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BUSINESS LAW

What is a sole proprietorship?

A sole proprietorship is the simplest form to conduct a business. The business is not a separate legal entity from its owner. There is no shifting of any assets from one individual to another individual or entity. The owner is personally liable for all debts of the business. All net income or losses of the business flow to the owner for tax purposes.

What is a C corporation?

A "C" Corporation is a separate legal entity, created pursuant to state law. It is a regular business corporation, and can enter contracts, sue and be sued, and own property in its own name. Unlike an S corporation, the law does not restrict the number or type of shareholders who can own stock in a C corporation. For instance, a non-U.S. citizen can own shares in a C corporation. A shareholder of a C corporation has limited liability on corporate debts, which means he is only liable to the extent of his capital contribution.

Operating a business as a C corporation has tax advantages and drawbacks. Net income or loss is taxed at the corporate level, and dividends are taxed to shareholders. This is known as "double taxation," which is a potential downside to structuring a business as a C corporation. However, there are methods to avoid the sting of double taxation especially when a sole shareholder-employee generates the bulk of revenues. For instance, section 162 (a) of the federal tax code allows a C corporation to deduct reasonable compensation paid to shareholder-employees, which lowers the amount of corporate earnings subject to tax. Wages paid to owner-employees of a C corporation are subject to Social Security and Medicare taxes, but dividends from C corporations to shareholders are not subject to Social Security and Medicare taxes. C corporations can also offer a number of tax-advantaged fringe benefits to employees, including owner-employees. Generally, health insurance premiums and life insurance premiums are deductible by the corporation and not taxable to employees or stockholders of a C corporation.

What is an S corporation?

Under state law and from a corporate law standpoint, an S corporation is essentially identical to a C corporation. A regular business corporation becomes an "S" corporation when its owner makes a valid S election with the Internal Revenue Service (IRS). The S designation means the corporation is not treated as a separate entity from its owner for tax purposes. Generally, the issue of "double taxation" is not a concern for an S corporation. As a "pass through" entity, an S corporation passes its profits and losses generally through to its shareholders. The S corporation as an entity is taxable on income only in limited situations (e.g., certain built in capital gains and passive income in excess of 25% of gross receipts). State corporate law provides a shareholder of an S corporation with limited liability for debts and wrongdoing of the corporation. It is referred to as a "small business corporation," and not all corporations qualify to be treated as S corporations. The designation carries restrictive rules about ownership, type of stock and business type. For example, an S corporation can not have more than 100 shareholders and individual shareholders must be U.S. citizens. Furthermore, an S corporation can issue only one class of stock, but the stock can have different voting rights.

What is a Limited Liability Company or LLC?

An LLC is a hybrid organization organized under state law with attributes of a partnership and a corporation. Usually, it has two or more members, but it can have only one. Like a sole proprietorship or an S corporation, a single member LLC is a "pass through" entity for tax purposes. Unlike an S corporation, there are no U.S. citizenship requirements for members, and no limits on the number of members. All members of an LLC may participate in management without risking loss of limited liability. LLC members are not liable to creditors beyond their agreed upon capital contribution.

Advantages of a limited liability company (LLC).

(1) An LLC is the most flexible business entity, because it can be structured or tailored to meet specific needs of individual business partners.

(2) An LLC provides limited liability protection for all members, which is analogous to the protection shareholders receive in a corporation but it is vastly superior to the unlimited liability that general partners are exposed to in a general or limited partnership.

(3) An LLC affords its members pass-through tax treatment. LLC members can avoid double taxation, which can be an issue with a corporation.

(4) An LLC is not subject to restrictions on the number or type of members. This feature of an LLC makes it a viable option for people who want pass through tax treatment but who can not qualify as owners in an S corporation. This feature also makes an LLC an attractive entity for someone who wants the benefits of pass-through tax treatment, but who wishes to avoid the risks of unlimited liability associated with operating a business as a sole proprietorship.

The tax treatment of fringe benefits depends on the type of business entity you choose.

