Welcome to the seventh of my ten-part series that can show you how simple-looking parts of a business deal, or overlooked parts of a business deal, can come back to haunt you. Thank you for visiting, and please also read my previous installments in this series on how to avoid getting into trouble now, instead of getting out of trouble later.  They can be found elsewhere in this blog, and they discuss letters of intent, due diligence, noncompetition clauses, automatic renewal clauses, sales tax, and intellectual property. I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to beware of than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

And by the way, I’ve moved.  I’m now with Kolesar & Leatham – a full-service, well-staffed law firm with a proud 25-year history in the State of Nevada.  My new contact information:  rgalin@klnevada.com; (702)362-7800; Kolesar & Leatham, 400 S. Rampart Boulevard, Suite 400, Las Vegas, Nevada  89145.

“Best Efforts”

When we use this phrase in casual discussions, we think we know what it means.  (Or maybe we really don’t know what it means, but it sounds good.)  But when you use this phrase in a contract, beware – a court might interpret it as meaning much more than you intended.

When you agree in a contract to make “best efforts” to do anything, “best” might mean expending sums of money you had no intention to expend, or spending all of your time on those efforts to the exclusion of everything else (think evenings, weekends and holidays here).  After all, anything less than everything you can possibly give or do is arguably not your best effort.

For example, think about promising to make best efforts to accomplish any of these:

• get financing to buy a business or property – does “best efforts” mean paying exorbitant loan fees and outrageous interest rates to get the financing?
• obtain your landlord’s or other third party’s consent to do your business deal – will the sky be the limit on the fees you pay to get their consent?
• complete construction or production by a certain date – how much overtime expense, premiums for special deliveries, special permit fees, etc. are you willing to pay to meet the deadline?
• obtain governmental approval or licensing – what conditions might the government impose on you as part of its approval or licensing?

If you really mean “reasonable” or “commercially reasonable” best efforts, your contract had better say so.  If you really mean best efforts as long as you don’t have to pay more than $1,000 to achieve the desired result, or best efforts as long as you can continue to run your business and your life in the normal course, you had better say so.  Don’t count on a court to read limitations into your best efforts obligations, if you didn’t see the need for them when you signed the contract.  To be on the safe side, think of “best efforts” as the closest thing to a guarantee, and if you are not prepared to guarantee something, reduce your best efforts obligation to one of reasonable or commercially reasonable best efforts. Otherwise, “best” might turn out to be worst for you.

Welcome to the sixth of my ten-part series that can show you how simple-looking parts of a business deal or, in the case of this installment, overlooked parts of a business deal, can come back to haunt you.  Thank you for visiting, and please also read my other installments about how to avoid getting into trouble in the first place, instead of how to get out of trouble later.  Parts I through V, which can be found elsewhere in this blog, discuss letters of intent, due diligence, noncompetition clauses, automatic renewal clauses, and sales tax.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to beware of than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

Intellectual Property

A potential buyer of a business might be thinking more about the physical condition of the assets and the title to the real property than about who owns the business’ intellectual property (“IP”).  So the due diligence might be concentrated on the former rather than the latter.  Moreover, as discussed below, the complexities of modern-day IP law are beyond the expertise of some general-practice attorneys, so things might just get overlooked.

But what must never be overlooked is that goodwill associated with the name, trademarks and logos of a business might be where the real value and future earning power lie.

IP is an intangible, and often valuable, asset that you cannot inspect the way you inspect a factory, warehouse, fleet of vehicles, head office or title to real estate.  In simplest terms, IP rights exist primarily through contracts and government registrations, and those rights could have limited lives, different legal statuses in different jurisdictions, and possibly scattered ownership among third parties (such as licensees and sub-licensees).  It could turn out that the seller of a business is merely a licensee of the business’ IP, and the license has a limited life or geographical scope, or is just not transferable to you.

If the seller merely holds a limited license to the IP, then depending on the chain of ownership of the IP, you might be unable to get all the rights that you want.  It might be a deal-killer, or it might just be a basis for you to demand other concessions from the seller to offset the less-than-expected value of the IP.  Either way, it is important to review the IP at an early stage of the negotiations, with the assistance of an IP law specialist, and to have the contract specify clearly what the seller owns, what you are getting and how the seller will get it to you.

Another caution:  As the practice of law continues to become more specialized and the field of IP law becomes more complex, some general-practice attorneys just do not have the background to deal with all that needs to be dealt with in a deal that involves important IP.  So if you are acquiring or selling IP as part of a business deal – or if you are not sure whether IP should even be a factor in the deal – let an IP law specialist look things over and leave the rest of the deal to your regular attorney.

