Marianne M. Jennings, J.D. Professor Emeritus, Legal and Ethical Studies in Business W.P. Carey School of Business Arizona State University

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The materials and presentation are not intended to be legal advice, but rather to make the participants sensitive to the legal environment in which they do business. The law varies from state to state and in its application to different fact situations. The intention of this presentation to make participants aware of their need to consult an attorney to review their business activities and become an informed consumer of legal services. Consult your firm’s legal counsel with questions about your business operations and use the information in this course to help you raise questions.

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Information for firm’s lawyer: All names under which the firm is now doing

business and has done business in the past All locations where the firm has an office All states in which the firm does business Type of business organization (partnership,

corporation) Number of owners (partners, shareholders) and the

percentage of ownership of each Number of full-time and part-time employees and

whether they are covered by any contracts: covenants-not-to-compete; union contracts

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Copy of employee handbook Number and types of employee benefit plans (retirement,

health, disability, etc.) Copies of form agreements used by the firm (employment

applications, invoices, purchase orders, sales contracts, etc.) Name of accountant for the firm History of violations of government regulations History of lawsuits by and against the firm Copies of contracts with manufacturers, sales

representatives, distributors Type and amount of hazardous materials sold and stored by

firm Copies of stationery and promotional literature

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CAUTION: Information in response to questions or assembled to give to the firm’s lawyer should be kept confidential and not shared with others. If the communication is intended to be privileged, don’t pass it along to others as well. You can lose the privilege by copying in others. Some of the information could be damaging to the firm and should be protected. If you are under investigation or audit, avoid making written memos, notes, tapes, computer files or tangible documentation. These items could be discovered by plaintiffs, employees, the government, or others. Contact the firm’s lawyer to find out how to protect the responses to the auditor or regulator under the attorney client privilege.

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I. Relationship issues with your manufacturer

II. Antitrust issues III. Relationships with employees,

partners, and purchasers IV. Product liability issues V. Business structure

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Liability protection Lack of bargaining power Strategic thinking

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Product liability “Broad Form Vendors Endorsement.” Strategy: The “Under the Bus” Advantage

Plaintiffs’ Lawyers Use

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What issues should be covered in the contract with the manufacturer?

What are the reporting/informational issues? What about lack of training programs? Lack of

sales support? Is there a trend to national reps? What are termination rights? Issues?

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Who has the bargaining power? There is no right to an ongoing relationship There is some precedent for good faith

reliance (Sons of Thunder , Inc. v. Borden, 690 A.2d 575 (N.J. 1997)), but there is a great deal of reliance required

Need to deal with “fear” on both sides: Fear of termination in reps Fear of slacker in manufacturers

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Commissions beyond termination date and/or, in the event of a change of ownership of a manufacturer (lasts for six to twelve months)

Notice requirements Cause terminations Convenience terminations Sale of manufacturer terminations Sale of rep firm terminations Timing and notice – 30 days to terminate; increase of 30 days for

each year of the relationship Equal rights on terminations No-cause-at-all terminations The role of semi-automatic terminations and their psychological

effect A goals and objectives clause

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Who books the business? Sales outside area? The problems of cross-

territory customers: engineering, procurement, manufacture

Split commissions where reps claim to represent the manufacturer

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Required training Trade shows

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Mediation and arbitration clauses Independent contractor status Bankruptcy rights/voidable preferences Competition: The Deep Discounter

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Manufacturer

Rep 1 Rep 2 Rep 3

Deep Discounter

Long-term relationship

Manufacturer outlet

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Manufacturer

Rep 1 Rep 2 Rep 3

Deep Discounter

Long-term relationship

Reports Discounter

Sides with Rep 2

In June 1997, XYZ Company, a widget manufacturer in the United States, entered into a written agreement to supply Discount Dealer with widgets for a two-year period. In return Discount Dealer agreed to promote, display, and sell XYZ's widgets. In May 1998, QR Dealer, another dealer for XYZ Company selling widgets in the same geographic area as Discount Dealer, complained to XYZ Company that Discount Dealer was a low-pricing, high-volume dealer, and that QR Dealer had been forced to lower its prices to compete with Discount Dealer.

Although XYZ Company does not suggest resale prices, XYZ Company is concerned that it will lose QR as a dealer. XYZ, therefore, is considering terminating its contract with Discount Dealer. Any problems?

Adapted from Robert B. Taylor, “Relationships Among Competitors” PLI (2004)

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(a) Can XYZ Company terminate Discount Dealer? Leegin case (U.S. Supreme Court 2007) (b) Would it make a difference if XYZ Company

had urged Discount Dealer to raise its prices? (c) Would it make a difference if QR Dealer was one

of several dealers who complained jointly about Discount Dealer's pricing policies?

(d) Does XYZ's market share for widgets make a difference?

