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The EU’s New General Data Protection Regulation: Implications for U.S. Businesses

Posted in Operating a Business, Tax, Technology Related Topics, Uncategorized

The EU’s new data privacy law, the General Data Protection Regulation, represents far-reaching changes that make it one of the strictest in the world. Randal Brotherhood discusses this new law and why U.S. businesses need to pay attention to it.


This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney Randal J. Brotherhood ,Washington University 1981, who is a shareholder in the Milwaukee law firm of Meissner Tierney Fisher & Nichols S.C., where he practices primarily in the areas of corporate law, representing both for-profit and tax-exempt entities, intellectual property, and securities law.


Virtually all U.S. businesses, nonprofit organizations, and other enterprises collect data from their customers or other individuals with whom they interact. All such enterprises should be aware of the European Union’s new General Data Protection Regulation, 2016/679, commonly known as the GDPR,1 which became effective on May 25, 2018.

The GDPR is a regulation under EU law pertaining to privacy and data protection for individuals within the EU and the European Economic Area. It is a sweeping legislative enactment generally considered to be the most far-reaching change in EU data protection law in many years, and possibly the strictest privacy law in the world.

The GDPR also governs the export of personal data outside the EU, and applies to parties – regardless of location – that collect personal data of individuals within the EU.

Because of this, businesses and other enterprises worldwide, and particularly in the U.S., have devoted considerable attention and resources to complying with the GDPR by the May 25 deadline, and still others are continuing to grapple with its requirements.

Applies Outside EU

The primary objective of the GDPR is to enhance the control individuals within the EU have over their personal data, and to simplify the regulatory environment for data collectors as to data privacy by establishing a single set of data privacy rules that apply throughout Europe.

It is noteworthy, however, that the GDPR has important implications for businesses and other enterprises well beyond the EU/EEA. This includes businesses in the United States, in that its provisions apply to enterprises located in the EU that process data of individuals residing in the EU, as well as any enterprise, regardless of location, that holds or processes personal data of an EU resident.2

Accordingly, any U.S. business that has individual EU customers or otherwise holds or processes transactions or data for individuals within the EU are subject to the GDPR’s requirements and its rigorous enforcement provisions.

Express Consent Required

For many businesses, the GDPR will change how data collectors approach the notion of data security, as evidenced by its requirement that an EU individual’s data, first, be stored only on systems designed and developed with a specific view toward data protection and, second, that such systems employ privacy settings set by default at the highest possible level of protection (these concepts being referred to in the GDPR as data protection “by design” and “by default,” respectively).3

The underlying notion is that an individual’s data are not to be publicly available (and cannot be used to identify the subject absent additional, separately stored information) without the express, opt-in consent of the individual data subject.4

Unless the individual has provided such express consent (rather than just a tacit failure to object) to the processing of his or her data for one or more specifically-stated purposes, the individual’s data may not be processed unless there is a specified legal basis for such processing and the purpose(s) of such data processing is disclosed to the individual.5 The data collector must be able to prove that it obtained such express consent from the data subject, who may revoke such consent at any time.6

Key GDPR Concepts

Although an exhaustive explanation of the GDPR is beyond the scope of this post, the following is a summary of some of its key concepts.

The GDPR Applies to Personal Data
The GDPR applies to the processing of “personal data” or any information relating to an “identifiable natural person”7 – that is, an individual who can be identified, directly or indirectly, by reference not just to common identifiers such as name, home address, telephone number, a photograph, or an email address, but also by less obvious identifiers such as bank or medical information, social networking posts, IP addresses, or any other data pertaining to location or to the physical, physiological, genetic, mental, economic, cultural, or social identity of such individual.8

These identifiers are considered to be personal data even if on their face they do not identify an individual, as long as they can be (or are capable of being) traced back to the subject individual without undue effort. It does not matter whether the individual’s personal data pertains to his or her personal or work-related capacities; if the data falls within the scope of “personal data,” regardless of whether it is personal, work-related or otherwise – it is subject to GDPR regulation.

It should be noted, however, that the GDPR does not apply to processing data “for a purely personal or household activity and thus with no connection to a professional or commercial activity.”9

Controllers and Processors
The GDPR directs most of its requirements toward “data controllers” (businesses or organizations the collect the data) and “data processors” (organizations that process data on behalf of a data controller, such as a third-party software or other service that a business may use to process data on its behalf).10

Data controllers are required under the GDPR to utilize only those data processors that provide sufficient assurances that they will implement appropriate technical and organizational measures to meet the GDPR’s requirements and protect the rights of individual data subjects.11

Privacy Management
Both data controllers and data processors are required to implement programs to assure compliance and be able to demonstrate such compliance to data subjects and regulatory authorities.12

Overall, the GDPR calls for a risk-based approach, that is, the utilization of controls which correspond to the degree of risk associated with the data processing activities. To this end, businesses that are data controllers must, for instance, put in place procedures to prevent data from being processed unless necessary for a specified purpose.13

Further, such businesses must incorporate technological and organizational measures appropriate to the nature of the business to ensure the protection of individuals’ personal data,14 including:

  • pseudonymization and/or encryption of data so that it cannot be attributed to individual without use of additional information;
  • restoring the availability of data in a timely manner in the event of a loss of data; and
  • regularly testing and evaluating the effectiveness of security measures.

Data controllers must maintain records of their processing activities, although there is an exclusion for small businesses (less than 250 employees) where data processing is not a significant risk.15

Additionally, controller/processor relationships must be documented and managed with contracts that specifically set forth the parties’ privacy and data protection obligations.

Data Protection Officers
Businesses that are data controllers or data processers are required under the GDPR to appoint a “data protection officer” if their essential activities involve, on a large-scale, regular monitoring of personal data or processing of sensitive data.16

A data protection officer must have IT processing, data security, and business continuity competence in personal data processing.

Lawful Basis for Processing of Personal Data
Unless a subject individual has provided express, affirmative consent to the processing of his or her personal data for one or more stated purposes, such data may not be processed unless there is at least one specified legal basis to do so.17

If the individual’s consent has not been obtained, the subject’s personal data may be processed only:

  • to comply with a legal obligation;
  • to perform a contract with the data subject;
  • to protect vital interests of the data subject when he or she is unable to give consent;
  • for the performance of a task carried out in the public interest or the exercise of official authority; or
  • for the purposes of legitimate interests of the data controller or a third party (but subject to certain fundamental rights and freedoms).18

Consent
If the data subject’s consent is the basis for the processing of his or her data, such consent must consist of:

 

“any freely given, specific, informed and unambiguous indication of his or her wishes by which the data subject, either by a statement or by a clear affirmative action, signifies agreement to personal data relating to him or her.”19

That is, such consent must be explicit for the data collected and for each purpose that the data are used, so that the controller can clearly show when and how the consent was obtained.

Accordingly, the purpose(s) for the individual’s data will be collected and used must be clearly and expressly disclosed to the data subject so that it is obvious what the data are going to be used for.

Consent must be demonstrable and freely given. A controller cannot require the disclosure of data as a prerequisite or condition of, for instance, the provision of services or the performance of a contract.20

Additionally, the data subject must be allowed to revoke consent in a manner no more burdensome than the manner in which consent was given.21

Information Provided at Data Collection
Individual data subjects have enhanced rights under the GDPR to access and obtain copies their data, as well as rights to require rectification or erasure of their personal data, to restrict further processing, and to lodge a complaint with a supervisory authority.22

Individuals must be informed of these rights and, in addition they must be given information about how their data will be processed.23

Breach and Notification
In the event a breach of security of an individual’s data in the hands of a data controller which gives rise to the destruction, loss, or unauthorized disclosure of such individual’s data, the data controller must notify the appropriate supervisory authority “without undue delay,” and “where feasible,” within 72 hours after having become aware of such breach.24 If such notification is not made within 72 hours, the data controller must provide a “reasoned justification” for the delay.25

Such notice is not required if the data breach is “unlikely to result in a risk for the rights and freedoms” of subject individuals,26 although how this exception is to be interpreted will likely require future clarification.

