Category: Corporate law

Private Email Woes Infect The Private Sector in Delaware

emailVice Chancellor J. Travis Laster’s ruling in Amalgamated Bank v. Yahoo!, Inc., C.A. No. 10774-VCL (Del. Ch. Feb. 2, 2016) should sound a tocsin to directors that their “private” emails may not be so private.  The ruling addressed Amalgamated Bank’s demand to inspect the books and records of Yahoo! pursuant to Section 220 of the Delaware General Corporation Law.  The bank sought to inspect, among other things, documents that reflect discussions or decisions of Yahoo’s full Board or Committee.  Documents covered by the demand included emails to and from the directors, from management or the compensation consultant, emails among the directors themselves, and documents and communications prepared by Yahoo officers and employees about the Board‘s deliberations.

Vice Chancellor Laster found that emails were records subject to inspection under Section 220 and that through Delaware’s jurisdiction over a corporation, a court can compel production of documents in the possession of officers, directors, and managing agents of the firm.  According to the Vice Chancellor, the court can impose sanctions or other consequences on the firm if the officer, director, or managing agent fails to comply. He further noted that if a personal email account was used to conduct corporate business, the email is subject to production under Section 220. Directors and corporate officers should therefore take heed that emails concerning corporate business may be subject to disclosure even if conducted using a private email address.

Article By Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP

© 2010-2016 Allen Matkins Leck Gamble Mallory & Natsis LLP

 

Tax Talk: When Reporting Gifts at Discounted Values, a Qualified Appraisal is Crucial

A common method for transferring wealth from one generation to the next involves contributing assets to a partnership or limited liability company, then transferring minority interests in the partnership or LLC to descendants or other family members.  Done correctly, the technique allows donors to reduce their taxable estates by making gifts at reduced values, because of discounts for lack of control and lack of marketability.  In so doing, the donor also effectively shifts the tax on any appreciation of the underlying assets to the younger generation.

In order to benefit from this estate planning technique, however, it is crucial that the gift is adequately disclosed on a gift tax return and its value backed by a qualified appraisal or a detailed description of the method used to determine the fair market value of the transferred partnership or LLC interest.  Unfortunately, we have encountered situations recently in which a gift was not supported by a qualified appraisal, leading the Internal Revenue Service to challenge the value claimed by the donor and to propose additional gift tax, penalties and interest.  Such challenges can lead to significant uncertainty, stress and legal expense—even if the donor’s valuation ultimately is sustained.

This article describes what constitutes a qualified appraisal and the information that is necessary if no appraisal is provided, and offers some practical advice for donors based on our recent experiences dealing with the IRS in audits and administrative appeals involving disputed gift tax valuations.

IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, requires donors to disclose whether the value of any gift reflects a valuation discount and, if so, to attach an explanation.  If the discount is for “lack of marketability, a minority interest, a fractional interest in real estate, blockage, market absorption, or for any other reason,” the explanation must show the amount of, and the basis for, the claimed discounts.  Moreover, in order for the statute of limitations to begin running with respect to a gift, the gift must be adequately disclosed on a return or statement for the year of the gift that includes all of the following:

  • A complete Form 709;

  • A description of the transferred property and the consideration, if any, received by the donor;

  • The identify of, and relationship between, the donor and each donee;

  • If the property is transferred in trust, the employer identification number of the trust and a brief description of its terms (or a copy of the trust);

  • A statement describing any position taken on the gift tax return that is contrary to any proposed, temporary or final Treasury regulations or IRS revenue rulings; and

  • Either a qualified appraisal or a detailed description of the method used to determine the fair market value of the gift.

While most of these requirements are straightforward, the last generally requires the donor to provide a more complete explanation.  Fortunately, the IRS has published regulations that describe what constitutes a qualified appraisal and what information must be provided in lieu of an appraisal.

With respect to the latter, the description of the method used to determine fair market value must include the financial data used to determine the value of the interest, any restrictions on the transferred property that were considered in determining its value, and a description of any discounts claimed in valuing the property.  If the transfer involves an interest in a non-publicly traded partnership (including an LLC), a description must be provided of any discount claimed in valuing the entity or any assets owned by the entity.  Further, if the value of the entity is based on the net value of its assets, a statement must be provided regarding the fair market value of 100% of the entity (determined without regard to any discounts in valuing the entity or any assets owned by the entity), the portion of the entity subject to the transfer, and the fair market value of the transferred interest as reported on the return.[1]

Donors and their counsel will rarely have the expertise needed to provide such a description.  While it may be relatively simple to provide some of the factual information, determining the appropriate actuarial factors and discount rates is a highly complex and specialized field.  Moreover, even if a donor or his or her counsel happened to have the relevant expertise, a description that is not prepared by an independent expert may be viewed suspiciously by the IRS because of a lack of impartiality.  Moreover, if the description (or the appraisal, for that matter) is prepared by the donor’s counsel, it may negate the attorney-client privilege, at least with respect to any work papers prepared by the attorney in connection with the description or appraisal.

