Tag: Business Law

A Continued Examination of Charitable Patient Assistance Programs Part Seven in a Series: Charitable PAPs: Donations and Transparency 2013-09-03

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In today’s challenging health care environment, Charitable Patient Assistance Programs (Charitable PAPs) have emerged to meet the needs of the nearly 30 million Americans that are underinsured and have difficulty paying out-of-pocket medical costs. As potential donors make strategic decisions to invest in Charitable PAPs, there are many elements that must be considered to ensure compliance with all applicable laws and regulations. For the previous alerts in the series, please refer here.

As Charitable PAPs are entrusted with donations to help patients, it is important that the organization is accountable to its donors and is in compliance with all relevant audit requirements. When considering a donation to a Charitable PAP, it is important to evaluate the organization’s commitment to regular and thorough independent, third-party reviews to verify program and financial transparency and to validate operations:

  • Does the organization undergo regular, independent financial audits? In most cases, non-profit 990s are prepared by an accredited and industry-recognized financial auditing firm typically named on the 990. Researching the firms can provide insight into the thoroughness of the audit.
  • Does the Charitable PAP agree to operate in a certain manner with its donors? Is compliance audited? It is possible to request copies of compliance audits to make sure the organization is adhering to applicable requirements and restrictions as outlined to donors.
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Is a Limited Liability Company (LLC) good for Canadians buying in the U.S.?

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If you are Canadian, the answer to that question is: it depends.

People purchasing real estate in the U.S. are faced with different challenges depending on whether they plan on using the property personally or renting it. In this article, we will address the latter issue and its different implications.

A Tax Efficient Structure

There are two main issues to be considered when renting property in the U.S.; income tax and liability. Because rental properties generate income, it is necessary to determine the most tax efficient structure in which to hold the property. On the other hand, because a third party (most likely a tenant) will be using the property, it is essential to create a structure that also offers creditor protection to protect against potential civil liability claims from such third party. A limited liability company (LLC) provides both those elements.

In the U.S., an LLC allows a purchaser to benefit from the low individual tax rates and therefore avoid the higher corporate tax rates inherent to owning property in a corporation. A corporation is an independent taxpayer and is taxed at a higher rate. However, an LLC is not an independent taxpayer but rather a “flow through” entity, which means that its revenue is taxed in the hands of its owner. Therefore, if the owner is an individual, the LLC’s revenue is taxed at the low individual rate.

Creditor Protection

Although one of the main goals of tax planning is to minimize tax, the main advantage of the LLC is creditor protection. When owning property in your personal name, you are exposed to liability claims from creditors such as a tenant who may have suffered injuries on your property while renting it. Should a judgement be rendered against you finding you liable for the injuries, the creditor could seek execution of this judgment not only against your U.S. property but also against the rest of your assets. However, when owning property in an LLC, only the assets in your LLC (i.e. your U.S. property) are within reach of the creditor.

The Issue for Canadian Buyers

After reading this, you may be thinking an LLC is the best solution for your U.S. real estate purchase. Unfortunately this structure can be disastrous for Canadian residents due to double taxation. Under the Canada-U.S. Tax Treaty, a Canadian resident is granted foreign tax credits for any tax paid to the Internal Revenue Service (“IRS”). Those credits can be used to offset the tax owed to the Canada Revenue Agency (“CRA”) on the same revenue or capital gain. Although the IRS considers the LLC as a flow through entity and taxes only the owner personally, the CRA does not recognize the flow through nature of the LLC but rather considers it a separate taxpayer, therefore creating a mismatch on said foreign tax credits. In this type of situation, the CRA will tax the owner of the property on the full amount of the revenue or capital gain and will not allow the use of any foreign tax credits for what was paid to the IRS. This is the known and dreaded double taxation. The owner of the property will pay taxes twice on the same revenue or capital gain, once in the U.S. and once in Canada. Depending on the values and amounts involved, Canadian residents can be required to pay in excess of 70% of taxes on their property income or capital gain due to double taxation. In extreme circumstances, this rate can even climb up to 80%.

