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The Way to Protect Your Business? What You Need to Know About Trade Secrets

What do Coca-Cola’s secret formula, McDonalds’ special sauce, and Google’s search algorithm have in common? Each is a protected trade secret. In other words, they are proprietary information vital to these companies’ survival and are among their most valuable corporate secrets.

A trade secret can be anything of value to your company that is unique and not known to persons outside the company. For example, a trade secret can be a recipe, process, formula, strategy, technique, or device that your competitors do not know, do not have, and cannot use.

Trade secret law can be less risky in some respects than other forms of intellectual property like patents, copyrights, and trademarks. The application process for a patent requires that a company disclose the secret itself. With that comes an inherent risk—should the application be denied, the secret is no longer a secret. While the protection afforded by trade secret law may be considered fragile, meaning constant vigilance is required to maintain secrecy, the secret remains a secret; while a patent, even after issuance, carries some risk of post-grant invalidation. By contrast, a trade secret owner may ultimately enjoy greater certainty by maintaining protection, potentially forever. However, a trade secret is entitled to protection only for as long as it is kept a secret. If the information is lawfully disclosed to the public, it is no longer confidential and loses its trade secret protection forever.

Governing Law: Both federal and state law recognize the time and money invested to gain competitive advantages like trade secrets and protect those advantages. Federal Law: Under the controlling federal legislation passed by Congress in 2016, the Defend Trade Secrets Act (“DTSA”) defines a trade secret as something used in a company’s business that (a) is not known or readily accessible by competitors, (b) has commercial value or that provides a competitive advantage in the marketplace, and (c) the owner of the information protects from disclosure through reasonable efforts to maintain its secrecy. Prior to the DTSA’s enactment in 2016, no federal statute promulgated a federal trade secret private right of action.

In addition to the DTSA’s rules regarding trade secrets, additional federal rules apply. The Economic Espionage Act of 1996 makes the theft of trade secrets a federal crime. The Act prohibits the theft of a trade secret by a person intending or knowing that the offense will injure a trade secret owner. The Act also makes it a federal crime to receive, buy, or possess trade secret information knowing it to have been stolen. The Act allows the government to punish thefts of trade secrets by imprisonment up to 15 years and/or fines up to $5 million, depending on whether the defendant is an individual or a corporation. A private party can still sue for trade secret theft even if the federal government files a criminal case under the Economic Espionage Act.

New York State Law: Prior to federal law, most states had some form of trade secret law that varied state to state. The Uniform Trade Secrets Act (“UTSA”) was published in 1979 and amended in 1985 to provide a uniform trade secret law. Many states, including Pennsylvania in 2004 and New Jersey in 2012, adopted the UTSA. Notably, New York did not adopt the UTSA and does not have its own state trade secret statute, and thus relies on the common law.

Under New York common law, “misappropriation” refers to the acquisition of a trade secret by someone who knows that the trade secret was acquired by improper means—theft, bribery, misrepresentation, breach, or inducement of a breach of duty to maintain secrecy. The New York statute of limitations requires that any action for misappropriation be filed three years from the date the misappropriation is discovered. Further, New York law requires that the use of the trade secret be continuous in the operation of a business, rather than one-time use.

Cartier v. Tiffany: Cartier recently filed suit against its luxury rival Tiffany & Co. in New York state court. Cartier v. Tiffany & Co., et al.,650925/2022 (N.Y. Sup.). Richemont-owned Cartier sets out claims against LVMH’s Tiffany & Co. for various contractual and tort claims and trade secret misappropriation against both defendants [Who is the other defendant?]. Cartier seeks preliminary and permanent injunctive relief to require defendants to refrain from using the allegedly misappropriated information and return it to Cartier, as well as a judgment for any “compensatory damages that may be caused by [Tiffany’s] wrongful conduct.”