The tax treatment of fringe benefits differ according to the type of business entity and whether the recipient of the benefit is classified under federal tax law as an employee for fringe benefit purposes. An owner-employee of a C corporation is considered an employee for fringe benefit purposes, and can receive many tax free fringe benefits. For example, a C corporation can provide an owner-employee with health and accident insurance as a tax deductible expense. However, the rules are more restrictive for a shareholder who owns more than 2 percent of the outstanding stock of an S corporation.

What is a subscription agreement?

A subscription agreement is a contract between you and a corporation regarding the amount of money or property you will transfer to the corporation for your shares of stock. It is useful to have a record of that understanding for purposes of tax and securities laws.

What is a trust?

A trust is a fiduciary relationship under which one party, the trustee,holds legal title to specific property and manages it for the benefit of designated persons, the beneficiaries, who are considered to own the equitable title in the property.

An S Corporation offers owner-employees a unique tax advantage.

Most people know that an S corporation is a "pass-through" business entity for tax purposes, which means the business entity is not taxed. Profits and losses pass through to the owners for tax purposes. However, a unique and advantageous feature of an S corporation that few people know about is that "constructive dividends," the net income that flows through to a shareholder, are not subject to withholding or social security taxes. Of course, salary income of an S-corporation shareholder-employee is subject to withholding and social security taxes, but "constructive dividends" are not. To qualify for this unique tax advantage, the shareholder/employee must receive a reasonable salary.

Five commonly used methods to value a business.

Often used methods to value a business include:

(1) Fixed price agreed up-front by the owners.

(2) Book value (i.e., assets minus liabilities).

(3) Multiple of book value.

(4) Capitalization of earnings.

(5) Appraisal.

Five creative ways a corporation can use stock as compensation.

Five forms of stock compensation are:

(1) Stock grants.

(2) Stock purchase plan.

(3) Rights to purchase stock or options.

(4) Performance shares.

(5) Stock appreciation or phantom rights.

Two reasons employees prefer incentive stock options.

Employees prefer incentive stock options, because no tax is due until he or she disposes of the underlying stock, and the sale is entitled to capital gains tax treatment. Incentive stock options can play an important role in a company's recruitment, retention, and compensation strategies.

Nonqualified stock options are a flexible form of compensation.

Nonqualified stock options may be awarded to consultants, directors, employees, key partners, and others. In contrast, incentive stock options can only be issued to employees.

The receipt of stock in exchange for services is a potential tax trap.

In general, under Section 351 of the Internal Revenue Code, no gain or loss is recognized on the transfer of property to a corporation solely for the exchange of stock if, immediately after the transfer, the corporation is controlled (80%+) by the transferors of the property. However, if you receive stock in exchange for future services, your receipt of the shares will immediately trigger tax liability. Therefore, it may be to your advantage if you can identify and only transfer title to "property" (e.g., cash, office equipment, intellectual property, etc.) in exchange for your ownership interest in a corporation.

Section 1244 stock can help ease the pain of a business loss.

No one likes to think about a business loss, but it pays to plan. If things don't work out, having Section 1244 stock might ease some of the pain. The issuance of Section 1244 stock gives qualifying shareholders a tax advantage when a small corporation suffers losses or goes out of business. Normally, a small corporation shareholder’s loss from the sale or exchange of stock is considered a capital loss and must be used to offset the amount of any capital gains during the year. If the shareholder has no capital gains, the loss can be used to offset ordinary income, but only to a limited extent. If things go poorly for a small business, Section 1244 might ease the pain because it allows a shareholder to deduct as ordinary losses, losses sustained when she disposes of small business stock. In order to receive this beneficial treatment, federal tax law has specific requirements for: (a) the corporation issuing the small business stock; (b) the stock itself; and (c) the shareholders of the corporation. Note that 1244 stock can only be issued in exchange for money or other property (not for services).

Stock redemptions explained.

A stock redemption occurs when a corporation purchases its own shares. Under corporate law, a stock redemption is considered a distribution. The board of directors may authorize a stock redemption only if the company is solvent (i.e., able to pay it's debts when they become due, and assets exceed liabilities). The purpose of the restriction is to protect creditors. Directors are personally liable for any distribution that does not satisfy the solvency tests.

