Michigan Business Law Journal Summer 2010

The Michigan Business Law JOURNAL CONTENTS Volume 30 Section Matters Issue 2 From the Desk of the Chairperson 1 Officers and Council Members 3 Summer 2010 Committees and Directorships 4 Columns Did You Know? G. Ann Baker 6 Tax Matters Paul L.B. McKenney 9 Technology Corner: Supreme Court Clarifies Privacy in the Workplace Michael S. Khoury and Michelle L. Coakley 11 Articles What Does That Operating Agreement Mean? Donald H. Baker, Jr. 13 Treatment of Single Member LLCs Under SBT and MBT after the Kmart and Alliance Decisions Donald A. DeLong 20 Property and Transfer Tax Considerations for Business Entitites Mark E. Mueller 27 Using Retirement Plan Assets to Fund a Start-up Company Adam Zuwerink 34 Protecting Competitive Business Interests Through Non-Compete Clauses Ryan S. Bewersdorf and Nicholas J. Ellis 40 Social Networking: Your Business Clients and Their Employees Are Doing It …Are You Advising Your Clients on How to Manage the Legal Risks? P. Haans Mulder and Nicholas R. Dekker 44 Secondary Liability and “Selling Away” in Securities Cases Raymond W. Henney and Andrew J. Lievense 49 The History and Future of Michigan Debtor Exemptions Thomas R. Morris 57 ICE Steps Up Its Aggressive Employer Audit Campaign James G. Aldrich 63 Case Digests 68 Index of Articles 70 ICLE Resources for Business Lawyers 77

Published by THE BUSINESS LAW SECTION, State Bar of Michigan The editorial staff of the Michigan Business Law Journal welcomes suggested topics of general interest to the Section members, which may be the subject of future articles. Proposed topics may be submitted through the Publications Director, D. Richard McDonald, The Michigan Business Law Journal, 39577 Woodward Ave., Ste. 300, Bloomfield Hills, Michigan 48304, (248) 203-0859, drmcdonald@dykema. com, or through Daniel D. Kopka, Senior Publications Attorney, the Institute of Continuing Legal Education, 1020 Greene Street, Ann Arbor, Michigan, 48109- 1444, (734) 936-3432, [email protected].

MISSION STATEMENT The mission of the Business Law Section is to foster the highest quality of professionalism and practice in business law and enhance the legislative and regulatory environment for conducting business in Michigan.

To fulfill this mission, the Section (a) provides a forum to facilitate service and commitment and to promote ethical conduct and collegiality within the practice; (b) expands the resources of business lawyers by providing educational, networking, and mentoring opportunities; and (c) reviews and promotes improvements to business legislation and regulations.

The Michigan Business Law Journal (ISSN 0899-9651), is published three times per year by the Business Law Section, State Bar of Michigan, 306 Townsend St., Lansing, Michigan.

Volume XXII, Issue 1, and subsequent issues of the Journal are also available online by accessing http://www.michbar.org/business/bizlawjournal.cfm

Postmaster: Send address changes to Membership Services Department, State Bar of Michigan, 306 Townsend Street, Lansing, Michigan 48933-2012. From the Desk of the Chairperson By Tania E. (Dee Dee) Fuller

You know the old saying, time flies active, more of the Section members will glean greater when you are having a good time. value from the Section. With me, that statement is true in so The Michigan Business Law Journal may be the most many ways! My term as the Business valuable product the Section produces, so we expect to Law Section chair is winding down, continue to provide this high quality publication. We and this is my last Michigan Business are also expecting to include some advertisements in the Law Journal chairperson article. The Journal to help defray its costs. Member feedback has last year really has been a lot of fun told us, however, that some prefer to have the Journal for me and, in that time, I think we have accomplished in paper form while others would prefer to receive it quite a bit. In this final article, I would like to summa- digitally. Until we have the technology to segregate and rize where we stand on many of our initiatives from last provide the Journal to each member only in the method September, and I would also like to update you on some they prefer, we now provide it to everyone in both me- Business Law Section plans and some upcoming Section diums. We are working with the State Bar to find a way activities. to obtain e-mail address information for those Business After many months of work, the Strategic Plan Com- Law Section members seeking their journal only via e- mittee submitted the proposed 2010 Strategic Plan and mail, but until that information is available, we will send Directives to the Business Law Council in April. The it to all Section members in paper form and provide it on Committee received feedback from Council members the Section Web site digitally. that resulted in some final tweaks to the document, The Strategic Plan touches on virtually every aspect and the final version was submitted to the Council in of the Business Law Section’s services and products, mid-May. Finally, the 2010 Strategic Plan and Directives and I urge you to become familiar with it. was approved at the May Business Law Section Council Over time we have learned that the lawyers in our meeting. The final document can be found on the Busi- Business Law Section have very diverse practice areas. ness Law Section Web page by clicking on Strategic Plan Some Section members, normally from the very large under Council Information. Alternatively, you can get firms, practice in very specific areas only, such as bank- to the Business Law Section Strategic Plan and Direc- ruptcy, banking, or mergers and acquisitions. These tives (June 2010 Update) by typing the following URL lawyers have a tremendous amount of technical ex- address into your browser: http://www.michbar.org/ pertise in those specialized areas. Other lawyers in our business/pdfs/Strategic_Plan.pdf. Section have much more varied practices, representing I would like to extend a sincere thank you to all of a variety of clients on a variety of matters every day. the Section members who served on this important Normally these are lawyers from smaller firms. With Committee. Admittedly, the document required a lot of that said, there are times when all of us come across is- time and energy, but it was a worthwhile endeavor. I sues that are outside of our comfort zone. It’s at times am pleased with the final product and hope you will be like these when we would like to ask a question and get too. some feedback from another lawyer. The Business Law As the Strategic Plan Committee worked through the Section wants to provide a resource for its members to results of our Business Law Section survey and crafted help when they have a practice question. As a result, the the provisions of the Strategic Plan, it became evident Section is establishing a LinkedIn page for members to that the most valuable services the Section offers to post practice questions, and hopefully others will pro- its members are through the various substantive law vide thoughtful responses and assistance. Please look committees. Section members not only appreciate but for this page in future months. also require information from our Section committees Over the last ten years or so, I have held various posi- regarding law changes and caselaw updates. They are tions and been active in the Business Law Council. Over also seeking practice tips and educational sessions. As a that period, Section members have approached me ask- result, we have established more formalized committee ing how they can get more involved in the Section. Un- responsibilities in the Strategic Plan, with hopes that the fortunately, I never really had a good answer. Finally, committee members will come to expect a continuum of we are putting together a process that will enable Busi- information from each of the Section’s substantive law ness Law Section members to get involved in the Section committees. Each committee is now expected to hold electronically. In a future E-Newsletter, you will notice one or more educational seminars each year. Those sem- a format change with a link that members can click on inars may be in the form of webinars that can be viewed to get involved. We are hoping that through this new online at the member’s convenience, or they may be full system, members can select areas of interest, join com- day or partial day seminars. Committees are also ex- mittees, and generally…get involved in the Section. I am pected to hold at least one regular committee meeting aware that we will need to work through some bugs as each year. Hopefully, as our committees become more we get this membership involvement technology work- 1 2 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010 ing the way we want, but I am delighted that we are moving in that direction. The Section is involved in so many interesting and ex- citing projects these days. If you are interested in learning more, please join me at the Business Law Section Annual Meeting on September 23 in Novi. Like last year, we will hold an educational program as well as the Annual Meet- ing and elections. Look for more details in an upcoming E-Newsletter. At the same meeting, we will also recognize the 2010 Section Schulman Award winner, who I am delighted to announce is Alex DeYonker. Alex has provided significant contributions to the Business Law Section over the years and we are thrilled to recognize him with this prestigious award. Finally, I wanted to remind everyone that the Business Law Section is again providing Business Law Boot Camp in Grand Rapids and southeast Michigan in the 2010/2011 year. Please extend an invitation to new business lawyers as well as lawyers who may be entering a new practice area or just want a refresher on business law topics. The courses are taught by some of the best business lawyers in the state who are experts in their respective fields. I am sure you will find these programs very interesting. This last year really has been a lot of fun for me, and I am so very grateful to have had an opportunity to make my contribution to the Business Law Section. 2009-2010 Officers and Council Members Business Law Section

Chairperson: TANIA E. FULLER, Fuller Law & Counseling, PC 700 W. Randall St., Suite B, Coopersville, MI 49404, (616)837-0022 Vice-Chairperson: ROBERT T. WILSON, Butzel Long, PC Stoneridge West, 41000 Woodward Ave., Bloomfield Hills, MI 48304, (248)258-7851 Secretary: EDWIN J. LUKAS, Bodman, LLP 1901 Saint Antoine St., 6th Floor, Detroit, MI 48226, (313)393-7516 Treasurer: MARGUERITE DONAHUE, Seyburn Kahn Ginn Bess & Serlin, PC 2000 Town Center, Ste. 1500, Southfield, MI 48075, (248)351-3567 TERM EXPIRES 2010: 13039 LEE B. DURHAM, JR.—1021 Dawson Ct., 34248 MATTHEW A. CASE—600 Lafayette E, MC 1924, Greensboro, GA 30642 Detroit, 48226 31764 DAVID FOLTYN—660 Woodward Ave, Ste. 2290, 53324 DAVID C.C. EBERHARD—12900 Hall Rd., Ste. 435, Detroit, 48226-3506 Sterling Heights, 48313 13595 RICHARD B. FOSTER, JR.—4990 Country Dr., Okemos, 48864 40894 JEFFREY J. VAN WINKLE—200 Ottawa St., NW, Ste. 500, 13795 CONNIE R. GALE—P.O. Box 327, Addison, 49220 Grand Rapids, 49503 13872 PAUL K. GASTON—2701 Gulf Shore Blvd. N, Apt. 102, Naples, FL 34103 TERM EXPIRES 2011: 14590 VERNE C. HAMPTON II—500 Woodward Ave., Ste. 4000, 54086 CHRISTOPHER C. MAESO—38525 Woodward Ave., Detroit, 48226 Ste. 2000, Bloomfield Hills, 48304 37883 MARK R. HIGH—500 Woodward Ave., Ste. 4000, 29208 JUDITH GREENSTONE MILLER—27777 Franklin Rd., Ste. 2500, Detroit, 48226-5403 Southfield, 48034 31619 JUSTIN G. KLIMKO—150 W. Jefferson, Ste. 900, 34329 DOUGLAS L. TOERING—888 W. Big Beaver, Ste. 750, Detroit, 48226-4430 Troy, 48084 34413 MICHAEL S. KHOURY—27777 Franklin Rd., Ste. 2500, 54806 CYNTHIA L. UMPHREY—201 W. Big Beaver Rd., Southfield, 48034 Troy, 48084 45207 ERIC I. LARK—500 Woodward Ave., Ste. 2500, TERM EXPIRES 2012: Detroit, 48226-5499 38733 JUDY B. CALTON—660 Woodward Ave., Ste. 2290, 37093 TRACY T. LARSEN—300 Ottawa Ave. NW, Ste. 500, Detroit, 48226 Grand Rapids, 49503 67908 JAMES L. CAREY—2630 Featherstone Rd., 17009 HUGH H. MAKENS—111 Lyon St. NW, Ste. 900, Auburn Hills, 48326 Grand Rapids, 49503 17270 CHARLES E. MCCALLUM—111 Lyon St. NW, Ste. 900, 37220 D. RICHARD MCDONALD—39577 Woodward Ave., Ste. 300 Bloomfield Hills, 48304 Grand Rapids, 49503 38485 DANIEL H. MINKUS—255 S. Old Woodward Ave., 3rd Fl., 39141 THOMAS R. MORRIS—7115 Orchard Lake Rd., Ste. 500, West Bloomfield, 48322 Birmingham, 48009 32241 ALEKSANDRA A. MIZIOLEK—400 Renaissance Center, EX-OFFICIO: Detroit, 48243 38729 DIANE L. AKERS—1901 St. Antoine St., 6th Fl., 18009 CYRIL MOSCOW—660 Woodward Ave., Ste. 2290, Detroit, 48226 Detroit, 48226 29101 JEFFREY S. AMMON—250 Monroe NW, Ste. 800, 18424 MARTIN C. OETTING—500 Woodward Ave., Ste. 3500, Grand Rapids, 49503-2250 Detroit, 48226 30866 G. ANN BAKER—P.O. Box 30054, Lansing, 48909-7554 18771 RONALD R. PENTECOST—124 W. Allegan St., Ste. 1000, 33620 HARVEY W. BERMAN—201 S. Division St., Lansing, 48933 Ann Arbor, 48104 19816 DONALD F. RYMAN—313 W. Front St., Buchanan, 49107 10814 BRUCE D. BIRGBAUER—150 W. Jefferson, Ste. 2500, Detroit, 20039 ROBERT E. W. SCHNOOR—6062 Parview Dr. SE, 48226-4415 Grand Rapids, 49546 10958 IRVING I. BOIGON—15211 Dartmouth St., Oak Park, 48237 20096 LAURENCE S. SCHULTZ—2600 W. Big Beaver Rd., Ste. 550, 11103 CONRAD A. BRADSHAW—111 Lyon Street NW, Ste. 900, Troy, 48084 Grand Rapids, 49503 20741 LAWRENCE K. SNIDER—190 S. LaSalle St., 11325 JAMES C. BRUNO—150 W. Jefferson, Ste. 900, Chicago, IL 60603 Detroit, 48226 31856 JOHN R. TRENTACOSTA—500 Woodward Ave., Ste. 2700, 34209 JAMES R. CAMBRIDGE—500 Woodward Ave., Ste. 2500, Detroit, 48226 Detroit, 48226 COMMISSIONER LIAISON: 11632 THOMAS D. CARNEY—100 Phoenix Drive, 54998 ANGELIQUE STRONG MARKS—500 Kirts Blvd., Troy, 48084 Ann Arbor, 48108 41838 TIMOTHY R. DAMSCHRODER—201 S. Division St., Ann Arbor, 48104-1387 25723 ALEX J. DEYONKER—850 76th St., Grand Rapids, 49518 3 2009-2010 Committees and Directorships Business Law Section

Committees

Commercial Litigation Financial Institutions Regulation of Securities Chairperson: Daniel N. Sharkey Chairperson: James H. Breay Chairperson: Jerome M. Schwartz Brooks Wilkins Sharkey & Turco Warner Norcross & Judd LLP Dickinson Wright, PLLC PLLC 111 Lyon St. NW, Suite 900 500 Woodward Ave., Ste. 4000 401 S. Old Woodward, Ste. 460 Grand Rapids, MI 49503-2489 Detroit, MI 48226-5403 Birmingham, MI 48009 Phone: (616) 752-2114 Phone: (313) 223-3500 Phone: (248) 971-1712 Fax: (616) 752-2500 Fax: (313) 223-3598 Fax: (248) 971-1801 E-mail: [email protected] E-mail: jschwartz@ E-mail: [email protected] dickinsonwright.com In-House Counsel Corporate Laws Chairperson: Matthew A. Case Uniform Commercial Code Chairperson: Justin G. Klimko Blue Cross and Blue Shield of MI Chairperson: Patrick E. Mears Butzel Long 600 Lafayette E., MC 1924 Barnes & Thornburg, LLP 150 W. Jefferson, Ste. 900 Detroit, MI 48226 300 Ottawa Ave., NW, Ste. 500 Detroit, MI 48226-4430 Phone: (313) 225-9524 Grand Rapids, MI 49503 Phone: (313) 225-7037 Fax: (313) 225-6702 Phone: (616) 742-3930 Fax: (313) 225-7080 E-mail: [email protected] Fax: (616) 742-3999 E-mail: [email protected] E-mail: [email protected] Law Schools Debtor/Creditor Rights Chairperson: Edwin J. Lukas Unincorporated Enterprises Co-Chairperson: Judy B. Calton Bodman LLP Chairperson: Daniel H. Minkus Honigman Miller Schwartz & Cohn LLP 1901 St. Antoine St., Fl. 6 Clark Hill, PLC 660 Woodward Ave., Ste. 2290 Detroit, MI 48226 151 S. Old Woodward Ave., Ste. 200 Detroit, MI 48226 Phone: (313) 393-7523 Birmingham, MI 48009 Phone: (313) 465-7344 Fax: (313) 393-7579 Phone (248) 988-1813 Fax: (313) 465-7345 E-mail: [email protected] Fax (248) 642-2174 E-mail: [email protected] E-mail: [email protected] Nonproﬁt Corporations Co-Chairperson: Co-Chairperson: Jane Forbes Judith Greenstone Miller Dykema Jaffe Raitt Heuer & Weiss PC 400 Renaissance Center 27777 Franklin Rd., Ste. 2500 Detroit, MI 48243-1668 Southﬁeld, MI 48034-8214 Phone: (313) 568-6792 Phone (248) 727-1429 Fax: (313) 568-6832 Fax (248) 351-3082 E-mail: [email protected] E-mail: [email protected] Co-Chairperson: Agnes D. Hagerty Trinity Health 27870 Cabot Dr. Novi, MI 48377 Phone: (248) 489-6764 Fax: (248) 489-6775 E-mail: [email protected]

4 Directorships

Legislative Review Mark W. Peters Edwin J. Lukas Director: Eric I. Lark Bodman, LLP Bodman LLP Kerr, Russell and Weber, PLC 201 W. Big Beaver Rd., Ste. 500 1900 St. Antoine St. 6th Fl., 500 Woodward Ave., Ste. 2500 Troy, MI 48084 Detroit, MI 48226 Detroit, MI 48226-5499 Phone: (248) 743-6043 Phone (313) 393-7516 Phone: (313) 961-0200 Fax: (248) 743-6002 Fax (313) 393-7579 Fax: (313) 961-0388 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected] Small Business Forum H. Roger Mali Nominating Cynthia L. Umphrey Honigman Miller Schwartz & Director: G. Ann Baker Kemp Klein Law Firm Cohn, LLP Bureau of Commercial Services 201 W. Big Beaver Rd., Ste. 600, 660 Woodward Ave., Ste. 2290, PO Box 30054 Troy, MI 48084 Detroit, MI 48226-3506 Lansing, MI 48909-7554 Phone: (248)528-1111 Phone (313) 465-7536 Phone: (517) 241-3838 Fax: (248)528-5129 Fax (313) 465-7537 Fax: (517) 241-6445 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected] Douglas L. Toering Justin Peruski Programs Grassi & Toering, PLC Honigman Miller Schwartz & Tania E. (Dee Dee) Fuller 888 W. Big Beaver, Ste. 750 Cohn, LLP Fuller Law & Counseling PC Troy, MI 48084 660 Woodward Ave., Ste. 2290, 700 W. Randall St., Ste. B Phone: (248) 269-2020 Detroit, MI 48226-3506 Coopersville, MI 49404 Fax: (248) 269-2025 Phone (313) 465-7696 Phone: (616)837-0022 E-mail: [email protected] Fax (313) 465-7697 Fax: (616)588-6373 E-mail: [email protected] E-mail: [email protected] Publications Director: D. Richard McDonald Technology Eric I. Lark Dykema Director: Jeffrey J. Van Winkle Kerr, Russell and Weber, PLC 39577 Woodward Ave., Ste. 300 Clark Hill, PLC 500 Woodward Ave., Ste. 2500 Bloomﬁeld Hills, MI 48304 200 Ottawa St., NW, Ste. 500 Detroit, MI 48226-5499 Phone: (248) 203-0859 Grand Rapids, MI 49503 Phone (313) 961-0200 Fax: (248) 203-0763 Phone: (616) 608-1113 Fax (313) 961-0388 E-mail: [email protected] Fax: (616) 608-1199 E-mail: [email protected] E-mail: [email protected] Section Development Christopher C. Maeso Director: Timothy R. Damschroder Dickinson Wright PLLC Bodman, LLP 38525 Woodward Ave., Ste. 200 201 S. Division St., Bloomﬁeld Hills, MI 48304 Ann Arbor, MI 48104 Phone (248) 433-7501 Phone: (734) 930-0230 Fax (248) 433-7274 Fax: (734) 930-2494 E-mail: cmaeso@dickinsonwright. E-mail: tdamschroder@ com bodmanllp.com

Daniel H. Minkus Mark R. High Clark Hill, PLC Dickinson Wright, PLLC 255 S. Woodward Ave., 3rd Fl. 500 Woodward Ave., Ste. 4000 Birmingham, MI 48009-6185 Detroit, MI 48226-5403 Phone: (248) 642-9692 Phone (313) 223-3500 Fax: (248) 642-2174 Fax (313) 223-3598 E-mail: [email protected] E-mail: [email protected]

5 DID YOU KNOW? By G. Ann Baker Flexibility for Entities Acts 124-126, respectively, on July 21, sealing of deeds and other written Providing Medical Services 2010. instruments to permit the seal of a The Municipal Health Facilities court, public officer, or corporation to Pending legislation will provide flex- Corporations Act, 1987 PA 230, au- be affixed electronically to an instru- ibility for using professional corpora- thorizes certain local governmental ment or writing or to an electronic tion and professional limited liabil- units to incorporate municipal health document. Public Act 57 amends ity companies to own, manage, and facilities corporations and subsidiary MCL 8.3n to provide that in all cases operate medical practices. municipal health facilities corpora- in which the seal of any court or pub- Public Act 139 of 1997 amended tions for establishing, operating, and lic office is required to be affixed to section 4 of the Professional Service managing health services. The act ap- any paper the word “seal” includes Corporation Act to provide that phy- plies to municipal hospitals and the seal affixed electronically on paper or sicians and surgeons licensed under transfer of ownership of public hos- affixed to an electronic document. different provisions of the public pital and other health care facilities. health code could be shareholders in Senate Bill 1115 would amend the Disclosure of Beneficial the same professional corporation. It Municipal Health Facilities Corpo- Owners of Corporations and did not include physician’s assistants rations Act to permit a county to re- LLCs who engage in the practice of medi- structure a municipal health facilities The U.S. Senate Homeland Security cine under the supervision of a physi- corporation or subsidiary corporation and Governmental Affairs Commit- cian and are not permitted to indepen- as a nonprofit corporation. Home tee held a second hearing on the dently practice medicine. Physician’s rule cities are permitted under MCL Incorporation Transparency and Law assistants, however, would like to be 117.4n to become a member or joint Enforcement Assistance Act, S. 569, able to acquire an ownership interest owner in an enterprise with a private in November 2009.2 The bill would in the medical practice in which they nonprofit corporation to create a sep- require states to obtain a list of the work. arate private nonprofit corporation beneficial owners of each corporation Senate Bills 26, 27, and 28 amend to establish, operate, or maintain a or limited liability company formed the Public Health Code, Professional medical facility for a public purpose.1 in the state and to ensure the list is Service Corporation Act, and Michi- Senate Bill 1115 would extend similar updated annually.3 gan Limited Liability Company Act flexibility to counties. Written testimony of U.S. Depart- to permit a physician’s assistant to The bill passed the Senate and was ment of Treasury, Assistant Secretary become a shareholder in a profession- on second reading in the House on for Terrorist Financing, includes rec- al corporation (“PC”) or member of a May 4, 2010. ommendations for amendments to professional limited liability company S.569.4 Kevin L. Shepherd, member (“PLLC”) with physicians. SB 26 adds Land Sales Act; Promotional of the ABA Task Force on Gatekeeper a new subsection to MCL 333.17048 Sales Regulation and the Profession, testi- to permit physicians to be sharehold- Public Act 49 of 2010 repeals the Land fied on behalf of the ABA in support ers in the same PC or members in the Sales Act, which regulates the dispo- of reasonable and necessary efforts to same PLLC as a physician’s assistant, sition of lots in subdivisions located combat money laundering, tax eva- and all requirements of part 170, 175, in other states that are offered for sale sion, and terrorist financing activity and 180 of the Public Health Code to Michigan residents. Public Act 48 but opposed the proposed regulatory must be met. The amendment re- of 2010 amends section 2511 of the approach of S.569.5 National Asso- quires a disclosure on license renewal Occupational Code, MCL 339.2511, ciation of Secretaries of State opposes form for physicians and physician’s to eliminate provisions pertaining S.569 and urged postponement of the assistants regarding whether they are to promotional sales in Michigan of markup process.6 a shareholder of a PC or member of property located outside of the state. a PLLC. A real estate broker who proposes Low Profit Limited Liability Senate Bills 27 and 28 amend the to engage in sales of a promotional Companies definition of “professional service” to nature of out-of-state property is no A limited liability company is a for- add physician’s assistant. The bills al- longer required to submit a descrip- profit entity and can be formed for low a physician to organize a PC or tion of the property and the proposed any lawful purpose for which a cor- PLLC with one or more physicians terms of sale to Department of Ener- poration could be formed under the or physician’s assistants, subject to gy, Labor & Economic Growth. Business Corporation Act. Public section 17048 of the Public Health Acts 566 and 567 of 2008 amended the Code but prohibit a PC or PLLC from Electronic Seal Michigan Limited Liability Company having only physician’s assistants as Public Acts 56 and 57 allow a seal Act to permit a limited liability com- shareholders or members. required on certain documents to pany to be identified as a “low-profit Senate Bills 26-28 were signed be affixed electronically. Public Act limited liability company.” The defi- by the Governor and became Public 56 amends MCL 565.232 regarding nition of “low-profit limited liabil- 6 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010 7 ity company” in MCL 450.4102(2)(m) 2. Tax year would like the forms delivered imposes restrictions on the purposes 3. Legal name and mailing to [email protected] or of a limited liability company desig- address calling (517)241-6470. nated as a low-profit limited liability 4. Any other names the organiza- 4. Online filing for a domestic cor- company, and the articles must state tion uses poration, some foreign profit corporations, and domestic and the business purpose for which the 5. Name and address of a principal LLC is being formed. When a low- foreign LLC annual statements officer and reports is available at www. profit limited liability company is 6. Web site address if the organiza- michigan.gov/fileonline. being formed, consideration must be tion has one 5. MICH-ELF applications for given to the IRS requirements regard- 7. Confirmation that the organiza- filer accounts may be faxed to ing program related investments. tion’s annual gross receipts are (517)241-6445 during regular The American Bar Association, normally $25,000 or less business hours of 8 a.m. and Section on Business Law, Commit- 8. If applicable, a statement that 5 p.m., Monday thru Friday, tee on Limited Liability Companies, the organization has terminated excluding holidays. Submit Partnerships and Unincorporated or is terminating (going out of documents by fax to MICH- Entities adopted a resolution regard- business ELF: (517)241-6437. Sub- ing L3Cs at the committee’s meeting mit documents by email to MICH- New regulations eliminated the 7 ELF: CDfi[email protected]. on April 23, 2010. The resolution advanced ruling process. The IRS now 6. Expedited review of documents states “RESOLVED, that at this time automatically classifies a new sec- the Committee formally opposes the for profit corporations, nonprof- tion 501( c)(3) organization as a pub- it corporations, limited liability incorporation into existing limited lic charity for its first five years if it liability company acts of low profit companies, and limited partner- can show in its application that it can ships is available for an addition- limited liability company (“L3C”) reasonably be expected to be public- al fee. Fees for expedited service amendments and respectfully urges ly supported. Information about the are set by Public Acts 217-220 of all state legislatures not to adopt L3C change is available at http://www. 2005 and are nonrefundable. legislation.”8 irs.gov/charities/charitable/article/ Seven states have adopted L3C 0,,id=184578,00.html. legislation. On January 13, 2010, a report on review of L3C legislation Corporation Division conducted by the Maine Secretary Contact Information of State was presented to the Maine The following contact information is NOTES Joint Standing Committee on Judicia- helpful for obtaining information or 1. Home rule cities are also permitted ry.9 The report does not recommend submitting documents to Corpora- under MCL 117.4n to form a nonprofit cor- the legislature amend the Maine stat- tion Division, Bureau of Commercial poration for “purposes that are valid public ute to provide for L3Cs. This report Services. purposes for cities.” 2. http://levin.senate.gov/newsroom/sup- and article by Daniel S. Kleinberger, 1. Questions regarding filing porting/2009/PSI.stateincorporation.031109. A Myth Deconstructed: The “Emperor’s requirements, status of a pend- pdf. New Clothes” on the Low Profit Limited ing document, or questions on 3. For discussion of S.569 see J.W. Verrett, Liability Company, are included in ma- the statutes administer by the Terrorism Finance, Business Associations, and the Corporation Division can be “Incorporation Transparency Act”, http://law- terial for 2010 International Associa- review.law.lsu.edu/Volumes/70/Issue3/VER- sent to CorpsMail@michigan. tion of Commercial Administrators RETT.pdf. gov. Conference.10 4. http://www.ustreas.gov/press/releases/ 2. Request preprinted reports and tg353.htm. Tax-Exempt Organizations determine fees due to renew cor- 5. http://www.abanet.org/poladv/letters/ porate existence or renew cor- additional/2009nov5_kevinshepherds_t.pdf. The January 21, 2010 IRS press release 6. http://www.iaca.org/downloads/ porate certificate of authority by 2010Conference/BOS/7c_Talking_Points_ reminded tax-exempt organizations sending the corporation name, to make sure to file their annual infor- NASS_Opposition_S569_Apr10.pdf. six-digit file number assigned by 7. http://meetings.abanet.org/webupload/ mation on time. The tax-exempt sta- Corporation Division, and how commupload/RP519000/relatedresources/ tus of a nonprofit organization that you would like the forms deliv- ABA_LLC_Committee-L3C_Resolution_and_ has not filed the required form in the ered to corprenew@michigan. explanation-2-17-10.pdf. last three years will be revoked. Orga- 8. http://meetings.abanet.org/webupload/ gov or calling (517)241-6470. commupload/CL580012/relatedresources/ nizations with gross receipts of less 3. Request preprinted annual state- ABA_LLC_Committee-L3C_Resolution_and_ than $25,000 file the 990-N (e-Post- ments and reports, certificate of explanation-2-17-10.pdf. card) (http://epostcard.form990.org) but restoration, and fees required to 9. http://www.iaca.org/downloads/ may choose to file a full 990. To file restore LLC to good standing by 2010Conference/BOS/6a_Resolve_2009_ the 990-N, the tax-exempt organiza- chapter_97_L3C.pdf. sending the LLC name, six-digit 10. http://www.iaca.org/downloads/ tion needs the following information: file number assigned by Corpo- 2010Conference/BOS/6b_Kleinberger_Myth_ 1. Employer identification number ration Division, and how you Deconstructed.pdf. 8 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

G. Ann Baker is Deputy Director of Bureau of Commercial Services, Department of Labor & Econom- ic Growth. Ms. Baker routinely works with the department, legislature, and State Bar of Michigan’s Business Law Section to review legislation. She is a past chair of Business Law Section and is the 2008 recipient of the Stephen H. Schulman Outstanding Business Lawyer Award. She is also a member of the State Bar Committee on Libraries, Legal Research and Legal Publications. TAX MATTERS By Paul L.B. McKenney

Bush Tax Cuts Sunset This Year, Act Now those married taxpayers filing jointly the lead times that may be involved, whose AGI exceeds $250.000. These particularly if bank lending is neces- There is an age old tax adage that for effective in 2013 surtaxes are revenue sary, the time to start to explore the year-end tax planning one should raising provisions in the recent health issue with your clients and begin im- defer the recognition of income and care legislation. plementation is now rather than after accelerate deductions. However, once Thanksgiving. every generation or so, there is a year Planning Implications Does it make sense to sell an ap- when that advice is flipped because If one has income that can be taken preciated asset today at a 15 percent of radical changes in tax rates. 2010 either now or in the future, then capital gains rate rather than at a 20 is that year. Also, the stepped-up there is a strong incentive to take percent rate next year? In some cases income tax basis at death rules that the income this year. This is par- it will. However the 5 percent (and predated World War II are repealed ticularly true as maximum dividend 8.8 percent beginning in 2013) gap for property passing from a 2010 rates increase from 15 percent to 39.6 is not as glaring as that on qualified decedent. percent next New Years Day. For dividends. No More Good Ole Tax Rate example, a closely held C corporation If there will be large income this could make an extraordinary divi- Days year because of special distributions dend (this may involve some bank or other acceleration of income, this At the end of this year, the lower borrowing, but many are doing it) in has to be factored into alternative Bush Administration’s individual 2010. Would the shareholders rather minimum tax (“AMT”) planning. dividend, income, and capital gain take a one-time large divided at 15 Higher rates will lower the likelihood tax rates regarding various individ- percent today rather than a series of of being in an AMT situation and, if ual rates sunset and become history. annual dividends at 39.6 percent (in in AMT, will involve fewer dollars This table illustrates the changes on 2011 and 2012) and at over 43 percent than would have been the case in the the highest rates: in 2013 and subsequent years? A per- past. This needs to be balanced as to haps more revealing economic analy- whether to take accelerated deduc- Maximum Rate 2010 2011- 2013 & sis is what it takes in gross dividend tions through this year against higher 2012 Later to net $1.00 at varying tax rates: income, or wait until next year. The Dividends 15% 39.6% 43.4% answers to these questions lie in the Ordinary Income 35% 39.6% 43.4% Tax Rate Gross Dividend numbers. It is strongly recommended to Net $1.00 Net Capital Gain 15% 20% 23.8% that you and your client run some 15% $1.18 projections. This is a case where there 39.6% $1.66 In addition to the maximum rates are very real benefits to being proac- 43.4% $1.81 increasing, lower brackets also rise in tive. 2011. The expiration of the 15 percent We have reviewed modeling of rate on qualifying dividends, the low- In plain English, on January 1, paying a capital gain tax on appre- est rate since before World War II, is 2011, an additional 48 cents of gross ciated assets in “now versus later” the most dramatic change. On Janu- dividend income ($1.66 minus $1.18) scenarios. Models looking out five ary 1, 2011, the maximum individual will be needed for an individual to years may be quite advantageous, de- rate rises to 39.6 percent because of still net $1.00 The funding source for pending on what is realistic and we the sunset provisions in the tax bills many companies with good balance suggest conservative, assumptions passed during the George W. Bush sheets and cash flows is to approach you make to pay the tax now, rather administration. Under the recently the lender now and make appropriate than later. This also factors into Roth enacted health care legislation, in- liquidity arrangements. IRA planning. This is the year that dividual “net investment income” Likewise, if an S corporation was a taxable conversion to a Roth IRA (i.e., dividends, interest, rents, capital at one time a C corporation and has C could be accomplished regardless of gains, and other passive income) will, corporation earnings and profits, then the income of the taxpayer. In many beginning in 2013, be subject to an if the corporation earnings are not ex- cases the income recognition on a additional 3.8 percent Medicare levy tracted this year at a 15 percent rate, Roth conversion, particularly with for married taxpayers filing jointly then they are locked in at tomorrow’s taxpayers who were closer to retire- with adjusted gross incomes exceed- far higher tax level. There is a special ment, make a Roth conversion unat- ing $250,000. This will bring the effec- election under Treas Reg 1.1368-1(f) tractive. However, those who were tive ordinary income rate on passive to have the distribution treated as on the edge before, given the higher income to 43.4 percent from today’s first coming from C corporation earn- tax rates in the future, may benefit by 35 percent. Beginning in 2013, there ings and profits. Here again many are making the Roth conversion in 2010, will also be an additional .9 percent planning for this once in a generation and recognizing the resultant phan- levy on compensation income for opportunity at the end of 2010. Given tom income.