If the data controller determines that a personal data breach “is likely to result in a high risk to the rights and freedoms” of subject individuals, it must – subject to certain exceptions – also notify the individuals affected by the data breach “without undue delay.”27

In the event of a data breach by a data processor, it must notify the data controller,28 but the GDPR does not otherwise impose any other notification or reporting obligation on the data processer.

Fines and Enforcement
Businesses should note that, for GDPR violations, the GDPR provides for liability, including fines, for both data controllers and data processors as well as remedies for data subjects.

Regulators may impose penalties equal to the greater of €10 million or 2 percent of the violator’s worldwide revenue, for violations of record-keeping, security, and breach notification requirements.29

Violations of obligations related to legal basis for processing, consent requirements, data subject rights, and cross-border data transfers are subject to penalties up to the greater of €20 million or 4 percent of the violator’s worldwide revenue.30 EU member states may impose additional penalties, which may include criminal penalties.31

Data subjects have the right to make complaints with “data protection authorities” maintained by EU member states, as well as to initiate judicial proceedings.32

Additionally, data controllers and processors can be held responsible to compensate affected data subjects for damages resulting from a GDPR violation.33

Considerations and Recommendations

Although many U.S. businesses may be tempted to disregard the GDPR as a non-U.S. regulation relevant only to large multinational corporations, this approach could do great harm to such enterprise if it has European customers or otherwise collects data from European individuals.

No matter the size or nature of the business, if it collects any kind of personal data on EU residents, it is very likely subject to the GDPR and its requirements.

Given the substantial monetary and other penalties for noncompliance, businesses of all sizes should clearly understand whether and how the GDPR applies to them, and establish a game plan for GDPR compliance as necessary.

Establishing a Game Plan for GDPR Compliance

Businesses and their legal advisers should start by assessing the extent to which they have EU customers and/or collect data from EU residents, and acknowledging that they may have to alter current data handling procedures in light of the GDPR.

This assessment should include a review of the types of personal data the business collects and holds, what the data are used for, and whether the business is collecting more information than is reasonably necessary for its legitimate business purposes.

Further, businesses should assess the documents (whether in written or electronic format) they require customers to sign when purchasing or obtaining products or services. It is likely that such documents may need revision in light of GDPR requirements, to ensure that customers know how the business is processing their data and why. This may include development and implementation of new processes for obtaining and verifying express (rather than tacit) customer consent to data collection, and for the transfer and deletion of such data when requested.

Given the GDPR’s reach well beyond the boundaries of the European Union, and the substantial fines and other sanctions that can arise for GDPR violations, businesses and other enterprises collecting data from EU residents are well advised to have a clear understanding of the GDPR and its applicability to their operations.

For more information on the GDPR, see Keith Byron Daniels’s article, New European Privacy Law: Its Effect on Wisconsin Lawyers, in the July/August 2018 issue of Wisconsin Lawyer magazine.

Endnotes

1The GDPR is formally known as “Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation).”

2 GDPR, Article 3(3).

3 GDPR, Article 25 (Data protection by design and default).

4 GDPR, Article 6(1)(a).

5 GDPR, Article 6(1)(b)-(f).

6 GDPR, Article 7(3).

7 GDPR, Article (4)(1).

8 GDPR, Article 4(1).

9 GDPR, Article 2(2)(c).

10 GDPR, Article 24 (Responsibility of the controller) and Article 28 (Processor).

11 GDPR, Article 24(1).

12 GDPR, Articles 24, 28.

13 GDPR, Article 24(1).

14 GDPR, Article 24 (Responsibility of the Controller; Article 40 (Codes of Conduct).

15 GDPR, Article 30(1), (5).

16 GDPR, Article 37 (Designation of the data protection officer).

17 GDPR, Article 6 (Lawfulness of processing).

18 See Footnote 5, above.

19 GDPR, Article 4(11).

20 GDPR, Article 7 (Conditions for consent).

21 GDPR, Article 7(3).

22 GDPR, Article 15 (Right of access by the data subject).

23 GDPR, Article 7(2).

24 GDPR, 33(1); GDBR, Recital 85 (Notification obligation of breaches to the supervisory authority).

25 GDPR, Article 33(2).

26 GDPR, Article 33(1).

27 GDPR, Article 34(1) and (3); GDPR, Recital 86.

28 GDPR, Article 33(2).

29 GDPR, Article 83(4).

30 GDPR, Article 83(5).

31 GDPR Article 84 (Penalties); GDPR, Recital 149 (Penalties for infringements of national rules).

32 GDPR, Article 77(1).

33 GDPR, Article 82 (Right to compensation and liability).

​​

 

Conducting an Annual Legal Review of a Nonprofit Organization

Posted in Nonprofit Entities, Operating a Business

This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney James M. Ledvina.


James Ledvina, Marquette 2009, is an attorney with Conway, Olejniczak & Jerry S.C., Green Bay, where he focuses his practice on business law and estate planning.


Annual legal reviews for nonprofit corporations can help maintain their tax-exempt status. James M. Ledvina outlines the steps to conduct legal reviews for a nonprofit entity, and discusses why they are necessary.

Many attorneys are involved with nonprofit entities, whether they donate to them, sit on their boards, or even create them.

Nonprofit entities are unique business entities at both the state and federal levels and can be fraught with compliance issues that could jeopardize their nonprofit status and inherent liability protection.

Most Nonprofits are Nonstock Corporations

In Wisconsin, most nonprofit entities are nonstock corporations subject to Wis. Stat. chapter 181.

As the name implies, nonstock corporations do not issue shares of stock and do not have shareholders. However, a nonstock corporation can have members who act as de facto shareholders (without any ownership interest) with the ability to elect the corporation’s directors.

Typically, a nonstock corporation’s board of directors controls the entity’s high-level activities and appoint officers to conduct the entity’s daily business, much like a typical business corporation.

A key difference between a nonstock corporation and a business corporation (subject to Wis. Stat. chapter 180) is that a nonstock corporation’s volunteers, directors, and officers are – with some exceptions – immune from liability arising out of their activities associated with the nonstock corporation.

Maintaining Tax-exempt Status Requires the Proper IRS Forms

Another key component of any nonprofit entity is the acquisition of tax-exempt status from the Internal Revenue Service (IRS).

There are many different types of tax-exempt entities, but the most prevalent is a 501(c)(3). Depending on the amount of the entity’s annual gross receipts, amongst other factors, an entity can automatically be tax-exempt, or it must file either Form 1023-EZ or Form 1023 with the IRS to acquire tax-exempt status.

If a nonprofit entity fails to file its tax return with the IRS, fails to file its annual report with the Wisconsin Department of Financial Institutions (WDFI), or fails to maintain corporate formalities, it can lose tax-exempt status, corporate status, and liability protection for its volunteers, officers, and directors.

What to Include in the Annual Review

Accordingly, attorneys representing nonstock nonprofit corporations should have their clients perform the following review on an annual basis:

1) Update Registered Agent and Principal Office
Search the WDFI’s online corporate records and update them accordingly to ensure that the entity’s registered agent and principal office are correct. For small nonprofit organizations with high turnover of officers and directors, this becomes especially important, to ensure that the proper person is receiving notifications from the state in a timely fashion.

2) File WDFI Annual Report
The WDFI will send an entity’s registered agent a postcard on an annual basis reminding the registered agent to file the entity’s annual report. If the registered agent fails to file the entity’s annual report timely, the WDFI may administratively dissolve the entity, which negates the entity’s corporate existence and liability protection under chapter 181.

3) File WDFI Charitable Organization Report
Subject to several exceptions, if a nonprofit entity solicits donations from the public, the entity must register as a charitable organization with the WDFI, and also file a separate charitable organization report with the WDFI on an annual basis.

4) Check Sales and Use Tax Exemption Status
Under Wisconsin law, certain nonprofit entities are exempt from paying sales and use tax on its purchases. However, it must acquire a Certificate of Exempt Status from the Wisconsin Department of Revenue (WDOR), and must submit Form S-211 to its vendors to prove that its purchases are exempt from sales and use tax.

