Nebraska’s New Standard for Special Litigation Committee Investigations

On July 12, 2024, the Nebraska Supreme Court clarified the standard for special litigation committee investigations in derivative actions involving limited liability companies, an issue of first impression in Nebraska. A derivative action is one brought by shareholders on behalf of a corporation that asserts a wrong against that corporation.

Under Neb. Rev. Stat § 21-168, when a limited liability company (“LLC”) is involved in a derivative proceeding, the LLC may appoint a special litigation committee (“SLC”) to investigate the matter to determine whether pursuing the action is in the best interests of the LLC. The SLC has the burden of showing its investigation was conducted independently, in good faith, and with reasonable care. If the Court determines the SLC met this burden, it must enforce the SLC’s recommendation as to whether the litigation should continue or be settled out of court.

In Tegra Corp v. Boeshart, 317 Neb. 100 (Neb. 2024), the Nebraska Supreme Court found that the SLC appointed by Boeshart had failed to use reasonable care in investigating Tegra Corp’s claims of breach of fiduciary duty and misappropriation of corporate assets. In this case, both Tegra Corp and Patrick and Sandra Boeshart own interests in Lite-Form Technologies, LLC (the “LLC”). Tegra Corp brought a derivative action against the Boesharts on behalf of the LLC. Pursuant to § 21-168, Patrick Boeshart appointed Cody Carse as a single-member SLC. The district court was satisfied with the SLC’s investigation and dismissed all claims against the Boesharts according to the SLC’s recommendation. Tegra Corp appealed.

The Nebraska Supreme Court reversed the district court’s ruling on the grounds that the SLC’s investigation was not conducted with reasonable care. The Court cited other jurisdictions that emphasize that thoroughness is the cornerstone of SLC investigations. Courts have noted that SLC’s weigh legal, ethical, commercial, promotional, public relations, fiscal, and other factors to come to a decision regarding a derivative action. Courts have considered the “length and scope of the investigation, the use of experts, the corporation or defendant’s involvement, and the adequacy and reliability of information supplied to the SLC.”

In Tegra Corp v. Boeshart, the Nebraska Supreme Court found that the SLC’s investigation was not conducted with reasonable care because the SLC did not consider the relevant law, failed to include a cost-benefit analysis, and deferred to the LLC’s members for its recommendation. The Court noted that determining whether pursuing the action is in the best interests of the company necessarily involves consideration of the “likelihood that the plaintiff will succeed on the merits, the financial burden on the corporation of litigating the case, the extent to which dismissal will permit the defendant to retain improper benefits, and the effect continuing litigation will have on the corporation’s reputation.” The Boesharts’ SLC did not conduct a legal or cost-benefit analysis and could not have done so because Mr. Carse did not gather the necessary data. Mr. Carse testified that he did not believe legal analysis was part of his duties and that his financial analysis consisted of estimations he made in his own mind, relying on intuition. His recommendation was that the LLC’s members vote on what to do about alleged misappropriation of assets and breach of fiduciary duties. The Court held that deferring to the LLC’s directors is not an exercise of reasonable care.

Finally, the Nebraska Supreme Court also clarified that, contrary to Mr. Carse’s understanding, it was not Tegra’s responsibility to provide the SLC enough evidence to support its allegations. Rather, when breach of fiduciary duties is alleged, the burden of proof is on the party holding that duty to establish its action was not such a breach. The committee bears the burden of proof.

Businesses in Nebraska now face a stricter standard when appointing an SLC under § 21-168. This standard enhances transparency and protects shareholder interests, while underscoring the importance of robust corporate governance practices. SLC’s are a rare feature of American jurisprudence by which defendants can escape litigation by appointing a committee that can control the court. In the future, courts will not be bound to enforce recommendations of SLC’s that conducted vacuous, cursory, or otherwise deficient investigations.

"Corporate Transparency Act: What Companies Need to Know and How to Comply"

Effective January 1, 2024, the Corporate Transparency Act and its corresponding regulations (the “CTA”) requires certain entities created or registered to do business in the United States to disclose certain company information to the Financial Crimes Enforcement Network, a bureau of the United States Department of Treasury. This information, referred to as Beneficial Ownership Information, must be filed online at the Financial Crimes Enforcement Network website.

Companies that are required to report are referred to as “Reporting Companies.” Generally, all companies are Reporting Companies unless they fit into one of the 23 exemptions provided by the CTA. The report requires certain information about the Reporting Company and its Beneficial Owners, as defined by the CTA.

For Reporting Companies formed prior to January 1, 2024, the report must be filed before January 1, 2025. For Reporting Companies formed in 2024, the report must be filed within 90 days of the Reporting Company receiving notice of its formation. Reporting Companies formed after 2024 will have 30 days from the Reporting Company receiving notice of its formation to file the report.

The report is only required to be filed one time. However, if there is any change to the required information, an updated report must be filed within 30 days of such change. These changes include, but are not limited to, the name of the company (including a new trade name), a change in Beneficial Owners, a change to a Beneficial Owner’s name, address, or unique identifying number (including a change to their driver’s license or other identifying document, in which case the Reporting Company will need to upload a new image of the identifying document).

A person who willfully violates the reporting requirements may be subject to civil penalties of up to $500 per day for each day the violation continues. They also may be subject to criminal penalties of up to two years in prison and a fine of up to $10,000.

If you need assistance determining whether your entity is a Reporting Company, who its Beneficial Owners are, or filing the report, the attorneys at Erickson Sederstrom can assist you in complying with these new federal requirements.

Declaration of Dissolution for Nebraska Limited Liability Companies and Nonprofit Corporations

In odd-numbered years, Nebraska limited liability companies and nonprofit corporations are required to file Biennial Reports with the Nebraska Secretary of State. If you have not filed the Biennial Report for your limited liability company or nonprofit corporation and you did not organize or incorporate in 2023, you likely received a Declaration of Dissolution, which states that the Nebraska Secretary of State has dissolved your company and it is now inactive. If you did not file your Biennial Report and you did not receive a Declaration of Dissolution, you will want to be sure to review the Nebraska Secretary of State records to ensure your company’s information is up to date.

If your company has been dissolved, you can reinstate it by filing an Application and Declaration of Reinstatement along with the 2023-2024 Biennial Report with the Nebraska Secretary of State.

If you would like assistance in reinstating your entity so that it is active and in good standing with the Nebraska Secretary of State, the attorneys at Erickson Sederstrom can assist you with this process.

Nebraska Delta-8 Update

As retailers continue to enter the Delta-8 THC market in Nebraska, much uncertainty remains regarding how long the unrestricted sale of Delta-8 THC products will continue in this state. Since we published our last article on Delta-8 THC in October 2021, several additional states have taken steps to ban or regulate Delta-8 THC products. This includes South Dakota, which recently passed a bill making it illegal for persons under 21 to buy Delta-8 THC products.

As we have previously discussed, Delta-8 THC provides a similar, but milder euphoric effect compared to the more common Delta-9 THC (which is abundant in commercially produced medical and recreational cannabis).  However, Delta-8 THC does not occur naturally in high concentrations in cannabis plants and must be extracted from CBD oil using a chemical synthetization process. Delta-8 THC became legal in Nebraska through a loophole in the Nebraska Hemp Farming Act, which made hemp products legal in Nebraska as long as they had a Delta-9 THC concentration of not more than 0.3 % on a dry weight basis.  

