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.

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

How to mitigate legal liability while reopening your business

As states begin to relax restrictions on social gatherings, businesses are trying to reopen in a manner that is safe for their employees, vendors, customers and clients. They’re also trying insulate themselves from the legal exposures they face as they work out a plan to get their business up and running.

“I’m getting a lot of questions from employers who want to do right on all of those fronts,” says Molly Meacham, a shareholder at Babst Calland. “They are really working hard, thinking through the issues, listening to state, local and federal government advice, all while trying to keep their businesses running.”

Smart Business spoke with Meacham about addressing the legal risks that come with operating during the pandemic.

What legal concerns do companies have as they reopen?

The most significant concern is that a company will have an outbreak at their workplace. If that happens, it means considering the company benefits employees should be entitled to, such as sick leave or short-term disability, if they are eligible for leave under the Family and Medical Leave Act (FMLA), if they are covered by Families First Coronavirus Response Act (FFCRA) and eligible for those leaves, or if they’re entitled to any accommodation under the Americans with Disabilities Act.

Another risk is that contracting the illness could lead to a lawsuit or workers’ compensation claim. In a classic workers’ compensation scenario, the employee would need to prove they contracted the virus at the workplace. Some states are reducing employees’ burden of proof, or covering COVID-19 illness for certain groups of employees. For those states that are not making changes, whether or not COVID-19 is covered by workers’ compensation is likely to be a hotly litigated issue.

The regulatory and legal burden on employers has increased dramatically with this pandemic. For example, the Department of Labor has hired a number of new Wage and Hour Division investigators to enforce wage and hour laws, including the new FFCRA. The increased regulatory burden and increased enforcement could lead to administrative action or civil liability for companies found to be in violation.

How can companies reduce their litigation exposure?

Some companies are looking at COVID-19 exposure liability waivers to provide some legal insulation. Those waivers are of limited utility against employee claims, as an employer typically cannot compel employees to waive future rights, their rights under workers’ compensation, or their right to make an OSHA complaint for an unsafe workplace. Therefore, employee waivers are likely to generate bad will and skepticism without much return.

The effectiveness and enforceability of waivers for customers, clients and third parties who are accessing a company’s premises depends on state law and the specifics of the waiver. Although those waivers may ultimately be enforceable in certain states, for some businesses the limited potential legal protection may be outweighed by the negative impact on the company’s business relationships. In addition, in some states those waivers may ultimately be unnecessary, as some states are passing legislation granting businesses immunity from liability for harm caused by COVID-19.

How can companies keep people safe and insulate themselves from legal repercussions?

It’s important to have a response plan in place. If there’s an incident or exposure in the workplace, the company should first care for the impacted employee, then ensure that other potentially impacted employees are promptly notified and removed from the workplace if necessary, and that steps are taken to disinfect the workplace.

For companies that have a plan in place that is compliant with federal, state and local guidelines and regulations, and the company clearly communicated that plan to employees and customers, it will be difficult for a court to second-guess those steps and say that a company should have done more.

These are difficult times. Through preparation, companies can balance safety with continued operations and maintain the safest possible premises for employees and third parties, such as vendors, customers and clients.

Insights Legal Affairs is brought to you by Babst Calland

Why useful public/private partnerships often go undiscovered

Governments offer many funding and other partnership opportunities to assist private enterprises. Businesses can benefit greatly from these public/ private partnerships, but first they need to be aware of what funding is out there. Awareness is often driven by government agencies, and industry and trade associations. However …

“There is no substitute for having a relationship with a trusted adviser who is well educated on both public and private funding mechanisms,” says Moore Capito, a shareholder at Babst Calland.

Smart Business spoke with Capito about public/private partnerships and strategies to better connect businesses with potentially helpful government opportunities.

Why isn’t there more participation in public programs by businesses?

How often or how readily businesses take advantage of government programs can depend on the type of program and the market sector. For example, agricultural businesses are heavy users of government programs — subsidies, for instance — because that’s been inculcated into that business segment. Many recent partnership opportunities have been geared toward the small business sector (i.e. Small Business Administration (SBA) programs; programs for Disadvantaged Business Enterprises; Minority-owned Businesses Enterprises; Women-Owned business Enterprises; and 8(a)/Minority or Women Owned Small Businesses; as well as SBA loans, including recent high-profile SBA loan programs like the Paycheck Protection Program (PPP) and Economic Injury Disaster Loan that were designed to support small businesses through the COVID-19 pandemic). However, there are plenty of existing government programs available to established businesses that are willing to take the time to look.

