Get your former boss to sue you in three easy steps

June 26, 2019

By Edward Robson

We spend a good deal of time advising clients on how to stay out of court. Some clients, however, find this approach too conservative, stodgy or dull and would prefer to be involved in otherwise avoidable litigation. They often complain that, “Things are just going too well for me,” or , “I need some drama in my life.” Since we do not want to alienate any client or potential client with practical, financially sound legal solutions, we are offering some tips on how to end up in court, lose money and dismantle that which you worked hard to build. Of course, if you are like most of our clients, we strongly suggest that you disregard everything that follows.

You have been with your current employer for some time and you are good at what you do. It’s time to leave the nest to start your own company. You like to challenge yourself, so rather than focusing solely on your new endeavor, you want to leave your current employer in such a way that you can be sure they will initiate distracting, time-consuming and expensive litigation against you. Here are a few suggestions to assure this result:

Steal things. Nothing makes your former employer happier than when you steal things before you leave. Staplers and mouse pads are a nuisance but customer lists, proposals to clients, pricing information, form documents or product specifications should get you into court quickly. Since most of these items are stored electronically, downloading them to a thumb drive or emailing them to your personal Gmail account should leave an easy trail for your employer’s IT department to track.

If you are clever enough to steal these items, you should expect your employer to seek a preliminary injunction – an order from a court to do or not do something – prohibiting you from working. Because of the emergency situation you have created for your employer, you should expect to incur significant legal fees quickly to prepare for significant court events early in the litigation.

Breach your non-compete. Restrictive covenants that limit a person’s ability to make a living are enforceable under Pennsylvania law but are disfavored and courts look closely at them to determine whether they are really necessary to achieve an employer’s legitimate business interests. In light of the opaque legal standard and the desire the avoid litigation, a negotiation between the former employer, employee and new employer regarding the scope of the employee’s employment is often a reasonable solution. The strength of the restrictive covenant, the employee’s role in the company and the job responsibilities at the new company would all inform this negotiation. But what’s the fun in that?

The adventurer leaves his employment by providing no notice to the former employer. He immediately begins work with the direct competitor located just down the street doing the same job he did with the former employer.

“Soften” your transition by diverting opportunities. Even absent any employment agreement, Pennsylvania law imposes a duty on employees to be loyal to their employers. This means that diverting customers, projects or opportunities that come to you because of your job may be a problem if you want to stay out of court. Although an employee may make plans and take steps to start a new venture while still employed, they may not do it on the employer’s time or using the employer’s resources.

The buccaneer business person will tell their customer contacts and subordinates that they are leaving months before they alert their employer. Since the departing employee wants to make sure she has the best employees for her new venture, she makes employment offers to all her subordinates. She will quietly promote her new venture at trade shows and other events that she is attending on behalf of the
employer.

Takeaway

If you are considering leaving your employment, engaging in this type of behavior carries a significant risk of litigation. The law is generally reluctant to restrain the free movement of labor but there are limits.

June 24, 2019November 2, 2020

Assets or Stock: The Form of Purchase DOES Make a Difference

June 24, 2019

By Edward Robson

Purchasing or selling a business can be accomplished in a number of ways. While the objective of the transaction is always the same – transfer of ownership from a seller to a buyer – the form of the transaction does make a difference. When it comes to the purchase or sale of a business, the form of the sale has significant implications, not only at the time of sale but with regard to operations going forward.

The purchase or sale of a business is generally accomplished by either a stock sale or a sale of substantially all of the assets of the company. The form of the transaction has important implications for both buyers and sellers in several key areas:

Liability

Purchasers of stock essentially “step into the shoes” of the seller. This means that the purchaser assumes all of the liabilities of the acquired business – whether known or unknown, whether past or future. Such liabilities may be extensive and include liability for debt or purchases; losses arising from injuries caused by products or services provided by the purchased entity; claims of trademark or patent infringement; and liabilities based on employment discrimination, wrongful termination or violation of wage and hour laws.

