Texas Small Business Law Blog

Supreme Court Deals Blow To Investor Recourse

This week the U.S. Supreme Court dealt a serious blow to investor recourse when it comes to recovery for corporate fraud.  No, this case did not involve Enron but the facts were close enough that the decision will probably affect pending litigation in those cases. 

In Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc. et al., the Court held that Section 10(b) of the Securities Exchange Act did not provide a private cause of action for investors against third parties for aiding and abetting a company in committing securities fraud.  Rather, that theory of liability is limited to SEC enforcement actions.  Thus individual investors must prove each element of Section 10(b) fraud and these investors failed to show reliance upon the defendants’ actions. 

In Stoneridge, the plaintiffs alleged that the defendants, Scientific-Atlanta and Motorola, had assisted Charter Communications in misrepresenting its securities filings to meet Wall Street expectations for revenue and cash flow.  Specifically, the plaintiffs claimed that Scientific-Atlanta and Motorola agreed to add a premium to each cable box they sold to Charter then turn around and buy an equivalent amount of advertising from Charter.  Only the companies involved knew the details of this arrangement, not the public at large. 

One of the required elements to prove liability under Section 10(b) is reliance upon a misrepresentation or omission.  In this case the agreement to overcharge for cable boxes and then purchase advertising led to misrepresented financial statements by Charter.  But the defendants, Scientific Atlanta and Motorola, were only involved in the agreement and not the actual SEC filings. 

The Supreme Court ruled that because the agreement was not publicly known there was no evidence that the investors relied upon that agreement.  More specifically, the shareholders relied upon the securities filings and not the underlying agreement.  As such, there is no liability to the shareholders under Section 10(b). Had Congress extended Section 10(b)’s coverage to include aiders and abettors, then the shareholders would not have to show reliance in order to recover.  But Congress expressed a clear intent to leave enforcement against aiders and abettors to the SEC so there was no cause of action under that theory. 

Free Franchise Tax Presentations

Well, this is a little late on notice but the Texas Comptroller’s Office is offering free presentations on the new Texas Franchise Tax that takes effect next year.  There are several remaining opportunities across the state:

            

            - Waco               11/1

            - Tyler                11/5

            - Houston          11/7

            - Harlingen        11/8

            - Arlington         11/13

            - San Antonio    11/14

There will also be a webcast made available later in November in case you cannot make it to a live presentation.  Topics that will be covered at the presentation include:

- Comparison of Current Law to New Law

- Tax Rates and Qualification for .5% Rate

- Entities Subject to Tax

- Passive Entities

- Revised Tax Base

- EZ Computation

- Discounts

- No Tax Due

- Total Revenue - Definition and Computation

- Cost of Goods Sold - Definition and Computation

- Compensation - Definition and Computation

- Gross Receipts and Apportionment

- Combined Reporting

- Business Loss Credit

- Proposed Rules

- Questions & Answers

For more information, including times, locations, and contact information, visit http://window.state.tx.us/taxinfo/franchise/tour.html

               

Foreign Corrupt Practices Act

The business world is only getting smaller as time goes on.  Small and mid-sized businesses have traditionally had markets that were limited to the local or regional level and only occasionally reached a truly national level.  But as world markets have opened up and expanded, small and mid-sized businesses are increasingly finding success on that global level.  As such, it is important to understand regulations that affect businesses operating internationally. 

The Foreign Corrupt Practices Act(“FCPA”) should be understood by each and every business operating abroad to avoid possible criminal and civil penalties.  The FCPA was enacted in response to widespread abuse and blatant bribery that was occurring by U.S. companies operating abroad during the 1970s.  Below is a summary of the Act, its enforcement, penalties, and defenses.   This is not intended to be  legal advice for any particular situation, rather it is a simple summary of the Act so SBO’s can better understand how it might affect their business and whether they should seek professional advice.

In its simplest form, the FCPA prohibits payments to foreign officials for the purpose of obtaining or retaining business.  However, one must understand how certain terms in that statement are defined and applied to truly understand the breadth of its impact. 

The first key term is payment.  The FCPA prohibits paying, offering to pay, and promising to pay money or anything of value.  Individuals and companies who get in trouble under this Act often get caught not for the payment of money, but for dinners, business retreats, vacations, and the like.  What might seem like a get in the door meet and greet activity could in fact subject your company to penalties under the FCPA.   When in doubt, seek a professional opinion.

