Limiting Your Liability for Copyright Infringement Caused by Others: Important Steps You Need to Take Soon

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:

  • Operate a website or app that does any of the following:
    • has “social” or “sharing” functionalities (for example, that allow users to provide comments or reviews, participate in discussions or user forums, or upload photos or other materials);
    • contains or publishes material submitted by third parties (such as product photos or descriptions in an online marketplace);
    • contains links to other websites or online materials;
    • helps users locate information (for example, a tool to search for and compare product or pricing information from various sources); or
    • has messaging functionalities where messages are stored—temporarily or permanently—on your servers (such as an “Inbox” where the user can exchange messages with your business or with other recipients); or
  • Provide a data service where the data consists—in whole or in part—of information provided at the direction of users or other third parties;
  • Operate servers, cloud services, hosting services or “software-as-a-service” offerings that allow users to submit, store, or publish content; or
  • Provide network services whereby material transmitted by users is temporarily stored (“cached”) in your system as an incidental function of your service.

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:

  1. Publish required contact information for the designated agent on a publicly-accessible page on the service provider’s website; and
  1. Provide the required contact information for the designated agent to the U.S. Copyright Office for inclusion in a public directory of such agents.

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:

  • providing links to third party information;
  • providing tools or functionality to locate third party information; or
  • automatic, temporary “caching” of third-party information (for example, as part of transmitting content from one user to another).

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.

  • First, if a service provider has validly designated an agent to receive notices of copyright infringement as required under the safe harbors, copyright claims that are made against the service provider—but are not sent to the service provider’s designated agent—generally do not count as putting the service provider “on notice” of the infringement, and do not trigger the obligation to remove (or disable access to) the material.
  • Second, a service provider who “takes down” allegedly infringing materials to protect itself against liability to a copyright claimant could inadvertently expose itself to liability to another party—namely, the party who originally provided the allegedly infringing content. (For example, disabling access to a customer’s content because of a copyright claim could be a breach of the service provider’s contract with that customer.)  To address this concern, the DMCA provides that a service provider will have no liability to any person for “taking down” material that is claimed to be infringing (though, in certain situations, the service provider must also notify the party who originally provided the allegedly infringing content and give them an opportunity to contest the “takedown” in order to take advantage of this additional protection against liability).

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 mstewart@fh2.com or (770) 399-9500 for more guidance.

The Dispute Resolution Clause in Your Contract Should Be More Than An Afterthought

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.

Before You Decide on Arbitration – Know the Pros and Cons

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.

Fundamental Provisions To Include in an Arbitration Clause

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.

  • Hybrid. Sometimes a contract will include a general arbitration clause as well as a more specific arbitration clause that covers, and may specify different terms for arbitration of, a very limited category of disputes.  For example, post-closing purchase price adjustment disputes in connection with the sale of a business are particularly well-suited for specific arbitration clauses.
  • Arbitrability. Who decides disputes over the validity and enforceability of the arbitration clause itself or whether a particular substantive dispute is within the scope of the arbitration clause?  Under both the GAC and the FAA, the threshold question of whether parties to a contract have agreed to arbitrate a dispute is normally a matter for a court to decide.  However, if the parties have clearly and unmistakably provided in the arbitration clause that the arbitrator will decide questions of arbitrability, then the arbitrator has jurisdiction to decide them.
    • The American Arbitration Association (“AAA”) Commercial Arbitration Rules and Mediation Procedures (the “AAA Rules”), the JAMS “Comprehensive Arbitration Rules & Procedures (the “JAMS Rules”) and the Henning Mediation & Arbitration Service (“Henning”) Rules for Arbitration (the “Henning Rules”) all provide that an arbitrator has the power to rule on his or her jurisdiction.

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.

  • For obvious reasons, ad hoc arbitration requires cooperation among the parties; however, the parties may not be in a cooperative mood after a dispute arises, which can be problematic. Without assistance from a neutral third party, the disputing parties often have difficulty reaching agreement on such basic procedural matters as the number of arbitrators, leading to undue delay and a possible lawsuit by one of the parties to move the arbitration along.
  • In an ad hoc arbitration the parties will rarely want to negotiate dispute resolution procedures or rules from scratch; thus, the parties should consider designating ad hoc arbitration rules to provide a framework for conducting the arbitration, such as the 2007 Non-Administered Arbitration Rules (the “CPR Rules”) published by the International Center for Conflict Prevention & Resolution (“CPR”).

