5 Major Mistakes Business Owners Make That Expose Them to Legal Risks

Legal Risk Management Seminar Cowles & Thompson, PC October 28, 2015

5 Major Mistakes Business Owners Make that Expose

Their Businesses to Huge Legal Risk, Severe Financial Loss and Bad Publicity

Failing to Meet Requirements for Company Records, Reporting, and

Governance

1

Failure to Negotiate and Use Contracts to Protect Company

Interests

2

Virtually Ubiquitous

Eligibility to File for Chapter 7 or

Chapter 11 Relief.

No insolvency requirements No debt ceiling limitations No income requirements

Chapter 7

Appoints an interim Chapter 7 Right to elect a different

trustee Trustee is authorized to hire

counsel and other professionals

Operate the Debtor’s Business

Chapter 11

Fiduciary of the bankruptcy estate

Remains in possession and control of its assets

The debtor will operate its business and conduct its affairs in the ordinary course

Unsecured Creditors’ Committee

Represents the interests of the unsecured creditors as a whole

Property of the Bankruptcy Estate

All legal and equitable interests of the debtor in property of any kind at the time the case is commenced, the proceeds of that property, and interests in property that the estate acquires after the commencement of the case.

The Automatic Stay

Operates as a stay of “the commencement or continuation… of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case.”

The Automatic Stay

Operates as a stay applicable to all entities, of any act to obtain possession of property from the estate or to exercise control over property of the estate.

The Automatic Stay

• The automatic stay contains exceptions

• Does not prevent the commencement or continuation of criminal proceedings against a debtor nor actions by the government in exercising its police and regulatory powers.

Automatic StayThe automatic stay protects only the

debtor and usually does not extend to separate legal entities.

However, despite the general rule, courts have held that the automatic stay can reach beyond a debtor to stay actions against non-debtor third parties, such as officers, directors and others.

Actions brought by the debtor are not stayed.

Executory Contracts and Unexpired Leases

Executory Contracts

Debtors are permitted to assume executory contracts and unexpired leases and assign those contracts or leases to third parties regardless of any prohibition on assignment in the contract or lease and over the objection of the non-debtor party

Executory Contracts

Contracts and leases cannot be assumed or assigned if applicable non-bankruptcy law would excuse the non-debtor party from accepting performance from or rendering performance to any party other than the debtor

Executory Contracts

As a condition to the assumption or assignment of a contract or lease, the debtor must:

(i) cure or provide adequate assurance of a prompt cure of any monetary defaults; (i i) compensate the non-debtor party for actual pecuniary loss resulting from the debtor's default; and (ii i) provide adequate assurance of the debtor’s (or assignee’s) further performance under the contract or lease

Executory Contracts

Upon rejection, the contract is deemed breached, as if such breach occurred immediately prior to the filing of the bankruptcy petition.

Rejection results in the non-debtor party having a general unsecured claim for damages arising from the rejection .

Setoff and Recoupment

The Code preserves any setoff rights a claimant may have under applicable non-bankruptcy law

Setoff

In order to establish a valid right of setoff, the parties obligations must arise prior to the commencement of the bankruptcy case and must be mutual obligations

Recoupment

• Right of recoupment is similar to that of setoff

• Recoupment must arise from the same transaction or occurrence

Reclamation

Reclamation allows a creditor to reclaim goods previously shipped to the debtor under the applicable provisions of the Uniform Commercial Code

Sale of Assets

Debtor in possession is permitted to operate the debtor’s business and as such may use, sell or lease estate assets in the ordinary course of that business

Debtor in possession is permitted to use, sell or lease assets outside the ordinary course of business either through a confirmed plan or by motion under section 363

Appointment of a Chapter 11 Trustee

The standard for appointment a trustee is “cause” which is defined to include fraud, dishonesty, incompetence or gross mismanagement

Dismissal and Conversion

The court may convert the chapter 11 case to one under chapter 7 or dismiss the case – whatever is in the best interest of creditors – for “cause”

Avoidance Actions

Preferences and Fraudulent Transfers

Fraudulent Transfers

(i) Made with the actual intent to hinder, delay or defraud a creditor; or (ii) made in exchange for less than reasonably equivalent value, (a) while the debtor was insolvent or which rendered the debtor insolvent, or (b) which left the debtor with inadequate capital to continue in business, or (c) which rendered the debtor unable to pay its debts as they became due.

