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The quarterly publication of Newman & Simpson, LLP contains timely articles which we have written. They are divided into three categories:

Business/Real Estate which focuses on issues of interest to business owners and real estate investors, Banknotes, which focuses on issues of interest to bankers and other creditors, and Personal Business, which focuses on general legal issues of interest. The following articles have appeared in past publications.

Once a buyer has identified a building to purchase, whether it is a warehouse, an office building or a multi-family residential building, he must perform due diligence before consummating the sale. The scope of due diligence depends upon the nature of the property being purchased so that, for instance, the due diligence in connection with the purchase of a vacant 300,000 square foot warehouse would undoubtedly be move involved than the due diligence in purchasing a two-family residence. However, many of the principles remain the same.

Building Conditions -- All of the functional systems of the building must be evaluated by appropriate professionals. These include the roof, heating, ventilating and air-conditioning equipment, electrical and plumbing. Similarly, exterior conditions such as loading docks, landscaping, lighting and parking areas must be evaluated. Signs of potentially substantial problems such as cracked support walls, should be fully investigated.

Leases -- Copies of all leases should be obtained and studied. It is important to understand where the responsibilities of the tenants end and the responsibilities of the landlord begin. In order to make a projection of the operating income of the property, all expenses paid or payable by the landlord should be reviewed as well as the payments by the tenants so that the buyer can determine whether or not the tenants are paying what they are obligated to pay. Care should be taken to review the leases for options to renew and to determine if they have been exercised. Similarly, any rights of first refusal or options to purchase should be clearly understood. Estoppel certificates should be obtained before closing.

Environmental -- While the law requires that there be compliance with the Industrial Site Recovery Act for any property involving an owner or user which has a standard industrial classification code which subjects it to the Act, compliance with ISRA is never sufficient. It is important to obtain a competent environmental review of every property before its acquisition because if there are any hazardous substances on or under the property, the new owner will be liable for their cleanup. Most commonly buyers engage qualified environmental consultants to perform what is called a Phase I environmental investigation. This includes review of records at the state and federal offices having jurisdiction over the property to determine if there are or were any files pertaining to this property or any neighboring properties. The neighboring properties are important because contamination can flow by ground water or surface water from one property to another.

The Phase I investigation also includes an examination of the property for areas of environmental concern. If such concerns are identified, the consultant may recommend further testing, some of which may involve excavation and lab testing and all of which is expensive. These are commonly called Phase II investigations. It is essential that the environmental risk in proceeding with any transaction be completely appreciated before proceeding.

Land Use -- A buyer must determine what are the permitted uses of the property and whether or not the property is in compliance with all applicable zoning laws. Care must be taken to look not just at the existing uses but the buyer's anticipated uses to be sure that they are permitted. This is particularly critical if the property is vacant or the buyer intends to occupy himself.

As part of such review, the buyer should try to determine if there are any applications pending for development or for variances on any neighboring properties which could adversely affect the subject property. While the buyer should review the zoning code, together with any files of the Building Inspector, Zoning Office or Planning Board regarding the subject property, there is rarely a good substitute for going to the building inspector and other town officials and asking pertinent questions.

Title and Survey -- Besides the minimum, obtaining marketable title, it is important to be sure that there are no easements or restrictions or subsurface conditions which could interfere with the use of the property or adversely affect its value. There may be restrictions on the type of use which are far more restrictive than the zoning ordinances. There may be set backs which are inconsistent with planned expansion for the property. There may be underground pipelines or easements for same which likewise interfere with the existing or anticipated use of the property. All of these items must be explored and understood before proceeding with the purchase.

This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.

New Jersey lawsuits follow the American Rule, requiring each party to bear its own legal fees absent a court rule or statute which provides a basis for shifting the attorney’s fees to another party. One major exception occurs when a contract provides for one party to pay another’s legal fees. This includes most bank litigation involving promissory notes or security agreements and suits on leases, guarantees and similar documents, which have specific provisions generally providing that either the creditor or the prevailing party can recover legal fees.

Another exception exists when there is a “fund in court,” a generic term describing a sum of money or an asset which is the subject of a court proceeding. In estate or trust litigation, in many instances, the costs of litigation are paid by the estate or trust and thus, ultimately, by all of the beneficiaries pro rata. The New Jersey Supreme Court has recently made it clear that even where a fiduciary steals money from a trust, the beneficiaries who sue that fiduciary can only recover their attorneys’ fees from the trust fund and not from the fiduciary personally, who remains liable for the damages he causes the trust but not for the attorneys’ fees incurred forcing him to pay.

Another large exception falls under the category of statutes which permit successful parties to recover counsel fees. There are hundreds if not thousands of such statutes, including the Law on Discrimination, the Lemon Law, the Consumer Fraud Act, the Anti-Trust Statutes, the Federal and State Securities Laws, Environmental Protections Laws, etc. If you file a claim under such a statute and are successful, then the court will add reasonable attorney’s fees to your recovery.

Despite all of the above exceptions, in most cases, each party must bear its own counsel fees regardless of the merit of the parties’ positions. To soften the harshness of the American Rule, New Jersey provides two additional vehicles for fee-shifting. The first is the Frivolous Litigation Rule. If one party sues for an improper purpose such as unnecessary delay or increasing costs or for a reason not warranted by existing law or for unsupported factual allegations, then the other party may demand that the pleading be withdrawn because it appears to violate the rule. If the first party does not withdraw the pleading within 28 days and the second party prevails, the prevailing party may then make a motion for sanctions. The sanction ultimately awarded deters repetition of such conduct by either requiring a penalty to be paid to the court or attorney’s fees to be paid to the prevailing party.

The second vehicle for general fee shifting is the offer of judgment rule. Under the rule, any party may file with the court and the opposing party an offer to take judgment in the offeror’s favor or to allow judgment to be taken against the offeror for a stated sum. If the claimant’s offer is not accepted and the claimant obtains a verdict at least as favorable as the rejected offer, then the claimant is awarded reasonable attorney’s fees and litigation expenses incurred after the non-acceptance. In an action for unliquidated damages such as a personal injury case, there are no allowances under this rule unless the amount of the recovery is in excess of 120% or less than 80% of the offer.