Guidelines for valuing a closely-held business.

Revenue Ruling 59-60 (1959-1C.B.237) includes eight factors, which have become the standard of appraisal for valuing a closely-held corporation. The revenue rule is used for income tax purposes and employee stock ownership plans. Consideration of the factors cited in Revenue Ruling 59-60 is the beginning analysis of any evaluation of the fair market value of a closely-held company.

How to evaluate an appraisal.

Always consider the following:

(1) The purpose of the valuation.

(2) Why the method used to determine value is reasonable.

(3) The factors considered in determing the valuation.

In a nutshell, you need to know if the appraisal is credible and defensable.

Consider personal goodwill when you buy or sell a business.

Personal goodwill is sometimes called professional goodwill or practice goodwill, and relates to the value associated with an individual's expertise, reputation, personality and other personal qualities that contribute to the success of a business. It exists in situations where there is no existing covenant not to compete. Personal goodwill does not belong to the business. It is distinct from enterprise goodwill. In some situations, a retiring owner who posesses personal goodwill may find it advantageous from a tax perspective to sell it to the acquiring company and enter into a covenant not to compete.

What is a trade name?

A trade name is a business name used to identify a particular commercial entity and to distinguish it from the business of others. While a trade name may be, and often is, a service mark as well, that is not always the case. The right to use a trade name, and the right to exclude others from using the same or a similar trade name, is based on the same principles applicable to trademarks and service marks, that is, the common-law principles of unfair competition. Depending on the circumstances, exclusive rights to the use of a trade name are enforceable under applicable laws.

What are "blue sky" laws?

Blue sky laws are state statutes that require you to disclose information during the offer and sale of securities (e.g., stock). The goal of these laws is to protect investors by ensuring that they are sufficiently informed about the risks of investment. All securities offering, even if exempt from registration, are subject to anti-fraud provisions. This means that you are responsible for any false or misleading statement or omission, whether oral or written, that is made during the offer and sale of any security. Under the law, the definition of a security is very broad, and encompasses much more than stock. Violation of blue sky laws can lead to private lawsuits and/or governmental prosecution against you.

Making a section 83b election could save you money when you receive restricted shares.

Section 83b refers to a provision in the U.S. tax code. It is a provision that you may elect to use when you receive restricted stock. Restricted stock carries a substantial risk of forfeiture. For instance, the stock award might say that you will forfeit the stock if you fail to meet certain future performance goals.

To understand how a section 83b election works, you must first understand how the receipt of restricted stock is treated under U.S. tax law. The basic tax rule is that you don't report income immediately when you receive an award of restricted stock. Instead, you report income when the stock vests (i.e., when the restrictions lapse). The income you report includes any increase in the value of the stock during the vesting period. This income is taxed as ordinary income, not capital gain. For example, assume Mary's company awards her 10,000 shares of restricted stock when the shares are worth $1.00. Mary's shares vest three years later at which time the shares are worth $5.00. Mary would report nothing when she receives the restricted shares, however, she must report $50,000 when her shares vest. Her substantial gain is compensation income, subject to ordinary income tax rates. Note that Mary is taxed when her shares vest whether or not she sells them at that time!

Here's how an 83b election might have helped Mary. Because she receives restricted stock, she can make a section 83b election. Under section 83b, she voluntarily pays tax when she receives the stock, but not when it vests. Thus, Mary reports $10,000 of compensation income when she receives the stock, but nothing when it vests. That's a far cry from the $50,000 in ordinary income that she must report if she fails to make a section 83b election. Furthermore, having made a section 83b election, Mary becomes eligible for capital gains tax treatment when she sells her stock. If she sells her stock for $50,000, she reports $40,000 as a long-term capital gain, thus saving her a great deal of money.

There is no guarantee that an 83b election will save you money. It is analogous to a bet on your company's future. The outcome depends on the situation, and is not predictable. However, you should seriously consider the advantages and disadvantages of an 83b election whenever you receive restricted stock.

Why a shareholders agreement is important to your success.

