Law Posts – Segal Coaching LLC

10 Essential Employment-Related Agreements

Starting a high-charging company or sorting out the employment landscape as a newly-landed executive? Here are 10 essential employment-related agreements you’ll want to be familiar with.

[Note: This post was written while I was a practicing attorney running a diverse solo law practice, and it is one of a small number of “legacy posts” that I have retained on the site. When published, this was one of my most popular posts. Since April 2015, I have been working as an executive coach and writer, and I am not currently available for legal engagements.]

1) Offer Letter. This is the initial offer of employment to a future employee. The letter should state the individual’s title, compensation, chief benefits (such as vacation time and 401(k)), intended start date and other basic facts. If the offer of employment is subject to certain conditions – generally they are – these should be outlined in the letter. These may include work authorization, background checks and drug screening, as well as (in some cases) agreement to be bound by certain contracts or employee handbooks. Generally an executive or other employee who receives an offer subject to a noncompete would be well-advised to ask for a copy of the agreement and read it, preferably with an attorney, prior to accepting the position. Note, however, that in certain jurisdictions a noncompete that is not presented prior to employment is not binding.

2) Employment Agreement. Although some companies use these indiscriminately, the most savvy among them save employment agreements for top employees who have the leverage to require them. Some employment agreements are rather basic documents that simply spell out the terms of the job. Others are complex, lengthy documents that include terms such as severance payments upon a termination with or without cause or change of control. All employment agreements should spell out the basic terms, such as duties, base and bonus compensation and length of guaranteed employment (if any) with relevant conditions attached. Employment agreements may also contain noncompete, non-solicit, confidentiality and other provisions, explained below.

3) Consulting Agreement. Consulting agreements are, as the name suggests, used to employ consultants on a long-term or temporary basis. At times, an individual may be an employee at one company and a consultant at an affiliated entity, and the consulting agreement serves to document the additional relationship and any related compensation. A consulting agreement should clearly spell out the services to be rendered, how they shall be delivered, what fees shall be paid and on what basis (e.g., hourly or monthly, upon receipt of an invoice or other time period) and the manner that the consulting arrangement can be terminated by either party. The agreement should also contain language that the consultant cannot bind the company, that he or she is an independent contractor responsible for deductions and taxes and similar provisions.

Businesses should consider carefully whether an individual taken on as a “consultant” or other “independent contractor” would not likely be recharacterized as an “employee”, as the financial penalties of failing to pay employment taxes and other consequences can be substantial. This is especially true if the business intends to operate solely through independent contractors and essentially treats them as employees (controlling scheduling, requiring services to be delivered on-site and other employment aspects).

4) Noncompete. Non-competition agreements or provisions are restrictive covenants that prohibit an employee from engaging in a competing activity. Their effectiveness depends on many factors, including the law of the controlling jurisdiction. In jurisdictions that tend to uphold noncompetes, whether as written or as modified (reduced in scope) by the court, two main factors are the length of the restriction and the geographic scope. Of all employment-related agreements, noncompetes can be the most complex and restrictive. Therefore, they are the most important to read and understand before signing.

Note: I do not give the above guidance lightly, as I have occasionally seen highly-educated, highly-paid individuals simply sign noncompetes and other restrictive covenants without even reading them. Not a smart thing to do, especially in this economy!

5) Non-solicitation. Non-solicit provisions – these are usually part of a larger agreement – restrict an executive or other employee from recruiting or hiring individuals from a current employer on behalf of a third party. They can also restrict other forms of “solicitation”, such as soliciting customers, investors or business opportunities. Since non-solicitation provisions do not “restrain employment” they can be easier to enforce in the courts than non-competition clauses.

6) Confidentiality. A confidentiality agreement is designed to keep non-public information from entering into the public domain. Generally there is no term or end date on the time period that the information needs to be kept confidential, as long as it has not become public (generally or known within the relevant industry) through no fault of the person receiving the confidential information. This is especially true in the case of trade secrets, which by their nature must remain confidential to retain their value.