Constructing the transaction as a purchase of assets of the company may enable a purchaser to avoid some potential liabilities inherent in a stock transaction. Yet, even asset purchases carry some risk of assumption of unknown liabilities. Asset purchasers may be responsible for undisclosed liabilities if it appears that they have implicitly accepted liabilities, or where there is sufficient continuity of enterprise that the transaction can be considered a de facto merger.

Scope of Purchase

One of the advantages of an asset purchase agreement is the opportunity it affords the buyer to “pick and choose” the assets that the buyer deems most desirable for the business. Obsolete inventory or redundant equipment can remain with the seller, in contrast to a stock purchase that transfers every and all assets owned by the business. Asset buyers, however, must be careful to ensure that the asset purchase agreement has a complete and comprehensive description of all of the assets necessary to operate the business or they will face some unwelcome surprises at closing.

Taxes

Tax and accounting treatment for asset purchases vary significantly from that afforded stock transactions. Purchasers of stock continue to carry assets on the books on the same basis as the seller. Stock sellers recognize a gain to the extent the sale price for the stock exceeds their basis. In contrast, an asset sale requires the buyer to adjust the basis of the assets that are acquired based on the fair market value. This may result in an increase or decrease in the book value and depreciation for such assets.

What is clear is that no form of transaction – stock purchase or asset purchase – is inherently “good” or “bad.” Each form has advantages and disadvantages for buyers and sellers and the decision of which form to adopt can be difficult – especially since what advantages one party may be disadvantageous to the other. In many cases, other elements of the transaction can be used to reduce risk and to satisfy the core objectives.

June 18, 2019November 2, 2020

Avoid Common Pricing Structure Mistakes When Selling Your Business

June 18, 2019

By Edward Robson

Negotiating a purchase price for a business is more complicated than haggling for a new car. Most business sales have at least some portion of the price paid after closing. This raises two questions for the seller—How much am I owed, and can I collect it? We see several common mistakes that business owners make when answering these questions.

Using Earn Outs Incorrectly

An “earn out” is a pricing structure where some or all of the purchase price is contingent upon the business hitting certain performance goals after closing. A properly used earn out typically overcomes two roadblocks to reaching an agreement on purchase price. Many disagreements over purchase price arise from disagreement over probability of certain outcomes. For example, a seller may assert that the business is worth 10 million dollars because it will sell 50 widgets next year. Buyer may say the business is worth only 8 million because it does believe the business will sell 50 widgets. An earn out can bridge this gap by making the 2 million dollar difference in purchase price contingent on the business selling 50 widgets.

An earn out may also allow the seller to capture value from the acumen or resources of the acquirer. If a target company has struggled because of lack of capital, market presence or other factors, acquisition by a larger company may increase profitability. A earn out may allow a seller to capture this upside by providing an additional upside contingent on the business hitting performance metrics that exceed past performance.

There are a number of risks associated with an earn out for a seller. It is often difficult to track whether a business has met its performance goals, particularly when the target business is integrated into an existing operating business. “Creative accounting,” in particular, overhead allocation, can make it appear as if a business is not performing or hitting its marks. Detailed provisions addressing the purchaser’s accounting practices help to reduce risk but such provision are fertile for disagreement and post-closing litigation.

Not Knowing Your Purchaser

If you are “taking back paper” – slang for accepting a promissory note in the place of a cash at closing – in a transaction, you are acting as a bank for your purchaser. Just like a bank, a well-advised seller should conduct due diligence on the potential buyer to evaluate its ability to make good on its promise to pay. This includes reviewing the purchaser’s financial statements, cash flow, other debts and ability to obtain money from other sources. A more generalized inquiry into the purchaser’s business track record is also important. How long has the purchaser been in business? Has the purchaser ever declared bankruptcy or does it have judgment against it? Is the purchaser highly leveraged?

Not Acting Like A Bank

A bank does not lend money without the borrower putting up collateral to back up its promise to pay; you shouldn’t either. The prudent seller treats the buyer as a bank would. Without adequate collateral, a seller may have a successful lawsuit against a judgment-proof entity or individual.

Of course, not all collateral is created equal. Clients who want to get the price they negotiated for their businesses like to see letters of credit, mortgages on real property and personal guarantees from the owners (and their spouses) of corporate buyers. Relying solely unsecured promissory notes from recently formed entities or a security interest in the assets of the business just sold is a recipe for disaster.

