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Choosing the Best Form of a Business Entity

August 9, 2011

by Kit F. Pettit, Esq.

With all of the types of business entities available to choose from when starting a new business, how do you know which business entity is best? There are LLC’s, LP’s, S-Corps and C-Corps, and each type of entity has its own advantages and disadvantages depending on a number of considerations. Some of the advantages and disadvantages are tax matters, asset protection, liability protection and transferability. Some of the considerations include the entity’s size, the type of business activity, desired governance structure and other business investment matters.

Typically, tax treatment is one of the most important factors in choosing the form of business entity. Among other things, one of the basics tax matters an entrepreneur should know when deciding which entity may best suit his or her business plan is that C-corporations are subject to double-taxation while S-corporations are generally not subject to the two layers of taxation. A new business owners should also be aware that limited liability companies and partnerships are flow through entities and the earnings of these types of entities are not subject to federal income tax, however, Pennsylvania treats all limited liability companies as corporations for capital stock taxes. There are numerous tax advantages and disadvantages for each type of entity and a skilled legal practitioner along with advice from an accountant can help an entrepreneur through this maze.

Once the entrepreneur is aware of the tax considerations, personal liability protection is often the next most important factor to consider. The various entities can have different liability shields. Careful planning and consideration should be given and knowledge of the statutory liability limitations is most important. For example, 15 Pa.C.S.A. § 1526 sets forth the statutory rules with respect to the personal liability of shareholders of a business corporation while 15 Pa.C.S.A. § 8922 provides the rules for personal liability of members and managers in partnerships and limited liability companies. Business trusts are governed by a different statute. 15 Pa.C.S.A. § 9506.

The governance structure and standards of conduct of the shareholders, partners or members is also a very important consideration when organizing and forming a new entity. The governance structure of each type of entity differs and there are business, legal and other reasons why an individual or group of individuals may prefer one management structure over another. In Pennsylvania, corporations have established governance principles and structural formalities that are for the most part defined by statute and case law. 15 Pa.C.S.A. § 1701 et al. Partnerships are primarily governed by contract between the partners, i.e., a partnership agreement, however, there are certain rights and duties of partners governed by statute. 15 Pa.C.S.A. §8331 et al. As for limited liability companies, they have significant flexibility with respect to governance of the company. For example, a Pennsylvania limited liability company can be “member-managed” which follows the general partnership rules, or it can be “manager-managed” which governance mechanism is most similar to that of a corporation. 15 Pa.C.S.A. § 8941.

The above matters highlight some basic and important considerations when starting a new business. Corporate formation and organization is more than an online “check-the-box” process. It takes knowledge and careful planning based on information provided by the client. For example, does a majority-member of a limited liability company really want unanimous consent provisions in the company’s operating agreement that would require the consent of a 5% member for certain company actions? Would you incorporate as an S-corporation if you anticipate distributions to some shareholders and not others? After all of the considerations have been discussed and the form of entity selection is made, an entrepreneur should also know that each type of entity has its own formation and organization requirements and respective formalities that should be properly observed and followed once incorporated or organized. Observation and practice of these important formalities such as annual meetings of members and shareholders is a part of the liability protection mechanism and should not be ignored or forgotten once your business is up and operating.

To Appear or Not to Appear? That is the question…

August 4, 2011

One thing that I’ve noticed time and time again in my practice is that clients are not always aware that they may need to appear in court at some point if they choose to take legal action against a debtor. In Pennsylvania, if the matter is not settled or if judgment is not obtained prior, it will go to either arbitration or trial. The factor that determines which type of hearing you will have is the amount for which you are suing. If that amount is over a certain limit (usually $25,000.00 or $50,000.00 depending upon the county) your case will go to trial and if it is below a certain amount it will go to arbitration. The arbitration that I refer to, however, is through the Court of Common Pleas and is not affiliated with the American Arbitration Association. It operates much like a trial except for the fact that your case is presented to a panel of three attorneys as opposed to a Judge. What many creditors do not realize is that regardless of whether the matter will first be scheduled for arbitration or trial, a witness must physically appear at the hearing to testify on behalf of the Plaintiff. I have been asked many times whether the witness may ‘appear’ by telephone. This has never been allowed in Pennsylvania Courts and it is expected that if you file suit in Pennsylvania you, or a credible individual with first-hand knowledge of the matter, are able and willing to appear in Pennsylvania Courts in regards to that suit. Although many cases come to an end through either settlement or judgment, by default or otherwise, long before trial or arbitration is scheduled , one must always prepare for a potentially lengthy litigation. Therefore, I would urge anyone considering filing suit in Pennsylvania to first ask themselves whether they will be able to travel to the county in which the suit is filed for one or more hearings. If the answer is ‘no,’ such action should be reconsidered so as not to spend even more money chasing a debtor who has already caused you a loss.