While lack of awareness can be a barrier, the administrative burden can also discourage participation. There tends to be significant paperwork necessitated by regulations designed for oversight. That takes time, and that can mean time away from day-to-day operations, something that not many businesses are positioned to absorb. Such regulations can frustrate the purpose of the programs because the true targets might find the time costs outweigh the financial benefits.

How has the Paycheck Protection Program increased overall awareness of government partnership opportunities?

The SBA’s PPP, offering forgivable loans to support small business payrolls through eight weeks of the COVID-19 pandemic, has shown that when attractive capital is put before companies, they’re going to snatch it up quickly. The initial PPP funds were exhausted in less than two weeks.

Long-term, a program like this could be something that triggers more interest among businesses in exploring other government programs. Perhaps, the awareness of the PPP loan program will cause businesses to look for other partnership opportunities. So, there’s some tangential learning that is likely to be a byproduct from this that stands to heighten awareness.

How do private businesses typically find out about public programs?

Good sources of information for available public programs are trade associations, chambers of commerce, farm bureaus, and business and industry councils. It’s also a good idea for businesses to call their local representatives, whether
at the state or federal level. Those representatives should be knowledgeable about what programs are out there.

Additionally, there are many tools available at the government level to help businesses succeed, even if they don’t consist of some type of funding. Some of these tools exist just to help steer businesses in the right direction, whether they’re established businesses or startups. Economic development entities are one example.

It’s always to a business’s benefit to be tuned in with what’s going on at the government level. The lesson from the current crisis is that it’s a good idea to develop a relationship with an adviser that can knowledgeably consult on the pros and cons of available programs and partnerships.

Insights Legal Affairs is brought to you by Babst Calland

How established companies can secure game-changing innovations

There is global consensus that large companies across various sectors need to innovate, be agile and anticipate new technologies, new markets and new demand cycles to stay competitive.

“We are seeing a paradigmatic shift among large companies,” says Justine M. Kasznica, a shareholder at Babst Calland. “Not only are these companies seeking to attract a diverse and innovative workforce, they are pursuing business-optimizing innovation and solutions, which are often found outside their walls.”

Smart Business spoke with Kasznica about how established companies are finding and taking control of technologies that set them up for a bright future.

How does internal innovation offer large companies a competitive advantage?

While large companies have traditionally innovated from within, recently this model has matured. Now large companies are creating R&D labs with a tech transfer capability designed to be more agile than the parent company. These innovation centers have a distinct culture that’s more agile, nimble, able to sustain high growth. In this model, the company funds and owns the innovations outright and can decide the best course of action to bring them to commercial life — as an asset of the company or a spinout entity that licenses the technology from the parent company and grows independently.

What should companies consider when acquiring companies for their technologies?

As an alternative way to innovate, many large companies search for and acquire companies to bring their technology and innovators in-house through M&A. In this model, due diligence is critical. In addition to financial assessment, it requires an evaluation of whatever technology is being purchased and whether the intellectual property (IP) is sufficiently protected. It further requires a review of employment, confidentiality and licensing agreements to ensure that the acquirer will be free to commercialize and develop the acquired technology assets.

How can companies leverage external innovation to add value?

Increasingly, large companies search for and identify technologies and technology companies in the early and high-growth stages outside of their organization and work with them as commercial partners, often as a prelude to acquisition. Using short-term evaluation agreements, large companies can evaluate a particular technology and test its commercial viability through the successful achievement of key performance indicators (KPIs) or other milestone-based criteria. These types of arrangements typically include inbound licensing of the IP.

When entering into a pilot or evaluation agreement, both parties are encouraged to protect their investment in the relationship by setting it up to convert to a long-term agreement if certain performance indicators are met. These KPI ‘gates’ present each party with an ability to shape the relationship, share in the development and enjoy the benefits of the innovative output. They also help each party mitigate the risks of overcommitting, with each gate presenting a chance to walk away.

