Ben Byrd’s article Dissenters’ Rights: Litigating “Fair Value” was published in the April 2017 Issue of The Litigator. Click Here for Full Article published by the Atlanta Bar Association.
Ben Byrd’s article Dissenters’ Rights: Litigating “Fair Value” was published in the April 2017 Issue of The Litigator. Click Here for Full Article published by the Atlanta Bar Association.
You buy insurance to protect your business (or you, personally) from claims. When a claim is covered by the terms of the policy, insurers have two separate duties: (1) to defend you; and (2) to pay damages. If there is an accident, you expect your insurer will perform these duties: hire a lawyer to defend you and pay lawfully proven damages, if any.
You become aware someone has been injured on your property, or claims your product has caused harm, or was injured in an accident with one of your employees. You notify your insurer and believe the claim will be handled. Then, you receive a letter from your insurer, indicating the insurer is investigating the claim and will hire a lawyer to defend you—but that it is reserving its right to change its mind—meaning that it can decide later to stop paying the lawyer or to refuse to pay the claim. You have received a “Reservation of Rights” letter (“ROR” letter ).
FIRST THINGS FIRST – DO NOT IGNORE THE ROR LETTER.
“ROR” letters are often long and complicated. They recite facts, contain excerpts of policy language, and state the insurer’s contentions. Although reading it and understanding it may be challenging, you should not ignore a ROR letter.
If you do not respond to the insurer’s letter, your lack of response will be taken as an implied agreement to the insurer’s contentions, as well as your acceptance of the services of the lawyer hired by the insurer under whatever terms the insurer outlines in the ROR letter. Furthermore, the letter may ask you to provide more specific information to aid the insurer’s investigation. Such cooperation is required under the insurance policy and requests should be responded to promptly.
Instead, you will want to have your attorney review the ROR letter, the policy, and the facts of the claim. Based on that review, your attorney can advise you how to best respond to the ROR letter, including:
THINGS TO LOOK FOR WHEN REVIEWING THE ROR LETTER.
There are certain requirements for an effective reservation of rights.
First, the ROR letter must “fairly inform” you of the insurer’s position and the specific basis for the insurer’s reservations about its coverage. The language of the ROR letter must be unambiguous. If it is ambiguous, the letter will be construed strictly against the insurer and liberally in your favor. A well-written ROR letter should tie the facts to the cited policy provisions and explain why the insurer believes those facts and policy provisions may result in no coverage.
Some issues affecting coverage may be known from the outset of a claim, e.g., the insured’s failure to give the insurer timely notice of the claim. Possible defenses based on issues known to the insurer should be listed and explained in the ROR letter. The insurer’s failure to list specific defenses it intends to assert may result in a waiver of the insurer’s defenses. However, other defenses to coverage may arise as the evidence is developed, e.g., where there is an exclusion in the policy and facts are learned later that support the exclusion. An insurer is afforded some time to investigate and analyze the circumstances before being required to provide the full basis for its coverage position. If those facts are not known at the outset of a claim and are learned later, the insurer may send a new or amended ROR letter.
Waivers of the insurer’s defenses are uncommon and even disfavored under Georgia law; however, arguing for a waiver can be highly important to you. If the insurer has waived its coverage defenses, you may be entitled to payment of all of your attorney’s fees and full payment of claims, up to the dollar amount of coverage you purchased.
In addition, you and your attorney should carefully review a ROR letter to:
You May Have a Right to Your Own Independent Counsel.
Most insurance policies allow the insurer to control the defense of the case and to select the attorney to defend the case. The lawyer hired by the insurance company is deemed to have an attorney-client relationship with both the insured and the insurer. Usually, joint representation of both the insured and the insurer is not a problem because the interests of the insured and the insurer are aligned. However, when the insurer defends and retains counsel under a ROR letter, the interests of the insured and the insurer may differ. If the differences between the interests of the insured and the insurer are: significant (not merely theoretical) and, actual (not merely potential), the insurer may have an obligation to pay for “independent counsel” to represent you, the insured. Under those circumstances, independent counsel is usually the attorney who normally represents your business or you, individually.
In addition, where the insurer chooses the lawyer to represent you, that lawyer may have an on-going business relationship with the insurer—which may result in a potential conflict of interest for that lawyer. The lawyer’s desire to receive additional work from the insurer may result in a conscious or subconscious steering of the claims to benefit the insurer rather than you, the insured —especially if there are truly conflicting interests. For example:
Where there is the potential for such a conflict of interest, some courts have ruled that the insurer must pay for independent counsel selected by the insured to handle the defense. Those courts recognize that the lawyer retained by the insurer cannot represent truly serious conflicting interests. The ultimate question is whether, under the facts and circumstances of a particular claim, the insurer’s reservation of rights renders it impossible for counsel selected by the insurer to defend both the interests of the insurer and those of its insured.
If the ROR letter creates a serious and actual conflict between your interests and those of the insurance company, you should ask the insurer to provide independent counsel. In Georgia, the independent counsel issue is not fully resolved. In 1963, a Georgia court held that attorneys, whether or not paid by insurance companies, owe their primary obligation to the insured they are employed to defend (i.e., you, not the insurance company). In 1989, a federal court held that the insurer must choose between denying a defense to the insured or providing a defense in cooperation with counsel retained by the insured and paid for by the insurer.
The ROR Letter May Contain a Requirement that You Reimburse Defense Costs.
The ROR letter may assert that you will be required to reimburse the insurer for attorney’s fees and other defense costs if it later determines there is no coverage. Your insurance policy may already obligate you to do this—however, if it does not and you fail to object to this requirement when presented in the ROR letter, the insurer will argue that your failure to object constituted a new agreement to reimburse the insurer for these fees and costs.
RESPONDING TO THE ROR LETTER.
Once you have reviewed the ROR letter, you should respond to the insurer in a timely manner. Your silence could be used against you. The response should:
COVERAGE LITIGATION AND NON-WAIVER AGREEMENTS.
If the insurer flatly denies coverage, you will have no insurance coverage for the claim you submitted to your insurer. You would need to hire a lawyer and fund the payment of any settlement or verdict. If, however, you have a good faith belief that the insurer acted wrongly in denying coverage, you may sue the insurer, alleging a breach of the insurance contract and seeking recovery of all your losses, including all of the fees paid to defend the case, the amount of any settlement or verdict paid, and possibly the fees incurred in proving the insurer breached the contract of insurance.
If the insurer agrees to defend under a reservation of rights, but you reject the insurer’s reasoning, you and the insurer could enter into an agreement expressly stating: that the insurer is not waiving its coverage defenses; that the insured preserves its right to demand coverage; the terms under which the insurer would defend the claim (such as who controls the defense, how strategy is determined, if settlement is pursued how it would be funded); that the lawyer retained by the insurer and paid by the insurer owes loyalty only to the insured and has a duty to protect the insured’s confidential information from disclosure to the insurer; whether separate counsel is required (and, if so, how legal bills are reviewed and paid); and, the rights of the parties once the claim is resolved (e.g., whether the insurer is entitled to reimbursement of defense costs paid). This agreement is called a “Non-Waiver Agreement”.
If there is a dispute over coverage and it is not possible to enter into a non-waiver agreement, the insurer must then file a separate action, called a “Declaratory Judgment Action,” asking the judge to review the matter and declare if there is coverage for the claims. You would be a defendant in that action and would need to hire your own attorney to convince the court there is coverage.
MAKE SURE THE INSURER’S LETTER IS CONSISTENT WITH YOUR POLICY AND THE LAW.
If you receive a ROR letter, your attorney should review the ROR letter, the policy, and the facts of the claim and advise you how to best respond. If we may be of assistance, contact Mike Reeves at firstname.lastname@example.org or (770) 399-9500.