That being said, even though LLCs should be avoided in the above-described situation, LLCs can be a valuable tool in a carefully planned structure. As general partner of a Limited Partnership for example. When used in such a structure, an LLC can help provide an extra layer of creditor protection to a Canadian resident while creating very limited tax consequences.

As you probably realised by now, the way you own property in the U.S. is crucial and putting your asset(s) in the wrong structure can lead to very unpleasant surprises. Always talk to a cross-border legal advisor before making any decisions in order to make sure you are aware of all the tax implications.

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Final Section 336(e) Regulations Allow Step-Up in Asset Tax Basis in Certain Stock Acquisitions

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Final regulations were issued last month under IRC Section 336(e). These regulations present beneficial planning opportunities in certain circumstances.

For qualifying transactions occurring on or after May 15, 2013, Section 336(e) allows certain taxpayers to elect to treat the sale, exchange or distribution of corporate stock as an asset sale, much like a Section 338(h)(10) election. An asset sale can be of great benefit to the purchaser of the stock, since the basis of the target corporation’s assets would be stepped up to their fair market value.

To qualify for the Section 336(e) election, the following requirements must be met:

  1. The selling shareholder or shareholders must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder or shareholders.
  2. The selling shareholder or shareholders must own at least 80% of the total voting power and value of the target corporation’s stock.
  3. Within a 12-month period, the selling shareholder or shareholders must sell, exchange or distribute 80% of the total value and 80% of the voting power of the target stock.

Although the rules of Section 338(h)(10) are generally followed in connection with a Section 336(e) election, there are a few important differences between the two elections:

  1. Section 336(e) does not require the acquirer of the stock to be a corporation. This is probably the most significant difference; and, to take advantage of this rule, purchasers other than corporations may wish to convert the target without tax cost to a pass-through entity (e.g., LLC) after the purchase.
  2. Section 336(e) does not require a single purchasing corporation to acquire the target stock. Instead, multiple purchasers—individuals, pass-through entities and corporations—can be involved.
  3. The Section 336(e) election is unilaterally made by the selling shareholders attaching a statement to their Federal tax return for the year of the acquisition. Purchasers should use the acquisition agreement to make sure the sellers implement the anticipated tax strategy

Section 336(e) offers some nice tax planning opportunities, by allowing a step up in tax basis in the target’s assets where a Section 338(h)(10) election is not allowed.

Example: An S corporation with two shareholders wishes to sell all of its stock to several buyers, all of which are either individuals or pass-through entities with individual owners. A straight stock purchase would not increase the basis of the assets held inside the S corporation, and an LLC or other entity buyer would terminate the pass-through tax treatment of the S corporation status of the target. A Section 338(h)(10) election is not available since the purchaser is not a single corporation. However, a Section 336(e) election may be available, whereby the purchase of the stock would be treated as a purchase of the corporation’s assets (purchased by a “new” corporation owned by the purchasers). The purchasers could then convert the purchased corporation (the “new” corporation with the stepped-up assets basis) into an LLC, without tax, thereby continuing the business in a pass-through entity (single level of tax) with a fully stepped-up tax asset basis.

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Worker Adjustment and Retraining Notification Act (WARN) Liability And Private Equity Firms

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Last month’s decision out of the Delaware District Court in Woolery, et al. v. Matlin Patterson Global Advisers, LLC, et al. was an eye opener for private equity firms and other entities owning a controlling stake in a faltering business.  Breaking from the norm, the Court refused to dismiss private equity firm MatlinPatterson Global Advisers, LLC (“MatlinPatterson”) and affiliated entities from a class action WARN Act suit alleging that the 400-plus employees of Premium Protein Products, LLC (“Premium”), a Nebraska-based meat processer and MatlinPatterson portfolio company, hadn’t received the statutorily-mandated 60 days advance notice of layoffs.