Since we published our last article on Delta-8 THC, we are not aware of any potential legislation that would impact Delta-8 THC sales in Nebraska nor has the Nebraska Attorney General issued any statement or opinion regarding its legality (as he was requested to do by Governor Ricketts).  However, there has been other activity that does not bode well for Nebraska Delta-8 THC retailers.  For example:

• CBD Oracle, a website that reviews hemp-derived products including CBD as well as Delta-8 THC products, sent 51 different Delta-8 THC products to FESA Labs, a licensed testing company in Santa Ana, California, to see if potency levels and other metrics printed on the products’ labels were accurate. The results of these tests determined that (i) 76% of tested products contained Delta-9 THC at greater than the 0.3% limit set by the 2018 Farm Bill, making them federally illegal (and illegal in Nebraska) and (ii) 77% of products tested had less Delta-8 THC than advertised, on average containing 15% less than the advertised amount.  The inaccurate labeling and the inconsistent (and illegal) THC levels contained in Delta-8 products have been a reason many opponents have used to push for restrictions on their sale.

•  The Food and Drug Administration has issued safety warnings regarding Delta-8 THC products based on the unregulated nature of the production process. Some manufacturers may use potentially unsafe household chemicals to make Delta-8 THC through the chemical synthesis process needed to extract it. Final Delta-8 THC product may therefore have potentially harmful by-products and contaminants due to the chemicals used in the process, and there is uncertainty with respect to other potential contaminants that may be present or produced depending on the composition of the starting raw material. In addition, manufacturing of Delta-8 THC products may occur in uncontrolled or unsanitary settings, which may lead to the presence of unsafe contaminants or other potentially harmful substances.

• The Attorney General for the State of Kansas issued an opinion in December 2021 which stated that Delta-8 THC is illegal under Kansas law.  While such opinion does not constitute binding law in Kansas, it has led to raids on certain Kansas Delta-8 retailers and County Attorneys pursuing charges against such retailers.

For now, Nebraska retailers appear safe, but that could change at any time.  Retailers are urged to move cautiously and limit any large-scale investments in a Delta-8 THC business until the future landscape becomes clearer.  If you have any questions about Delta-8 THC or other cannabis issues, attorneys at Erickson | Sederstrom can assist you. Attorneys Shay Garvin or Andrew Collins can be reached (402) 397-2200.

Medicinal Cannabis in Nebraska May be Coming Soon

A registered ballot question committee, Nebraskans for Medical Marijuana, has been working to gather signatures to place two initiatives on the Nebraska ballot in November later this year.   If these initiatives are added to the ballot, and confirmed by a majority of voters, they would serve to legalize the possession and use of cannabis for medicinal purposes in Nebraska.

The legalization of cannabis for medicinal purposes would be a significant departure from Nebraska’s historic stance against it.  While the Nebraska Hemp Farming Act was passed in 2019, the intent of this legislation was to legalize industrial hemp in Nebraska, and not the use of cannabis for any of its psychoactive properties (for medicinal use or otherwise).  In addition, several medicinal cannabis bills have been proposed and failed in the unicameral in the past few years.  Also, in 2020, a medicinal cannabis measure that would have been on the 2020 ballot was invalidated by the Nebraska Supreme Court after a determination that the initiative violated Nebraska’s single subject rule.  

However, the tide may be changing.  Many former cannabis opponents have recently appeared to alter their stance on medicinal cannabis.  For example, in January 2022, former State Senator Mike Groene, who had previously been outspoken against the subject, sponsored LB1275, which would legalize cannabis use for a limited number of medical conditions and authorize a defined number of dispensaries to operate in the state. In addition, Governor Ricketts (who appeared in an ad as recently as December 2021 advocating against medicinal cannabis) recently stated that he was “open to learning more about [LB1275]”.   Advocates for medicinal cannabis in Nebraska believe that these shifting viewpoints are evidence that cannabis opponents believe they can no longer keep the public sentiment on the issue at bay, and such opponents would rather control medicinal cannabis through legislation instead of a voter approved constitutional amendment.

In anticipation of medicinal cannabis becoming a reality in Nebraska, potential cultivators, processors, retailers, and other participants have already begun making plans for this possible new market.Since cannabis that is used to treat medical conditions is currently illegal under federal law (making transportation across state lines illegal), such cannabis is typically grown and processed in the state where it will be sold.In Nebraska, legal medical cannabis would likely result in the construction and/or leasing of large-scale cultivation and processing facilities where medicinal cannabis goods would be grown and produced, as well as new markets for the transportation, storage, and retail sale of such goods.We are currently advising clients on a multitude of issues related to these new markets, including banking, leasing, and transportation. If you have any questions about cannabis issues, the attorneys at Erickson | Sederstrom can assist you. Attorneys Shay Garvin or Andrew Collins can be reached (402) 397-2200.

2022-2023 Occupation Tax Report

The 2022-2023 Occupation Tax Reports (“OTRs”) are now due for all domestic and foreign Nebraska corporations. OTRs are biennial reports that must be filed with the Nebraska Secretary of State by March 1, 2022. If the report is not filed, along with the applicable fee, by April 15, 2022, the entity will be administratively dissolved by the Nebraska Secretary of State.

The OTRs may be filed online at the Nebraska Secretary of State website or by mail. The Secretary of State has begun mailing out reminder cards to the registered agent for each domestic and foreign Nebraska corporation. If you have not received your notice, make sure your records are up to date with the Nebraska Secretary of State.

If you would like assistance in filing your OTR or with updating your records with the Nebraska Secretary of State, the corporate attorneys at Erickson Sederstrom can provide you with the help you need to assure that your entity remains active and in good standing with the State of Nebraska.

Removing Minority or Legacy Shareholders the Right Way

The best practice for dealing with minority shareholders is a well thought out buy-sell agreement which includes simple to follow and execute buy-out or redemption provisions.  But what if your small business (for example a multigenerational agribusiness or family farm) has legacy shareholders who are not subject to a buy-sell agreement?  Even worse, what if those shareholders are irrational, create conflict and/or are not contributing in a meaningful way to the business?  Most state corporate statutes (including Nebraska) contain a simple solution by allowing a squeeze-out maneuver through the creation of fractional shares (i.e. script) which in turn allows the corporation to simply cancel the minority shareholder’s shares in exchange for tendering cash equal to the fair value of their stock.  This can be a win-win for family and small businesses because it allows the business to move forward without having to deal with issues created by the presence of the minority shareholder and also provides a fair mechanism for valuing the shares of minority shareholders when their position is liquidated.  You should consult with an experienced attorney about the ins and outs of executing this maneuver if you want to remove a minority shareholder.  Often a simple letter from your counsel to the minority shareholder’s counsel is all that is needed to resolve your disputes with the minority shareholder.

