapt to doing more activity. However, it’s not always in a positive way, as the outcome of excessive activity can include muscle and bone loss, decreased metabolic rate, and often overuse injury.
Exercise quality, then, has to be defined by intensity. Intensity is directly related to the quality of muscular contraction — our volitional effort — and the corresponding rate of fatigue. There is an inverse relationship between exercise intensity, which can be called quality, and exercise volume, or quantity.
You can work hard or you can work long, but you cannot work your hardest and longest at the same time. In order to sustain long-duration activity, you must reduce the intensity. Doing more volume will always result in hitting a point of diminishing returns. Using more intensity, within the constraints of safety, produces better results.
What is considered high-quality exercise?
The characteristics of high-quality exercise are:
- High-intensity strength exercise.
- Progressive in nature.
- Brief — 30 minutes or less.
- Infrequent — once or twice per week.
- Designed to fatigue the muscle as safely, deeply and effectively as possible.
- Done in a cool environment, meaning temperatures between 62 to 68 degrees Fahrenheit.
- Executed with focus.
- Done slow and under control by minimizing acceleration and momentum when changing direction of movement.
- Requires between six and 12 repetitions.
- Completed without rest between exercises.
- Continued until the point of momentary muscular failure.
- Resistance is increased when at the high end of the repetition range.
By engaging in strength training in this manner you’ll get the most out of your workout.
Joshua Trentine is the president of Overload Fitness. Reach him at (216) 292-7569 or www.overloadfitness.com.
Insights Health & Fitness is brought to you by Overload Fitness
Recovering from a flood or fire is hard for a business. But dealing with problems caused by a lack of business continuity plans or inadequate insurance can make it worse.
“The better you can plan for how to deal with an incident, the better off you’ll be,” says Lawrence J. Newell, CISA, CBRM, QSA, CBRM, manager of Risk Advisory Services at Brown Smith Wallace. “I say ‘incident’ because it could be something not always thought about in typical disaster terms, such as a breach of credit card information.”
Smart Business spoke with Newell and William M. Goddard, CPCU, a principal in the firm’s Insurance Advisory Services, about developing business recovery plans and the insurance options available to reduce risk.
What goes into a business continuity/recovery plan?
One component is a business impact analysis, placing a value on what the business needs to operate. Layered underneath are the business processes, which include the business continuity plan and its identifying process flows. For example, length of shutdown is part of the business continuity plan, which contains timelines.
Then there is the disaster recovery plan, which covers anything the business depends on that is IT related. Information has more value than just the data because of the intelligence built around it. So you need to identify where that data is processed, stored or transmitted.
There is also a communication plan, making sure an incident is communicated upward, downward and outward — upward to the executive management team, downward to the enterprise and outward to customers and business affiliates. Part of the communication plan is identifying the impact, whether it’s a simple outage or a more widespread incident such as a tornado, flood or hurricane.
What options are available to manage risk?
In the example of a credit card breach, there are risk reduction processes such as applying security standards developed by the credit card industry. There’s also cyber risk insurance, which insures costs to locate the problem, including hiring experts to do that, notification of cardholders, and business interruption loss.
What do businesses need to know about disaster coverage in insurance policies?
Generally, what we think of as disasters — earthquakes, hurricanes — are covered under property insurance. But business insurance policies also contain sublimits. For instance, you can have $100 million insurance coverage, but the sublimit might be $25 million for a flood. Policies carry different sublimits, and a company planning to use insurance to cover these disasters needs to be aware of them.
What is co-insurance, and how does that impact claim payments?
After a loss, the insurance company will judge the value of a building, say it’s $1 million. A co-insurance clause is typically 90 percent, meaning that the building should be insured to 90 percent of its value — so you’ve bought $900,000 insurance coverage on a $1 million building. If it burned to the ground, you would be paid $900,000. But if you only bought $800,000 insurance coverage and were supposed to buy $900,000, all recovery is based on having 88.8 percent of the coverage you should have. If a small warehouse fire causes $100,000 in damages, you wouldn’t be paid $100,000, but $88,800. This concept of co-insurance is frequently in policies and can be punitive for loss recovery.