Both of our litigators, Mike Reeves and Ben Byrd, have been recognized as Georgia Super Lawyers for 2017. Their primary area of practice is Business Litigation. Mike has received this recognition many times. This year marks the first time Ben Byrd has been included in the list of Super Lawyers. He was included among Georgia Rising Stars in 2014.
What are dissenters’ rights, and why do they exist?
There is a general feeling among transactional lawyers that corporate shareholders are becoming more and more likely to assert their right to “dissent” from a corporate transaction and liquidate their shares. While it is hard to prove or disprove whether this feeling is accurate, it is nevertheless useful to understand the nature of the right to dissent and to examine some of the issues these claims present in litigation.
In an earlier era, corporate law required shareholders to vote unanimously in favor of major changes to a corporation’s structure or operations. As a result, a single shareholder could thwart a deal, regardless of how good it was for the entire ownership. On the other hand, the unanimity rule protected the individual shareholders, who had no legal right to liquidate their shares in the face of a transaction they did not like. Over time, though, the unanimity requirements were loosened, and today a simple majority of shareholders can make most corporate decisions. In theory, this change gave a company’s ownership the flexibility it needs to take advantage of opportunities that might otherwise be missed because of single holdout. But with that flexibility came the risk that controlling shareholders will exercise their power at the expense of the minority.
Two scenarios are distressingly common. Imagine that Tom, Dick, and Harry are equal owners of Pin Heads, Inc., which owns a chain of bowling alleys. If Tom and Dick decide to cut Harry out of the business against his will, all they have to do is form another corporation without Harry and then vote to sell Pin Heads’ assets to the new entity, leaving Harry out in the proverbial cold. This is the classic “freeze out” or “squeeze out” situation. Worse, if Tom and Dick sell Pin Heads’ assets to their new company for less than market value, they haven’t just frozen Harry out of the operation, they have stolen his equity as well.
Consider another scenario: Pin Heads has done well and is now worth $3 million. Our three shareholders reasonably expect to receive $1 million each if the company is sold. Because they are in control, Tom and Dick negotiate the sale of the company’s assets to an unrelated buyer for just half a million dollars, which will eventually be distributed to the shareholders equally. At the same time, Tom and Dick negotiate sweetheart agreements with the buyer just for themselves. These agreements might require Tom and Dick to provide “consulting” services to the buyer, or not to compete with the buyer, or maybe both. In return for these commitments, the buyer will pay Tom and Dick—you guessed it—$1.25 million each. (Harry, of course, isn’t offered a contract.) Tom and Dick’s agreements may not have any real value to the buyer, but that is exactly the point. The contracts are a sham that Tom and Dick have created to divert money from the buyer to themselves when it ought to have gone to the corporation as a whole. Harry is again left out in the cold.
To protect Harry and his fellow minority shareholders, most states—including Georgia—passed statutes allowing a shareholder to “dissent” from certain corporate transactions that change the fundamental nature of the business and to liquidate his shares for their “fair value.” In Georgia, the right to dissent is available both to shareholders of corporations and members of limited liability companies, and it is triggered most often when there is a merger or asset sale.
When there is such a transaction, the company must notify the shareholder of the transaction and his right to dissent. The dissenting then notifies the company of his intent to dissent. After receiving notice that a shareholder dissents, the corporation must offer the shareholder what it believes to be the fair value of the shareholder’s interest, along with certain financial information supporting that valuation. The shareholder can either accept the corporation’s offer or counter with his own valuation. But if the shareholder and the corporation cannot come to an agreement, the corporation must institute a court action to determine the fair value of the dissenter’s shares. The valuation proceeding is a nonjury, equitable hearing, so it must be brought in the superior court. Although it presents some opportunities for either party to stumble, this basic procedure is not terribly complicated. The bigger challenge by far is proving fair value.
What is “fair value”?
The Georgia Code defines fair value as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action.” This definition is remarkably circular, and there is almost no Georgia case law expanding the meaning of fair value. However, the little authority that does exist establishes that “a shareholder should generally be awarded his or her proportional interest in the corporation after valuing the corporation as a whole.” In effect, the “fair value” of a minority interest may be different from the “fair market value” of that same interest.
To illustrate, assume Pin Heads is worth $3 million. On the open market, Harry’s one-third interest in the company would likely be worth less than $1 million. After all, with partners like Tom and Dick, who would want to buy Harry’s shares? But under the dissenter’s rights statute, Harry would be entitled to his pro rata portion of the company’s value, without any discounts to account for the lack of marketability or control associated with his individual shares—that is, $1 million. This is an important point, but it still leaves us with the task of determining the value of the company as a whole.
Because there is so little Georgia authority on this point, the practitioner must look to other sources for guidance. Fortunately, it is generally agreed that a dissenting shareholder is entitled to be compensated for what he has lost, which is an interest in a “going concern” and not just a share of the corporation’s liquidated assets. As such, he is entitled to his share of the company’s “intrinsic” value—that is, the present value of all future benefits that would flow to the company’s owners from its operations—not just the price the company would bring if it were sold.
This conceptual difference between intrinsic value and market value is not always obvious to parties or to courts. Moreover, the distinction is blurred by the fact that, as a practical matter, the intrinsic value and market value of a given company will often coincide (a point we will return to below). Nevertheless, the practitioner must remember that these are two distinct measures of value.
Proving Value: Cash flows and multiples.
Business valuation is an established field that exists separate and apart from any role it plays in dissenters’ rights cases, but its tools are essential to the dissenters’ rights process. The litigator must be comfortable enough with business valuation techniques to understand why each expert has chosen a given tool and how his conclusions would change if a different tool were used.
Mainstream valuation theory rests on the idea that the intrinsic value of any financial asset, such as a share of corporate stock, is the product of the expected cash flows its owner will receive, on a risk-adjusted basis. Therefore, the value of a business is a function of the money it is expected to make in the future, not the money it has made in the past. This can seem counterintuitive, especially because we are accustomed to hearing businesspeople and financial analysts speak about companies’ values in terms of some multiple of their past revenues or profits. But it is important to remember that these multiples are a reflection of the likelihood that a company’s past performance (good or bad) will continue in the future. So, even when it is defined in terms of past performance, value is still fundamentally about the future.
Business valuation, then, is inherently forward-looking, and this forward-looking orientation distinguishes it from other related disciplines. Accounting, for example, is a system for recording financial transactions that have already happened, so by its very nature it is backward-looking. This is not to say that accounting is not a part of valuation. In fact, accounting information is absolutely necessary for valuation. But financial statements and other accounting data on their own are merely necessary for performing a proper valuation. They are never sufficient.
The business valuation profession recognizes various approaches for valuing a company. Two of these approaches—the “income approach” and the “market approach”—are typically the most useful for determining the value of company as a going concern. Within these approaches there are various methods, but as a practical matter the litigator will generally only encounter three of them.
Under the income approach, the “discounted cash flow” (or “DCF”) method is the one most commonly encountered in litigation matters. A DCF analysis is used to forecast or project a company’s future cash flows—and therefore its intrinsic value—directly. It involves two steps: First, the expert must identify (or produce) reliable projections of the company’s future cash flows. Then, she must “discount” those earnings to their present value in order to take into consideration the time value of money and the risk that the expected cash flows may never materialize.
The DCF method is widely accepted, so much so that an expert must have a good reason for not performing a DCF analysis or risk having his opinions as a whole discarded. Nevertheless, the DCF method is not flawless. For one thing, it is generally disfavored for the expert to create his own projections for the purpose of performing a DCF analysis. It is far more credible for the expert to use projections that were created either by company management or by a third-party for reasons unrelated to the litigation. But not every company has projections that are independent of the litigation matter, so often a DCF analysis simply can’t be done.
