Category: Corporate law

More than a “Board” Game: How Companies Thrive with Diversity, Equity and Inclusion

Over the past few years, California has enacted legislation that requires public companies in California to meet certain diversity metrics with respect to their boards of directors. These board-specific requirements follow the development of empirical data that supports the following conclusions: (1) diversity in public corporations’ boards of directors was severely lacking and (2) diversity at a top level can make a company perform better. But diversity, equity and inclusion (“DE&I”) does not end at the top, though that is a great place to start.

To that end, in 2018, Senate Bill 826 was signed into law to advance equitable gender representation on California corporate boards. The law required that by the end of 2019, all domestic general corporations and foreign public corporations whose principal offices are located in California must have a minimum of one female on its board of directors. By the end of 2021, the law requires an increase to a minimum of two female directors if the corporation has five directors, or a minimum of three female directors if the corporation has six or more directors. And in order to add teeth, the California Secretary of State is authorized to impose fines for violations of these requirements: $100,000 for a first violation, or for failure to timely file board member information with the Secretary of State, and $300,000 for a second or subsequent violation. See Cal. Corp. Code Sections 301.3 and 2115.5.

In September 2020, Assembly Bill 979 was signed into law, requiring boards of California public corporations to include directors from underrepresented communities by the end of 2021. An individual from an underrepresented community is defined as “an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender.” By the end of 2022, those requirements grow to two board seats if there are five to eight board seats total, and three board seats for companies with nine or more board seats. Similar fines are available for non-compliance ($100,000/$300,000). See Cal. Corp. Code Sections 301.3, 301.4 and 2115.6.

While there is ample justification for these board-specific legislative changes, DE&I go far beyond the make-up of a board of directors and impact the entirety of a company. Recently, we spoke with Melynnie Rizvi, Deputy General Counsel and Senior Director of Employment, Inclusion and Impact at SurveyMonkey on our podcast, The Performance Review, to discuss how DE&I can make a company thrive. (Check out the episode here – where you can also get MCLE self-study credit).

Among the salient points: To thrive with DE&I, it cannot just happen in the boardroom – it’s the whole company. According to Ms. Rizvi, companies should let those initiatives permeate further into the company culture and be included in a company’s business plans. There are a number of reasons companies should focus on developing programs and policies to enrich DE&I efforts:

Reason 1: It is the right thing to do.

Though business can be cutthroat, more often than not, the right business decision is also just the right thing to do. Put simply, developing an environment that champions diversity is not only consistent with California law, it is good for your employees and good for your consumers. This dovetails with an ancillary benefit – it is good for a company’s image. Brand loyalty and awareness is more important than ever, both for recruiting solid talent, and making consumers happy. More and more employees and consumers are making choices about which company to support based on the company’s outward facing DE&I initiatives or protocols. As this data becomes clearer, we see more and more employees sharing positive sentiment toward racial justice and racial equality. According to Ms. Rizvi, a SurveyMonkey poll recently found that the majority of employees in the tech sector want to work for companies that take a stand on social issues.

Reason 2: It is good for business.

Indeed, research and data have shown that a focus on DE&I, along with other initiatives related to environmental, social and governmental programs, actually result in better financial performance for companies. Here are some examples cited in SB 826 and AB 979:

  • “According to a report by [an international consulting firm], for every 10 percent increase in racial and ethnic diversity on the senior-executive team, earnings before interest and taxes rise 0.8 percent.”
  • “A study by [a research firm] found that the high tech industry could generate an additional $300 billion to $370 billion each year if the racial or ethnic diversity of tech companies’ workforces reflected that of the talent pool.”
  • “In 2014, [a large financial institution] found that companies with at least one woman on the board had an average return on equity (ROE) of 12.2 percent, compared to 10.1 percent for companies with no female directors. Additionally, the price-to-book value of these firms was greater for those with women on their boards: 2.4 times the value in comparison to 1.8 times the value for zero-women boards.”
  • “A 2017 study by [a finance company] found that United States’ companies that began the five-year period from 2011 to 2016 with three or more female directors reported earnings per share that were 45 percent higher than those companies with no female directors at the beginning of the period.”
  • “[A large financial institution] conducted a six-year global research study from 2006 to 2012, with more than 2,000 companies worldwide, showing that women on boards improve business performance for key metrics, including stock performance. For companies with a market capitalization of more than $10 billion, those with women directors on boards outperformed shares of comparable businesses with all-male boards by 26 percent.”

There are a number of ways to measure performance but, at minimum, seeing an increase in profitability is usually top of mind. Moreover, focusing on recruiting and training a more diverse talent pool can open a company up to a wider range of backgrounds and ideas, which can lead to better products and services.