How can insurance costs be reduced?
Insurance companies will inspect your property and following their recommendations can make you a better risk, reducing premiums. It’s also important to figure out exactly what coverage you need — it’s best to get an independent adviser. There have been many court cases involving inadequate insurance; they’re expensive to bring and hard to win. It’s better to get it right when you buy the policy, so you should have someone other than the person who’s selling you the insurance answer your questions and conduct an analysis of your needs.
William M. Goddard, CPCU, is a principal, Insurance Advisory Services, at Brown Smith Wallace. Reach him at (314) 983-1253 or email@example.com.
Lawrence J. Newell, CISA, CISM, QSA, CBRM, manager, Risk Advisory Services, at Brown Smith Wallace. Reach him at (314) 983-1218 or firstname.lastname@example.org.
Insights Accounting is brought to you by Brown Smith Wallace
Whether you are looking to manage your own assets, control how your assets are distributed after your death, plan for incapacity or enable your business to continue uninterrupted should something happen to you, trusts can help you accomplish your estate planning goals. By establishing a trust, you ensure that the assets gathered during your life will not disappear because of the inexperience or inability of beneficiaries. A byproduct of that is the peace of mind that comes from knowing your loved ones will continue to be financially protected.
“One of the benefits of a trust is that it’s established based on the unique needs and objectives of the individual and the individual’s family, and tailored to meet those needs,” says Susan L. Nelson, CTFA, Senior Trust Executive and Senior Vice President at First Commonwealth Advisors.
Smart Business spoke with Nelson about the benefits and management of trusts.
What are the different types of trusts?
There are many types of trusts, the most basic being the revocable and irrevocable. The type of trust you use will depend on what you are trying to accomplish. A revocable trust, often referred to as a living trust, allows the individual establishing the trust to remain in control of the assets and allows them to change the beneficiary, the trustee, the trust terms and even end the trust. The grantor can use the trust for investment management, bill paying, tax planning and avoidance of probate. It can continue on in the event of incapacity, providing seamless financial management for the grantor, and can continue on after death for the benefit of others. Once the grantor dies, the trust becomes irrevocable.
An irrevocable trust is where the grantor gives complete control to an independent trustee who manages the assets for the grantor and beneficiaries. You cannot easily change or revoke this type of trust. It’s frequently used to minimize potential estate taxes by reducing the taxable estate of the grantor because the assets transferred to this trust, plus any future appreciation, are removed from the grantor’s gross estate. Additionally, property transferred through an irrevocable trust will avoid probate and may be protected from future creditors.
What are the benefits of trusts?
Some benefits are:
- Continuous financial management in the event of incapacity.
- Professional investment management.
- Financial privacy — a trust isn’t public like a will.
- Probate avoidance with no lapse in asset protection and investments — probate can take a year or more, depending on the complexity.
- Asset management for inheritances.
- Creditor protection for heirs. If a beneficiary is going through bankruptcy, money in the trust cannot be touched.
Trusts can provide lifetime financial protection for a surviving spouse or disabled child, an inheritance for children from an earlier marriage, can minimize estate taxes and provide a future legacy for charity. Trusts can be used in order to protect, preserve and transfer wealth for the benefit of individuals, families and organizations. While trusts can be used for myriad circumstances, they are not for everyone. Discuss the advantages and benefits of a trust for your situation with a financial adviser.
How should a trust be managed?
Every trust is based on your needs and objectives. When setting up the trust, determine what you’re trying to accomplish so you and your financial adviser can decide how to reach those objectives. One of the first things looked at are tax implications and how to reduce pain points. Providing for future beneficiaries should also be examined. After the trust is established, you’ll need to meet periodically to discuss the investment portfolio and life changes to be certain the trust still meets your needs.