“Foreign official” is specifically defined under the Act and means, “any officer or employee of a foreign government or any department, agency, or instrumentality thereof, or of a public international organization, or any person acting in an official capacity for or on behalf of any such government or department, agency, or instrumentality, or for or on behalf of any such public international organization.”  In laymen’s terms, the FCPA prohibits payments to anyone who is even remotely connected to a foreign government, including employees of government controlled business entities.  Again, when in doubt about a particular situation seek a professional opinion.

The next term to note is “obtaining or retaining business.”  The Department of Justice is the primary enforcement agency of the FCPA and defines “obtaining or retaining business” broadly.  It is not limited to simply acquiring or renewing a particular contract.  In addition, the business benefit does not have to accrue to the person responsible for the prohibited payment; it could go to a third party and still subject the payor to liability.  This definition might not be helpful in a practical way, but serves as a warning that the prohibition can cover a wide variety of activities.  Understanding what is prohibited is easier by looking at what acts are specifically excluded from the prohibition.

Put another way, the FCPA prohibits payments for anything other than “routine governmental action.”   This term is specifically defined in the FCPA to include “an action which is ordinarily and commonly performed by a foreign official in: (1) obtaining permits, licenses, or other official documents to qualify a person to do business in a foreign country; (2) processing governmental papers, such as visas and work orders; (3) providing police protection, mail pick-up and delivery, or scheduling inspections associated with contract performance or inspections related to transit of goods across country; (4) providing phone service, power and water supply, loading and unloading cargo, or protecting perishable products or commodities from deterioration; or (5) actions of a similar nature.” The term is also specifically defined to NOT include, and thus prohibit, “any decision by a foreign official whether, or on what terms, to award new business or to continue business with a particular party.”

There are a variety of penalties that could apply to any person or company caught violating the FCPA.  For criminal penalties, business entities may face fines of up to $2 million dollars.  Individuals could face fines up to $100,000 as well as five years in jail.  The Attorney General may seek civil penalties in addition to the criminal penalties enforced by the Department of Justice.  Individuals should be aware that companies are prohibited from paying their fines under the FCPA.  Also, the actual amount of the fine may exceed the limits above under the Alternative Fines Act which allows a fine up to two times the amount of the benefit sought by the violator.  In case these are insufficient deterrents, there are also private causes of action available to competitors under the RICO statutes and other state or federal law. 

There are several defenses available to any inquiries or charges under the FCPA.  However, the defenses are always specific to a particular situation and thus not worth discussing in detail here.  The important thing for a SBO is to be aware that this Act exists, and to seek a professional opinion when doing business internationally to ensure you are not subjecting yourself to any penalties under the FCPA or other regulatory acts. 

Dealing With Younger Employees and Generation Gaps

This past Sunday’s edition of the Houston Chronicle had an interesting article in the business section.  Jacqueline Taylor provides a Q&A column that gives employers tips on dealing with younger employees.  Ms. Talyor provides insight into several generations and their individual work styles, from the “command and control” generation to those that don’t like to be micromanaged, to the self-confident generation that disregards authority.  Her answer includes several tips on handling the communication gap and difference in style of each generation to develop a healthy and successful working relationship.

But Don't Steal Those General Terms and Conditions

Yesterday’s post pointed you to a discussion on the advantages of using General Terms and Conditions in your business and gave you some ideas on the things you might incorporate into them.   Today, I point you to a cautionary discussion of how you generate those terms and conditions. 

Brett Trout recently posted on IowaBiz.com about the risks involved in copying contracts from online sources.   According to Mr. Trout, some of the risks include awkward or inappropriate language in the contract, negative treatment if the contract ends up in court, failing to properly address the unique circumstances of your business, and even copyright infringement. 

General Terms and Conditions

Who wouldn’t like to cut down on their paperwork and speed up the process of taking and processing orders, no matter their industry?  Well have no fear, a suggestion is here.

Imke Ratschko, author of the New York Small Business Law Blog, recently posted on the advantages of using General Terms and Conditions to increase your efficiency.  This post does a great job of describing the advantages to using General Terms and Conditions as well as suggesting the types of terms a business might incorporate into them.  While this is a relatively common technique, I caution you to consult an attorney to ensure the general terms are adequate, effective in your jurisdiction, and properly incorporated into each individual agreement.

Employee vs. Independent Contract (Addendum)

Last week I addressed the importance of properly labeling a worker as an employee or an independent contractor.  I’ve come across some additional resources on this topic and I wanted to point them out to you.