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”).

  • Arbitral Rules are neutral and self-executing; i.e., they provide for the arbitration to move forward despite the refusal of a party to respond to the initial arbitration demand or to appear at the hearing.
  • Arbitral institutions generally provide administrative, logistical and secretarial support to the parties, and also handle the arbitrator’s fees and billing. Generally, with the exception of fee schedules, most Arbitral Rules allow the parties to vary the procedures set out in such rules.
  • Not all Arbitral Rules are created equal. The choice of which arbitral institution will administer the arbitration is exceedingly important, as the arbitral institution’s Arbitral Rules will apply to fill in any “gaps” or terms on which the parties did not specifically agree when drafting the arbitration clause (g., the number and selection of arbitrators, the scope of arbitration, location of the arbitration, permitted discovery and motions, and the type and substance of the award issued by the arbitrator).  Each of the AAA Rules, the JAMS Rules and the Henning Rules may provide different outcomes with respect to any given situation.
  • All of this comes at a cost. An arbitral institution typically will charge both a filing fee (which is often based on the size of the claim and any counterclaim), which must be paid in order for the arbitration to proceed, and a cancellation fee if the arbitration hearing is cancelled within a designated time period prior to its scheduled start date.  The filing and cancellation fees can be significant, and the difference in the filing and cancellation fees between some of the arbitral institutions can be staggering.

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.

  • Some of the advantages of using a sole arbitrator are: it is generally easier and quicker to select one arbitrator than three; one arbitrator is much less expensive than three; and scheduling hearings is easier because there is only one arbitrator’s schedule involved. The final award also tends to be issued faster than with three arbitrators because there is no need to get input and agreement from the two other arbitrators.
  • One of the primary advantages of having three arbitrators is that it lessens the chance of an “outlier” award; that is, having more than one arbitrator will tend to moderate an award, and the panel members are more likely to compromise their respective views in order to agree upon a final award.
  • The parties may want to consider providing for one arbitrator for certain types of disputes (such as those under a designated dollar amount) and three arbitrators for all other disputes.

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.

  • Thus, if an interstate commerce contract with an arbitration clause provides that Georgia law will be the governing law of the contract, the GAC will apply to the arbitration to the extent it does not conflict with the FAA.
  • The parties could also provide that Georgia law will be the governing law of the contract, but specify that the FAA will apply to the arbitration clause.

8.  Type of Award and Limitations on Awards. There are two main types of awards:

  • a “standard award” (also called a “general,” “regular” or “bare” award) that includes only the relief granted and to whom, and does not include any reasons supporting the award; and
  • a “reasoned award” that includes the reasoning of the arbitrator.

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.

  • High-low” arbitration is where the parties agree to a range for the award but do not share the range with the arbitrator. An award over the “high” amount is reduced to that amount, and an award under the “low” amount is increased to that amount, but an award within the range is not adjusted.
  • Baseball” arbitration is a type of arbitration where each party to the arbitration submits a proposed monetary award to the arbitrator and to the other party. After there has been a presentation of evidence, the arbitrator will choose one award from the two submitted awards without modification.
    • A key element of baseball arbitration is the incentive for each party to submit a highly reasonable number, since this increases the likelihood that the arbitrator will select that number.
    • This type of arbitration has been used in Major League Baseball salary disputes for many years, and it has been increasingly used in commercial contract disputes in recent years, primarily when the parties’ dispute involves only a monetary amount.

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 domestic commercial contract arbitrations, particularly under the FAA, the arbitration clause must contain an “entry of judgment” provision similar to the following: “Judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof.”

Some Additional Provisions to Consider

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.

Summary

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.