(e) Would it make a difference if XYZ Company also sold widgets in the same geographic area as Discount Dealer and QR Dealer?

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Shift from just sales to intelligence gathering (“eyes and ears” for the manufacturer in the territory)

Sales projections Emerging product issues and ideas Assistance with accounts payable Less assistance from manufacturer with training

and support The issues with information retention, disclosure,

and turning it over upon termination (credit standing)

Partner vs. employee vs. independent contractor

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Manufacturer soliciting rep’s representatives (employees)

One year controls after rep’s reps leave re business

See discussion on covenants not to compete

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Why do they want the information? Sales tracking and furnishing reports: Territory

change fodder? The turn-over of records upon termination –

privacy, communications, e-mail disclaimer and privacy

The antitrust issues

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Does the firm communicate with competitors about prices?

Discussing prices with competitors can lead to severe penalties against the firm and persons involved. (Antitrust issues (Apple/Publisher case))

Tying arrangements Price discrimination (Robinson-Patman)

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Manufacturer Manufacturer Manufacturer

MR

C1 C2 C3 C4 C5

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Customer

Manufacturer’s Rep

Mfr. Mfr. Mfr. Mfr. Mfr.

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Customer

Pitching: Rep 1

Rep 1 Rep 2 Rep 3 Rep 4 Rep 5

Agreement on who wins

Incorporate Mutual fees in all prices

AIG and the bid-rigging Recent Justice Department actions in this area Car parts price-fixing: U.S. Justice

Department simultaneous raid of all offices representing the car parts manufacturers

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1. How are prices determined and quoted to customers?

2. Are personnel trained not to discuss prices with

competitors or others in the trade? 3. How are sales territories determined?

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Supplier of High-Demand Item

Processor 1 (outbids) (corners market)

Processor 2 Processor 3

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Employment applications may only ask certain questions: Discrimination issues

Disciplinary processes and actions Proof of citizenship and form I-9 are required

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1. Audit I-9 compliance regularly (one form for each employee hired since

1986) 2. Don’t fudge (PATRIOT Act) 3. “Good faith” defense doesn’t apply to having

no I-9s at all; the Wal-Mart defense on using another firm does not apply either

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Does the firm have contracts with its employees? In many states, having employee contracts limits

the employer’s ability to discharge employees. Does the firm have an employee handbook? A properly written handbook can prevent many

employee claims. Is there adequate documentation of all employee

actions, evaluations, reprimands?

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Feds estimate they will collect $7 billion from employers over misclassification of employee vs. independent contractor

Estimate is that 30% of companies misclassify employees as independent contractors (about 3.4 million workers total)

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20 factor common law test Degree of control Nature of work Level of Education Location of office Existence of office Payment for staff/assistance Percentage of income earned per principal Label is irrelevant Nature of compensation Previous employment

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Amount of income from you Independent office and purchase of office supplies Payment methods Income tax payment Benefits REMEMBER: personal liability even for corporate

directors for not withholding pay taxes “The laws are unclear in this area, and legitimate

clarification is one thing. But if it’s just a way to justify enforcing very unclear laws against employers who can have a legitimate disagreement with the Labor Department or IRS, then we’re concerned.”

▪ Randel K. Johnson, senior vice president Chamber of Commerce

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Common Law Liability Issues Agency - Contracts Express Implied Apparent Authority – watch disassociated partners

Agency - Torts Master/Servant Relationship Scope of Employment Doctrine of Respondeat Superior

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The protection in the clause: (1) is no greater than is required for the protection

of the legitimate interest of the employer, (2) does not impose undue hardship on the

employee, and (3) is not injurious to the public.

A violation of any prong renders the covenant invalid.

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Statutory Law vs. Common Law

1. Protecting legitimate interests:

2. Reasonable in time

3. Reasonable in scope Limited in duration Limited in scope Limited to what is reasonably necessary

Does not violate public policy (blue pencil rule)

Trade secrets

Goodwill

Confidential information

State law (California and North Dakota)(Colorado limitations to executives and Massachusetts $125,000)(quirky differences)

Necessary (something to protect) e.g. sales techniques; preservation of customer relationships; customer lists (California)

Reasonable in time and geographic scope Balance between their right to earn a living and your need

to protect proprietary information and goodwill: The problem of inevitable disclosure

Things that help: advance knowledge of covenant; nature of market; their conduct; bargaining power

Litigation is expensive, lengthy, and detracts from your business

Alternative approaches: Payment during the noncompete period 41

The executive in energy drinks (All Sport) at PepsiCo who left PepsiCo to work for Quaker Oats on its energy drinks (Gatorade); Quaker’s Snapple vs. Pepsi’s Lipton PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995)

Starwood executive who worked on young, hip hotel brand development to work for Hilton’s young, hip hotel brand development Starwood Hotels & Resorts Worldwide, Inc. v. Hilton Hotels Corporation, 2009 WL

1025597 (S.D.N.Y.) Thomas English Muffins’ executive who knew the

“Nooks and Crannies” secret Bimbo Bakeries USA, Inc. v. Botticella, 613 F.3d 102 (3rd Cir. 2010)

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Promise not to recruit other employees from the firm if they leave

Different from non-compete More easily enforced

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Casual Male won a $1.5 million settlement against both a former associate and a competitor.

