REPORT FROM COUNSEL
FALL 2008 ISSUE
CONTRACTS: NOT ALWAYS WHAT THEY SEEM
By Richard K. Helm
Many companies, from retail stores to manufacturing facilities, from warehouses to offices, use supplies. Sometimes these supplies take the form of uniforms, towels, throw rugs, mats and similar items.
There are hidden traps. Many suppliers offer contracts which call for lengthy terms and provide for substantial penalties. Typically, the term may be for multiple years. The contract may call for payment of "liquidated damages" for any cancellation of the contract. These are typically a multiple of the weekly or monthly price, calculated for the remainder of the contract term.
These contracts may be submitted for signing to employees who do not have actual authority to sign, or who may not review and consider the consequences. Ultimately, if the service is poor, if another provider offers a better price, or there is a change of need, the service contract may be difficult to cancel. This may result in demands by the supplier for very large sums of money. If the supplier's contract was signed without thought, you may find it has been drafted entirely in favor of the supplier, with provisions for substantial interest (18% is not unusual) and/or late charges and penalties, along with a requirement that the customer must pay the attorney fees if they resist paying off.
An example would be a six-year contract for uniforms and towels. If your company decided to cancel with three years remaining on a simple contract for rental of uniforms at the rate of $200 per week, it could result in a demand for over $15,600 of punitive "liquidated damages" (3 years x 52 weeks x $200/week x 50% "liquidated damages") to be paid by your company to the service provider.
The best cure is attention to detail and a strict chain of command. Staff members should be reminded periodically not to sign contracts on behalf of the company, and to refer them to a designated person who has responsibility. This person should review all contracts carefully, particularly looking at length or term of the contract, interest rates, attorney fee provisions, cancellation clauses and "liquidated damages" clauses.
Obviously, an ounce of prevention is very beneficial. Our firm is consulted on a regular basis by businesses that have already entered into a contract, making extrication from the contract both difficult and potentially very expensive. All contracts are negotiable, and service contracts are typically negotiable to a one-year term, renewable each year, allowing much greater flexibility to the customer. Consult your attorney before signing any contract.
EMPLOYERS: DON'T LET TIPS TRIP YOU
Employers in service industries are well advised to pay close attention to their practices and policies affecting customers' tips for their employees. There are a variety of ways in which missteps can run afoul of federal or state laws, including the federal Fair Labor Standards Act (FLSA).
Employees might contend, for example, that the employer is effectively reducing their tip income by imposing various fees or other charges on customers. Or, contrary to a requirement in the FLSA, employees who are paid less than the minimum wage might not be getting enough in tip income to make up the difference between their hourly rate and the minimum wage. Recent cases in the news involved yet another alleged violation, sometimes taking place on a very large scale, where employees are made to share tip income with fellow employees who supervise them.
In one of the tip-sharing cases, a state court ruled in favor of a class of plaintiffs consisting of baristas, or coffee counter servers, whose tips were required to be shared with their shift supervisors, in violation of state law. Change left for tips apparently adds up, as the judgment for the tens of thousands of servers, for about an eight-year period, topped $100 million, including interest.
The case was not cut-and-dried, as the supervisors were themselves hourly workers who had customer service duties in addition to the responsibility of scheduling workers and giving directions to the baristas. It was not a case of highly paid bosses dipping into the tip jars filled by customers they never saw in person.
When a shift supervisor hands a customer his latte and muffin, and the customer responds with a tip, the customer may assume that the money, or at least part of it, goes to the supervisor. Instead, under the ruling, the supervisors must now keep their hands off the tips, and the employers must ensure such an outcome.
In the wake of this case, similar lawsuits have been filed against the same employer, a national chain, and against other employers in other states. Companies in the restaurant, hotel, gaming, transportation, and delivery businesses face the largest risks for mishandling the treatment of tips. There is another pending case in which casino dealers have complained that an employer's new policy illegally requires them to share tips with floor supervisors.
The legal issues surrounding the treatment of tips are murky enough in any one state, but further complicating the matter is the fact that there are variations among the states and between the statutes for a state and for the federal government. This makes it especially risky for national employers to assume that a one-size-fits-all policy on tips will be sufficient for all of their locations.