While the American Rule is actively followed in New Jersey, the exceptions and interpretations create many opportunities. Using them to your advantage can change your bargaining positions in litigation, whether or not you ever ask a judge to “pull the trigger” and award counsel fees.

Every owner of real property in the State of New Jersey has the right to appeal the assessment of his property. However, most people misunderstand the nature of this appeal process or even what is actual being appealed.

Each year the assessor of each municipality must set forth the assessment of every property in the municipality as of October 1. This assessed value will be the basis for the levying of taxes in the following tax year. This assessed value may have little relationship to the fair market value. However, the assessed value is the basis for the taxation of that property because once the municipality determines the tax rate for the year, it multiplies that rate times the assessed value of each property and sends out tax bills accordingly. For example, if a property is assessed at $300,000.00 and, after adopting the budget, the town strikes a tax rate of $3.50 per hundred dollars evaluation, then the total taxes for this property would be $10,500.00 per year, payable in quarterly installments due on February 1, May 1, August 1 and November 1. While the budget process in each town will determine the tax rate and the amount of taxes paid by each property owner, a property owner does not have a right to appeal his taxes but only his assessment.

In an ideal world, every property would be assessed at its fair value every year and each property owner would pay his fair share of taxes accordingly. However, it is not an ideal world and there are generally significant variances between assessed values and fair market values. Particularly in an inflationary market, as fair values increase, unless the assessments are revised, they will become a smaller and smaller percentage of the fair values.

In order to take into account these changes, each year what is called an average ratio or equalization ratio is determined for each town. It is the ratio of the total of all assessed values of property in the town to the total of all fair values. This is calculated based upon the sales of properties in the town during the prior year. As will be discussed below, this ratio must be factored into computing a tax appeal.

Each year the assessor in each town sends out a postcard to each property owner with the assessed value of the property and the estimated taxes. The card will indicate the deadline for filing an appeal which is generally April 1. This may be extended in certain cases where the town or the county has been delinquent in setting the tax rate.

If the assessment is $750,000.00 or less, then appeal must be taken first to the County Board of Taxation in the county in which the property is located. If the assessment exceeds $750,000.00, then appeal may be taken either to the County Board of Taxation or to the State Tax Court. In either case, the deadline must be met.

Regardless of the forum, the issue in the appeal will be what should be the correct assessment of the property given its fair value on the valuation date, the prior October 1, and the equalization ratio. Thus, for example, if the true value of the property on October 1, 1998 based upon an appraisal is $300,000.00 and the average ratio in that town for the 1999 is 80%, then the property should be assessed for $240,000.00. If the property is assessed for more than $240,000.00, then it is over assessed, but there may or may not be a meritorious appeal.

The major caveat is the effect of what is known as the "common level range." That is a corridor of 15% above and below the average ratio for the town for the year in question. Thus, if the average ratio of assessed values to true values was 80%, the common level range would be from 65% to 95%. The effect of the common level range is that if the ratio for the particular property's assessed valuation to its fair valuation (as determined by the county tax board or the State Tax Court) exceeds the upper limit (95%), then the taxpayer will be entitled to relief by applying the average ratio (80%) to the true value to compute the assessed value. However, if the ratio of the assessed value to the fair value is within the common level range (less than 95%), then the property owner cannot obtain any relief at all.

Using our example, the the fair value were $260,000, then the ratio of assessed value ($240,000) to fair value vould be 92%, which is within the common level range and the property owners would obtain no reduction at all. However, if the fair value were $250,000, the ration of assessed value to fair value would be 96% which is outside the common level range. This would entitle the property owner to a reduction in his assessment by multiplying the fair value ($250,000) by the average ratio (80%), yielding a new assessment of $200,000.

To compute the financial effects of the reduction one must apply the tax rate. Using our example, if the assessed value were reduced from $240,000.00 to $200,000.00, a $40,000.00 reduction, you multiply $40,000 times the tax rate of $3.50 per hundred (in our example), yielding a tax savings of $1,400.00 per year. If this is a result of a judgment as opposed to a settlement, then interest will be paid. In a settlement, interest is generally waived and often the payments owed the property owner is applied to future installments of taxes as part of the bargain.

Practically speaking, it is very rare to try a case in either the County Board of Taxation or the State Tax Court. Almost all cases are settled and, often within the common level range. However, the taxpayer must make out a potential case that meets the statutory requirement of 15% over assessment or else there will be no settlement.

Whether the real property is held as an investment, an operating business property or a residence, the assessment should be reviewed annually to determine if it warrants appeal. For a business, this is the cost of doing business which is a part of managing a business properly. For a homeowner, it is just sensible planning.

Most businesses are owned by small groups of people and are, therefore, “closely-held.” If the business is a corporation, they own stock and are stockholders. The percentages of ownership vary widely from equal ownership to skewed percentages.

Usually the owners of the majority of the shares can elect the board of directors, which in turn elects the officers and thereby controls the operation of the corporation. Absent a stockholders agreement providing specified rights, a minority stockholder cannot elect directors, cannot participate in management, cannot compel the payment of dividends and cannot demand employment. The only rights of a minority stockholder are to share in any dividends, to share upon liquidation of the corporation, if ever, and, perhaps, to vote on certain major corporate decisions such as sale of the company.

This imbalance of power between majority stockholders and minority stockholders has lead to many cases of corporate oppression, where the majority uses its position unfairly against the minority. Examples of such oppression are firing a minority stockholder who is employed by the corporation for no reason related to that person’s employment performance; making changes in corporate operations to hurt the minority stockholder’s status, power or financial standing; refusing to distribute profits although substantial cash is available; and refusing to hold meetings of stockholders or the board of directors. Any material, unjust disparate treatment of the minority stockholder may qualify as oppression. Corporate oppression is often used to “squeeze-out” a minority stockholder - to force him to sell his stock on a distressed basis.

Because of the fundamental unfairness of these acts, the New Jersey Legislature passed the Corporate Oppression Act 25 years ago, which has also been applied to limited liability companies and partnerships. It gives minority stockholders who are victims of corporate oppression and can prove it a number of invaluable rights.

First, a court may appoint a custodian selected by the court to run the corporation without actually declaring a receivership.

Second, the court may appoint a provisional director to serve on the board of directors and to vote on matters of importance coming before the board. This most often occurs when there is split voting power and the corporation is unable to function.

