BUSINESS FORMATION & SALES BLOG

One of the few ways to undermine the choice of law provision in your contract is to cite the wrong state’s law when you are trying to enforce it. That can be construed as a waiver of the choice of law.

A good example of this was a recent decision by the United States District Court for the Eastern District of California. The Court held that the parties, by their conduct, waived the New York law provision of the arbitration agreement by citing California law in their motion papers. This case involved an action for declaratory and injunctive relief by a California corporation against a Workers Compensation insurance provider.  Ellison Framing, Inc. v. Zurich American Insurance Company, 2011 WL 1322387 (E.D. Cal.).

The plaintiff, Ellison Framing, Inc., (“Ellison”) was a California corporation with its operations located entirely within California. Id. at 1.  Ellison purchased and renewed its Workers Compensation Insurance from the defendant, Zurich American Insurance Company (“Zurich”). Id. On November 15, 2010, Ellison filed a complaint with the California Department of Insurance claiming that Zurich had overcharged it with improper fees. Id. Zurich responded by making a demand for arbitration with the American Arbitration Association based on the arbitration clause of the parties deductible agreements. Id.

Based on the arbitration agreement and the venue provision contained within the agreement, the American Arbitration Association (AAA) determined that the arbitration would be conducted in Schaumburg, Illinois. Id. Ellison responded by filing an action in the Superior Court of California, “seeking declaratory and injunctive relief on the grounds that the venue provision of the arbitration agreement is unconscionable.” Id. Zurich moved this action to the United States District Court for the Eastern District of California based on diversity jurisdiction. Id.

The Court granted Zurich’s motion to compel arbitration because Ellison’s claim, that Zurich fraudulently overcharged by using improper fees fell within the scope of arbitration agreement. Id. at 5. But, the Court held that in spite of a choice of law provision in the agreement providing New York law as the governing law for all disputes, the parties, by their conduct, had waived the New York law provision by citing only to California law in their motion papers. Id.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC

In 1981, a New York insurance company, William J. Hofmann Agency (“Hofmann”), entered into an Agency Agreement (“Agreement”) with an insurance underwriter, Kemper. Both parties hoped the arrangement would prove mutually profitable, but those expectations were dashed when one party prospered and the other faced bleak profits. Hofmann enjoyed substantial growth in its volume of business while Kemper experienced high loss ratios.  This imbalance led to a rift between the business partners and Kemper sought to exercise his termination rights under the Agreement in order to sever the unprofitable relationship.

To preserve its revenue stream, Hofmann tried to mend the relationship woes.    But when those efforts failed, Hofmann claimed fraud under the New York Franchise Sales Act (the “Franchise Sales Act”) in order to dispute the alleged illegal termination, New York Franchise Sales Act, N.Y. Gen. Bus. Law § 680 et seq. (McKinney).

The Franchise Sales Act was enacted to combat abuses accompanying the growth of the franchising industry. See A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc., 663 N.E.2d 890, 892 (1996). The Act requires that franchises comply with comprehensive disclosure and registration requirements. Id. In addition, it spells out an expansive antifraud provision as well as civil remedies specific to franchisors. Id.

However, before a business entity may recover under the Act, the business must be an actual franchise. Id. Also, any such claim must be brought within a three-year statute of limitations, which begins to run on the date the parties enter into the franchise agreement.  See N.Y. Gen. Bus. Law § 691(4) (McKinney); see also Zaro Licensing, Inc. v. Cinmar, Inc., 779 F. Supp. 276, 287 (S.D.N.Y. 1991).

In the lawsuit involving these parties, Keeney v. Kemper National Insurance Co., the insurance company contended that because it made premium payments to Kemper, a franchise relationship had resulted. Keeney v. Kemper National Insurance Co., 960 F. Supp. 617 (E.D.N.Y. 1997). . However, the court dismissed the cause of action on the grounds that the Agreement was a “‘garden variety’ commercial contract,” not a franchise agreement under the Act as a matter of law.  Id.

The lesson here is that if a business entity seeks relief under the New York Franchise Sales Act, that entity must first ensure it is an actual franchise.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC

Are the days of shopping online free of sales tax coming to an end? If certain senators get their way, they could be.

In a 1992 decision, the Supreme Court held that a business must have a physical presence – a “nexus” – within a state in order for that state to require the business to collect a sales tax. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). This rule has enabled online retail companies such as Amazon.com to reap significant profits while not having to pass along a sales tax to their customers. In its decision in Quill Corp., the Court stated that “Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes.” Id. at 318.

As states search for more money in a tough economic climate, Congress is beginning to exercise the power the Court gave them. It is considering proposed legislation that would allow states to tap into this previously untouched revenue. The Main Street Fairness Act, sponsored by Sen. Dick Durbin (D – Ill.), would allow states to require online and mail-order retailers to collect state and local sales taxes.

The amount of money states could collect through such a change in the law is substantial. The National Conference of State Legislatures estimates that nationwide, the estimated total is more than $11 billion.

A number of states have already enacted laws that address this issue. In 2008, the New York Legislature passed a bill that expanded the definition of nexus to include certain online retailers, including Amazon. Under the State’s law, an online retailer has nexus in New York and must collect sales tax if their sales affiliates in the state generate more than $10,000 in annual revenue for the retailer. Amazon brought suit and alleged the law violated both the commerce and due process clauses, but the state Appellate Division determined that the New York law was constitutional. See Amazon.com, LLC v. New York State Dept. of Taxation & Fin., 2010 NY Slip Op 7823 (N.Y. App. Div. 1st Dep’t 2010).  California, Illinois, Connecticut and several other states have passed similar legislation during the past few years.