For these reasons and others, we strongly recommend that donors obtain an appraisal from an independent, reputable valuation firm before claiming discounts with respect to a gift of a partnership or LLC interest.  The applicable Treasury regulations provide that the requirement described above will be satisfied if, in lieu of submitting a detailed description of the method used to determine the fair market value of the transferred interest, the donor submits an appraisal of the transferred property prepared by an appraiser who meets all of the following requirements:

  • The appraiser holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis;

  • Because of the appraiser’s qualifications, as described in the appraisal that details the appraiser’s background, experience, education, and membership, if any, in professional appraisal associations, the appraiser is qualified to make appraisals of the type of property being valued; and

  • The appraiser is not the donor or the donee of the property or a member of the family of the donor or donee or any person employed by the donor, the donee or a member of the family of either.

Further, the appraisal itself must contain all of the following:

  • The date of the transfer, the date on which the transferred property was appraised, and the purpose of the appraisal;

  • A description of the property;

  • A description of the appraisal process employed;

  • A description of the assumptions, hypothetical conditions, and any limiting conditions and restrictions on the transferred property that affect the analyses, opinions and conclusions;

  • The information considered in determining the appraised value, including, in the case of an ownership interest in a business, all financial data used in determining the value of the interest that is sufficiently detailed to allow another person to replicate the process and arrive at the appraised value;

  • The appraisal procedures followed, and the reasoning that supports the analyses, opinions, and conclusions;

  • The valuation method used, the rationale for the valuation method and the procedure used in determining the fair market value of the asset transferred; and

  • The specific basis for the valuation, such as specific comparable sales or transactions, sales of similar interests, asset-based approaches, merger-acquisition transactions and the like.[2]

While there is no firm rule on when or how often appraisals must be obtained, appraisals that are more than a year old may be less reliable—particularly if there is good reason to believe that the value of the underlying assets has changed—and thus more vulnerable to challenge.

An appraisal that meets all of the requirements described above is not unassailable, of course, but if the IRS does choose to challenge a gift tax valuation that is supported by such an appraisal, the donor will be in a significantly stronger position in the resulting examination or proceeding than a donor who failed to obtain a qualified appraisal or opted to rely on a stale appraisal.

In sum, obtaining a qualified appraisal is a crucial step in any estate planning or gifting strategy that involves making gifts of assets valued at a discount.  Although donors may occasionally balk at the time and expense of preparing a reliable appraisal, it is almost certainly less time-consuming and costly than battling the IRS in an examination, administrative appeal or in litigation and should give donors confidence that their gifts are unlikely to be successfully challenged by the IRS.

Article By Ivan H. Gold of Schiff Hardin LLP
© 2015 Schiff Hardin LLP

[1] Treas. Reg. § 301.6501(c)-1(f)(2)(iv).

[2] Treas. Reg. § 301.6501(c)-1(f)(3).

Proxy Advisory Firms Release Policy Updates for 2016

Institutional Shareholder Services (ISS) and Glass Lewis, two leading proxy advisory firms, recently published their 2016 proxy voting guidelines, which include updates applicable to the 2016 proxy season.

Institutional Shareholder Services

Key policy updates for US companies reflected in ISS’s 2016 proxy voting guidelines include:

Overboarding: Beginning in 2017, ISS will issue negative vote recommendations for non-CEO directors who sit on more than five public company boards (down from six under the current policy). For CEOs, the outside directorship limit will remain at two. In 2016, ISS will note in its analysis whether a director is serving on more than five public company boards.

Unilateral Board Actions: For established public companies, ISS will continue its policy of generally recommending that shareholders withhold votes (in uncontested elections) from directors who have unilaterally adopted a classified board structure, implemented supermajority vote requirements to amend the bylaws or charter or otherwise adopted charter or bylaw amendments that diminish the rights of shareholders. The negative recommendation would continue in subsequent years until the unilateral action is reversed or approved by stockholders. For newly public companies that have taken action to diminish shareholder rights prior to or in connection with an IPO, directors may be subject to negative vote recommendations under the updated policy, determined on a case-by-case basis (with significant weight given to shareholders’ ability to change the governance structure in the future through a simple majority vote and their ability to hold directors accountable through annual director elections).

Compensation of Externally Managed Issuers: The updated “Problematic Pay Practice” policy provides that an externally managed issuer’s failure to provide sufficient disclosure for shareholders to reasonably assess the compensation practices and payments made to executive officers on the part of the external manager will be deemed a problematic pay practice, and will generally warrant a recommendation to vote against the issuer’s “say-on-pay” proposal.

