August 27, 2014

Account Stated

iStock_000007946595Small.jpgOn December 12, 2008, Layne and Anita Dellamuth bought flooring materials and installation services from Carpets Unlimited. The Dellamuths made a downpayment that left a balance of a little more than $23,000. Carpets Unlimited subcontracted the installation services to Jared Keeton, who performed that work later the same month, but apparently not to the liking of the Dellamuths because a dispute arose between them and Keeton about the quality of the installation. In addition, the Dellamuths objected to additional charges that Keeton added to the amount owed. In February 2009 Carpets Unlimited corrected the work at no additional cost to the Dellamuths.

By August 2011 the Dellamuths still had not paid Carpets Unlimited the remaining $23,000. Carpets Unlimited sent the Dellamuths a letter and invoice, demanding payment, by certified mail, which the Dellamuths signed for on August 27. Another letter and invoice, sent on June 26, 2012, was returned unclaimed. In August the same year, Carpets Unlimited sued the Dellamuths, and the trial court granted Carpets Unlimited's motion for summary judgment. The Dellamuths appealed, and today the Indiana Court of Appeals affirmed the trial court's decision.

An interesting aspect of this case is that Carpets Unlimited did not sue on the basis of breach of contract. Instead, Carpets Unlimited sued solely on the basis of a legal theory known as account stated, a theory that is more often used as an alternative basis for a lawsuit, included in a complaint primarily as a back-up theory in case the plaintiff's breach of contract fails for one reason or another, perhaps because the contract is held to be unenforceable.

An account stated is an agreement between two parties that a statement of an amount owed by one of the parties to the other is correct and an agreement, either express or implied, that the person owing the amount will pay it. Once an account stated is established, it becomes an independent, enforceable agreement; the creditor no longer has to prove the elements of the contract or other basis of the original obligation. Instead, the burden shifts to the debtor to show that the amount is not owed.

Perhaps the most important aspect of account stated - the most powerful for the creditor and the most dangerous for the debtor - is that an agreement need not be expressed but can be implied. If the creditor sends an invoice or account statement to the debtor, and the debtor fails to object within a reasonable time after receiving the invoice or statement, the debtor is deemed to have agreed that the amount set forth in the invoice or statement is correct and to have agreed to pay that amount.

In this case, the Dellamuths failed to object to the August 2011 letter and invoice and were deemed to have accepted the amount of the invoice as a correct statement of the amount they owed and to have agreed to pay that amount. Carpets Unlimited did not have to prove that a contract with the Dellamuths existed or that the materials had been delivered and the services properly performed. Instead, the burden shifted to the Dellamuths to prove that they did not owe the amount of the invoice, and they did not (and presumably could not) do so.

However, the Dellamuths argued two other points that, in other circumstances, might have worked. First, they pointed to case law holding that once a dispute has arisen about debtor's obligation, the debtor need not continue to object to future statements from the creditor. In this case, the Dellamuths argued that by complaining to Keeton about the quality of the installation and they no longer needed to object to statements from Carpets Unlimited in order to avoid an implied acceptance of those statements. The Court of Appeals rejected that argument, pointing out that Carpets Unlimited had corrected the installation and that, although the Dellamuths objected to additional amounts that Keeton added to the total obligation, Carpets Unlimited's invoice was for the $23,000 balance to which the Dellamuths had never objected.

Second, the Dellamuths claimed that the relationship between them and Carpets Unlimited could not give rise to an account stated, pointing to case law holding that prior dealings between the parties is a prerequisite to account stated, apparently arguing that there could be no account stated because they had not previously done business with Carpets Unlimited. The Court of Appeals disagreed, looking to case law from other states to clarify that the requirement for prior dealings between the parties means that there must have been prior dealings that gave rise to the debt described in the account statement. Accordingly, the Court held that the contract between the Dellamuths and Carpets Unlimited for materials and services, as well as the delivery of the materials and performance of the services, satisfied the requirement for prior dealings.

There are two sides to the moral of this story. On the debtors's side, never ignore an invoice or an account statement because you think you do not owe it. Instead of ignoring it, object - and do it in writing to make a record of the objection. On the creditor's side, account stated can be a powerful way to shore up your ability to recover amounts that are owed to you. If in doubt, send a statement or invoice - preferably by a method that includes confirmation of receipt -- and see if the debtor objects.

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August 19, 2014

Small Businesses Not Included in Proposed Reporting Requirement for Government Contractors

iStock_000041719054Small.jpgThe Department of Labor's Office of Federal Contract Compliance Programs ("OFCCP") has issued a notice of proposed rulemaking that would require certain government contractors to submit an Equal Pay Report to the government as a supplement to the Employer Information Report (EEO-1) that is already required.

If a final rule is adopted as proposed, the Equal Pay Report will require companies to report the number of workers within each EEO-1 job category, the total W-2 wages of all workers in each job category, and the number of hours worked by all workers in each job category, all broken down by race, ethnicity, and sex. Only aggregate information will be reported; no information regarding individual wages will be required. In addition, the reports will not include any information on worker qualifications or experience that might help explain any differences among the groups within a job category.

Small Businesses Excluded

Small businesses -- those with fewer than 100 employees -- are excluded from the new reporting requirements. In addition the new reporting requirements apply only to companies that hold a contract, subcontract, or purchase order with the Federal government that, including modifications, covers a period of more than 30 days and is worth at least $50,000.

Purpose of the New Reporting Requirement

According to the Department of Labor, working women earn only 77% of the wages earned by working men, and the gap is even greater for African American women and Latinas. The new reporting requirement is intended to address that situation in two ways: First, it will provide the Department of Labor with a source of information to facilitate enforcement actions against government contractors who violate equal pay regulations. However, enforcement actions will not be based solely on the reported information. Instead, the agency will use the information in targeting and prioritizing its enforcement actions. Second, the Department of Labor will use the reports to compile and issue summary data to assist government contractors with their own internal compliance programs.

Where the Proposed Rule fits in the Rulemaking Process

The notice of proposed rulemaking, or NPRM, was published in the Federal Register on August 8, 2014. (Generally, the NPRM is the first official step in the creation of an administrative rule or regulation, but sometimes it is preceded by an advance notice of proposed rulemaking, or ANPRM.) This NPRM has a 90-day comment period, which means that Department of Labor will accept written comments from the public until November 6, 2014. The NPRM contains not only the proposed regulatory language that, if adopted, would be placed into the Code of Federal Regulations, it also includes an extensive preamble with an executive summary, a discussion of the background of the proposed rulemaking, a section-by-section discussion of the proposed rule, and an analysis of other factors, including the need for the regulation and the anticipated costs of the proposed rule.

Once the comment period closes, the agency will analyze all the comments submitted by the public and, probably, issue a final rule by publishing it in the Federal Register. The notice of the final rule will include the language of the final regulation as well as a preamble that usually includes a summary of the comments recieved from the public and the agency's response to those comments.

How to Submit Comments

If you would like to submit your own comments on the NPRM for the Equal Pay Report, you may do so by any of the following means:

  • You may submit them online at the Federal rulemaking portal,
  • If your comments consist of six pages or less, you may fax them to (202) 693-1313.
  • You may mail them to Debra A. Carr, Director, Division of Policy and Program Development, Office of Federal Contract Compliance Programs, Room C-3325, 200 Constitution Avenue, N.W., Washington, D.C. 20210.

Note that the comments must be received (not merely postmarked) by November 6, 2014. You may view comments submitted by others here.