The complaint states that Tiffany & Co. lured former Cartier employee Megan Marino away from her role as its Assistant Manager for Jewelry Merchandising to learn more about Cartier’s “High Jewelry” collection, where pieces typically cost $50,000 to $10 million.

Cartier claims Marino was bound by non-disclosure and non-solicitation agreements she had signed as part of her role at Cartier and that she breached those agreements by using Cartier’s confidential business information to benefit Tiffany. This information includes Cartier’s “very sensitive and valuable” internal company documents that Marino forwarded to her personal email. Specifically, Marino “referenced a [Cartier] Excel spreadsheet” that “detailed Cartier’s confidential, High Jewelry assortment information.” Based on that spreadsheet, Cartier alleges, Marino “created a new Excel document, derived entirely from Cartier’s confidential information,” including “the total number of High Jewelry pieces at various Cartier locations in the U.S.” Cartier maintains this information is “only accessible by a limited number of Cartier employees [and] not known outside of Cartier” and “allow[s] a sophisticated competitor to replicate key strategies and, with relative ease, to reverse engineer how Cartier allocates, merchandises, and prices its High Jewelry stock.” Cartier claims the proprietary and confidential nature of this information amounts to a trade secret-protected asset.

Cartier further claims Tiffany has a history of poaching employees and maintains a “disturbing culture of misappropriating competitive information.” Given the alleged pattern, Cartier asserts that Tiffany now possesses “a substantial amount of [its] confidential and trade secret information that it obtained from Marino and other former Cartier employees” as a result of their “unlawful taking of Cartier’s valuable confidential information and trade secrets.”

Even if Cartier successfully establishes that it maintains trade secret information that Tiffany misappropriated, the case is hardly straightforward. Establishing damages in cases like this is particularly challenging, as it is difficult to assign a dollar value to trade secret information that will compensate the plaintiff for the economic loss caused by the defendant’s misappropriation. As a result, courts generally have quite a bit of discretion in fashioning damages awards.

Article By David H. Siegel of Norris McLaughlin P.A.

For more intellectual property legal news, click here to visit the National Law Review.

Small Businesses Don’t Recognize Risk of Cyberattack Despite Repeated Warnings

CNBC surveys over 2,000 small businesses each quarter to get their thoughts on the overall business environment and their small business’ health. According to the latest CNBC/SurveyMonkey Small Business Survey, despite repeated warnings by the Cybersecurity and Infrastructure Security Agency and the FBI that U.S.- based businesses are at an increased risk of a cyber-attack following Russia’s invasion of Ukraine, small business owners do not believe that it is an actual risk that will affect them, and they are not prepared for an attack. The latest survey shows that only five percent of small business owners reported cybersecurity to be the biggest risk to their company.

What is unfortunate, but not surprising, is the fact that this is the same percentage of small business owners who recognized a cyber attack as the biggest risk a year ago. There has been no change in the perception among business owners, even though there are repeated, dire warnings from the government. Also unfortunate is the statistic that only 33 percent of business owners with one to four employees are concerned about a cyber attack this year. In contrast, 61 percent of business owners with more than 50 employees have the same concern.

According to CNBC, “this general lack of concern among small business owners diverges from the sentiment among the general public….In SurveyMonkey’s polling, 55% of people in the U.S. say they would be less likely to continue to do business with brands who are victims of a cyber attack.” CNBC’s conclusion is that there is a disconnect between business owners’ appreciation of how much customers care about data security and that “[s]mall businesses that fail to take the cyber threat seriously risk losing customers, or much more, if a real threat emerges.” Statistics show that threat actors are targeting small to medium-sized businesses to stay under the law enforcement radar. With such a large target on their backs, business owners may wish to make cybersecurity a priority. It’s important to keep customers.

Article By Linn F. Freedman of Robinson & Cole LLP

For more cybersecurity legal news, click here to visit the National Law Review.