Nebraska Still Allows Structured Avoidance of Capital Gains Taxes (Even to Family Members)

Every Nebraskan business owner (or their trust) should be aware that they are entitled to claim a one-time capital gains exemption from the sale of their stock.  The exemption is seemingly not available when there are less than five shareholders and at least two of those shareholders who are not related to each other – but not so fast.  Artful drafting of sale documents would allow the placement of strawmen shareholders to meet these requirements which would create substantial tax savings for a just a few additional pages of paperwork.  Normally this sort of structuring is a no-no under normal tax rules.  But not in Nebraska.  The Nebraska Supreme court in 2016 interpreted the statute to allow this sort of structuring and the Legislature has not yet acted to update the statute to prevent this practice.  Nebraska business owners should consult their accountants and deal counsel to make sure that if this benefit is available to them that their documents are drafted in a way that takes advantage of the statute as interpreted by the Supreme Court. 

MLB Team Sued for Trademark Infringement by Roller Derby Team

Major League Baseball’s Cleveland Indians organization has been sued by the Cleveland Guardians, a local roller derby team, for trademark infringement. Earlier in 2021, the Indians announced their intent to transition from the Cleveland Indians to the Cleveland Guardians beginning with the 2022 season. The Cleveland Guardians filed suit to protect their trademark rights in the name. You can read the Associated Press’s reporting on the matter here.  

Trademarks and other intellectual property are becoming increasingly important assets in today’s business landscape, especially in our digital, online world. The business law and intellectual property lawyers at Erickson | Sederstrom can help you understand the contours of protecting, managing and exploiting your intellectual property assets, and, when necessary, assist you through the dispute process relating to infringement or other issues.

This post was created by Andrew Collins and Blake Schneiderwind, corporate and business attorneys at Erickson | Sederstrom, P.C., who can be reached at 402-397-2200.

Nebraska Delta-8 THC and CBD Retailers Beware

On the heels of the boom in cannabidiol (“CBD”) sales, many Nebraska CBD retailers have recently been marketing and selling products containing Delta-8 tetrahydrocannabinol (“Delta-8 THC”), which is an isomer of Delta-9 tetrahydrocannabinol (“Delta-9 THC”). Delta-9 THC is the common compound in marijuana that provides euphoric effects to it users.  Marijuana plants and other products containing Delta-9 THC in concentrations high enough to provide users with any such effects are generally illegal under federal and Nebraska law.  Delta-8 THC provides a euphoric effect similar to Delta-9 THC, but milder, and due to a loophole in the federal and Nebraska law, as further discussed below, products containing Delta-8 THC are arguably legal in Nebraska and many other states.   

The Delta-8 THC market was born when producers began looking for ways to turn extra CBD extracted from hemp into something else profitable. Using a chemical synthetization process, they were able to produce Delta-8 THC from CBD, and incorporate Delta-8 THC into products that could be marketed as a legal recreational drug in many states.

Under the Nebraska Hemp Farming Act (the “Nebraska Hemp Act”), “Hemp” is legal in Nebraska and removed from the Nebraska Controlled Substances Act.  Hemp is defined as “the plant Cannabis sativa L. and any part of such plant, including the viable seeds of such plant and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 % on a dry weight basis” (emphasis added) . Thus, as long hemp derivative products (such as CBD and Delta-8 THC) do not contain Delta-9 THC in excess of 0.3%, a plain reading of the statute indicates that Delta-8 THC and products containing Delta-8 THC would be classified as Hemp, and are legal in Nebraska.  Many other states have similar industrial hemp statutes that purport to make Delta-8 THC products legal in the same manner. 

Under the federal 2018 Farm Bill (the “Farm Bill”), “Hemp” was removed from the federal Controlled Substances Act.  In addition, under the Farm Bill, the definition of Hemp is the same as it is under the Nebraska Hemp Act, meaning that Delta-8 THC products that do not contain Delta-9 THC in excess of 0.3% are legal under federal law. 

However, despite the purported legality of Delta-8 THC under Nebraska and federal law, Nebraska retailers face a myriad of risks.  In 2020, the Drug Enforcement Agency (“DEA”) issued an Interim Final Rule that stated, in part, that “all synthetically derived tetrahydrocannabinols [regardless of THC content] remain schedule I controlled substances.”  There is some debate over whether Delta-8 THC is “synthetically derived,” but there appears to be a conflict between this DEA Rule and the Farm Bill.  In any event, Delta-8 THC retailers face risk of DEA enforcement for the possession, distribution, or transportation of products containing Delta-8 THC.   In addition, the Food and Drug Administration (“FDA”) retains authority to regulate products that contain cannabis or cannabis derivatives under the federal Food, Drug and Cosmetic Act.  Currently, Delta-8 THC products do not appear to be prohibited by FDA regulations. However, the FDA recently issued a consumer update warning of the dangers of Delta-8 THC products, including contamination concerns from potentially unsafe manufacturing methods.  Thus, Delta-8 retailers also risk that the FDA may take steps to ban or more tightly regulate these products.

At the state level, the tide appears to be shifting, as more states are closing the legal loophole that purports to make Delta-8 THC legal under laws similar to the Nebraska Hemp Act. For example, Colorado (which allows recreational marijuana use) has banned Delta-8 THC since May 2021, and Texas recently did the same in October 2021.  As of the date of this article, sixteen other states have restricted or banned Delta-8 THC. In Nebraska, Governor Rickett’s office has generally taken a negative position towards cannabis and its derivative products, and Governor Ricketts recently asked the state Attorney General to review the legality of Delta-8 THC.  Recall that prior to the enactment of the Nebraska Hemp Act, certain Nebraska sellers of CBD products were raided and charged with criminal drug trafficking offenses. The Nebraska Supreme Court eventually found in favor of the sellers, but only after years of the defendants expending extensive legal fees. Nebraska Delta-8 THC retailers could face a similar situation.

There is also the risk that Delta-8 THC retailers may inadvertently possess and/or sell products containing Delta-9 THC in amounts greater than 0.3%, in which event they would be subject to potential felonies under the Nebraska Controlled Substances Act.  Thus, such retailers are advised to take as many steps as possible to confirm that its Delta-8 THC products fall within the definition of Hemp under Nebraska law, and don’t contain Delta-9 THC in amounts greater than 0.3%.

Persons considering entering the Delta-8 THC market should carefully consider these risks, and be prepared to handle the effects of a Delta-8 THC ban or restriction under Nebraska or federal law. If you have any questions about Delta-8 THC or other cannabis issues, attorneys at Erickson | Sederstrom can assist you. Attorneys Shay Garvin or Andrew Collins can be reached (402) 397-2200.

SBA Removes Loan Necessity Review for Certain PPP Loans

The United States Small Business Association (“SBA”) will no longer require loan necessity review for Payment Protection Program loans of $2 million or more and any open requests for additional information regarding the loan necessity review can be closed.

 The loan necessity review required completion of the Loan Necessity Questionnaire (SBA Form 3509 for for-profit borrowers and SBA Form 3510 for not-for-profit borrowers) which led to a lawsuit by the Associated General Contractors of America against to the SBA that challenged the legality of the forms.

The changes are effective immediately and the SBA will issue guidance on this issue which will provide more details.

