Corporate Law

Should We Notify Our Insurance Company?

Posted on by Mike Reeves

On March 28, 2018, a federal judge in Atlanta excused Fulton County’s insurance company from paying more than $6.5 million. Valuable insurance coverage was lost because the County failed to provide timely notice to its liability insurance company.

Insurance policies are contracts between the insurance company and the insured. Those contracts require the insured to take various actions after an accident. Two of the most important are to give the insurance company notice of an accident and to send any potentially covered lawsuit to the insurance company. Coverage may be lost if the insurance company has included language in the policy stating that a failure to provide notice will result in a forfeiture of coverage or that the notice provision is a condition precedent to coverage. Put more simply, late notice may excuse the insurance company from paying, as it did Fulton County’s insurance company.

The notice clauses enable insurance companies to promptly learn of the accident so they may investigate the circumstances, determine whether it is prudent to participate in negotiations, or, if negotiations are not successful, to ensure the lawsuit is properly defended. Courts recognize the importance of prompt notice and will enforce clearly stated consequences of late notice.

The insured’s duties and the consequences of the insured’s failure to give prompt notice depend on the nature of the coverage, the language of the policy, and the law of the state whose statutes and cases are used to construe the policy. Insurance policies may be personal or commercial, they may be “first party” or “third party.” They may be “occurrence” or “claims made.” They may be “primary” or “excess.” These variations are critical but are beyond the scope of this brief article.

Here, we focus on a few of the principles common to almost all insurance contracts. For example, liability policies require that notice of an occurrence (an event that could give rise to a claim) be given to the insurance company “immediately” or “promptly” or “as soon as practicable.” In addition, most policies require the insured to notify the insurance company if a claim is made or, if suit is brought, to forward the suit papers to the insurance company. A typical notice provision follows:

Duties In The Event Of Occurrence, Offense, Claim Or Suit

a. You must see to it that we are notified as soon as practicable of an “occurrence” or an offense which may result in a claim. To the extent possible, notice should include:

(1) How, when and where the “occurrence” or offense took place;

(2) The names and addresses of any injured persons and witnesses; and

(3)  he nature and location of any injury or damage arising out of the “occurrence” or offense.

b. If a claim is made or “suit” is brought against any insured, you must:

(1)  Immediately record the specifics of the claim or “suit”’ and the date received; and

(2)  Notify us as soon as practicable.

You must see to it that we receive written notice of the claim or “suit” as soon as practicable.

As indicated by this language, policies generally impose two duties: (1) a duty to notify the insurance company of an incident, accident, occurrence, or claim; and (2) an independent duty to notify the insurance company of a lawsuit.

The duty to give notice of an incident, accident, occurrence, or claim arises when the insured has reason to know of the possibility of a claim, regardless of whether the insured believes that he or she is liable, or that the claim is valid. Under Georgia law, the duty to provide notice to an insurance company is triggered when an insured actually knew or should have known of a possibility that it might be held liable for the occurrence.

In determining if there is a possibility of a claim that should be reported to the insurance company, a prudent insured will consider, for example: whether the insured is aware a person is injured; whether the insured is aware the injuries require treatment; and whether the insured is aware of the extent of related damage to property such as a vehicle (suggesting the severity of the collision).

Even Short Delays Can Avoid Coverage
Under Georgia law, while the “as soon as practicable” language affords some leeway as to timing, courts applying Georgia law have held that short delays can nonetheless result in the loss of coverage. Where no valid excuse exists, the failure to give notice for a period as short as three months has been found to be unreasonable.

Late Notice May Result In Loss Of Coverage
If an insured unreasonably fails to give timely notice, the insurance company is not obligated to provide either a defense or coverage:

  • An insured’s own determination of its lack of liability is not an excuse. The insured may not justify failure to provide notice by claiming that it determined that it had no liability for the incident.
  • The insured’s duty to give notice arises upon actual knowledge of a claim; however, the insured’s duty may also arise in the absence of actual knowledge. The insurance company – and then a court – will look at all of the facts and circumstances to determine whether the insured had enough information that he or she “should have known” a claim was possible. For example, where insured heard that someone had fallen from a fire escape and that someone was observed taking photographs of the scene, it was unreasonable for insured to delay five months before giving notice.

Similarly, a failure to promptly forward suit papers may result in loss of coverage:

  • The failure of an insured to forward a complaint to an insurance company until 46 days after its receipt breached a provision of a policy requiring prompt forwarding of suit papers, and allowed the insurance company to avoid both of its obligations – to defend the suit and to pay for any resulting judgment.

The policy language is critical. Where notice to the insured is not a condition precedent to coverage, the insurance company may void coverage only if the insurance company is able to show that it was prejudiced by the late notice. On the other hand, where the policy language indicates timely notice is a condition precedent, Georgia cases hold that the insurance company  need not prove that it was prejudiced by the delay.

Some types of insurance have their own, specific rules. For motor vehicle insurance, an insurance company seeking to avoid coverage due to late notice bears the burden of showing both that the delay by the insured was unreasonable and that this unreasonable delay prejudiced the insurance company’s ability to defend the case.

Giving Notice to the Insurance Company
Insureds should carefully read the policy and strictly comply with the notice requirements of the policy, both as to whom notice should be sent and the manner in which it should be sent.

Who May Give Notice?
Usually, the insured gives notice of a claim or sends copies of a lawsuit directly to the insurance company, Georgia law does not require that notice come only from the insured. Anyone who follows the policy language may give notice, as long as reasonable and timely.

Indeed, with respect to motor vehicle insurance, Georgia statutes specifically provide that a copy of a complaint and summons may be sent by a third party to the insurance company or to the insurance company’s agent by certified mail or statutory overnight delivery within ten days of the filing of the complaint.

To Whom Should Notice Be Given?
It is always safest to notify the insurance company directly, at the place indicated in the policy.

An insured may be accustomed to working with an independent insurance agent for most of their “day-to-day” insurance-related dealings. However, an insured should be aware that giving notice to an independent agent likely does not constitute valid notice to the insurance company. Under Georgia law, independent insurance agents or brokers are generally considered the agent of the insured, not of the insurance company.

However, under limited circumstances, an independent insurance agent may be considered an agent of the insurance company, such that notice to the agent is considered notice to the insurance company itself. For example, an independent insurance agent may be considered an agent of the insurance company if the insured can prove that the insurance company granted the agent or broker authority to bind coverage on the insurance company’s behalf. Alternatively, if an insurance company holds out an independent agent as its agent and an insured justifiably relies on such representation, the independent agent will be considered the agent of the insurance company. The insured will bear the burden of proving that the independent insurance agent is an agent of the insurance company. Gathering and presenting this evidence is expensive and time-consuming but may help to save coverage.

Late Notice May Be Excused
Not every late notice results in a loss of coverage. There are some circumstances in which courts have come to the rescue of insureds when the insurance company has denied the claim because of “late notice.” The insured has the burden of showing justification for a delay in providing notice. Some examples from Georgia cases include:

  • Even though 19 months elapsed before the insured gave notice, the court properly let a jury determine whether the insured acted reasonably where the insured had no actual knowledge of an accident, there were no facts to show the insured should have known, and the insured notified the insurance company immediately when evidence of a claim came to its attention.
  • Even though the insured was aware of an accident, its late notice may be excused because no one appeared to be injured in the accident and there was no significant property damage.

Gathering and presenting evidence that the insured’s delay was excusable under the circumstances is expensive and time-consuming but presenting and proving the grounds for an excuse may prevent the insurance company from denying coverage.

Call Your Lawyer, Provide Notice To The Insurance Company, And Forward Suit Papers
Whenever the insured is aware of an occurrence or a potential claim, the insured must promptly review the language of the applicable policy. The insured should not speculate there is no liability. Neither should the insured speculate there is no coverage. The insured should give notice even if the insured is unsure if the policy provides coverage.

Similarly, the insured must not assume that things can be “worked out” with the other party without involving the insurance company. An insured must not fail to give notice just because it believes the it has no liability or that the claimant or some other party was at fault. The other party or the other party’s insurance company may not agree.

The rules are complex, and the inquiry is very fact-specific. As the Georgia Court of Appeals recently stated:

We recognize that our jurisprudence on the question of what constitutes sufficiently prompt notice under an insurance contract … is not easily harmonized. Indeed, some of our prior decisions are difficult to reconcile with each other, as is not uncommon in an area that calls for a fact-specific inquiry.

In other words, call an experienced lawyer.

Because the consequences of failing to comply with the terms of an insurance policy could be fatal to coverage, a person or a business who becomes aware of an occurrence, or who receives a claim, demand letter, or lawsuit, should seek legal counsel as soon as possible. Ask about the specific rules applicable to the kind of policy at issue, about the details of when, by whom, and to whom notice must be given, and about the law of the state whose law will be used to construe the policy. And if the insured has failed to give prompt notice of an occurrence or claim, or to forward suit papers, the insured must consult a lawyer immediately to see if the delay may be  excused so that the insured is not left facing liability without insurance coverage.

If we may be of assistance, contact Mike Reeves at mreeves@fh2.com or (770) 399-9500.

DAVID V. GOLIATH – Using Indemnification Clauses to Level the Contractual Playing Field

Posted on by Scott Harris

Not all parties to contracts are created equal. In fact, more often than not one party to a contract may have considerably greater bargaining power and financial resources than the other party. This can give the stronger party an incentive to misbehave.  So how can you protect yourself when you are the “David” in a David v. Goliath scenario? Consider using an indemnification[1] clause to help level the playing field.

Indemnification clauses can be among the most important provisions to include in contracts for several reasons.  First, the mere existence of an indemnification clause can help ensure that a party gets what it bargained for under a contract, by giving the other party a reason to “think twice” before breaching the agreement.  Second, in the event the other party does breach the agreement, a well-crafted indemnification clause can give the non-breaching party more leverage to resolve matters favorably, before trial.  Third, an indemnification clause can help the non-breaching party recover its legal expenses incurred in enforcing the contract, thus removing the most costly obstacle to a “David” standing up to a “Goliath”.

Illustration – The David v. Goliath Scenario. Assume David and Goliath enter into a contract where David will pay $50,000 upon Goliath’s delivery of widgets. But, when it comes time for Goliath to deliver the widgets, he refuses.  Goliath may have accepted a higher offer from someone else for the widgets because he knows that David has fewer resources than Goliath and is unlikely to sue.

