Buying a Business

Posted on June 11, 2013 by John McDuff

When you want to buy a business, there is no substitute for a thorough, detailed inspection of everything related to the business. Some of the inspection will be the review of things that are in writing; some of the inspection will be visual; and some of the inspection will be conversational.

However, do not rely in any respect on what the seller tells you. If the seller gives you access to any of his employees, talk with them about the business. The seller’s motivation is to make the business look as good as possible. The purposes of your investigation are different. You want to find the flaws in the business. What are the flaws that you do not find? Representations and Warranties are the heart of your purchase contract. They protect you from the flaws that you did not find.

In Representations and Warranties you receive a promise that there are no flaws with respect to each of the aspects of the business, other than the flaws disclosed in writing, in the contract. The Representations and Warranties are no substitute for the thorough, detailed inspection that you make of all aspects of the business. Remember, you do this inspection before a contract is signed. You discover flaws this way, and the Representations and Warranties are for the flaws that you did not find. A good lawyer will see that you have the seller make strong Representations and Warranties.

You will also need to get a covenant not to compete, covenant not to solicit, and covenant not to disclose, from the seller. I have discussed each of these covenants in the immediately preceding entries that I have made in my blog. I’ll have more on buying a business in my next post.

Posted in Business Transactions, Buying or Selling a Business |

Covenants Not to Disclose

Posted on May 29, 2013 by John McDuff

Covenants not to disclose are becoming a part of a series of covenants that are frequently used together with covenants not to compete and covenants not to solicit. I have posted blog entries on these other covenants. Usually in the circumstance where all three covenants are used together, we have an individual who is either a key employee hire, or a key employee leaving.

Covenants not to disclose may also be used alone, such as in “nondisclosure agreements” that are used in circumstances such as a potential buyer investigating a selling company. There, confidential information of the selling company is transmitted to the potential buyer, for the purpose of the investigation. No company wants to aid its competitors by having its confidential information shared with them, so a covenant not to disclose can be essential.

Of course, in some circumstances, a selling company may also be able to get a covenant not to solicit and a covenant not to compete from the potential buyer. However, these covenants, if used in these circumstances, are usually not as comprehensive as the normal covenants not to compete and not to solicit.

Everyone is familiar with the phrase “trade secrets”. Under the law, this status can only be conferred in certain circumstances. Trade secrets covenants only provide part of the protection a company needs from competitors. The purpose of a covenant not to disclose is to include a substantial amount of information that has been kept confidential, even though it cannot be treated as a trade secret.

A distinguishing feature of a covenant not to disclose from a covenant not to compete and a covenant not to solicit is the length of time that the covenant may cover. In my prior blog posts, I have pointed out the fact that these other covenants must be limited in term to a certain number of years. But, a covenant not to disclose can be open-ended, and be in effect as long as the information remains confidential.

And this particular covenant can be very useful. The only true way to prevent others from competing with you is to deny them information, and to deny the person or company the opportunity to use the confidential information to compete, in the first place.

Please call me, if you want some covenants inserted into your agreements.

Posted in Business Transactions |

Covenants Not to Solicit

Posted on April 23, 2013 by John McDuff

While a covenant not to compete can prevent a leaving employee from competing with you, using all of the information you gave him and all of the skills that you taught him as an employee, there are still some risks when an important employees leaves.

Companies build up a huge investment in finding, interviewing, training, teaching, and paying employees. What would it cost to do this again, because someone took some of your employees? Moreover, the cost of interruptions in a company’s operations is substantial, because there are key functions that are not being performed while the replacement employee is found and trained. There is a loss of productivity and profits.

But the bottom line is the value of the network between a company’s employees. Their interactions as a team are learned. They have to learn not only their functions, but also the functions of those with whom they interact. And there is the personal side of things. You learn how each other works, and how to interact with them as people. When the network breaks, due to the loss of a few employees, profits go down dramatically. And, while it takes time and money to get a new employee, the time to repair a network is even more of a problem.

To prevent a leaving employee from recruiting part of your team and network away from you, you must have an ironclad covenant not to solicit. With one in place, the leaving employee is liable in damages if he or she tries to hire any of your other employees. On occasion, this covenant will include a provision that the leaving employee cannot hire any of your employees, even if you do not solicit them, and they simply come to you, and apply for a job. No hiring them.

This covenant can be particularly important if the leaving employee competes with you. If you cannot prevent the competition on a covenant not to compete, you can slow them down by barring your network from migrating to her or him.

The longest period that I have seen for a covenant not to solicit is three years. Generally, you see one or two year covenants not to solicit, to avoid possible legal ramifications of a restriction on your employees’ employment options. When you have your covenant not to solicit written, do not have a period longer than two years.