Fourth, and most significantly, the court may order the sale of all shares of the corporation’s stock held by either the majority stockholder or the minority stockholder to the corporation or to the other stockholder. In such case, the court will determine the stock’s “fair value” which will be the purchase price. After determining fair value, the court will set the terms of payment. If the court determines that any party to the suit acted “arbitrarily vexatiously or otherwise not in good faith,” it may also award reasonable expenses, including counsel fees, to the other parties.

The Corporate Oppression Act also applies in cases of corporate deadlock when either (a) there is such a division in voting power that the stockholders have not been able to elect directors at the last two scheduled annual meetings or (b) the directors or officers are unable to act on important corporate issues regarding management of the corporation due to deadlock.

The court may often appoint a custodian or provisional director before discovery and before there has been any final determination of either corporate oppression or deadlock. The goal is to maintain the company's operational status quo pending the litigation and to prevent wrongful acts during the litigation. While such appointments are burdensome, since they include the expense of the appointee and the potential unwieldiness of dealing with an outsider, they often bring dramatic protection for the minority stockholders.

The Corporate Oppression Act applies to every closely-held corporation in New Jersey. Therefore, good planning should try to strike a proper balance in the governing documents between the rights of the majority and the minority. Similarly, where voting power is equal, good planning should anticipate deadlock because people will always disagree. The alternative of a compulsory buyout in court is long and expensive. Often there is no other way out if problems have not been anticipated and provided for in corporate documents.

In today’s world, almost anything can be accomplished without leaving home or office. Overnight delivery services, the telephone, the fax machine and the mail have all facilitated doing business with little or no travel. And now, widespread usage of the internet has made remote business easier than ever before.

While business can be transacted from the comfort of home, lawsuits still involve travel, employing attorneys in the state the lawsuit was filed and considerable additional inconveniences which technology cannot eliminate. The disparity between the convenience of doing business anywhere in the world and the burden of defending a lawsuit halfway around the globe is actually widening with each technological advance. While a New Jersey resident can do business more easily in California, he is also more susceptible to suit in California’s courts.

“In personam jurisdiction” is the legal term for any court’s power over an individual or business entity. While jurisdictional law can vary from state to state, most states’ courts exercise the broadest jurisdictional powers permitted by the United State Constitution. The Constitution requires that a court exercise jurisdiction only over a defendant with sufficient contacts within a state that he should reasonably expect to appear in court in that state.

Those contacts deemed sufficient to confer jurisdiction over a defendant, called “minimum contacts,” can be divided into two categories. Contacts related directly to the facts of a given lawsuit confer “specific jurisdiction.” For example, when a defendant has allegedly breached a written contract that required him to perform significant work in the forum state, that fact will usually confer specific jurisdiction. Contacts not related to the case at hand confer “general jurisdiction,” i.e. jurisdiction for any lawsuit. To establish general jurisdiction, the defendant’s contacts must amount to a regular presence in the forum state.

Significant factors in determining whether or not the courts of a given forum state will exercise specific jurisdiction include the following: Did the defendant solicit the relationship with the plaintiff in the forum state? Did the defendant travel to the forum state to meet with the plaintiff? Did the defendant know that the relationship with the plaintiff would have a significant impact in the forum state? In accident cases, the state in which the accident occurred will usually have jurisdiction. In products liability cases, specific jurisdiction is usually applied very broadly, because one who markets a dangerous product is usually subject to jurisdiction wherever it is sold.

Significant factors in determining whether or not the courts of a given state will exercise general jurisdiction include: Does the defendant do business with residents of the state? Does the defendant own property located in the state? Does the defendant regularly travel to the state? If a defendant has an office or home in the state, then there is always general jurisdiction.

Internet business creates special problems which the courts are only beginning to address. For example, if a buyer and seller meet online, where is the meeting geographically? If the user of a website defames another individual through a posted message, where is the libelous statement disseminated? Because the internet is accessible everywhere on the globe, normal jurisdictional questions become extremely complicated.

For now, and until a generally accepted law of internet jurisdiction is established, it is best to assume that when you do business online you do it globally. This means that you could find yourself traveling long distances to defend your actions, so beware and be careful!

Any business, such as a corporation or a limited liability company, acts through its agents, including its officers and employees. Recently, New Jersey’s Supreme Court has revisited the question of when an officer is personally liable for his own conduct within the scope of his employment.

An officer of a corporation is liable for his own intentional wrongdoing, whether or not that wrongdoing occurred within the scope of employment and without regard to any benefit accruing to the officer. Thus, if an officer of a corporation, while acting within the scope of his employment, commits an assault, an act of fraud, or a theft, that officer will not be excused from personal liability simply because he was acting on a corporation’s behalf.

By contrast, an officer cannot be held liable for a corporation’s breach of contract, even if he is directly involved in the corporation’s efforts or failure to fulfill its contractual obligations. Only a party to a contract is liable for its breach, and an officer is not considered a party to the corporation’s contract, even if he negotiated and signed it, so long as he did so solely on the company’s behalf.

The more difficult question is what happens when the officer is negligent in the course of his employment? Clearly, the company is liable, but what about the officer?

New Jersey’s courts have rarely had occasion to address this issue. Other states have held that an officer is liable for negligence if he participated in the negligent act. New Jersey’s Supreme Court has not clearly ruled, although it did note recently that there is precedent in this state suggesting that this “participation” rule would be adopted.

There is, however, an important caveat. It is always necessary to distinguish whether the officer participated in a negligent breach of a contractual obligation or in a non-contractual act of negligence. Negligence consists of the breach of a duty of care. Where the duty of care exists solely because of a contract, the officer’s participation cannot be the basis for personal liability. However, if the duty of care is one imposed by law, then the question of personal liability of the officer remains open in this state.

· Officer A is participating in the manufacture of a widgit. Due to his negligent mistake, the widgit is built to the wrong specifications and is, consequently, unusable. The Buyer sues the corporation that employs Officer A for economic losses and Officer A for negligence. However, Officer A only violated the duty of care pursuant to the contract and is not personally liable.

· Officer B is participating in the manufacture of a seatbelt for use in an amusement park ride. Due to his negligent mistake, the seatbelt is defective, and someone is physically injured. Officer B owed a legal duty to the public and may, depending upon future rulings in this state, be personally liable.

