Category Archives: Commentary

Non-Compete Agreements Can Add to Your Purchase Price

Commentary: In her previous posting on this Blog, Lisa Miller, Esq. previously articulated a number of the legal issues to consider in connection with the execution of a non-compete agreement in selling a business. From the Seller’s point of view, it is also important to consider how agreeing to a non-compete can increase the value of his business.

Offering a non-compete in connection with the sale of a business can be very enticing to a potential buyer, adding value to the potential purchase price. A buyer is obviously interested in the business that has been established, and arguably the buyer’s interest reflects a respect for the clientele and services that are associated with that business. In a way, having a buyer interested in a business can be construed as a compliment. However, the seller’s ability to build a business and thrive can also be a threat to a potential buyer. A buyer may be less inclined to purchase a business if he knows that the seller can go down the street, recreate his original business model and compete with the new business owner. For this reason, buyers may be more willing to engage in the sale and pay more for a business where this threat has been eliminated.

However, there are a variety of factors for the seller to keep in mind when making this determination. If it were not for this agreement, would he have planned to engage in business that is now restricted? If so, is the purchase price, or the added consideration in addition to the base price, enough to warrant him giving up that opportunity?

As always, it is strongly recommended that a seller consult with an attorney prior to entering into a non-compete to be sure that the written agreement properly reflects the deal that he believes he made. A non-compete arrangement will often have very specific parameters — if they are not outlined to match the deal made, the seller could be agreeing to more than he originally bargained for.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Exercise Caution When Using Letters of Intent

Commentary: Letters of intent (“LOI”) are often intended to serve as a “non-binding” method by which to outline pertinent deal points. However, a problem lies in that an LOI, in certain situations can be construed as a binding agreement. Therefore, while an LOI can be helpful in setting an agenda of sorts for negotiation purposes, it can also create unintended binding obligations. The upside is that it can allow the parties to discuss the pertinent business points of a deal prior to negotiating all of the details of a sale agreement. The downside is that LOI’s are generally brief and will simply outline some of the overarching points to an agreement. They rarely discuss the “nitty gritty” of a deal, in terms of the logistics and details of how the transaction will work. Therefore, there is an inherent danger in having a written document that memorializes some of the points of a transaction, but not all. Under certain circumstances, it might be deemed to be a contract in and of itself.

For this reason, it is critical that these documents be used cautiously. The danger is two-fold. First, the purpose of the letter of intent is generally to make sure that the parties are on the same page. If they are not, and the transaction later falls through, it arguably means that at least one of the parties may not want to be bound to the original terms of the letter of intent. This is particularly true given that the letter of intent arguably did not reflect the anticipated deal, since the deal fell through.

In addition, the LOI may discuss generalities without specifics. For example, suppose a letter of intent for a sale of business memorialized that the parties anticipated a sale price of $750,000.00; that an ongoing consulting agreement would be entered into with the business seller; that the seller would agree to a non-compete agreement; and that the seller would license certain intellectual property to the purchaser. The letter of intent may be as basic as that, without providing any information as to when the purchase price is paid; what intellectual property will be licensed and under what terms; what the intellectual property license fee would be; or what the terms of the other agreements would be. This arguably leaves a great deal of room for ambiguity with regard to the details that would still need to be negotiated between the parties; and each could have a different idea of what those other aspects should include. It is risky for parties to be bound to a general concept without ensuring that they are in agreement concerning the implementation.

It is therefore critical that parties exercise caution in drafting letters of intent in the first place. If they nevertheless decide that a letter of intent is necessary, buyers and sellers should be cognizant of the terms that they are including in such a document, and should generally include language that explicitly states that the letter should not be construed as a binding agreement.

Moreover, it goes without saying that the parties should consult with counsel prior to reaching the point of drafting or certainly signing a letter of intent. An attorney can help evaluate these aspects of the transaction and document them properly.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Caution When Negotiating A Contract For The Sale Of Real Estate

Commercial Real Estate: Commentary: The New Jersey Statute of Frauds requires that certain contracts be in writing. The most well-known type of contract subject to these requirements are contracts for the sale of personal property for $500 or more be in writing. In addition, contracts for the sale of real estate are generally required to be in writing. Quite surprisingly, however, under certain circumstances an oral agreement concerning the transfer of a real estate interest may be enforceable.

Specifically, an oral agreement concerning the sale of real estate will be enforceable where it is established by clear and convincing evidence that the following has been articulated (a) a sufficient description of the real estate; (b) the nature of the interest that is to be transferred; (c) the identity of the transferor and transferee of the interest; and (d) the existence of an agreement. The “agreement” can be found from this perspective even where the parties anticipated the drawing up of a written and more formal contract of sale.

If you think of a transaction for the sale of residential property, the above terms are generally agreed upon earlier on in the negotiations. What that means is that a buyer and seller arguably could be bound by an oral agreement for the sale of real estate even though they contemplated negotiating additional terms and incorporating them in a written contract of sale at a later point in the transaction.