"Back-room" personnel, shift supervisors, hostesses, greeters, drink servers, and other similar positions could be treated differently depending on what state you are in. Employers should regularly assess their job descriptions and tip-sharing policies against applicable state and federal laws. This kind of audit is useful not only for detecting or avoiding possible violations, but for laying the groundwork for a potential "good-faith" defense under the FLSA if litigation ensues.
LANDOWNER GETS SETTLEMENT FOR "TAKING"
When the government takes aim at private property to be taken for some public purpose, more often than not any resulting litigation is a contest overhow much the property owner should be paid, rather than whether the exercise of the power of eminent domain was appropriate in the first place.
From the landowner's standpoint, it is important to realize that adequate compensation is not determined simply on the basis of the current use of the property. Instead, the landowner is entitled to the value of the property based on its "highest and best" use (whether that use already exists or is only in the eye of a developer), so long as such a potential use is not too speculative or otherwise foreclosed by applicable laws and regulations.
The importance to a property owner of negotiating compensation on the basis of a best-case, but realistic, development scenario for the property is illustrated by a recent case in which the owner of a vacant, 22,000-square-foot lot settled with a town for compensation in an amount that was about 27 times higher than the amount initially offered by the town.
The lot was zoned for residential use, although at the time of the condemnation action the owner had no building or development plans. Appraisers hired by the town offered an opinion that the vacant lot's best use was only as open space, or as a buffer for an abutting lot. They reasoned that compliance with the town's lot area and frontage requirements, as well as with its road standards for improving the dirt road on which the lot was located, would be so burdensome as to make any development of the property prohibitively expensive. They also indicated that extensive development costs would preclude development even if the lot was considered to have grandfathered status that would protect it from certain town requirements.
For its part, the landowner retained experts who opined that the lot was, in fact, suitable for residential purposes and should be valued as such when arriving at a compensation figure for the taking. As the town's experts had noted, there were various requirements on the books that, in theory, could be costly to comply with. However, an examination of past rulings by the town's zoning and conservation officials showed that the lot was likely to be exempted from some of the requirements. Moreover, improvement of the dirt road, which would have been an especially big-ticket item, was not likely to be required.
Both sides were necessarily looking into the future to some extent, but the landowner was able to depict a scenario for the lot that was optimistic enough to bring about a favorable monetary settlement with the town.
CYBER INSURANCE FOR BUSINESSES
Businesses have been dependent on computerized information for some time now, but it has been only relatively recently that insurance companies have devised and offered insurance policies specifically tailored to the potential losses from a variety of problems that can affect a computer system.
An early impetus for cyber insurance was anticipation in the late 1990s of losses associated with the coming of "Y2K." That concern turned out to be overblown, but the threats that have spurred cyber insurance offerings since then are real enough, including viruses, hackers, and legal injuries to others from information on a company's website. One study has found that the average annual technology- related financial loss for United States companies more than doubled just from 2006 to 2007.
Another development that prompted more cyber insurance policies was the realization, which sometimes came as a surprise to insured businesses, that general liability policies did not cover computer problems. Cyber insurance is a good idea for all of the usual reasons associated with insuring against business losses. But it also makes sense because of the particular costs associated with responding to a computer data breach, especially now that many states have adopted data breach notification laws.
This kind of postmortem after a breach could include such measures as notifying affected customers, paying for credit monitoring for those customers, replacing compromised credit or debit cards, and undertaking forensic analyses of affected databases. All in all, there are some expensive scenarios to insure against.
Categories of Losses
The losses covered by cyber insurance generally fall into two categories: first-party losses, meaning those affecting the business itself; and third-party losses, meaning incidents mainly affecting outside parties, including the customers of a business. Of course, the same underlying problem can cause both kinds of losses, such as when unauthorized access to a computer system shuts down the computer system of a company whose customers or clients rely on that system through an extranet.