No transaction is without risk but thoughtful negotiation and good advice can help to minimize the chances of turning a happy time into a sore subject.

May 20, 2019November 2, 2020

Taxation of Trusts—Guidance Coming From the Supreme Court?

May 20, 2019

By Joseph Frabizzio

The U.S. Supreme Court recently heard oral arguments in a case, North Carolina Department of Revenue v. Kaestner 1992 Family Trust, Docket No. 18-457 (argued on April 16), in which a trust challenged a North Carolina law that taxes resident-beneficiaries on the income earned and retained by a nonresident trust. The trust prevailed at the trial level, appellate level and in the North Carolina Supreme Court, but the U.S. Supreme Court granted the North Carolina Department of Revenue’s petition for a writ of certiorari on the question of whether the due process clause of the Fourteenth Amendment prohibits states from taxing trusts based on trust beneficiaries’ in-state residency. The petitioner asserted that there was a split among the nine states that had considered taxation of trust income based on a beneficiary’s residence and that the split could only be resolved by the Supreme Court. While we await the court’s decision, this case presents an interesting mix of arguments regarding the proper analysis of the minimum contacts inquiry and a public policy appeal by the petitioner to “modernize” trust taxation along the lines of a recent court decision that eliminated the physical-presence requirement in the sales tax context.

General Trust Taxation Rubric

Taxation of income from trusts involves looking at federal law, state law, the language of the applicable trust, and the identity and location of the grantor, trustee, beneficiaries and assets held by the trust. In short, the analysis can be complex. Some states, looking to bring in additional revenue, have passed laws expanding the reach of their power to tax trust beneficiaries. One distinguishing feature of the North Carolina law is that it taxes beneficiaries who have not actually received taxable income from a trust.

There are a few preliminary trust tax issues to understand. Income from a trust is sometimes taxed at the trust level, while at other times it is taxed to beneficiaries. Trusts known as revocable (or living) trusts permit the grantor of a trust to revoke the trust. These trusts are generally ignored for both federal and Pennsylvania trust tax purposes and income is taxed just as if the individual grantor had received it. There are also other types of irrevocable grantor trusts which are taxed to the grantor for federal tax purposes and, in a minority view, to the trust itself for Pennsylvania purposes. These grantor trusts can be utilized by estate planning attorneys to leverage estate and gift tax savings. This leaves the traditional nongrantor irrevocable trust, which is the type of trust at issue before the court.

For these nongrantor trusts, most forms of taxable income actually distributed to a beneficiary or that are required to be distributed to a beneficiary are taxed to that beneficiary. Essentially, the trust takes a deduction for the distributed income, with possible limitations for some forms of income such as capital gains, and distributes a K-1 to the beneficiary. States that impose an income tax would generally require that the individual beneficiaries then report the income on their individual tax return just as they would report any other income received. A trust that retains income and is not required to distribute it, on the other hand, will pay tax at the trust level. For federal income tax purposes, this can have negative consequences since the tax brackets are compressed and trusts reach the highest rate of taxation at just $12,750 in annual income. For a trust with a Pennsylvania grantor, Pennsylvania trustee and Pennsylvania beneficiaries, the state tax consequences are what one would expect: the taxable income, whether paid by the trust or the beneficiary is taxed at Pennsylvania’s flat tax rate of 3.07%.

For Pennsylvania, as well as some other states, a distinction must be made regarding income sourced to a particular state, such as rental income from a property in Pennsylvania or a trust’s income from ownership of a company operating in Pennsylvania, versus nonsource income. Nonsource income would include investment income from ownership of stock of a company not located in Pennsylvania. Current Pennsylvania law provides that it can tax income of a nonresident trust that receives Pennsylvania-sourced income or a nonresident trust beneficiary who receives a distribution from such a trust, but only to the extent that income relates to the Pennsylvania source property. Merely having a beneficiary who resides in Pennsylvania, however, with no other ties to Pennsylvania will not trigger taxation by the state. Of course, Pennsylvania would tax actual distributions of income made to a Pennsylvania resident by a nonresident trust.