9 10 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

Traditionally taxpayers have done and the respective accountants in this Paul L.B. McKenney some year-end “balancing” via sell- exercise. You will be serving your cli- of Varnum Riddering ing some stocks at a loss to balance ent well to trigger this process and Schmidt & Howlett off gains realized earlier in the year. present them with the opportunity LLP, Novi, specializes in federal taxation. He That exercise will be particularly im- to achieve considerable savings on is chair of the Sales, portant this year. income tax liabilities. Exchanges and Basis Committee of the Taxation Section Inherited Property—Decades of the American Bar Association, of Stepped-Up Basis Law and he is a member of the Taxa- Repealed For 2010 tion Section of the State Bar of There is also a one-time tax trap for Michigan. inherited property. For decades the rule was that if property was passed from a decedent, then the beneficiaries, estate, or trust, as the case may be, received a so-called “stepped-up basis” equal to the fair market value at the date of death under IRC 1014. As part of the one-year repeal of the estate tax in 2010, a) the IRC 1014 basis rules were also repealed, and b) a modified carryover basis regime applies to property passing from 2010 decedents. See IRC 1022 and 6018. The 2010 modified carryover basis rules apply regardless of the value of the decedent’s estate. For example, assume that a taxpayer who bought a stock 30 years ago for $10 per share dies this year and the estate sells it for $80 per share date of death value(that ratio of appreciation is less than the increase in the Dow Jones Industri- als Average over that time). In 2010 only, there would be but a $10 basis for the estate and a $70 per share taxable gain. Clients who have inherited property from those dying this year need to factor this into their year-end planning. Likewise, terminally ill clients’ planning is impacted, particularly on loss assets. For example, if a terminally ill taxpayer bought stock a few years ago at $50 per share and it is worth but $10 today, if sold while the taxpayer is still alive, then a $40 per share loss is recognized. That could be netted against gain realized by selling appreciated assets. Action Steps It is highly recommended that you meet with clients who will be affected by these changes, discuss them, and quantify the costs of various strategies. You will likely want to include the business owners, other clients, TECHNOLOGY CORNER By Michael S. Khoury and Michelle L. Coakley Supreme Court Clarifies Privacy in the Workplace

Our common advice to clients has • Scope of authorized use of firm Michael S. Khoury of long been to be specific in employ- computers, phones, and other Jaffe Raitt Heuer & ment policies to make employees technologies, including internet Weiss, PC, Ann Arbor aware that they have no expectation usage. and Southfield, practices in the areas of of privacy in the workplace. How- • A clear statement that an employ- information technol- ever, there have been mixed signals ee has no expectation of privacy ogy, electronic com- from the courts about the legality of for any information stored on merce, intellectual property, and company access to personal informa- company computers or systems, commercial and corporate law. tion generated using employer tech- or data transmitted through the nology. The United States Supreme use of company technology. Court took one more step to address These issues are still developing and certain of these issues and the scope we may hear more from the courts. of constitutional rights of an employ- From a drafting standpoint, explicit Michelle L. Coakley is ee to privacy in the recent case of City policies are the employer’s best bet. a partner in the South- of Ontario v Quon, decided June 17, If you, as an attorney, are com- field office of Jaffe 2010.1 municating with an individual cli- Raitt Heuer & Weiss. In Quon, a police sergeant was is- She is a member of ent, should you be concerned? Your sued a text messaging device by his the Firm’s Litigation department. A dispute arose about individual client should not use the Practice Group, spe- the access of the police department to company’s e-mail system or Inter- cializing in commercial litigation some of his personal text messages. net for anything related to their own and employment law since 1998. The department policy was very sim- personal legal affairs. In addition to ilar to most company policies, mak- being accessible by the employer, you ing it clear that officers (or employees need to question whether any privi- in general) had no expectation of pri- lege can be maintained if your client vacy for any information generated understands that there is no expecta- using the employer’s technology. Ser- tion of privacy. While this issue has geant Quon sued the city of Ontario, had alternative interpretations, the California claiming that the depart- client’s use of personal e-mail not ment’s access to the messages was an accessed through the employer’s illegal search that violated his Fourth technology is best. Amendment rights. The Ninth Circuit Court of Ap- peals upheld the position of Sergeant Quon, but the Supreme Court unani- mously reversed that decision. In its NOTES decision, the Supreme Court indicat- 1. No 08-1332, 2010 US LEXIS 4972 (June 17, 2010). ed that a governmental employee using government equipment who had been warned not to expect privacy had no legitimate expectation of privacy when a search is conducted for a legitimate work-related purpose. How will this apply to private employers? The Supreme Court declined to rule on the specific application beyond a governmental employee, so that is yet to be determined. Howev- er, it is certainly a clear signal that the continued use of technology policies in employee manuals is worthwhile. What should be included in a company policy? The following categories are fairly commonplace: 11

What Does That Operating Agreement Mean? A Primer on LLC Capital Accounting for the Non-Specialist

By Donald H. Baker, Jr.

Introduction What is Capital Accounting and With the widespread adoption of the limited How Does It Work? liability company as a preferred entity for- Practitioners involved in forming limited lia- mat for non-public entities, business practi- bility companies are no doubt familiar with tioners are forced to grapple with provisions language often found in operating agree- in operating agreements that adopt detailed ments mandating that “capital accounts be accounting and tax treatments generally established and maintained for each mem- beyond the traditional expertise of non-tax ber.” Normally this language comes along lawyers. These accounting and tax issues are with detailed rules about how such an not present in forming a standard corpora- account is to be maintained and adjusted tion, but are thrust on the practitioner any over time. Taken together, these rules gen- time even the most basic multi-member LLC erally describe “capital accounting” as an is formed. While the “standard” LLC operat- accounting method. ing agreement approaches to these matters Capital accounting is a system of financial are at this point generally familiar (though accounting for general and limited partner- perhaps less well understood), they are not ships, and sometimes LLCs, that keeps a re- simply “boilerplate.” I fear that we (and of cord of each member’s equity financial inter- course our clients) are often insufficiently actions with the company on a member-by- aware that these provisions mandate specific member basis.1 Each member has a separate economic relationships and results among equity or “capital” account that keeps track the members, i.e., who gets what money. of these interactions. The sum of all of the It is entirely possible that use of these stan- members’ capital accounts equals (as a math- dard approaches can unknowingly mandate ematical certainty) the total member equity results that are inconsistent with the client’s shown on the balance sheet of the company business “deal.” (which in turn equals assets minus liabili- I should note at the outset that this is not ties). Since capital accounts are maintained intended to explain comprehensively how on a partner-by-partner (or member-by- the “special language” in operating agree- member) basis, it is entirely possible that the ments works as relates to profits and loss al- entity may have positive members’ equity, locations for tax purposes. These subjects are but some members have a positive capital well beyond what can reasonably be treated account and others have negative capital ac- in a brief article. Instead, my goal is to explain counts. This disaggregation feature contrasts and simplify, for the non-specialist, the op- sharply with an entity approach to equity ac- eration of the capital accounting provisions counting used in corporate accounting (even found in the typical operating agreement. in S corporations), where equity transactions Although some of the related tax allocation are tracked only in the aggregate, rather than provisions are surveyed in a cursory way, on a member-by-member basis, and is the my focus here is economic—making sure that key characteristic of capital accounting as a the parties have a clear idea of the economic method. impact that their choice of the “typical” lan- Capital accounting, as a financial account- guage found in an operating agreement has ing method, is the traditional form of equity on their business arrangements with other accounting used by partnerships and lim- members, in hopes of avoiding unintended ited partnerships and can be said, for these consequences. particular entities, to form part of the body 13 14 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

of accounting practice known as “generally 3. The member’s capital account is decreased accepted accounting principles” (“GAAP”). each year by: However, capital accounting is not mandat- i. any cash distributed by the company ed for limited liability company use, either to that member; by GAAP or the Michigan Limited Liability ii. the net agreed value (established by Company Act. Indeed, for limited liability agreement among of the members) of companies, which are something of a statu- any non-cash assets distributed to the tory hybrid between corporations and lim- member; ited partnerships, capital accounting must be adopted in the operating agreement if it is iii. any losses of the company allocated to have an economic effect on the member’s to that particular member. relations with one another that trumps cer- Capital accounting is only an accounting tain statutory default provisions that would methodology. It does not mandate any par- dictate different results. Under the LLC ticular economic treatment among the mem- Act, it is clear that the members are free to bers/partners corresponding to the account- adopt many methods of economic allocation ing results. (and, therefore, accounting for their dealings However, if this accounting method is among the members), so long as the alloca- to be meaningful, the member’s capital action is expressed in an operating agreement. counts become highly relevant in tracking Many Many practitioners have the mistaken their long-term economic relationship, par- practitioners impression that capital accounting is manda- ticularly on the occurrence of key events in the entity’s life. For purposes of economic have the tory if an LLC is to be taxed as a partnership for federal income tax purposes. For reasons matters, these include rights to distributions, mistaken which follow, this is not the case, although it allocations of profits and losses, and, particu- impression may well have an impact on whether certain larly, how money is distributed when the allocations of profits and losses for tax pur- company is liquidated. Capital accounting that capital poses will be respected by the IRS—for tax language therefore can typically be found accounting is purposes only. running through the entirety of the operating Capital accounting typically works as fol- agreement when discussing these important mandatory if lows: events. an LLC is to 1. The company establishes for each mem- be taxed as a ber a “capital account,” which is a run- Capital Accounting in Operating ning balance of all capital contributions Agreements: The Tax Background, partnership made by each member and all distribu- How We Got Here, and the Typical for federal tions made to the member; Three-Prong Tax Provisions income tax 2. The member’s initial capital account Found in Operating Agreements balance is the initial capital contributed purposes. As noted above, capital accounting is not to the company. For cash contributions, mandatory for LLCs to be taxed as partner- the value is obvious, but for property ships for federal income tax purposes. How- contributions, the members must agree ever, it is typically adopted for this purpose. on an appropriate “book value” that Why? will be treated as the value of that con- Much of the original impetus for wide- tribution. This is entirely a matter of eco- spread adoption of the LLC format arose nomic agreement between the members from a desire to have a business entity that and should be addressed in the operat- could be treated as a partnership for federal 2 ing agreement. The member’s capital income tax purposes, while enjoying corpo- account is increased each year by: rate-like limited liability.3 i. the amount of any additional cash Since partnership taxation was the reason contributed by the member to the for forming such entities in the first place, company; operating agreement forms, understandably, ii. the net agreed value (established by imported from the world of limited part- agreement among the members) for nership agreements standard language de- any non-cash property contributed to signed to comply with IRS “safe harbors” for the company; respecting the parties’ agreed allocation of iii. any profits of the company allocated profits and losses under the partnership taxa- to that particular member (addressed tion sections of the Internal Revenue Code. below). Under IRS regulations for partnership taxa- WHAT DOES THAT OPERATING AGREEMENT MEAN? 15 tion under IRC 704, which continue in effect the so-called “alternative economic effect until this day, members’ allocations of profit test.” Under this test, capital accounting and losses are respected if they have “sub- was likewise required, as was liquidation stantial economic effect.” The safe harbor in accordance with positive capital account provided that “economic effect” was present balances. However, the operating agreement where the partnership agreement (or operat- could substitute a so-called qualified income ing agreement) provides that, throughout the offset provision for Negative Capital Account life of the entity : Restoration. A qualified income offset provi- 1. capital accounts are maintained for each sion mandates that partners who unexpect- member, generally in keeping with the edly receive an adjustment, allocation, or capital accounting method outlined distribution that brings their capital account above (as extensively detailed in the balance negative will be allocated all income Treasury Regulations); and gain in an amount sufficient to eliminate 2. on liquidation of the entity, liquidation the deficit balance as quickly as possible. proceeds are distributed to the members Under the regulations, only allocations of only in accordance with positive capital losses that do not drive a partner into a nega- account balances; tive capital account situation are protected.4 3. if a partner has a deficit balance in his Thus, if the alternative economic effect test or her capital account following the liq- is adopted in such a way that the company’s Under the uidation of the partner’s interest in the loss allocations will always be respected, partnership, that partner is obligated to losses will be allocated only among mem- regulations, restore the amount of such deficit bal- bers having positive capital accounts until all only ance to the partnership by the end of the positive capital accounts have been reduced allocations of taxable year (“Negative Capital Account to zero, after which a different treatment fol- Restoration”). lows. losses that See Treas Reg 1.704-1(b). Non-Recourse Deductions and Minimum do not drive a Note that there are two “events” that the regulations mandate as the operative event Gain Chargebacks partner into for making sure that capital accounting has What would happen in the special case of a a negative meaning: (1) the liquidation of the entity, and limited liability company where all members capital (2) the liquidation of a particular member’s have zero capital accounts and then a loss interest in the entity. In the first instance, only occurs? How was that loss to be allocated? account members having positive capital account bal- Such a condition could only occur where situation are ances receive distributions, and in the second the entity had liabilities that exceeded the any partner having a deficit must restore tax basis of its assets. Since no member was protected. it, whether on liquidation of the entity as a responsible to repay those liabilities because whole or only of that partner’s interest. of the protection of limited liability, a loss deduction would have no economic effect Qualified Income Offsets and Limited under the traditional safe harbor or under the Liability Companies alternate economic effect test. Since all capi- For limited liability companies (and for lim- tal accounts would be reduced to zero (under ited partnerships), Negative Capital Account my hypothetical), the second safe harbor has Restoration presented a major problem: been complied with but does not resolve the members expected to enjoy limited liability, issue. and yet the safe harbor, if mandated, would So, the IRS regulations permitted the create a potentially unlimited obligation to adoption of yet a second variation to cover contribute capital to the company just to meet “non-recourse” deduction, which is the inclu- the economic effect test, primarily so that loss sion of language in the operating agreement allocations would be respected. For LLCs, the called a “minimum gain chargeback” provi- member’s intentions were that no member sion. The effect of a minimum gain charge- ever had to restore a negative capital account back provision is really to mandate that if a (unlike a limited partnership where the gen- non-recourse deduction is allocated to a par- eral partner would have such a responsibility ticular member, positive income will later under limited partnership laws). be allocated to that member if, when, and to In response to this dilemma, the IRS regu- the extent that the member’s “share” of mini- lations provided an alternative to Negative mum gain is later reduced (which can occur, Capital Account Restoration in the form of for example, when the non-recourse debt giv- 16 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

ing rise to that deduction is paid down or the What could be simpler—or, as with all “underwater” property is sold for an amount things in the movie business, is it? Jennifer sufficient to pay off the debt). Although these contributes the $1,000,000, Brad runs it, and provisions are hyper-technical and will not all goes well until their ugly celebrity break- be analyzed here, suffice it to say that such up. They sell the movie studio for $400,000, a language is typical in operating agreement loss of $600,000 ignoring other factors, and it forms designed to produce tax “comfort” as now comes time to distribute proceeds. Who far as deductions are concerned. gets the money? To summarize, because of these historical developments, it is typical to find in operat- Option 1 – The 50-50 “deal” ing agreements provisions with these charac- Brad and Jennifer came in asking for simply teristics: a “50-50 deal,” so, at least without more, the 1. mandatory use of capital accounting; proceeds are distributed as follows: 2. agreeing on a percentage or other meth- Brad gets $200,000 (1/2 of the proceeds), a od of allocating profits and losses; gain of $200,000. 3. allocating losses only to members hav- Jennifer gets $200,000 (1/2 of the pro- ing positive capital account balances; ceeds) for an $800,000 loss. 4. modifying the “normal” allocation of profits and losses (for tax and capital Option 2 – The Typical Language accounting purposes) by including a If the operating agreement contains the Typi- qualified income offset provision; cal Language, the result differs vastly. The 5. modifying the “normal” allocation of Typical Language mandates: profits and losses pertaining to non- 1. When Jennifer contributes the recourse deductions (for tax and capital $1,000,000, she receives a $1,000,000 accounting provisions) by including a capital account. Brad has an opening minimum gain chargeback provision; capital account balance of zero. and 6. providing for liquidation in accordance 2. When the movie studio is sold for with positive capital account balances $400,000, there is a net $600,000 loss. but no negative Capital Account Resto- Although they would otherwise share ration is required. profits and losses on a 50-50 basis, the For purposes of the rest of this article, I’ll call presence of a restriction on allocating this the “Typical Language.” losses to members in such a way as to drive their capital negative means that An Illustration: Who Gets What on none of that loss is allocated to Brad, a Reversal of Fortune? who began with a zero capital account. We come now to the central point of this So, all $600,000 of the loss is allocated article—taken as a whole, these provisions, for book and tax purposes to Jennifer. even though developed as a tax compliance Following that allocation, Jennifer has a technique, mandate specific economic results $400,000 capital account, Brad has zero. among the members that may or may not be 3. After sale of the studio, the LLC is liqui- in keeping with their understanding. dated in accordance with positive capi- Let’s take a simple example. Let’s assume tal accounts. Result? that we have new clients, Jennifer and Brad, who want to form a new limited liability Brad gets zero. company to take advantage of their celebrity Jennifer gets $400,000 (for a $600,000 status and start a movie studio, perhaps to loss). obtain the still-new Michigan Film Credit. They agree that Jennifer, who has most of How About the Upside? the money, is going to contribute $1,000,000 What if we change the facts so that the studio to the LLC to build the studio and produce is sold not for $400,000, but for $3,000,000? movies. Brad will contribute no money, but What result then? will operate the studio and “make rain.” In their initial interview, they say simply that Option 1 Again, the Pure 50-50 Deal they want a “50-50 deal” and leave it to you Jennifer $1,500,000 (a $500,000 gain) to craft the deal. Brad $1,500,000 (a $1,500,000 gain) WHAT DOES THAT OPERATING AGREEMENT MEAN? 17

Option 2 – Typical Language approach). Or, perhaps if asked the question 1. Again, when Jennifer contributes the about this reversal of fortunes, they would $1,000,000, she receives a $1,000,000 have dictated that Jennifer would be paid capital account. Brad has an opening back all of the proceeds until she received capital account balance of zero. $1 million, after which proceeds would be 2. When the movie studio is sold for distributed 50-50. Or if asked the question in $3,000,000, there is a net $2,000,000 gain. the context of an upside, perhaps they would That gain, per the parties’ agreement, is have meant that it was the gain that was to be allocated 50-50. Since there is no loss shared 50-50, not the proceeds. allocation that would implicate the qual- Which result should obtain—Option 1 or ified income offset or minimum gain Option 2? The illustration simply shows that chargeback, it is allocated $1,000,000 to even in the most rudimentary of LLC forma- Brad and $1,000,000 to Jennifer. Capital tion scenarios (like this one), we as practi- accounts after this allocation are then: tioners have to ask the members what result Jennifer $2,000,000 they intend. There simply is no substitute Brad $1,000,000 for inquiry and discussion. Even though the 3. The LLC is liquidated in accordance technical language used to provide a tax safe with positive capital accounts, so Jen- harbor is hyper-technical, it simply cannot be nifer gets $2,000,000, and Brad gets treated as boilerplate legalese, because it does, $1,000,000. and is intended to have, economic impact. This is why the IRS developed the approach Interpreting the Results in the first place. The point here is that the A case can be made that, under either circum- Typical Language mandates the Option 2 re- stance, Option 1 or Option 2 are economically sult, under which Jennifer loses, and Brad’s “fair” and could be agreed on by reasonable possible expectations may be frustrated. minds who thought about it carefully. In the The Right Questions to Ask? Reversal of Fortune scenario, under Option 1, from Brad’s point of view, he ends up receiv- As the Brad and Jennifer example illustrates, ing “compensation” for his participation uncritical use of capital accounting will man- in the enterprise in the amount of $200,000, date a particular accounting result, in this and since he was 50-50, he also experienced a case the result of Option 2 on liquidation of $300,000 loss from his expectation to receive the LLC, a result that may or may not be in the full benefit of a $500,000 contribution keeping with the members intentions. The made by Jennifer. On the other hand, under best way that I have found to avoid unintend- Option 1, Jennifer bears the full economic ed results here is to tease out this economic weight of an $800,000 cash loss ($200,000 of issue by asking clients a series of questions which ends up in Brad’s pocket). Option 2, designed to test their intentions under (at on the hand, protects Jennifer’s investment least) the two fact patterns illustrated above. primarily, and Brad receives nothing. Let me offer the following (suggested) script In the upside scenario, since there is more as a possibility: money floating around, Option 1 produces a “Jennifer and Brad, you’ve indicated that result that gives both parties 50 percent of the you want a “50-50 deal. But this means dif- proceeds without goring Jennifer’s ox. Still, ferent things to different people. Let me ask although they are sharing proceeds 50-50, you three questions to narrow down what they are not sharing gain 50-50. On a net end you mean.” result basis, the gain is allocated $1,500,000 to Question 1: Jennifer, let’s say you con- Brad and $500,000 to Jennifer. tribute $1 million to the LLC. Six months later The problem of course is that Brad and the LLC proves unsuccessful. You and Brad Jennifer may never have thought about the want to give it up. You find a buyer who is specifics of result they wanted if their ven- willing to give back some but not all of your ture resulted in a loss, and they experienced money, and offers $500,000 to buy you both a nasty celebrity breakup, or what they really out. Who do you intend should receive the meant by 50-50. In hindsight, it is possible that $500,000? Should it be divided 50-50 between they meant simply that whatever happened you, or does it all go to Jennifer? on liquidation, those proceeds would be di- Question 2: Let’s say Jennifer contrib- vided 50-50, regardless of the fact that Jenni- utes $1 million to the LLC. Two years later, fer contributed all of the funds (an Option 1 the LLC proves very successful. You decide 18 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

to sell it. A buyer offers you $3 million, which A book up gives Brad “credit” within the op- you decide to take. Who gets the $3 million? erating agreement for his contribution of an Does it get divided 50-50, or does the first “asset”—goodwill—with a value of $1 mil- million go to repay Jennifer and the balance lion. While the good will may be illusory, it get split 50-50? results in recording an additional $1 million Question 3: Let’s say Jennifer contributes asset and a corresponding credit of $1 million $1 million. The day afterward, Brad dies. Jen- to Brad’s book capital account. Then, you can nifer decides to liquidate the company. Who feel confident that if you include language gets the $1 million? Does it all go back to Jen- that liquidation will be made to members nifer, or is it split 50-50 with Brad’s estate? having positive (book) capital accounts, it Obviously, these questions are designed will result in a distribution of 50 percent to to test whether they want an Option 1 or Op- Brad and 50 percent to Jennifer, whether it is tion 2 result. If they want an Option 2 result, a loss or a gain. then it is safe to mandate capital accounting, This is deceptively simple, as it comes and you can use the Typical Language with- with some tax complexities. Since Brad has out remorse and without any special account- contributed an asset with zero tax basis ing adjustments in its implementation. (goodwill) but a credit of $1 million on his Question 3, in fact, serves an additional book capital account, the rules of IRC 704(c) purpose to which I find that most clients would mandate that tax (not book) income be give short shrift: Brad’s part of the “deal” allocated among Brad and Jennifer in such a was to operate the studio, but his death way as to reduce that book-tax difference as leaves this impossible. Since Brad can’t ren- rapidly as possible. The regulations specify der these services, Jennifer isn’t getting the various permissible methods for doing so. value for which she bargained in reaching The 704(c) regulations are well beyond the a 50-50 deal. If services are to be part of the scope of this article, but I raise the point to economic arrangement, then capital account- explain why practitioners must be intention- ing and a mandated Option 2 result simply al in their use of this accounting technique as do not account for this economic reality, and well. modifications must be made. In addition, it Still, these tax issues aside, the book up allows a discussion with Brad to the effect does achieve the result of being able to use that if capital accounting is used and Brad capital accounting and therefore complies receives credit for a capital accounting for with the tax safe harbor under IRC 704(b), services to be rendered, it is likely that Brad permitting a true 50-50 deal in the Option 1 will recognize taxable income under IRC 83 sense. the minute that his capital account is established and credited with half of the opening Conclusion contribution. My principle exhortation to my fellow attor- But what if the answers direct you to an neys who are forming LLCs as business enti- Option 1 result? Knowing what you now ties is simply to be intentional and critical know about capital accounting and tax safe when adopting the Typical Language into harbors, can you still use the Typical Lan- their standard operating agreements. Capital guage and achieve the safe harbor, but end accounting, without adjustment, mandates up with an Option 1 outcome? specific economic results among the members—results that will have an impact in Having Our Cake and Eating it Too making distributions, allocating profits and The answer is yes. Recall that capital account- losses, and particularly in allocating distri- ing is a financial accounting method, rather bution proceeds when the LLC is liquidated. than principally a tax accounting method. When the clients’ intentions are discovered With the tax safe harbor in mind, it is under- using a series of questions like the kind out- standable that practitioners will prefer using lined above (and there are many other good the Typical Language rather than accom- ones that other practitioners are using as plishing the same tax protection by a hand- well), you can determine whether (a) you crafted means. want to use capital accounting since the par- The way to achieve this result is to use ties intend the result that it dictates, (b) you the Typical Language for capital accounting, want to use capital accounting but need a but to have the parties agree on a so-called “book up” or other modification in order for “book up” for financial accounting purposes. the economic results to be correct, or (c) you WHAT DOES THAT OPERATING AGREEMENT MEAN? 19 want to avoid using capital accounting at all Donald H. Baker, Jr. is a and are comfortable with an entity approach principal with the law firm to equity accounting, in which case you will of Safford & Baker, PLLC, simply have to test on a yearly basis whether of Bloomfield Hills and Ann Arbor, with a practice con- the parties’ allocations of profits and losses centration in representing for tax purposes will be respected. technology, software, new media and other companies that seek to commercialize and finance intellectual properties. He has been an Associate Adjunct Professor in the Masters of Tax program at Walsh College, teaching part- NOTES nership taxation, consolidated tax returns and corporate reorganizations. 1. Capital accounting does not address non-equity transactions between members and the company, such as, for example, member loans. In fact, use of member debt in this way is a typical means used to avoid the effect of normal capital accounting rules, although it does present its own tax complexities. 2. Although the tax basis of the property contributed may well have an impact on the allocations of deductions among the members for tax purposes, that difference has no impact on the financial accounting for the item contributed. 3. The ancestors of limited liability company operating agreements were developed at a time before the IRS check-the-box regulations permitted election of any other treatment, so the main tax issue was whether the operating agreement, on its face, complied with IRS regulations differentiating for tax purposes between partnerships, on the one hand, and associations taxed as corporations under IRC 7701, on the other. While the check-the-box regulations have done away with the need for drafting with this issue in mind, legacy operating agreements sometimes continue to have language directed toward it. 4. Treas Reg 1.704-1(d). Treatment of Single Member LLCs Under SBT and MBT after the Kmart and Alliance Decisions

By Donald A. DeLong

Introduction disregarded entity, “its activities are treated Prior to the 2009 Michigan Court of Appeals’ in the same manner as a sole proprietorship, 9 decisions in Kmart Michigan Prop Servs, LLC v branch, or division of the owner.” In other Department of Treasury1 and Alliance Obstetrics words, the fact that an SMLLC is a separate & Gynecology, PLC v Department of Treasury,2 legal entity under Michigan law is not rel- most taxpayers and practitioners believed evant under the Internal Revenue Code; the that a single member limited liability com- activities of the SMLLC will be treated as pany’s (SMLLC) election under the federal those of its owner, and it will not file a sepa- “check-the-box” regulations was determina- rate income tax return from its sole owner. tive of how that SMLLC would be treated The SMLLC may elect to be treated as under Michigan’s now repealed Single Busi- a corporation under the Internal Revenue ness Tax Act (SBTA).3 It now appears that an Code, and if it does, it is treated as an asso- SMLLC may choose to be treated differently ciation with activities separate from those of under the Internal Revenue Code and the its owner and must file separate returns from SBTA, and possibly the Michigan Business those of its owner. If an SMLLC does not Tax Act (MBTA).4 This change will impact make an election to be treated as a corpora- not only choice of entity decisions, but other tion, it will be treated as a disregarding entity tax decisions regarding the elections that under the default rules.10 SMLLCs will make under the federal and Michigan tax statutes. Treatment of SMLLCs Under the SBTA Under the SBTA, a tax was imposed on Federal and State Tax Law every “person” with business activity in Background Michigan.11 “Person” was defined as “an individual, firm, bank, financial institution, Treatment of SMLLCs under the Check-the- limited partnership, copartnership, partner- Box-Regulations ship, joint venture, association, corporation, The tax classification of SMLLCs under the receiver, estate, trust, or any other group or 12 Internal Revenue Code is determined under combination acting as a unit.” A limited the check-the-box regulations.5 For the pur- liability company is not enumerated in the poses of this article, an SMLLC is an entity types of entities defined as a “person,” nor organized under the Michigan Limited Lia- did the statute state how an SMLLC is to bility Company Act6 (MLLCA) that has only be treated under the SBTA. On November one member or owner. The check-the-box 29, 1999, the Michigan Department of Trea- regulations make clear that “…whether an sury (MDT) issued Revenue Administrative organization is an entity separate from its Bulletin (RAB) 1999-9, which attempted to owners for federal tax purposes is a matter state that SMLLCs would be classified the of federal tax law and does not depend on same under the SBTA as under the Inter- whether the organization is recognized as an nal Revenue Code and the check-the-box entity under local law.”7 Therefore, for fed- regulations. In RAB 1999-9, the MDT stated eral tax purposes the exact nature of how the that any such election or default classifica- SMLLC is organized under Michigan law is tion under the check-the-box regulations not determinative of how it will be treated was effective “for all components of the SBT under the Internal Revenue Code. return that are related to federal income tax” A business entity that has a single owner and “[a] taxpayer who elects entity classifica- can choose to be classified as a corporation tion at the federal level shall file the Michigan or as a disregarded entity for federal tax pur- SBT return on the same basis and reflect the poses.8 If the business entity is treated as a same tax consequences.” 13 This RAB specifi- 20 TREATMENT OF SINGLE MEMBER LLCS UNDER SBT AND MBT 21 cally states that if an SMLLC is treated as a In Alliance, the plaintiff, Alliance Obstet- disregarded entity “…at the federal level it rics & Gynecology, PLC was a limited liability is treated as a branch, division, or sole pro- company with a single member. The plaintiff prietor for SBT purposes.”14 Therefore, under had made an election under the check-the- this RAB, an SMLLC would be classified in box regulations to be treated as a corporation the same manner under the SBTA as under for federal income tax purposes. According- the check-the-box regulations. ly, the plaintiff filed a separate single business tax return and claimed a small business Kmart and Alliance Court of Appeals credit under MCL 208.36. The MDT disal- Decisions lowed the small business credit because, un- The Court of Appeals in Kmart held that der MCL 208.36(2)(b)(i), a corporation whose Kmart Michigan Property Services, LLC officers earned more than $115,000 during the (KMPS) was not required to be consistent tax year was not entitled to the small busi- in its self-classification in its Michigan and ness credit. Since the plaintiff had elected to federal tax filings for any given year.15 KMPS be treated as a corporation for federal income was a Michigan limited liability company tax purposes, the MDT determined that this wholly owned by Kmart Corporation. KMPS was a binding classification for all purposes filed a separate single business tax return under the SBTA, including the calculation of from its sole member, Kmart Corporation, the small business credit.18 A business even though KMPS was treated as a disre- The Michigan Court of Appeals in Alli- garded entity for federal tax purposes. The ance cited its decision in Kmart for the propo- entity that MDT determined that it would not accept the sition that classifications under the federal has a single separate return of KMPS and, instead, would and state statutes were not binding on one 19 owner can disregard this entity and treat it as if it were a another. The Court stated that limited li- division of Kmart Corporation. ability companies are not corporations under choose to be The MDT relied on RAB 1999-9 in arguing Michigan law and that “[b]usiness entities classified as a that KMPS was required to use the same enti- such as plaintiff that are neither a corpora- ty classification that it had chosen for federal tion nor a partnership should not be required corporation or tax purposes with respect to its filings under to elect a classification inconsistent with its a disregarded 20 the SBTA. The Court of Appeals found that organization under state law.” The Court in entity for while RAB 1999-9 was entitled to respectful Alliance held that the plaintiff was not to be consideration, it was not legally binding.16 treated as a corporation for purposes of cal- federal tax Since this Revenue Administrative Bulletin culating the small business tax credit under purposes. was not legally binding, the Court looked MCL 208.36(2), and, thus, it was entitled to to the language of the SBTA to determine take the credit.21 whether KMPS was required to file an SBT return. The Michigan Court of Appeals de- Response to Kmart Decision by MDT and termined that KMPS did fit within the defini- Michigan Legislature tion of a “person” conducting business activ- On February 5, 2010, the MDT issued a ity within the state of Michigan.17 According notice to taxpayers regarding the impact of to the SBTA, all persons conducting business the Kmart case. The MDT stated “pursuant to activity within the state were required to file Kmart, persons that are disregarded entities an SBT return. The Court concluded that for federal tax purposes that filed as a branch, KMPS was correct in filing an SBT return division, or sole proprietor of their owner for even though it did not file a separate federal SBT purposes (‘previously disregarded enti- income tax return since it was a disregarded ties’) must now file a separate SBT return for entity under the check-the-box regulations. all open tax periods. Previously disregarded The Kmart decision was released on May entities are considered non-filers for statute 12, 2009. On August 4, 2009 the Michigan of limitation purposes under MCL 205.27a.”22 Court of Appeals revisited this issue in the The MDT stated that SMLLCs were required Alliance decision. The Court in Alliance came to file or amend their returns for all open tax to the same conclusion as the Court did in its years under rules laid out by the Kmart deci- Kmart decision under a different set of facts. sion and the February 2010 Notice. All these In Kmart the taxpayer was a disregarded en- returns were due on or before September 30, tity under the federal check-the-box regula- 2010. Returns not filed on or before Septem- tions, whereas in Alliance the taxpayer elect- ber 30, 2010 would have interest assessed ed to be treated as a corporation. for any deficiencies, which interest would 22 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

be added to the deficiency from the time the (8) Notwithstanding any other pro- tax was originally due. Interest on refunds vision in this act, for a taxpayer that would be calculated and added to the refund filed a tax return under former 1975 commencing 45 days after the claim is filed.23 PA 228 [the SBTA] that included in The MDT would assess a penalty against any the tax return an entity disregarded previously disregarded entities that did not for federal income tax purposes file a return by September 30, 2010.24 More- under the internal revenue code, over, the MDT stated that previously disre- both of the following shall apply: garded entities would be considered non-fil- (a) The department shall not ers for statute of limitations purposes.25 This assess the taxpayer an addition- meant that SMLLCs would have to go back al tax or reduce an overpayment and file tax returns for all years in which because the taxpayer included their revenues exceeded the filing threshold. an entity disregarded for federal However, SMLLCs that previously filed SBT income tax purposes on its tax returns that included one or more previous- return filed under former 1975 ly disregarded entities had to amend their PA 228. returns for all open years, but they could not (b) The department shall not amend their SBT returns beyond the stat- require the entity disregarded The Michigan ute of limitations set forth in MCL 205.27a. for federal income tax purposes Legislature, The February 2010 Notice was going to be a on the taxpayer’s tax return filed tremendous administrative burden on both under former 1975 PA 228 to file recognizing SMLLCs and the MDT. a separate tax return. this burden The Michigan Legislature, recognizing (9) Notwithstanding any other pro- and the this burden and the inherent unfairness of vision in this act, if a taxpayer filed the MDT’s position in its February 2010 No- a tax return under former 1975 PA inherent tice, introduced House Bill 5937. In March 228 that included in the tax return an unfairness 2010, this bill was reported out of committee. entity disregarded for federal income The committee report described the situation of the MDT’s tax purposes under the internal reve- as follows: nue code, then the taxpayer shall not position in Taxpayers that relied on the Depart- claim a refund based on the entity its February ment’s policies for many years now disregarded for federal income tax face the tremendous task of filing purposes under the internal revenue 2010 Notice, new or amended returns for all “open code filing a separate return as a dis- introduced periods”. Since the Department con- tinct taxpayer.27 House Bill siders previously disregarded enti- It is important to analyze what PA 38 does ties to be nonfilers, returns must be and what it does not do. First, PA 38 does not 5937. filed for all tax years for which the amend the SBTA to change the definition of entities exceed the SBT filing thresh- “person” and, in fact, does not amend the old. For some taxpayers, this look- SBTA at all. Second, PA 38 makes no mention back period will be as long as 10 or 20 of the MBT and should not have any impact years. If the affected taxpayers have on the interpretation of this tax act. Third, PA a tax liability, they will be charged 38 does not approve nor disapprove of the interest for the entire time the tax analysis or holdings of Kmart and does not was due. On the other hand, if tax- even mention the Alliance decision. PA 38 payers’ liability is reduced, refunds does state in its enacting section the follow- will be paid only for the four years ing: prescribed by the Act.26 This amendatory act is curative, House Bill 5937 was passed by the Michi- shall be retroactively applied, and gan Legislature and signed by the Governor is intended to correct any misinter- on March 31, 2010 as 2010 Public Act 38 (PA pretation concerning the treatment 38). PA 38 became effective on March 31, of an entity disregarded for federal 2010. PA 38 amended section 207a of 1941 income tax purposes under the inter- Public Act 122, as amended by 2003 Public nal revenue code under former 1975 Act 23, being MCL 205.27a. In pertinent part, PA 228 that may have been caused PA 38 amends MCL 205.27a by adding the by the decision of the Michigan court following language: of appeals in Kmart….28 TREATMENT OF SINGLE MEMBER LLCS UNDER SBT AND MBT 23