Preferences

The analysis focuses on whether the creditor’s position was improved by the transfer during the preference period

Definition of a Preference

1. There must be a transfer of property to or the benefit of the creditor;

2. The transfer must be on account of an antecedent debt owed by the debtor before the transfer was made;

3. The transfer must have been made with the debtor was insolvent;

Definition of a Preference

4. The transfer must have been made on or within 90 days prior to the filing date of the bankruptcy petition (or within one year if the transferee was an insider of the debtor); and

5. The transfer must have enabled the creditor to receive more than it would have received in chapter 7

Definition of Transfer of Property

Almost any conceivable mode of disposing of property is included.

Defenses to Preference Claim

New ValueContemporaneous

ExchangeOrdinary Course

New ValueThe creditor must have given the debtor money or money’s worth, new credit or a release of property previously transferred that is not secured by an otherwise unavoidable security interest and on account of which the debtor did not make an otherwise unavoidable transfer

Contemporaneous Exchange

• If the transfer was intended by the debtor and the transferee to be a contemporaneous exchange;

• The exchange was for new value; and

• The exchange was contemporaneous or substantially contemporaneous

Ordinary Course

• Transfer must have been incurred in the ordinary course of business or financial affairs of both the debtor and the creditor; and

• The transfer was made in the ordinary course of the debtor and the creditor; or

• The transfer was made according to ordinary business terms

Ordinary Course

If the timing of the payments made by the debtor to you during the 90 days pre-petition are not consistent with the debtor’s pre-preferential period payments, the preference period payments may be preferential

Ordinary Course

Courts will review the manner, the amount and the timing of the payments made to see whether the preference period transactions fall within the typical range for either the parties’ or the industry’s payment terms

Preventative Measuresto Avoid a Preference

Maintain routine payment schedulesRequire cash in advance or on

deliveryObtain collateralAlways accept payment

Fraudulent Transfers

• Transfers made by a debtor with the actual intent to hinder, delay or defraud

• Transfers made for less than reasonably equivalent value

• Transfers by a partnership to a general partner while the partnership is insolvent or by which it became insolvent

• Transfers to self-settled trusts in which the debtor is a beneficiary

Badges of Fraud• Transfer made to an insider• Debtor retain possession or control• Transfer was concealed• Debtor was in litigation• Transfer involved all the debtor’s assets• Debtor was insolvent or was rendered

insolvent• Unreasonable consideration for the transfer• Transfer was outside the ordinary course• Transfer involved shell entities

Constructive Fraud• Transfer for less than reasonably

equivalent consideration• Transfer leaves the debtor with

unreasonably small capital• Transfer caused the debtor to incur

debts beyond its ability to pay

Defenses to Fraudulent TransferGood Faith

Savings clause for an initial transferee that gives reasonably equivalent value to the debtor for the transfer and the transferee exhibits good faith

Burden of proof is on the transferee

Failure to Proactively Deal With Workplace Issues

3

EMPLOYEE HANDBOOKS

Employers should have them(!)o Without a handbook, it’s more difficult to

defend EEOC charges of discrimination, unemployment, etc.

o Also, handbook is basic source of information for employees on rules at their place of employment.

EMPLOYEE HANDBOOKS

But employers want to avoid curtailing “at-will” employment with handbooks, and in Texas, they generally can.

EMPLOYEE HANDBOOKSHandbooks are not generally treated as binding contracts:

"There is a 'generalized rejection [by Texas courts] of the claim that employment manuals issued unilaterally by an employer can per se constitute written employment contracts and create specific limitations which take the cases out of the at-will doctrine.“ Hays v. HCA Holdings, Inc., 2015 U.S. Dist. LEXIS 131960 (W.D. Tex. 2015)

EMPLOYEE HANDBOOKS

Avoid promises of lifetime employment, termination only for good cause, etc.

