Officer Liable for Restitution of Corporation’s Gains in Violation of FTC Act

In Federal Trade Commission v. Commerce Planet, Inc. (9th Cir. March 3, 2016) 16 C.D.O.S. 2355, the Federal Trade Commission (FTC) sued Commerce Planet, Inc., and three of its top officers for violating § 5(a) of the FTC Act, which prohibits unfair or deceptive business practices (15 U.S.C. § 45(a)). The company and two of the individual defendants settled with the FTC. The remaining defendant, appellant Charles Gugliuzza, elected to stand trial. After a 16-day bench trial, the district court found that Commerce Planet had violated § 5(a) and held Gugliuzza, the company’s former president, personally liable for the company’s unlawful conduct. The court permanently enjoined Gugliuzza from engaging in similar misconduct and ordered him to pay $18.2 million in restitution.

Gugliuzza challenged the validity of the restitution award. Among other things, he contended that the district court either lacked the authority to award restitution at all or, at the very least, had to limit the award to the unjust gains he personally received, which in this case totaled roughly $3 million.

The federal courts have established a two-pronged test for determining when an individual may be held personally liable for corporate violations of the FTC Act. The FTC must prove that the individual: (1) participated directly in, or had the authority to control, the unlawful acts or practices at issue; and (2) had actual knowledge of the misrepresentations involved, was recklessly indifferent to the truth or falsity of the misrepresentations, or was aware of a high probability of fraud and intentionally avoided learning the truth. The court found that the FTC’s evidence satisfied both prongs of this test.

Gugliuzza contended that any such award must be limited to the unjust gains each defendant personally received. The court disagreed, holding that he could be held jointly and severally liable for the full amount of the award against the corporation, not just the amount he received as a result of the corporation’s unlawful conduct.

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Don’t go to MyFTB.com. It’s not the official site.

To access your MyFTB account, go to the FTB’s website: www.ftb.ca.gov . Note that the word “my” is NOT part of the URL.

MyFTB.com has been reported as a malware site.

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Acquirer Can Enforce Arbitration Agreement with Acquired Company Employees

The following is the text of an e-bulletin that I authored and that was published by the Corporations Committee of the Business Law Section of the State Bar of California.

Francisco Marenco was employed by 180 Connect, Inc. As a condition of employment, he entered into an arbitration agreement that required both parties to submit to binding arbitration all claims arising from the employment relationship. Subsequently, 180 Connect was acquired by DirecTV LLC in 2008. DirecTV retained 180 Connect’s employees, and Marenco continued working for DirecTV until February 2010.

Marenco brought a putative class action against DirectTV, contending that it violated state wage and unfair-competition laws. DirecTV moved to compel arbitration pursuant to the arbitration agreement signed with 180 Connect. Marenco objected, arguing that DirecTV lacked standing to enforce the arbitration agreement because it was not a party to the agreement. DirecTV responded that as a successor in interest to 180 Connect, it had succeeded to all the rights and obligations arising from 180 Connect’s employee relationships, including the arbitration agreement between Marenco and 180 Connect.

The trial court granted the motion to compel arbitration, and the court of appeal, in what it referred to as a case of first impression, affirmed, concluding that DirecTV had standing to enforce the arbitration agreement.

By suing DirecTV for unpaid wages, Marenco acknowledged the existence of an employment relationship with it. DirecTV, the surviving corporation, assumed all of the disappearing corporation’s rights and liabilities, including the obligations owed to the disappearing corporation’s employees.

Although DirecTV was not a signatory to the arbitration agreement between Marenco and 180 Connect, the court said that the agreement formed one of the terms of employment for Marenco. When Marenco sued DirecTV for violating the terms of his employment, DirecTV was entitled to invoke the arbitration clause to compel Marenco, as a signatory plaintiff, to arbitrate his claims pursuant to the employment agreement.

Citing the principle that a voluntary acceptance of the benefit of a transaction constitutes consent to the obligations arising from it, the court ruled that continued employment provides implied consent to maintaining the existing terms of employment, including the arbitration agreement.

It’s hard to conclude from the opinion whether the acquisition was a purchase of assets with an assumption of liabilities or a merger. There are discussions in the opinion to support both conclusions, but in an April 2008 8-K report filed with the SEC, 180 Connect announced that it had entered into a merger agreement with DirecTV. Consequently, while there is dictum that would support the holding applying to an asset acquisition with an assumption of liabilities, the case may be binding precedent only with respect to mergers.

