Many an article or blog post concerns minority shareholder rights, shareholder oppression or shareholder “freeze out”.  As business and litigation lawyers, we are always mindful of the rights between and among business owners, what can and cannot be done in furtherance of those rights and the legal mechanisms applicable to the exercise of those rights.  We frequently write on the strategies available to a minority shareholder such as examination of books and records, claims of breach of fiduciary duty and the potential for appointment of a corporate receiver or custodian. 

This is not that article. 

The fact is, being a minority shareholder means that, by definition, there are often things you simply cannot control.  A shareholder or member in a business entity who possesses less than a controlling stake must have reasonable expectations as to the rights attendant to such ownership and understand the limits of such rights so as to make informed decisions concerning the investment of time, energy and money in pursuit of the collective enterprise.    

Let’s start with who owns the remaining shares in the company.  In the absence of an agreement to the contrary, the majority shareholder is free to transfer the majority (said another way; controlling) interest in the company without the consent of the minority.  A transaction can result in a change in control such that the minority shareholder suddenly works for someone entirely new.  While a minority shareholder can enjoy “dissenter’s rights”, such rights are applicable in very narrow situations specified by statute.   In fact, in the absence of a prohibition, the stock in a business entity is readily transferrable, just like on an exchange, if a buyer and/or seller can be identified.

Internally, a minority shareholder can find it difficult to impact the direction of the business.  Depending on the by-laws of the entity and, frankly, the will of the majority, a minority shareholder may or may not have a voice on the board of directors and thus may not possess a vote on material decisions such as the persons who will fulfill critical roles in the executive branch of the business such as the officers of the corporation. More importantly, a minority shareholder may not have input on the financial operations of the company including distributions, financing arrangements, major purchases of inventory, equipment or talent.  All of which can dramatically affect the annual bottom line.

Even employment is not guaranteed to a minority in interest.  In the absence of an agreement to the contrary, the employment of a minority shareholder may simply be at will in the same way as the sales force, the administrative assistants or the custodian.  Certainly, terminating a minority’s employment could be one of the factors argued in a freeze out, but in the absence of other factors, termination of employment alone may not give rise to a cause of action.  Certain courts have suggested continued employment may be implicit in a “founder” but those situations are few and far between and a plaintiff/minority shareholder must be prepared with more to argue than the end of employment if freeze out is alleged. 

In business, like politics, being in the minority means sometimes you are powerless to immediately change the course of the company.  Sometimes, a group of shareholders can band together to pool their collective influence for their mutual benefit.  Other times, the best strategy is to become the majority even when the acquisition of additional shares comes at an unnecessary or unanticipated cost.  Under any circumstances, rights afforded to the majority are not constrained solely because a minority shareholder does not agree with a particular course of action.  

As a litigator, I am often contacted by minority shareholders who are frustrated by their lack of control or influence.  While the law offers certain protection for holders of such minority interests, those remedies are factually limited and are often unsatisfactory even if granted in full after significant expense in litigation.  Certainly an appropriate agreement outlining the respective rights and obligations can change the analysis.  Business owners should consider, and plan for, what rights their stake in the company provides.          

This is the fourth installment of my continuing blog series explaining the main elements of a contract, which are outlined on the attached infographic . My goal is to demystify some of these basic provisions to help business owners have a better general understanding of what they are signing.

This article discusses representations, warranties, and covenants, which are the “bones” of the parties’ agreement. These provisions represent the statements of the underlying facts, mutual assurances, and promises of performance which form the basis of the parties’ mutual understanding. It’s not uncommon to find these concepts used interchangeably in a contract – “ABC represents, warrants, and covenants…”, but the meaning and effect of each of these are quite distinct from one another. It’s important to understand these distinctions so that your contracts accurately reflect the assumptions, obligations, and risks that you are comfortable with.

A representation is a statement of past or present fact (either express or implied) made by one party to induce the other party to enter into the agreement. For example, the seller of a business might represent that gross revenues from the business were a certain dollar amount for the past several years or that there are no claims asserted against the business. If a representation proves to have been untrue when made, the injured party will have a claim of fraudulent misrepresentation if she can prove that: (i) the party making the representation knew or should have known the statement was false when made; (ii) the other party intended the injured party to rely on the statement; and (iii) the injured party’s reliance on the statement in entering into the agreement was justifiable. The injured party can seek monetary damages for its losses or it may ask the court to rescind (void) the entire contract. It is therefore very important to avoid “over-representing” in your contracts.