North Carolina’s Statute

North Carolina’s law is more expansive. The heart of the dispute presently before the court is whether North Carolina may tax undistributed income of a trust if the only contact with the trust consists of a beneficiary who lives in North Carolina. The Kaestner trust was originally formed in New York and the trustee had no operations or residence in North Carolina. As a constitutional matter, the trust argued that the due process clause should not allow North Carolina to tax the income of the trust since it would be unable to exercise jurisdiction over the trust in a judicial proceeding. Considering the issue in terms of a minimum contacts analysis, the court will likely analyze whether a trust, its trustee and effectively other beneficiaries can be subject to a state’s taxation merely because one of its beneficiaries happens to live in that state.

The law is well-established that a state may tax an actual distribution received by a trust beneficiary in a state in which the trust does not reside. From a practical standpoint, this makes sense. As a beneficiary, one can choose to live in any state. Such beneficiaries have made a choice to subject themselves to the jurisdiction of that state. A beneficiary motivated to save taxes on distributions from a trust might choose to live in Florida, which has no state income tax. The trust, however, cannot exercise control over where its beneficiaries live. Therefore, if the trust’s income is retained by the trust and not distributed, the question is whether a foreign state could then subject any portion of that income to taxation.

A key component of the court’s analysis is likely to be whether serving in a fiduciary relationship to a beneficiary constitutes a sufficient nexus to allow a nonresident trust to be taxed and whether the tax imposed is sufficiently related to values connected to North Carolina. The petitioner argues that there are sufficient minimum contacts because, in what it termed a “fairness-based analysis,” the mere status as beneficiaries of a trust who avail themselves of the benefits of living in North Carolina, such as public roads, police and fire services, is enough to constitute sufficient minimum contacts with the state.

Another component of the court’s focus may be whether the speculative interest of that beneficiary, who had not actually received a distribution, allows North Carolina to impose tax on the trust in this situation. In its brief and at oral arguments, counsel for the trust stressed that the North Carolina beneficiary at issue was a contingent beneficiary of the trust. The trustee had complete discretion whether to make distributions to the beneficiary at issue in this case and there were no distributions made to that beneficiary during the relevant time period. Not only did the trust retain the income, it was conceivable that no trust assets might ever be distributed to that beneficiary. Instead, the trust assets could be distributed to other contingent or remainder beneficiaries who might live in any one of several states at the time they receive the assets.

The petitioner also argues that prohibiting its tax on due process grounds would open up the use of trusts as a tax shelter since individuals could forum shop for a state that does not impose income tax and allow the trust to grow without being taxed. The counter to this position is that states may choose to tax undistributed income in the place where the trust is administered or may impose a throwback tax that would tax the previously untaxed income of a beneficiary in the year that the beneficiary actually receives a distribution.

In sum, this case presents an opportunity to learn how the court will apply due process arguments to trust taxation in light of an increasing focus on income tax planning as the federal estate and generation-skipping transfer taxes impact fewer families.

May 20, 2019November 2, 2020

Budgeting for Prevention: Getting the Most Out of Your Legal Services Dollars

May 20, 2019

By Edward S. Robson

One of the quickest ways a business can incur legal expenses is to be involved in contentious litigation. Sometimes litigation is just a fact of business life. Businesses can be sued without justification or as an effort to intimidate rather than resolve a dispute. Other entities behave so badly that their conduct compels even the most litigation adverse clients to sue them.

While sometimes litigation is the only option, our litigators spend a fair bit of time on litigation that could have been avoided – or at least made easier – if attorneys had been involved earlier in the process. Unfortunately, many smaller and even mid-market businesses fail to properly budget for legal support for their ongoing business operations. Although this may result in meager short-term savings, any savings are more than outweighed by expensive and disruptive litigation.

Before you write off this post as shameless self-promotion, keep in mind that we are not suggesting that attorneys need to be involved in every business activity. There are certain areas, however, where prospective legal counsel can help to avoid costly litigation later. Here are a few ways you can maximize the bang you receive for your legal buck.

Corporate Formation and Relations Among Owners

Some of the most contentious litigation we handle arises from disputes among owners of closely-held companies. Often, such “business divorce” litigation could have been avoided completely if the owners had sought counsel at the formation of the business and properly documented their decisions in an operating agreement.