Profits Interest as Equity-Based Incentive: Keeping Your Team Motivated

Say you own one-half of an LLC that is taxed as a partnership. You and your partner invested the initial capital that was necessary to get the business up and running, and you both built the business with the help of a few key employees. With the business still in the growth phase, you want to make sure that you motivate and retain these key employees who are helping you grow your company. What should you do? You and your partner might want to consider causing the LLC to issue the key employees a profits interest in the LLC.

What is a Profits Interest?

From a tax-standpoint, an LLC can issue two basic types of membership interests: capital interests and profits interests. A capital interest is an interest in a partnership or LLC taxed as a partnership that entitles the recipient to share immediately in the proceeds of liquidation. A capital interest normally results from a capital investment and provides recipients with participation in current and future equity value, a share of income, and distributions. When someone receives a capital interest in an LLC in exchange for a corresponding capital contribution, this is typically a tax-free event. When someone receives a capital interest in exchange for services, this is taxable compensation to the service provider.

Profits interests are distinct from capital interests, providing no current right to share in the proceeds of liquidation as of the date of grant. Instead, they typically only provide a holder with the right to share in those profits of the business that arise after the recipient acquires the interest. The primary goal of issuing profits interests is typically to give a service provider the ability to participate in the growth of the enterprise without incurring tax on the receipt of the interest, and to enjoy at least some long-term capital gain treatment (instead of ordinary income treatment) on proceeds they receive on a sale of the LLC or similar liquidity event.

Structuring a Profits Interests

Usually, as long as the profits interest is structured properly and capital accounts are booked up on entrance of the profits interest member, the IRS should not treat the grant of a vested or unvested profits interest as a taxable event. Most practitioners design profits interests so that they meet IRS safe harbor standards for ensuring profits interest treatment. These standards include:

The profits interest must not relate to a substantially certain and predictable stream of income from the entity’s assets, such as income from high quality debt securities or a net lease,
The recipient of the profits interest must not dispose of it within two years of receipt, and
The profits interest may not be a limited partnership interest in a publically traded partnership.

The issuing entity’s partnership or operating agreement should be closely examined upon the issuance of a profits interest. Things to consider with respect to newly issued profits interests include whether such recipients should have voting rights similar to that of members who contributed capital to the enterprise. Additionally, the agreement should be updated to clearly define how the profits interests will be valued relative to capital interests under current buy-out or redemption provisions. Oftentimes, practitioners ensure that a profits interest has no right to share in liquidation proceeds on the grant date by valuing the company as of that date, and providing that a profits interest holder will not share in distributions except to the extent a threshold established based on the value is exceeded. Also, booking up capital accounts is generally critical to ensuring that the profits interest does not entitle the recipient to any proceeds of liquidation if the entity was liquidated on the grant date.

To the extent the profits interest issued is unvested at the time of issuance, most practitioners opt to make an 83(b) election to ensure tax-free treatment upon receipt. When a profits interest is issued, it has no value. If the profits interest is vested, there is no question that it is taxed at the time of receipt, at $0. Unvested property is taxed at the time of vesting, on the property’s value at the time of vesting. Hence, if the profits interest has appreciated in value since the time of grant, then there would be ordinary income at the time of vesting. To avoid this treatment, recipients of profits interests can make an 83(b) election, which is an election to treat the profits interest as vested for tax purposes at the time of grant and to be taxed on the value of the profits interest at the time of grant. There is some IRS guidance that states that an 83(b) election is not necessary. However, that issue is beyond the scope of this article and a so-called “protective 83(b) election” is usually still made to assist in easing the minds of profits interest holders who want to ensure that the interest is not taxable when it vests.

Tax Consequences of a Profits Interest

The recipient of a properly structured profits interest is not taxed on receipt because the IRS views the profits interest’s value as $0. Because the profits interest is treated as having no value, there is no deduction that corresponds to the issuance of the profits interest for the entity. The profits interest will be treated as having a $0 basis, and no capital account. Going forward, the recipient should be treated as an equity owner under the terms of the governing partnership or operating agreement for the entity starting on the date on which the profits interest was granted. The recipient should receive a K-1 and pay taxes on income that is passed through from the entity. Capital accounts should be adjusted accordingly, just as is the case for any other member.

