As you probably heard, the U.S. District Court for the Eastern District of Texas issued a nationwide preliminary injunction on December 3, 2024 to stop the Federal government from enforcing the Corporate Transparency Act (the “CTA”) and the regulations implemented under the CTA. The case is called Texas Top Cop Shop, Inc. et al. v. Garland, et al. The court referred to the CTA as “quasi-Orwellian” and decided that it was “likely unconstitutional.”

It took just two days for the U.S. Department of Justice to appeal this ruling to the United States Court of Appeals for the Fifth Circuit. The Financial Crimes Enforcement Network (FinCEN), the agency charged with enforcing the CTA, issued a press release reassuring reporting companies that no action will be taken against them for failing to file their beneficial ownership information while the Texas court’s order remains in place. FinCEN did not, however, indicate whether it would provide a grace period for filing should the injunction be lifted. It noted that reporting companies may continue to voluntarily file those reports during the period that the stay is in effect. Yesterday, the Department of Justice filed a motion with the District Court to lift the injunction while the Fifth Circuit considers the appeal. If this motion is granted, reporting companies (other than the plaintiffs named in the Texas Top Cop Shop case) would be required to file their beneficial ownership reports as if the District Court injunction had never been entered.

Attention owners of closely held businesses! A recent decision by the Supreme Court could impact the amount of taxes owed by your estate at death. In Connelly v. United States, the Supreme Court held that the value of life insurance proceeds received by a closely held corporation upon the death of an owner increases the fair market value of the corporation for estate tax purposes. Connelly overturns a previous understanding that a company’s contractual obligation to redeem (purchase) a deceased owner’s shares in the business offsets the value of life insurance proceeds earmarked for that redemption. Since there was no offset, the taxpayer in Connelly owed additional federal estate tax reflecting the (post-death) increased value of his shares in the corporation. Thus, because redemption obligations no longer offset the value of life insurance proceeds, closely held businesses will need to reassess insurance funded redemption arrangements to avoid adverse federal estate tax consequences for their owners.

Additionally, Connelly illustrates the importance of defensible valuation methods under buy-sell agreements. For estate tax purposes, the law disregards the value set by buy-sell agreements unless the agreement sets the fair market value of the business. The requirements to determine fair market value of a closely held business are set forth in Section 2703 of the Internal Revenue Code. In Connelly, the buy-sell agreement ultimately did not control the value of the closely held corporation for estate tax purposes. While the Supreme Court did not specifically address whether the agreement could have withstood Section 2703, Connelly demonstrates what not to do when determining the value of closely held businesses under buy-sell agreements. Failure to properly value the business, as was the case in Connelly, could lead to higher valuations for estate tax purposes. As such, Connelly demonstrates the importance of defensible valuation methods to avoid unintended estate tax consequences.

For the past couple years, we warned you in our business law blog that this time would come. It’s here; the federal Corporate Transparency Act (the “Act”), requiring many businesses to report beneficial ownership information about their owners and anyone with substantial control of the company, went into effect on January 1, 2024. This means that any “reporting company” in existence prior to January 1, 2024 has until January 1, 2025 to report; any reporting company that was formed on or after January 1, 2024 but before January 1, 2025 has 90 days after formation to report; and any reporting company formed on or after January 1, 2025 has 30 days after formation to report.

It should be noted that on March 1, 2024, the United States District Court for the Northern District of Alabama held that the Act was unconstitutional because Congress exceeded its authority. National Small Business United d/b/a the National Small Business Association, et al. v. Yellen, Case No. 5:22-cv-1448-LCB. The Financial Crimes Enforcement Network (FinCEN), the agency overseeing the administration of the Act, has announced that it will abide by the court’s order for as long as it remains in effect. This means that it will not seek enforcement against the plaintiffs in the case (Isaac Winkles, reporting companies of which Mr. Winkles is a beneficial owner or applicant, and members of the National Small Business Association as of March 1, 2024). It seems likely that this decision will be appealed. In the meantime, we encourage all entities formed after January 1, 2024 (other than those who were members of the National Small Business Association as of March 1, 2024) to comply with the Act given the 90-day compliance period. Entities already in existence on January 1, 2024 may want to await further developments given that their compliance deadline is months away.