A jury determined that Robert Yarbrough broke his contract with the company after he violated non-competition obligations and leaked company secrets after leaving Casual Male for Westport Big & Tall. He was required to pay $1.1 million in damages.

Westport Big & Tall, a competitor of Casual Male, had to pay $400,000 to Casual Male for interference with contractual relations.

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Trademarks for logos Trade dress protections Copyrights for manuals

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1. Is trade secret information clearly marked and kept in a secure location?

2. Is access to secret information restricted? 3. Do employees sign nondisclosure agreements? 4. Are customer lists secure or available to

everyone? 5. Are personnel advised to maintain trade secrets

and of the consequences to the firm if unauthorized disclosure occurs?

6. How do the different states in which the firm does business treat trade secrets?

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Does the firm have secret processes or information about products that competitors could use to duplicate products? Secret or confidential information must be protected for it to remain secret and be entitled to protection under the law. Role of covenants in protection of trade secrets Separate out your confidentiality agreement from your non-compete agreement – makes it easier to enforce

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Google recruited two senior executives ... who then recruited other employees from eBay. Those employees used PayPal trade secrets to develop Google digital commerce products. The resulting lawsuit alleges that one of the former eBay executives “transferred digital documents outlining PayPal's mobile-payment and point-of-sales strategies just days before leaving the company for Google. EBay says those documents were critical to its mobile-payments strategy.” In leaving eBay, the suit alleged that the eBay executive took not only his personal inalienable human capital but he also allegedly misappropriated trade secrets and shared them with a competitor, breached his fiduciary duties, and violated an agreement not to solicit fellow employees.

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Eagle Gate College hired an admission consultant from Stevens-Henager College (Janna Miller). After she was hired, Ms. Miller hired other employees from Steven-Henager, and some of those employees had access to a confidential database at Steven-Henager that included leads for recruiting students. Before leaving Stevens-Henager, the employees went into the college’s database on leads and altered the information on the individuals in the list in such a way that it impeded or prevented Stevens-Henager’s ability to contact those leads. One Stevens-Henager official said, “We continue to use any leads that come into the college from time to time, and with the loss of adequate phone numbers ... it became difficult, if not impossible, to use our own leads. …”

Stevens-Henager College v. Eagle Gate College, 248 P.3d 1025 at 1028 (Utah App. 2011).

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Common Law Contracts

Uniform Commercial Code

Relationship Contracts

What form contracts does the firm use? Form contracts should be used with caution unless the firm’s

lawyer has received them. “Borrowed” forms could be inapplicable and cause the firm exposure to liability or loss. Watch your cutting and pasting

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Do sales contracts contain permissible disclaimers? The Uniform Commercial Code allows

disclaimers of warranties in certain situations: 1. Warranty of title 2. Express warranty 3. Warranty of merchantability 4. Warranty for a particular purpose

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TYPE CREATION RESTRICTION DISCLAIMER

Express Affirmation of fact or promise of performance (samples, model, descriptions)

Must be part of the basis of the bargain

Cannot make a disclaimer inconsistent with an express warranty.

Implied warranty of Merchantability

Given in every sale of goods by a merchant (“fit for ordinary purposes”)

Only given by Merchants (1) Must use “merchantability” or general disclaimer of “as is” or “with all faults” (2) if written (record) must be conspicuous

Implied Warranty of Fitness for a Particular Purpose

Seller knows of buyer’s reliance for a particular use (buyer is ignorant)

Seller must have knowledge; buyer must rely on that knowledge

Can disclaim with “as is” or “with all faults” or use of specific terms

Title Given in every sale; warranty is also against infringement

Does not apply in circumstances where apparent warranty is not given

1. How and by whom are products designed? 2. How are products tested? 3. Does the manufacturer carry product liability

insurance? 4. What quality control procedures does the

manufacturer use?

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5. Are the proper warning labels attached to the product?

6. Are clear instructions included with the product? 7. Is product advertising factual and accurate, without

boasting and false claims? 8. Has anyone ever been injured by a product? 9. How are customer complaints and suggestions about

the product handled?

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What type of organization is the firm? A sole proprietorship, partnership, corporation, limited liability company, limited liability partnership. The type of organization will determine the

rights and obligations of its owners. A corporation, for example, enjoys limited liability in most situations where proprietorships and partnerships do not.