According to the plaintiffs, Premium’s performance began to decline in 2008 and, upon the downturn, the defendants became more and more involved in Premium’s day-to-day operations, including by making business strategy decisions (e.g., to enter the kosher food market), terminating Premium’s existing President, and installing a new company President.  Things got bad enough that, in June 2009, the defendants decided to “furlough” all of Premium’s employees with virtually no notice and close the plant.  The defendants then, in November 2009, converted the furlough to layoffs, and Premium filed for bankruptcy.  According to the plaintiffs, Premium’s head of HR raised WARN Act concerns back in June, when the decision to close the plant and furlough the employees was made, and the defendants ignored the issue.

With Premium in bankruptcy, the plaintiffs, unsurprisingly, turned to MatlinPatterson and the other defendants as the targets of their WARN Act claim, asserting that they and Premium were a “single employer.”  The Court then applied the Department of Labor’s five-factor balancing test, namely (1) whether the entities share common ownership, (2) whether the entities share common directors or officers, (3) the existence of de facto exercise of control by the parent over the subsidiary, (4) the existence of a unity of personnel policies emanating from a common source, and (5) the dependency of operations between the two entities.  This test often favors private equity firms, and on balance it did so in Woolery too, with the Court finding that the plaintiffs had made no showing as to three of the five factors.  The Court nevertheless refused to grant the defendants’ motion to dismiss, holding that the complaint alleged that the defendants had exercised de facto control over Premium and then essentially giving that factor determinative weight.

No one should be surprised by the decision given the plaintiffs’ allegations, which had to be accepted as true at the motion to dismiss stage.  They presented an ugly picture of a private equity firm dictating the most critical decisions (to close plant, layoff employees) and then attempting to duck the WARN Act’s dictates. The decision is nevertheless a cautionary tale for private equity firms and at first blush it presents a catch 22: (a) do nothing and watch your investment sink or (b) get involved and risk WARN Act liability.

So what is a private equity firm, lender or majority investor to do?  Obviously, the best scenario is to build in the required 60-day notice period or, if applicable, utilize WARN Act exceptions, including the “faltering company” and “unforeseen business circumstances” exceptions.  Even where that’s not possible, private equity firms and other controlling investors need not take a completely hands off approach.  They would, however, be best-served (at least for WARN Act purposes) to do the following:

  • Provide only customary board-level oversight and allow the employer’s officers and management team to run the employer’s day-to-day operations
  • Although Board oversight and input can occur, continue to work through the management team on major decisions, including layoffs and potential facility closures
  • Avoid placing private equity firm or lender employees or representatives on the employer’s management team
  • Have the employer’s management team execute employment contracts with the employer, not the private equity firm or lender, and have the contracts, for the most part, create obligations only to the employer
  • Allow the employer to maintain its own personnel policies and practices, as well as HR oversight and function

What the courts are primarily concerned with in these cases are (a) a high degree of integration between the private equity firm or lender and the actual employer, particularly as to day-to-day operations, and (b) who the decision-maker was with regard to the employment practice giving rise to the litigation (typically the layoff or plant closure decision).  Private equity firms and lenders that have refrained from this level of integration have had, and should continue to have, success in avoiding WARN Act liability and returning the focus of the WARN Act discussion to the actual employer.

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The Good Angel Investor (Part 1): Doing the Deal

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At a time when lean startups often require considerably less than $1 million dollars to develop the proverbial minimum viable product and even validate the same with some customers, angel investors are playing an increasingly important role in startup financings.  And that’s a good thing, particularly in places outside of the major venture capital centers, where institutional venture capital is scarce.

Most startups successfully launched with angel capital will want to tap deeper pools of capital later on, often from traditional venture capital investors.  That being the case, entrepreneurs and their angel investors should make sure that the structure and terms of angel investments are compatible with the likely needs of downstream institutional investors.  Herewith, some of the issues entrepreneurs and angels should keep in mind when they sit down and negotiate that first round of seed investment.