The Trademark Filing Process

Trademarks are important pieces to many businesses. They are how people associate a business with a particular service or product. While there are certain common law protections provided to trademark holders even if they do not file with the United States Patent and Trademark Office (“USPTO”), filing with the USPTO provides the most protection for a mark. This will serve as a general outline of the process for filing trademark applications with the USPTO. 

Identifying the Mark and Goods and/or Services Provided

The first step is to identify the mark you wish to protect. This could be a design mark (ie. a logo), a wordmark (ie. a word or phrase), or both. The key is to determine how you are using or plan on using the mark and identifying whether certain colors or fonts are going to be integral portions of your mark. Another key thing to identify is what goods and/or services are going to be provided in connection with the mark. This aids in the review of existing marks and is required in the application process.

Reviewing Existing Marks

Once you have identified your mark, you should review USPTO records to determine whether there are any existing registered marks that will create issues for your application. The most common would be a mark that creates a “likelihood of confusion.” The determination of whether there is a likelihood of confusion involves an analysis of numerous factors, including the similarity of the marks, the similarity of goods and/or services, and the geographic proximity of where the goods and/or services are provided.

Use in Commerce

The next step is to determine whether you are, or will soon be, using the mark in commerce. A “use in commerce” is a public-facing use, such as use in advertising, on a website, or on packaging for a product. This determination drives which type of application will be filed with the USPTO.

Which application to file

Whether your mark is being used in commerce will guide which application needs to be filed with the USPTO. A Section 1(a) application is used when the mark is being used in commerce. A Section 1(b) application is used when the mark has not been used in commerce. There are various other types of applications but Section 1(a) and Section 1(b) applications are the most common.

Application Timeline

Section 1(a)

After filing a Section 1(a) application, the USPTO reviews the application and the applicant receives a response in approximately three months. The response is typically one of two types: an office action or a notice of publication.

An office action is a letter from the USPTO identifying issues with the application that must be addressed before the mark can be registered. These range from administrative issues such as disclaimers as to certain portions of the mark or adjusting descriptions of the marks or the goods and/or services, to likelihood of confusion refusals.

If an office action is issued and the applicant decides to continue to pursue registration, the applicant has 6 months from the date the office action was issued to file a response. If an applicant does not respond within 6 months, the application will be abandoned. If a response is filed, within 1-2 months the USPTO will either approve the mark for publication or issue a final letter which an applicant can appeal.

Once an application is approved for publication, the mark will be published in the Trademark Official Gazette, allowing others to oppose the registration and, if no one opposes, the mark will be officially registered with the USPTO in approximately 3 months.

Section 1(b)

A Section 1(b) application follows a similar pattern to the Section 1(a) application except for one key distinction: once the application is approved and the mark is published for opposition, the applicant has 6 months to file either a Statement of Use showing the mark being used in commerce or an extension, which provides an additional 6 months for the applicant to start using the mark in commerce. An applicant can file up to 5 separate 6 month extensions.

Post Registration Maintenance

Once your mark is officially registered, there are certain filings that need to be done between the 5th and 6th year after registration, between the 9th and 10th year, and then every 10 years thereafter to show that you are still using the mark.

 The trademark filing process is lengthy with various nuances throughout. If you have a mark that you believe could be registered with the USPTO, Erickson | Sederstrom has attorneys that can assist with this process from start to finish or anywhere in between

COVID-19 Impacts Ordinary Course Defense When Defending Preference Claims

As a business owner or manager, it is frustrating to receive a bankruptcy preference demand letter.  Unless you want to pay the preference demand, you have little choice but to undertake a defense.  Unfortunately, the business disruptions caused by the COVID-19 pandemic have further complicated the legal landscape surrounding defense of preference claims.  The purpose of this article is to briefly summarize preference procedures, explain the COVID pandemic impact regarding preferences, and discuss some general strategies for businesses responding to or defending against preference claims.

I.                     Preference Process

Transfers made by a business within 90 days of it filing a bankruptcy petition under the Bankruptcy Code are potentially subject to a preference action.  In many cases, such transfers consist of payment for goods or services received by the bankrupt party in the months prior to filing its bankruptcy petition.  The preference statutes are intended to prevent the bankrupt party from preferentially transferring assets to favored parties or individuals before the bankruptcy is filed, to the detriment of other creditors, during the time leading up to the bankruptcy (when the business is likely insolvent). 

Bankruptcy trustees and debtors-in-possession have the right to seek the return into the bankruptcy estate of preferentially transferred assets or funds, so the assets can be allocated and distributed as part of the orderly bankruptcy process.  11 U.S.C. § 547(c)(2).  Typically, a preference claim begins with a demand letter being sent to the party who received the funds, demanding that payment be made back to the bankruptcy estate.  If the preference claim is not resolved based upon the demand letter, the matter may progress to an adversary proceeding, a lawsuit within the bankruptcy case for recovery of the alleged preference funds.

The most common defense against preference claims is that the transfer at issue to the bankrupt party was made “in the ordinary course” of business.  Proving the “ordinary course’ defense requires the party defending against the preference claim to show:  (A) the transfer was made in the ordinary course of business or financial affairs of the debtor and the transferee or (B) the transfer was made according to ordinary business terms.  11 U.S.C. § 547(c)(2).  (A) requires a subjective comparison of the historical transactions between this debtor and this creditor.  (B) requires an objective comparison with other transactions between parties in the same industry.  Either way, the question is whether the alleged preferential transfer was “ordinary”. 

II.                   COVID Impact

With the impact of COVID-19 since early 2020, very little has been “ordinary” about how many, or even most, businesses or industries have functioned.  This lack of normality makes it more difficult to present and prove the “ordinary course” defense.  When a course of dealing between the debtor and creditor, or even an entire industry, has been disrupted due to impacts of COVID-19, parties defending against preference actions need to think creatively.  Referring back to the business relationship between debtor and creditor preceding the 90 day preference period might not provide much value, if that time frame was influenced by COVID-19 effects. 

 III.                 Defense Perspective

When defending against preference claims, creditors preparing a defense need to take a broader look than in the past and be prepared to present extensive evidentiary support.  Developing and presenting an effective defense requires the assistance of experienced counsel to identify the best way to identify and present supporting evidence.

Questions for the creditor to evaluate include:

What relationship did this debtor and this creditor have prior to COVID-19 impacts and what changed?  How can these separate periods be quantified?  When was the last time their business relationship was “ordinary”?  If the transfer that is the subject of the preference claim was affected by COVID-19, what still makes it “ordinary”?

Was this transfer “ordinary” pursuant to a broader analysis of industry practices?  How can the industry be redefined to show what is “ordinary”?

As discussed above, defending against preference claims requires a solid understanding of relevant bankruptcy law, and effective application of bankruptcy law to the current business environment.  Erickson|Sederstrom’s bankruptcy attorneys are ready to help if your business needs to defend against a preference demand. 

Erickson|Sederstrom Elects Matt Quandt and Shay Garvin as Partners; Connor Orr Joins the Firm

ERICKSON | SEDERSTROM is pleased to announce that MATTHEW D. QUANDT and SHAY GARVIN have been elected Partners and CONNOR W. ORR has joined the firm as an Associate.

