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 limitied 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.

Thumbnail image for Legal Form Tax Status Table cropped.jpg

Now you won't make the same mistake that the SBA made.


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March 21, 2014

The Confusing Status of the Indiana Statute of Limitations for Breach of Written Contracts

iStock_000005882706Small.jpgSuppose that eight years ago, you hired a construction contractor to build an addition to your house in Indiana. Shortly after the construction was finished, you noticed that the roof shingles on the addition weren't quite the same color as those on the rest of the house. You checked the bundle of extra shingles that the contractor left behind and compared the information on the label with the specification in the contract. Sure enough, the contractor used the wrong shingles. Not only were they the wrong color, but they were also a lower quality than the contract specifications required. Even so, you were busy at the time and never got around to calling the contractor to get him to correct the mistake. Now you have a potential buyer for the house who is threatening to back out of the deal unless you replace the shingles. You call the contractor and demand that he correct his mistake. He refuses, saying it is too late for you to complain about the problem, that you should have called him as soon as you noticed it. Are you out of luck or not?

Statutes of Limitations

The key to answering the question is to determine the applicable statute of limitations. A person who has the right to sue someone for breach of contract (or, for that matter, the right to sue for other reasons) cannot wait forever to do it. How long the person can wait is determined by the statute of limitations that applies to the particular type of claim. In Indiana, there are two different statutes that might apply to the situation described above:

Which one applies?

It has been more than six years, but less than ten, since the addition to your house was finished and you noticed the problem with the shingles. Which statute applies?

Certainly your construction contract called for the payment of money, but don't most contracts do that? Is every contract that requires payment of money subject to the six-year statute of limitations, regardless of the rest of the contract? If so, that leaves the ten-year statute of limitations to cover only those contracts that do not involve the payment of money at all. On the other hand, maybe the idea is that the six-year statute of limitation covers contracts that do not involve anything other than the payment of money.

Surprisingly, there are very few published Indiana court decisions that address the question of which written contracts are covered by the six-year statute of limitations and which are covered by the ten-year statute, even though those statutes originated in 1881. However, the Indiana Supreme Court addressed the question with respect to an earlier version of the statutes in 1923.

The Ten-Year Limitation

The case was Yarlott v. Brown (192 Ind. 648, 138 N.E. 17, for those who would like to look it up), and the question was the statute of limitations on a mortgage. (At the time, the two statutes of limitation on written contracts were 10 years and 20 years, rather than 6 years and 10 years. A lawsuit was brought more than ten years, but less than 20 years, after the loan was supposed to be repaid.) Even though people commonly refer to the loans they take out to buy their homes as "mortgages," in reality the mortgage is actually a document that reflects the lender's right to foreclose on the property if the loan is not repaid; the obligation to pay the loan itself is set out in another document, called a note. However, in Yarlott, even though the mortgage was accompanied by a note, the mortgage contained not only the right of the lender to foreclose; it also repeated the obligation to repay the loan. It was clear that the statute of limitations on the note itself -- a written contract for the payment of money -- expired after ten years. But what about the mortgage? If it had not mentioned the repayment of th loan, it would have been subject to the longer statute of limitations. Did the fact that it repeated the obligation to repay the loan move it to the shorter limitation, the one that applied to "promissory notes, bills of exchange, and other contracts for the payment of money"?

The Indiana Supreme Court said no, the 20-year statute of limitations applied to the mortgage, despite the fact that it also provided for the payment of money. The Court reasoned that

. . . a mortgage differs in essential particulars from a promissory note, bill of exchange, or other written contract for the payment of money of the same kind as notes and bills. On the other hand, many actions which may be brought on such a mortgage bear a close resemblance to actions for the collection of judgments of courts of record, which are liens on real estate, or to actions for the recovery of possession of real estate. A familiar rule of statutory construction is that, where words of specific and limited signification in a statute are followed by general words of more comprehensive import, the general words shall be construed to embrace only such things as are of like kind or class with those designated by the specific words, unless a contrary intention is clearly expressed in the statute.

The underlining in the above quotation is ours, not the court's, but those words are the key to understanding the decision. The shorter statute of limitations applies to written contracts that are similar to promissory notes and bills of exchange.

Now what about your construction contract? Even though it involves the payment of money, a construction contract is very different from a promissory note or bill of exchange. Doesn't that mean that the applicable statute of limitations is ten years and that you still have the right to expect the contractor to pay for the cost of replacing your shingles? Well, maybe not.

Or is it the six-year limitation?

In 1991, the Indiana Court of Appeals stated that a teacher's contract -- which is also very different from a promissory note or bill of exchange -- was a contract for the payment of money and therefore subject to the statute of limitations of six years, not ten. Aigner v. Cass School Tp. of Porter County, 577 N.E.2d 983. The decision did not even mention Yarlotte v. Brown or the possibility that the period of limitations might be ten years instead of six. However, the lawsuit regarding the teacher's contract was brought within two years, so it was not barred regardless of which the two statutes of limitations applied.

So where does that leave your claim against your former contractor? If a teacher's contract is subject to a six-year statute of limitations, isn't your construction contract also subject to a six-year limitation? It certainly seems so. But if you sue the contractor, you may be able to persuade the court that the Court of Appeals decision regarding the teacher's contract was simply wrong because it failed to follow the precedent set by the Indiana Supreme Court in Yarlott v. Brown. Alternatively, perhaps you can pesuade the court that the statement in Aigner about the six-year statute of limitations is not binding precedent because that result in that case would have been the same even if the ten-year limitation applied. Unfortunately, you might have to go all the way to the Indiana Supreme Court to get a favorable decision on either rationale.