7) Work for Hire and Assignment of Inventions. Intellectual property, such as copyrights, generally belong to the employer absent a special agreement to the contrary. This is not true in certain contexts where the creation is entirely unrelated to an individual’s work assignment (e.g., if an engineer in charge of quality control wrote a Broadway play in his or her spare time.) For independent contractors (ICs), work for hire and assignment provisions should be in place to delineate who owns any non-tangible property that the IC has created for a company. In some cases, the parties should draft carve outs for intellectual property (from copyrights to trading algorithms) that were created by an employee or consultant prior to employment if such individual wishes (with the company’s agreement) to retain as his or her property and license it for use, rather than transfer it, to the company with which he or she is employed or engaged. Provisions that assign ownership of any or certain intellectual property or inventions (i.e., assignment of inventions provisions) often accompany work for hire provisions, as a backstop to assure the rights of a company that expects work for hire provisions to uphold its ownership.

8) Indemnification. In the employment context, an indemnification agreement is offered to a key individual who may be exposed to liability under his or her fiduciary duties or for other reasons. A company should offer a broad indemnity as well as insurance to the individual to induce him or her to take on a role of responsibility. There are relatively standard provisions that should accompany all indemnities, although the language used to express them may vary, and these should be carefully drafted and/or reviewed.

9) Severance. In the case of top executives, severance terms may be agreed in advance at the time of employment or upon a promotion. For other employees, they may be extended upon termination. Severance agreements include, among other provisions, the amount of severance offered in lieu of the contracted notice period, any extension of benefits, a noncompete (if applicable) and a release.

10) Release. A company may ask for a release of all potential claims by an employee against the company in exchange for consideration offered. The consideration must be in addition to whatever money or property the employee was already entitled, and the amount will vary based on factors such as the employee’s regular compensation when employed. An employee should read a release agreement with care to ensure that he or she is not releasing claims that have already vested in the employee or would vest upon termination, such as vested stock that was part of a benefits package.

There is an additional document – not an “agreement” per se – that is often critical in the employment relationship. This is the employee handbook.

From an employer’s standpoint, once a small handful of employees is hired it is helpful to start putting company policies in place. At some point, based on size and other factors, an employee handbook is a veritable necessity. It should be acknowledged in writing by all employees upon employment and again upon each significant revision (or at least annually). From an employee’s standpoint, it is important to know that although a handbook is not an individual contract between each employer and employee, employees are bound by its terms.

This short summary obviously does not cover all of the nuances of the above agreements.

Nothing posted on this site constitutes legal advice or forms an attorney-client relationship. You should consult your attorney to discuss the facts of your situation. This is a public forum. Please do not post confidential information.

Quick Trademark Tip: Basic Searches for a Trademark on TESS

From time to time, potential clients call me with the idea of registering a trademark, and I ask them if they have first looked on TESS (the Trademark Electronic Search System). Some have never even heard of TESS. This post is a brief introduction.

TESS is the first stop for a trademark search, and to save yourself time and aggravation, you can check TESS before contacting a lawyer. This is also called a “knockout” search, since you can knock out names that would clearly present an issue if you tried to register your mark. If there is a clear conflict (i.e., likelihood of confusion) between your proposed mark and a registered mark, there is no reason to pursue the issue further. Back to the drawing board!

More specifically, TESS is the search engine to access the the U.S. Patent and Trademark Office (USPTO) database of registered and pending marks. You can start at www.uspto.gov, an easy entry point to remember, then click on >> trademarks. There you will find How-To Videos, FAQs and other information, as well as TESS and other links.

Once you have opened TESS, you have three search options. For new users, it is often helpful to use the basic word search. If you type in a word, you will pull up records that include that word. You will not, however, pull up other words that may sound the same but have a slightly different spelling. For example, you won’t find KOOL KIDS (two words) if searching for KOOLKIDS (one word). It’s a good idea to search for your mark in as many common variations as you can reasonably imagine.