If the above enacting language is read in PA 38 does away with the requirement of fil- light of MCL 205.27a(8), it does not appear ing separate returns, but not the analysis of that PA 38 is disapproving the analysis of Kmart as described above. Kmart, but just “correcting any misinterpre- tation” regarding the treatment of SMLLCs Impact Under the SBTA “that may have been caused” by the Kmart PA 38 and the Kmart and Alliance decisions decision. What PA 38 does do is reflected in affect SMLLCs and their treatment under the the actual language of MCL 205.27a(8). PA 38 SBTA in several ways. While Kmart’s inter- changes the requirements for filing returns pretation of “person” is not changed, PA under the SBTA that were made mandatory 38 does not allow SMLLCs to file separate by the February 2010 Notice. Under PA 38, if returns if they have elected to be treated as the owner of an SMLLC filed a return treat- disregarded entities under the check-the-box ing the SMLLC as a disregarded entity then regulations, but SMLLCs that have already (1) the MDT cannot increase or decrease that filed separate returns should not have to owner’s tax liability because the owner did amend their returns because PA 38 does not not file a separate return for the SMLLC, and require this, and the February 2010 Notice (2) the owner cannot be required to file a sep- has been rescinded. Those SMLLCs who did arate return. PA 38 also states that the own- file separate returns may be subject to audit er cannot file a separate SBT return for the challenge by the MDT because of its interpre- PA 38 SMLLC if it originally filed its return treat- tation in its April 2010 Notice. ing the SMLLC as a disregarded entity. Sig- SMLLCs that elected to be treated as cor- and the nificantly, PA 38 does not mention anything porations and that took the small business Kmart and about owners of SMLLCs that may have filed credit under MCL 208.36 should still be able separate returns even though they may have to take the small business credit under the Alliance elected to be treated as disregarded entities analysis of the Michigan Court of Appeals decisions under the federal check-the-box regulations. in Alliance. This means that an SMLLC that affect SMLLCs Reading the language of the committee re- paid in excess of $115,000 to a member is not port, PA 38, and its enacting language togeth- disqualified from taking the small business and their er, it appears that PA 38 actually “repeals” credit because the member is not consid- treatment the MDT’s February 2010 Notice because it, ered an officer or shareholder of the SMLLC. in essence, does away with this Notice’s SBT SMLLCs that did not take the small business under the filing requirements, without addressing the credit on any open year returns because of SBTA in analysis of Kmart. “compensation” to a member in excess of several ways. On April 12, 2010 the MDT issued a $115,000 might consider filing an amended “new” Notice rescinding its previous Febru- return and seeking a refund. ary 2010 Notice.29 The April 2010 Notice says The impact on SMLLCs under the SBTA that “2010 PA 38 reinstates the law govern- is admittedly limited due to its repeal effec- ing disregarded entities under the SBT in ef- tive December 31, 2007. Only SMLLCs who fect prior to Kmart.”30 It also goes on to say have open years or who are subject to audit that the February 2010 Notice is rescinded will be able to rely on Kmart and Alliance. and concludes “that RAB 1999-9 and RAB Impact Under the MBTA 2000-5 reflect the correct interpretation of the law regarding the treatment of disregarded Filing a Separate Return If an Election entities under the SBT.”31 It appears that the Is Made To Be Treated As a Disregarded MDT in its April 2010 Notice interprets PA 38 as doing away with the analysis of Kmart Entity Under the Check-the-Box altogether, which as pointed out above does Regulations not appear to be the case. The MBTA has two different types of The Kmart decision made two impor- taxes. The MBTA imposes a modified tant determinations. First, that RABs, while gross receipts tax (GRT) on taxpayers with entitled to respect, were not binding on the Michigan nexus at the rate of 0.8 percent.32 Court’s interpretation of the SBTA and by ex- It also levies the business income tax (BIT) tension any Michigan tax act. Second, Kmart on taxpayers with Michigan business activ- interpreted “person,” as defined in the SBTA, ity at the rate of 4.95 percent.33 The term to mean SMLLCs and that the check-the-box “taxpayer” is defined as “a person or a uni- regulations did not affect that definition, thus tary business group liable for a tax, interest, requiring SMLLCs to file separate returns. or penalty under this act….”34 A person is 24 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

defined in MCL 208.1113(3) as including a is included in the unitary business limited liability company. As a result, except group. Each United States person for a unitary business group, which will be included in a unitary business group discussed later, an SMLLC is a person subject or included in a combined return to the MBT, just as Kmart decided under the shall be treated as a single person SBT. and all transactions between those The approach that the MDT will take on persons included in the unitary busi- this issue can be gleaned from the Frequently ness group shall be eliminated from Asked Questions (FAQs) issued by the MDT the business income tax base, modi- since the passage of the MBTA. Specifically, fied gross receipts tax base, and the FAQs Mi25 and Mi28 reveal that the MDT will apportionment formula under this follow RAB 1999-9. Mi 25 asks “Does the MBT act.37 follow the federal check-the-box regulations?” Unitary business group is defined, in perti- with answers that can be summarized as fol- nent part, as: lows: (1) Yes, the MBT follows the federal regulations; (2) for single-member disre- a group of United States persons, garded entities, the single member is an MBT other than a foreign operating entity, taxpayer and the SMLLC will be treated as a 1 of which owns or controls, direct- sole proprietorship, branch, or division; and ly or indirectly, more than 50% of (3) an SMLLC will only be a MBT taxpayer if the ownership interest with voting it elects to be taxed as a corporation for fed- rights or ownership interests that eral tax purposes and is not part of a unitary confer comparable rights to voting group.35 rights of the other United States per- FAQ Mi 28, in pertinent part, asks: “Are sons, and that has business activities single member limited liability compa- or operations which result in a flow nies…disregarded for federal tax purposes of value between or among persons also disregarded under the MBT?”36 The an- included in the unitary business swer to this question is that the MBT general- group or has business activities or ly conforms to the check-the-box regulations operations that are integrated with, and SMLLCs will be treated as sole proprietor- are dependent upon, or contribute to ships, branches, or divisions of the sole mem- each other. For purposes of this sub- bers. Both FAQs Mi25 and Mi28 were issued on section, flow of value is determined April 15, 2008 before the Kmart and Alliance deci- by reviewing the totality of facts and sions. In light of April 2010 Notice, they are not circumstances of business activities likely to be rescinded. Therefore, SMLLCs that and operations.38 are not part of a unitary business group could A full discussion of the unitary business argue that they can file as a corporation or a group concept is beyond the scope of this disregarded entity regardless of how they file article, but an SMLLC whose sole member under the check-the-box regulations. SMLLCs is an entity organized in the United States that are not part of a unitary business group will be part of a unitary business group will for the most part be SMLLCs whose sole and will be required to include its business members are individuals or foreign entities, not United States entities such as corporations, activities as part of its sole member’s tax re- partnerships or limited partnerships, or limit- turn. In short, SMLLCs with members that ed liability companies. These types of SMLLCs are United States entities will not be able should make an independent analysis of the to file separate returns under the analysis tax impact on them from a federal income tax of Kmart because of the unitary business 39 and MBT standpoint taking into consideration group rules. the likelihood of challenge from the MDT if Some SMLLCs might consider organizing audited. their parent entities as a foreign corporation SMLLCs whose sole members are enti- in light of the unitary business group rules to ties must take into consideration the uni- avoid having to file a single consolidated re- tary business group rules. A unitary busi- turn. If the tax benefits are substantial, some ness group must: taxpayers may consider organizing the sole file a combined return that includes member of the Michigan SMLLC as a foreign each United States person, other entity, but only if the foreign entity is an “op- than a foreign operating entity, that erating” entity. TREATMENT OF SINGLE MEMBER LLCS UNDER SBT AND MBT 25

The Small Business Tax Credit the check-the-box regulations. Practitioners The MBT, like the SBT, has a small business should consider doing an analysis of sav- tax credit.40 A taxpayer that qualifies for the ings that might be achieved. The impact of small business tax credit effectively reduc- the Kmart and Alliance decision on the MBT’s es its MBT liability (combination of GRT, BIT, treatment of SMLLCs is less dramatic. Many and surcharge) to 1.8 percent its adjusted busi- SMLLCs that might have considered filing ness income. To qualify for the credit, a tax- separate returns under the SBT will prob- payer must not exceed $20 million of gross ably not be able to do so under the MBT as receipts and $1.3 million (adjusted for inflation a result of the unified business group rules. after 2008) of adjusted business income.41 As However, SMLLCs that do not fall within the under the SBT, the MBT disqualifies entities unitary business group rules might consider whose owners have compensation over cer- taking the position that they are not bound tain thresholds. As applied to SMLCCs, if its by the check-the-box regulations in connec- sole member receives more than $180,000 as a tion with their classification under the MBT distributive share of the SMLLC’s adjusted since it appears that the rationale of the Kmart business income (minus the loss adjustment), and Alliance decisions are still valid, notwith- the SMLCC is disqualified from using this standing the MDT’s position. This might credit. In addition, a corporation is disquali- present a planning opportunity for SMLLCs. fied from taking this credit if the compensa- However, any SMLLC that takes this position and director’s fees of a shareholder or tion should only do so with the knowledge an officer exceed $180,000. that the MDT will probably not agree with In Alliance, the SMLLC (i.e., the plain- this analysis. tiff) elected to be taxed as a corporation under the check-the-box regulations, but claimed the small business credit despite NOTES its sole member receiving in excess of 1. 283 Mich App 647, 770 NW2d 915 (2009). $115,000 from the SMLLC. The court in Al- 2. 285 Mich App 284, 776 NW2d 160 (2009). liance pointed out that the term “corpora- 3. MCL 208.1 et seq., which was repealed by 2006 tion” was not defined in the SBTA. Since PA 325 effective December 31, 2007. 4. MCL 208.1101, et seq., which became effective the SMLLC in Alliance was not a corpora- January 1, 2008. tion under Michigan law, it was not a cor- 5. Treas Reg 301.7701-1 (the check-the-box regula- poration for purposes of the SBTA and the tions). small business credit. 6. MCL 450.4101 et seq. The MBT, however, does define the term 7. Treas Reg 301.7701-1(a)(1). 8. Treas Reg 301.7701-2(a). “corporation” as “a taxpayer that is required 9. Id. or has elected to file as a corporation under 10. Treas Reg 301-7701-3(b)(ii). the internal revenue code.”42 Based on this 11. MCL 208.31(1). definition, an SMLLC that elects to be treat- 12. MCL 208.6(1). ed as a corporation under the check-the-box 13. RAB 1999-9 at 2. regulations will fall within the definition of a 14. Id. 15. Kmart, 283 Mich App at 654. corporation for the purposes of MBT, includ- 16. Id. ing the small business credit under the MBT. 17. Id. Accordingly, an SMLLC in the same situa- 18. Alliance, 285 Mich App at 286. tion as the plaintiff in Alliance will not be able 19. Id. to make that same argument and will be dis- 20. Id. qualified from using this credit. 21. Id. 22. “Notice to Taxpayers Regarding Kmart Michi- gan Property Services LLC v. Dept of Treasury, The Conclusion Single Business Tax, RAB 1999-9, and RAB 2000-5” The decisions in Kmart and Alliance have a (February 5, 2010) (the February 2010 Notice), which significant impact on SMLLCs that have open can be found at http://www.michcpa.org/Content/Pub- lic/Documents/Direct%20File%20Links/Kmart%20No tax years to which the SBT applies. Despite tice%20Retroactive%20Application%20Amended%20 the MDT’s April 2010 notice that PA 38 has Returns.pdf. “repealed” the Kmart decision, it appears 23. Id. that the analysis of this decision is still via- 24. Id. 25. Id. ble. Therefore, affected SMLLCs might con- 26. “Disregarded Entity: SBT Returns H.B. 5937: Analy- sider filing returns or amended returns that sis As Reported From Committee” (March 25, 2010). classify the SMLLCs differently than under 27. MCL 207.27a(8). 26 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

28. MCL 207.27a, enacting section 1. Donald A DeLong of the 29. “Rescinded: Notice to Taxpayers Regarding Law Offices of Donald A. Kmart Michigan Property Services LLC V Dep’t Of Trea- DeLong, PC, Southfield, sury, The Single Business Tax, RAB 1999-9, and RAB Michigan practices in the 2000-5” (April 12, 2010) (hereinafter referred to as the areas of general business April 2010 Notice), which can be found at: http://www. and corporate law, michigan.gov/documents/taxes/Kmart_Notice_Retroac- tive_Application_Amended_Returns_1_310402_7.pdf. representation of private foundations and charitable 30. Id. organizations, estate planning and 31. Id. probate administration, and real estate 32. MCL 208.1203. law. 33. MCL 208.1201. 34. MCL 208.117(5). 35. Michigan Business Tax Frequently Asked Ques- tions, page 82 (April 15, 2008), which can be found at http://www.michigan.gov/documents/taxes/MBTFAQ_ 208917_7.pdf. 36. Id. at page 84. 37. MCL 208.1511. 38. MCL 208.1117(6). 39. The unitary business group rules will also require more SMLLCs to file MBT returns since the filing threshold of $350,000 will more likely be reached when filing as part of a unitary business group than separately. SMLLCs, whether they elected to be treated as corporations or disregarded entities under the check- the-box regulations will become part of larger groups of entities under these rules and SMLLCs that were not subject to the SBT because of its threshold of $350,000 will now be subject to the MBT. 40. MCL 208.1417. 41. Id. 42. MCL 208.1107(3). Property and Transfer Tax Considerations For Business Entities

By Mark E. Mueller

Business attorneys are often called on to is to effectuate a dissolution of advise in restructuring business entities, the corporation, limited liability forming new companies, transferring inter- company, partnership, or trust and ests among individuals and entities, and it is necessary to transfer the title of moving assets around. Quite often the parties real property from the entity to the to the transactions are related and everyone is stockholders, members, partners, in agreement as to what is to happen. In such beneficiaries, or creditors. an environment, details are often neglected (ii) A transfer between any limited and it might be tempting to be less than thor- liability company and its members ough in analyzing the transaction in all of its if the ownership interests in the aspects. Clients often assume that if no cash is limited liability company are held changing hands, there is little concern about by the same persons and in the same taxes. This article is a reminder to check the proportion as in the limited liability property tax issues that attend even these company prior to the transfer. friendly deals. With state and local budgets (iii) A transfer between any under tremendous pressure, we can expect partnership and its partners if tax authorities to scrutinize transactions and the ownership interests in the claimed exemptions. partnership are held by the same persons and in the same proportion State Real Estate Transfer Tax as in the partnership prior to the Is the transfer taxable under the State Real transfer. Estate Transfer Tax Act, MCL 207.521-537 (iv) A transfer of a controlling (“SRETT”)? The SRETT Act imposes on the interest in an entity with an interest seller or grantor a 0.75 percent transfer tax1 in real property if the transfer of on (1) contracts for the sale of real property, the real property would qualify for (2) deeds or instruments of conveyance exemption if the transfer had been of real property for consideration, and (3) accomplished by deed to the real contracts for the transfer or acquisition of a property between the persons that controlling interest in an entity in which real were parties to the transfer of the property comprises at least 90 percent of the controlling interest. fair market value of the entity’s assets. MCL (v) A transfer in connection with the 207.523. reorganization of an entity and the There are numerous exemptions to the beneficial ownership is not changed. SRETT, specified in MCL 207.526. For trans- and fers to an entity by one or more of the own- • (t) A written instrument evidencing ers or by a related entity, the key exemptions a contract or transfer of property to are: a person sufficiently related to the • (p) A conveyance that meets 1 of the transferor to be considered a single following: employer with the transferor under (i) A transfer between any section 414(b) or (c) of the internal corporation and its stockholders revenue code of 1986, 26 USC 414. or creditors, between any limited The exemption under Section 6(p) will ap- liability company and its members or ply to a transfer from a dissolving entity to creditors, between any partnership its owners in dissolution. If property is con- and its partners or creditors, or tributed to an LLC or partnership (but not between a trust and its beneficiaries a corporation), and the interests in the en- or creditors when the transfer tity are unchanged as a result of the transfer, 27 28 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

then the transfer of the property is exempt ship interest is valuable consideration for the under Section 6(p)(ii) and (iii). For example, transfer of his property to the LLC. The value if Able and Baker each contribute $50 to form is “the current or fair market worth in terms a new LLC with 50 percent membership in- of legal monetary exchange at the time of the terests each, and then Able contributes real transfer.”2 Able exchanged his property for a estate worth $50,000 and Baker simultane- membership interest that has value greater ously contributes $50,000 cash, it seems that than $100, and such exchanges are taxable.3 the interests have remained the same both Lawyers who prepare deeds for such con- before and after Able’s transfer and would veyances and claim the $100 exemption put therefore be exempt. It is not at all clear that themselves at risk of civil and criminal penal- this is the intended result under the statute. ties under MCL 205.27.4 If the new LLC promptly dissolves with Able getting the cash and Baker getting the prop- Application of Transfer Tax to erty (which should be exempt under Section Controlling Interest Transfers 6(p)(i) as a transfer in dissolution), then the The SRETT was imposed on transfers of property has effectively been transferred “controlling interests” by amendments to from Able to Baker for a net consideration of the Act contained in Public Act 473 of 2008, $50,050 in cash without paying the SRETT. which was given a retroactive effective Application of the “single employer” ex- There are date of January 1, 2007. The amendment emption under Section 6(t) is not readily ap- was an attempt by the legislature to close numerous parent from the language of the statute and a perceived loophole. In commercial real requires a bit of further study. The reference exemptions estate transactions, it had become somewhat to IRC 414(b) or (c) directs us to the concept common to drop the subject real estate down to the of a group of entities under common control. SRETT, This can be a parent-subsidiary group (basi- into a subsidiary LLC (a transfer that would cally, an 80 percent control test), or a broth- be exempt from the SRETT), and to then specified in er-sister group. RAB 1989-48 provides that a convey the LLC interests to the buyer rather MCL 207.526. brother-sister group consists of two or more than giving a deed. This tactic avoided the organizations conducting business if: need to record a deed conveying the property • the same five or fewer individuals own to the buyer and thereby evaded the SRETT. a controlling interest (at least 80 per- The SRETT amendment added a definition cent) in each organization, and to the Act, setting an 80 percent threshold for a “controlling interest,” and modified • taking into account the ownership of the definition of “value” for purposes of each of those persons only to the extent determining the tax base in a transaction that such ownership is identical with respect to each organization, those per- involving the transfer of a controlling sons are in effective control (more than interest. 50 percent) of each organization. Consider a simple case. Suppose Able, The Michigan Department of Treasury uses Baker, and Charlie are the three equal RAB 1989-48 (originally issued in connec- members of an LLC, which in turn owns tion with the Single Business Tax) to define a commercial rental property valued at entities under common control for purposes $950,000, plus cash and other holdings of the SRETT. RAB 1989-48 contains several valued at $50,000 for a total of $1,000,000. useful examples and is required reading for The members each sell their membership interpretation of the Section 6(t) exemption. interests in the LLC to Delta, which thereby Undoubtedly, some taxpayers have been acquires a controlling interest in the LLC tempted to misuse the exemption set forth (100 percent). The new SRETT amendments in 6(a), which exempts instruments in which impose the transfer tax on the sellers in this the “value of the consideration for the prop- “transfer or acquisition” because the real erty is less than $100.00.” If Able and Baker property owned by the LLC comprises more form a real estate LLC, with Able contribut- than 90 percent of the fair market value of the ing the real estate worth $50,000 and Baker LLC’s assets. The tax base is the “value of the contributing $50,000 cash, and each receives real property or interest in the real property, a 50 percent membership interest, it’s tempt- apportioned based on the percentage of the ing to claim the $100 exemption since there’s ownership interest transferred or acquired no cash changing hands between Able and in the entity.”5 This yields a tax base equal the new LLC. But Able’s 50 percent member- to $950,000 x 100% = $950,000, and a tax of PROPERTY AND TRANSFER TAX CONSIDERATIONS FOR BUSINESS ENTITIES 29

$7,125, payable by the three sellers in the transfers, but it will apply to most transfers amount of $2,375 each. of real property by or to legal entities. Now suppose things are a little more complicated. Able owns a 50 percent Property Tax Valuation Uncapping membership interest, Baker 35 percent, and Does the transfer cause uncapping of the Charlie 15 percent. Able and Baker each sell taxable value of the property under MCL their membership interests in the LLC to 211.27a? Beginning in 1995, annual increases Delta, which thereby acquires a controlling in the taxable value of real property were lim- interest in the LLC (50%+35%=85%). In this ited to the lesser of five percent or the infla- case, there should be a transfer tax equal tion rate.9 The limitation applies until there to 0.75 percent of $807,500 (85 percent of is a “transfer of ownership,” whereupon the $950,000), or $6,056.25, payable by Able and taxable value for the calendar year after the Baker. If the tax is proportionately allocated transfer is equal to the property’s state equal- between them, Able would pay $3,562.50 and ized value.10 The transfer of ownership starts Baker would pay $2,493.75. the process over, and future annual increases The act does not address what happens if in the taxable value are again limited.11 This Able sells his 50 percent interest to Delta, and removal of the limitation on taxable value then Baker, in a separate transaction a few following a transfer of ownership has come months later, sells his 35 percent interest to to be called “uncapping.” Beginning Delta. On closing with Baker, Delta might be Uncapping is caused by a transfer of said to have acquired a controlling interest. ownership, which Section 27a(6) of the Act in 1995, Is the tax base 35 percent of $950,000, reflect- defines as “the conveyance of title to or a annual ing only the transaction by which Delta “ac- present interest in property, including the quired” a controlling interest? Or is it 85 per- beneficial use of property, the value of which increases in cent including Able’s sale too? If Able’s sale is substantially equal to the value of the fee the taxable is to be included in the tax base, is he then re- interest.”12 Conveyances by deed, land con- value sponsible for paying the tax even though his tract, by will, or in trust are covered, as are sale in itself was not taxable? Is Baker’s sale changes in the beneficial interests under a of real not a transfer or acquisition of a controlling trust.13 A conveyance of more than 50 per- property interest at all, since it is only 35 percent? cent of the ownership interest in a corpora- These and other questions have caused the tion, partnership, LLC or other entity is also were limited SRETT amendments to be roundly criticized, deemed to be a transfer of ownership of the to the lesser not so much for the closing of a loophole, entity’s real property under Section 27a(6)(h) of five percent but for an overall lack of clarity and the of the Act.14 impracticality of various provisions.6 Since no deed is filed for a conveyance or the of entity interests, such a transfer might not inflation rate. County Transfer Tax ever come to the attention of the property as- Is the transfer subject to the county Real sessor, so the statute requires the affected en- EstateTransfer Tax under MCL 207.501-513? tity to notify the assessor by filing a Property MCL 207.502 imposes on the grantor a Transfer Affidavit no more than 45 days after 0.11 percent transfer tax7 on: the transfer.15 (a) Contracts for the sale or exchange There are numerous transfers that are of real estate or any interest therein or expressly excluded from uncapping, set any combination of the foregoing or forth in Section 27a(7), including transfers any assignment or transfer thereof. between spouses, transfers subject to a life (b) Deeds or instruments of estate in the grantor, foreclosures, transfers conveyance of real property or any to a trust for the benefit of the grantor or his interest therein, for a consideration. or her spouse, etc. The key statutory exemp- The tax is collected by each county for trans- tions for transfers by or to business entities fers of property in the county. The county are set forth in Section 27a(7), subsections (j), tax pre-dates the SRETT and contains some, (k), (l), and (m): but not all, of the same exemptions. Unlike • (j) A transfer of real property or other the SRETT and the General Property Tax Act ownership interests among members (discussed below), the county tax does not of an affiliated group. As used in this have exemptions for transfers between affili- subsection, "affiliated group" means ates or entities under common control.8 The 1 or more corporations connected by county tax does not apply to entity interest stock ownership to a common parent 30 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

corporation. Upon request by the state such a group will avoid uncapping for trans- tax commission, a corporation shall fur- fers between parent and subsidiary corpora- nish proof within 45 days that a transfer tions or between brother-sister subsidiary meets the requirements of this subdivi- corporations of the same parent. sion. A corporation that fails to comply with a request by the state tax commis- Public Trading (MCL 211.27a(7)(k) sion under this subdivision is subject to The administrative impossibility of tracking a fine of $200.00. changes of ownership resulting from normal • (k) Normal public trading of shares of public trading of shares in a publicly traded stock or other ownership interests that, entity no doubt gave rise to the “public trad- over any period of time, cumulatively ing” exemption set forth in Section 27a(7)(k). represent more than 50% of the total This does not mean that public companies ownership interest in a corporation or always get a pass, however. The State Tax other legal entity and are traded in mul- Commission (“STC”) has identified six types tiple transactions involving unrelated of transfers for public companies that may individuals, institutions, or other legal result in uncapping: entities. • The merger of two or more companies; • (l) A transfer of real property or other • The acquisition of one company by The ownership interests among corpo- another or by an individual; rations, partnerships, limited liabil- • The initial public offering (IPO) of the exemption ity companies, limited liability partner- stock of a company (an IPO occurs that should ships, or other legal entities if the enti- when a company’s stock is first offered be of keen ties involved are commonly controlled. for sale to the public); Upon request by the state tax commis- • A secondary public offering of the stock interest sion, a corporation, partnership, limited of a company (a secondary public offer- to lawyers liability company, limited liability part- ing occurs when a company whose nership, or other legal entity shall fur- working stock is already publicly traded issues nish proof within 45 days that a transfer additional new stock for sale to the pub- with meets the requirements of this subdivi- lic); sion. A corporation, partnership, limited individual • The trading of the stock of a privately liability company, limited liability part- held company (a privately held com- owners of nership, or other legal entity that fails to pany is a company whose stock is not comply with a request by the state tax small and available for sale to the public); and commission under this subdivision is medium subject to a fine of $200.00. • A takeover involving a public offer by someone to buy stock from present business • (m) A direct or indirect transfer of real stockholders in order to gain control of property or other ownership interests entities will a company.16 resulting from a transaction that quali- be Section fies as a tax-free reorganization under Commonly Controlled Entities (MCL section 368 of the internal revenue code, 27a(7)(l)… 211.27a(7)(l) 26 USC 368. Upon request by the state tax commission, a property owner shall The exemption that should be of keen interest furnish proof within 45 days that a to lawyers working with individual owners transfer meets the requirements of this of small and medium business entities will be subdivision. A property owner who Section 27a(7)(l), which concerns transfers of fails to comply with a request by the real property or ownership interests among state tax commission under this subdi- legal entities if those entities are “common- vision is subject to a fine of $200.00. ly controlled.” As we saw with the SRETT, the Michigan Department of Treasury relies Affiliated Groups (MCL 211.27a(7)(j) mostly on RAB 1989-48 to determine wheth- The affiliated group exemption under Sec- er entities are commonly controlled. The bul- tion 27a(7)(j) presumably refers to a group letin describes three categories of common or chain of commonly owned corporate enti- control: ties that would qualify as an affiliated group • a parent-subsidiary group of trades or under IRC 1504, so as to be allowed to file a businesses, consolidated federal income tax return under • a brother-sister group of trades or busi- IRC 1501. Transfers between corporations in nesses, or PROPERTY AND TRANSFER TAX CONSIDERATIONS FOR BUSINESS ENTITIES 31

• a combined group of trades or business- Rule. The rule speaks of transfers between es (a speciﬁc combination of a parent two entities owned by the same individu- subsidiary group and a brother-sister als in the same proportions. The example group of trades or businesses). has two individuals transferring property The STC guidelines take some liberties here, that they own 50/50 to an entity they own departing from the strict application of RAB 50/50. “Entities” says the STC, “means cor- 1989-48. First, the STC notes that in order for porations, partnerships, limited liability entities to be commonly controlled under companies, limited liability partnerships, or RAB 1989-48, they must be engaged in a busi- any other legal entity.”18 Individuals do not ness activity. The guidelines give an example appear on the list. of a husband and wife who, for estate plan- For contrast, the STC then draws the same ning reasons, convey their residence to an example again, but instead of a 50/50 LLC, LLC owned by the wife.17 The STC notes that the individuals convey their 50/50 owned the “entities involved (the husband and wife property to an LLC that is owned 49/51. This and the limited liability company)” cannot makes all the difference under the Propor- be entities under common control according tionate Ownership Rule, and, in such a case, to RAB 1989-48 because no business activity the STC says the entities are not under com- exists in the situation. mon control. The STC goes on to state that certain situ- With these examples, the STC guidelines The STC ations will constitute common control even appear to dispense with two requirements of though the strict requirements of RAB 1989- RAB 1989-48 as to who can be an “entity un- goes on to 48 are not met, such as: der common control.” First, RAB 1989-48 no- state that Property (or an ownership interest) is where contemplates individuals as “entities conveyed from one entity to another under common control.” Second, the STC certain entity and both entities are owned by itself notes that RAB 1989-48 requires such situations the same individual(s) with the same entities to be engaged in a business activity. will constitute percentage of ownership. Neither of these requirements is imposed on Let’s call this the Proportionate Owner- our cottage owners in the examples. Instead, common ship Rule. The guidelines give the following the STC creates the Proportionate Ownership control even example: Rule seemingly out of whole cloth. Other though Example: Individual A and individu- commentators have also questioned the Pro- al B own a lakefront cottage property portionate Ownership Rule.19 the strict together as tenants in common, each As the STC giveth, so the STC taketh requirements with an undivided 50 percent inter- away. In another departure from RAB 1989- est. This is the only such property 48, the STC dispenses with the constructive of these individuals own and they use ownership rules set forth in the Bulletin: RAB 1989-48 the property solely for recreational Michigan Revenue Administrative are not met… purposes, residing there from time Bulletin 1989-48 refers to Internal to time. For liability protection pur- Revenue Service regulations con- poses, individual A and individual cerning constructive ownership (also B convey the property to a limited commonly known as ownership liability company. Individual A and attribution). It is the opinion of the individual B are the only members of State Tax Commission that, although the limited liability company, each Michigan Revenue Administra- having a 50 percent ownership inter- tive Bulletin 1989-48 is to be used in est. Even though these entities (indi- determining entities under common vidual A, individual B, and the limit- control, the Internal Revenue Service ed liability company) are not entities regulations concerning construc- under common control under Michi- tive ownership are to be disregard- gan Revenue Administrative Bulle- ed. Application of the regulations tin 1989-48, these entities are consid- regarding constructive ownership ered to be under common control by (ownership attribution) would result policy of the State Tax Commission in transfer of ownership exemptions and this property transfer would not that were clearly not intended by the be a transfer of ownership. legislature.20 First, let us note that the example does not Unfortunately, the STC guidelines do not really exemplify the Proportionate Ownership inform us as to what the supposed intent of 32 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

the legislature was. The legislature presum- cent). Again, together they own 100 percent ably knew what “commonly controlled” of both companies. But considering their in- meant when it included that language in dividual interests only to the extent they are the statute. At the time, RAB 1989-48 was identical in both companies, we see that the already the Michigan Treasury’s published same “group” is not in effective control of guidance on commonly controlled entities ABC Two. We can only count 33.3 percent of under Michigan tax law. Able’s interest in ABC Two, plus the 5 percent for each of Baker and Charlie. This comes to Corporate Tax Free Reorganization (MCL only 43.3 percent—not enough for effective 211.27a(7)(m) control. So in this example, the transfer re- Finally, Section 27a(7)(m) exempts transfers sults in uncapping. of real property or ownership resulting from For another example, assume that Able, transactions that qualify as a tax-free reorga- Baker, and Charlie are siblings and in 1990 nization under IRC 368. Section 368 applies they inherited a commercial property as only to corporate reorganizations. equal tenants in common. The property is leased to their small business, an auto repair Hypotheticals shop. Their lawyer advises them to form an Returning to our examples, if Able, Baker, LLC and contribute the property for liability and Charlie are equal owners of ABC One, protection and ease of management. They LLC, and they own ABC Two, LLC as fol- form ABC, LLC and contribute the property lows: Able (40 percent), Baker (40 percent) by deed, taking equal membership interests and Charlie (20 percent), will a transfer by in exchange. Under the statute, this is clearly deed of real property from ABC One to ABC a transfer of ownership, and no exemption Two result in uncapping? seems to apply. The property is not being The transfer of the real estate by deed conveyed among entities under common is a “transfer of ownership” under Section control. Each of the individuals is under his 27a(6)(a). Is there an exemption? Since these own control. The Proportionate Ownership are LLCs and not corporations, and the inter- Rule described in the STC guidelines does ests are not publicly traded, we can look only not seem to apply either for the same reason: to Section 27a(7)(l) for an exemption as enti- the individuals are not entities. The only ba- ties under common control. The test will be sis for claiming the exemption in this transac- whether ABC One and ABC Two can qualify tion appears to be the STC’s example in the as a brother-sister group under RAB 1989-48 guidelines—an example that has been called as discussed above. Assume the entities have into question by the Michigan Tax Tribunal.21 business activities. In our case, Able, Baker, This seemingly innocuous transfer into the and Charlie own 100 percent of both ABC LLC may result in a huge increase in proper- One and ABC Two, so they satisfy the ﬁrst ty taxes. Did the lawyer advise them of that? prong. To satisfy the second, we need to see How about the state and county transfer tax- if as a group, they meet the minimum level es that may also be due? of effective control in both entities, considering their individual interests only to the ex- Conclusion tent those interests are the same in each en- Before advising a client on (i) a conveyance tity. Able and Baker each own 33.3 percent of real property to or from a business enti- of ABC One for a total of about 67 percent. ty, or (ii) a transfer of entity interests where Clearly they are in effective control of ABC the entity owns real property, lawyers need One. Looking at ABC Two, Able and Baker to stop, think, and read the statutory provi- each own 40 percent, but we can consider sions and exemptions for transfer taxes and this only to the extent that their respective uncapping, combined with the administra- ownership is the same in both companies, i.e. tive guidance and caselaw, which are far a maximum of 33.3 percent each. The sum from simple. Seemingly minor changes in of these interests also exceeds 50 percent, so your facts can make the difference between Able and Baker are also in effective control whether a transfer is taxable or exempt, and of ABC Two. Therefore, the transfer between the difference between good advice or bad. the entities should not result in uncapping. Suppose the same example, except that ABC Two is owned as follows: Able (90 percent), Baker (5 percent), and Charlie (5 per- PROPERTY AND TRANSFER TAX CONSIDERATIONS FOR BUSINESS ENTITIES 33