On the other hand, the decision in Aigner has been around more than 20 years, and it has not been overturned yet. Indiana courts may continue to follow Aigner for most written contracts, narrowly applying Yarlott to those that, even though they involve the payment of money, "bear a close resemblance to actions for the collection of judgments of courts of record, which are liens on real estate, or to actions for the recovery of possession of real estate." All we can say is that anyone with a claim for breach of a written contract that involves any payment of money is far better off to file the lawsuit within six years; to wait longer is, at best, risky.

We invite others who may be able to shed light on this question to send us a message using the contact form on this page.

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February 20, 2014

New Reporting Requirement for Businesses and Nonprofits -- Change in responsible party

Reports.jpgThe Internal Revenue Service's application for an employer identification number (or EIN) requires the applicant to submit the name and tax identification number (usually a social security number) of the applicant's "responsible party." That is true whether the application, Form SS-4, is submitted on paper or online, and it is true for any type of organization applying for an EIN, including corporations, limited liability companies, partnerships, trusts, and tax exempt organizations. That is the last time most organizations ever think about the "responsible party." Until now.

On May 6, 2013, the Internal Revenue Service published a final rule that requires any business, nonprofit organization, trust, or other entity with an EIN to report any change in the entity's responsible party. Here are the answers to some questions that essentially every business and tax exempt organization should know.

Who is a "responsible party"?

The answer differs a bit for various types of organizations. For companies with shares traded on a public exchange or securities registered with the U.S. Securities Exchange Commission, the responsible party is defined fairly unambiguously:

For corporations, the responsible party is the principal officer. For partnerships, the responsible party is a general partner. For trusts, the responsible part is the trustee, grantor, or owner. For disregarded entities, the responsible party is the owner.

For other entities, the definition is more ambiguous:

The responsible party is "the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets."

For business corporations, the responsible party may be the president or chairman of the board; for LLCs, a member; for partnerships (including limited partnerships, such as family limited partnerships), a general partner.

The issue of identifying a responsible party for a nonprofit organization may be particularly problematic because, in many organizations, no single person who has the authority to control, manage, or direct the organization and -- in particular -- to control the disposition of its funds and assets. In fact, we often tell the boards of directors of our nonprofit clients that, collectively, they have full authority to control the organization but, individually, they have no authority at all. Even so, the IRS requires the designation of a responsible party, and the organization must decide who best fits the definition. For some organizations, that may be the executive director or CEO; for others, it may be the president or chairman of the board.

Our LLC has three members, all with the same rights and authority. Who is the responsible party?

If more than one person qualifies as a responsible party, the entity must select one of them by whatever criteria the entity chooses.

When and how must changes be reported?

As of January 1, 2014, any change in an entity's responsible party must be reported on IRS Form 8822-B within 60 days after the change takes effect. Changes made prior to January 1, 2014 must be reported before March 1, 2014.

Our organization obtained an EIN years ago, and we have no idea who was listed as the responsible party. But Form 8822-B requires us to list not only the new responsible party, but also the old one. What do we do with that?

The best course is probably to submit Form 8822-B without the information about the old responsible party and attach a statement explaining what you have done to locate the information and why it is unavailable despite those efforts. [Revised February 21, 2014, to include the idea of attaching a statement -- a suggestion from James W. Foltz, Attorney at Law, of Indianapolis, Indiana.]

Our nonprofit has filed Form 990 (or 990-EZ or 990-N) every year, and we always have to list the organization's principal officer. Isn't that good enough?

From what we know at the moment, probably not. Even if the responsible party and the principal officer are the same person, Form 8822-B calls for the responsible party's social security number, but Form 990 does not. The same thing is true for the tax matters partner identified on Form 1065 filed by partnerships and by LLCs taxed as partnerships.

I called the IRS and tried to get some more specific information about the new reporting requirement, and the person I spoke with had never heard of this new requirement. Are you sure about it?

We had the same experience, but, yes, we're sure. We hope the IRS will issue guidance that clarifies some of the details, but we're sure the rule is in effect.

What happens if we do not file Form 8822-B or file it late?

That's the good news. As far as we can tell, there is no penalty for failing to file or for filing late. Even so, everyone with an EIN, including small businesses and tax exempt organizations, should comply with the rule using the best understanding of the requirement and the best information available.

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February 11, 2014

The 2014 IRS Mileage Rates

Odometer.jpgIf you use a vehicle for business, medical, or moving purposes, or in providing volunteer services to a charitable organization, you may be able to deduct at least a portion of the cost on your income tax return. There are two alternatives for calculating the amount of the deduction, but the simplest is to keep track of the number of miles driven and multiply by the appropriate standard IRS mileage rate.

The standard mileage rates are based on an annual study of the costs of operating a motor vehicle, conducted by the IRS and an independent contractor. The information used in deriving the standard rate for business purposes include both fixed and variable automobile costs, such as insurance, fuel, maintenance, and repair costs. Only variable costs are considered in calculating the standard rate for medical and moving purposes. The charitable rate is fixed by statute.

What are the rates?

On December 6, 2013, the IRS announced the standard mileage rates for 2014. The rates as of January 1, 2014, are:

• 56 cents/mile for business miles driven for business purposes
• 23.5 cents/mile for miles driven for a medical purpose or a moving purpose
• 14 cents/mile for miles driven as a volunteer to a charitable organization.