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August 11, 2014

LLC Veil Piercing: Required Corporate Formalities, revisited

iStock_000014425910XSmall.jpgOne of the factors for determining when the owners of an LLC (or a corporation) may be held liable for the obligations of the business is whether the required corporate formalites have been observed. A while back, we posted an article about the required corporate formalities for Indiana limited liability companies. One of them is that each Indiana LLC must maintain certain records and must make them available to members for inspection and copying. Notably, that requirement is not a default provision that can be reduced or eliminated by the operating agreement.

Last week the LLC Law Monitor blog by Doug Batey of Stoel Rives commented on a Massacusetts case, Kosanovich v. 80 Worcester Street Associates, LLC, No. 201201 CV 001748, 2014 WL 2565959 (Mass. App. Div. May 28, 2014), that imposed liability on the sole member of a Massachusetts limited liability company primarily because of the LLC's failure to maintain records. Doug described the case (correctly, in my view) as "an outlier decision on veil-piercing" for piercing the veil based on so little.

First, a quick summary of Massachusetts veil-piercing law as described in the decison by the Appellate Division of the Boston District Court. A corporate veil may be pierced only in rare circumstances and only to defeat or remedy fraud, wrong, or injustice. Massachusetts courts weigh twelve factors, but the analysis is not merely an exercise in counting factors. The twelve factors are (1) common ownership (presumably relevant when multiple entities are involved); (2) pervasive control (which is not enough, by itself, to pierce the veil); (3) confused intermingling of business assets; (4) thin capitalization; (5) nonobservance of corporate formalities; (6) absence of corporate records; (7) no payment of dividends; (8) insolvency at the time of the litigated transaction; (9) siphoning away of corporation's funds by dominant shareholder; (10) nonfunctioning of officers and directors; (11) use of the corporation for transactions of the dominant shareholders; and (12) use of the corporation in promoting fraud.

In this case, the LLC was owned and entirely controlled by one person, a construction contractor who set up a separate LLC for each of his projects. The only record the LLC produced was a copy of the articles of organization. The owner testified that some of the records might have existed at one time but that they might have been lost when his former partner left the business. There were no tax records, no checkbook, no statements from subcontractors -- none of the records that one would ordinarily expect to be created in the ordinary course of a construction contracting business. The court upheld the trial judge's decision to hold the owner liable based on only two of the twelve factors: pervasive control (which, taken alone, would be insufficient) and the absence of corporate records.

One gets the sense that the court (and almost certainly the plaintiff's lawyer) was frustrated by the absence of records because they are also the records that, if they existed, might have served as evidence of the other veil-piercing factors and of the independent prerequisites of fraud, wrong, or injustice. Nonetheless, there was no evidence of any of the ten other factors nor evidence of fraud, wrong, or injustice. Had there been proof that the owner had destroyed records, it might have justified an inference that the records destroyed would have proven enough to pierce the veil, but there was no evidence of that, either. The evidence proved was that the owner completely neglected business records, but not that he destroyed them. As Doug stated in his blog, "The court's reliance on [the owner's] inadequate record-keeping effectively placed on his shoulders the burden to prove that he was innocent of violating any of the other 12 factors."

Would the result have been the same under Indiana law? I do not believe so, or at least I do not believe that it should, based in part on a provision of the Indiana Business Flexibility Act, the statute that governs Indiana LLCs. As mentioned in the first paragraph, the statute requires Indiana LLCs to maintain certain records and to make them available to members for inspection and copying. However, Ind. Code section 23-18-4-8(e) specifies that failure to maintain those records does not constitute grounds for holding the owners personally liable for the obligations of the LLC. Even without that provision, I do not believe Indiana courts would pierce the veil of an Indiana LLC under similar circumstances, but I think that provision forecloses any possibility of the owner of an Indiana LLC (sole owner or otherwise) being held liable just because the LLC does not maintain the required records.

As Doug also pointed out, lawyers (including this one) advise their business clients to observe formalities of running a business and to maintain good records, including those required by the Indiana Business Flexibility Act, and this case, even if it is an outlier, and even if an Indiana court would not reach the same result, is an example of a business owner who paid a price for not doing so.

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August 8, 2014

Copyright Conundrum: A monkey's selfie

iStock_000028482722Small.jpgOkay, this article in the Washington Post is just too good not to mention.

As reported in 2011 by the Guardian, British photographer David Slater spent three days in an Indonesian national park following and photographing crested black macaques, a type of monkey. At some point, he set up his camera on a tripod and left it unattended for a few minutes. When he returned, he found that the macaques had taken the camera and were taking pictures with it, apparently intrigued by the sound of the shutter. As it turns out, they took some pretty good pictures, including some of themselves. That's right - monkey selfies.

At least one of the pictures was posted on Wikimedia Commons. As Wikimedia has now disclosed, it received from Mr. Slater a "take-down notice" under the Digital Millenium Copyright Act (or DMCA). The take-down provisions of DMCA are intended to deal with some of the unique intellectual property issues created by the internet, including the issue of an online service provider (or "OSP," such as Wikimedia) being liable for copyright infringement when infringing material is posted on the OSP's web site. If the owner of copyrighted material (text, a photograph or other image, video or audio recording, etc.) discovers his material has been posted online, the copyright owner can send a notice to the OSP demanding that it be taken down. If the OSP complies, it will not be liable for infringement. However, the OSP is also required to notify the person who posted the material that it has been taken down, and that person has the opportunity to challenge the allegation of infringement.

In Mr. Slater's case, Wikimedia declined to take down the photograph because it does not believe that Mr. Slater owns the copyright to the photographs. Instead, Wikimedia explained to the ABA Journal that, in its view, no one owns the copyright to the photograph -- not Mr. Slater because he didn't take the photo and not the monkey because monkeys can't own copyrights. And that gives us a good opportunity to discuss how a copyright originates and who owns it.

Copyright protection under title 17 of the United States Code is afforded to "original works of authorship fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device." Examples of works of authorship include literary works; musical works (including lyrics); dramatic works; choreography; pictorial, graphic, and sculptural works; motion pictures and other videographic works; audio recordings; and architectural works. The standard for originality is low; a work is "original" if it was created independently by the author, i.e., without copying another work. In earlier years, the copyright to an original work of authorship did not exist until the work was published, but under today's statute the copyright exists as soon as the work is created. (Once the work is published, some complicated rules dealing with the nationality of the authors and the country in which it is first published kick in, but in most cases publication does not affect the copyright under U.S. law.)

In most cases, the author of a work owns the copyright except for a couple of situations in which the work is considered a "work made for hire." First, works created by their employees while acting within the scope of their employment are "works made for hire," and the copyright belongs to the employer. Second, the copyright to a few types of specially ordered or commissioned work belongs to the person who commissioned the work, and not to the author, if they agree in writing that the work is to be considered as a work made for hire. Of course, the author of a work may agree to transfer the copyright to another person, and the agreement can be made even before the work exists. In that case, the copyright is essentially transferred immediately after its creation.

So what about the monkey's selfie? Does a copyright exist, and, if so, who owns it? I'm not about to try to answer that question, but here are some possible arguments and questions to consider.