If you need assistance with arbitration, buy-sell agreements, or outside general counsel, contact Attorney Richard Burt. Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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Guidance on Best Practices in M&A Transactions

The Corporations Committee of the Business Law Section of the State Bar of California just published an e-bulletin that I prepared. The e-bulletin alerts attorneys to a paper written by Leo Strine, Jr., chief justice of the Delaware Supreme Court, Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation Target Zone. I recommend the paper highly for business lawyers, even those who don’t practice in the area of contested mergers.

If you need assistance with arbitration, buy-sell agreements, or outside general counsel, contact Attorney Richard Burt. Serving San Jose, CA and all of the San Francisco Bay area, Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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Real Estate Withholding Credit for Pass-Through Entities

The California Franchise Tax Board (FTB) has recently published a reminder about credit for real-estate withholding. According to the FTB:

Pass-through business entities that pass through their income, deductions, and credits to the owners must also pass through the real estate withholding credit. What is a pass-through entity? It is an S corporation, limited partnership, or limited liability company. A general partnership is treated the same as a pass-through entity, though technically it is not one.

The FTB advises that it cannot refund that part of the real estate withholding credit that exceeds the pass-through entity’s total tax or fee due.

S corporations, limited partnerships, and LLCs may use the withholding to offset their outstanding liability, tax, or fee. Any excess withholding must be allocated to the shareholders, partners, or members.

General partnerships don’t have a California income tax or franchise tax liability and must allocate the entire amount of the real estate withholding credit to the partners.

The pass-through entity’s withholding must flow through to the shareholders, partners, or members (typically, in accordance with the allocation of gain from the sale of the real estate). The shareholders, partners, or members can claim the withholding credit against their individual tax liabilities as long as they are not themselves a pass-through entity.

For more information, see FTB Pub. 1017, Resident and Nonresident Withholding Guidelines.

If you need assistance with arbitration, buy-sell agreements, or outside general counsel, contact Attorney Richard Burt. Serving San Jose, CA and all of the San Francisco Bay area, Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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Perfected Security Interest Yields to Breach of Fiduciary Duty

If a party succeeds in perfecting a security interest in personal property by breaching a fiduciary duty, the security interest may be disregarded for the benefit of the person owed the fiduciary duty.

In Feresi v. The Livery, LLC (2014) 232 Cal. App. 4th 419, Renee Feresi and James Mesa were a married couple who during the term of their marriage acquired a 25% interest in The Livery, LLC. The LLC began with four investors who owned equal shares. Mark Hartley’s family trust was an investor, and he served as the LLC’s president and managing member.

In May 2006, Feresi and Mesa were divorced, and Feresi was awarded one-half of the community’s interest in the LLC. Mesa was also required to make the monthly payments on Feresi’s home mortgage and to pay it off within five years. Mesa’s financial obligations to Feresi were secured by Mesa’s interest in the LLC and other properties.

Feresi did not file a Uniform Commercial Code Financing Statement (UCC-1) to perfect her security interest in Mesa’s share of the LLC. She instead gave Hartley and the other members of the LLC written notice that the dissolution judgment awards her one-half of Mesa’s share of the LLC and that Mesa pledged his retained share as security for his financial obligations to her. Amendments to the books and records of the LLC showed Feresi as a member with a 12.5 percent ownership interest. Corporate tax returns identify Feresi as an LLC member.

By 2008, Mesa was struggling financially and fell behind on his obligations to Feresi, his ex-wife. In October 2008, Hartley made a short-term loan to Mesa of $200,000 from the Fitzgerald-Hartley Pension Plan. Although Hartley knew Mesa’s membership share in the LLC secured his financial obligations to Feresi, Hartley nevertheless secured the loan from his pension plan by the same 12.5% membership share Mesa pledged to Feresi in 2006.

Hartley did not disclose to Feresi either that his pension plan intended to loan money to Mesa or that it would be secured by Mesa’s membership share.

Later that month, Feresi notified Hartley (as president and manager of the LLC) that she intended to enforce Mesa’s obligations to her by taking the 12.5% share of the LLC and certain other properties he pledged. She asked the family law court to compel Mesa to convey his 12.5% membership share in the LLC to her. Hartley determined that Feresi had not filed a UCC-1 financing statement to perfect her security interest in Mesa’s membership share of the LLC.

Hartley took advantage of this circumstance by filing a UCC-1 financing statement to perfect his pension plan’s security interest.

The family court subsequently ordered Mesa to transfer his interest to Mesa, which he did, and Feresi notified Hartley and the other LLC members that Mesa’s transfer was complete and that the LLC’s records should be amended to identify her as the owner of a 25% membership interest.

Several months later, Mesa failed to repay the loan from Hartley’s pension plan, and Hartley took action to foreclose on the security interest held by his pension plan. Feresi sued to stop the foreclosure. The court granted an injunction and ruled that Feresi took her interest free and clear of the security interest of Hartley’s pension plan.