In a simple TESS search, you also may not access all of the marks that could cause refusal of your registration on likelihood of confusion on other grounds. In other words, a TESS search is a first step to help you avoid some trees as you begin to predict whether a path can be cleared for your mark. After that, there are professional search firms that can help you along with a comprehensive search, which may be the next step in the process, in addition to trademark lawyers who can help you (if needed) interpret the results and (if advisable) continue to registration.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation. This is a public forum. Please do not post confidential or fact-specific information regarding your legal questions on this site.

Section 83(b) Election for StartUp Founders

So they don’t get hit with a tax crunch that could be entirely avoided with timely planning, founders of U.S. startups should be aware of Section 83(b) of the Internal Revenue Code. Here’s a post about what Section 83(b) does, when it should be elected and why it is important.

Corporate founders generally enter restricted stock purchase agreements that provide for their stock to vest over a number of years. Under a vesting schedule, the company has the right to repurchase any unvested stock at cost upon the founder’s separation from the company. The right to repurchase generally lasts for a period of three to five years, provided that the founder continues to provide services to the company.

One common arrangement is a four-year vesting period with a one-year cliff. In this case, at the end of the first year a founder would receive 1/4 of the shares, and the remaining 3/4 vest monthly in equal portions over the remaining 36 months. However, founders can mix and match such grants to reflect each founder’s relative investment in and importance to the organization.

Whether it is a “four year with one year cliff” arrangement or another milestone or time-based vesting trigger, restricted stock keeps the founders engaged and involved, since they do not acquire certain rights in the stock, such as the right to sell, until the stock vests. As a result of such vesting restrictions, the IRS views the acquisition of the stock for tax purposes as the date it is released from the restrictions.

No/Minimal Tax Upon Purchase; Tax Upon Vesting

In a typical startup, the founder purchases “cheap stock” at a low fair market value, which minimizes taxes at stock issuance. A common pre-money valuation is, for example, five million shares at $0.001 per share (one tenth of a penny), with the founders contributing a total of $5,000.00 for the shares issued to them. This assumes that there is no need for a significant cash investment to fund operations.

Founders/employees then earn their equity over time in exchange for their longevity with and services to the company. When the stock is released from restrictions (i.e., becomes fully vested), there is a taxable event. At this point, if the company is successful, the value of company stock on a post-money valuation may have significantly increased. For example, those five million shares may later be worth $1.00 per share, for a total fair market value of $5,000,000.00. If the founders’ equity contributions were diluted by, for example, a Series A preferred stock round of $4,000,000.00, the total increase in value to the founders’ shares would be $995,000.00 (i.e., the then-current $1,000,000.00 value of the founders’ stock less their $5,000.00 initial investment).

If the founders’ restricted shares all vest as of a single $5,000,000.00 vesting date in the example above, taxes would be owed collectively by the founders on the full amount of $995,000.00. Of course, if the shares vest over time, the valuation of the company will fluctuate over time, resulting in an accounting headache. In either case, it is a potential tax nightmare. This may be true even if transfer restrictions (other than vesting) or market forces dictate that the founder cannot liquidate his or her shares.

What is an 83(b) Election?

To know what purpose Section 83(b) serves, you first need to understand Section 83(a) of the tax code. Under 83(a), if an individual receives property in exchange for services, he or she pays tax on the excess of the fair market value of the property over the purchase price. This makes sense in the context of a consultant, for example, who may be wholly or partially compensated in kind (i.e., other than cash) by means of a stock grant or discounted purchase price.

A founder who has to earn his or her shares over time is also treated by the IRS as a service provider under 83(a). In other words, if the ownership of the shares must be forfeited when the founder’s relationship to the startup terminates, the IRS views the shares as having been granted in exchange for services.

Section 83(a) does not impose an immediate tax. Instead, such grants of restricted shares are only taxed when they are no longer subject to “a substantial risk of forfeiture”.

