Business and Corporate

By Wade Iverstine and Eric Lockridge

A 2013 change to Louisiana’s revocatory action now exposes a secured lender’s collateral and guarantees to the risk of avoidance litigation for ten years, up from three years, after the closing date.

Start here if you just asked, “What is a revocatory action?” This post explains how the revocatory action effects multi-party secured loans, and how the 2013 legislative change has only become relevant since August 2016.

The Context

Below is a diagram of a common secured loan structure, where an existing family of organizations borrows money for a newly formed subsidiary to purchase assets:

Blog Article Diagram

The loan is supported by upstream and cross-stream security. The signatures and collateral granted by the subsidiaries are “upstream” security grants as they support the parent’s obligations. Each is a “cross-stream” security grant as it supports the other subsidiaries’ obligations. The parent’s obligations and collateral grants are “downstream” as they support the subsidiaries’ loan obligations. Downstream security grants are typically not at risk, because a benefit to one of the subsidiaries increases the value of the parent’s ownership interest in the subsidiary.

Upstream and cross-stream security grants can be annulled where, as in many transactions, the loan does not benefit all loan parties in perfectly equal proportions. Louisiana’s “revocatory action” allows a subordinate creditor to avoid, or “claw back,” an obligation or grant of collateral if it causes or increases the grantor’s insolvency.[1] In the example shown above, the economic value of the loan flows disproportionately to the parent and newly formed subsidiary. Under these circumstances, the upstream and cross-stream security grants increase the liability side of the existing subsidiaries’ balance sheet without a proportionate increase in the value of the assets of those entities. This disproportionate flow of value and liability subjects the upstream and cross-stream grants to annulment in a revocatory action if the grants caused or increased the existing subsidiaries’ insolvency.

Why is a Three-Year-Old Change Relevant Only Since August 2016?

Before August 1, 2016, Louisiana law limited a lender’s avoidance risk to, at most, three years after the closing date. After three years the Louisiana “revocatory action” expired without exception.

On August 1, 2013, the Louisiana Legislature created an exception to the three-year limitations period.  Under the new law, the three-year limitations period does not apply in “cases of fraud.”[2]  The phrase “cases of fraud” is not defined, and courts have thus far skirted the question by interpreting the 2013 legislative change as a substantive change, not procedural.[3] According to that interpretation, the fraud exception only applies to transfers closing after August 1, 2013. Since the three-year limitations periods on those loans began to expire on August 1, 2016, the meaning of “fraud” has become very relevant to bankruptcy trustees and unsecured creditors looking to expand the limitations period to attack loans that closed over three years ago.

As we get further from August 1, 2016, more loans will become subject to litigation over what is a case of fraud.

The Change Adds (at Least) Seven Years and Uncertainty to Avoidance Risk

In effect, the “cases of fraud” exception expands a three-year risk to a ten-year risk for secured lenders. If the three-year peremptive period does not apply in cases of fraud, the general prescriptive period rule in Louisiana provides that “[u]nless otherwise provided by legislation, a personal action is subject to a liberative prescription of ten years.”[4] Moreover, unlike the three-year limitations period which is a peremptive period (which for our non-Louisiana readers is similar to a “statute of repose”), the ten-year prescriptive period is subject to interruption. It takes no imagination to think of the changes that can occur in a borrower’s business over a ten-year period compared to a three-year period. And if that change is negative, a bankruptcy trustee or unsecured creditor will want to attack the upstream and cross-stream grants to the secured lender.

In addition to enjoying an expanded limitations period, bankruptcy trustees and unsecured creditors now enjoy a blank slate in litigating what the Louisiana Legislature meant by “cases of fraud.” Is this a constructive fraud concept or does the plaintiff need to show actual fraudulent intent? As the case law develops on this question, the uncertainty advantages the unsecured creditors and bankruptcy trustees in negotiations with secured lenders.

Extra Diligence to Consider

In light of the heightened avoidance risk in Louisiana, some diligence practices which may have been reserved for larger loan transactions now look more reasonable for smaller loans that involve multiple obligors.

For example, the lender may require a solvency opinion by a financial expert to establish that as of the closing date the upstream or cross stream guarantees did not create or increase the grantor’s insolvency. In addition, a fairness opinion is often used in other jurisdictions to establish evidence that the borrower obtained sufficient value from the loan to support its guarantee or collateral grant. Whether a debtor received equivalent value to its security grant is relevant in jurisdictions that follow the Uniform Fraudulent Transfer Act, but is not particularly relevant to the balance sheet test in a revocatory action. However, because we do not know how courts will interpret “cases of fraud,” a fairness opinion in addition to a solvency opinion may be warranted for transactions subject to Louisiana’s revocatory action for evidence that a particular grant was supported by the particular value of the loan flowing to the subsidiary.

The new exposure also warrants a re-examination of the secured lender’s standard loan documents to ensure that the credit departments understand and are actively conducting the solvency and debt-coverage tests provided in their forms.

More generally, the expanded reach of the Louisiana revocatory action warrants closer scrutiny and diligence expense that was not as critical to preventing transfer avoidance before the legislative change.

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[1] La. Civ. Code art. 2036.

[2] La. Civ. Code art. 2041.

[3] In re Robinson, 541 B.R. 396, 400 (Bankr. E.D. La. 2015); Cotter v. Gwyn, No. CV 15-4823, 2016 WL 4479510, at *12 n.102 (E.D. La. Aug. 25, 2016).

[4] La. Civ. Code art. 3499.

SEC

By David P. Hamm, Jr.

On October 26, 2016, the SEC adopted final rules that (1) modernize Rule 147, (2) create a new Rule 147A, (3) amend Rule 504, and (4) repeal Rule 505 (collectively, the “Amendments”). The adopting release can be found here. Several of the significant changes brought about by the Amendments are broadly summarized below.

Modernization of Rule 147 and Creation of New Rule 147A

Rule 147 was adopted in 1974 for the purpose of providing guidance to issuers conducting unregistered offerings under Section 3(a)(11). This section provides an exemption from registration for “[a]ny security which is part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or, of a corporation, incorporated by and doing business within, such State or Territory.”