On appeal, the court held that if a perfected security interest is created by breaching a fiduciary duty owed to another person, then equitable principles may be applied to give priority to an earlier unperfected security interest. The court said that Hartley was obligated to act with the utmost loyalty and in the highest good faith when dealing with any member of the LLC, including Feresi.

Hartley was not permitted to obtain any advantage over Feresi (or any other member of the LLC) by even the slightest misrepresentation or concealment. Hartley breached his fiduciary duty to Feresi by destroying the value of her security interest in Mesa’s LLC membership interest to advance his own. Hartley had actual knowledge of Feresi’s security interest in Mesa’s membership interest, knew that Mesa was in default on his obligations to Feresi, and knew that Feresi’s security interest was immediately enforceable. Hartley loaned money to Mesa, created a conflicting security interest in Mesa’s membership interest, and then surreptitiously perfected it to gain an advantage over Feresi.

Hartley took advantage of Feresi’s ignorance by concealing this from her, and betrayed her trust and confidence by perfecting his pension plan’s security interest ahead of hers. In doing so, Hartley breached the fiduciary duties of loyalty and good faith he owed to Feresi. Under these circumstances, the trial court properly refused to enforce the security interest held by Hartley’s pension plan.

Although the UCC gives statutory priority to the holder of a perfected security interest even if the holder is unjustly enriched at the expense of an unsecured creditor, the court found that the provision of the UCC that its provisions are to be supplemented by “principles of law and equity” allowed for the security interest of the pension plan to be disregarded.

Contact the offices of Richard Burt Attorney and Counselor at Law with your questions regarding Perfected Security Interests.

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Richard Burt Law: Handling M&A Transactions

Smart merger and acquisition transactions can be a key component of business growth and on-going success. Business attorney Richard G. Burt is ready to assist at every stage of a merger or other acquisition transaction and to assure that the business deal is carefully documented and legally sound, with help on negotiation tactics as well as preparation of M&A agreements, contracts, and other documents, due diligence, and closing, Mr. Burt works assiduously to accomplish a transaction in which his client’s interests are protected.

Comprehensive Merger & Acquisition Services–From Start to Finish

Whether the business to be bought or sold is part of a corporation, limited liability company, professional practice, or sole proprietorship, Mr. Burt provides the knowledge and experience necessary for all variety of business buy/sell transactions, whether on the buy side or the sell side. The services include:

  • Drafting of confidentiality agreements or non-disclosure agreements (NDAs)
  • Letters of intent, including advice on the finer business points often not considered by buyers or sellers
  • Negotiation and drafting of:
    • acquisition agreements, such as an asset purchase agreement, a stock purchase agreement, or a merger agreement
    • covenants not to compete (non-compete clauses)
    • employment agreements and consulting agreements
    • ancillary agreements, documents, and instruments, such as escrow agreements, officers’ certificates, bills of sale, assignments of leases and contracts, third-party consents, promissory notes, security agreements, and UCC financing statements
  • Corporate law (or LLC law) compliance for authorization of the transaction
  • Due diligence services
  • Obtaining tax-clearances
  • Providing and reviewing legal opinions
  • Closing the transaction

Achieving success in a merger or other acquisition transaction requires timely responses, knowledge of the law, skill in negotiation, and familiarity with M&A customs and practices. Mr. Burt’s approach is to provide practical counsel to help his clients achieve their goals.

Business Transaction Expertise Specific to the Silicon Valley & California

Located in the heart of Silicon Valley, Mr. Burt’s California business law firm has been assisting clients in the area for over 30 years. As a long-time M&A attorney in California, Mr. Burt knows that CA state law is important to the planning stages of a deal prior to the initiation of the transaction, and he is intimately familiar with California statutes, laws, and rules.

Our Legal Team Stands Ready to Serve

Mr. Burt has the experience, legal knowledge, and business acumen to plan and execute successful business transactions, large and small. He provides careful, thorough representation tailored to meet the specific needs and goals of each client while guiding the client through every step of the transaction. He offers the skill of a large-firm lawyer while maintaining the individual client focus and personalized service usually associated with smaller firms.

To learn more about Mr. Burt’s services, or to obtain legal help with a merger and acquisition transactions, please call today at (408) 286-7333 or fill out the online contact form. You will receive a response promptly.