Sometimes both kinds of duties exist at once. A good example is a law firm. Law firms enter into contracts with their clients that require that individual attorneys exercise due care in their representation of the client, while the law also imposes that duty upon the attorneys. No attorney is immune from personal liability for his own negligence because he is working for a law firm, even if that firm is a professional corporation or a limited liability company. The same rule applies for doctors.

The personal liability of officers for negligence occurring in the scope of their employment is a changing area of the law. While future cases will determine how it develops in this state, be aware that there is a national trend in favor of expanding the personal liability of corporate officers.

Despite the lowering of capital gains tax rates, tax-free exchanges under Internal Revenue Code Section 1031 continue to be popular for real estate investors because a taxpayer can defer much or even all of the gain on the sale of his property and “roll it over” into another property. Anyone who invests in real estate should become familiar with tax-free exchanges.

In a classic tax-free exchange, the taxpayer would come to a closing with another party and they would swap deeds to two properties making whatever monetary adjustments were necessary. Since it is rare for two parties to want to buy each other’s property, most exchanges involve three parties. Often a Qualified Intermediary facilitates the exchange for a fee. A typical tax-free exchange works as follows:

Tony Taxpayer has apartments in Englewood worth $2,000,000. He wants to sell them and reinvest the proceeds in a shopping center in Hackensack owned by Susie Seller. The Hackensack shopping center is worth $5,000,000 and she wants to sell for cash. Bob Buyer wants to buy the Englewood Apartments for cash. With the assistance of Isaac Intermediary, each party will end up with what he or she wants.

Party Owns/Has Wants

Typically the exchange is not simultaneous but deferred. In the first leg of the exchange, Tony sells the Englewood Apartments to Bob for cash. However, by using Isaac as intermediary, the sale is actually done by Isaac, who retains the cash. Tony cannot have actual or constructive receipt of the cash proceeds of the sale.

Within 45 days of the date of the closing, Tony must identify the replacement property he wants to buy, which in this case is the Hackensack shopping center. He must close on that shopping center within 180 days of the closing of the sale of the Englewood Apartments or the due date of his tax return (including extensions) whichever is earlier. During that period, he enters into a contract to buy the Hackensack Shopping Center from Susie for $5,000,000. Prior to the closing, he assigns the contract to Isaac who closes with Susie, using the cash from the Englewood closing plus additional cash and mortgage financing provided by Tony. After the second closing, Tony has the Hackensack Shopping Center, Bob has the Englewood Apartments, Susie has received cash and Isaac has earned a fee.

The taxation of this transaction works as follow: Tony Taxpayer owns the Englewood Apartments, subject to a $1,000,000 first mortgage, with the following tax characteristics:

If Tony were to sell the Englewood Apartments, he would incur a tax liability of approximately $260,000 on that realized gain.

However, by acquiring the Hackensack Shopping Center in an exchange, Tony reinvests all of the $1,000,000 of cash proceeds from Englewood as follows:

Under this exchange, there is no recognized gain or tax due because there is no “boot.”

“Boot” is any consideration received other than real property. There are two types of boot: “cash boot” and “mortgage boot.” Cash boot is cash or anything else of value received. Here Tony has not received any net cash – he has used all $1,000,000 of the proceeds from Englewood to buy Hackensack. Mortgage boot is the excess of the liabilities assumed at the sale over the mortgages assumed on the purchase. Tony has not received any mortgage boot because the $1,000,000 mortgage paid off on Englewood is less than the new $3,500,000 Hackensack mortgage.

The “price” for not paying the tax on the sale of Englewood is the reduction of the basis of Hackensack by the amount of the gain deferred:

By using the tax-free exchange, Tony has avoided paying $260,000 in taxes and has been able to reinvest that money at the small cost of having a reduced basis in Hackensack. Tax-free exchanges are highly advantageous and should be considered whenever proceeds of a sale are being quickly reinvested in a new property.

Controlling the cost of legal services

It is never too late to reduce spending on legal services. If you agree, we would recommend that you carefully consider the following suggestions on how to lower your legal bills.

We spend a great deal of money on insurance. Premium costs anticipate risk (i.e., defense costs and claims payments) plus a generous allowance for insurance company administrative overhead and profit. Given the plethora of potentially uncovered claims (for example, claims for breach of contract, non-payment, unfair competition, wrongful discharge, regulatory charges, etc.) it is not difficult to make a compelling case for legal “audits” of everything from purchase order forms to employee manuals. Since we already “know” your business, we can help you prioritize and budget reasonable expenditures on significant measures to protect your business against expensive claims and losses. Consider the following questions:

(a) Are your customers contractually obligated to pay reasonable service charges, attorneys' fees and costs if you are forced to hire an attorney to collect amounts due?

(b) Have your employees executed confidentiality and non-disclosure agreements covering your marketing strategies, customer and supplier relationships, and intellectual property?

(d) Given the almost unlimited grounds for employment lawsuits, have your employees agreed to forego jury trials in favor of mandatory arbitration of all employment claims?

These and many more “what if?” scenarios merely suggest the same principle that underlies the concept of preventative maintenance—an ounce of prevention…

It is probably not possible to look at any invoice for legal services and rationalize the expense on an item-by-item basis. How can one justify a ten-minute phone call between lawyer and client where nothing is resolved, very little productive information is exchanged, yet a $50 charge appears on the bill? The best response is this: In many situations it is an idea conceived in an instant or a few minutes’ skillful closure of weeks of settlement discussions that produces the greatest portion of the final result. It is simply not possible to bill $50 for “unproductive” conversations and $1000 for five minutes of creative legal work that saves the day. We believe that thorough and efficient legal services performed at competitive billing rates by experienced, competent counsel will get our clients from Point A to Point B at the lowest total cost.

The fact that billing is predicated on the amount of time expended should never preclude the use of project budgets or fee “caps” for many routine legal services. We can often bill at fixed or capped fees for segments of transactional work and other common projects. Initial drafts of many agreements, business governance documents, trusts and wills can be generated quickly and inexpensively. While differing circumstances to complete a particular project will dictate a wide range of costs, it is not unusual for a law firm to stay within budget in terms of anticipated total fees.