BUT—even these seldom create enforceable contracts nullifying employment at will.

EMPLOYEE HANDBOOKS

General statements …simply do not justify the conclusion that the speaker intends by them to make a binding contract of employment.

For such a contract to exist, the employer must unequivocally indicate a definite intent to be bound not to terminate the employee except under clearly specified circumstances.

EMPLOYEE HANDBOOKS

General comments that an employee will not be discharged as long as his work is satisfactory do not in themselves manifest such an intent. Neither do statements that an employee will be discharged only for "good reason" or "good cause" when there is no agreement on what those terms encompass.

EMPLOYEE HANDBOOKS

Without such agreement the employee cannot reasonably expect to limit the employer's right to terminate him. An employee who has no formal agreement with his employer cannot construct one out of indefinite comments, encouragements, or assurances. Montgomery County Hosp. Dist. v. Brown, 965 S.W.2d 501, (Tex. 1998)

EMPLOYEE HANDBOOKS

Handbooks are generally not binding on the employer. They are nothing more than a guideline. If the employer included a phrase providing they are not contractual, then they will not be binding. e.g., progressive discipline provisions can be ignored if offense is serious.

EMPLOYEE HANDBOOKS

NLRB, however, frowns on too-broad at will disclaimers. e.g.: “I further agree that the at-will employment relationship cannot be amended, modified or altered in any way.”

NLRB thought that this language would cause employees to conclude that the at-will language means that their at-will status cannot be changed through collective bargaining.

EMPLOYEE HANDBOOKS

Here are some examples of issues that should be in a handbook:Acknowledgment of Receipt of Employee HandbookAttendance PolicyAt-Will Employment; Handbook not a contractCompany-Issued Credit CardsConfidentiality of InformationConflict of InterestDriver PolicyDrug-Free Workplace Policy

EMPLOYEE HANDBOOKSDiscrimination, Harassment and Disrespect Toward Others

(including sexual harassment) FMLA Policy Fringe BenefitsExempt/Nonexempt employees Internet, E-Mail, and Computer Usage Policy Limits on Leave BenefitsMedical Absence WarningsMedical Information Confidentiality PolicyNeutral Absence Control Policy

EMPLOYEE HANDBOOKS Overtime Relationships Within The Workplace Request for Change in Employment Status Searches Smoking Policy Social Media Use Policy Vacation and Sick Leave Video Surveillance / Search Consent Wage Deduction Authorization Agreement Wage Overpayment/Underpayment Policy Work Schedules and Recording of Work Time

INDEPENDENT CONTRACTORS

So-called “misclassification” of workers as independent contractors when they are really employees is a top priority for the federal government. There are joint working agreements between IRS, DOL/WH, TWC to exchange info on employers who have a lot of misclassified employees.

INDEPENDENT CONTRACTORS

Traditional common law test centered on “control” over the details of the way the work is performed, and Texas courts addressing state law issues still focus a lot on control.

INDEPENDENT CONTRACTORS

USDOL and other federal agencies, and the federal courts, look beyond control to include other factors.

DOL FACTORS

The extent to which the work performed is an integral part of the employer’s business. Whether the worker’s managerial skills affect his or her opportunity for profit and loss. The relative investments in facilities and equipment by the worker and the employer.

INDEPENDENT CONTRACTORS

4) The worker’s skill and initiative. 5) The permanency of the worker’s relationship

with the employer. 6) The nature and degree of control by the

employer.

EMPLOYEE PRIVACY ISSUES

Non-consensual use of employees’ name or likeness

Publication of Private Information

Intrusion into Seclusion, i.e. searches of person, property, medical exams, tests

TRADITIONAL PRIVACY ISSUES

EMPLOYEE PRIVACY ISSUESSearches

Key is to obtain employee consent at time of hire, and to remove any reasonable expectation of privacy employee might have

Developing Privacy Issues

Medical Records• ADA requires that medical information be kept in separate files• HIPPA does apply to health insurance plans, etc.; HOWEVER

EMPLOYEE PRIVACY ISSUES

Information received as an employer record is not protected by health privacy rule. e.g.; FMLA health care provider certification info.