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Misleading Certificate of Status Solicitations

The California Secretary of State has issued warnings about misleading certificate of status solicitations. Directors and officers of corporations and managers and members of limited liability companies (LLCs) should be wary of such solicitations. As a public service, the text of the Secretary of State’s warning is repeated below (with minor modifications):

Letters are being sent to businesses registered with the Secretary of State directing them to submit $49.50, respond by a certain date, complete a form, and send the money and documentation to a private entity named “California State Corporations.”  According to the letter, California State Corporations will provide a “certificate of status.”  However, these Certificates of Status are fraudulent because only the Secretary of State can issue a Certificate of Status.  An example of the form and fraudulent “certificate of status” are available through the Secretary of State’s website at www.sos.ca.gov/business/be/alert-misleading-solicitations.htm.

A certification of the entity’s status, also known as the Certificate of Status, only can be issued by the Secretary of State who is the official custodian of business entity records for the State of California. The fee for this certificate is $5.00.  The private entity has no affiliation or authorization to act on behalf of the State of California or the Secretary of State and is illegally issuing fraudulent Certificates of Status for entities registered with the California Secretary of State.

These solicitations are not being made by the California Secretary of State’s office and are not being made by or on behalf of any governmental entity. Although a business entity can use an intermediary to submit filings, request a certificate of status, and pay fees to the Secretary of State’s office, no business is required to go through another private entity in order to obtain documents or certificates from the Secretary of State’s office and no private entity can issue these documents.

If you have received a similar letter and have questions, contact out office. Additionally, if you need assistance with arbitration, buy-sell agreements, business entity formation, or outside general counsel, contact Attorney Richard Burt. Serving San Jose, CA and all of the San Francisco Bay area, Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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Out-of-State LLC Owning Property in California

Many California residents are members of LLCs formed under the law of other states (often referred to as “foreign LLCs”). California, being hungry for tax revenue, often tries to tax the LLC on the ground that it is doing business in California. Obviously, if a Delaware LLC owns rental property in California and is generating rental income from the property, it would be considered to be doing business in California.

But what if the resident forms an out-of-state LLC simply to hold raw land or a personal residence for the owner (either a principal residence or vacation home)? Ownership alone is not a business activity, and assuming there is no rental of the property, it might seem that the LLC is not doing business in California. But things are not always what they seem when it comes to tax law in California.

Under California Revenue and Taxation Code § 23101(b)(3), if a foreign (out-of-state) LLC’s real property and tangible personal property in California exceeds $51,186, the foreign LLC is statutorily deemed to be doing business in California. Given that most California real property is worth more than $51,186, any foreign LLC that owns real property in California is likely to be doing business in California, which will require it to register with the Secretary of State, file tax returns with the Franchise Tax Board, and pay tax to California.

By the way, in case you are wondering why an odd number like $51,186 was chosen, the answer is that the original figure was $50,000, and the FTB is authorized to increase the original figure by an inflation factor, which it has done.

If you need assistance with arbitration, buy-sell agreements, or outside general counsel, contact Attorney Richard Burt. Serving San Jose, CA and all of the San Francisco Bay area, Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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Out-of-State Business Entity Doing Business in California

An out-of-state business entity is a corporation or limited liability company formed under the law of another state (say, Delaware or Nevada). An out-of-state entity is often referred to as a “foreign” corporation or as a “foreign” LLC. An out-of-state business entity is permitted to conduct business in California, but it must first register with the California Secretary of State as a foreign business entity and obtain a certificate of registration to transact intrastate business.

There are penalties for an out-of-state business that does business in California without registering, which include inability to sue on contracts and monetary penalties.

Let’s say that an out-of-state business entity entered into a contract with a party in California, which the other party has breached. The entity wishes to sue in California, but the other party objects on the ground that the out-of-state entity has not registered to do business in California (also referred to as “qualifying to do business”).  At that point, the out-of-state entity has a choice to register with the California Secretary of State or drop the lawsuit. But even if the lawsuit is dropped, the out-of-state entity will still be subject to taxes, penalties, and interest that will continue to accrue until it registers.

Once the out-of-state entity registers with the California Secretary of State, it will need to file tax returns and pay tax to California just as it would if it were a California entity. If the foreign business entity has already done business in California for number of years, it will have incurred penalties and accrued interest for failure to file tax returns and pay taxes in California. Before picking a state to incorporate in (or to set up an LLC) based on cocktail-party chatter, a founder or entrepreneur would be well-served to make that choice based on competent legal advice. As part of the service of organizing a corporation or forming an LLC, I provide clients with advice on the choice of jurisdiction in which to form the business entity.

If you need assistance with arbitration, buy-sell agreements, or outside general counsel, contact Attorney Richard Burt. Serving San Jose, CA and all of the San Francisco Bay area, Mr. Burt can be reached at (408) 286-7333 or by filling out the online contact form.

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