  1. Don’t get hung up on valuation.  Seed stage opportunities are difficult to put a value on, particularly where the entrepreneur and/or the investor have limited experience.  Seriously mispricing a deal – whether too high or too low – can strain future entrepreneur/investor relationships and even jeopardize downstream funding.  If you and your seed investor are having trouble settling in on the “right” price for your deal, consider structuring the seed round as convertible debt, with a modest (10%-30%) equity kicker.  Convertible debt generally works where the seed round is less than one-half the size of the subsequent “A” round and the A round is likely to occur within 12 months of the seed round based on the accomplishment of some well-defined milestone.
  1. Don’t look for a perfect fit in an off-the-shelf world.  In the high impact startup world, probably 95% of seed deals take the form either of convertible debt (or it’s more recent twin convertible equity) or “Series Seed/Series AA” convertible preferred stock (a much simplified version of the classic Series A convertible preferred stock venture capital financing).  Unless you can easily explain why your deal is so out of the ordinary that the conventional wisdom shouldn’t apply, pick one of the two common structures and live with the fact that a faster, cheaper, “good enough” financing is usually also the best financing at the seed stage.
  1. On the other hand, keeping it simple should not be confused with dumbing it down.  If the deal is not memorialized in a mutually executed writing containing all the material elements of the deal, it is not a “good enough” financing.  The best intentioned, highest integrity entrepreneurs and seed investors will more often than not recall key elements of their deal differently when it comes time to paper their deal – which it will at the A round, if not before.  And the better the deal is looking at that stage, the bigger those differences will likely be.
  1. Get good legal advice.  By “good” I mean “experienced in high impact startup financing.”  Outside Silicon Valley, the vast majority of reputable business lawyers have little or no experience representing high impact entrepreneurs and their investors in financing transactions.  When these “good but out of their element” lawyers get involved in a high impact startup financing the best likely outcome is a deal that takes twice as long, and costs twice as much, to close.  More likely outcomes include unconventional deals that complicate or even torpedo downstream financing.  This suggestion is even more important if your deal is perchance one of those few that for some reason does need some custom fitting.
  1. Finally, a pet peeve.  If you think your startup’s future includes investments by well regarded institutional venture capital funds, skip the LLC tax mirage and just set your company up as a Delaware “C” corporation.  If you want to know why, ask one of those “experienced high impact startup lawyers” mentioned in point 4 above.
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The Top Five Intellectual Property Traps in M&A Transactions

Recently posted in the National Law Review an article by Carey C. Jordan of McDermott Will & Emery  regarding intellectual rights in M&A transactions:  

 

In M&A transactions, many lawyers assume that intellectual property (IP) rights will automatically transfer with the purchase and that IP issues can be cured by general representations and warranties. While getting strong representations and warranties covering intellectual property is useful, relying on a breach of representations and warranties as the only remedy to protect the covered IP can doom the deal to failure or lead to unexpected surprises after closing, including requiring significant changes to future business plans and opportunities. If the target’s IP rights are important to the ultimate deal, then those IP rights must be investigated thoroughly in the due diligence and fully understood.

A due diligence investigation into a company’s intellectual property assets is essentially a methodical audit which will cover at least the following main areas:

  • Patents
  • Know-how
  • Copyright
  • Trademarks
  • Infringements
  • Licenses and collaboration agreements

Failure to examine these during due diligence in a manner appropriate to the deal at hand can lead to reevaluation, repricing or structural changes of the transaction.

For example, Volkswagen outbid BMW in 1998 to buy Rolls Royce and Bentley and their British factory from Vickers PLC for $917 million. But an odd twist in the deal allowed the Rolls-Royce aerospace company to sell rights to the ROLLS-ROYCE trademark to BMW out from under Volkswagen for $78 million. Thus, after the deal closed, Volkswagen did not have the rights to use the ROLLS-ROYCE mark. Only after a separate deal was made with BMW to avoid litigation, did Volkswagen gain the ability to manufacture a trademarked ROLLS-ROYCE car.

Thus, IP due diligence in an M&A transaction should not be overlooked and should be undertaken early in the process. The following are five common IP issues that may impact M&A transactions.