Why choose a professional trustee?
Institutional fiduciaries are pros at what they do, have professionals on staff with years of experience, and are on the cutting edge of regulatory and tax law changes. They may be the best option for reliability, experience, responsiveness, neutrality and arms-length objectivity with beneficiaries, objective investment guidance, convenience and consistency over time. An institutional fiduciary doesn’t age or die.
Susan L. Nelson, CTFA, is a senior trust executive and senior vice president at First Commonwealth Advisors. Reach her at (724) 832-6062 or email@example.com.
Follow up: To learn more, call (855) ASK-4-FCA, or visit ask4fca.com.
Insights Wealth Management is brought to you by First Commonwealth Bank
Holding the line on health care costs has long been an ongoing concern of insurers, employers and consumers. In recent years the use of value-based networks for providers has become more popular. These networks are also sometimes referred to as narrow, tiered or high-performing networks.
Essentially, value-based networks encourage members to utilize the more efficient providers — meaning hospitals or physicians — by either narrowing networks, or by lowering copayments or deductibles for providers in different tiers in the network.
“Value-based networks are a variation on the long-established practice of having one level of benefits for in-network providers and another level for those out of network,” says Andrea Gioia, executive director for Product Innovation at UPMC Health Plan. “The difference is, with a value-based network the member can choose the providers he or she prefers based on the criteria that are most important to him or her.”
Smart Business spoke with Gioia about how value-based networks can make sense for employers who are looking to reduce health care costs.
How does a value-based network system work?
A value-based network system is an attempt by insurers and employers to contain costs by offering health benefits plans that offer employees a real choice. Depending on the provider they choose, the employee may be able to pay lower copayments or have a lower deductible.
More financial responsibility falls on the member in terms of decision-making and, as a result, this should encourage initiatives that will provide better information about the cost and quality of health care in order to make more informed decisions.
The health insurer makes the determination about which tier hospitals or physicians will be on. This could be based on the rates the insurer is charged, as well as the quality and efficiency of care being offered. With a value-based network system, when an insurer saves money by getting lower rates from certain hospitals, those savings are passed along to the member in the form of lower out-of-pocket costs such as a lower copayment or a lower deductible.
Quality is determined through claims-based methods, external certification and health information technology.
Why are value-based network systems becoming more available?
A lot of factors are at work, including the fact that there is a demand for more consumer-driven options. Certainly, employers as well as employees are increasingly interested in finding ways to contain health care costs and hold down the cost of premiums. Value-based networks can deliver in both areas.
What could be the consequences of value-based networks?
Ideally, a value-based network system should engage its members in the process. Members have more incentive than ever to be involved in choosing providers and treatment because they are exposed to higher out-of-pocket expenses.
In addition, this could spur competition between providers to cut costs and raise quality standards in order to avoid landing on the higher-priced tiers. Estimates have indicated that tiered products, on average, are priced 10 to 15 percent lower than non-tiered and HMO products.
Health insurers tend to support value-based networks because it gives consumers skin in the game. The consumer will have a financial interest in health care decisions beyond the cost of a premium.
Can value-based networks impact quality?
When a provider’s tier is tied to quality, the potential is certainly there that a value-based network will not only encourage better value but also drive providers to perform better and more efficiently. As cost and quality information becomes more available to consumers of health care, the more likely it will be that consumers will base their health care decisions on this information. This has the potential to drive change in health care in a positive direction.
Andrea Gioia is an executive director, Product Innovation, at UPMC Health Plan. Reach her at (412) 454-8293 or firstname.lastname@example.org.
Save the date: Join UPMC WorkPartners for an upcoming webinar, “Keys to a Successful Health Management Incentive Program,” at 10 a.m., June 27. To register, contact Lauren Formato at email@example.com or (412) 454-8838.