The National Economic Situation is NOT Insurmountable (But We’re Making it That Way!)

July 31, 2011

 (But We’re Making it That Way!)

When it comes to the national economic situation, the numbers are so large that we are blown away and feel unable to think about them in rational terms. True, they are large numbers. But many of us have learned to work on situations of financial distress for small companies and large, as well as people with small debt and small income and those with large debt and large income. The principles are the same.

If a client (company, family, individual or city) spends more than it takes in, there are short- and long-term consequences, as well as short- and long-term strategies to deal with it.

Strategies fall into a few basic categories, generally always a permutations of either:

1. Charge more for what you sell.

2. Spend less to produce what you sell.

3. Sell more of what you sell.

Get more money! Increasing revenue is a good thing. How one does that depends on the circumstance and whether the client has the ability to sell more product, get a better (or second) job, bring in a strategic partner, etc. In a small business, the owners can work harder, provide more services (or value) and advertise to create more volume. These are but a few of the options. Sometimes the client can discount its products to create more volume and more cash (while, this may present some issues on the back end if the basic cost structures and markets don’t change). However you do it, getting more revenue is important. Selling unused (or under-used) assets can help. Collect accounts that are slow pay. Sell unused raw materials. Lease or sell unused capacity. Clean out the garage and have a garage sale.

Spend less money! Cut expenses that can be cut. Do more with fewer employees. Eat out less often. Get non-working family members to work instead of paying staff. Negotiate reductions with vendors. Create efficiencies.

As a business, credit and bankruptcy lawyer, I have been involved in literally thousands of discussions about how to fix financial problems for people and businesses. It generally comes down to the same thing. And everyone knows what to do, but the most common response is: “If I do X, it will only affect the cash by a small amount and it won’t fix the problem. A business that comes up short by $10,000 every year could cut out free coffee in the kitchen and save $200 a month, but they perceive that as so small as compared to the $10,000, they don’t do it. They look for the $10,000 solution and there isn’t one. If it were that easy, they would have done it already! Think about finding $1 trillion of shortfall and how hard that could be if we are looking for the $1 trillion solution!

These problems are generally solved by taking a number of small steps simultaneously. Slow the bleeding (if you can’t stop it). Sell some languishing assets. Find some increased sources of revenue. Negotiate some cash savings with creditors. These are but a few of the options that struggling families and companies look to. None of them solves the problem by itself. Maybe all of them together only slow the slide until the economy comes back (or the big customer settles its strike or the next budget year starts and the other breadwinner gets back to work or…).

But you have to do something or, more appropriately, a bunch of somethings. And you have to watch the results closely, track them to see how it is going. You also have to keep finding new things to do to cut expenses, build revenue, slow cash outlays, and so on.

Sometimes if you delay too long and fail to see the cliff ahead of you, you’ll fall off that cliff. That, in my experience, comes most often from either following a single decision maker who makes the wrong decision (certainly a risk in a small business with a strong personality at the helm) or from analysis paralysis (thinking about things so long that you do nothing and drive off the cliff).

Former Senator Everett Dirksen is credited with saying “a billion here, a billion there. Before you know it, you are talking about real money.” The flip side of the numbness we feel to these large numbers is that we feel the inability to affect them unless we are affecting large numbers. That is a fallacy. Small impacts multiplied by large instances create large impacts.

If we have a $10,000 deficit this year and we cut 5% off of every expense, we save $500. If we cut out a few dinners, movies and concerts altogether, we will be sad for a while, but we’ll save $1000. If we take the bus instead of drive to work, we’ll save another $500. Stop smoking and save $500. Right there we have $2500 of savings. Then we look to increasing revenue and cashflow. A part time job for a family member. A reduction of staff by 1 person. Before you know it, we are talking about real impact.

In making these decision, we have hard choices. If the decision maker really likes to smoke cigarettes, but doesn’t care as much for movies, it will likely result in not cutting out cigarettes, while cutting out more movies. These are choices that can be made. Making them is hard and if we have too many decision makers who are also unwilling to compromise because they are trying to make long-range philosophical impact, there are lines in the sand which we will be be able to cross. That will prevent us from making any decisions about driving directions, speed and distance, causing us to argue while the car drives off the cliff.

Pretty simple, huh?

Bob Bernstein

Mediation in Bankruptcy

July 29, 2011

by Maribeth Thomas, Esq.