The Future of Profits Interests

The history of how profits interests are taxed is riddled with controversy. In addition, politicians continue to discuss the desirability of profits interests (also sometimes called “carried interests”), in the context of private equity and hedge funds. However, the foregoing analysis reflects the IRS’ stated position on profits interests based on several Revenue Procedures that were issued to address the topic pending additional guidance. Until the IRS or Department of Treasury issues additional guidance, the current rules will generally remain applicable to small businesses and startups who are issuing profits interests.

Overall, profits interests are a unique and creative way to give people who are rendering services to the LLC or partnership a stake in the enterprise. They can generally be viewed as similar to options, except that they also provide the holder with a stake in the losses of the entity. With the increasing use of LLCs for startup operations, the use of profits interests as an incentive compensation mechanism has grown in the past years.

ARTICLE BY Katie K. Wilbur of Varnum LLP

The Effect of “Brexit” on Tax-Qualified Plans

The decision by British voters in a June 23, 2016 referendum to leave the European Union has significantly affected both the equity and debt segments of international financial markets. As with other market dislocations, the decision has also affected US tax-qualified plans, since they invest in those markets as a source of funding and use corporate bond rates for a variety of derivative purposes. The effects differ, however, between defined benefit (DB) and defined contribution (DC) plans.

Potential Effects of Brexit on DB Plans

In the case of DB plans, Brexit potentially has implications for funding levels, lump sum payments, Pension Benefit Guaranty Corporation (PBGC) premiums, and financial accounting results—all of which are the responsibility of the plan sponsor (rather than participants).

Specifically, the vote has triggered a decline in interest rates—including corporate bond rates—that may have at least a short-term adverse effect on the funded status of many DB plans, since (i) corporate bond rates are the proxy used to determine the present value of liabilities for minimum funding purposes, and (ii) a decrease in rates triggers an increase in liabilities (present value inversely goes up as interest rates go down).

This effect will be mitigated somewhat, however, since DB plans generally can use a 25-year average of interest rates (with a 90% floor) for funding purposes, which tends to “smooth out” periodic spikes like Brexit. Still, if interest rates (which are already at historically low levels) decline further or continue to be depressed by the aftershocks of Brexit, more headwinds for DB plans seeking to improve their funded status will be created.

By contrast, DB plans must use a market rate of interest—that is, without “smoothing”—for lump sum, PBGC variable premium, and financial accounting purposes. As a result, any downward trajectory of interest rates triggered by Brexit will more directly affect DB plans for these three purposes. Thus, for example, the dollar amount of lump sums paid to employees will increase as rates fall (that is, lump sum present values grow inversely to interest rates).

This effect on the calculation of lump sum payments may be delayed somewhat, since most plans use a “look back” date for the related interest rates (such as the rate in effect two months before the start of the plan year in which the lump sum was paid). Nevertheless, if interest rates stay low or decline, these lower rates ultimately will roll into effect for lump sum calculation purposes. Plan sponsors that are otherwise so inclined may view this as an impetus to offer lump sum windows or annuity buyouts—sooner rather than later (and before any lower interest rates roll into effect). This is especially true of annuity buyouts, since insurance companies tend to use rates for premium calculations that are even more conservative (i.e., lower) than the corporate bond rates used under ERISA.

Similarly, the PBGC variable rate premium is essentially determined using the same rate as is used for lump sums, but without a lag. This will increase the liabilities that form the basis for determining the amount of the variable premium.

Finally, the use of spot fixed income rates for financial accounting purposes will have an adverse effect on a company’s balance sheet to the extent they trigger an increase in reportable plan liabilities. The impact will be much more pronounced than is the case with minimum funding considerations, since the use of spot rates does not allow the impact of currently falling rates to be offset by the prior year increases used in a “smoothing” approach.