Let’s look at David’s options. David would almost certainly be entitled to recover “contract damages” for Goliath’s breach – such as the difference in price David must pay to acquire substitute widgets from an alternate source. But actually winning and collecting those contract damages comes with its own significant costs.  If David were to sue Goliath for breach (assuming he could afford to) David must hire an attorney.  However, under American contract law principles, David will not be entitled to reimbursement for the attorneys’ fees that he incurs fighting Goliath.  This results in a very real likelihood that David’s costs to pursue a lawsuit against Goliath will be greater than the amount he may actually recover in damages. This means that David may end up “winning” the lawsuit, but lose money overall after factoring in legal costs.

In short, because the American contract law on damages does not generally reimburse plaintiffs for their attorneys’ fees in contract breach actions, plaintiffs like David face an economic disincentive to stand up for their rights. Conversely, breaching parties like Goliath can have a perverse incentive to breach, particularly if the other party is financially weaker. This is where an indemnification clause can help level the playing field.

I.  Anatomy of an Indemnification Clause.

Indemnification clauses can help address the shortcomings of American contract law on damages by shifting liability or expense from one party to the other.

Here is a simple indemnification clause from a two-party contract:

Indemnitor shall indemnify, hold harmless, and defend indemnitee, to the fullest extent, from and against all claims, demands, actions, suits, costs and expenses (including, without limitation, attorneys’ fees and costs), losses, damages, settlements, and judgments (each, a “Claim”), whether or not involving a third party claim, arising out of or relating to: (i) any breach of any representation or warranty of indemnitor in this Agreement; or (ii) any breach or violation of any covenant of indemnitor in this Agreement, in each case whether or not the Claim has merit.

The three basic components of an indemnification clause are (1) the Parties, (2) the Claims, and (3) the Trigger Events. Each is explained below.

  1. Parties. The effect of an indemnification clause is to shift certain expenses and legal responsibilities from one party, the “indemnitee” or benefitting party, to the contract’s other party, the “indemnitor” or obligated party.
  2. Claims. “Claims” are the things the indemnitee is protected from or against. Claims can be:
  • an allegation (such as a claim or demand asserted by the indemnitor or a third party);
  • a formal legal proceeding (such as an arbitration, lawsuit, settlement, or judgment); or
  • a monetary amount (such as a loss, liability, cost, or expense incurred by the indemnitee).

(While this article focuses on “Direct Claims”, meaning a Claim by one party to the contract directly against the other party, indemnification clauses can also be used to shift liability and expense associated with a Claim asserted against the indemnitee by a third party, known as a “Third-Party Claim”.)

  1. Trigger Events. Usually, an indemnification clause is limited only to those Claims that arise out of, or result from, certain enumerated occurrences or circumstances (the “Trigger Events”). For our simple indemnification clause above the Trigger Events are limited to breaches of the indemnitor’s representations, warranties, and covenants (i.e., the indemnitor’s promise to do something) in the contract. But there can be many other types of Trigger Events; for example, the indemnitor’s violation of laws, its products or services infringing the rights of others, its acts causing personal injury or property damage, etc.

II.  Indemnification for Direct Claims.

With an understanding of the components of an indemnification clause, now let’s reconsider how our illustration might play out if the contract between David and Goliath had contained our simple indemnification clause.

In this instance, David could still sue Goliath for his contract damages.  But now, David has a bigger, more powerful “stone in his sling”.  Specifically, because his lawsuit is a Claim of a specified Trigger Event (Goliath’s breach of his covenant/promise to deliver widgets as required by the contract), David can also make a claim for reimbursement of David’s attorneys’ fees in bringing the lawsuit. The fact that Goliath may now be saddled with having to pay David’s legal fees will likely influence David’s decision to enforce his contractual rights against Goliath.

III.       Effects of Indemnity on Indemnitor Breaching Party.

As we can see, having an indemnification clause for Direct Claims substantially changes the economic calculus in favor of the plaintiff. It has considerable effects on the defendant breaching party, as well.

  1. The Threat of Having to Pay for Two Sets of Lawyers. In a lawsuit to enforce a contract with an indemnification clause, the breaching indemnitor is faced with the possibility of ending up paying for two sets of attorneys—its own and the plaintiff/indemnitee’s. Adding an indemnification clause to the mix has a substantial economic and psychological effect on the indemnitor. While protracting and delaying litigation is a time-honored tradition for some defendants, the benefits of being stubborn is much less compelling when weighted against the potential of having to pay both sides attorney’s fees. This fact weighs more and more heavily on indemnitors as legal fees mount and litigation progresses.
  2. Encouraging Settlement and Dispute Resolution. The example above assumes that a lawsuit was filed and proceeds all the way to trial and judgment. However, the vast majority of lawsuits are concluded before judgment, either by settlement or dismissal. Having an indemnification clause can be beneficial to resolving a lawsuit early on and even before a lawsuit is filed because as the indemnitee’s attorneys’ fees rise, the typical benefit of delay and protraction to the indemnitor diminishes. This increases the likelihood of earlier and more reasonable settlement.
  3. The Indemnitor May “Think Twice” Before Breaching the Contract At All. Of course, David would probably be happiest if Goliath simply performed the contract and avoided a dispute entirely. The mere presence of a clause that could make Goliath responsible for David’s costs of enforcing the contract may give him ample economic incentive to play by the rules of the contract from the outset.

III.  Conclusion.

While the particular facts and circumstances of the parties should always be considered, in many circumstances including a properly-drafted indemnification clause can enhance the parties’ likelihood that they will receive what they bargained for under the contract.

________________________

If you have questions regarding indemnification clauses or need further guidance on how to structure your business relationships, contact Scott Harris at SHarris@fh2.com or (770-399-9500).

[1] As used in this article, the terms “indemnity” and “indemnification” include three slightly different legal obligations: indemnity (to reimburse for an incurred expense or cost), hold harmless (a release from liability), and defend (the agreement to defend against a legal claim).  The three are slightly different concepts, but their effect is the same. They shift liability or expense from one party to the other.

It’s the New Year: Have You Checked Your Marks Lately?

Posted on by Michael Stewart

The start of a new year provides a time to reflect on past successes and lessons learned. It’s also a time to chart the course ahead to achieve your goals. One important goal for any business is to protect the uniqueness and “brand identity” that distinguishes it from others. And, there is no more valuable asset of brand identity than a company’s trademarks and service marks.

Like any business asset, trademarks and service marks must be used properly in order to maintain and enhance their value. Failure to do so can result in your trademarks and service marks losing their value and, eventually, allowing copycats to “steal” value from your business.

So, here are a few New Year’s tips to 1. ensure that you know how to properly use (and, thereby, legally strengthen) your trademarks and service marks, and 2. keep from weakening (or even losing) your trademarks and service marks.

I.  First, Some Basics:

What Is a Mark? What Is Its Purpose?

In short, a “trademark” is a word or symbol (or a combination of both) used to identify a business’s products to distinguish them from similar products offered by others.  Conversely, a “service mark” is used to identify services (rather than products) offered by a business to distinguish those services from similar services offered by others.  (Unless stated otherwise, the rest of this article uses the term “Mark” to include both trademarks and service marks.)

Marks help customers differentiate between products or services offered by one business and products or services offered by another.  Customers rely extensively on Marks when making purchasing decisions between different brands of the same product. They purchase one product instead of another, more often than not, based on perceptions of the respective quality and reputation associated with a specific brand (the Mark)—often without ever sampling the actual product or service. (Who opens a Coca-Cola beverage to taste it before buying it over a generic labeled store brand?) The ability of Marks to distinguish competing products or services and drive buying decisions is what makes them so valuable.  Such value is worthy of protection. And protection starts with proper usage.

What Do We Mean by “Proper Usage” of Marks?

Proper usage of Marks is all about clearly and consistently presenting the Mark in a way that the consumer easily recognizes that the Mark indicates a specific source (or brand) of products or services. The antithesis of this is when a Mark is used in such a way that it is perceived as merely a generic name for a product or service. Proper Mark usage indicates a specific source or brand. (Think: “Buy a BMW automobile”.)  Improper usage allows the Mark itself to be mistaken for the generic name of a category of products or services. (Bad: “Hand me a Kleenex”; “Make me a Xerox”.)  As customers come to associate your Mark with the specific quality and reputation unique to your brand, properly presenting a Mark preserves—and, over time, strengthens—the Mark’s ability to distinguish your business’s products and services from those of another company in the minds of customers.

II.  Do a “Proper Usage” Check-Up: Some Things to Look For.

A.  Present Your Mark as an Adjective – Not as a Noun or a Verb. You should always use your Mark as an adjective followed by a noun (the generic name of your products or services). Never use your Mark as a standalone noun or verb, even as a “shorthand” description of the products or services.  Failure to consistently present your Mark as a modifier to differentiate your company as the source of products or services leads consumers to think that your Mark is merely a generic name (whether as a noun or verb) for the type of products or services you provide. If that happens, your Mark may no longer be “distinctive”—meaning that customers no longer view it as a basis for distinguishing between your products and services and similar products and services of others. Once your Mark is no longer distinctive, it can lose the legal protections accorded to a trademark or service mark. This includes the right to exclude others from using your Mark.

Here are some examples of correct and incorrect uses of a Mark in a sentence.

Correct:   “Use BUZZ cloud data services to manage your data.” (“BUZZ” modifies cloud data services—good!)

Incorrect: “Use BUZZ to manage your data.” (“BUZZ” used as a shorthand noun—bad.)

Incorrect: “BUZZ your data management!” (“BUZZ” used as a verb—bad.)

TIP – One way to determine whether you are using your Mark properly as an adjective is to delete the Mark from the sentence in which it appears.  If the sentence still makes sense after deletion, that’s a good sign that the Mark was being used properly in the sentence.

EXCEPTION:  Sometimes a business uses the same term as both a Mark (a brand name for its products and services – an adjective) and as a name for the business itself (a noun).  (Think “BMW”, which is used both as the name of the company and as a brand name for the automobiles offered by that company.) When the business is merely using the term to refer to itself as a company or corporate entity, it is permissible to use the term as a standalone noun—but the business should nonetheless remain vigilant to follow the rules of proper Mark usage when it is using that term as a brand name for the business’s products and services (an adjective).

