Sale of Business Law Blog

“Personal Client Defense” May Not Apply to a Breach of a Restrictive Covenant Signed in Connection with the Sale of a Business

A restrictive covenant is a provision of an employment contract that restricts the rights of the employee after he leaves a job. For example, a restrictive covenant might prevent a former employee from providing similar services to clients that he established a relationship with while he worked at his previous job. Such a restriction would typically limited to a fixed period, usually between six months and two years. It may also prevent the former employee from providing similar services within a certain number of miles from his former place of employment.

In general, New York courts will uphold restrictive covenants if they are not overly broad or unduly restrictive. However, where an employer sues its former employee for breach of such a covenant, the employee may be able to argue that he brought his own personal clients to the employer. Indeed, under New York law, even where the covenant is not on its face overly broad or unduly restrictive, it may still be unenforceable as to a former employee’s “personal clients.” In determining whether a particular client is considered a “personal client” for purposes of this defense, courts will generally look at whether the client was acquired prior to the hiring of the former employee and how much the former employer contributed to the acquisition of the client.

Notwithstanding that the personal client defense is well established under New York caselaw, an important exception exists where the covenant not to compete was signed during the sale of a business or a merger. In Weiser LLP v. Coopersmith, 2008 WL 2200233 (1st Dept. 2008), the New York Supreme Court Appellate Division, First Department held that where an agreement incorporating a restrictive covenant was signed by the parties in connection with a merger, the personal client defense was not available. In that case, the defendants had merged with the plaintiff to form a new firm and then left that firm to start their own practice. The Court held that the personal client defense could not succeed because the duty not to complete was ancillary to the merger agreement. As such, the Court found that the plaintiff had a right to enjoin the defendants from taking the assets and goodwill of their former company.

The Weiser opinion clearly suggests that a defendant will be very unlikely to prevail on a personal client defense where he signed a covenant not to compete in connection with the sale of a business. In light of this decision, New York courts are likely to find that personal clients that an individual brought into a firm are part of the assets and goodwill acquired by the company in the sale.

Accordingly, when a party seeks to merge or purchase a business, it is imperative that the terms of a restrictive covenant are clearly set forth in detail at the outset. To avoid any confusion, and possibly the preclusion of the personal client defense, the assets to which the restrictive covenant applies should be clearly defined. Otherwise, a party who brought client’s into the business may be left with little in the event that he wishes to strike out on his own.

Comments/Questions: ljm@gdnlaw.com
© 2008 Nissenbaum Law Group, LLC

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Non-Compete Agreements Can Add to Your Purchase Price

Commentary: In her previous posting on this Blog, Utilizing Non-Compete Agreements in the Sale of a Business, Lisa Miller, Esq. previously articulated a number of the legal issues to consider in connection with the execution of a non-compete agreement in selling a business. From the Seller’s point of view, it is also important to consider how agreeing to a non-compete can increase the value of his business.

Offering a non-compete in connection with the sale of a business can be very enticing to a potential buyer, adding value to the potential purchase price. A buyer is obviously interested in the business that has been established, and arguably the buyer’s interest reflects a respect for the clientele and services that are associated with that business. In a way, having a buyer interested in a business can be construed as a compliment. However, the seller’s ability to build a business and thrive can also be a threat to a potential buyer. A buyer may be less inclined to purchase a business if he knows that the seller can go down the street, recreate his original business model and compete with the new business owner. For this reason, buyers may be more willing to engage in the sale and pay more for a business where this threat has been eliminated.

However, there are a variety of factors for the seller to keep in mind when making this determination. If it were not for this agreement, would he have planned to engage in business that is now restricted? If so, is the purchase price, or the added consideration in addition to the base price, enough to warrant him giving up that opportunity?