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FORM TRANSFER CONTROL

TAXES DISSOLUTION LIABILITY***

Sole proprietorship

Transfer through sale of business

Individual pays on individual return

Death; voluntary Individual

Partnership Transfer interest but not partner status w/o approval of others

Partner takes profits and losses on individual return (flow-through)

Dissolution upon death; withdrawal of partner (disassociation)

Partners are personally liable

Limited Partnership

More easily transferred

Same as partnership (flow-through)

Death of general partner

General partner is personally liable; limited partners liable to extent of contribution

Corporation Shares (with reasonable restrictions) are easily transferred

Corporation pays taxes; shareholders pay taxes on dividends

Dissolved only if limited in duration or shareholders vote to dissolve

No shareholder personal liability unless

(1) Water or (2) Corporate veil

S corporation or Subchapter S

Restrictions on transfer to comply with S corporation

Flow-through: Shareholders pay taxes on profits; take losses

Same as above Same as above

C corporation As for corporation Corp. pays taxes Shareholders pay taxes

Same as above Same as above

Limited liability company (LLC)

No admission without consent of majority

Flow-through treatment Dissolved upon death, bankruptcy, time

Limited with exceptions for personal negligence of owners

Limited liability partnership (LLP)

No admission without consent of majority

Flow-through treatment Dissolved upon death, bankruptcy, time

Varies by state but liability for acts of partners is limited in some way

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General Partnership

Limited Partnership

Limited Liability Company (LLC)

Limited Liability Partnership ( (LLP)

Corporations*

Creation

No formality required.

Filing a certificate of limited partnership with appropriate state office.

File articles of organization with appropriate agency

Registration of LLP filed with appropriate state government agency.

File articles of incorporation with appropriate agency

Liability*

Unlimited liability of each partner for firm debts.

General partners: unlimited liability for firm debts.

Limited partners: no liability beyond loss of investment.

All members are liable for LLC debts to the extent of their capital contributions and equity in firm. No personal liability beyond such.

No liability for partners beyond their contributions and equity in firm, except unlimited personal liability for their own wrongful acts and those of persons whom they supervise.

Limited liability except: water, corporate veil

Management

All partners according to their partnership agreement or the UPA or RUPA .

General partners according to their partnership agreement or the ULPA or RULPA .

Limited partners risk liability as mgrs.

By members of firm, who may delegate authority to managers.

All partners according to partnership agreement or the LLP statutes. .

Officers and board

Dissolution

As set forth in the partnership agreement or the UPA or RUPA.

As set forth in the partnership agreement or the ULPA or RULPA. .

As set forth in LLC statute or articles of organization.

As set forth in partnership agreement or LLP

statutes

Major corporate transaction (Vote)

*S or Subchapter S Corporations formed under state law; tax status election (Small Business Job Protection Act of 1996).

Questions to Ask When Forming a Partnership:

1. Who will the partners be? 2. What assets does each partner have? 3. What credit rating does each partner have? 4. What authority should each partner have to contract for

partnership?

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5. What liability does each partner have? 6. What will happen when a partner retires or

withdraws? 7. What happens on the death, divorce, or disability

of a partner? 8. How are disputes among the partners to be

resolved (court, arbitration or mediation)? 9. What does my accountant say?

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Questions to Ask When Forming a Limited Liability Company? 1. Is there a state law authorizing formation of a LLC? 2. Is tax status clear? 3. Have filing requirements been complied with? 4. Has a management structure been established? 5. How will profits and losses be allocated? 6. Will registration in another state be permitted? 7. The problems with no perpetuity

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Questions to Ask When Forming and Operating a Corporation: 1. Are all shareholders, directors and officers aware of the formal

requirements to operate as a corporation? 2. Have all the statutory requirements to incorporate been met? 3. Are formal directors’ and shareholders’ meetings held and

minutes kept? Wage tax issues? (Accountant) 4. Are important transactions formally authorized before they

occur? 5. Is the corporation minute book kept up to date? 6. What activities of the corporation could cause the shareholders,

directors, or officers to have personal liability?

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How many owners are there, and what percentage of the firm does each own? Percentage of ownership can determine control of the

firm. If there is more than one owner, then an agreement among them would help in succession planning and control of the firm.

What are the firm’s plans for growth? The firm’s plans for the future may require a change in

structure.

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Valuation issues Impact of litigation Life insurance policies

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Check tax implications of sale/purchase Make sure ownership is transferred: shares vs.

property Do your due diligence – audited financials Covenants not to compete

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Tax issues Marital issues Control Smooth transition Keep in mind the value of your business rests

with you and your partners

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What about Obama care? What about consolidation of reps? What about reduced commissions?

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