Understanding available options and their impact on fees is critical to controlling costs. For instance, we will often discuss due diligence requirements with the client and help prioritize and delegate back that function to others, including the client’s own management. However, there can be circumstances where confidentiality or work force limitations require a considerable effort on the part of the law firm to complete much of the due diligence. Similarly, we are often asked to handle all negotiations in a particular transaction, while in others we are merely scriveners of the “handshake” deal.

Only litigation defies budgeting (the other side is largely responsible, although the courts are nearly as unpredictable). How to manage litigation will be a subject covered in the next LawLine.

Law firms are in the service business. However, as with any service, it's not how much you spend that ultimately determines the quality of the product. Through advance planning and well reasoned, businesslike decision making, you can control expenditures and acquire the quality legal services you need to protect and increase your assets.

Litigation is sometimes necessary, but never productive for business. How much will it cost? More than you want to spend. If you can afford to litigate a case, you can probably settle it for less. Litigation would generally be a viable strategy to resolve virtually any business difficulty if only the other side did not participate. Unfortunately, it's a fact of life in today’s business climate that even the “winner” rarely comes out whole. That being said, consider the following cost-control measures:

(a) Designate one key employee as point person to interact with counsel. While a particular case might require the participation of several employees, efficiency is drastically improved through the use of a liaison who is knowledgeable about the facts of the case, can easily coordinate document productions, the scheduling of conferences and proceedings, and is readily available to assist counsel and provide continuity to the litigation effort.

(b) Don’t attempt to litigate at “low cost.” Keep in mind that your side has no control over the tactics of the opposing parties. Instructing counsel to keep the case going at a “minimum” level is a sure recipe for disaster. As a rule, the stronger you are at the start of the case, the more likely you are to gain real time and money advantages in the course of the litigation. Nothing sends a clearer message to the other side than an easily recognizable lack of litigation resolve. It is actually easier for us, as your counsel, to estimate the cost of a well thought out, properly coordinated initial litigation strategy than a tepid offense or reactive defense.

(c) Always make business decisions. Clients ask us “How much should I pay,” or “How much will they pay?” The answer to the first is a business decision you should make based on a legitimate risk-reward analysis predicated on the advice of counsel. The answer to the second question with you as plaintiff should be discussed and considered before you file a lawsuit. The real difficulty occurs when you base the required “result” on the money spent; that procedure a skews the legitimate business decision making process into an ever increasingly unobtainable or unrealistic objective.

(d) Pick your battles. There are certainly circumstances that justify litigation expense. Many clients use litigation as a tactical device to achieve specific business objectives beyond the result of a particular case. For instance, one large employer will not entertain a settlement demand from any employee threatening suit for a meritless employment claim, but will immediately take steps to resolve a claim with at least some reasonable basis in fact and law. This consistently maintained policy has served the company well—nuisance claims are virtually non-existent and most employees have a sense that legitimate grievances will be disposed of fairly and efficiently. At the same time, meritless claims have been aggressively defended, and, without exception, disposed of satisfactorily. Another client is highly adamant about strictly enforcing its valued contract assets; it is always willing and ready to start litigation at the drop of a hat. As a result, the reputation it has garnered within its business community is one of enviable respect; its rate of contract renewal is the highest in its industry.

While we have had some clients complain about spending a few thousand dollars to resolve a case from start to finish, others have been incredibly appreciative after spending hundreds of thousands on legal fees and paying a significant sum to settle the case. We have never hesitated to attempt to dissuade a client from litigating a dispute if alternative solutions made good business sense. On the other hand, we have tried hard to persuade clients to anticipate and plan for disputes well in advance of their onset. In our collective experience we have learned one truth about judges, juries and our court system: Predictability is not litigation’s strong suit. As with all business decisions, research, preparation and reasoned judgment usually yield the best results.

With ever increasing frequency employers are demanding and employees are signing agreements that limit the employment and other business options available to the employee after termination of employment. Those portions of the employment contract are commonly known as restrictive covenants.

Typically, restrictive covenants include restrictions on the employee's right to work for competitors and to solicit customers of the employer. An example of a restrictive covenant is as follows:

For a period of two years after the termination of employment for any reason, employee agrees that he shall not work in or have any interest in any business which is competitive to that of employer, and employee will not contact, solicit, or accept any business from any customer of employer.

Because these covenants are enforceable only to the extent that they are reasonable under the circumstances, their enforceability can never be determined in the abstract but rather only in the context of the particular facts and circumstances of the employer and employee in question.

Then, even if the covenant is found enforceable, it may be limited in its application by its geographical area, its period of enforceability, and its scope of activity.

An employer's interest in stifling competition is not a legitimate interest in this context. Conversely, if an employee was handed a large number of customers when he started working for his employer, and the employer had developed these customers over many years, the employer would have a legitimate interest in maintaining these customer relationships and preventing the employee from interfering with them. An employer's legitimate interest is increased dramatically in the context of a business acquisition where the employee was previously a principal of the seller.

All restrictive covenants impose some hardship on the employee. The determination of whether or not the hardship is undue is whether it is too harsh a burden on the employee given the legitimate interest of the employer. For example, if an employee came to the job with many years of experience in the industry and many contacts in the industry and worked on customers given to him by the employer as well as customers he developed on his own, a court would be reluctant to foreclose him from working in the industry.

As one court said, "What [the employee] brought to his employer, he should be able to take away." Stated differently, a tradesman who brings tools to his employer may on separation leave with them. Similarly, a scientist who has entered into an employment relationship with a head full of scientific data, some of which he used for the benefit of his employer, may then use it for the benefit of another. As another court said, "Princeton is not to have the exclusive right to Einstein's services just because he is Einstein."

The public interest is implicated in some employer/employee relationships. A good example is that of physicians, where there is a strong public interest in providing medical care generally and in ensuring patients access to their physicians. Thus, it is unlikely that a court would ever enjoin a physician from giving services to a patient. However, a court will enjoin a physician from opening an office within a certain distance of his former employer for a certain period of time. The distance would not prevent the patient from reaching him at his new office but would still give some measure of protection to the employer. In Bergen County, New Jersey, we have seen two- to five-mile restrictions for two years and more upheld by the courts in this context.

After analyzing all of the relevant factors in a given case, courts will often rewrite or "blue pencil" restrictive covenants so that what remains is reasonable under the three-part test set forth above. A prohibition on competition in a large industry might be reduced to a portion of the industry or a prohibition on competition might be eliminated, but a ban on solicitation might remain. A proscribed geographical area or the time period of the restriction might be reduced.