B.  Present Your Mark Consistently in Form and Format. Your Mark should always be presented consistently.  Consistent repetition of your Mark in the exact same form helps consumers recognize and remember it. This, in turn, strengthens consumers’ association of your Mark with the specific quality and reputation unique to your business. So:

  • Don’t vary the spelling or punctuation of your Mark; and
  • Avoid presenting your Mark in plural or possessive forms. (However, this does not apply if your Mark is actually plural (like “BUNCHES”) or a possessive (like “BOB’S”).)

C.  Make Your Mark Stand Out. Consider taking additional steps to make your Mark stand out as a unique identifier for your brand of products and services. For example, if your Mark is a word or a phrase (rather than a logo), differentiate the Mark visually from surrounding text.  Present your Mark in ALL CAPS or in a different color font.  Making your Mark stand out,  reinforces the word or phrase as a Mark instead of a generic reference.

D.  Use the Correct ®, TM, or SM Symbol and Use It Correctly.  Proper use of the correct ®, TM, or SM symbol is crucial to preserving rights in your Marks for several reasons.  It publicly reinforces that the word(s) or logo to which the symbol is affixed are being used as a Mark and not a generic name for goods or services, and it puts potential infringers on notice of your claim to rights in your Mark.  Furthermore, in some cases, it may eliminate certain defenses available to those infringing your Mark and affect the types of infringement damages you might recover for an infringement of your Mark.

Here are tips on how to determine which is the correct symbol to use with your Mark and how to use that symbol properly.

  • Use the ® symbol if your mark is registered with the USPTO in connection with the products and/or services on which the mark is being used in that particular instance.
  • Conversely, don’t use ®—and do use either the TM or SM symbol, as applicable—if you have not obtained a USPTO registration for your Mark or if you are not using the Mark, in that particular instance, with the particular products or services listed in your Mark’s USPTO registration.
    • Use the TM symbol when the Mark is being used in connection with products.
    • Use the SM symbol when the Mark is being used in connection with services.
  • Place the correct ®, TM, or SM symbol immediately following the Mark, not after the generic name of the product or service with which your Mark is associated. For example, for the Mark “BUZZ” registered with the USPTO for cloud data services, an example of appropriate usage would be “Use BUZZ®  cloud data services”—not “Use BUZZ cloud data services®”. (If there was no USPTO registration for “BUZZ” or if “BUZZ”, is not registered with respect to “cloud data services,” you would change the ® to a SM symbol.)

EXCEPTION: As noted, sometimes a business uses the same term as both a Mark and as a name for the business itself.  Trademark symbols should never be used where the business is merely referring to itself as a company or corporate entity (a noun), as opposed to a “brand name” for specific products or services (adjective).

Conclusion:  Start the new year off right by making sure your business is using and presenting its Marks properly. Appropriate presentation and use of your Marks will: strengthen customers’ association of your Mark with the particular products or services with which it is associated; help you protect your Mark against infringement; and increase the value of your business’s unique “brand identity.”

If you have questions regarding trademarks and service marks, including selection, proper usage, and protection of these valuable business assets, contact Mike Stewart at mstewart@fh2.com or (770) 399-9500 for more guidance.

Terms and Conditions May Not Apply – How to Make Sure Your Terms and Conditions Work for You

Posted on by Ben Byrd

“Additional terms and conditions apply” is a phrase we have all heard from a voice-over on a late-night infomercial hawking vegetable juicers or subscriptions to a knife-of-the-month club. But just what are “terms and conditions” and how are they different from a normal contract? And what concern are they to businesses that occupy, shall we say, more reputable corners of the marketplace?

What are “terms and conditions”?

As an initial matter, every contract has “terms”. These are simply the various promises that the parties to a contract make to each other: WidgetCo shall provide Customer with 600 widgets. In return, Customer shall pay WidgetCo $1,000 per widget. These are both terms.

Terms can be conditional—if Customer pays within 30 days of delivery, WidgetCo will give Customer a 5% reduction off the quoted purchase price. But conditional terms are still terms and, legally, there is no meaningful distinction between terms and conditions. Like “cease and desist” or “will and testament”, “terms and conditions” is simply a stock phrase that has become a fossilized part of legal language.

As a practical matter, though, when we hear the phase “terms and conditions”, what is usually meant are contract terms that have two characteristics. First, they are boilerplate terms—that is, standardized terms that are ancillary to the “real” terms of the deal that have been hammered out between the two parties with respect to the transaction at hand (for example, quantity purchased, delivery dates and locations). Second, they are often contained in a document (often titled “Terms and Conditions”) that is separate from the primary “deal-specific” document (such as a purchase order or statement of work) that gives rise to a particular deal. Terms and conditions are often, but not always, dictated by the seller of the goods or services without negotiation. It is in this sense that we will use the phrase “terms and conditions” in this article.

Considerations in using separate “terms and conditions”:

It can be useful to structure a transaction so that there are separate terms and conditions, and it is a practice that is especially common in internet-based commerce. Nevertheless, if you choose to employ terms and conditions, there are several considerations you must account for. Otherwise, you may end up with a contract different from the one you thought you agreed to.

Do you have a meeting of the minds? The first challenge that terms and conditions present is that they have a funny way of never making it into the contract at all. Any lawyer can tell you that a commercial contract is a “meeting of the minds” – that is, an agreement – between the buyer and the seller. In short, terms that both parties agree to become a part of the contract. Those that haven’t been agreed to do not.

The legal burden is on the party seeking to enforce a term to prove that the term was agreed to by both parties to be part of their “deal”. And, generally, this requires proof that the other party (i) had notice of the additional terms and an opportunity to review them, and (ii) agreed to be bound by them.

A problem with separate terms and conditions is that one party may not be aware that they exist at all. (In fact, a cynic might conclude that one reason terms and conditions are so popular is they seem to allow one party to insert terms into a deal without bringing them to the other party’s attention.) But if one party isn’t aware of certain terms, that raises the possibility that there was no meeting of the minds as to those terms, and so they do not become a part of the parties’ contract.

  • Imagine, for example, WidgetCo sells widgets through its website, widgetsforless.com. Within that website is a web page laying out the terms and conditions for purchases made through the website. However, a customer never has to visit that page to complete an order, nor is there a specific reference or link to the terms and conditions during the order process—so a customer can place an order without ever being exposed to the “other terms and conditions”. Instead, the website may contain just a general—and inconspicuous—statement that merely browsing or using the website binds the customer to the terms and conditions. This approach is often referred to as a “browse wrap” agreement. (The word “wrap” is an allusion to the earlier practice of selling software with terms and conditions included inside a box wrapped in shrink-wrap.)

In this situation, can we really say—or prove—the customer has knowingly agreed to those terms? Without something more, that is a very hard conclusion to reach, and courts usually agree. Browse wrap terms are often found to be unenforceable for the fundamental reason that they were never mutually agreed to—because the customer did not have adequate notice of the terms.

  • Now imagine WidgetCo uses a printed order form that contains the statement “WidgetCo’s standard Terms and Conditions apply”. This is better, because WidgetCo’s customer should at least be on notice that there are other terms out there that it needs to be aware of. But does WidgetCo’s customer really know the substance of the terms it’s agreeing to when it submits the order form? Can it find out what it’s agreeing to? If not, whose fault is that—WidgetCo’s or the customer’s? In this case, it would be WidgetCo’s fault—while WidgetCo has notified the customer that additional terms apply, it has not given the customer any opportunity to review those terms. As such, the customer cannot be said to have agreed to terms that it could not review.

To avoid these questions, the best practice would be for WidgetCo to include a copy of its separate terms and conditions with the primary contract document and to get some affirmative manifestation that the customer agrees to those terms, such as a signature on the terms and conditions document.

But that is not always possible. So, at a minimum, WidgetCo needs to include a provision in the main document that clearly and unambiguously

  • incorporates the additional terms into the parties’ agreement; and
  • provides clear direction on how the customer can find those terms to review them.

So long as the terms and condition of a contract have been made available for review by a party, the law will usually presume that the party read them and understood their contents—even if the party chose (for whatever reason) to not actually review the terms.

A useful provision could look something like this:

This transaction is subject to WidgetCo’s standard Terms and Conditions, last modified August 1, 2015. WidgetCo’s full Terms and Conditions are available to Customer on WidgetCo’s website at www.widgetsforless.com/terms_and_conditions. 

In an e-commerce context, the same thing can be accomplished by having the buyer/user click a box signaling that he or she agrees to the seller’s terms and conditions, with the actual terms and conditions being available for review via a conspicuous hyperlink. (This is commonly referred to as a “click wrap” agreement, as distinguished from browse wrap.)  Where the terms are available for review by clicking on a conspicuous hyperlink, courts again generally presume that the buyer/user has read them and understood their contents before checking the “I agree” box—even if the buyer/user later admits that they chose to not click on the hyperlink or to actually review the terms.

Can you prove what  terms and conditions the parties agreed to? At this point, we do know the customer has agreed to a set of terms and conditions. But, we still may not necessarily be able to prove what those terms and conditions are. That brings us to our next issue.

In this case, the terms and conditions are almost certainly for WidgetCo’s benefit, so it is likely WidgetCo that is going to want to assert the rights and protections they provide if the deal falls apart. That means the burden will be on WidgetCo to prove the content of the terms and conditions to a court. Experience has shown that that can be harder than it sounds.

Let’s assume WidgetCo’s customer has clearly and unambiguously signaled its consent to be bound by WidgetCo’s  terms and conditions that were in effect on the date their deal was struck. If the terms and conditions were reproduced in full on a document that the customer signed, it’s easy to prove what terms and conditions were agreed to.  But if he has signed a printed document containing a provision like the one in the section above, or he has checked a box on WidgetCo’s website showing his assent—i.e., in both cases, where the terms were made available to the customer through a hyperlink or web address—what now?  Especially if WidgetCo has since revised the terms and conditions found on its website?

Almost by their nature, terms and conditions change over time (a point we will discuss further below). More than once, a business has appeared in court ready to prove how their current terms and conditions appear on their website, only to be told that their current terms and conditions are irrelevant. What matters, of course, are the terms and conditions that were in place at the time this contract was formed with this customer. If the business has not maintained the entire history of its terms and conditions in a structured way—and many businesses do not—it may find itself unable to prove what earlier terms and conditions were in place on the date that this customer entered into the contract.