From a legal perspective, it is significant to consider the implications such a law would have for companies and entrepreneurs who conduct business online. It is likely that at the very least, items such as the terms and conditions and sales total pages of such a company’s website would have to be modified to reflect such a revised law.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC

A nonprofit company should generally maintain a solid boundary between its activities and those of a related for profit company. A recent decision of the New Jersey Supreme Court highlighted why this is so important.

In that case, the Court held that nonprofit companies could lose their property tax exemptions if they commingle their affairs with affiliated entities that operate for profit. International Schools Services v. West Windsor Township, 207 N.J. 3 (N.J. 2011).

The plaintiff, International Schools Services, Inc. (ISS), was a nonprofit corporation that ensured that American children living overseas receive a quality education. In 1999, ISS created Independent Schools Group, Inc. (ISG), a for profit corporation that provided insurance and investment services to the educational community abroad. In 2002, ISS created ISS Financial and Insurance Network Inc. (ISSFIN), a for profit corporation that provided insurance services to ISS clients. The headquarters of both ISG and ISSFIN was located on ISS-owned property in West Windsor, New Jersey. Both ISG and ISSFIN paid below-market rates for their lease of the office space and ISS issued an unsecured loan to ISG. Additionally, ISS’ president was a member of the board of directors for both for profit entities.

West Windsor granted ISS a property tax exemption from 1990 through 2001 under New Jersey Statute 54:4-3.6. However, after reviewing the entity’s activities, the town revoked the exemption based on ISS’ close relationship with ISG and ISSFIN. The Tax Court rejected the plaintiff’s appeal and the Appellate Division partially agreed.

In 1984, the New Jersey Supreme Court set out three criteria for a nonprofit corporation to meet in order to secure a tax exemption for its real property:

1. It must be organized exclusively for the moral and mental improvement of men, women and children.
2. Its property must be actually and exclusively used for the tax-exempt purpose.
3. Its operation and use of its property must not be conducted for profit.

Paper Mill Playhouse v. Millburn Township, 95 N.J. 503, 506 (N.J. 1984).

The Legislature has since amended the second prong of the test, removing the requirement of exclusivity and instead permitting an exemption for property that is “actually used” in connection with tax-exempt functions. The Court considered this change and asked “whether the Legislature’s elimination of the exclusivity requirement allows a nonprofit entity to conduct for profit activities in a commingled fashion on its owned and occupied property.” International Schools Services at 6.

The Court determined that the Legislature did not intend for such a result, because doing so would allow a nonprofit entity “to claim a property tax exemption when it has become inseparably entangled with for profit entities” and thus “would allow indirect taxpayer subsidization of those entities.” Id. at 42. The Court upheld West Windsor’s denial of the tax exemption “because the commingling of effort and entanglement of activities and operations by ISS and its profit-making affiliates was significant and substantial, with the benefit in the form of direct and indirect subsidies flowing only one way – from ISS to the for profit entities.” Id. at 4.

This decision is important for nonprofit companies that have close corporate relations with for profit companies that might jeopardize their ability to receive tax exemptions. It suggests that allowing a nonprofit entity to get too close – financially or otherwise – with a for profit entity could leave the nonprofit without the tax exemptions they value so greatly.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC

Most people selling their business are unaware (at lease at the outset) that the contract of sale normally includes some sort of indemnification language. There are many variations, but in the typical case, this means that the seller agrees to hold the buyer harmless from claims of third parties relating to what the seller did or did not do when they owned the business. Likewise, the buyer holds the seller harmless from claims of third parties for what the buyer does or does not do after the sale concludes.

Obviously, there are many legitimate variations to this approach. For example, if the seller is going to continue as a consultant or even employee to the business, the indemnification may need to take into account that he should continue to have some sort of indemnification obligation. Likewise, one might decide to define the indemnification obligation as applying to no more than a fixed upper amount or limit it to a certain period of time.

In the extreme case, a buyer or seller might want to take the position that there should be no indemnification provision at all. This includes situations in which the business is being sold for a relatively small sum that is less than the business is actually worth. In such a case, the seller may insist that it is being sold “as is” and “with all flaws” the same way as distressed real estate. In other words, the price figures in the risk inherent in having no indemnification clause.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC

No one enters into a franchise assuming that someday, they will need to file a lawsuit to enforce their rights. Unfortunately, however, sometimes that need does arise. The first and foremost question at that point, from the franchisee’s perspective, is can I receive reimbursement for my legal fees and costs?

Fortunately, in limited circumstances, the law does provide just such a remedy. The New Jersey Franchise Act (N.J.S.A. 56:10-10) states:  “Any franchisee may bring an action against its franchisor for violation of this act in the Superior Court of the State of New Jersey to recover damages sustained by reason of any violation of this act and, where appropriate, shall be entitled to injunctive relief.  Such franchisee, if successful, shall also be entitled to the costs of the action including but not limited to reasonable attorney’s fees. “

The court in Westfield Centre Service, Inc. v. Cities Service Oil Company, 172 N.J. Super 196, 203 (Ch. Div. 1980) analyzed the need for this statutory provision from the perspective of the disparity in bargaining power between the franchisor and franchisee.  “Where such disparity exists the right to award counsel fees against the more powerful party is justifiable in an effort to maintain a reasonable balance between them.”  Id. Thus in order to level the playing field, a franchisee can usually recover his attorney fees in a successful suit against a franchisor.

The general rule of thumb is that when a statute includes an attorney’s fee reimbursement provision, the Legislature is seeking to encourage lawsuits that would further a public policy objective.  Essentially, the Legislature is hoping that private individuals and entities will litigate such matters and, therefore, discourage the very practices that the statute outlaws.  For example, in this case, the Legislature determined that it was in the public’s interest to encourage lawsuits by the franchisees against franchisors who might take advantage of the latter’s superior bargaining power and resources.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC