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of the work we perform for our clients.
Selected Business Law Updates April 24, 2023
In brief: most non-compete agreements are unlawful in the District of Columbia, and may soon become unlawful nationwide by action of the Federal Trade Commission; D.C. has significantly expanded its human rights laws; and the financial crimes agency FinCEN has adopted a nationwide rule that would require small businesses to file reports identifying their owners in an effort to thwart money-laundering – the rule, however, is already being challenged in court by a small business organization. I also want to note a legal trend in wage transparency, and offer a reminder about privacy policies for customer PII.
1. The U.S. Federal Trade Commission on April 23, 2024 adopted a rule declaring most non-compete clauses in employment to be unlawful. The rule was struck down by the Northern District of Texas in the case Ryan LLC v. FTC. Observers expect the Commission to appeal, and the appeal deadline is approaching. (Updated Oct. 13, 2024.)
2. The District of Columbia has already enacted a law severely limiting the use of non-compete clauses in employment. That law took effect on October 1, 2022. Section 32-581.03a of the law requires employers to provide disclosures to employees if its policies include the exceptions to the definition of a non-compete provision, either within 30 days after October 1, 2022, or whenever the employer changes its policy. Employers are also required to provide a specific notice to its highly compensated employees (those earning more than $150,000 per year, or medical specialists who earn more than $250,000 per year, as follows: “The District’s Ban on Non-Compete Agreements Amendment Act of 2020 limits the use of non-compete agreements. It allows employers to request non-compete agreements from highly compensated employees, as that term is defined in the Ban on Non-Compete Agreements Amendment Act of 2020, under certain conditions. [Name of employer] has determined that you are a highly compensated employee. For more information about the Ban on Non-Compete Agreements Amendment Act of 2020, contact the District of Columbia Department of Employment Services (DOES).”.
3. Human Rights in D.C. The District of Columbia has passed an amendment to the D.C. Human Rights Act to expand the universe of workers protected under the Act, as well as codify workplace harassment as an unlawful discriminatory practice. First, the amendment expands the Act's definition of a protected "employee" to now also include individuals "working or seeking work as an independent contractor" as well as unpaid interns. However, the amendment states that an independent contractor for purposes of the Act "does not mean a service vendor who provides a discrete service to an individual customer." Next, the amendment adds "homeless status" to the Act's list of protected classes in employment, as well as with regard to public accommodation, housing and other purposes. The amendment also clarifies that workplace harassment based on any protected characteristic is unlawful.
4. A new FinCEN regulation would create a minor reporting requirement for most small businesses. It is not due to take effect until the beginning of 2024, and even then, existing businesses would have until January 1, 2025 to file their first report as the regulation now stands. The regulation is FinCEN's Beneficial Ownership Information Reporting regulation, adopted under a 2021 law called the Corporate Transparency Act (part of the Bank Secrecy Act). Its goal is to root out money launderers by identifying the "beneficial owners" of most small corporations, LLCs, and other businesses in the U.S. that are formed by filing papers with a state agency. As such, the regulation should not apply to sole proprietors or partnerships by agreement (those not formed by a state registration); similarly, it will not apply to tax exempt (non-profit) entities, accounting firms, or certain other regulated entities. It does not appear that the regulation will require a periodic report - only an initial report, and then a supplemental report whenever a change in ownership is made. We do not yet know what form the report will take. Here is a link to some additional information: https://www.fincen.gov/beneficial-ownership-information-reporting
5. New laws in California, Washington and New York City, and an apparent trend nationwide, to require covered employers to disclose wage ranges in job advertisements (or even to their current employees). Section 32-1452 of D.C.’s labor code is a wage transparency law giving employees the right to discuss wages with their coworkers.
Online Contracts - Best Practices (part 4) June 5, 2018
May a person offering to make a contract require the use of digital signatures, or even the use of a specific digital signature platform such as DocuSign? It is axiomatic that the offeror is "master of his offer," and would seem that an offeror is entitled to require that an acceptance be in the form of a DocuSign digital signature. After all, is it not the case that an offeror may say, "I will contract with you for X, Y and Z, but in order to accept this offer, you must tap the words ' I accept ' in Morse code while standing on your head and playing the LP version (not an mp3) of The Mothers of Invention's album Weasels Ripped My Flesh" ?
It is elementary that "An offer may invite or require acceptance to be made by an affirmative answer in words, or by performing or refraining from performing a specified act, or may empower the offeree to make a selection of terms in his acceptance," but "unless otherwise indicated by the language or the circumstances, an offer invites acceptance in any manner and by any medium reasonable in the circumstances." Rest. 2d Contracts §30. In short, as the Restatement declares, "The offeror is the master of his offer." Accord Flack v. Laster, 417 A.2d 393 (D.C. 1980).
The comments to the Restatement address a more conventional signature requirement, signing on the proverbial "dotted line," and explain that an offer requiring acceptance by signing on the dotted line may not be accepted by telegram. The Supreme Court in 1819 described the rule eloquently in Eliason v. Henshaw: "It is an undeniable principle of the law of contracts, that an offer of a bargain, by one person, to another, imposes no obligation upon the former until it is accepted by the latter, according to the terms in which the offer was made. Any qualification of, or departure from, those terms, invalidates the offer, unless the same be agreed to, by the person who made it. Until the terms of the agreement have received the assent of the parties, the negociation is open, and imposes no obligation on either." Eliason v. Henshaw, 17 U.S. 225, 4 L. Ed. 556 (1819). In that ancient case, no contract was formed when an offer to purchase flour, specifying that an answer was to be delivered at Harper's Ferry, was met with a letter agreeing to the terms, actually delivered to the offeror, but in Georgetown instead of Harpers Ferry.
The manner of signing as a necessary incident of acceptance has been addressed in various decisions. In Beard Implement Co. v. Krusa, 208 Ill.App.3d 953 (1991), a purchase order by a farm equipment dealer did not mature into a contract when, despite the requirement that it was "subject to acceptance by dealer," but was never signed by the dealer. Id., 954. Even though the defendant signed the purchase order and there was evidence presented at trial that he stated "I'll take the deal," the court held "that the purchase order . . . 'unambiguously' required the signature by plaintiff's 'dealer' in order to be a proper acceptance of defendant's offer. Because plaintiff's 'dealer' never signed the purchase order, no contract ever existed." In Kroeze v. Chloride Group, Ltd., 572 F.2d 1099 (5th Cir 1978), the offeror expressly, unambiguously, and unequivocally required that the Transmittal Letter be signed in order to be a proper acceptance of the offer. The delivery of an acceptance with a typed "signature" was held insufficient.
In addressing whether an offeror may require a signature with specific characteristics, such as a digital signature, or one executed on a specified computer platform such as DocuSign, digital signature legislation is of little help. The Federal ESIGN Act, for example, requires that digital signatures be recognized in commerce, with certain exceptions, but says nothing of an offeror's ability to require a digital signature. The Uniform Electronic Transactions Act, a uniform law published in 1999 by the National Conference of Commissioners on Uniform State Laws, and adopted in 47 states and the District of Columbia, "does not require a record or signature to be created, generated, sent, communicated, received, stored, or otherwise processed or used by electronic means or in electronic form." UETA §5(a).
The ESIGN Act defines "electronic signature" as "an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record." 15 U.S.C. §7006(5). State laws have adopted this definition (e.g., New York Electronic Signatures and Records Act, NYCLS, State Technology Law §302).
Nor does the ESIGN Act "require any person to agree to use or accept electronic records or electronic signatures, other than a governmental agency with respect to a record other than a contract to which it is a party." 15 U.S.C. §7001(b)(2).
The master-of-his-offer doctrine entered into a debate within the Washington Supreme Court in an early decision analyzing a shrink-wrap license under traditional contract formation principles. In M.A. Mortenson Co. v. Timberline Software Corp., 140 Wn. 2d 568 (2000) the question was presented whether boxed software accompanied by a shrink-wrap license was already the subject of a contract at the time the buyer received notice of the license, and thus, whether the license, with its shrink-wrap mode of acceptance, was only an offer to modify the existing contract. The majority held that the terms of the license were part of the contract between M.A. Mortenson and Timberline, as the product of a "layered" contracting process, similar to those described in Brower v. Gateway 2000, Inc., 246 A.D.2d 246, 250-51, 676 N.Y.S.2d 569 (1998), Hill v. Gateway 2000, Inc., 105 F.3d 1147 (7th Cir.), cert. denied, 522 U.S. 808, 118 S. Ct. 47, 139 L. Ed. 2d 13 (1997), and ProCD, Inc. v. Zeidenberg, 86 F.3d 1447 (7th Cir. 1996). In each of these cases, a buyer received software accompanied by a shrink-wrap license, which notified the buyer (before opening the software packaging) that he/she had the right to return the product if unwilling to accept the license terms.
The debate between the majority and dissent in M.A. Mortenson focused essentially on whether a contract was formed by an initial exchange of offer and acceptance to a set of material terms, rendering the delivery of a software box bearing a shrink-wrap license a proposal to modify the contract. The dissent (by Justice Richard "Don't-Hold-Back" Sanders) minced no words in accusing the majority of according "blind deference to software manufacturers' preferred method of conducting business." The dissent argued persuasively (although apparently not so as to persuade the majority) that an offer, acceptance, payment, shipment of goods, and receipt by the buyer appeared to be a completed contract for the sale of goods - an unremarkable proposition. According to Justice Sanders, when the buyer received the goods for which he had contracted and paid, there was a contract, and the shrink-wrap terms constituted an offer to modify which the buyer was not bound to accept.