Therefore, if a business intends to rely on separate terms and conditions, it is essential that it maintain records of its various terms and conditions in such a way that it can prove the contents of the terms and conditions that every individual customer has actually agreed to. To do this will require the business to:

  1. Maintain all prior versions of its terms and conditions in a repository;
  2. Make sure that the repository uses a system that will show not only the version that was in effect on a given day, but also that the customer could have accessed them or did in fact access them (for example, the website containing the terms was not “down” or unavailable at the time; a record showing that the customer clicked the link or “checked the box” (if applicable)); and
  3. Make sure that the repository system is designed so that future employees will be able to testify with certainty about what terms and conditions were in effect on a given date. (Murphy’s Law dictates that all the employees from the time of the sale will be long gone, years later, when the terms actually become relevant to a dispute.)

Are the terms and condition “subject to change”? A common characteristic of standard terms-and-conditions forms is a provision that the terms and conditions themselves are subject to change, usually at the sole discretion of the party that drafted them and often without notice to the other party. The terms may then go on to say that any such change automatically becomes binding on the other party as soon as the change is made. These types of provisions would obviously be useful to the drafting party if they were enforceable. The problem is, they often aren’t.

Again, a contract is an agreement by two parties to a common set of promises. Imagine WidgetCo’s terms and conditions contain the following language:

All invoices shall be paid within 30 days. All invoices that remain unpaid after 30 days shall incur interest at the rate of 4 percent per annum.

If WidgetCo can retain the right to change any term at any time and in its sole discretion, what’s to stop WidgetCo from amending its terms and conditions to require payment within 14 days? Or 4 days for that matter? Why couldn’t it raise the interest rate to 12% and disavow any warranties at the same time? In fact, while it was at it, why couldn’t WidgetCo change its terms and conditions to say that a customer representative had to come to the home of WidgetCo’s president and mow her lawn every Sunday until the balance is paid?

These scenarios may seem absurd, but they illustrate the fundamental unfairness that a unilateral “subject-to-change at will” clause presents. The law recognizes this unfairness and so, generally, renders “subject-to-change at will” provisions unenforceable.  In some cases, courts have gone even further to find that the mere presence of a “subject-to-change at will” provision makes the entire contract unenforceable from the outset.

To make changes to your terms and conditions binding on the other party, you need to comply with the same fundamental requirements as were needed to form the initial contract. That generally means:

  1. Giving the customer actual notice of the new terms;
  2. Getting the customer’s consent to the new terms (which can be express or implied, depending on the circumstances); and
  3. Giving some new promise or performance—or giving up an existing right—in return for the customer’s agreement to make changes to the existing deal.

The last of these is probably the least intuitive for non-lawyers. That is because to be a legally enforceable contract, an agreement cannot be just a meeting of the minds. To be enforceable, an agreement also has to have “consideration” given by each party to the other.  Without new consideration, changes to terms and conditions will generally be found to be an unenforceable attempt to unilaterally modify the terms agreed to by the parties.

Consideration is a legal term of art that refers to the thing that each party agrees to, or gives up, as its part of the deal. For example, in a commercial transaction, the seller promises to give up goods or services, and the buyer gives up his money. These promises are consideration. When the terms of an agreement are changed, the customer’s agreement to proceed under the new, changed terms is usually the necessary consideration given on the part of the customer—but the seller must give something in return as well. It could be a promise to accept future orders from the customer (if the seller would otherwise have the right to refuse such orders), a relaxing of payment terms, or something else.   Depending on the facts and the type of business at hand, the possibilities are potentially limitless—so long as the seller gives something in exchange for the customer’s agreement to accept the changed terms.

In the end, terms and conditions are a fixture of modern commerce, especially online commerce, but they present issues that must be addressed before they can be effective. If you have any questions about your business’s terms and conditions, please contact Ben Byrd at bbyrd@fh2.com or (770) 399-9500 to discuss further.

Considering Business in California?–Think of These Laws First

Posted on by Scott Harris

Your business is growing and fortune is shining. Out-of-state opportunities are increasing. Perhaps you are considering expanding operations. If you haven’t already, you’re likely to end up serving the world’s sixth largest economy[i]—California.  And who wouldn’t want to be in California? It has nearly 40 million consumers.

Before heading out with your sunscreen and order book, there are a few intricacies of California law that any out-of-state business—as well as any business already operating in California—should keep in mind when doing business involving California-based employees or parties.[ii]

1.  Contract Law.

a.  Restrictive Covenants. Employers would do well to take Section 16600 of the California Business and Professions Code seriously when it says:

. . . every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.[iii]

Section 16600 is the cornerstone of California’s strong public policy favoring worker mobility over employers’ restrictive covenant protections. It prohibits non-compete and employee non-solicitation restrictions in employment agreements, and probably most customer non-solicitation restrictions.[iv] The law covers:

  • employees living in California working for out-of-state employers;
  • out-of-state workers of California companies; and
  • out-of-state workers working in California for out-of-state companies.

That’s broad.

Naturally, over the years employers have attempted various tactics to avoid Section 16600. One popular approach is for out-of-state employers to have their employment agreements with California-based employees governed by out-of-state laws and decided in out-of-state forums that are willing to enforce such restrictive covenants. California recently responded to these tactics with a legislative counterpunch. Effective for agreements entered into or renewed in or after 2017, employment agreements that deprive a California resident working in-state from the protections of California’s laws by use of out-of-state choice of law, out-of-state litigation forums, or arbitration provisions are now voidable, unless the employee was represented by counsel in negotiating the agreement.[v]  Out-of-state employers now face a dilemma. Do they include out-of-state governing law and dispute resolution provisions for their in terrorem effect (knowing that they are likely unenforceable) or do they make sure the employee has his or her own legal counsel, and risk educating the employee about the valuable protections of California law that he or she may be giving up in signing the agreement? Stay tuned.

Employers still thinking they can get around Section 16600 would be wise to consider Section 17200 of the Business and Professions Code. Section 17200 makes it an unfair trade practice to attempt to enforce a provision prohibited by Section 16600.

b.  Trade Secrets. So, in the face of California’s strong public policy favoring employee mobility over employers’ restrictive covenant protections, what can an employer do? Answer: protect its trade secrets and confidential information.

California protects trade secrets,[vi] including perhaps the most valuable item for many employers—customer lists.[vii] In fact, some restrictions in employment agreements that operate very much like non-competes and customer non-solicitations have been enforced by California courts under the so-called “trade secrets exception” to Section 16600, where those provisions were deemed to protect against unfair competition by misappropriation of the employer’s trade secrets and confidential information.[viii] So, employers should take note: they might get a second bite at the restrictive covenant “apple” if they word their agreements appropriately.

c.  Commission Plan Agreements. California requires employers to provide employees receiving commissions and performing services in California with written commission plan agreements.[ix] Such agreements must describe how commissions are computed and paid. Employers must also collect signed acknowledgments of receipt from employees for such agreements. Failure to comply bears penalties of $100 for the first violation and $200 for subsequent violations, per employee per pay period.[x] That adds up.

2.  Community Property. California is a community property state.[xi] In California, community property is any property (other than a gift or inheritance) acquired or debt incurred by either spouse, between marriage and permanent separation. Further, quasi-community property is property that would have been community property, had it been acquired while either spouse was domiciled in California. At the time a divorce is filed in California, each spouse has a one-half interest in each separate item of community property and each item of quasi-community property.

Why should a business located outside of California be concerned about California’s community property law? Consider the situation of a married entrepreneur living outside of California who incorporates his 100%-owned, closely-held business outside of California. Things are going so well that he decides to temporarily relocate to California to oversee a West Coast expansion. During the relocation, his spouse files for divorce—in California. Even though the company was formed outside of California, all of its stock is held in the name of the entrepreneur and all of the stock was issued when the entrepreneur was not a California resident; at divorce in California his spouse owns a one-half community property interest in all the stock of the out-of-state corporation. It matters not that the couple had no intention to move to California when the business was started or during its growth. Now, consider that the corporation receives an unsolicited offer to purchase the business. The entrepreneur wishes to accept the offer. The spouse does not. What happens?

In the absence of an agreement, there is a stalemate. The entrepreneur cannot obtain the approval of a majority of the company’s outstanding stock to approve any merger or asset sale, or a direct sale of a majority of the outstanding stock. Moreover, the company would be deadlocked in any shareholder vote where the two spouses cannot agree.

To avoid a situation like this, companies (even those incorporated outside of community property jurisdictions like California) should consider having the spouses of all shareholders sign carefully-drafted shareholder agreements, even when those spouses do not hold shares and do not live in community property states. Such agreements should certainly be put in place before any shareholder or their spouse moves to California, even temporarily.

3.  Employment Law. California’s public policy protecting workers has caused it to adopt numerous laws that are outside of the mainstream of most other states. Here are just a few examples.

a.  Independent Contractors vs. Employees. For employers, independent contractors hold several advantages over employees. In California, for independent contractors, employers do not have to: (a) pay payroll taxes; (b) comply with minimum wage, overtime, meal periods, and rest breaks; (c) comply with vacation rules; (d) provide workers’ compensation insurance; or (e) make unemployment or disability insurance payments or social security contributions. These advantages provide a strong incentive for employers to categorize workers as independent contractors instead of employees—even if they may not be.