As always, it is strongly recommended that a seller consult with an attorney prior to entering into a non-compete to be sure that the written agreement properly reflects the deal that he believes he made. A non-compete arrangement will often have very specific parameters -- if they are not outlined to match the deal made, the seller could be agreeing to more than he originally bargained for.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC
Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Exercise Caution When Using Letters of Intent

Commentary: Letters of intent (“LOI”) are often intended to serve as a “non-binding” method by which to outline pertinent deal points. However, a problem lies in that an LOI, in certain situations can be construed as a binding agreement. Therefore, while an LOI can be helpful in setting an agenda of sorts for negotiation purposes, it can also create unintended binding obligations. The upside is that it can allow the parties to discuss the pertinent business points of a deal prior to negotiating all of the details of a sale agreement. The downside is that LOI’s are generally brief and will simply outline some of the overarching points to an agreement. They rarely discuss the “nitty gritty” of a deal, in terms of the logistics and details of how the transaction will work. Therefore, there is an inherent danger in having a written document that memorializes some of the points of a transaction, but not all. Under certain circumstances, it might be deemed to be a contract in and of itself.

For this reason, it is critical that these documents be used cautiously. The danger is two-fold. First, the purpose of the letter of intent is generally to make sure that the parties are on the same page. If they are not, and the transaction later falls through, it arguably means that at least one of the parties may not want to be bound to the original terms of the letter of intent. This is particularly true given that the letter of intent arguably did not reflect the anticipated deal, since the deal fell through.

In addition, the LOI may discuss generalities without specifics. For example, suppose a letter of intent for a sale of business memorialized that the parties anticipated a sale price of $750,000.00; that an ongoing consulting agreement would be entered into with the business seller; that the seller would agree to a non-compete agreement; and that the seller would license certain intellectual property to the purchaser. The letter of intent may be as basic as that, without providing any information as to when the purchase price is paid; what intellectual property will be licensed and under what terms; what the intellectual property license fee would be; or what the terms of the other agreements would be. This arguably leaves a great deal of room for ambiguity with regard to the details that would still need to be negotiated between the parties; and each could have a different idea of what those other aspects should include. It is risky for parties to be bound to a general concept without ensuring that they are in agreement concerning the implementation.

It is therefore critical that parties exercise caution in drafting letters of intent in the first place. If they nevertheless decide that a letter of intent is necessary, buyers and sellers should be cognizant of the terms that they are including in such a document, and should generally include language that explicitly states that the letter should not be construed as a binding agreement.

Moreover, it goes without saying that the parties should consult with counsel prior to reaching the point of drafting or certainly signing a letter of intent. An attorney can help evaluate these aspects of the transaction and document them properly.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC
Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Adding Corporate Value: Making the Most of Your Intellectual Property

Intellectual Property: As a business owner prepares to sell its business, he seeks to highlight what the company has to offer a potential buyer. This may be the customer base, current accounts, inventory, equipment and other items. But, often what the buyer really wants is the intangible aspects of the business that have been built over the years. This is particularly evident in service-based businesses. Often times, the principal asset of such a business is its immense goodwill and name recognition. It is this, which the potential buyer often hopes to leverage off of in taking over the business.

This perspective highlights the importance of properly protecting and assessing the value of the intangible assets that one is transferring in the sale. If a business owner can present a solid book of intellectual property rights that are being transferred, and show that all have been properly protected and utilized, that increases the value of the intangible assets, and thus can help to increase the overall purchase price that may be asked.

To do this, it is important that a company properly identify and protect its intellectual property. Trademark protection is a huge aspect of this. Set forth below is a non-exclusive list of tips a business can undertake in order to protect its trademark rights. It is important to note that the following summarizes legal concepts that applied as of its posting in August of 2008; it does not account for future changes in the law.

Conduct an IP Audit. The first step to protecting intellectual property is to fully identify it. Though this discussion focuses on trademark rights, it is worth noting that many companies will also have an expansive combination of intellectual property including trademarks, copyrights, trade secret and perhaps patents. Prior to offering the company for sale, one should take a full evaluation of the value of its marketing materials, contracts and products. Underlying each of those will be critical intellectual property. For trademark purposes, the “easy” ones are the company’s name and logo. However, also potentially protected under trademark law are particular product names that the company has developed, unique service names and slogans. Further, the website, marketing materials, brochures and even price lists are ripe for copyright protection. In order to protect this intellectual property, one first needs to identify and treat it as such.