The majority reasoned that the contracting process was "layered," and that the contract was not fully formed until the buyer saw the shrink-wrap license, affirmatively waived the right to return the merchandise for a full refund, and ripped into the box. It is difficult to reconcile the majority's approach with the accepted view that a contract can be formed by a sufficiently clear exchange of promises. One way might be to advert to common knowledge about software boxes; such an approach would require imputing to every buyer of software an expectation that when the product is delivered, it will be accompanied by additional material terms, because that is how software is often packaged. This analysis is fundamentally unsatisfying. In our practice, for example, we have represented a seller of custom software to academic end users, and it was clear throughout each negotiation that the licenses were no less a material term than any other, and would not under any circumstances have been presented after delivery of the product on a take-or-leave basis.
Applying M.A. Mortenson to the digital signature question, imagine a seller ("S") sends a buyer ("B") a written offer to contract for X, Y and Z (being all of the material terms of the contract); B communicates acceptance in a timely and reasonable way; and S then transmits the identical offer electronically, but in a DocuSign "envelope," insisting that S will not consider the contract formed until the DocuSign process is complete. (It is not the writer's intent to single out DocuSign; the issues noted could arise with any digital signature platform.) One might reason that this is S's prerogative, and not without good reason. S, after all, may have an internal document management system that depends on using a consistent digital signature platform, or may have been injured in the past by a party denying the authenticity of a signature, or by a party who turned out to be a forger - all understandable concerns. On the other hand, digital signature platforms are not without pitfalls. First, they may require degree of technical sophistication to use them effectively. Because of technical difficulties, a party may not be able to provide a digital signature in time, or at all. And the various purposes for which a signature or initials might be solicited by the digital platform are not always clear and not always the same: a signature can indicate the adoption of a writing as a legal act, or that a writing has been received or read, or that it has been read and agreed to in full, or only in part. See, e.g., Morey v. Chambers, 2006 Mass. Super. LEXIS 216, *6 (2006) (a party may be presumed to have read a document at the time he signed it); R.C. Durr Co. v. Bennett Industries, Inc., 590 S.W.2d 338, 339-340 (Ky. App. 1979) (a Kentucky statute required a signature to be affixed at or near the end of a document because "a signature so placed raises the logical inference that the document expresses all which the signer desires to authenticate and to which he intends to be bound," while "a signature in the middle of a writing gives no such assurance and gives no indication of an intent to be bound by matters which do not appear above the signature"). Even so, less than perfectly conforming signatures have been held to be valid and binding. See, e.g., Guardian v. Gentry, 219 Ky. 569, 293 S.W. 1094 (1927) (signature below the acknowledgment to a deed held valid); Lucas v. Brown, 187 Ky. 502, 219 S.W. 796 (1920) (signature under the attestation clause of a will upheld). Finally, for a thorough (if tedious) exposition of the confusion that digital signing can create, see Bardstown Capital Corp. v. Nationstar Mortg., LLC, NO. 2016-CA-000280-MR, 2017 Ky. App. Unpub. LEXIS 807 (November 3, 2017). (For that matter, why do so many signature problems crop up in Kentucky?)
The reasoning in M.A. Mortenson may not provide a clear answer to the question of insistence on a digital signature. A buyer ("B") may have received an offer and communicated acceptance in a clear, reasonable and timely way. The Mortenson dissent would argue that such a buyer has done all that is necessary to form a contract. The majority, with its "layered" contracting process, might insist that when B received the subsequent communication requiring execution through the Docu-Sign platform, B was still at liberty to walk away, and therefore, that the contract formation process was still in flux. In the context of signing of formal written agreements, however, this approach would suggest that a fully executory agreement might never mature into an enforceable contract so long as a party were able to say "uh, there's just one more thing. . ." It may also cast into doubt the integrity of the integrated written agreement, as several courts have observed.
Moreover, the manner of execution of an agreement should never be considered a material or essential term of the contract, and thus, like other formalities, should fall within the category of methods of acceptance. In other words, the manner of execution is not analogous to a shrink-wrap license as a lesser term of the contract which could be supplied later in a "layered" contracting process as described in M.A. Mortenson.
The concept of a "signature" has been defined throughout the history of the law, almost invariably, with reference to the intent, the practices, and the acts, of the signer, not his/her contracting counterpart. See, e.g., Salt Lake City v. Hanson, 19 Utah 2d 32, 425 P.2d 773 (1967) ("it is the intent rather than the form of the act that is important," and "while one's signature is usually made by writing his name, the same purpose can be accomplished by placing any writing, indicia or symbol which the signer chooses to adopt and use as his signature and by which it may be proved, e.g., by finger or thumb prints, by a cross or other mark, or by any type of mechanically reproduced or stamped facsimile of his signature, as effectively as by his own handwriting"); Ohio Rev. C. §3501.011 (" 'sign' or 'signature' means that person’s written, cursive-style legal mark written in that person’s own hand," except "for persons who do not use a cursive-style legal mark during the course of their regular business and legal affairs, 'sign' or 'signature' means that person’s other legal mark that the person uses during the course of that person’s regular business and legal affairs that is written in the person’s own hand"); Borish v. Graham, 655 A.2d 831, 835-836 (Del. Ct. 1994) ("any symbol executed or adopted by a party with present intention to authenticate a writing," citing 6 Del. C. § 1-201(39)). The fact that a signature is in pencil does not invalidate it, Myers v. Vanderbelt, 84 Pa. 510, 513, nor the pasting of a signature from a prior document. Wells Will, 1965 Pa. Dist. & Cnty. Dec. LEXIS 59, *4 (1965). Black's Law Dictionary, cited in various jurisdictions, defines "signature" as "the act of putting down a man's name at the end of an instrument to attest its validity [and] the name thus written." The definition continues, "A 'signature' may be written by hand, printed, stamped, typewritten, engraved, photographed or cut from one instrument and attached to another, and a signature lithographed on an instrument by a party is sufficient for the purpose of signing it; it being immaterial with what kind of instrument a signature is made."
It seems worth repeating: "It is immaterial with what kind of instrument a signature is made."
If an offering party desires to do business only with persons who will execute agreements on the DocuSign platform, the best practice would be to specify DocuSign as the sole method of acceptance when making the initial offer, for example, by indicating that the product is available only through a digital process, or that inquiries and acceptances will not be accepted by postal mail, courier, or fax. Buyers should be aware of the various ways in which acceptance may be required in the digital world, and should clarify in the beginning of a contracting process what form of acceptance, and agreement, will be acceptable to the seller.
Online Contracts - Best Practices (part 3) February 23, 2018
Meyer v. Uber Techs., Inc., 868 F.3d 66 (2nd Cir. 2017) remains the leading federal case on enforceability of click- and browse-wrap agreements. In Meyer, the federal appeals court in New York held that an agreement created using the Uber contracting interface was enforceable, applying California law (with a statistically better chance of affirmance than its sister court located in California). The court held that the site provided reasonable notice to "a reasonably prudent smartphone user" that a contract would be formed. The court essentially recognized a presumption (rebuttable, we trust) that the customer was not a first-time smartphone user. In evaluating the clarity of notice that an agreement would be formed by clicking or browsing activity, the court considered such attributes as:
- An uncluttered payment screen (containing only fields for the user to credit card details, to register for an account, or to connect digital wallets to the account);
- A clear warning to the user that he or she would be deemed to agree to the terms of service and privacy policy by creating an account;
- Close proximity of hyperlinks to the terms and conditions, and privacy policy;
- A compact screen, visible at once, requiring minimal scrolling; and,
- Contrasting fonts and backgrounds; and distinct hyperlinks.
We recently encountered a merchant who was attempting to use a conventional written agreement, rendered in PDF format, purporting to require a digital signature using the "DocuSign" platform. While not technically an online contract, a document proffered by e-mail through a digital signature platform can give rise to a similar set of issues. In this instance, there was an unexplained failure to connect with DocuSign, and a number of hours were lost attempting to manually sign the agreement, only to learn that the merchant would accept nothing but a DocuSign signature. Neither of the primary digital signature laws (Uniform Electronic Transaction Act of 1999, federal ESIGN Act of 2000) requires the use of an intermediary like DocuSign. Identical language in these laws provides only that signatures and contracts may not be denied legal effect, validity, or enforceability solely because they are in electronic form. See 15 U.S.C. §7001. Section 9(a) of the UETA also provides that an electronic record or electronic signature is attributable to a person if it was the act of the person, a fact which "may be shown in any manner, including a showing of the efficacy of any security procedure applied to determine the person to which the electronic record or electronic signature was attributable." Another important aspect of the UETA is the requirement that a record of the transaction be capable of being printed or stored by the non-proffering party, a requirement cannot varied or waived unless another provision of law permits it.