Matt has been with the firm for two years, before which he litigated at a reputable Kansas City firm. His practice focuses on civil litigation, including catastrophic injury and wrongful death, trucking and transportation, construction defect, product liability, and professional liability. He is also a member of TIDA (the Trucking Industry Defense Association). He received his J.D. from the Washburn University School of Law (cum laude) and his B.S. from Baker University (cum laude). He is admitted to practice law in the state and federal courts of Nebraska, Kansas, and Missouri.

Shay has been with the firm since 2019. Prior to joining Erickson | Sederstrom, he practiced for several years with a nationally recognized firm in Lincoln. Shay focuses his practice on transactional areas, including mergers and acquisitions, business formation, securities offerings, debt and equity financing, and general counsel. Shay also has extensive experience in the transportation industry and is active in the Nebraska logistics community. He received his J.D. and M.B.A. in 2015 from the University of Nebraska and his B.A./B.S. from the University of Arizona. He is admitted to practice law in Nebraska.

Connor has joined the firm representing both individual and commercial clients for litigation and general counsel matters. Connor graduated from Creighton University Magna Cum Laude in 2014 with a Bachelor’s degree in Economics, then went on to obtain his Juris Doctorate from the Creighton University School of Law in 2017. He is a member of both the Nebraska and Iowa State bars, and has extensive litigation experience representing clients in both state and federal courts for matters including commercial contract disputes, insurance defense, personal injury, construction defects, product liability, wrongful death, trucking and transportation, and disputes concerning both commercial and residential real estate. He also has experience providing estate and business planning services, providing advice to help guide families and small, local business owners through both prosperous and difficult times.

The Acquired Immunity Doctrine – Will the Nebraska Supreme Court Take the Next Step and Adopt the Entire Doctrine?

The acquired immunity doctrine is an affirmative defense that may be available to state construction contractors that are sued by a third party for alleged construction plan design defects.  Here is the scenario: The Nebraska Department of Transportation (“Department”) contracts with a road contractor to remove and replace part of a state highway.  The Department designs the construction plans and requires the contractor to follow the plans as designed.  Part of the construction plans include a traffic control plan.  The traffic control plan complies with the Manual on Uniform Traffic Control Devices (“MUTCD”).  Traffic control is subcontracted to a traffic control manager.  The traffic control subcontractor has no discretion to deviate from the traffic control plan and must set up all traffic devices at the required locations as the Department orders. The subcontractor sets up the traffic devices as the traffic control plan requires.  

Subsequently, a third party is injured in the construction zone and alleges that additional or different traffic devices should have been used on the project.  The Department retains its sovereign immunity because: 1) the Department’s choice of devices was discretionary, and a matter of engineering judgment; and, 2) under Nebraska’s State Tort Claim Act, the Department retains its sovereign immunity for “Plans for Construction of or improvement to highways.” See Neb. Rev. Stat. §§ 81-8,219 (9) & (11) (Reissue 2014). Yet, the subcontractor is sued for the traffic plans’ alleged design defects even though the Department designed the plan and is immune from liability. Can the subcontractor raise the Department’s sovereign immunity as an affirmative defense?  The answer is “yes,” and the defense is called the “acquired immunity doctrine.”  

The acquired immunity doctrine “provides that a contractor who performs its work according to the terms of its contract with a governmental agency, and under the governmental agency’s direct supervision, is not liable for damages resulting from its performance.” Lopez v. Mendez, 432 F.3d 829, 833 (8th Cir. 2005) (citing Smith v. Rogers Group, Inc., 348 Ark. 241, 72 S.W.3d 450, 455 (2002)) (emphasis added). “Thus, if damages result from the contractor’s performance of a construction contract with the state, ‘and the damages result from something inherent in the design and specifications required by the public agency, the contractor is not liable unless he is negligent or guilty of a wrongful tort.’” Lopez, 432 F.3d at 833 (quoting Guerin Contractors, Inc. v. Reaves, 270 Ark. 710, 606 S.W.2d 143, 144 (1980)). “The purpose of the doctrine is to protect an ‘innocent contractor who has completely performed the work to the government’s plans and specifications.’” Lopez, (quoting Smith, 72 S.W.3d at 456).

The Nebraska Supreme Court has not yet adopted the acquired immunity doctrine.  But the Supreme Court has adopted the immunity’s fundamental concept. That is, the Supreme Court has said “where a construction contractor follows plans and specifications supplied by the owner which later prove to be defective or insufficient, [the contractor] is not responsible to the owner for loss or damage resulting therefrom as a consequence of the defectiveness or insufficiency of such plans and specifications.” Lindsay Mfg. Co. v. Universal Sur. Co., 246 Neb. 495, 506-07, 519 N.W.2d 530, 539-40 (1994); see also Langel Chevrolet-Cadillac, Inc. v. Midwest Bridge & Constr. Co., 213 Neb. 283, 287, 329 N.W.2d 97, 100-01 (1983) (citations omitted); Central Neb. Pub. Power & Irr. Dist. v. Tobin Quarries, Inc., 157 F.2d 482, 485-86 (8th Cir. 1946) (applying Nebraska law); State v. Commercial Cas. Ins. Co., 125 Neb. 43, 50, 248 N.W. 807, 808-09 (1933).

This is the acquired immunity doctrine. Furthermore, although the Nebraska’s State Tort Claims Act excludes independent contractors from the term “state agency,” “the acquired-immunity doctrine creates an exception to this rule.” See Neb. Rev. Stat. § 81-8,210(1); see also Lopez, 432 F.3d at 833. The reason for the exception “is to protect an ‘innocent contractor who has completely performed the work to the government’s plans and specifications.’” Lopez, 432 F.3d at 833 (quoting Smith, 72 S.W.3d at 456).  In fact, other jurisdictions with tort claims acts like Nebraska’s Act and that have the same “state agency” exclusion for contractors as Nebraska’s Act, still have adopted the acquired immunity doctrine to protect innocent contractors that follow the state’s construction plans. See id. at 833-34 (discussing the acquired immunity doctrine under Arkansas law); see also McLain v. State, 563 N.W.2d 600, 605 (Iowa 1997); Fraker v. C.W. Matthews Contracting Co., Inc., 272 Ga. App. 807, 614 S.E.2d 94 (2005); Garrett Freightlines v. Bannock Paving Co., 112 Idaho 722, 731, 735 P.2d 1033, 1042 (1987).

For example, the Iowa State Tort Claims Act also excludes independent contractors from the term “state agency.” I.C.A § 669.2(5). But the Iowa Supreme Court nevertheless adopted the acquired immunity doctrine to protect its independent contractors from liability. Specifically, in McLain v. State, supra, the plaintiffs sued the State of Iowa, its general contractors, and a subcontractor working in an interstate construction zone. The plaintiffs claimed that the construction zone was unreasonably dangerous because the traffic warning signs failed to warn motorists of traffic congestion. McLain, 563 N.W.2d at 601. The district court granted the general contractor and subcontractor summary judgment under the acquired immunity doctrine and in affirming summary judgment, the Iowa Supreme Court held:

The rule is well established that a contractor for the State is not liable to a third party for damages if the contractor complies with the State’s plans and specifications and is not negligent in performing its work . . . . In other words, in those situations the contractor shares the same immunity as the State.

