Ward on Iowa Limited Liability Company Law

Fooling with the Shareholder Franchise Could Invite Judicial Scrutiny

As you all know, loan agreements include financial and non-financial covenants imposed on the borrower.  Failure to maintain a covenant leads to an event of default.  A financial covenant might be maintaining a certain debt-to-equity ratio.  A non-financial covenant might be preventing a change in control of the board of directors.  Changing the make-up of a board of directors, is of course, the right of the shareholders.  When a board of directors agrees that such a change could trigger a default under a loan it may be impermissibly intruding on the shareholders' franchise.

Here is what Vice Chancellor Lamb had to say on the subject in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., 2009 WL 1337150 (May 12, 2009):

“This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. In the context of the negotiations of a debt instrument, this is particularly troubling, for two reasons. First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements. Second, the board, when negotiating with rights that belong first and foremost to stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders. This is never more true than when negotiating with debtholders, whose interests at times may be directly adverse to those of the stockholders. Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment.”

The case is on appeal.

-Marc Ward

8th Circuit Makes General Contractors their "Brother's Keeper"

On February 26, 2009, in Secretary of Labor v. Summit Contractors, Inc., 2009 U.S. App. LEXIS 3755, the United States Court of Appeals for the Eighth Circuit overturned the decision of the Occupational Safety and Health Review Commission (“OSHRC”) and held that a controlling employer can be cited for OSHA violations even when it did not create the hazard and none of its employees were even exposed to the hazard giving rise to the citation. 
 
Summit Contractors (Summit) was the general contractor for a construction project in Little Rock, Arkansas.  It subcontracted the entire project, and therefore had only 4 employees on the site:  a project superintendent and three assistant superintendents.  All Phase Construction (All Phase) was the subcontractor responsible for the exterior brick masonry work.  On two or three occasions Summit’s project superintendent observed All Phase employees operating without personal fall protection on scaffolds lacking guard rails.  The superintendent advised All Phase to correct the problems; however, when the All Phase employees moved the scaffold to another location, they would again work without fall protection and guardrails.  None of Summit’s employees were exposed to the hazard. 
 
An OSHA Compliance Safety and Health Officer observed All Phase employees working on scaffolds over ten feet above ground without fall protection or guardrails.  In addition to citing All Phase, the officer issued a citation to Summit, based on OSHA’s controlling employer citation policy.   That policy provides that OSHA may issue citations to general contractors at construction sites who have the ability to prevent or abate hazardous conditions created by subcontractors through the reasonable exercise of supervisory authority, regardless of whether the general contractor created the hazard or whether the general contractor’s own employees were exposed to the hazard.
 
The OSHRC had held that the multi-employer policy violated 29 C.F.R. §1910.12(a), which provides:
The standards prescribed in part 1926 of this chapter are adopted as occupational safety and health standards under section 6 of the Act and shall apply, according to the provisions thereof, to every employment and place of employment of every employee engaged in construction work.  Each employer shall protect the employment and places of employment of each of his employees engaged in construction work by complying with the appropriate standards prescribed in this paragraph.
 
The Eighth Circuit concluded that the plain language of the regulation does not preclude the Secretary of Labor’s controlling employer citation policy and therefore the Commission abused its discretion in determining that the controlling employer citation policy conflicted with § 1910.12(a). 
 
As the Eighth Circuit acknowledged, the controlling employer citation policy places an enormous responsibility on a general contractor to monitor all employees and all aspects of the worksite.   “Control” resulting to exposure to a citation under the policy can be established by contract, or by the exercise of control in practice.  Even in the absence of explicit contract provisions granting the right to control safety, or where the contract says the employer does not have such a right, an employer may still be found to be a controlling employer, based on a combination of contractual rights that give it broad responsibility at the site involving almost all aspects of the job.  Responsibilities of key significance in this analysis include the authority to resolve disputes between subcontractors and  set schedules and determine construction sequencing, because of the likelihood that these matters may affect safety. 
 
It is of small consolation that the standard OSHA will use to determine if the controlling employer exercised reasonable care to prevent and detect violations on the site is a lower one than that required of an employer with respect to protecting its own employees. How frequently and closely a controlling employer must inspect to meet its standard of reasonable care will depend upon the scale of the project, the nature and pace of the work, and how much the controlling employer knows about the safety history and practices of the employer it controls.  More frequent inspections are needed if the controlling employer knows that the other employer has a history of non-compliance, or, at the beginning of a project if the controlling employer has no knowledge of the other employer’s compliance history. 
 
Challenges to OSHA’s controlling employer citation policy can be expected to continue.  The two to one decision in Summit was a narrow one and it included a vigorous dissenting opinion.  The decision did not evaluate OSHA’s overall multi-employer citation policy and, although the issue was not raised by the parties, the Court suggested that OSHA may need to submit the policy to the informal rulemaking process for continued use in enforcement.  Nevertheless, at the present time, general contractors and construction managers must be vigilant in their supervision of the worksite to avoid liability for the safety infractions of other employers. 