For owners of closely-held businesses, a shareholders agreement , also known as a buy-sell agreement, is one of the most valuable documents. This is an agreement that usually includes you, the corporation, and the other shareholders. A properly written shareholders agreement can provide the following benefits:

(1) A mechanism to sale your shares and liquidate your investment.

(2) A mechanism to resolve disputes between business partners quickly and fairly. This can save you a great deal of the time and heartache that usually comes with a messy business divorce.

(3) Restrictions on the transfer of stock so you are protected against unwanted shareholders (i.e., business partners) and the creditors of other shareholders. A shareholders agreement can also help you avoid personal liability for violations of state or federal securities laws. Lastly, if your company is an S corporation, a buy-sell agreement is essential. By restricting the transfer of shares, the agreement facilitates the preservation of the S election, which is very important because it is the avenue on which pass-through tax benefits flow.

Two important points about employees' rights to inspect personnel files in Oregon.

1. Oregon law requires an employer to provide an employee with a "reasonable opportunity" to inspect his personnel file.

2. An employer must fulfill an employee's request for a copy of his personnel file within 45 days of the request.

Key points about employment reference liability in Oregon.

If your business gives employment references, keep in mind that Oregon law provides immunity from civil liability to employers who respond to employment reference checks, but the statute is not a blanket release. On its face, the statute does not apply to current employees.

To qualify for immunity, an employer must be disclosing information about a former employee's job performance to a prospective employer of the former employee upon request of the prospective employer or of the former employee. The employer is presumed to be acting in good faith unless the information is knowingly false or deliberately misleading, is given with a malicious purpose, or violates the civil rights of the former employee.

INTELLECTUAL PROPERTY LAW

Choose a strong trademark.

A trademark is a word, name, symbol, or device used to indicate the source of goods or services. Trademarks answer the question: Whose product or service is it? A fanciful, arbitrary or coined name is inherently strong and receives the strongest protection. Suggestive names can also be very strong trademarks, however, a descriptive name is not protectable unless it has acquired secondary meaning, i.e., when consumers have come to associate the name with a particular business, product or service.

What is a suggestive trademark?

A trademark is suggestive when a consumer must use her imagination, thought, or perception to reach a conclusion about the nature of the goods or services.

Your trademark needs to be distinctive to qualify for trademark protection.

A prerequisite for trademark protection is that the mark must be "distinctive" either because of its inherent nature or because its use in commerce has caused your customers to identify it with your business so that it has acquired what is called "secondary meaning."

Distinctiveness is judged on a continuum: (a) arbitrary marks, (b) suggestive marks, (c) descriptive marks, and (d) generic terms. Arbitrary marks (also called fanciful or coined marks) bear no relationship to the goods. Suggestive marks hint at (but do not describe) what a product is. Descriptive marks identify a characteristic, quality, or other aspect of a service, and are weak and can not be federally registered on the Principal Register unless they have acquired secondary meaning. Finally, generic terms identify a category of goods recognized by an industry (e.g., PC for personal computer). Unless it is used with a nongeneric component, a generic mark can never be protected.

Beware of common law trademarks: dangers beneath the surface.

A common law trademark is an unregistered mark, and is acquired when a company uses a term to identify goods or services in commerce and identifies it as a trademark. You will not find these kinds of trademarks in a casual search. They are hidden dangers. Actual use, not registration, triggers the acquisition of common law rights. The scope of protection for an unregistered mark hinges upon the extent of the trademark's actual use, which makes it important to carefully review the nature of the goods and services branded under an unregistered mark. If another company owns a valid common law trademark, it can potentially sue your business for using a confusingly similar mark.

Do not confuse the right to use a trademark with the right to federally register it.

Your business may have the right to use a trademark but not have the right to register it with the United States government. Generally, the right to use a trademark is based on who uses it first. The first business to use a distinctive mark in a trade area generally has priority over others who are using marks that are confusingly similar.

Your right to register a mark with the federal government is determined by other considerations. The government can refuse an application to register a trademark for a variety of substantive reasons, including likelihood of confusion with another mark; merely descriptive or generic; primarily geographically descriptive; primarily merely a surname; or identifies a living person.