A warranty is essentially a promise that an assertion made by a party is true, coupled with an implied promise of indemnity if the assertion made by the party is false. As such, a warranty is both present-focused, like a representation, and forward-looking, like a covenant. If a warranty is breached, the injured party is entitled to be made whole; this usually means that the injured party can recover the difference between the value of the contract as agreed upon and the value of the contract in light of the breach. In other words, the injured party is entitled to receive the benefit of the bargain he initially made. The injured party is not required to demonstrate that he relied on the warranty or that the other party knew that the warranty was false when made.

Often, but not always, representations and warranties go hand-in-hand to allow the parties to preserve remedies that are as broad as possible. In complex agreements, the parties usually spend a significant amount of time negotiating how the risks embodied by representations and warranties should be allocated by qualifying and limiting these concepts (e.g., a representation is true to the best of the maker’s knowledge and/or in all material respects).

Product and service warranties are specialized contractual provisions that are actually hybrids of representations, warranties, and covenants. These provisions commonly create limited express warranties that apply to the products or services, identify specific contractual remedies for breach, and disclaim implied warranties that are provided by law.

A covenant is a party’s promise to perform an action or to refrain from performing an action. It relates to the future, as opposed to representations, which are provided as of a specific date. An example of a covenant is a borrower’s promise to make loan payments in accordance with the terms of a promissory note. Covenants can be express or implied. Pennsylvania law imposes an implied covenant of good faith and fair dealing in most contracts.

Stay tuned for Part 5 of this series, which will move on to discuss some possible hidden perils of what is commonly dismissed as “just boilerplate” language.

This post continues my series explaining the main elements of a contract, which are outlined on the attached infographic. My goal is to demystify some of these basic provisions to help business owners have a better general understanding of what they are signing.

Another key element of a typical contract is a condition. A condition is an event that must occur or a fact that must be true before a party is obligated to perform his obligations under a contract. Conditions are used to allocate risk by making a party’s obligations, which would otherwise be absolute, dependent on circumstances that are usually outside of that party’s control. The risk of those circumstances not occurring is thus shifted to the other party. For example, your agreement to buy a parcel of real estate might be conditioned on your ability to obtain financing. If you are unable to get financing, you are not obligated to proceed with the sale. Your failure to perform your obligations is excused and is not a breach; the seller will have no claim for damages against you based on your failure to perform. A condition is not necessarily tied to a third party’s performance of an action (such as a bank agreeing to lend money to the buyer) but is sometimes linked to the performance of an obligation by the other party. Some conditions are dependent on weather or similar events that are altogether outside of the contracting parties’ and third parties’ control.

Sometimes a condition is drafted so that its non-fulfillment excuses some, but not all, of a party’s obligations under the agreement. As a result, if the condition is not met, the agreement remains in force as to all other obligations. On the other hand, a condition may be drafted so that the entire agreement will terminate if the condition is not satisfied (such as the property sale example above). It is important to note that the party benefitting from the condition may choose to waive the condition and proceed with performance under the agreement. Further, if the party whose obligations are conditioned performs those obligations even though the condition has not been satisfied, he may be deemed to have waived the condition.

Conditions are not necessarily identified in a single specific section of a contract, but often are sprinkled throughout the agreement where the parties’ obligations are identified. Because of the impact of an unsatisfied condition, it is important to be able to recognize conditions on the other party’s obligations before you enter into the agreement. Look for words such as “if”, “provided that”, “in the event that”, “subject to”, “on the condition that”,  “conditioned on”, and “contingent on”.

Before you sign any contract, you should be sure to assess whether any of your obligations should be conditioned on the occurrence of facts or events. If so, it is important that those conditions be clearly identified. Similarly, you should review the agreement to identify any conditions to the other party’s obligations and their impact on the agreement overall and your rights under the agreement. Ask yourself:

• Does the agreement set out unrealistic, vague or unpredictable conditions under which the other party could be released from its contractual obligations to me? Will I have incurred unnecessary expenses prior to the determination whether the condition has been satisfied (e.g., purchase of supplies or services)? 
  What impact will a release of the other party’s obligations have on my business (e.g., finding a substitute vendor)?