-Joan Fletcher

jfletcher@dickinsonlaw.com

Walker, Ward and Nelson to Write Sample Forms

David Walker and I have been tapped to write sample forms for the Iowa State Bar Association's Business Law Manual.  Chris Nelson of the Belin law firm will also assist.  We expect to have the samples ready this Spring and include a form for the Statement of Authority.

Small Bank Tax Equity Act

Legislation that would permit state chartered banks to operate as LLCs has been introduced in Congress by Senators Orrin Hatch and Blanche Lincoln.  Many state laws, including Iowa's, and FDIC regulations allow banks to operate as LLCs, but IRS regulations require such entities to be taxed as corporations.  The Small Bank Tax Equity Act would change that.

The American Bankers Association and the Independent Community Bankers support the bill.

-Marc Ward

Major Disaster Leave Sharing Plans

The Internal Revenue Code provides that, except as otherwise provided by law, a tax is imposed on all income from whatever source derived.  Several years ago, the Internal Revenue Service determined that, under certain tightly-defined parameters, an employee who donated leave to a bank which was available for use by other employees with medical emergencies generally did not realize any income.  (In the normal course, the IRS would hold that this was no different than the employee getting cash for the leave and donating the cash, thus creating an income tax liability for the employee making the gift.)

Following the Hurricane Katrina catastrophe, the IRS established parameters under which an employer could establish a written major disaster leave-sharing plan.  Like the tax code generally, this type of plan entails some significant IRS-imposed requirements, including that it is available only for a “major disaster as declared by the President under § 401 of the Stafford Act, 42 U.S.C. § 5170, that warrants individual assistance or individual and public assistance from the federal government under that Act.”  In late May, President Bush issued a Stafford Act declaration with regard to certain storms, tornadoes and flooding in Iowa, and that declaration has been subsequently amended.  While many of our clients have established a “disaster leave-sharing program,” we are concerned that other businesses may not be aware of the possibility. 

The parameters established by the IRS for an acceptable plan (that is, one that will not result in income to the leave-donating employee) include that the donated leave may be used only by other employees who have been “adversely affected” (under the IRS standards, “if the disaster has caused severe hardship to the employee or a family member of the employee that requires the employee to be absent from work”) by the major disaster.  The IRS standards also require that the written plan have a “reasonable limit, based on the severity of the disaster, on the period of time after the major disaster occurs during which a leave donor may deposit the leave in the leave bank, and a leave recipient must use the leave received from the leave bank.” 

Following Hurricane Katrina, the IRS also put in place a program under which employees could make a tax-deductible contribution to certain charities by making a donation of “leave” through a program sponsored by an employer.  That program was specific to Hurricane Katrina, and has since lapsed.

If you have questions about creating or operating a "major disaster leave-sharing plan," a "medical emergency leave-sharing plan," or other arrangements whereby your employees may provide assistance, please contact the Dickinson attorney with whom you normally work or a member of the firm's Employment and Labor Law Practice Group at employmentlaw@dickinsonlaw.com.

Payroll Deposits and FDIC Insurance

This is a little off-topic, but important.  Many businesses pay their employees on Fridays.  The FDIC likes to close banks on Fridays. 

Payroll deposits are treated just like any other deposit for purposes of determining whether the deposits are insured by the FDIC.  So for instance if you have a $40,000 operating account at your bank, a $50,000 capital expenditures account, and a payroll account of $30,000, you have $20,000 at risk.

If you fund your payroll account on a periodic basis from other sources timed to meet the Friday payroll, you might be making a deposit at the same time the FDIC is about to close the bank.

The solution might be to start paying your employees on Wednesdays.

"One must be so careful these days."  (T.S. Eliot, The Wasteland)

-Marc Ward

Incorporation Transparency and Law Enforcement Act

US Senator Carl Levin, joined by Senators Coleman and Obama, introduced the Incorporation Transparency and Law Enforcement Act on May 1.  If enacted, the law will require every LLC and corporation in America to report annually to their state of organization or incorporation the names and other information about their owners.  The idea behind the bill is to provide civil and criminal law enforcement authorities with a data base to find those business entities "being misused to commit terrorism, money laundering, tax evasion, or other misconduct."  A lot of this information is already available to the IRS.

There will be exceptions for publicly traded corporations and business entities which a state "with the concurrence from the Homeland Security and Justice Departments" has decided "should be exempt because requiring beneficial information from them would not serve the public interest or assist law enforcement."   According to Senator Levin, "these exemptions are expected to be narrowly drafted and rarely granted."

Millions of small businesses will be burdened with the time and expense of this law, and pay the penalties for errors and forgetfulness, so the federal government can smoke out a few evil doers (as if they will comply with the law or not find a loophole in the first place.)

Wouldn't a much better solution be to identify those businesses or transactions most susceptible to abuse and require those members/shareholders to be revealed?  Financial institutions already have to identify their owners to regulators and those shareholders owning 10% or more must submit to background checks.  A narrowly written and less intrusive law should not be that difficult.

The Iowa Secretary of State already asks Iowa limited liability companies to voluntarily reveal their ownership in biennial reports even though neither the current Iowa LLC Act (Iowa Code 490A.131) or the new Iowa LLC Act require such information (similarly situated are corporations under Iowa Code 490.1622). 

-Marc Ward