The U.S. government maintains two registers for trademarks.

The Unites States Patent and Trademark Office maintains the Principal Register and the Supplemental Register. Only distinctive marks qualify for listing on the Principal Register. Distinctive marks include arbitrary marks, suggestive marks, and descriptive marks that have acquired secondary meaning.

Registration on the Principal Register gives trademark owners greater rights. The Supplemental Register is reserved for marks that are at least capable of distinguishing services from others. Most of the marks on the Supplemental Register are weak marks, such as merely descriptive marks that have not obtained secondary meaning in the marketplace, and marks that are merely geographically descriptive, or primarily a surname.

Cancelation of another company's trademark does not mean that it is available for your use.

If you search the federal trademark database and find that the government canceled someone's trademark, do not assume that the mark is available for you to use. Cancelation of a mark by the federal government does not necessarily mean the owner has legally abandoned it. Trademark rights accrue from using a mark, and not registration. The prior owner may have intent to resume use, which may mean the business retains rights to the mark. Never assume that a mark is available for your company's use based solely on the fact that the federal goverment canceled the prior registration.

The state is not responsible for the business name you register.

This is a source of confusion for some business people. If you contact the state and ask if a certain name is "available," the state will run a check of its database and let you know if the name is available. What may sound like a confirmation by the state does not, however, mean that you will not violate another business' rights if you use it. It is important to understand the limitations of a state's quick name check.

In Oregon, the statutory standard used to determine whether or not a business name "is available" is whether the name is "distinguishable upon the state's records" from other names recorded in the categories that are reviewed. However, that is not the only legal standard you need to be concerned with!

Your adoption and use of a business name is subject to a prior user's right to use the same or a similar name. The first company to adopt and use a trade name in connection with a business acquires the exclusive right to its use in connection with the same or a similar business, at least in the market area of that company's business. Whether another company can prevent you from using a particular business name depends on whether your business name causes, or is likely to cause, confusion in the marketplace. The responsibility to avoid trademark infringement rests on you, not the government employee.

Copyright law does not protect ideas.

Copyright law protects the particular form or way in which you express ideas. However, the ideas themselves are not protected by copyright law. Trade secrets is the body of law that protects valuable information that is not generally known to the public and that you keep secret. Before you share confidential information with a prospective business partner, consider asking them to sign a properly drafted nondisclosure agreement (NDA) or confidentiality agreement. An NDA is a good way to protect your valuable ideas.

Five reasons to register your copyright.

Copyright registration benefits include:

(1) A public record of your copyright claim.

(2) Satisfaction of a prerequisite for filing an infringement lawsuit.

(3) A presumption of validity of your copyright claim.

(4) Eligibility for an award of statutory damages for infringement.

(5) Eligibility to have your attorneys fees paid by the infringer.

These benefits can give you (the plaintiff) signficant leverage when facing an alleged infringer.

Take care to preserve your company's trade secrets.

A trade secret is any information of commercial value that a business keeps secret. To acquire a trade secret, a business simply needs to create and keep a secret with commercial value. Trade secret status can apply to a wide range of things including ideas, business plans, inventions, processes, financial data, customer and prospect lists, marketing plans, and other valuable information. If it is valuable information and the business takes measures to keep it safe, then it probably qualifies as a trade secret. Trade secret status for informatoin can last indefinitedly as long as the business takes appropriate steps to protect the information. However, information loses its trade secret status if:

(1) You disclose it without receiving a promise of confidentiality (e.g., disclosure without an NDA during a meeting or negotiation session).

(2) The recepient discovers the information independently and in a lawful manner.

(3) The recepient gets it from a third party source who had the right to supply it without restrictions.

(4) It is disclosed publicly (e.g., the information is posted on the Internet, in a newsgroup, or revealed at a conference).

If particular information is important to your business' competitive advantage, then it is vital that you keep it secret and take appropriate steps to avoid improper disclosures.

Take steps to preserve your patent rights.