Even if projections are available, some caution must be exercised before they are blindly adopted by an expert. For a DCF analysis to have any value, the projections that are used must be both reliable and current as of the valuation date. If favorable projections exist, a dissenting shareholder can almost be certain that the company will claim there was some reversal of fortune between the date of the projections and the date of the valuation that renders the projections useless. Similarly, if the projections were created primarily to attract investors and not to guide management decisions, it is very possible that they are unreasonably optimistic and so can’t be used without some sort of adjustment. It is the litigator’s job to determine, through careful fact discovery, the reliability of any projections before they become the basis of an expert’s opinion. Again, although the DCF method is not always available, it must always be considered.
In contrast to the DCF method (and income approach generally), the market approach is an indirect measure of value. The market approach assumes that markets are reasonably efficient and therefore the prices at which companies (or shares of companies) sell are generally an accurate reflection of their intrinsic value. There are different methods under the market approach, but at a high level they all contain the same basic elements. First, the expert identifies companies that are similar or “comparable” to the company in question. By comparing the market value of these companies to some common financial metric, such as earnings, the expert can create a ratio or “multiple,” which can then use to estimate the market value of the subject. For example, if we wanted to value our fictional company Pin Heads, our expert would first look at companies similar to Pin Heads that have recently sold. If companies similar to Pin Heads have recently sold for three times their annual earnings, our expert can then infer that Pin Heads would also sell for three time its annual earnings.
There are two principal methods for applying the market approach. One uses publicly traded companies as comparables (the guideline public company method), and the other looks at sales of privately held companies (the guideline merged and acquired company method). Both methods present similar challenges. The first of these is identifying which companies, if any, are truly “comparable” to the business at issue. If you are trying to value a company that owns bowling alleys, you aren’t likely to find another chain of bowling alleys that has sold recently, so you will have to cast your net more widely. Would a chain of go-cart tracks be sufficiently similar to the bowling alley business? What about amusement parks? Unfortunately, there is no objective measure of comparability, and you will quickly find that a certain amount of subjectivity is unavoidable. An unscrupulous expert can use his discretion to select comparables that push the data toward a conclusion that favors his client.
The second challenge is creating the right multiple. Even if an expert has chosen comparable companies that are in the same general business as the subject company, they will differ from each other (and the target company) with respect to fundamental financial characteristics, such as their size, growth potential, and riskiness. Each of these differences will affect a company’s future prospects, so the expert cannot just simply calculate the comparable companies’ multiples and then mechanically apply the average to the subject company. Instead, she should try to determine how, and to what degree, the subject company differs from those in her set and adjust her final multiple accordingly. In theory, an expert might consider an elaborate multi-variable regression analysis to identify which fundamental characteristics have an effect on value and the relative significance of each. In practice, this almost never happens, and multiples must be adjusted by less formal methods. Unfortunately, an expert often adjusts his multiples by relying only on his own subjective “judgment.” The opportunities to abuse this process are obvious.
This discussion may seem to paint an unfairly cynical picture of valuation practice. After all, these techniques guide the allocation of enormous sums of capital in the financial markets, and they are regularly accepted as valid by courts in all sorts of cases involving the value of businesses. Nevertheless, the litigator is wise to remember that valuation is ultimately as much “art” as it is “science.”
The role of transaction price and other considerations.
While a dissenter’s case almost always involves a battle of valuation experts, one factor that can never be ignored is the transaction price—that is, the price that the buyer has actually paid to acquire the business in question. If markets were perfectly efficient, with all parties having perfect knowledge and negotiating at arm’s length, we would expect the purchase price to track a company’s intrinsic value very closely, if not match it exactly. And even without perfect efficiency, market forces do push transaction prices toward intrinsic or fair value. Courts recognize this, and they often rely heavily on transaction price when assessing fair value.
The Delaware courts, for example, have repeatedly held that “the fact that a transaction price was forged in the crucible of objective market reality (as distinguished from the unavoidably subjective thought process of a valuation expert) is viewed as strong evidence that the price is fair.” The apparent objectivity of transaction price has led more than one court to discount the opinions of the parties’ experts entirely and rely solely on transaction price when determining the fair value of a company.
Not every deal, however, will lead to a transaction price that approximates fair value. For example, the magic of finance often creates opportunities for “synergy”—that is, where the combination of two companies is more valuable than the sum of its two parts standing alone. Synergy is often a prime motivator in acquisitions, and if a buyer can create synergies by acquiring the target company, it may be willing to pay more than what the target company, standing alone, is worth to its current owners. In that case, the deal might result in a transaction price that is higher than the target’s intrinsic value.
Conversely, a company’s controlling shareholders might be willing to accept less than fair value for the company as a whole if they can structure the deal so they benefit in some way other than receiving their share of the transaction price (for example, by entering into valuable personal contracts with the buyer). In that case, the deal might result in a transaction price that is lower than the target’s intrinsic value. In the end, transaction price can be very important evidence of fair value, but only “so long as the process leading to the transaction is a reliable indicator of value and [transaction]-specific value is excluded.”
Again, the dissenter’s rights statute does not account for transaction price or, for that matter, any other factor that may weigh on the issue of fair value. But as a practical matter transaction price looms over every judicial appraisal of fair value. Therefore, from the shareholder’s perspective, it isn’t sufficient just to assert that the company was worth more than what was paid for it, even if that assertion is supported by a gold-plated expert report. The shareholder must also carry the implicit burden of showing there was some defect in the transaction, such as self-dealing, that resulted in a sale for less than fair value.
Better yet, the dissenter will also prove how the missing value was diverted, in whole or in part, to the controlling shareholders. If the controlling shareholders accomplished this through contracts with the buyer, the dissenter should be prepared to offer expert testimony regarding the true value of the controlling shareholders’ promises under the contract. (This may require the dissenter to retain a second expert with expertise in executive compensation or related areas.) Again, none of these elements are literally required by the dissenter’s statute. But without this showing, it is hard for even the best expert opinion to prevail over transaction price.
This paper can only scratch the surface of the issues that will confront the litigator in a dissenters’ rights case. For understanding valuation in general, Investment Valuation by Aswath Damodaran and Financial Valuation by James Hitchner are both essential resources. Likewise, The Lawyer’s Business Valuation Handbook by Shannon Pratt and Alina V. Niculita is useful for understanding how these principles are applied in business disputes.
If you have any questions about dissenters’ rights or the fair value of your share in a company, please contact Ben Byrd at email@example.com or (770) 399-9500 to discuss further.
 See Note, Freezing Out Minority Shareholders, 74 Harv. L. Rev. 1630 (1961); Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 3 fn. 1 (1985)(discussing squeeze-out mergers).
 The history and theory behind dissenter’s rights is treated at length in Barry M. Wertheimer, The Purpose of the Shareholders’ Appraisal Remedy, 65 Tenn. L. Rev. 661 (1998).
 O.C.G.A. § 14-2-1301 et seq. (corporations); O.C.G.A. § 14-11-1001 et seq. (LLCs). Because the two statues are substantively identical, we will refer only to the Business Corporation Code.
 O.C.G.A. § 14-2-1302.
 O.C.G.A. § 14-2-1320 to 1324.
 O.C.G.A. § 14-2-1325.
 O.C.G.A. § 14-2-1330(b).
 O.C.G.A. § 14-2-1301(5).
 Blitch v. Peoples Bank, 246 Ga. App. 453, 457 (2000).