Dividing equity can trigger difficult conversations among owners and many owners avoid the practical realities by dividing ownership interests equally among all owners. Experienced attorneys can provide advice on how to approach the allocation of interests and identify common areas of future disagreement. Addressing and resolving such issues early in the business venture can create the conditions for smooth operations and reduce the possibility of acrimonious litigation.

Legal advice is especially critical when there is a change of ownership. Adding new investors or accommodating investors who want to “cash out” can present hidden legal risks. Investing additional capital whether in the form of a loan or capital contribution frequently triggers changes in the ownership structure, while selling the business outright potentially creates significant legal issues for years after the event. Knowledgeable counsel can help owners navigate both immediate and long term issues and can work to resolve them in a non-adversarial way.

Growing the Business

Growing the business through acquisition of another business or a franchise can be a stressful process. Even “small” acquisitions carry the risk of hidden liabilities that can impact the new owner. We routinely assist clients in their legal due diligence and can facilitate financial due diligence by recommending other knowledgeable professionals. We can advise or participate in negotiation with sellers, lenders, suppliers and possible investors and prepare transaction documents. Once agreement is reached, we can ensure proper recording and transfer to enable a smooth and timely closing. Most importantly, we can assist with the post-sale obligations and adjustments that are frequently part of the acquisition process.

Customers And Supplier Disputes

Customer relations are both important and challenging. Not every job goes perfectly and contrary to popular wisdom, the customer is not always right. If a customer fails to pay, alleges defects in your product or service, or posts defamatory statements on the web, a call to counsel can be timely. We routinely work in the background to help resolve customer disputes before the relationship degrades into litigation. This may be as simple as providing advice in anticipation of your meeting with the customer, ghost writing a letter to send to the customer, or writing a “nastygram” on our letterhead. Even if the dispute cannot be resolved without to litigation, letters we have drafted for clients can favorably frame the issue if litigation does occur.

Issues with key suppliers can also pose serious issues for businesses. Suppliers may impose significant restrictions on customers, and defects in materials or services can cause businesses to incur operational and reputational damages in excess of the costs of the materials. Moreover, in the case of an exclusive supplier or a distribution arrangement, businesses may need to proceed cautiously in an effort to preserve the relationship. Our goal in such disputes is not simply to “win the issue” but to arrive at a workable solution that can preserve a business relationship that is worth saving.

Dealing with Problematic Employees

Terminating an employee is never easy; it frequently represents a hiring failure. The process is stressful for both the employer and the employee and is fraught with legal risks. When it is necessary to terminate an employee, discussing the matter with your legal team prior to the termination allows them to help you build a record and handle the termination in a way that will put you in the strongest position possible if the employee initiates litigation later.

Early legal help can significantly reduce the risk of employment-related litigation. There are many laws that impact the employment relationship and every disgruntled employee thinks that they have a legal claim. Misclassification of workers as independent contractors or non-exempt employees can be a source of significant liability for employers. The failure to pay or withhold taxes and overtime associated with these errors can expose a company to serious financial penalties that significantly exceed the cost of compliance. Legal counsel can ensure that the way you pay your employees, the hours they work, and the taxes you withhold all comply with the law and can prevent tremendous liability later.

Employees may also threaten an employer’s intellectual property by soliciting customers or suppliers, removing files or equipment or disclosing confidential information to a new employer. Employers may have legal recourse in such situations – even in the absence of a signed employment agreement. Timely conversation with an attorney is necessary in order to ensure quick action to protect disclosure of proprietary information. Having someone available who is knowledgeable about the law and about your business is the first step in protecting intangible business assets.

Creating Form Agreements

Many clients retain us to review and negotiate significant contracts. That’s great… but they often overlook their form agreements – statements of work, terms and conditions, bid proposals, construction contracts, license agreements, purchase orders, master service agreements – that are part of their daily operations. “Boilerplate” has legal consequences and well drafted provisions can provide a significant advantage in the event of litigation. For example, form agreements we have prepared for clients have successfully forced disgruntled customers into arbitration, limited our clients’ liability to nominal amounts, and allowed them to collect attorneys’ fees from deadbeat customers that exceeded the amount initially in dispute.