“Exempt” or “Nonexempt” – Important Upcoming Changes to FLSA Regulations

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:

  • increase the employee’s compensation to the new threshold amount in order to continue classifying him or her as “exempt” under the FLSA; or
  • re-classify him or her as “nonexempt” and become subject to payment of FLSA-mandated minimum wage and overtime.

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:

  • you are currently classifying all your employees properly under the FLSA; and
  • you identify any of your currently “exempt” who employees will become “nonexempt” on December 1st, absent an increase in their compensation.

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.

I.  Classification of Employees as “Exempt” and “Nonexempt”: A Brief Summary

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:

  • executives;
  • administrative employees;
  • professional employees, both “learned” and “creative”;
  • certain computer employees;
  • outside sales employees; and
  • highly-compensated employees.

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.

II.  The New Regulations: Redefining the White Collar Exemption

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:

  • the threshold salary level for the salary basis test will be $913 per week (or $47,476 annually); and
  • the minimum total annual compensation requirement for highly compensated employees will be $134,004 (which must include at least $913 per week paid on a salary or fee basis).

Notable Other Terms of the New Regulations:

  • If an executive, professional, or administrative employee’s salary is close to the new salary levels, an employer may use nondiscretionary bonuses or incentive payments (including commissions) to satisfy up to 10 percent of the new threshold salary level. These payments must be made during the year, at least quarterly.  For highly compensated employees, a catch-up payment equal to the amount necessary to meet the annual threshold may be made in the last pay period of the payroll year.
  • The salary and compensation levels will be automatically reset every three years, beginning on January 1, 2020.

III.  What Does This Mean for You?

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:

  • Start times, stop times, breaks, lunch hours, quitting times and, of course, overtime must be subject to rigid rules and carefully monitored. Many exempt employees enjoy a great deal of flexibility with respect to, for example, their lunchtime from day to day, working long hours on a project when they are “on a roll” and choosing when they arrive at and leave work.  This will have to change radically when an exempt employee is reclassified as a nonexempt employee.
  • The reclassified employees will be obligated to track their time precisely, incurring annoying recordkeeping responsibilities they did not have before.
  • The employer may be compelled to pay a reclassified employee less basic compensation in order to budget his or her overtime pay, which may or may not ultimately be paid. This will create financial uncertainty for the employee.
  • If an employer prohibits overtime, the reclassified employee may feel his or her ability to get the work done in the time allowed has been compromised.

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:

  • Emphasize that the new rules are law imposed by the US Federal government; they are not your idea. However, you are required to comply.  Reassure reclassified employees of their value to the company and let them know where to go to express their concerns and get answers to their questions.
  • Provide training on the new timekeeping requirements and educate employees as to the importance of accurately documenting their time worked –even if it’s something as “trivial” as answering some emails in the evening at home. This is a very hard habit to start.
  • Prohibit working “off the clock.” It is common for reclassified employees to decide that they will simply work the hours they need to and not record them if additional hours are required. This is absolutely illegal under the FLSA and if the employer permits it, the employer is liable for substantial penalties, in addition to paying the employee for any applicable overtime.
  • Be aware that if your reclassified employees are required to travel, special rules apply to what portions of travel time are compensable and how.

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.

IV.  Do Not Panic: Create an Action Plan Now

Bottom Line: 

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.

Action Plan: 

  • You need to evaluate your employee population to determine whether any of your currently exempt employees will become nonexempt on December 1, 2016 absent increased compensation.
  • You should take the time to review your work force as a whole to identify any employees who have been misclassified as exempt or nonexempt.
  • If any of your exempt employees will become nonexempt on December 1st under the new regulations, you need to decide what makes sense from a financial and budgeting perspective—should you increase their compensation so that they remain exempt or reclassify them as nonexempt as of December 1, 2016?
  • Based on that evaluation, develop an action plan as needed to educate reclassified employees and to make the transition as smooth as possible.

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 sarpin@fh2.com or (770) 399-9500.

Suzanne M. Arpin Joins FH2 as Partner

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.