DocuSign, has been the subject of relatively little litigation in the years since digital signature legislation was first enacted. Perhaps this is a testament to its efficacy and broad acceptance, but the need for vigilance in the use of such platforms remains, as illustrated by the case ADHY Invs. Props. LLC v. Garrison Lifestyle Pierce Hill LLC, 41 Misc. 3d 1211(A), 980 N.Y.S.2d 274 (2013). The case recounts the efforts of a party to disavow execution of a contract that was signed by his colleague, in his name, using the DocuSign platform. An evidentiary hearing was required to establish the fact of contract execution. The court considered evidence ranging from general, at best, to extremely vague. Surely a central goal of electronic transaction legislation, as with the use of signed, written agreements in general, is elimination of the need for evidentiary hearings to establish contract formation. A case like ADHY may suggest the need for a higher quality of proof from those who wish to enforce contracts, or stronger legal presumptions of validity in the use of electronic document signing platforms. At least, however, it demonstrates that the acceptance of digital signature technology has not eliminated protracted litigation over contract formation.
Another question raised by the practices of this DocuSign-captive merchant is whether the means of affixing a signature to a written contract has any significance under the law of contracts, given the permissive, rather than mandatory, operation of the electronic transaction laws. We will address this question in the coming weeks.
Online Contracts - Best Practices (Part 2) November 22, 2017
If online contracts are important to your business or activities in any way - if performance could have material consequences for you, financial or otherwise - you should understand the terms to which you and the online provider are agreeing, and be prepared to prove the terms of the agreement to which you assented in the same way that documents are entered in evidence generally.
Portions of a website can be authenticated for admission in evidence pursuant to Federal Rules 901(a) and 902(5) by including the web address from which they are printed and the date of printing. See EEOC v. DuPont (E.D. La. Oct. 18, 2004). The party authenticating is required to demonstrate what was actually on the Web site, that the exhibit accurately reflects it, and that it is it attributable to the owner of the site. See Lorraine v. Markel Am. Ins. Co., 241 F.R.D. 534, 555 (D. Md. 2007), citing Gregory P. Joseph, Internet and Email Evidence, in Trial Evidence in the Federal Courts: Problems and Solutions 559, 562 (ALI-ABA Course of Study, Feb. 28-29, 2008). Normally, this would be done through precise oral testimony with a proper foundation.
Web content changes frequently, and genuine confusion over the true content of an online contract is likely. In the Facebook advertising litigation in 2011-12, for instance, the court characterized Facebook's online advertising contract as an example of such confusion (it is "not clear exactly what comprises the contract") and described the composition of the contract as "a moving target." In re Facebook, Inc., PPC Adver. Litig., 282 F.R.D. 446 (N.D. Cal. 2012). The court found that a "Click Agreement," a "Place Order" button, and the Statement of Rights and Responsibilities ("SRR") may form part of the contract, but that a "Glossary of Ad Terms" appearing on a "Help Center" page, although published by Facebook in relation to the contract, was not.
While courts may interpret internet contracts strictly against the drafting party, see Harold H. Huggins Realty, Inc. v. FNC, Inc., 575 F. Supp. 2d 696 (D. Md. 2008), that will not always save the day. In the Facebook advertising litigation, Facebook's periodic revision of its online advertising contract had unexpected consequences for the aggrieved parties: the confusion created by Facebook's own actions stymied the plaintiffs' attempt to certify a class. The Facebook litigation involved the terms of an online contract for advertising, and how to determine whether the advertiser was required to pay for certain "clicks" by internet users. One plaintiff had accepted Facebook's Advertising Terms and Conditions (the "ATCs") which provided, "Facebook will determine, in its sole discretion, how to measure the number of impressions, inquiries, conversions, clicks, or other actions taken by third parties in connection with my advertisements, and all charges will be based on such measurements," while others contracting at different times had agreed, "You will pay for your Orders in accordance with our Payment Terms. . . The amount you owe will be calculated based on our tracking mechanisms. . ." and that Facebook was "not responsible for click fraud or other improper actions that affect the cost of running ads." These seemingly minor variations in contract terms were held to prevent a finding that the claims of would-be class representatives were typical, as required for class certification.
Waiting until a dispute materializes to capture and print a web based contract can have adverse consequences. In the event of litigation, each party can be expected to be asked for the documents they contend make up the agreement, in discovery, during settlement negotiations, on summary judgment, and at trial. For the non-drafting party, the ability to produce copies of the pages making up the web-based agreement may be important to achieving a positive outcome. Without a comprehensive copy of the agreement as it existed on the day of contracting, the non-drafting party will be at the mercy of the drafting party, who will control the evidence of the agreement in discovery, settlement negotiations, and at trial. If printed too long after the relevant date (for instance, after a dispute has arisen), there may be foundational problems with testimony that purports to equate the web pages with the pages as they existed at the time of contracting. Fed.R.Evid. Rule 901(a) (the proponent must produce evidence sufficient to support a finding that the item is what the proponent claims it is). Years after the fact, it is difficult to imagine a witness testifying to the precise content of multiple pages of a website on a given day. Thus, exclusion of the proffered copy for lack of foundation or authentication (or relevance) would not be surprising.
At a minimum, the unprepared litigant will be at the mercy of third parties who may have archived the website where the agreement was found, such as the Internet Archive and "Wayback Machine." This is risky, as one author has observed, because the Internet Archive collects snapshots of web pages through its own web crawler (similar to the process used by Google, web crawlers systematically visit websites to extract and store content) and the crawlers of a collaborator, Alexa Internet, Inc.; not all sites are captured, but captures are prioritized based on the frequency with which sites are searched. See Eltgroth, D., Note: Best Evidence and the Wayback Machine, 78 Fordham L. Rev. 181 (2009). Beware the Internet Archive's "Save Page Now" feature, which ostensibly allows a user to capture a web page as it appears at a given point in time "for use as a trusted citation in the future," so long as the website allows crawlers. It does not appear that Save Page Now will crawl more than the discrete page within a site entered by the user.
An amendment to Fed.R.Evid. Rule 902 (Evidence That Is Self-Authenticating) will take effect next week (December 1, 2017), to add certain computer generated records to the list of items for which the process of authentication is relaxed. Thus, when the drafting party offers the online contract into evidence at trial, there may be no authenticating witness present who can be cross examined about the certainty that the exhibit constitutes the contract as it existed when consummated, or about variations in the terms that the other party recalls.
In the absence of reliable software that will capture all pages making up a web based contract, there is no substitute for the painstaking process of visiting and capturing each page that appears to be part of the contract, or incorporated in it.
Online Contracts - Best Practices August 12, 2017
Businesses that must manage numerous, complex agreements are familiar with contract management software, or should be. A valuable introduction to these products is the article, The Best Contract Management Software of 2017, by Ken Contrata, writing for PC Magazine. "At its most basic, contract management often centers on four key functions: Contracts must be stored, key provisions must be tracked, a system must exist to find a contract based upon specific criteria, and information contained within or implicated by the contracts must be understandable or reportable." PC Magazine, The Best Contract Management Software of 2017, July 19, 2017 (https://www.pcmag.com/article2/0,2817,2489199,00.asp [viewed August 8, 2017]). This article reviewed a sampling, from among hundreds of contract management systems, ranging in price from $59 to over $20,000 (per year).
At the higher end of the price spectrum was software by Gimmal LLC, offering features such as "greater efficiency at every stage of the contract lifecycle," "stay[ing] on top of autorenewals and tak[ing] advantage of incentives," "centralized storage and tracking," transparency and collaboration, and other accessibility and search features. https://www.gimmal.com/contract-management/ [viewed August 8, 2017])
It is unclear, however, that any of these programs, from Gimmal on down, provides a fundamental service needed by anyone who enters into contracts online: identifying and storing the documents that make up the contract. It is becoming increasingly difficult to identify the writings that make up an integrated contract. In the case of online agreements, parties are usually confronted with screens of varying sizes and design, often including embedded content, links, apps, APIs, and similar elements. The Second Circuit recently noted, perhaps as a matter of law (or judicial notice), that "a reasonably prudent smartphone user knows that text that is highlighted in blue and underlined is hyperlinked to another webpage where additional information will be found." See Meyer v. Uber (16‐2750‐cv) (August 17, 2017).
We begin our examination of this problem with a few words of basic advice. First, while a court may save you from contract terms that are consequential, and were difficult to identify at the time of contracting, it is important to at least attempt to identify the essential terms of any agreement, including one consummated online. Second, the party proffering the contract will undoubtedly retain an electronic record of the terms offered, and will be prepared to prove those terms in court (or more likely, in arbitration). However, the drafting party may not accurately record the terms exactly as they appeared when you communicated your assent. By retaining a record of what you viewed and assented to, by printing (or saving to PDF) all of the relevant terms you can locate, you may prevail in a dispute over the meaning or applicability of a term. Third, you should be prepared to prove the terms of the agreement to which you assented in the same way that documentary evidence is authenticated generally.
In the coming weeks we will say more about each of these issues, about the importance of the subject in general, and about better management and performance of contracts (with or without expensive software).
Jurisdictional Tri-fecta June 19, 2017
The Supreme Court has held that the due process doctrine of specific jurisdiction limits a state's ability to exercise jurisdiction over a party with ample contacts within the state if the cause of a plaintiff's injury was not connected to actions in the state, in Bristol-Myers Squibb Company v. Superior Court Of California, San Francisco County (No. 16-466). This decision rounds out the Court's move this term to restrict plaintiffs' forum choices. The fact that Bristol-Myers contracted in California for the nationwide distribution of the allegedly harmful drug was not only held to be an insufficient contract, but Justice Alito, writing for the majority, described this argument as a "last-ditch effort" by the plaintiffs to save their choice of forum. It is significant that the Court left open the possibility that a federal court might properly exercise jurisdiction under Fifth Amendment principles even when the state court across the street could not do so. The decision also acknowledges that plaintiffs from different states may join in a single (or consolidated) action in the courts of a state that has general jurisdiction over the defendant (in this case, Delaware or New York, where the defendant was incorporated and headquartered, respectively).