Insights Health Care is brought to you by UPMC Health Plan
Most news surrounding the implementation of the Patient Protection and Affordable Care Act (PPACA) pertains to the employer penalties for noncompliance with the large employers’ shared responsibility provision that begins with the 2014 plan year. However, how does PPACA apply if an employer has fewer than 50 full-time equivalent employees?
Smart Business spoke with Whitford about how smaller business owners need to be counting employees carefully and preparing for PPACA provisions.
How is employer size defined?
A large employer is defined as having 50 or more full-time equivalent employees during a testing period that can be from six to 12 months. Full time is defined by the government as 30 hours per week.
The term equivalent is used to account for those who work less than 30 hours per week. For example, if an employer has 30 full-time employees working 30 hours each week and three part-time employees working 20 hours each week, it has 32 full-time equivalent employees. The part-time hours per month are added, then divided by 130 to determine additional full-time equivalent employees.
There is some relief for seasonal workers.
How does PPACA apply to small employers?
The employer penalties are just one piece. All employers are subject to certain rules if providing a health insurance plan, such as:
- Waiting periods for eligibility cannot exceed 90 days, beginning in 2014.
- Continuing to cover dependents of employees until age 26, in most cases.
- Providing a Summary of Benefits and Coverage to each employee at specific events, such as open enrollment.
- Supplying 60-day notification for any plan changes, except at renewal.
What are some other considerations?
If a plan is not grandfathered — hasn’t changed since the law went into effect in 2010 — then it must continue to waive all cost sharing for preventive care services, which includes women’s preventive care for plans renewing on or after Aug. 1, 2012.
Employers also must offer employees information on the public insurance exchange whether providing health coverage or not. The law requires this notice be distributed each March; however, it has been delayed in 2013, pending Department of Labor guidance.
In 2014, all non-grandfathered small group plans will have limits on the deductibles charged in-network. The maximum deductible will be $2,000 per individual and $4,000 per family. There also will be out-of-pocket limits that apply to all non-grandfathered plans. These limits are the same as those for high deductible health plans, which this year is $6,250 for an individual and $12,500 for a family.
How will the pricing methodology change?
The biggest change for small employers will be the pricing methodology applied to group insurance plans. Insurance companies will be unable to use gender, industry, group size or medical history, and therefore are limited to family size, geography, tobacco use and age. The companies can charge the oldest ages no more than three times what they charge the youngest ages. Many insurance companies use a ratio of 7:1 or higher, so this should result in higher rates for younger, healthier groups and better rates for older, less healthy groups. In addition, there will be new taxes and fees passed through to the employer in 2014.
Where do small employers have flexibility?
A small employer, with fewer than 50 full-time employees, has more flexibility in determining how many hours an employee must work to be benefits-eligible. For example, a small employer can establish 37.5 hours as the minimum to be eligible for the company health plan, so employees regularly working less than 37.5 hours aren’t eligible. Those employees most likely are eligible for a subsidy to purchase coverage in the public insurance exchange. But, as a small employer not subject to the employer penalties, there are no financial consequences.
Because of the complexities, employers are encouraged to review their employee count and other pending health care reform legislation with a qualified advisor.
Chuck Whitford is a client advisor at JRG Advisors, the management arm of ChamberChoice. Reach him at (412) 456-7257 or firstname.lastname@example.org.
Insights Employee Benefits is brought to you by ChamberChoice
The Compliance Safety Accountability (CSA) initiative, rolled out in 2011, is the most recent way the federal government regulates the heavy truck and bus industries to ensure safe operation of commercial vehicles on our highways.
Companies directly affected are trucking companies, hazardous material haulers, some private carriers, heavy truck fleets and bus companies. But shippers, freight brokers and any companies that hire motor carriers to handle business transportation needs should review and monitor the safety scores of the companies they use.
“Courts have found liability in hiring a motor carrier with known safety issues and violations. This has placed an even greater need for motor carriers and other transportation companies to ensure they have good CSA scores,” says Kevin Forbes, sales executive at ECBM.