Potential Effects of Brexit on DC Plans

In the case of DC plans, participants generally bear the primary risk (and reward) of their investment choices, as allowed by ERISA Section 404(c). Thus, they will bear the risk of both declining bond prices and more volatile financial markets generally. Plan fiduciaries may want to consider alerting participants to the issues raised by Brexit, the possible impact on plan investments, the advisability of staying the course in turbulent markets, diversification considerations, and any other Brexit-related issues relevant to participation in the DC plan, but should be careful to avoid providing specific investment recommendations or advice that may be subject to ERISA’s fiduciary obligations.

Conclusion

In the case of both DB and DC plans, the fiduciary responsible for selecting investments (such as an investment committee) should continue to monitor developments in the financial markets and react as appropriate, in light of the plan’s investment policy statement and the general fiduciary requirements of ERISA. Federal courts and the US Department of Labor have consistently stated that ERISA fiduciaries are not held to a standard of omniscience, but they are required to exercise “procedural prudence” in selecting and monitoring plan investments. This sort of prudence would include adhering to the processes and other mandates established in the fiduciary’s charter or other governing document.

How Will the Exit of the United Kingdom from the European Union (“Brexit”) Affect U.S. Corporations Doing Business in the UK?

On June 23, 2016, the UK voted in a referendum to leave the EU. The UK government will now initiate the procedure under Article 50 of the Lisbon Treaty leading to the UK’s withdrawal from the EU. The UK will be immediately excluded from the European Council and the Council of Ministers, and a negotiation period of two years will commence during which the terms of its withdrawal and of its future relationship with the EU will be determined. No member state has initiated this procedure before, and so it is impossible to predict what this future relationship will be. Furthermore, the UK’s relationships with non-EU states will have to be independently reestablished, as it will no longer be entitled to rely on the bilateral treaties with those states it enjoyed whilst an EU member state.

This Client Alert will focus on the likely impact of Brexit on the laws of the UK influencing key business areas for U.S. corporations doing business in the UK.

M&A

The UK Companies Act 2006, which embodies UK law as it relates to both public and private companies, has been significantly influenced by EU directives, however, it is highly unlikely that Brexit will result in any changes to UK company law, so the basic mechanics of acquisitions and disposals of UK companies will remain the same. The vast majority of M&A transactions in Europe take place between private companies, either by means of an acquisition of shares or of assets, and Brexit will not affect the laws governing such transactions.

The EU Takeover Directive harmonises public company takeovers in the EU and is modelled on the UK Takeover Code, which regulates takeovers of public limited companies in the UK. Brexit is therefore unlikely to have any significant impact on takeovers.

The EU Cross-Border Mergers Directive enables a private or public company in one EU member state to merge with a company in another member state. Brexit means that UK companies will cease to benefit from this regime.

Brexit may possibly affect competition law in the longer term. Currently anti-competitive agreements and abuses of dominant positions in the UK are policed by the Competition and Markets Authority under laws and procedures which mirror EU regulations. In the case of mergers, however, larger transactions are dealt with by the European Commission on a “one-stop-shop” basis to save the parties having to file in several states. Brexit could lead to a decoupling of UK competition law from that of the EU and the end of the “one-stop-shop,” at least for UK mergers.

Commercial Contracts

Existing contracts which continue beyond Brexit could be affected in a number of ways, for example:

Depending on how the contract is drafted, Brexit might constitute a “material adverse change,” entitling the parties to terminate;
Provisions which have EU territorial scope, such as restrictive covenants or exclusive sales rights, will no longer include the UK;
If import duties are imposed as a result of Brexit, contractual pricing mechanisms may operate to shift the burden of such additional costs onto one of the parties making performance more costly.

New contracts should take such matters into account, and now that Brexit is a reality, parties should negotiate how its consequences will be dealt with and who bears the risk.