Trademark Act's "Disparagement Clause" Held Unconstitutional June 20, 2017
The Supreme Court has invalidated a well known obstacle to federal trademark registration, the "disparagement clause" of 15 U. S. C. §1052(a). Matal v. Tam, 582 U. S. ____ (2017) ("The Slants" case). Even under the relaxed standard for evaluating restrictions on commercial speech (that is serve “a substantial interest,” and be “narrowly drawn”) the disparagement clause could not survive. Not reaching the question whether the government has an interest in protecting underrepresented groups from objectionable speech, or promoting the flow of commerce by eliminating the friction threatened by discriminatory trademarks, the Court held that the disparagement clause is not narrowly drawn to achieve these ends. The very formulation that might have saved the clause by not burdening particular viewpoints was its downfall. Justice Alito reasoned that the clause would apply to trademarks like “Down with racists,” “Down with sexists,” “Down with homophobes” - in other words, trademarks that disparage the discriminatory viewpoints of persons or groups. For this reason, in the words of the Court, the clause was in reality a "happy-talk" clause. And by implication, the federal government does not have a substantial interest in promoting "happy talk." The full opinion can be viewed at https://www.supremecourt.gov/opinions/16pdf/15-1293_1o13.pdf .
Waiting for the Other (International) Shoe to Drop June 9, 2017
A notable part of the Supreme Court's agenda this term has been restricting plaintiffs' forum choices. To date, the Court has restricted the choice of forum in patent disputes, TC Heartland LLC v. Kraft Foods Group Brands LLC (No. 16-341), and for railroad injuries, BNSF Railway Co. v. Tyrell (No. 16-405). Still to be decided is Bristol-Myers Squibb Company v. Superior Court Of California, San Francisco County (No. 16-466), argued April 25, 2017, in which Bristol-Myers Squibb contends that despite its far-reaching activities in California involving the drug "Plavix," which plaintiffs claimed was the cause of their injuries, California courts nonetheless lacked specific jurisdiction over the claims of nonresidents who attempted to join their claims with those of California residents. There is no question that Bristol-Myers Squibb has more than sufficient contacts with California to make the exercise of general jurisdiction fair, and thus constitutional. The issue is whether those courts may exercise specific jurisdiction - that is, jurisdiction over the controversy. Were Bristol-Myers to prevail, the result would be that plaintiffs residing in 33 different states would be required, as a matter of federal constitutional law, to pursue their claims in the courts of their respective states. One might question why Bristol-Myers would prefer exposure to 33 different proceedings (or some other large number) potentially requiring the employment of many more lawyers and potentially resulting in conflicting rulings of law or fact. The likely answer is that if there is any forum shopping to be done, Bristol-Myers wants to be the one doing it. A defendant litigating in 33 different courts has the ability to choose which cases to try and which to settle, to push some cases and attempt to delay others, and to downplay the magnitude of the harm. In short, Bristol-Myers would prefer to divide and conquer. Notably, Justice Gorsuch asked whether there were considerations of "federalism," that is, whether states had an interest in deciding disputes irrespective of where their citizens chose to sue. Most clues from the oral argument, however, suggest that the Court views the desired outcome of Bristol-Myers as too radical, and as antithetical to the goal of efficiency, for example, through multi-district litigation, consolidation, and streamlining procedures. On the other hand, a Bristo-Myers victory could be seen as consistent with the Court's recent trend of restricting the fora available to plaintiffs regardless of defendants' extensive, regular and systematic contacts with a number of jurisdictions. We should have an answer before the end of the term.
Star Athletica: an Important Decision for Makers of Artsy Products March 23, 2017
The Supreme Court held Wednesday (6-2) that copyright protection extends to a feature incorporated into the design of a "useful article" if two tests are satisfied: it must be possible to perceive the feature as a work of art separate from the useful article (in two- or three-dimensions), and the feature must qualify as a protectable work (pictorial, graphic, or sculptural) either on its own or fixed in some other tangible medium of expression. Star Athletica, L.L.C. v. Varsity Brands, Inc., et al., No. 15–866 (March 22, 2017).
The litigants are sellers of cheerleading uniforms. Varsity Brands sued Star Athletica for infringing their copyrights in five designs, all of which are described as fairly unexceptional ornamentation of the kind often found on athletic clothing (mainly stripes and chevrons). The District Court had ruled against Varsity on the ground that the designs themselves were useful, or "utilitarian," in that they identified the garments as "cheerleading uniforms." This was certainly an unsatisfying conclusion, in that chevrons and stripes can at least identify uniforms of different kinds (a Marine Corps drill sergeant could conceivably be considered a "cheerleader" of a kind, but we would hesitate to suggest it). The Court of Appeals for the Sixth Circuit reversed the District Court, 799 F. 3d 468, 471 (2015), holding that, in its view, one could tell that the garment in question was a cheerleading uniform even if the designs were removed (could this be the sort of abstract thinking that differentiates the appellate bench from their counterparts on the trial court?)
The Supreme Court affirmed, but based on an analysis that did not depend on an evaluation of the utility of the useful article sans design features. Justice Thomas began the analysis with Section 101 of the Copyright Act, which requires a separability analysis for any “pictorial, graphic, or sculptural features” incorporated into the “design of a useful article.” Finding that “design” refers here to “the combination” of “details” or “features” that “go to make up” the useful article, based on an Oxford English Dictionary definition, and that such features could include pictoral or sculptural elements, he reasoned that such features could be separable if they would have been eligible for copyright protection if originally fixed in some tangible medium other than a useful article (say, a cheerleading uniform).
The analysis is the same whether the non-functional features were created first as a work of art or as a component of the useful article. Mazer v. Stein, 347 U. S. 201, 214 (1954). And assuming that our Supreme Court should be deciding disputes over the making of cheerleading uniforms, the decision then gets creepy in a hurry, encouraging "imaginatively removing the surface decorations from the uniforms and applying them in another medium would not replicate the uniform itself."
Justice Breyer argued in dissent that the designs are not separable because "imaginatively removing them from the uniforms and placing them in some other medium of expression—a canvas, for example—would create “pictures of cheerleader uniforms.” We are confident that the Justice has no actual experience making pictures of cheerleading uniforms.
The dispute proved a serviceable vehicle for several additional precepts. First, an artistic feature that would be eligible for copyright protection on its own cannot lose that protection simply because it was first created as a feature of the design of a useful article, even if it makes that article more useful. Next, there can be no "distinction between 'physical' and 'conceptual' separability," meaning essentially that one may remove artistic features from a cheerleading uniform mentally as well as by physical or mechanical means. Finally, the Court rejected any notion that the intent of the designer was relevant to the analysis ("as reflecting the designer’s artistic judgment exercised independently of functional influence"), nor would the marketability of the artwork be relevant.
One can only imagine the drudgery that the Court was required to endure while waiting for the cert. petition in a case like this one.
Private "Statutes" of Limitations July 14, 2016
Contracts are often used to limit liability, to varying degrees of success. It could be said that a continuum exists from contractual terms that specify performance, moving to the allocation of rights and responsibilities, to limitation of liability, to limitation of remedy, and finally to limiting the very process by which a remedy may be pursued. Pre-dispute agreements to arbitrate are now a well-accepted example of the latter, and are enshrined in federal commercial law in a way that seems (to some) wholly at odds with any notion of federalism and state judicial remedies or contract law.
Another less common means of limiting contracting parties' access to legal processes is the contractual modification of the applicable statute of limitations. By this means, contracting parties, most often those with superior bargaining power, are able to impose shorter statutes of limitations on their contracting counterparts. "[I]n the absence of a controlling statute to the contrary, a provision in a contract may validly limit, between the parties, the time for bringing an action on such contract to a period less than that prescribed in the general statute of limitations, provided that the shorter period itself shall be a reasonable period. Order of United Commercial Travelers v. Wolfe, 331 U.S. 586 (1947). "Such shorter periods, written into private contracts, also have been held to be entitled to the constitutional protection of the Fourteenth Amendment under appropriate circumstances." Id.
A recent California case, Ellis v. U.S. Security Associates, 224 Cal. App. 4th 1213 (1st Dist. 2014) described the legal and policy considerations. Statutes of limitations “come into the law not through the judicial process but through legislation," and represent "a public policy about the privilege to litigate." The policies underlying such statutes are to give defendants reasonable repose, thereby protecting parties from defending stale claims, to stimulate plaintiffs to pursue their claims diligently, and to promote disposition of cases on the merits rather than on procedural grounds.