For a complete overview of the 2016 updates to ISS’s proxy voting guidelines, click here. ISS also recently updated both its Equity Plan Scorecard frequently asked questions (FAQs) and QuickScore 3.0. The updated 2016 US Equity Plan Scorecard FAQs, effective for meetings on or after February 1, 2016, can be found here, and QuickScore 3.0 can be found here.

Glass Lewis

Significant policy updates to Glass Lewis’s 2016 proxy season guidelines include:

Conflicting Management and Shareholder Proposals: Going forward, Glass Lewis will consider the following factors when it is analyzing and determining whether to support conflicting management and shareholder proposals: (1) the nature of the underlying issue; (2) the benefit to the shareholders from implementation of the proposal; (3) the materiality of the differences between the management and shareholder proposals; (4) the appropriateness of the provisions in light of the company’s shareholder base, corporate structure and other relevant circumstances; and (5) a company’s overall governance profile and, specifically, its responsiveness to previous shareholder proposals and its adoption of “progressive” shareholder rights provisions.

Exclusive Forum Provisions: Glass Lewis will no longer automatically recommend a “withhold” vote against the chairman of the nominating and corporate governance committee of a company that adopts exclusive forum provisions in connection with its initial public offering. Instead Glass Lewis will weigh exclusive forum provisions in a newly public company’s governing documents with other provisions that Glass Lewis believes unduly limit shareholder rights (e.g., supermajority vote requirements, classified board and/or a fee shifting bylaw). Glass Lewis will continue, however, to recommend voting against the chairman of the nominating and corporate governance committee when a company adopts an exclusive forum provision without shareholder approval outside of an IPO, merger or spin-off.

Nominating Committee Performance: Glass Lewis may consider recommending shareholders vote against the chair of the nominating committee where the board’s failure to ensure the board has directors with relevant experience––either through periodic director assessment or board refreshment––has contributed to a company’s poor performance. Notably, Glass Lewis does not define “poor performance.”

Overboarding: Beginning in 2017, consistent with ISS’s policy update described above, Glass Lewis will generally recommend voting against (1) any director who serves on more than five public company boards and (2) any executive officer of a public company who serves on a total of more than two public company boards. Like ISS, during 2016, Glass Lewis may note a concern where a director serves on (x) more than five total boards for directors who are not also executives, and (y) more than two boards for a director who serves as an executive officer of a public company.

For a complete overview of Glass Lewis’s 2016 proxy voting guidelines, click here.

Article By Jonathan D. Weiner, Mark J. Reyes & Andrew S. Herrington-Gilmore of Katten Muchin Rosenman LLP

©2015 Katten Muchin Rosenman LLP

Business Succession Planning: An Ounce of Prevention Today

If you told a family business owner that he or she had a one in three chance of survival as a result of a current condition, you would likely get their attention. However, when you tell that same owner that their business, as it currently exists, has a one in three chance of survival in the event of their death the response is often “I will worry about that tomorrow.” The failure to plan may put the family’s financial well-being at risk. This article will address the conflicts that cause family businesses to fail to survive into successive generations and the potential solutions which should be implemented to alleviate such conflicts.

Why Do Family Businesses Fail?

Family businesses fail twice as often because of relationship issues within the family as due to management issues. Which child or children will work in the business and which will not? Which child will be in charge? Will all family members be supported by the business and what internal and external resentments will be heightened by that decision? If the head of the family does not effectively balance the goals of securing the future success of the business with family unity, survival is unlikely. Recognizing the disparate characteristics between family operations and business operations is a start. Families are fueled by emotion and businesses are fueled by logic. Families rely on history and are resistant to change whereas businesses need to adapt and grow. Families accept shortcomings and rationalize poor performance while businesses fire those who are unproductive. Families seek equality while businesses reward achievement. Acknowledging and addressing these conflicts is essential to a successful business succession plan.

Developing the Plan.

1. Identifying Objectives. The first decision to be made by the business owner is the identification of goals and objectives. What does the owner want to happen; i.e., sale versus transfer by gift. When should it happen, today, five years from now or only on death? How should it happen, gifts, sale, inheritance? Who should be involved, children employed by the business only, all children, descendants, in-laws?

2. Identifying Financial Needs. The financial needs of the business owner and spouse will often be determinative with respect to the previously-mentioned objectives. If the business is the owner’s primary asset and therefore the primary method for funding retirement, then value realization is key. The threshold question is what is the business worth? Owners often have an elevated opinion as to the business’s value given it is the culmination of their life’s work. A professional business appraiser will value the business more objectively. The next question is will the realization of that value adequately fund the owners’ expected level of retirement? Finally, on what basis will those funds need to be paid, how does the owner insure future security, and will the business survive under the weight of those payments?