Rule 147 has not been substantively amended since its enactment. In light of this reality, the SEC noted: “[D]ue to developments in modern business practices and communications technology in the years since Rule 147 was adopted, we have determined that it is necessary to update the requirements of Rule 147 to ensure its continued utility.”[1]

In addition to modernizing the existing Rule 147, the SEC also created a new Rule 147A. The amended Rule 147 and the new Rule 147A “are substantially identical, except that . . . new Rule 147A allows an issuer to make offers accessible to out-of-state residents and to be incorporated or organized out-of-state.”[2]

Given the similarity of the Amendments (except as specifically set forth above) as they relate to existing Rule 147 and new Rule 147A (collectively, the “Rule 147 Amendments”), they will be treated together in this portion of the article. The Rule 147 Amendments can be divided under six headings:

1. Modification of “Doing Business” Requirements

Two significant changes were made to the “doing business” requirements of Rule 147.  First, the Rule 147 Amendments add an alternative “doing business” test based upon the location of a majority of the issuer’s employees.  Under the new “employee test,” an issuer can satisfy the “doing business” requirement by showing that a majority of its employees are based in the state where the offering is being made. This is a relatively straight forward test that, in many cases, will not require a significant amount of analysis.[3]

Second, the Rule 147 Amendments change the relationship of the “doing business” requirements from conjunctive to disjunctive. That is, an issuer no longer has to meet all of the “doing business” requirements. Rather, the issuer now only needs to satisfy one of the “doing business” requirements. This is a significant change that greatly reduces the difficulty of satisfying the existing “doing business” requirements.[4]

2. Addition of “Reasonable Belief” Standard

The Rule 147 Amendments include a “reasonable belief” standard in connection with the issuer’s determination as to the purchaser’s residence. The necessity of the inclusion of this standard is highlighted in the adopting release as follows:

“Under current Rule 147(d), regardless of the efforts an issuer takes to determine that potential investors are residents of the same state in which the issuer is resident, the exemption is lost for the entire offering if securities are offered or sold to just one investor that was not in fact a resident of such state.”[5]

In connection with the inclusion of a “reasonable belief” standard, the Rule 147 Amendments require the issuer to obtain a written representation from each purchaser as to its residence. The receipt of the written representation, however, is not the end of the story. The determination as to whether the issuer has a “reasonable belief” as to the residency of a purchaser is determined on the basis of all the facts and circumstances.[6]

3. Revision of Entity Residence Tests

For both issuing and purchasing entities, the Rule 147 Amendments replace the “principal office” test with the “principal place of business” test for the purpose of determining residency. The “principal place of business” is the “location from which the officers, partners, or managers of the [entity] primarily direct, control and coordinate the activities of the issuer.”[7]

4. Six-Month Resale Limitation

The Rule 147 Amendments make two significant changes to the existing resale limitation in the context of Rule 147 offerings. The current resale limitation is triggered by the termination of the Rule 147 offering and lasts for a period of nine months. The resale limitation adopted by the Rule 147 Amendments is shorted to a six-month period and is now triggered by date of purchase by each purchaser.[8]

It is significant to note that securities issued in reliance upon Rule 147 and Rule 147A are not “restricted securities” under Rule 144(a)(3). Accordingly, the resale of such securities must, as a general matter, only comply with state securities laws.[9]

5. Addition of Bright-Line Integration Safe Harbor

The Rule 147 Amendments adopt a “bright-line integration safe harbor” which precludes the integration of offers or sales of securities made prior to the commencement of a Rule 147 or Rule 147A offering and certain specified offers and sales made after the completion of a Rule 147 or Rule 147A offering.[10]  Of particular note, the Rule 147 Amendments provide that an offer or sale of securities made more than six months after the completion of a Rule 147 or Rule 147A will not be integrated.

6. Disclosure and Legend Requirements 

The Rule 147 Amendments change the mode of the disclosure requirements by allowing the disclosures to be made in the same form that the offer is made.  Thus, if the offer is made orally, the disclosures can be made orally to the offeree at the time of the initial offer. However, every purchaser must be given a written disclosure a reasonable period of time before the actual sale in reliance on Rule 147 or Rule 147A.

The Rule 147 Amendments also provide specific language to be used in connection with the required legend (the existing version of Rule 147 does not provide specific language).

Finally, it should be noted that securities sold under Rule 147 and Rule 147A are not “covered securities” for purposes of the National Securities Markets Improvement Act of 1996 (“NSMIA”) and compliance with applicable state securities law is still required.

The Rule 147 Amendments will be effective on April 20, 2017.

Amendment of Rule 504

The Amendments increase the aggregate amount of securities that can be offered and sold in reliance on Rule 504 during any twelve-month period from $1,000,000 to $5,000,000. The last increase to the maximum aggregate amount under Rule 504 was in 1988 when the cap was raised from $500,000 to $1,000,000.  Further, the adopting release appears to express an openness to raise the cap higher (perhaps $10,000,000 as was suggested by a commenter) after having the opportunity to observe market activity with the new cap.[11]

Prior to the Amendments, Rule 504 did not include a bad actor disqualification provision. The Amendments incorporate by reference the bad actor disqualification provision of Rule 506(d).  The utilization of the same bad actor provision in the context of Rule 504 and Rule 506 is part of the SEC’s overall effort to create a “consistent regulatory regime across Regulation D” and simplify due diligence efforts on the part of issuers.[12]

Like securities sold under Rule 147 and Rule 147A, securities sold under Rule 504 are not “covered securities” for purposes of NSMIA and compliance with applicable state securities laws is still required.

The amendments to Rule 504 became effective on January 20, 2017.

Repeal of Rule 505

Given the increase of the Rule 504 threshold from $1,000,000 to $5,000,000, the SEC repealed Rule 505 because of its belief that it was no longer needed. Even before the amendment to Rule 504, only 3% of Regulation D offerings were made in reliance upon Rule 505.[13]

The repeal of Rule 505 will be effective on May 22, 2017.