Given this risk, parties to a real estate transaction in New Jersey should proceed cautiously and act with the understanding that they may be bound to their oral representations. There are a few things that can be done to lessen the risk that an oral agreement will be binding. First, they should avoid utilizing letters of intent or term sheets. But, if they do utilize such a document, they should explicitly state on its face that they do not intend to be bound by the terms therein until a written agreement is executed. In addition, when they are negotiating orally with respect to the terms, they should provide the other party to the transaction a short correspondence and/or email at the very outset that they do not intend to be bound to any terms as stated orally or any other writings until a formal contract for sale is executed. In this situation, they should also reiterate their position orally to the other side and take notes of these conversations. In these notes, they should make particular note of those items as to which they have not yet come to an agreement. Although the risk continues, this may help to generally preclude the Court from finding that an oral agreement for the sale and purchase of real estate is enforceable. Of course, this is a nonexclusive list. Further, none of these suggestions is a guarantee that the parties will be protected from such a risk, and the particular facts of each situation are critical in determining a legal strategy. However, they should be kept in mind when a real estate deal is being negotiated.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Utilizing Non-Compete Agreements in the Sale of a Business

Commentary: Non-compete agreements can be employed as effective tools to protect the buyer of a business from direct or indirect competition from the seller. Certainly, buyers and sellers will often include a non-compete agreement as a term of the sale transaction itself. However, in utilizing these agreements, it is crucial for both parties to the sale to remain aware of two key points. First, restrictions on competition are generally only enforceable to the extent that they are reasonable. And second, in the sale of a business, a covenant not to compete could have significant tax implications for the buyer and seller alike.

A non-compete agreement will typically state that in exchange for a specified payment (which could be part of the sale price), the seller will promise not to go into a similar type of business, within a certain geographic area for a specified period of time. In some cases, the agreement will also prohibit the seller from using certain confidential trade secrets or business processes that are being transferred to the buyer. Again, however, it is critical to keep in mind that a court will only enforce a non-compete provision if it is reasonable in scope and duration. Thus, a non-compete clause should generally only restrict the seller from working or being affiliated with a business that is similar or at least in the same industry as the one he is selling.

The question becomes how narrowly to define the industry. Moreover, the restriction should arguably be limited to the same geographic area from which the seller’s business derived its customers, and it should only apply for a reasonable period of time. What is reasonable will depend on the specifics of the industry, the business and even the region. Notably, different states have different standards for evaluating the “reasonableness” of a non-compete agreement.

Although we are not offering tax advice, it is essential to keep in mind that non-compete agreements could have significant implications for the parties to the transaction. In negotiating a sale price for the business, the buyer and seller must decide upon what portion of the purchase price is to be allocated to the covenant not to compete. The basic issue is that with an asset sale of a business, each asset sold is treated separately for tax purposes. Under current law, those assets treated as capital gains are taxed at a significantly lower rate than those treated as ordinary income. However, gains on certain intangible assets, such as covenants not to compete, are not generally eligible for capital gains treatment. Thus, in allocating the purchase price to the various assets of the business, the parties should keep in mind that allocating even a small portion of the purchase price to the covenant not to compete could significantly lower the after- tax amount that the seller will make from the sale.

In light of these potentially significant business and tax implications, both the buyer and the seller should use careful consideration in determining the structure of a non-compete agreement and the value associated with the covenant not to compete that is being transferred to the buyer. The best practice for both parties is to consult a tax professional to assist in defining the terms of the purchase.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Caution When Negotiating A Contract For The Sale Of Real Estate

Commentary: The New Jersey Statute of Frauds requires that certain contracts be in writing. The most well-known type of contract subject to these requirements are contracts for the sale of personal property for $500 or more be in writing. In addition, contracts for the sale of real estate are generally required to be in writing. Quite surprisingly, however, under certain circumstances an oral agreement concerning the transfer of a real estate interest may be enforceable.

Specifically, an oral agreement concerning the sale of real estate will be enforceable where it is established by clear and convincing evidence that the following has been articulated (a) a sufficient description of the real estate; (b) the nature of the interest that is to be transferred; (c) the identity of the transferor and transferee of the interest; and (d) the existence of an agreement. The “agreement” can be found from this perspective even where the parties anticipated the drawing up of a written and more formal contract of sale.

If you think of a transaction for the sale of residential property, the above terms are generally agreed upon earlier on in the negotiations. What that means is that a buyer and seller arguably could be bound by an oral agreement for the sale of real estate even though they contemplated negotiating additional terms and incorporating them in a written contract of sale at a later point in the transaction.