NOTES Mark E. Mueller of Driggers, 1. Technically, the tax rate is $3.75 for each $500 Schultz & Herbst advises (or any fraction thereof) of the consideration, so if business owners and the consideration is not a multiple of $500, the tax investors on original base is rounded up to the next $500 increment. MCL formation and governing 207.525(1). structure of new businesses, 2. MCL 207.522(g). buying or selling a business, 3. Hansen Plaza, LLC v Michigan Dept of Treasury, MTT Docket No. 263743 (2001). contractual arrangements between 4. See also State Real Estate Transfer Tax Questions partners, and evaluating and negotiating and Answers, 74 Mich. B J 196 (February 1995). deals with vendors and customers. 5. MCL 207.522(g). 6. For an excellent discussion of the SRETT amendments and these criticisms, see J. Scott Timmer, The Application of State Transfer Tax to Entity Interest Transfers, 36 Michigan Real Property Review 84 (Sum- mer 2009). 7. The tax rate is $0.55 for each $500 (or any fraction thereof) of the consideration, so if the consideration is not a multiple of $500, the tax base is rounded up to the next $500 increment. MCL 207.504. 8. Robert F. Rhoades and Nancy G. Itnyre, Property Tax Cap and Transfer Taxes, 27 Michigan Real Property Review 63 (Summer 2000). This article is especially useful for its detailed table setting forth the application of the SRETT, the General Property Tax Act, and the County Tax to various transactions. 9. MCL 211.27a(2)(a). 10. MCL 211.27a(3). 11. MCL 211.27a(4). 12. MCL 211.27a(6). 13. Id. 14. MCL 211.27a(6)(h). 15. Id. 16. Transfer of Ownership and Taxable Value Uncapping Guidelines, Mich. Dept. of Treasury, State Tax Commission/Property Tax Division, March 31, 2001, http://www.michigan.gov/documents/Trans- fer_of_Ownership_Q&A_128474_7.pdf. 17. Such a transfer will also result in the loss of the Principal Residence Exemption. MCL 211.7cc. 18. Transfer of Ownership and Taxable Value Uncapping Guidelines, p. 20. 19. David E. Nykanen, The Danger of the Unin- tended Uncapping: Issues in Estate Planning and Financ- ing Transactions, Michigan Real Property Review (Fall 2009). This article discusses a small claims case before the Michigan Tax Tribunal, Lakewood Cottages, LLC v Township of Sanilac, MTT Docket No 302715 (Jan 6, 2005), which seems to call the Proportionate Ownership Rule, or at least the STC examples, into question. 20. Transfer of Ownership and Taxable Value Uncapping Guidelines, Mich. Dept. of Treasury, State Tax Commission/Property Tax Division, March 31, 2001, http://www.michigan.gov/documents/Trans- fer_of_Ownership_Q&A_128474_7.pdf. 21. Lakewood Cottages, LLC v Township of Sanilac, MTT Docket No 302715 (Jan 6, 2005). Using Retirement Plan Assets to Fund a Start-up Company

By Adam Zuwerink

Introduction 100% of their plan accounts in the employer- After working for a manufacturing company sponsor’s stock, both of which are allowable for the past 20 years, a client approaches you provisions in a qualified retirement plan. who has recently been let go and is looking After the plan has been properly set up, forward to starting the next phase of life by the individual rolls over the previous 401(k) purchasing a local restaurant franchise. Your account to the new plan tax-free and directs client has a substantial 401(k) account with the corporation to issue capital stock in ex- the manufacturing company that could be change for the rollover funds in the plan. used as seed capital to purchase the franchise The stock is held as a plan asset with a value and obtain bank financing. But your client is equal to the account proceeds received by the younger than 59½ and is not excited about corporation from the plan. the prospect of paying income tax on the dis- At the end of the day, the corporation tribution, plus a 10 percent excise tax to the now has cash available to purchase the fran- Internal Revenue Service (IRS) for the early distribution of his 401(k) funds.1 chise and pay for start-up costs, and the plan Your client recently attended a franchis- participant owns employer stock as a retire- ing seminar at which a company gave a ment plan investment. Because the stock is presentation about using the 401(k) account viewed as having the same value as the cash funds to purchase stock in a newly formed proceeds and is still an asset of the plan, no operating company for the franchise busi- distribution has been made and the presump- ness without paying income tax or the early tion is that no income or excise tax is due un- distribution excise tax. Your client insists that der Internal Revenue Code (IRC) 72. the company has assured him such a transac- Often the plan is then amended to no tion has been approved by the IRS, but you longer allow for the investment of employer still think it sounds too good to be true. stock by plan participants, effectively grand- The purpose of this article is to highlight fathering the investment already made, but the concerns and potential pitfalls of utilizing cutting off the right of future plan participants this “roll-over as business start-up” (ROBS) to also become owners of the company. transaction.2 The first section outlines the basic steps in completing a ROBS transaction, While each piece of the above transaction followed by a discussion of a memorandum is technically allowed by the IRS, a number from the IRS’ Director of Employee Plans out- of red flags are raised by the transaction as a lining the IRS’ concern with ROBS, and con- whole. The most important of these is that it cluding with a discussion of how the United is prohibited for a participant to directly use States Department of Labor (DOL) may view retirement plan funds in a business owned ROBS as a prohibited transaction subject to by the participant, which is discussed further additional excise taxes. below. Roll-overs as Business Start-ups Internal Revenue Service The first step in completing the ROBS trans- Memorandum action is to set up a C corporation with a After becoming aware of a number of pro- number of authorized, but unissued, shares moters pushing the ROBS transactions at of stock.3 Once incorporation is complete, the next step is to set up a tax-qualified retire- franchise seminars, Michael Julianelle, Direc- ment plan, with the shell C corporation as tor of Employee Plans for the IRS, issued a the employer-sponsor of the plan. The plan memo on October 1, 20084 outlining a num- document must allow for plan participants to ber of concerns the IRS had after reviewing roll-over funds from a previous employer’s the plans of nine ROBS transaction promot- qualified plan, and for participants to invest ers. 34 USING RETIREMENT PLAN ASSETS TO FUND A START-UP COMPANY 35

Nondiscrimination Requirements of a plan in the fiduciary’s own interest.12 A A ROBS transaction is often set up so that plan fiduciary is defined as including anyone only the persons involved with setting up who renders investment advice for a fee on a 13 the business are allowed to purchase the regular basis. The Julianelle Memo raises the employer’s stock, and the right to purchase concern that if an investment advisor takes a the stock is taken away before other employ- portion of the stock purchase proceeds as a ees are hired. One of the cardinal rules of fee for implementing the ROBS transaction, the IRC’s retirement plan rules is Section and the advisor continues to provide advice 401(a)(4), which states that a plan may not to the plan on a regular basis, that person discriminate in favor of highly compensated becomes a plan fiduciary who is in violation 14 employees, defined generally as either a 5 of the prohibited transaction rules. percent owner, or employee who had more Permanency than $110,000 in income during 2009 or One of the requirements of implementing a 2010.5 The regulations under IRC 401(a)(4) qualified retirement plan is that it “must be state that the benefits, rights, and features created primarily for the purposes of proof a plan must be nondiscriminatory,6 and viding systematic retirement benefits for the timing of plan amendments taking away employees.”15 While the IRS has not histori- rights and benefits of participants is subject cally challenged permanency issues when a to a facts and circumstances discrimination plan is terminated, the Julianelle Memo indi- A ROBS test.7 The Julianelle Memo raises the concern cates this is a factor the IRS will review if a that a plan amendment taking away the right transaction is plan is terminated shortly after the purpose to an employer stock offering could be a dis- of the ROBS transaction is ended.16 often set up criminatory practice designed to benefit only so that only the initial owners of the company.8 Exclusive Benefit the persons The Internal Revenue Code requires that in Valuation of Stock order for a retirement plan to be qualified as involved with Valuation rules are an often overlooked tax exempt, no part of the plan’s assets can setting up aspect of modern 401(k) retirement plans be used for purposes other than the exclusive that allow for individual plan participants benefit of employees or their beneficiaries.17 the business to have their own investment account full The Julianelle Memo states that so long as the are allowed of publicly traded mutual funds and stocks person rolling over the assets is a plan par- to purchase that are valued on a daily basis. But IRS rules ticipant and the funds obtained in exchange require that all assets in a plan be valued on for the stock are actually used for business the employer’s 9 a regular basis, no less than annually. As start-up costs, the plan is not in violation of stock, and discussed further below, failure to properly the exclusive benefit rules.18 But the Julianelle document that the employer securities were Memo does state that some of the ROBS the right to exchanged for their fair market value is auto- transactions the IRS reviewed were used to purchase matically a prohibited transaction subject to set up a business for someone other than the 10 excise tax. initial account owner, or the stock proceeds the stock is The Julianelle Memo calls into question were used to buy personal assets, such as a taken away the validity of many start-up business valu- Mercedes or RV.19 This violation would sub- before other ations that it reviewed, often being given a ject the retirement plan assets to immediate single sheet of paper simply stating the valu- income taxation as a non-qualified plan. employees are ation of the company equals the value of the hired. available proceeds from the retirement plan Plan Not Communicated to Employees account.11 At the very least, a company en- A qualified retirement plan carries a continu- gaging in a ROBS transaction must actually ing administrative burden in that the terms of start operations and have an expert provide a the plan must be communicated to all newly true enterprise value for the company every hired employees, or the plan risks losing year. its qualified status and all assets becoming immediately taxable.20 One of the communi- Promoter Fees cation requirements is that all participants in ROBS transactions are being promoted by a 401(k) plan must be given the opportunity some investment companies that receive to defer a portion of their salary to the plan.21 their fees from a portion of the stock purchase The Julianelle Memo identified that, in some proceeds, but the IRC prohibits a retirement cases, the retirement plan was simply put on plan fiduciary from dealing with the assets the shelf and forgotten about after the ROBS 36 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

transaction was complete and the stock assets excise tax savings for any ROBS transaction received.22 less than $100,000. It must be communicated clearly to the client early on that, to pass muster under the Sale of Employer Stock Julianelle Memo analysis, the ROBS transac- The focus of the Julianelle Memo was the ini- tion must be part of a retirement plan that tial transaction of using plan assets to pur- is intended to be a permanent benefit avail- chase the employer stock, but it fails to dis- able to all employees while the company is cuss the endgame of getting the stock back operating. It cannot simply be a vehicle to out of the plan. As discussed below, having obtain tax-free funds to start a business with the plan participant simply purchase the no thought of actually operating a retirement stock from the plan likely runs afoul of the plan. DOL’s prohibited transaction regulations. And if the stock is sold to an unrelated third Additional Considerations party, the plan participant will be required to In addition to the concerns outlined in the pay income tax on the entire stock purchase Julianelle Memo, your client must be aware price when it is distributed from the plan. of a number of administrative costs and It is very important that anyone contem- burdens of owning employer stock within a plating a ROBS transaction be thoroughly start-up company’s retirement plan. It is very advised of the on-going tax and administrative costs associated with the plan. The anal- Tax Considerations important ysis will be different for each client, and the that anyone While a ROBS transaction may appear to be benefits do not always outweigh the costs, tax advantageous through the initial avoid- especially as the size of the roll-over account contemplating ance of income taxation, a thorough examina- decreases. a ROBS tion of on-going tax considerations must be considered. Taxes will be paid on the corpo- transaction Department of Labor Restrictions rate and individual level because the ROBS Many ROBS promoters took the Julianelle be thoroughly transaction must be completed through a C Memo as the government sanction they were corporation. But it must also be remembered looking for and began touting the plans as advised of that the actual owner of the company is the “approved by the IRS.”23 But as ESPN college retirement plan and all dividends must be the on-going football analyst Lee Corso likes to say, “Not paid to the plan, not the individual, thereby so fast, my friend.”24 tax and negating a potential lower dividend tax rate administrative for corporate distributions to individual Executive Order: Reorganization Plan No. 4 owners. costs of 1978 Also, the ROBS transaction is only seeking associated to delay income taxation on the retirement ac- The Julianelle Memo includes the cryp- with the plan. count funds, not avoid it. At some point, the tic paragraph: “We have also coordinated funds will still be subject to income taxation our consideration of ROBS plans with the when distributed from the retirement plan. Department of Labor (DOL). As will be noted The only real potential tax avoidance is the later, the transfer of enterprise stock within a 10 percent excise tax on early distributions. ROBS arrangement could raise ERISA Title I prohibited transaction issues. Although our Administrative Costs coordination efforts are not yet finalized, The Julianelle Memo makes clear that the they remain ongoing.”25 IRS will scrutinize a ROBS transaction very Essentially, this means that even if the closely and make sure that every “i” is dotted ROBS transaction complies with every sin- and “t” crossed in the retirement plan. This gle procedural requirement outlined in the means that on top of the administrative costs Julianelle Memo, the IRS is not actually the to set up the individualized retirement plan federal governmental department autho- itself, an annual valuation of the stock must rized with making the final determination on be completed by a qualified business valua- whether a ROBS plan is a prohibited transaction expert, annual tax returns must be pre- tion subject to a potential 115 percent excise pared and filed, someone must take the time tax.26 to administer the plan on an on-going basis, When ERISA was enacted in 1974, it con- etc. These costs can easily range from $5,000- tained its own fiduciary duty rules,27 but it also $10,000 or more in the first year or two alone, added similar prohibited transaction rules to which automatically negates the 10 percent the Internal Revenue Code. With oversight of USING RETIREMENT PLAN ASSETS TO FUND A START-UP COMPANY 37

ERISA placed with the Department of Labor, or a highly compensated employee of the President Carter signed an executive order employer sponsor. in 1978 that transferred oversight and inter- Based solely on the above definitions, a pretation of the prohibited transaction rules ROBS transaction would appear to be a pro- in the Internal Revenue Code from the De- hibited transaction because the principal in partment of Treasury to the DOL. That order control of the plan’s employer sponsor is di- provides: recting the plan to purchase company stock All authority of the Secretary of on that person’s behalf to invest in the dis- the Treasury to issue the following qualified company. In fact, ERISA Section described documents pursuant to 406(a)(1)(E) specifically provides it is a pro- the statutes hereinafter specified is hibited transaction for a plan to acquire em- hereby transferred to the Secretary ployer securities or real property.30 But like of Labor: (a) regulations, rulings, any good federal statute, there is an excep- opinions, and exemptions under section to the rule that all but negates it. tion 4975 of the Code.28 Where many ROBS promoters hang their hat is ERISA Section 408(e), which exempts Internal Revenue Code Section 4975 from the prohibited transaction rules the ac- IRC 4975 imposes a 15 percent excise tax on quisition or sale of employer securities by a a “disqualified person” who engages in a retirement plan so long as: (1) the acquisition In light of retirement plan “prohibited transaction.” An or sale is for adequate consideration, and (2) additional 100 percent excise tax is imposed no commission is charged in connection with the fact that during the taxable period after the prohibited the transaction.31 authority 29 transaction occurs. In light of the fact that authority rests rests with the For purposes of IRC 4975 and a typi- with the Department of Labor to rule on cal ROBS transaction, the term “prohibited prohibited transactions, the taxpayer has the Department of transaction” means any direct or indirect: (a) burden to prove to the DOL that it falls under Labor to rule sale or exchange, or leasing, of any property an exception to the general rule that a plan between a plan and a disqualified person; (b) may not purchase employer securities. It be- on prohibited lending of money or other extension of credit comes obvious that the Julianelle Memo does transactions, between a plan and a disqualified person; (c) not in fact answer the question whether a the taxpayer furnishing of goods, services, or facilities be- ROBS transaction is a prohibited transaction tween a plan and a disqualified person; (d) because the IRS does not have the authority has the transfer to, or use by or for the benefit of, a to make such a determination. burden disqualified person of the income or assets of a plan; (e) act by a disqualified person who is DOL Advisory Opinion 2006-01A to prove to the a fiduciary whereby he deals with the income The question then becomes, how will the DOL that it or assets of a plan in his own interests or for Department of Labor view such a transac- falls under an his own account; or (f) receipt of any consid- tion? Unfortunately, we still do not have eration for his own personal account by any a direct answer from the DOL. While the exception disqualified person who is a fiduciary from Julianelle Memo was a preemptive pro- to the general any party dealing with the plan in connec- nouncement of how the IRS views ROBS, the tion with a transaction involving the income DOL will only answer the question through rule that a or assets of the plan. an advisory opinion if someone asks them. plan may not And for purposes of IRC 4975 and a typi- And as of now, no one has asked them. purchase cal ROBS transaction, the term “disqualified What evidence we can gather from prior person” includes a person related to the re- advisory opinions shows it is likely the DOL employer tirement plan who is: (a) a fiduciary; (b) a will not look kindly on ROBS transactions. securities. person providing services to the plan; (c) an While first recognizing the fact DOL regula- employer any of whose employees are cov- tions acknowledge a disqualified person can ered by the plan; (d) an owner, direct or in- transact business with a company in which direct, of 50 percent or more of a company a plan has invested, DOL Advisory Opinion which is the plan sponsor employer; (e) a 2006-01A states: member of the family of any individual de- Regulation section 2509.75-2(c) and scribed in the preceding classes; (f) an officer, Department opinions interpreting director (or an individual having powers or it have made clear that a prohib- responsibilities similar to those of officers or ited transaction occurs when a plan directors), a 10 percent or more shareholder, invests in a corporation as part of 38 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

an arrangement or understanding NOTES under which it is expected that the 1. See Internal Revenue Code (IRC) Section 72(q). corporation will engage in a transac- 2. The phrase “Rollovers as Business Startups” was coined by Michael D. Julianelle, Director of Employee tion with a party in interest (or dis- Plans for the IRS, and the general consensus is that the qualified person).32 acronym “ROBS” was purposefully chosen because of A broad reading of this statement calls the IRS’ skepticism towards these transactions. 3. The entity must be a C corporation, rather than into question the entire validity of ROBS an S corporation or limited liability company, because of transactions, as the fundamental purpose of the prohibited transaction rules of IRC 4975(f)(6). the scheme is for a disqualified person to pro- 4. Julianelle, Guidelines Regarding Rollovers as Busi- ness Start-ups, IRS Employee Plans Director Memo- vide funds to the company that it controls. randum, October 1, 2008, located at: http://www.irs. Even a narrow reading of the DOL opinions gov/pub/irs-tege/rollover_guidelines.pdf (hereafter, “Julianelle Memo”). place severe restrictions on how the retire- 5. IRC 414(q)(1). ment plan funds can be used as the money 6. Treas. Reg. 1.401(a)(4)-4(e)(3). must not be used directly for a transaction in- 7. Treas. Reg. 1.401(a)(4)-5. volving the disqualified person. For example, 8. Julianelle Memo, 7. the money should be used only for payment 9. Rev. Rul. 80–155, 1980–1 C.B. 84. 10. See ERISA 406; ERISA 408(e). of a franchise fee or to purchase equipment, 11. Julianelle Memo 9. and should not be used to pay a disqualified 12. IRC 4975(c)(1)(E). person’s salary or make rent payments to a 13. IRC 4975(e)(3). company owned by a disqualified person. 14. Julianelle Memo 10. 15. Julianelle Memo 11, citing Treas. Reg. 1.401- Conclusion 1(b). 16. Id. It has been reported that as many as 30 per- 17. IRC 401(a)(2). cent of recent franchisees have chosen to 18. Julianelle Memo 12 use 401(k) roll-over money to help fund the 19. Id. franchise start-up,33 which means it is only 20. Treas. Reg. 1.401-1(a)(2). 21. IRC 401(k)(2). a matter of time before more concrete guid- 22. Julianelle Memo 12-13. ance and regulations will be provided by 23. See, e.g., SDCooper Company ERSOP® Plans, the IRS and DOL. If a client approaches you located at http://ersop.com/ersop-faq.html; DRDA, P.C.’s White Paper on Rollovers as Business Startups, about using retirement plan monies to fund located at http://www.borsaplan.com/DRDAWhitePa- a business start-up, alarm bells should ring per_ROBS.pdf. on both a legal and practical level. From a 24. http://www.espnmediazone.com/bios/Talent/ practical perspective, the IRS and DOL rules Corso_Lee.htm 25. Julianelle Memo 4. and regulations are set up with the intended 26. See IRC 4975. purpose of making sure people save for their 27. ERISA 406, 408. For purposes of this article, retirement years, and the inherent risks of the terminology of IRC 4975 is used and the DOL often uses the terms located in ERISA and the IRC at mortgaging the future to pay for the present the same time (e.g. “party in interest” under ERISA and must be made with a full understanding of “disqualified person” under the IRC) the potential costs if the business does not 28. Executive Order: Reorganization Plan No. 4 of 1978, Section 102, located at http://www.dol.gov/ebsa/ survive. From a legal perspective, your client regs/exec_order_no4.html. must be fully informed of the legal require- 29. The taxable period for imposition of the 100% ments outlined in the Julianelle Memo excise tax is defined in IRC 4975(f)(2) as beginning on the date the prohibited transaction occurs and ending on regarding setting up and maintaining the the earliest of the date the prohibited transaction is cor- retirement plan and the prohibited transac- rected, the date the excise tax is assessed, or the date of tion excise tax risks due to the uncertain sta- mailing of notice of deficiency. 30. 29 USC 1106(a)(1)(E). tus of the transaction scheme with the DOL. 31. 29 USC 1108(e). Remember, if it sounds too good to be true, it 32. DOL Advisory Opinion No. 2006-01A (Jan. probably is. 6, 2006), located at http://www.dol.gov/ebsa/regs/aos/ ao2006-01a.html, citing 29 CFR 2509-75-2(c); DOL Advisory Opinion No. 75-103 (Oct. 22, 1975); 1978 WL 170764 (June 13, 1978). 33. Dugas, Entrepreneurs turn to 401(k)s to fund start-up businesses, USA Today, February 19, 2010. USING RETIREMENT PLAN ASSETS TO FUND A START-UP COMPANY 39

Adam Zuwerink is an associate with Parmenter O’Toole in Muskegon practicing in the areas of business and real estate transactions, with an emphasis on employee beneﬁts and retirement plan design. He is a member of the Business and Real Estate Sections of the State Bar, and a member of the Young Lawyers Sec- tion Executive Council. Protecting Competitive Business Interests Through Non-Compete Clauses: What Interests Can Legitimately Be Protected?

By Ryan S. Bewersdorf and Nicolas J. Ellis

Introduction eral antitrust provisions of the MARA were Today more than ever before, employment interpreted as prohibiting only those agree- agreements tend to contain some form of ments that were unreasonable restraints on non-competition provisions. For higher-level trade, essentially returning to the traditional 5 executive employees, such provisions are vir- common law rule. In 1987, the legislature tually ubiquitous. These provisions are also amended the MARA such that it specifically creeping into medical profession employ- permits the use of non-compete agreements ment agreements. As the economy improves between an employer and employee under 6 and hiring increases, more employees will be certain conditions. able to change jobs. As that happens, a new wave of non-compete litigation likely will MARA’s Noncompetition Provision result. Thus, employers should assess their Today, non-compete agreements between current non-compete agreements, and when an employer and employee are governed by hiring employees, carefully draft new non- MCL 445.774a(1), codifying the 1987 amend- compete agreements to make sure they can ment to the MARA. This statutory provision withstand judicial scrutiny in the event litiga- provides that: tion occurs. Any employer seeking to include An employer may obtain from an a non-compete in its employment agreements employee an agreement or covenant would be well advised to consider the rules which protects an employer’s reason- that govern enforcement of such provisions. able competitive business interests and In Michigan, the enforceability of a non-com- expressly prohibits an employee pete agreement between an employer and from engaging in employment or a employee is governed by statute.1 In addition line of business after termination if to codifying the traditional rule that such the agreement or covenant is reason- agreements must be reasonable, the statute able as to its duration, geographical also requires that the agreement must pro- area, and the type of employment or tect “the reasonable competitive business line of business. To the extent any interests” of the employer. This article will such agreement or covenant is found address the way courts have interpreted this to be unreasonable in any respect, requirement, and the kind of interests that a court may limit the agreement to fall within its scope. render it reasonable in light of the circumstances in which it was made A Brief History Of Non-Compete and specifically enforce the agree- Agreements Under Michigan Law ment as limited (emphasis added). Michigan initially followed the general com- The statute imposes two requirements for mon law rule that non-compete agreements a non-compete to be enforceable.7 The latter were enforceable as long as they were rea- part of the statute incorporates the tradition- sonable.2 However, between 1905 and 1985, al common law model based on determining non-compete agreements were prohibited the reasonableness of the non-compete with by statute as an illegal restraint of trade.3 In respect to its geographic scope, duration, 1985, the Michigan Anti-Trust Reform Act and the scope of employment that is cov- (“MARA”) repealed the statutory provi- ered.8 However, the first part of the statute sion that specifically prohibited non-com- further restricts the enforceability of non- pete agreements.4 After this repeal, the gen- compete agreements to those that protect an 40 PROTECTING COMPETITIVE BUSINESS INTERESTS THROUGH NON-COMPETE CLAUSES 41 employer’s “reasonable competitive business protected the employer’s reasonable com- interests.”9 petitive business interest because a physi- But what is a reasonable competitive busi- cian who establishes patient contacts and ness interest? While the Michigan Supreme relationships as a result of the goodwill of an Court has not provided an extensive defini- employer’s medical practice is in a position to tion for this term, a fairly comprehensive pic- unfairly appropriate that goodwill, and thus ture can be drawn by analyzing other deci- unfairly compete with a former employer on sions made by the lower Michigan courts. departure.19 Enforcement of the non-compete agreement provides the employer with time Interpretation of “Reasonable to regain the goodwill of its patients and Competitive Business Interests” prevents former employees from using con- By the Courts tacts gained during employment to gain an 20 The best way to understand how courts have unfair advantage in competition. Similarly, interpreted the term “reasonable competitive in Radio One, Inc v Wooten, the court consid- business interest” is to begin with what it ered a non-compete agreement between a does not cover. Contrary to what many peo- radio personality and his former employer 21 ple might expect, the term does not include radio station. The court made an analogy to merely protecting the employer from general the St Clair Med case, and noted that, despite 10 the defendant’s pre-existing fame, the radio competition. Courts have consistently held Courts have that employers do not have an interest in pre- station had built listener goodwill through venting employees from competing through its efforts and expenditures to promote the consistently the use of general knowledge, skill, or facility defendant, and it was entitled to a period of held that acquired by the employee through training time to promote a new radio personality to 22 or experience during employment.11 try to retain its listeners and sponsors. employers To protect a reasonable competitive busi- Confidential Information do not have ness interest, a non-compete agreement must an interest protect against the employee (or presumably Courts consider confidential business infor- a competitor through hiring the employee) mation to cover a range of topics related in preventing gaining an unfair advantage in competing with to the running of a business. In particular, courts have stated that employers have an employees the former employer.12 The term “unfair” is interest in protecting such confidential infor- itself somewhat subjective and ambiguous. from mation as pricing schemes, price markups, To date, courts have either recognized, or competing marketing strategies, and sales strategies or spoken of, three different categories where techniques.23 They also have recognized an through the employers have an interest in protecting interest in protecting patient or customer themselves from unfair competition: use of general lists.24 However, the confidential information • preventing employees from taking in question must actually provide a com- knowledge, existing customers,13 petitive advantage. Between 2007 and 2008, skill, • preventing an employee from using federal courts addressed the same identical 14 confidential information, and non-compete clause between Kelly Services, or facility • protecting an employer’s investment in Inc. and three different former employees. acquired 15 specialized training. The court upheld the clause against two by the higher level employees who accepted simi- Existing Customers lar positions with competitors.25 However employee The courts’ unfair competition concern with with regard to a lower level employee, then through regard to taking existing customers is that performing clerical work for a competitor, the employee has generally developed a rela- the court held that the clause did not protect training or tionship with the customer through his or her the employer’s reasonable business interests experience position as an employee. Often, an employer because the information the former employee during has invested its resources in developing, or had access to was of no use, and provided no helping the employee develop, the relation- competitive advantage, in her new role.26 employment. ship.16 Courts speak of this as preventing the employee from appropriating the “goodwill” Specialized Training that the employer has built.17 In St Clair Med v The last area where courts have acknowl- Borgiel, the court addressed the enforceability edged a reasonable competitive business of a non-compete agreement between a phy- interest on the part of employers, protect- sician and his former employer.18 The court ing an investment in specialized training, determined that the non-compete agreement remains poorly defined. Courts have con- 42 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

sistently stated that preventing an employee NOTES from competing through the use of general 1. In contrast, non-compete agreements in most training is not a reasonable competitive busi- other situations, such as the purchase of a business, are 27 governed solely by common law principles, however ness interest. This is true even where the on- similar these may be. See Bristol Window & Door, Inc v the-job training has been extensive and cost- Hoogenstyn, 250 Mich App 478, 495, 650 NW2d 670 ly.28 They have, however, indicated that this (2002). may not be the case where specialized training 2. Bristol Window & Door, 250 Mich App at 489. is involved.29 Unfortunately, there have not 3. Former MCL 445.761. 4. Bristol Window & Door, 250 Mich App at 492- yet been any decisions under Michigan law 93. that address the difference between general 5. Compton v Joseph Lepak DDS, PC, 154 Mich App and specialized training. Thus, this factor of 360, 366, 397 NW2d 311 (1986). the “reasonable competitive business inter- 6. MCL 445.774(a)(1). ests” test remains unsettled. 7. Kelly Servs v Eidnes, 530 F Supp 2d 940, 950 (ED Mich 2008). 8. MCL 445.774(a)(1). Conclusion 9. Id. When drafting a new non-compete agreement 10. St Clair Med, PC v Borgiel, 270 Mich App 260, or assessing a current one, an employer must 266, 715 NW2d 914 (2006) (citing United Rentals consider not only the reasonableness of the (North America), Inc v Keizer, 202 F Supp 2d 727, 740 (WD Mich 2002)). restrictions it is imposing, but exactly what 11. St Clair Med, 270 Mich App at 266; Kelsy-Hayes interest it is seeking to protect. The interests Co v Maleki, 765 F Supp 402, 406-07 (ED Mich 1991), that are involved will usually depend on the vacated pursuant to settlement 889 F Supp 1583. facts of the situation, and to some degree 12. St Clair Med, 270 Mich App at 266 (citing Follmer, Rudzewicz & Co, PC v Kosco, 420 Mich 394, will depend on the yet unknown capacity 402 n 4, 362 NW2d 676 (1984)). in which the employee will seek to compete. 13. St Clair Med, 270 Mich App at 266; Radio One, While courts have recognized a reasonable Inc v Wooten, 452 F Supp 2d 754, 758-59 (ED Mich competitive business interest in: (1) pro- 2006); Edwards Publns, Inc v Kasdorf, No 281499, 2009 Mich App LEXIS 109, *10-13 (Jan 20, 2009) tecting existing customers, (2) confidential see also Neocare Health Sys, Inc v Teodoro, No 255558, information; and (3) specialized training, no 2006 Mich App LEXIS 240, *6 (Jan 26, 2006) (assess- Michigan court has clearly addressed what ing whether period of five years reasonably protected “plaintiff’s legitimate business interest in protecting its constitutes specialized training. Therefore, patient base.”). focusing on the two interests of protecting 14. Rooyakker & Sitz, PLLC v Plante & Moran, existing customers and confidential informa- PLLC, 276 Mich App 146,158, 742 NW2d 409 (Mich tion will usually be the most straightforward App 2007); St Clair Med, 270 Mich App at 266-67; Eidnes, 530 F Supp 2d at 950; Whirlpool Corp, v Burns, way for an employer to satisfy the reason- 457 F Supp 2d 806, 812 (WD Mich 2006). able competitive business interest test under 15. St Clair Med, 270 Mich App at 266. Michigan law. Employers should consider 16. Radio One, 452 F Supp 2d at 758-59. setting out the specific competitive business 17. St Clair Med, 270 Mich App at 268. interests it is trying to protect within the non- 18. Id. at 262-63. compete agreement itself. While this is espe- 19. St Clair Med, 270 Mich App at 268 (citing Weber v Tillman, 259 Kan 457, 467-469, 913 P2d 84 cially important where the agreement will be (1996); Berg, Judicial Enforcement of Covenants not to applied to lower level employees for whom Compete Between Physicians: Protecting Doctors’ Interests an employer’s interest may not be as readily at Patients’ Expense, 45 Rutgers LR 1, 17-18 (1992)). apparent, it should also be done for upper 20. St Clair Med, 270 Mich App at 268. 21. Radio One, 452 F Supp 2d at 756. level employees. The potential harm resulting 22. Id. at 759. from an upper level employee turning into a 23. Eidnes, 530 F Supp 2d at 950; Kelly Servs, Inc v competitor is often much greater than where Noretto, 495 F Supp 2d 645, 657 (ED Mich 2007). a lower level employee is involved. It may be 24. St Clair Med, 270 Mich App at 266-677; God- easier to show a reasonable competitive busi- lan, Inc v Greg Whiteford & DCL, Inc, No 227696, 2003 Mich App LEXIS 610 (Mar 11, 2003). ness interest where upper level employees 25. Eidnes, 530 F Supp 2d 940; Noretto, 495 F Supp are concerned, but setting out these interests 2d 645. ahead of time for all non-compete agreements 26. Kelly Servs v Green 535 F Supp 2d 180, 185-86. can save on discovery and other litigation 27. St Clair Med, 270 Mich App at 266; Kelsy-Hayes expenses later. Above all, in order to satisfy Co, 765 F Supp at 406-07. 28. Follmer, Rudzewicz & Co, PC v Kosco, 420 Mich the reasonable competitive business interest 394, 402 n 4, 362 NW2d 676. test, employers should always be prepared 29. St Clair Med, 270 Mich App at 266-67. to show an interest beyond merely insulating themselves from general competition. PROTECTING COMPETITIVE BUSINESS INTERESTS THROUGH NON-COMPETE CLAUSES 43

Ryan S. Bewersdorf is an attorney in the Detroit ofﬁce of Foley & Lardner LLP. He is a member of the ﬁrm’s Busi- ness Litigation, Bankruptcy & Business Reorganizations, and Intellectual Property Litigation practice groups. Mr. Bewers- dorf holds degrees from the University of Michigan Law School (J.D., 2003) and the University of Michigan-Dearborn (M.B.A., 2000, and B.S.E. in mechanical engineer- ing, 1997).