1. Target Does Not Actually Have the Critical Patent Rights

A target company may not actually own the IP rights that it represents that it owns. This may be due to a failure to update the title through corporate name changes or lien releases, or a failure to ensure that employees have properly assigned their rights to IP assets developed with company resources to the target. This latter situation is particularly problematic. For example, under U.S. patent law, each joint inventor has the right to use and to license patented technology to a competitor without accounting to the other owner in the absence of an agreement to the contrary. As a result, a non-assigning employee can license a key competitor of the buyer (and even keep the royalties) without notifying the target. The problem can be more acute in the case of an independent contractor, who may not have an obligation to assign rights to the target. It is therefore important to review contractor agreements related to any IP relevant to the transaction to confirm that the agreements address ownership of any IP created by the contractor.

Trademarks must be evaluated in terms of their goods, services and countries of registration to confirm that they cover the buyer’s intended uses in intended markets. Certain countries recognize common law trademark rights, based on use of a mark, while other jurisdictions give priority to the first party to file a trademark application, regardless of use. Internet domain names are subject to fewer formalities, but must be investigated as well. Domain name registrations may expire and, if expired, the domain names can be bought by anyone. It is also important to confirm that important domain names are owned by an entity relevant to the transaction, as opposed to an information technology (IT) professional within the company, a licensee or another entity.

2. Prior Agreements Limit IP Rights

Sometimes, the target’s IP rights may be subject to prior agreements that restrict their use in other markets or fields of use. The target may have existing licenses or agreements with respect to some or all of its IP rights. For instance, the target may have granted a third party exclusive use in a key field of use, territory or patent, which may limited the buyer’s full and expected use of the IP rights.

For example, when the Clorox Company purchased the PINE-SOL business and trademark from American Cyanamid in 1990, Clorox planned to leverage the strength of the PINE-SOL mark into other products. Clorox purchased the PINE-SOL assets and mark subject to a prior 1987 agreement that Cyanamid had entered into with the owner of the LYSOL trademark to settle a trademark dispute years earlier. That prior agreement restricted Cyanamid (and subsequently Clorox) from expanding the use of the mark beyond the PINE-SOL pine cleaner. Clorox tried to void the terms of the settlement agreement through litigation, but was unsuccessful.

Licensors of intellectual property may argue that a merger in which a licensee does not “survive” as a separate corporate entity may void the license – even if the license agreement contained no prohibition against merger, acquisition or transfer. This argument is based on an arcane line of federal cases holding that patent licenses are not assignable unless expressly made so. More recently, some federal courts have extended this rule in ways that affect corporate mergers, and have found, in effect, that certain mergers can constitute transfers that void patent licenses. This is especially problematic in an acquisition of a licensee.

Additionally, in certain instances in which the U.S. government has provided funding to an entity (usually a nonprofit, university or small business), the U.S. government may retain certain rights to any relevant patents developed from that research, and any subsequent grants relating to those rights (e.g., a license or acquisition) will remain subject to the government’s retained rights. These government “march-in” include the right to license the invention to a third party, without the consent of the patent holder or original licensee, where it determines the invention is not being made available to the public on a reasonable basis.

3. Target is Subject to Pending/Threatened Infringement Claims

No buyer wants to buy an expensive IP-related lawsuit through an acquisition. Any potential litigation or enforcement risks must be assessed and independently analyzed, including evaluating potential indemnifications. Although others exist, two primary areas for inquiry in this context include potential patent infringement and copyright liabilities.

For potential patent liability issues, a purchaser does not want to spend a great deal of time and money to acquire rights that it will not be able to exploit because of third party’s potential infringement lawsuit. Potential litigation and enforcement risks may be identified through the target’s legal opinions, cease and desist letters, freedom to operate studies and similar materials, which should be requested and analyzed in the due diligence process.