And a final caution:  If you are the prospective seller of a business, or if you are working on a future exit strategy with no immediate plans to sell, now is the time for an IP law specialist to see what you have, what you need to protect through registrations or other procedures, or what might be infringing on other persons’ IP rights.  If you have material weaknesses in this area, be sure to remedy them before you expose yourself and your business to a potential buyer.

Welcome to the fifth of my ten-part series that can show you how simple-looking parts of a business deal can come back to haunt you or, in the case of this installment, just cost you a lot of extra money.  Thank you for visiting, and please also read my other installments about how to avoid getting into trouble in the first place, instead of how to get out of trouble later.  Parts I, II, III and IV discuss letters of intent, due diligence, noncompetition clauses, and automatic renewal clauses, and they can be found elsewhere in this blog.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to beware of than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

Sales Tax

In a sale of the assets of a business, tangible personal property is generally subject to sales tax even if the deal is for substantially all of the business. There are certain exceptions and exemptions, but don’t just assume they will be applicable. Assume the opposite, especially if the seller has sold any other tangible personal property during the prior 12 months.

When you negotiate the purchase or sale of a business, don’t be silent about who pays the sales tax (which is no small sum at Clark County’s current rate of 8.1%).  And don’t assume that the buyer is always the one who must bear this expense just because it works that way at the supermarket.

The two guiding principles here are (1) it can be a matter for negotiation between the buyer and seller as to who will bear this expense (or maybe the parties will share it) and (2) if the contract is silent about who bears the sales tax expense, the seller could get stuck with it because the buyer might have to withhold part of the purchase price and pay it directly to the government to satisfy the sales tax liability. Trying to slip this subject past the seller by being silent about it in the contract, though, is not the way to go. Tax laws are complex, and silence is likely to lead to disputes and possibly litigation if one party tries to spring liability on the other party at the closing, instead of addressing this issue up front in the contract.

Buyers, of course, don’t want to add sales tax to their payment obligations in a deal, but putting this burden on the seller just reduces the price that the seller negotiated hard to get in the first place.  So the only way both sides come away happy is if one of those exceptions or exemptions that I mentioned above is available.  It can get complicated.  But addressing this subject at the early stage of negotiations, when the deal price is still under discussion, is the best way to avoid surprises or heated disputes later on.

You are selling your company for cash – up front.  The buyer is doing due diligence, but you just care about signing the contract and getting the money, so no due diligence by you.  So why does your lawyer spend so much time and send you a big bill?  Here are some things your lawyer might handle in a “simple” deal like this:

1) Representations And Warranties (R&Ws) – Besides the buyer’s due diligence on you before signing the contract, expect the buyer to request loads of R&Ws in the contract by you about your company.  (“As is” deals, with no R&Ws, are few and far between, and they generally bring lower prices because of the risks to the buyer.)  Depending on how cautious – or picky – the buyer is, R&Ws can be maddeningly long and detailed – and they can be a trap!  Long after the deal closes, if the buyer finds inaccuracies in your R&Ws, he might come after you and demand some money back.  This can get sticky, as there could be arguments about whether the buyer was really damaged by the inaccuracies or whether they were just harmless errors.  But you don’t want to wind up in that kind of fight, even if you win (in or out of court).

Your lawyer’s task is to wade through pages of R&Ws and seek to delete, modify, or limit them in ways that won’t trip you up later if you have overlooked something.  Another task is to help you understand what is actually being asked of you in the R&Ws (this might require translation from legalese to plain English), and guide you in providing whatever information is needed for accuracy.

This not the most fun part of the deal for anyone; many clients can’t even sit through these negotiations.  And it might wind up being the most time-consuming and expensive part.  But time well spent by your lawyer now on R&W negotiations might give you the best protections later, after your deal has closed.

2) The Buyer’s Lenders – The buyer might be paying you with borrowed money.  So the deal might require more than just negotiating with the buyer.  The buyer’s lenders might want to conduct separate due diligence on you and they might demand post-closing protections on the buyer’s side (such as more nasty R&Ws) to keep the deal from going bad later and causing a loan default.  So you and your lawyer might wind up negotiating with the lenders as well as with the buyer, and fielding the lenders’ due diligence requests, even though they aren’t even a party to your contract.  This can turn into a three-sided negotiation, and lenders can be more demanding than the buyer.  So before you even get started, ascertain whether the buyer needs financing to do the deal; if so, your lawyer might have to work through various issues with the lenders, even if you and the buyer see eye-to-eye on everything.