Conclusion

As the adopting release noted: “The final rules will primarily impact the financing market for startups and small businesses.”[14]  The Amendments could potentially revitalize and expand the use of Rule 147 and Rule 504 in the context of intrastate and regional offerings, thereby giving smaller issuers more viable options as they seek to raise capital through securities offerings.

Additionally, the revisions to Rule 147 and the enactment of new Rule 147A will likely expand the utilization of intrastate crowdfunding offerings as “most states that have enacted crowdfunding provisions require issuers that intend to conduct intrastate crowdfunding offerings to use Rule 147.”[15]

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[1]  Exemptions to Facilitate Intrastate and Regional Securities Offerings, SEC Release No. 33-10238, 18 (Oct. 26, 2016). Of note, the release goes so far as to discuss particular disclosure requirements in the context of Twitter or like social media platforms with similar space limitations. Id. at 18-19.

[2]  Id. at 26. It should also be noted that new Rule 147A does not have a limit on the permitted size of the offering.

[3] The adopting release does anticipate potential complications that could arise given the ever-changing and mobile workplace: “[I]f an employee provides services in the Maryland, Virginia and Washington, DC metro area out of the offices of a company in Maryland, the employee would be based in Maryland for purposes of this test.” Id. at 33.

[4]  The SEC noted the onerous nature of the existing “doing business” requirements: “Given the increasing “interstate” nature of small business activities, we believe it has become increasingly difficult for companies, even smaller companies that are physically located within a single state or territory, to satisfy the issuer “doing business” requirements of current Rule 147(c)(2).” Id. at 30.

[5]  Id. at 36.

[6] Id. at 37. The adopting release mentioned several data points that may be of particular importance: (1) an existing relationship between the issuer and purchaser, (2) recent utility bill, (3) pay-stub, (4) state or federal tax returns, (5) identification documentation such as a driver’s license, and (6) information obtained by the utilization of credible databases. Id. at 37-38.

[7]  One nuance of interest (particularly in Louisiana) for purchasing trusts is that a trust in a jurisdiction where trusts are not deemed to be a separate entity will be “deemed to be a resident of each estate or territory in which its trustee is, or trustees are, resident.” Id. at 40.

[8]  Id. at 43-47.

[9]  The adopting release did note the risk of being deemed an “underwriter” or as one participating in a “distribution” if securities are acquired with a view to distribution. Id.at 47.

[10]  Id. at 49-54. The post-sale safe harbors include offers or sales (1) registered under the Securities Act, except as provided in Rule 147(h) or Rule 147A(h), (2) exempt from registration under Regulation A, (3) exempt from registration under Rule 701, (4) made pursuant to an employee benefit plan, (5) exempt from registration under Regulation S, (6) exempt from registration under Section 4(a), and (7) made more than six months after the completion of an offering conducted pursuant to Rule 147 or 147A.

[11]  Id. at 77-78.

[12] Id. at 78.

[13] The empirical data behind this percentage was taken from Form D filings with the SEC from 2009 to 2015. Exemptions to Facilitate Intrastate and Regional Securities Offerings, SEC Release No. 33-10238, 11 & n.22 (Oct. 26, 2016).

[14]  Id. at 88.

[15]  Id. at 91. According to the North American Securities Administrators Association (“NASAA”), as of July 18, 2016, 35 states had enacted crowdfunding statutes. A link to NASAA’s intrastate crowdfunding update can be found here. A link to the NASAA’s Intrastate Crowdfunding Directory can be found here.

stock

By David P. Hamm, Jr.

In In re Books-A-Million, Inc. Stockholders Litigation, the Delaware Court of Chancery dismissed a suit by minority stockholders (the “Plaintiffs”) alleging that several fiduciaries breached their duties in connection with a squeeze-out merger (the “Merger”) through which the controlling stockholders of Books-A-Million, Inc. (the “Company”) took the Company private.[1]  The decision, authored by Vice Chancellor J. Travis Laster, provides additional guidance regarding the utilization of the business judgment rule in the context of controller buyout.

The MFW Requirements

The default standard of review in the context of a controller buyout is the entire fairness test.[2]  However, the business judgment rule serves as the operative standard of review if the six requirements set forth by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. (the “MFW Requirements”) are satisfied, namely:

“(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent [and disinterested]; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitely; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.”[3]

Bad Faith and the Second MFW Requirement

In Books-A-Million, the court concluded that all of the MFW Requirements were satisfied. In so doing, the court shed significant light on the second MFW Requirement; namely, that the Special Committee be independent and disinterested.[4]  The most significant contribution of the case was the court’s treatment of the plaintiffs’ allegation of bad faith as a basis for their claim that the second MFW Requirement had not been satisfied. The court acknowledged the novelty of the plaintiffs’ claim by stating the following:

“It is not immediately clear how an argument regarding bad faith fits within the M&F Worldwide framework. The Delaware Supreme Court did not discuss whether a plaintiff could seek to call into question the independence of a director by contending that although appearing independent, the director did not in fact act independently for the benefit of the stockholders but rather in pursuit of some other interest, such as to benefit the controlling stockholder.”[5]

The heart of the plaintiffs’ bad faith claim was the fact that a third-party offer existed that was greater than the controller offer. The third party offer was $0.96 more per share. The court summarized the plaintiffs’ argument as follows: “The Complaint contends that it is not rational for a director to take a lower priced offer when a comparable, higher priced offer is available. Because no one rationally would do that, the plaintiffs contend that the independent directors must have had some ulterior motive for not pursuing [the third party offer].”[6]

In rejecting the plaintiffs’ argument, the court quoted extensively from Chancellor Allen’s analysis in Mendel v. Carroll.[7]  In Carroll, Chancellor Allen distinguished a third-party offer and a controller offer on the grounds of a control premium:

“The fundamental difference between these two possible transactions arises from the fact that the Carroll Family [the controller] already in fact had a committed block of controlling stock. Financial markets in widely traded corporate stock accord a premium to a block of stock that can assure corporate control.”[8]

The court in Books-A-Million applied the control premium concept as follows in relation to the relative levels of the third-party and controller offers:

“On the facts alleged, one can reasonably infer that Party Y’s [the third party] offer was higher because Party Y was seeking to acquire control and that the Anderson Family’s [the controller] offer was lower because it took into account the family’s existing control over the Company.”[9]

In a footnote, the court cited several sources establishing recognized control premiums and signaled that control premiums falling outside of an acceptable range could potentially give rise to an inference that a company’s fiduciary duties acted in bad faith. [10]

Application of the Business Judgment Rule

Given the satisfaction of each of the MFW Requirements, the court utilized the business judgment rule as the operative standard of review. The utilization of the business judgment rule, as is typically the case, was the death knell for the plaintiffs. The court went so far as to say that: “It is not possible to infer that no rational person acting in good faith could have thought the Merger was fair to the minority. The only possible inference is that many rational people, including the members of the Committee and the numerous minority stockholders, thought the Merger was fair to the minority.”[11]

Conclusion

While Books-A-Million is helpful on several points, the case breaks new ground on the treatment of a bad faith claim within the MFW Framework.  Controllers and their counsel should take note of the importance of any control premium falling within the acceptable range cited by the court; namely, from 30% to 50%. Any premium in excess of the range cited could potentially expose a corporation’s fiduciaries to an allegation of bad faith, thereby triggering the entire fairness test as the operative standard of review.

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[1] C.A. No. 11343-VCL, slip. op. (Del. Ch. Oct. 10, 2016, available here.

[2]  Id. at 16 (citing Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997)).

[3]  88 A.3d 635, 645 (Del. 2014).

[4]  The plaintiffs did not contest the satisfaction of the third, fifth, and six MFW Requirements. The court’s analysis in the context of the first and fourth MFW Requirements do not advance any new ground and, therefore, are not discussed in this brief article.

[5]  Books-A-Million, C.A. No. 11343-VCL, slip op. at 23.

[6]  Id. at 25-26.

[7]  651 A.3d 297 (Del. Ch. 1994).

[8]  Id. at 304.

[9]  Books-A-Million, C.A. No. 11343-VCL, slip op. at 34.

[10]  Id. at 35 & n.16.

[11]  Id. at 42.

 

 

Day

By Michael D. Lowe

Last week, thousands of employees throughout the county skipped work as part of “a day without immigrants” demonstration. The employees were protesting the Trump administration’s recent actions regarding immigration. The stated intent was to negatively impact the nation’s economy in an effort to highlight the contributions of immigrant labor. Restaurants were the primary target. Businesses from New York to San Francisco were forced to temporarily close as employees either failed to report to work or “walked out.” In many cases, the protesting employees included both immigrants and their co-workers.

Several employers embraced the protests and promised not to discipline the participating employees. However, many employers took the opposite approach. According to various media reports, hundreds of employees in a number of different cities were terminated after they refused to report to work. With reports that additional demonstrations are likely, employers should prepare for the possibility that one or more employees might choose to participate.

As an initial matter, an employer should communicate its expectations to its employees in advance of any demonstration. If possible, this communication should be documented by internal memo, email, or even text message. Employees should also be reminded of any applicable attendance policies.

While the refusal to report to work is a legitimate non-discriminatory basis to terminate an employee, an employer must be consistent in its response. An employer that terminates some employees, while excusing the absences of others, may face a claim of disparate treatment. Those employers with a unionized workforce should consult labor counsel with regard to any collectively bargained rights.

Finally, affected employers should prepare for media coverage and press inquiries. The demonstrations have already garnered international attention as the debate regarding the Trump administration’s immigration policies shows no signs of slowing down. Employers should clearly define who within its organization may respond to media inquiries and what information will be shared. Any comments made following an employee’s termination will almost certainly be used in any resulting legal action.

other-agreements

By Dean P. Cazenave

When lenders and borrowers want to modify the terms of an existing loan agreement, and the modifications are extensive and will affect many provisions of the agreement, the lender’s lawyer will often choose to draft an “amended and restated agreement” in order to document those modifications. A single amended and restated agreement will often be easier to read than would be the original agreement and a separate amendment (or a series of separate amendments). When they do so for a secured financing, the parties almost always intend that the collateral that secured the original loan agreement continue to secure the obligations under the amended and restated credit agreement;, as a result of a recent decision by the U.S. Court of Appeals for the Sixth Circuit, it is important that the document clearly states that it is not intended as a novation of the obligations under the original loan agreement.

Recently, in Bash v. Textron Financial Corporation (In re Fair Finance Company), 834 F.3d 651 (6th Cir. 2016), the U.S. Court of Appeals for the Sixth Circuit reversed a determination of the District Court for the Northern District of Ohio that an amended and restated loan agreement did not constitute a novation of the original loan agreement. In so doing, the court held, in largely reversing the dismissal of an adversary proceeding arising out of a Chapter 7 bankruptcy case, that the amended and restated loan agreement may actually have constituted (or at least it is ambiguous as to whether it constituted) a novation of the original loan agreement. If the amended and restated loan agreement did in fact constitute a novation, the security interests granted pursuant to the original loan agreement would have terminated at the time that the parties entered into the amended and restated loan agreement. The circuit court, after reversing the district court’s determination, remanded the question to the lower court for further proceedings.

The district court had rejected the novation argument, but the Sixth Circuit reversed, finding that the following provisions of the amended and restated loan agreement created a question of fact as to whether it was the parties’ intent to wholly replace and extinguish (i.e. novate) the original loan agreement and the security interest granted thereunder:

  • The statement that the restated loan agreement was for “valuable consideration, the receipt and sufficiency of which are hereby acknowledged”;
  • The language that the restated loan agreement “constitutes the entire agreement of Borrowers and Lender relative to the subject matter” thereof and would “supersede any and all prior oral or written agreements relating to the subject matter”; and
  • The re-grant of the security interest under the restated loan agreement.

It is cause for concern that all of the provisions the Sixth Circuit found were evidence of a novation in In re Fair Finance Company are regularly found in amended and restated loan documents throughout the broader loan market.