* * *

Here, the evidence in the record reflects that [the general contractors and subcontractor] complied with all State plans and specifications and did not perform their work in a negligent manner. Throughout the project, the State controlled all decisions regarding the placement and installation of the traffic control devices. [The subcontractor] installed the warning signs as it contracted to, and on the day of the accident, the signs were in their proper locations and in complete working order.

Id. at 605 (citations omitted).

The Iowa court also noted that monitoring the effectiveness of the signs was “part of the decision-making process of whether to install additional signs,” which was a decision retained by the State and immunized by statute. Id. The Iowa Supreme Court then held that “[b]ecause [the general contractors and the subcontractor] complied with the State’s contract specifications, we conclude as a matter of law that they may share immunity with the State . . . .” Id.

            Here, like McLain, the subcontractor in our scenario followed the traffic control plan and the traffic plan complied with the MUTCD.  Also, the third-party’s claim that the traffic control plan should have included different or additional traffic devices is a claim against the Department because the Department designed the Traffic Plan —not the subcontractor. The Department, however, is immune from liability because: 1) the traffic plan’s design was a matter of engineering judgment; and, 2) the traffic plan was part of the Project’s “Plans for Construction” for a highway improvement. Neb. Rev. Stat. §§ 81-8,219 (9) & (11). Thus, the subcontractor is cloaked in the Department’s sovereign immunity because it “complied with all State plans and specifications and did not perform their work in a negligent manner. [And] [t]hroughout the project, the Department controlled all decisions regarding the placement and installation of the traffic control devices.” McLain, 563 N.W.2d at 605.

            Now, we need the right case to be taken to the Nebraska Supreme Court.  And remember, in Nebraska you can now file an interlocutory appeal on an order denying summary judgment based on the assertion of sovereign immunity.  Neb. Rev. Stat. § 25-1902.  

Solar Land Leases

Most Nebraskans and Iowans have become accustomed to seeing wind farms popping up across the prairies of the Midwest. However, fewer of us may realize that solar farms, which are large-scale, ground-mounted arrays of photovoltaic (PV) panels, are emerging as a potential renewable energy alternative to wind power.  Consequently, landowners in certain areas are being approached by developers of solar farms to discuss a potential lease of their land for the housing of a solar farm.

 The use of solar energy is on the rise in the United States and in Nebraska.  In fact, according to the Solar Energy Industries Association, solar energy production in Nebraska is expected to increase over 500% during the next five years.  The increase is due to two main factors.  One factor is the tax incentives offered by state and federal governments that help offset the cost of solar development (which incentives may be increased further under a Biden administration).  The other factor is that the cost of PV cells has decreased significantly over the last few years (and will likely continue to decrease).  

 The rapid growth of solar energy production has caused owners of large tracts of land (including farmers) to consider whether alternative uses of their land may bring them a higher rate of return.  However, solar farm developers are generally very selective when choosing potential land for a solar farm.  The primary criteria such developers use when choosing land are (i) frequency of sunlight (including the absence of sunlight blocking obstructions), (ii) proximity to important infrastructure like roads and grid connection points and (iii) quality of terrain (flat and free from large rocks is most desirable).   When a developer does find land that meets these criteria, it may aggressively pursue a long-term “solar lease” with the owner of the land for the development of a solar farm.  In these instances, a landowner should seek the advice of legal counsel before entering into a solar lease, as it will affect the use of and earnings from the land for generations.  Items to consider prior to agreeing to a solar lease include the following:

1.      Lease Term – Due to the significant investment made by the developer, solar leases are generally going to be for at least 20 years, during which time the land will be unavailable for other purposes.  Thus, a landowner should ensure he or she is willing to devote the land for this use for the entire length of the lease.  Solar leases may also include options by the developer to extend the term of the lease and/or obtain rights to use additional land owned by the landowner.  These terms should be negotiated carefully, and the implications should be fully understood by the landowner.    

 2.      Compensation – Landowners should be particularly careful about the way their compensation is structured.  A flat rental rate will provide a landowner with a steady and certain income stream on the land.  However, a developer may try to structure all or a portion of the rent based on the developer’s income and/or revenue.  This is generally ill-advised to the extent it can be avoided, as it reduces the certainty of income to the landowner.

 3.      Landowner Remedies – A landowner should ensure he or she will have a sufficient remedy in the event of a breach of the solar lease by the developer.  Developers may be newer companies without significant assets.  To the extent possible, a landowner should seek parent/owner guarantees and/or security deposits for his or her protection in the event the developer fails to fulfill its obligations under the solar lease.

 4.      Rights of Others – Mortgages, deeds of trust, farm leases and other rights in the landowner’s property that may be granted to others could preclude granting a solar lease on the land.  A landowner should ensure that no such other rights in the land have been granted that could conflict with the solar lease.  Failure to do so could cause a landowner to be in breach of other agreements and/or the solar lease, resulting in significant costs to the landowner.

 5.      Land Impact – The installation of a solar farm may cause long-term damage to the soil and/or irrigation systems of farmland.  It may take considerable time and expense after the termination of a solar lease and removal of equipment for the land to be returned to a condition suitable for crop production.  The allocation of the costs of returning the land to such condition should be addressed in the solar lease.

6.      Taxes – Solar leases may impact the classification of land as agricultural for tax purposes. This can increase a landowner’s taxes going forward, and may result in recapture of prior tax reductions.  A landowner should understand the tax impact of any solar arrangement and the lease should allocate which party is responsible for taxes during the lease term, including any tax increases. 

 7.      Risk and Insurance – The lease should include customary indemnification and allocation of risk provisions.  The parties should also ensure that adequate insurance is carried by both to cover such obligations.

 8.      Maintenance – The developer is typically going to be the party that is responsible for maintaining the solar equipment, but the lease should also clearly specify which party is charged with maintaining access to such equipment and/or the area surrounding the solar equipment.

 9.      Community Perceptions – A landowner should consider how a solar lease may impact his or her relationship with the community.  Community members may object to the installation of a solar farm in their community for a variety of reasons.  These include (i) opposition to the appearance of solar panels on the landscape, (ii) concern over the impact  the construction and maintenance of a solar farm may have on neighboring properties (including property values) and (iii) distrust of outside developers.

Entering into a solar lease is a major decision, and landowners should not take entering into one lightly.  If you have any questions regarding a potential solar lease on your land, please contact a member of our Real Estate group.

The material in this publication was created as of the date set forth above and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

Structuring the Sale of a Business

Selling Assets Versus Equity

One of the more critical initial items to consider when selling a business is determining whether the sale involves selling the equity or assets of the business.  The choice of structure will have an impact on several items, including, (i) the tax consequences to each of the buyer and seller, (ii) the party responsible for the company’s liabilities, and (iii) third-party consents required to consummate the transaction.  In many cases, the buyer and seller will benefit differently depending on the structure, so it is important for the seller of a business to fully understand the impact of each structure.  This article will briefly describe the mechanics of an asset sale and equity sale, and then discuss some important items that are implicated depending on the chosen structure.  