 Delaware in particular has a well-developed body of case law on the issue of fair value in the context of dissenter’s rights. Further, the Georgia statute is based on the original Model Business Corporations Act, the comments to the Model Act are useful as guidance. Blitch v. Peoples Bank, 246 Ga. App. 453 (2000). Although the Model Act has been amended since the Georgia statute was passed, the Georgia Court of Appeals has even looked to the changes in the Model Act for guidance. Id.
 See Cede & Co. v. Technicolor, Inc., 542 A.2d 1182 (Del. 1988)(equating “fair value” and “intrinsic worth”). In Atlantic States Construction, Inc. v. Beavers, 169 Ga. App. 584 (1984), the Georgia Court of Appeals adopted intrinsic value as the standard for fair value. However, that opinion is only physical precedent, and it has been abrogated in other respects by later opinions. Blitch, 246 Ga. App. at 457 fn. 21.
 See Cede & Co., 542 A.2d at 1188 fn. 8 (noting that market price may not reflect intrinsic value).
 The current version of the Model Business Corporations Act, for example, provides that fair value is to be determined “using customary and current techniques generally employed for similar businesses in the context of the transaction requiring appraisal.” MBCA, § 13.01(4)(ii).
 See, e.g., Lippe v. Bairnco Corp., 288 B.R. 678, 689 (S.D.N.Y. 2003) aff’d, 99 F. App’x 274 (2d Cir. 2004); In re Med Diversified, Inc., 334 B.R. 89 (Bankr. EDNY 2005).
 See In re ISN Software Corp. Appraisal Litigation, 2016 WL 4275388 at *5 (Del. Ch. 2016)(experts’ creation of projections “inherently less reliable than using long-term management projections”); In re Radiology Assocs., Inc. Litig., 611 A.2d 485, A.2d 490–491 (Del. Ch. 1991)(discussing need for projections not created by expert).
 See Highfields Capital, Ltd. v. AXA Financial, Inc., 939 A.2d 34 (Del. Ch. 2007)(favoring DCF that relied on current management projections over analysis that relied on outdated projections).
 See In re Appraisal of Ancestry.com, Inc., 2015 WL 399726 (Del. Ch. 2015)(rejecting valuations based on projections that were not created in the ordinary course of business, but only to attract buyers).
 See, e.g., Merion Capital, L.P. v. 3M Cogent, Inc., 2013 WL 3793896, at *23 (Del. Ch. 2013)(rejecting expert’s choice of multiples based only on professional “judgment call”); In re IH 1, 2015 WL 5679724 (D. Del. 2015)(rejecting opinion of expert who made “judgment call” to reduce comparable multiples by 50% without any explanation).
 See, Matter of Shell Oil Co., 607 A.2d 1213, 1121 (Del. 1992)(“Valuation is an art rather than a science.”); In re Smurfit–Stone Container Corp. S’holder Litig., 2011 WL 2028076, at *24 (Del. Ch. 2011)(“[U]ltimately, valuation is an art and not a science.”)
 Van de Walle v. Unimation, Inc., 1991 WL 29303, at *17 (Del. Ch. 1991).
 E.g., Union Illinois 1995 Investment L.P. v. Union Financial Group, Ltd., 847 A.2d 340 (Del. Ch. 2003).
 M.P.M. Enter., Inc. v. Gilbert, 731 A.2d 790, 797 (Del. 1999).
 Union Illinois, 847 A.2d at 357.
The Trump presidency brings with it a lot of uncertainty for a number of reasons. Among them, President Trump has his own unique ideas and intends to create his own agenda apart from that of any political party.
BUT TRUMP HAS A TAX PLAN
The Trump Tax Plan. One part of Trump’s agenda that is pretty clear is his proposed tax reforms, which are aligned with traditional conservative Republican thinking: cut taxes and shrink government. It is therefore likely to receive significant support. On the Trump campaign’s website, the Trump Tax Plan is set forth in very simple terms and is summarized below.
Income Tax. Trump wants to simplify the U.S. tax structure by, among other things, imposing only three tax brackets on individuals (12%, 25% and 33%) and only one on businesses (15%). Currently, there are seven individual tax brackets (10%, 15%, 25%, 28%, 33%, 35% and 39.6%) and eight corporate tax brackets ranging from 15% to 39%.
Application of “Corporate” Tax to Pass-Through Entities. Trump has suggested cutting taxes on the owners of “pass-through” entities, such as S corporations, limited liability companies and partnerships, to 15%. Under current law, the taxable income of such entities is passed through to their owners and taxed at the owners’ tax rates, which in the case of an individual could be as high as 39.6%.
Repatriation of Corporate Cash. U.S. companies hold an estimated $2.5 TRILLION outside the United States (although Trump thinks it’s double that), which is currently escaping the U.S. tax system entirely. Trump intends to incentivize such companies to repatriate these funds by taxing amounts that come back to the United States at a rate of 10% in a one-time repatriation program.
Elimination of Corporate “Tax Breaks”, But . . . Trump proposes eliminating “most corporate tax expenditures.” However, one new corporate tax break is proposed. Currently, capital investments must be expensed through depreciation deductions over a period of years. The Trump Tax Plan would allow manufacturing companies to elect to immediately expense their capital investments in full in lieu of deducting interest expense. This could strategically lower reported income and therefore income taxes for businesses.
Capital Gains Tax. Long-term capital gains (on investments held for more than one year) will remain at the current rates of 0%, 15% and 20%. In addition, short-term capital gains (on investments held for one year or less) will continue to be taxed as ordinary income, but subject to the new tax brackets.
Obamacare Taxes. The Affordable Care Act imposes a number of taxes and penalties on both individuals and businesses. Most significantly, it imposes a 3.8% Medicare surtax on net investment income. This is one of the principal funding mechanisms for the program. Trump has promised to repeal Obamacare and replace it with a program that is not funded by increased taxes.
Other Initiatives Impacting Personal Income Taxes. Following are some of the additional initiatives Trump currently proposes that will impact personal income taxes.
WHAT WILL HAPPEN?
Assuming all of the above reforms are enacted, the Internal Revenue Code will be in for its most significant overhaul since 1986.
U.S. Businesses Will Pay Lower Taxes, But . . . As noted above, the current corporate tax rate is as high as 39%. However, few businesses pay taxes at the highest rate because of the myriad ways the current law permits the rate to be reduced through deductions, credits, etc. The tax rate businesses actually pay is called the “effective” tax rate. Estimates of the current average effective tax rate that U.S. businesses pay range from 11% to over 30%.
Thus, while the implementation of a 15% business tax will reduce the income taxes paid by a significant number of business taxpayers, the overall reduction in taxes will in all likelihood be less than the proposed reduction from 39% to 15% would seem to indicate.
U.S. Businesses Will Have More Cash, But . . . With the significantly lower tax rate, coupled with the repatriation program, it is likely that U.S. businesses will have more disposable cash in the United States. It will be interesting to see how these funds are put to use. The hope is that those funds will be used for hiring more workers, business reinvestment, and expansion. However, many commentators believe that this “tax windfall” is more likely to benefit shareholders through stock buybacks and dividends, which is what happened when the U.S. initiated a repatriation tax holiday in 2005.
The Very Wealthy Will Benefit the Most. There are many studies which show that the more wealthy the individual, the more that individual will benefit from the Trump Tax Plan. For example:
WHAT SHOULD YOU CONSIDER DOING NOW?
It is practically impossible to provide any meaningful guidance at this point because, as we said in the beginning, uncertainty reigns. President Trump’s cabinet picks are apparently not in full agreement with his articulated agenda, and Trump himself vacillates on what he thinks should happen and how. We believe, however, that Trump and the Republican majorities will make significant changes to the U.S. tax system in a way they believe will benefit the U.S. economy.
Questions? Call us.