3. Developing Successor Management. It is often difficult for an owner to relinquish day-to-day control. However, the development of successor management is essential for emergency as well as long-term planning. An emergency plan should be established utilizing existing personnel and outside professional advisors such as accountants, attorneys and financial advisors. A long-term plan may include the next generation of family members, key employees or some combination of the two. The formulation of this plan should commence five to ten years in advance of the date of the owner’s retirement. If the future leader is a family member, it is important that he or she be qualified for the position and have the support of employees and other family members. A gradual transition will allow for the development of the successor’s capabilities. Further, as the successor becomes more accustomed to increased responsibility the existing owner can adapt to the loss of responsibility. Such advance planning will more likely result in a smooth transition.

4. Retaining Key Employees. Family businesses often have a few key employees who are critical not only to the eventual succession of the leadership of the business but also to the emergency plan that should be in place in the event of the death or disability of the leader. The following four techniques can be utilized to retain key employees.

a. Employment Agreements. An Employment Agreement will summarize the duties and responsibilities of the employee. However, to encourage retention, the Agreement can also incorporate legal restrictions such as a covenant not to compete and financial incentives such as profit sharing or incentive compensation arrangements. These financial incentives can also utilize vesting periods to encourage continued employment and productivity.

b. Non-qualified Deferred Compensation Plan. A Deferred Compensation Plan is an agreement where the company promises to pay a benefit to the employee at his or her retirement, death or disability as long as the employee continues to be employed for a stated period of time or if the employee is employed upon the sale of the business. If the employee does not continue to be employed, the benefit is forfeited. If properly structured, the payments are taxed to the employee and deducted by the company at the time of payment.

c. Phantom Stock Plan. A Phantom Stock Plan or Stock Appreciation Rights Plan will provide an employee with a benefit that will simulate the appreciation in value of a common stock ownership in the company during the period the employee is employed. This arrangement will compensate the employee for his or her contribution to the success and increasing the value of the company. Vesting provisions can also be utilized to retain the services of the employee. Finally, such a plan avoids the entanglements that can come with true stock ownership by an employee such as voting rights, possible breach of fiduciary duty claims and the obligation to repurchase the stock upon termination of employment.

d. Change of Control Agreement. A Change of Control Agreement can be utilized with the previously-mentioned arrangements to provide comfort to an employee that his or her terms of employment such as compensation and benefits will not be changed for a set period (one to three years) following the transfer of the business. Even if the employee is terminated, the Agreement will guarantee continued payment or a bonus for continuing to be employed with the business until the sale.

Executing the Plan.

The key to effectively executing the plan is balancing the owner’s financial security with fairness and family harmony. The following are alternatives and considerations:

1. Sell the Business to Active Children. If the business is sold to active children for its fair market value as determined by an independent appraiser, then all family members are effectively treated equally. The purchasing children get the business, the financial future of the owner and the owner’s spouse is secured and upon the death of the survivor of them, both active and non-active children can inherit equally. The issues of conflicting opinions and the disparate needs of active and non-active children are eliminated. The downside of this approach is its tax inefficiency. The owner will recognize capital gains and the active children will purchase with after-tax dollars.

2. Business Real Estate. If the owner owns the real estate on which the business is operated, the owner could consider retention of the business real estate subject to a long-term lease. The lease would provide the owner and the owner’s spouse with a continuing source of income. Retention of the business real estate could also provide an asset for the equalization of the inheritance of non-active children. Finally retention of this asset would reduce the lifetime transfer cost of the business interest to the active children.

3. Voting and Non-Voting Stock. Whether the owner of the business wants to transfer ownership currently or needs to use the business to equalize the inheritance of active and non-active children at death, consideration should be given to recapitalizing the company with voting and non-voting stock. Active children can receive the voting stock to allow for the effective management of the company and non-active children can receive the non-voting stock to allow for the continued participation in the growth of the value of the company. Active children should have Employment Agreements to ensure them fair compensation and protect non-active children from the misdirection of company assets. The non-voting stock could be subject to “call” options by the active children and could be subject to a “put” option by the non-active children to allow for a fair separation of interests should one be necessary. A “buy-sell” agreement between the shareholder children can incorporate the “put” and “call” as well as the transfer on death or disability of a shareholder child.

4. Equalize with Non-Business Assets. If there are sufficient non-business assets in the estate of the owner, then equalization of inheritances is more easily accomplished. Ownership interests in the business can be transferred during life or at death to active children and the non-business assets can be transferred to the non-active children. Since all assets are valued at fair market value at death, equality can be made more apparent.

5. Tax Minimization. Although financial security and family fairness are often the primary goals of succession planning, tax minimization is normally also a high priority. Various planning techniques can be incorporated in the context of succession planning discussed above.

Conclusion.

Succession planning does not happen by accident. Successful planning for the termination of ownership of a business interest should be started well in advance of when the ownership will be terminated.

Article By Natale A. Messina & Marcel J. Bernier of Murtha Cullina
© Copyright 2015 Murtha Cullina

Importance of Making Sure Your Corporate Status is Up to Date

On September 8, 2015, the United States Civilian Board of Contract Appeals (CBCA) dismissed a claim for lack of jurisdiction when it determined that a contractor was not in good standing at the time of the filing, and thus it could not file the claim.