Use Your Mark. Trademark rights start from the use of the mark. That’s worth repeating: one gains rights from trademark law by using the mark. What does this mean? Its impact is two-fold. First, it means that use trumps registration. Accordingly, while registration is critical, if one register a mark that someone else used first, that other party has prior rights to it. Next, even if one has trademark registration for the mark, one must continue to utilize it in order to maintain those rights. If one fails to continuously utilize the mark, that could arguably be deemed an abandonment of the intellectual property rights to it. In order to argue that the company has rights to trademarks, it will need to be able to show that it actually used the mark. A mere idea for a mark that has not been used will arguably do little to add value as an intangible asset.

Evaluate the Mark. Because trademark rights lie in use of the mark, it is critical that prior to launch, one conducts an investigation to identify others’ use of that, or a similar, mark. A good starting point, of course, is checking the United States Patent and Trademark Office (USPTO)’s database, to see whether a similar mark has been registered. However, this is not enough. However, that database only demonstrates marks that are registered with the USPTO. It is not an exhaustive search, and it will not include an indication of parties that are using the mark but have not registered it. Again, because use trumps registration, it is critical to know more generally whether other parties are using the mark.

There are various resources available in order to conduct those searches, including utilizing private investigators to conduct them. For several reasons, it is critical to conduct such a search at the outset. First, it could save significant money. We generally recommend that our clients engage an investigator to conduct such a search prior to commencing a trademark registration. This enables the company to evaluate the likelihood of a successful registration.

For instance, if a search reveals that there are numerous other companies who have registered a similar mark in a similar industry, it is likely that the USPTO would identify those other marks as obstacles to registration, and could even deny registration on that basis. Identifying such obstacles at the outset can enable one to evaluate the risk and identify potential problems prior to incurring governmental filing fees and legal fees.

Moreover, if one identifies a potential conflict with others’ use of the mark one can address it before it becomes a problem. For instance, one may evaluate others’ usage of similar marks and determine that it would be best to simply redevelop the proposed mark. It is far better to do that at the outset, prior to incurring significant marketing money and building goodwill and branding associated with the mark, only to later abandon it. Last, but certainly not least, such an evaluation at the outset can help to avoid litigation. If a company proceeds to develop and use a mark without conducting such an evaluation, it may do so while completely unaware that the mark infringes upon another party’s use. Unfortunately, even innocent infringement could result in an infringement lawsuit and force one to cease use of the mark. Again, a proper evaluation in the beginning of the process can help to ward off such potential problems by allowing a company to evaluate the risks inherent in using a particular mark. Use of a trademark that arguably infringes on third party rights will certainly be less valuable as an asset to be sold. Moreover, such third party use may be discovered in a buyer’s due diligence and could in fact serve as a deterrent to the buyer.

Develop a Strong Mark. The selection of marks is critical to the ability to enforce rights to the mark. Trademark law has created a scale of marks, in which the strength of the mark is directly correlated to the creativity of the mark. For instance, the strongest marks are usually those that are made-up words (i.e., Kodak®) or are otherwise unrelated to the services or goods being provided under the mark. It is far more difficult to obtain trademark registration and protection to terms that are either generic or that merely describe goods and services. For instance, a name such as “Joe’s Landscaping” is arguably generic for a landscaping services company. Generic terms are not entitled to trademark protection at all. Moreover, if the company name is “Beautiful, Colorful Gardens,” that name arguably simply describes the services being provided. To obtain trademark protection in that situation, one would need to prove that the name has acquired what is termed as “secondary meaning.” This essentially means that consumers associate the mark “Beautiful, Colorful Gardens” with that particular company and understand and assume that that a particular entity is the source of the services being provided. In other words, they do not simply see it as a description for the goods and services that any landscaper might provide. Again, the more unique the name, and the greater “mental leap” that needs to be taken to connect your goods and services with the name, the stronger the mark.