  • Certainly the photographs taken by the macaques are within the scope of what is ordinarily considered a work, and they qualify as original. In addition, they are fixed in a tangible medium of expression that satisfies the requirement for a copyright to exist. But is there an author so that they can be considered original works of authorship? It seems logical to assume that the copyright statute presumes that an author must be a human being, so perhaps there is no copyright to the pictures because they are not orginal works of authorship.
  • Why would Mr. Slater not be considered an author? It was his camera, and he created the circumstances that permitted the monkeys to take the camera and trigger the shutter. What if the pictures of the monkeys had been taken by a camera on the tripod with the shutter activated by a motion detector? If (as seems likely) that would be protected by copyright, what distinguishes it from pictures taken by the monkeys physically activating the shutter?
  • Imagine someone leaves a piece of fabric outdoors, fabric that fades in the sunlight. The fabric moves around in the wind so that sometimes it is folded over on itself, creating a pattern on the fabric as it fades. Would the person who placed the fabric outdoors would have a copyright to the pattern? If so, wouldn't Mr. Slater be in an analogous position? Or does it matter whether the person placed the fabric outdoors, intending to create a work of original authorship, or accidentally left the fabric outdoors with no intention of creating anything?
  • What about "elephant art," or paintings made by elephants holding paintbrushes with their trunks? It seems hard to distinguish those paintings from the monkey selfies, so as one goes, the other would likely go as well.
  • Wikimedia seems to admit that there's a copyright, but opines that Mr. Slater doesn't own it. I'd think that the only way a copyright can exist is if Mr. Slater is the author (because, as discussed above, I think an "author" must be human), which means he is also the copyright owner. It seems to me that Wikimedia's stronger argument is that no copyright exists because there is no author. But that's just me.

As I said, I'm not attempting to answer the question of the copyright of the monkey selfies or any of the other above questions, but it will be interesting to see how this gets resolved.

And about the picture at the top of this article? It's a ring-tailed lemur, not a monkey, but it's the best stock photo I could find, and there was no way I was going to use the actual monkey selfies because I'm not at all sure that Wikimedia is right.

[Update August 31, 2014: On August 19, the U.S. Copyright Office issued a proposed third edition of the U.S. Copyright Office Practices. Section 306 provides, "The U.S. Copyright Office will register an original work of authorship, provided that the work was created by a human being. . . . The Copyright Office will not register works created by nature, animals, or plants." It goes on to list several examples of works that will not be registered, including a "photograph taken by a monkey." So at least in the tentative position of the U.S. Copyright Office, Wikimedia got this one right -- the photograph is in the public domain.

And here's what the monkey has to say about it: A Statement from the Monkey.]

Continue reading "Copyright Conundrum: A monkey's selfie" »

July 28, 2014

LLCs and Apparent Authority II

iStock_000007115543Small.jpgLast week I posted an article about apparent authority of a member or manager of an Indiana limited liability companies to bind the LLC, usually by signing a contract on behalf of the company, including a discussion of a 2013 decision of the Indiana Court of Appeals, Cain Family Farms vs. Shrader Real Estate & Auction, addressing the common law doctrine of apparent authority and the provisions of the Indiana Business Flexibility Act that bestow apparent authority on members and managers. Under the facts presented by the record, the court held that apparent authority existed and, in particular, "Whether we consider the question of apparent authority under the common law or the
Indiana Business Flexibility Act, the outcome is the same."

As discussed in last week's Indiana Business Law Blog post, one can imagine situations in which the statute would establish apparent authority but the common law analysis would not, and vice versa. It seems clear that a member or manager has authority to bind a limited liability company if the Indiana Business Flexibility Act says so, even if the member or manager would not have apparent authority under the common law analysis. But what if it's the other way around? Will an Indiana court enforce a contract signed by a member or manager on behalf of the LLC if the member or manager would have apparent authority under the common law but not under the Indiana Business Flexibility Act? Although the Cain Family Farm decision does directly address that question, the Court of Appeals appears to treat the two bases of apparent authority as independently viable, implying that Indiana courts will recognize the apparent authority of a member or manager under the common law even if apparent authority does not exist under the Indiana Business Flexibility Act.

Since I posted the article last week, I've corresponded with my friend John Cunningham, a New Hampshire attorney, a recognized expert on LLCs, a blogger, and co-author of Drafting Limited Liability Company Operating Agreements, my go-to reference for LLC law and operating agreements. I asked John about the question, and he pointed me to the official commentary of the Revised Uniform Limited Liability Company Act, which discusses why the RULLCA leaves the issue of apparent authority of members to the common law. See RULLCA Section 301.

After reflecting on my correspondence with John and reading the commentary to the RULLCA, I've come to believe that the path on which the Court of Appeals appears to have placed Indiana law is a good one. Note that question of apparent authority is irrelevant if the member or manager has actual authority to bind the company, and it cannot be used by another party to avoid a contract with a limited liability company over the LLCs objection. (If nothing else, the LLC can always ratify the contract.) The question arises only when an LLC tries to avoid a contract signed by a member or manager in the absence of actual authority, and the question is, who suffers the consequences -- the LLC or the other party? Although the Indiana Business Flexibility Act creates some areas of relative certainty (which I believe is superior to the intentional silence of the RULLCA), it also denies apparent authority under some circumstances in which the other party to the contract reasonably believes, based on the conduct of the LLC, that the member or manager is acting within his or her authority.

In my personal view, it is better public policy to err on the side of enforcing contracts in those situations by maintaining the common law doctrine as a viable basis for apparent authority, independent of the statutory basis. First, the LLC is in the best position to control the actions of its members or managers, and the operating agreement can provide a remedy when one of them misbehaves. Second, the LLC is also in the best position to control its own actions and to avoid conduct that cloaks its representatives with apparent authority when they lack actual authority. Third, to fail to enforce a contract that the other party entered into in good faith, based on a reasonable belief that the member or manager had authority to bind the company (or to require prospective counterparties to consult the public record before signing a contract with a limited liability company) could cause others to be overly cautious, even leery, of doing business with LLCs.

Whether Indiana courts agree with this analysis remains to be seen.

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July 24, 2014

LLCs and Apparent Authority

iStock_000007115543Small.jpgWhether a particular person has the authority to execute a contract on behalf of another person or entity is a standard question of agency law. If the principal has expressly or impliedly authorized an agent to execute contracts on behalf of the principal, the agent is said to have actual authority. However, a person who does not have actual authority can nonetheless bind the principal if that person has apparent authority.

Common Law Standard for Apparent Authority

The common law analysis of apparent authority is well established. An agent has apparent authority when a third person reasonably believes, based on the conduct of the principal, that the agent has authority. The reason for the belief need not be an actual statement by the prinicipal but can be (and usually is) found in the circumstances in which the prinicipal places the agent, but it is essential that the third party's belief is based on the conduct of the principal; the statements or actions of the agent cannot create apparent authority. Moreover, if the third person knows that the agent has no actual authority, apparent authority does not exist.

Apparent Authority under the Indiana Business Flexibility Act

The Indiana Business Flexibility Act (Article 23-18 of the Indiana Code) contains different rules for the authority of members and managers of limited liability companies, and the rules are slightly different for LLCs formed on or before June 30, 1999 (Section 23-18-3-1), and LLCs formed after that date (Section 23-18-3-1.1).

If the LLC's articles of organization do not provide for managers (i.e., a member-managed LLC), each member is an agent of the LLC for the purpose of the LLC's business and affairs. Accordingly, the act of any member for those purposes, including the execution of a contract, binds the LLC, subject to the following exceptions:

  1. The member does not have actual authority and the person with whom the member is dealing knows that the member does not have actual authority.