Reason 3: It may keep you out of court.

DE&I initiatives can help prevent companies from facing discrimination or pay equity lawsuits. These lawsuits can be costly, time-consuming, and an overall business distraction – not to mention – bad for publicity. By addressing any deficiencies in diversity now, you may prevent your company from litigation heartache in the future. Moreover, SB 973, another of California’s recent laws, requires covered employers (100+ employees) to file a pay data report (Form EEO-1) with the Department of Fair Housing and Employment on or before March 31, 2021, and each year thereafter, that states the number of employees by race, ethnicity, and sex for the prior calendar year in 10 covered job categories. See Gov. Code Section 12999.

So perhaps that leaves you wondering, what should my company do? Systemic changes take time and can be difficult to get started and/or sustain. They require buy-in from the top all the way down. This will typically require a multi-faceted approach, but according to Ms. Rizvi (seriously, go listen to the podcast) here are a few ideas:

  1. Integrate DE&I into your business goals/objectives. Make this a priority with specific benchmarks and deliverables, just as you would set a profit target.
  2. Hold people accountable for lack of progress, and reward achievements. Just as you would hold someone accountable for missing a sales goal, or releasing a product behind schedule, companies could consider measuring job performance, at least in part, on how DE&I initiatives are performing.
  3. Look for ways to implement across the company, not just at the top. And this should go between departments as well. For example, it is one thing if your workforce is majority female, but if they all work only in one department, have you really created the diverse environment across the company to make it thrive? Not likely.
  4. Find ways to improve DE&I advocacy. This can be within the organization, or external, such as partnering with different social justice groups, or engaging in efforts to develop new legislation.
  5. Implement policies consistent with these goals. This means fine-tuning anti-discrimination policies, developing diversity initiatives, and crafting policies related to social justice initiatives.

There are a number of ways employers can create an environment that champions DE&I. But at minimum, California has spoken and requires covered companies to start this process in the boardroom. But as data continues to show, the need for DE&I runs all the way through a company, and can drastically transform not just the public’s perceptions, but your company’s bottom line.

©2020 Greenberg Traurig, LLP. All rights reserved.

ARTICLE BY Kurt A. Kappes and Michael Wertheim of Greenberg Traurig, LLP
For more articles on corporate law, visit the NLR Corporate & Business Organizations section.

Why All Publicly Held Corporations Do Not File Corporate Disclosure Statements

California’s female and underrepresented communities quota requirements apply to “publicly-held corporations”.  California’s Corporate Disclosure Statement requirement applies to “publicly-traded corporations”.  California’s Secretary of State’s website describes publicly held corporations as a “subset of publicly traded corporations”.  This is not strictly accurate.  See Some Differences Between “Publicly Held” and “Publicly Traded” Corporations.

Moreover, not ever foreign corporation meeting the definition of a “publicly held corporation” is required to file a Corporate Disclosure Statement pursuant to California Corporations Code Section 2117.1.  Why?  A foreign publicly held corporation is required to file a Corporate Disclosure Statement only if it has registered to transact intrastate business pursuant to Section 2117.  Some publicly-held corporations do not transact intrastate business in California.  They may, for example, simply be holding companies.  Under Section 191(b) a foreign corporation is not be considered to be transacting intrastate business merely because its subsidiary transacts intrastate business or merely because of its status as, among other things, a shareholder of a domestic corporation or a foreign corporation transacting intrastate business.

A Day To Be Wary?

Today is, of course, the Ides of March.  The word “ides” is derived from the Latin word for the 15th of the month in March, May, July and October and the 13th in the other months.  The Latin word is derived from the still older Etruscan word meaning to divide.  The 15th is roughly the dividing day of the month.  The assassination of Julius Caesar in 44 BCE made the date famous.

According to the Greek historian Plutarch, a seer warned Julius Caesar of this day while Caesar was on his way to the Senate:

ὥς τις αὐτῷ μάντις ἡμέρᾳ Μαρτίου μηνὸς, ἣν Εἰδοὺς Ῥωμαῖοι καλοῦσι, προείποι μέγαν φυλάττεσθαι κίνδυνον ἐλθούσης δὲ τῆς ἡμέρας προϊὼν

(“A seer was telling Caesar on this day of the month of March, which is called the Ides by the Romans (Εἰδοὺς in Greek), a great danger was coming . . . “)

Fifteen centuries after Plutarch wrote these lines, William Shakespeare incorporated the seer’s warning into his play, Julius Caesar:

Soothsayer. Beware the ides of March.