These rates apply to the use of automobiles, including includes cars, vans, pickups, and panel trucks. With fuel prices generally decreasing, the standard rates miles driven in 2014 for business, medical, and moving expenses are one-half cent below the rates for miles driven in 2013. The charitable rate is the same in 2014 as it was in 2013.

What counts as "Business" miles?

While commuting to and from work does not count toward business mileage, there are many trips that may be characterized as business trips for purposes of calculating mileage, including driving to meet a client, driving to a bank to making a business transaction, driving to pick up mail from the post office, and driving to a supply store to make purchases for your business.

Of course it is easy to forget to keep track of your miles driven, but if you are disciplined about it, the savings can add up. For example, if you are in the 28% tax bracket, the deduction for 100 business miles may reduce your federal income tax by about $15.00.

Other considerations:

As mentioned above, the use of standard mileage rates is not the only alternative for calculating the deduction for the use of a vehicle. Taxpayers may instead calculate the actual costs of using their vehicle, including costs of gas, oil, registration fees, repairs, tires, and insurance. However, calculating the actual costs of using a vehicle for taxation purposes of often takes more time and effort. Broadly speaking, the more economical the vehicle is, the more likely that the standard mileage rate will give you a better deduction. Conversely, if the operating costs of a vehicle are high, the more likely the actual cost method will give you a better deduction.

If a taxpayer uses the depreciation method under the Modified Accelerated Cost Recovery System (MACRS), or claims a Section 179 deduction for a vehicle, she may not use the mileage rates. Additionally, the standard rate for business purposes cannot be used for more than four vehicles simultaneously.

December 15, 2013

Social Media and Two Remarkably Unremarkable Contract Cases

bored woman.jpgConsider these two relatively recent cases, one from Massachusetts and one from Indiana, both involving allegations of breach of contract through the use of social media:

  • A vice president of a recruiting firm leaves her job and goes to work for another recruiting firm. She has a covenant not to compete with her first employer that prohibits her from providing recruiting services within a specified list of "fields of placement" and within a specified geographic area. She updates her LinkedIn profile to reflect the new job. A message goes out to her list of over 500 contacts, including a number of her former employer's customers. Her former employer sues, alleging (among other things) that her LinkedIn update violated the covenant not to compete.
  • The agreement between an IT contractor and one of its subcontractors prohibits the subcontractor from soliciting or inducing the contractor's employees to leave their jobs. The subcontractor posts a job opening on LinkedIn where it could be viewed by anyone who had joined a particular public group. One of the contractor's employees sees the job posting, contacts the president of the subcontractor, and expresses an interest in the job. At a later meeting, the employee tells the subcontractor his compensation requirements and what he is looking for in a job. The subcontractor makes an offer of employment, and it is accepted. The contractor sues the subcontractor for breach of the covenant not to solicit its employees.

Although the law sometimes struggles to keep up with technology, in each of these cases the court decided the issue very readily, relying on standard contract law.

The first case is KNF&T, Inc. v. Muller, a case filed earlier this year in Massachusetts Superior Court. In filing the lawsuit, the plaintiff asked for a preliminary injunction. After reviewing the law on covenants not to compete and explaining that they are to be construed narrowly, the court denied the plaintiff's request, noting that, although Ms. Muller's LinkedIn profile mentioned things such as "staffing services" and "recruiting," it made no mention at all of any of the fields of placement that were listed in her covenant not to compete and, therefore, did not breach her agreement with KNF&T.

The second case is Enhanced Network Solutions Group, Inc. v. Hypersonic, decided by the Indiana Court of Appeals in 2011. In doing so, the court had to determine the meaning of "solicit" and "induce," as those words were used in the covenant not to solicit the contractor's (ENS's) employees. Because neither the contract nor Indiana case law defined them, the court looked to the ordinary dictionary definitions. Citing Black's Law Dictionary, the court explained that "soliciting" involves requesting or seeking to obtain something, and "inducing" means enticing or persuading someone to do something. The court held that Hypersonic did not solicit or induce the employee to leave ENS, but rather the employee solicited Hypersonic. In fact, it appears that the court did not even consider the LinkedIn job posting as a close call, mentioning only that the employee "made the initial contact with Hypersonic after reading the job posting on a publicly available portal of LinkedIn."

Do these cases mean that one cannot violate a noncompete agreement or a nonsolicitation agreement by posting something on a social media site? Not at all. In fact, it seems entirely possible that the Massachusetts case would have gone the other way if Ms. Muller's LinkedIn profile had mentioned one fields of placement from which she was barred by her agreement with her former employer. Similarly, the Indiana case might have gone the other way if someone from Hypersonic had sent an email message specifically addressed to the ENS employee with a link to the LinkedIn job posting, particularly if the message encouraged him to apply.

Indeed, what is noteworthy about these cases is that the social media aspect of them had no bearing on the courts' analyses. The Massachusetts case would likely have turned out the same way had Ms. Muller sent out paper announcements saying the same thing her LinkedIn profile said, and the Indiana case would likely have turned out the same way had the job posting been a classified ad in a newspaper. The courts had to plow no new ground to deal with them.

In that sense, these cases are unremarkable. Remarkably so.