  2. The act is not apparently for the purpose of carrying on the LLC's business and affairs in the usual manner, unless the member has been granted actual authority by the operating agreement or by unanimous consent of the members.

  3. For LLCs formed after June 30, 1999, the articles of organization provide that the member does not have the authority to bind the company.

If the LLC's articles of organizations provide for managers, a member acting solely in the capacity of a member is not an agent of the LLC and does not have authority to bind the LLC, except to the extent provided by the articles of organization. Instead, each manager is an agent of the company and has authority to bind the LLC, subject to the following exceptions:

  1. The manager does not have actual authority and the person with whom the manager is dealing knows that the manager does not have actual authority.

  2. The act is not apparently for the purpose of carrying on the LLC's business and affairs in the usual manner, unless the manager has been granted actual authority by the operating agreement or by unanimous consent of the members..

  3. For LLCs formed after June 30, 1999, the articles of organization provide that the manager does not have the authority to bind the company.

Although Sections 3-1 and 3-1.1 of the Indiana Business Flexibility Act speak only of authority and agency, not of apparent authority and apparent agency, it seems clear that those sections deal with apparent authority and that actual authority of managers and members is addressed elsewhere, in Section 23-18-4-1. Indeed, the only Indiana decision to address Section 3-1.1, Cain Family Farm, L.P. vs. Schrader Real Estate & Auction Company, describes that section as a source of apparent authority and not actual authority.

Comparison of Common Law and Statutory Bases for Apparent Authority

The following table summarizes the main differences between the common law basis of apparent authority and the statutory basis.

Common law analysis of apparent authority

Apparent authority of members and managers under Indiana Business Flexibility Act

Applies to any agent of the company.

Applies only to members or managers.

Apparent authority created by conduct of the company.

Apparent authority created by the articles of organization; no other conduct necessary.

The person with whom the member or manager is dealing must have a reasonable belief that the member or manager has authority based on the company's conduct.

As long as the person with whom the member or manager is dealing does not have actual knowledge that the member or manager lacks authority, that person's subjective belief is irrelevant.

No exception for acts outside the usual course of business

No authority for acts outside the apparent usual way the company does business, unless the authority is granted by the operating agreement or by unanimous consent of the members.

When we're dealing with managers of an LLC or with members in a member-managed LLC, the statute confers authority more broadly than the common law because no other conduct on the part of the LLC is necessary. However, the statutory exceptions are also broader because the common law contains no exception for acts outside the usual way the LLC does business. In addition, the statute denies authority to members of a manager-managed LLC (except to the extent the articles of organization confer authority) but the common law analysis treats the members of a manager-managed LLC no differently than any other agent. In other words, it is possible for a manager or member to have apparent authority under the statute but not under the common law, and vice versa. What happens then?

One possibility is that the statute is now the exclusive source of apparent authority for members and managers of LLCs. That would not appear to cause any problems when the statute confers apparent authority more broadly than the common law standard, but what about situations that fall into one of the broader statutory exceptions, for example when the member of a manager-managed LLC takes an action that a third party would reasonably believe, based on the conduct of the LLC, the member was authorized to take? Does the statute abrogate the common law in that situation?

It appears that it does not. In the Cain Family Farms decision mentioned above, the Court of Appeals considered the apparent authority of a member to bind a member-managed LLC. In doing so, the Court of Appeals analyzed the member's authority under both the common law and the Indiana Business Flexibility Act. Perhaps because the Court found that apparent authority existed under both analyses, it did not expressly decide which one would control in the event of a conflict. Nonetheless, the implication seems to be that both sources of apparent authority remain viable and that the LLC will be bound by the actions of a member or manager if either the common law or the Indiana Business Flexibilty Act impute that authority to the member or manager.

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July 21, 2014

Covenant or Condition? Why does it matter?

iStock_000025338621Small.jpgI remember a story told by a business owner who had been involved in the negotiation of a very complicated contract, with both sides represented by high-priced lawyers. In one particularly brutal negotiating session, the lawyers argued at length about a particular provision, with one side saying it should be a warranty and the other side saying it should be a covenant. At long last, they reached some sort of agreement, and everyone took a break for dinner. The business owner related that, as he rode down the elevator with his lawyer, he asked, "What's the difference between a covenant and a warranty?" The answer: "Not much." And that is not too far from the truth. But it would be a very different story if the question had been, "What is the difference between a covenant and a condition?"

The importance of the distinction between a covenant and a condition was driven home by a 2010 decision from the Ninth Circuit Court of Appeals. The decision received a great deal of attention at the time, and I used it as an assignment in the law school class I was teaching on contract drafting. Even though the decision has been thoroughly discussed from every angle, it still serves as a useful reminder to lawyers not to be careless with license agreements and to pay particularly close attention when drafting conditions.

The case was MDY Industries v. Blizzard Entertainment, and it dealt with a license agreement for the popular online role-playing game, World of Warcraft, or WoW. The license agreement prohibited the licensee from using bots to simulate people playing WoW. There was no question that the licensee had violated that term of the agreement. The question was whether the provision was a covenant or a condition.

A covenant is a promise by a party to a contract to do something or not to do something. If the promise is broken, the breaching party is liable to the other party for monetary damages -- usually the amount of money required to put the non-breaching party in the same situation it would have occupied if the covenant had not been broken.

In contrast, a condition is a fact that must exist (or not exist) before another substantive provision of a contract takes effect. In the context of a license agreement, the other substantive provision is the license itself. If the conditions to a license are not satisfied, the license is void. And if the license is void, the breaching party will probably be liable for infringement of the underlying intellectual property -- in this case, the copyright to the software.

So the question before the Ninth Circuit was whether the crucial contract provision was a promise by the licensee not to use bots or a condition on the grant of the license itself. If the former, the licensee would be liable for monetary damages, which would amount to relatively little. However, if the prohibition on using bots was a condition to the license, the licensee would be liable for copyright infringement, including statutory damages that could greatly exceed the damages owed for breach of contract.

In analyzing the provision, the Ninth Circuit noted that the folowing language was under a heading, "Limitations on Your Use of the Service."

You agree that you will not . . . create or use cheats, bots, "mods," and/or hacks, or any other third-party software designed to modify the World of Warcraft experience . . .

First the court disregarded the heading, using the common rule of contract interpretation that headings are for convenience only and are not part of the actual language of the contract. Once that was done, the court noted that there was nothing else about the language to connect the prohibition on bots to the scope of the license or the effectiveness of the grant of the license. Instead, the provision was written merely as an ordinary agreement, or a promise. If the copyright owner's real intent when the license agreement was drafted was to restrict the scope of the license, it could easily have done so by designating the prohibition as a condition to the license. The resolution of the case, or at least part of the case, turned on that subtle, technical drafting issue.

So if you are ever in a contract negotiation and your lawyer is arguing with the other side that a provision should be a covenant instead of a warranty, or vice versa, you might want to take a break and, outside the negotiating room, ask your lawyer if it is really worth the time to argue about it. However, if your lawyer is arguing with the other lawyer about a covenant versus a condition, you can be fairly certain it really is worth the time.

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July 17, 2014

Anticipatory Breach and Mitigation of Damages revisited: The Indiana Supreme Court Clears the Minefield

iStock_000030882778Small.jpgLast year we wrote about a decision of the Indiana Court of Appeals, Fisher v. Heyman, that addressed the amount of damages owed to the seller of a condominium after the buyers refused to go through with the sale unless the seller corrected a minor electrical problem. See "Anticipatory Breach and Damage Mitigation: A Minefield for Real Estate Sellers?" Today the Indiana Supreme Court overruled the decision of the Court of Appeals.