Caesar. What man is that?

Brutus. A soothsayer bids you beware the ides of March.

In Thornton Wilder’s historical novel, The Ides of March, Caesar exclaims: “I govern innumerable men but must acknowledge that I am governed by birds and thunderclaps”.  The story, of course, ends with Caesar’s assassination and a different kind of “March madness”.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP

ARTICLE BY Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on California corporate law, visit the NLR Corporate & Business Organizations section.

7 Keys to Selecting the Best Corporate Intelligence Firm

When you need to conduct a corporate investigation or gather intelligence in order to make a strategic business decision, you need to know that you are relying on complete and accurate information. There is no tolerance for uncertainty, and there is no room for error. If the information gathered is anything less than comprehensive, you will not have the insights you need; and, while you could get lucky, what was supposed to be an informed decision could end up doing more harm than good.

With this in mind, when you need to make an informed decision on a matter with significant business implications, you need to rely on the advice of experienced investigators and advisors. In short, your choice of corporate intelligence firms matters. So, how do you choose? Here are seven key factors to consider:

1. Professional Background and Corporate Intelligence Experience

While you are choosing a corporate intelligence firm, it is ultimately the people you choose that matter most. It is the firm’s personnel who will be investigating, gathering intelligence, and providing advice, so you need to know that these individuals have the background and experience required in order to assist your company effectively.

In most cases, companies will benefit greatly from choosing a corporate intelligence firm that employs former federal investigative agents—and ideally former federal investigative agents who spent decades in civil service. This includes not only former agents with the Federal Bureau of Investigation (FBI), but former agents with the U.S. Department of Justice (DOJ), the U.S. Postal Inspection Service (USPIS), and subject matter-specific agencies and departments such as the U.S. Department of Defense (DOD), the U.S. Drug Enforcement Administration (DEA), and the U.S. Department of Health and Human Services (DHHS). Working within these agencies in an investigative capacity offers extensive training and high-level experience, and this experience will often translate directly to the corporate intelligence sector.

Of course, there are differences between conducting a government investigation and proactively gathering corporate intelligence, so experience in the private sector is an important consideration as well. When choosing a corporate intelligence firm, you should feel free to inquire about the public and private experience of each of the individuals who will be assisting your company. There are plenty of corporate intelligence firms out there—some of which offer far more experience than others—and you should look until you find a firm with personnel who you believe have the knowledge and capabilities required to meet your company’s needs.

2. Experience in Your Company’s Specific Area of Need

In addition to general investigative and intelligence-gathering experience, it is also important to choose a firm with personnel who have experience in your company’s specific area of need. For example, conducting a routine compliance audit is a very different matter from investigating an employee’s allegations of harassment or discrimination. Likewise, investigating a possible data security breach is wholly unlike conducting an internal investigation in response to a federal target letter, civil investigative demand (CID), or subpoena.

Different investigative and intelligence-gathering needs call for different procedures, the implementation of different policies, and the utilization of different skill sets. As a result, when looking for a corporate intelligence firm, it is important to focus not only on experience in general, but experience in similar and related scenarios as well.

3. State-of-the-Art Technological Resources

In today’s world, the extraordinary amount of data that companies generate and utilize on a day-to-day basis adds a layer of complexity to corporate investigations that did not exist 20 years ago. When gathering data, it is necessary to rely on state-of-the-art technological resources that ensure both (i) comprehensive data gathering, and (ii) industry-standard (or better) data security. If any data or (any data resources) get overlooked, then not only could the investigation fail to provide necessary intelligence, but it could also potentially expose the company to greater risk as the result of failing to uncover a possible litigation threat or defense strategy.

A corporate intelligence firm should be able to quickly and seamlessly connect its technological resources with your company’s IT platform, and its personnel should be able to work with the senior members of your company’s IT department to quickly implement a systematic and effective data collection plan. Your company’s corporate intelligence firm should be able to work directly with your company’s IT, data storage, and data security vendors as well—all while maintaining strict confidentiality and absolutely preserving the integrity of your company’s sensitive and proprietary data.

4. Nationwide Capabilities

In many cases, it is difficult to tell exactly where a corporate investigation will lead. While some intelligence-gathering efforts (i.e. compliance audits) will remain entirely internal affairs, investigations spurred by government inquiries, third-party allegations, and possible data security breaches can lead to additional investigative needs and the potential for litigation across the country (if not around the world). As a result, when choosing a corporate intelligence firm, it is important to choose a firm that has nationwide capabilities. It should have sufficient personnel and technological resources to follow your company’s investigation wherever it may lead, and it should have a track record of efficiently handling corporate investigations on a nationwide scale.