5) Review Sales Tax Collection and Remittance Compliance
Despite being exempt from paying sales and use tax on its purchases, the WDOR requires some nonprofit entities to collect and remit sales tax to the WDOR for its sale of certain items and services. A nonprofit entity should review its sales on an annual basis to ensure that it is compliant with the WDOR’s rules regarding the collection and remittance of sales tax. This is especially important, as the WDOR has the ability to pierce a corporation’s corporate veil and collect the taxes, penalties, and interest from whomever the WDOR deems was responsible for collecting and remitting such taxes to the WDOR.

6) File Federal Tax Return and Ensure Federal Tax Exempt Status
By May 15 of each year, an officer should file the nonprofit entity’s tax return with the IRS, which – depending on the gross receipts of the entity, amongst other factors – will be on Form 990-N, 990-EZ, 990-PF or 990. If an entity fails to file its tax return for three consecutive years, the IRS will automatically revoke the entities’ tax-exempt status. On an annual basis, an officer should search the entity’s name on the IRS’s online Tax Exempt Organization Search to ensure that it is still tax exempt, and that it can receive tax-deductible donations. If a nonprofit entity loses its tax-exempt status because it failed to file its tax returns, the entity can retroactively regain its tax-exempt status by resubmitting Form 1023 or 1023-EZ to the IRS.

7) Corporate Governance
The entity should memorialize its corporate activities, including the election of its board of directors and officers, in written resolutions in its corporate record book.

Avoid Costly Errors Through an Annual Review

With the transition of officers and directors and the complexity of the reporting requirements, it is easy for an entity to overlook a component of its legal compliance. An entity can correct these errors, but it is time consuming and costly to do so. Accordingly, it is important to be vigilant to remain compliant with all of laws applicable to a nonprofit entity.

 

Suiting the Needs of the Client: Modifying the WB-17 Offer to Purchase

Posted in Buying, Owning and Selling a Business, Operating a Business

This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney J. William Boucher.

Many business attorneys will recognize the WB-17 Offer to Purchase – Business Without Real Estate Interest form developed by the Wisconsin Department of Regulation and Licensing.  The WB-17 is popular because of its pre-printed nature, and thus apparent fairness, and its familiarity to attorneys, agents and business owners alike, especially in smaller sale-of-business transactions. Even though it is a pre-printed form, the WB-17 can be modified by addendum.   There are several important revisions that buyers and sellers should consider.

Buyer Considerations

Although it is more common that a buyer of assets submits the initial draft of a purchase agreement, the WB-17 is more pro-seller than a typical buyer’s first draft. Buyers should consider addressing the following issues:

  • Parties to the Contract. The WB-17 is worded to be a transaction between the buyer and a business selling assets. Therefore, shareholders, members, or other owners of the seller aren’t automatically parties to the transaction as defined at lines 6-12. Buyer’s counsel should be aware of this, as it affects the buyer’s remedies for any post-closing claims regarding the sale. Upon consummating the sale and distributing net sales proceeds to its owners, the seller may not have any remaining assets.  Any claim made by the buyer against the seller post-closing may be an empty remedy. For example, if the seller is a corporation, the buyer’s remedies against the shareholders of the corporation for claims under the WB-17 would be limited to amounts distributed to the shareholders in liquidation of the corporation (Wis. Stat. § 180.1408(2)). Unless the buyer is able to pierce the corporate veil of liability protection of the seller, this would be a difficult hurdle to overcome.
  • Definition of Purchased Assets. The buyer would normally agree to purchase all assets of the seller, other than those specifically excluded by the seller. The WB-17, on the other hand, requires the buyer to list all the assets it is buying. As a consequence, any asset inadvertently omitted by the buyer will remain an asset of the seller.
  • Excluded Liabilities. The WB-17 does not address assumed or excluded liabilities. The buyer will want to clarify that is not assuming any liabilities of the seller, other than any liabilities specifically assumed by the buyer in the agreement.
  • Working Capital Adjustment. A working capital adjustment to the purchase price (or other purchase price adjustments) would protect the buyer from actions taken by the seller before closing that were outside the ordinary course of business, such as accelerating the collection of accounts receivable. The buyer and the seller would agree on a target working capital amount at closing, and the purchase price would be adjusted up or down based on a post-closing calculation of the actual working capital of the seller as of the closing.
  • Qualifications of Seller’s Representations. Detailed at lines 91-102, all of the representations of seller in the WB-17 are qualified by the seller’s knowledge. There is no breach of a representation unless the seller had knowledge of the misrepresentation.  It is uncommon in a negotiated sale-of-business transaction for all representations to be qualified by knowledge, especially fundamental representations about the business. While the definition of Conditions Affecting the Business at lines 322-377 ostensibly provides protection for the buyer, adding clarity to the application of the knowledge qualifiers should be considered.
  • Additional Seller Representations. The buyer should strongly consider adding seller representations about the business that are not specified in the WB-17.  There are some glaring omissions, including the lack of any representations regarding  taxes, title to the assets, customers and suppliers, contracts, and due authorization.   The buyer may also want to strengthen the seller’s financial statement representation to provide that the financial statements fairly present the operations of the business or, if appropriate, were prepared in accordance with GAAP.
  • In lines 91-102 of the WB-17, the seller makes representations about Conditions Affecting the Business.   Buyers may want those seller representations to also be warranties of the seller for several reasons.   Elements of a cause of action for a warranty claim differ from those of a misrepresentation claim and may not require, for example, reasonable reliance by the buyer on the warranty.   In addition, the calculation of damages available under a warranty claim may in some instances be greater than the damages available under a misrepresentation claim.
  • The WB-17 does not contain an indemnification provision. Indemnification  provisions are very important, especially to the buyer, for several reasons:  (i) they allow  the indemnified party  to recover attorney fees; (ii) they expand the right to pursue claims against the seller to directors, officers, shareholders, employees, members, etc.; and (iii) they provide a mechanism for handling any third-party claims, including notice, and control of the defense .
  • Contingencies and Right to Cure. Other provisions that deserve review are the financing and appraisal contingencies at lines 394-471, and a seller’s right to cure at lines 472-479. While important for real estate deals or other deferred sign and close transactions, these provisions don’t serve much of a purpose for asset purchase agreements that utilize a simultaneous sign and close.
  • Non-Compete and Non-Disclosure. The WB-17 does not contain any language regarding non-competition or non-disclosure of confidential information by the seller or its owners. These issues could be addressed by separate agreements or an addendum, but identifying these issues and discussing the possible risks is paramount.

Seller Considerations

Even though the WB-17 is generally more favorable to sellers, several topics still deserve sellers’ attention.

  • Caps and Baskets. The seller should consider adding language via an addendum to limit claims brought pursuant to the seller’s representations at lines 91-102. While it mainly depends on the size and complexity of the deal, the concepts of caps and baskets limit the amount of recoverable damages. A cap provides a maximum amount that is recoverable from the seller, while a basket requires damages to reach a certain threshold before the buyer is able to recover any damages.
  • Survival Period. The WB-17 does not limit or state a survival period for the seller’s representations. As a result, claims for breach of any representation could be made within the statute of limitations (six years in Wisconsin for contract claims).   In a negotiated asset purchase agreement, the general survival period for representations is typically much shorter (e.g., 18-24 months), although a longer survival period is common for fundamental representations about the business.
  • Exclusive Remedy. Another method to reduce the seller’s exposure to potential claims is to add an exclusive remedy provision, which would limit the buyer’s remedies for breach of the seller’s representations to remedies specified in the agreement.
  • Non-Reliance on Other Representations. The seller should modify the WB-17 to confirm that the buyer is not relying on any representations or warranties made outside of the four corners of the WB-17.   This would limit the buyer’s ability to pursue a claim based on any statement made outside of the WB-17.
  • Specific Performance. Line 217 of the WB-17 states that the buyer may sue for specific performance if the seller defaults. The seller should strike this provision to eliminate the possibility of a forced sale in the event of a dispute.

