FAIRFAX LAWYERS KEEP YOU UPDATED ON DC METRO LAWS

A SERVICE OF GROSS & ROMANICK, PC

Friday, April 22, 2011

Restricting Competition Following A Business Sale

A Purchaser of an existing business must not overlook the need to restrict the selling parties from competing with the newly acquired business after the sale. Because the seller has access to all existing contacts and customers of the business (as well as knowledge of the business’ trade secrets, methods and know-how), the seller poses a true competitive threat to the business after the sale. To diminish the threat of such competition, a covenant not to compete must be included in the terms of the sale. A covenant not to compete will restrict the seller from engaging in business practices that are competitive to the buyer’s newly acquired business. It is important that the seller, all of its owners and key employees execute a non-compete agreement.

Drafting an enforceable covenant not to compete is no easy task. In Virginia, courts will enforce a covenant not to compete only if it is: (a) narrowly drawn to protect the business interests of the protected party, (b) not unduly burdensome on the restricted parties' ability to earn a living, and (c) not against public policy. Courts will evaluate the covenant not to compete on its own merits on a case by case basis, taking into account the circumstances of the businesses and individuals involved. A covenant will not be enforced if it is deemed by the Court to be too broad in duration, geographic range or restricted activities. Thus, the broad, boilerplate non-compete language found on many standard form buy-sell agreements, may not work.

The attorneys at Gross & Romanick, P.C. have considerable experience drafting non-compete agreements. We know the law, we know the cases, and we know how to protect the buyer’s interests.

Stock Purchase or Asset Purchase?

There are two principal methods for buying or selling an existing business: a stock purchase and an asset purchase. The advantages and disadvantages of each method should be assessed in every business sale. The purpose of this article is to explain in very general terms how these methods (and the resulting implications) differ. You may also want to view our YouTube video on asset purchases at: http://www.youtube.com/watch?v=UtM8GXiOSwE

In the stock purchase, the buyer purchases the existing ownership interests of the business. If the business is a corporation, the buyer is purchasing stock. If the business is a limited liability company, the buyer is purchasing membership interests. By making such a purchase, the buyer acquires an ownership interest of the existing business and assumes all rights and responsibilities which come with such ownership. Typically, such rights and responsibilities are set forth in the by-laws or shareholder agreements of a corporation, or the operating agreement of a limited liability company. The stock purchase is typically used when the existing business has valuable contracts or licenses that cannot be transferred.

In the asset purchase, the buyer purchases the existing assets of the business, but does not purchase any ownership interest in the seller’s business entity. Oftentimes, the selling entity will be terminated after the asset purchase. The asset purchase is typically used so that the buyer can acquire the business and assets of the selling entity without paying or assuming all of the selling entity’s debts. In some cases, the trade name of the seller is one of the assets purchased by the buyer, and the buyer will operate under the same as the seller after the sale; by this process, the buyer purchases the brand and existing goodwill of the seller, but does not assume the selling entity’s liabilities. Transferring the name without transferring the liabilities can be very complex and should only be handled by an experienced lawyer, or the buyer may assume responsibility for disclosed and undisclosed liabilities of the seller.

In every sale, the parties should consider the advantages and disadvantages of both methods. Typically, the buyer will choose the method of purchase after commencing a due diligence investigation of the business. A proper due diligence investigation will reveal the corporate organization and registration of the seller, the specific assets owned by the seller, the existing contracts and obligations of the seller and the history of seller’s taxes, liens and legal disputes, etc. This information will oftentimes determine how the buyer wishes to proceed. A more detailed explanation of the issues a purchaser should investigate can be found here.

The attorneys at Gross & Romanick, P.C. have substantial experience in preparing and negotiating both stock purchase transactions and asset purchase transactions. They understand the implications of each method on both the buyer and the seller, and can artfully draft the sale documents to protect the best interests of their clients.