Restrictive covenants are multiplying in employer/employee relationships. Post-employment restrictive covenants are always vital to the employee and often important to the employer. They should be carefully considered by both sides in every case. Through careful drafting, one can eliminate a significant portion of the uncertainty that comes with judicial intervention.

While sexual harassment is a rapidly evolving area of law, it has been clear for a long time that quid pro quo harassment is actionable. Quid pro quo harassment occurs when an employer attempts to make an employee's submission to sexual demands a condition of his or her employment.

The more dynamic area of sexual harassment claims are those based upon a hostile workplace environment. Here, the harassing conduct generally consists of unwelcome sexual touching or comments although they are not necessary elements of a claim. A female plaintiff must prove that a reasonable woman would consider the conduct sufficiently severe or pervasive to alter the conditions of employment and create an intimidating, hostile or offensive working environment. Needless to say, claimants need not be women and the claims need not be based upon heterosexual unwelcome comments or touching.

While most cases involve unwelcome conduct occurring over a period of time, the unwelcome conduct can consist of a single severe act of offensive touching or of multiple randomly occurring incidents. More commonly, there is a pattern of harassing conduct which cumulatively creates a hostile workplace environment.

Much of the sexual harassment litigation involves whether or not the employer is liable for the acts of the employee doing the harassing. That determination is made on a case by case basis and depends on many factors, including whether or not the harasser was a supervisor; if a supervisor, his or her authority concerning the management of subordinates; and whether or not the employer was negligent. It is this last area, employer-negligence, where employers can and should act preemptively.

To avoid a claim of negligence, an employer must use due care. Due care in this context has several elements.

First, an employer must have in place a well-publicized, preferably written, anti-harassment policy. Sexual harassment cannot be tolerated in any workplace and it must be official policy to say so.

Second, each employer should have effective formal and informal complaint mechanisms. If there is a claim of sexual harassment, the employee must know to whom he or she should complain and an investigation should result which is thorough and fair to all concerned. The employee receiving the complaint and conducting the investigation should document all steps. Appropriate disciplinary action must be taken at the conclusion of the investigation if warranted.

Third, there should be training, especially for supervisory employees, concerning what constitutes offensive conduct which makes a workplace abusive or hostile to members of one sex or another. In addition, the training should explain how the complaint and investigative mechanisms operate.

Fourth, there should be some type of effective monitoring mechanism so that the employer can learn whether or not the policies and the complaint mechanisms are trusted and working effectively.

Fifth and most importantly, there must be an unequivocal commitment from the top down that having a workplace free of sexual harassment is not just words but is backed up by consistent firm practice.

Regardless of the procedures in effect, due care always includes a duty to act when evidence of harassment is brought to the attention of supervisory employees. If supervisors learn of potentially abusive conduct, they must investigate, determine if it is harassment and, if warranted, take steps to eradicate it. Supervisors cannot ignore signs of harassment without exposing the employer to liability.

Employment litigation is a booming area of the law. Employers should prepare for the battle not just to win if sued, but because it is the right thing to do to make the workplace a pleasant, productive environment for all.

LIABILITY OF CORPORATE DIRECTORS

by Daniel Simpson, Winter 1999

All corporations share the same basic structure: they are owned by the stockholders who elect the directors who manage the corporation by appointing officers, including a President, who actually run the business. Unfortunately, few people appreciate the responsibilities and liabilities that one assumes as a director of a corporation. Understanding these issues is important before deciding whether or not to accept an offer to become a director. Similarly, one should appreciate these matters before offering a directorship to someone else.

Each and every director is obligated to be familiar with the business and to keep informed about general activities. This is true whether or not the Board of Directors meets frequently or never. This is true whether the minute book is filled with minutes or has absolutely none.

The obligation to keep informed is a continuing one so directors may not close their eyes to misconduct by officers and then claim as a defense that they did not observe the misconduct. It has been said, "the sentinel asleep at his post contributes nothing to the enterprise he is charged to protect."

While a director's duties are to generally monitor corporate affairs and policies rather than to be involved with management on a day-to-day basis, a director should be sure that the Board meets regularly and that he or she attends all, or at least, most meetings. In fact, a director who fails to attend a meeting will be presumed to approve all actions taken unless he files a dissent with the secretary of the corporation within a reasonable time after learning of the action. This is particularly important because certain corporate actions which a director approves can be the basis for statutory liability, including the declaration of dividend or the redemption of shares when there is not sufficient surplus or the distribution of assets to shareholders upon dissolution without paying or providing for all known debts and obligations.

Included in the duty to generally monitor corporate affairs is the obligation to maintain familiarity with the financial status of the company as revealed in its financial statements. In addition, the review of those financial statements may require a director to make further inquiry concerning matters disclosed therein. For instance, if financial statements were to reveal substantial new stockholder loans while the company was losing money, a director should investigate.

Directors are bound to exercise ordinary care in the discharge of their responsibilities, understanding that they have obligations not only to stockholders but to creditors of the corporation. Thus, if a company fails due to misappropriations which a director in the exercise of due care should have discovered, the director may be liable to creditors who are not paid when the company closes.

Part of the obligation of ordinary care is to acquire the knowledge necessary to exercise that due care. Thus, if a director does not feel that he or she has sufficient business experience to be able to perform the responsibilities of a director, he or she should either acquire that experience very quickly or resign the position.

To meet the duty of due care, a director may be under a duty to do more than just object to actions taken at Board meetings. He or she may be may be obliged to seek advice from counsel concerning the propriety of actions taken by officers, other directors or himself or herself.

Contrary to popular belief, there is no such thing as a figure-head director. "A director is not an ornament but an essential component of corporate governance" with attendant responsibilities and liabilities.

The purpose of this article is to explain what a limited liability company ("LLC") is, the special words which comprise the lexicon of LLCs and why LLCs are the entity of choice for most new businesses.

The LLC is a creature of statute from state to state just like a corporation is. It is a legal entity created by filing a document with the New Jersey Department of Treasury called a Certificate of Formation. The Certificate of Formation need not be complex, although it can be. It must state the name of the LLC, the name and address of the registered agent for service of process and the duration which may be perpetual or some shorter period.