Nicolas J. Ellis is an attorney in the Detroit ofﬁce of Foley & Lardner LLP. He is a member of the ﬁrm’s Business Litigation practice group. Mr. Ellis holds degrees from the University of Michigan Law School (J.D., 2009) and Michigan State University (2006). Social Networking: Your Business Clients and Their Employees Are Doing It…Are You Advising Your Clients on How to Manage the Legal Risks?

By P. Haans Mulder and Nicholas R. Dekker

Introduction indicate they plan to include social media in Social networking sites such as Facebook, their marketing mix in the next 12 months by LinkedIn, and Twitter have experienced phe- including a page on a site such as Facebook, 12 nomenal growth in recent years. Between LinkedIn, or MySpace. 2005 and 2008, the number of adult Internet Besides marketing to customers, busi- users who have a social networking profile nesses have been using social networking quadrupled from 8 percent to 35 percent.1 sites for other purposes. Eighty percent of Since 2009, that number has increased to companies were planning to use social net- 13 approximately 50 percent of Americans.2 The work sites to find or attract candidates. In frequency of use has also grown dramatically. addition, 45 percent of employers use social 14 The minutes spent on social networking sites networking sites to screen job candidates. has increased by 210 percent over the last year, and the average time spent increased What are Social Networking Web 143 percent during that same time period.3 Sites? Of these sites, Facebook, LinkedIn, and The term social networking invariably evokes Twitter have seen significant growth.4 As of names like Facebook, Twitter, and LinkedIn.15 February 9, 2010, Facebook had 400 million In legal scholarship, social networking sites registered users.5 The average time spent by have been defined as web-based systems that U.S. users on Facebook increased by 368 per- allow persons to perform three functions: (1) cent between December of 2008 and one year build a public or semi-public profile within later.6 Also, as of February 9, 2010, the busi- a system, (2) construct a list of other users ness and professional social networking site, with whom they share a connection, and (3) LinkedIn, had 60 million users.7 One of the view their list of connections and others that more recent, but fastest growing social net- are within the system.16 These sites allow for working sites, Twitter, had 6 million unique the development of three different types of monthly visitors and 55 million monthly vis- social interactions.17 The first is the develop- its as of that same date earlier this year.8 Be- ment of identity through profiles. A profile tween 2008 and 2009, the number of users on is a description of the user and their char- Twitter increased 579 percent from 2.7 mil- acteristics, and the characteristics depend lion to 18.1 million.9 on the nature of the Web sites. For example, In addition to the rapid increase in indi- LinkedIn is oriented to business use, so the viduals’ use of social networking sites, busi- characteristics include such items as current nesses have also become early adopters. The employment, past employment history, and percentage of small businesses that use social recommendations. Sites that are focused on networking sites doubled from 12 percent to social use (such as Facebook) include infor- 24 percent from 2008 to 2009.10 According to mation like gender, birthday, hometowns, a recent survey, 45 percent of small compa- and religious as well as political views. The nies with fewer than 100 employees now use second criterion of social networking sites is Facebook and Twitter to promote their busi- the development of relationships among peo- nesses.11 Another study found that about 9 ple using these sites (which can be called con- percent mid-market companies use Twitter nections, friends, followers, etc.). The third to market their business and that 32 percent and last attribute of these sites is the empha- 44 SOCIAL NETWORKING: YOUR BUSINESS CLIENTS AND THEIR EMPLOYEES ARE DOING IT 45 sis of community among the people who are the Olive Garden discharged a supervisor af- using the sites. These sites allow users to post ter she posted photos on MySpace of herself, a variety of information, which can include her under-age daughter, and other restau- photographs, journal entries, personal inter- rant employees hoisting empty beer bottles.29 ests, and other personal information.18 Virgin Atlantic Airlines also discharged 17 flight attendants as a result of their Facebook Why is Social Networking posting in which they criticized the airline’s Important to Businesses and How safety standards and insulted airline employ- are the Early Adopters Using It? ees.30 The Philadelphia Eagles fired an em- These sites have allowed businesses to mar- ployee when he posted on Facebook that his ket and communicate with their customers in employer was “retarded” for allowing a rival 31 a variety of innovative ways.19 For example, a franchise to acquire one of its star players. Los Angeles-based manufacturer and retailer of clothing and gear for skiers and snow- What Legal Issues May Arise in boarders developed a Facebook fan page and the Workplace with the Use of its e-commerce went from $0 to $25,000 in Social Networking Sites? three months.20 The owner of a Milwaukee There are no federal or state laws that pro- restaurant indicated that its sales were up hibit businesses and employers from using 25 percent after his first year of using social social networking sites for various human There are networking sites.21 H&R Block has created relations functions regarding employees and a Facebook fan page to aggregate its social job applicants. Further, employment law in no federal or media activities and in doing so engage its Michigan is premised on an employees’ “at state laws customers and offer tax advice as well as will status.”32 In other words, the termination that prohibit resources.22 The online shoe retailer, Zappos, of an employee could be any reason or no rea- uses Twitter for employees to communicate son at all, and even an arbitrary or capricious businesses with its customers about their passion for discharge is not actionable.33 Despite the gen- and footwear.23 eral freedom to contract in the employment In addition to the marketing and commu- law context and the lack of specific regula- employers nications, a number of businesses use social tion of employer’s use of social networking from using networking sites for employment or human sites, there are a number of statutes or com- social relations functions. Thirty-five percent of mon law theories that pose legal risks for employers decided not to offer a job based employer’s or their employee’s use of social networking on information that was included on a social networking sites. sites for networking site.24 More than 50 percent of The first set of statutes relates to employ- employers attributed the decision not to ex- ment discrimination.34 More notably at the various tend a job offer based on provocative photos, federal level, this includes Title VII and the human while 44 percent identified candidates’ refer- Americans with Disabilities Act, which pro- relations ences to the use of drugs and alcohol.25 tect against discrimination related to vari- A more notorious example of using social ous “status” categories. This could also im- functions networking sites for human relations func- plicate Michigan’s equivalent state law, the regarding tions includes the City of Bozeman, Montana. Elliot-Larsen Civil Rights Act.35 Information It attempted to require all of its job applicants that relates to these protected class catego- employees to disclose their user name and password so ries (such as race, gender, religion, etc.) are and job that the human relations department could found on many social networking sites and applicants. access their social networking sites for back- may easily become known to employers.36 ground checks.26 Due to the national media Using this information to make employment attention, the City of Bozeman discarded this decisions (whether that is hiring, firing, pro- requirement. moting, etc.) could result in liability under Employers are also monitoring employ- these statues. Further, failing to discipline ees’ use of social networking sites.27 This is other employees could result in a disparate understandable considering a study found treatment claim. For example, Delta Airlines that 74 percent of employed Americans sur- dismissed a female flight attendant after veyed believe it is easy to damage a compa- discovering “inappropriate” photographs ny’s reputation via social networking sites.28 in her Delta uniform that were posted on a Some of the results of monitoring and dis- blog. The flight attendant sued Delta alleging covering objectionable activity have become among other claims sex discrimination be- publicly known. For example, in May 2007, cause it purportedly failed to discipline male 46 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

employees who maintained blogs contain- employment action, but she stated that she ing similar content.37 These issues could also gave her password to management because arise on a retaliatory basis when an employee she believed she would have “gotten in some has complained about the workplace. sort of trouble” if she did not. The group of Another category of liability is for protec- employees filed suit alleging, among other tion that extends to non-work related con- claims, invasion of privacy. In analyzing the duct. Certain states such as New York have claim, the court stated that privacy interests statutes that prohibit discrimination based on legal recreational activities. Michigan does must be balanced against an employer’s in- not have this statutory protection. For this terest in managing the business. In apply- reason, companies that are only operating in ing these principles, the court indicated the Michigan should have much more discretion plaintiffs had created an invitation only In- under common law to regulate the lifestyles ternet discussion space and that they had an and off-duty conduct of employees.38 As an expectation that only invited users would be example, a Michigan court held that even if entitled to read the discussion. On this basis, an employer had minimal or no factual basis the court held that there was an issue of ma- for its decision to exclude employees from terial fact as to whether one of the employees employment based on their associations, it had voluntarily provided authorization to There are a would not be a public policy exception to the at-will employment rule.39 Similarly, the access the Web site. If this case provides any number of Sixth Circuit Court applying Michigan law precedent for courts in other jurisdictions, issues has upheld a number of decisions that at- employers could be exposed to liability if will private sector employers can dismiss an they take strong-arm action in accessing em- that an employee for certain types of relationships ployees’ profiles on social networking sites. employer can and conduct that is not approved by the em- The federal Computer Fraud and Abuse 40 proactively ployer. Act may also be at issue for employers.44 This A third area of concern relates to poten- statute makes it illegal to “intentionally ac- address tial violations of the National Labor Rela- cess without authorization a facility through tions Act. If an employer takes any action in their which an electronic communication service is to restrain an employee’s effort to organize employee other employees related to a labor dispute, provided” or intentionally exceed authorized 45 handbook this could constitute an unfair labor practice. use of information. This type of activity can regarding Due to the low cost and effectiveness of so- result in both criminal and civil liability, as cial networking sites, it is likely a medium seen in Pietrylo.46 In Pietrylo, the court focused social media that unions either currently or will use to or- on what is “conduct authorized” under the policy. ganize. Employers should be mindful of not statute. Based on a dispute in facts, the court interfering in this process. concluded that summary judgment should One of the most significant areas of con- be denied and the lower court needed to de- cern is the right of privacy.41 There are four termine whether authorization was in fact commonly recognized varieties of invasion freely given. of privacy in Michigan. The two that are pertinent to employment law and these issues The last area that this could arise is defa- are: (1) intrusion on the employee’s seclu- mation. Although no cases currently discuss sion or solitude into its private affairs, and this theory, it could conceivably arise in a (2) public disclosure of embarrassing private context in which information that is ultimate- facts about the employee.42 This was also one ly incorrect is learned on a social network- of the claims that was asserted and adjudi- ing site and then it becomes disseminated to cated in federal district court in New Jersey.43 other employees and even outside the orga- The plaintiffs were employees of a restaurant nization. To the extent this fits within the ele- group. They created a group on MySpace ments of defamation, it could also expose an and posted comments “venting” about their employer to liability. employer. The group was entirely private and “could only be joined by invitation.” A All of these issues underscore the liability manager of one of the restaurant group’s lo- exposure of an employer’s use of social net- cations asked one of the plaintiffs to provide working sites and highlight the importance a password to access the site. The plaintiff of having a clear and consistent policy re- was never explicitly threatened with adverse garding its use of social networking sites. SOCIAL NETWORKING: YOUR BUSINESS CLIENTS AND THEIR EMPLOYEES ARE DOING IT 47

What Considerations Should Reports/2009/Adults-and-Social-Network-Websites.aspx (January 14, 2009). Employers Address in Their 2. Study Says Almost Half of Americans Use Social Employee Handbooks? Networks, http://hothardware.com/News/Study-Says- Almost-Half-Of-Americans-Use-Social-Networks/ There are a number of issues that an employ- (April 9, 2010). See also Social Media Becomes Part of er can proactively address in their employee Mainstream Media Behavior, http://rismedia.com/2010- handbook regarding social media policy.47 04-11/social-media-becomes-part-of-mainstream-media- behavior/ (April 11, 2010). The first is to require employees to be clear 3. Led by Facebook, Twitter, Global Time Spent on that their opinions are not the views of the Social Media Sites up 82% Year over Year, http://blog. company and to make this evident within nielsen.com/nielsenwire/global/led-by-facebook-twitter- global-time-spent-on-social-media-sites-up-82-year-over- the posting of information. More generally, year/ (January 22, 2010). a policy should require that employees exer- 4. There are many more social networking sites. cise good judgment in communications that Wikipedia maintains a list of the more notable sites at relate directly or indirectly to the company. http://en.wikipedia.org/wiki/List_of_social_network- ing_websites To eliminate any invasion of privacy claim, 5. How Over 400 Million People Use Facebook, the policy should be clear that employees http://www.webpronews.com/topnews/2010/02/09/ do not have any expectation of privacy in how-over-400-million-people-use-facebook (February 9, their use of the Internet. Employees should 2010). 6. Led by Facebook, Twitter, Global Time Spent on also be notified that conduct in violation of Social Media Sites up 82% Year over Year, http://blog. the policy could result in discipline includ- nielsen.com/nielsenwire/global/led-by-facebook-twitter- [N]ot to ing, termination based on conduct that is global-time-spent-on-social-media-sites-up-82-year-over- year/ (January 22, 2010). stifle the defamatory, obscene, libelous, or disloyal to 7. http://en.wikipedia.org/wiki/LinkedIn. use of social the company. Further, the policy should also 8. http://en.wikipedia.org/wiki/Twitter. make clear that the sharing of confidential, 9. Report: Time Spent On Social Media Sites networking proprietary, or private information is pro- Increased By 82% Year Over Year, http://www.social- sites for valid hibited and that any trademarks or service times.com/2010/02/report-time-spent-on-social-media- sites-increased-by-82-year-over-year/ (February 23, marks cannot be used without permission 2010). purposes, of the company. In addition, there should be 10. More Small Businesses Using Social Media to employees an outright prohibition on selling or promot- Attract New Customers, http://www.inc.com/news/ articles/2010/03/small-business-use-of-social-media- should be ing of product or services that compete with doubles.html# (March 19, 2010). the company. Finally, not to stifle the use of 11. Small Businesses Use Facebook, Twitter encouraged to social networking sites for valid purposes, for Promotion, http://www.eweek.com/prestitial. consult with employees should be encouraged to consult php?type=rest&url=http%3A%2F%2Fwww.eweek. com%2Fc%2Fa%2FWeb-Services-Web-20-and- with the human relations department to deal SOA%2FSmall-Businesses-Use-Facebook-Twitter-For- the human with any issues proactively. Promotion-634033%2F&ref=http%3A%2F%2Fwww. relations google.com%2Fsearch%3Fq%3Dsmall%2Bbusinesses %2Buse%2Bfacebook%252C%2Btwitter%2Bfor%2B department Conclusion promotion%2B-%2Bweb%2Bservices%2Bweb%2B20 It is undeniable that the use of social net- %2Band%2Bsoa%2Bfrom%2Beweek%26rls%3Dcom. to deal with working sites has exploded in recent years. microsoft%3Aen-us%3AIE-SearchBox%26ie%3DUTF- 8%26oe%3DUTF-8%26sourceid%3Die7%26rlz%3D1 any issues Businesses are adopting and seeing the value I7GGLL_en (October 20, 2009). in using these sites. This use has been extend- 12. Businesses Increasingly Using Social Networking, proactively. ed to employment issues. While this infor- Study Finds, http://www.eweek.com/c/a/Midmarket/ mation can be very valuable to employers Businesses-Increasingly-Using-Social-Networking-Study- Finds-285771/ (October 22, 2009). (in terms of making employment decisions), 13. Survey shows influx of companies using social there are a number issues that employers networks for recruiting, http://blogs.zdnet.com/feeds/ should be advised on to minimize the like- ?p=1197. lihood of a claim by an applicant who has 14. Nearly Half of Employers Use Social Network- ing Sites to Screen Job Candidates, http://thehiringsite. not been hired or an employee who has been careerbuilder.com/2009/08/20/nearly-half-of-employ- disciplined or terminated based on informa- ers-use-social-networking-sites-to-screen-job-candidates/ tion that was made available through social (August 20, 2009). 15. An article in the Journal of Computer-Mediated networking sites. Communication includes a very insightful history of the sites. Boyd, D.M. & Ellison, N.D., Social Network Sites: Definition, History, and Scholarship Journal of Computer- Mediated Communication, 13 CU, article II (2007). Id. 16. See Id. Another description of social networking site is available at http://en.wikipedia.org/wiki/social_ NOTES network_service. 1. Pew Internet & American Life Project, Adults and 17. Grimmelmann, James, Saving Facebook, 94 Iowa Social Network Websites, http://www.pewinternet.org/ L Rev 1137 (2009). 48 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

18. Burnside, Ian, Six Clicks of Separation: The Legal public sheriff because his relationship and cohabitation Ramifications of Employers Using Social Networking Sites with a married woman did not infringe on his right of to Research Applicant, 10 Vand J Ent & Tech L 445 association and is guaranteed by the First and Fourteen (2008). Amendments); Beecham v Henderson County, 422 F3d 19. 35+ Examples of Corporate Social Media and 372, 378 (6th Cir 2005) (deputy county clerk was prop- Action, http://mashable.com/2008/07/23/corporate- erty terminated since court officials could decide if it was social-media/. See also How Small Businesses Are “unacceptably disruptive to the workplace for woman Using Social Media for Real Results, http://mashable. employee in an office of one of the county’s courts to be com/2010/03/22/. openly and deeply involved with a romantic relation- 20. How to Use Social Networking Sites to Drive Busi- ship with man still married to a woman employed in the ness, http://www.inc.com/guides/using-social-network- other county court down the all). ing-sites.html (January 25, 2010). 41. On June 17, 2010, the U.S. Supreme Court 21. How Small Businesses Are Using Social Media for rejected a police officer’s claim that the city audit of his Real Results, http://mashable.com/2010/03/22/small- personal text messages was an illegal search under the business-social-media-results/ (March 22, 2010). Fourth Amendment. City of Ontario v Quon, __ US __, 130 S Ct 2619 (2010). While certain aspects of the legal 22. See Id. analysis may apply, it is difficult to ascertain what signifi- 23. See Id. cance this decision will have to state common law inva- 24. Sharon Nelson, John Simek & Jason Foltin, The sion of privacy cases because it only addressed a violation Legal Implications of Social Networking, 22 Regent U L of the Fourth Amendment. Rev 1 (2009-10). 42. Lansing Ass’n of Sch Adm’rs v Lansing Sch Dist, 25. See Id. 216 Mich App 79, 549 NW2d 15 (1996), affirmed in 26. Klein, Jeffrey S. and Pappas, Nicholas J., Legal part and reversed in part on other grounds Bradley v Sara- Issues Arising Out of Employees’ Use of Social Network Web nac Bd of Educ, 455 Mich 285, 565 NW2d 650 (1997). Sites, 10/5/2009 NYLJ 3 (2009). 43. Pietrylo v Hillstone Rest Group, No 06-5754 27. In fact, a company recently released a prod- (FSH), 2009 US Dist LEXIS 88702 (Sept 25, 2009). uct that automates the monitoring of employees’ use 44. 18 USC 2701 et seq. of social networking sites. Service monitors workers’ 45. 18 USC 2701. social network use, http://www.networkworld.com/ 46. Pietrylo v Hillstone Rest Group, No 06-5754 news/2010/032610-service-monitors-workers-social-net- (FSH), 2009 US Dist LEXIS 88702 (Sept 25, 2009). work.html (March 26, 2010). 47. As mentioned previously, In addition to the legal 28. 2009 Deloitte LLP Ethics & Workplace Survey, risks that have been addressed, it is important to note Social networking and reputational risk in the work- that a study has shown that there is significant reputa- place, http://www.deloitte.com/assets/Dcom-Unit- tional risk with employees’ use of social networking sites. edStates/Local%20Assets/Documents/us_2009_eth- 2009 Deloitte LLP Ethics & Workplace Survey, Social ics_workplace_survey_220509.pdf. networking and reputational risk in the workplace, 29. Don Aucoin, MySpace Versus Workplace, Boston http://www.deloitte.com/assets/Dcom-UnitedStates/ Globe, May 29, 2007, at D1. Local%20Assets/Documents/us_2009_ethics_work- 30. Crew Sacked Over Facebook Post, BBC News, place_survey_220509.pdf. http://news.bbc.co.uk/2/hi/uk_news/7703129.stm (October 31, 2008). 31. Eagles Employee Fired For Facebook Post, New York Times, http://fifth-down.blogs.nytimes. com/2009/03-10-eagles-employee-fired-for-facebook- post (March 10, 2009). 32. It is well established that employment contracts for an indefinite duration are presumptively terminable at the will of either party. Lytle v Malady, 458 Mich 153, 579 NW2d 906 (1998). 33. Lynas v Maxwell Farms, 279 Mich 684, 273 NW 315 (1937); Bracco v Michigan Tech Univ, 231 Mich App P. Haans Mulder is a share- 578, 588 NW2d 467 (1998); Schipani v Ford Motor Co, holder with Cunningham 102 Mich App 606, 302 NW2d 307 (1981). Dalman PC in Holland, 34. This could include: Title VII of the Civil Rights Michigan. His practice areas Act of 1964, 42 USC 2000e et seq.; the Elliot-Larsen include business law and Civil Rights Act, MCL 37.2101 et seq.; the Age Dis- crimination in Employment Act of 1967, 29 USC 621 estate planning. et seq.; the Pregnancy Discrimination Act, 42 USC 2000e(k); and the Civil Rights Act of 1991, 42 USC 1981. 35. MCL 37.2101 et seq. 36. 42 USC 2000e et seq. 37. Simonetti v Delta Airline, Inc, Case No. 1:05- Nicholas R. Dekker is an CV-2321, Complaint filed (ND Ga September 7, 2005); associate with Cunning- Legal Issues Arising Out of Employees’ Use of Social Net- work Websites (2009). ham Dalman PC in Holland, 38. Employment Law in Michigan An Employer’s Michigan. His practice areas Guide, ICLE (2005). include business and corpo- 39. Prysak v RL Polk Co, 193 Mich App 1, 483 rate law, construction law, NW2d 629 (1992). environmental law, pro- 40. Flaskamp v Dearborn Pub Schs, 385 F3d 935 bate law, real estate law, and wills and (6th Cir 2004) (teacher denied tenure base on out- trusts. of-classroom conduct with former student; Marcum v McWhorter, 308 F3d 635 (6th Cir 2002). (dismissal of Secondary Liability and “Selling Away” in Securities Cases

By Raymond W. Henney and Andrew J. Lievense

Introduction theories of secondary liability. Under Michi- Based on media accounts, there appears to be gan law, when an investment is truly “sold an increase in the number of Ponzi schemes away” from the brokerage firm, the firm po- and other fraudulent investments. The rise of tentially can be held liable pursuant to claims these nefarious ventures may be explained, of vicarious liability, apparent authority, neg- in part, by an investment public that is weary ligence couched as a failure to supervise, and of the volatility of traditional markets and is “control person” liability under the Michigan susceptible to projects promising safety, sta- Uniform Securities Act. Moreover, liability bility, and reliable investment return. may arise in more uncommon circumstances. Generally, for a registered securities For example, a brokerage firm can be liable brokerage firm to market investments for for the broker’s conduct even after the bro- purchase directly from the issuer, the firm ker leaves a firm. This article discusses each is obligated to conduct an investigation or of these theories and when, under Michigan due diligence of the investment opportuni- law, a brokerage firm can be liable for such 3 ties.1 Consequently, perpetrators of these claims. ruses typically seek to avoid this scrutiny and do not sell their projects as approved Vicarious Liability and Apparent investments through brokerage firms. These Authority schemes instead are sold directly by the issu- The initial question in “selling away” cases er to the investor and not through a market or is the scope of the securities brokerage firm’s an exchange. On other occasions, these coun- liability for the actions of its broker under terfeit schemes appear as corporations that theories of vicarious liability and apparent sell stock on the over-the-counter markets. authority. The brokerage firm, obviously, These stocks normally are priced extremely cannot be vicariously liable unless its broker low, are thinly traded, and are not approved is found to be primarily liable.4 The broker for solicited sale by brokerage firms. probably cannot be found primarily liable Nonetheless, individual securities brokers based solely on the fact that he or she vio- affiliated with a brokerage firm often will in- lated industry rules or the brokerage firm’s troduce their clients to such fraudulent in- policies prohibiting selling away activities.5 vestments even though the investment is not Consequently, an investor seeking to hold a through the brokerage firm with whom they brokerage firm liable must first establish that are associated. On those occasions, when the the broker is liable under some actionable investment is solicited and/or sold without claim, such as misrepresentation or malfea- the approval of, and not through, a securities sance.6 brokerage firm, the investment commonly is Further, the brokerage firm may not be known as being “sold away.” Various secu- vicariously liable for the selling away activi- rities industry rules prohibit brokers from ties of its broker where the firm was unaware “selling away” regardless of whether the bro- of the activity, and the broker acted outside ker receives any compensation for the trans- the scope of his or her association with the action.2 Moreover, brokerage firms virtually brokerage firm and for the broker’s own pur- always have their own policies that prohibit pose. For example, in Smith v Merrill Lynch “selling away” activities and procedures for Pierce Fenner & Smith,7 a customer brought a preventing the activity. claim under a theory of respondeat superior Brokerage firms, however, cannot simply against a brokerage firm for the employee rely on these rules and internal procedures stockbroker’s failure to repay a personal to avoid potential liability in the event their loan from the customer to the stockbroker. brokers violate the rules and “sell away.” The Michigan Court of Appeals held that Brokerage firms can be liable for the “selling the brokerage firm was not liable as a mat- away” actions of their brokers under certain ter of law where the stockbroker was “acting 49 50 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

to accomplish a purpose of his own” because piece of paper authorizing any unexplained the firm “could not be held vicariously liable transaction. for [the stockbroker’s] independent action.”8 Similarly, in Kohn v Optik, a non-Michigan Additionally, courts have recognized that vi- case,16 the court made it clear that “where the carious liability is inappropriate where the irregularity on the actions of the employee broker’s conduct violates industry rules and provide notice to the third party that the the brokerage firm’s own policies.9 Logically, employee is acting outside the scope of the in such circumstances, the broker could not employee’s employment, the employer is not be deemed to be acting on behalf of the bro- bound by the employee’s action as no ap- 17 kerage firm, so the brokerage firm could not parent authority exits.” In dismissing the be vicariously liable. investor’s agency law claim, the court noted Claimants frequently confuse vicarious that: liability with apparent authority by arguing it is uncontested that Plaintiff did that vicarious liability applies because the not open a regular account with [the broker was selling a security and the broker- brokerage firm], that Plaintiff did not age firm authorized the broker to sell securi- send her checks to the brokerage, and ties. But in typical situations, the brokerage that Plaintiff never received a single firm did not actually authorize the broker to receipt, statement, or other com- While sell the investment away from the firm, in- munication bearing [the brokerage firm’s] name. Thus, the irregularity Michigan stead the broker was acting beyond the scope of his or her authority, which negates a claim of the transaction at issue provided notice to Plaintiff that [the registered courts have of vicarious liability.10 representative] was acting outside Moreover, just because a brokerage firm clearly set the copy of his employment.18 authorizes the broker to sell securities does In Harrison I, the court delineated addi- forth the not mean the broker has the apparent au- tional factors important in analyzing a claim requirements thority to sell all securities, such as unap- under an apparent authority theory: to show proved securities. “[A]pparent authority must be traceable to the principal and cannot Here the undisputed facts show Har- rison did not open an account with apparent be established by the acts and conduct of the Dean Witter but, instead, transferred authority, agent.”11 Consequently, courts must analyze money to Kenning and Carpenter for the surrounding facts and circumstances of few Michigan them to place in Carpenter’s employ- the sale to determine if liability for apparent ee account at Dean Witter for subse- courts have authority may exist.12 Those facts and circum- quent investment. In so doing, Har- stances include the supervision activities of applied the rison expected to enhance his return the brokerage firm and the objective reason- requirements by paying the lower commission ableness of the investor’s belief that the sale in the charged Dean Witter employees, was through and approved by the brokerage although he was not an employee 13 securities firm. Thus, courts look to more than just the entitled to the benefit. It is clear nei- context. relationship between the brokerage firm and ther Kenning nor Carpenter had the the broker when considering claims under authority, actual or apparent, to use an “apparent authority” theory. Courts also the account thusly; Dean Witter’s look to the details of the transaction between rules expressly forbade it, as would 14 the claimant and the broker. ordinary prudence.19 While Michigan courts have clearly set The Harrison I court concluded that no “rea- forth the requirements to show apparent au- sonably prudent person” could conclude that thority, few Michigan courts have applied the employees had the authority because the the requirements in the securities context. In investment transactions “were not regular on one such case, Carsten v North Bridge Holdings, their face and could not appear to be within Inc,15 the investor did not know the broker the ordinary course of business.”20 had left the brokerage firm. The court found Thus, a claimant asserting a claim against that the broker was not acting with the ap- a brokerage firm for vicarious liability and parent authority of the brokerage firm in part apparent authority based on the actions of because the broker had left the firm, the bro- a broker must allege more than simply that ker was not authorized to sell unapproved there was an employment relationship be- securities, and the investor did not rely on tween the brokerage firm and the broker. The the brokerage firm when she signed a blank claimant must allege facts, and come forward SECONDARY LIABILITY AND “SELLING AWAY” IN SECURITIES CASES 51 with evidence, that the brokerage firm was that it will result in a significant increase in aware of, was involved in, or benefited from the cost to invest. the transactions at issue. Also, under the Michigan Uniform Secu- rities Act, a brokerage firm can be held liable Failure to Supervise and Control for the sale of unregistered securities by one Person Liability of its brokers, the sale of securities by a bro- Michigan courts recognize a claim against a ker who is not properly registered, or for the brokerage firm based on the firm’s supervi- misrepresentation of its broker, if the broker- sion, or failure to supervise, a broker. The age firm is a “control person.”26 A brokerage claim is couched either as a negligence claim firm typically, but not always, is considered for the failure to supervise21 or as a claim for a “control person” for a broker it licenses and “control person” liability under the Michigan supervises as it typically “directly or indirect- 27 Uniform Securities Act.22 ly controls” its brokers. The brokerage firm, Michigan courts recognize a failure to su- however, can avoid liability if it “sustains the pervise claim arising from a duty to supervise burden of proving that the controlling person based on the special relationship between an did not know, and in the exercise of reason- individual (such as an investor) and another able care could not have known, of the exis- entity or person (such as a brokerage firm).23 tence of the conduct by reason of which the 28 This duty comes from the securities regula- liability is alleged to exist.” In the brokerage Michigan firm context, the reasonable care or “good tions, such as NASD Rule 3010(a), which pro- courts vides that broker dealers “shall establish and faith” defense essentially concerns a broker- maintain a system to supervise the activities age firm’s “failure to supervise” a registered recognize of each registered representative, registered representative, and thus overlapping with 29 a failure to principal, and other associated person that the failure to supervise claim. Accordingly, is reasonably designed to achieve compliance a brokerage firm generally is not liable for supervise the underlying violation if it establishes that with applicable securities laws and regula- claim arising it maintained “a reasonable system of super- tions, and with applicable NASD Rules.”24 vision, enforced that system with reasonable from a duty Thus, a failure to supervise claim coinciden- diligence, and that the [brokerage firm] did tally embodies a similar standard for super- to supervise not directly or indirectly induce the viola- vision as the criterion set forth in the rules of tions by its [registered] representative.”30 based on the securities regulators. Courts consider many factors to determine the special In analyzing the duty imposed on bro- whether the good faith defense bars “control kerage firms, the standard is reasonable, not relationship person” liability, such as: to whom and where perfect, supervision. As stated by one regula- the investor sent checks, whether the invest- between an tory body: ment procedures were typical, and whether individual The standard of ‘reasonableness’ is the investment procedures were part of the (such as an determined based upon the circum- broker’s efforts to circumvent compliance stances of each case…. The burden is efforts by the brokerage firm.31 Courts also investor) and on the staff to show that respondent’s consider the rules and procedures in place to another entity procedures and conduct were not prevent the underlying violation, the broker- reasonable….It is not enough to dem- age firm’s implementation of those rules, and or person onstrate that an individual is less than a whether the brokerage firm had actual notice (such as a model supervisor or that the supervision or should have known of the underlying vio- 25 brokerage could have been better. lation—meaning whether “red flags” were From the regulators’ point of view, as well present and investigated.32 firm). as a court’s, a reasonableness standard is Again, the decision in Kohn33 is instruc- desirable for at least two reasons. First, the tive. In Kohn, the court ruled, as a matter of reasonableness standard provides flexibility law, that no “control person” liability existed in evaluating different circumstances and against the brokerage firm.34 In reaching that factual situations. Second, the required level conclusion, the Kohn court considered numer- of supervision must consider the cost to ous factors, such as: whether the fraudulent consumers for access to the capital markets. investments were even available through the Supervisory costs necessarily are reflected in brokerage firm; whether the broker disclosed brokerage firms’ commissions and fees. Per- his affiliation with the brokerage firm to the fect or near perfect supervision will require investors; whether the brokerage firm autho- the expenditure of such significant resources rized the broker to solicit for the investments; 52 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

where the investor sent investment checks; can be liable to another brokerage firm if it whether the investor received receipts, ac- stays silent even though it knows that there count documents, account numbers, corre- is a reasonable possibility that the broker has spondence, confirmation slips, or monthly engaged in, and may continue to engage in, statements from the brokerage firm; and the unlawful activity at a subsequent bro- whether any documents even mentioned the kerage firm. While, no Michigan court has brokerage firm. The Kohn court concluded addressed this issue directly, courts applying that: statutes and regulations substantially similar Plaintiff was not reasonably relying to those enacted in Michigan have done so, on [the broker] as a [broker] of [the and brokerage firms must be cautious not to brokerage firm], but was placing run afoul of these requirements. her money with him for purposes The seminal case for imposing liability on other than investment in markets to a brokerage firm for the conduct of a former which he had access only by reason broker is Twiss v Kury.37 In Twiss, defendant of his relationship with [the broker- E.F. Hutton (“Hutton”) learned that its sales age firm]; it is uncontested that [the representative, Kury, was involved with out- investment] was not traded on any side business activities in violation of securi- market to which [the broker] had ties laws and regulations. In response, Hut- Beyond being access solely because of his relation- ton requested and received Kury’s resigna- ship with [the brokerage firm] and tion. Hutton then filed with the regulators a liable for that [the brokerage firm] did not Form U-538 incorrectly stating that the termi- the actions manage the purchase transaction.35 nation was voluntary and failing to disclose Thus, courts have ruled against claimants its investigation and the probable violations of a current asserting failure to supervise and control committed by Kury. Kury remained in the broker, some person claims in “selling away” cases when securities industry and, four years later, was courts have the broker controls the transaction and the found to have sold interests in what turned brokerage firm receives no benefits from the out to be a $2.4 million Ponzi scheme. recognized transaction.36 The plaintiffs in Twiss were all persons that, under It is evident from the above discussion who became Kury’s clients after his resigna- that whether a brokerage firm may be liable tion from Hutton. The plaintiffs asserted neg- certain as a “control person” and whether the “good ligence claims, alleging that Hutton breached circumstances, faith” defense applies is a fact-intensive in- a duty to Kury’s then and future custom- a brokerage quiry. As a result, even in “selling away” ers when it misrepresented the reasons for cases where a brokerage firm was complete- Kury’s termination and failed to submit a firm can be ly mislead by its broker, it can be difficult proper and accurate Form U-5 to the regula- liable for the to convince a court to dismiss an investor’s tory authorities. On appeal, the court found actions of a claim on the pleadings and some discovery that Florida law imposed a duty “to report likely will be warranted. the fact of [Kury’s] termination to the [state former broker agency], to accurately state the reason for even after Liability For Foreseeable Harm such termination, and to specify any illegal After Termination or unprofessional activity committed…then the broker Beyond being liable for the actions of a cur- known by Hutton. The rule required Hut- is no longer rent broker, some courts have recognized ton to make the report to the Department by 39 associated that, under certain circumstances, a broker- filing a form U-5.” Thus, Hutton was liable age firm can be liable for the actions of a for- to the plaintiffs even though they had never with the mer broker even after the broker is no lon- been Hutton’s customers. brokerage firm. ger associated with the brokerage firm. For Like Florida, the NASD bylaws impose example, imagine a situation where a bro- the same duties to file and later correct Form kerage firm discovers its broker is violating U-5 disclosures.40 In a Notice to Members is- the rules or is engaged in some other activity sued in 1988, the NASD explained that one that could potentially harm investors (such purpose of the obligation to provide accu- as engaging in unreported outside business rate information on the Form U-5 is that the activities or selling away) and then fails to “[f]ailure to provide this information may [] take steps to remedy the harm or to notify subject members of the investing public to other brokerage firms that may be looking to repeated misconduct and may deprive mem- hire the broker engaged in the wrongful con- ber firms of the ability to make informed hir- duct. In this circumstance, a brokerage firm ing decisions.”41 Subsequently, in 2004, the SECONDARY LIABILITY AND “SELLING AWAY” IN SECURITIES CASES 53