Conclusion

The WB-17 Offer to Purchase – Business Without Real Estate Interest form contains many standard terms and conditions for the purchase and sale of assets of business and is a useful document for small sale-of-business transactions.  Nonetheless, sellers and especially buyers should consider modifying the WB-17 to suit their particular needs in a transaction.

J. William Boucher, University of Wisconsin Law School 2015, is an attorney with O’Neil Cannon Hollman DeJong and Laing in Milwaukee where he concentrates his practice on entity formation and organization, mergers and acquisitions and general business law.

 

The ABC’s of Consulting Agreements- Key Terms to Consider

Posted in Uncategorized

This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney Walter J. Skipper.

 

One of the most common and repeated requests I receive from clients is to draft a consulting agreement or a professional services contract.

When doing so, it’s important to consider the key terms to be addressed and defined within the document. Here are 15 important lessons to follow when drafting the agreement:

1) Specify the actual services or work that will be done. Clearly describe services to be provided and/or tangible work product to be delivered, and what is needed from others to be able to complete the project. Try to avoid broad descriptions.

For example, if you are helping with strategic matters, specify “gather a list of key findings, issues, and recommendations.” Draft in objective words.

2) Describe the fixed fee or specify the hourly costs. Make sure to detail what out-of-pocket costs are allowable and when pre-approval is needed. List when it’s paid and consequences if not timely paid.

3) Address the use of subcontractors. Generally, it’s helpful to state whether parties are permitted to use subcontractors and, if so, whether there are any limits on such use, such as requiring folks to honor their confidentiality requirements.

4) One of the most important contract terms is to address agreed upon service levels; the normal generic terms used are “timely, professional and workmanlike manner in accordance with industry standards.”

5) Define the client’s responsibilities. After setting the fee, the next most important step is to spell out what the consultant will need (and when) from the client, in order to be able to timely and effectively deliver on what has been promised.

The consultant often must rely on receiving decisions, approvals and information from the client, which means it is very important for the agreement to also specify that the provider is responsible for the content and the consultant can rely on the information without verification.

6) Discuss the ownership rights to intellectual property. After addressing the work, it is important to designate who owns the intellectual property that is created and who is free to license it.

The traditional approach is to stipulate that, upon full payment, the client shall have all right and title in interest in the deliverables. But sometimes it is appropriate to further limit the client’s use through third parties or, if they are free to do so, to further specify. And, if the case, state that the consultant retains ownership of all materials prepared prior to the engagement.

7) List out the time period to accept the deliverables. List out the time period when the deliverables are deemed accepted, or by whom any objectives must be raised – otherwise the consultant is left open for future claims. It is best to give a reasonable amount of time, such as 30 days, allowing people to correct, collect, and identify non-conforms.

8) Address warranty terms and steps for any breaches. One of the most contentious areas in this type of contract are the warranty terms. The best practice is to state the warranty to deliver in accordance with the specifications, provide for an effort to address any breaches and then address the important exclusions for implied warranties of merchantability, non-infringement, or fitness for a particular purpose, or otherwise.

9) Provide a risk allocation provision. Generally, since the consultant will only be earning a set fee and not sharing in the client’s profits, it’s extremely important to limit potential damages to specified amount, such as fees paid, or to provide some other mutually acceptable arrangement.

10) Address that each consultant is an independent contractor and that the consultant is responsible for FICA, FUTA, income tax withholding, any pension plan or health benefit plan. It is normal to require a consultant to indemnify the client for any employment taxes. It’s helpful, for tax purposes, to state that the contractor will determine the method and means of performing the services that assist with being treated as an independent contractor.

11) Address termination rights. Normally, there is a longer notice period if the termination is for convenience (i.e., without cause), while termination for cause is often effective immediately. Accordingly, defining what constitutes “cause” is also significant.

12) It’s fair to state that all parties will comply with all applicable federal, state and local laws, statutes, ordinances, regulations, and judicial and administrative orders and degrees, including, but not limited to, all laws related to safety, health and the environment.

13) Other folks address insurance, and require comprehensive or CGL, business automobile liability, workers’ compensation, employers’ liability, excess or umbrella liability, errors & omissions, and the coverage amounts.

14) Address indemnities. Who is responsible for any claims or damages? And is there a different level of liability for damages that arose from gross negligence, willful misconduct, or fraud?

15) Other traditional contract terms. Finally, the agreement needs to list out the limitation of liability and the traditional legal terms, such as: governing law, jurisdiction and venue, waiver, notice, counterparts, and force majeure.

More Tips

Keep in mind that the primary goal is to help set expectations, so that folks can understand their deal and avoid disputes. Also, it’s good to discuss everything up front, as the parties often have not thought through these terms.

 

 

This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership

Wisconsin Supreme Court Takes Aim at Non-Solicitation Clauses

Posted in Buying, Owning and Selling a Business, News and Recent Decisions, Noncompete Agreements, Uncategorized

How does a business stop a former employee from poaching the business’ employees after the employee has left employment of the business? Generally, to achieve this goal, employers have entered into a contract with the employee that includes a restriction called a “non-solicitation provision”. In a recent case, The Manitowoc Company, Inc., v. Lanning, the Wisconsin Supreme Court made a landmark decision which imposes significant limitations on employers with respect to non-solicitation provisions in employment contracts pursuant to Wisconsin Statute section 103.465.

Case Background

            I wrote about this case when the Wisconsin Court of Appeals issued its opinion in 2016, but to refresh my regular readers’ memories, here’s a brief summary of the facts of the case:

Lanning was an experienced, well-connected engineer for The Manitowoc Company, Inc. (“Manitowoc”) a company that manufacturers construction cranes and food service equipment. After working for Manitowoc in its construction crane division for over 25 years, Lanning left to work for a competitor. During his time with Manitowoc, he and Manitowoc had executed an agreement by which Lanning agreed that he would not “solicit, induce or encourage any employee(s) to terminate their employment with Manitowoc or to accept employment with any competitor, supplier or customer of Manitowoc.” (emphasis added) for a period of two years after the termination of his employment with Manitowoc.

Within the restricted two-year period after Lanning’s departure, Manitowoc alleged that Lanning breached this covenant by engaging in competitive activities such as actively recruiting (or poaching) some of Manitowoc employees to work for his new company. Manitowoc then sued Lanning for violation of the above quoted provision in the agreement. Lanning argued that the provision was unreasonable and violated Wisconsin Statute section 103.465, (the statute governing restrictive covenants in employment agreements) which would thereby make the whole provision unenforceable.

The Circuit Court ruled that the provision did not violate the statute, but Lanning appealed, and, as explained in my previous post, the Court of Appeals reversed, stating that the non-solicitation provision was unreasonably overbroad and violated section 103.465.

 

The Wisconsin Supreme Court’s Decision

            The Wisconsin Supreme Court agreed with the Court of Appeals, holding that because the clause in the Agreement restricted Lanning from soliciting, inducing, or encouraging any employee of Manitowoc to leave their employment, it was overbroad, and an unreasonable restriction on Lanning that violated Wis. Stat. section 103.465. The Court supported this holding by asserting that common law states that no business has a legally protectable interest in preventing the poaching of ALL of its employees from a stranger, and therefore, the provision attempting to do that is illegal under the statute. The Court went on to state that an employer only has a legally protectable interest in preventing the poaching of some of its employees, and those employees are limited to certain classes. The Court set forth some examples of these classes of employees that might warrant protection, such as top-level employees, employees with special skills or special knowledge important to the employer’s business, or employees with skills that might be difficult to replace. The Court did not elaborate any further beyond those general examples or apply them to Manitowoc, specifically.

Key Takeaways

What does this mean for Wisconsin employers?