Suzanne may be reached at sarpin@fh2.com or at 770-399-9500. For more information on Suzanne, please click here

FH2 Alert – New Federal Trade Secret Law Requires Changes to Your Form Agreements

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:

  • Applies to More than Just Your “W-2 employees”:  Under the DTSA, an “employee” for whom you must include the required notice includes not only your W-2 employees, but also any individual performing work for your business as a contractor or consultant.
  • Applies to “Any Contract or Agreement that Governs the Use of a Trade Secret or Other Confidential Information”:  Depending on your business, this could implicate revising multiple forms of contract documents that your business currently uses with its employees, contractors and consultants, such as employment agreements, invention assignment or “work made for hire agreements”, independent contractor agreements and confidentiality/non-disclosure agreements.
  • Noncompliance Also Limits Remedies under the DTSA:  Failure to include this notice when required also means that the employer cannot recover double damages or attorneys’ fees under the DTSA when bringing a claim for trade secret misappropriation against that employee.
  • Be Mindful of Existing Agreements:  The notice requirement applies to “contracts and agreements that are entered into or updated after” May 11, 2016. So, while the DTSA does not require you to amend agreements you executed before May 12, 2016 solely to add the new notice, it does require you to add the notices to those agreements if you amend or update them for other reasons after May 11, 2016.

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.

Why You Should Prepare Your Business For Sale (Whether or Not You Are Selling)

Thinking about selling your business—eventually? Here’s some advice on how to maximize its value, reduce costs and minimize risks. (P.S. This advice is equally as useful if you’re not selling your business.)

As it turns out, business buyers are looking for the same things as business owners—sound businesses that produce predictable cash flows with quantified risks. (Who wouldn’t want that?) But what makes a “sound” business? A “predictable” cash flow? A “quantified” risk? These are subjective concepts ultimately intended to support the most tangible of outcomes: a factually-derived, cold, hard purchase price.

Because previous performance does not guaranty future results, financial performance is not the only factor helpful in determining a business’s value.  Buyers want assurances that past performance is likely to be repeated (and/or improved).  So, when valuing a business, buyers want to see tangible proof that the business’s valuable relationships and assets are protected and its risks are quantified (and, where possible, managed). This proof supports the proposition that past financial performance is more likely than not to be repeated or improved and gives buyers something tangible to “put their hands on” in valuing a target business. This proof allays buyers’ natural skepticism and allows corporate sales to be concluded cheaper and faster. So important is this proof that, we submit, creating and maintaining it increases a business’s value—whether or not the business is being sold.

So, what is this “proof”? That depends on the particulars of a given business’s valuable relationships, assets and risks.  What are the business’s sources of revenue?  Where does its money come from? Upon what assets and properties are the business’s cash flow dependent? What are the risks to that cash flow? To illustrate, let’s apply these principles to a hypothetical manufacturing business.

“Proof”A Hypothetical Manufacturing Business

Our manufacturer obtains the bulk of its revenue from selling finished goods. What’s necessary for our manufacturer to continue producing cash flows from sales of finished goods? That depends on the particulars of this manufacturer. It could include intangible things like its relationships with customers, vendors and sources of raw materials, and unique manufacturing “know-how” that makes what or how they manufacture more valuable. It could also include physical assets, like its manufacturing facility, particularly if it is strategically located near customers or raw materials, so that it allows the manufacturer to save transportation costs and time, making its prices cheaper and its products faster to deliver than its competitors. The “proof” of these things (both intangible and physical) might include: customer and vendor contracts; proprietary trade secrets, confidential information or even patents supporting unique manufacturing processes; and the deed or lease for its manufacturing facility.

What are the risks to the manufacturer’s continuing cash flows? Again, these depend on the manufacturer’s circumstances. What if the manufacturer is threatened by an infringement lawsuit from a competitor? What if the long-term lease for its manufacturing facility is coming to an end? What if its source of supply for a key raw material is threatened? These things are important for assessing risks to the business’s ability to continue producing its historic cash flows. Proof of these matters would include copies of the infringement lawsuit and the contested patent or other intellectual property upon which such suit is based. It would also include files documenting the status of lease renewals or the search for an alternative location. Lastly, the manufacturer’s current raw material contract for the threatened source of supply would be critical, as would be contracts representing the status of negotiations or agreements to secure alternative sources of supply.