Strength of the mark might be an issue when seeking registration: often times the USPTO’s examining attorneys will review this as a pre-condition to granting registration. However, it also will come into play in the event of litigation. For instance, if a business has operated for twenty years as “Beautiful, Colorful Gardens,” it might be upset if someone opened a business down the street and marketed their services as “Colorful, Beautiful Gardens.” The likely first step would be to try to force the latter party to cease utilizing the mark, and to try to recoup damages for their use of an arguably confusing mark (the same words simply re-arranged). However, at this point, that new company may be able to defend itself by arguing that the mark is merely descriptive and therefore not entitled to trademark protection. If they prevail on this argument and if one is unable to prove secondary meaning, one may be unable to stop their use, nor obtain damages.

Registration of the Mark. Once a business owner has made a final decision as to the mark, and has put it to use, the next step is to register it. Through the registration process, one submits the image of the mark to the USPTO, along with a description of the use and materials demonstrating that use. Notably, one can register variations of the mark. For instance, if the business is registering a company name, it may present that name in a stylized form, or in standard letters -- both forms can be registered -- although, they are considered to be two distinct marks, and thus, two separate applications. Next, one must indicate to the USPTO how the mark is being used. This involves developing various descriptions that depict the use of the mark. Importantly, a business’s use could be quite expansive, and it is important to register for all uses of the mark, not just the primary use. For example, the operation of an online business may touch on outside services, as well as services provided online, email services, and/or electronic forums, etc. Each of these should be reflected in the application.

Although we previously discussed the importance of use of the mark over registration, registration is nevertheless a critical aspect in protecting trademark rights. Having a registered trademark provides numerous benefits over rights as a mere common law trademark owner. For instance, once a mark has been registered, the owner is provided a legal presumption that he has valid ownership of the mark and an exclusive right to use it in connection with the registered goods and services. Further, once the mark has been registered for five or more years, the trademark owner is provided an additional legal presumption that your mark is valid -- this presents various arguments and defenses that may be raised by a third party in the event of a dispute. For example, in the previous example relating to “Beautiful, Colorful Gardens,” had there been a federal registration for the mark for more than five years, “Colorful, Beautiful Gardens” would generally be prevented from arguing that the mark was invalid as a descriptive mark, thus eliminating that potential defense. As a registered trademark owner, one is also entitled to bring suit in Federal court, and thus have the ability to leverage US registration into registration and applications in other countries. Thus, having a mark that is properly registered arguably increases the value of the mark.

Maintaining Registration. Once one has registered a trademark, there are certain procedures with to which one must adhere in order to maintain it. First and foremost, as previously stated, the business must continue to use its mark. However, in addition, even once one has received the registration, there will be periodic filings that need to be made with the USPTO in order to continue the registration. For instance, after the fifth year of registration, the trademark owner must submit to the USPTO a declaration of continued use. Through this filing, it is essentially certifying to the government that it is continuing to utilize the mark per the registration, and must provide additional specimen to the USPTO proving that use. There are incremental filings that will also need to be submitted thereafter. If one fails to timely submit these post-registration reports, he may be deemed to have abandoned the registration, and can therefore lose the benefits of being a registered trademark holder.

Notice. The appropriate notice designation should also be used in conjunction with the mark. If the business has not yet registered the mark (this includes the time period in which one has submitted an application but registration is still pending), it can utilize the designation “TM” or “SM,” for trademarks and service marks, respectively, in order to notify the public of a potential claim to rights in that mark. Once the business has obtained trademark registration, the notice should be modified to use the ® symbol. Importantly, one can only utilize the registered symbol if he has a registered mark, and only in connection with those goods and services for which he is registered. However, this notice is critical, because failure to consistently use the registered notice in conjunction with the mark can prevent one from obtaining damages in the event that one sues a third party for infringing use. This can be a crippling penalty for neglecting a notice that is easy to utilize.

Enforcing the Mark. Once the business has registered and clearly established the trademark rights, they need to be enforced. Unfortunately, this area of the law can fall under the umbrella of “you snooze, you lose.” Essentially, if one fails to enforce rights he may be deemed to have waived them. Therefore, if a business knows that someone is infringing on its rights and fails to act to enforce the rights and prevent the infringing use, it may be deemed to have consented to that use. Accordingly, if the business changes its veiwpoint a year or two later, it may be too late. This is often referred to as the doctrine of “laches.” Moreover, if one does this too many times one could additionally be deemed to have waived all rights. For instance, suppose that a business learns that Company F is patently infringing its rights and is stealing a large number of customers and profits as a result of their use. When it sues Company F, the Court may look to the fact that the business has allowed Companies A, B, C and D to utilize the mark freely and without limitation.