The case began with a purchase agreement for a condo between Gayle Fisher, the seller, and Michael and Noel Heyman, the buyers. The purchase agreement permitted the buyers to have the condo inspected and to terminate the agreement if the inspection revealed major defects. The inspection report showed that some electical outlets and lights did not work. The Heymans informed Fisher that they would terminate the contract unless Fisher corrected the problem by a specified date. Fisher did not meet the deadline, and the Heymans refused to go through with the purchase. However, shortly after the deadline passed, Fisher had an electrician repair the problems, for which the electrician charged her $117. By then, however, the Heymans had found another property and refused to purchase Fisher's condo. Fisher put the condo back on the market, but the best offer she received was $75,000 less than the price that the Heymans had agreed to pay. In the meantime, she incurred additional expenses that raised her damages to over $90,000.

The buyers argued that they believed the electrical problem was a major defect that allowed them to back out of the deal. However, the trial court and the Court of Appeals disagreed with the buyers, holding that the demand for repairs was an anticipatory breach, a concept we discussed in our previous blog post. The Supreme Court decision changes nothing about that aspect of the Court of Appeals decision. Both the Court of Appeals and the Supreme Court held that trial court did not err by finding that the electrical problems were not a "major defect" and that the buyers breached the purchase agreement by making a demand that they were not entitled to make. The difference between the two opinions is how to analyze the seller's duty to mitigate damages.

When one party breaches a contract, the other party is entitled to damages sufficient to put the non-breaching party in the same position it would have occupied had the contract been performed. However, the non-breaching party must use reasonable efforts to mitigate the damages. This case illustrates the concept nicely. The original purchase price was $315,000. Sometime later, Fisher received, but rejected, an offer of $240,000. Ultimately, she sold the condo for $180,000. The trial court found (and the Supreme Court affirmed) that Fisher acted unreasonably when she rejected the offer of $240,000. Accordingly, the most she could recover was the difference between $315,000 and $240,000, not the difference between $315,000 and $180,000. The question, however, is whether the doctrine of mitigation of damages required Fisher to comply with the Heymans' demand to have the electrical problem fixed. If so, she would be able to recover only $117, the amount it cost her to fix the electrical problems. Last year, the Court of Appeals said yes.

Today, the Supreme Court said no, agreeing with Judge Cale Bradford of the Court of Appeals. In his dissenting opinion, Judge Bradford reasoned that the doctrine of mitigation of damages does not require the non-breaching party to accede to a demand that creates a breach. The Supreme Court agreed with that reasoning and elaborated that, just as a non-breaching party may not put itself in a better position than it would have been had the contract been performed as agreed, neither can the breaching party. Here, the buyers agreed to pay $315,000 for a condo that had minor electrical problems (if tripped ground fault interrupters and burnt out light bulbs can be considered "problems"), and the seller was not obligated to sell them a condo with no electrical problems for the same price. Result: The Heymans owed Fisher not $117, but more than $90,000.

Setting aside the legal arguments, the Supreme Court decision avoids some very practical, real-world issues that would have been posed by the Court of Appeals decision. Had that decision stood, the law in Indiana would have allowed a party to a contract to continue to make additional demands on the other side, confident that the worst thing that could happen is that it would be required to pay the incremental cost of the demand. Conversely, the party on the receiving end of those demands would be forced to choose between acceding to them or being satisfied with the incremental cost of the demand, regardless of the magnitude of its actual damages.

A simple example: Imagine a musician who agrees to perform at a concert for $20,000. The organizer of the concert has already incurred another $30,000 in expenses and sold $100,000 worth of tickets. At the last minute, the musician refuses to go on stage unless he is paid an additional $10,000. The organizer would be forced to choose between paying the additional $10,000 or suffering a loss of $80,000, while being able to recover no more than $10,000. Surely that is not how mitigation of damages is supposed to work.

[Note: In discussing the example of the last paragraph, this post originally mentioned a loss of $130,000 rather than $80,000, but that's not the way damages are calculated. The organizer's damages would be the cost of refunding the price of the tickets ($100,000) less the $20,000 that the organizer originally promised the musician. The $30,000 in expenses would have been incurred even if the concert proceeded, giving the organizer a profit of $50,000. If the musician breached, the organizer would have to refund the price of the tickets, leaving the organizer with a $30,000 loss. To put the organizer in the same position it would have occupied had the contract not been breached -- i.e., with a $50,000 profit -- the musician would owe the organizer $80,000.]

Continue reading "Anticipatory Breach and Mitigation of Damages revisited: The Indiana Supreme Court Clears the Minefield" »

July 9, 2014

Office Lease: No signature, no personal guaranty

iStock_000014240498_Small (1).jpgBJ Thompson Associates, Inc. leased an office from Jubilee Investment Corp. The lease included the following language:

Guaranty of Performance In consideration of the making of the above Lease by LANDLORD with TENANT at the request of the undersigned Guarantor, and in reliance by LANDLORD on this guaranty the Guarantor hereby guarantees as its own debt, the payment of the rent and all other sums of money to be paid by TENANT, and the performance by TENANT of all the terms, conditions, covenants, and agreements of the Lease, and the undersigned promises to pay all LANDLORD'S costs, expenses, and reasonable attorney's fees (whether for negotiations, trial, appellate or other legal services), incurred by LANDLORD in enforcing this guaranty, and LANDLORD shall not be required to first proceed against TENANT before enforcing this guaranty. In addition, the Guarantor further agrees to pay cash the present cash value of the rent and other payments stipulated in this Lease upon demand by LANDLORD following TENANT being adjudged bankrupt or insolvent, or if a receiver or trustee in bankruptcy shall be appointed, or if TENANT makes an assignment for the benefit of creditors.

Even though the above language referred to "the undersigned Guarantor," the lease had no signature block for a guarantor. It had signature blocks for only the landlord and tenant. The signature block looked like this

BJ Thompson Associates, Inc.

By: ____________________

Date: __________________

followed by the address for BJ Thompson Associates, Inc. and the word "TENANT." It was signed by BJ Thompson, the sole shareholder and president of BJ Thompson Associates, Inc.

The original term of the lease was for one year, but the tenant held over for a number of years. (In essence, the lease was automatically renewed for successive one-year terms.) Eventually, however, the tenant moved out three months into the year and stopped paying rent. The landlord sued both BJ Thompson Associates, Inc. for rent for the remaining nine months, and it also sued BJ Thompson personally on the theory that he had personally guaranteed his company's obligations under the lease. The trial court dismissed the complaint against BJ Thompson personally because he had signed the lease only on behalf of his company as tenant and not on his own behalf as guarantor. In an unpublished opinion, the Court of Appeals agreed.

A guaranty is a promise by one person to pay the obligations of another person. When landlords sign leases with small businesses, it is common for them to require the lease to be personally guaranteed by the business owners, and the same thing occurs with other types of contracts as well. A guaranty is simply a particular type of contract, and it is governed by the same rules that apply to the interpretation and enforcement of other contracts. However, a guaranty is also one of several types of contracts subject to the statute of frauds, which says that, in order for a contract to be enforced, the contract must be in writing and must be signed by the party against whom it is being enforced.