California counterbalances this incentive in several ways. First, California law establishes various rebuttable presumptions that workers are employees and not independent contractors.[xii] In such cases, the burden is on the employer to rebut the presumption that the worker is an employee and to prove that he or she is an independent contractor. Adding to an employer’s difficulty in establishing that a particular worker is an “independent contractor,” is the fact that there is no single definition of, or test for, the term in California. Different tests apply for different situations.[xiii] Second, California law makes persons vicariously and individually liable for advising employers to willfully misclassify workers as independent contractors, rather than employees.[xiv] Third, the burden of proving that a particular worker is an independent contractor shifts to the employer once the worker shows he performed any service for the employer.[xv] These and other principles should make any employer, and its executives, very careful when attempting to classify California workers as independent contractors, rather than employees.

b.  Minimum Wage. California’s minimum wages (note the plural) are higher than the current $7.25 federal rate. In California, the state’s minimum is $10 for employers with less than 25 employees and $10.50 for employers with 25 or more employees. (It will increase to $15 by 2022.) Cities, however, can set their own minimums that are above the state’s. Examples include: San Francisco ($14 effective July 1, 2017); Oakland ($12.86); and San Jose ($10.50).

c.  Vacation. While California does not require mandatory paid vacation, employers offering vacation are prohibited from adopting policies requiring employees to “use or lose” accrued vacation days.

d.  California Leave Laws. Under certain conditions, California provides up to six months of paid leave for the birth or adoption of a child. Separate from paid family leave, California also provides numerous grounds for employees to demand unpaid leave, including participation in a child’s school activities and meeting with the child’s teachers. Leave time can be up to 40 hours in a 12-month period. Employers must, therefore, be careful before terminating employees for absence, lest such absences be protected under leave laws. They should always check the law before disciplining or terminating any employee for absences.

e.  The California Family Rights Act (“CFRA”) and the federal Family and Medical Leave Act (“FMLA”). California affords greater rights than the FMLA for pregnancy, pregnancy disabilities, and bonding leave time. The FMLA requires allowing up to 12 weeks to be taken in the first year, but such leave must be taken all at one time. CFRA allows 12 weeks to be taken in the first year in as many as five two-week chunks, plus two additional one-week chunks of time.

f.  Non-Exempt (Hourly) Employees. Hourly employees are entitled to these privileges in California.

  • Meal periods. Employers must provide an unpaid meal break of not less than 30 minutes for each six-hour shift, and must provide a second 30 minute unpaid meal period if the employee works more than 10 hours per day.[xvi] During the meal break an employer cannot exercise control over the employee’s activities, nor can an employer require that the meal break be spent on the employer’s premises.
  • Rest breaks. Employers must provide paid rest breaks of: (a) ten minutes for every shift lasting between 3.5 and six hours; (b) 20 minutes for shifts lasting between 6 and 10 hours; and (c) 30 minutes for shifts between 10 and 14 hours.
  • Day of Rest. Workers cannot be forced to work for seven consecutive days in the same work week.
  • Overtime. Overtime in Calfornia is calculated on a daily and weekly basis.  Overtime rates kick in after the 8th hour in any day and 40 hours in the week.[xvii] Out-of-state workers temporarily working in California are covered by the same rule.[xviii]

g.  Paid Sick Leave. Employers are required to provide paid sick leave for exempt and non-exempt employees.[xix] Sick days accrue at the rate of one hour per 30 days worked, but not less than 24 hours (three work days) for any 12-month period. An employer’s comparable paid time off policy can satisfy the paid sick leave obligation.

h.  Final Pay. Employers are required to immediately pay all wages due to an employee who is discharged or quits.[xx] Willful failure to pay such wages timely incurs a daily penalty of one day’s wages for each day such payment is late.

Conclusion: Employers incorporated or located outside of California need to be aware of California’s laws, particularly when they employ workers based in or temporarily assigned to California. Knowing these laws can prevent a host of unwelcome surprises, as well as the loss of valuable corporate assets.

If you have questions regarding doing business in California or California law, contact Scott Harris at SHarris@fh2.com or (770-399-9500) for more guidance.

[i] Chris Nichols, Does California really have the ‘6th largest economy on planet Earth?’ PolitiFact (July 26, 2016), available at http://www.politifact.com/california/statements/2016/jul/26/kevin-de-leon/does-california-really-have-sixth-largest-economy-/

[ii] This article is only a limited sampling of California law and does not include every issue warranting consideration.

[iii] The statute contains three exceptions involving: a sale of goodwill of a business; partners in advance of dissolving or dissolution of a partnership; and agreements among members of a limited liability company.

[iv] See Edwards v. Arthur Anderson LLP, 44 Cal.4th 937 (Cal.2008) (striking down a non-compete, customer non-solicitation, and employee non-solicitation in an employment agreement). But see Loral Corp. v. Moyes, 174 Cal.App.3d 268, 219 Cal.Rptr. 836 (1985) (enforcing a covenant prohibiting a former employee from “raiding” the former employer’s employees).

[v] California Labor Code Section 925.

[vi] California Uniform Trade Secrets Act at California Civil Code Section 3426 et seq. A recently publicized example of the extent to which California protects trade secrets is the partial injunction won by Waymo (a Google affiliate) in its lawsuit against Uber involving self-driving car technology. See Waymo LLC v. Uber Technologies, Inc., No. C 17-00939 WHA, 2017 WL 2123560 (N.D. Cal. May 15, 2017).

[vii] Brocade Communications Systems, Inc. v. A10 Networks, Inc., 873 F.Supp.2d 1192, 1214 (N.D. Cal. 2012) (under CUTSA, “confidential customer-related information including customer lists and contact information, pricing guidelines, historical purchasing information, and customers’ business needs/preferences … is routinely given trade secret protection.”).

[viii] See Kindt v. Trango Systems, Inc., No. D062404, 2014 WL 4911796 (Cal. Ct. App. Oct. 1, 2014) (enjoining former employee’s use of former employer’s customers’ identities under unfair competition theory); see also StrikePoint Trading, LLC v. Sabolyk, No. SACV071073DOCMLGX, 2008 WL 11334084 (C.D. Cal. Dec. 22, 2008) (enforcing restrictive covenants preventing employee from undertaking “any employment or activity competitive with Employer’s business wherein the loyal and complete fulfillment of the duties of the competitive employment or activity would call upon Employee to reveal, to make judgment on or otherwise to use, any confidential information or trade secrets of Employer.”).

[ix] California Labor Code Section 2751.

[x] California Labor Code Section 2699(f)(2).

[xi] The eight contiguous-states girding the United States’ southern and western perimeter in the “Community Property Belt” are: Louisiana, Texas, New Mexico, Arizona, California, Nevada, Idaho, and Washington. The ninth is outlier Wisconsin.  A tenth, Alaska, applies community property if both spouses opt-in.

[xii] When determining whether a worker is an employee or independent contractor for issues including wage & hour, meal periods, rest breaks, and workers’ compensation insurance, the California Department of Labor Standards Enforcement presumes that a worker is an employee. California Labor Code Section 3357. Where a worker performs services requiring a license or provides services for another who is required to have a license, that worker is presumed to be an employee. California Labor Code Section 2750.5 and California Business and Professions Code Section 7000 et seq., respectively.

[xiii] For example, the three-factor test for when a worker performing licensed services is an independent contractor is at California Labor Code Section 2750.5.

[xiv] California Labor Code Sections 226.8 and 2753.

[xv] See Bowerman v. Field Asset Services, Inc., No. 3:13-CV-00057-WHO, 2017 WL 1036645 (N.D. Cal. March 17, 2017).

[xvi] California Labor Code Section 512.

[xvii] California Labor Code Section 510.

[xviii] Sullivan v. Oracle Corp., 254 P.3d 237 (Cal. 2011).

[xix] California Labor Code Section 246.

[xx] California Labor Code Section 203.

The Consumer Review Fairness Act – Outlawing Consumer Gag Clauses In Your Customer Contracts

Posted on by Laura Arredondo-Santisteban

Does your company use form service agreements, purchase contracts, or online terms to conduct its business with customers? If so, you should review those documents immediately to make sure you are compliant with the new Consumer Review Fairness Act of 2016 (CRFA), which makes it unlawful in many cases to use your “standard terms” to control what your customer says about you, your products, or services.

The rise of social media and online review sites have provided consumers with an expansive ability to obtain instantaneous evaluations (good and bad) from others regarding a product or service.  This feedback can be great for businesses that receive good reviews posted online. But, as often is the case, there is nothing like a disgruntled customer to lead to a poor review being posted online.

As such, some businesses have attempted to restrict customers’ ability to publish negative reviews by inserting non-disparagement or “gag” clauses in their form contracts and online terms of service. These gag clauses limit consumers’ ability to post negative reviews by giving the company an express right to take legal action (and sometimes to recover money damages or specified penalties) against customers who post negative reviews or who complain to the Better Business Bureau. Some companies even attempted to exert control over consumer commentary by requiring that the consumers transfer copyrights in their reviews or other “feedback” about the products and services to the company.

The inclusion of these clauses, and companies’ attempts to enforce them, not only gained media attention, but also caught the attention of regulators at the state and federal levels.  In 2015, the Federal Trade Commission (FTC) filed a complaint against Roca Labs, Inc. and its principals for taking or threatening to take legal action against consumers who purportedly violated certain non-disparagement provisions that were included in their website’s “Terms and Conditions.” Under Roca Labs’ terms, purchasers allegedly agreed to not “speak, publish, cause to be published, print, review, blog, or otherwise write negatively about [Roca Labs], or its products or employees in any way.” These efforts by Roca Labs, the FTC alleged, constituted unfair acts or practices in violation of Section 5 of the Federal Trade Commission Act.

The Consumer Review Fairness Act of 2016 – Things to Do Now

As of March 2017, the CRFA makes certain clauses in “form contracts” void and unenforceable if the clause: prohibits or restricts an individual from sharing reviews of a seller’s goods, services, or conduct; imposes a penalty or fee against an individual who writes a review; or purports to transfer intellectual property in review or feedback content.  Furthermore, the CRFA makes it unlawful to even offer a form contract containing such a gag clause (meaning that it may be an illegal “unfair or deceptive trade practice” to continue to have such provisions in your contracts, even if you have no intention of enforcing them).

The CRFA broadly defines “form contracts” as any contract “imposed on an individual without a meaningful opportunity for such individual to negotiate the standardized terms,” and includes a website’s terms and conditions, as well as a company’s “standard terms” for purchasing products or services (whether in paper or electronic form). (The term “form contract” does not, however, include employer-employee or independent contractor contracts.)

More specifics about the CRFA are provided below – but your company should be taking steps immediately to review its form contracts – including any online terms and conditions – and to remove provisions that:

  • restrict individuals from sharing their honest reviews about you, your products, or services, or penalizes those who do; or
  • claim copyright in an individual’s reviews or feedback about you, your products, or services.

What Specific Conduct Does the CRFA Prohibit?