Under 83(b), a special, one-time irrevocable tax election may be filed within 30 calendar days (with no exceptions) of the date of the initial stock grant with respect to shares that have a substantial risk of forfeiture. The founder or other service provider thereby elects to pay tax (if any) upfront on the difference between the fair market value at issuance and the purchase price. This difference, often called the “spread”, is usually at or close to zero.

Note that 83(b) elections are not applicable to stock grants that are unrestricted or in those special cases where the company has the right to buy back a founder’s shares at fair market value (rather than the purchase price).

In the absence of an 83(b) election for restricted stock, a founder is liable for taxes on the increase of any vested stock – the difference between the purchase price and the fair market value on the vesting date. If shares vest over a number of months, this means there is a taxable event in each month that shares vest, tied to the fair market value as of the vesting date. This is true even if the shareholder continues to hold the shares. In addition, the holding period for long term capital gains does not begin until the shares are vested.

By contrast, with an 83(b) election in place, the founder incurs no taxable income as the shares vest over time. Only capital gains tax (on the gain) would be payable upon sale, with a holding period commencing on the date of the stock issuance.

83(b) Not For Everyone in All Situations

Elections under Section 83(b) do not benefit all holders of restricted stock. For example, an employee in a mature startup may be issued restricted stock at a steeply discounted price and will likely not want to take an immediate tax hit on the spread between the market value of the stock and the discounted price paid. If the company then fails, a substantial tax was then paid for no actual benefit. Second, there are tax complications that can arise if some of the founders contribute property (such as IP) in addition to cash.

Timing of an 83(b) Election

83(b) elections must be made in the 30-day time period following the stock grant. The election should be mailed via certified mail to the IRS Service Center where an individual normally files his or her tax returns. There are a number of formalities that need to be followed, including reporting the election on an end-of-year return, that are outside the scope of this blog post.

Founders or others holding restricted stock should consult a tax advisor or business attorney to fully understand the pros and cons of unvested stock and the 83(b) election as well as the procedures for making one.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here or updated to the law that are relevant to your situation.

Five Scary Legal Blowups You Can Avoid in Your Business

It’s Halloween. Kids get scared by monsters and spooky Jack O’Lanterns. Adults may relive pent-up fears from the rest of the year or (hopefully) get a playful reprieve.

Here are five scary legal blowups you can avoid in your business by careful, timely planning. Start tomorrow, after resting up from the Tricks and Treats.

1) You have an unstable or otherwise difficult business partner and do not have proper agreements. This seems like an obvious point, but unfortunately it is often overlooked. Document your rights and obligations with your business partners before disputes arise. If you visit Avvo.com or one of the other sites at which “real people” can post questions anonymously to attorneys, a topic you will see over and over again is how to dissolve a business relationship in which there are no legal agreements governing the relationship of the parties. A little investment upfront to work out what happens in a dispute will not only save you stress if there’s a meltdown or bombshell, or your business partner suddenly disappears or dies (which does happen), but it also will contribute to amicable relations in the good times.

2) You don’t know what your lease says. I am continuously surprised at how many friends and clients come to me with questions like – can I get out of my lease early without penalty? how do I do it? Your lease may be one of your biggest expenditures as a business. You should know what it says before you sign it, and you should write it down in a memo (or at least handwritten notes) that you file with the lease, so you remember later what it says. This goes for all big ticket contracts, in fact. Know not only how much they cost to stay in, but how much it would cost you to get out of them if needed.

5) Your address is wrong with the Secretary of State or contract counterparties and you do not receive notice of fines or litigation. If you do not update your address, you will not be notified, and this is to your detriment. Fines and penalties can pile up, and if you do not receive notice of a litigation a default judgment can be entered against you without your knowledge or ability to defend yourself. Have an individual in your organization (and a backup) who is charged with reviewing key matters if your contact information changes temporarily or permanently.