In this case, the lease included language obligating "the undersigned Guarantor," but it did not identify BJ Thompson as the guarantor, and, although BJ Thompson signed on behalf of his company, the tenant, nothing in the lease identified his as the guarantor and nothing in the signature blocks indicated that he was signing in any capacity other than as the agent of his company.

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July 2, 2014

Streamlined Application for Tax Exempt Organizations

iStock_000018610908Small.jpgAs anticipated, the Internal Revenue Service announced a streamlined, much simpler and shorter version of Form 1023, the Application for Recognition of Tax Exempt Status.

Standard Form 1023

The standard Form 1023 is 26 pages long, not counting a 38-page instruction booklet, 3 additional pages of instructions the IRS has added to the front of the form making changes to the form and the instructions, and a 2-page checklist to make sure the entire submission package is complete and compiled in the correct order. But that's not all -- one of the most important sections of the form, Part IV, is only about a quarter-page long but it calls for the applicant to attach a detailed narrative description of the organization's activities explaining how each of them supports the organization's charitable purpose, and several other sections leave so little room to include all the necessary information that most applicants find it necessary to attach addtional pages. With all that, and with the other information that must be submitted, such as articles of incorporation and bylaws, Form 1023 submission packages can easily reach 50, 60, or 70 pages.

The IRS says that they currently have a nine-month backlog of Form 1023 applications, and it is possible that number is actually an understatement. Once received by the IRS, Form 1023 applications go through a sort of triage process. Applications that are complete and do not appear to pose significant obstacles to approval are directed into a queue to be processed more quickly than applications that will require the IRS to request significantly more information. Just this week our office received a determination letter for a Form 1023 that had been pending for more than seven months, and that application was, presumably, directed through the quicker process.

Form 1023-EZ

In contrast, Form 1023-EZ is less than three pages long, although that is a little misleading because it still requires an instruction booklet with 10 pages of instructions to explain how to complete the form, a 7-page worksheet that must be completed in order to determine if the organization is eligible to use the streamlined form, and a 3-page list of National Taxonomy of Exempt Entities (NTEE) Codes from which the applicant must select the code that best fits the organization. Nonetheless, Form 1023-EZ should be considerably less burdensome than the standard form.

After completing the worksheet, the applicant must file the form online at, which requires a username and password obtained through free registration. Any applications submitted on paper are automatically deemed incomplete.


Most organizations with annual revenues less than $50,000 for the current year, each of the previous three years, and the next two projected years are eligible to submit Form 1023-EZ. However, some types of organizations must submit the standard Form 1023 regardless of revenues. Here is a partial list of organizations that are ineligible for Form 1023-EZ:

  • Those organized as limited liability companies.

  • Churches and associations or conventions of churches. (Note: Churches are not required to submit an application for recognition of tax exempt status, but if they do not, they will not have a determination letter from the IRS, which can be useful for various reasons. Those that wish to receive a determination letter will continue to submit Form 1023 rather than 1023-EZ.)Schools, colleges, and universities.

  • Hospitals, medical research organizations, and hospital organizations.

  • Health maintenance organizations (HMOs).

  • Accountable care organizations (ACOs).

  • Supporting organizations (i.e., charitable organizations that are derive their status as public charities from their supporting relationship to another charitable organization that is a public charity).

  • Credit counseling organizations.

  • Organizations that have previously had their tax exempt status revoked except organizations that have had their tax exempt status revoked for failing to file Form 990 (or 990-EZ or 990-N) for three consecutive years.

That last part is significant because many smaller organizations have lost their tax exempt status for failure to file Form 990, and Form 1023-EZ will be available to those wishing to have their tax exempt status reinstated.

Continue reading "Streamlined Application for Tax Exempt Organizations" »

June 30, 2014

Partnership Dissolved, but Partner Still Liable

iStock_000023649013Small.jpgLast year the Indiana Court of Appeals decided a case that illustrates some of the hazards of operating a business as a general partnership. The case is Curves for Women of Angola vs. Flying Cat, LLC.

In 2001, a married couple, Dan and Lori, purchased a fitness and health franchise known as Curves for Women that they intended to operate in Angola, Indiana. The franchise agreement, which Dan and Lori both signed, contained the following affirmation:

We the undersigned principals of the corporate or partnership franchisee, do as individuals jointly and severally, with the corporation or partnership and amongst ourselves, accept and agree to all of the provisions, covenants and conditions of this agreement[.]

At no time did Dan and Lori form a corporation or limited liability company to own the franchise - not before signing the franchise agreement and not after.

At about the same time, Dan and Lori leased space in which to operate the business, known as Curves for Women of Angola. The landlord was Flying Cat, LLC. Both Dan and Lori signed the lease, each in the capacity of "Owner." The lease was for a term of three years, with options to renew for additional three-year terms.

After the lease was signed, the business began operation. Lori managed the day-to-day operations, and Dan handled the responsibilities for accounting and equipment maintenance. The profits from the business were treated as joint marital property, available to both Dan and Lori.

In 2004, Dan and Lori exercised the option to renew the lease. As with the original lease, they both signed the renewal agreement.

In 2005, Dan and Lori separated. Over the next two years, they made several attempts to reconcile, but in 2007 Lori filed for divorce.

After she filed for divorce, Lori signed a second lease extension with Flying Cat, LLC. Dan did not sign the renewal agreement. At the time the second lease extension was signed, the business was already behind in its rent, and over the next two to three years, it fell even further behind. In 2010, Flying Cat, LLC sued Curves for Women of Angola, Lori, and Dan, claiming that, as partners, Lori and Dan were both personally liable for the back rent owed by the partnership.

First, the Court of Appeals held that a partnership existed between Dan and Lori. In doing so, the court cited Ind. Code § 23 4 1 7, which provides that, with certain inapplicable exceptions, the receipt by a person of a share of the profits of a business is evidence that a partnership exists. Once a partnership exists, each partner is personally liable for all the obligations and debts of the partnership. In addition, it requires the signature of only one partner to form a contract that binds the partnership and, by extension, binds all the partners.

However, Dan argued that he was not bound by the second lease extension that Lori signed after she filed for divorce, pointing to the fact that her petition clearly indicated her intent to terminate the business relationship with Dan. The Court of Appeals agreed with Dan that the partnership was dissolved when Lori filed her petition, but nonetheless held that Dan was liable for the second lease extension.

The basis for the holding lies in Ind. Code § 23 4 1 35(1)(b), which provides that a partner can bind the partnership after dissolution if the other party to the transaction knew that the partnership existed prior to dissolution and had no knowledge or notice that the partnership had been dissolved. Notice can be provided by publishing a notice of the dissolution in a newspaper of general circulation in the place where the partnership regularly conducted business. The Court of Appeals noted that the landlord knew of the partnership prior to dissolution, that the landlord had no knowledge or notice of the dissolution, and that no notice had been published in the local newspaper. Accordingly, Lori's signature on the second lease extension bound the partnership and, by extension, Dan, even though the partnership was already dissolved.

Because each partner to a general partnership is liable for all the obligations and debts of the business, including obligations and debts incurred by one partner even without the knowledge of the others, it is hard for us to imagine a situation in which we would advise a client to organize a business as a general partnership. Even so, general partnerships exist, and, as this case illustrates, a partner leaving the partnership must take appropriate measures - including publication of a notice of dissolution - to protect himself or herself from incurring further liability.