Specifically, under the CRFA a provision in a form contract is void if it:

  • prohibits or restricts an individual who is a party to such a contract from engaging in written, oral, or pictorial reviews, or performance assessments or analysis of, including by electronic means, the goods, services, or conduct of a person by an individual who is a party to a form contract;
  • imposes penalties or fees against individuals who engage in such communications; or
  • transfers or requires the individual to transfer intellectual property rights in review or feedback content.

Furthermore, the mere presence of one of these prohibited terms in a form contract constitutes a violation of the CRFA – even if you never try to enforce the provision.

There Are Limits to the CRFA – Not All Customer Commentary is Protected.

The CRFA does not require businesses to permit people to post reviews on their company’s website. However, if a business does solicit and allow consumers to provide feedback on its website, then it should keep in mind that the CRFA does not safeguard all content contained in consumers’ reviews.

In essence, the CRFA seeks to prevent companies from including provisions in their form contracts that threaten or penalize people for posting honest reviews about a company’s products, services, or conduct.  However, the CRFA does not protect defamatory or obscene posts. In addition, a business may still include provisions in its form contracts that prohibit postings that: breach confidentiality obligations imposed by law; reveal confidential information or trade secrets; contain personnel, medical, or law enforcement information; or contain computer viruses or malware.

Websites that permit consumer reviews also retain the right to remove or refuse to display content if it is unrelated to the goods or services offered, or is clearly false or misleading. However, the FTC cautions businesses that it is “unlikely that a consumer’s assessment or opinion with which you disagree meets the ‘clearly false or misleading’ standard.” Finally, businesses may also continue including “feedback clauses” in their agreements with consumers, which give the company certain rights to use feedback provided by customers, as long as such clauses take the form of a non-exclusive license (rather than requiring the consumer to transfer ownership of the feedback).

What Are the Penalties for Violating the Consumer Review Fairness Act?

Violations of the CRFA will be treated the same as violating a FTC rule that defines an unfair or deceptive trade practice. The FTC and state attorneys general have authority to enforce the CRFA. Enforcement will begin on December 14, 2017, and will apply to contracts with clauses in effect on or after that date.

Companies that violate the act by including prohibited gag clauses in their form contracts could be subject to steep financial penalties, as well as a federal court order. While the CRFA does not include a private right of action, individuals may still be able to sue under various states’ deceptive trade practice statutes (or “mini-FTC acts”), if those statutes provide for a private right of action. The CRFA specifically states that it shall not “be construed to affect any cause of action brought by a person that exists or may exist under State law.”

For Further Guidance:

If you have questions regarding complying with the CRFA or how to effectively respond to a negative review left for your business, contact Laura Arredondo-Santisteban at LArredondo@fh2.com or (770) 399-9500 for more guidance.

I Thought My Insurance Would Cover This. What’s This Letter From The Insurance Company?

Posted on by Mike Reeves

You buy insurance to protect your business (or you, personally) from claims. When a claim is covered by the terms of the policy, insurers have two separate duties: (1) to defend you; and (2) to pay damages. If there is an accident, you expect your insurer will perform these duties: hire a lawyer to defend you and pay lawfully proven damages, if any.

You become aware someone has been injured on your property, or claims your product has caused harm, or was injured in an accident with one of your employees. You notify your insurer and believe the claim will be handled. Then, you receive a letter from your insurer, indicating the insurer is investigating the claim and will hire a lawyer to defend you—but that it is reserving its right to change its mind—meaning that it can decide later to stop paying the lawyer or to refuse to pay the claim. You have received a “Reservation of Rights” letter (“ROR” letter ).

FIRST THINGS FIRST – DO NOT IGNORE THE ROR LETTER.

“ROR” letters are often long and complicated. They recite facts, contain excerpts of policy language, and state the insurer’s contentions. Although reading it and understanding it may be challenging, you should not ignore a ROR letter.

If you do not respond to the insurer’s letter, your lack of response will be taken as an implied agreement to the insurer’s contentions, as well as your acceptance of the services of the lawyer hired by the insurer under whatever terms the insurer outlines in the ROR letter. Furthermore, the letter may ask you to provide more specific information to aid the insurer’s investigation. Such cooperation is required under the insurance policy and requests should be responded to promptly.

Instead, you will want to have your attorney review the ROR letter, the policy, and the facts of the claim.  Based on that review, your attorney can advise you how to best respond to the ROR letter, including:

  • challenging any unsupported or incorrect assertions;
  • seeking withdrawal of the reservations;
  • negotiating a non-waiver agreement; and/or
  • initiating or defending coverage litigation.

THINGS TO LOOK FOR WHEN REVIEWING THE ROR LETTER.

There are certain requirements for an effective reservation of rights.

First, the ROR letter must “fairly inform” you of the insurer’s position and the specific basis for the insurer’s reservations about its coverage. The language of the ROR letter must be unambiguous. If it is ambiguous, the letter will be construed strictly against the insurer and liberally in your favor. A well-written ROR letter should tie the facts to the cited policy provisions and explain why the insurer believes those facts and policy provisions may result in no coverage.

Some issues affecting coverage may be known from the outset of a claim, e.g., the insured’s failure to give the insurer timely notice of the claim. Possible defenses based on issues known to the insurer should be listed and explained in the ROR letter. The insurer’s failure to list specific defenses it intends to assert may result in a waiver of the insurer’s defenses. However, other defenses to coverage may arise as the evidence is developed, e.g., where there is an exclusion in the policy and facts are learned later that support the exclusion. An insurer is afforded some time to investigate and analyze the circumstances before being required to provide the full basis for its coverage position. If those facts are not known at the outset of a claim and are learned later, the insurer may send a new or amended ROR letter.

Waivers of the insurer’s defenses are uncommon and even disfavored under Georgia law; however, arguing for a waiver can be highly important to you. If the insurer has waived its coverage defenses, you may be entitled to payment of all of your attorney’s fees and full payment of claims, up to the dollar amount of coverage you purchased.

In addition, you and your attorney should carefully review a ROR letter to:

  • determine if the ROR letter is timely;
  • verify that the dates, coverage amounts, and facts recited in the letter are accurate;
  • compare the policy language in the letter to your policy, assuring the language is the same and noting errors or incomplete selections;
  • determine if the insurer is reserving its rights to deny coverage of the entire claim or just a part;
  • determine if the same facts would be used to determine your liability for damages and the coverage issues; and
  • look to see if the insurer is claiming the right to make you reimburse it for the fees of the lawyer it hired to defend you.

You May Have a Right to Your Own Independent Counsel.

Most insurance policies allow the insurer to control the defense of the case and to select the attorney to defend the case. The lawyer hired by the insurance company is deemed to have an attorney-client relationship with both the insured and the insurer. Usually, joint representation of both the insured and the insurer is not a problem because the interests of the insured and the insurer are aligned. However, when the insurer defends and retains counsel under a ROR letter, the interests of the insured and the insurer may differ. If the differences between the interests of the insured and the insurer are: significant (not merely theoretical) and, actual (not merely potential), the insurer may have an obligation to pay for “independent counsel” to represent you, the insured. Under those circumstances, independent counsel is usually the attorney who normally represents your business or you, individually.

In addition, where the insurer chooses the lawyer to represent you, that lawyer may have an on-going business relationship with the insurer—which may result in a potential conflict of interest for that lawyer. The lawyer’s desire to receive additional work from the insurer may result in a conscious or subconscious steering of the claims to benefit the insurer rather than you, the insured —especially if there are truly conflicting interests. For example:

  • Where there are multiple claims, some potentially covered and some potentially non-covered, the lawyer retained by the insurer may consciously or subconsciously conduct the investigation and development of the evidence in a way that makes it more likely that the jury’s verdict would award damages on the non-covered claims rather than those claims for which the insurer is obligated to provide coverage.
  • If the policy excludes coverage arising from certain conduct and the insurer reserves the right to disclaim coverage based on whether that conduct occurs, there is a conflict of interest: you will want to show that any legitimate damages resulted from covered acts and the insurer will want to show that damages arise from your acts within the exclusion.

Where there is the potential for such a conflict of interest, some courts have ruled that the insurer must pay for independent counsel selected by the insured to handle the defense. Those courts recognize that the lawyer retained by the insurer cannot represent truly serious conflicting interests. The ultimate question is whether, under the facts and circumstances of a particular claim, the insurer’s reservation of rights renders it impossible for counsel selected by the insurer to defend both the interests of the insurer and those of its insured.

If the ROR letter creates a serious and actual conflict between your interests and those of the insurance company, you should ask the insurer to provide independent counsel. In Georgia, the independent counsel issue is not fully resolved. In 1963, a Georgia court held that attorneys, whether or not paid by insurance companies, owe their primary obligation to the insured they are employed to defend (i.e., you, not the insurance company). In 1989, a federal court held that the insurer must choose between denying a defense to the insured or providing a defense in cooperation with counsel retained by the insured and paid for by the insurer.

The ROR Letter May Contain a Requirement that You Reimburse Defense Costs.

The ROR letter may assert that you will be required to reimburse the insurer for attorney’s fees and other defense costs if it later determines there is no coverage. Your insurance policy may already obligate you to do this—however, if it does not and you fail to object to this requirement when presented in the ROR letter, the insurer will argue that your failure to object constituted a new agreement to reimburse the insurer for these fees and costs.

RESPONDING TO THE ROR LETTER.

Once you have reviewed the ROR letter, you should respond to the insurer in a timely manner. Your silence could be used against you. The response should:

  • state that you are reserving all of your rights under the policy;
  • state that you will cooperate and will provide the information the insurer requested to the attorney the insurer retained to defend you;
  • correct any errors as to dates or facts set forth in the ROR letter;
  • identify any misquoted or omitted policy language that is beneficial to you;
  • state your disagreement with the insurer’s contentions;
  • reserve the right to hire independent counsel (at the insurer’s expense), if there is a conflict of interest; and
  • challenge the insurer’s effort to have you reimburse it for defense costs, unless that right is already given to the insurer in the policy.

COVERAGE LITIGATION AND NON-WAIVER AGREEMENTS.

If the insurer flatly denies coverage, you will have no insurance coverage for the claim you submitted to your insurer. You would need to hire a lawyer and fund the payment of any settlement or verdict. If, however, you have a good faith belief that the insurer acted wrongly in denying  coverage, you may sue the insurer, alleging a breach of the insurance contract and seeking recovery of all your losses, including all of the fees paid to defend the case, the amount of any settlement or verdict paid, and possibly the fees incurred in proving the insurer breached the contract of insurance.