Counseling on Major Business Decisions

Although most businesses think of attorneys primarily with respect to litigation, the firm also functions as counselors providing impartial advice on how the law might affect potential decisions and identifying legally compliant alternatives that might meet the client’s needs. Businesses considering entering a new market or a new business channel have been well served by a discussion of legal issues. Many products and services are regulated by specialized state or federal agencies and the impact of such regulations should be considered before entering such a market. For example, serving liquor at an establishment, accepting payment in bitcoin, on-line marketing to children, ad claims that a product “kills germs” or running a promotional sweepstakes – all require regulatory compliance. We can help to identify regulatory hurdles so ensure that your new initiative does not result in unexpected legal liability.

Strategic Advantage

Timely and proactive interaction with counsel – not just in response to litigation – not only avoids problems but can also result in a competitive advantage for the business. Law can be an important tool to protect small businesses from unscrupulous competitors, preserve intellectual property and properly secure payments. Regular communication with counsel on operational and strategic issues is the best way to ensure that the law works for your business and that entities get the most out of the money they spend on legal issues.

May 17, 2019May 17, 2019

Edward Robson named to Super Lawyers 2019

May 17, 2019

Robson & Robson managing shareholder Edward Robson was recently selected for inclusion on the Super Lawyers® Rising Stars list for the state of Pennsylvania. He has been named to this list every year since 2013.

Super Lawyers recognizes excellent lawyers in every state. Its Rising Stars list includes, at most, 2.5% of the attorneys in any one state.

May 6, 2019May 6, 2019

Enjoy a Beer on Us at Conshohocken Brewery’s New King of Prussia Location

Enjoy a Beer on Us at Conshohocken Brewery's New King of Prussia Location

May 6, 2019

Join us as we enjoy a low-key happy hour with our clients and “friends of the firm,” which, if you are reading this, means you. No topic, no agenda; just an opportunity to mingle with some fresh faces and check out Conshohocken Brewery’s newest location on us.

RSVP: [email protected]

WHEN: Thursday, May 16, 2019 from 5 to 7 p.m.

WHERE: 3100 Horizon Dr., King of Prussia, PA

May 3, 2019May 3, 2019

Regina Robson named to Beta Gamma Sigma

May 3, 2019

Regina Robson was recently made a member of the Beta Gamma Sigma chapter at St. Joseph’s University. Beta Gamma Sigma is an academic honor society whose purpose is to foster personal and professional excellence among its members with a particular emphasis on ethical leadership. Congratulations, Regina on this wonderful honor.

April 12, 2019November 2, 2020

The Hazards of ‘Weaponizing’ Capital Call and Dilution Provisions

The Hazards of 'Weaponizing' Capital Call and Dilution Provisions

April 12, 2019

By Edward S. Robson

There are many ways that an owner of a closely-held business can use their superior financial resources to gain an advantage over their co-owners in a dispute. One common way is the use of a capital call provision to dilute the interest of minority owners or to create off-setting claims against them. “Weaponizing” capital call and dilution provisions can be an effective sharp elbow tactic in business divorce situations but practitioners should be wary of the risks that come with it.

Weaponized capital calls are typical in situations where there are claims of shareholder oppression and where there is a significant disparity in financial resources between owners. Such a strategy usually is in response to a claim by a minority owner that the majority owner has breached their fiduciary duty to the minority owner, the company or both. Faced with the prospect of litigation from the minority owner, the majority owner causes the company to exercise a right provided in the entity’s governing documents to demand that each of the owners contribute additional capital to the company. In initiating the capital call, it is the expectation of the majority member that the minority member will have insufficient financial resources to make the necessary capital contribution within the time specified in the operative documents. Failure to make a timely contribution could result in dilution of the minority’s interest, trigger a mandatory sale of their interest to the majority or, minimally, create a counterclaim against the minority owner that would act as a setoff against any amounts that might be awarded to the minority owner.

Majority holders considering a capital call in the context of a dispute with a minority owner should exercise caution. Even when expressly permitted by the governing documents, using capital call provisions in bad faith can give rise to claims for breach of fiduciary duty and the implied obligation of good faith and fair dealing.