Continue reading "Partnership Dissolved, but Partner Still Liable" »

June 2, 2014

Family Businesses: Succession planning for LLCs

iStock_000017700348Small.jpgOwners of Indiana LLCs (and their lawyers) can learn some lessons from a recent case involving an Alabama LLC. The case is L.B. Whitfield, III Family LLC v. Virginia Ann Whitfield, et al.

The Whitfield Case

L.B. Whitfield, III owned half of the voting stock in a business that had been in his family for generations. The other half had belonged to L.B.'s brother, who died and left the stock to a trust for the benefit of his son. L.B. had four children, his son Louie, and three daughters. After his brother's death, L.B. became concerned that the 50/50 voting balance might be disturbed if, after he died, his stock were to be divided among his four children. To prevent that from happening, L.B. created a manager-managed Alabama limited liability company to hold his half of the voting stock. L.B. was the sole member, and he and Louie were the two managers. Upon his death, his interest in the LLC passed in four equal shares to his four children in accordance with his will.

After L.B.'s death, Louie continued as manager, and the four children were treated as members of the LLC. About 10 years later, a dispute arose between Louie and his sisters, and the dispute escalated into litigation. Ultimately, the litigation was resolved on a theory that was not argued in the original pleadings and, in fact, appears not to have occurred to the lawyers involved until several months into the case.

The Alabama Supreme Court noted that L.B. had been the sole member of the LLC and that, after he died, the LLC had no members. His will gave them equal shares of his econimic rights in the LLC (his "interest"), but economic rights in an LLC and membership are two different things. The Court further noted that, under the Alabama LLC statute, a limited liability company that has no members is dissolved and its affairs must be wound up, a process which includes payment of its debt and distribution of its remaining assets to the holders of interest in the LLC (who are not necessarily members). Accordingly, the Court held that the assets of the LLC should be distributed in four equal shares to Louie and his sisters.

Interestingly, the Alabama statute provides a way that L.B.'s heirs could have become members and avoided the dissolution of the LLC, but they had to do it by mutual written agreement within 90 days of L.B.'s death, and there was no such written agreement.

How does it work in Indiana?

If the Whitfield case had involved an Indiana LLC, the results might well have been the same. Unless other provisions (discussed below) have been made to avoid the result, when the single member of an LLC dies, that member will be dissociated (i.e., will cease to be a member) (Ind. Code 23-18-6-5(a)(4)), the LLC will have no members, and, as a result, it will be dissolved (at least if the LLC was formed after June 30, 1999) (Ind. Code 23-18-9-1.1(c)). As a result, the member's heirs will not receive an ongoing business; instead, they will receive only the rights to receive distributions from the dissolved LLC after all obligations are satisfied -- which may be far less valuable than the business would have been as an ongoing concern.

Note that there are other scenarios that can create a similar result. Under Ind. Code 23-18-6-4.1(e) (which applies only to LLC's formed after June 30, 1999), a member who assigns her entire interest to another person ceases to be a member. If the person making the assignment is the sole member, the person who receives the interest can become a member, Ind. Code 23-18-6-4.1(b) provides that the person who receives the interest can become a member "in accordance with the terms of an agreement between the assignor and the assignee." But what if there are no such terms? What if the agreement simply says, "Seller hereby assigns her interest in the LLC to Buyer," but doesn't mention membership? In that case (unless the operating agreement already deals with the situation some other way), the LLC will have no members, and it will be dissolved. In other words, the person who thought he bought an ongoing business may well have bought only the rights to receive distributions from a dissolved LLC.

Now, what if there are multiple members and one of them dies? In that case, the LLC is not dissolved (at least not if it was formed after June 30, 1999), but the member's heirs may not become members. Although they may inherit the deceased member's interest (i.e., rights to receive distributions), they will become members (and therefore have the right to participate in the management of the company), only if the operating agreement makes some other provisons or the other members unanimously consent.

What should you do?

If you own an LLC, or if you own part of an LLC, and these possibilities make you uncomfortable, you need a business succession plan that includes two different components. First, it should include appropriate estate planning tools to make sure that your economic interest in the LLC goes to the people you want to taken care of after your death. For example, you may want to designate a transfer-on-death beneficiary to your interest in the LLC. Second, the LLC should have an operating agreement with appropriate provisions to ensure that your heirs benefit not only from the right to receive distributions from the LLC but also the right to participate in its management, along with other rights of membership. There are different ways to do that; an attorney with experience in business succession planning, particularly with Indiana LLCs, can help you choose the best one for you.

Continue reading "Family Businesses: Succession planning for LLCs" »

May 14, 2014

Indiana Supreme Court Holds Police Interrogation Went Too Far

100_3697.JPGOrdinarily, I leave this area of the law to the Smith Rayl Criminal Defense Division and my partner, Susan Rayl, but today (well, yesterday by the time I'm writing this) the Indiana Supreme Court issued a decision, written by Justice Stephen David, that deserves notice here, even though it has nothing to do with business law or nonprofit organizations. In Bond v. State, the Court held that the defendant's confession was involuntary, and therefore inadmissible as evidence against him, because it was obtained through interrogation by a police officer who told the defendant, an African American from Gary, Indiana, that his race would prevent him from getting an impartial jury or a fair trial.

The officer's interrogation strategy was to persuade the defendant that the police knew he was guilty and that the only way he could improve his situation was to confess. Over a period of three hours, the officer suggested that the defendant might be charged with a less serious crime if he confessed and told the defendant that a confession would allow him to see his children and talk to his mother. Then, about two hours into the interrogation, the officer told the defendant:

[d]on't let twelve people who are from Schererville, Crown Point--white people, Hispanic people, other people that aren't from Gary, from your part of the hood--judge you. Because they're not gonna put people on there who are from your neck of the woods. You know that. They're not gonna be the ones to decide what happens to you. You know that. I know that. Everybody knows that. All they're gonna see is, oh, look at this, another young motherf***** who didn't give a f***.

About an hour later, the defendant confessed.

Although both the trial court and the Court of Appeals criticized the officer's statement, neither found it sufficiently coercive to render the confession inadmissible. In a unanimous decision filled with quotations from U.S. Supreme Court decisions, an article by the Court's former Chief Justice, and the writings Dr. Martin Luther King, Jr., the Supreme Court disagreed.

The Court acknowledged that police are given wide latitude in interrogating suspects. Many people (including many suspects who are later charged and convicted) are surprised to learn that the police are not required to tell the truth during interrogations, and the Supreme Court specifically noted that the other interrogation tactics used in this case (suggesting that a confession might lead to a lesser charge and promising to let the defendant see his family in exchange for a confession) were acceptable. But the suggestion that the defendant could not get a fair trial because of his race went too far. Justice David wrote:

[I]n this case Bond was intentionally deceived as to the fairness of the criminal justice system itself because of the color of his skin. Regardless of the evidence held against him or the circumstances of the alleged crime, he was left with the unequivocal impression that because he was African American he would spend the rest of his life in jail. Unless he confessed. And in unfortunate days gone by, this might have been the case. But no one wants to go back to such a time or place in the courtroom, and so we will not allow even the perception of such inequality to enter the interrogation room.

For a number of reasons, the decision is likely to serve as strong precedent. For example, confession was ruled involuntary despite the fact that an hour elapsed between the officer's racial statements and the confession itself. Moreover, the Court made it clear that it did not believe the interrogator was racially motivated, which means that defendants seeking to have similar confessions excluded from evidence will not be required to prove that police officers are themselves racists. In addition, because the officer did not expressly refer to the fact that the defendant was African American, veiled references are not likely to save an otherwise impermissible interrogation. Finally, the Court's express approval of the other interrogation tactics means that the officer's racial statement alone was sufficient to taint the entire interview and therefore the confession that it produced.