3) Noncompetition Agreement – Are you planning to take the money and enjoy retirement, or continue earning a living?  If the latter, it can get complicated.  If you read Part III of my blog series, “Top Ten Pitfalls In Negotiating And Drafting Business Contracts,” you know what can happen with noncompetition clauses.  (If you haven’t read it yet, here you go – https://richardgalin.com/2014/06/17/top-ten-pitfalls-in-negotiating-and-drafting-business-contracts-part-iii-noncompetition-clauses/.)

While R&W negotiations can be long and tedious, noncompetition clause negotiations can be long and heated.  After all, the potential conflict between the buyer and seller is clear – the buyer doesn’t want you to take business from him after he pays a lot of money for your company, but you still want to earn a living doing what you do best.  And there is more involved here than just negotiating.  There are laws and court decisions in many states about the permissible scope of noncompetition agreements, and each state can have different limits.  Your lawyer needs to be up to speed, and might need to bring the buyer’s lawyer up to speed, on what is legal and what crosses the line in your state.

4) Post-Closing Employment Agreement – Your future plans might be a double whammy when it comes to legal fees.  Per #3 above, the more employment freedom you want, the more heartburn the buyer might give you.

But let’s turn it around with this example:  You are valuable to the buyer, and you want to remain with the company after you sell it.  So part of the deal is for you to stay on with the buyer as an employee or consultant.  That should keep you from competing, maybe more easily than a noncompetition agreement would.  Now, though, there are two different deals and contracts being negotiated and drafted – one for the sale of your business, the other for your future relationship with the buyer.

You might know how to negotiate the sale of your business.  Maybe you’ve been planning that exit strategy for some time.  But if you’ve been your own boss for so long, do you know how to negotiate with the new boss who will be running your company?  And are you getting stock options, performance bonuses, or other special incentives that have to be negotiated and drafted into your contract?  Or are you more concerned about your future boss’ termination rights under the contract, given that you’ve been accustomed to doing all the hiring and firing.

You can’t leave yourself out in the cold in these negotiations.  It might be all new to you, but many business lawyers deal with these scenarios on a regular basis, and you need the right lawyer.  It really can get expensive, even though you thought you were just signing a contract and getting a check.  But it beats getting sued later for a breach of R&Ws, or having your deal messed up by lenders whom you don’t even know, or being restricted from earning a future living, or getting tied down in a miserable employment agreement.  Be prepared to pay for expert advice now, and enjoy life later.

Welcome to the fourth of my ten-part series that can show you how simple-looking parts of a business deal can come back to haunt you.  Thank you for visiting, and please also read my other installments about how to avoid getting into trouble in the first place, instead of how to get out of trouble later.  Parts I, II and III, which discuss letters of intent, due diligence, and noncompetition clauses, can be found elsewhere in this blog.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to be said than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

Automatic Renewals

You’ve entered into a contract for three years, the contract was long and loaded with legalese, and the closer you get to the end of the three years, the less you remember about the technicalities. You are just looking forward to moving on in another direction once the three years are up.

But, maybe when you were entering into the contract, both parties loved each other and hoped that if all went well, the relationship would go on and on. Or something like that.

Well, this might be overlooked – until too late: many contracts have an automatic renewal clause that keeps renewing the contract unless one party gives a written notice to the other party, well in advance of the so-called expiration date, specifically stating that the contract will not be renewed. Advance notice requirements of 90 to 120 days are not uncommon, and the consequences of overlooking them can be severe.

This type of clause is often overlooked in pre-signing negotiations because at that time, you don’t see it having any impact on you. At that time, you might just be thinking about getting the contract signed so you can start doing business. However, it becomes a pitfall later on if you haven’t calendared the notice deadline, or if the notice deadline is so early that it is hard to make a timely decision about whether to renew, renegotiate, or move on.

If the other party to the contract insists on one of these clauses and you don’t particularly want it, and especially if it is a long-term contract, don’t hesitate to object or demand a good reason for it (and maybe demand some concessions in return). Maybe the real reason the other party wants that clause is to lull you into renewing before you even know that you have renewed!

Welcome to the third of my ten-part series that can show you how simple-looking parts of a business deal can come back to haunt you.  Thank you for staying with it – or thank you for being a new visitor – and read about how to avoid getting into trouble, instead of how to get out of trouble.  Parts I and II, which discuss letters of intent and due diligence, can be found elsewhere in this blog.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but with fair warning – it is so abbreviated that it only has seven pitfalls, and there is much more to be said than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

Noncompetition Clauses

There are multiple pitfalls here – some are easier to spot than others.