But what if there was no proof or paperwork documenting these relationships, assets or risks? What if the manufacturer relied upon its president’s personal relationships with vendors and suppliers, instead of having contracts with such parties? How would a buyer be able to evaluate the likelihood and strength of continued cash flows based on those relationships? What if the president intends to retire after the business is sold? What if the manufacturer has not filed applications for patents to protect its unique manufacturing processes or taken steps to protect the confidentiality of its trade secrets (making it very easy for another company to use those processes)?  What if the manufacturer has not secured written confidentiality obligations from its employees and contractors who are familiar with such matters (and who could take them with them when they leave)? What if there was no written lease for the manufacturing facility, but instead, the lease was based on a “handshake deal” between the manufacturer’s president and the lessor many years ago?

Such a lack of proof supporting valuable relationships and assets and allowing quantification of risks obviously makes cash flows much more difficult to predict. In fact, at some point, gaps in proof might make future cash flow predictions so tentative that a transaction, at any price, might not even be possible. Moreover, even if the business is not being sold, a lack of such proof increases the risk within which the business operates—and its value, even to the current owner.

It’s Time to Determine what “Proof” Your Business Has—and What It Needs

So, what should the prudent company executive do? Our recommendation is to:

  • identify the assets, sources of revenue, critical relationships and risks unique to your business; then
  • list the sources of “proof” that your business needs to maintain, support and quantify how these are likely to affect future revenues. (Don’t forget your business’s proof of its relationships with its most valuable resource—its employees.)

Once the business has listed the proof that it needs to maintain, it should then:

  • identify areas where insufficient or no proof exists and begin documenting those matters to substantiate important relationships and assets;
  • evaluate existing sources of proof to make sure they are adequate, up-to-date, organized, and available; and
  • create systems allowing these proofs to be accessible, organized and secure.

Going through these procedures will cause the business to focus on those things that generate and maximize your business’s value—whether or not you are currently considering its sale!

Start Today. Some Areas of “Proof” to Consider

Below is an incomplete list of typical relationships, assets and risks that businesses might consider in evaluating their “proofs.” (Apply these to your unique circumstances before settling on the list of “proof” that is most relevant to your business.)

As you can see from this list, there are many things to consider when documenting—and thereby maximizing—proof of your business’s value. What’s important is that the business start developing this proof early and continue to identify where additional proof may be needed or improved.

If you need help identifying, prioritizing, creating, or improving the particular “proofs” for your business, we can help. Contact Scott Harris at Friend, Hudak & Harris, LLP.