As to open-source software, the GNU General Public License governs a large number of open-source products. Open-source code can only be tightly integrated into other open-source products, and a condition of using the code is that the user also publishes its modified version of the code to the public. The Free Software Foundation enforces the GNU General Public License. This can be problematic in an acquisition, especially when the software is a valuable piece of the assets being acquired. There have been instances where an acquiree has been sued by the Free Software Foundation after acquiring a company that had allegedly incorporate open-source code into its software. In at least one instance, the acquirer had to release the acquired software to the public as a result. Open-source liability can kill a deal and affect the value of a transaction. In the absence of insurance, some companies will accept a reduction in deal price.

4. Significant Barriers Exist to Exploitation of the Technology

With regard to patents and the ability to exploit the acquired patented technology, significant barriers may exist. Third parties may have blocking IP rights that prevent the buyer from exploiting the target’s IP or expanding the business as planned. Sometimes, this risk is not specifically known even to a target. Thus, the buyer’s freedom to operate often should be analyzed before completing the transaction, to make sure that the buyer will be able to use the assets purchased as intended in the conduct of the business operations, or as proposed to be used according to the buyer’s future plans. A freedom-to-operate analysis should be performed, which is an assessment of whether making, using sale, offering to sell or importation of a product in the U.S. will infringe any third-party patents.

If third party IP rights are identified that may block or limit the buyer’s use of particular IP rights, and a meaningful design-around is not possible, then it may be necessary to license or acquire ancillary rights to such third party blocking IP rights. Alternatively, the target could seek to invalidate the blocking IP at the United States Patent and Trademark Office (e.g., through a reexamination) or in a court. The inquiry is more complex when pending claims are published yet not issued, so the inquiry not only requires construction of the claims and infringement analysis, but also estimation of whether the published claim(s) will issue. Evolving application of infringement under the doctrine of equivalents and other changing legal standards through judicial decisions only adds to the complexity and cost of the analysis.

Of course, this still leaves unknown barriers to the exploitation of technology. Included in this category are issues such as unpublished patent rights that could block a buyer, misappropriation of technology, reverse engineering by competitors who have then patented improvements to a target’s trade secrets or even competitors who independently discover trade secrets and patent them, and the like. To the extent these can be explored, it is wise to do so. However, there are risks in any deal, and wise IP counsel can consider the impact of potential unknowns based on the industry and technology involved in the contemplated transaction.

5. Target’s IP Rights Are Encumbered by Liens

IP rights may also be encumbered by liens. To record and perfect a lien against both patents and trademarks in the United States, Uniform Commercial Code (UCC) filings need to be made. Although not legally required, most lenders also record the security agreement in the U.S. Patent and Trademark Office (USPTO). Under U.S. copyright law, however, only a lien recorded in the U.S. Copyright Office will perfect a security interest in copyrights. Due diligence should include reviewing reports from all of the applicable filing offices.

In sum, early and comprehensive IP due diligence in M&A transactions is important because it can lead to a reevaluation, repricing or restructuring of the proposed transaction.

© 2011 McDermott Will & Emery

Entrepreneur’s Guide to Litigation – Blog Series: Complaints and Answers

Recently posted at the  National Law Review  by John C. Scheller of Michael Best & Friedrich LLP an entrepreneur’s guide to the litigation process.

A.  The Complaint

Litigation begins with a Complaint. “Complaint” is capitalized because it is a specific legal document, rather than a garden-variety complaint about something. The Complaint lays out the plaintiff’s specific legal claims against the defendant. It needs to contain enough facts that, if everything stated is true and there are no extenuating circumstances, a judge and jury could find in favor of the plaintiff.

As an example, Paul Plaintiff is suing Diana Defendant for violating a contract. Paul files a Complaint with a court claiming several facts: 1) Diana signed a contract to buy widgets; 2) Paul delivered the widgets; and 3) Diana did not pay the agreed-upon amount. If the court finds that these facts are true, then, unless there were extenuating circumstances, Diana probably breached a contract with Paul and should pay damages.

Paul’s Complaint also needs to allege facts showing that he has a right to be in that court. For example, if Paul wants to sue Diana inTexas, he has to show that the case and the parties have some connection toTexas. If he wants to sue her in a federal court, he has to meet a number of other criteria. (Federal court is generally only available if the parties are based in different states and the damages are relatively substantial or if the legal question is one of federal law.)