Last year, we warned you in our business law blog that a new law, the federal Corporate Transparency Act, would be going into effect that would require many businesses to provide information about their owners and anyone who controls the company to the federal government. We now know that this law will take effect on January 1, 2024. Reporting companies in existence prior to that date have until January 1, 2025 to comply; companies formed on or after that date must comply within 30 days after formation. Once the data has been entered, companies are obligated to update any information that becomes outdated or is incorrect. The information will be included in a database that will be used to combat money laundering, financing of terrorism, and other illegal activities.

Reprinted from the April 2023 edition of Business Law Today. Further duplication without permission is prohibited.

By Susan A. Maslow

In the late 2010s and early 2020s, ESG—a wide-capturing acronym standing for “environmental, social and governance”—roared into action, emerging both domestically and abroad as one of the defining trends in investing, regulation, finance, and corporate governance.

ESG’s proponents have long sought a unified framework through which to describe interrelated standards of environmental sustainability and human rights, and bring them into greater alignment with the private sector’s traditional profit-seeking goals. This change in approach arguably gained in prominence after the Business Roundtable’s 2019 declaration on the purpose of the corporation, endorsing a vision of corporations being led for the benefit of all stakeholders, not just shareholders. Though many question the sincerity and commitment of the Roundtable, the ESG movement was super-charged, and it achieved mainstream status during the 2020 protests for racial justice, which spurred companies to integrate new goals for diversity, equity, inclusion, and racial justice into their broader ESG policies. Over the course of the last eighteen months, public company boards have been sued for breaches of fiduciary duty based on alleged failures to react to ESG factor “red flags.”

On January 1, 2021, Congress enacted the Federal Corporate Transparency Act (the “CTA”), pursuant to which a secure database will be established to assist law enforcement agencies in combatting money laundering, financing of terrorism, and other illegal activities. The objective of the CTA is to prevent bad actors from using shell companies to obscure the provenance of their ill-gotten gains.

The database will be administered by the Financial Crimes Enforcement Network (“FinCEN”), an agency of the U.S. Department of Treasury. Companies will be required to provide information relating to their beneficial owners (generally, individuals owning 25% or more) and persons who are in control (generally, individuals holding significant decision-making authority). There are exceptions, such as publicly traded companies, companies with annual gross receipts exceeding $5 million that have more than 20 full-time U.S. employees and a physical office in the United States, and companies already subject to Federal government oversight (e.g., banks).

The European Commission published the long-awaited Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence (the “EU Directive”) on February 23, 2022. It has been suggested that text found in the EU Directive “risks making the law ineffective” by implying that companies can fulfil their obligations by simply adding clauses in their contracts with suppliers and verifying compliance with “suitable industry initiatives or independent third-party verification”. The criticism is that the “contractual assurances” and verification required by Items 2(b) and 4 of Article 7, and Items 3(c) and 5 of Article 8 allow companies to shift their responsibilities on to their suppliers and to knowingly get away with harm by conducting ineffective audits or participating in voluntary industry schemes that have failed in the past.

The argument that companies can find an easy safe harbor within the EU Directive is misguided. Such condemnation places undue emphasis on the first two elements to achieve the negation of civil liability under Article 22 and ignores the third factor. A company must prove not only that (i) it used appropriate contract clauses (under to-be-provided Commission guidance), and (ii) it verified compliance, but must also prove (iii) it was reasonable to expect the action taken, including the verification process, “would be adequate to prevent, mitigate, bring to an end or minimize the extent of the adverse impact.” The last element is unfairly discounted by those that fear delivery of a safe harbor to industry influences. In addition, due account is not given to Article 22’s additional text that insists company efforts (or absence of efforts) to remediate any discovered damage and the extent of pre-harm support and collaboration to address adverse impacts in its value chains (or absence of support and collaboration) is also to be considered in determining liability.