Western States Federal Contracting, LLC (Western States) filed a protest seeking damages from the Department of Veterans Affairs (VA). The VA filed a motion to dismiss, asserting that Western States did not have the right to sue because it was not in good standing in its state of incorporation due to unpaid taxes in the amount of $981.

On several occasions, the CBCA ordered Western States to show that it was in good standing and had the right to sue. Although Western States was not in good standing in Delaware, where it was incorporated, Western States first attempted to show it was in good standing in Arizona, where it was conducting business. CBCA rejected this showing and ordered Western States to show it was in good standing in Delaware. Western States was unable to make this showing.

After Western States paid its overdue tax bill, and regained its good standing in Delaware, it argued that its good standing status should be retroactive. The CBCA found that Western States did not have standing to pursue its damages claim because it was not in good standing when it filed its appeal.

In addition to the having the capacity to sue and be sued, here are three other primary reasons why keeping your business in good standing status is good for business.

1. Lenders, Vendors, and Others Might Require a Good Standing Certificate

Lenders sometimes require good-standing status in order to approve new financing. They generally view a loss of good standing status as an increased risk which may increase the cost of financing or even limit the ability to obtain financing. Other businesses might require a Certificate of Good Standing for certain transactions, requests for proposals (RFPs) or contracts. Or, you may need one to sell the business, for real estate closings, or for mergers, acquisitions, or expansions. If a business can’t provide a Certificate of Good Standing, it raises a compliance “red flag” that indicates something’s wrong with the company’s state status.

2. Keeping Your Business Good Standing Often Saves Money in the Long Run

If a business doesn’t maintain its good-standing status, the state likely will make an involuntary adverse status change for the company, labeling it as “delinquent,” “void,” “suspended” or “dissolved,” depending on the state and the compliance problem. The most common reasons for losing good standing include a missed annual report, problems regarding the company’s registered agent-and-office, or unpaid fees or franchise taxes. The cost of fixing these mistakes can add up; preventing these mistakes is not expensive. By simply keeping your LLC or corporation in good standing, you could help:

  • Keep overall operating costs lower—filing on time avoids extra fees and fines from sapping your budget.

  • Prevent a state from administratively dissolving the LLC or corporation (and then having to try for a reinstatement) or worse yet, have to start all over again because your LLC or corporation has been permanently “purged”.

  • Maintain the limited liability protection that an LLC, corporation, or other business entity provides.

  • Preserve your rights to your LLC’s or corporation’s legal name in state records.

  • Keep your business poised for sudden contract opportunities, bids, or deals with other companies that require a Certificate of Good Standing to pursue or seal the deal.

3. Good Standing Helps When You Expand Into Other States

When you form your LLC or corporation, the state generally considers you to be “organizing” a business “entity.” Your business entity (e.g., LLC, corporation) has the right to do business in the state of organization only. If you want to expand and do business in other states, you’ll need to register to transact business in those states, too. Usually, the new state(s) ask for a Certificate of Good Standing from your formation state (or your “domestic” state) before they’ll let you register.

Checking Your Good Standing

Still, it’s not always easy to know which regulations and obligations apply to your corporation or LLC. Compliance can seem complicated or costly at times. Regulations change. And it can be difficult to keep track of the various deadlines your company must meet.  However, compliance can be done easily and inexpensively, relative to the cost of noncompliance.  We recommend that at least annually, you or your legal counsel should confirm that your LLC or corporation is in good standing in its state of formation as well as every state with which you are conducting business.

All states allow steps to be taken for a not-in-good-standing corporation or LLC to restore its standing, and that if good standing is restored, generally it will be as if the corporation or LLC had consistently remained in good standing.

Article By Michelle DiCintio of Odin, Feldman & Pittleman, P.C.

© 2015 Odin, Feldman & Pittleman, P.C.

Jury Awards $1.6M to Sarbanes-Oxley Whistleblower

A New York federal jury awarded $1.6M in compensatory damages to a whistleblower in a Sarbanes-Oxley whistleblower retaliation lawsuit. The verdict is consistent with a recent trend of large jury verdicts in whistleblower retaliation claims, including a six million dollar verdict in the Zulfer SOX case. According to the verdict form, the full amount of the verdict awarded to whistleblower Julio Perez was for compensatory damages. Under the whistleblower provision of SOX, there is no cap on compensatory damages.

While employed at Progenics Pharmaceuticals as a Senior Manager of Pharmaceutical Chemistry, Perez worked with representatives of Progenics and Wyeth to develop Relistor, a drug that treats post-operative bowel dysfunction and opioid-induced constipation. In May 2008, Progenics and Wyeth issued a press release stating that the second phase of trials “showed positive activity” and that the two companies were “pleased by the preliminary findings of this oral formulation” of Relistor. Within two months of the issuance of the press release, Wyeth executives sent a memo to Progenics senior executives informing them that the second phase of clinical trials failed to show sufficient clinical activity to warrant a third phase of trials. The Wyeth memo specifically stated: “Do not pursue immediate initiation of Phase 3 studies with either available oral tablets or capsule formulations.”