Posted in Business Contracts |

Covenants Not to Compete

Posted on April 12, 2013 by John McDuff

Let’s say that you are an employee at a company and you have signed an employment contract. Either in your contract or in a separate document that was signed and dated on the same day, you have agreed to not compete with your employer’s business. Then, you decide you want to leave your current job to start your own business. However, your new venture would breach your employment contract since it is in the same area of business as your former employer’s company.

In a covenant not to compete, a court will first consider the area in which you cannot compete. It must be reasonable. Usually this includes the area in which the former employer currently does business and perhaps the immediate surrounding area. If your former employer has drafted the area in an expansive fashion, it will become void in court and a smaller area will be decided upon. However, if your business is in the same city as your former employer’s it is unlikely that the court will side in your favor.

The next consideration is the length of time in which you cannot compete. Once again, a court will only enforce what is reasonable. If the length of time is unreasonable, the court will decide what is reasonable. The longest I’ve seen is five years, but that is unusual. Typically, this would be judged as unreasonable. What if the length is one or two years? Should you wait to start your business? Or can you proceed, with the odds on your side?

Well, the definition of the business with which you cannot compete may hold the answer. Perhaps this definition is too broad. What is reasonable? Well, the answer is similar to the same issue in anti-trust matters. What is the market where the employer competes? If your employer manufactures, but does not retail, toys, does the market include toy retail, or just the toy manufacturing business? This also is a matter of the court’s judgment. If a judge or jury is likely to rule that your product is not covered by the covenant’s definition of business, the employer will probably not pursue you, even if you fall within a reasonable area and time.

Of course, your employer may attack you, even if the covenant will probably not apply to you. The pursuit could drive you out of business, by making you spend a lot of money on attorney fees. Then again, your employer would have to spend a lot of money, too. Consult a knowledgeable and experienced attorney to decide whether you are going to have a problem with your covenant not to compete, and what can be done about it.

Posted in Business Transactions |

Evaluation of a Case

Posted on March 19, 2013 by John McDuff

What are the Motives of the Case?

When there is a dispute, every client wonders whether they should file suit. You have to decide why you want to sue: to gratify emotions, for the principle of the matter, or to gain money. You must consider your motives very carefully.

To Gratify Emotions?

Suing to gratify your emotions is a temporary relief. When you file suit, your emotions may be gratified, however, this has happened at a great cost. You are now in a lawsuit and the cost of that suit can be very high. How much money would you pay to gratify an emotion? Tens of thousands? A hundred thousand? Do you think such a trial will gratify your emotions? In the end, you will have to decide if the emotion was worth the financial cost. I will not file a lawsuit for you based upon your emotions alone. It never turns out well. In hindsight, you regret having spent the money.

For the Principle of the Matter?

The same is true, if you want to sue “on principle”. I will not file a lawsuit for you on principle alone. In practice, I usually find that you want to sue upon both—emotion and principle. The two are intimately tied together. When one undertakes a great cost based upon these emotions, one usually regrets having spent the money. I will not file a suit for you based upon emotion and principle alone.

Financial Goals

You must have a financial goal to justify a suit. Or at least one that I will file. You must think—not believe—that you will get more money than you will spend. To reach this conclusion, you must have some idea of your chances of winning, how much you can collect, and what the cost is.

Evaluating your chances of winning is a challenging task. One cannot say 60-40 or 70-30, with a degree of accuracy. I will tell you if you have a strong case, and are more likely to win, than not. In contrast, I may say the outcome is 50-50. If I say that you have a weak case, it is probably best to not sue.

You measure your chances of winning against how much you can collect, if you win. Notice that I did not say that the measurement is against how much a judgment will be, if you win. Many judgments are worthless-because nothing can be collected. You do not sue an insolvent defendant. You had better sue someone who has more assets than you can reasonably expect a judgment to be. I can also help with this assessment.

Lawsuits cost a lot of money. You may think that you can file one, and then drop it, if a settlement does not occur quickly. What if the defendant countersues you? Then you cannot just drop it, on your own. To get the defendant to drop the suit with you, you will most probably need a settlement, even if it is not on the terms you would like. Let’s say that you file, and negotiate a settlement. Including the draft of the settlement documents, you may have spent ten thousand dollars. Many people think that mediation is a low-cost means to reach a settlement. It is true that mediation usually results in a settlement. However, it will probably take five thousand dollars or more to participate in a mediation. So, let’s say the total cost is fifteen thousand. But wait, the defendant must also want to mediate right away—which is usually not the case. Some discovery will have to be done, before both parties are prepared to mediate. Some discovery will cost at least ten thousand dollars. Maybe thirty. You get the idea. If you try the case, depending upon its complexity, you may altogether spend from seventy-five thousand to two hundred thousand. I will also help you through this phase of your evaluation.