Significantly, the Sixth Circuit distinguished this case from In re TOUSA, Inc., where a district court ruled that the execution of an amended and restated agreement did not constitute a novation. The amended and restated agreement in TOUSA contained an explicit statement that the parties intended that the security interest and liens granted in the original security agreement would continue in full force and effect. The district court in TOUSA explained that notwithstanding the general language in the amended and restated agreement that all prior agreements were being restated in their entirety, the specific terms the parties agreed to must be given effect.

While one may question the sufficiency of the evidence that the Court relied on in finding that the parties may have intended to effect a novation, the lesson that a lawyer drafting an amended and restated financing agreement should draw from this decision is the importance of clearly and expressly stating the parties’ intent that the amended and restated agreement not constitute a novation. When drafting an amended and restated financing agreement, a lawyer should include an express statement that the agreement is not intended to constitute a novation or a termination of the obligations under the original agreement, and in the context of a secured financing, that the security interests created pursuant to the original agreement are intended to continue and to secure the obligations under the amended and restated agreement.

liquor-bottles

By Jill Gautreaux

The City of New Orleans (“the City”) has amended and re-enacted a gallonage tax on alcoholic beverages of low and high alcoholic content. A “gallonage tax” is a tax on alcoholic beverages based upon the amount, calculated in gallons, of alcoholic beverages sold. The current ordinance became effective on January 1, 2017, but industry members have sought to enjoin the implementation of this “new” tax. The ordinance closely follows the wording of the State gallonage tax statutes, which causes the tax to apply to wholesalers or Louisiana manufacturers because they are the first parties to come into possession of the alcoholic beverages in the State of Louisiana. The City ordinance does not have the effect that it apparently intended, and is worded as follows:

Section 10-511 – Who is liable for tax.

The taxes levied in sections 10-501 and 10-502 of this division shall be collected, as far as practicable, from the dealer who first handles the alcoholic beverages in the city. If for any reason the dealer who first handled the taxable alcoholic beverages has escaped payment of the taxes, those taxes shall be collected from any dealer in whose hands the taxable beverages are found.

On February 9, 2017, the City Council introduced an ordinance to amend Section 10-511, which qualified the word “dealer” in the first sentence and the first phrase of the second sentence with “wholesale”. Nevertheless, according to the current wording of the ordinance, if the wholesale dealer has “escaped” the tax, the retailer will be responsible for paying the tax to the City.

There is a strong likelihood that New Orleans alcoholic beverage retailers will end up having to pay some of this tax if the ordinance is enacted and enforced as currently written. Several large wholesale companies, including Southern Glazers, Southern Eagle, and Republic, do not have any physical presence within the City of New Orleans, and therefore should not be subject to the tax.

A few trade organizations have challenged the enforceability of the ordinance in Orleans Parish Civil District Court. The plaintiffs were successful in obtaining a temporary restraining order, but were denied a preliminary injunction. The temporary restraining order has lapsed, but, as of this date, the City has indicated that it will not collect the tax until the litigation has concluded. One City official has suggested that if the City prevails, that the tax due will be retroactive to January 1, 2017.

 

Accessibility computer icon

By Price Barker, Brian Carnie, and Michael Lowe

Disability access lawsuits have become a cottage industry and they have found their way into Louisiana, Texas and Arkansas.  Most are brought by the serial litigants working with same law firm.  These plaintiffs visit a business for the primary purpose of discovering an Americans with Disabilities Act (ADA) accessibility violation and then file a federal court lawsuit without giving the property owner, tenant or business advance notice of their complaint or an opportunity to fix the problems.

Now we are seeing a growing trend of “drive by” or “Google” disability access lawsuits.  The tag “drive-by” lawsuit came about due to accusations in many of these cases that either the plaintiff, or their lawyer, simply drove by the business, observed an alleged violation, and then filed suit.  The tag “Google lawsuit” arose from the belief of several business owners who have been sued that the ADA violations (such as the failure to have a lift seat at a hotel swimming pool) were discovered using Google earth.  In “drive-by” or “Google” lawsuits, the plaintiff almost always seeks attorneys’ fees, expert witness fees, and other litigation costs, as well as other concessions from the business they have sued.  Under federal law, business owners often have to pay both sets of attorneys’ fees, and if they do not settle, or make the corrections to their property demanded in the suit, it may end up costing them many thousands of dollars more, leading to accusations that these suits are simply money-making ventures for the plaintiff bar.

The ADA was passed by Congress in 1990.  Every private business in the United States open to the public must comply with the ADA.  This includes restaurants, bars, convenience stores, hospitals, hotels, shopping centers, and other retail locations.  The accessibility requirements of the ADA are very specific, and extensive.  There are thousands of requirements to be found in the 275-page ADA manual, which has specific requirements for things such as the slope and length of wheelchair ramps, the location and signage for handicap parking spots, and the height and location of door handles, sinks, toilets, and grab rails.

ADA access litigation is not limited to parking lots, sidewalks, restrooms and other alleged physical barriers in a “brick and mortar” establishment.  A growing number of lawsuits are being filed claiming that the business’ Web site does not provide adequate accessibility to the visually or hearing impaired.  Since 2010, the United States Department of Justice (DOJ) has delayed issuing specific regulatory guidance directly addressing the accessibility standards for commercial Web sites.  That does not mean that businesses do not have to try to comply with the general requirements of the ADA, nor does it prevent DOJ enforcement or suits by private plaintiffs.

Numerous ADA access lawsuits have been filed in federal court in Shreveport.  One of the recently filed claims is a class-action filed by a registered sex offender against a local municipality, claiming that the office where he is required to register as a sex offender is now violating the ADA by not providing him with a sign language interpreter.

So what should a business owner do to avoid this expensive headache?  A good starting point is to make your business an unattractive target.  Visit your location to see if there are any obvious ADA violations that would catch the attention of a “drive-by” plaintiff.  For example, look for un-ramped entrance steps, poorly maintained routes from handicap parking spaces to the entrance, handicap parking spaces with no access aisle, and observe the slope of your handicap parking spaces.  If you can see a slope, it is probably non-compliant.  And if you can see the slope, you can bet the plaintiff driving by will too.