Rush Nigut, author of Rush on Business,recently  addressed this same employee vs. independent contract topic on his blog.  I should also give Rush a shout out for pointing me in the direction of this next blog that recently addressed the issue as well.

Tripp Atkins, author of Thoughts about Law, Business, Online Marketing & Life, recently analyzed seven factors that the IRS will use when analyzing whether a particular worker is an employee or independent contractor.  This link will send you to a final discussion of the topic that links to each of the seven prior posts.

Where Texas Falls in the Rankings

A couple of interesting rankings have come out in the past month or so that might be of interest to SBO’s across the country. 

The first is the American Justice Partnership’s annual ranking of the 50 states by business liability climate.  Texas finished 18^th in this ranking and probably would have been higher if not for what the report refers to as the “judicial hellholes” of southern Texas.   Texas was praised for leading the way with reasonable limits on non-economic and punitive damages, as well as joint liability reform and the sixth lowest insurance loss ranking in the country. 

The second ranking came from Forbes.com which ranked The Best States for Business.  Texas came in fourth this year, a two spot drop from its second place finish last year.  Of the six factors considered in the rankings, Texas finished in the top 10 for three of them.  The other three were not quite as good as Texas finished outside the top 20 on Quality of Life, Labor, and Business Costs. 

Recent Posts on S-Corps

S-Corporations are one the more common business entities that I receive inquiries about and it appears that S-Corps have been a hot topic in the Texas blog world recently. 

Greg Price, author of the blog From Greg’s Head, has a two part post about S-Corps.  Part 1 discussed the process of forming and electing S-Corp status.  Part 2 discusses the tax and liability advantages this entity offers the SBO. 

Ryan Roberts, author of The Startup Lawyer, recently posted on S-Corps as wells.  His post on How to Make a Late Election for S-Corporation Status discusses the qualifications and process involved in making a late election for S-Corp status.

Employee vs. Independent Contractor

The distinction between an employee and an independent contractor is important for every employer to understand.  While most SBO’s know there is a difference between the two, most SBO’s do not understand how to distinguish or establish the relationship they intend or desire.  The distinction is important as it can affect a variety of things including the SBO’s tax liability, workers’ compensation requirements, and liability for the actions of the employee or independent contractor. 

In Texas, courts generally start with the presumption that the relationship is one of employer and employee.  If there is a contract involved and that contract designates the worker as an independent contractor, then that label is dispositive absent extraneous evidence that the contract is a sham.  But if you think labeling a worker an independent contractor is an easy solution to solving the problem, not so fast. 

What will constitute the extraneous evidence that would overcome the independent contractor label can come in many forms.  It can come in the form of a superseding agreement between the SBO and the worker.  However, and this is the thing most commonly misunderstood by SBO’s, there does not need to be a formal agreement for a court to decide that an independent contractor label is nothing more than a sham. 

Other factors a court might consider are the same factors that a court will consider when there is no contract defining the relationship between the employer and the worker.   Deciding the proper label is a fact intensive determination but it is critical because the outcome will often dictate the result of the overall case.

Some of the extraneous factors a Texas court will consider include:

-          The extent of the employer’s control over the details of the work;

-          The actual control exercised by the employer;

-          The type of occupation and whether that occupation is usually done with an employer’s supervision;

-          Whether the employer is engaged in a distinct occupation or business;

-          The skill required of the worker;

-          Whether the employer is or is not in business;

-          Integration of the worker’s work in the employer’s business;

-          The employer’s right to discharge the worker;

-          The worker’s opportunity to receive profit or loss from the business;

-          The length of time and permanency of the relationship;

-          Whether the worker supplies the instrumentalities of the work, such as tools, supplies, materials, and the place of work;

-          Whether payment is made by the time or by the job;

-          Whether the parties believe they are creating an employer-employee relationship; and

-          Whether payment is on a contingency basis, with the worker receiving no payment unless the work is done.

No single one of these factors is determinative of the outcome and some of the factors will not apply in any given case.  In every case though, the actual control exercised by the employer will be the most important factor considered even though it is not dispositive. 

The bottom line is that an SBO cannot simply say that a particular worker is an independent contractor and expect that decision to have legal effect.  The consequences for failing to properly determine the relationship between the SBO and worker can be quite serious, resulting in legal liability to third parties, insurance issues, and penalties for unpaid employment taxes.  For these reasons, it is critical that an SBO seek help from a professional when defining the nature of an employment relationship is important to the SBO’s business.