Continue reading "Social Media and Two Remarkably Unremarkable Contract Cases" »

October 3, 2013

Celebrate Disability and Employment Awareness Month with the Indianapolis Business Leadership Network on October 8

Two office workers one in wheelchair.jpg[Today's article is written by guest author Attorney Juli Paini, Director of the Office of Disability Affairs of the City of Indianapolis, publicizing an event hosted by the Indianapolis Business Leadership Network. Our thanks to Scott Beauchamp of Indianapolis Yellow Cab, a member of IBLN, for letting us know about it. The presence of the article on our blog does not in any way imply an endorsement of Smith Rayl by Juli, the City, IBLN, Scott, or Indianapolis Yellow Cab, and none of them is our client. -- MS/SRLO]

Since the passage of the Americans with Disabilities Act (ADA) in 1990, individuals with disabilities have enjoyed the right to equal access in employment as well as barrier-free participation in our communities, from dining in a restaurant to exercising the right to vote. Unfortunately, twenty three years after passage of the ADA, individuals with disabilities continue to experience low rates of employment and high rates of underemployment. According to the United States Department of Labor, this past June only 17.8% of people with disabilities were employed, compared to 63.6% of people without disabilities. This gap remains constant even for college graduates, who experience a 50.6% employment rate compared to that of 89.9% for college graduates without disabilities. (John J. Heldrich Center for Workforce Development and the Kessler Foundation, 2012).

Enter the Indianapolis Business Leadership Network (IBLN), a like-minded group local employers convened by the City of Indianapolis Office of Disability Affairs. The IBLN, based upon a national model, uses a business-to-business approach to further the employment of persons with disabilities and to promote the benefits and contributions of a diverse workforce. Its goal is to create employer awareness through strong partnerships and collaboration, connecting Indianapolis employers with the resources they need to successfully employ individuals with disabilities. The IBLN Steering Committee, with representation from the City of Indianapolis, Indianapolis Yellow Cab, Eli Lilly, WellPoint, Teachers Credit Union and the YMCA of Greater Indianapolis, hosts networking and educational opportunities for central Indiana employers to share best practices and information regarding the inclusion of individuals with disabilities in the diversity planning process.

On October 8, from 8:30-10:30a, the IBLN is hosting "Strategies for Recruiting College Students with Disabilities" for human resource and diversity professionals. The event, held at the Central Library, is free with 1.25 HRCI credits pending. The event will feature national expert Alan Muir, University of Tennessee, Career Opportunities for Students with Disabilities, as well as local experts Greg Fehribach, attorney and Fellow at the Bowen Center for Public Affairs at Ball State University, Larry Markle and Donnelle Henderlong of Disability Services at Ball State University, and Michele Atterson of Student Disability Services at Butler University.

To learn more about this event and register, contact Juli Paini, Director, City of Indianapolis Office of Disability Affairs, at 327-3798 or jpaini@indy.gov.

September 26, 2013

Nonprofit Growth and Trends

Growth chart.jpgPeter Orszag at Bloomberg wrote an interesting article about the growth of nonprofit organizations from 2008 onwards. One study cited was done by Nonprofit HR Solutions, entitled "Nonprofit Employment Trends Survey."

The article and the survey both painted an optimistic picture about nonprofit organizations post-millennium. They were viewed as a source of jobs and growth (nearly 5% of GDP according to Mr. Orszag) in contrast to the for-profit sector which has contracted, according to a study performed by researchers at Johns Hopkins University.

One key finding of the Nonprofit HR Solutions study was that nonprofits are continuing to grow and expand with no signs of slowing down. A full 40+% of institutions plan to add positions in the upcoming year, an upwards trend from the 33% in 2011.

Another interesting observation is that nonprofits may be facing a leadership vacuum. As one generation heads for retirement, plans for succession are not clearly developed. Whether or not this affects organizational stability remains to be seen, as nonprofit growth may attract qualified individuals needed as the for-profit sector continues to contract.

According to the survey, many nonprofits are ill prepared to deal with turnover, particularly in leadership positions. They have not developed succession plans or implemented measures to prevent key employees with needed knowledge, skills, or qualifications from leaving - either laterally to another nonprofit or to the for-profit sector or to government employment. A lack of a retention strategy could, in theory, lead to a brain drain or a boom-bust phenomenon where growth sectors lack the knowledge needed most as the lucrative lure of the private sector exacerbates the problem at precisely the wrong time.

Nonprofits, according to the survey, continue to explore social networking sites as a recruitment tool. Although non-traditional, such sites like Facebook and LinkedIn offer inexpensive, almost ubiquitous tools. There is also potential for growth in this sector, as it relates to another survey finding: the difficulty of attracting and retaining employees in the under-30 demographic.

As job markets in the for-profit sector contract, candidates who might have otherwise never considered a job in the non-profit sector take positions at these institutions. This creates a benefit for these non-profits in that they have a larger applicant pool to choose from. Due to corporate cost-cutting and austerity measures, the phenomenon is not limited to entry-level jobs but encompasses all levels of seniority.

Ironically, the success of nonprofit organizations may ultimately lead to a darker spot on the horizon. As Mr. Orszag points out, some politicians question whether tax-exempt status gives nonprofit organizations an unfair advantage over for-profit businesses that offer similar services. Although some nonprofits provide the same or similar services that are also provided by for-profit businesses (hospitals are an example that often comes to mind), many tax exempt organizations satisfy needs that would go entirely unmet if left to the private sector. Regardless of one's political views, it is an area to watch in future discussions of tax reform.

Despite some uncertainties, if nonprofits can continue to expand, retain, and plan for leadership transitions, the future is bright indeed.