 

Merger Dictionary Definition Word Combine Companies Businesses

By Linda Perez Clark

Recent cases have highlighted the importance of seller contractually protecting and retaining ownership over communications that, pre-closing, are subject to the attorney-client privilege.  The absence of such language in a merger or asset/stock purchase agreement can lead a court to conclude that such communications are owned by the buyer/surviving corporation.

Such was the result in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), where more than a year post-closing, after the buyer sued the seller for allegedly fraudulently inducing buyer to enter into the merger, the seller asserted ownership over pre-merger privileged communications maintained on the surviving corporation’s computer system.

The court ruled in the buyer’s favor, and held that the surviving corporation owns and controls such communications, noting that the seller had not been proactive in either protecting the communications from seller’s access, or contractually preserving ownership.   The court specifically noted that under Delaware law, all property, rights, privileges, etc. become property of the surviving corporation (the same is true under Louisiana law, LSA-R.S. 12:1-1107);  a contrary result can only be achieved by contractual agreement.

Accordingly, a clause addressing ownership and control over such communications, and proactively protecting them from disclosure, is critical.

 

louisiana

By Linda Akchin and Chris Dicharry

INTRODUCTION

Louisiana law imposes a sales tax on “sales at retail.”  “Sale at retail” is defined in the sales tax law, and the definition provides that the term does not include “sales of materials for further processing into tangible personal property for sale at retail.”    This provision is commonly referred to as the “further processing exclusion.”[1]  The most recent Louisiana Supreme Court’s decision interpreting this “further processing exclusion,” Bridges v. Nelson Indus. Steam Co., 2015-1439 (La. 5/3/16), 190 So.3d 276 (the “NISCO decision”), recently became final.  The decision is significant for all taxpayer-manufacturers.  It provides an excellent explanation of applicable legal principles relating generally to interpretation of the further processing exclusion and a comprehensive explanation of the three-prong jurisprudential test for application of the exclusion.  In response to the NISCO decision, and before it became final, the Legislature passed an Act amending the further processing exclusion.[2]  The purpose of this writing is to (i) provide some general information regarding applicable rules of law to be gleaned from the NISCO decision; and (ii) identify questions arising from the recent legislative amendment to the law.

THE SUPREME COURT DECISION

The further processing provision applies to byproducts.

The NISCO decision is the first in which the Supreme Court directly addresses the question of whether the further processing exclusion from tax applies to purchases of materials that are further processed into a byproduct of a manufacturing process.  The Supreme Court held that it does.  Noting that the exclusion applies to “tangible personal property,” and the sales tax regulation interpreting the exclusion provides that whether materials are further processed or simply used in the processing activity will depend entirely upon an analysis of the “end product,” the court reasoned that it found nothing in the law that requires the “end product” be the enterprise’s primary product, explaining:

“The plain language of the statute makes the exclusion applicable to articles of tangible personal property.  There simply is no distinction between primary products and secondary products. . . . At the end of the day, the ash [NISCO’s byproduct] is produced and sold . . . making it an ‘article of tangible personal property for sale at retail.’”[3]

The NISCO decision applies and interprets the long-established three-pronged test for application of the exclusion.

The Court applied the jurisprudentially-established three-pronged test for application of the further processing exclusion as it related to NISCO’s ash byproduct:  The test is:

(1) the raw materials become recognizable and identifiable components of the end products;

(2) the raw materials are beneficial to the end products; and

(3) the raw materials are materials for further processing, and as such, are purchased with the purpose of inclusion in the end products.[4]

In applying the test the Court clarifies and reinforces aspects of the application of the test that all taxpayers would be well-served to keep in mind.   Those clarifications include:

(1)       The further processing provision constitutes an “exclusion” not an “exemption” from tax, and as such, must be liberally construed in favor of the taxpayer;[5]

(2)       When the material purchased is processed into less than all of the end products produced, the analysis involves only consideration of the end product(s) into which the material is further processed, without regard to other end products.[6]

(3)       In order to satisfy the “benefit” prong of the test it is not necessary to conduct tests to determine the qualities of the material purchased or its beneficial impact on the end product.  It is sufficient that elemental components of the material purchased become integral components of the molecular makeup of the end product.  That “integration” is in and of itself of some benefit to the end product.[7]

(4)       The “purpose” prong of the test does not involve a primary purpose test; and the “purpose” test involves a “manufacturing purpose” inquiry, not a “business purpose” or “economic purpose” inquiry.  Only the manufacturing process and the physical and chemical components and the materials involved in the process are germane to the “purpose” test.[8]

(5)       There is no legal basis for an “apportionment” approach to the further processing exclusion, whether based upon the percentage of the material or some assigned value of the components that actually end up in the end product, and any such approach is impractical in application.[9]

The New Law

The 2016 Legislative amendment, effective June 23, 2016, amends the law to provide that “[t]he term ‘sale at retail’ does  not include sale of materials for further processing into articles of tangible personal property for sale at retail when all of the criteria in Subsubitem (I) of this Section are met.[10]  Those criteria consist of a re-statement of the three-pronged test:  (1) the raw materials become a recognizable and identifiable component of the end product; (2) the raw materials are beneficial to the end product; and (3) the raw materials are material for further process, and as such are purchased for the purpose of inclusion into the end product.

The amendment goes further, however, and adds a “Subitem II” to the definition of “sale at retail.”  This addition represents new law and provides, in short, that “[i]f the materials are further processed into a byproduct for sale, such purchases of materials shall not be deemed to be sales for further processing and shall be taxable.”  The term “byproduct” is defined to mean “any incidental product that is sold for a sales price less than the cost of the materials.”

QUESTIONS CREATED BY THE NEW LAW

Did the Legislature intend to overrule the NISCO decision?