Once the Certificate of Formation has been filed, then the LLC can transact business. The LLC is a separate legal entity that can hold title to property, hire employees and enter contracts. The principal advantage of an LLC is that, like a corporation, the owners are not liable to third-party creditors of the LLC (unless they are liable for a reason other than being an owner, such as commission of a tort personally). However, unlike a corporation, the LLC is taxed as a partnership. Consequently, the LLC files a partnership income tax return but pays no taxes, as all items of income and loss pass through the LLC to the individual members.

The owners of the LLC are not called stockholders but members. What members own in the LLC is not stock but their membership interests. There is no fixed management structure for an LLC. This is both an advantage and a disadvantage. The advantage is that the management structure of each LLC can be tailored precisely to suit the members. The disadvantage is that unless a fairly comprehensive document called an Operating Agreement is prepared, there will be no management structure. This flexibility is in contrast to the rigid, well-understood structure of corporations, where the stockholders elect the directors, who, acting as a board, elect the officers, who run the corporation. That is not necessarily so with an LLC. The election of managers can be provided for, or they can be designated by name in the Certificate of Formation of Operating Agreement along with provisions for succession. Similarly, the authority of the managers may be limited or unlimited, as provided in the Operating Agreement. If a more formal management structure including officers such as president, vice president, and secretary is desired, the Operating Agreement can so provide.

The capital structure of an LLC can be anything that is desired. There can be different classes of interest with different returns on investment and different voting rights or no voting rights at all. All of these requirements must be spelled out in the Operating Agreement. In market contrast, in the world of S Corporations, there can only be one class of stock other than the occasional separate class which is identical financially but has different or no voting rights.

Like a well drafted stockholders agreement or partnership agreement, an Operating Agreement will, in addition to setting forth management structure, capital structure and profit and loss sharing, will also have provisions generally restricting the transferability of interests and providing for the purchase of interests in the event of death, bankruptcy or disability, and the potential finding of the same through insurance.

Unlike an S Corporation, any person or entity may be a member in LLC. For example, an LLC is often the preferred entity of choice for ownership of real estate by two or more corporations, other LLCs or other business entities or individuals.

While there are many advantages to the LLC, please do not believe that corporations are dead. They are not. However, an LLC should be considered as an alternative every time a person or persons form a new business entity.

Two recent developments in the area of employment law have created a considerable impact on the responsibilities of employers in protecting the rights of current and potential employees. The first concerns the most recent amendment to the Conscientious Employee Protection Act (CEPA), signed into law by Governor McGreevey on September 14, 2004. Under CEPA, or the New Jersey “Whistleblower” statute as it is more commonly known, employers are now required, in addition to prominently posting notice of their employees’ protections, obligations, rights and procedures under CEPA, to annually distribute such notices to each employee. The notices can be in writing or sent electronically and must be in English and Spanish, as well as any other language spoken by a majority of the employer’s employees.

Employers who are unsure as to the proper form to use for compliance under CEPA can obtain, for a fee, copies of an approved form of notice from the New Jersey Commissioner of Labor. The approved forms can, at the request of the employer, be provided in a language other than English or Spanish.

The new requirement of annual distribution of notices under CEPA does not apply to all employers. Those employers with less than 10 employees are exempt from the obligation to distribute the notices. However, the exemption does not apply to the continued requirement, applicable to every employer in New Jersey, to conspicuously display the notice at the workplace.

The second important development can be found on the federal level and is a direct result of the impact of the war in Iraq on our nation’s workforce. On September 20, 2004, the U.S. Department of Labor (USDOL) issued a set of proposed regulations designed to help both employees and employers understand their rights and obligations under the Uniformed Services Employment and Reemployment Rights Act (USERRA). USERRA was enacted by Congress in 1994 to protect the employment rights of our military men and women once they return from military service to civilian life. The purpose of the new regulations is to help clarify the often confusing language found in USERRA in light of their increased applicability in the face of the largest mobilization of National Guard and reservists since World War II.

In order to accomplish its goal, the USDOL issued the regulations in aion and answer format, using plain language instead of legalese. They are designed to explain how the many goals of USERRA shall be implemented, including the prevention of discrimination against current employees and job applicants based on their military service; the withholding of paid leaveand other earned benefits and promotions from service members during their time away from civilian employment; and the protection of the rights of service members to report back to their civilian jobs after their military service has concluded.

In addition to serving as a guide to employees of their rights under USERRA, the proposed regulations are a useful roadmap for employers who are unsure as to what actions they are permitted to take when confronted with a current or potential employee who is suddenly called upon to satisfy a military obligation. They explain, among other things, the types of employers, employees and service activities covered under USERRA; the type of notice required to be given to an employer by an employee leaving for military service; the procedures to be taken for seeking reemployment upon completion of military activity; the defenses to reemployment given to employers upon completion of the employee’s military service; and the benefits that employers must confer upon returning employees.

Since the USDOL has declared its intention to vigorously enforce the protections granted under USERRA, it is certainly in the best interest of employers to review the regulations in order to prevent potential employee complaints and to be in a position to proffer a proper defense if such a complaint is actually filed.

It is important to note that the regulations are proposed and therefore subject to revision by the USDOL. The regulations can be obtained or reviewed by visiting www.regulations.gov and clicking on the appropriate link. Comments on the regulations may be submitted through November 19, 2004 at the website.

Few concepts involving real property or secured transactions are less understood than Landlord’s Liens. Landlord’s Liens encompass a bundle of rights that a landlord has to recover unpaid rent from the personal property of his tenant. In fact, most landlords have no liens until they distrain, a concept which contributes to the confusion.

Long before the New Jersey State Constitution was adopted in 1947, landlords who were not paid their rent could distrain the personal property of the tenant, typically by padlocking the premises. The landlord would then cause the property to be sold and the proceeds to be applied to the unpaid rent. New Jersey has an 1877 statute, still in effect, which specifically authorizes this procedure.

Except in the case of certain industrial facilities which will be discussed below, a landlord does not actually have a lien on the tenant’s property prior to distraint. The landlord has the right to be paid up to one year’s rent from property of the tenant in the leased premises which property is taken by execution, attachment or court order. Thus, if a judgment creditor of a tenant causes a sheriff to levy upon equipment or inventory in a leased facility, the sheriff will be obligated to pay the landlord up to one year’s rent arrearage out of the proceeds of sale.