If you are running a technology business that deals with content provided by users or other third parties—or even if your business simply has an interactive web presence that allows users to post their own comments or photos or contains links to other websites—there are important changes you need to know about to limit your liability for copyright infringement caused by your users and other third parties. Here’s what you need to know.
Since 1998, the Digital Millennium Copyright Act (DMCA) has provided certain “safe harbors” that limit a “service provider’s” liability for copyright infringements caused by content provided by users or other third parties. If the service provider meets the requirements of a particular safe harbor, it will have no liability for monetary damages or (almost all) injunctive relief for copyright infringement arising out of content provided by third parties.
Under new regulations that became effective December 1, 2016, the U.S. Copyright Office imposed new, detailed registration and renewal requirements that a service provider must meet in order to qualify for—and maintain—the limitations on liability afforded under the DMCA. Furthermore, the regulations signal the U.S. Copyright Office’s intent to extend the new registration requirements to service providers who were not clearly required to comply with these requirements under the DMCA previously—meaning that certain businesses who may have believed since 1998 that they were exempt from these registration requirements must now comply with the new regulations—or risk losing important protections against liability for copyright infringement.
THINK YOUR BUSINESS IS NOT A “SERVICE PROVIDER”? THINK AGAIN.
Section 512 of the U.S. Copyright Act defines a “service provider” broadly to mean any “provider of online services or network access, or the operator of facilities therefor.” As such, your business is likely a “service provider” within the meaning of the DMCA if you, for example:
A BRIEF HISTORY OF THE DMCA AND THE “NOTICE AND TAKEDOWN” PROVISIONS OF THE SAFE HARBORS.
Under U.S. copyright law, simply creating a copy of someone else’s copyrightable subject matter without permission is a copyright infringement—even if that copy was created automatically through a technological process initiated at the direction of someone else. (For example, a user’s submission of materials to your website may result in a copy of these materials being automatically created on the website servers.) Similarly, merely linking to infringing materials can give rise to a copyright infringement—even if you had no reason to know that the linked material was infringing.
Because automated copying and linking of online content are both inherently necessary to the operation of the Internet, Congress recognized that holding website operators and other service providers strictly liable for these activities in all cases could hinder the growth of the Internet and the advancement of related technologies (including networking and e-commerce). As a result, when enacting the DMCA in 1998, Congress specifically provided certain “safe harbors” to protect service providers against claims of copyright infringement arising out of temporary or permanent storage of user-provided materials or linking to infringing materials.
Though each safe harbor has differing requirements (based on the activity of the service provider that is alleged to cause an infringement), the “notice and takedown” component is common to almost all DMCA safe harbors. Under the “notice and takedown” component, a service provider can immunize itself from monetary liability to a copyright claimant by: (i) appointing an agent to receive notices of copyright infringement occurring via its service and (ii) upon receiving notice of an infringement, acting expeditiously to remove or block access to (“take down”) the infringing material.
Appointment of an Agent to Receive Copyright Notices—Required Steps.
As written, the DMCA provided specific instructions for appointing an agent for only one of the safe harbors—albeit the one with potentially the greatest applicability to most businesses, namely, the safe harbor against liability for information uploaded to or stored on websites or servers by users. Under this safe harbor, the service provider must do both of the following for the appointment of an agent to be valid and meet the requirements for the safe harbor:
WHAT HAS CHANGED WITH THE NEW REGULATIONS?
Since 1998, the Copyright Office has required that a service provider use a paper form to appoint its designated agent, which was then scanned into an electronic format and made available to the public via an online directory (there was also a fairly hefty filing fee of $135.00 per filing). In addition to being cumbersome and non-searchable, over time much of the information contained in the directory became outdated (due to businesses not updating their contact information) and cluttered with defunct service providers. Given this, effective December 1, 2016, the U.S. Copyright Office implemented a mandatory online mechanism for service providers to provide the required contact information for their designated agent. This new mechanism places the burden on service providers to keep their information accurate and up-to-date or risk losing the protection of the DMCA safe harbors.
Key Points of the New Regulation:
1. Mandatory Electronic Filing with the Copyright Office to Appoint an Agent. Starting December 1, 2016, all service providers seeking the protections of the safe harbor must use the U.S. Copyright Office’s online registration mechanism to appoint an agent to receive notices of copyright infringement. Paper filings will no longer be accepted by the Copyright Office.
Note – The Notice on Your Website is Still Required. Be aware that the new mandatory electronic filing procedure does not eliminate the separate legal requirement that the service provider also publish the contact information for the appointed agent in a publicly-accessible page on the service provider’s website. Failure to do so will mean that the service provider will not get the benefit of the safe harbor, even if the service provider has made the required filing with the Copyright Office.
2. You Need to File under the New System Even if You Previously Appointed an Agent with the Copyright Office. As noted, the Copyright Office has maintained a directory of appointed agents since 1998, and you (or your attorney) may have already filed an appointment of copyright agent under the old system. However, in an effort to clear out the outdated information that has accumulated in that time, on December 31, 2017, all appointments filed before November 30, 2016 will become invalid. In short, even if you filed under the old system, you need to make a new filing under the new system if you wish to preserve the limitations on liability under the DMCA safe harbor beyond 2017.
3. Service Providers Must Renew the Appointment of Their Agent At Least Every Three (3) Years. Once filed, each appointment will expire and become invalid three (3) years after the appointment is made, unless the service provider makes a filing with the Copyright Office to renew the appointment. Failure to renew the appointment will mean that the service provider loses the limitation on liability afforded by the safe harbor.
Note – There is a nuance to this “three (3) year rule”: to encourage service providers to keep their agents’ contact information current, the new regulations provide that the “three 3 year clock” is reset each time the service provider changes their appointment information (for example to change the name or address of their appointed agent). In this case, the three (3) year clock starts running anew from the date the service provider updates its appointment with the Copyright Office.
Example: Service Provider files with the Copyright Office to appoint an agent on March 1, 2017. That appointment will expire three (3) years later (March 1, 2020) unless validly renewed.
However, if Service Provider makes a subsequent filing on June 1, 2017 to update its appointment, the three (3) year clock is reset from the date of the “update” filing (June 1, 2017), and will not expire until June 1 2020.
4. The New Filing Requirement Applies to the “System Caching” and “Linking/Search Tool” Safe Harbors As Well. While several of the DMCA safe harbors require the service provider to act promptly to remove (or disable access to) allegedly infringing information once its appointed agent is notified, only one safe harbor—the one for “information stored by others”—specifically states that the agent must be appointed by a filing with the Copyright Office coupled with public notice on the service provider’s website. However, the explanatory comments to the new regulations make clear that this filing requirement—as well as the requirement of a public notice on the service provider’s website—are required to qualify for the DMCA safe harbors for “system caching” and “linking/search tool” activities as well.
This means that, even if you do not allow users to store information on your website or system, you should still make a filing under the new system if you wish to limit your liability for websites or business activities that involve:
ADDITIONAL—BUT OFTEN UNSUNG—BENEFITS OF THE DMCA AND THE SAFE HARBORS.
Obviously, the ability to avoid all monetary liability for certain copyright infringement claims is a prime motivator for service providers to obtain—and maintain—protection under the DMCA safe harbors. But there are two additional benefits available to a service provider under the DMCA that are often overlooked.
While the new regulations described above have a significant impact on the “notice and takedown” component of the DMCA safe harbors, bear in mind that complying with these new regulations is not the only thing you need to do to qualify for the benefits of the safe harbors. There are numerous safe harbors that may apply to your business activities, and each has additional specific requirements and conditions that must also be met before you can claim protection under an applicable safe harbor. If you have questions regarding the DMCA safe harbors or how to structure or protect your online business operations, contact Mike Stewart at firstname.lastname@example.org or (770) 399-9500 for more guidance.