Improper exercise of capital call provisions may breach the fiduciary duty of loyalty. By setting the terms of the capital call that he or she will have to answer, a majority owner is engaged in self-dealing. Absent a provision in the company’s operative documents to the contrary, courts evaluate self-dealing transactions using an “entire fairness” analysis. Under this approach, the majority owner has the burden to show that the transaction was objectively fair to the company. A majority owner that is unable to meet this high bar will have breached their fiduciary duty to the company.

Weaponizing capital call provisions also risks breaching the implied duty of good faith and fair dealing. Operating agreements, partnership agreements and shareholder agreements are contracts and are subject to the duty of good faith and fair dealing. Just as in any other agreement, courts will not permit a party to a contract to exercise its contractual rights in such a way as to deprive the counterparty of the benefit of its bargain. Contractual provisions that provide an unfettered right to make a capital call invite court scrutiny as to whether the capital call was made in good faith. In evaluating whether a majority owner has complied with its obligations to act in good faith, courts perform a fact-intensive inquiry about the circumstances and the motivations surrounding the exercise of the contractual right and the reasonable expectations of the parties as reflected in the agreement.

There are several strategies for reducing the risks associated with making a capital call. Majority owners can address the risk prospectively by taking the time to create robust operating documents. Fiduciary duties can often be modified or eliminated in operative documents, thereby creating predictability for the majority when engaging in corporate transactions.

Even with the existence of supportive documents, proper exercise of a capital call requires a bona fide business need for capital coupled with a reasonable exercise of the right. Whether a bona fide need exists and whether the capital call was reasonable is a fact-intensive inquiry. Courts will evaluate the timing of the capital call, the capital needs it purports to address, the treatment of past capital calls and the motivations of the majority in making it. Notwithstanding the unpredictability associated with such an inquiry, certain practices can help a majority act with confidence in causing a capital call.

Seeking the assessment of independent directors or managers involved with the company may buttress assertions that the capital call is being made in good faith and may avoid application of the “entire fairness” analysis. If there is no way to avoid the entire fairness standard, the majority owner should be prepared to demonstrate and substantiate a bona fide business purpose that justifies a demand for additional capital. This might require the use of business valuation or accounting experts ready to explain cash flow or other financing issues. At a minimum, the majority should be ready with clear documentation of the need for capital and the amount required. Capital calls for excessive amounts smack of bad faith and suggest that the majority is attempting to exploit the minority owner.

The majority should also be ready to explain why it caused the company to raise money with a capital call rather than other financing sources that would not require additional money from the owners. Well-documented and unsuccessful efforts to obtain bank or other third-party financing before resorting to a capital call can provide helpful justification. Majority owners should be especially wary if the new capital is being used to retire loans or pay debts owed to the majority owners or their affiliates. In such cases, a capital call might only compound claims of self-dealing.

Lastly, majority owners should be prepared for the prospect that a minority owner may, through strategic alliances with other investors or lenders, make a timely contribution, potentially maintaining the status quo ante.

Majority owners do well to remember that no matter how favorable the language of the governing agreements, courts exercising equity powers may not look kindly on capital calls whose purpose is strategic rather than operational.

November 30, 2018November 2, 2020

Client Advocacy Isn’t Personal: A Lesson from The National Trial Advocacy Program

November 30, 2018

For those who practice primarily in civil litigation, there are regrettably few opportunities to hone courtroom skills—and even fewer to receive constructive feedback from knowledgeable colleagues. The National Trial Advocacy Program which I recently completed provides both. The three-day program is hosted by the American Inns of Court in conjunction with the Inns of Court College of Advocacy in London. It is conducted by a group of experienced English barristers, the small subset of British attorneys whose practice consists exclusively of litigation.

The program relies on the “Hampel” method, a six-step training methodology widely used in England and Wales. It requires the barrister trainers to provide detailed criticism on specific facets of participants’ mock opening and closing statements, oral arguments and witness examinations. Participants benefit both from receiving criticism of their own performances and those of their peers.