But if employer is plan administrator, Health Privacy Rule applies.

Employer Monitoring of Electronic Resources

• Give employees notice, get consent, get acknowledgement

• Electronic Communications Privacy Act has both civil and criminal sanctions for secret monitoring, eavesdropping

Video Monitoring

If no audio, not subject to ECPAbut can still be invasion of privacy, so give employees notice, get consent, get acknowledgement

EMPLOYEE PRIVACY ISSUES

Examples of video monitoring which got employers into trouble:

• Employer put video cameras in women’s restroom based on rumors of drug sales, but kept them there two years

• Hooter’s franchise took secret videos of applicants changing into proposed Hooter’s uniforms

Lack of Comprehensive Immigration Compliance Plan to Avoid Violations

and Claims

4

Investigates employers for compliance with employment employer verification rules and removes

undocumented aliens from the United States.http://www.ice.gov

Investigates and prosecutes charges of immigration-related unfair employment practices

www.usdoj.gov/crt/osc

U.S. Department of JusticeOffice of Special Counsel (OSC)

PM Packing ordered to pay $27,200 (reduced from $53,762) for paperwork violations, including failure to prepare I-9 for 22 employees.

Golf International ordered to pay $57,650 (reduced from $136,697) for paperwork violations, including failure to sign section 2 for 110 employees.

Demand of Specific I-9 Documents Prohibited

RECENT CASES

Miami Dade County Public Schools paid $90,000 penalty and $125,000 for back payYellow Cab Companies of Nevada paid $445,000 in civil penaltiesAbercrombie paid approximately $156,000 in back pay

Immigration Compliance Plan

Recommended Policies and Procedures

I-9 procedures for hiring and re-verification

Anti-discrimination policies

Retention of I-9 forms

E-Verify procedures

Investigation of violations

Group trainingIndividual trainingSample trainingOngoing and periodic

Training and Supervision

Secure Recordkeeping

Separation Centralized Retention

Retention Calculation

Date of Hire__________+ 3 years =____________

Date of Separation ________+ 1 year = _________

Take the later date and enter it here: _____________________________________

Retention Date

Consistency – do not treat workers differently because of immigration status

No “citizen only” policy

Do not demand specific documents, e.g. “green card”

Do not re-verify “green card” when the card expires

Do not demand more documents than needed to complete I-9

Anti-Discrimination Procedures

Viol

atio

ns re

porti

ng a

nd in

vest

igat

ions Consistency

Credible reporting

Enforce, enforce, enforce!

Prepare for government audit

Identify errors

Identify training issues

Demonstrates good faith compliance

I-9 Self Audits

Conduct training

Ensure corrections are made

Review audit report and implement procedural changes

Maintain ongoing project attitude

Post-Audit Implementation

ICE Enforcement Action

Responding to ICE Enforcement Actions

Choose a point person Ask to see documents

authorizing the search of premises or employees (warrant)

Make copy of the warrant, notice of inspection (NOI), subpoena, etc.

Responding to ICE Enforcement Actions Ask about purpose

and scope of inspection

Accompany agents on the search

Comply with the warrant but do not volunteer information not covered by warrant

Responding to ICE I-9 Inspection

If I-9 inspection, don’t waive right to 3-day notice (ask for extension)

Separate I-9 forms from personnel files

Offsite review – make copies of all documents submitted

Onsite review – conference room or somewhere separate from work areas

Call an experienced attorney immediately upon receipt of the NOI or initiation of enforcement action and do not allow agents to talk with employees before calling an attorney.

NO Annual Legal Review toUncover Hidden Risks and Reduce

Potential Losses

5

Legal Check-Up

• Diagnosis

• Treatment

• Prevention

Thank You

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