The dispute resolution clause in a commercial contract is sometimes referred to as the “midnight clause” because it is often addressed at the end of contract negotiations (and many times after midnight) as an “afterthought,” with very little consideration given to its consequences. Many times the lawyer drafting the contract will use whatever dispute resolution clause was used in the last contract he or she drafted, considering it to be a “standard” or “boilerplate” provision. There is, however, no such thing as a “standard” or “boilerplate” dispute resolution clause.
Each dispute resolution clause should be carefully drafted to fit the needs of the parties and the deal which, among other things, involves taking into account the likely types of disputes, the parties’ long-term relationship, and the applicable laws. Clearly, one size does not fit all, and a poorly drafted or incomplete dispute resolution clause can do more harm than good. Paying attention to dispute resolution issues at the time the contract is drafted can avoid costly surprises later on, when the ability of the now disputing parties to agree on anything has diminished significantly. It is a classic case of “you can pay me now or pay me later.”
The focus of this article is the arbitration clause in a domestic commercial contract in the State of Georgia.
Choosing to settle a given dispute by binding arbitration—rather than by litigating the dispute in court—is often perceived as having the benefit of being a less costly and more streamlined method of resolving the parties’ differences (although in recent years that has not always been the case). However, when deciding whether to include an arbitration clause in a contract, the parties (and their attorneys) should bear in mind that it is extremely difficult to overturn an arbitration award in Georgia. (Technically, a party cannot appeal an arbitrator’s award. The party can instead apply to a trial court for an order to vacate or modify the award, but only on the very limited grounds specified in the Georgia Arbitration Code (“GAC”) or the Federal Arbitration Act (“FAA”).) As stated by the Georgia Court of Appeals, “a litigant seeking to vacate an arbitration award has an ‘extremely difficult’ task.” Because of this finality, before including an arbitration clause in a contract governed by Georgia law, it is very important that the consequences of such inclusion be fully understood by both the attorney and his or her client.
Once the decision has been made to incorporate an arbitration clause into your contract, what should it include? While each arbitration clause should be drafted to fit the needs of the parties and the deal, there are certain fundamental provisions that should be included in all arbitration clauses.
1. Agreement to Arbitrate. The parties’ intent to resolve their disputes by arbitration should be clearly stated in the arbitration clause. The arbitration clause should also state that any award will be “final and binding” to make it clear that the parties intend the award to be enforceable by the courts without any review of the sufficiency of the evidence underlying the award.
2. Scope of Arbitration. The arbitration clause should be clear as to what types of disputes are subject to arbitration. Ambiguity can result in protracted and expensive litigation over what is arbitrable. This defeats one of the primary benefits of arbitration—avoiding litigation. For example, if the parties want to limit arbitration to only certain types of disputes (e.g., contract disputes or disputes under a designated dollar amount), the arbitration clause should be drafted to specifically cover only such disputes. On the other hand, if the parties intend that all potential disputes be arbitrated, including tort claims, fraud in the inducement, etc., the following language (or something similar) should be included in the arbitration clause: “All disputes arising out of, connected with, or relating in any way to this Agreement, shall be determined by final and binding arbitration.”
3. Choice of Ad Hoc or Administered Arbitration.
An ad hoc arbitration is one in which the parties have chosen to conduct the arbitration without the assistance of an arbitral institution, such as AAA, JAMS or Henning. While ad hoc arbitration avoids the administrative fees charged by arbitral institutions (which can be substantial), the trade-off is that the parties will assume the administrative and planning responsibilities generally performed by the arbitral institution.
An administered arbitration is one in which the parties have chosen to conduct their arbitration with the assistance of an arbitral institution and pursuant to such institution’s procedural rules (referred to generically as “Arbitral Rules”).
4. Number, Selection and Qualifications of the Arbitrators. It is generally advisable for the parties to specify the number of arbitrators in the arbitration clause and how they will be selected. The naming of a specific individual as the arbitrator should be avoided, since that person may not be available (or even alive) at the time of a dispute. In almost all cases an arbitration will be heard before a sole arbitrator or a panel of three arbitrators.
If three arbitrators are to be used, a common method of selection is the party-appointed method, in which each party selects one arbitrator, and then the two party-appointed arbitrators select the third arbitrator to serve as the chair. Another method is the list method, in which the arbitral institution provides a list of potential arbitrators to the parties and the parties strike the persons they do not want and rank the remaining names in their order of preference.
One of the major advantages of arbitration is that the parties can specify in the arbitration clause the qualifications that a potential arbitrator should have (e.g., someone who is in the same industry as the disputing parties or has substantive knowledge in the disputed area), although too much specificity should be avoided because it can significantly reduce the number of qualified arbitrators. This works well with three-member panels where it is possible to require that one of the arbitrators have certain qualifications (e.g., must be an accountant or engineer), which will ensure that the desired technical expertise is represented on the panel, while also having a chair with experience in the arbitration process.
5. Location. The parties should agree to the location of the arbitration in their arbitration clause. Under the FAA, the parties’ choice of a location for the arbitration must be honored; however, under the GAC the arbitrator has the power to choose the time and place of hearings despite the parties’ agreement.
6. Interim Relief. Most Arbitral Rules provide that arbitrators can grant interim relief (e.g., a temporary restraining order) unless the arbitration clause limits that authority. Be aware that a party can inadvertently waive its right to enforce an arbitration clause by engaging in actions that are inconsistent with the right to arbitrate, such as by applying to a court for interim relief before or during an arbitration. While both the AAA Rules and the JAMS Rules provide that a request by a party to a court for interim relief will not be considered a waiver of a party’s right to arbitrate, the parties can avoid any confusion by specifically providing in the arbitration clause that a party does not waive its right to arbitrate by applying to a court for interim relief.
7. Governing Law. Most commercial contracts include a choice of law clause that governs the interpretation and enforcement of the contract, although the law that governs the interpretation and enforcement of the arbitration clause can be different. The FAA applies to arbitration clause agreements in connection with transactions involving interstate commerce, which generally include most arbitration clause agreements. Georgia courts apply federal arbitration law whenever the dispute arises out of a transaction involving interstate commerce, and they tend to exclude the use of any state arbitration law when the FAA is applicable. However, a U.S. Supreme Court decision indicates that while the FAA preempts application of state laws that conflict with the federal policy favoring arbitration clause agreements, it does not necessarily preclude application of state procedural arbitration laws chosen by the parties and not in conflict with federal law and policy.
8. Type of Award and Limitations on Awards. There are two main types of awards:
In practice, most awards are standard awards, and an arbitrator generally will issue a reasoned award only if required by the arbitration clause or the applicable Arbitral Rules.
In general, the cost of a reasoned award is considerably higher than the cost of a standard award, and the decision to require a reasoned award should not be made lightly, particularly when the amount in dispute is not significant. However, whether the decision is to require – or prohibit – the issuance of a reasoned award, the parties should specifically include this decision in the arbitration clause, as the different Arbitral Rules can vary widely on whether the arbitrator must issue a “standard” or “reasoned” award if the arbitration clause is silent on this point.
Limitations on an award can be included in the arbitration clause. The following two variations, which are typically used with monetary damage claims, limit the discretion of the arbitrator, prevent the dreaded “compromise” award, and in most cases are less expensive.
9. Entry of Judgment. Under both the GAC and the FAA, a party can have the award confirmed and made a judgment of the court. While an arbitrator’s award is binding on the parties and does not require affirmation from a court to take effect, when a party refuses to abide by the award, confirmation and entry of judgment are essential for enforcement.