A comprehensive cyber insurance policy should encompass both kinds of risks. These are the typical categories of coverage:
* First-party business interruption, covering lost revenue experienced during downtime due to accidents or security breaches (but typically not losses due to catastrophic regional power outages);
* First-party electronic data damage, such as the compromise of data from a virus infection;
* First-party extortion, including the demands made by hackers;
* Third-party network security liability, arising from compromise and misuse of data stemming from identity theft and credit-card fraud;
* Third-party network liability in the form of court judgments obtained by persons harmed by problems originating with a business's computer system; and
* Third-party media liability, aimed at the full range of potential liability from matter published in interactive online communications.
LLC RULING FAVORS TAXPAYERS
Anna was the mother of three children and the widow of the man who invented the heart defibrillator implant. In 1992, she created a trust for each of her daughters and gave a portion of her substantial interests in patent licenses to the trusts. In 2001, she created a limited liability company (LLC), to which she made some large transfers. She then gave a 16% interest in the LLC to each of the trusts, keeping a 52% interest to herself. Only four days later, Anna died suddenly and unexpectedly.
The IRS claimed a deficiency of millions of dollars in estate taxes. It pointed to a part of the Internal Revenue Code that provides that all property is to be included in a decedent's estate to the extent that the decedent has transferred an interest in the property while retaining for life the possession or enjoyment of, or income from, the property. There is an exception to this general rule in cases of a bona fide sale for full and adequate consideration in money, but the IRS argued that the exception did not apply in the case of Anna's estate.
In a somewhat surprising decision, given a recent trend favoring the IRS in such disputes, the United States Tax Court sided with the estate and kept the LLC assets out of the gross estate for estate tax purposes. The court ruled that the bona fide sale exception applied, notwithstanding that the LLC activities were not in the nature of a "business." It was sufficient that Anna had "legitimate and significant nontax reasons" for creating and funding the LLC, including joint management of family assets, pooling family assets to maximize investment opportunities, and providing for each of her daughters on an equal basis.
Some practical lessons for minimizing estate tax liability while using family LLCs emerge from the case of Anna's estate. They include the following: (1) document the legitimate and significant motivations, unrelated to estate taxes, for forming such an entity; (2) continue the entity after the decedent's death, to avoid the appearance of an ordinary trust; (3) if, as in Anna's case, the donor dies unexpectedly a short time after the gifts, be prepared to demonstrate that the death was unexpected; and (4) keep sufficient assets outside of the entity to cover the donor's living expenses, to avoid the possibility that the donor will treat the assets of the entity as her own. The planning, drafting, and advice associated with a family LLC entails resolution of complex issues and requires the guiding hand of a knowledgeable professional.
FEDERAL ESTATE TAX
The federal estate tax credit, currently at $2 million, is set to increase to $3.5 million in 2009. This means that in 2009 you can leave up to $3.5 million to your heirs without any federal estate tax liability.
If Congress takes no action, the federal estate tax will be repealed altogether in 2010. While this is an unlikely scenario, it does underscore the uncertainty involved in estate planning over the next few years. Make sure to meet with a professional to review your plan.
BICYCLE SAFETY
When a car or truck has a collision with a bicycle, the bicycle rider usually loses, no matter who legally had the right of way. Bicycle riders should take extra care to obey the following safety tips:
Remember: Bikes Are Vehicles, Too
Legally, bicycles traveling on a road are required to be treated in the same way as any other vehicle traveling on the road would be. This means that, as a bicyclist, you must obey the same laws as other drivers do. Do not run red lights, change lanes without signaling, or commit other infractions. If you would not do it in a car, don't do it on a bike.
Wear a Helmet
The easiest way to protect yourself is to always wear a helmet when you ride. Some jurisdictions require all riders to wear helmets, but even where it is not required, wearing an approved helmet can significantly reduce the chance of serious head injuries in the event of an accident.
Be Visible
Because bicycles are so much smaller than cars and trucks, it is important to make sure that others using the road can see you. Make sure that your bicycle has reflectors on the front and back and even on the wheels. When riding at night, wear light-colored clothing and use a light.
Be Aware
The best safety advice is to be aware of the conditions around you and be careful when riding. Always look both ways when entering a street and stay on the correct side of the street when riding. Keep a lookout for drivers who may not be looking out for you. Like other drivers, bike riders should ride defensively.