Even worse, following our example, suppose that Company E is utilizing the mark in a confusing way and in addition is providing horrible service. As a result, in addition to lost profits from their infringement, the business reputation could also be damaged, thus arguably diminishing the value of the trademark. In such a situation, when one sues Company F, Company F could arguably say that due to Company E’s damaging (and unstopped) use, the damages are negligible. For all these reasons and more, it is critical that one carefully monitor the market to quickly identify and diffuse any wrongful use of your trademarks. Again, when assessing the value of intangible assets such as intellectual property, a potential buyer may look to see the strength of a mark and how well the seller has prevented others’ infringing use.

Contract for Trademark Protection. In order to best protect intellectual property rights, it is critical to specifically address them when entering into business transactions. For instance, if a business is granting a third party a right to utilize its company name or marks, it should make sure that the appurtenant rights and obligations are very clearly and specifically detailed. In such an event, and without limitation, the licensor should make it clear what if any, consideration is being provided in exchange (i.e., a royalty), and whether or not the license is exclusive or non-exclusive. If it is exclusive one should carefully define that exclusivity. Moreover, the trademark owner should ensure that certain protocols are in place to enable it to maintain quality control over the products or services being associated with the mark. If the trademark owner fails to maintain quality control over either the depiction or usage of the mark or over the goods and services that are associated with the mark, it may be hampered later on in trying to obtain damages for someone else’s damaging use.

Register with US Customs. As a registered trademark holder, one has the ability to file for registration with US Customs and Border Protection. This can allow a business to obtain a head start in preventing counterfeit goods from entering the country. Moreover, as a registered rights holder with US Customs, a business may even provide the agency with certain information or criteria relating to suspected infringers (e.g., the specific importer, manufacturer, country of origin, etc.). Once a business has a registered trademark, one can leverage that application into registration with US Customs by filling out an online application.

Again, each of these are critical for increasing the strength of a business’s trademark rights, and thus increasing the value of the intangible assets that may be sold in a corporate sale.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

In New York, LLP Liability Shield Does Not Apply to Obligations Between Partners

Corporate Law: Individuals seeking to buy into a partnership in New York should be wary of the fact that their personal assets may be at risk in the event of a future dispute with the other partners of the company. Pursuant to a 2007 decision handed down by the New York Court of Appeals, the partners in a firm operating as a limited liability partnership, or LLP, are not shielded from personal liability in disputes with one another. Ederer v. Gursky, 9 N.Y.3d 514 (N.Y. 2007).

Under well-established principles of New York partnership law, when a claim is brought against an LLP, individual liability is generally limited to only those partners directly involved in the activity underlying the claim. However, the Court of Appeals in Ederer held that the legislative intent behind the New York LLP statute was clearly to protect partners from claims brought against the partnership by third parties, and was not meant to interfere with the fiduciary duties and obligations existing between the partners themselves.

In Ederer, one partner in an LLP filed suit against his former partners for money he claimed he was owed when he withdrew from the firm pursuant to a partnership agreement. The claimant’s former partners disputed the claim but also asserted that they were shielded from personal liability because of the firm’s status as an LLP. The Court held that the liability shield does not protect the partners from personal liability for breaches of the partners’ obligations to each other.

Per the dissent in Ederer, it is noteworthy that the decision could create unfair results for partners with relatively smaller interests in an LLP. In practice, the minority partners could be held personally liable for claims of former partners who had much larger interests in the firm. In that respect, the decision arguably gives preferential treatment to such majority partners over both the other partners of the LLP and other third party creditors.