NASD reinforced the importance of filing If an agent registered under this timely and accurate Form U-5’s, and cor- act terminates employment by or rections when necessary, by increasing the association with a broker-dealer or NASD’s enforcement options for the failure issuer,…the broker-dealer, invest- to timely submit amendments to the U-5.42 ment adviser, or federal covered The Twiss claim, however, is not an effort investment adviser shall promptly to imply a cause of action under the Florida file a notice of termination. If the reg- securities act or the NASD/FINRA rules. istrant learns that the broker-dealer, Rather, the reporting requirements of the issuer, investment adviser, or federal Florida act, as well as the NASD and FINRA covered investment adviser has not rules, inform the common law malfeasance filed the notice, the registrant may claim in defining the class of individuals to file the notice. whom the brokerage firm is liable for the The prior version of the Michigan Uniform subsequent misconduct of its broker. For ex- Securities Act contained a similar provi- ample, Twiss relied upon Palmer v Shearson sion.47 Lehman Hutton, Inc,43 where the court stated: Pursuant to MCL 451.2408(1), the state ad- The violation of a duty created by ministrator has adopted Form U-5, the Uni- statute is recognized at common law form Termination Notice for Securities Industry as satisfying the duty of care require- Registration, as the appropriate form to satisfy the In other ment in a negligence action, pro- requirements that the brokerage firm file a notice 48 words, a vided the injured party is in the class of termination. Thus, a brokerage firm has a the statute seeks to protect and the duty to file a U-5 with the State of Michigan brokerage injury suffered is the type the statute on the termination of its broker’s connection firm can was enacted to prevent. with the brokerage firm. A brokerage firm be liable …. also is under a continuing obligation to correct a U-5 to include matters that occur or …A statute creates a duty of care to another become known after the initial submission of upon one whose behavior is the sub- the form.49 brokerage ject of the statute to a person who is Further, in another context, Michigan firm that in the class designed to be protected courts have followed the reasoning in Palmer hires the by the statute, and that such duty that statutory obligations can inform and will support a finding of liability for identify the class of individuals who can broker in negligence when the injury suffered bring a common law malfeasance claim. For question for by a person in the protected class is example, in Transportation Dep’t v Christian- that which the statute was designed sen,50 the defendant was driving a flatbed negligence for 44 to prevent. truck loaded with machinery. The height of violating its Thus, the enactments and rules that re- the machinery was above the legal limit and duties. quire a brokerage firm to file a properly struck a highway overpass. The machin- completed Form U-5 inform the common ery was knocked off the truck and onto the law malfeasance claim of the parties who highway where it struck plaintiff’s vehicle. can bring a Twiss claim against the broker- The court noted that the “legal effect of [the age firm. Those parties are clearly investors defendant’s] violation of the statutory duty who are harmed by the broker’s subsequent of care, standing alone, would be enough to conduct. But other brokerage firms that hire establish a prima facie case of negligence.” the broker with no knowledge of the broker’s The court further explained, however, that prior wrongful activity may be as well be- this “presumption of negligence” could be cause one purpose of Form U-5 is to permit rebutted by applying the “statutory purpose subsequent employers to make informed hir- doctrine.” Under this doctrine, the court con- ing decisions.45 Thus, brokerage firms also sidered whether the statute was intended may be able to bring and prevail on claims to protect against the result of the violation, pursuant to Twiss.46 In other words, a broker- whether the plaintiff was within the class age firm can be liable to another brokerage intended to be protected by the statute, and firm that hires the broker in question for neg- whether the violation was the proximate con- ligence for violating its duties. tributing cause of the plaintiff’s injuries.51 Michigan law imposes the same duties These principles also would apply to a found in the Florida act and the NASD rules. brokerage firm accused of failing to complete For example, MCL 451.2408(1) states: an accurate Form U-5. The claimant’s com- 54 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

mon law negligence claim would be informed particularly challenging because the activ- by the statutory violations, and the success ity is necessarily done outside the brokerage or failure of such a claim would depend, in firm and typically done clandestinely. Ulti- part, on an analysis of whether the claimant mately, the incentives are clear, but no sys- is within the class of individuals protected by tem of supervision is bullet-proof—and the the statute. Other courts have either followed law does not require such a system, only a Twiss, reached a similar result, or endorsed reasonable one. its reasoning.52 To be clear, a Twiss claim properly understood is not simply the failure to report suspected or actual wrongdoing. Liability also can arise from the failure to take correc- NOTES tive action. A Twiss claim is grounded in a 1. See, e.g., NASD Notice to Members 03-71. Due common law malfeasance claim for failure to diligence obligations likely developed after the adoption of Section 11 of the Securities Act of 1933. A brokerage supervise. The malfeasance can be evinced in firm may not be liable under Section 11 of the Securities two different ways, each of which may be ac- Act of 1933 for misstatements or omissions of material tionable. First, the brokerage firm may have fact in a securities offering registration statement if it can prove that it had “after reasonable investigation, reason- had actual knowledge of a violation and took able grounds to believe and did believe” there were no no corrective action, thereby permitting the misstatements or omissions of material fact. violation to continue after the broker left the 2. For example, Financial Industry Regulatory Agen- brokerage firm. Second, the brokerage firm cy (“FINRA”) Rule 3040 prohibits associated persons from “participat[ing] in any manner in a private securi- may have knowingly failed to disclose the ties transaction” unless the associated person discloses to, activity on broker’s Form U-5 or otherwise and obtains approval from, the licensing brokerage firm. as required by the NASD/FINRA rules and This Rule distinguishes participation with or without compensation to the associated person. If the associated state regulation. person is to receive compensation, then he or she must Consequently, the first and fundamental have prior written approval of the licensing broker- element is that the brokerage firm knowingly age firm. If the associated person is not to receive any compensation, then he or she needs to provide written permitted the broker to engage in improper disclosure of their contemplated participation to his or conduct without taking steps to gain compli- her licensing brokerage firm prior to involvement in the ance. If the brokerage firm is guilty of such transaction. The purpose of prior notification is to allow the brokerage firm to prohibit or regulate the activity. conduct, then the brokerage firm may be lia- 3. Where appropriate, this article will cite federal ble for malfeasance. Further, while terminat- case law in addition to Michigan law because in many ing a broker may be a proper remedial action contexts, such as the Michigan Uniform Securities Act, for selling away activities, termination alone Michigan law is the same as or similar to federal law. Kirkland v EF Hutton & Co, 564 F Supp 427, 446 (ED is not sufficient. The focus is on the disclo- Mich 1983); Pukke v Hyman Lippitt, PC, No 265477, sure (or lack of disclosure) of the broker’s im- 2006 Mich App LEXIS 1801 (June 6, 2006). proper conduct on his Form U-5. A broker- 4. The pre-condition for such secondary theories of liability as vicarious liability is that there first is a finding age firm’s failure to disclose the real reason of primary violation. PR Diamonds, Inc v Chandler, 364 for the termination on the Form U-5 (instead, F3d 671, 696-97 (6th Cir 2004); Southland Secs v Inspire giving the broker a clean bill of health), can Ins Solutions, Inc, 365 F3d 353, 383 (5th Cir 2004) (“Control person liability is secondary only and cannot be the basis of liability. But it must be re- exist in the absence of a primary violation.”); Heliotrope membered that liability is not limited simply Gen, Inc v Ford Motor Co, 189 F3d 971, 978 (9th Cir to improper disclosure on the Form U-5. It 1999) (secondary liability as a controlling person cannot exist without a primary violation); SEC v First Jersey Secs, is first predicated upon the knowing failure Inc, 101 F3d 1450, 1472 (2d Cir 1996) (In order to find to take corrective action when the brokerage secondary liability, plaintiffs must show a primary viola- firm learns of the improper conduct. tion by the controlled person whom the controlling persons control.); Behrens v Wometco Enters, Inc, 118 FRD 534, 539 (SD Fla 1988) (“As with all secondary liability Conclusion under the securities laws, a primary violation of those In most cases, brokerage firms already take laws must first be found.”). great care to prevent their brokers from sell- 5. There can be no primary liability for any violation of regulatory rules because the courts generally have held ing away, and for good reason. Not only that there is no private right of action for violations of does selling away expose brokerage firms such rules. See, e.g., Vennittilli v Primerica, Inc, 943 F to possible secondary liability, but any cus- Supp 793, 798 (ED Mich 1996) (the “Sixth Circuit has held that there is no private cause of action for violation tomer funds that are invested in unapproved of National Association of Securities Dealers rules.”) investments necessarily are not invested in (citing Craighead v EF Hutton & Co, 899 F2d 485, 493 approved investments, which generate com- (6th Cir 1990)); Lantz v Private Satellite Television, 813 F Supp 554, 556 (ED Mich 1993) (“the Sixth Circuit missions for the brokerage firm. Supervision has held that these rules [NYSE and NASD] do not pro- and prevention of selling away activities is vide a private right of action.”). SECONDARY LIABILITY AND “SELLING AWAY” IN SECURITIES CASES 55

6. For examples of causes of actions against brokers trol) and with Mosley v American Express Financial Advi- under Michigan law, see R. Henney & M. Hindelang, sors, Inc, 256 Mont 27, 38, 230 P3d 479 (2010) (weigh- Investor Claims Against Securities Brokers Under Michigan ing Martin, Hollinger, and Hauser and concluding that Law, 28 Mich Bus L J 50 (Fall 2008). “as a general rule a broker-dealer controls its registered 7. 155 Mich App 230 (1986). representatives, whether directly or indirectly”). 8. Id. at 236. See also Cocke v Trecorp Enters, Inc, 28. Id. It may be questioned whether the disagree- No 198201, 1998 Mich App LEXIS 2311, *14 (Feb 20, ment noted in footnote 24 regarding whether a broker- 1998) (“summary disposition is appropriate ‘where it age firm is a “control person” of its brokers is really an is apparent that the employee is acting to accomplish a application of the “good faith” defense. The cases do not purpose of his own.’”). always make it clear. 9. Harrison v Dean Witter Reynolds, Inc, 974 F2d 29. See, e.g., Hunt v Miller, 908 F2d 1210, 1214 873, 891 (7th Cir 1992) (Harrison I) (dismissing inves- (4th Cir 1990). The analysis for “control person” liabil- tor’s vicarious liability claim because “[the brokerage ity is similar under both federal securities laws and under firm’s] rules expressly forbade” the acts in question). Michigan securities law. Kirkland v EF Hutton & Co, 10. Grewe v Mt Clemens Gen Hosp, 404 Mich 240, 564 F Supp 427, 446-47 (ED Mich 1983); Pukke v 253, 273 NW2d 429 (1978). Hyman Lippitt, PC, No 265477, 2006 Mich App LEXIS 11. Meretta v Peach, 195 Mich App 695, 698-699, 1801, *13 (June 6, 2007). 491 NW2d 278 (1992). 30. Harrison v Dean Witter Reynolds, Inc, 79 F3d 12. Id., at 699. 609, 615 (7th Cir. 1996) (Harrison II) (requiring a showing that the fraudulent activity was so obvious that 13. Sanders v Clark Oil Refining Corp, 57 Mich App the control person must have been aware of it). 687, 691, 226 NW2d 695 (1975) (“plaintiff’s belief in the agent’s authority ‘must be a reasonable one’”). 31. Harrison I, 974 F2d at 881. 14. See Harrison I, 974 F2d at 881 (dismissing 32. Id. See also Mosley, 356 Mont at 39 (ruling investor’s vicarious liability claim because “[the broker- after trial that no “control person liability existed and age firm’s] rules expressly forbade” the acts in question considering whether the broker acted in his role as a and because no “reasonably prudent person [could] nat- representative of the brokerage firm when he sold the urally suppose that [registered representative] possessed investment, whether the investment had any relation- the authority” for the acts in question). See also Sanders, ship to the brokerage firm or was an authorized product, 57 Mich App at 691-92. whether the purchase of the investment required access to a market through the firm, and whether the invest- 15. 2006 Mich App LEXIS 230 (Jan 24, 2006) ment was “the kind of investment for which a customer 16. 1993 US Dist LEXIS 7298 (CD Cal, Mar 30, typically relies on a broker with access through his firm 1993). to a stock exchange,” whether the investor received a 17. Kohn, 1993 US Dist LEXIS 7298 at *17. statement from the brokerage firm, whether the investor 18. Id. ever invested money through the brokerage firm, wheth- 19. 974 F2d at 884. er the investor was told it was an authorized product, 20. Id. and whether the brokerage firm had knowledge of or a 21. While there is no case in Michigan based on a financial interest in the investment). failure to supervise in the securities broker context, there 33. Kohn. are cases in the employer/employee context generally (see 34. Id. at *7-8 generally Millross v Plum Hollow Golf Club, 429 Mich 35. Id. at *8. 178, 192, 413 NW2d 17 (1987)), and other states have 36. See Harrison I; Harrison II; Kohn; Bradshaw v applied the doctrine to brokerage firms in the securities Van Houten, 601 F Supp 983, 906 (D Ariz 1985). context. Burns v Rudolph, 2005 Ohio App LEXIS 6222 37. 25 F3d 1551 (11th Cir 1994). (Ohio App 9 Dist, Dec 28, 2005). 38. A form U-5 is a disclosure required of brokerage 22. MCL 451.2509(7) (“The following persons are firms on the termination or departure of a broker. The liable jointly and severally with and to the same extent as form requires the brokerage firm to disclose (a) if the persons liable under subsections (2) to (6): (a) A person termination was for cause and why, (b) if the brokerage that directly or indirectly controls a person liable under firm was aware of any wrongful conduct of the broker at subsections (2) to (6), unless the controlling person sus- the time of the broker’s termination, or (c) if the broker- tains the burden of proving that the controlling person age firm was conducting an investigation of the broker at did not know, and in the exercise of reasonable care the time of his termination. could not have known, of the existence of the conduct by reason of which the liability is alleged to exist”). 39. Id. at 1556. Significant amendments to the Michigan Uniform 40. NASD Bylaws, Art. V, sec. 3(a) & (b) (note that Securities Act went into effect in 2009. See Public Act this rule remains applicable to brokerage firms after the 551. The previous “control person” liability statutes was FINRA merger); see also Andrews v Prudential Secs, Inc, MCL 451.810. 160 F3d 304, 305-06 (6th Cir 1998). 23. Mason v Royal Dequindre, Inc, 455 Mich 391, 41. NASD Notice to Members 88-67 (emphasis 397, 566 NW2d 199 (1997) (stating that a special supplied). relationship gives rise to an exception to the general 42. NASD Notice to Members 04-77. rule that there is no duty to protect someone from third 43. 622 So2d 1085, 1090 & n. 8 (Fla App Dist 1, parties). 1993). 24. NASD Rule 3010(a) (emphasis supplied). 44. Palmer, 622 So2d at 1090; see also Twiss, 25 25. In re William Lobb, NASD Compl. No F3d 1556 (examining whether plaintiffs “were within 07960105, p 5 (4/6/00) (emphasis supplied). the class of persons these provisions were designed to 26. MCL 451.2509(7). protect”). 27. Id. Compare Martin v Shearson Lehman Hutton, 45. See NASD Notice to Members 88-67. Inc, 986 F2d 242, 244 (8th Cir 1993) (status as employ- 46. See also Prudential Securities, Inc v Am Capital er of broker was sufficient to establish it as control Corp, 1996 US Dist LEXIS 7196 (NDNY May 15, person); Hollinger v Titan Capital Corp, 914 F2d 1564, 1996) (holding that a brokerage firm’s claim against 1573-76 (9th Cir 1990) (same) with Hauser v Farrell, another brokerage firm for having “violated its duty to 14 F3d 1338 (9th Cir 1994) (recognizing that a broker’s inform defendant of” factors leading to its employee’s conduct is not always within the brokerage firm’s con- termination on the Form U-5, and that “it would not 56 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

have registered [the employee] as its representative, and Raymond W. Henney is a hence would not have incurred liability…,” is arbi- partner of Honigman Miller trable). Schwartz and Cohn LLP and 47. MCL 451.601(b) of the previous version of the securities act stated: “When an agent begins or ter- is Co-Chair of the firm’s Secu- minates a connection with a broker-dealer or issuer, or rities and Corporate Gover- begins or terminates those activities that make him or nance Litigation Group. her an agent, the agent as well as the broker-dealer or issuer shall immediately notify the administrator in writing on a form prescribed by the administrator.” 48. MCL 451.2605 delegates to power to issue form to the administrator. the Department of Energy, Labor & Economic Growth’s website contains the Form U- 5. Under the former securities act, § 451.601(b), the administrator had adopted Rule 451.602.2(2), which Andrew J. Lievense is an stated that: “A notice of agent termination shall contain the information specified in U-5.” This Rule is still in associate of Honigman Mill- effect while the state agency adopts new rules imple- er Schwartz and Cohn LLP menting the updated securities act. and concentrates his prac- 49. See the Instructions to the Form U-5. Also, tice in general commercial MCL 451.603 of the former securities act stated that “If litigation, including repre- the information contained in any document filed with senting securities brokerage the administrator is or becomes inaccurate or incomplete in any material respect, the registrant shall promptly firms in disputes with investors in federal file a correcting amendment unless notification of the court, state court, and FINRA arbitration correction has been given under section 201(b).” While proceedings. this language appears to have been removed from the updated securities act, brokerage firms are still under an obligation to disclosure new information and file an amended U-5. 50. 229 Mich App 417, 420 (1998). 51. Id. 52. See, e.g., Prymak v Contemporary Fin Solutions, 2007 US Dist LEXIS 87734 (D Colo Nov 29, 2007) (recognizing a negligence claim against a securities dealer based on its failure to fulfill its statutory duty of filing a truthful Form U-5, but rejecting a private right of action for a violation of the requirement); SII Investments, Inc v Jenks, 2006 US Dist LEXIS 51753 (MD Fla July 27, 2006) (affirming arbitration award where SII failed to make numerous required disclosures on a Form U-5 relating to its employee who later sold unregistered securities to claimant); Palmer v Shearson Lehman Hutton, Inc, 622 So2d 1085 (Fla App Dist 1, 1993). One state court has rejected Twiss where a state statute existed that expressly “prohibits the recognition of an private-party state law statutory civil tort liability.” Ugarte v Atlas Sec, Inc, 2004 Cal App LEXIS 1721 *18 (Cal App 3 Dist, Apr 1, 2004). The History and Future of Michigan Debtor Exemptions

By Thomas R. Morris

Michigan has both a general debtor-exemp- trict courts) were stated with yet another tions statute and a bankruptcy-specific stat- variation.5 Another 1809 law provided for an ute. The bankruptcy-specific exemptions, exemption not referenced in contemporane- MCL 600.5451, have been held unconstitu- ous acts on the subject. “Arms, ammunition tional. The general judgment-debtor exemp- and accoutrements,” required under an 1809 tions, MCL 600.6023, have not kept pace with militia law to be kept by “every free, able inflation or with changes in property owner- bodied white male inhabitant” were exempt ship. under that militia statute.6 That exemption, This article examines the history of Michi- unlike the militia, remains in effect. gan and federal bankruptcy exemption law Later versions of the territorial exemption and examines the options for changes to provisions show evidence of more legislative Michigan’s law. care, but the list of exempt property shifted Territorial Laws every few years. In 1821, the law concerning executions became more detailed.7 The 1821 In 1787, with the enactment of the Northwest law was more generous, allowing, for exam- Ordinance, what is now Michigan became ple, for twenty sheep, provisions necessary part of the “Territory of the United States for one year, and a detailed variety of books.8 northwest of the River Ohio.” In 1805, Michi- In 1825, the exemptions enacted in 1821 were gan achieved status as a territory. expanded.9 In 1827, the number of sheep was Michigan’s territorial government soon trimmed to ten.10 A separate statute “for the adopted laws on debtor-creditor relations, but the laws of Michigan’s pioneer days had relief of insolvent debtors” was enacted on a haphazard quality. One of the first laws en- the same date in 1827, yet it provided less acted in 1805 by the new territorial govern- comprehensive exemptions for debtors sub- 11 ment concerned debtors imprisoned for debt. ject to its provisions. In 1828, the 1825 ex- A debtor who had been discharged from emptions were revived with respect to claims debtor’s prison was allowed the following that accrued prior to January 1, 1828, and dif- exemptions with respect to future collections ferent exemptions were made applicable to by his judgment creditors: claims that accrued after January 1, 1828.12 his wearing apparel and household No provision was made for claims that ac- furniture necessary for himself, his crued on January 1, 1828. In 1833, this tempo- wife and children, and tools neces- ral dichotomy ended.13 sary for his trade or occupation….1 In 1807, an exemption of just “one cow and Statehood one sheep” was provided with respect to Following statehood on January 26, 1837, judgments issued by district courts.2 The the existing exemptions were adopted in the first general exemption law was enacted in Revised Statutes of 1838. The quality and con- 1809, which allowed for more sheep but did sistency of legislation in this field improved. not provide a “tools of the trade” exemption According to Justice Potter (writing in found in the law providing for a discharge 1935), Michigan’s debtor-creditor law was from debtor’s prison: influenced by the state of the economy: one cow and ten sheep, and such suit- [With the Panic of 1837] ‘The able apparel, bedding, tools, arms, fancy values of landed proper- and articles of household furniture ty melted like snow in the April as may be necessary for upholding sun…one manufactory after another life….3 stopped, and the number of those In 1810, the court system was altered.4 Exemp- who could find neither bread nor tions related to judgments issued by justices work increased by thousands and (whose jurisdiction replaced that of the dis- tens of thousands.’ 57 58 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

The panic of 1837…bore particularly son to carry on the profession, trade, hard upon the people of Michigan…. occupation, or business in which he To extricate themselves from their is wholly or principally engaged, not situation, the Legislature in 1842 exceeding in value two hundred and passed…the first exemption law fifty dollars; relating to personal property in this 9. A sufficient quantity of hay, grain, feed State worthy of the name.14 and roots for properly keeping for six Indeed, in 1842, personal property exemp- months the animals in the several sub- tions were again expanded, and the value divisions of this section exempted from limits were increased several fold.15 But execution, and any chattel mortgage, when the numerous versions of the personal bill of sale, or other lien created on any property exemptions from the late territorial part of property above described, except era are considered, it is evident that the 1842 such as is mentioned in the eight sub- statute included little new material. Given division of this section, shall be void, that much of the development of Michigan unless such mortgage, bill of sale or lien exemption law took place in the late 1820s be signed by the wife of the party mak- and early 1830s, which were a time of nation- ing such mortgage or lien, (if he have al prosperity and of rapid growth in Michi- one). With the gan,16 the connection, perceived by Justice In 1848, the first homestead exemption Potter during the Great Depression, between was enacted. Before its enactment, a judg- adoption hard times and exemption laws, is vague. ment debtor was afforded a one-year redemp- of the In 1846, with the adoption of new Revised tion period following an execution against a Constitution Statutes, the cumbersome 1842 list of exemp- homestead, and the property would not be tions was reorganized and simplified. The sold on execution if the rent or profits could of 1850, list is repeated here because it is recognizable pay the judgment within seven years.18 The exemptions in our current non-bankruptcy statute. 1848 law provided for a homestead of up to 1. All spinning-wheels, weaving-looms 40 acres or, if located in a city or village, one were given an with the apparatus, and stoves put lot.19 There was no dollar-value limit to the elevated legal up and kept for use in any dwelling- exemption. status house; With the adoption of the Constitution of 2. A seat, pew, or slip, occupied by such 1850, exemptions were given an elevated le- by being person or family, in any house or place gal status by being constitutionally guaran- constitutionally of public worship; teed. Personal property was to be exempt in guaranteed. 3. All cemeteries, tombs, and rights of an amount not less than $500. The 1850 Con- burial, while in use as repositories of the stitution modified the homestead exemption dead; by limiting it to $1,500 in value.20 4. All arms and accoutrements required by During the remainder of the nineteenth law to be kept by any person; all wear- century, despite several financial recessions ing apparel of every person or family; and panics, the exemption laws received little legislative attention. An exemption for a 5. The library and school books of every sewing machine was added in 1861.21 An ex- individual and family, not exceeding emption for shares in a building and loan as- one hundred and fifty dollars, and all sociation was added in 1887.22 Other changes family pictures; during this period of time were technical.23 6. To each householder, ten sheep, with their fleeces; and the yarn or cloth man- The Twentieth Century ufactured from the same; two cows, During the first eighty years of the twentieth five swine, and provisions and fuel for century, Michigan exemption law changed comfortable subsistence of such house- in small increments. The Constitution of 1908 holder or family for six months; retained a separate article concerning exemp- 7. To each householder, all household tions.24 It kept in place the same minimum goods, furniture, and utensils, not for personal property and raised the home- exceeding in value two hundred and stead exemption to $2,500. Minor changes fifty dollars; to the exemption law were enacted in 1929 8. The tools, implements, materials, stock, (raising dollar amounts)25 and 1939 (adding apparatus, team, vehicle, horses, har- disability benefits).26 Procedural changes re- ness, or other things, to enable any per- garding the homestead exemption were THE HISTORY AND FUTURE OF MICHIGAN DEBTOR EXEMPTIONS 59 made in 1945.27 In 1961, dollar amounts were rated exemptions allowed by state law as of raised, other minor changes were made, and the date of the petition.38 the list was codified at MCL 600.6023.28 The The long run of the 1898 Act ended in Constitution of 196329 raised the homestead 1978 with the adoption of the current Bank- to a minimum of $3,500 and personal proper- ruptcy Code.39 The Bankruptcy Code allows ty to a minimum of $750. MCL 600.6023 was each debtor (or married couple) a choice of amended accordingly to raise the homestead either (i) the exemptions available under amount.30 state and federal nonbankruptcy law, or (ii) The most significant twentieth century the exemptions specified in the Bankruptcy additions to the exemption statute were en- Code.40 Each state, however, is permitted to acted in the 1980s. In 1984, MCL 600.6023 was “opt out” of the federal exemptions and re- amended to add an exemption for an IRA.31 strict its residents to exemptions allowed un- Funds held in 401(k) and other accounts der state law. “qualified” under the Internal Revenue Code Michigan has not opted out of the federal and were added in 1989.32 These additions exemptions, so Michigan residents have a resulted from the growth in tax-favored de- choice between the “state” and “federal” ex- 41 fined-contribution retirement savings plans. emptions. Currently, the federal exemptions Although the exemption statute changed are more generous for most debtors, but the in small steps over the last century, that relative advantages of each set of exemptions Although the vary between debtors and have varied over period of time was an era of great growth in exemption statutory law. Exemption law made its own time with changes to each set of exemptions. With bankruptcy exemptions now provided contribution to this growth: statutes sepa- statute for under the Bankruptcy Code, exemptions rate from the general exemption statute were provided in Michigan law are invoked in changed in added to allow exemptions for insurance pol- fewer cases. They are nevertheless impor- icies, public-employee pensions, and welfare small steps tant for Michigan bankruptcy debtors who and veterans’ benefits.33 A separate scheme over the last choose the state exemptions, such as a mar- for exemptions is contained in the State Cor- ried debtor without joint debt and with sub- century, that rectional Facility Reimbursement Act.34 Thus, stantial assets held in tenancy by the entirety. many of the twentieth century additions to period of time They also apply to debtors who are not eli- exemption law are not contained in the gen- gible for bankruptcy relief or who choose not was an era of eral exemption statute. to seek it. great growth A Brief History of Bankruptcy Michigan’s Bankruptcy-Specific in statutory Exemptions Exemption Statute law. The first two federal bankruptcy acts speci- The latest change to Michigan exemptions fied their own exemptions. Those exemp- resulted in the adoption of the bankruptcy- tions were less comprehensive than the specific exemptions codified in MCL 600.5451. contemporary Michigan exemptions. The The process from which the bankruptcy- Bankruptcy Act of 1800 allowed for only “his specific exemptions resulted was described or her necessary wearing apparel, and the recently by Judge James Gregg: necessary wearing apparel of the wife and In 2001, an Advisory Committee to children, and necessary beds and bedding of the Civil Law and Judiciary Subcom- 35 such bankrupt.” The Act of 1800 remained mittee of the House Civil and Judi- in effect until December 1803. The next bank- ciary Committee of the Michigan ruptcy law was in effect from 1841 to 1843, Legislature (“Advisory Commit- and it provided exemptions that were slight- tee”) was formed to review and, if ly more generous.36 appropriate, provide recommenda- The Bankruptcy Act of 1867 provided ex- tions to update the property exemp- emptions that included the types of necessi- tion laws. The Advisory Committee ties that had been exempt under the 1841 Act, labored for two years before issu- but it also allowed property to be exempt un- ing a Report and Recommendations der state law.37 The 1867 Act remained in ef- to the Subcommittee (“Report and fect until 1878. Recommendations”). The Report The next bankruptcy law was the Bank- and Recommendations suggested ruptcy Act of 1898. The 1898 Act did not pro- many changes to the general Michi- vide federal exemptions, but rather incorpo- gan exemption statute, § 600.6023, 60 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

including an increase in the $3,500 MCL 600.5451. This presents several prob- Michigan homestead exemption to lems. First, any debtor who plans his or her $30,000 ($45,000 if the debtor or a affairs in reliance on the bankruptcy-specific dependent of the debtor was over 65 exemptions, or who invokes them in a bank- or disabled). The Report and Recom- ruptcy case, may be surprised, and his or her mendations did not recommend lim- counsel embarrassed, when the bankruptcy itation of these new exemptions only court disallows the exemptions. Second, the to bankruptcy proceedings. Report state exemptions are important for certain and Recommendations of the Advisory bankruptcy debtors, in particular married Committee Regarding Proposed Modifi- persons hoping to use the tenancy-by-the- cations to the Michigan Exemption Stat- entirety exemption. utes, the Purpose and Policy of Michigan The other arguable defect in Michigan’s Exemption Laws (August 11, 2003). exemption law is the failure of the general With few changes, the new (non-bankruptcy) exemptions to keep up exemptions suggested by the Report with inflation and with changes in property and Recommendations were adopt- ownership. As discussed in Pontius, the 2003 ed by the Michigan Legislature in legislative advisory committee acknowl- 2004, to be effective on January 3, edged the need to update the exemptions. 2005, as § 600.5451. However, the Leg- But the bankruptcy-specific statute absorbed islature limited the application of the law the impetus to improvement and left the gen- only to proceedings involving “[a] debt- eral provision neglected. The dollar-amount or in bankruptcy under the Bankruptcy exemptions (such as $1,000 in furnishings Code.” Applying the new statutory and a $3,500 homestead) are smaller in rela- exemptions only to federal bank- tive value than ever before. There is no ex- ruptcy proceedings was without emption for medically-prescribed devices, or explanation in either the legislative for an automobile other than as a “tool of the history or the Advisory Committee trade.” Further, there have been vast chang- records. [Citation omitted].42 es to the types and amounts of property re- One explanation for the adoption of the quired for a debtor and his or her household bankruptcy-specific provision is that it rep- to live productively and self-sufficiently. resented a compromise between the propo- Michigan’s non-bankruptcy homestead ex- nents and opponents of liberalized exemp- emption, which was one of the first if not the tions. The opponents, taking into consid- first in the nation, at $3,500, is the now the eration the interests of creditors, collection lowest among those states with a homestead attorneys, and court officers, resisted change exemption. (The median homestead exemp- to the general exemptions, but they were less tion under state law is approximately $50,000. concerned with exemptions in bankruptcy. Maryland, Delaware, Pennsylvania and New The proponents may have felt that modern- Jersey have no non-bankruptcy homestead ization of the bankruptcy exemptions was exemption). the priority. As is further explored below, it If the bankruptcy-specific statute is even- is also possible to question the role of non- tually upheld by the Sixth Circuit or the bankruptcy exemptions in the current sys- United States Supreme Court, the remaining tem of debtor-creditor law. question will be whether the non-bankruptcy exemptions require updating. The useful- Defects in Michigan’s Exemption ness of exemptions outside of bankruptcy Law is debatable. In the nineteenth century, Judge Gregg, in In re Pontius (quoted above), bankruptcy relief was not widely available. found MCL 600.5451 to be unconstitution- The federal bankruptcy statutes were in ef- al. Two other bankruptcy judges have also fect for only about 20 years in that century, reached this conclusion.43 Judge Dales, also of and the first bankruptcy act was applicable the bankruptcy court for the Western District only to merchants and traders.46 The central- of Michigan, more recently upheld the stat- ity of state exemptions continued with the ute against a constitutional challenge.44 Some first “permanent” bankruptcy law, the 1898 other states’ bankruptcy-specific exemptions bankruptcy act, which relied on state exemp- have been upheld,45 so the constitutional tions.47 In 1979, when the current Bankruptcy issues can be debated. Nevertheless, the exis- Code became effective, federal exemptions tence of these issues undermines reliance on became an option for the first time since THE HISTORY AND FUTURE OF MICHIGAN DEBTOR EXEMPTIONS 61