But it was South Dakota, not California, that took the lead in giving meaning to these policies. Order of United Commercial Travelers involved a South Dakota statute that anticipated this very problem from a very early date in the 20th Century. South Dakota law was nothing if not progressive, at least in its aim to preserve judicial remedies. One statute provided that "Every stipulation or condition in a contract, by which any party thereto is restricted from enforcing his rights under the contract by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void." S.D. Rev. Code §897 (1919). The statute was revised in the South Dakota Code of 1939 (§10.0705) to provide, "Every provision in a contract restricting a party from enforcing his rights under it by usual legal proceedings in ordinary tribunals or limiting his time to do so, is void." A similar provision remains in force today, as South Dakota Codified Laws Anno. §53-9-6, except that the statute now acknowledges the validity of pre-dispute agreements to arbitrate, as the Federal Arbitration Act and the supremacy clause requires it must. The modern statute is unique in that it sets a minimum limitation period for an action on a contract at two years. In a contract under South Dakota law, the party in whose interest it would be to cut off liability cannot impose anything short of a generous limitations period - two years - on the initiation of a legal action to enforce contractual rights.
Mississippi is another state with unexpectedly progressive laws in this area. Miss. Code § 15-1-5 provides "The limitations prescribed in this chapter shall not be changed in any way whatsoever by contract between parties, and any change in such limitations made by any contracts stipulation whatsoever shall be absolutely null and void, the object of this section being to make the period of limitations for the various causes of action the same for all litigants." Covenant Health Rehab of Picayune, L.P. v. Brown, 949 So. 2d 732 (Miss. 2007).
Most states do not have statutes comparable to these. There, freedom of contract within reasonable limits is the rule. See, e.g., Parilla v. IAP Worldwide Servs. VI, Inc., 368 F.3d 269 (3d Cir. 2004) (holding a thirty day limitation period unconscionable); Wilkins v. Hartford Life & Accident Ins. Co., 299 F.3d 945, 948-49 (8th Cir. 2002) (barring suit based upon three-year contractual limitations period that would have expired even if statute were tolled during plan's consideration of claim); Soltani v. Western & Southern Life Ins. Co., 258 F.3d 1038, 1042-47 (9th Cir. 2001) (upholding a six-month limitation provision, but striking down a 10-day contractual notice of suit requirement as unconscionable); Taylor v. Western & Southern Life Ins. Co., 966 F.2d 1188 (7th Cir. 1992) (six month limitation period held reasonable, even in the employment context, because there was credible evidence that the parties against whom the clause operated were aware of its inclusion and understood it); White v. Sun Life Assur. Co., 488 F.3d 240 (4th Cir. 2007) ("We could not agree more that ERISA generally affords plans the flexibility to set limitations periods" citing a decision of the 11th Circuit upholding Northlake Reg'l Med. Ctr. v. Waffle House Sys. Employee Benefit Plan, 160 F.3d 1301, 1302-04 (11th Cir. 1998) (enforcing ninety-day limitations period that did not begin to run until denial of claim). The Fourth Circuit was concerned mainly with the "lack of fair notice" of the limitation, something that would pose a significant problem when administering a broad and detailed employee benefit scheme under ERISA.
Some lessons that may be drawn from these varying approaches are that courts are concerned with the fairness, notice and reasonable length of contractual limitations periods, and that unlike in the area of agreements to arbitrate, there cannot yet be a national one-size-fits-all approach to contractual provisions of this kind.
Trademark and trademark substitutes February 23, 2016
We have had interesting discussions with colleagues recently about whether to seek trademark registration in specific circumstances. Trademark is a right that exists under state law, with a federal law overlay providing for registration, publication, and enhanced remedies. There are many requirements for establishing an enforceable trademark and registering it with the U.S. Patent and Trademark Office. Most of these requirements also make sense from a business perspective. One of the first questions to ask, and one that is not often asked, is what you hope to accomplish by adopting a trademark, and the related question, to what extent you are willing to expend money and time to maintain it. A sound and enforceable trademark is very likely important to your business strategy, especially if you have plans for growth and/or an ultimate sale to an acquirer. An online article by Forbes magazine reported the estimated value of Google's trademark alone at $113 billion (not googol yet, but a lot).
A trademark must be distinctive, that is, different from the trademarks of your competitors, should not be descriptive (although it can be), and cannot be generic. Adopting a fanciful trademark - one that does not explicitly describe or suggest your goods or services - is widely regarded as important. It is important for the obvious reasons that it is more likely to be available, and to stick in the mind of your customers and potential customers, It is also important for the less obvious reasons that it is more likely to be granted registration by the PTO without limitations, and that it will be easier to "police," that is, to identify in searches for potential infringing, diluting, or generic uses.
There are other regimes for protecting commercial names, including corporate registration, state trade name registration, adoption of a URL, enforcing rights of personality and publicity, registration with a labor or trade organization, or copyright. Each has advantages, disadvantages, and limitations, as does federal trademark registration. For example, the federal trademark requirement that a name or mark be used in connection with the offering goods or services in commerce does not apply to personality and publicity rights, to the adoption of a corporate name, or to copyright. A trademark cannot be registered if it is the "name, portrait, or signature identifying a particular living individual" - so dead people are fair game - while many states recognize personality and publicity rights that would prevent the appropriation of the name or likeness of a person after death. 15 U.S.C. §1052(c). The identity of a president cannot be registered as a trademark during the life of his widow (perhaps this should be updated to include "her widower," and soon) except by the widow's written consent of the widow (notice that a president apparently loses the right that most of us possess to control the use of his/her name or likeness after death, at least for a time).
When thinking about a new business venture, it is not difficult to perform preliminary trademark searches on the website of the PTO. Internet searches using Google search, or other search engines (for as long as they may exist), can also be useful to identify marks in use, and also potential marks in the form of URLs (always bearing in mind the important distinction between trademark registration, and adoption of a URL). Unless you are a professional in the field, relying on your own informal searches as a basis for adoption of a mark is not advised.
The Corporate Veil: Taking Stock February 11, 2016
"Piercing the corporate veil," that is, removing the protection of limited liability which shareholders normally enjoy, is not a rule of law, or a collection of rules of law, so much as it is a metaphor for the desire to do justice in the face of a key principle - perhaps the bedrock principle - of our capitalist system. The principle is limited liability for corporate shareholders. We will say more of this later, but for now, we observe that no one who purchases 100 shares of General Electric expects to be held personally liable for the liabilities or obligations of that enormous company, and this principle is considered by many to be fundamental to raising the capital that gives our economic system its name.
We know the "corporate veil" is a metaphor because no less a luminary than Benjamin Cardozo, in 1926, wrote: "The whole problem of the relation between parent and subsidiary corporations is one that is still enveloped in the mists of metaphor." Berkey v. Third A. R. Co., 244 N.Y. 84 (N.Y. 1926). Presumably, the metaphors to which the justice was referring are "piercing the corporate veil," the "alter ego" doctrine, "looking behind" the corporation, "setting aside" the corporate form, and the like. However, even a casual review of cases in this area reveals that even seemingly technical concepts like undercapitalization also lurk in the mists. For this posting we have undertaken only a casual review, because whether, and when, to "pierce the corporate veil" has been called the most heavily litigated issue in corporate law. Most likely, this is because it is litigated not in the context of a corporate dispute, but in tort actions in which a corporation is found to be un- or under-insured, and otherwise unable to respond in damages for injuries to others. There are a lot of decisions on various aspects of the issue, but sadly, precious little principled analysis.
Thus, to call the resulting hodgepodge of legal and equitable theories a "doctrine," "principle" or "rule of law" dignifies it undeservedly. Our casual review of the case law, and some scholarly commentary, reveals that the metaphors are driven not by any fundamental rules about corporate existence, but by the motivation to compensate injured persons, including tort victims and other creditors, to redress wrongs that lie somewhere between actual fraud and unfairness, or to punish the greed or grandiosity of a dominating shareholder.
Leaving aside fraud, which is absent from the vast majority of tort cases in which the veil is pierced, inadequate capitalization is a leading element in the application of the veil-piercing remedy. Whether this means capitalization at the time of formation, or at the time of the injury or other transaction, or at all times and for all purposes, has been the subject of a long and vigorous debate. Compare De Witt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co., 540 F.2d 681 (4th Cir. 1976) (capital inadequate because it dwindled over time), and J-R Grain Co. v. FAC, Inc., 627 F.2d 129, 135 (8th Cir. 1980) (inadequate capitalization measured at the time of formation). Not long ago, a Virginia Circuit held that undercapitalization, combined with failing to follow corporate formalities, furnished a sufficient basis for piercing the corporate veil. ACE Electric Co. Inc. v. Advance Technologies, Inc., et al. (Civil Case No. CL09-971) (April 29, 2011). In that case, the corporation entered into a "major" contract (resulting in a judgment of liability against the corporation of roughly $140,000) with "only $10,000-$15,000 in the bank and owing back taxes. . ." In the view of that court, the corporation was "grossly undercapitalized," viewed not as of the time of its founding, but at the time it entered into the contract in issue. In an earlier Massachusetts case, by contrast, the court credited the corporation's capital with loans from its shareholders, and held that initial capitalization that was 25% of the value of the corporation's projects was not "too thin." George Hyman Constr. Co. v. Gateman, 16 F. Supp. 2d 129 (D. Mass. 1998).
Some first principles can be perceived through these mists of metaphor. (While we're on the subject of metaphors, "mists" seems altogether too gentle, the state of the case law being more in the nature of a morass.) Consider these: (1) issue stock, (2) sell it for money or something of real value, and (3) raise capital in some proportion to a reasonable, written plan for the expected activities of the corporation. By issuing stock, you will have taken a major step toward capitalization, and also the observance of corporate formalities, because it has been held to be both. Besides these, it is essential to adopt the simplest of corporate formalities, procedures for corporate operations and decision-making, and to follow them. Finally, I propose what I will call a new "Warren Buffet rule" for operating the corporation - evaluate any corporate action by asking "if my corporation were purchased by Warren Buffet, would it nonetheless engage in this transaction, because it is good for the corporation, or at least consistent with the reason the corporation exists?"