Although the trainers’ comments are meant to address particular issues in a participant’s performance, some comments have broader application that all litigators should consider. One such criticism is to avoid injecting personal opinion into courtroom advocacy. Indeed, since the program, I have noticed that this a common practice for many attorneys. Attorneys that inject their personal opinion and, by extension, themselves into their advocacy create a variety of risks for themselves and their clients.

An attorney injects herself into litigation anytime she does something that invites an evaluation of her personal credibility, skill or judgment. Although there are a variety of situations where this can arise, it commonly arises in oral argument and closing statements. The practice is disfavored in both contexts, albeit for different reasons and with different results.

Injecting personal opinion into oral argument often takes the form of “I think” statements. “I think the prosecution has failed to present a prima facie case.” This rhetorical style makes for unpersuasive and anemic oral advocacy. “I think” or “I believe” invites a court to think – and perhaps opine – “I don’t care what you think Mr. Robson.” Saying “I believe Jones v. Smith requires XYZ” invites a court to question the judgment of the attorney in a way that saying “Jones v. Smith requires XYZ” does not. Moreover, like the passive voice, it suggests a lack of confidence and obscures the source of the information: “I do not think that this is a breach of the agreement” is less informative than “the plain language of Section 1.1 permits the client to terminate the agreement and so there is no breach.”

Vouching for a client or referencing personal experience at trial is another particularly perilous way attorneys can inject themselves into litigation. Vouching for a client by claiming “I would never represent a client that would do XYZ” invites a jury to evaluate the scruples of the attorney in a way that saying “Mr. Jones credibly testified that XYZ” does not. Introducing personal experiences of the attorney converts the attorney from an advocate to a litigant.

Using these techniques can be the basis for reversal of a jury verdict and violates the rules of professional conduct. A number of state and federal courts have reversed jury verdicts after attorneys injected their personal opinions, often in bizarre ways. For example, the Eighth Circuit reversed a jury verdict in a sexual harassment case after plaintiff’s counsel provided the jury with an account of her (counsel’s) experience of being sexual harassed by her law school professor. A Florida appellate court reversed a jury verdict after counsel explained how his client’s “day-in-the-life video” gave him (counsel) nightmares. This type of conduct also violates Rule 3.4(e) of the Model Rules of Professional Conduct which prohibits attorneys from claiming personal knowledge of the facts or stating their personal opinion at trial.

Avoiding personal commentary in court proceedings is more than a trial practice technique, it is the tip of a larger lesson on how to reduce stress in sharp-elbowed litigation. Injecting yourself into litigation can take a subtle toll on the attorney. An attorney who has taken the client’s problems personally enough that they are willing to put their own credibility on the line has likely compromised their ability to give objective advice. It causes the attorney to suffer through litigation in the same way the client does. Every obnoxious move by opposing counsel and every adverse ruling becomes a personal affront that begets stress, anxiety and, possibly, unethical retaliatory behavior. The client, the attorney and the entire litigation process benefit when an attorney cultivates and maintains a professional detachment that allows him or her to evaluate both the strengths and weaknesses of their case and to dispassionately assess the behavior of the adversarial party.

While it is easy to recognize the risks of “getting personal” in litigation, refraining from such actions requires a conscious, conscientious effort. The world has become a less formal place and courtroom advocacy is not immune from the trend. Influenced by unrealistic dramatic portrayals of attorneys in books, films and television, clients expect their attorney to assume the client’s problems as if they were their own. Clients sometimes misconstrue detachment as disinterest and interpret undisciplined passion and ad hominem arguments as effective advocacy.

The British tradition of more detached, but pointed, courtroom advocacy sets a helpful example for American lawyers. Small changes, like avoiding personal opinion in the courtroom, can help counsel maintain the separation that makes for effective advocacy. Excising the “I thinks” and similar statements from courtroom vocabulary can make for more persuasive arguments. Avoiding references to the client as “we” and to the arguments as “ours” can help to create the space necessary to consider the issues, rather than the personalities. If a client’s case depends on the credibility of a witness, counsel should endeavor to have the factfinder evaluate the credibility of the witness, not the attorney. While no panacea exists, such conscious changes remind both litigator and client that we serve our client best when we represent them and not ourselves.