B.  Response to a Complaint

Once the defendant officially learns of the Complaint, she has a certain limited time to file some sort of response with the court. The time to respond, however, does not run from when the plaintiff filed the lawsuit, but generally when he officially delivered notice of the Complaint to the defendant. (There is a timeline that starts ticking when the defendant becomes aware of a state court lawsuit she wants to “remove” to federal court.) The amount of time for the defendant to respond varies by what court the case is in, but is generally a short period of time.

After receiving the complaint, the defendant has three options: 1) Ignore the Complaint and have the court grant judgment in favor of the plaintiff; 2) Tell the court that the Complaint is defective and ask for dismissal; or 3) Answer the Complaint. Option one is usually not a good plan; courts do not look favorably on defendants who ignore the legal process, and this option prevents a defendant from fighting the plaintiff’s claims.

Option two does not deal with the merits of the plaintiff’s issue. It is simply telling the court that the Complaint is defective for a variety of reasons including, for instance, how it was served, who the parties are (or are not), which court the case is in, or simply that, even if everything is true, the plaintiff cannot win. For example, if Paul sues Diana, but never tells Diana about the suit, Diana can then ask the court to dismiss the case. Also, if Diana works for DefendCo and Paul’s contract was actually with DefendCo and not with Diana, personally, she may be able to have the case dismissed because Paul sued the wrong party. If Paul sued Diana in a federal court inTexaswhen both parties are residents ofCaliforniaand neither has ever been to or done business in Texas, then Diana may be able to get the case dismissed, at least from theTexascourt.

Finally, there is the “So, what?” defense. If the Complaint doesn’t actually allege a cause of action, the defendant can ask the court to dismiss it. This usually happens because the plaintiff simply assumes a fact, but does not include it in the Complaint. If, for example, Paul alleges only that Diana failed to pay him a certain amount of money, but does not allege that a contract existed between them, then Diana can essentially say “So, what?” and ask the court to dismiss the case. She would ask the court to dismiss the case because, even if true (she really did not pay him any money), he did not plead any facts showing that she was supposed to pay him money. The defendant is not admitting the truth of the allegation; she is just saying that even if true, the plaintiff cannot win.

Finally, a defendant can file an Answer. Again, “Answer” is capitalized because it is a specific legal document. In an Answer, the defendant responds, paragraph by paragraph, to each of the plaintiff’s allegations. The defendant must admit, deny, or say that she does not know the answer to each specific allegation. Saying “I don’t know” functions as a denial.

For example, Paul’s Complaint probably alleges that Diana lives at a certain address. Assuming Diana actually lives there, she has to admit that fact. Paul may allege that he delivered the correct number of working widgets to Diana. If the widgets were not what she actually ordered or did not work, Diana would deny that allegation. Finally, Paul may claim that those widgets cost him a certain amount of money. Diana likely has no way to know how much Paul paid for the widgets, so she would say she does not know – thus leaving Paul to prove that allegation.

Also in the Answer, the defendant can claim affirmative defenses. Those tell the court that there were extenuating circumstances so that, even if everything the plaintiff says is true, the court should not find in favor of the plaintiff.

For example, if Paul told Diana not to worry about paying him for the widgets for six months but then turned around and immediately sued her, she would claim that as an affirmative defense.

Finally, the Answer may contain counterclaims. These claims are the defendant counter-suing the plaintiff for something. The counterclaims may be related to the original suit or not. Usually they are related, but they do not have to be. This section follows the same rules as if the defendant were filing a complaint.

For example, Diana may counterclaim against Paul because he sent her the wrong widgets and, perhaps, add a claim that when Paul delivered the widgets to her warehouse, he backed his truck into her building and caused damage. She would then counterclaim for breach of contract and property damage. The court would then sort out the whole mess to decide who owed whom how much.

Click Here: to view the previous post in the Entrepreneur’s Guide to Litigation – Blog Series: Introduction

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