Potential “Proofs” for Businesses to Consider

  1. Customers: contracts with each customer; list of customers lost and added in the past three years; purchasing policies; credit policies; list of unfilled orders; advertising or marketing contracts, programs and materials; and list of major competitors.
  2. Contracts with Third Parties: subsidiary, partnership or joint venture agreements; “insider” contracts between the business and officers, directors, shareholders and the business’s affiliates[1]; license agreements (both those for licensing of the business’s intellectual property to others, as well as those permitting the business to use intellectual property that it does not own); security agreements, debts, mortgages, collateral pledges, etc.; guarantees by or in favor of the business; installment sales agreements; distribution, sales representative, marketing or supply agreements; letters of intent or agreements relating to the purchase or sale, merger or consolidation of the business or its assets; agreements to purchase equity in other entities; contracts with customers, quotes, purchase orders, invoices and warranty terms; and non-disclosure or non-competition agreements to which the business is a party.
  3. Products and Services: list of all products or services sold in the past three years or currently under development; tests, evaluations and other data regarding existing or developmental products or services; descriptions of all products and services, correspondence, applications and reports relating to regulatory application and approval for products and services; and descriptions of all complaints and warranty claims.
  4. Legal Matters: articles of incorporation or organization and all amendments; bylaws and amendments; voting agreements; shareholder and/or operating agreements (whichever is applicable for the particular entity); stock ledgers and certificates, subscription agreements and shareholder lists; stock option, stock purchase plans and grant or award agreements under each; puts, calls, warrants, subscriptions and convertible securities; minutes of director, director committee and shareholder meetings (both annual and special meetings); certificates of authority to conduct business as an out-of-state company or LLC; list of all states and countries where the business has employees, property (whether owned or leased) and conducts business; annual company reports filed in each state; and list of all trade names and registrations for fictitious names.
  5. Financial Information: last three to five years’ year-end balance sheets, income statements, statements of changes of financial position (whether audited or not); auditor’s and CPA’s letters and responses; most recent interim financial statements; list of all debts (both long- and short-term); credit reports; general ledger accounts; descriptions of internal control policies; and projections, budgets and strategic plans.
  6. Real Property: list of all business locations; deeds; mortgages; leases (including renewals); title insurance policies; surveys; and zoning approvals, variances and use permits.
  7. Personal Property: lists of all personal property of the business, describing the property, its type, location, and date of acquisition; motor vehicle registrations; all property leases, including vehicles; and list of capital equipment purchased or sold in the past three years.
  8. Intellectual Property: lists of patents, copyrights, trademarks and service marks, and all registrations for same; list of trade secrets and confidential information of the business; any agreements or other documentation evidencing the business’s ownership of, or rights in, such intellectual property.
  9. Employee and Consultants: employee lists with name, address, last three years’ salary and bonus, title, position description, initial employment date, and years of service; employment agreements; consulting agreements; non-disclosure, non-solicitation and non-compete agreements; invention disclosure and intellectual property assignment agreements; separation agreements; employee handbooks; lists of accrued holiday, vacation and sick day leave; employee benefit plans and their descriptions; workers’ compensation claims and history; discrimination, grievances, harassment, labor disputes, requests for arbitration, workers’ compensation, unemployment, and wrongful termination claims and history; list of all employee benefits plans, summary plan documents and descriptions of qualified and non-qualified plans; list and description of all health, welfare and disability insurance policies and self-funded plans; and collective bargaining agreements.
  10. Licenses & Permits: business licenses; any governmental approvals, consents or permits; and copies of applications to, or proceedings before, regulatory agencies.
  11. Environmental: for each property ever owned or occupied: environmental audits, list of hazardous substances, environmental permits and licenses; property owned or occupied; and lists describing all environmental litigation, investigations, liabilities or continuing indemnification obligations.
  12. Taxes: copies of all foreign, federal, state, and local tax reports and returns for the last three to five years; sales and use tax returns; audit or revenue agency reports; tax settlement documents; employment tax filings; and tax liens.
  13. Claims and Litigation: a description of any pending or threatened litigation; copies of insurance policies possibly providing coverage as to pending or threatened litigation; all documents relating to any injunctions, consent decrees, or settlements to which the business is a party; and list of any unsatisfied judgments.
  14. Insurance: list and copies of the business’s general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, worker’s compensation, and other insurance policies; and list of insurance claims history for past three years.

[1] Which means any person or entity, controlling, controlled by, or under common control with, the company.

Background Checks on Job Applicants: 3 Things You Need to Know

Are you using criminal background checks as part of your hiring process? If so, your use of them is subject to federal law. We can show you how to avoid some common – and dangerous – pitfalls when using background checks to safeguard your business.

Georgia law requires every employer to use “ordinary care” to ensure that its employees don’t pose an unreasonable risk of harm to others. Georgia courts have held that, at least sometimes, ordinary care will require an employer to perform a background check before hiring a potential employee. For example, in 2007 our Court of Appeals held that a home-security company that knew its salesmen would be entering customers’ homes as part of their job could be held liable for failing to run a background check on a salesman who later attacked a customer. Underberg v. Southern Alarm, Inc., 284 Ga. App. 108 (2007). Given the potential for liability, it isn’t surprising that many employers run criminal background checks on potential employees as a matter of course. But even though it might be required, running a background check on a potential hire carries its own risks if you fail to comply with applicable law governing how you procure and use background checks in the hiring process.

Before you use a background check in your hiring process, here are three things you need to know:

  • Federal law governs how you obtain the background check and what you do with it;
  • You have to get the potential employee’s consent before you begin; and
  • You have to take certain actions both before and after you reject the potential employee.