• What actions or omissions (by me or key staff) could result in a release of the other parties’ contractual obligations?

• Are any conditions on my performance needed to provide a way out in the case of prohibitive or unacceptable changes in circumstances down the line?

In summary, contractual agreements will ultimately only yield the intended benefits to your business if they are enforceable, and that means understanding under what conditions some or all of the other party’s obligations might be excused.    

Stay tuned for Part 4 of this series, which will move on to the next contract element shown on the infographic: Representations, Warranties, and Covenants.

In 2008, Pennsylvania enacted the Home Improvement Consumer Protection Act (HICPA) designed to protect home owners from unscrupulous contractors.  However, it is also a trap for the unwary home improvement contractors.  In addition to its registration requirements, HICPA specifies what must be in a contract for home improvement services and what may not be in these contracts. 

HICPA applies not only to contractors performing renovations and remodels, but also many other types of services including most landscaping work, security systems, fencing companies and concrete work.  Any individual or company performing these services needs to be aware of the requirements imposed by HICPA and can read more in this client alert. 

A corporation or limited liability company provides multiple advantages to business owners which is why business lawyers so frequently recommend their use. Among the most significant of these advantages is limited liability, a concept grounded in the fact that the entity has a separate legal existence from its owners and therefore its obligations are not those of its shareholders or members. Of course an owner may voluntarily agree to be responsible for such obligations as, for example, would be the case if he or she guarantees the entity’s bank borrowing. The shield of limited liability is not, however absolute. It can be breached rendering owners financially responsible for the entity’s obligations. In Pennsylvania, as in most states, there is a strong presumption against ignoring the distinction between the entity and its owners. However certain conduct by business owners will result in the court’s “piercing the veil” – ignoring the distinction between the corporation or limited liability company and its owners. Generally, courts will pierce the veil when those in control of the entity use that control, or use the entity’s assets, to further his, her or their own personal interests. While there is no single test to determine when the piercing of the veil is appropriate courts look to many factors.

These include:

1. Is the entity undercapitalized?

2. Did the owners fail to adhere to requisite formalities such as holding shareholder and directors meetings and keeping appropriate records?

3. Was the entity insolvent at the relevant time?

4. In the case of a corporation were dividends paid or were corporate funds siphoned into the pockets of the controlling shareholders?

5. Was there a functional board of directors and corporate officers managing the affairs of the entity?

6. Was there substantial intermingling of the financial affairs of the entity and its owner(s)? 7. Under the circumstances, was the entity form used to perpetrate a fraud? Generally, the court will pierce the corporate veil when a review of these factors shows that the form is a sham, constituting a facade for the operations of the dominant shareholder or member making the entity effectively the “alter ego” of the individual(s).

This post continues my series explaining the main elements of a contract, which are outlined on the attached infographic. My goal is to demystify some of these basic provisions to help business owners have a better general understanding of what they are signing.

Moving through the structure of a typical contract, next up is offer, acceptance, and consideration.  Together, these clauses define what the offering party is promising to do (or refrain from doing) in exchange for the compensation the other party is willing to pay or provide. They basically comprise the tit for tat, or the meat of the obligations and privileges which are being offered. This is often referred to as a “meeting of the minds.” While this might seem obvious on its face, the devil may be in these details, so it is vital that you know and understand the specific nature of your obligations and be sure that they are sustainable, practical, and likely to result in a benefit to your bottom line or some other benefit to your business.   So what can happen when parties fail to clearly memorialize their “meeting of the minds”? Here are a few scenarios that could result:

• The parties might become embroiled in a “battle of the forms”, particularly in the sale of goods context where a buyer submits a purchase order using their company’s form, and the seller responds using their own terms and conditions form containing different and/or additional terms.