Corporate bylaws: necessary, useful, or just a nuisance? February 5, 2016
An element of a finding that a corporation is a "sham," or the "alter ego" of its shareholders, is a failure to observe corporate formalities. While the lack of bylaws has been listed by courts along with numerous other more serious failures to observe corporate formalities, it alone has never been held to support setting aside the corporate entity to impose liability on shareholders. Some corporation codes (North Dakota and Minnesota) have expressly made bylaws optional. Others are equivocal, suggesting that bylaws "shall" be adopted at the initial organizational meeting, but then imposing no specific requirements for the form or content of the bylaws, and authorizing the shareholders to repeal them. Thus, while bylaws have their place in larger corporations in which effective governance may require a well developed set of rules, it is doubtful that they are necessary, or even useful. But how often do the shareholders of small corporations consult their bylaws to ensure that they are in compliance as they carry on the regular business of the corporation? A compelling argument can be made that bylaws do nothing more than to create pitfalls for the owners of a corporation to be caught failing to follow their own operating procedures. For most small corporations, the need for bylaws, and the mischief they can cause, could be obviated by two simple default rules: for giving notice of necessary shareholders' and directors' meetings, and for voting at such meetings. Corporation codes lacking these rules should be amended to include them. If you choose to adopt and maintain corporate bylaws, keep them simple, consult them regularly, and comply.
Consultant's book is not commercial speech for purposes of a Lanham Act Claim, December 2, 2015
The Lanham Act protects competitors from a variety of unfair methods of competition, including "passing off." In simplest terms, this occurs when a firm dresses its product up as that of another, hoping to make sales based on the good will of the other firm. It is counterfeiting, in a sense.
In Keel v. Axelrod, (E.D. Pa. No. 15-1507), Frank Keel sued fellow political strategist David Axelrod over a passage in his recently published memoir, Believer: My Forty Years in Politics. Keel alleged that Axelrod used the book to market his services as a political strategist, and that Keel "a single passage of Axelrod's 488-page book Believer violates the Lanham Act, essentially by passing off Keel's work as Axelrod's.
Keel asserted that Axelrod "falsely took credit for political consulting services that Keel provided," giving Axelrod an unfair "reputational" advantage.
The Lanham Act, at 15 U.S.C. 1125(a), provides "Any person who, on or in connection with any goods or services, or any container for goods, uses in commerce any word, term, name, symbol, or device, or any combination thereof, or any false designation of origin, false or misleading description of fact, or false or misleading representation of fact, which . . . is likely to cause confusion, or to cause mistake, or to deceive as to the affiliation, connection, or association of such person with another person, or [11] as to the origin, sponsorship, or approval of his or her goods, services, or commercial activities by another person . . . shall be liable in a civil action by any person who believes that he or she is or is likely to be damaged by such act." The District Court followed the majority rule that a Lanham Act claim under Section 1125 requires that the speech at issue be commercial, citing Farah v. Esquire Magazine, 736 F.3d 528, 541 (D.C. Cir. 2013) and the cases collected in that opinion.
There is no question that books are published and promoted today for commercial purposes beyond just the publishing revenues and author royalties for which their creators hope. People in the consulting fields undoubtedly use books and other materials they author to market their expertise and talent. But the District Court recognized a line between the use of a book as an ancillary tool to support marketing efforts, and "a direct solicitation of services to specific clients." The Court noted that the book was "nationally marketed," suggesting there is room for an argument like Keel's in the case of a local, self-published work which may indeed have marketing as its primary purpose. The line is not clear, or easy to identify in all cases, but it appears to be the right decision.
What kind of protection can you expect from a nonexistent corporation?
In a word, nonexistent. September 10, 2015
The promoters of a new business can, understandably, be eager to project a solid corporate image. Often, the rush to promote the great new idea overtakes the mundane work of incorporating and completing important post-incorporation tasks. At the organizing stage, in dealing with third parties, being less than completely candid about the existence vel non of the corporation can be extremely risky. Until the appropriate state office (Secretary of State, Department of Corporations, or the like) issues a certificate of incorporation, there is no corporation, and promoters who do not take certain precautions may expose themselves to liability without limit.
Before a corporation is formed, the people who actively promote its business (sometimes called promoters) can incur personal liability for obligations undertaken in the corporation's name. This is the rule in a majority of jurisdictions, although there are variations in its application. One promoter may incur unlimited personal liability; several promoters working together may be treated as a general partnership, with the additional risk that each will incur liability for the actions of the others.
In one New York case, the promoter of a corporation that was not yet in existence at the time he made a contractual commitment was not able to avoid liability on summary judgment, because his individual liability was held to be a question of intent. Universal Indus. Corp. v. Lindstrom, 92 A.D.2d 150, 151-152 (N.Y. App. 1983). Important to the court's analysis was the absence of any written agreement relieving the promoter of personal liability, nor was there any other documentary evidence of an intention that he not be liable. The court explained, "As a general rule a person contracting in the name of a proposed corporation is personally liable on the contract unless the parties have otherwise agreed. . ." because "one who assumes to act for a nonexistent principal is himself liable on the contract in the absence of an agreement to the contrary."
So what is the nature of an agreement made on behalf of a corporate not yet organized? According to Fletcher, a leading treatise on corporate law, where it is clear that a third party intends to agree only with the non-existent corporation, the agreement is deemed an offer by the third party that can be accepted (to form a contract) after the corporation has been established. Otherwise, the general rule of promoter liability will likely be applied.
The Supreme Court of Washington has described these rules as well settled. In Washington, however, a statute allows a promoter to avoid liability by demonstrating that third parties with whom she dealt pre-incorporation "also knew that there was no incorporation." RCW 23B.02.040.
The Maryland Court of Appeals, in Isle of Thye Land Co. v. Whisman, 262 Md. 682 (1971), held that a promoter was relieved of personal liability on a pre-incorporation contract because the actions of the other party indicated a willingness to look to the corporation for performance. 262 Md. at 705 ("The evidence supports the conclusions that Dr. Whisman understood that when a controlling and managing corporation was formed, he would look to it for the performance of the contractual obligations.")
In the District of Columbia, "all persons who assume to act as a corporation without authority to do so shall be jointly and severally liable for all debts and liabilities incurred or arising as a result thereof." D.C. Code § 29-302.04. An unreported decision of the District Court observed, "When a corporate promoter signs a contract or note on behalf of the corporation, he or she is personally liable until the corporation is properly chartered and assumes the promoter's obligations. T St. Dev., L.L.C. v. Dereje, 2005 U.S. Dist. LEXIS 38713 (D.D.C. Dec. 19, 2005), citing Robertson v. Levy, 197 A.2d 443, 446 (D.C. 1964). While this suggests that the assumption by the corporation, once formed, might relieve the promoter of liability, the holding in Robertson, was that such liability was not discharged when the certificate of incorporation was issued, nor even after the corporation began performing the agreement.
In pre-incorporation communications, even a few words, like "incorporation pending," might later help to demonstrate that third parties were aware they were not dealing with an existing corporation. The protection from an approach like this would be minimal, but it would be something. The better practice is to state clearly, in writing and using complete sentences, that the corporation has not yet been formed, and that the promoters are proposing an agreement of the corporation, when formed, and not on their own behalf. The best practice is to obtain the third party's written agreement or acknowledgment of these facts.
Trademark, Copyright, Linking, and Most Everything in Between September 4, 2015
IP watchers should be intensely interested in Tween Brands v. Bluestar Alliance, No. 15-cv-2663 (S.D. Ohio). On Tuesday, the District Court granted limited expedited discovery in the early phase of this fascinating intellectual property dispute. The parties seemed to be on the verge of settlement, but efforts at conciliation broke down, and litigation resumed apace. Thus, unlike that vast majority of infringement and licensing cases which are settled confidentially and add nothing to an understanding of the important legal principles involved, this case might be instructive.
The women's clothing chain "The Limited" developed a line of clothing for early and pre-teen girls, branded "Limited Too." In 1999, The Limited licensed "Limited Too" to a company now known as Tween. Tween developed and registered a copyrighted daisy design which it used in connection with the Limited Too brand. See http://www.shopjustice.com/girls-clothing/daisy-sweater/3281104 (viewed 9/3/15).
By 2009, Tween was operating more than 500 Limited Too stores pursuant to its license agreement with the Limited. Tween renamed its stores "Justice." The license agreement between Tween and The Limited terminated in 2015, and Bluestar Alliance, LLC announced that it had purchased the Limited Too brand trademarks from The Limited. On its website, Bluestar displayed a daisy design similar to Tween's, in connection with the Limited Too logo, a reference to Tween's slogan "It's a Girl's World," and a photograph featuring five young models. See http://bluestaralliance.com/limited-too/ (viewed 9/3/15).
Tween has sued Bluestar alleging that the photograph on Bluestar's site depicts Justice models wearing Justice clothing. Tween registered a copyright in the photograph, and in the clothing designs worn by the five models in the photograph. Bluestar concedes that it did not acquire the copyright in these items. Tween alleges that Bluestar infringed its copyright in the daisy design, and that Bluestar was creating market confusion by allowing the website limitedtoo.com to direct users to Tween's website, shopjustice.com.