Of course, contractual safeguards must be put in place to ensure the security of company IP, data and customer information, as well as regulatory compliance and other risk-mitigating protections.

How does strategic investment enable access to new technologies and innovations?

Some large companies establish investment divisions or entities, often run independent of the company, that operate under a venture capital model. These strategic corporate investment groups scour the world for high-growth, disruptive technologies and innovations, which they then invest in. Some corporate venture arms invest in high-growth targets as a way to make money for the company and broaden its value base through revenue. More commonly, they invest in companies developing technologies or innovations that strategically align with the parent company’s interest, where the portfolio company, if successful, becomes an acquisition target for the parent company.

Whatever the approach, large companies should work to understand the innovation landscape and the ways they can leverage it to stay ahead of the competition.

Insights Legal Affairs is brought to you by Babst Calland

How to create a strong trademark with a new product or business name

A trademark or service mark identifies a company as the source of a particular set of goods or services. It protects the association, in a consumer’s mind, between goods or services and the company that sells or produces them.

“We try to protect the goodwill a company has earned by registering and enforcing their trademarks to make sure no one obtains an unfair business advantage by trading off our clients’ goodwill in the marketplace,” says Carl Ronald, shareholder at Babst Calland.

Smart Business spoke with Ronald about adopting trademarks.

How long do trademarks last?

Theoretically, trademarks can last forever. Realistically, though, trademark protection lasts as long as you continue to use a name or logo in the marketplace. There are two types, registered and unregistered, and the latter is often called “common law” marks.

A registered trademark is a text or design mark that a company applies for with the United States Patent and Trademark Office. So long as the business continues to use the mark and appropriate maintenance procedures are complied with, the registration will be good for an unlimited number of renewable terms of 10 years each.

Common law marks, on the other hand, last as long as they continue to be used in commerce but convey less protection.

What’s the procedure for protecting a new product or business name?

First, identify the word or logo you wish to use with your product or service, and decide whether you’re likely to use it longer than a few years, in order to justify the cost. Is this a name for a core product, or a slogan that plays off a current event or product line that may change seasonally or annually?

Next, evaluate the strength of the mark. The strongest are made-up word(s) that don’t describe what you sell, like Xerox or Apple. Suggestive marks convey a characteristic of the goods or services being sold but don’t exactly describe them. An example of this slightly weaker mark is Netflix. Descriptive marks describe product features, such as Cold and Creamy for ice cream. It’s natural to want to use descriptive words in the name of a new product or business. Unfortunately, this tendency can lead to the adoption of trademarks that are weak source indicators.

After you’ve selected a mark, a clearance search can ensure your use of the mark won’t create confusion in the marketplace due to another pre-existing mark for similar goods. Assuming there are no conflicting marks, you’re free to begin using it in association with your products and services, while, ideally, filing a trademark application.

What if you expand into a new geography and someone’s already in that market?

This classic conflict is another reason to do a nationwide search and obtain a federal registration. If you’re an unregistered user of a mark, you’re likely out of luck. If you’re a registered user, you’re in a much better position if you registered before the other company began use of its identical or confusingly similar mark. You can likely compel them to stop using the mark. If they started using it first, your federal registration still provides some leverage. While you probably can’t force them to stop using the mark, you would have the power to keep them from expanding.

Where do businesses misstep with this?

Some companies confuse a corporate name with a trademark. The two overlap but aren’t identical. When adopting a new name, the exact name may not be taken, but that doesn’t mean a particular mark won’t infringe on the rights of another.

The question isn’t whether the marks are identical. The issue is whether adopting a mark in association with those particular goods or services is likely to cause confusion in the marketplace. Will consumers not understand the true source of those goods or services? Will they think there’s an affiliation or sponsorship between the two entities? A confusingly similar trademark can create just as many problems as an identical one.

What’s your takeaway for business owners?

When introducing a new product or service name or founding a new company, have a clearance search performed prior to adopting the new name. If the goods or services are offered on the internet or in more than one state, file a federal trademark application to protect your rights.

Insights Legal Affairs is brought to you by Babst Calland

The rise of representations and warranty insurance

Representations and warranties insurance, which has become more affordable for merger and acquisition transactions, is growing much more prevalent in recent years as the market for such insurance has grown more competitive.

“If you haven’t paid attention or you’re not a regular acquirer of businesses or assets, your opinion of reps and warranties insurance might be dated,” says Kevin T. Wills, shareholder and chair of the corporate and commercial group at Babst Calland.

Smart Business spoke with Wills about how representations and warranties insurance works and what to consider with this risk mitigator.

What are the benefits of utilizing reps and warranties coverage?

These policies can be advantageous for both buyers and sellers.

For a seller, it can reduce or eliminate any need to holdback or escrow a portion of the purchase price with respect to post-closing indemnification claims for breaches of representations and warranties. This provides a seller with a cleaner exit with less contingent liabilities and more certainty as to the sale proceeds. Additionally, if a seller is going to have an ongoing relationship with the buyer, it also avoids the potential awkwardness a lawsuit may cause.

On the buyer side, it can make your bid more attractive if the seller knows that it will not be responsible for post-closing claims for breaches of representations and warranties. It helps with the negotiation of the purchase agreement because a seller is less concerned with their post-closing exposure for breaches of representations and warranties, which saves time and reduces legal fees. Also, in some instances, the coverage limit and duration that the buyer acquires — the amount of the insurance policy and the term thereof— may exceed what the seller would be willing to give in a negotiated indemnification context. Further, liability baskets and caps do not need to be negotiated with an insurance company.

What are some limitations to be aware of?

A representations and warranties policy is not a cure all; an insurance policy is not a guarantee of recovery.

Further, this insurance only covers breaches of representations and warranties. It does not cover, for example, items such as breaches of covenants of a seller; breaches for which the buyer had knowledge at closing; retained liabilities of the seller, unless they can be tied to a breach of a representation; purchase price and working capital adjustments that might be negotiated in a purchase agreement; and extraordinary losses (those exceeding the policy amount). The policy will contain certain exclusions based on the insurance company’s underwriting that won’t be covered as well.

That is why it is critical for buyers to truly understand the policy binder before obtaining the coverage. Just because a buyer has expended $50,000 in underwriting fees, does not mean the buyer should proceed to pay the premium of 2 to 3 percent of the purchase price if the coverage does not look right once the buyer reviews the policy.

Where wouldn’t reps and warranties coverage make sense?

A strategic buyer who conducts robust due diligence and is familiar with the subject matter of the transaction may not want to spend additional money to acquire a policy. Further, the lower the deal value, the higher the sticker shock and impact on the deal may be. Percentages are universal, but 2 to 3 percent of $20 million, which is a typical minimum deal value for an insurance carrier, can have a greater impact to the bottom line than 2 to 3 percent of $1 billion.

How often are claims paid out?

Claims are typically subject to arbitration, so claims payment is not usually public. However, a payment history is being established and there is a growing track record of honoring claims. For example, insurance carrier AIG reported that in 2018 it had a 19.4 percent claims frequency and the average claim payout was $19 million.

What’s your takeaway for business owners?

Representations and warranties coverage appears to be here to stay and is something to seriously consider for your next deal. Further, it may be something that buyers are obligated to do, especially in a bid process. Some sellers with a desirable business or assets are requiring buyers to buy representations and warranties insurance.

Insights Legal Affairs is brought to you by Babst Calland

Trucking regulators look to alleviate cost increases, while keeping safety first

The trucking industry is still adjusting to the final transition to electronic logging devices (ELDs). Some relief may be on the horizon, however, as federal regulators consider whether to relax the hours of service requirements.

“Every solution has unintended consequences, and that is exactly what we are seeing now,” says Boyd A. Stephenson, associate at Babst Calland. “The supply chain is like a balloon, where everything is interconnected. You push on one part and another piece will pop out.”

Paper logbooks are left to the discretion of the driver, while ELDs record driving time automatically to ensure driving hours are strictly followed. The idea is to make the roads safer. Effective now, strict enforcement of the ELD mandate applies to all drivers, unless they operate under the short-haul rule exemption.

The trucking industry is dealing with rising transportation costs and an overall driver shortage in an economic expansion. Freight volumes also grew more slowly in 2019, with trade conflicts and tariff increases taking a toll on growth.

An American Transportation Research Institute survey found that the top industry concerns for 2019 were driver shortages, hours of service, driver compensation and detention or delays at customer facilities. These obstacles increase trucking costs, which get passed on to shippers that need their goods transported.

Smart Business spoke with Stephenson about hours of service rules and other industry changes that businesses should be aware of in 2020.

Why did the Federal Motor Carrier Safety Administration (FMCSA) feel a need to change the hours of service rules?

With ELDs in place, drivers cannot adjust their logs. Difficulties like wait time while cargo is loaded or unloaded, weather and traffic have highlighted the need to adjust the hours of service and let drivers spend more time on the road. Based on strong industry feedback, the FMCSA proposed more flexible hours of service in August, which it hopes will alleviate some industry challenges.

The agency proposes to:

  • Extend the short-haul exemption, where drivers are not required to keep logbooks. As of now, to be considered short haul, a driver must drive only within a 100 air-mile radius, start and return to the same location with 12 hours of duty time, drive no more than 11 hours and have 10 consecutive hours off between shifts. The updated exemption would apply to those who drive 150 air miles and allow short-haul drivers to be on duty for 14 hours.
  • Give more flexibility for driver breaks and sleeper berth requirements.
  • Allow one off-duty break, lasting between 30 minutes and three hours, that would allow the driver to pause the clock on his or her 14-hour window.

The majority of truck traffic operates under the short-haul exemption, and more liberalized hours of service should have wide-ranging effects on the overall supply chain, such as flexibility and lower costs.

With the comment period over, the FMCSA hopes get a final rule out this year.

What is the Beyond Compliance program, and what does it mean for fleet operators?

Regulators also would like to implement the Beyond Compliance program, which would give incentives to fleet operators that adopt proven safety tools, technologies or practices, such as collision warning. With the comment period closing in February 2020, the final rules have yet to be determined. However, short-haul drivers that use ELDs and implement the Beyond Compliance program may have one incentive, as they will be more likely to be sent on their way if a roadside inspection site is busy. Compliance with this program factors into the carrier and driver history that is already considered.

Businesses with truck fleets should be proactive with safety technology, as these investments can pay off. Not only will adopting these technologies deprioritize a truck’s chance of getting inspected, but the resulting improved safety performance makes the truck safer, which also lowers the required inspection rate and factors into insurance costs.

Insights Legal Affairs is brought to you by Babst Calland

The crackdown on aftermarket defeat devices on vehicles

Recent enforcement efforts by the Environmental Protection Agency (EPA) have resulted in a marked upswing in cases — civil and criminal — against parts manufacturers and installers of aftermarket defeat devices on vehicles, including some less than obvious targets.

Aftermarket parts are replacement or additional vehicle or engine parts not made by the original equipment manufacturer. Most aftermarket parts do not violate the Clean Air Act, but some are designed to reduce or eliminate the effectiveness of required emissions controls.

“Business owners need to ensure their company-owned vehicles and engines are legal,” says Julie Domike, shareholder at Babst Calland. “Many of these enforcement cases have been against companies or individuals that produce or install ‘tuners,’ engine control module reprogrammers that disable emission control systems with preloaded software (tunes). These defeat devices are obvious enforcement targets. However, other devices or software could also fall in this category; therefore, liability could extend to other aftermarket suppliers.”

Smart Business spoke with Domike and Gina Falaschi, associate at Babst Calland, about the EPA’s enforcement efforts.

Where might businesses be at risk?

Mechanics sometimes look to increase fuel economy, boost the performance of the vehicle, reduce maintenance costs, or reduce vehicle downtime associated with routine maintenance, such as regenerating diesel particulate filters. The illegal methods of doing this involve removing or disabling emissions control devices on vehicles, such as the diesel particulate filter, exhaust gas recirculation valve and selective catalytic reduction system. Because removing vehicle hardware will result in a check engine notification or may put the vehicle into ‘limp home’ mode, severely limiting power, these changes must be accompanied by an illegal alteration of the software to override its response to missing or disabled hardware.

It is important to realize when employees add aftermarket defeat devices to company vehicles, businesses could have significant Clean Air Act liability, and right now the EPA is actively looking for these violations.