• Parties can ask the court to apply certain legal theories to supplement the “four corners of the document” where the intent of the parties may not be clear from the contract itself. For example, even if there is no formal consideration, courts can apply the theory of promissory estoppel to enforce a party’s promise to do something if the other party relied on that promise to his or her detriment.

• Another equitable remedy allows the court to compel a party to make restitution if that party is enriched at the expense of the other party and the surrounding circumstances lead the court to conclude that it is unjust.

• Pennsylvania has a little-known statute called the Uniform Written Obligations Act, which allows the court to infer that consideration exists where the agreement includes language that clearly and expressly states that the parties intended to be legally bound by the agreement.

Stay tuned for Part 3 of this series, which will move to the next element on the infographic: Conditions.

Visit ammlaw.com to learn more about our contract review services, or Joanne Murray.

As a business owner, after spending countless hours researching and visiting commercial space, and finally finding the right location, you are often presented with a lengthy commercial lease.  Many will focus on the rent and term of the lease, but overlook the other details.  It is important to have an attorney review any commercial lease, whether you are entering a new lease or renewing an existing lease.  Far too often, the business owner only consults an attorney when a problem arises – and they are surprised to find out that the terms do not mean what they thought at the outset.  

Key areas that the business owner should review with their attorney are:  
•    Common area maintenance costs and calculations
•    Confessions of judgment
•    Responsibility for repairs
•    Insurance requirements
•    Subletting and assignment
•    Legal options in the case of a breach.  

Often there is room for negotiation, but even if there is not, you can gain valuable knowledge by consulting with an attorney so that you have a full understanding of your rights and obligations, and can plan accordingly.

While consulting with an attorney may result in a modest increase to the amount of legal fees associated with the cost of starting up a business, it is important for small business owners to recognize the long term impact of signing a lease that has not been negotiated, or at least reviewed, by an attorney, and may save money in the long run.

People often ask, “What kind of lawyer are you?”  After my stock (and feeble) comedic response of “a good one”, I often say I am a “commercial litigator”.  I explain that our practice includes litigation of disputes which arise between businesses and business owners.  Commercial litigation includes a wide range of potential issues ranging from business torts to breach of contract, both internal to a business entity, and between two or more separate entities.  While there are a wide range of potential issues which must be considered, there are certain basic tenets which I always discuss with our clients before recommending litigation or taking on their representation.   

First, do you have an agreement which might apply to the situation and, if so, what does that agreement say about your position?  Agreements can come is various shapes and sizes, such as corporate by-laws, a formal shareholder agreement, a proposal combined with an acceptance or performance, or even a simple exchange of emails.  Documentary evidence is key, as a litigator is challenged to explain why the written word should not be impactful.       

Second, what is your goal? The kiss of death as to our representation is a client who says “it’s not about the money, it’s the principle”. When I was a young lawyer I had a mentor who gave sage advice when he communicated the firm’s policy that litigation was only appropriate when money was involved.  He would politely say, “we don’t litigate over principle”.  In many ways and in most situations that adage applies.  However, in the corporate setting, sometimes the connection to money is not readily evident or direct such as with regard to disputes over corporate control or enforcing a covenant not to compete.  In many situations, I caution stakeholders to take the long view and weigh the probable outcomes from a purely practical standpoint, taking care never to  lose sight of their long range business goals.   

Third, what is your capacity for litigation and business distraction?  Litigation not only costs money in terms of attorney fees, accountant fees, experts and costs, but participation also requires commitment of a leader’s most valuable commodity; time.  Business people are first and foremost concerned with business (daily operations, management and the bottom line).  Litigation invariably requires substantial client involvement in developing strategy, reviewing pleadings, searching for documents, reviewing documents produced by other parties and preparation for testimony.  I advise potential parties to litigation to think long and hard about the cost/benefit to the business of such an undertaking.

Fourth, what can you hope to recover or save; and what will it cost to do so?  While a corollary to litigation about money, it is not the same question.  The evaluation of potential cost is complex and issue dependent.   In a recent case, settlement discussions in a commercial litigation setting were driven by the anticipated six figure cost to translate thousands of pages of information from Chinese characters to English.  Costs of experts on any issue involving an opinion on issues ranging from the standard of care applicable to a corporate officer, to whether a machine functioned in the way represented, can rapidly accumulate.  Unless there is a provision in an agreement which provides for the recovery of attorney fees or such recovery is otherwise permitted under law, those fees and costs are not recoverable.