Equity Sales

 A sale of equity involves the buyer, which may be an individual, group of individuals, or a company, purchasing the stock (in the case of a corporation) or interests (in the case of an LLC or partnership) of the business directly from the owner(s) of the equity.  After the sale of the equity is consummated, the  buyer takes the entire business as a whole, including all of the business’s assets and liabilities.

Diagram 1 shows the structure of a proposed equity sale.  Note that ABC, LLC is the target company and owned by the seller prior to the sale.   The buyer is proposing to transfer cash to the seller in order to purchase the equity of ABC, LLC.  Diagram 2 shows the results of the transaction after the closing, with the buyer owning the equity of ABC, LLC and the seller now holding the cash from the buyer.  Note that the buyer takes ABC, LLC with all of the assets and liabilities of the company and, except as may be agreed between the buyer and seller, the company is still responsible for satisfying all of the liabilities it had when it was owned by the seller.

Asset Sales

In contrast to an equity sale, a sale of the assets of a business involves the buyer (almost always an entity) purchasing only certain assets and assuming only certain liabilities of the target company.  After the sale is consummated, the target company retains any unpurchased assets and liabilities that were not assumed by the buyer.

Diagram 3 shows the structure of a proposed asset sale.  Note that ABC, LLC is the target company and the buyer is proposing to transfer cash to the target company in order to purchase certain assets and assume certain liabilities of ABC, LLC.  Diagram 4 shows the results of the transaction after the closing, with the buyer owning the purchased assets and liabilities and the target company now holding the cash from the buyer, as well as certain retained assets and liabilities.  This is an important distinction from an equity sale since the cash generated from the asset sale may now need to be used to pay off certain retained liabilities.

Impact of Structure

Tax Consequences

In an asset sale of a business with significant depreciable assets, the buyer will often receive a tax benefit while the seller may experience a tax disadvantage.  This is because the purchase price in such an asset sale is often greater than the basis of the depreciable assets.  This allows the buyer to receive a stepped-up basis in such assets and further depreciate the assets to reduce the buyer’s income.  Meanwhile, the seller will have to pay taxes at the ordinary income rate for the difference between the assets’ basis and the purchase price.

In an asset sale without significant depreciable assets, the tax benefit to the buyer (and disadvantage to the seller) will generally be much lower.

In an equity sale, the seller typically receives a tax advantage because in most equity sales, the equity that is sold receives tax treatment as a capital gain (which is taxed at a lower tax rate than ordinary income). State rates for capital gains vary by state. In Nebraska, capital gains may be avoided altogether through the use of certain tax planning strategies.

There are also certain tax elections that may apply to some transactions that can provide benefits to both the buyer and seller.  For example, a 338(h)(10) election made in connection with the sale of stock allows a seller to receive capital gains tax rates on the sale and the buyer to receive a stepped-up basis in the assets. 

Treatment of Liabilities

As touched on above, in a sale of equity, all of the liabilities of the target company stay with the target company after the sale.  This means that the seller of equity generally does not have to worry about responsibility for further liabilities of the company after the sale (although the seller will likely have agreed to backstop the buyer for certain undisclosed liabilities that may arise for some period after the closing). 

Contrast this with an asset sale, where the buyer of the assets generally takes few liabilities.  This means that the seller of the assets will remain responsible for future liabilities of the target company, and owners of the target company may thereafter remain liable for several years after dissolution. This is why asset sales are generally preferred by buyers and equity sales are generally preferred by sellers.

Assignment of Intangible Assets

In a sale of equity,  contracts (such as leases, customer agreements, etc.) transfer with the target company by operation of law.  This means that, unless any contracts have restrictions on a change of control of the target company, there is no need to obtain the consent of contract counterparties in order to consummate the transaction. 

However, in a sale of assets, such transfer does not occur automatically, and most contracts will have a restriction on assignment without the consent of the counterparty.  This can take considerable effort depending on the number of consents that are needed, and may jeopardize the confidentiality of the transaction.  Thus, all other items being equal, a sale of equity is generally preferential if the target company has a large number of material contracts.

The bottom line is that the choice of transaction structure can have a significant impact on the pre-closing duties and post-closing obligations of the parties and have a direct effect on the amount of cash that the seller ultimately receives from the transaction. Thus, any business owner should seek competent legal advice to understand the risks and benefits of various transaction structures very early on in a potential sale process.

Nebraska Supreme Court Upholds Premises Liability Standard, Rejecting Foreseeability as a Conclusory Factor

In Sundermann v. Hy-Vee, the Nebraska Supreme Court found that Hy-Vee was not liable to the plaintiff, Sundermann, who sustained serious injuries when she was struck by a pickup truck while using an air compressor to fill her tires in a Hy-Vee parking lot.  Sundermann v. Hy-Vee, Inc., 306 Neb. 749 (2020).  In support of its holding, the Nebraska Supreme Court applied the framework for premises liability and rejected the trial court’s finding that Hy-Vee was liable based upon a more general foreseeability analysis.  Id at 764.  The premises liability test holds that a possessor of land is subject to liability for an injury caused to its lawful visitor by a condition on the land if

(1) the possessor either created the condition, knew of the condition, or by the existence of reasonable care would have discovered the condition; (2) the possessor should have realized the condition involved an unreasonable risk of harm to the lawful visitor; (3) the possessor should have expected that a lawful visitor such as the plaintiff either (a) would not discover or realize the danger or (b) would fail to protect himself or herself against the danger; (4) the possessor failed to use reasonable care to protect the lawful visitor against the danger; and (5) the condition was a proximate cause of damage to the plaintiff. 

Id.  Applying these elements to the facts, the first element was satisfied because Hy-Vee designed the parking lot area and chose where to place the air compressor.  Id at 767.  In considering the second element, the court viewed the evidence in the light most favorable to the plaintiff and assumed that there was a genuine issue of material fact regarding whether the location of the air compressor created an unreasonable risk of harm.  Id at 771.  When considering the third element, the law holds that “a land possessor is not liable to a lawful entrant on the land unless the possessor has or should have had superior knowledge of the dangerous condition.”  Id at 770.  Further, a landowner will not be liable for a dangerous condition unless the landowner “should have expected” that the plaintiff “either would not discover or realize the danger or would fail to protect himself or herself against the danger.”  Id. 

The open and obvious doctrine states that a possessor of land is not liable to an invitee for harm caused by any activity or condition on the land when the danger is known or obvious to the invitee.  Id.  The court found that the dangers of parking in the drive aisle to use the air compressor were obvious and the plaintiff would have appreciated the risks associated with parking where she did and crouching down to fill her tires.  Id.  Further, there was no evidence that Hy-Vee had any reason to believe that Sundermann would become distracted and unable to recognize the obvious risk, but rather Sundermann testified that she was aware of the danger and was watching for traffic.  Id.  Because the open and obvious doctrine clearly applies, Hy-Vee is not liable under the doctrine.