The Ederer case highlights the need for careful drafting of a partnership agreement, or other applicable documentation, at the outset of a company’s establishment. Many ignore this critical aspect because they are still in the “honeymoon” period. However, before buying into a partnership, it is crucial to clearly set forth each partner’s rights and obligations at the beginning and to prepare for the potential that some or all of the partners may want to go different ways in the future. It also emphasizes the importance that the document be customized to the company’s and the partners’ unique needs, rather than be left to chance by using “form” agreement that is not fully vetted by an attorney.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Caution When Negotiating A Contract For The Sale Of Real Estate

Commercial Real Estate: Commentary: The New Jersey Statute of Frauds requires that certain contracts be in writing. The most well-known type of contract subject to these requirements are contracts for the sale of personal property for $500 or more be in writing. In addition, contracts for the sale of real estate are generally required to be in writing. Quite surprisingly, however, under certain circumstances an oral agreement concerning the transfer of a real estate interest may be enforceable.

Specifically, an oral agreement concerning the sale of real estate will be enforceable where it is established by clear and convincing evidence that the following has been articulated (a) a sufficient description of the real estate; (b) the nature of the interest that is to be transferred; (c) the identity of the transferor and transferee of the interest; and (d) the existence of an agreement. The “agreement” can be found from this perspective even where the parties anticipated the drawing up of a written and more formal contract of sale.

If you think of a transaction for the sale of residential property, the above terms are generally agreed upon earlier on in the negotiations. What that means is that a buyer and seller arguably could be bound by an oral agreement for the sale of real estate even though they contemplated negotiating additional terms and incorporating them in a written contract of sale at a later point in the transaction.

Given this risk, parties to a real estate transaction in New Jersey should proceed cautiously and act with the understanding that they may be bound to their oral representations. There are a few things that can be done to lessen the risk that an oral agreement will be binding. First, they should avoid utilizing letters of intent or term sheets. But, if they do utilize such a document, they should explicitly state on its face that they do not intend to be bound by the terms therein until a written agreement is executed. In addition, when they are negotiating orally with respect to the terms, they should provide the other party to the transaction a short correspondence and/or email at the very outset that they do not intend to be bound to any terms as stated orally or any other writings until a formal contract for sale is executed. In this situation, they should also reiterate their position orally to the other side and take notes of these conversations. In these notes, they should make particular note of those items as to which they have not yet come to an agreement. Although the risk continues, this may help to generally preclude the Court from finding that an oral agreement for the sale and purchase of real estate is enforceable. Of course, this is a nonexclusive list. Further, none of these suggestions is a guarantee that the parties will be protected from such a risk, and the particular facts of each situation are critical in determining a legal strategy. However, they should be kept in mind when a real estate deal is being negotiated.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Are E-mails Sufficient To Satisfy The New York Statute Of Frauds? It Depends.

Commercial Real Estate: The New York Statute of Frauds requires certain agreements to be in writing in order to be enforceable. Among the types of agreements that must be in writing are those conveying an interest in real estate (other than a lease for a term not exceeding a year) and a contract to pay compensation for services rendered in negotiating a purchase and sale of real estate. However, New York, by statute, provides different standards as to what constitutes a writing for these purposes.

Specifically and with respect to a contract to pay compensation for services rendered in negotiating a real estate transaction, an email exchange between the parties will constitute a writing where it contains the essential terms and there is an indication by the sender of the email as to his intention to authenticate this transmission. This is because this section of New York’s General Obligations Law was amended to specifically include a provision that written text produced by electronic signals constitutes a writing.

However, and with respect to an agreement for the purchase and sale of real estate, it appears that an email exchange is insufficient to constitute a writing even if it contains all of the essential terms and the e-mail sender authenticates the transmission. Thus, the revision made to the statute as to the brokerage services was not made to the statute pertaining to a conveyance of real estate.

In this day and age, the use of email to transact and conduct business is commonplace and occurs in a large quantity and variety of transactions. It makes sense for the legislature to deem certain agreements as more important than others and, thus, require a higher standard for them to be deemed “in writing.” However, once this determination is made, it is confusing to the public to render an e-mail a sufficient writing with respect to certain agreements and not others. It will not be surprising if the New York State Legislature clarifies this. Hopefully, this will occur sooner rather than later so that the general public can proceed with certainty as to whether or not they are bound.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Utilizing Non-Compete Agreements in the Sale of a Business

Commentary: Non-compete agreements can be employed as effective tools to protect the buyer of a business from direct or indirect competition from the seller. Certainly, buyers and sellers will often include a non-compete agreement as a term of the sale transaction itself. However, in utilizing these agreements, it is crucial for both parties to the sale to remain aware of two key points. First, restrictions on competition are generally only enforceable to the extent that they are reasonable. And second, in the sale of a business, a covenant not to compete could have significant tax implications for the buyer and seller alike.