Additionally, COVID-19 pandemic has changed the way that many companies do business. In some cases, these changes are likely to be permanent. In particular, the substantially increased prevalence of remote working and service delivery are likely here to stay. Not only does this mean that there will be additional challenges during the corporate investigative process, but it means that data (and paper files) will be spread across a much broader geographic area as well. This makes it imperative to choose a corporate intelligence firm with the capabilities required to quickly and effectively gather data, conduct interviews, and undertake other necessary investigative measures wherever it may be necessary to do so.

5. Preservation of the Attorney-Client Privilege

When preparing for a corporate investigation, it is important not to overlook the critical importance of preserving the attorney-client privilege. Without establishing the attorney-client privilege and ensuring that it covers the entirety of the investigation, any and all information uncovered through the investigative process could potentially become subject to disclosure during a government investigation or through discovery in civil litigation.

“When conducting a corporate investigation, it is imperative to preserve the attorney-client privilege. If your corporate intelligence firm is not able to do so, then the government or any counterparties in civil litigation may be entitled to access the data obtained during – and the records generated as the work product of – the investigation.” – Attorney Nick Oberheiden, Ph.D., Founder of Oberheiden P.C.

While some corporate intelligence firms work in conjunction with independent law firms, others utilize the services of in-house lawyers. The latter model not only streamlines the process and ensures that all individuals who are working on the investigation are able to efficiently work together, but it can also substantially reduce the costs involved. By engaging a corporate intelligence firm that can handle all aspects of your company’s investigative needs while also preserving the attorney-client privilege, you can ensure that your company is protecting its legal and financial interests to the fullest extent possible.

6. Relevant Subject Matter Knowledge

Earlier, we noted the importance of choosing a corporate intelligence firm with personnel who have specific experience with the type of inquiry that your company needs to conduct (i.e. a compliance audit, data security breach assessment, or pre-litigation internal investigation). In addition, it is important to choose a firm with personnel who have relevant subject matter as well. From data security to federal securities and antitrust law compliance, corporate intelligence needs can pertain to an extremely broad range of issues, and it is essential that the investigators and advisors working with your company are well-versed in the substantive issues at hand.

7. Support and Insights Beyond the Investigation

Finally, when choosing a corporate intelligence firm, you need to choose a firm that can provide support and insights beyond your company’s immediate investigative needs. Based on the intelligence that has been gathered (or that is likely to be gathered), what are your company’s next steps? If your company is facing a federal investigation or a potential lawsuit, what defensive measures are necessary, and how does this inform the investigative process? If the investigation reveals shortcomings in your company’s compliance policies and procedures, what additions or modifications are necessary? Depending upon the circumstances at hand, these are just a few of the numerous critical questions that may need to be answered.

When choosing a corporate intelligence firm, it is imperative to look beyond the firm’s investigative and intelligence-gathering capabilities to its ability to advise your company based upon the intelligence it gathers. The broader the firm’s capabilities – and the broader its investigators’, consultants’, and attorneys’ experience and subject matter knowledge – the more your company will be able to get out of the engagement. When a corporate investigation is necessary, cutting corners is not an option, and choosing a firm that cannot follow through on the intelligence it gathers can be a costly mistake.

Oberheiden P.C. © 2020
For more, visit the NLR Corporate & Business Organizations section.

Once More Into The Breach – Or Should That Be Conflict?

A common contractual representation is that the execution and delivery of the agreement does not constitute a breach of one or more other agreements or charter documents.  Sometimes, the representation is that the execution and delivery do not “conflict with” or “violate”.  Is there any difference between a “breach”, a “conflict” or a “violate”?

“Breach” is a word of Old English origin (bryce, meaning a fracture or breaking).  “Conflict” and “Violate” in contrast are of Latin origin.  At the siege of Harfleur,  King Henry V urged his troops to fill the the breach:

“Once more unto the breach, dear friends, once more;
Or close the wall up with our English dead.

W. Shakespeare, Henry V, Act III, Sc. 1.

“Conflict” is derived from conflictus which is the singular, perfect, passive participle of confligere meaning to come together in a collision.  “Violate” is derived from violatus which is the perfect, passive participle of violare meaning to injure or dishonor.  To some, these words may connote different meanings (or shades of meaning) and it is possible that a particular agreement will define what constitutes a breach, conflict or violation.  However, I am not aware of any California precedent that assigns different meanings to these terms as a general matter.