If this lawsuit proceeds, we may see the development of concepts that elude even those with a subtle understanding of copyright and trademark law. Here, although Tween is no longer a licensee of Limited Too, and the current licensee is willing to drive business to Tween's site and brand, Tween takes issue. Although its trademarks have not been infringed, Tween seeks to use copyrightable elements of its products to challenge marketing activity (normally the realm of trademark). The interplay of copyright and trademark, regimes that serve markedly different purposes, is particularly interesting in the marketing of apparel (which can have design elements that are marks). We hope the parties can find the common ground necessary to settle their differences, but part of us hopes they don't.
A Case Study in Electronic Contracting and Alternative Dispute Resolution August 27, 2015
Berkson v. Gogo LLC, No. 14-cv-1199 (E.D.N.Y.) provides a rich case study in online contracting, traditional contract law, alternative dispute resolution, and the "appropriate" use of the courts for the resolution of disputes. By "appropriate," we are referring to the views of large enterprises that can be very strategic in their choices of forum and dispute resolution procedures, matters to which the typical consumer, eager to get online for a small fee, gives little thought. We can begin with the simplest point, and advance toward the more complex.
The ADR issue in Berkson can be disposed of on the very simple ground that Gogo LLC failed to follow its own requirement, in the contract of adhesion it drafted, for modification of agreements. (The case almost certainly will not be resolved on this basis because the more technological issues are just too tantilizing.)
When the plaintiffs initially formed their agreements with Gogo LLC, according to Gogo they indicated their acceptance of a slate of contract terms that included the following:
"Amendments. We may amend this Agreement from time to time. lf we make material changes to the Agreement, we will notify you by sending you an email to the email address specified in your Account. You agree that such amended Agreement will be effective thirty (30) days after being sent to you, and your continued use of the Service after that time shall constitute your acceptance of the amended Agreement." (ECF 23-1.)
There is no indication that Gogo LLC followed its own requirement for a valid acceptance. In its memorandum supporting arbitration, where one would expect to see the argument, Gogo asserted, "On at least a dozen [sic] after cancelling Gogo's service in January 2013, Berkson purchased Gogo's in-flight Internet service. Sladky Decl. ¶ 7. On at least 15 occasions after cancelling the Gogo monthly service in February of 2013, Welsh purchased Gogo's in-flight Internet service. See id. ¶ 9. On each such occasion, and as is required in order to subscribe, Plaintiffs acknowledged and agreed to the Terms of Use then in effect. Id. ¶¶ 8, 10. Those Terms of Use (put in place in December of 2012) contained a section entitled "Dispute Resolution/Arbitration" . . .
Gogo's valiant attempt to show that the plaintiffs had subsequently clicked their way through the sign-up screens was unavailing, not only for the reasons cited by the court, but for a much simpler one: Gogo did not follow its own rules when it added the arbitration and forum selection provisions. It is an elementary principle of contract law that the offeror is master of his (or her) offer. A purported acceptance which materially deviates from the terms of an offer operates as a rejection and effects a termination of the offer. Trade & Indus. Corp. v. Euro Brokers Inv. Corp., 222 A.D.2d 364, 369 (N.Y. App. Div. 1st Dep't 1995), citing New Hampshire Ins. Co. v Wellesley Capital Partners, 200 A.D.2d 143, 148, 612 N.Y.S.2d 407 (and cases cited).
The first lesson, of which we will say more in the coming weeks, is that a contracting party, especially a large commercial actor entering into high-volume, standard form contracts, must be scrupulous in understanding the meaning of its own contract documents, and what it must do in order to perform, give notices, modify terms, and the like. It is remarkable in this case that Gogo created a trap for itself, and fell headlong into it. Although the District Court preferred to use the rich factual record as an 83 page teaching vehicle in the law of click- and scroll- wrap agreements, Gogo could as easily have lost its bid for arbitration in a two-sentence decision: Gogo placed clear limits on its ability to modify its contractual relationship with its customers. When it failed to modify the terms of its contract as its own document required, by sending an e-mail message to its customer, it gave its customer no means of assenting to the proposed new terms.
Years of Agony In Store for California's Latest Attempt to Limit Mandatory Arbitration, August 26, 2015
California appears on the verge of enacting AB 465, which would amend Section 925 of California's Labor Code to invalidate any contract requiring an employee to waive any "legal right, penalty, remedy, forum, or procedure for a violation of any provision of this code." This is the latest in many campaigns by California's legislature and judiciary to blunt the effects of the Federal Arbitration Act, 9 U.S.C. §1, et seq.
Section 2 of the Federal Arbitration Act provides, "A written provision in any . . . contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." See Preston v. Ferrer, 552 U.S. 346, 352-353 (2008).
The FAA generally preempts state laws which target arbitration, and stand as an obstacle to the purposes of the Act. Volt Info. Scis. v. Bd. of Trs., 489 U.S. 468, 472 (1989); AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011). However, the FAA certainly does not require arbitration of all contract disputes, or even all disputes arising under contracts containing an arbitration clause. The Supreme Court held in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-404, 87 S. Ct. 1801, 18 L. Ed. 2d 1270 (1967) that attacks on the validity of an entire contract, as distinct from attacks aimed at the arbitration clause, are for the arbitrator to decide. If the arbitrator concludes that arbitration of a substantive dispute under the contract cannot be compelled, the purposes of the FAA have been satisfied.
California has often taken a place at the forefront of resistance to the FAA. The California Supreme Court in 2005 applied the California Civil Code's prohibition on unconscionable contracts, Cal. Civ. Code §1670.5(a), to hold that most collective arbitration waivers in consumer contracts are unconscionable, and that the proponent of such contracts could not compel arbitration of disputes. This rule was invalidated by the U.S. Supreme Court in AT&T Mobility on the ground that it stood as an obstacle to the purposes of the Federal Arbitration Act, and was thus preempted. Thus, while the parties to a contract may agree to limit the issues subject to arbitration, or to arbitrate according to specific rules (see AT&T Mobility and cases cited at 1748), or not to arbitrate at all, the state may not impose such limitations as a matter of state dispute resolution policy.
Whether California's latest attempt to curb federally mandated arbitration will withstand the ultimate test is debatable. On one hand, the new Civil Code provision, on its face, does not single out arbitration, nor does it invalidate arbitration of all matters in the employment relationship (i.e., only those that implicate the protections of the Labor Code). But it is very likely that the Supreme Court will find that thwarting the FAA is central to its purpose. On the other hand, the new provision purports to define an improper condition of employment that, carried to its logical extreme, could oust California's Labor Commissioner from jurisdiction over large fields of employment, and presumably hindering the state's ability to regulate employment practices. The proper resolution may be found in the recognition that the contract of employment is a complex contract involving an ongoing relationship in which work is exchanged for compensation, under fairly heavy state and federal regulation. The state is, in a sense, a party to all employment contracts by reason of the many rules engrafted onto such contracts by state law. It would not require great imagination to envision a regulatory scheme in which the state, as a party, stood ready to take up the cause of any employee injured by a violation of the rules governing employment (much as the EEOC is empowered to do). In this sense, the state is at least an interested party. As a general rule, an arbitration provision is not binding on parties who did not assent to it. Unfortunately, it does not appear that California's new rule takes this additional step, and for that reason, it is probably doomed to the fate met by the state's many anti-arbitration policies that preceded it.
Threats on Facebook December 7, 2014
In Elonis v. United States, the U.S. Supreme Court considered whether the federal criminal "threat" statute unconstitutionally burdens freedom of expression by permitting a conviction without proof of subjective intent. The case was argued December 1, 2014. The defendant, although seemingly lacking any semblance of human decency, would appear to have the better part of the legal argument.
In briefing on certiorari following a conviction for communicating a threat across state lines in violation of 18 U.S.C. §875(c), the defendant argued that, in the absence of an implied element of subjective intent, the statute would impose criminal punishment for negligent speech in violation of the First Amendment. In most basic terms, a defendant could be convicted upon proof that a reasonable person would have understood the offending words to constitute what is known in the law as a "true threat."
The government argued that Section 875(c) requires only a general intent, that is, that the defendant knew the words he was communicating, and that they would be understood by a reasonable person as constituting a serious, or "true" threat.
The difference between a threat and the various violent or harmful acts (generally, "violence") that a person might threaten is that the threat is intended to place its object in fear of one or more harmful acts. The harm addressed by criminal threat statute is different from the harm addressed by the statutes proscribing actual violence.
The ACLU noted in its amicus brief that the speaker need not intend to carry out the threat. This is clear from the first two subsections of the statute. The speaker might intend that the threat have an effect on its object without having to follow through with the threatened violence.
The Supreme Court has held that various elements of intent can be engrafted onto the language of a statute by implication. The presumption in favor of implying scienter into criminal statutes generally requires only proof of general intent: that the defendant knew what he was doing. Carter v. United States, 530 U.S. 255, 268 (2000). But also, the Court has held, the implied intent must be sufficient "to separate wrongful conduct from 'otherwise innocent conduct.' " For example, to avoid criminalizing the innocent activity of gun ownership, the Court interpreted a firearms statute to require proof that the defendant knew that the weapon in question had certain characteristics that would bring it within the ambit of the law. See Carter, 530 U.S. 255, 268-269 (2000), citing Staples v. United States, 511 U.S. 600 (1994).