When you buy a business, you don’t want the seller to turn around and open a competing business across the street, or across the county. Or if you hire a key employee and show him the ropes, you don’t want him to take that knowledge to a competitor later on. But if you don’t have a properly-drafted noncompetition clause in your contract, don’t expect a court to protect you.

Or, if you have a noncompetition clause that covers, for example, a 50-mile radius, and the other party sets up shop 50 miles plus one block away, don’t expect a court to give you that extra block.

The bottom line here is that our free enterprise system encourages competition, so courts are not looking to restrict people from running a business or earning a living, just to protect someone else who failed to bargain for that restriction in the first place. And in some states, such as California, many of those restrictions are void even if you have them in your contract.

On the other hand, what if you are the one who is being restricted? Do you know what you are getting yourself into? If you can’t have a competitive business or employment wherever the other party does business, that might seem OK when you sign the contract. But suppose the restriction lasts for two years and during that time, the other party expands its business geographically or is bought by another company with a nationwide presence. In that case, you may be restricted far more than you had imagined.

And all of the above assumes that the noncompetition clause is valid in the first place. That is a big, and maybe dangerous, assumption.

Before you get too aggressive about imposing restrictions, remember that courts generally evaluate noncompetition clauses for reasonableness and enforceability on a case-by-case basis. If a clause is deemed unreasonably broad, then even though your counter-party signed it, a court might invalidate it – entirely! So you could find yourself worse off if you were supposed to be the protected party, or better off if you were supposed to be the restricted party, than if you had negotiated a less restrictive clause in the first place.

There are ways to deal with these issues without falling into quicksand. Attorneys who are well-versed in this complex area can advise on what restrictions courts typically allow. And there are drafting methods to avoid having the restrictions struck down in their entirety even if they are too broad. If you are in a state that does not allow noncompetition restrictions (regardless of reasonableness), you need legal advice up front about that, so you can structure the other terms of your deal to make it worthwhile, knowing that you cannot restrict competition when the contract ends.

So given all of the surprises you could encounter when you try to negotiate or enforce a noncompetition clause (or try to avoid one), don’t be surprised if the noncompetition clause of your contract turns out to be the most time-consuming one to complete.

This is the second of a ten-part series that may show you how the simplest-looking parts of a business deal can come back to haunt you.  Stay with it and read about how to avoid getting into trouble, instead of how to get out of trouble. Part I, which discusses letters of intent, can be found elsewhere in this blog.  I have published an abbreviated version of this whole series in the January 2014 issue of Nevada Business magazine. Here is the link, but I warn you – it is so abbreviated that it only has seven pitfalls, and there is much more to be said than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

Due Diligence – Too Little? Too Much?  Help!!

“Due diligence” is a frequently-used term in business deals. But what does it really mean, how much will it cost, and how long will it take?

Chapters can be devoted to each question.  Suffice to say, though, that unless you are selling something for cash up front, at an early stage of negotiations you should consult with your advisers about what unwelcome post-closing surprises there could be, and tailor your due diligence accordingly.

Suppose you are just buying some widgets – but what if the seller has pledged the widgets as collateral to secure a loan – will that lien remain on the widgets after you buy them? And where do you search to find out about the liens?

Or maybe you are buying a company that is well-positioned in an industry and has lucrative contracts that you will take over. But what if those contracts have a “change in control” clause that allows the contracts to be canceled when someone buys the company? And what if the other parties to those contracts want to use that clause as leverage to make you renegotiate on less favorable terms? Or what if those contracts have been in effect for many years, but if you examine them, you find that either side always has the right to terminate with 30 days’ notice? In those cases, the long life of those contracts might come to an abrupt end after you step in.

Or let’s say you are just buying certain parts of a company’s business, and they checked out OK.  But what if you didn’t do your due diligence on the company’s contracts that you aren’t buying, and it turns out that the company is breaching those contracts by selling other parts of its business to you – do you think that is just the seller’s problem? Try telling that to the plaintiffs who sue you for inducing the seller to breach those contracts, even though they aren’t even a part of your deal.

The list could go on and on about what could happen without due diligence. And the consequences of inadequate due diligence can be devastating.

In business deals, the time that attorneys spend on due diligence can far exceed the time spent on negotiating and drafting the contract.  As a result, the behind-the-scenes diligence work, which you might not even be thinking about, could wind up being far more expensive than the actual negotiations and contract work.