Shakespeare generally preferred to use words of Anglo Saxon origin to those of Latin origin.  This may be attributable to Shakespeare’s reportedly week knowledge of Classical languages.  As Ben Johnson, a rival remarked, Shakespeare knew “small Latin and less Greek”.  However, I believe that the power and appeal of Shakespeare’s plays is partly due to his use of Anglo Saxon and Old English words.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP

ARTICLE BY Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP
For more, visit the NLR Corporate & Business Organizations section.

“Gig” Workers May Become Eligible to Receive Equity Compensation

The Securities and Exchange Commission (the “SEC”) recently voted to propose temporary rules to permit companies to provide equity compensation to certain workers known as “gig” or “platform” workers.

Under the Securities Act of 1933 (the “33 Act”), every offer or sale of securities must be registered with the SEC unless the issuer relies upon an exemption to such registration. Recognizing that the offers or sales of securities in the form of equity compensation differ from the regular process of raising capital from investors, a limited exemption is provided to issuers under Rule 701 of the 33 Act. Rule 701 currently exempts certain sales of securities by private companies made to compensate employees, consultants, and advisors.

Through the proposed new Rule 701, the SEC is recognizing the existence of certain types of employment relationships in the “gig economy” that fall outside the scope of the traditional employer-employee relationship. These are the “gig” or “platform” workers who have become important to the economy with the increased use of technology. Gig workers use a company’s internet platform to find a specific type of work or “gig” to provide services to end-users. Some common examples are ride-sharing, food delivery, and dog-sitting services. These workers are generally not considered employees, consultants, or advisors, and thus have not been eligible to receive securities pursuant to compensatory arrangements under Rule 701. Under the proposed amendment to Rule 701, however, companies would be permitted to compensate these platform workers with equity compensation, subject to certain conditions.

For an issuer to compensate platform workers pursuant to the proposed new Rule 701, the platform workers will have to provide bona fide services pursuant to a written contract or arrangement by means of an internet platform or other technology-based marketplace platform or system provided by the issuer. Additionally, the issuer is required to operate and control the platform, the proposed issuance of securities to the platform worker must be pursuant to a written compensation arrangement or plan, the issuer must take reasonable steps to prohibit transfer of the securities offered to the platform worker, and the securities issued must not be subject to individual bargaining or the worker’s ability to elect between payment in securities or cash. The offering per worker must be within certain caps on the amount ($75,000) during a 36-month period and a percentage of the value of the compensation (15%) received by the platform worker during a 12-month period. This exemption, if adopted, would be available for a period of five years.

The proposal is subject to a 60-day comment period following its publication in the Federal Register.

Given the benefits that equity compensation offers to both employers and employees, this exemption should provide benefits to both issuers and platform workers in the “gig economy.”

©1994-2020 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
ARTICLE BY Daniel I. DeWolf of Mintz
For more, visit the NLR Corporate & Business Organizations section.

Why Is The WSJ Attacking A Dead Bill?

Last Friday, The Wall Street Journal published an alarming Op-Ed piece concerning a California Bill, AB 2088, that would impose a wealth tax on any person who spends more than 60 days inside the state’s borders in a single year.   The idea of a transient wealth tax is a very bad idea, but why is the WSJ spilling ink on the bill now?

AB 2088 started its brief life in February of this year as a bill to amend, of all things, the Education Code.  In March, it became a bill that would amend the Elections Code.  It was not until August 13, that the bill was gutted and amended to impose a wealth tax on sojourners to the Golden State.  The bill, however, never made it out of the house of origin.  When the session ended, the bill died.  The current legislative biennium began earlier this month and it is possible that the authors will resurrect the wealth tax idea in a new bill.  The bill introduction deadline is not until February 19, 2021 and we may have to wait until then to see if a reincarnated bill is introduced.  Even if after that deadline, it is possible that the legislature will gut and amend another bill to implement the tax.

The WSJ’s attack on a dead bill reminds me of a story about Charles V, the Holy Roman Emperor.  After defeating the Lutheran princes in the First Smalkaldic War, he entered the university town of Wittenberg where Martin Luther was buried.   Encouraged to desecrate Luther’s remains, Charles reportedly proclaimed “Let [Luther’s bones] rest until Judgment Day . . . I don’t make war on the dead . . .”.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP
For more, visit the NLR Corporate & Business Organizations section.

Are Diversity Riders Legal?

Some venture capital firms have recently begun including so-called “diversity riders” in their term sheets.  In general, these require that the issuer and the lead investor make commercially reasonable efforts to include a member of an underrepresented community as an investor in the financing.  However well-intentioned the proponents of these clauses may be, the question arises whether they run afoul of state laws forbidding discrimination in private sector.