Once you have judged whether proceeding is a good financial decision, you must acknowledge the personal cost to you of filing suit. Lawsuits may take as little as three months, if the defendant is willing to mediate. Perhaps fourteen months, if you have to try the case. Along the way, you must devote time to the suit. And, the suit always causes some stress. You do not know what the outcome will be. This is just not stressful; it is also a distraction.

Whether to sue is a joint decision—of you and your lawyer.

Posted in Business Litigation, Litigation, Tax Litigation |

Mediation

Posted on February 26, 2013 by John McDuff

It seems like everyone knows what mediation is like. Within a mediation case, there is the plaintiff with lawyer, the defendant with lawyer, and the mediator who stands between them. Most people think that mediation is where disputes are resolved, through discussion of the issues between the parties, through the mediator. There is, in fact, a joint meeting session to start the day. But I have never seen it resolve the issues. Typically, people just say what’s strong about their case.

In practice, there is little to no attempt to resolve disputes throughout the mediation. Mediation is an all-day negotiation session, in an attempt to arrive at a settlement. Some mediators try to point out the strengths of the other party’s case. However, the party and his/her lawyer have already evaluated the strength of each party’s case, before the mediation commences. A good lawyer will also help her/his client determine the party’s bottom-line, as to how low they are willing to go, to reach a settlement. A good lawyer will also advise his/her client that negotiation can continue, through the lawyers, even if a settlement is not reached during the mediation.

It would seem that the mediation would end within a few hours. However, it is not uncommon for the settlement negotiation to take all day. The time-consumer may be when the party and her/his lawyer discuss, all alone, what size of offer the party wants to make next.

There is pressure from the mediator, and the other party, to settle on the day of mediation, and sign a settlement agreement. That’s why you are present at the mediation, to make a binding settlement. Courts also pressure settlement through mediation. Indeed, in most counties, such as Travis, mediation is required, before trial.

And the mediation system works, for the parties who really are interested in reaching a settlement, and therefore are willing to substantially discount what they have requested in the suit. In the past, the parties’ lawyers negotiated settlements between themselves. But with mediation, many more suits are settled.

Posted in Business Litigation |

Causes of Action in Fraud Litigation

Posted on February 12, 2013 by John McDuff

As you know, fraud is generally a misrepresentation of facts. There are, of course, other requirements. The misrepresentation must be intentional, and made to obtain a benefit, such as money. Lawyers generally call intent to misrepresent scienter. Frequently this is the most difficult requirement to prove

To be actionable, the misrepresented fact must be the reason why you gave something of value to the perpetrator. If the fact were true, you would have gone forward with the transaction. If the fact were untrue, you would not have gone forward with the transaction.

Of course, you must pay a lawyer to pursue your claim. You may find a good lawyer who will represent you, for a contingent fee. If you lose, you do not have to pay. If you win, you pay a percentage of your recovery to your lawyer. However, frequently fraud is just a cause of action thrown into the mix, along with causes of action based upon other reasons, such as breach of contract. You may have to pay a lawyer an hourly rate for this type of case.

Retrieving what you lost due to the fraud is one aspect of recovery. Everybody knows about punitive damages. You may also be able to recover this type of damages, as the fraud may be particularly egregious. Scienter is important in the jury’s decision about punitive damages. A thorough discussion of the subject of punitive damages is beyond the scope of this blog entry.

There are some other causes of action based upon misrepresentation that you may plead, in addition to the active misrepresentation. Instead of saying something false, the perpetrator can hide something that, if known, would cause the victim to make a different decision, such as whether to pay the perpetrator for something. This cause of action is known as “fraud by nondisclosure”.

Another cause of action based upon a misrepresentation is “negligent misrepresentation”. This cause of action is not fraud, but is related to fraud. Both contain a misrepresentation. However, this cause of action does not require that the misrepresentation be intentional. Scienter is not necessary here. Instead of intent, we have a misrepresentation made due to negligence. The defendant should have known that her/his representation was not true. The defendant did not investigate to determine the truth, when a reasonable person would have.

The cause of action for negligent misrepresentation is frequently plead along with fraud. If you can’t prove intent, then argue that the behavior was negligent. In fact, I plead, when I can, all three causes of action—fraud, fraud by nondisclosure, and negligent misrepresentation.

Posted in Business Litigation |

Contracts

Posted on January 7, 2013 by John McDuff

The law says that every time two people agree to exchange things of value, a contract has been formed. Of course, there are qualifiers to this basic principle, but this definition is almost always true. So what does it mean to have a contract? It means that the two things must be exchanged, as agreed, or the party who fails to transfer their thing can be held liable. This is an example of breach of contract.