Alternate dispute resolutions such as mediation have become prevalent in bankruptcy proceedings and often result in much success for all parties involved. Mediation is not an official judicial proceeding and instead is designed to encourage collective agreement amongst parties to a dispute. The mediation process is informal and is most often entered into voluntarily by the parties.

In particular, mediation can be especially effective in Chapter 11 bankruptcies as a tool to construct a consensual plan of reorganization. The mediation process provides the debtor with an opportunity to negotiate, with the assistance of a neutral third party, with creditors in an informal setting to reach a settlement that is fair and in the best interests of all involved parties. Furthermore, by providing the debtor with an opportunity to resolve claims outside of court, both money and time can be saved by avoiding potentially expensive and lengthy litigation.

Mediation may also be useful in the chapter 7 context to resolve disputes involving preference, avoidance, non-dischargeability, fraudulent conveyance and claims allowance actions. Most recently, jurisdictions have implemented mediation procedures to prevent foreclosures. Such programs have been pioneered in Florida courts and require the debtor to file a chapter 13 bankruptcy. The programs work to reduce foreclosures by reducing monthly payments and, in certain instances, forgiving mortgage principal. Early statistics demonstrate that the programs created by bankruptcy courts are significantly more successful in stopping foreclosures than programs implemented in the state court system.

The Bankruptcy Court for the Western District of Pennsylvania has adopted mediation procedures as a method of dispute resolution under Local Rule 9019-2. General Court Procedure # 4 establishes the specific requirements and standards for the mediation process. While the court can direct a party to mediation, a party may request mediation from the court through a signed stipulation or by the filing of a motion. It is important to remember that the mediation process does not delay any other proceedings in the bankruptcy case. If the mediator assigned to the case requires compensation, such costs are usually shared between the parties involved in the mediation. Each party and its primary attorney, must be present at the scheduled mediation conference, as well as any other parties in interest whose presence is necessary for a full resolution of the matter. Importantly, all material, both oral and written, that is produced at a mediation conference is to remain confidential. However, any material presented at the conference that would otherwise be discoverable or admissible is not exempted from discovery in a court proceeding merely by its use in mediation. If the parties are able to reach a settlement through mediation, the mediator must submit a fully executed stipulation to the court within twenty days after the conclusion of mediation. If the mediation conference does not result in a successful resolution of the dispute, the matter proceeds as scheduled before the court. For a full description of the procedures for mediation before the Bankruptcy Court of the Western District of Pennsylvania, please refer to the court’s General Court Procedures which can be found on the court’s website: http://www.pawb.uscourts.gov/.

Forum Selection Clauses – Controlling where you Litigate

July 5, 2011

Once a lawsuit is filed to collect on an outstanding debt, a number of factors that were not present prior to the filing of a lawsuit become serious impacting factors on the outcome of the case and ultimately the collection of the debt. Such factors include the costs of witness travel and hiring local counsel to litigate in distant locales.

These two factors are easily eliminated by a properly drafted forum selection clause. A forum selection clause is a contractual provision, whereby the parties to the contract agree that all future legal disputes between the parties will be litigated in a particular forum. Often such clauses are overlooked or left out of documents because no one expects a relationship to go south when it is first being formed. However, A valid forum selection clause offers a creditor not only the savings and comfort of litigating at “home,” but provides an additional pressure point on a debtor who may have to travel to defend.

For a legal analysis of the state of forum selection clauses in Pennsylvania, please click here.

Bankruptcy as a Creditor Sword

June 9, 2011

It is a very common situation for a creditor to be owed a large sum of money from a debtor who continues to operate by paying other creditors or parties. Naturally, this is very frustrating. It can also be very disturbing because at the same time there are rumblings of the debtor’s financial instability. At this point, the creditor must decide on a course of action.

Certainly, the creditor has the option of filing a state court breach of contract action and working toward obtaining a judgment. However, litigating a lawsuit takes time and even more time is spent to execute on the judgment. The passage of time affords the debtor the opportunity to continue paying others and ultimately wind down the business.

There is another option, which is often overlooked. Force the debtor into bankruptcy. This is done by filing an involuntary bankruptcy petition. The reason for an involuntary bankruptcy is to prevent and protect creditors from unfair activities and treatment by debtors. The greatest advantage to an involuntary bankruptcy is that it forces bankruptcy upon the debtor rather than allowing the debtor to ultimately file on its own terms. This is extremely important because of the ability to recover payments or wrongful transfers by the debtor within certain time frames leading up to the filing of the bankruptcy petition. These payments and transfers can be brought back into the bankruptcy estate to be properly distributed by the bankruptcy court.