Purchasing a Business: Legal Due Diligence

Purchasing an existing business can be a complicated process with several stages. Perhaps the most important stage is the completion of the “due diligence” study by the purchaser. Oftentimes, the due diligence study reveals areas of concern and areas of seller mismanagement that the purchaser is unaware of during the “courting” stage of the process. Thus, regardless of the structure of the purchase transaction (asset purchase, stock purchase, membership interest purchase, merger, etc.), it is imperative that the purchaser conducts a thorough review of the business, both from a financial perspective and from a legal perspective. While an experienced attorney can provide guidance for the financial review, engagement of a CPA is the better course of action. Hiring an experienced attorney is critical, however, for the legal review. The attorney will investigate the various legal issues that most purchasers overlook or do not even consider while focusing on the big picture deal. Based upon the findings of the due diligence review, the attorney will make recommendations to the purchaser and will attempt to structure the deal to protect the purchaser’s best interests. Some of the issues that are most commonly overlooked by purchasers include, but are not limited to, the following:

1. Formal business organization.

What type of entity is the business? LLC, Corporation or other type? Who are the owners? What agreements exist between the owners? Who are the managing members, directors or officers? What approvals are required for the sale to take place?

2. Registration, permits and licenses.

Where is the business registered? Is the business in good standing in all places where it is registered? Does the business need to be registered elsewhere? What permits and licenses are required to operate the business? Are the existing permits and licenses transferable?

3. Asset review.

What assets are owned by the business? What assets does the business finance or lease? Where are the assets located? Are there recorded and/or unrecorded liens on the assets? Which assets are going to transfer in the deal? Which assets are not going to transfer? Are the assets transferable?

4. Contract review.

What existing contracts is the business a party to? Are the contracts transferable? How must the contracts be transferred? Does the business sale result in a breach of any contract? What contractual obligations will the purchaser be bound to following the sale?

5. Employee issues.

Who are the existing employees and independent contractors? Will they remain with the company after the sale? Are there existing employment contracts? Will the purchaser want employees and independent contractors to execute new agreements? Is there an employee handbook? Are there employee benefit plans in place? Are there any disclosed or undisclosed employment disputes or potential violations of employment laws?

6. Existing Lawsuits and Judgments.

Are there existing lawsuits against the business? Are there outstanding claims against the business or its owners? Are there existing judgments against the business that have not been satisfied and released? Are there potential lawsuits or administrative claims?

7. Taxes.

What types of tax is the business required to pay? Have all prior taxes been paid? Are there any outstanding tax liens or assessments? Have all employee taxes been properly paid? Is there some contingent liability such as employees being improperly classified as exempt or non-exempt?

8. Creditor Issues.

Who are the creditors of the business? How much debt exists? Is the debt going to be assumed? Are creditors going to be paid out of the purchase price?

9. Other Issues

Insurance coverage; Franchise considerations; Environmental concerns; Customer relations; Intellectual property matters; etc.

The information learned from a thorough due diligence review will be critical to the purchaser’s decision of whether or not to go forward with the purchase. In some cases, the anticipated structure of the deal will change based on the information that the attorney discovers, as the purchase agreement must be designed to protect the purchaser from expected and unexpected legal problems following the sale.

Some ambitious (and imprudent) business purchasers believe that hiring an attorney to conduct legal due diligence will only “throw cold water” on the deal that the parties want to consummate. However, some of the most commonly litigated issues that arise following a business sale (including fraud and breach of contract) can often be eliminated by having an attorney complete a legal due diligence review prior to the closing of the deal. Thus, a small investment prior to closing the sale may eliminate substantial legal expenses (and perhaps worse) after completion of the sale.

The attorneys at Gross & Romanick, P.C. have substantial experience representing clients throughout the process of acquiring a business. They understand the issues that the purchaser must investigate and consider, and know how to structure the deal to protect the purchaser’s best interests. Gross & Romanick, P.C. also represents sellers, who have other issues to consider in the course of a business sale (which issues will be the subject of another article).

Gross &Romanick P.C. Handles Large Corporate Acquisition

Gross & Romanick, P.C. is proud to announce that its client has successfully closed on the purchase of the D.C. area’s premier moving company, “Two Guys and a Truck”. Our firm represented the purchaser from the initial stages of contract negotiation through the closing of the multi-million dollar transaction. This was a very complex acquisition involving the purchase of the assets of various entities, as well as the purchase of ownership interests in other entities. Gross & Romanick prepared the various agreements necessary to document the complex sale, and performed the closing in our Fairfax office. Part of the transaction involved the acquisition of a franchise operation and the issuance of a new “Two Guys and a Truck” franchise in Washington, D.C. Edward Gross and Christopher DeSimone, the Gross & Romanick attorneys handling the transaction, conducted substantial legal due diligence and were able to structure the deal to limit the purchaser’s liability exposure. In addition, Gross & Romanick negotiated a favorable lease extension with the landlord. Following the closing and the exchange of the keys to the business, both the Buyer and Seller were pleased with the handling of the transaction and were enthusiastic about their future endeavors.