1843.48 Bankruptcy relief is now widely avail- NOTES able, although somewhat restricted following 1. An act for the relief of poor prisoners who are the 2005 amendments that added the means committed by execution for debt, §4, Laws of the Ter- 49 ritory of Michigan (Lansing: WS George & Co, 1871- test. With the prevalence of bankruptcy as 84), (hereafter LTM), vol 1, p 83, 87 (Oct 4, 1805). an option for persons with unmanageable 2. An additional act concerning district courts, §12, debt and the availability to Michigan resi- LTM, vol 2, p 7, 9 (April 2, 1807). dents of the federal bankruptcy exemptions, 3. An act concerning executions, §2, LTM, vol 4, p 57, 58 (Feb 18, 1809). state-law exemptions have diminished in im- 4. An act to abolish the courts of districts, and to portance. They are nevertheless useful, for define and regulate the powers, duties and jurisdiction of example, to an elderly person whose only in- justices in matters civil and criminal, § 7, LTM, vol 4, p come is social security (exempt under federal 98, 99 (Sept 16, 1810). 5. Id. See also An act to regulate and define the law) and who otherwise would not need to duties and powers of Justices of the Peace and Con- file bankruptcy. The arguments against more stables, in civil cases, §30, LTM, vol 1, p 604, 620 (May liberal non-bankruptcy exemptions include 20, 1820). the argument that it is not bad policy to force 6. An act concerning the Militia of the Territory of Michigan, § 1, LTM, vol 2, p 47 (Feb 10 1809); An act a debtor seeking relief into bankruptcy since to provide for organizing and disciplining the Militia, § bankruptcy is a comprehensive remedy with 1, Laws of the Territory of Michigan (Detroit: Sheldon both relief for debtors and protections for & Reed, 1820), (hereafter LTM 1820), p 177 (April 20, 1820). creditors. 7. An act subjecting Real Estate to the payment of debts, and concerning Executions, LTM, vol 1, p 860 Options Available (April 5, 1821), LTM 1820 p 429. The Business Law Section of the State Bar, 8. Id, §20. 9. An act to amend an act entitled “An act subject- through its Debtor/Creditor Rights Com- ing real estate to the payment of debts, and concerning mittee, has addressed the constitutional and executions”, LTM, vol 2, p 234 (March 30, 1825). reform issues. The following options for a 10. An act concerning Judgments and Executions, § resolution of the crisis caused by the rulings 25, LTM, vol 2, p 487, 492 (April 12, 1827). invalidating the bankruptcy-specific statute 11. An act for the relief of insolvent debtors, §16. LTM, vol 2, p 396, 403 (April 12, 1827). have been identified: 12. An act to amend an act entitled “An act con- 1. Obtain a ruling from the court of appeals cerning Judgments and Executions”, LTM, vol 2, p 703 upholding Jones/ Schafer and overruling (July 3, 1828). Pontius and Wallace and retain the cur- 13. An act to amend an act entitled “An act concerning Judgments and Executions”, § 2, LTM, vol 3, p rent statutes basically as they are today. 1073 (April 20, 1833). Judges Gregg and Hughes may have 14. Kleinert v Lefkowitz, 271 Mich 79, 83, 259 NW correctly decided the constitutional 871, 872 (1935). issue, in which case, the second option 15. 1842 PA 48, repealed by Revised Statutes1846, title 33, ch 173, § 1. would deserve more serious consider- 16. Finkelman, Paul and Hershock, Martin, eds, ation. The History of Michigan Law (Athens: Ohio U Press 2. Merge MCL 600.5451 and 600.6023, rais- 2006), ch 2, p 38. ing the general exemptions to the levels 17. Revised Statutes 1846, title 22, ch 106, § 27. 18. An act subjecting Real Estate to the payment of currently only available in bankruptcy. debts, LTM, vol 2, p 42 (Feb 4 1809); An act subject- This would resolve the constitutional ing Real Estate to the payment of debts, and concerning issue presented by the bankruptcy-spe- Executions, § 4, LTM, vol 1, p 860 (April 5, 1821), LTM 1820, p 429. cific statute. Language for such a pro- 19. 1848 PA 109, Compiled Laws 1871, ch 198, posal has been prepared by the Debt- §6137 . or/Creditors Rights Committee of the 20. Const 1850, art 16. Business Law Section of the State Bar, 21. 1861 PA 143, Compiled Laws 1871, ch 198, but the proposal has not yet resulted in §6132. legislation. 22. 1887 PA 50, § 16. 23. See 1849 PA 185; 1863 PA 156; 1893 PA 43. 24. Const 1908, art 11. Conclusion 25. 1929 PA 87. At present, to rely on the bankruptcy-specific 26. 1939 PA 225. state exemptions is to skate on thin ice. Any 27. 1945 PA 14. bankruptcy debtor who chooses the state 28. 1961 PA 236, Ch 60, § 6023, eff Jan 1, 1963. exemptions should be advised to be prepared 29. Const 1963, art 10, §3. to rely on other exemptions if challenged. 30. 1963 PA 40. 31. 1984 PA 83, MCL 600.6023(1)(k). A liberalization of the general state exemp- 32. 1989 PA 5, MCL 600.6023(1). tions should be considered, but opposition 33. Other exemptions are listed in section 3 of the by creditor groups should be expected. proposal. 62 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

34. 1935 PA 253; 1984 PA 282, MCL 800.401 et Thomas R. Morris is a mem- seq. ber of the West Bloomfield 35. Bankruptcy Act of 1800, § 5, 2 Stat 19 firm of Silverman & Morris, 36. Bankruptcy Act of 1841, § 3, 5 Stat 440. P.L.L.C. His firm concen- 37. West Bankruptcy Exemption Manual, § 1.01(c); trates its practice in the areas 14 Stat 517. 38. West Bankruptcy Exemption Manual, § of bankruptcy, commercial 1.01(d); 30 Stat 544. law, workouts, bankruptcy 39. 11 USC 101 et seq., eff October 1, 1979. litigation, and similar matters, and repre- 40. 11 USC 522(b). sent both debtors and creditors, as well as 41. MCL 600.5451. landlords, financial institutions, and ordi- 42. In re Pontius, Opinion Regarding Constitutional- nary businesses. Mr. Morris is a member ity of Michigan Bankruptcy Specific Exemptions, 08-04124 of the Council of the Business Law Sec- (Bankr WD Mich, Dec 22, 2009), at 3-4. Available at tion and the Debtor/Creditor Rights Com- miwb.uscourts.gov/opinions. mittee, but the opinions expressed herein 43. In re Wallace, 347 BR 626 (Bankr WD Mich 2006), and In re Vinson, 337 BR 147 (Bankr ED Mich are his own. 2006), rev’d 347 BR 620 (ED Mich 2006). given to the author. 44. In re Dorothy Ann Jones and In re Steven M. Schafer, Opinion and Order Regarding Constitutionality of Exemption Statute, 09-09415 and 09-03268 (Bankr WD Mich, April 22, 2010). Those cases are on appeal. 45. See e.g. In re Peveich, 574 F3d 248 (4th Cir. 2009). 46. Bankruptcy Act of 1800, § 1, 2 Stat 19. 47. Bankruptcy Act of 1898, § 6, 30 Stat 544. 48. 11 USC 522. 49. 11 USC 707.

This version is dated April 27, 2010. The author may continue to update this article. A copyright is claimed, but permission is granted to copy and disseminate the article for educational purposes and ICE Steps Up Its Aggressive Employer Audit Campaign: The Use of Forfeiture Laws to Seize the Assets of Businesses Employing Illegal Aliens

By James G. Aldrich

Background On November 19, 2009, ICE announced In a departure from the Bush-administration the issuance of an additional 1,000 NOIs to emphasis on worksite raids, United States employers across the United States “associ- Immigration and Customs Enforcement ated with critical infrastructure.” ICE stated (“ICE”) announced on July 1, 2009, that it that the 1,000 entities that received NOIs had issued Notices of Inspection (“NOI’s”) to were selected based on “investigative leads 652 businesses nationwide requesting their and intelligence” and because of the busi- employment eligibility verification documen- ness’ “connection to public safety and na- 8 tation.1 The action stemmed from the direc- tional security.” Although this might sound tions issued by Secretary Janet Napolitano, of like an effort aimed at preventing terrorism, the United States Department of Homeland at least some of the notices were directed to Security (“DHS”), to immigration enforce- agricultural and other companies employing ment authorities to “apply more scrutiny to low-skill labor. the selection and investigation of targets as Under federal law and regulations, em- well as the timing of raids.”2 ployers are required to complete and retain Under its new strategy, ICE stated it a Form I-9 for each individual they hire for would focus its resources on the auditing employment in the United States. Form I-9 and investigation of employers suspected of requires employers to review and record the cultivating illegal workplaces by knowingly individual’s identity and employment eligi- employing illegal workers instead of reli- bility document(s), and to determine wheth- ance on workplace raids.3 These notices are er the document(s) reasonably appear to be intended to alert business owners that ICE genuine as well as related to the individual.9 would be inspecting their hiring records to An additional method for employers to determine whether they are complying with verify employment eligibility is through the employment eligibility verification laws and use of the E-Verify program. This is an online regulations. ICE stated it believes these in- system that accesses Homeland Security and spections are one of the most powerful tools Social Security databases and can provide the federal government has to enforce em- almost instant confirmation of a worker’s ployment and immigration laws, and it has ability to work in the United States. How- indicated its increased focus on holding em- ever, the USCIS has announced it intends to ployers accountable for their hiring practices begin data-mining the information it obtains and efforts to ensure a legal workforce.4 Im- through E-Verify to identify patterns of mis- migration officials stated the notices are the use and fraudulent documentation.10 “first step in ICE’s long-term strategy to address and deter illegal employment.”5 Forfeiture and Other Risks for ICE has confirmed the 652 businesses re- Business Owners and Managers ceiving NOI’s were not selected randomly, Not only has the U.S. government changed but rather as a result of leads and informa- its approach to investigating employment tion obtained through other investigative eligibility compliance by U.S. employers, it means.6 The names of the companies were has stepped up the penalties it seeks when not released. In Fiscal Year 2008, ICE issued it finds violations. Federal authorities have 503 similar notices throughout the year.7 begun taking the unusual step of seeking the 63 64 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

forfeiture of an actual business (and/or its sub-contracting to hire illegal aliens from assets) that is suspected of employing illegal August 2006 through April 2008. aliens.11 The French Gourmet, a San Diego- The court ordered Taylor to forfeit to the area bakery, its president, and a manager government $185,363, which represented were charged in April 15, 2010, with conspir- the amount of proceeds obtained as a result ing to engage in a pattern or practice of hir- of the offense and to pay a fine of $36,000, ing and continuing to employee unauthor- representing a $3,000 fine for each of the 12 ized workers (a misdemeanor) and 14 felony illegal aliens who worked under company counts, including making false statements supervision. A company supervisor also and shielding undocumented alien employ- pleaded guilty in a separate but related case ees from detection. In addition to imprison- to harboring illegal aliens. Taylor was also ment and fines, the government is also seek- sentenced to serve five years of probation, to ing forfeiture to the United States assets used implement an employment-compliance plan, in or derived from the alleged illegal activi- and to pay the $185,363 forfeiture amount ties including the restaurant itself and the in monthly installments during the first 30 property on which it sits.12 months of probation.16 According to the indictment, the owner and managers certified on the firm’s Em- Hanover, Maryland Restaurant ployment Verification Forms (I-9) that the On February 16, 2010, the owner of a Hanover, Under federal documents they examined appeared to be Maryland Chinese restaurant was arrested law and genuine, and to the best of the their knowl- and charged with transporting, employing, edge, the employees listed on the I-9 were and harboring illegal aliens. The criminal regulations, eligible to work in the United States. They complaint alleges that, between January 2009 employers then placed the workers on the company’s and February 4, 2010, Yen Wan Cheng know- are required payroll and paid them by check until they ingly hired aliens who were not authorized received “No Match” letters from the Social to work in the United States, transported the to complete Security Administration (SSA) advising that aliens to their jobs, and harbored them in and retain a the Social Security numbers being used by residences she provided. According to the the employees did not match the names of criminal complaint, five aliens were specifi- Form I-9 the rightful owners of those numbers. The in- cally identified during the investigation as for each dictment also alleges that after receiving the working at the restaurant and residing in a individual “No Match” letters, the company conspired home Cheng owns in Columbia, Maryland. to pay the undocumented employees in cash She faces a maximum sentence of three years they hire for until the workers produced a new set of em- in prison for employing illegal aliens and five employment ployment documents with different Social years in prison each for transporting illegal Security numbers.13 aliens, harboring aliens, and harboring aliens in the United In May 2008, ICE agents executed a search for financial gain.17 States. warrant at The French Gourmet and arrested 18 undocumented workers. The men face up Reno, Nevada Electronics Firm to five years in prison and a fine of $250,000 On March 4, 2010, the owner of a Reno elec- on each count.14 tronics manufacturing company was indict- ed by a federal grand jury on six counts of Other Recent Enforcement Actions encouraging illegal aliens to reside in the ICE has reported that in Fiscal Year 2009, United States and aiding and abetting them. worksite investigations resulted in a total According to the indictment, between March of 410 criminal arrests, including 114 man- 2005 and May 2009, Hamid Ali Zaidi, owner agement personnel.15 In addition, it has of Vital Systems Corporation, allegedly announced these recent enforcement actions: encouraged six illegal aliens to work at his company and therefore to reside in the Unit- Missouri Roofing Company ed States, knowing that such residence was On February 3, 2010, the owner of a Bolivar, in violation of federal law. If convicted, Zaidi Missouri, roofing company was sentenced faces up to five years in prison and a $250,000 in federal court to forfeit more than $180,000 fine on each count.18 and pay a $36,000 fine for knowingly hiring illegal aliens following a worksite enforce- Illinois Staffing Companies ment investigation conducted by ICE. Rus- On April 26, 2010, in federal court in the sell D. Taylor pleaded guilty September 14, Northern District of Illinois, the president 2009, to knowingly hiring, contracting, and and office manager of two Bensenville, Illi- ICE STEPS UP AGGRESSIVE EMPLOYER AUDIT CAMPAIGN 65 nois staffing companies were charged with Inc. were arrested during the investigation, illegally employing illegal aliens to staff their and six were later charged with various crim- customers’ needs. Clinton Roy Perkins, and inal offenses related to document fraud and Christopher J. Reindl, president and office re-entry after deportation.20 manager, respectively, of Anna II Inc., and Can Do It Inc., were charged with one count Maryland Painting Company of unlawfully hiring illegal aliens between Robert T. Bontempo, owner of Annapolis October 2006 and October 2007. In addition Painting Services (APS) pleaded guilty on to employing illegal workers, the defendants April 23, 2009, to employing illegal aliens and are alleged to have paid wages in cash and money laundering. He admitted to know- failed to deduct payroll taxes or other with- ingly hiring and employing these people, holdings. Federal authorities also seek for- failing to properly document them, and pay- feiture from Perkins of $488,095, seized from ing them with cash.21 He was sentenced to various company bank accounts, as well as six months confinement in a halfway house the Bensenville office. as part of three years probation. As part of Both defendants allegedly failed to require his plea agreement, he forfeited five bank the aliens that Perkins hired to provide docu- accounts, ten vehicles, and seven properties ments establishing their immigration status purchased with the profits from his painting or lawful right to work in the United States. business. These assets were estimated to be 22 Employers In addition, they are alleged to have directed worth over $1,000,000. low-level supervisory employees to transport who fail to Other Penalties illegal workers back and forth between loca- document the tions. Both also allegedly provided fake six- Employers who fail to document the employ- digit numbers to a client, claiming they were ment eligibility of their employees (or who employment the last six digits of the aliens’ Social Security do it improperly) can also be liable for civil eligibility charges and penalties. numbers, knowing the workers were present of their in the United States illegally and lacked valid Hiring or Continuing to Employ Social Security numbers. employees Unauthorized Aliens They also, allegedly, repeatedly with- (or who do it If DHS determines that the employer has drew funds in the amount of $9,800 from improperly) bank accounts to pay their employees’ wages knowingly hired unauthorized aliens (or con- in cash, believing that withdrawing amounts tinued to employ aliens knowing that they are can also be or have become unauthorized to work in the less than $10,000 would avoid triggering liable for civil the banks’ currency transaction reporting United States), it can issue a cease and desist order prohibiting such activity and requiring requirements. If convicted, they each face a charges and payment of the following civil fines: maximum penalty of five years in prison and penalties. a $250,000 fine.19 1. First Offense: Not less than $375 and not more than $3,200 for each unauthorized Illinois Construction Companies alien for offenses after March 27, 2008 Wedekemper’s Inc. and Wedekemper’s Con- ($275.00/$2,200.00 before that date); struction Inc., two Illinois construction com- 2. Second offense: Not less than $3,200 and panies, pleaded guilty to charges related to not more than $6,500 for each unau- employing illegal aliens on April 23, 2010. thorized alien for offenses after March Wedekemper’s Inc. was fined $500 and for- 27, 2008 ($2,200.00/$5,500.00 before that feited $5,500, while Wedekemper’s Con- date); or struction Inc. was fined $2,500 and forfeited 3. Subsequent Offenses: Not less than $12,500. The companies were also ordered $4,300 and not more than to pay a $50 special assessment fee for every $16,000 for each unauthorized alien count charged against them and participate for offenses after March 27, 2008 in the E-Verify employment eligibility verifi- ($3,300.00/$11,000.00 before that date.23 cation system for five years. The investigation began in June 2009, through a tip to ICE that a Failing to Comply with Form I-9 previously deported alien was employed by Requirements Wedekemper’s Constructions Inc. The inves- An employer that fails to properly complete, tigation found that several other illegal aliens retain, and/or make available for inspection were also employed by the company. Seven Forms I-9 as required by law, can face civil employees of Wedekemper’s Construction, money penalties of not less than $110 and 66 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

not more than $1,100 for each violation.24 In official action which may be taken determining the amount of the penalty, DHS with respect to such alien; will consider: (ii) knowing or in reckless disregard 1. The size of the business of the employer of the fact that an alien has come to, being charged; entered, or remains in the United 2. The good faith of the employer; States in violation of law, transports, 3. The seriousness of the violation; or moves or attempts to transport or 4. The history of previous violations of the move such alien within the United employer; and States by means of transportation or otherwise, in furtherance of such 5. Whether or not the individual was an violation of law; unauthorized alien.25 (iii) knowing or in reckless disregard Civil Document Fraud of the fact that an alien has come to, Employers found by DHS or an administra- entered, or remains in the United tive law judge to have knowingly accepted States in violation of law, conceals, a fraudulent document to verify a worker’s harbors, or shields from detection, or employment eligibility may be ordered to attempts to conceal, harbor, or shield cease and desist from such behavior and to from detection, such alien in any pay a civil money penalty as follows: place, including any building or any means of transportation; 1. First offense: Not less than $375 and not more than $3,200 for each fraudulent (iv) encourages or induces an alien to document that is the subject of the vio- come to, enter, or reside in the Unit- lation. ed States, knowing or in reckless dis- 2. Subsequent offenses: Not less than regard of the fact that such coming $3,200 and not more than $6,500 for to, entry, or residence is or will be in each fraudulent document that is the violation of law, shall be punished as subject of the violation.26 provided in subparagraph (B); or (v) (I) engages in any conspiracy to Criminal Penalties commit any of the preceding acts, or Persons or entities convicted of having (II) aids or abets the commission of engaged in a pattern or practice of know- any of the preceding acts. ingly hiring unauthorized aliens (or continu- Harboring can bring a maximum of five ing to employ aliens knowing that they are years in prison for each alien harbored.28 If or have become unauthorized to work in the the employer harbors the alien for financial United States) after November 6, 1986, may gain, the maximum penalty increases to ten face fines of up to $3,000 per employee and/ years.29 The maximum fine for harboring is or six months imprisonment.27 $250,000 or double the gain to the employer, whichever is greater.30 Harboring In addition to using forfeiture statutes, Feder- Money Laundering al authorities have also begun bringing charg- Although commonly associated with drug es of harboring against U.S. employers. INA dealing, employers of illegal aliens can also 274(a)(1)(A)(i)-(v); 8 USC 1324(a)(1)(A)(i)-(v) be criminally charged with money laun- defines the offense: dering. 8 USC 1961(1)(F) includes “any act 1) (A) Any person who- which is indictable under the Immigration (i) knowing that a person is an alien, and Nationality Act, section 274 (relating brings to or attempts to bring to the to bringing in and harboring certain aliens” United States in any manner what- under its definition of racketeering. 8 USC soever such person at a place other 1956(c)(7)(A) includes, by reference to 8 than a designated port of entry or USC 1961(1)(F), harboring illegal aliens as place other than as designated by an offense for which an employer can be the Commissioner, regardless of charged with money laundering. whether such alien has received The penalties for money laundering are prior official authorization to come up to ten years in prison and fines of up to to, enter, or reside in the United $500,000 or twice the amount laundered, States and regardless of any future whichever is greater.31 ICE STEPS UP AGGRESSIVE EMPLOYER AUDIT CAMPAIGN 67

Conclusion 17. U.S. Immigration and Customs Enforcement (February 17, 2010), “Howard County Restaurant Now more than ever, it is critical that Owner Arrested Following Worksite Investigation” employers audit their own Form I-9s in (http://www.ice..gov/pi/nr/1002/100217baltimore. advance of receiving an NOI. When assess- htm). 18. U.S. Immigration and Customs Enforcement ing charges and penalties, federal authorities (March 4, 2010) “Owner of Reno Electronics Firm will look at the employer’s good-faith com- Faces Federal Charges for Employing Illegal Aliens” pliance with Form I-9 regulations that impose (http://www.ice.gov/pi/nr/1003/100304reno.htm). 19. U.S. Immigration and Customs Enforcement on employers an on-going duty to deter- (April 24, 2010), “Managers of 2 Suburban Staffing mine compliance with U.S. law. Given that Companies Charged with Hiring Illegal Aliens” (http:// enforcement efforts now include targeting www.ice.gov/pi/nr/1004/100426chicago.htm). business owners and managers and the threat 20. U.S. Immigration and Customs Enforcement (April 23, 2010), “2 Illinois Companies Plead Guilty, of prison and significant financial sanctions, Sentenced for Employing Illegal Aliens” (http://www. many employers have begun taking steps to ice.gov/pr/nr/1004/100423stlouis.htm). determine whether their employment eligi- 21. U.S. Immigration and Customs Enforcement (April 23, 2009), “Maryland Employer Pleads Guilty bility documentation complies with federal to Hiring Illegal Aliens, Money Laundering” (http:// requirements. While this includes reviewing wwwice.gov./pr/nr/0904/090423baltimore.htp). and correcting existing I-9s and establishing 22. U.S. Immigration and Customs Enforcement (September 4, 2009), “Owner of Annapolis Painting a sound compliance policy, it is absolutely Services Sentenced for Money Laundering and Hir- essential that each employer understands its ing Illegal Aliens” (http://www.ice.gov/nr/pr/0909/ responsibilities and how to fulfill them. 090904baltimore.htm). 23. 8 CFR 272a.10(b)(1)(ii)(A)-(C). 24. 8 CFR 274a.10(b)(2). 25. 8 CFR 274a.10(b)(2)(i)-(v). NOTES 26. 8 CFR 270.3(b)(1)(A) and (C). 27. INA 274A(f)(1), 8 USC 1324(f)(1), 8 CFR 1. U.S. Immigration and Customs Enforcement 274a.10(a). (July 1, 2009), “652 Businesses Nationwide Being Served with Audit Notices Today” (http://www.ice.gov/ 28. INA 274(a)(1)(3)(ii), 8 USC 1324(5)(1)(B)(ii). pr/nr/0907/090701washington.htm). 29. INA 274(a)(1)(B)(i), 8 USC 1324(a)(1)(B)(i). 2. Hsu, Spencer S. (March 29, 2009) “DHS Signals 30. 18 USC 3571(b)(3). Policy Changes Ahead for Immigration Raids” Washing- 31. 18 USC 1756(a)(1)(B). ton Post (http://www.washingtonpost.com/wpdyn/content/article/2009/03/29/AR2009032901109.htm). 3. U.S. Immigration and Customs Enforcement (July 1, 2009), “652 Businesses Nationwide Being Served with Audit Notices Today” (http://www.ice.gov/ pr/nr/0907/090701washington.htm). 4. Id. 5. Id. 6. Id. 7. Id. 8. U.S. Immigration and Customs Enforce- James G. Aldrich of Dickin- ment (November 19, 2009), “ICE Assistant Secretary son Wright PLLC, Bloomfield John Morton Announces 1,000 New Workplace Hills, Michigan specializes Audits to Hold Employers Accountable for Their Hiring Practices” (http://www.ice.gov/pi/nr/0911/ in a full range of immigration 091119washingtondc2.htm). matters. He provides coun- 9. USCIS, M-274, Handbook for Employers (Rev. sel to closely held and fam- 04/03/09)N, p.6. ily businesses in the areas 10. 74 Fed. Reg., No. 98, pp 23957-23958 and of corporate, international, and business 24022-24027 (May 22, 2009). planning. In addition, he researches 11. Indictment, United States v The French Gourmet, investment opportunities in the United Inc. (1), Michael Malecot (2), and Richard Kauffmann (3), United States District Court, Southern District of States for international clients. California, Case No. 10-CR-1417 (April 15, 2010). 12. Id. 13. Id. 14. U.S. Immigration and Customs Enforcement (April 21, 2010), “San Diego Area Bakery, Its Owner and Manager, Indicated on Federal Charges for Hiring Undocumented Workers” (http://www.ice.gov/pi/ nr/1004/100421sandeigo.htm). 15. Id. 16. U.S. Immigration and Customs Enforcement (February 3, 2010), “Missouri Roofing Company Owner Sentenced for Hiring Illegal Aliens” (http:// www.ice.gov/pi/nr/1002/100203springfield.htm). Patents—Business Methods Case Digests Bilski v Kappos, __ US __, 130 S Ct 3218 (2010). Petitioners sought patent protection for a claimed invention explaining Arbitration—Class Arbitration to buyers and sellers of commodities how they could hedge Stolt-Nielsen SA v AnimalFeeds Int’l Corp, __ US __, 130 S against the risk of price changes in the energy marker. The Ct 1758 (2010). Plaintiff brought a putative class action patent examiner rejected the application, explaining that it against petitioners asserting antitrust claims for prices was not implemented on a specific apparatus and merely manipulated an abstract idea. The United States Court of that petitioners allegedly charged their customers over Appeals for the Federal Circuit heard the case en banc and a period of several years. Other parties brought similar affirmed, holding that a claimed process is patent-eligible claims and, in a consolidated proceeding, the parties were under 35 USC 101 if: (1) it is tied to a particular machine ordered to arbitrate their dispute pursuant to a clause in or apparatus, or (2) it transforms a particular article into a charter party agreement. The arbitrators ruled that the a different state or thing. In re Bilski, 545 F3d 943 (2008). arbitration clause allowed for class arbitration. The district The court concluded the machine-or-transformation test is court vacated the award but the Second Circuit reversed, the sole test under 35 USC 101 and was therefore the test concluding that there is no federal maritime rule of cus- for determining patent eligibility of a process under that tom and usage against class arbitration and that applicable statute as well. Applying the machine-or-transformation state law did not establish a rule against class arbitration. test, the court held that petitioners’ application was not The United States Supreme Court reversed, finding that patent-eligible. a party may not be compelled under the Federal Arbitra- The United States Supreme Court affirmed but held tion Act to submit a dispute to class-action arbitration un- that the machine-or-transformation test is not the sole test less there is a contractual basis to conclude that the party for determining whether an invention is a patent-eligible in fact agreed to do so. In other words, an arbitrator may process. The court also rejected the contention that 35 USC not infer solely from an agreement to arbitrate that there is 101 completely excludes business methods. Although 35 an implicit agreement that authorizes class-action arbitra- USC 273 indicates that some business methods are eligi- tion. The court noted that class-action arbitration changes ble for patents, it does not suggest wide patentability for the nature of the arbitration to such an extent that it cannot inventions of that type. The court ruled that the hedging be presumed that the parties agreed to do so merely by concept described in the application was an unpatentable agreeing to submit disputes to an arbitrator. abstract idea and that permitting such a patent would pre- empt this approach in all fields. Because the application in Employment Arbitration Agreement— this case could be rejected under prior precedents on the Determination for Court or Arbitrator unpatentability of abstract ideas, the court did not need to define further what constitutes a patentable process. Rent-A-Center, W, Inc v Jackson, __ US __, 130 S Ct 2772 (2010). After plaintiff filed an employment-discrimina- Limited Liability Companies—Applicability tion suit against his former employer, the employer filed of De Facto Corporation Doctrine a motion under the Federal Arbitration Act to dismiss or stay the proceedings in district court and to compel arbi- Duray Dev, LLC v Perrin, No 287722, 2010 Mich App LEXIS tration under a mutual agreement to arbitrate claims. 607 (Apr 13, 2010). Plaintiff real estate developer entered Plaintiff opposed the motion on the ground that the entire into an excavation contract with an individual defendant arbitration agreement was unconscionable under state law. (Perrin) and Perrin Excavating, LLC, on September 30, The district court granted the employer’s motion, finding 2004. On October 27, 2004, a contract that was intended to supercede the previous contract was entered into by that the agreement gave the arbitrator authority to decide plaintiff and Outlaw Excavating, LLC, only, with the lat- whether the agreement was enforceable. A divided Ninth ter recently formed by defendant Perrin and another per- Circuit reversed on the question of who had the author- son. There were two contracts because Perrin had not ity to decide whether the agreement is enforceable and formed Outlaw Excavating, LLC, when the first contract affirmed the conclusion that the provision in question was was executed and at the time of the second contract the not unconscionable. parties believed that the Outlaw Excavating LLC had been The United States Supreme Court reversed, stating that properly formed. After a breach of contract dispute arose, a party’s challenge to a separate contract provision does it was discovered that Outlaw did not obtain status as a not prevent a court from enforcing a specific agreement to “filed” LLC until November 29, 2004, and therefore it was arbitrate, and arbitration provisions are severable from the not a valid LLC when the parties executed the second con- rest of the contract. Unless plaintiff challenges the provi- tract. The trial court ruled in plaintiff’s favor, finding that sion delegating the arbitration of threshold issues specifi- Perrin was in breach of the contract. In a posttrial memo- cally, it should be treated as valid and enforceable, with randum, Perrin argued that he was not personally liable any challenge to the agreement’s validity as a whole del- for the damages for breach alleging that the LLC was liable egated to the arbitrator. under the de facto corporation doctrine. CASE DIGESTS 69