In addition to the fundamental provisions discussed above, some additional provisions that should be considered are:
Costs and Fees. Generally, unless the parties otherwise agree, the arbitrator may award the payment of the costs, fees and expenses associated with the arbitration (e.g., the arbitrator’s compensation and the arbitral institution’s administrative fee) against one of the parties or allocate the costs between the parties.
Attorneys’ Fees. Under both the GAC and the FAA, an arbitrator has the power to award attorneys’ fees if the parties expressly agree in the arbitration clause. Most Arbitral Rules allow for the allocation of attorneys’ fees if such allocation is stated in the arbitration clause or allowed by applicable law.
Interest. If the parties want an award to bear interest, the best practice is to expressly authorize the arbitrator to award interest in the arbitration clause.
Punitive Damages. The general rule is that an arbitrator can award punitive damages unless the parties expressly and unambiguously preclude such awards in their arbitration clause. Thus, if the parties wish to prohibit the arbitrator from awarding punitive damages, specific language to that effect should be included in the arbitration clause.
Expedited Procedures. In an expedited arbitration, the parties adopt procedures that significantly shorten the time from demand to award. Both AAA and JAMS have rules and procedures for expedited/streamlined arbitrations and CPR has adopted fast track arbitration rules for ad hoc arbitrations.
Appellate Review. The finality of arbitration awards is a significant benefit of arbitration; however, a significant drawback is the other side of the coin – the lack of meaningful court review of arbitration awards. As discussed above, an arbitration award can be vacated only on very limited grounds, and errors of law, errors of fact, and errors of judgment are not grounds for reversal.
While the parties cannot expand the scope of review by the courts in their arbitration clause, it is possible to agree to broad appellate review by another arbitration panel. JAMS and AAA have arbitration appeal procedures for awards issued by their respective organizations, and CPR has adopted appellate arbitration rules that can be used regardless of whether the original arbitration was conducted under the CPR Rules. All of these appellate arbitration procedures and rules permit an appeal based on law and/or fact (similar to judicial appeals) to a panel of experienced appellate arbitrators.
Confidentiality. Confidentiality is often assumed to be one of the primary advantages of arbitration. However, and much to the surprise of many lawyers, while arbitration proceedings are in fact private, they are not necessarily confidential (e.g., an arbitration award enters into the public domain when an enforcement proceeding is commenced). Thus, if the parties intend for the arbitration proceedings, documents and award to be confidential, this should be included in the arbitration clause.
Time Limits. Whether due to business considerations or the desire to save costs, the parties may want to provide for time limitations in the arbitration clause. These types of provisions require that the arbitration conclude within a certain number of days following the filing of the demand for arbitration or the appointment of the arbitrator, and/or require that the award be issued within a certain number of days following the closing of the hearing. When time limits are used they should not be unreasonably short and the arbitration clause should make the time limits subject to adjustment at the discretion of the arbitrator. This avoids putting the award at risk if the time limits are not met.
Scope of Discovery. It is generally accepted that discovery is the primary driver of expense and delay in arbitration, and as arbitration has become more like litigation, the use of discovery in commercial contract disputes has increased. Most, if not all, Arbitral Rules provide for some sort of limited discovery, and they empower the arbitrator to manage the discovery process. In order to save hearing time, the parties may want to specifically allow for depositions in the arbitration clause, but with a limit on the number and duration of the depositions. The parties should also consider eliminating or severely limiting interrogatories and requests for admission, both of which can be expensive and often fail to produce meaningful information.
Consider Limits on Dispositive Motions. In arbitration, dispositive motions (motions seeking an order disposing of all or part of the claims of the other party without further proceedings) can cause significant delay and unreasonably prolong the discovery period. Moreover, they are typically based on lengthy and expensive briefs, and dispositive motions involving issues of fact are generally denied, in part because one of the grounds for vacating an arbitral award under the FAA is the arbitrator’s refusal to hear relevant evidence.
However, dispositive motions can on occasion improve the efficiency of the arbitration process if directed to discrete legal issues, such as defenses based on statute of limitations or clear contractual provisions, in which case an appropriately framed dispositive motion can eliminate the need for expensive and time-consuming discovery. As such, the parties should consider which dispositive motions should be allowed in an arbitration proceeding and then memorialize their understanding on this point in the arbitration clause.
Arbitration is a creature of contract, which means the parties can design the arbitration clause to fit their needs. While it may be difficult during contract negotiations to look ahead to how the deal might fall apart in the future, investing the time up front to negotiate an effective arbitration clause could result in significant savings in both time and money in the long run.
Classifying Your Employees as “Exempt” or “Nonexempt”
under U.S. Wage and Hour Laws:
Important – and Potentially Costly – Changes
You Need To Know About
Exempt Employees May Become Nonexempt: What You Should Consider Now
The U.S. wage and hour laws (the “Fair Labor Standards Act” or the “FLSA”) require employers to pay every employee a minimum wage and overtime—unless the employee is exempt from the law. If an employee is exempt, the FLSA does not apply to or protect such employee.
The FLSA puts the burden on employers to classify employees correctly as either “exempt” or “nonexempt” in accordance with regulations promulgated by the Department of Labor—and the employer can be subject to onerous liability for failing to classify employees properly.
You need to be aware that the Department of Labor has promulgated new regulations that could have a significant impact on whether you choose to—and even whether you are able to—continue to classify certain of your employees as exempt. As discussed further below, as of December 1, 2016, certain employees may no longer be classified as “exempt” unless they are paid significantly more—meaning you, as an employer, will need to decide whether to:
This may present a serious challenge for employers with exempt employees who are expected to, and regularly do, work more than 40 hours in a given week to complete the required responsibilities of their positions.
THEREFORE, NOW IS THE TIME TO MAKE SURE:
With respect to any such employees who may be subject to reclassification, you then need to decide whether to reclassify them (and pay overtime) or increase their compensation in light of the new regulations issued by the Department of Labor.
The FLSA requires that most employees in the United States be paid at least the federal minimum wage for all hours worked and overtime pay at time and one-half the regular rate of pay for all hours worked over 40 hours in a workweek. However, there are a number of categories of employees that are exempt. Those exempt groups include bona fide:
Together, the forgoing exempt groups are referred to as the “white collar exemptions.”
The White Collar Exemptions
As a general rule, to qualify for one of the white collar exemptions, employees generally must meet certain tests regarding their job duties and be paid on a salary basis at not less than $455 per week (until November 30, 2016—starting December 1, 2016, this number goes up to $913 per week.) But, even then, the exemption requirements are not as straightforward as they appear at first glance—for example, a different salary test applies to the “highly-compensated employee exemption”, and the “outside sales employee exemption” is subject only to a duties test and does not have a minimum compensation threshold at all. So careful attention must be paid to the specific requirements of each exemption when considering whether a given employee is exempt from minimum wage and overtime requirements.
Job titles do not determine exempt status. In order for an exemption to apply, in addition to meeting any applicable threshold compensation requirements, an employee’s specific job duties must meet all the “duties” requirements of the Department of Labor’s regulations (the “duties tests”) for the specific exemption claimed. For example, simply giving an office worker an “administrative” title does not automatically entitle you to claim that the employee is subject to the “administrative exemption”—as that exemption is only available to administrative employees whose primary duties include the exercise of “discretion and independent judgment with respect to matters of significance.” Similarly, merely giving an employee a title indicating they are a “professional” does not mean he or she will be entitled to the “professional exemption”—that exemption is reserved for employees whose primary duties include performance of work requiring “advanced knowledge . . . in a field of science or learning . . . customarily acquired by a prolonged course of specialized intellectual instruction.” The “outside sales employee exemption” is reserved for your sales employees who are “customarily and regularly engaged away from the employer’s place or places of business”—employees who primarily work in your offices to receive and facilitate sales (such as in a call-center or sales department) would not be covered by this exemption.