In sum, bankruptcy is not always a bad thing for unsecured creditors. It just simply depends upon whose terms the bankruptcy is filed.

 

Deficiency Judgments under Pennsylvania Law

Often, when foreclosing on a piece of real property, a secured creditor’s focus and objective is limited to the recovery of the property. However, in this economic climate, more and more secured creditors are electing to pursue a deficiency balance against the debtor because the underlying debt owed exceeds the value of any real property that is recovered.

Deficiency Judgments in Pennsylvania are governed by statute. 42 Pa.C.S. § 8103. In order to establish a deficiency balance, a judgment creditor must first file a Petition to Fix the Fair Market Value of Real Property Sold. This Petition must be filed within six (6) months, “following execution and delivery of the sheriff’s deed for the property sold in connection with the execution proceedings.” 42 Pa.C.S. § 5522(b)(2). Therefore, it is important that a creditor make the decision to pursue a deficiency balance as soon as possible.

The purpose of the petition is to establish a fair market value of the real property sold, so that figure can be offset against the total amount of the debt owed. This process recognizes that the secured creditor who purchases the real property at foreclosure sale for Sheriff’s costs, usually a couple thousand dollars, cannot then pursue the debtor for the full remaining balance of the debt. Establishing the fair market value and crediting it against the debt owed prevents the secured creditor from receiving a windfall.

The Petition is filed as a supplementary proceeding on the same docket in which the judgment was entered. If an answer is filed to the Petition alleging that the fair market value of the property is more than the value stated in the petition, then the court shall hear evidence and fix the fair market value of the property sold. This is usually a battle of appraisals that turns on what parties’ appraiser appears more qualified and credible to the court.

While the deficiency judgment process in Pennsylvania seems quite simple, there are two important factors that cannot be overlooked: 1) Timing; and 2) Hiring a qualified appraiser. These are both issues that can easily be address by your creditors’ rights attorney.

DON’T SUBMIT TO STORAGE FEE EXTORTION

May 6, 2011

While I subscribe to the belief that a secured lien holder should always know the location of its collateral, I understand that is essentially impossible to practice. Which is why a secured lien holder may some day find themselves in a position where they find their collateral in the possession of a third party. Often that third party is a garage looking to be paid for repairs, towing or storage with respect to the collateral.

Under Pennsylvania law, the secured lien holder is generally on the hook for repairs and towing charges. The theory being that the secured lien holder receives any benefit bestowed upon the collateral. However, a dispute often arises over storage fees. Particularly, where a garage stores the collateral and then makes no effort to inform the secured lien holder of the collateral’s location.

With typical charges of $25.00-$35.00 per day, these storage fees can quickly accumulate. A garage is entitled to any storage fees incurred after the secured lien holder gave “consent” to storing the collateral. Obviously, if the secured lien holder gave express consent to store the collateral, there is no issue. The problem arises in instances of implied consent. Implied consent will be found when the garage has sent notice to the secured lien holder that they have the collateral and the secured lien holder does not pick up the collateral.

However, most problems arise when express consent is not given and notice is not sent. The secured lien holder after months of contacting the Debtor about delinquent payments finally hears from the Debtor that the collateral has been at the local garage for months. So what does a secured lien holder do?

1. Immediately contact the garage and find out exactly what amount of money they are demanding. Obtain a break down of the charges identifying what is for repairs, towing, storage, etc. Also, find out what they are charging per day to store the collateral.

2. Immediately make a reasonable offer, in writing, to the garage to resolve the matter. Pennsylvania case law provides that if a garage declines a reasonable offer to a secured lien holder, then the garage cannot seek any storage fees if it is later found consent to storage did not exist.

3. It is usually best to settle. However, if the garage is unreasonable, then immediate legal action should be taken by contacting your creditors’ rights attorney.

The Use of Facebook in Litigation – How will Pennsylvania react?

April 2, 2011

Undoubtedly, social networking sites such as Facebook will change the face of the legal practice in a number of ways, some foreseeable, some not. Already, Facebook in Litigation is used in criminal investigations, used for “cyber-bullying” and has been the subject of privacy disputes due to school administrations’ use of Facebook to suspend students for activities such as underage drinking.