The court of appeals stated that the LLCA provides and there was no precedent indicating that the trial court precisely when an LLC comes into existence, as MCL should have applied the doctrine. 450.4202(2) provides that “[t]he existence of the limited liability company begins on the effective date of the articles Single Business Tax—Contributions for of organization as provided in [MCL 450.4104].” MCL Employment Benefits 450.4104(2) requires that the articles be delivered to the Ford Motor Co v Department of Treasury, No 283925, 2010 Bureau of Commercial Services and, after delivery, the ad- Mich App LEXIS 925 (May 20, 2010). The Department con- ministrator “shall endorse upon it the word ‘filed’ with his ducted an audit of plaintiff to determine plaintiff’s tax due or her official title and the date of receipt and of filing[.]” under the Single Business Tax Act (SBTA) for years 1997 to MCL 450.4104(6) further provides that “[a] document filed 1999 and assessed plaintiff with a tax liability of $21,726,713 under [MCL 450.4104(2)] is effective at the time it is en- above the SBTA taxes already paid by plaintiff because dorsed[.]” the Department determined that voluntary contributions Once an LLC comes into existence, limited liability ap- made to an irrevocable trust created under the Voluntary plies, and a member or manager is not liable for the acts, Employees’ Beneficiary Association (VEBA) amounted to debts, or obligations of the company. MCL 450.4501(3). employee compensation that was taxable under the SBTA. However, a person who signs a contract on behalf of a The court of appeals held that contributions plaintiff made company that is not yet in existence generally becomes to the VEBA in the tax years in question did not constitute personally liable on that contract. It is well established that compensation under the SBTA and, therefore, were not a corporation can nevertheless become liable if (1) it either subject to the SBTA tax. ratifies or adopts that contract after it comes into existence, (2) a court determines that a de facto corporation existed Single Business Tax—Remanufacturing at the time of the contract, or (3) a court orders that a cor- Midwest Bus Corp v Department of Treasury, No 288686, poration by estoppel prevented the opposing party from 2010 Mich App LEXIS 790 (Mar 16, 2010). Plaintiff filed a arguing against the existence of a corporation. In this case, declaratory judgment action following an audit for single Perrin signed the articles of organization for the LLC on business tax years 1999 through 2004, and the receipt of the same day as the second contract, October 27, 2004, and tax due bills. Plaintiff alleged that it was in the business of then signed the October 27, 2004, contract on behalf of the selling bus parts and remanufacturing buses and that its LLC. The Bureau did not endorse the articles of organiza- remanufacturing contracts with various transit authorities tion until November 29, 2004. Therefore, under the LLCA, involved primarily the sale of tangible personal property—bus parts, regardless of whether plaintiff’s installation the LLC was not in existence on October 27, 2004, and it of those parts was also included in the contracts. Plaintiff did not adopt or ratify the second contract, thus making argued that revenue from the sales at issue, which gave rise Perrin personally liable for the LLC’s obligations unless a to the disputed tax due bills, should have been sourced to de facto LLC existed or an LLC by estoppel applied. the destinations where they were shipped as sales of tangi- The de facto corporation doctrine allows a defectively ble personal property under MCL 208.52, and not sourced formed association to attain the legal status of a corpora- to Michigan, under MCL 208.53, where the installation tion, while the corporation by estoppel doctrine prevents services were performed. On the other hand, defendants a party who dealt with an association as though it were a argued that plaintiff’s business of remanufacturing buses corporation from denying its existence. The court found did not merely involve the sale of bus parts. Instead, plain- that the similarities between the Business Corporation Act tiff remanufactured buses, which meant that the service of and LLCA support the conclusion that the acts should be actually installing the bus parts was not merely inciden- interpreted consistently and that the de facto corporation tal to the sale of the parts but that rehabilitation was the doctrine applies to both corporations and LLCs. The pur- primary purpose of the business contracts. Thus , revenue poses for forming a limited liability company and a corpo- from the disputed sales was properly sourced to Michigan, ration are similar and both acts contemplate the moment under MCL 208.53, where the services were performed, when an LLC or corporation comes into existence. Thus, in and plaintiff was not entitled to any refund or other relief. this case, the de facto corporation doctrine applied to the The trial court agreed with defendants and granted their LLC and, as a result, the LLC and not Perrin individually motion for summary disposition. was liable for the breach of the October 27, 2004, contract. The court of appeals affirmed. A remanufacturing con- Similarly, the corporation-by-estoppel doctrine—which tract is predominantly for the provision of a service—a is an equitable remedy where its purpose is to prevent rehabilitation service. Thus, for purposes of the sales fac- one who contracts with a corporation from later denying tor under the Single Business Tax, these are sales “other its existence to hold the individual officers or partners li- than sales of tangible personal property” and, because the able—applies to LLCs as well as corporations. However, services were provided in Michigan in this case, the sales the trial court did not make a clear and obvious mistake by were “in this state” under MCL 208.53. not applying the corporation-by-estoppel doctrine to the LLC when the issue was not raised by the appealing party Index of Articles (vol 16 and succeeding issues) Adequate assurance of performance demand, 23 No 1, partners and partnership claims, equitable subordin- p. 10; 29 No 3, p. 14 ation, 16 No 1, p. 6 Administrative expense claims under BACPA 2005, 26 prepayment penalty provisions in Michigan, enforce- No 3, p. 36 ability in bankruptcy and out, 16 No 4, p. 7 ADR prepayment premiums in and out of bankruptcy, appeals of arbitrability, effect on lower courts, 26 23 No 3, p. 29 No 2, p. 37 priority for creditors providing goods to debtors in arbitration, pursuit of investors’ claims, 16 No 2, p. 5 ordinary course of business, 28 No 1, p. 18 commercial dispute resolution, new horizons, 22 proof of claim, whether and how to file, 30 No 1, p. 10 No 2, p. 17 reclamation and administrative offense claims, 26 mediation 17 No 1, p. 15; 26 No 3, p. 49 No 3, p. 36 “real time” conflict solutions 28 No 2, p. 31 tax tips for bankruptcy practitioners, 27 No 2, p. 30 Advertising injury clause, insurance coverage, 24 No 3, trust fund statutes and discharge of trustee debts, p. 26 28 No 1, p. 11 Agriculture UCC 2-702, use in bankruptcy, 29 No 3, p. 9 Farm Security and Rural Investment Act of 2002, 22 Banks. See Financial institutions No 3, p. 30 Business claims, intersection of statute and common law, succession planning for agribusinesses, 24 No 3, 27 No 1, p. 29 p. 9 Business continuity planning, 28 No 1, p. 9 Annuity suitability requirements, 27 No 2, p. 15 Business Court in Michigan, 25 No 3, p. 9 Antiterrorism technology, federal SAFETY Act, 24 Business-income-loss claims, 27 No 1, p. 24 No 3, p. 34 Business judgment rule Antitrust compliance program for in-house counsel, 22 corporate scandals and business judgment rule, 25 No 1, p. 42 No 3, p. 19 Assignments for benefit of creditors, 19 No 3, p. 32 Disney derivative litigation, 25 No 2, p. 22 Assumed names of LLCs, 28 No 3, p. 5 Certificated goods, frontier with UCC, 24 No 2, p. 23 Attorney-client privilege, tax matters, 24 No 3, p. 7; 26 Charitable Solicitations Act, proposed revisions, No 3, p. 9. See also E-mail 26 No 1, p. 14 Automotive suppliers Charities. See Nonprofit corporations or organizations disputes in automotive industry, lessons learned, Chiropractors and professional service corporations, 26 No 2, p. 11 24 No 3, p. 5 extending credit in era of contractual termination for Choice of entity convenience, 26 No 1, p. 49 2003 tax act considerations, 23 No 3, p. 8 requirements contracts, enforceability, 28 No 2, p. 18 frequently asked questions, 25 No 2, p. 27 Bankruptcy. See also preferences getting it right the first time, 26 No 1, p. 8 after-acquired property and proceeds in bankruptcy, Circular 230 and tax disclaimers, 25 No 2, p. 7 28 No 1, p. 28 Class Action Fairness Act of 2005, 25 No 3, p. 15 Bankruptcy Abuse Prevention and Consumer Protec- Click-wrap agreements under UCC, mutual assent, 26 tion Act of 2005, 25 No 3, p. 27; 26 No 3, p. 18 No 2, p. 17 composition agreements, alternatives to bankruptcy, COBRA changes under 2009 Stimulus Act, 29 No 2, p. 31 28 No 3, p. 43 Commercial finance lease agreements, 26 No 2, p. 21 cross-border insolvencies, 26, No 3, p. 10 Commercial impracticability, issues to consider, 29 No 1, default interest, 23 No 2, p. 47 p.16 dividends and other corporate distributions as avoid- Commercial litigation. See also ADR able transfers, 16 No 4, p. 22 business court in Michigan, 25 No 3, p. 9 foreclosure, bankruptcy forum to resolve disputes Class Action Fairness Act of 2005, 25 no 3, p. 15 30 No 1, p. 17 document production, 28 No 2, p. 13 franchisors, using bankruptcy forum to resolve dis- economic duress, proving in Michigan, 26 No 2, putes, 16 No 4, p. 14 p. 25 in-house counsel’s survival guide for troubled times, electronic discovery, 22 No 2, p. 25; 27 No 2, p. 9; 27 22 No 1, p. 33 No 3, p. 37 intellectual property, protecting in bankruptcy cases, future lost profits for new businesses, proving in post- 22 No 3, p. 14 Daubert era, 26 No 2, p. 29 landlord-tenant issues, 26 No 3, p. 32 Competitor communications, avoiding sting of the un- litigation roadmap, 28 No 1, p. 34 bridled tongue, 18 No 1, p. 18 mortgage avoidance cases, 26 No 3, p. 27 Composition agreements, alternatives to bankruptcy, 28 ordinary course of business, 23 No 2, p. 40; 26 No 1, No 3, p. 43 p. 57 Computers. See Technology Corner. overview of Bankruptcy Reform Act of 1994, 16 No 4, Confidentiality agreements, preliminary injunctions of p. 1 threatened breaches, 16 No 1, p. 17 70 INDEX OF ARTICLES 71

Contracts. See also Automotive suppliers decedent’s estates, eroding creditors’ rights to collect doctrine of culpa in contrahendo and its applicability to debts from, 19 No 3, p. 54 international transactions, 24 No 2, p.36 fiduciary duties of directors and officers to creditors drafting, 28 No 2, p. 24 when company is insolvent or in vicinity of electronic contracting, best practices, 28 No 2, p. 11 insolvency, 22 No 2, p. 12 letters of intent, best practices, 25 No 3, p. 44 judgment lien statute, advisability of legislation, 23 liquidated damages and limitation of remedies clauses No 2, pp. 11, 24 16 No 1, p. 11 necessaries doctrine, Michigan’s road to abrogation, setoff rights, drafting contracts to preserve, 19 No 1, 19 No 3, p. 50 p. 1 nonresidential real property leases, obtaining exten- Corporate counsel. See In-house counsel sions of time to assume or reject, 19 No 3, p. 7 Corporations. See also Business judgment rule; Nonprofit prepayment penalty provisions in Michigan, enforce- corporations; Securities ability in bankruptcy and out, 16 No 4, p. 7 Business Corporation Act amendments, 21 No 1, p. 28; out-of-court workouts, 19 No 3, p. 9 29 No 1, pp. 5, 10 personal property entireties exemption, applicability corporate governance, 28 No 3, p. 9 to modern investment devices, 22 No 3, p. 24 correcting incomplete corporate records, 29 No 3, p. 31 receiverships, 19 No 3, p. 16 deadlocks in closely held corporations, planning ideas trust chattel mortgages, 19 No 3, p. 1. to resolve, 22 No 1, p. 14 Criminal law and matters, white collar-crime investiga- Delaware and Michigan incorporation, choosing tion and prosecution, 27 No 1, p. 37 between, 22 No 1, p. 21 Cross-border insolvencies, 26 No 3, p. 10 Delaware corporate case law update (2005), 25 No 2, Cross-cultural negotiations, 27 No 2, p. 39 p. 49 Cybercourt for online lawsuits, 21 No 1, p. 54 derivatives transactions, explanation of products Cybersquatting and domain name trademark actions, involved and pertinent legal compliance conside- 22 No 2, p. 9 rations, 16 No 3, p. 11 Data breach notification act, 27, No 1, p. 9 dissenter’s rights: a look at a share valuation, 16 No Deadlocks in closely held corporations, planning idea to 3, p. 20 resolve, 22 No 1, p. 14 dividends and other corporate distributions as avoid- Defamation claims for businesses, intersection of statute able transfers, 16 No 4, p. 22 and common law, 27 No 1, p. 29 drag-along rights under Michigan Business Corpora- Delaware and Michigan incorporation, choosing between tion Act, 28 No 3, p. 20 22 No 1, p. 21 employment policies for the Internet, why, when, and Delaware corporate case law update (2005), 25 No 2, how, 19 No 2, p. 14 p. 49 foreign corporations, internal affairs doctrine, 27 Derivatives transactions, explanation of products in- No 1, p. 48 volved and pertinent legal compliance consider- insolvency, directors’ and officers’ fiduciary duties to ations, 16 No 3, p. 11 creditors when company is insolvent or in vicin- Did You Know? ity of insolvency, 22 No 2, p. 12 acupuncture, 26 No 2, p. 7 interested directors, advising re selected problems in assumed names of LLCs, 28 No 3, p. 5 sale of corporation, 16 No 3, p. 4 Business Corporation Act 2009 amendments, 29 No 1, minority shareholder oppression suits, 25 No 2, p. 5 p. 16 chiropractors and professional service corporations, opportunity doctrine in Michigan, proposed legisla- 24 No 3, p. 5 tive reform, 28 No. 3, p. 15 educational corporations or institutions, 24 No 1, professional service providers and Miller v Allstate Ins p. 5; 24 No 3, p. 5 Co, 28 No 3, p. 26 expedited filing, 25 No 3, p. 6; 26 No 1, p. 5 proposed amendments to Business Corporation Act fee changes for authorized shares 25 No 3, p. 6; (2005), 25 No 2, p. 11 26 No 1, p. 5 Sarbanes-Oxley Act of 2002, 22 No 3, p. 10 finding the proper agency, 25 No 2, p. 5 shareholder standing and direct versus derivative LLC Act amendments (2002), 23 No 2, p. 5 dilemma, 18 No 1, p. 1 low profit LLCs, 29 No 1, p. 6; 29 No 2, p. 5 tax matters, 27 No 1, p. 8 mold lien act amendments, 22 No 2, p. 5 technical amendments to Michigan Business Corpora- names for business entities, 23 No 1, p. 5; 25 tion Act (1993), 16 No 3, p. 1 No 1, p. 5 tort liability for corporate officers, 26 No 3, p. 7 nonprofit corporation amendments, 28 No 2, p. 7 Creditors’ rights. See also Bankruptcy; Entireties professional corporations, 22 No 1, p. 5; 27 No 2, property; Judgment lien statute p. 6 assignments for benefit of creditors, 19 No 3, p. 32 service of process on business entities and other claims in nonbankruptcy litigation, 19 No 3, p. 14 parties, 30 No 1, p. 5 cross-border secured lending transactions in United special entity acts, 25 No 3, p. 5 States and Canada, representing the lender in, summer resort associations, 24 No 3, p. 6 16 No 4, p. 38 tort liability for corporate officers, 26 No 3, p. 7 72 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

uniform and model acts, 24 No 2, p. 5 Foreclosure, use of receiver or bankruptcy as alternative viewing entity documents, 24 No 3, p. 5 to, 30 No 1, p. 17 Digital signatures, 19 No 2, p. 20 Foreign corporations, internal affairs doctrine, 27 No 1, Disaster preparations for law firms, 21 No 1, p. 7 p. 48 Discovery of electronic information in commercial litiga- Foreign defendants, serving in Michigan courts, 30 No 1, tion, 22 No 2, p. 25; 28 No 2, p. 13 p. 49 Dissenter’s rights: A look at a share valuation, 16 No 3, Foreign trade zones, 24 No 3, p. 40 p. 20 Franchino v Franchino, minority shareholder oppression Dissolution of Michigan LLC when members deadlock, suits, 25 No 2, p. 16 25 No 3, p. 38 Franchises Domain names, 21 No 1, p. 48; 22 No 2, p. 9 bankruptcy forum to resolve disputes, 16 No 4, p. 14 Drag-along rights under Michigan Business Corporation less-than-total breach of franchise agreement by fran- Act, 28 No 3, p. 20 chisor, loss or change in format, 16 No. 1, p. 1 Economic duress, proving in Michigan, 26 No 2, p. 25 Petroleum Marketing Practices Act, oil franchisor– E-mail franchisee relationship, 18 No 1, p. 6 encryption and attorney-client privilege, 19 No 2, Gaming in Michigan, primer on charitable gaming, 26 p. 26 No 1, p. 21 monitoring of e-mail and privacy issues in private sec- “Go Shop” provisions in acquisition agreements, 27 tor workplace, 22 No 2, p. 22 No 3, p. 18 unencrypted Internet e-mail and attorney-client privi- HITECH Act and HIPAA privacy and security issues, 29 lege, 19 No 2, p. 9 No 2, p. 9 Educational corporations, 24 No 1, p. 5; 24 No 3, p. 5 I.D. cards, security vs privacy, 27 No 3, p. 11 Employment. See also Noncompetition agreements Immigration Internet policies: why, when, and how, 19 No 2, p. 14 E-verify program and its application to federal con- monitoring of e-mail and privacy issues in private sec- tractors, 29 No 1, p. 36 tor workplace, 22 No 2, p. 22 tax criminal prosecution, employer I-9 compliance, 28 sexual harassment, employer liability for harassment No 3, p. 34 of employees by third parties, 18 No 1, p. 12 Independent contractors, tax issues, 28 No 2, p. 9 Empowerment zones, business lawyer’s guide to, 17 India, mergers and acquisitions, 28 No 2, p. 43 No 1, p. 3 Information security, 23 No 2, p. 8; 23 No 3, p. 10 Entireties property In-house counsel exemption for personal property, applicability to mod- antitrust compliance program, 22 No 1, p. 42 ern investment devices, 22 No 3, p. 24 pension funding basics, 25 No 1, p. 17 federal tax liens, 22 No 2, p. 7; 23 No 2, p. 28 risk management, 25 No 1, p. 10 LLC interests, 23 No 2, p. 33 survival guide for troubled times, 22 No 1, p. 33 Estate tax uncertainty in 2010, 30 No 1, p. 8 Insolvency, directors’ and officers’ fiduciary duties to Ethics, disaster preparations, 21 No 1, p. 7 creditors when company is insolvent or in vicinity Exemptions from securities registration, client interview of insolvency, 22 No 2, p. 12 flow chart, 29 No 3, p. 39 Installment contracts under UCC 2-612, perfect tender Export controls and export administration, 24 No 1,p. 32 rule, 23 No 1, p. 20 Farm Security and Rural Investment Act of 2002, 22 No 3, Insurance p. 30 business-income-loss claims, 27 No 1, p. 24 Fiduciary duties risk management for in-house counsel, 25 No 1, insolvent company or in vicinity of insolvency, duties p. 10 of offices and directors to creditors, 22 No 2, scope of advertising injury clause, 24 No 3, p. 26 p. 12 Intellectual property LLC members, duties and standards of conduct, 24 bankruptcy cases, 22 No 3, p. 14 No 3, p. 18 domain name trademark actions, 22 No 2, p. 9 Film tax credit and secured transactions, 29 No 3, p. 21 Interested directors, advising re selected problems in sale Financial institutions of corporation, 16 No 3, p. 4 cross-border secured lending transactions in United International transactions States and Canada, representing the lender in, applicability of doctrine of culpa in contrahendo, 24 26 No 4, p. 38 No 2, p. 36 federal legislation giving additional powers to banks documentary letters of credit, 25 No 1, p. 24 and bank holding companies, 20 No 1, p. 1 foreign trade zones, 24 No 3, p. 40 Gramm-Leach-Bliley’s privacy requirements, applica- Internal affairs doctrine, foreign corporations, 27 No 1, bility to non-financial institutions, 20 No 1, p. 13 p. 48 new Banking Code for new business of banking, 20 Internet. See also E-mail; Privacy; Technology Corner No 1, p. 9 corporate employment policies: why, when, and how, revised UCC Article 9, impact on commercial lending, 19 No 2, p. 14 21 No 1, p. 20 cybercourt for online lawsuits, 21 No 1, p. 54 Force majeure and commercial impracticability, issues to data breach notification act, 27, No 1, p. 9 consider, 29 No 1, p. 16 digital signatures, 19 No 2, p. 20 INDEX OF ARTICLES 73

domain names, 21 No 1, p. 48; 22 No 2, p. 9 Lost profits for new businesses in post-Daubert era, 26 jurisdiction and doing business online, 29 No 1, p. 23 No 2, p. 29 proxy materials, Internet delivery, 27 No 3, p. 13 Low profit LLCs, 29 No 1, p. 6; 29 No 2, p. 27 public records, using technology for, 19 No 2, p. 1 Malware grows up: Be very afraid, 25 No 3, p. 8 sales tax agreement, 23 No 1, p. 8 Material adverse effect clauses, Delaware court’s pro- year 2000 problem, tax aspects, 19 No 2, p. 4 seller attitude towards, 29 No 1, p. 28 Investing by law firms in clients, benefits and risks, 22 Mediation instead of litigation for resolution of valuation No 1, p. 25 disputes, 17 No 1, p. 15 Joint enterprises, recognition by Michigan courts, 23 Mergers and acquisitions No 3, p. 23 disclosure of confidential information, 29 No 2, p. 39 Judgment lien statute India, framework and issuess, 28 No 2, p. 43 advisability of legislation, 23 No 2, pp. 11, 24 multiples as key to value or distraction, 23 No 1, p. 31 new collection tool for creditors, 24 No 3, p. 31 Michigan Business Tax, 28 No 1, p. 40; 29 No 1, p. 40 Judicial dissolution of Michigan LLC when members Minority oppression deadlock, 25 No 3, p. 38 LLCs, minority members, 27 No 1, p. 11 Landlord-tenant issues under BACPA 2005, 26 No 3, shareholder suits, 25 No 2, p. 16 p. 32 Mold lien act, 22 No 2, p. 5, 26 No 3, p. 44 Law firms, benefits and risks of equity arrangements with Mortgage avoidance cases in Michigan’s bankruptcy clients, 22 No 1, p. 25 courts, 26 No 3, p. 27 Leases Names for business entities, 23 No 2, p. 5; 25 No 1, p. 5 commercial finance lease agreements, 26 No 2, Necessaries doctrine, Michigan’s road to abrogation, 19 p. 21 No 3, p. 50 obtaining extensions of time to assume or reject, 19 Negotiations, cross-cultural, 27 No 2, p. 39 No 3, p. 7 Noncompetition agreements Letters of credit in international transactions, 25 No 1, geographical restrictions in Information Age, 19 No 2, p. 24 p. 17 Letters of intent, best practices, 25 No 3, p. 44 preliminary injunctions of threatened breaches, 16 Liens. See also Judgment lien statute No 1, p. 17 how to find notices of state and federal tax liens, 24 Nonprofit corporations or organizations No 1, p. 10 amendments, 28 No 2, p. 7 mold lien act, 22 No 2, p. 5; 26 No 3, p. 44 Charitable Solicitations Act, proposed revisions, 26 special tools lien act, 23 No 1, p. 26; 26 No 3, p. 44 No 1, p. 14 Life insurance, critical planning decisions for split-dollar compensating executives, 24 No 2, p. 31 arrangements, 23 No 3, p. 41 intermediate sanctions, slippery slope to termination, Limited liability companies (LLCs) 2002 LLC Act amendments (PA 686), 23 No 1, p. 34; 26 No 1, p. 27 23 No 2, p. 5 IRS Form 990 changes—nonprofit governance in a fish anti-assignment provisions in operating agreements, bowl, 29 No 2, p. 11 impact of UCC 9-406 and 9-408, 24 No 1, p. 21 lobbying expenses, businesses, associations, and non- buy-sell provisions of operating agreements, 19 No deductibility of, 17 No 2, p. 14 4, p. 60 low profit LLCs, 29 No 1, p. 6, 29 No 2, pp. 6, 27 entireties property, 23 No 2, p. 33 proposed amendments to Michigan Nonprofit Corpo- family property and estate planning, operating agree- ration Act, 17 No 2, p. 1; 23 No 2, p. 70; 26, No 1, ments for, 19 No 4, p. 49 p. 9 fiduciary duties and standards of conduct of members Sarbanes-Oxley Act of 2002, impact on nonprofit enti- 24 No 3, p. 18 ties, 23 No 2, p. 62 joint venture, operating agreements for, 19 No 4, p. 34 shuffle up and deal: a primer on charitable gaming in low profit LLCs, 29 No 1, p. 6; 29 No 2, pp. 6, 27 Michigan, 26 No, p. 21 manufacturing business, operating agreements for, tax exemptions, 26 No 1, p. 33 24 No 4, p. 2 trustees, nonprofit corporations serving as, 17 No 2, minority member oppression, 27 No 1, p. 11 p. 9 piercing the veil of a Michigan LLC, 23 No 3, p. 18 Uniform Prudent Management of Institutional Funds real property, operating agreements for holding and Act, 29 No 2, p. 17 managing, 19 No 4, p. 16 volunteers and volunteer directors, protection of, 17 securities, interest in LLC as, 16 No 2, p. 19 No 2, p. 6 self-employment tax for LLC members, 23 No 3, Offshore outsourcing of information technology services, p. 13 24 No 1, p. ; 24 No 2, p. 9 series LLCs, 27 No 1, p. 19 Open source software, 25 No 2, p. 9; 29 No 2, p. 49 single-member LLCs vs member’s judgment creditors, Optioning the long-term value of a company, effect on 29 No 1, p. 33 shareholders, 27 No 3, p. 33 Liquidated damages and limitation of remedies clauses, Ordinary course of business, bankruptcy, 23 No 2, p. 40; 16 No 1, p. 11 26 No 1, p. 57 Litigation. See Commercial litigation Partnerships 74 THE MICHIGAN BUSINESS LAW JOURNAL — SUMMER 2010

bankruptcy, equitable subordination of partners and investment securities, revised UCC Article 8, 19 No 1, partnership claims, 16 No 1, p. 6 p. 30 interest in partnership as security under Article 9, investor claims against securities brokers under Michi- 19 No 1, p. 24 gan law, 28 No 3, p. 50 Pension funding basics for in-house counsel, 25 No 1, Internet delivery of proxy materials, 27 No 3, p. 13 p. 17 limited liability company interests as securities, 16 Perfect tender rule, installment contracts under UCC 2- No 2, p. 19 612, 23 No 1, p. 20 privacy laws and regulations, application to employ- Personal property entireties exemption, applicability to ment relationships in securities industry, 27 No 3, modern investment devices, 22 No 3, p. 24 p. 25 Petroleum Marketing Practices Act, oil franchisor– public debt securities, restructuring, 22 No 1, p. 36 franchisee relationship, 18 No 1, p. 6 real-time disclosure, SEC, 24 No 2, p. 20 Piercing the veil of a Michigan LLC, 23 No 3, p. 18 Sarbanes-Oxley Act of 2002, public issuers in distress, Preferences 23 No 2, p. 55 defending against preference claims, 29 No 3, p. 26 SEC small business initiatives, 16 No 2, p. 8 earmarking defense, gradual demise in Sixth Circuit, small business regulatory initiatives, progress or puff- 30 No 1, p. 25 ery, 16 No 2, p. 1 minimizing manufacturer’s exposure by asserting small corporate offering registration, 16 No 2, p. 13 PMSI and special tools liens, 30 No 1, p. 41 Uniform Securities Act, technical compliance is ordinary terms defense, 30 No 1, p. 34 required, 17 No 1, p. 1 Preliminarily enjoining threatened breaches of non- venture capital financing, terms of convertible pre- competition and confidentiality agreements, 16 ferred stock, 21 No 1, p.9 No 1, p. 17 what constitutes a security, possible answers, 16 No 2, Prepayment penalty provisions in Michigan, enforceabil- p. 27 ity in bankruptcy and out, 16 No 4, p. 7 Self-employment tax for LLC members, 23 No 3, p. 13 Prepayment premiums in and out of bankruptcy, 23 Service of process No 3, p. 29 business entities and other parties, 30 No 1, p. 5 Privacy foreign defendants, 30 No 1, p. 49 Sexual harassment, employer liability for harassment of drafting privacy policies, 21 No 1, p. 59 employees by third parties, 18 No 1, p. 12 Gramm-Leach-Bliley requirements, applicability to Shareholders non-financial institutions, 20 No 1, p. 13 dissenter’s rights: a look at a share valuation, 16 No 3, monitoring of e-mail and privacy issues in private p. 20 sector workplace, 22 No 2, p. 22 minority shareholder oppression suits, 25 No 2, p. 16 securities industry, application of privacy laws to, oppression and direct/derivative distinction, 27 No 2, 27 No 3, p. 25 p. 18 Professional service providers and Miller v Allstate Ins optioning the long-term value of a company, effect on Co, 28 No 3, p. 26 shareholders, 27 No 3, p. 33 Proof of claim, whether and how to file, 30 No 1, p. 10 standing and direct versus derivative dilemma, 18 Public debt securities, restructuring, 22 No 1, p. 36 No 1, p. 1 Public records, using technology for, 19 No 2, p. 1 Shrink-wrap agreements under UCC, mutual assent, Receiverships, 19 No 3, p. 16; 28 No 2, p. 36; 20 No 1, 26 No 2, p. 17 p. 17 Single-member LLCs vs member’s judgment creditors, 29 Risk management for in-house counsel, 25 No 1, p. 10 No 1, p. 33 S corporations Small Business Administration business designations and audit targets, 25 No 3, p. 7 government contracting, 24 No 1, p. 29 losses, how to deal with, 29 No 3, p. 34 Software licensing watchdogs, 25 No 1, p. 8 SAFETY Act and antiterrorism technology, 24 No 3, p. 34 Special tools lien act, 23 No 1, p. 26 Sarbanes-Oxley Act of 2002, 22 No 3, p. 10 Split-dollar life insurance arrangements, critical planning nonprofit entities, 23 No 2, p. 62 decisions, 23 No 3, p. 41 public issuers in distress, 23 No 2, p. 55 Subordination agreements under Michigan law, 24 No 1, relief for smaller public companies, 26 No 1, p. 42 p. 17 Securities Succession planning for agribusinesses, 24 No 3, p. 9 abandoned public and private offerings, simplifying Summer resort associations, 24 No 3, p. 6 Rule 155, 21 No 1, p. 18 Taxation and tax matters arbitration, pursuit of investors’ claims, 16 No 2, p. 5 2001 Tax Act highlights, 22 No 1, p. 7 basics of securities law for start-up businesses, 24 2004 Tax Acts: What you need to tell your clients, 25 No 2, p. 13 No 1, p. 30 disclosure of confidential information, 29 No 2, p. 39 2009 tax rate increase, 28 No 3, p. 7 exemptions from registration, client interview flow aggressive transactions, tax consequences, 27 No 3, chart, 29 No 3, p. 39 p. 9 “Go Shop” provisions in acquisition agreements, attorney-client privilege, 24 No 3, p. 7; 26 No 3, p. 9 27 No 3, p. 18 avoiding gift and estate tax traps, 23 No 1, p. 7 INDEX OF ARTICLES 75

bankruptcy, tax tips, 27 No 2, p. 30 commercial lending, impact of revised Article 9, 21 C corporations, less taxing ideas, 27 No 1, p. 8 No 1, p. 20 charitable property tax exemptions, 26 No 1, p. 33 compromising obligations of co-obligors under a note, choice of entity, 23 No 3, p. 8; 26 No 1, p. 8 unanswered questions under revised UCC Arti- Circular 230 and tax disclaimers, 25 No 2, p. 7 cle 3, 16 No 4, p. 30 estate tax uncertainty in 2010, 30 No 1, p. 8 demand for adequate assurance of performance, 23 federal tax liens, 22 No 2, p. 7; 23 No 2, p. 28; 27 No 2, No 1, p. 10; 29 No 3, p. 14 p. 11 federal tax lien searches, consequences of Spearing how to find notices of state and federal tax liens, 24 Tool, 27 No 2, p. 11 No 1, p. 10 film tax credit and secured transactions, 29 No 3, p. 21 immigration and tax criminal prosecution, employer I- forged facsimile signatures, allocating loss under UCC 9 compliance, 28 No 3, p. 34 Articles 3 and 4, 19 No 1, p. 7 independent contractors, 28 No 2, p. 9 full satisfaction checks under UCC 3-311, 19 No 1, Internet sales tax agreement, 23 No 1, p. 8 p. 16 IRS priorities, 24 No 1, p. 7; 24 No 2, p. 7 installment contracts under UCC 2-612, perfect tender Michigan Business Tax, 28 No 1, p. 40; 29 No 1, p. 40 rule, 23 No 1, p. 20 nonprofit organizations, intermediate sanctions, 26 investment securities, revised Article 8, 19 No 1, No 1, p. 27 p. 30 payroll taxes—don’t take that loan, 29 No 2, p. 7 notice requirement when supplier provides defective preparer rules, 28 No 1, p. 7 goods, 23 No 1, p. 16 S corporations, 25 No 3, p. 7; 29 No 3, p. 7 partnership interest as security under Article 9, 19 self-employment tax for LLC members, 23 No 3, p. 13 No 1, p. 24 Swiss bank accounts disclosures, 29 No 1, p. 7 sales of collateral on default under Article 9, 19 No 1, Tax Increase Prevention and Reconciliation Act of p. 20 2005, 26 No 2, p. 8 setoff rights, drafting contracts to preserve, 19 No 1, year 2000 problem, 19 No 2, p. 4 p. 1 Technology Corner. See also Internet shrink-wrap and clink-wrap agreements, mutual business continuity planning, 28 No 1, p. 9 assent, 26 No 2, p. 17 business in cyberspace, 24 No 3, p. 8 Uniform Prudent Management of Insitutional Funds Act, computer equipment, end-of-life decisions, 26 No 2, 29 No 2, p. 17 p. 9 Valuation disputes, mediation instead of litigation for cybersquatting and domain name trademark actions, resolution of, 17 No 1, p. 15 22 No 2, p. 9 Venture capital data breach notification act, 27, No 1, p. 9 early stage markets in Michigan, 25 No 2, p. 34 electronic contracting, best practices, 28 No 2, p. 11 financing, terms of convertible preferred stock, 21 electronic discovery, 27 No 2, p. 9 No 1, p. 9 HITECH Act and HIPAA privacy and security issues, White collar-crime investigation and prosecution, 27 29 No 2, p. 9 No 1, p. 37 I.D. cards, security vs privacy, 27 No 3, p. 11 Year 2000 problem, tax aspects, 19 No 2, p. 4 information security, 23 No 2, p. 8; 23 No 3,p. 10; 29 No 1, p. 9 insider threats to critical infrastructures, 28 No 3, p. 8; 29 No 3, p. 8 Is It All Good? 22 No 2, p. 29 malware, 25 No 3, p. 8 offshore outsourcing of information technology services, 24 No 1, p. 8; 24 No 2, p. 9 open source software, 25 No 2, p. 9; 29 No 2, p. 59 paperless office, 22 No 2, p. 35 software licensing watchdogs, 25 No 1, p. 8 UCITA, 23 No 1, p. 8 Terrorism, federal SAFETY Act and antiterrorism technology, 24 No 3, p. 34 Third-party beneficiaries in construction litigation, 27 No 2, p. 25 Tools, special tools lien act, 23 No 1, p. 26; 26 No 3, p. 44 Trust chattel mortgages, 19 No 3, p. 1 UCITA, 23 No 1, p. 8 Uniform Commercial Code anti-assignment provisions in LLC operating agreements, impact of UCC 9-406 and 9-408, 24 No 1, p.21 bankruptcy, use of UCC 2-702 in, 29 No 3, p. 9 certificated goods, frontier with UCC, 24 No 2, p. 23 ICLE’s 22ND ANNUAL Business Law INSTITUTE The Business Law Section of the State Bar of Michigan thanks the 2010 sponsors of the Business Law Institute:

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