Given this risk, parties to a real estate transaction in New Jersey should proceed cautiously and act with the understanding that they may be bound to their oral representations. There are a few things that can be done to lessen the risk that an oral agreement will be binding. First, they should avoid utilizing letters of intent or term sheets. But, if they do utilize such a document, they should explicitly state on its face that they do not intend to be bound by the terms therein until a written agreement is executed. In addition, when they are negotiating orally with respect to the terms, they should provide the other party to the transaction a short correspondence and/or email at the very outset that they do not intend to be bound to any terms as stated orally or any other writings until a formal contract for sale is executed. In this situation, they should also reiterate their position orally to the other side and take notes of these conversations. In these notes, they should make particular note of those items as to which they have not yet come to an agreement. Although the risk continues, this may help to generally preclude the Court from finding that an oral agreement for the sale and purchase of real estate is enforceable. Of course, this is a nonexclusive list. Further, none of these suggestions is a guarantee that the parties will be protected from such a risk, and the particular facts of each situation are critical in determining a legal strategy. However, they should be kept in mind when a real estate deal is being negotiated.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

The Potential Benefits of Utilizing an LLC to Purchase Commercial Real Estate

Commentary: Taking into consideration general principles of corporations law, utilizing an LLC to purchase a commercial property may provide numerous business and tax benefits for the buyer. This may be especially true where a buyer is interested in purchasing multiple properties.

In particular, a buyer may want to set up a “parent” LLC which would act as the owner of various “subsidiary” LLCs. Each separate subsidiary would then be utilized to purchase a single commercial property. Structuring the ownership of the properties in this manner may create substantial tax savings for the buyer.

For instance, if each transaction were structured so that the parent loans the subsidiary the monies to fund the purchase, the respective subsidiary would be responsible for the repayment of the loan, and thus the subsidiary would be deemed to have little equity in the property and thus little assets. As a result, a subsequent transfer of the property by the LLC (to the owner’s children, for instance) would likely have little, if any, tax consequences.

Moreover, it is well-established that an LLC can be deemed to be a disregarded entity for tax purposes. As a general rule, the income of an LLC will “pass through” to the owner of the company, so that the LLC itself is not required to report such income on its tax returns. Thus, the owner could streamline the taxes and other expenses associated with each of its various properties, while at the same time avoiding double taxation on the income generated from each property. Double taxation is a common pitfall of utilizing C-Corporations. For example, if the buyer were to set up a series of subsidiary corporations, as opposed to LLCs, each corporation would have to pay separate corporate income tax for each entity. In addition, the buyer would then have to pay personal income tax on any monies that are income to him (whether through distribution of profits or otherwise). If, on the other hand, if the buyer uses the LLC form to set up his subsidiary companies, the income of each LLC “passes through” to the buyer so that he is only taxed on it once, by reporting it on his personal income tax return.

In addition, as long as each LLC is created and operated in the proper form, the liabilities associated with each respective property will generally not attach to the other companies’ properties. In other words, in most instances each LLC will be only be liable for its own debts and obligations. For example, assume that company A owns a piece of property worth $300,000.00 (Building A) and Company B owns property worth $1,000,000.00 (Building B) and both Company A and B are owned by Company C (the parent company). If Company A is sued and a judgment is reached against it for $500,000.00, the judgment-creditor cannot generally look to collect its judgment against Company B’s property. The alternative would be if Company A owned both properties. In that instance suppose an accident happened in Building A for which the company is deemed liable. In that situation, the judgment-creditor would likely be able to collect against both buildings, since both would be the assets of the judgment-debtor.

When determining if the real estate holding company should be established as an LLC or a corporation, it should be noted that the form of ownership set up by the buyer is unlikely to be an issue to the seller. That being said, if a seller were taking a promissory note from the buyer or the buyer was to otherwise have ongoing liability to the seller, such a structure (whether as a corporation or an LLC) may be a concern to the seller. Insofar as the above-mentioned structure devoids the company of all assets but the one company, a seller may be limited in its rights. This is because, as mentioned above, the assets of each separate subsidiary LLC may be relatively small.

In light of the foregoing, before purchasing an interest in commercial real estate, it may be wise for a potential buyer to formulate an appropriate ownership structure and consider forming a limited liability company through which to effectuate each such transaction. Accordingly, an attorney should be consulted at the outset so as to structure the purchase(s) in a way that is most beneficial to the buyer.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

The Tax Clearance Certificate Requirement for the Sale of a New Jersey Business

Commentary: One of the steps that business people frequently overlook when planning to purchase or sell an interest in a business in New Jersey is the tax clearance certificate. Under New Jersey law and regulation, the Division of Revenue (“Division”) requires that when a business is being sold or dissolved, the Division must be given the opportunity to analyze whether any state taxes are due and owing. If they are, notice is given to the effect that in order for the closing to take place, suitable arrangements to pay those taxes must be made.

One of the reasons this is so important is that often businesses are being sold specifically because they have become unable to pay their expenses as they come due. Therefore, the Division takes the approach that this may be the last point at which it can easily collect the back taxes owed by the seller of the business. While it is true that there can be personal liability to the business owner for failure to remit payroll taxes for example, nevertheless, the Division does not want to have to chase the person after his or her interest in the business is transferred.

Importantly, the tax clearance certificate is necessary even if less than the entire business is being sold. Also, even if the business is being dissolved, rather than sold, the tax clearance certificate may be required.

More information can be found at the Division of Revenue’s web site at http://www.state.nj.us/treasury/revenue/dissolvewithdraw.htm.

Comments/Questions: ljm@gdnlaw.com