Why is the EPA so concerned?

The EPA has significant enforcement power under the Clean Air Act to ensure that national air quality standards are maintained. The EPA is particularly concerned about the increase in air pollution from the transportation sector. While EPA enforcement against stationary sources has recently decreased, the EPA has increased enforcement against vehicle and equipment manufacturers in both criminal and civil venues. When vehicles are tampered with, they have significantly increased emissions, especially nitrogen oxide (NOx), which contributes to ground level ozone, a criteria pollutant regulated by the EPA.

The EPA reports its enforcement efforts have uncovered over half a million vehicles that have been tampered with, potentially increasing emissions by the equivalent of 9 million trucks.

Who exactly could be liable?

The EPA has historically brought civil enforcement actions against vehicle and engine manufacturers for engine software that allowed NOx emissions to increase. The agency, however, has expanded enforcement to manufacturers, retailers and installers of tuners, as well as individuals who remove emissions control systems from vehicles, especially trucks. Those who modify vehicle fleets by adding equipment may also violate the Clean Air Act by causing excess emissions due to weight increases. The EPA sees this as tampering.

With the EPA’s current emphasis on enforcement, retailers could be subject to civil enforcement for selling aftermarket defeat devices. Additionally, those who manufacture and sell devices that they know or should know are being used to tamper with emissions control equipment could be targeted by EPA enforcement.

What action should business owners take?

Be aware of the issue; ensure it is not happening in your organization or with your vehicles. Inform your employees that this is not condoned behavior and if anyone has touched a vehicle in this fashion, it needs to be fixed. Beyond that, add education about the Clean Air Act, and what’s permissible under it, to your company’s environment, health and safety training.

Insights Legal Affairs is brought to you by Babst Calland

How to prepare to defend against “bet-the-company” litigation

Bet-the-company litigation is a term recently created to refer to complex litigation that could result in a company going bankrupt and going out of business — it’s a new name given to an existing phenomenon. These cases, as the name implies, are deadly serious and could lead to the loss of intellectual property or an injunction that prevents the company from engaging in business. 

Typically, these cases are initiated by a plaintiff that’s looking to put a competitor out of business or gain a competitive advantage in a market. These are time-consuming, expensive and very high-risk gambits. However rare they might be, companies in certain industries should know the risk exists and take steps to prepare themselves for a lengthy, resource-exhausting fight. 

Smart Business spoke with Robert T. Glickman, the managing principal at McCarthy, Lebit, Crystal & Liffman Co. LPA, about strategies companies can use to prepare for and defend themselves against bet-the-company litigation.

How is bet-the-company litigation different from other commercial litigation?

As opposed to standard commercial litigation, bet-the-company litigation is to be avoided at all cost. However, most often a company is forced into litigation and has no choice but to oppose a claim because, if it’s successfully prosecuted, the company could be put out of business. 

Also, because the opponent’s goal is to close the client’s business, these cases are far harder to resolve through settlement. And litigation in these cases inevitably lasts longer than standard commercial litigation. I defended a case that lasted 12 years without an appeal and the legal bills were in the tens of millions of dollars for both parties. 

Who is most likely to initiate bet-the-company litigation?

From a plaintiff’s perspective, these cases involve large companies — as in, Fortune 500 companies — most of which have a history of being litigious. This type of litigation occurs more frequently in industries that are controlled by one to four players. Satellite TV and technology, for example, are industries in which just a few companies are trying to control the market. Smaller companies that are faced with litigation by a much larger, resource-rich company are in a precarious position because there is little regard for the amount of money they’re willing to spend to drive a competitor out of business.

How can companies prepare for bet-the-company litigation? 

Anyone looking to operate in an industry dominated by a few large companies should give serious thought to buying insurance that will provide coverage for certain claims brought against them. This at least provides some protection against a plaintiff with seemingly bottomless resources and an overall goal of causing as much harm as possible. There are lots of types of insurance available, so companies should talk with a broker to determine what’s best for their situation. Having this insurance can be a deterrent — plaintiffs are far less likely to engage in litigation with a company whose legal bills are being paid by a large insurance company. 