A non-compete agreement will typically state that in exchange for a specified payment (which could be part of the sale price), the seller will promise not to go into a similar type of business, within a certain geographic area for a specified period of time. In some cases, the agreement will also prohibit the seller from using certain confidential trade secrets or business processes that are being transferred to the buyer. Again, however, it is critical to keep in mind that a court will only enforce a non-compete provision if it is reasonable in scope and duration. Thus, a non-compete clause should generally only restrict the seller from working or being affiliated with a business that is similar or at least in the same industry as the one he is selling.

The question becomes how narrowly to define the industry. Moreover, the restriction should arguably be limited to the same geographic area from which the seller’s business derived its customers, and it should only apply for a reasonable period of time. What is reasonable will depend on the specifics of the industry, the business and even the region. Notably, different states have different standards for evaluating the “reasonableness” of a non-compete agreement.

Although we are not offering tax advice, it is essential to keep in mind that non-compete agreements could have significant implications for the parties to the transaction. In negotiating a sale price for the business, the buyer and seller must decide upon what portion of the purchase price is to be allocated to the covenant not to compete. The basic issue is that with an asset sale of a business, each asset sold is treated separately for tax purposes. Under current law, those assets treated as capital gains are taxed at a significantly lower rate than those treated as ordinary income. However, gains on certain intangible assets, such as covenants not to compete, are not generally eligible for capital gains treatment. Thus, in allocating the purchase price to the various assets of the business, the parties should keep in mind that allocating even a small portion of the purchase price to the covenant not to compete could significantly lower the after- tax amount that the seller will make from the sale.

In light of these potentially significant business and tax implications, both the buyer and the seller should use careful consideration in determining the structure of a non-compete agreement and the value associated with the covenant not to compete that is being transferred to the buyer. The best practice for both parties is to consult a tax professional to assist in defining the terms of the purchase.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

Caution When Negotiating A Contract For The Sale Of Real Estate

Commentary: The New Jersey Statute of Frauds requires that certain contracts be in writing. The most well-known type of contract subject to these requirements are contracts for the sale of personal property for $500 or more be in writing. In addition, contracts for the sale of real estate are generally required to be in writing. Quite surprisingly, however, under certain circumstances an oral agreement concerning the transfer of a real estate interest may be enforceable.

Specifically, an oral agreement concerning the sale of real estate will be enforceable where it is established by clear and convincing evidence that the following has been articulated (a) a sufficient description of the real estate; (b) the nature of the interest that is to be transferred; (c) the identity of the transferor and transferee of the interest; and (d) the existence of an agreement. The “agreement” can be found from this perspective even where the parties anticipated the drawing up of a written and more formal contract of sale.

If you think of a transaction for the sale of residential property, the above terms are generally agreed upon earlier on in the negotiations. What that means is that a buyer and seller arguably could be bound by an oral agreement for the sale of real estate even though they contemplated negotiating additional terms and incorporating them in a written contract of sale at a later point in the transaction.

Given this risk, parties to a real estate transaction in New Jersey should proceed cautiously and act with the understanding that they may be bound to their oral representations. There are a few things that can be done to lessen the risk that an oral agreement will be binding. First, they should avoid utilizing letters of intent or term sheets. But, if they do utilize such a document, they should explicitly state on its face that they do not intend to be bound by the terms therein until a written agreement is executed. In addition, when they are negotiating orally with respect to the terms, they should provide the other party to the transaction a short correspondence and/or email at the very outset that they do not intend to be bound to any terms as stated orally or any other writings until a formal contract for sale is executed. In this situation, they should also reiterate their position orally to the other side and take notes of these conversations. In these notes, they should make particular note of those items as to which they have not yet come to an agreement. Although the risk continues, this may help to generally preclude the Court from finding that an oral agreement for the sale and purchase of real estate is enforceable. Of course, this is a nonexclusive list. Further, none of these suggestions is a guarantee that the parties will be protected from such a risk, and the particular facts of each situation are critical in determining a legal strategy. However, they should be kept in mind when a real estate deal is being negotiated.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com