California’s Unruh Civil Rights Act, for example, provides:

” All persons within the jurisdiction of this state are free and equal, and no matter what their sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, sexual orientation, citizenship, primary language, or immigration status are entitled to the full and equal accommodations, advantages, facilities, privileges, or services in all business establishments of every kind whatsoever.”

Cal. Civ. Code § 51(b).   The question, of course, is whether an obligation to include particular persons based on sex, race, color etc. runs afoul of “full and equal” advantages.  Notably, the protection of the Act extends to “all persons” and is not confined to a limited class of protected persons.  The use of the word “all” and the phrase “every kind whatsoever” makes it clear that the phrase “business establishments” is to be interpreted in the broadest sense reasonably possible.

It is quite obvious that if an issuer or lead investor discriminates in favor of one class of persons, it is not treating all persons in a “full and equal” manner.  Further, discrimination in favor of one class of persons (however defined) necessarily involves discrimination against all persons who do not belong to that class.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on California Corporate Law, visit the National Law Review Corporate & Business Organizations section.

“Is You Is or Is You Ain’t:” Membership in an LLC

The New Jersey Superior Court, Appellate Division case Giordano DeCandia v. Anthony T. Rinaldi, LLC d/a The Rinaldi Group and Anthony Rinaldi, (N.J. App. Div., Oct. 5, 2020) per curiam, is about whether the plaintiff was or is a member of the LLC, and the economic consequences of that determination. The Appellate Division affirmed the rulings of the trial court (in a bench trial), except for reversing one of the defendants’ counterclaims. The case is most important for two reasons: first, it underscores the potential for chaos resulting from the uncertainties of oral versus written claims; and second, it reveals that the New Jersey judiciary, even at the intermediate appellate level, still finds a limited liability company (even 27 years after the first NJ LLC statute was adopted) a strange and challenging creature. The critical issue of membership is nicely captured by the rather famous old jazz song written by Louis Jordan and Billy Austin and first recorded on October 4, 1943, just over three weeks after your author was born. As its title invokes, when uncertainty abounds, it is difficult to have more than an ephemeral relationship.

Membership in an LLC

Rinaldi had a construction management and general contracting business in New York and New Jersey. In 2003, he formed the LLC as a manager-managed LLC, with himself as both the sole member and the manager. Plaintiff DeCandia began working for the LLC in 2011, with a compensation package of a salary plus a 10% ownership interest, with the ability (based on the amount of work the plaintiff brought in) to go to 20% of “net profits on that work.” The plaintiff signed an operating agreement on February 14, 2011. The Capital Contribution schedule attached to that 2011 agreement stated that the “plaintiff’s ownership interest is performance-based rather than through capital contributions.” The plaintiff received an LLC membership certificate reciting the arrangement. Rinaldi later testified that “profit-sharing is a prevalent and customary compensation mechanism within the commercial construction industry.” It is worth noting that the LLC’s comptroller also testified that the parties advised of the arrangement and that she had a similar profit-sharing deal. On September 25, 2013, the parties signed an amended operating agreement (the “2013 agreement”), adding two more members as the company grew, and giving them similar percentage interests. The plaintiff received an increase to a 20% interest, and a replacement LLC membership certificate reciting the new terms. The old certificate was voided.

In 2015, Rinaldi and the plaintiff began negotiating a buy-sell agreement, to buy out a deceased member’s interest from the surviving spouse, in case either Rinaldi or the plaintiff died. The Court notes that the initial draft of the agreement said that plaintiff would own “twenty percent of the common stock of the LLC.” On October 19, 2015, the parties, two other LLC “employees” (the Court’s term), and the LLC’s accountant met to discuss the buy-sell agreement, tax implications, and financial liabilities related to being (what the Court calls) “an equity partner.” Plaintiff, per the accountant, purportedly said that he was interested in “profits, not taxes.” The Court also reports, without any clarifying explanation, that plaintiff “wanted to avoid any personal liability on the LLC’s bonds.” The plaintiff may have been referring to payment and performance bonds, which are usual in the construction business, as opposed to debt instruments. In that meeting, Rinaldi disclosed that the LLC was under criminal investigation by the New York City Borough of Manhattan District Attorney after the NY Department of Buildings found that numerous safety violations by the LLC caused death at a construction site. Testimony asserted that the plaintiff became frightened that his LLC membership certificate might expose the plaintiff to criminal liability. Rinaldi told the plaintiff that if he was scared, he should resign and turn his LLC membership certificate over to the LLC’s attorney. Shortly after, the plaintiff did so, without signing the certificate or providing any other “explanatory writing.” No buy-sell agreement was ever entered into with the plaintiff. The Court states that after that October meeting, the plaintiff received his salary plus bonuses, but no “profit-sharing.” The plaintiff never sought to recover his membership certificate.