Articles 4 to 11, 25 and 26 of the EU Directive impose due diligence obligations on subject companies and address the duty of care required of their directors in setting up and overseeing due diligence. The EU Directive has numerous “Whereas” clauses expressing a desire to incorporate the UNGPs and OECD Guidelines which require shared responsibility between buyers and suppliers. It should not be read as suggesting companies avoid liability by simply demanding conventional representations and warranties from a first-tier supplier without shared responsibility for thorough retrospective and prospective investigations to identify, prevent and end adverse impact. Any company that believes “contract assurances” without a detailed and regularly reviewed corporate strategy to address human rights, climate change and environmental consequences using contracts as one of multiple tools is destined to be found liable for damages.

Perhaps Article 22 with respect to a company’s potential civil liability could be clearer with respect to this point if it included a reference to Articles 4,5 and 6 in lieu of the existing limited reference to the obligations laid down in Articles 7(Preventing potential adverse impacts) and Article 8 (Bringing actual adverse impacts to an end). But Article 12 (Model contract clauses) of the EU Directive includes a promise that the Commission will provide guidance for model contract clauses and Article 13 (Guidelines) states the Commission, in consultation with Member states, stakeholders, the European Union Agency for Fundamental Rights, the European Environment Agency, and appropriate international bodies may issue guidelines for specific sectors or specific adverse impacts. The to-be-developed model contract clauses should reflect the characteristics and obligations found in Version 2 of the Model Contract Clauses (the “MCCs”) drafted by the American Bar Association Business Law Section’s Working Group found here Center for Human Rights. The MCCs include provisions which require:
● a joint responsibility by buyer and seller to engage in human rights due diligence, in line with the UNGPs and the OECD Guidance;
● a commitment by buyer to engage in responsible purchasing practices that will support supplier’s obligations to avoid adverse human rights impacts; and
● in the event of an adverse impact, a joint commitment that: (a) the parties will prioritize victim-centered human rights remediation above conventional contract remedies (that compensate the non-breaching party, not victims); and (b) each party’s participation in remediation shall be proportionate to each party’s causation of or contribution to the adverse impact.

The EU Directive and the right contract clauses and due diligence guidance can change the way supply chains in global markets have worked for centuries. Finally, a real tool to address modern slavery and the environmental destruction of entire communities.

Model Contract Clauses to Protect Workers in International Supply Chains, Version 2.0

A working group formed under the American Bar Association (ABA) Business Law Section has announced a revised set of model contract clauses for international supply chains. The 2021 Report and Model Contract Clauses, Version 2.0 (MCCs 2.0) from the Working Group to Draft Human Rights Protections in International Supply Contracts are now finalized and can be found on the ABA Center for Human Rights site.  The MCCs 2.0 are one of several initiatives within the Business Law Section’s implementation of the ABA Model Principles on Labor Trafficking and Child Labor. The MCCs 2.0 are offered as a practical, contractual tool to assist inside and outside corporate counsel in efforts to reflect their clients’ commitment to stated human rights policies and desire to abide by international human rights soft and evolving hard law. Given the likely European Union and United Kingdom implementation of mandatory human rights due diligence, the mounting number of Withhold Release Orders in US ports, and growing investor concern with respect to environmental, social and governance (ESG) liability, the Model Contract Clauses should be of interest to all companies with complex supply chains and those that provide such companies legal services. Designed as a modular, practical tool for corporate counsel, the 2021 MCCs 2.0 are the first model contract clauses to implement “human rights due diligence” obligations in supply contracts. They attempt to integrate the principles contained in the UN Guiding Principles on Business and Human Rights (the “UNGPs”) and the OECD Due Diligence Guidance for Responsible Business Conduct into international contracts. The MCCs translate these principles into contractual obligations that require buyer and supplier to cooperate in protecting human rights and make both parties responsible for the human rights impact of their business relationship.