Debt and Equity Financing

Similar considerations apply to financing transactions on Brexit as apply to M&A deals and commercial contracts. Generally the effect on such transactions will be insignificant.

In the case of loan facility documents, EU territorial clauses may be affected by the UK’s departure from the EU, and Brexit may trigger an event of default in the case of particularly harsh “material adverse change” provisions. The imposition of tariffs and duties and the consequences of market disruption as a result of Brexit might lead to lenders passing on increased costs to borrowers. Brexit might also cause a UK borrower to make an inadvertent misrepresentation (for example, that it is in compliance with EU laws and regulations). It is difficult to see how Brexit would prejudice English law security taken under a security document (with the one exception of intellectual property rights – see below).

Equity financing documents, such as placing and underwriting agreements and prospectuses, will be similarly affected. In addition, the possible loss of the “passporting” regime for the sale and distribution of securities throughout the European Economic Area (EEA) would adversely affect fundraising outside the UK. On an IPO or bond issue, issuers should consider a Brexit-related risk factor disclosure in their prospectuses, especially if their business is likely to be adversely affected by Brexit.

Funds and Asset Management

Brexit could have potentially significant adverse consequences for funds and asset managers in the UK.

Initially, UK fund managers will be treated as non-EEA alternative investment fund managers and lose their managing and marketing passports into the EU. Currently, thanks to the “passport” regime, under the Alternative Investment Funds Management Directive (AIFMD), both UK and non-UK funds can be managed by UK-regulated fund managers operating out of the UK, and such fund managers can market and distribute the fund throughout the EU. Such fund managers will cease to qualify for a passport on Brexit. Under current rules, they could only market such funds as alternative investment funds to EEA investors under local private placement arrangements, if applicable.

Also, as undertakings for collective investment in transferable securities (UCITS) must be EU domiciled and managed by an EU management company, Brexit could be potentially disastrous for a UK-domiciled UCITS fund.

UCITS funds are subject to strict investment rules, including a maximum investment of 30 percent of their assets in non-UCITS collective investment schemes. Brexit will result in many such funds having to alter their investment mandates to take account of the UK no longer being a member of the EU. Similarly, even non-UCITS funds, whose investment policies are to invest in EU securities, will have to readjust their portfolio investments in UK companies or amend their policies.

Employment

The vast majority of UK employment law is “home grown,” such as protection against unfair dismissal, the right to a payment on redundancy, protection against sex, race, nationality, ethnic origin and disability discrimination, and the right to a minimum wage. EU directives have contributed to UK employment law in areas such as the protection of employment rights on the transfer of undertakings, the obligation to consult with employees in the case of mass redundancies, working time limits and minimum holiday pay.

These EU-derived employment laws have become so integral to UK employment law that it is unlikely that Brexit will affect them.

In fact, previous UK governments have tended to “gold plate” EU directives and regulations (for example, the Working Time Directive allows full-time employees 20 days of paid annual leave, but the UK application of that law allows 28 days). It is possible that, outside the EU, a future UK government will review certain aspects of the legislation which have not sat well with UK businesses since their inception, including in particular, the weekly limit on working hours, regulations relating to agency workers and work councils and even those in respect of collective consultation with employees in general.

As in the case of commercial contracts, employment agreements with EU territorial scope may be affected (for example, in the case of covenants not to compete or solicit customers or employees in the EU after termination of employment).

Brexit may deny the UK access to the “single market” of the EU, including the right of free movement of workers between the UK and the remaining EU member states. This will adversely affect the ability of UK companies to manage a cross-border skilled and experienced workforce.