The Potential Benefits of Utilizing an LLC to Purchase Commercial Real Estate

Commentary: Taking into consideration general principles of corporations law, utilizing an LLC to purchase a commercial property may provide numerous business and tax benefits for the buyer. This may be especially true where a buyer is interested in purchasing multiple properties.

In particular, a buyer may want to set up a “parent” LLC which would act as the owner of various “subsidiary” LLCs. Each separate subsidiary would then be utilized to purchase a single commercial property. Structuring the ownership of the properties in this manner may create substantial tax savings for the buyer.

For instance, if each transaction were structured so that the parent loans the subsidiary the monies to fund the purchase, the respective subsidiary would be responsible for the repayment of the loan, and thus the subsidiary would be deemed to have little equity in the property and thus little assets. As a result, a subsequent transfer of the property by the LLC (to the owner’s children, for instance) would likely have little, if any, tax consequences.

Moreover, it is well-established that an LLC can be deemed to be a disregarded entity for tax purposes. As a general rule, the income of an LLC will “pass through” to the owner of the company, so that the LLC itself is not required to report such income on its tax returns. Thus, the owner could streamline the taxes and other expenses associated with each of its various properties, while at the same time avoiding double taxation on the income generated from each property. Double taxation is a common pitfall of utilizing C-Corporations. For example, if the buyer were to set up a series of subsidiary corporations, as opposed to LLCs, each corporation would have to pay separate corporate income tax for each entity. In addition, the buyer would then have to pay personal income tax on any monies that are income to him (whether through distribution of profits or otherwise). If, on the other hand, if the buyer uses the LLC form to set up his subsidiary companies, the income of each LLC “passes through” to the buyer so that he is only taxed on it once, by reporting it on his personal income tax return.

In addition, as long as each LLC is created and operated in the proper form, the liabilities associated with each respective property will generally not attach to the other companies’ properties. In other words, in most instances each LLC will be only be liable for its own debts and obligations. For example, assume that company A owns a piece of property worth $300,000.00 (Building A) and Company B owns property worth $1,000,000.00 (Building B) and both Company A and B are owned by Company C (the parent company). If Company A is sued and a judgment is reached against it for $500,000.00, the judgment-creditor cannot generally look to collect its judgment against Company B’s property. The alternative would be if Company A owned both properties. In that instance suppose an accident happened in Building A for which the company is deemed liable. In that situation, the judgment-creditor would likely be able to collect against both buildings, since both would be the assets of the judgment-debtor.

When determining if the real estate holding company should be established as an LLC or a corporation, it should be noted that the form of ownership set up by the buyer is unlikely to be an issue to the seller. That being said, if a seller were taking a promissory note from the buyer or the buyer was to otherwise have ongoing liability to the seller, such a structure (whether as a corporation or an LLC) may be a concern to the seller. Insofar as the above-mentioned structure devoids the company of all assets but the one company, a seller may be limited in its rights. This is because, as mentioned above, the assets of each separate subsidiary LLC may be relatively small.

In light of the foregoing, before purchasing an interest in commercial real estate, it may be wise for a potential buyer to formulate an appropriate ownership structure and consider forming a limited liability company through which to effectuate each such transaction. Accordingly, an attorney should be consulted at the outset so as to structure the purchase(s) in a way that is most beneficial to the buyer.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Please visit our website at www.gdnlaw.com and our other blogs at www.nissenbaumlawblog.com; www.foreclosuredefenselawblog.com; www.saleofbusinesslawblog.com; www.internetdefamationlawblog.com; www.constructionlawinfoblog.com; www.filmproductionlawblog.com; www.internetlawinfoblog.com; and www.njbusinesslawblog.com