In 2021, entities formed in Pennsylvania and entities formed in other states that have registered to do business in Pennsylvania must file a Decennial Report with the Department of State. This requirement applies to business corporations, non-profit corporations, limited liability companies, limited partnerships, and limited liability partnerships. If a report is not filed, the entity will no longer have exclusive use of its company name or trade name and the name will become available for others to use it. While an entity can file after the December 31, 2021 deadline, a third party registering with the name during the gap period will have rights to the name, and the original entity will not be permitted to reinstate its exclusive rights to the name.

Earlier this year, the Department of State mailed notices to the registered address for each entity regarding its name, however, you should not rely on receiving such a notice to determine whether or not you have to file. All entities are required to file unless they made new or amended filings between January 1, 2012 and December 31, 2021.

The required forms can be found on the Department of State website at https://www.dos.pa.gov/BusinessCharities/Business/Resources/Pages/Decennial-Filing.aspx. There is a filing fee of $70, and the filing deadline is December 31, 2021.

If you are not sure whether you need to file this report for your entity, or if you have any questions regarding this requirement, feel free to contact us. We caution you not to rely upon the Pennsylvania Department of State’s website search feature to tell you whether or not your entity is required to file the decennial report.

When a business owner gets divorced, the business is often the major asset subject to distribution.  Accordingly, the business and its’ ongoing operations are almost always implicated in the divorce.  In most cases that I see, the business is a small business with  one owner or a few owners.  In the best case scenario, the business owners have planned in advance for situations that arise in a divorce through a Shareholders Agreement, Prenuptial Agreements and/or Postnuptial Agreements.  Hopefully, the parties’ respective family law and business law attorneys can work together to best protect the business owner to ensure as smooth a transition as possible.  Hopefully, the relevant agreements have set forth a valuation formula which can be upheld at law  for purposes of the divorce.  Counsel can also work together to insure that income is clearly defined and reported so that support is less contentious.  Additionally, advance planning can be used to address the below issues so that a divorce does not mean the end to the business.  While advance planning is not a guarantee, it will provide additional protections to the business owner.

A divorce can impact internal and external business relationships, support (between spouses and child support), equitable distribution (division of marital property) and business control.  In terms of business relationships, banking relationships can come into play, especially if the spouse is a personal guarantee of the loan.  It is often not easy or possible to have the spouse removed from the guarantee.  The spouse may also have a role in the business and it may not be feasible for them to remain involved.  For example, in cases where the spouse is client facing, a delicate balance will be necessary to transition the spouse out of the business without negatively impacting the business.  This can be a challenge if the divorce is acrimonious.  Finally, the roles of the parties within the business may create sustainability issues going forward.  In some cases, one spouse has a particular talent (i.e. software development, marketing creativity or scientific knowledge) which cannot be easily replaced and without which the business may not be able to survive.  Such issues impact valuation but also succession and strategy on distribution of assets.  

As for support, when a business owner is a party to a support action, whether for support for a spouse or for a child, calculating income can be challenging.  The definition of income for purposes of determining support is very broad and is not the same as taxable income.  There can be practical issues in obtaining information and documents which reflect the income.  Legal issues can also arise, such as whether income is being reported or if the court can compel income or retained earnings to be distributed from the business to the owner to pay support.

In equitable distribution, the business must be valued so that division of the assets can occur.  Business control also comes into play.  It is unusual for parties to retain joint ownership or for the non-business owner spouse to receive shares of the business so creativity and/or structured payments are often necessary unless there is enough cash reserved for an outright payment.  The payout can cause a financial strain for the business.  

To best protect a business in the event of a divorce of the business owner, it is advisable for business owners to have advance planning through the mechanisms listed above.  While not a guarantee, it will place the business owner spouse in a much better position than ignoring these issues all together.