The court therefore found that the third element could not be satisfied, stating “even when a land possessor is aware lawful visitors are choosing to encounter an obvious risk, it does not necessarily follow that the land possessor has reason to expect the lawful visitors will fail, or be unable, to protect themselves from that risk.  Id.  Hy-Vee had not received any safety complaints before about that location, and there had not been any prior accidents that would lead Hy-Vee to believe lawful visitors would fail to protect themselves from the obvious risk associated with choosing to park in the drive aisle.  Id.  Further, Hy-Vee had no reason to expect that the plaintiff would not appreciate the danger posed by her activities.  Id.

            Because the third element could not be satisfied, Hy-Vee could not be held liable for Sundermann’s injuries.  This case was significant in rejecting the analysis used in the trial court, which focused on whether it was reasonably foreseeable that a lawful visitor would be injured in such a way.  This court instead focused on the premises liability standard, in which foreseeability is a consideration, but not a conclusory factor.

Buy-Sell Agreements

Buy-Sell Agreements, sometimes referred to as Shareholder Agreements in corporations or Members’ Agreements in LLCs, serve as a valuable tool in small businesses, especially in the area of transition planning. Generally, Buy-Sell Agreements are entered among equity holders and the business and dictate when and how an equity interest can or must be purchased or sold, and by whom. Some attorneys refer to them as “prenups for business owners,” because they generally govern how business owners can or must separate from one another, and what will become of the respective ownership interests upon such separation. The primary functions of these types of agreements are to protect the value of the various stakeholders’ interest in the business and ensure smooth and workable transitions in ownership of the business by preventing disagreements and potential lawsuits from undercutting the efficient operation of a business. Every business lawyer has stories of disputes, costs and expenses, time and even businesses that could have been saved had the lawyer advised and the client or clients agreed that a properly drafted Buy-Sell Agreement should be negotiated and entered. This article will discuss some of the key concepts Buy-Sell Agreements typically cover.

General Structure
Most Buy-Sell Agreements are intended to allow the equity holders in a business one or more mechanisms to divest themselves of their interest in the business, and/or protect their interest in the business in the event another equity holder elects to divest. This means, most often, that one stakeholder or another has either (1) a right or an obligation to purchase another stakeholder’s interest in certain events; or (2) a right or an obligation to sell such stakeholder’s interest in certain events. These mechanisms take many forms and should be specifically designed and drafted to meet the needs and goals of the applicable small business and its equity holders. In the most typical agreements, they prevent a party from divesting without meeting certain requirements.
For example, in some small businesses, the most important goal is to achieve some stability and consistency and a clear process and power structure in the event of a transition. In others, the primary objective is to protect one party’s investment in the company, or the value derived therefrom, either for that equity holder or that equity holder’s family and loved ones. In other businesses, the primary objective is to allow an equity holder to avoid being locked into a company controlled by others. All of these are potential interests that can be balanced in negotiating and implementing a Buy-Sell Agreement.

Triggering Events
One of the core features of a typical Buy-Sell Agreement is that certain events or circumstances trigger a right or obligation to sell or purchase an interest in the business. The most commonly agreed upon triggering events include those over which the relevant member has little or no control, such as death, disability or termination; those over which the relevant member may have some measure of control, such as divorce or bankruptcy; and those over which the member likely has control, such as an election to transfer or sell such member’s interest in the business, retirement, or other voluntary separation from the business. There may be others, depending on the specific circumstances of the business and its stakeholders. Depending on the surrounding circumstances, and the exact interests the stakeholders intend to protect, different triggering events may trigger different rights and obligations. For example, the operators of a business may wish to treat a retirement more favorably than a voluntary resignation prior to retirement age, or may wish to treat a termination for cause differently from an election to leave the business for health or other reasons. A Buy-Sell Agreement is flexible enough to allow for these variations in treatment in order to conform to the needs and desires of the stakeholders.

The Purchaser
Another important concept to build into a Buy-Sell Agreement is the appropriate purchasing party – who specifically has the right or obligation to purchase the equity interest? The most common potential purchasers are 1) the company or 2) the other equity holder(s). This portion of a Buy-Sell Agreement allows for some creativity. The Agreement can be structured so that, upon a triggering event, the remaining equity holders have the option to purchase the interest and if they decline, the company then has the option (or obligation) to purchase the interest. The roles can be flipped, with the company having the first option and the equity holders the second. There is flexibility in determining who will purchase the interest and whether they have the option or obligation. This is an important conversation topic for equity holders and gives them some flexibility to achieve a good result for all interested parties from a variety of perspectives, including tax treatment, operations, cash flow, and others.

Valuation
Another important element of a Buy-Sell Agreement is how the purchase price or other consideration to be paid in connection with a transaction will be determined. In most scenarios, this starts with a methodology for valuing the interest to be sold and determining what value the parties seek to protect. This valuation can take many different forms, including an agreement among the equity holders (annual or otherwise), a third-party appraisal, or implementation of a predetermined formula for calculating value. It can also account for certain discounts or other adjustments at the parties’ discretions, such as marketability and lack of majority control. These valuation methods and potential adjustments should dovetail with the agenda of the parties in making the agreement, including possible variation for precise circumstances, as contemplated previously in discussing triggering events. In considering and fleshing out these issues in advance, parties can take full advantage of a Buy-Sell Agreement in preventing uncertainty and attendant disputes down the road.

Transaction Terms
Another key element to consider is how the sale and purchase of the equity interest will play out. This includes determining when, where, and how the payment will be made. The process is dependent on the facts and circumstances surrounding the company, such as whether the company or other buyer has sufficient cash available at any given time to pay in full or if financing will be required. The stakeholders have to weigh and balance the potentially competing interests of a departing equity holder receiving value, the remaining equity holders’ access to and available resources, the company’s cash flow and other operational considerations. A Buy-Sell Agreement can be negotiated and structured to protect any or all of those interests to the extent the stakeholders deem it necessary or appropriate.

Specific Provisions
Buy-Sell Agreements often address other potential transaction scenarios, providing stakeholders with certain rights or obligations on account thereof. For example, drag-along rights generally allow a majority stakeholder to force a minority stakeholder to participate in a transaction the majority stakeholder has elected to consummate. Conversely, tag-along rights generally allow a minority stakeholder a right to force its way into such a transaction. Shootout provisions generally allow one stakeholder to elect to trigger a mechanism for a buyout and another stakeholder to elect who will purchase and who will sell, or some other material aspects of the transaction. Buy-Sell Agreements can contain preferential rights for certain buyers or other acquirers, or provisions intended to benefit certain groups of stakeholders to the exclusion of others. All of these provisions depend, again, on the particular circumstances surrounding the business and the parties’ balancing of potentially competing interests in the business.

Conclusion
Buy-Sell Agreements, “pre-nups for business owners,” are an adaptable tool that stakeholders can use to manage transition in a business to properly balance the potentially competing interests among various stakeholders and the business itself. As discussed, they can be negotiated and implemented to fit a wide variety of circumstances and address a wide variety of needs or interests. Business owners should consider implementing a Buy-Sell Agreement or similar arrangement in some form at the earliest opportunity, as they allow business owners to achieve a degree of certainty in the business environment, which is rarely, if ever, a negative. Lawyers should raise the possibility as early as possible and do what they can to educate business owner clients about the advantages a solid Buy-Sell Arrangement can provide.