Patents cover new, useful, and "nonobvious" inventions and processes. It is best to file a patent application before you publicly disclose your invention. File international applications within one year of your first national application. In the United States, a company may file a patent application up to one year following the date of first sale, offer for sale, public use, or publication of the invention. However, the patent laws of many foreign countries are not as lenient. A company may forfeit the right to file a patent application in some foreign countries if the filing occurs after the date of first sale, offer for sale, public use, or disclosure. Be careful with your inventions. See advice from an experienced patent attorney early.

What a patent means (in the real world).

Patent law covers new, useful, and "nonobvious" inventions, which includes business methods. Having patents in your company's intellectual property portfolio can be very beneficial. However, many business people don't understand that having a patent does not mean:

(1) Someone can not challenge its validity. In fact, it's common for an alleged infringer to challenge the validity of a patent.

(2) Someone can not design around the patent claims. Anyone can make a product with a similar function as yours as long as they design it in a way that avoids your specific patent claims.

(3) Someone will not use the "patented" technology. A patent gives you the right to sue for infringement. It gives you the legal right to go after infringers. Like any right to sue, the ultimate value of a patent may depend on how deep your pockets are.

REAL ESTATE LAW

Use an option contract to gain control of real estate.

In real estate, an option gives the holder the right, but not the obligation, to buy a property in the future. If the holder complies with the terms of the option, the seller must sell. An option is often an effective way to gain control of property.

How to know when to sell commercial property (from an income perspective).

To determine whether to sell or hold income producing property, first evaluate the expected future performance of the property. Then, investigate the alternative investments available in which you can reinvest the cash from the sale, and the tax consequences of selling one property and acquiring another. If the property is sold, you will have to pay capital gains taxes, mortgage balance, other taxes, and selling expenses (if any) before you will have funds available for reinvestment. Before you sell, consider whether you will be able to reinvest your sales proceeds and earn an after-tax internal rate of return greater than the return you expect to earn if you keep the property.

Is a Letter of Intent enforceable?

Beware of the fine print!

Before you sign on the dotted line of a letter of intent:

(1) Look for a disclaimer. Check to see that the letter of intent contains a disclaimer, which clearly indicates that the parties do not intend to be bound by its terms.

(2) Make it clear that only the contract will bind. Make sure the letter of intent provides that only the written contract or purchase agreement to be negotiated and drafted later will bind the parties.

(3) Take care regarding nonsolititation provisions. Be very careful if the letter of intent contains a nonsolicitation provision, a common clause that prohibits you and/or the other side from seeking or entering into a letter of intent or purchase agreement with a third party usually within a specified time period. Make sure the intent of any nonsolicitation provision is clear, and that you uphold your end of the bargain.

(4) Take care regarding due diligence provisions. Be very careful if the letter of intent contains a due diligence provision, a common clause that gives one side or both the right to receive and review certain documents about a proposed deal within a specified time period. Make sure the intent of the parties regarding any review provision is clear.

(5)Watch out for good faith bargaining provisions. Does the letter of intent contain a promise by one side or both to negotiate in good faith or to close the deal? The presence of such a requirement will be a key factor in determining the nature and amount of damages you may be liable for (or entitled to) in the event of a breach.

(6) Get legal help!!! Don't treat a letter of intent lightly. The best time a lawyer can help you is before mistakes are made. A so-called "nonbinding" letter of intent can be tricky, because it may not legally mean what most people believe. The fact that both parties say it is "nonbinding" may not be legally relevant at all. Whether a letter of intent is an enforceable contract depends on the fine print and the situation.

What is a qualified intermediary?

In a 1031 exchange, an investor who sells investment property defers capital-gains taxes if he or she invests the proceeds in "like kind" property within 180 days. However, to qualify for the favorable tax treatment, the investor can't touch the money from the sale. Instead, the investor must place the money into a 1031 exchange account until it's used to buy a new property. This is where a "qualified intermediary" or man-in-the-middle comes in. The investor hires an intermediary to handle the money in the 1031 exchange account until the investor is ready to close on a new property, which consummates the 1031 exchange. While many commercial banks and title insurance companies offer intermediary services through affliated companies, the intermediary services industry is largely unregulated. Learn more about "qualified intermediaries", and how to choose one wisely.