Continue reading "Nonprofit Growth and Trends" »

September 11, 2013

Home Improvement Contracts

House painter.jpgIndiana has a relatively little known statute, the Home Improvement Contracts statute located in Title 24, Article 25, Chapter 11 of the Indiana Code, that protects the customers of home improvement contractors by establishing certain minimum contract requirements. Home improvement contractors are well advised to ensure that their contracts comply with the statute because those who violate it may find themselves on the receiving end of a lawsuit under companion Chapter 0.5 (Deceptive Consumer Sales) filed either by their customers or by the Indiana Attorney General. This article describes only some of the statutory requirements, and home improvement contractors who want to make sure they comply should seek legal advice.

Applicability

The Home Improvement Contacts statute applies to contracts between a consumer and a "home improvement supplier" for any alteration, repair, replacement, reconstruction, or other modification to residential property, whether the consumer owns, leases, or rents the residence, but only if the contract is for more than $150. The statute defines "home improvement supplier" as someone who engages in or solicits home improvement contracts, even if that person does not actually do the work. For example, if a homeowner buys installed carpet from a carpet store, the contract to install the carpet is covered by the Home Improvement Contracts statute even if the store owner doesn't actually perform the installation but instead subcontracts the work to someone else.

Contract Requirements

Not surprisingly, home improvement contracts must be in writing. Although the Home Improvement Contracts statute does not include an express requirement for a written contract, and although the definition of "home improvement contract" includes oral agreements, as a practical matter it is impossible for an oral contract to comply with the statute.

Section 10(a) of the Home Improvement Contracts statute includes a laundry list of requirements. For example, the contract must include the name of the consumer and address of the home; the name, address, and telephone number of the contractor; the date the contract was presented to the consumer; a reasonably detailed description of the work; if specifications are not included in the description, then a statement that specifications will be provided separately and are subject to consumer approval; approximate start and end dates for the work; a statement of contingencies that may seriously alter the completion date; and the contract price.

The requirement that the contract contain specifications (or a statement that specifications will be supplied later for approval by the consumer) deserves a little more attention. The statute defines specifications as "the plans, detailed drawings, lists of materials, or other methods customarily used in the home improvement industry as a whole to describe with particularity the work, workmanship, materials, and quality of materials for each home improvement." Note that a specification must describe the work, workmanship, materials, and quality of materials with particularity.

Consider, for example, a contract to paint the exterior of a home. Does it comply with the requirement for a contract to contain specifications if the only description of the work is, "Paint all exterior siding and window frames with gray exterior latex paint"? Does that describe the work "with particularity"? Probably not. For example, it does not specify the number of coats of paint, obviously a significant consideration. Moreover, the specification of "exterior latex paint" is probably inadequate in light of the range of quality and prices of exterior latex paint available on the market, and "gray" is probably not specific enough either, given that paint stores carry a wide spectrum of colors that can reasonably be called gray.

Specific Requirements and Accommodations for Work Covered by Insurance

Section 10(b) of the statute deals with special issues presented by contracts to repair damage that is to be covered by an insurance policy. Several of the provisions provide alternative ways for the contract to comply with the general requirements listed in Section 10(a). For example, the requirement to include the start date can be satisfied by specifying that the repairs will begin within a specified amount of time after it is approved by the insurance company. Similarly, the contract price can be expressed by stating the amount owed by the consumer in addition to the amount of the insurance proceeds, and that includes a contract provision that the contractor will not charge the consumer any amount above the amount of the insurance proceeds. Note, however, that because of the prohibitions in Section 10.5 (discussed below), the consumer is responsible for any insurance deductible.

More importantly, Section 10(b) requires home improvement contracts for repairing exterior damage that covered by insurance to give the consumer a right to cancel the contract within three days of receiving notice from the insurance company denying coverage for some or all of the repairs. The contract must include some very specific language dealing with the right to cancel, and it also must include a form, attached to but easily removable from the contract, that the consumer can use to cancel the contract.

Prohibitions

Section 10.5 of the statute also contains some prohibitions that home improvement contractors need to know about. One has already been mentioned -- contractors are prohibited from paying or rebating to the consumer any part of an insurance deductible or giving any sort of gift, allowance, or anything else of monetary value to the consumer to cover the insurance deductible, including things like referral fees and payments in exchange for the consumer allowing the contractor to place a sign in the yard.

As another example, Section 10.5(d) contains a blanket prohibition on home improvement contractors acting as public adjusters.

Continue reading "Home Improvement Contracts" »

August 19, 2013

Is Your Business's Confidentiality Agreement Enforceable? Part 2

In a previous post we discussed a few basic principles of confidentiality agreements (also known as non-disclosure agreements or NDAs). That post discussed the basic of these agreements and the important principles of restrictive covenants and trade secrets. Left unanswered was the critical question: How long can, or should, a confidentiality obligation last?

Reasonable Periods of Confidentiality
Now let's get back to the question of a reasonable amount of time for confidentiality obligations to last with respect to CBI that does not meet the definition of a trade secret. As discussed above, a factor is the nature of the CBI owners legitimate business interests that are protected by the agreement. An example of a legitimate business interest of the owner is to protect the confidentiality its cost of goods sold or COGS. Disclosure of that information to competitors may give them an unfair advantage when bidding for the business of new customers. But how long does that legitimate business interest last? That depends on the nature of the goods and the nature of the industry. In some industries, costs are sufficiently stable that knowledge of a company's COGS from five years ago enables a competitor to make an accurate estimate of the company's COGS today, and a court might consider a confidentiality period of five years to be very reasonable. In other industries, costs change much more quickly, and a court might find that a confidentiality period of five years is unreasonable and rule that the agreement is unenforceable -- unless the COGS also meets the definition of a trade secret. Confidentiality man whispering to woman.jpg

Here's where things get more complicated because the definitions of CBI in most confidentiality agreements are not identical to the definition of a trade secret. In most cases, all trade secrets are also CBI, but not all CBI qualifies as a trade secret. So what to do?