The first question that arises is whether the clarifications to the three-prong jurisprudential test that are set forth in the NISCO decision may be applied under the amended law’s verbatim codification of the three-prong jurisprudential test.  It is a well-accepted rule of statutory construction that those who enact statutory provisions are presumed to act deliberately and with full knowledge of existing laws on the same subject, with awareness of court cases and well-established principles of statutory construction, with knowledge of the effect of their acts and a purpose in view; and that when the Legislature changes the wording of a statute, it is presumed to have intended a change in the law. [11]  Thus, legislative language will be interpreted based upon assumption that the Legislature was aware of judicial decisions interpreting those statutes, including among others, the NISCO decision.[12]  Because the amended law adopts the three-prong judicial test verbatim, we believe a strong argument may be made that there is no legislative intent to vary from the Supreme Court’s interpretations of that test, except to the extent the language of the amended law expressly varies from the Supreme Court’s prior interpretations.  The Legislature has never hesitated to expressly state its intent to legislatively overrule a Louisiana Supreme Court decision, when that is indeed its intent.  Here, no express statement of such intent was made, and we do not believe that the Louisiana Supreme Court will infer intent to overrule any aspect of the NISCO decision, except to the extent the language of the amendment is inconsistent with the court’s interpretation in NISCO.

What constitutes a “byproduct” for purposes of the new law?

In cases where a product is sold for a sales price less than the cost of its materials, questions will likely arise as to whether the product is an “incidental product.”  Because the term “incidental product” is not statutorily defined by the legislature, we must give the words their commonly-accepted meaning.  The word “incidental” means “being likely to ensue as a chance or minor consequence,” or “occurring merely by chance or without intention or calculation.”[13]  Many products sold for a sales price less than the cost of their materials are intentionally manufactured and sold.  They are not manufactured by accident; and they are not the result of chance.  Instead, a conscious decision is made to choose a process design that will in fact create certain byproducts, with the intention to sell all the products of the process – both “primary products” and “byproducts,” with an overall profit motive.  While any particular byproduct may be of minor consequence economically speaking, when viewed in a vacuum, it may not be of economic “minor consequence” to the overall finances of the taxpayer; or it may not be of minor consequence in terms of volumes manufactured and sold, or investment made to develop, manufacture, market and sell the byproduct.  In our opinion, the Legislature’s amendment – a clear intent to vary from the NISCO decision’s holding that the further processing exclusion applies to all end products – merely creates more uncertainty, resulting in many more sales and use tax disputes and consequent litigation.  The taxing authorities will undoubtedly argue that the intent of the amendment was to create a rule to be applied when a byproduct, viewed in a vacuum, is not profitable; but that is not what the Legislature said.  The Legislature adopted a rule to be applied to “incidental products,” without defining that term.  Thus, we believe a proper interpretation requires that a determination must first be made regarding whether the byproduct is an “incidental product;” and only if it is an incidental product, does the second part of the “test” – whether it is sold for a sales price less than the cost of its material – apply.

May the new law be applied retroactively?

Taxpayers may expect the taxing authorities to impose the new law going forward.  Serious questions arise, however, regarding the applicability of the new law to taxes already reported and paid, or incurred, before the new law became effective.

The new law expressly provides that it “shall not be applicable to any existing claim for refund filed or assessment of additional taxes due issued prior to the effective date of this Act for any tax period prior to July 1, 2016, which is not barred by prescription.”  If a taxpayer’s claim or dispute with the taxing authority falls within the language of this provision, the new law should not be applied by the taxing authorities.  It is not clear what is meant by the terminology “claim for refund filed.”  Does it mean the submission of a refund request or claim with the taxing authority, or a suit for refund, or both?  Likewise, it is not clear what is meant by “assessment of additional taxes due issued” – does it include notices of intent to assess (“proposed assessments”), notices of assessment (“final assessments”), petitions for redetermination of assessments, or suits to collect tax, or all four.  We recommend that taxpayers apply the most liberal interpretation of the language unless and until guidance is provided by regulation or judicial decision.

There will undoubtedly be cases in which no claim for refund has been filed or assessment issued before the effective date of the act, but involving tax periods prior to July 1, 2016.  In such cases, we believe a strong argument may be made that retroactive application of the new law to pre-amendment tax periods is unconstitutional.  The Legislature stated in the Act that it “is intended to clarify and be interpretive of the original intent and application of” the further processing exclusion, and that “[t]herefore, the provisions of this Act shall be retroactive and applicable to all refund claims submitted or assessments of additional tax due which are filed on or after the effective date of this Act.”  Despite this statement by the legislature, we believe that the amendment to the law is not merely clarifying and interpretive.  We believe the changes are substantive in nature.  Generally, substantive laws may be applied prospectively only.  And despite express legislative intent to the contrary, it is uniquely the province of the courts to determine if an Act is substantive, or merely clarifying and interpretive.  And, if the law is substantive, it will not be applied retroactively by the courts because to do so impinges upon the authority of the judiciary in violation of the constitutional doctrine of separation of powers and divests taxpayers of substantive rights and causes of action that accrued and vested in the taxpayer before the effective date of the Act, such that imposition of the new law would constitute a denial of due process.[14]

Was the amendment to the law constitutionally enacted?

In the case of an attempt by a taxing authority to apply the new law retroactively to pre-amendment tax periods, or in the case of a purely prospective application of the new law to post-amendment tax periods, a question still exists regarding the constitutionality of the law’s enactment.  The Louisiana Constitution provides that enactments levying a new tax or increasing an existing tax require a two-thirds vote of both houses of the Legislature to become law.[15]  Here, the Act at issue did not have a two-thirds vote of the House of Representatives.  A viable legal argument exists that because the law amends definitions in a manner that makes previously non-taxable transactions taxable, it constitutes either a “new tax” or an “increase in an existing tax,” thus requiring a two-thirds vote of both houses of the Legislature. [16]  Unless and until this issue is resolved in the courts, a taxpayer would be wise to seek legal counsel and consider its options before voluntarily paying tax on materials purchased for further processing into a byproduct.

__________________________________________________________

[1] La. R.S. 47:301(10)(c)(i)(aa), before amendment effective June 23, 2016; see La. Act No. 3 (2nd Extra. Sess. 2016) (“Act 3 of 2016”).

[2] Act 3 of 2016, supra.

[3] NISCO, pp. 8-9, 190 So.3d at 282.

[4] Id. at pp. 7-8, 190 So.3d at 281, quoting International Paper, Inc. v. Bridges, 2007-1151, p. 19 (La. 1/16/08), 972 So.2d 1121, 1134.