Perez saw the confidential Wyeth memo and on August 4, 2008, he sent a memo to Progenics’ Senior Vice-President and General Counsel in which he alleged that Progenics was “committing fraud against shareholders since representations made to the public were not consistent with the actual results of the relevant clinical trial, and [Plaintiff] think[s] this is illegal.” The next day, Progenics’ General Counsel questioned Perez about the confidential Wyeth memo. Progenics then terminated Perez’s employment, claiming he had refused to reveal how he had obtained the Wyeth memorandum.

Perez brought suit under SOX, alleging that Progenics terminated his employment because of his August 4, 2008 Memorandum, and denying that he refused to answer questions about his access to the Wyeth memo. Progenics again claimed that it terminated Perez’s employment because he failed to explain how he got the memo. The memo’s intended recipients denied giving Perez a copy of the memo. During the litigation, Perez argued that the memo was distributed widely within Wyeth and that he had not “misappropriated” it.

Following an investigation, OSHA did not substantiate Perez’s SOX complaint. Perez removed his SOX complaint to federal court in November 2010. On July 25, 2013, Judge Kenneth Karas issued an order denying Progenics’ motion for summary judgment. The case was hard-fought, with more than 120 docket entries concerning pre-trial matters. Perez was represented by counsel when he filed his SOX claim in federal court, but proceeded pro seshortly before Progenics moved for summary judgment through trial.

Recent Sarbanes-Oxley Whistleblower Jury Verdicts

On March 5, 2014, a California jury awarded $6 million to Catherine Zulfer in her SOX whistleblower retaliation against Playboy, Inc. (“Playboy”).  Zulfer, a former accounting executive, alleged that Playboy had terminated her in retaliation for raising concerns about executive bonuses to Playboy’s Chief Financial Officer and Chief Compliance Officer.  Zulfer v. Playboy Enterprises Inc., JVR No. 1405010041, 2014 WL 1891246 (C.D.Cal. 2014).  She contended that she had been instructed by Playboy’s CFO to set aside $1 million for executive bonuses that had not been approved by the Board of Directors.  Id.  Zulfer refused to carry out this instruction, warning Playboy’s General Counsel that the bonuses were contrary to Playboy’s internal controls over financial reporting.  Id.  After Zulfer’s disclosure, the CFO retaliated by ostracizing Zulfer, excluding her from meetings, forcing her to take on additional duties, and eventually terminating her employment.  Id.  After a short trial, a jury awarded Zulfer $6 million in compensatory damages and also ruled that Zulfer was entitled to punitive damages.  Id.  Zulfer and Playboy reached a settlement before a determination of punitive damages.  The $6 million compensatory damages award is the highest award to date in a SOX anti-retaliation case.  Id.

The Ninth Circuit recently affirmed a SOX jury verdict awarding $2.2 million in damages, plus $2.4 million in attorneys’ fees, to two former in-house counsel.  Van Asdale v. Int’l Game Tech., 549 F. App’x 611, 614 (9th Cir. 2013).  The plaintiffs, both former in-house counsel at International Game Technology, alleged that they had been terminated in retaliation for disclosing shareholder fraud related to International’s merger with rival game company Anchor Gaming.  Id.  Specifically, plaintiffs alleged that Anchor had withheld important information about its value, causing International to commit shareholder fraud by paying above market value to acquire Anchor.  Van Asdale v. Int’l Game Tech., 577 F.3d 989, 992 (9th Cir. 2009).  When the plaintiffs discovered the issue, they brought their concerns about the potential fraud to their boss, who had served as Anchor’s general counsel prior to the merger. Id. at 993.  International terminated both plaintiffs shortly thereafter. Id. 

In addition, a former financial planner at Bancorp Investments, Inc. who alleged that he was terminated for disclosing trade unsuitability obtained a $250,000 jury verdict in the Eastern District of Kentucky in late 2013.   Rhinehimer v. Bancorp Investment, Inc., 2013 WL 9235343 (E.D.Ky. Dec. 27, 2013), aff’d 2015 WL 3404658 (6th Cir. 2014).

Zulfer, Van Asdale, and Rhinehimer highlight the importance of the removal or “kick out” provision in SOX that authorizes SOX whistleblowers to remove their claims from the Department of Labor to federal court for de novo review 180 days after filing the complaint with OSHA.