One one might consider writing a confidentiality agreement that, for CBI that qualifies as a trade secret, lasts for as long as that is true and, for all other CBI, lasts for only, say, three years. And one can certainly write a contract with precisely that provision, but it will pose a dilemma for the recipient: The recipient will probably not be able to tell the difference between CBI that qualifies as a trade secret and CBI that does not. Here are some possible ways to resolve that dilemma.

  • The recipient may decide to simply live with the dilemma and assume that all CBI must be protected essentially forever. Some recipients find that acceptable.
  • The owner of the CBI may accept a time limitation for all CBI, including CBI that qualifies as a trade secret. However, that may create other problems for the CBI owner. Note the second part of the definition of a trade secret -- it must be subject to reasonable precautions to protect its secrecy. Is it a reasonable precaution to disclose information under a confidentiality agreement that permits the disclosure or use of the information after a certain period of time? Some courts say no, with the result that the information loses its status as a trade secret.
  • The confidentiality agreement may impose a limit that applies to ALL CBI, but only if, and for as long as, the CBI qualifies as a trade secret. In that case, the owner accepts the possibility that some CBI may have no protection at all because it never qualifies as a trade secret. For some owners in some situations, that is a more acceptable risk than the possibility of having its CBI lose status as a trade secret.

In short, there is no single solution that works in every case. Each situation must be negotiated individually, with the interests of both sides of the agreement taken into account.

Continue reading "Is Your Business's Confidentiality Agreement Enforceable? Part 2" »

August 19, 2013

Is Your Business's Confidentiality Agreement Enforceable? Part 1

Confidentiality man whispering to woman.jpgConfidentiality agreements (also known as non-disclosure agreements or NDAs) are common in today's business world. They are sometimes in the form of stand-alone agreements, often used when two businesses are discussing a potential deal and at least one of them needs to disclose to the other information that is not available to the public (sometimes called confidential business information or CBI). Other times, they are embedded in agreements with a broader scope, such as employment contracts, service contracts, and contracts for the sale and purchase of a business.

The fundamental concept of a confidentiality agreement is simple. The person receiving or possessing the other person's CBI promises not to disclose it to others and (usually) not to use the information for any purpose other than the discussions of a potential transaction or the purpose of the larger contract in which the confidential provision is embedded.

The details, however, can be tricky, and one of the thornier details is the question of how long the obligations of nondisclosure and nonuse last. Naturally, the person disclosing the CBI wants the commitments to last forever, but the person making the commitments wants them to expire at some point in time, not necessarily because he or she wants to use or disclose the information, but because he or she wants the possibility of being sued for breach to come to an end, and the sooner the better.

So how long can, or should, a confidentiality obligation last? Before answering that question, a little review of some legal principles is in order. Note that these issues are very fact-sensitive and that the law varies a fair amount from state to state. For that reason, this discussion is based on general concepts; the results may be very different in any particular case.

Restrictive Covenants
Confidentiality agreements are sometimes considered to be within a larger category of contracts known as restrictive covenants, i.e., agreements that in one way or another restrict commercial trade. With freedom of trade and commerce being so important to American society, restrictive covenants are not favored by public policy or the law. That doesn't mean restrictive covenants are necessarily void or illegal, but they may be unless the restrictions are sufficiently narrow. At least some courts have held that confidentiality obligations can last for only a reasonable period of time (with an exception discussed below), and a confidentiality obligation that lasts too long may result in a court refusing to enforce the agreement.

Unfortunately, there are no clear rules to tell us what amount of time is reasonable for the duration of a confidentiality obligation. Instead, there are factors that must be weighed and balanced. Those factors include the nature of the legitimate business interests of the owner of the CBI; the effect of the restrictions on the person making the non-disclosure and non-use commitments; and the public interest.

So far we know that it may be necessary for a confidentiality obligation to expire after a reasonable period of time, and, if it doesn't, the agreement may be unenforceable. HOWEVER, there is a major exception, and that exception is for CBI that also meets the definition of a "trade secret."

Trade Secrets
Although "confidential business information" does not have a universal meaning,the definitions contained in most confidentiality agreements are broad enough to encompass "trade secrets," a term defined by state statute. In Indiana, section 24-2-3-2 of the Indiana Code defines a trade secret as information that


  1. has independent economic value because others who could obtain economic value from the information do not have the information and cannot reasonable acquire it; and

  2. is the subject of reasonable efforts to maintain its secrecy.

Trade secrets are a form of intellectual property, and the trade secret statute provides protection against improper use or disclosure, in addition to the protection provided by a confidentiality agreement. Unlike most forms of intellectual property, such as patents, trade secrets never expire; they remain protected by statute for as long as the information continues to meet the definition. For that reason, some courts have ruled that the requirement for confidentiality agreements to be limited to a reasonable period of time is subject to an exception for trade secrets. To the extent a confidentiality agreement covers a trade secret, the confidentiality obligation is permitted to last forever, or at least for as long as the information continues to qualify as a trade secret under the statutory definition.