Smart Business spoke with Forbes about the CSA program and its impact on insurance.
How does the Federal Motor Carrier Safety Administration’s CSA work?
The goal is to reduce the number of crashes and crash-related deaths involving large trucks; statistics show the federal government’s involvement in safety compliance has helped. With local partners like state police and Department of Transportation (DOT) officials performing inspections and collecting data, the government uses the CSA system to rate motor carriers and bus companies against their peers and create standards of safety compliance. Motor carriers that don’t follow safety regulations can be put out of business.
How has the safety measurement system (SMS) changed?
The SMS is the database that stores and sorts the safety information collected by the various enforcement agencies. The old model was limited in its scope and effectiveness. The new system breaks the safety areas into seven categories called BASIC, or Behavioral Analysis and Safety Improvement Categories, which are:
- Unsafe driving.
- Hours of service, the amount of time drivers are allowed to drive.
- Driver fitness.
- Controlled substance/alcohol.
- Vehicle maintenance.
- Hazard substance compliance.
- Crash indicator.
Information collected during roadside inspections and DOT compliance audits is used to promote safety by rating carriers in these areas. By monitoring these, the system seeks to identify problem motor carriers that need compliance review, as well as notify motor carriers of issues they might be having so they can focus on those areas.
How has CSA affected insurance?
The initiative stores information on all of the different roadside inspections for each company, which is available online to anyone at ai.fmcsa.dot.gov/sms. With this information and more at the underwriter’s fingertips, motor carriers and bus companies have had to focus on keeping BASIC category scores down to ensure competitive insurance pricing.
This trend will likely continue as the CSA program provides regulators and insurance carriers with long-term data trends. Insurance companies are using the data to develop predictive modeling programs that identify loss-indicating trends of transportation companies. In renewal negotiations there is sometimes a greater focus on CSA scores than that company’s specific loss history.
How can businesses decrease their risk?
For transportation companies, a proactive approach to understanding the regulations should provide for lower insurance costs, quality shipper/customer relationships and more money to the bottom line.
The CSA regulation places a greater onus on the drivers, so proper communication and education of the driver workforce is necessary. Strong hiring practices are crucial. Investing in newer equipment and technologies also can help reduce scores. Vehicles can be equipped with safety features such as lane departure warnings, rollover warning devices, computer/video monitoring devices for driver behavior and more.
Companies must monitor their scores and see what areas they need to focus on. Your broker can help you in this constantly changing process.
Kevin Forbes is a sales executive at ECBM. Reach him at (610) 668-7100, ext. 1322 or email@example.com.
For more information about risk management, see ECBM's blog.
Insights Risk Management is brought to you by ECBM
Growing a business in today’s environment is as challenging as ever — especially with relatively stagnant overall economic growth. That’s why it’s more important than ever to hold onto existing customers.
According to Christopher F. Meshginpoosh, a director in the Audit & Accounting practice at Kreischer Miller, companies frequently spend too much time trying to win new customers and not enough trying to hang onto existing customers.
Smart Business spoke with Meshginpoosh about techniques that companies can use to create an organization where every employee is driven to meet the needs of its customers.
Why do some companies struggle with customer service?
It’s often a function of a lack of processes that ingrain and reinforce the importance of customer service. When an entrepreneur starts a new business, he or she understands the value of customer relationships because he or she worked hard for those relationships and can’t afford to lose them.
However, as the company grows, employees are added who lack that same perspective. Without formal processes — training, documented expectations, reward systems, etc. — the focus on customer service can gradually erode.
Additionally, all too often, companies treat customer service like a department. For the record, I didn’t come up with that — it’s on the website of Zappos, a company with an almost legendary commitment to customer service. Every employee has the ability to strengthen or damage a customer relationship, so it’s important for companies to make sure they hire people who have demonstrated an ability to put customers first.