If the insurer agrees to defend under a reservation of rights, but you reject the insurer’s reasoning, you and the insurer could enter into an agreement expressly stating: that the insurer is not waiving its coverage defenses; that the insured preserves its right to demand coverage; the terms under which the insurer would defend the claim (such as who controls the defense, how strategy is determined, if settlement is pursued how it would be funded); that the lawyer retained by the insurer and paid by the insurer owes loyalty only to the insured and has a duty to protect the insured’s confidential information from disclosure to the insurer; whether separate counsel is required (and, if so, how legal bills are reviewed and paid); and, the rights of the parties once the claim is resolved (e.g., whether the insurer is entitled to reimbursement of defense costs paid). This agreement is called a “Non-Waiver Agreement”.

If there is a dispute over coverage and it is not possible to enter into a non-waiver agreement, the insurer must then file a separate action, called a “Declaratory Judgment Action,” asking the judge to review the matter and declare if there is coverage for the claims. You would be a defendant in that action and would need to hire your own attorney to convince the court there is coverage.

MAKE SURE THE INSURER’S LETTER IS CONSISTENT WITH YOUR POLICY AND THE LAW.

If you receive a ROR letter, your attorney should review the ROR letter, the policy, and the facts of the claim and advise you how to best respond. If we may be of assistance, contact Mike Reeves at mreeves@fh2.com or (770) 399-9500.

FH2 Litigators Recognized by Super Lawyers®

Posted on by Friend, Hudak & Harris

Both of our litigators, Mike Reeves and Ben Byrd, have been recognized as Georgia Super Lawyers for 2017.  Their primary area of practice is Business Litigation. Mike has received this recognition many times.  This year marks the first time Ben Byrd has been included in the list of Super Lawyers.  He was included among Georgia Rising Stars in 2014.

For more information on Mike, his practice and his accomplishments, Click Here.        For more information on Ben, his practice and his accomplishments, Click Here.

Dissenters’ Rights in Georgia: Litigating “Fair Value”

Posted on by Ben Byrd

What are dissenters’ rights, and why do they exist?

There is a general feeling among transactional lawyers that corporate shareholders are becoming more and more likely to assert their right to “dissent” from a corporate transaction and liquidate their shares. While it is hard to prove or disprove whether this feeling is accurate, it is nevertheless useful to understand the nature of the right to dissent and to examine some of the issues these claims present in litigation.

In an earlier era, corporate law required shareholders to vote unanimously in favor of major changes to a corporation’s structure or operations. As a result, a single shareholder could thwart a deal, regardless of how good it was for the entire ownership. On the other hand, the unanimity rule protected the individual shareholders, who had no legal right to liquidate their shares in the face of a transaction they did not like. Over time, though, the unanimity requirements were loosened, and today a simple majority of shareholders can make most corporate decisions. In theory, this change gave a company’s ownership the flexibility it needs to take advantage of opportunities that might otherwise be missed because of single holdout. But with that flexibility came the risk that controlling shareholders will exercise their power at the expense of the minority.

Two scenarios are distressingly common. Imagine that Tom, Dick, and Harry are equal owners of Pin Heads, Inc., which owns a chain of bowling alleys. If Tom and Dick decide to cut Harry out of the business against his will, all they have to do is form another corporation without Harry and then vote to sell Pin Heads’ assets to the new entity, leaving Harry out in the proverbial cold.[1] This is the classic “freeze out” or “squeeze out” situation. Worse, if Tom and Dick sell Pin Heads’ assets to their new company for less than market value, they haven’t just frozen Harry out of the operation, they have stolen his equity as well.

Consider another scenario: Pin Heads has done well and is now worth $3 million. Our three shareholders reasonably expect to receive $1 million each if the company is sold. Because they are in control, Tom and Dick negotiate the sale of the company’s assets to an unrelated buyer for just half a million dollars, which will eventually be distributed to the shareholders equally. At the same time, Tom and Dick negotiate sweetheart agreements with the buyer just for themselves. These agreements might require Tom and Dick to provide “consulting” services to the buyer, or not to compete with the buyer, or maybe both. In return for these commitments, the buyer will pay Tom and Dick—you guessed it—$1.25 million each. (Harry, of course, isn’t offered a contract.) Tom and Dick’s agreements may not have any real value to the buyer, but that is exactly the point. The contracts are a sham that Tom and Dick have created to divert money from the buyer to themselves when it  ought to have gone to the corporation as a whole. Harry is again left out in the cold.

To protect Harry and his fellow minority shareholders, most states—including Georgia—passed statutes allowing a shareholder to “dissent” from certain corporate transactions that change the fundamental nature of the business and to liquidate his shares for their “fair value.”[2] In Georgia, the right to dissent is available both to shareholders of corporations and members of limited liability companies[3], and it is triggered most often when there is a merger or asset sale.[4]

When there is such a transaction, the company must notify the shareholder of the transaction and his right to dissent. The dissenting then notifies the company of his intent to dissent.[5] After receiving notice that a shareholder dissents, the corporation must offer the shareholder what it believes to be the fair value of the shareholder’s interest, along with certain financial information supporting that valuation.[6] The shareholder can either accept the corporation’s offer or counter with his own valuation. But if the shareholder and the corporation cannot come to an agreement, the corporation must institute a court action to determine the fair value of the dissenter’s shares. The valuation proceeding is a nonjury, equitable hearing, so it must be brought in the superior court.[7] Although it presents some opportunities for either party to stumble, this basic procedure is not terribly complicated. The bigger challenge by far is proving fair value.

What is “fair value”?

The Georgia Code defines fair value as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action.”[8] This definition is remarkably circular, and there is almost no Georgia case law expanding the meaning of fair value. However, the little authority that does exist establishes that “a shareholder should generally be awarded his or her proportional interest in the corporation after valuing the corporation as a whole.”[9] In effect, the “fair value” of a minority interest may be different from the “fair market value” of that same interest.

To illustrate, assume Pin Heads is worth $3 million. On the open market, Harry’s one-third interest in the company would likely be worth less than $1 million. After all, with partners like Tom and Dick, who would want to buy Harry’s shares? But under the dissenter’s rights statute, Harry would be entitled to his pro rata portion of the company’s value, without any discounts to account for the lack of marketability or control associated with his individual shares—that is, $1 million.[10] This is an important point, but it still leaves us with the task of determining the value of the company as a whole.

Because there is so little Georgia authority on this point, the practitioner must look to other sources for guidance.[11] Fortunately, it is generally agreed that a dissenting shareholder is entitled to be compensated for what he has lost, which is an interest in a “going concern” and not just a share of the corporation’s liquidated assets. As such, he is entitled to his share of the company’s “intrinsic” value—that is, the present value of all future benefits that would flow to the company’s owners from its operations—not just the price the company would bring if it were sold.[12]

This conceptual difference between intrinsic value and market value is not always obvious to parties or to courts. Moreover, the distinction is blurred by the fact that, as a practical matter, the intrinsic value and market value of a given company will often coincide (a point we will return to below). Nevertheless, the practitioner must remember that these are two distinct measures of value.[13]

Proving Value: Cash flows and multiples.

Business valuation is an established field that exists separate and apart from any role it plays in dissenters’ rights cases, but its tools are essential to the dissenters’ rights process.[14] The litigator must be comfortable enough with business valuation techniques to understand why each expert has chosen a given tool and how his conclusions would change if a different tool were used.

Mainstream valuation theory rests on the idea that the intrinsic value of any financial asset, such as a share of corporate stock, is the product of the expected cash flows its owner will receive, on a risk-adjusted basis. Therefore, the value of a business is a function of the money it is expected to make in the future, not the money it has made in the past. This can seem counterintuitive, especially because we are accustomed to hearing businesspeople and financial analysts speak about companies’ values in terms of some multiple of their past revenues or profits. But it is important to remember that these multiples are a reflection of the likelihood that a company’s past performance (good or bad) will continue in the future. So, even when it is defined in terms of past performance, value is still fundamentally about the future.

Business valuation, then, is inherently forward-looking, and this forward-looking orientation distinguishes it from other related disciplines. Accounting, for example, is a system for recording financial transactions that have already happened, so by its very nature it is backward-looking. This is not to say that accounting is not a part of valuation. In fact, accounting information is absolutely necessary for valuation. But financial statements and other accounting data on their own are merely necessary for performing a proper valuation. They are never sufficient.

The business valuation profession recognizes various approaches for valuing a company. Two of these approaches—the “income approach” and the “market approach”—are typically the most useful for determining the value of company as a going concern. Within these approaches there are various methods, but as a practical matter the litigator will generally only encounter three of them.

Under the income approach, the “discounted cash flow” (or “DCF”) method is the one most commonly encountered in litigation matters. A DCF analysis is used to forecast or project a company’s future cash flows—and therefore its intrinsic value—directly. It involves two steps: First, the expert must identify (or produce) reliable projections of the company’s future cash flows. Then, she must “discount” those earnings to their present value in order to take into consideration the time value of money and the risk that the expected cash flows may never materialize.

The DCF method is widely accepted, so much so that an expert must have a good reason for not performing a DCF analysis or risk having his opinions as a whole discarded.[15] Nevertheless, the DCF method is not flawless. For one thing, it is generally disfavored for the expert to create his own projections for the purpose of performing a DCF analysis. It is far more credible for the expert to use projections that were created either by company management or by a third-party for reasons unrelated to the litigation.[16] But not every company has projections that are independent of the litigation matter, so often a DCF analysis simply can’t be done.

Even if projections are available, some caution must be exercised before they are blindly adopted by an expert. For a DCF analysis to have any value, the projections that are used must be both reliable and current as of the valuation date.[17] If favorable projections exist, a dissenting shareholder can almost be certain that the company will claim there was some reversal of fortune between the date of the projections and the date of the valuation that renders the projections useless. Similarly, if the projections were created primarily to attract investors and not to guide management decisions, it is very possible that they are unreasonably optimistic and so can’t be used without some sort of adjustment.[18] It is the litigator’s job to determine, through careful fact discovery, the reliability of any projections before they become the basis of an expert’s opinion. Again, although the DCF method is not always available, it must always be considered.