Nonexempt Employees (Including “Blue Collar” Employees)
Obviously, your employees who do not meet the applicable compensation and duties tests for any available exemptions must be treated as “nonexempt” under the FLSA. But you should also be aware that certain employees must be treated as “nonexempt” no matter how highly they are compensated.
The white collar exemptions do not apply to manual laborers or other “blue collar” workers who perform work involving repetitive operations with their hands, physical skill and energy. FLSA-covered, non-management employees in production, maintenance, construction and similar occupations such as carpenters, electricians, mechanics, plumbers, iron workers, craftsmen, operating engineers, longshoremen, construction workers and laborers are entitled to minimum wage and overtime premium pay under the FLSA, and are not exempt no matter how highly paid they might be.
The Consequences of Misclassification
In recent years, FLSA cases have become very attractive to plaintiffs’ employment lawyers, who began filing lawsuits after realizing that many employers are in violation of the FLSA. These lawsuits often turn into very expensive class actions.
One of the most common mistakes employers make is misclassifying nonexempt employees as exempt. The penalties are quite harsh and are not very flexible or negotiable. In addition to back pay, employees may recover what are referred to as “liquidated damages” equal to the pay employees should have received. In other words, employees can recover double “back pay” damages for unpaid overtime. In addition, successful plaintiffs are entitled to recover the full amount of their attorneys’ fees which often are more than the double back pay damages.
Part-Time Versus Full-Time: Same Rules Apply. The same compensation and duty tests apply to part-time and full-time workers. Therefore, part-time workers must meet the exact same minimum threshold salary and duty tests as full-time employees in order to be exempt from the FLSA. No proration applies to the minimum threshold salary levels for part-time employees.
In 2014, President Obama directed the Department of Labor to reevaluate and update the regulations defining which white collar workers were subject to overtime laws. New regulations were published in May, 2016. Unless Congress acts to change the regulations, they will become enforceable on December 1, 2016. The Department of Labor estimates that over 4 million additional U.S. workers will be subject to the minimum wage laws and be entitled to overtime pay in 2017 as a consequence of the new regulations.
Key Provisions: New Minimum Salary and Annual Compensation Thresholds
The new regulations focus primarily on updating the salary and compensation levels needed for executive, administrative and professional workers to be exempt. Currently, to qualify for the white collar exemption, a worker must have the required job duties and either receive a minimum salary of $455 per week or $23,660 per year (the “salary basis test”) or total compensation of at least $100,000 to qualify as a highly compensated employee.
On and After December 1, 2016:
Notable Other Terms of the New Regulations:
From a Financial and Budgeting Perspective. The new regulations significantly narrow the scope of the white collar exemption and, thus, significantly broaden the number of employees who are subject to the FLSA. Employees who were previously “exempt” may soon be “nonexempt” and entitled to overtime pay if they work more than 40 hours a week. After December 1, 2016, all employees (other than those subject to the outside sales employee exemption) who earn less than $47,476 per year must be classified as nonexempt and be paid overtime at “time and one-half” for all hours worked over 40 hours per week.
As you plan your staffing and budget for 2017, you should anticipate these changes and determine how best to address them from a business perspective. If overtime is truly a necessary component of any reclassified employee’s work, you may have to budget for more payroll.
From an Employee Morale and “Business Culture” Perspective. If you decide to raise salaries in order to meet the new threshold, you will likely have happy employees. However, if you are instead leaning toward maintaining salaries at their current levels, you should also consider the consequences of reclassifying formerly-exempt employees as “nonexempt.” At first blush, it may sound advantageous to be reclassified as nonexempt and be entitled to overtime pay. However, such reclassification may be detrimental to employee morale and you will need to address this.
The over-arching concern of the FLSA is that nonexempt employees be paid for time actually worked, and if that time exceeds 40 hours a week, overtime must be paid at time and one-half. The flip side of this apparently good intention is that employers must very strictly monitor and control the time an employee spends working. You might consider the effect the following may have on your employees and your established business culture:
All this may feel a lot like a demotion to a reclassified employee. In order to avoid this, you should communicate early and often with the affected employees and give them training and easy access to designated management so that their concerns can be vetted and addressed. You should consider doing the following:
Review Your Policies and Handbooks: Decide Whether Changes Should Be Made. If your workforce can operate efficiently without overtime hours, consider prohibiting it absent express written authorization from management. Whatever policy you adopt, be sure to review your handbooks, policies, or notices to be sure your employees are aware of company policy as well as their right to receive approved overtime if they are nonexempt.
Consider Structured Agreements with Reclassified Nonexempt Employees. To create some predictability for both the employer and the employee, one option is to implement a compensation structure that pays nonexempt employees an annual salary factoring in a certain amount of overtime. The FLSA permits this—however, there must be an express written agreement in place and regardless of the agreed working hours, if the employee works more overtime than contemplated, he or she must be compensated for it at time and one-half.
Beware of Perceived Discrimination. If you have employees with the same job title or duties that are paid differently, with some exempt and some nonexempt, be careful. Although there is no requirement that such a group be classified the same, generally speaking, employees with the same job title who perform the same duties and responsibilities should be paid similarly, unless you can clearly articulate a justification for the difference. Otherwise, the difference may give rise to a claim of discrimination under various federal laws.
As of December 1, 2016, it’s likely that many of your employees who earn less than $47,476.00 per year must be classified as nonexempt and paid overtime at a rate of time and one-half times their regular rate.
Need Help? Have Questions?
If you need help or have any questions about properly classifying your employees under the FLSA or about other employment law matters, please contact Suzanne Arpin at email@example.com or (770) 399-9500.
We are pleased to announce that Suzanne M. Arpin has joined our Firm as a Partner.
Suzanne practices corporate and transactional law, with a focus on employment law matters including employee benefits, executive compensation, ERISA litigation, and executive compensation program implementation.
On May 11, 2016, President Obama signed the Defend Trade Secrets Act of 2016 (the “DTSA”) into law. The DTSA—which went into effect immediately after being signed—creates a new right for trade secret owners to sue under federal law when their trade secrets are misappropriated, and also provides the trade secret owner with significant remedies for misappropriation (including seizure, injunctive relief, damages, and, in certain cases, double damages and attorneys’ fees). But the DTSA also provides individuals with immunity for certain permitted disclosures of a trade secret—and requires an employer to notify its employees (including contractors and consultants) of these immunities in any contract or agreement with the employee that governs the use of trade secrets or other confidential information.
We will provide more in-depth guidance on the DTSA soon. However, you need to know now that compliance with the DTSA necessitates immediate changes to certain of your form agreements with employees and individual independent contractors and consultants to incorporate the notices mandated by the DTSA.
Specifically, starting May 12, 2016, the DTSA requires all employers to include a new notice “in any contract or agreement with an employee that governs the use of a trade secret or other confidential information” if that contract or agreement is either entered into or updated after May 11, 2016. This required notice must inform the employee about certain immunities from liability under federal or state trade secret law for disclosing a trade secret in connection with “whistleblower” activities or in legal documents filed under seal.
Some important points on this new notice requirement:
Note—The DTSA provides that the mandatory notice requirement may also be satisfied by including in your agreement a reference to a “policy document” (for example, a handbook) that is provided to the employee and sets forth your reporting policy for a suspected violation of law. However, even then, your agreements may still need to be updated to include such a reference, and the associated “policy document” should be reviewed to ensure it complies with the DTSA.
If you would like assistance with revising your agreements to comply with the new requirements under the DTSA, or if you have questions about the DTSA or protecting your trade secrets generally, contact Mike Stewart at Friend, Hudak & Harris, LLP.