What steps can management take to improve customer service?
That’s an easy one: Look in the mirror. If management wants every person in the organization to demonstrate the importance of customer service, then the first step is to make sure that they demonstrate it. And that doesn’t just mean managers of the sales or customer service functions. If you want happy employees who thrive on meeting or exceeding the needs of customers, then managers in charge of production, human resources, administration and other functions also must walk the walk.
How can companies reinforce the importance of customer service?
One easy way is to publicly recognize those who demonstrate an outstanding commitment to customer service. Do you have an employee who went out of his or her way to solve a problem for a customer? Don’t just tell that person, tell everyone.
Additionally, make sure reward systems and incentive programs include explicit customer service goals. While some people seem to have an innate ability to want to make customers happy, others may need a little additional motivation. As a result, it’s important to ensure that annual reviews and compensation programs include explicit customer service objectives. If your reward systems simply focus on metrics like profitability or efficiency, then you run the risk of driving short-term profits at the risk of long-term customer losses.
How do you know if your efforts are moving the needle?
While there are many formal methods such as customer service surveys or monitoring customer service metrics, one easy way is to routinely have your employees ask a simple question: What did I do to add value to the customer relationship?
Everyone gets bogged down in the details once in a while, but they should still be able to step back and determine whether their actions strengthened or damaged a customer relationship. If they can’t routinely point to actions that strengthened a relationship, then there’s room for improvement. If they can, then they’re well on their way to creating strong, lasting customer relationships.
Christopher F. Meshginpoosh is a director, Audit & Accounting, at Kreischer Miller. Reach him at (215) 441-4600 or firstname.lastname@example.org.
Insights Accounting & Consulting is brought to you by Kreischer Miller
You’ve been in business for several years and it is profitable. You have a decision to make: Do you want to invest in the business and buy a facility, or will you continue to lease?
With the help of your accountant, you should carefully examine the anticipated capital requirements of your business. Evaluate your ability to obtain capital or loans. Don’t box yourself into being cash poor and unable to meet business obligations or take advantage of opportunities.
“The prevailing reason that businesses fail is insufficient capital. Draining capital to pay for a real estate project could be a cause,” says Howard N. Greenberg, managing member at Semanoff Ormsby Greenberg & Torchia, LLC.
“My colleague, Jeffrey Rosenfarb, a principal in Hart Corporation, a national industrial real estate firm, advises that small manufacturing firms overwhelmingly desire to own versus rent, whereas larger corporations generally prefer leasing.”
Smart Business spoke with Greenberg about some pros and cons of leasing or purchasing industrial real estate.
What issues should be examined when considering purchasing a facility?
First, what’s the nature of your business? Manufacturing that utilizes heavy, difficult-to-move equipment is where purchasing may be desirable, to avoid being at a landlord’s mercy when your lease expires. Or is it light manufacturing or distribution, that moves easily?
Second, can you obtain a facility that will remain adequate for your needs? Plan for potential future expansion. Have your counsel review the local zoning code to determine what can be built, either now or in the future.
Do you contemplate children in the business? Real estate can provide a source of income and inheritance. Counsel will need to prepare an agreement that deals with numerous issues including governance, death, disability, termination of employment and sale of the business.
Where do you want to invest your limited capital? Be sure that you will not need capital to expand your business versus acquiring a building. Lending rates are at historic lows, encouraging acquisition. Consult counsel concerning special types of financing such as tax free industrial development or state-provided financing, as well as tax abatements.
What issues should you consider if you determine to lease?
Check locally to ensure there are adequate reserves of industrial rentals available. With any lease, secure options to: extend the term; terminate early; purchase the building; for a right of first refusal; and for the ability to assign the lease or sublet in connection with your business sale.
If I decide to purchase, what entity should purchase the property, and how should the lease be structured?