In contrast to the DCF method (and income approach generally), the market approach is an indirect measure of value. The market approach assumes that markets are reasonably efficient and therefore the prices at which companies (or shares of companies) sell are generally an accurate reflection of their intrinsic value. There are different methods under the market approach, but at a high level they all contain the same basic elements. First, the expert identifies companies that are similar or “comparable” to the company in question. By comparing the market value of these companies to some common financial metric, such as earnings, the expert can create a ratio or “multiple,” which can then use to estimate the market value of the subject. For example, if we wanted to value our fictional company Pin Heads, our expert would first look at companies similar to Pin Heads that have recently sold. If companies similar to Pin Heads have recently sold for three times their annual earnings, our expert can then infer that Pin Heads would also sell for three time its annual earnings.

There are two principal methods for applying the market approach. One uses publicly traded companies as comparables (the guideline public company method), and the other looks at sales of privately held companies (the guideline merged and acquired company method). Both methods present similar challenges. The first of these is identifying which companies, if any, are truly “comparable” to the business at issue. If you are trying to value a company that owns bowling alleys, you aren’t likely to find another chain of bowling alleys that has sold recently, so you will have to cast your net more widely. Would a chain of go-cart tracks be sufficiently similar to the bowling alley business? What about amusement parks? Unfortunately, there is no objective measure of comparability, and you will quickly find that a certain amount of subjectivity is unavoidable. An unscrupulous expert can use his discretion to select comparables that push the data toward a conclusion that favors his client.

The second challenge is creating the right multiple. Even if an expert has chosen comparable companies that are in the same general business as the subject company, they will differ from each other (and the target company) with respect to fundamental financial characteristics, such as their size, growth potential, and riskiness. Each of these differences will affect a company’s future prospects, so the expert cannot just simply calculate the comparable companies’ multiples and then mechanically apply the average to the subject company. Instead, she should try to determine how, and to what degree, the subject company differs from those in her set and adjust her final multiple accordingly. In theory, an expert might consider an elaborate multi-variable regression analysis to identify which fundamental characteristics have an effect on value and the relative significance of each. In practice, this almost never happens, and multiples must be adjusted by less formal methods. Unfortunately, an expert often adjusts his multiples by relying only on his own subjective “judgment.”[19] The opportunities to abuse this process are obvious.

This discussion may seem to paint an unfairly cynical picture of valuation practice. After all, these techniques guide the allocation of enormous sums of capital in the financial markets, and they are regularly accepted as valid by courts in all sorts of cases involving the value of businesses. Nevertheless, the litigator is wise to remember that valuation is ultimately as much “art” as it is “science.”[20]

The role of transaction price and other considerations.

While a dissenter’s case almost always involves a battle of valuation experts, one factor that can never be ignored is the transaction price—that is, the price that the buyer has actually paid to acquire the business in question. If markets were perfectly efficient, with all parties having perfect knowledge and negotiating at arm’s length, we would expect the purchase price to track a company’s intrinsic value very closely, if not match it exactly. And even without perfect efficiency, market forces do push transaction prices toward intrinsic or fair value. Courts recognize this, and they often rely heavily on transaction price when assessing fair value.

The Delaware courts, for example, have repeatedly held that “the fact that a transaction price was forged in the crucible of objective market reality (as distinguished from the unavoidably subjective thought process of a valuation expert) is viewed as strong evidence that the price is fair.”[21] The apparent objectivity of transaction price has led more than one court to discount the opinions of the parties’ experts entirely and rely solely on transaction price when determining the fair value of a company.[22]

Not every deal, however, will lead to a transaction price that approximates fair value. For example, the magic of finance often creates opportunities for “synergy”—that is, where the combination of two companies is more valuable than the sum of its two parts standing alone. Synergy is often a prime motivator in acquisitions, and if a buyer can create synergies by acquiring the target company, it may be willing to pay more than what the target company, standing alone, is worth to its current owners.[23] In that case, the deal might result in a transaction price that is higher than the target’s intrinsic value.

Conversely, a company’s controlling shareholders might be willing to accept less than fair value for the company as a whole if they can structure the deal so they benefit in some way other than receiving their share of the transaction price (for example, by entering into valuable personal contracts with the buyer). In that case, the deal might result in a transaction price that is lower than the target’s intrinsic value. In the end, transaction price can be very important evidence of fair value, but only “so long as the process leading to the transaction is a reliable indicator of value and [transaction]-specific value is excluded.”[24]

Again, the dissenter’s rights statute does not account for transaction price or, for that matter, any other factor that may weigh on the issue of fair value. But as a practical matter transaction price looms over every judicial appraisal of fair value. Therefore, from the shareholder’s perspective, it isn’t sufficient just to assert that the company was worth more than what was paid for it, even if that assertion is supported by a gold-plated expert report. The shareholder must also carry the implicit burden of showing there was some defect in the transaction, such as self-dealing, that resulted in a sale for less than fair value.

Better yet, the dissenter will also prove how the missing value was diverted, in whole or in part, to the controlling shareholders. If the controlling shareholders accomplished this through contracts with the buyer, the dissenter should be prepared to offer expert testimony regarding the true value of the controlling shareholders’ promises under the contract. (This may require the dissenter to retain a second expert with expertise in executive compensation or related areas.) Again, none of these elements are literally required by the dissenter’s statute. But without this showing, it is hard for even the best expert opinion to prevail over transaction price.

This paper can only scratch the surface of the issues that will confront the litigator in a dissenters’ rights case. For understanding valuation in general, Investment Valuation by Aswath Damodaran and Financial Valuation by James Hitchner are both essential resources. Likewise, The Lawyer’s Business Valuation Handbook by Shannon Pratt and Alina V. Niculita is useful for understanding how these principles are applied in business disputes.

If you have any questions about dissenters’ rights or the fair value of your share in a company, please contact Ben Byrd at bbyrd@fh2.com or (770) 399-9500 to discuss further.

**********

[1] See Note, Freezing Out Minority Shareholders, 74 Harv. L. Rev. 1630 (1961); Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 3 fn. 1 (1985)(discussing squeeze-out mergers).

[2] The history and theory behind dissenter’s rights is treated at length in Barry M. Wertheimer, The Purpose of the Shareholders’ Appraisal Remedy, 65 Tenn. L. Rev. 661 (1998).

[3] O.C.G.A. § 14-2-1301 et seq. (corporations); O.C.G.A. §  14-11-1001 et seq. (LLCs). Because the two statues are substantively identical, we will refer only to the Business Corporation Code.

[4] O.C.G.A. § 14-2-1302.

[5] O.C.G.A. § 14-2-1320 to 1324.

[6] O.C.G.A. § 14-2-1325.

[7] O.C.G.A. § 14-2-1330(b).

[8] O.C.G.A. § 14-2-1301(5).

[9] Blitch v. Peoples Bank, 246 Ga. App. 453, 457 (2000).

[10] Id.

[11] Delaware in particular has a well-developed body of case law on the issue of fair value in the context of dissenter’s rights. Further, the Georgia statute is based on the original Model Business Corporations Act, the comments to the Model Act are useful as guidance. Blitch v. Peoples Bank, 246 Ga. App. 453 (2000). Although the Model Act has been amended since the Georgia statute was passed, the Georgia Court of Appeals has even looked to the changes in the Model Act for guidance. Id.

[12] See Cede & Co. v. Technicolor, Inc., 542 A.2d 1182 (Del. 1988)(equating “fair value” and “intrinsic worth”). In Atlantic States Construction, Inc. v. Beavers, 169 Ga. App. 584 (1984), the Georgia Court of Appeals adopted intrinsic value as the standard for fair value. However, that opinion is only physical precedent, and it has been abrogated in other respects by later opinions. Blitch, 246 Ga. App. at 457 fn. 21.

[13] See Cede & Co., 542 A.2d at 1188 fn. 8 (noting that market price may not reflect intrinsic value).

[14] The current version of the Model Business Corporations Act, for example, provides that fair value is to be determined “using customary and current techniques generally employed for similar businesses in the context of the transaction requiring appraisal.” MBCA, § 13.01(4)(ii).

[15] See, e.g., Lippe v. Bairnco Corp., 288 B.R. 678, 689 (S.D.N.Y. 2003) aff’d, 99 F. App’x 274 (2d Cir. 2004); In re Med Diversified, Inc., 334 B.R. 89 (Bankr. EDNY 2005).

[16] See In re ISN Software Corp. Appraisal Litigation, 2016 WL 4275388 at *5 (Del. Ch. 2016)(experts’ creation of projections “inherently less reliable than using long-term management projections”); In re Radiology Assocs., Inc. Litig., 611 A.2d 485, A.2d 490–491 (Del. Ch. 1991)(discussing need for projections not created by expert).

[17] See Highfields Capital, Ltd. v. AXA Financial, Inc., 939 A.2d 34 (Del. Ch. 2007)(favoring DCF that relied on current management projections over analysis that relied on outdated projections).

[18] See In re Appraisal of Ancestry.com, Inc., 2015 WL 399726 (Del. Ch. 2015)(rejecting valuations based on projections that were not created in the ordinary course of business, but only to attract buyers).

[19] See, e.g., Merion Capital, L.P. v. 3M Cogent, Inc., 2013 WL 3793896, at *23 (Del. Ch. 2013)(rejecting expert’s choice of multiples based only on professional “judgment call”); In re IH 1, 2015 WL 5679724 (D. Del. 2015)(rejecting opinion of expert who made “judgment call” to reduce comparable multiples by 50% without any explanation).

[20] See, Matter of Shell Oil Co., 607 A.2d 1213, 1121 (Del. 1992)(“Valuation is an art rather than a science.”); In re Smurfit–Stone Container Corp. S’holder Litig., 2011 WL 2028076, at *24 (Del. Ch. 2011)(“[U]ltimately, valuation is an art and not a science.”)

[21] Van de Walle v. Unimation, Inc., 1991 WL 29303, at *17 (Del. Ch. 1991).

[22] E.g., Union Illinois 1995 Investment L.P. v. Union Financial Group, Ltd., 847 A.2d 340 (Del. Ch. 2003).

[23] M.P.M. Enter., Inc. v. Gilbert, 731 A.2d 790, 797 (Del. 1999).

[24] Union Illinois, 847 A.2d at 357.