  1. The Court for the first time expressly acknowledged what most in the legal community had already predicted—that non-solicitation clauses in employment contracts are subject to the notoriously restrictive Wisconsin statute section 103.465. If there was any question about it, the question is now answered.
  2. The most obvious takeaway is that employers can no longer prohibit a departed employee’s solicitation of “all” employees in non-solicitation clauses. As such, all current agreements with employees containing restrictive covenants should be reviewed. If the agreements contain language prohibiting solicitation of anything other than specific groups of employees, the agreement should be amended, and additional consideration for the amendment must be provided to the employee in exchange for the amendment. Any language prohibiting solicitation of “all” employees should be removed, and all future agreements should be drafted without this broad prohibition to avoid having the agreement ruled unenforceable.
  3. The other major takeaway is that non-solicitation clauses in employment related agreements must now identify specific employees or classes of employees that an employee is prohibited from soliciting after the employment relationship ends. These specific employees or classes of employees must be those in which the employer has a “protectable interest.” Determining what employees fall within these classes may be challenging given that the Court did not provide much guidance on the permissible scope of these classes of employees that warrant protection. This will be fact intensive for each business, and will warrant an in-depth discussion with clients regarding the nature of its employment base. This is likely to be a controversial area of law in the future, probably to be tested soon in the courts given the lack of guidance on this point by the Supreme Court in Lanning.

Final Thoughts

I think this decision creates potentially unintended consequences for small businesses in Wisconsin. A majority of businesses in Wisconsin, and most of our firm’s clients, are small to medium sized businesses. A large business with 13,000 employees like the Manitowoc Company may not actually suffer significant detriment from losing entry level employees, and a restriction preventing solicitation of ALL of those employees probably is broader than necessary to protect its competitive interests. However, the loss of any employee for a small business may be significant. As such, it is possible that a restriction to prevent solicitation of all of a small business’ workforce might be reasonable in certain circumstances, but the Court’s holding now deters them from attempting to assure themselves that reasonable protection in non-solicitation agreements with employees. I am hopeful that the Court has the opportunity soon to clarify this holding as applied to small businesses to avoid these consequences.

There are many open questions still outstanding in this area, and it is inevitable that we’ll get the answers to these questions as they work their way through the courts. In the meantime, businesses will want to ensure they are protecting themselves against potential poaching of their employees to the maximum extent legally permissible. The business attorneys at Schober Schober & Mitchell, S.C. are experienced in drafting employee restrictive covenant agreements and pay close attention to the often-changing landscape of employment restrictive covenant law.

If you or your business need a review of your current employee restrictive covenant agreements or are looking into establishing these agreements in your business, we would be happy to help. Contact me at jmk@schoberlaw.com or visit our website at www.schoberlaw.com if you have any questions.

Mergers & Acquisitions and the Tax Cuts and Jobs Act

Posted in Buying, Owning and Selling a Business, News and Recent Decisions, Operating a Business, Tax

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog,” and was written by Attorney James Phillips.

 

The passage of the Tax Cuts and Jobs Act brings significant changes to the structure, financing, and agreements in mergers and acquisitions transactions. James Phillips details the more noteworthy provisions that apply in 2018 and beyond.

At the end of 2017, President Trump signed into law the Tax Cuts and Job Act (Act), with many provisions effective for tax years beginning after Dec. 31, 2017.

The Act contains a number of changes that may affect the structure, financing, and agreements related to mergers and acquisitions (M&A) transactions.

Here is a summary of the more significant provisions:

Tax Rate and Certain Deduction Changes

  • Corporate Rates. The Act changes the federal income tax rate applicable to C corporations to a flat rate of 21 percent (down from a maximum of 35 percent).
  • Individual Rates. The Act changes the maximum individual income tax rate on ordinary income from 39.6 percent to 37 percent. The maximum income tax rate on long-term capital gain and qualified dividends remains unchanged at 20 percent and the net investment income tax rate remains unchanged at 3.8 percent. The Section 1202 exclusion of 100 percent of the gain on the sale of qualified small business stock (among other requirements, C corporation stock) held for more than five years remains unchanged.
  • Individual Deductions. Itemized deductions for state and local taxes for individuals are now limited to $10,000 in combined income and property taxes for tax years 2018 through 2025, provided that the deduction for state and local taxes incurred in carrying on a trade or business or for the production of income is retained (such as business taxes imposed on pass-through entities and taxes on Schedules C and E).
  • Pass-through Business Rate. The Act provides for a deduction of up to 20 percent of “qualified business income” earned through partnerships, S corporations and sole proprietorships (including single member LLCs). There are a number of special rules and limitations. This deduction is not available for capital gains, dividends and interest (other than interest allocable to a trade or business). Owners of certain service businesses are subject to phase out rules, and the deduction can be limited to a percentage of wages and depreciable property. This deduction can result in an effective marginal income tax rate of 29.6 percent on qualifying income (plus the 3.8 percent net investment income tax [NII] if applicable).
  • Choice of Entity. The new, lower corporate income tax rate will require more analysis of the preferable way to conduct business operations and structures transactions. The lower corporate rate permits businesses to grow their equity and pay down debt at a faster rate. In many circumstances the ability to avoid the higher shareholder rate applicable to a pass-through, the benefit of shareholders not being involved in corporate tax planning and compliance, the ability to capture net operating losses at the corporate level for carryforward, the potential for the 1202 capital gain exclusion upon a stock sale, the new foreign tax regime, the decrease in the value of a step up in asset basis upon a sale due to the lower corporate income tax rate, the deductibility of state taxes, and others, will make C corporations more desirable. On the other hand, if a business is likely to produce sizable cash distributions to the owners on a current basis, or a sale is likely to be structured for tax purposes as an asset sale (whether asset purchase, forward merger or sections 336 or 338 elections) in the not too distant future, pass-through structures may continue to be preferable, although potentially more costly in the short run.
  • Blocker Entities. The new lower corporate income tax rate may make blocker entities much more common in a variety of situations.
  • Valuation. The change in the income tax rates could result in a change in the value of a variety of assets, but how it will affect transactions is unclear. Some changes could increase value (larger after-tax cash flow due to lower rates) but some changes could decrease value (a reduction in value of tax assets). For example, the value of a step up in basis upon a transaction structured as an asset purchase for tax purposes is worth less with lower income tax rates.

Interest Deduction Limitations

In general, net business interest expense deductions will be limited to 30 percent of “adjusted taxable income,” plus business interest income. The annual tax increment (ATI) is initially related to earnings before interest, taxes, depreciation, and amortization (EBIDTA), but after 2022 will more closely relate to earnings before interest and taxes (EBIT). The amount of interest not allowed as a deduction for a year is treated as paid in the succeeding year, subject to that year’s limitation.

  • Exceptions. The interest expense limitation does not apply in certain cases, including taxpayers whose average annual gross receipts for the three-tax-year period ending with the prior tax period do not exceed $25 million, and electing real estate activities for which the taxpayer must then use a longer depreciation life.
  • Debt versus Equity. The lower corporate rate tax benefit of interest deductions, combined with the potential for deferral of interest deductions and the more favorable individual income tax rate for dividends, is designed to decrease the benefit of debt compared to equity, and in certain cases may lead to less leverage.

Corporate Alternative Minimum Tax and Net Operating Losses

The Act repeals the corporate alternative minimum tax (AMT), but puts in place new limitations on net operating losses (NOLs). The Act eliminates NOL carrybacks but allows indefinite carryforwards. NOL deductions can only offset up to 80 percent of taxable income. The inability to carry back a loss means NOLs arising from a transaction, such as extraordinary compensation payments or other transaction-related items, can no longer be carried back to produce a tax benefit for the seller. And the inability to carry back a loss of a target company to offset pre-closing tax liabilities may change the structure of tax indemnities.

Full Expensing of Certain Property

The Act provides for a deduction of the entire cost of certain property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Thereafter, the percentage immediately deductible is phased down over five years. The Act applies to not only new tangible personal property, but also used property and computer software.

  • Thus, a purchaser in acquisition structured as an asset sale for tax purposes could purchase tangible personal property at its tax basis and immediate expense the cost rather than step into the shoes of the seller and inherit the depreciation deductions that would otherwise could have been spread over seven years.
  • While asset-treatment acquisitions will still most likely be driven by purchase prices in excess of tax basis giving rise to increased intangible amortization and fixed asset depreciation, the ability to accelerate the cost of used property due to 100 percent expensing will produce some new and interesting negotiations for sellers and purchasers. The interplay of the 100 percent expensing and NOL and interest limitations for the purchaser, and recapture and tax cost for the seller, will require careful modelling of transactions.