Keep the building owner entity distinct from the entity that occupies it. The building owner entity should be a limited partnership, limited liability company or S corporation to enable you to utilize tax advantages like depreciation and amortization, and to permit gifting. Also, you may want to divvy up interests differently in the operating company versus ownership in the real estate company. You could decide to bring a partner into your business, but not into the building ownership.
You will need a lease between the two entities, especially if you’re going to sell the business and not the real estate. As a landlord, limit the tenant’s options and set a reasonable term.
Does new construction make sense versus purchasing and rehabbing an existing building?
With new construction or significant rehab, you must have a reliable contractor and architect. Assume that it’s going to cost at least 15 percent more and take 15 or 20 percent longer than initially estimated. Weigh the aggravation of new construction versus having your building the way you want. However, over the past 15 to 20 years, sale or leasing of existing facilities has far exceeded new construction, per Rosenfarb.
Buying and holding an industrial property usually works out well for the owner. For heavy manufacturing, building ownership, or a long-term lease with renewal options, is the way to go.
Howard N. Greenberg is a managing member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-0200 and email@example.com.
Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC
Parties often have lengthy negotiations before they enter into a final written contract. Various promises and representations are made and relied on during those negotiations.
“Be sure to incorporate all important terms and promises into the final written contract,” says Shelby Drury, of counsel with Novack and Macey LLP. “Later, if there is a dispute that results in litigation about the contract, the court is unlikely to allow either party to introduce evidence of promises or representations that are not stated in the written contract.”
Smart Business spoke with Drury about the admissibility of promises or agreements that are not stated in the final, written contract, and how to draft a contract in a way that makes it clear whether or not the parties intend to incorporate prior or contemporaneous agreements.
How do courts determine the contracting parties’ intent?
Illinois courts generally follow the ‘four corners rule,’ which provides that a written contract speaks for itself and the intent of the parties is to be determined from the language used in the contract without looking at outside evidence.
What if a party relied on earlier promises or agreements that are not expressly stated in the final, written contract?
Generally, parties are bound by the contract as written and may not bring in evidence of additional promises or agreements. The ‘parol evidence rule’ bars evidence of prior or contemporaneous oral or written agreements and discussions or promises offered to explain or contradict the plain, unambiguous terms of a written contract. Significantly, the rule bars evidence of promises or agreements that contradict a written contract as well as evidence of additional consistent terms. The reason for this was explained by the Illinois Supreme Court, which stated, ‘when parties sign a memorandum expressing all the terms essential to a complete agreement, they are to be protected against the doubtful veracity of the interested witnesses and the uncertain memory of disinterested witnesses’ concerning its terms.
Are there exceptions to the parol evidence rule?
Yes. If the court finds that the contract is unclear or ambiguous because its language is susceptible to more than one meaning, then the court may allow parol evidence to help resolve the ambiguity. Also, if the contract is incomplete, the court may allow evidence of additional consistent terms to supplement or explain it. Additional exceptions apply to contracts that are covered by the Uniform Commercial Code.
Is there anything that contracting parties can do for extra assurance that prior agreements or promises will not be admissible in a lawsuit concerning the contract?
It is wise to include an ‘integration clause’ in the final contract to make clear that the parties agree that:
1) The contract is complete.
2) Negotiations and representations made prior to the written contract are not part of the agreement.
3) The parties intend that the contract be interpreted solely based on its plain language.
A typical integration clause provides: ‘This agreement constitutes the entire understanding between the parties hereto and supersedes and cancels all prior written and oral negotiations, understandings, representations or agreements with respect to the subject matter of this agreement.’
What if the parties want to include terms not included in the contract?
In that case, the parties should expressly incorporate such other agreements by reference in the final, written contract. They should do this by identifying the title and date of such agreements and expressly stating in the final, written contract that such agreements are incorporated by reference.
Shelby Drury is of counsel at Novack and Macey LLP. Reach her at (312) 419-6900 or firstname.lastname@example.org.
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