Companies can also insulate themselves from some damages by using single-purpose entities, breaking out assets such as real estate and ancillary companies so they can’t be easily sued. 

Also, prepare a war chest ahead of time if there’s concern that a large competitor could threaten the business. That’s important because bet-the-company litigation is fast and hard-hitting. These cases almost always involve emergency injunctive relief as a weapon, which can bring a case to court in as little as two weeks. Companies that are not prepared for this possibility can quickly be outmaneuvered.

Companies worried about the threat of litigation should also have a lawyer prepared ahead of time. It’s best to work with a firm that has expertise in the company’s industry and trial lawyers who’ve tried complex cases. That doesn’t mean the biggest firm is the best. Companies need experience and expertise that’s affordable. Establish a formal relationship with the firm because conflicts can arise quickly and a conflict could mean the ideal lawyer isn’t available when needed.

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

How to prepare for California’s sweeping privacy law

In 2018, California signed into law the first state-level comprehensive privacy act, the California Consumer Privacy Act of 2018 (CCPA), which goes into effect Jan. 1, 2020. Due to the CCPA’s broad scope and reach beyond California, as well as its large fines and penalties for noncompliance, the law is influencing and setting a high bar for data protection practices nationwide. Since the CCPA was signed, several states have proposed or enacted similar legislation, turning privacy and cybersecurity into a patchwork of state-led experimentation.

“More states are developing privacy laws, which will make it difficult for companies to track and comply with every state’s privacy act, not to mention the privacy regimes in non-U.S. jurisdictions, such as Europe’s General Data Protection Regulation (GDPR),” says Justine Kasznica, shareholder at Babst Calland.

In the absence of a uniform approach to privacy and cybersecurity, businesses need to be aware of the state, federal and foreign laws being introduced and enacted — even if their operations are not yet affected.

Smart Business spoke with Kasznica about how California’s privacy law, and others, will impact companies.

How does California’s privacy act work?

The CCPA protects consumers who are residents of California, giving them rights to disclosure, access, deletion and control (opt-out and portability rights), as well as imposing a prohibition on antidiscrimination. It also addresses the data privacy rights of children under the ages of 13 and 16.

The CCPA is modeled on the GDPR, articulating similar consumer rights (even if terms differ) and imposing business obligations and enforcement mechanisms. While compliance with GDPR may facilitate CCPA compliance, the two privacy regimes deviate in their definitions of personal information/data, scope of the rights protected, affected organizations, and penalties and enforcement.

The CCPA applies to for-profit entities (and certain nonprofits) that do business in California and collect or direct the collection of personal information of consumers, if such entity:

  • Has total annual gross revenue in excess of $25 million a year.
  • Receives, sells or shares the personal information of 50,000 or more consumers, households or devices of California residents.
  • Derives 50 percent or more of its annual revenue from selling personal information of California residents.

With the rapidly changing privacy regulatory landscape, how should businesses react?

Companies need to evaluate how they operate and collect, store and process personal information. Many U.S. businesses will need to change their data privacy practices to comply with the CCPA, GDPR and other privacy laws. Even those companies that are not subject to a particular privacy law may be affected if they partner or do business with companies that need to comply with a law, and the obligations pass on by contract.

A pragmatic approach to privacy law compliance would be to:

  • Perform a data privacy assessment that captures what kind of personal information an organization collects, for what purpose it is collected and how the information is being used. Achieving consensus on the definition and categories of personal information/data is critical.
  • Understand which privacy laws and regulations apply or will apply. If you believe your organization is subject to the CCPA, reach out to experts in legal, risk and IT who can help ensure compliance.
  • Work with legal counsel to modernize or update your terms and conditions, privacy policies, cookie and other data collection policies.
  • Redesign and deploy new internal and user-facing processes, safeguards and tools to enable individuals to exercise their rights, as required. This may include new communication tools, notices, banners and opt-in or opt-out features, as well as data access, correction and deletion procedures. Be sure to plan ahead; budget time and resources for the changes.

Bottom line: Whether your organization falls within the scope of the CCPA or not, a wait-and-see approach is not a good strategy. Privacy laws are only going to become more important as the landscape evolves, and the GDPR and CCPA are just the beginning.

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