By March 2017, things had deteriorated to the point that Rinaldi terminated the plaintiff. The plaintiff, apparently anticipating that deterioration had contacted a competitor of the LLC in 2016. On the plaintiff’s last day with the LLC, he sent his wife the LLC’s proposed budget for a job it was bidding on; she forwarded the budget to the competitor, which submitted a rival bid. The plaintiff then met with the executives of the potential customer and urged them to hire the LLC’s competitor. The employment agreement plaintiff signed on April 28, 2017, recited that he did not have an ownership interest in any competitor of his new employer. On September 15, 2017, the plaintiff sued the LLC, and Rinaldi, seeking a declaratory judgment that he was a 20% owner of the LLC and other relief. Defendants counterclaimed that the plaintiff had breached his common law duty of loyalty as an employee AND his duty of loyalty as a member of the LLC. The trial court held against the plaintiff on all claims and granted the defendants’ counterclaims. The Appellate Division upheld the trial court’s rulings on all but the counterclaim for breach of the duty of loyalty as a member of the LLC. That statutory obligation applies to members of a member-managed limited liability company, but the LLC was manager-managed so that the duty applied only to managers; Rinaldi was the sole manager. The plaintiff’s efforts to assert equitable claims relating to minority oppression and the like failed because, as both the trial court and the Appellate Division found, the plaintiff’s double-dealing gave him “unclean hands.”

“Is You Is or Is You Ain’t”

Carefully written documents could have resolved most of the factual ambiguities. But both trial and appeal courts found sufficient basis for concluding that the plaintiff had voluntarily withdrawn from the LLC, one of the acts of dissociation that ends membership. Given the trial, the Court’s determination that the plaintiff was not a member or had withdrawn as a member, it is not clear how the trial court could have found that the plaintiff had violated a duty of loyalty owed by a member of a limited liability company. Even more troubling in both opinions (beyond the occasional inaccurate language, e.g., limited liability companies do not have “common stock;” a member of a limited liability company is not an “equity partner”) is the finding that the concept of a contingent percentage interest in an unincorporated business was mere compensation and did not result in plaintiff owning a membership interest in the LLC. That is simply a misstatement of the law. A person may become a member of a limited liability company with a present, vested interest or with a contingent, earning-based interest. Or as it appears from the recitals noted in the Appellate Division opinion, both. The plaintiff’s original deal was:

  • salary;
  • 10% membership interest; and
  • contingent 10% “profit-sharing” interest based on the work plaintiff brought in

Ultimately, as both courts held that plaintiff had given up “whatever ownership interest he may have held in the LLC,” the issue was moot. But the language in the Appellate Division opinion might well allow a future court to find that someone who is in fact a member of a limited liability company in New Jersey is not a member at law – a troubling risk and a reason to consider forming an unincorporated entity under the law of a jurisdiction other than New Jersey.

©2020 Norris McLaughlin P.A., All Rights Reserved
For more articles on corporate law, visit the National Law Review Corporate & Business Organizations section.

Is A Corporation’s Address A Trade Secret?

“Cryptocurrency” is a hybrid word form from the Greek adjective, κρυπτός, meaning hidden, and the Latin participle, currens, mean running or flowing.  The word “currency” is also derived from currens, perhaps based on the idea that money flows from one person to the next in an economy.  Literally, cryptocurrency, is secret money.  But there are secrets and there a secrets.

Recently, a cryptocurrency exchange sued one of its employees for violating the Defend Trade Secrets Act of 2016, 18 U.S.C. § 1831-39.  Among other things, the company alleged that the erstwhile employee had disclosed the “physical address” of the company in a complaint filed in a state court action.  Until now, I had never considered that a company’s physical address might be a secret.  The company argued that “keeping its physical address secret serves to protect it from ‘physical security threats,’ providing as an example of such threats ‘a recent spate of kidnappings’ of persons who work for cryptocurrency exchanges”.  Payward, Inc. v. Runyon, U.S. Dist.

Judge Maxine M. Chesney ruled for the defendant, finding that the plaintiff had failed to allege how its competitors would gain an economic advantage by knowing the company’s address.  Accordingly, Judge Chesney found that the plaintiff had not pled that the address met the definition of a trade secret under the DTSA.

I was somewhat nonplussed by the idea of an office address being a secret (trade or otherwise).  After all, the plaintiff, a Delaware corporation, had filed a Statement of Information with the California Secretary of State disclosing the address of its principal executive office (which is the same as its principal executive office in California).  That filing is a readily accessible public record.  It may be, however, that the address disclosed by the defendant was for another location not disclosed in the Statement of Information.