As Justice David wrote,

[D]espite nearly two hundred years of effort by civil rights activists, legislatures, law enforcement, courts, and others, the perception remains that racial discrimination still exists within our justice system: from police treatment to jury selection to jury verdicts and sentences. And the perception is especially common within the African-American community. It defines reality for many African Americans faced with, serving in, or incarcerated by our criminal courts, and unquestionably has roots in our nation's tortured history of race relations. That there remains such fear or mistrust of the justice system is why all courts must remain vigilant to eradicate any last vestiges of the days in which a person's skin color defined their access to justice.

Continue reading "Indiana Supreme Court Holds Police Interrogation Went Too Far" »

April 5, 2014

Indiana Limited Liablity Companies and the Required Formalities

iStock_000034659194Small.jpgA primary reason to organize a business as a corporation or a limited liability company (LLC) is to protect the owners from personal liability for the debts of the business. Sometimes, however, a court may "pierce the corporate veil" of a business to hold the owners of the business personally liable for the company's obligations.

In deciding whether to pierce the corporate veil, Indiana courts examine and weigh several factors, including whether the owners of the business have observed the required formalities for the particular form of organization. One of the reasons we generally favor LLCs for small businesses is that there are fewer required formalities for LLCs than for corporations, which in turn means that there is not only a lower administrative burden associated with LLCs, but also fewer opportunities for business owners to miss something. However, there are a few requirements, discussed below.

1. An Indiana LLC must have written articles of organization, and the articles must be filed with the Indiana Secretary of State .

There's almost no need to mention this one because an LLC does not even exist until its articles of organization are filed with the Secretary of State, but for the sake of being complete . . .

The articles of organization must state:

  • The name of the LLC, which must include "limited liability company," "LLC," or "L.L.C."
  • The name of the LLC's registered agent and the address of its registered office (discussed in more detail below).
  • Either that the LLC will last in perpetuity or the events upon which the LLC will be dissolved.
  • Whether the LLC will be managed by its members or by managers. (Technically, the articles can remain silent on this point, in which case the LLC will be managed by its members, but the Secretary of State's forms call for a statement one way or the other.)

2. An Indiana LLC must have a registered agent and a registered office within the State of Indiana.

The purpose of this requirement is to give people who sue the LLC a way to serve the complaints and summons. The registered office must be located within Indiana, and it must have a street address. A post office box is not sufficient. The registered agent must be an individual, a corporation, an LLC, or a non-profit corporation whose business address is the same as the registered office's address.

The registered office and registered agent must be identified in the articles of incorporation and in the business entity reports (discussed below) filed every other year with the Indiana Secretary of State, but the requirement to have a registered office and registered agent applies all the time, not just when those filings are made. If the LLC's registered agent resigns, the LLC must name a new one and file a notice with the Secretary of State within 60 days.

In addition, LLCs formed after July 1, 2014, are required to file the registered agent's written consent to serve as registered agent or a representation that the registered agent has consented. That new requirement was established by Senate Bill 377, passed by the 2014 General Assembly and signed into law by the governor.

3. An Indiana LLC must keep its registered agent informed of the name, business address, and business telephone number of a natural person who is authorized to receive communications from the registered agent.

This is another new requirement contained in Senate Bill 377. It takes effect on July 1, 2014.

4. An Indiana LLC must maintain certain records at its principal place of business.

The required records are:

• A list of the names and addresses of current and former members and managers of the LCC.
• A copy of the articles of organization and all amendments.
• Copies of the LLC's tax returns and financial statements for the three most recent years (or, if no tax returns or statements were prepared, copies of the information that was or should have been supplied to the members so they could file their tax returns).
• Copies of any written operating agreements and amendments, including those no longer in effect.
• A statement of all capital contributions made by all members.
• A statement of the events upon which members will be required to make additional capital contributions.
• The events, if any, upon which the LLC would be dissolved.
• Any other records required by the operating agreement.

[Note: Ind. Code 23-18-4-8(e) provides that the failure to keep the above records is NOT grounds for imposing personal liability on members for the obligations of the LLC. It's more likely to become an issue in the event of a dispute among the members. Thanks to Josh Hollingsworth of Barnes & Thornburg for reminding me. MS:4/7/2014].

5. An Indiana LLC must file a business entity report with the Secretary of State every two years.

The report is due at the end of the month that contains an even-numbered anniversary of the filing of the articles of organization. Failure to file the report within 60 days of the due date is grounds for administrative dissolution of the LLC.

Continue reading "Indiana Limited Liablity Companies and the Required Formalities" »

March 25, 2014

The Difference Between Tax Status and Legal Form of a Business or Nonprofit

iStock_000005953904Small.jpgI just read a report by the Small Business Administation that includes a wealth of statistics and other information about small businesses in the United States. As useful as the report is, it contains a mistake that, although commonly made, one would not expect from the SBA. The last item in the report asks the question, "What legal form are small businesses?" That's a good question, but the SBA didn't answer it. Instead, it answered another question, "What is the tax status of small business?" Even though the two questions are related, they are nonetheless distinct, and answering the second question does not answer the first.

Legal Form of a Business or Nonprofit

As we've discussed before, businesses are commonly organized according to one of a handful of legal forms: sole proprietorships, general partnerships, corporations, and limited liability companies. There are a few others used less frequently, including limited partnerships, limited liability partnerships, and professional corporations. Tax exempt organizations are commonly organized as nonprofit corporations, but they can also be organized as unincorporated associations, charitable trusts, and sometimes limited liability companies.

The legal form of a business or tax exempt organization is primarily related to two fundamental attributes: who controls the organization, and who is liable for the organization's obligations. For example, if a business is structured as a general partnership, the partners collectively control the business and the partners are individually liable for the obligations of the partnership. In contrast, if a business is structured as a corporation, it is probably controlled by a board of directors, elected by the shareholders and acting through the officers. Unless something goes wrong, neither the shareholders, the directors, nor the officers are liable for the corporaton's obligations.

Tax Categories

Although selecting the legal form of an organization determines the attributes of control and liability, it does not determine how much income tax the organization must pay. There are four common possibilities of tax status for businesses and nonprofit organizations, categorized by the applicable subchapter of Chapter 1 of Subtitle A of Title 26 of the United States Code (also known as the Internal Revenue Code): Subchapter C (the default provisions for corporations), Subchapter S (which is an alternative to Subchapter C that can be elected by small business corporations that meet the eligibility criteria), Subchapter K (for partnerships), and Subchapter F (for tax exempt organizations). Finally, some types of legal forms that have a single owner, such as sole proprietorships, are diregarded for income tax purposes, with their income reported on the owner's income tax return. Those businesses or nonprofit organizations are known as, appropriately enough, "disregarded entities."

Each of these tax categories can apply to more than one type of legal form of organization, and with two exceptions (sole proprietorships and general partnerships), each legal form has more than one possibility for the tax category, as shown in the chargt below. Even nonprofit corporations have more than one possibility; while most nonprofit corporations are organized with the intent of qualifying for Subchapter F (exempt organizations), if a nonprofit corporation fails to meet the criteria for tax exemption, it will be subject to taxation under Subchapter C.

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