4) You do not have a federal registration for your trademark or service mark, and someone applies for it first. If you have already invested considerable time in creating and advertising your business name and are operating in multiple states, or you have a serious intent to do so, it is worth the small investment to hire an attorney and, if he or she advises, file a federal trademark application. In the long run, it is more economical – and causes less headaches and heartaches – to either (1) have your registration completed first, without the need to try to cancel a competitor’s application on grounds that you are the prior, senior user, or (2) know before expending even further time and funds in a mark that registration may not be available. (See my prior post about choosing a mark and make sure that, if your attorney advises, you complete a trademark search as well.)

5) You have “independent contractors” on the books who are really employees. Businesses often hire individuals as independent contractors or consultants without considering the serious downside if they are reclassified as employees. Take a look at the Department of Labor’s press releases about employee misclassification for some of the enforcement activity in this area. There is no single standard to distinguish between employee or independent contractor (e.g., click here re: the FLSA or here for the NY DOL). What is clear is that simply calling someone a consultant does not mean he or she is not an employee. And the penalties can haunt you longer than any ghost on Halloween.

Law Office of Anne Marie Segal is located in Stamford, Connecticut, provides legal counsel to businesses and individuals in Connecticut and New York and advises select national and international clients. Please visit www.amscounsel.com for more information.

A Tangled Web: State Charitable Solicitations Laws

Non-profits that operate or intend to fundraise in multiple states need to familiarize themselves with the tangled web of state charitable solicitations laws. While none of these laws is particularly complicated on its own, sorting through the web is quite a task. Regulators in various states have brought enforcement actions against charities that are not in compliance with the laws, and in some cases the penalties can be steep.

In some cases an ounce of prevention is worth a pound of cure, as the old saying goes. Executive Directors and Boards should make judicious decisions about how and where to fundraise with full knowledge of these laws, so that they can eliminate (or at least mitigate) their risk of running afoul of them.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation.

Becoming a Corporation: How to Transition from “Me” to “the Company”

[Note: This post was written while I was a practicing attorney running a solo law practice. Since April 2015, I have been working with attorney, executive and entrepreneur clients as a career coach and writer, and I am not currently available for legal engagements.]

A client of mine recently received her filing receipt evidencing incorporation in the State of New York. Her astute next question was “now what?” She had been carrying on business in her own name and wanted to know how to begin conducting her activities as a corporation.

She was asking, in other words, “how do I transition from me to the Company?”

This is a great question. I am sure that, by knowing to ask it, this client is off to a great start. One of the most important features of a corporation is that is generally offers limited liability, so corporate protocol must be followed to make sure the corporate structure is respected. This is often called “i’s” dotted and “t’s” crossed. In practice it means, among other things, that:

– company and individual activities are kept separate (especially in cases where money is involved),

– the company’s board of directors (“Board”) and officers do what is expected of them (and each individual role is respected), and

– the company follows the direction of the Board and Chief Executive Officer or, as this title may be designated at a nonprofit entity, Executive Director.

Here are some of the important, initial steps you will need to take. There may be others in your home state and for your particular entity and activities, but these are generally universal:

1) If you were the sole incorporator and have not yet elected a Board or have until now filled all roles, you will need to elect your Board. It is generally preferable to have at least five Board members, although you can start with a smaller Board and expand if you only have a small core group of dedicated directors at the beginning. Choosing your Board is one of the most important decisions of a young organization. You should give careful consideration to who will best advance the organizations’s goals and take their roles and duties seriously.

Electing the Board – or expanding the Board – is done at an organizational Board meeting and recorded in the minutes of the meeting. Alternatively, Board members can be elected by unanimous written consent of the Board.

2) The Board, in its organizational meeting or via written consent, will also elect officers of the corporation. Core officer roles are generally President, Secretary and Treasurer. A Vice President is also commonly elected to serve as an alternate to the President. In some states, these roles can all be filled by one individual, although generally that is not recommended to avoid potential conflicts of interest and provide for good corporate governance.