Trade

Many UK trade laws derive from EU law such as the following:

Product safety
Consumer protection
Laws on unfair contracts
The rights of commercial agents
On-line shopping
Payment services
Laws on hazardous chemicals
Certification of electrical and medical devices

Most of these laws have become enshrined in UK law for many years and are unlikely to be affected by Brexit. However some, which derive from secondary legislation, would lapse unless a post-Brexit government were to preserve them (for example, the regulations governing consumer protection from unfair trading, general product safety, and consumer contracts in respect of “distance” sales of goods and services to consumers).

The withdrawal of the UK from the EU “single market” could entail import duties on the export of products and services from the UK to the EU. Also institutions, such as banks, trading companies and professional firms, such as lawyers and accountants, would cease to enjoy the single market in the provision of services, which could lead to the restructuring or even relocation of their EU-based offices.

Intellectual Property

As one of the largest creators of intellectual property in the EU, the UK and its entrepreneurial innovators could be significantly affected by Brexit.

The Community Trade Mark would cease to apply in the UK. This would require trade marks to be registered both in the UK and as CTMs, incurring additional costs and potentially adversely affecting existing trade mark licenses and security over trade marks.

Currently UK patents are protected and registered under UK legislation, and so Brexit will not affect them (or European patents designating the UK). From 2017, a new EU patent system, the Unitary Patent, is scheduled to be launched, with its new court, the Unified Patents Court, expected to take its seat in London. Brexit would exclude UK patents from this unified system, and London will lose its new court.

Data Protection

The UK law on data protection is based on EU law but dates back to 1998, and so it is unlikely to be significantly affected by Brexit. There are current EU proposals to strengthen the law under the General Data Protection Regulation, and it is likely that the UK will now adopt this.

Post-Brexit cross-border transfers of personal data to the UK are unlikely to be automatically permissible from EU member states. The UK would have to apply to the European Commission for a decision that its data protection standards are adequate to protect the privacy of EU residents (which means the EU standards would have to be met in any event). In the recent case of Schrems, the European Court of Justice held that the United States had not complied with European data protection standards (as Facebook had allegedly transferred consumers’ data to the NSA) and abolished the “safe harbour” rules which had hitherto permitted such transfers from the EU to the United States. If the EC were to deny or restrict the terms of its adequacy decision, the UK could find itself in a similar position to that of the United States after Brexit, which could seriously adversely affect technology providers with UK-based data centres offering services to EU clients.

Conclusion

The legal consequences of Brexit are difficult to quantify. Much will depend on the exit terms negotiated between the UK and the remaining EU member states and the status of the continuing relationship between the UK and the EU after Brexit. Such matters will not be known for at least two years. In the interim the status quo will survive.

ARTICLE BY Jonathan Maude, Richard L. Thomas & Sam Tyfield of Vedder Price

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

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.

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.

In 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

Email Notice Without Consent Is Not Notice

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

Exclusive Study Analyzes 2014 IPOs – Initial Public Offerings

Proskauer’s Global Capital Markets Group has just released its second annual IPO Study, the group’s analysis of U.S.-listed initial public offerings in 2014 and identification of year-over-year comparisons and trends. As with last year’s first edition, it yields a number of noteworthy observations and insights.

The study examines data from 119 U.S.-listed 2014 IPOs with a minimum deal size of $50 million, and also includes separate industry sections on health care; technology, media and telecommunications; energy & power; financial services; industrials; and consumer/retail. This edition expands on last year’s to include an appendix focusing on foreign private issuers, as 2014 experienced a meaningful return of IPO issuers from Europe and Asia. It also makes year-over-year comparisons of extensive data about deal structures and terms, SEC comments and timing, financial profiles, accounting disclosures, corporate governance and deal expenses.

Underlying the study is the proprietary IPO database that we created for the first edition and have subsequently expanded and enhanced, a valuable resource for sponsors and companies considering an IPO as well as for IPO market participants and their advisors.

Download Proskauer’s 2015 IPO Study

ARTICLE BY

Frank Lopez

Proskauer Rose LLP

Tag: corporations

The Way to Protect Your Business? What You Need to Know About Trade Secrets

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