Thursday, April 14, 2011

Business Owner and Landlord's Liability for Criminal Assaults: How Adequate is Your Security?

A sales clerk abducted from a Northern Virginia shopping mall obtained a $360,000 settlement from the owners and operators because a former mall employee sodomized her, attempted to rape her and threatened to kill her. Yet, a woman who was attacked in a parking lot after attending a dinner theatre had her favorable verdict reversed on appeal to the Virginia Supreme Court. What is the difference between these two cases? Apparently, the main distinction was that 170 crimes had occurred at the mall in the past four years, while the dinner theatre had only two prior isolated acts of violence.

Duty to Foresee Imminent Danger

In the dinner theatre case (Wright v. Webb) the Court held that an owner did not have a duty to foresee acts of criminal violence and that two acts are insufficient to "lead a reasonable person ... to conclude that there was an imminent danger of criminal assault which required the invitor to take action to protect Webb." The mall which settled for $360,000 had numerous acts of violence, but hired only had one security guard to monitor the mall's interior.

Changes in Premise Liability Article

The Webb case would have a very different result if the business was the type that either "attracts" or "provides a climate" for assaultive crimes. But, what this standard means is difficult to define. Thus, a 24 hour Hardee's located in a bad neighborhood and catering to a "club crowd", which possesses guns and drugs, was not sufficient to prove that the business established a "climate" for criminal activity. On the other hand a car wash was held liable for maintaining a nuisance because of the behavior of its patrons who used and sold narcotics, consumed alcohol, littered and played loud music. Thus, we can assume that a criminal act committed by a patron of the car wash might result in liability to the owner. Nevertheless, even if the premises is permeated with criminal behavior, maintaining adequate security may still overcome liability for criminal acts against patrons.

Inadequate Security

A 1992 study indicates the average jury verdict in an inadequate security case is $3.35 million, with an average out of court settlement of $545,800. In a recent Texas case a jury awarded $17 million to a residential tenant who was raped by an intruder who had broken into the management offices and stole the woman's unit key. The victim had requested a deadbolt lock from the inside but the management company refused because the lease prohibited measures that would make the unit inaccessible to the management company, a policy which violated state law. In addition, the keys were stolen the day before the actual crime and no preventative action was taken; thus, it was foreseeable that there was danger of an imminent crime.

If a case goes to trial, the plaintiff will hire an expert who will identify the reasonable and appropriate preventative security measures which should have been taken by the owner. This same type of expert should be hired by an owner before a crime occurs in order to establish a security plan. Follow the plan, because a deviation can be used against the owner. Indiscriminate notation of problems by security personnel must be avoided; another recent large settlement resulted from the mall's personnel categorizing some teenage assaults as sexually related, as well as overdocumentation and exaggeration of many petty problems which occurred at the mall. Furthermore, failure to warn tenants of crimes that have been committed on the property and false assurances about security measures are cited as reasons for lawsuits.

In a case involving imminent danger of criminal assault, the Virginia Supreme Court reversed a judge who threw out a premises liability case. The case involved a restaurant which was sued for permitting a patron who was threatening a customer to return to the restaurant after he was initially escorted outside. Because this patron later assaulted the same customer upon reentry, the Court found sufficient evidence that the restaurant might have had notice that the assailant was likely to commit an assault o n a customer.

Standard of Care

Violation of federal, state, county and other municipal statutes, ordinances and regulations can be used by a plaintiff to establish negligence per se. The Residential Landlord Tenant Act authorizes localities to require charley bars, secondary locks on sliding glass doors and special locks on windows. Many municipalities have passed lighting requirements for parking lots, parking garages, common areas and other specific places. Virginia Code Section 9-183, et.seq. establishes licensing requirements for security guards. Follow these requirements.

The American National Standard Institute (ANSI) and other industry standards can help determine the specifications that should be followed. A focus on actual practices of comparable entities assists in discovering a standard of care. By surveying competitors an owner knows where closed circuit television cameras are normally used or how fire escape access is limited.

Conclusion

Do a realistic assessment of the likelihood of a crime being committed against your tenant or customer. Based upon that assessment, structure and follow a security plan which may include more security guards and structural solutions. Finally, do not violate any building codes designed to promote safety!

***

The above is not meant to replace legal counsel. If you'd like to speak to one of Gross & Romanick's lawyers, please call 703-273-1400 or fill out our online information request form.