Here's where that leaves us: With respect to trade secrets, confidentiality obligations do not need to expire. (In fact, as we'll see later, they should not expire.) With respect to other CBI, confidentiality obligations may need to expire after a reasonable period of time to ensure enforceability. In the next article, we will consider how to deal with that bifurcation.

Continue reading "Is Your Business's Confidentiality Agreement Enforceable? Part 1" »

August 10, 2013

National Criminal History Background Checks for Child Care Workers

Child care worker.jpgLast session, the Indiana General Assembly passed, and Governor Pence signed, House Enrolled Act 1494, amending Indiana Code Title 12, Article 17.2 by establishing new requirements for national criminal history background checks for employees and volunteers of regulated child care providers.

A national criminal history background check involves the submission of an individual's fingerprints to the Federal Bureau of Investigation for comparison to a national database. (Note that there is a separate process for background checks for individuals under 18 years of age.) The new requirement for a national background check replaces a previous requirement for a background check at the state level, but it is in addition to the requirement for substance abuse testing.

This article discusses the new requirement for background checks in broad terms. More detailed information is available from the Bureau of Child Care of the Indiana Family and Social Services Administration. Note also that HEA also creates some other new requirements for some child care providers that are not addressed by this article.

Applicability

The requirement for background checks applies to essentially all individuals who have any contact with children at any type of regulated child care providers, which include

For all types of regulated providers, background checks are required for all individual caregivers, including both employees and volunteers. For child care homes, the requirement also extends to any member of the household who is 18 years of age or older (or, if younger than 18, who has been previously been charged with a crime and waived from juvenile court to adult court), even if he or she will have no contact with children.

Background checks are required when the child care center, home, or ministry applies for a license or registration; when an unlicensed provider applies for certification of eligibility to receive CCDF funding; when a new employee is hired or a new volunteer begins work; and every three years after that. The requirements for new applications and new employees and volunteers (and for child care homes, new household members) took effect on July 1, 2013. Other regulated providers have until July 1, 2014, to comply with the requirements for existing caregivers and household members.

Prohibitions

The purpose of the background check is to identify individuals who are prohibited from being child care provider, an employee or volunteer of a child care provider, or a member of the household at a child care home. An application for a license, registration, or CCDF certification may be denied if the provider, a caregiver, or (for child care homes) a household member has been convicted of certain types of felonies or misdemeanors or if the individual has been charged of such a crime while the application is pending. Note that only convictions or pending charges count; previous charges that were dismissed or resulted in an acquittal do not disqualify an individual.

Continue reading "National Criminal History Background Checks for Child Care Workers" »

July 30, 2013

Positive Change in Indiana LLC Laws - Part Two: Even More Flexibility in Management Structure

100_3698.JPGEarlier this year the General Assembly passed HEA 1394 which made several changes to the Indiana Business Flexibility Act, the statute that governs limited liability companies. We have already looked at some changes to the Act that enhance the use of Indiana LLCs for estate planning purposes. This article discusses new alternatives for LLC management structure.

The Indiana Business Flexibility Act already provided for a great deal of flexibility for management structure. One of the key steps in designing the management structure of a limited liability company is to establish who has the apparent authority to bind the company, for example by signing contracts on behalf of the LLC. Prior to the changes there were essentially two choices. In a member-managed LLC, the members have that authority. In a manager-managed LLC, the members appoint managers (who may or may not also be members) who have that authority.

HEA 1394 provides a third choice -- officers, who may or may not be members. At first blush, there may seem to be little difference between officers and managers because, like the managers in a manager-managed LLC, officers have the apparent authority to bind the LLC to third party agreements. But there is at least one important difference: In a manager-managed LLC, only the managers, and not the members, have the apparent authority to bind the company. The new revisions allow the members of an LLC to establish officers who have the apparent authority to bind the company, while also retaining that authority themselves. In fact, a manager-managed LLC can also have officers. In that case, both the managers and the officers, but not the members, have apparent authority to bind the LLC.

HEA 1394 includes other changes to the statute that enhance the alternatives for LLC governance. For example, the Act now permits the operating agreement to make certain significant decisions, including mergers, dissolutions, and amendments to the operating agreement, subject to the approval of a third party who need not be a member.

One context in which such provisions may prove useful is in estate planning. Imagine the founder of a business, held by a limited liability company, with multiple heirs, who wants the business to remain in the family. Although the operating agreement may create significant restrictions on transfers of membership interests and admission of new members, the heirs could later agree to amend the operating agreement to remove those restrictions. The Act now allows the operating agreement to name a trusted outside party who must approve any amendments to the operating agreement, thus increasing the likelihood that the founder's desires will be honored.

Continue reading "Positive Change in Indiana LLC Laws - Part Two: Even More Flexibility in Management Structure" »

July 1, 2013

Positive Changes to Indiana LLC Law - Part One: Estate Planning

100_3698.JPGEarlier this year the Indiana General Assembly passed House Enrolled Act 1394, which takes effect today, July 1, and makes several amendments to the Indiana LLC statute, officially known as the Indiana Business Flexibility Act. This is the first of two articles discussing those changes. This first article addresses some amendments that should enhance the use of LLCs for estate planning purposes, and the second will discuss changes that expressly address the use of officers in the management of limited liability companies.