Sale of US Partnership Interest by Foreign Partner

A foreign person’s gain on sales after Nov. 27, 2017, of interests in a partnership engaged in a U.S. trade or business will be taxed as effectively connected income up to the extent a sale of assets would have been so treated, requiring the selling partner to pay U.S. tax on the sale.

Sales of such partnership interests after Dec. 31, 2017, will be subject to withholding unless the seller provides an affidavit stating that the seller is a U.S. citizen. If the purchaser fails to withhold, the partnership is required to withhold from the transferee’s distributions the amount the transferee should have withheld.

  • The IRS has delayed the effective date for the withholding for administrative reasons for publicly-traded partnerships. The IRS has requested comments on the rules to be issued under the withholding requirement to, among other things, determine how liabilities of the partnership affect the amount realized.
  • Much like Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) certificates in the case of the sale of U.S. real property or U.S. real property holding corporations, affidavits will likely become the norm in a sale of a partnership interest.

International Taxation

There are significant changes to the taxation of international activity that will require taking a new look at the structure of domestic and foreign operations.

In many cases taxes on international operations can be lower if the U.S. owner is a C corporation. M&A transactions often present an opportunity to reorganize international operations in a more tax efficient manner.

Note: The foregoing is a summary and is not tax advice directed at any particular situation. The specific statutory provisions and tax advisors should be consulted before taking any particular action.

This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.

 

James Phillips, University of Iowa College of Law 1979, is a shareholder with Godfrey and Kahn in Milwaukee where he practices in the areas of domestic and international tax structuring, planning and controversy matters, corporate and business law, acquisitions and venture capital.

Wisconsin Benefit Corporations, a Profit/Non-Profit Hybrid

Posted in Business Formation, News and Recent Decisions, Operating a Business, Tax



We do a lot of non-profit work. Oftentimes, we are working with new startups that are driven by strong social motivation, but to form and survive need investment capital. This puts us at a crossroad: do we go non-profit and non-stock or conventional corporation? Now, Wisconsin, joining 33 other states, has another alternative: the Benefit Corporation.

Non-profit corporations must have certain characteristics in order to qualify as exempt entities under section 501(c) of the Internal Revenue Code. Charitable organizations qualify under 501(c)(3). Such qualification requires a charitable “purpose” and further requires that in no case may the corporation dissolve and distribute anything to its members or board, but instead, must go to another similarly organized entity. It also allow its donors to deduct contributions to the organization. Its income is not taxed.

If an entity is motivated to protect investor’s capital, make a return on such capital and distribute proceeds upon dissolution to its owners, then it is a “for profit” entity. As such, its income is taxed.

In the past, such entities could not “crossover.” They were one or the other. With the enactment of Chapter 204 of the Wisconsin Statures, on November 27, 2017, Wisconsin now allows corporations to be profit driven and to exist to promote one or more public purposes.

Why is this so important? Because, in the past, the directors of a non-profit had no owners to be responsible to. They promulgated the non-profit’s purpose, regardless of its impact upon the bottom line. Directors of profit corporations owed a fiduciary obligation to the owners to act in their best interests — which oftentimes meant they had to act primarily in consideration of what their actions would do to the bottom line. In addition, for-profit directors could consider three other factors in their decision making:

  • the effect upon employees
  • the impact upon customers
  • how their actions would be perceived by the communities within which they served

Under new Chapter 204, benefit corporation directors may now consider the following additional factors:

  • the effect upon subsidiaries and suppliers
  • any impact upon the local or global environment
  • the interests of customers as beneficiaries of the corporation’s benefit purposes
  • the short term and long term interests of the corporation
  • the ability and extent to which it may accomplish the corporation’s benefit purposes
  • other factors the directors or officers deem important

Note how the last item is a huge “catch all!”

So, what are these “public benefits” that the new benefit corporation must espouse? “A benefit corporation shall have a purpose of creating general public benefit.” Sec. 204.201(1) Wis. Stats. A “General public benefit” is “a material positive impact on society and the environment by the operation of a benefit corporation taken as a whole, through activities that promote some combination of specific public benefits.” Sec 204.120(5) Wis. Stats. Under that section’s subsection (7), “Specific public benefits” are:

  • (a) Providing low-income or under-served individuals or communities with beneficial products or services.
  • (b) Promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business.
  • (c) Preserving the environment.
  • (d) Improving human health.
  • (e) Promoting the arts, sciences, or advancement of knowledge.
  • (f) Increasing the flow of capital to entities with a public benefit purpose.
  • (g) The accomplishment of any other particular benefit for society or the environment.

The owners may sue directors who fail to consider the corporation’s benefit purposes. Directors are broadly protected if they do. Sec. 204.301(3) Wis. Stats. There shall be a designated “benefit director” who shall have the powers to carry out the statute’s intent. Sec. 204.302 Wis. Stats. The law promotes transparency, inasmuch as the corporation has to provide its shareholders an annual statement that includes:

  • objectives to promote public benefits, as set by the board
  • standards the board adopted to measure progress
  • factual information regarding the success of meeting objectives
  • an assessment regarding the success of meeting objectives

The articles or bylaws may extend such transparency by making such statement available to the public. Sec. 204.401 Wis. Stats.

While the concept of a benefit corporation is quite new, it may be the right form to do business for owners who are motivated to solve social or environmental issues. It assures such owners continued control in order to achieve such goals. Such goals may be used to promote the corporation and may be seen by others dealing with the corporation as a consideration when doing so. Employees may be drawn by such purpose; customers may choose to buy from such a company; communities may be proud to bring such operations into their midst; and owners may benefit by improving the world and making a profit at the same time!

If you, or any group you work with is interested in exploring this new form within which you may do business, please contact our business law experts at Schober Schober & Mitchell, S.C. at (262)785-1820.

Other reading:

Navigating U.S. Export Barriers: What All Small Businesses Should Know About Complying with U.S. Export Control Regulation

Posted in Operating a Business, Other Legal Issues

By:   Ngosong Fonkem[1]

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog.”

The first five rounds of the scheduled seven rounds of the modernization and renegotiation of the North American Free Trade Agreement (“NAFTA”) has drawn to a close. Although the current administration has made reducing the U.S. bilateral trade deficits with its trading partners the benchmark for measuring success,[2] exports of U.S. made products to unauthorized end-user, end-use, or destination country without the required export license can lead an unaware U.S. exporter into legal trouble. This is of particular concern to small and medium-size businesses (“SME”) who often lack resources to employ necessary staff or counsel to assist them to navigate the very complex and cumbersome U.S. export control regulations. The U.S. International Trade Administration (“ITA”) reports that SME account for ninety-eight percent (“98%”) of all U.S. exporters,[3] and three-fourths of the exported items are controlled under U.S. export control regulations.[4] Thus, an elementary understanding of U.S. export regulation is vital to any small business looking to expand and benefit from new markets abroad.

What is an Export?

 The starting point for any export control compliance analysis is to understand how an export is defined under U.S. law. Specifically, if an item leaves the U.S. border via carried mail, email, fax, upload or download, mentioned in a phone conversation, or a U.S. exporter accepts a foreign client visit to its facility or permit visual inspection of plans or blueprints, such items or actions are considered an export and are thus subject to U.S. export license requirements.[5] Further, all foreign origin items shipped or transmitted through the U.S. are also considered exports.[6]

Which Federal Agencies Regulate Exports?