[5] Id. at pp. 5-6, 190 So.3d at 280-281.

[6] Id. at pp. 7-9, 190 So.3d at 281-282.

[7] Id. at pp. 9-10, 190 So.3d at 282-283.

[8] Id. at pp. 4, 10-13, 190 So.3d at 279, 283-285/

[9] Id. at pp. 13-15, 190 So.3d at 285-286.

[10] Act 3 of 2016, supra (emphasis added)

[11] Borel v. Young, 2007-0419, pp. 8-9 (La. 11/2/07), 989 So.2d 42, 48 (emphasis added).

[12] State v. Campbell, 2003-3035, pp. 8-9 (La. 7/6/04), 877 So.2d 112, 118.

[13] Merriam-Webster’s Collegiate Dictionary (11th ed. 2012) (emphasis added).

[14] See e.g. Mallard Bay Drilling, Inc. v. Kennedy, 2004-1089 (La. 6/29/05), 914 So.2d 533); Unwired Telecom Corp. v. Parish of Calcasieu, 2003-0732 (La. 1/19/05), 903 So.2d 392; and Bourgeois v. A.P. Green Indus., Inc., 2000-1528 (La. 4/3/01), 783 So.2d 1251; La. Const. Art. II, §§1-2; La. Const. art. I, §2; U.S. Const. Amend. XIV, §1.

[15] La. Const. Art. VII, §2.

[16] See e.g. Dow Hydrocarbons & Resources v. Kennedy, 1996-2471 (La. 5/20/97), 694 So.2d 215.

 

 

Amanda Wynn looks over historical court documetns that were rescued from the flooded basement of the Milwaukee County Historical Society Friday morning. Whynn, a curator at the Old World Third St. facility, staff and volunteers layed out wet records and artifacts that had been stored in the facilities basement. JOHN KLEIN/JKLEIN@JOURNALSENTINEL.COM

By Ben K. Jumonville

For several businesses in the Baton Rouge area, one of the many implications of the recent flooding is the loss of business records that are subject to retention requirements under various state and federal laws. In light of the destruction of many such records in the flood, a question arises as to the applicability of these retention requirements and the steps a business should take to maintain compliance with the law.

Under federal laws, businesses generally remain subject to their record-keeping obligations, but the IRS and the Department of Labor have provided some guidance in the past on how businesses who have lost records in a natural disaster can comply with the law.

With respect to records required to substantiate business losses and other tax deductions, the Internal Revenue Code addresses the loss of records due to circumstances beyond the taxpayer’s control. Specifically, Treasury Regulation § 1.274-5T provides that “[w]here the taxpayer establishes that the failure to produce adequate records is due to the loss of such records through circumstances beyond the taxpayer’s control, such as destruction by fire, flood, earthquake, or other casualty, the taxpayer shall have a right to substantiate a deduction by reasonable reconstruction of his expenditures or use.”

When claiming this exception, the taxpayer must be diligent about the reconstruction of records. Corroborating records or testimony regarding the specific expenses incurred is required, and a deduction will be denied if a business makes no attempt to recreate its destroyed records. Similarly, if the reconstruction is uncorroborated or perceived as unreliable, the deduction can be denied for lack of substantiation.

According to the Disaster Resource Guide published by the IRS, a business seeking to create a “reasonable reconstruction” of its lost business records should obtain copies of invoices from its suppliers, copies of bank statements, and copies of the last year’s federal, state and local tax returns, including payroll tax returns and business licenses, as these will reflect gross sales for a given time period.

In addition to reconstructing destroyed records, the Tax Court has indicated that it is necessary to document the extent of the destruction at the facility where the records were stored and the extent of the records that were lost. For instance, where the taxpayer did not provide evidence as to flood water damage at his record-keeping facility, the Tax Court denied the deduction, observing that it was not obligated to accept a taxpayer’s “unverified and self-serving testimony.” Darling v. C.I.R., 89 T.C.M. (CCH) 1334 (Tax 2005).

There is somewhat less guidance with respect to a business’s obligations to maintain records related to employees and employee benefit plans under applicable federal laws such as ERISA or COBRA. Generally speaking, these laws do not anticipate how to apply the record-keeping rules when a natural disaster occurs and records and businesses are destroyed.

Although there is no statutory guidance on the record-keeping requirements under these laws after a natural disaster, the Department of Labor has previously considered this issue in advisory opinions and in rules published in the Code of Federal Regulations. According to the DOL, the loss or destruction of records required to be maintained under ERISA does not discharge the business from its statutory duty to retain such records. 29 CFR Part 2520.

The DOL has also indicated that there is a general duty to reconstruct the records required to be retained under ERISA. That said, whether lost or destroyed records can, or should be, reconstructed and whether the persons responsible for the retention of records are, or should be, personally liable for the cost incurred in connection with the reconstruction of records is “necessarily dependent on the facts and circumstances of each case.” DOL Advisory Opinion 84-19A (April 26, 1984).

For instance, if reconstruction cannot be accomplished without excessive or unreasonable cost, a company would not be under a duty to reconstruct or attempt to reconstruct the lost or destroyed records. Further, if a company has access to other documents from which the lost or destroyed records could reconstructed and such other documents would be available to the company for the remainder of the requisite retention period, reconstruction of the destroyed records would not be required, provided that the company “make such agreements and arrangements necessary” to ensure that such other documents would remain available. DOL Advisory Opinion 84-19A (April 26, 1984).

In sum, if you or your business lost records in the flood which were subject to retention requirements, the best course of action is to undertake reasonable efforts that demonstrate good faith compliance with the law. Such steps include documenting the destruction done to the building in which your records were stored, the types of records that were kept prior to the flood, and the measures taken to remediate the problem. To the extent reasonable, make a good faith effort to reconstruct the lost records. Ultimately, if a business can show that it took the most reasonable and appropriate steps to comply with its record-keeping requirements, it may be able to persuade the IRS or other governmental authority to waive applicable sanctions.

For more helpful information on record reconstruction, the Disaster Resource Guide published by the IRS contains specific steps that individuals and businesses can take to reconstruct their records.