Permissible Purposes for LLCs
With the new amendments, Section 6 of the Indiana Business Flexibility Act now explicitly states that LLCs may be used not only for business purposes but also for personal and nonprofit purposes. For an example of a personal purpose, a married couple who own a vacation cabin and want it to remain in the family after they are gone might place the cabin in a limited liability company and then, by gift, by will, or by other means, transfer the ownership of the LLC to their children or grandchildren. Because the cabin is not used to generate income, the purpose of the LLC is personal, not business.

Although the circumstances in which the IRS will grant an LLC recognition of tax-exempt status under Section 501(c)(3) are limited, the change to the Indiana Business Flexibility Act confirms that Indiana LLCs may be used for those purposes.

It is debatable whether the amendment actually expands the purposes for which an LLC may be used because the prior language was in fact quite broad; however the new language reduces the uncertainty behind permissible purposes by expressly authorizing personal and nonprofit purposes.

Transferring LLC Interests to Heirs
There are two other changes that should increase the use of LLCs for estate planning, both to Section 10 of the Indiana Business Flexibility Act. One of the changes expressly permits LLC interests to be held in what is known as "joint tenancy with right of survivorship" or simply a "joint tenancy." A joint tenancy involves two or more people who both own property but with one key difference from other forms of common ownership: the right, upon death of one of the tenants, for the remaining tenant(s) to take the entire property as an undivided whole. In a simple scenario, two spouses own a home as joint tenants - when one dies, the other takes title to the entire home -- without going through the sometimes costly probate process.

The other change expressly permits LLC interests to be held as Transfer-upon-death property. This simply means that upon the holder's death the member interest can pass to one or more named beneficiaries, again without having to go through probate. However, unlike joint tenancy, the beneficiary does not own any interest in the property until the death of the original owner.

Estate Planning with the New Amendments
Historically, a corporation was the standard entity of choice for businesses, and limited partnerships have been one of the frequently used tools of estate ploanning. In recent years, however, LLC's have overtaken corporations in popularity for businesses. With changes such as the ones to the Indiana Business Flexibility Act, LLCs may also replace limited partnerships in popularity for estate plans.

Continue reading "Positive Changes to Indiana LLC Law - Part One: Estate Planning" »

June 25, 2013

Anticipatory Breach and Damage Mitigation: A Minefield for Real Estate Sellers?

iStock_000010957775XSmall.jpgA ruling in a recent case, Fischer v. Heymann, illustrates the pitfalls one can encounter when selling real estate. By not changing a light bulb and pushing the little red button on a couple of electrical outlets, the seller lost over $90,000!

The Case
Gayle Fischer entered into a contract to sell a condominium to Michael and Noel Heymann for $315,000. The buyers could inspect the property and, if they found serious defects, cancel the sale unless she agreed to fix the problems. On February 10, 2006 the Heymanns demanded that Fischer fix some minor problems: a couple outlets weren't working and a light bulb needed to be changed. Fischer wrote back on Feb. 13th, saying she'd respond by Feb. 28th. The Heymanns wrote back two days later, demanding a response by Feb. 18th. Fischer did not make any further replies until the 19th, when the Heymanns attempted to cancel the contract, and the lawsuit ensued, with Fischer claiming total damages of more than $94,000, including $75,000 in direct damages (which represented the difference between the agreed price of $315,000 and the best offer Fischer later received, $240,000.)

The Decision
The Court of Appeals applied two standard contract principles but to reach a result that may seem surprising. First, the buyers committed an "anticipatory breach".or "breach by repudiation," which occurs when one party declares its intent to breach the contract. Here, the Heymanns' refused to buy the condo unless Fischer made repairs, which the Court of Appeals held was an anticipatory breach. (The Heymanns would have had the right to cancel the contract if the defects in the condo were serious, but they weren't.) An anticipatory breach is treated the same as an actual breach. Fischer did not need to wait until Heymanns failed to show up at the closing.

Second, once a breach has occurred (anticipatory or otherwise), the other side has an obligation to mitigate damages, or to take reasonable steps to avoid 'piling up' additional damages. One way of mitigating damages when a buyer backs out of a real estate purchase is to attempt to find another buyer. Here, the agreed price was $315,000. If the best price Fischer could get from another buyer was $300,000, the Heymanns would have owed her only $15,000. However, if Fischer passed up the $300,000 offer and later sold it for only $240,000, the Heymanns would still owe only $15,000 because that's what the damages would have been if Fischer had mitigated.

Although the Court of Appeals did not describe its analysis quite this way, it essentially treated the Heymanns demand for repairs as a breach of the original purchase agreement and a new offer to buy the condo for the same price after the repairs were made, repairs which cost only $117 -- the price for an electrician to make a service call to reset the ground fault interruptors and change a light bulb. Certainly, if, immediately after the Heymanns breached, a third person had offered to buy the property for the same price, less $117, mitigation of damages would have required Fischer to accept it. The Court of Appeals held that mitigation of damages required Fischer to make the repairs requested by the Heymanns. Result: The Heymanns owed Fischer $117, not $94,000!

Note that these principles apply to contracts in general, not just to real estate purchase agreements. Does it surprise you that one party can make the other party choose between accepting an amendment to the contract or collecting damages that are worth no more than the amendment? That's effectively what happened in this case, and it surprised the Court of Appeals judge who dissented from the decision. I don't know if Fischer's lawyer has petitioned to transfer the case to the Indiana Supreme Court. If so, it will be interesting to see if the Supreme Court accepts the case. And if the decision stands, it will be interesting to see how later Indiana court decisions apply Fischer to other situations.

Continue reading "Anticipatory Breach and Damage Mitigation: A Minefield for Real Estate Sellers?" »