A landlord which is not paid its rents may also act proactively to perfect its lien on the tenant’s property within its premises by distraining the property. Prior to 1983, distraint was done the old fashioned way--by padlocking. In 1983, the New Jersey Supreme Court held that that process was unconstitutional because the tenant did not have a right to be heard by an impartial judicial officer before being deprived of its property. Today, a landlord may only distrain a tenant’s property within the leased premises by going to court and obtaining a temporary restraining order distraining the property. To do so, the landlord must show the court that it has a lease, that there is a breach, i.e. unpaid rent, and that the tenant has property on the premises.

Significantly, because the Supreme Court specifically authorizes this procedure, trial court judges are far more likely to grant emergent relief of this kind than in other applications for restraining orders.

If the court orders the distraint, then the landlord must follow the balance of the 1877 statutory framework. Thus, once the distraint has been effected, the tenant has ten days after receiving notice to make a motion to recover its property. Next, on two day’s notice, the landlord may have the goods inventoried and appraised by three persons sworn by the county sheriff or local constable. [In practice, this procedure does not occur without the landlord’s active involvement in hiring such persons.] Finally, on five day’s public notice, the landlord can hold a public sale conducted by the sheriff. The proceeds of sale are applied to the costs of distraint and sale and then to the unpaid rent.

There are certain important factors to keep in mind. First, there is no landlord’s lien with respect to premises solely used as a residence. [A residential apartment used partially for business purposes is still a residence.] Second, the lien does not apply to property removed by the tenant from the premises. The lien only applies to property on site. This is why you will sometimes see tenants moving in the middle of the night, like the Baltimore Colts. Third, the landlord can only distrain one year’s arrears of rent. [This is among the reasons why most leases provide that all monies which a tenant owes, such as common area charges, taxes etc., are considered “additional rent.”] Fourth, the landlord does not have a true lien until the distraint occurs. Until that time it just has a right to obtain the lien and a right to be paid in the event some other creditor seizes the tenant’s property pursuant to a writ of execution, attachment or court order. [Therefore, the landlord’s right to obtain a lien is subordinate to a perfected security interest to a financing company or bank.]

There is special type of lien for certain industrial facilities under the Loft Act. The Act applies to a “mill, factory or loft” leased to a tenant for “manufacturing or other purposes.” Unlike the general statute on landlord’s liens, the Act creates a lien from the date the rent is unpaid, without any requirement to distrain. This lien, however, gives priority up to only six months rent. This lien can prime a secured creditor unless the secured creditor’s lien is placed on the property prior to the commencement of the lease.

As a result of the above statutory framework, most lenders providing financing to tenants require that the landlords sign a document called a “Landlord’s Waiver” before extending the financing. This is often a negotiated document which typically provides that the landlord waives its common law and statutory lien and right to distrain; that the secured party may, on notice to the landlord after default, remove its collateral from the leased premises; that the secured party will pay for damage from any removal; and, often times, that the secured party will pay rent and utilities during some time period while it is removing the property.

The agreements are a benefit to both sides. From the lender’s perspective, it is obvious. From the landlord’s perspective, he is not going to have an operational tenant unless the tenant has financing, so providing a waiver of lien is just part of the bargain. Further, being assured of repair of damage from removal of equipment and any rental for the period of a lender’s use of the premises is a plus. Finally, the landlord is not generally making its credit decision based upon potential resort to the tenant’s personal property.

While most people consider their bank accounts to be "their money," actually they represent amounts owed by the bank to the customer. This is the converse of a normal bank loan where the bank is the creditor and the depositor is the debtor. A bank obtains a right of setoff when it has the legal right to apply the money it "owes" to its customer as represented by an account against monies owed by its customer on a loan.

The first requirement to establish a right to set-off is that the account to be set off must be the property of the same customer who is indebted to the bank. Thus, if a corporation owes money to the bank, the bank cannot set off the account of the corporation's president or of a sister corporation or even a subsidiary unless those parties have given their guarantees of the corporate debt. In that case, they would also be indebted to the bank as guarantors and their accounts would also be subject to setoff.

The second requirement to establish a right to set-off is that the account must be deposited without restrictions. There are many types of accounts which are not subject to setoff. These would include payroll accounts, trust accounts or other special purpose accounts. When a bank accepts accounts with such designations, it acknowledges that these accounts are for special purposes and are not subject to a right of setoff in the event the owner of the account defaults on a loan to the bank.

The third requirement to establish a right to set-off is that the indebtedness to the bank must be due and owing. Thus, until there has been a default and acceleration, the only payments which are due and owing are the current unpaid installments, so a settoff cannot exceed those amounts. After default and acceleration, of course the full amount of principal and accrued interest is due.

While the right of setoff arises from case law extending back hundreds if not thousands of years, typically banks will include a specific contractual right of setoff in loan documents and new account agreements. While this language does not materially alter the right of setoff, it can make it much easier to convince a judge that a setoff was lawful. For example, the typical form guarantee provides for a right of setoff against accounts of the guarantor. Upon default by the borrower, if the bank exercises its right of setoff against an account of the guarantor, it is much easier for the bank to point to the language in the guarantee in which the guarantor specifically agreed to such a right of setoff than to argue from ancient cases that such a right exists.

Many bankers are uncertain how setoff rights are affected by the filing of a bankruptcy. The Bankruptcy Code specifically recognizes setoffs which are taken before the filing of the petition, although the name on the bank account must be exactly the same as the name of the party indebted to the bank. The party indebted to the bank could be liable as a borrower or guarantor but the names must be the same. For example, bankruptcy courts have not permitted setoff of a joint account when the debt was only owed by one party.

However, the Bankruptcy Code has a special preference section just for setoffs. Just as a bank cannot ordinarily acquire additional collateral within 90 days of a bankruptcy unless it gives new value, so a bank may be forced to give back some or all of its setoff. The easiest way to understand the rule is to imagine that the setoff is taken on the day in the 90-day period which is least advantageous to the Bank, ie, the date on which the setoff would have been the lowest possible amount. The Code requires the bank to return the difference between the amount actually setoff and that hypothetical amount. For example, if the amount owed by the debtor to the bank remains essentially constant throughout the 90-day pre-petition period, then the maximum amount of a permitted setoff is the lowest balance in the account during that 90-day period.