ARTICLE BY Jason Zuckerman of Zuckerman Law

© 2014 Zuckerman Law

Puerto Rico Supreme Court: Former Exec Cannot Sue Individual Board Members for Breach of Employment Contract

A former employee cannot sue individual members of a corporation’s board of directors for breach of an employment contract and negligence in execution of fiduciary duties, where: 1) the individual board members are not parties to the employment contract; and 2) the employee and his relatives are not shareholders with standing to sue board members for alleged breach of fiduciary duty, the Puerto Rico Supreme Court has held. Randolfo Rivera San Feliz et al v. Junta de Directores de Firstbank Corporate et al., 2015 TSPR 61, 196 DPR ___ (2015).

Plaintiff Randolfo Rivera was a former executive of a banking entity in Puerto Rico. The terms of his employment were established in a contract with the bank. The contract provided that any decision regarding the contract, including termination of employment, had to be approved by at least two-thirds of all the members of the bank’s board of directors. The contract also contained a clause requiring arbitration of any controversy regarding the interpretation of the employment contract.

The bank terminated Rivera’s contract in June of 2010. He filed a lawsuit against the bank in Puerto Rico Superior Court, alleging unjust dismissal and breach of contract under the law of Puerto Rico. While this litigation was pending, Rivera filed a separate lawsuit against each member of the board of directors, requesting damages for breach of contract and alleged negligence in the execution of their fiduciary duties. He asserted the board members wrongfully allowed his termination in violation of his employment contract. Rivera’s partner, children, and siblings were included as co-plaintiffs in the second lawsuit, each alleging emotional and economic damages arising out of the employment termination.

The initial lawsuit between Rivera and the bank was dismissed by the court for lack of jurisdiction in light of the employment contract’s arbitration provision.

The second lawsuit, against the board of directors, also was dismissed at the pleadings stage. The court held Rivera and his family may not sue individual members of the board of directors for violation of their fiduciary duty, because such a claim was available only to shareholders of a corporation through a derivative action and neither Rivera nor his relatives were shareholders. Rivera and his relatives appealed the dismissal of this lawsuit and the case eventually came before the Puerto Rico Supreme Court.

Puerto Rico’s highest court upheld dismissal of the action because a non-shareholder does not have standing to sue individual directors of a corporation for an alleged violation of their fiduciary duty. The Supreme Court reiterated that a breach of fiduciary duty claim requires an existing relationship between plaintiffs and defendants, such as the one that exists between shareholders and a corporation’s board of directors. The Court also held that the board of directors could not be liable for breach of contract because it was the corporation, and not the individual members of the board, that was a party to the contract.

Associate Justice Annabelle Rodriguez-Rodriguez dissented. She noted that the employment contract at issue had a clause that was undisputed which provided for arbitration of all controversies related to interpretation of the contract. Since the second lawsuit was based on alleged breach of fiduciary duty arising out of the termination of the contract, she would have dismissed for lack of jurisdiction in light of the arbitration clause and abstained from analyzing the nature of the claims for purposes of a standing issue.

In light of Puerto Rico law governing employee terminations, employers should tread carefully when drafting employment contracts that contain specific reasons for termination, as well as notification requirements.

ARTICLE BY Maralyssa Álvarez-Sánchez of Jackson Lewis P.C.

Jackson Lewis P.C. © 2015

What Is The FTC Looking at When It Reviews Merger Agreements?

In our last post, we spoke about a proposed merger between office supply chains Office Depot and Staples. As we noted, Office Depot shareholders recently voted to go forward with the acquisition, but the Federal Trade Agreement still has to review the agreement and make a decision, which could make or break the process.

FTC_FederalTradeCommission-SealIn reviewing any merger agreement the Federal Trade Commission—or the Department of Justice, depending on which agency reviews the agreement—an important consideration is the impact the transaction will have on the market. Speaking generally, federal law prohibits mergers that would potentially harm market competition by creating a monopoly on goods or services.

According to the FTC, competitive harm often stems not from the agreement as a whole, but from how the deal will impact certain areas of business. Problems can arise when a proposed merger has too much of a limiting effect based on the type of products or services being sold and the geographic area in which the company is doing business.

With that having been said, most mergers—95 percent, according to the FTC—present no issues in terms of market competition. Those that do present issues are often resolved by tweaking the agreement so as to address any competitive threats. In cases where the reviewing agency and the businesses cannot agree on a solution, litigation may be necessary, but it often isn’t.

Any company that plans on going forward with a merger or acquisition needs to have a clear understanding of the law and the review process. This is especially the case if issues come up regarding competitive threats.

ARTICLE BY Business and Corporate Law Practice Group of McBrayer, McGinnis, Leslie and Kirkland, PLLC
© 2015 by McBrayer, McGinnis, Leslie & Kirkland, PLLC. All rights reserved.

Email Notice Without Consent Is Not Notice

Allen Matkins Law Firm

The California General Corporation Law unequivocally authorizes the giving of notice of stockholder meetings by electronic transmission.  Section 601(b) provides “Notice of a shareholders’ meeting or any report shall be given personally, by electronic transmission by the corporation . . .”.  The statute further provides that notice is deemed to have been given when sent by electronic transmission by the corporation.  Nonetheless, sending notice by email may not be valid because the statute provides that notice by electronic transmission is valid only if it complies with Section 20 of the Corporations Code.