3) If you have already undertaken activities in your individual name or as an incorporator – such as incorporate or make some initial payments to third parties – it may be that the Board needs to review and ratify your prior actions. For example, the Board would ratify and approve the incorporator(s)’ act of forming the corporation.

If your prior activity has been substantial, it is possible that that only certain activities should be ratified, and this may depend on the nature of the activity and ongoing relationships. At the same time, if there are contracts in your individual name that should now belong to the company, these may need to be assigned to the corporation or terminated. It can get complicated if there has been substantial activity or in certain circumstances, so if you have any doubt, speak with a business attorney about how to sort this out.

4) The Board should also authorize other important actions to be undertaken by officers of the corporation, such as applying for an Employer Identification Number (EIN) and opening a bank account. (Note that the IRS now allows a company to apply for its EIN online. Click here.)

5) The newly-formed corporation should also draft and adopt bylaws, which the Secretary of the corporation will insert into the minute book along with the Certificate of Incorporation, all board resolutions and other important corporate documents. I suggest to my clients that they keep an electronic copy of all documents as well as paper copies, even if the laws of their home state allow for only electronic versions. In the digital database, care should be taken to name files in an identifiable manner and to keep the documents secure. The contents of the bylaws should reflect what the corporation will actually do – not simply be copied from a form – and it is a best practice to have a copy at Board meetings to which the directors can refer if needed.

6) State and local tax law matters and registrations need to be addressed.

7) The corporation should put basic policies in place, such as a conflict of interest, whistleblower and document-destruction policies. Over time as the company grows, these policies may be worked into an employee handbook.

8) The corporation should hire an accountant or bookkeeper – or designate someone with expertise from within its ranks – to keep track of revenues and expenses as well as tax and other deadlines.

The above steps provide an overview of certain important first steps for a new corporation. Depending on the nature of the organization, there may be other important steps to consider, but as a minimum these steps should be followed. As discussed above, these are not simply “formalities” but rather will allow for effective governance of a corporation and go a long way toward preserving limited liability for its directors and officers.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation.

Never, Ever Unstaple a Will (And Did I Mention Never, Ever?)

Who would have thought that a small and simple object that (can draw blood if squeezed into a finger but otherwise) appears relatively harmless could blow your entire estate plan?

The common staple remover. An enemy of well-drafted last will and testaments and well-made estate plans nationwide.

Here’s what I tell my clients:

Never, ever unstaple a will. Never, ever, ever. And did I mention never, ever? Don’t do it!

To drive home the point with a memorable comparison, I even have joked with some clients on occasion that unstapling a will is like having an affair. (I only say this when I am pretty well assured the joke will be properly received.) You can try to put it – i.e., the marriage or the will – back together again, but it will never go back exactly the same as it was before. There are always some holes that cannot be filled and some room for distrust that it is difficult to overcome.

There are always some holes that cannot be filled and
some room for distrust that it is difficult to overcome.

Unstapling a will can call the entire document into question. Was a page added or removed? Is it a complete and properly ordered copy? Even if the pages are numbered and initialed, how can we (sometimes many years later) be sure that no one did an artful yet fraudulent switch of parts of the document he/she did not like?

It is such a serious issue that, if a will is to be proven in probate court as the correct, complete and valid original last will and testament, there is a process of submitting an affidavit by the person who unstapled the will, discussing the reason for the unstapling, when and how it happened, and by whom. The court is understandably concerned that there was no foul play involved, and wills with multiple staple holes are regarded with suspicion.

So what should you do instead, if you need a copy of your will?

If you need a copy of your will, you should make a copy of a copy, not of the original. Or you can make a copy of the original without unstapling it, making sure that you do not damage any of the pages in the process. It’s not a good idea to have too many copies of your will floating around in any case, since you may wish to change it later and do not want someone with an older copy trying to challenge the later will. If you have any doubts, contact your local estate planning attorney before taking action that can have serious legal consequences to one of the most important documents in your legal life.

So let’s not forget. I repeat: Never, ever unstaple your will! Never, ever!

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship.

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