All U.S. exporters must fully comply with all applicable U.S. export regulations. Because these laws are administered by several different federal agencies, navigating through the myriad of applicable regulations is a daunting task. Although numerous federal agencies administer exports control regulations,[7] three agencies are of significance. These three agencies are within the following federal departments: The Department of Commerce, the Department of State, and the Department of the Treasury. First, within the Department of Commerce, the Bureau of Industry and Security (“BIS”) enforces the Export Administration Regulations (“EAR”). The EAR regulates the export and re-export of non-military and “dual use” commodities, software, and technology. The EAR also contains the Commerce Control List (“CCL”), which requires licenses for certain exports. Second, within the Department of State is the Directorate of Defense Trade Controls (“DDTC”) that administers the International Traffic in Arms Regulations (“ITAR”). ITAR contains the U.S. Munitions List (“USML”) and controls defense articles, defense services, and related technical data as these terms are defined by the USML and the Arms Export Control Act. Third, within the Department of Treasury is the Office of Foreign Assets Control (“OFAC”) that administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals. Note however that in 2009 the U.S. government began implementing the Export Control Reform Initiative (“ECRI”), which will make significant changes to existing export control system.[8] As of August 2015, Phase Two of the planned three phases is nearly complete.[9] When fully implemented, the ECRI will create a single control list, single licensing agency, unified information technology system, and enforcement coordination center.

What are the Penalties for Non-compliance?

 On June 22, 2016, the BIS published new Administrative Enforcement Guidelines,[10] which aimed to promote greater transparency and predictability to the administrative enforcement process. Further, based on the BIS guidelines, fines for export violations can reach $1 million per violation in criminal cases and up to twenty years prison term, while for administrative cases, it can result in penalties of up to $250,000 and a denial of export privileges.[11] Further, based on the enforcement actions that have been carried out so far by the various agencies, it appears penalties have been applied non-discriminately for each export violation.

 What are the Processes for Determining Whether an Export License is Warranted? 

First determine whether the product at issue has an Export Control Classification Number (“ECCN”) by checking the product against the EAR. The EAR will list reasons why that particular product falls under BIS control. Use this information to determine whether an export license is required, based on where the product is being exported to. Any product that does not have and ECCN is designated as EAR99, which usually does not need an export license, unless it is exported to an embargoed country or in support of a prohibited end-use. If the product is controlled, compare the ECCN against the Commerce Country Chart in the EAR to determine whether or not a license is required. Last, the U.S. maintains a list of restricted parties, which are persons or entities that U.S. exporters are prohibited from exporting to without a license. This may include EAR99 items that otherwise do not require a license based on the country of export. It is important to note that even the most harmless product might be intended for uses not envisioned by the U.S. exporter.

Disclaimer: The views and opinions expressed in this article are those of the author and do not

necessarily reflect the official policy or position of Addison-Clifton.

[1]Ngosong Fonkem, JD.MBA.LLM.BA is a senior advisor at Addison-Clifton LLC, focusing on its Asian Market Services practice sector. His professional legal and business experience is diverse, working cross-culturally in the USA and internationally on a variety of issues involving commercial transactions and government procurements, energy consulting, compliance and risk management, and fulltime member of the Faculty of Law at Multimedia University in Malaysia. Ngosong received his B.A. from University of Wisconsin-Green Bay (2008), J.D./MBA from West Virginia University College of Law (2011), and LL.M. from Tulane Law School (2012).

[2] USTR Releases NAFTA Negotiating Objectives. https://ustr.gov/about-us/policy-offices/press-office/press-releases/2017/july/ustr-releases-nafta-negotiating. https://ustr.gov/sites/default/files/files/Press/Releases/NAFTAObjectives.pdf

[3] “Profile of U.S. Exporters Highlights Contributions of Small- and Medium-Sized Businesses,” International Trade Administration, April 8, 2015.  Available at http://blog.trade.gov/2015/04/08/profile-of-u-s-exporters-highlights-contributions-of-small-and-medium-sized-businesses.

[4] Data is obtained from a 2013 National Small Business Association and Small Business Exporters Association Exporting Survey. “2013 Small Business Exporting Survey,” National Small Business Association and Small Business Exporters Association, at p. 13. Available at www.nsba.biz/wp-content/uploads/2013/06/Exporting-Survey-2013.pdf

[5] 15 CFR §734.2(b)(1); 15 CFR §734.2(b)(4). https://www.bis.doc.gov/index.php/documents/regulation-docs/412-part-734-scope-of-the-export-administration-regulations/file

[6] Id.

[7] Some of these federal departments and agencies include, Department of Energy, Department of Agriculture, the Drug Enforcement Administration, Food and Drug Administration, Nuclear Regulatory Commission, and etc.

[8] https://2016.export.gov/ecr/

[9] Id.

[10] https://www.bis.doc.gov/index.php/enforcement/oee/penalties

[11] https://www.bis.doc.gov/index.php/enforcement/oee/penalties

 

Author’s Bio and contact information.

Ngosong Fonkem graduated from West Virginia University College of Law 2011 (JD/MBA) and Tulane Law School 2012 (LLM), is a senior advisor at Addison-Clifton LLC, Brookfield, Wisconsin, where he assists U.S. and foreign companies with day-to-day compliance with U.S. trade laws and related audits, investigations, intervention, and civil enforcement proceedings; and doing business in Asia.

You Can Lead an Issuer to Rule 506(c), but You Can’t Make Them Advertise

Posted in Business Formation, Business Litigation, Operating a Business

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog,” and was written by Attorney Lindsay M. Fedler.