What is the take-away from all of this? Due diligence must be specifically tailored to your needs and expectations in your deal. Too little, and the surprises can be devastating. Too much, and you will have sticker shock when you get the legal bill.

In a contract to buy a business, the buyer often requests from the seller a long list of promises, referred to as “representations and warranties,” about the business.  If any of them are found to be untrue before the deal closes, the buyer might threaten to cancel the deal and demand an expense reimbursement, or try to renegotiate the purchase price, or all of the above.  If the problem is discovered after the closing, the buyer might demand reimbursement of part or all of the purchase price to compensate for being misled by false representations and warranties.

The representations and warranties section of a contract can be the lengthiest part of the document, and the details of it can be mind-numbing.  Often the buyer demands information about the business that the seller doesn’t even know.  For example, a buyer might want to know if any of the seller’s customers or suppliers have breached their contracts with the seller.  Or the buyer might want to know if, at any time since the beginning of recorded history, any hazardous materials were ever stored on or below the ground where the business is located.

On many subjects, the most that a seller can say is, “To the seller’s knowledge,….”  So if the buyer discovers a problem that the seller had no “knowledge” of, is the seller in the clear?  Or is this where the trouble begins?

Well, in most cases the seller is not like you and me, because we are both humans.  Sellers are usually business entities, with employees, officers, directors, stockholders, etc., each of whom might know something about the business that the others don’t know.  So when the seller says it has no knowledge of something, who exactly has no knowledge?  And what if the seller’s management has no actual knowledge about a problem but could easily have learned of it with a simple email or phone call to someone else down the line?  Does “knowledge” then mean “should have had knowledge”?  If the answer is no, are we rewarding the seller for carelessness?  If the answer is yes, then “knowledge” has taken on a quite different meaning.

The basic answer is that in the world of business contracts, you should not rely on a dictionary for the meaning of knowledge.  Your contract should contain a carefully drafted, lawyerly (ugh!) definition of that word.

If you are the buyer, you might want the seller’s “knowledge” to include whatever the seller’s management could have discovered through a reasonably thorough investigation or consultation with lower-level employees.  But the seller probably wants knowledge to mean “actual, current knowledge, with no further inquiry” of just a few named individuals who run the company (and be sure to name them).  And neither the buyer nor the seller wants to roll the dice and leave it to a judge or jury later to decide later on what knowledge means after a dispute arises.

So if you really want to know what is knowledge, be prepared for some tough negotiations and careful contract drafting.  Otherwise, you might wind up with “knowledge” of what you don’t even know, and it could cost you.

This is the first of a ten-part series that may show you how the simplest-looking parts of a business deal can come back to haunt you. Stay with it and read about how to avoid getting into trouble, instead of how to get out of trouble.  I have published an abbreviated version of this series in the January 2014 issue of Nevada Business magazine.  Here is the link, but I warn you – it is so abbreviated that it only has seven pitfalls, and there is much more to be said than what you will see in that article! http://www.nevadabusiness.com/2014/01/seven-pitfalls-avoid-negotiating-business-contracts/

1) Letters Of Intent – More Harm Than Good?

Before we even get to a contract, let’s look at where a pitfall lies – the innocent-looking letter of intent.

You’re excited about your deal, and you don’t want the other party to walk away before you can draw up a contract.  So you decide to take a baby step first – put the main deal points into a letter of intent, label it “non-binding,” get both sides to sign off so you can start work on a real contract.  If you change your mind, or something better comes along, you can just walk away because you didn’t sign a contract and the letter of intent is non-binding, right?

Not so fast.   

True, letters of intent normally do not obligate you to enter into a contract later on.  But be careful about friendly phrases like, “we are just agreeing to talk about doing a deal on these basic terms.…” It can mean more than you want it to mean. 

A court may interpret your statement as meaning “agreeing to talk in good faith…” even if you didn’t say it.  And if both parties agreed to talk in good faith about doing a deal on the basic terms that you listed, you may be unable to walk away or ask for better deal terms later in the negotiations, the way you thought you could.  True, you don’t have a contract for the deal yet, but you might already be stuck in a binding contract to conduct good faith negotiations intended to lead to the deal, even if you no longer want it.

There are ways to avoid this.  A truly non-binding document can be carefully drafted that way.  But if it were so simple, there would not be so many cases that have held a party to be in breach of a letter of intent, with resulting liability, because it mistakenly thought the phrase “non-binding letter of intent” meant what it said.