One: Federal law applies when you run a background check on a potential employee.

Even though state law may require a company to perform a background check, federal law imposes a completely independent set of requirements. That is because of the federal Fair Credit Reporting Act (or “FCRA”). 15 U.S.C. § 1681 et seq. To judge by its name, you might think the FCRA only applies to credit reports, not criminal background checks. You would be wrong. The FCRA is worded so broadly that many other types of reports fall within its purview. The statute applies to almost any commercially prepared report about a person’s “character, general reputation, personal characteristics, or mode of living” if the report is used to determine that person’s eligibility for employment. That statutory definition includes criminal background reports. See Farmer v. Phillips Agency, Inc., 285 F.R.D. 688 (N.D. Ga. 2012).

Two: You have to get the applicant’s permission before you get the report.

The FCRA requires a company to take specific steps any time it uses a background report in the hiring process. Before you get a background check, you must:

  • Tell the potential employee in writing that you intend to get a background report and get the applicant’s written permission to do so before ordering the report. And,
  • Certify to the company that is providing the report that you have complied with the FCRA’s requirements that you disclosed your intent to get the report and you got the applicant’s permission before you obtained the report. You also have to certify that you will comply with the FCRA’s dispute-resolution requirements, which are described below.

Three: You have to give the applicant a chance to respond to the report before you reject the applicant, and then you have to provide additional notice once you make the decision.

Once you get the report, the FCRA controls how you use it. Before you reject an applicant based on a background report, you must give the job-seeker:

  • A copy of the background report that you are relying on;
  • A summary of the employee’s rights under the FCRA prepared by the federal Consumer Financial Protection Bureau (CFPB), which include the right to dispute with the reporting agency any incomplete or inaccurate information contained in the report (a copy of the summary can be found on the CFPB’s website at http://files.consumerfinance.gov/f/201410_cfpb_summary_your-rights-under-fcra.pdf); and
  • Five days to raise any objection to the contents of the report.

If you have met these requirements, you can then reject the potential employee’s application. But your obligations don’t stop there. Once you have made the decision to reject the applicant, you must notify the applicant that you have declined him on the basis of the report and also provide him with:

  • The name, address, and phone number of the consumer reporting agency that supplied the report (including a toll-free telephone number established by the agency if the agency compiles and maintains files on consumers on a nationwide basis);
  • A statement that the consumer reporting agency that supplied the report did not make the decision to reject the applicant and cannot give the applicant the specific reasons for that decision; and
  • A notice of the person’s right to dispute the accuracy or completeness of any information the consumer reporting agency furnished, and to get an additional free report from the agency if the person asks for it within 60 days.

Be aware that these requirements apply if the report has played any role in your decision to reject the applicant. The report does not have to be the only factor in your decision, or even the primary one.

If you fail to meet any of these requirements, the applicant can sue you. What’s at stake if you get sued? Potentially a lot. At a minimum, the rejected applicant can recover any actual damages that she suffered as a result of the violation. You should be aware that “damages” include the applicant’s attorneys’ fees and court costs, which often far exceed any economic damages that the applicant directly suffered. Remarkably, actual damages can also include emotional distress. So even if the applicant did not suffer any measurable economic harm, you can still face a claim for substantial damages. Even worse, if a court finds that your failure to comply with the statute was “willful,” it can impose additional penalties, including punitive damages.

These types of suits are surprisingly common – one Atlanta law firm that specializes in FCRA cases has filed over 800 of these suits on behalf of rejected job applicants. To make matters worse, any liability you face for a failure to comply with the FCRA may not be covered under your business’s general liability insurance policy. To be covered by insurance, you will almost always need a separate employment-practices liability policy, and even then you will need to confirm that your specific policy provides coverage for violations of the FCRA. At a minimum, you will need to carefully follow the procedures described in the insurance contract regarding giving notice of the claim to the insurer.

As in so many areas of the law, an ounce of prevention is worth a pound of cure. If you have any doubts about your procedures or the state of your business’s insurance coverage when it comes to the use of background checks, contact Ben Byrd at Friend, Hudak & Harris for more guidance.