One can sue on breach of contract, but it is wise to ask yourself the following questions. First, is it cost-effective to sue? Second, does the breaching party have anything that can be taken, to satisfy a judgment? Third, do you have the time to spend on a suit? Fourth, can you handle the stress that is involved in being in a lawsuit? I guess that all of this depends on how much the breach of contract has damaged you. If you have lost a great deal, you can easily answer “yes” to all of these questions. And in a suit for breach of contract you can recover attorney fees. However, if the amount that you have lost is not so great, perhaps you continue your life and forget about what happened. Discussing these questions with a lawyer may lead to a wise decision about a breach of contract.

What about proof that a contract exists? The law sets forth four or so factors to consider in reaching a conclusion. But most often it is as simple as I have said, an agreement to exchange two things of value. Oral contracts can be difficult to prove directly, as there may be a “swearing match” as to whether an agreement was made. There are several different ways to indirectly support a finding that there was a contract, but it is beyond this blog entry to discuss them. Suffice it to say that you need to discuss this with a lawyer.

Written agreements are easier to prove to be contracts. The writing can be short, or very detailed and extensive. Generally, a contract for a small exchange can be as simple as a letter signed by both parties. This could fit a situation where a loss of something valuable in a breach of contract is a loss that can be easily absorbed. Or a lawyer can write a simple contract for you of about three pages. When the amount at stake becomes larger, it is important that all of the factors that could affect the act of exchange be written, as well. When the amount at stake becomes very large, you will want your lawyer to also write provisions that would protect you, in the case of a breach of contract lawsuit.

Of course, contract law is very complicated and difficult to learn. But this entry sets forth the basics, which may be enough to tell you when you can do something very small on your own, or tell you that you need a lawyer, for sure. And tell you how complicated creating a contract may be, and therefore some idea of the cost involved. In the last month, I have written contracts as long as 18 pages, plus 15 pages of exhibits attached to the contract, and 6 collateral documents. And as short as three pages. It depends on what is at stake.

Posted in Business Contracts |

Defending Yourself

Posted on December 21, 2012 by John McDuff

Occasionally I run into someone who wants to get enough free information and advice from me, to where they can do the legal work themselves. On other occasion, I talk with someone who has researched their area of law on the internet and thinks that they know all that is necessary to do the work themselves.

Abe Lincoln once said that people who represent themselves have a fool for a client. His point is that you can never give yourself good advice, because you are biased. The same is true with regard to your judgment in a legal matter. And too much that is personal finds its way into a legal matter.

And there is the people factor. You are dealing with this matter for the first time, and your lawyer, if that person has a lot of experience, has probably dealt with some of the people involved, or people who occupy the same place as in other matters like yours. And certainly this experienced lawyer has handled a few matters similar to what you want to address.

There is a certain type of skill in your interactions with others on a legal matter. Experienced lawyers have learned the way to interact with others that is especially tailored to getting a “yes” in a matter. Usually the other person has a considerable amount of discretion in a matter. And circumstances like handling a situation to where a transaction closes, defending yourself before a revenue officer and getting a good resolution, or finishing a small lawsuit in a cost-effective manner that gets you results are good examples of when an experienced lawyer adds value, reduces risk, and gets a smile on your face.

Posted in Litigation |

False Return Preparers

Posted on December 1, 2012 by John McDuff

False Return Cases

Tax Return Preparers Intentionally Committing Tax Fraud

I recently noticed a couple of false return cases. The indictments and guilty pleas were a result of tax return preparers intentionally preparing and filing false income tax returns, a form of tax fraud. Internal Revenue Service-Criminal Investigation found the evidence and put it together for the prosecutors. In each of these cases, the preparer faces a maximum of three years in jail.

The key here is to avoid being indicted as an aider and abettor to preparing and filing false returns. The best way to avoid this is to pick your tax return preparer carefully. Be sure that you have someone who is reputable. CPA’s generally have high ethical standards. One is less likely to run into a false preparer in the CPA practice, than one will with tax return services.

Beware the preparer who promises you a refund. If the preparer is good, they will find and maximize a refund. But if a refund is not there, it’s not there and the preparer will not manufacture one.

Typically the false return preparer will insert into the return false deductions. Regardless whether you have a reputable preparer, give yourself some insurance. Take the time to review all of the deductions taken, to see if there is a deduction that is for an unreasonable amount. Also look for a category of expense where an amount has been taken, but you know that you have never spent money under that classification of expense.

False return preparers have on occasion understated income. This is unlikely when your income is declared on a W-2. But if you have a business, false preparers will fiddle with the amount of income reported for the business. They may report income to the extent that you have received Forms 1099, and nothing else. Once again, get yourself some insurance. Examine the amount of income on the return and compare it to your knowledge of your business. Is the number on the return about what you make a month?

All in all, do not become associated with a false return!

Posted in Tax Fraud |