Many people believe most capital is raised by companies (“Issuers”) making initial public offerings or trading on major exchanges such as the NYSE or NASDAQ. Notable 2017 examples include Snap! (parent company for social media app Snapchat) and real estate site Redfin. Generally, issuers must register publicly offered securities with the Securities and Exchange Commission (“SEC”) – a process involving extensive information reporting and expense.
However, most companies opt to raise capital from the private markets through private offerings exempt from registration if certain conditions are met, which reduces their regulatory burden, costs, and time required to raise new capital. Private offerings have increased substantially since the beginning of the Great Recession.[1] A large portion is raised through Regulation D, which is comprised of three rules: Rule 504, Rule 506(b) and Rule 506(c). Between 2009 and 2014, ten times as many private Regulation D offers were made (about 163,000) as there were public offerings (about 15,500).[2]
Today, over 90 % of issuers engaging in private offerings use the exemptions available under Rule 506. Two key terms applying to Rule 506 exemptions are “accredited investor” and “bad actor”.
An accredited investor[3] can be:
• Institutional, such as a bank, private business development company, or certain types of charitable organizations and trusts;
• A person associated with the issuer, such as a director, executive officer, or general partner;
• Individual investors meeting net worth or income requirements:
o Income: Individual or joint income must have exceeded $200,000 or $300,000 respectively in the previous two years (with no reasonable expectations of a change in the current year);
o Net Worth: the investor’s individual or joint net worth must exceed $1 million dollars (excluding the value of the investor’s primary residence); or
• An entity in which all equity owners are accredited investors.
If certain persons or entities involved in the offer and sale of the issuer’s securities engage in conduct which constitutes a disqualifying event under the definition of a “bad actor,” the issuer cannot use Regulation D exemptions.[4] “Covered persons” include:
• The issuer, its predecessors and affiliated issuers;
• The issuer’s directors, executive officers, general partners, managing members, and any other participating officers;
• Beneficial owners of 20% or more of the issuer’s voting securities;
• Promoters;
• Investment managers (if the issuer is a pooled investment fund); and
• Any person compensated for soliciting investors.
Disqualifying events[5] include:
• Criminal convictions, court injunctions and restraining orders involving the purchase or sale of securities, falsified SEC filings, or other securities related business.
• Final orders of certain state and federal regulators, certain SEC orders, and US Postal Service false representation orders.
• Suspensions or expulsions from memberships in a self-regulatory organization (SRO) such as FINRA, or from association with an SRO member.
Only events occurring after September 23, 2013 are disqualifying.[6] Disqualifying events occurring before September 23, 2013 must still disclosed to prospective investors.[7] A “look back” period of five to ten years may apply, measured from the date of the disqualifying event. For example, the date of the final order issued by a state securities regulator triggers the look-back period – not the date(s) of the underlying conduct.
There are some exceptions to bad actor disqualification. The issuer will not be disqualified if it shows it did not know and could not have reasonably known that a disqualified person participated in the offering, or the court or regulatory authority entering the relevant order, judgment, or decree advises in writing that disqualification under the rule should not result as a consequence.[8]
Rule 506(b) and (c)
In 2012, Title II of the JOBS Act amended Rule 506, directing the SEC to permit general solicitation and advertising in some Rule 506 offerings. As a result, the Rule 506(c) exemption allowing for general solicitation and advertising so long as all investors are accredited became effective on September 23, 2013. Rule 506(b) preserves Rule 506 as it existed before the adoption of Rule 506(c).
The exemptions under Rules 506(b) and (c) share several characteristics. Under both:
• Issuers may raise an unlimited amount of funds through the offer and sale of its securities to unlimited accredited investors;
• Prior to the sale of securities, issuers must decide what information should be provided to accredited investors, and ensure that it does not violate antifraud provisions of the securities laws; and
• The securities are not subject to the specific registration requirements of states where they are offered and sold, in contrast to Rule 504. While issuers must still file a notice form and pay a fee to the state(s) where the securities will be offered, there are no additional requirements above what is needed to complete Form D. Some states mandate electronic filing of Rule 506 document through the Electronic Filing Depository (“EFD”). For information on electronic filing procedures, check out https://efdnasaa.org, containing contact information for actual human regulators in each state to answer all questions related to Regulation D filings.
506(b)
In addition to raising unlimited funds from accredited investors, an issuer may sell its securities to up to 35 non-accredited investors under the 506(b) exemption. The issuer must reasonably believe each non-accredited investor has enough knowledge and experience in financial and business matters to properly evaluate the investment, otherwise known as the “sophistication” requirement, which is somewhat open to interpretation. Frequently, an issuer requires the prospective investor to complete a questionnaire certifying the investor as accredited or non-accredited, and if not, whether the investor has sufficient knowledge or experience in financial and business matters to make an informed decision about the investment.
Issuers must provide non-accredited investors with disclosure documents about the issuer and its securities depending on the offering size, and any information distributed to accredited investors.[9]
Advertising in connection with the offer or sale of 506(b) exempt securities is strictly prohibited. Issuers may approach investors if a substantive, pre-existing relationship exists.
506(c)
Unlike 506(b), under 506(c) an issuer may advertise the offer and sale of its securities under 506(c), through social media, email, and more traditional media (print and radio). No substantive pre-existing relationship with the prospective investor is required.
However, an issuer relying on 506(c) may only sell to accredited investors, with more stringent requirements for verifying the investor’s accredited than under 506(b).
Self-verification by a prospective investor of accredited status is insufficient – the onus is on the issuer to verify accredited status under 506(c). The SEC suggested several non-exhaustive ways to meet the verification requirement for accredited investors under 506(c)(2)(ii)(A)-(D):
• Income verification. Review investor’s two most recent years’ tax returns and obtain the investor’s written representation of a reasonable expectation of reaching the necessary income level in the current year.
• Net worth verification. Review bank and/or brokerage statements, tax assessments, or independent appraisal reports within the prior three months plus the investor’s written representation that all liabilities necessary for determining net worth were disclosed.
• Third party verification. Confirmation from a broker, investment adviser, attorney, or CPA verifying the investor met the accredited investor requirements in the past three months.
• Prior investor self-verification. If the investor purchased the same issuer’s securities as an accredited investor in a Rule 506(b) offering prior to September 23, 2013 and continues to hold the securities, the issuer can obtain the investor’s certification at the time of the sale of securities under Rule 506(c) that he or she qualifies as an accredited investor.
An accredited investor qualifying based on joint annual income or net worth requires the issuer to review documentation for and obtain a written representation from both spouses.
The stricter verification requirements result from the possibility that participation of non-accredited investors in a 506(c) offering using advertising makes the issuer ineligible under both 506(b) and (c). If an issuer using 506(c) does not advertise but inadvertently sells to a non-accredited investor, the filing can effectively be revised to a 506(b) exemption. However, once advertising is introduced, the offering will forever be a 506(c) offering and cannot be converted to a 506(b) offering allowing for sophisticated non-accredited investors.
Rule 506(c)’s Impact on Issuers
One big advantage of raising capital under Rule 506(c) is the ability to advertise to a far larger market than under Rule 506(b). However, issuers have been slow to embrace Rule 506(c), with the vast majority of Regulation D filings continuing to be made under Rule 506(b). Perhaps the field of private offerings has prohibited advertising for so long that issuers are wary of using it without more regulatory guidance, or maybe it’s the more stringent verification requirements for ensuring all investors are accredited, especially where advertising is used pursuant to Rule 506(c).
Some third party platforms are attempting to bridge the gap as a middleman for accredited investors and issuers. These platforms verify investors’ accredited status for the issuers advertised through the platform, in exchange for compensation or some portion of the proceeds raised. The platform also accepts some responsibility for “drawing the line” for advertising content of the issuer.
While Congress intended Rule 506(c) to expand investment opportunities and access to capital, time will tell if issuers take advantage.

[1] S. Bauguess et al., Securities and Exchange Commission, Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009-2014, 10 (2015). (https://www.sec.gov/dera/staff-papers/white-papers/30oct15_white_unregistered_offering.html)
[2] Id. at 7.
[3] 17 C.F.R. § 230.501(a)(1)-(8).
[4] 17 C.F.R. § 230.506(d)
[5] 17 C.F.R. §§ 230.506(d)(1)(i)-(viii)
[6] 17 C.F.R. § 230.506(d)(2)
[7] 17 C.F.R. § 230.506 (e)
[8] 17 C.F.R. § 230.506(d)(2)
[9] 17 C.F.R. § 230.502(b)(2)


Lindsay Fedler, University of Wisconsin Law School 2013, is an attorney with the Wisconsin Department of Financial Institutions in Madison, Wisconsin where she specializes in the areas of securities and franchise laws and regulations at the state and federal level, and prosecutes enforcement actions on behalf of the Division of Securities. She may be reached at lindsay.fedler@wisconsin.gov . The Department of Financial Institution’s website is www.wdfi.org .

How to Dissolve Your Unneeded Wisconsin Corporation

Posted in Buying, Owning and Selling a Business, Operating a Business

Sometimes keeping a corporation going serves no useful purpose. If you have such a corporation, here are some useful steps to consider.

Typical corporate terminations involve both a “liquidation,” the act of converting all corporate assets to cash, paying all outstanding bills, and distributing the remaining cash to the shareholders in exchange for their stock, and a “dissolution,” the legal steps necessary to end the corporation’s existence.

Five actions (and their associated paperwork), generally cover what needs to be done:

  1. Approving an intent to dissolve;
  2. Creating a Plan of Liquidation;
  3. Filing Articles of Dissolution;
  4. Completing the Liquidation; and
  5. Limiting future liability.
Empty Board Room

Empty Board Room of Inactive Corporation

The first step is accomplished at either a joint Shareholder and Director meeting with an appropriate action taken, or by unanimous execution of a joint Shareholder and Director Consent Resolution. At that time , a Plan of Liquidation will be approved, generally setting the timeframe within which the corporation’s assets will be converted to cash and bills will be paid; the shareholders will also sign over their stock certificates for a proportionate “liquidating distribution.” The Articles of Dissolution are then filed with the Department of Financial Institutions.

A Plan on Liquidation should reference that the Corporation’s Accountant will file Form 966 entitled “Corporate Dissolution or Liquidation”, a necessary action.

Once the initial resolution is passed, all future actions can be summarized as “winding up the affairs of the corporation.” See Wis. Stat. § 108.1405. After the Articles of Dissolution are filed, the Directors and Officers retain authority to act with respect to such wind up activities. This includes allowing an officer to sign the corporation’s final tax return as well as checks to shareholders, which will complete the liquidation.

Finally, in order to shorten the time claims may be filed against the corporation, it is advisable to publish a Notice of Dissolution per Wis. Stats. § 180.1407. Specific creditor’s claims may be further barred by following a simple Notice procedure set forth in Wis. Stats. § 180.1406.

If you or anyone you know needs to consider ending the existence of a corporation, please consider calling on our business law team at Schober Schober & Mitchell, S.C. You may reach us at (262) 785-1820 or (262) 569-8300.