Etymologists use the term “hybrid word” to refer to a word that is formed by the combination of words from two different languages.  Greek-Latin hybrids are the most common form of hybrids in English.  English does have hybrids formed from other languages.  For example, “chocoholic” is a hybrid formed from New and Old World languages – Nahuatl, xocolatl, and Arabic, اَلْكُحُول (al-kuḥūl).  

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on corporate law, visit the National Law Review Corporate & Business Organizations section.

Amrock Lawsuit Spotlights Consequences of Litigious Gamesmanship

Trade Secret Litigation Commentary

 

On June 3, the Texas Fourth Court of Appeals reversed and remanded the dumbfounding $740 million award in Title Source v. HouseCanary – a welcome development for American innovation and business collaboration. On the back of years-long litigation, a fresh trial of the case can offer important signals for corporations on the risks and rewards of collaboration, as well as deliver much-needed guidance on best practices to navigate already murky trade secret protections.

For the uninitiated, litigation between HouseCanary and Title Source (now Amrock) was borne out of a contract the two companies entered in 2015. The arrangement obligated the delivery of an automated valuation model (AVM) and an app to Title Source at a rate of $5 million per year for HouseCanary’s efforts. Title Source intended to use the software and app as a platform to provide customers the ability to assess property values digitally alongside other services the company offers, like title insurance and closing services. After HouseCanary failed to meet its contractual obligation to deliver a working AVM app, Title Source sued for breach of contract.

HouseCanary then filed a counter claim including allegations that Title Source had misappropriated proprietary information, in this case trade secrets, in an attempt to make an app of its [Title Source’s] own. After a six-week trial that concluded in March 2018, a Texas jury decided in favor of HouseCanary and awarded nearly three-quarters of a billion dollars – one of the largest tort settlements of the year.

Should anyone be keeping score at home, that means the case’s settlement was valued at nearly 150 times the annual payout HouseCanary was to receive from its work with Title Source and dwarfed the firm’s multiple rounds of venture funding by over $600 million. For HouseCanary, litigation proved more profitable than any of its own business ventures, and the settlement certainly outstripped the going market rates on AVMs.

By the conclusion of the original trial, it seemed clear that Title Source had not misappropriated HouseCanary’s trade secrets or proprietary information in building its own app. Further, HouseCanary’s own expert witness testified that there weren’t “any fingerprints, any clues, any reference to any HouseCanary technology” in the app Title Source developed on its own.

Regrettably, the jury’s finding against Title Source was based on inaccurate and incomplete information, unsubstantiated inadmissible character attacks, and back-of-the-napkin math from a questionable damages ‘expert.’ It seemed to be more focused on sticking it to corporate America rather than the actual facts and merits of the case. Not only was the jury gravely mislead, but they also never heard critical information which came to light days after the trial concluded.

Post-trial statements by a former HouseCanary executive turned whistleblower clarified that there was never a “working version” of the app to be delivered to Title Source, and per three more former HouseCanary executives, that the company didn’t have “any IP to steal.” The cogency of HouseCanary’s allegations were further thrown into question when the company, six weeks after the trial’s closure, moved to seal a number of exhibited documents from court record.

As I wrote previously, once the sealing motion was overturned, the documents should “provide another look at the technology in question, which will provide clarity whether there were trade secrets to be stolen.” This is especially important when considered in tandem with the whistleblower testimony.

These and other erroneous inclusions and fatal procedural errors led to a Texas appellate court overturning the verdict and ordering a new trial. The ramifications of the decision in the new trial promise to be immense, especially if HouseCanary invokes Texas’ Uniform Trade Secrets Act for a second time. The Act has been adopted by 47 states total, and significantly broadens the implications of this trial for business operations in all kinds of industries by setting precedent for other lawsuits.

Trade secret litigation has increased tremendously in the past decade, with over 2,700 cases since 2009; add on the massive original settlement and the ruling may very well set the tone for the future of trade secret litigation and the standard of intellectual property protections.

Given the new evidence that has emerged since the jury delivered its decision in 2018, the cards certainly appear stacked against HouseCanary successfully duping the retrial jury. There is little doubt that businesses and innovators everywhere will be awaiting the verdict of the Texas court for clarity on trade secret protections and our court system’s tolerance for overwhelmingly apparent legal gamesmanship.

© George Nethercutt

Authored by George Nethercutt of The George Nethercutt Foundation, a guest contributor to the National Law Review.

For more on trade secrets, see the National Law Review Intellectual Property law section.