The above is not to discourage litigation of bona fide disputes; of which we handle many.  It is simply imperative that the lawyer and the client be on the same page as to expectations, risks and litigation management.  These questions can assist in forming the framework of a solid attorney client relationship in a commercial litigation setting, which goes a long way toward developing realistic expectations, reducing the stress inherent in the process,  and optimizing the chances of a successful outcome.

In my many years of practice as a commercial litigator dealing with conflicts between shareholders, it has become clear time and again that one of the best things business owners can do when in business with multiple shareholders or partners is to have a well-defined agreement which governs the operations of the business.  Not only can that agreement memorialize the respective rights and obligations of the parties, it can also provide dispute resolution mechanisms which may serve the parties well in the event of material disagreement. Utilizing the powers granted by the Business Corporations Law and granted by the terms of an agreement governing business owners can be complex and risky but can often force an acceptable resolution when the status quo is no longer tenable.

In the case of a corporation, a shareholders agreement or by-laws will often identify the corporate office which holds supreme executive authority subject only to removal of that corporate officer by a vote of the directors. If the officer controls sufficient votes from the board, removal by a disgruntled shareholder may be impossible. The acts of the executive are subject to the business judgment rule and granted a certain amount of deference at law.  

A majority shareholder who holds the top executive office is free to wield that power, consistent with the business judgment rule, in many ways -  including business dealings with outside parties and, generally, with respect to employment decisions.  If the disgruntled shareholder is an employee of the company, which is often the case in small business, that shareholder’s continued employment may be at the discretion of the majority.  Termination of employment, if justified, is a use of corporate power which often impacts on the relative negotiating positions.      

Of course, a majority shareholder who exercises corporate authority can be faced with claims that the minority has been “frozen” or “squeezed” out of the business.  In such cases, it is important that the majority have “clean hands” and has avoided self-dealing, corporate waste or fraud as such allegations, if proven, could result in the appointment of a custodian or receiver and a loss of control.  Certainly the majority cannot transfer the assets of the business to a new entity controlled solely by the majority.   However, the existing entity can be managed in a way that maximizes benefit to the majority consistent with the exercise of business judgment.  The existence of a dispute between shareholders does not in and of itself negate the discretion afforded by the business judgment rule.        

AMM counsels clients through the minefield of corporate authority and with regard to available strategies to address disputes which arise between business owners. 

This post continues my series aimed at explaining the main elements of a contract. These elements are outlined on the attached infographic. My goal is to define the key elements of a contract and to offer some tips and cautions to avoid costly mistakes as you approach these essential documents in your day-to-day business operations.

First up: the preamble and recital sections. The preamble of a contract is the introductory paragraph that identifies the parties to the agreement. It is typically followed by paragraphs known as recitals (also called the background section). Sometimes, these recital paragraphs are labeled “Whereas”. Taken together, the preamble and the recitals tell the who, what, when, and why of the transaction. In other words, they should tell the reader who the parties to the agreement are, the date of the agreement, and what the parties hope to accomplish by entering into the agreement.

As with stories told in other settings, inaccuracies and ambiguities in the preamble and recitals of a contract can cause problems down the road. One of the underlying purposes of a contract is to set forth the agreement of the parties so that their expectations can be enforced by a court or other tribunal. An accurate and detailed introduction to the contract can educate the person who is charged with resolving the dispute as to who the parties are, why they entered into the contract, and what their expectations were at the time the agreement was entered into.

One of the most common mistakes in these preliminary sections of a contract is to incorrectly name the owner of the business as a party, rather than using the entity name. This mistake results in the owner being personally obligated as a party to the contract, which is clearly not the result an owner expects after taking the trouble to incorporate.

While it may be tempting to gloss over these preliminaries without questioning their accuracy, I highly recommend taking the time to carefully review this section in every contract to be sure the story it tells is true and complete. It could prevent costly conflicts later.

Stay tuned for Part 2 of this series, which will move to the next element on the infographic: offer, acceptance, and consideration.