Section 20 imposes two general conditions and one specific condition to the giving of notice by electronic transmission.  First, the recipient must have provided an unrevoked consent to the use of those means of transmission for communications under or pursuant to the Corporations Code.  Since the term “electronic transmission by the corporation” includes several different means of transmission, the consent must be to the form of transmission (e.g., facsimile or email).  Second, the electronic transmission must create “a record that is capable of retention, retrieval, and review, and that may thereafter be rendered into clearly legible tangible form”.  Finally, if the recipient is an individual shareholder who is a natural person, the consent to the transmission must be preceded by, or include, a clear written statement to the recipient as to:

  • any right of the recipient to have the record provided or made available on paper or in non-electronic form,

  • whether the consent applies only to that transmission, to specified categories of communications, or to all communications from the corporation, and

  • the procedures the recipient must use to withdraw consent.

Nearly two decades ago, I wrote about the Corporations Code move into Cyberspace, The California Corporations Code Enters Cyberspace: 1995 Legislation Tackles New On-Line Technologies, 18 CEB California Business Law Reporter 5 (1996).

More On The SEC’s Backwards Rule Proposal

In this February post, I argued that the SEC got it backwards when it proposed new rules requiring disclosure of whether hedging transactions by directors, officers and others are permitted.  My point was that directors and officers don’t need the company’s permission to engage in these transactions.  The relevant disclosure is whether the company prohibits hedging transactions that would otherwise be permitted.  The SEC’s proposed rules misleadingly imply that permission is required.

Recently, I was reading an account of the interactions between the first American consul to Japan, Townsend Harris, and Governor Okada of Shimoda, Japan.  The Japanese government was concerned that the Americans would survey the coast of Japan and pressed Harris to prohibit any surveying by American vessels.  The following record illustrates how the want of permission might be argued into a prohibition:

The Japanese: There is not article in the treaty which prohibits surveying.

Harris: There is no article which prohibits it.

Moriyama [a member of the Governor’s staff]:  Not to permit it means that we refuse it.

Dai Nihon Komonjo, Bakumatsu Gaikoku Kankei Monjo, XV, 63.

If this seems a bit of obscure history, John Wayne actually played Townsend Harris in the 1958 film, The Barbarian and the Geisha, directed by John Huston.

By Keith Paul Bishop

Of Allen Matkins Leck Gamble Mallory & Natsis LLP

Taking Control of Cybersecurity: A Practical Guide for Officers and Directors

Foley and Lardner LLP

Major cybersecurity attacks of increased sophistication — and calculated to maximize the reputational and financial damage caused to the corporate targets — are now commonplace. These attacks have catapulted cybersecurity to a top priority for senior executives and board members.

To help these decision makers get their arms around cybersecurity issues, Foley Partners Chanley T. Howell, Michael R. Overly, and James R. Kalyvas have published a comprehensive white paper entitled: Taking Control of Cybersecurity — A Practical Guide for Officers and Directors.

The white paper describes very practical steps that officers and directors should ensure are in place or will be in place in their organizations to prevent or respond to data security attacks, and to mitigate the resulting legal and reputational risks from a cyber-attack. The authors provide a blueprint for managing information security and complying with the evolving standard of care. Checklists for each key element of cybersecurity compliance and a successful risk management program are included.

Excerpt From Taking Control of Cybersecurity: A Practical Guide for Officers and Directors

Sony, Target, Westinghouse, Home Depot, U.S. Steel, Neiman Marcus, and the National Security Agency (NSA). The security breaches suffered by these and many other organizations, including most recently the consolidated attacks on banks around the world, combined with an 80 percent increase in attacks in just the last 12 months, have catapulted cybersecurity to the top of the list of priorities and responsibilities for senior executives and board members.

The devastating effects that a security breach can have on an enterprise, coupled with the bright global spotlight on the issue, have forever removed responsibility for data security from the sole province of the IT department and CIO. While most in leadership positions today recognize the elevated importance of data security risks in their organization, few understand what action should be taken to address these risks. This white paper explains and demystifies cybersecurity for senior management and directors by identifying the steps enterprises must take to address, mitigate, and respond to the risks associated with data security.

Officers and Directors are Under a Legal Obligation to Involve Themselves in Information Security

The corporate laws of every state impose fiduciary obligations on all officers and directors. Courts will not second-guess decisions by officers and directors made in good faith with reasonable care and inquiry. To fulfill that obligation, officers and directors must assume an active role in establishing correct governance, management, and culture for addressing security in their organizations.

Download This White Paper

ARTICLE BY

Chanley T. Howell
James R. Kalyvas
Michael R. Overly
OF
Foley & Lardner LLP