Facebook has also been a sought-after source of information for attorneys involved in active litigation in a variety of areas of the law. Whether it’s a civil or criminal matter, a case can often be expeditiously closed due to a few posts made by either the Plaintiff or Defendant on Facebook or other social networking site. Often times, however, an individual’s public posts may not reveal much in regards to an active litigation matter though the individual’s private posts and messages may disclose much more. The question is, how can an attorney ethically gain access to the private information located within an opposing party’s social network site?
It is tempting to have another individual, such as a friend, secretary or paralegal, send a “friend request” to an opposing party in order to gain access to the information that is not made public on their Facebook page. To do so, however, would violate a number of the Pennsylvania Rules of Professional Conduct, including, but not limited to, Rule 5.3 (Responsibilities Regarding Nonlawyer Assistants) and 8.4 (Misconduct).

Rather, there are a few non-binding cases out there that suggest that private information from an individual’s social network site may be obtained through discovery requests. One case in particular comes from Jefferson County, Pennsylvania and illustrates what may be Pennsylvania’s emerging view toward discovery and social networking sites. In McMillen v. Hummingbird Speedway, the Plaintiff claimed that he was injured when the Defendant rear-ended him during a cool down lap after a stock race.
After the Plaintiff posted information on the public portion of his Facebook and MySpace accounts which indicated that he may not actually be injured, the Defendant requested Plaintiff’s usernames and passwords to his social network accounts in Interrogatories. The Plaintiff objected to this request and the Defendant filed a Motion to Compel. The Court granted Defendant’s Motion and ordered the Plaintiff to produce his usernames and passwords to his Facebook and MySpace accounts to Defendant’s counsel, only (the Defendant, himself, was not permitted access to the accounts). The Court further ordered that the Plaintiff was prohibited from taking steps to alter or delete existing information or posts from his Facebook and MySpace accounts.

 

The Court stated: “Under Pennsylvania’s broad discovery rules, as long as it is relevant to the litigation, whether directly or peripherally, a party may obtain discovery regarding any unprivileged matter. Pa.R.C.P. 4003.1.” McMillen v. Hummingbird Speedway, 2010 Pa.Dist. & Cnty. Dec. LEXIS 270, 2. “In this case, the Plaintiff asked the Court to recognize communications shared among his private friends on social network computer sites as confidential and privileged and thus protected against disclosure.” Id, at 3.The Court noted that Pennsylvania law does not favor evidentiary privileges “for they are in derogation of the search for the truth.” Id, (quoting) Hutchison v. Luddy, 414 Pa. Super. 138, 606 A.2d 905, 908-09 (Pa. Super. 1992) (quoting) Herbert v. Lando, 441 U.S. 153, 175, 99 S. Ct. 1635, 60 L. Ed. 2d 115 (1979).
The Court also pointed to the terms and privacy policies of both Facebook and MySpace stating that they “clearly express the possibility of disclosure” barring the Plaintiff from successfully maintaining that the element of confidentiality protects his Facebook and MySpace accounts from discovery. Id at 10.
The Court went on to state “whatever relational harm may be realized by social network computer site users is undoubtedly outweighed by the benefit of correctly disposing of litigation.” Id, at 11.

The fact that the Plaintiff first posted public information that was relevant to the matter and, therefore, suggested that additional relevant information may be located in the private sections of his Facebook and MySpace pages was clearly taken into account. Had he not made the public posts, I believe that the Court may have ruled differently.
Although this case is not binding, it may be an indication of what is to come from Pennsylvania Courts with respect to social networking sites and litigation. Will Pennsylvania adopt a narrow interpretation of confidentiality? Only time and additional ill-advised posts from plaintiffs and defendants will tell.

What Creditors Should Do Just Before Sunrise

March 2, 2011

NACM Teleseminar Presentation February 23

February 23, 2011

Bob Bernstein and Nick Krawec will present a 60 minute teleconference today at 3:00 p.m. Eastern for National Association of Credit Management on Things Your Creditors Rights Lawyer Should be Telling You Before & During the Litigation Process. Still time to register!
See: http://www.nacm.org/teleconferences.html

Staying connected: Pros and Cons

February 19, 2011

Bernstein Law firm got its first computer in 1971. It was bigger than a refrigerator! We’ve all come a long way. It might be an old story, but I continue to marvel at how our firm’s technology use allows me to “place shift” by staying connected working in whatever location I happen to find myself. Recently, Ellie and I spent a couple of weeks vacationing in Florida. With my Mac, IPad and IPhone, it was easy for me to connect with clients, debtors, adverse parties and Courts when necessary. It permitted me to stay involved as required. All of them have programs or apps to allow connection to our Terminal Services so I can be viewing and using all of my office programs from the beach if need be, Of course, the other side is that I was not truly “vacated,” but I would prefer my disconnectedness in small doses, knowing that I can get stuff done tomorrow or this afternoon. I know there are different views about how connected to be. Please share your perspective.