Implying the requirement of a "true threat" presumably serves this purpose. A statement is a "true threat" when the defendant intentionally uses words in a context or under such circumstances wherein a reasonable person would foresee that the statement would be interpreted by those to whom the maker communicates the statement as a serious expression of an intention to inflict bodily injury or take the life of an individual.
In Elonis's trial, the judge instructed the jury, consistent with federal case law, that the offending statement must communicate "a serious expression" of "an intent to commit an act of unlawful violence" as understood by a reasonable person in the circumstances. The instruction distinguished a "true threat" from "idle or careless talk, exaggeration, something said in a joking manner or an outburst of transitory anger." But the trial court muddied the waters by adding "the government is not required to prove that the defendant himself intended for the statement to be a true threat,” and that "the test for whether any of the Facebook postings described in the indictment were true threats is an objective test which focuses on what a reasonable person in the position of the defendant as the maker of the statement would expect to be the reaction to the statements.”
Missing from the trial court's examples of "otherwise innocent" speech (idle or careless talk, exaggeration, joking, or an angry outburst) was one obvious category: a fervent and longstanding wish that violence would befall the object of the speaker's statements, a wish which, in the absence of any intent to carry out the violence or to place the object in fear of the same, should be protected.
Another infirmity in the statutory language is illustrated by a simple example not addressed in the parties' briefs. On its face, the statute would punish a person who communicates, in all "seriousness," a "true threat" to cause harm to the person of another - even if the threat were made by a third person not the speaker. For example, if Larry sends an e-mail to Curly, informing him that Moe is mad as hell and has threatened to poke Curly's eye out, the elements of the statute have been satisfied. Would anyone argue that Curly was harmed by Larry's e-mail? On the contrary, it would appear that Larry has done a great service to Curly by warning him of Moe's violent intentions. Yet this would be punishable under the statute unless the intent to threaten is an element.
The statute as it was applied also creates problems under the Fifth Amendment. Relieving the government of the burden of proving intent places the onus on the defendant to come forward with evidence to establish the context of his speech, for example, that the utterance was nothing more than "an outburst of transitory anger" (see the jury instruction, above). It is likely that many defendants prosecuted under Section 875 would not have access to witnesses or other evidence on the issue of context or intent, thus requiring them to waive their testimonial privilege if they desire to explain the innocence of their speech.
The difficulties in the government's position are that the statute requires so many additional conditions to be implied that it is difficult or impossible to guess what conduct, with what type of intent, is made criminal. Equally pernicious is the fact that the government may obtain a conviction under the statute whether or not the jury finds proof beyond a reasonable doubt that, in context, the defendant expressed a serious intent to do violence which would have been understood as such by a reasonable person. As instructed (specifically the proviso that "the government is not required to prove . . .") the jury was left to develop a sense whether or not the threat was a serious one, or the hyperbolic expression of extreme anger, without the benefit of a standard of proof. In evaluating the validity or wisdom of a statute like Section 875(c), we should not be guided by any notion that the violent sentiments expressed by Elonis were suggestive of domestic violence; it is easy to condemn such speech as lacking any redeeming value. Expressions of rage toward terrorists, or the government, would present a much harder case. Perhaps it is clear why this case was selected as a test of the applicability of Section 875 to threats on Facebook.
Can a Corporation Perform Surgery, and Other Questions
About the Tortured History of the Corporate Practice of Professions September 12, 2014
It is commonplace today for several providers of professional services - lawyers, physicians, accountants, and others - to go into business together, and structure their business as a corporation, a limited liability company, or the more recent limited liability partnership. There is a proliferation of suffixes denoting these combinations, such as P.C. or P.A. (for corporations), P.L.L.C. (for limited liability companies) and L.L.P. (limited liability partnership). The use of the traditional partnership form is becoming a rarity. Large professional enterprises that once organized as general partnerships, later formed into "partnerships of professional corporations," and have more recently been evolving into newer forms such as the limited liability partnership or "Swiss Verein" (a club or confederation with a structure for governance, but lacking common ownership, sharing of profits and losses, and systems for assuming or limiting liability). The aim of this series of essays is to bring some clarity to the often mysterious world of the corporate practice of the professions.
The corporation is a legal fiction with a long and colorful history, that in time evolved into a legal "person" for most purposes. Historians trace the corporation to ancient Rome, where the state would grant a charter to a private entity to perform some public good, usually on an exclusive basis. In later times, England and other nations granted corporate charters to promote trade, again on an exclusive basis, giving rise to various trading and shipping companies and trade guilds. By the late Nineteenth Century, with the rise of private corporations and their importance in the economy, the concept of a special charter granted by the state gave way to a movement for "free incorporation" - that is, incorporation available to all for any proper business purpose. (Endnote 1.)
At the start of the Nineteenth Century, Chief Justice Marshall was equivocal about the personal nature of the corporation, describing it as an "invisible, intangible, and artificial being," and "mere legal entity." With all respect to the Chief Justice, an esteemed professor of law once said that when the word "mere" appears in a judicial opinion, it is a signal that the court has decided, with little or no analysis, that the "mere" thing is not legally significant. The Court held that a corporation is "certainly not a citizen. . . unless the rights of the members, in this respect, can be exercised in their corporate name." Bank of United States v. Deveaux, 9 U.S. 61, 86-87 (1809). The opinion continued that the term "citizen," as used in the Constitution, "ought to be understood . . . to describe the real persons who come into court, in this case, under their corporate name." "It never could be intended that an American registered vessel, abandoned to an insurance company composed of citizens, should lose her character as an American vessel; and yet this would be the consequence of declaring that the members of the corporation were, to every intent and purpose, out of view, and merged in the corporation." In essence, as will be discussed later, the Supreme Court regarded a corporation in much the same way that the law now regards partnerships, limited liability companies, and unincorporated associations: as persons who have joined together to pursue an enterprise under a common name, but retain their personal identities even when acting routinely through their business entity.
It took less than 101 years for the modern conception of the corporation as a legal person, distinct from its owners, to be enshrined in law, such that a corporation was considered to be a person, without question, within the meaning of the Fourteenth Amendment to the Constitution. Southern R. Co. v. Greene, 216 U.S. 400, 412-413 (1910).
As a person, a corporation was capable of entering into many kinds of legal relationships, and assuming liability for its actions; conversely, the owners and agents of the corporation were shielded from liability for many of their actions done in the name of the corporation, and importantly, from being compelled to contribute to pay debts and losses that the corporation was unable to pay for itself. (Needless to add, these principles are in no way absolute. Corporations cannot marry or vote, for example, and individuals who commit heinous wrongs in the name of their corporate employers generally cannot escape direct liability.)
We cannot call to mind much less list the myriad activities for which corporations are formed. They provide all manner of goods and services, perform works of charity, operate great institutions of higher learning, and perform many other functions. It goes without saying that corporations manufacture airliners, life-saving pharmaceuticals, fire engines, and burglar alarms; they employ scientists, engineers, pilots, and countless other persons whose specialized knowledge can mean the difference between life and death on a daily basis. Why, then, would it matter if a doctor, accountant or lawyer practiced her profession in the corporate form? Leaving aside questions that might be raised by legal realists, such as whether the policies were informed by protectionist or anti-competitive sentiments (see n.2), was there any real threat to the public from professionals being allowed to practice in the corporate form?
One understandable concern (which has since been addressed by professional corporation statutes) was whether a professional could limit her liability for negligence by performing the profession as a shareholder or employee of a corporation (n.3). It has universally been considered inappropriate for lawyers, at least, to seek to limit their liability to clients. This was not a concern with practice in the partnership form, in which each partner generally shares liability for the actions of other partners (n.4). Even in the absence of a positive rule of law, however, this objection could have been addressed by codes of ethics (n.5), and by insurance arrangements in which the activities of individuals within a corporation were insured to the same extent as the corporation itself (n.6).
Other rationales for the ban on corporate practice of the professions were, we might say, less satisfying. States forbade professional persons to conduct business in the corporate form for reasons that can scarcely bear analysis, such as the distaste for a "learned profession" being sullied by the trappings of a commercial enterprise. Equally specious was the rationale that the independent judgment of a professional would be significantly impaired if she were required to answer to a corporate board or stockholders. In the case In re Co-operative Law Co., 198 N.Y. 479, 92 N.E. 15, (1910), the court painted a grim picture of the attempted practice of law by a classical corporation of the industrial era:
"The relation of attorney and client . . . involves the highest trust and confidence. . . cannot be delegated without consent, and it cannot exist between an attorney employed by a corporation to practice law for it, and a client of the corporation, for:
"he would be subject to the directions of the corporation,
and not to the directions of the client. . .
"he would not owe even the duty of counsel to the actual litigant. . .
"the corporation would control the litigation. . .
"the money earned would belong to the corporation. . .
"and the attorney would be responsible to the corporation only. . . .
"His master would not be the client but the corporation,
conducted it may be wholly by laymen, organized simply
to make money and not to aid in the administration of justice
which is the highest function of an attorney and counselor of law.
"The corporation might not have a lawyer among its
stockholders, directors, or officers. Its members might be
without character, learning or standing. There would be . . . no
stimulus to good conduct from the traditions of an ancient
and honorable profession. . .
"There would be "no guide except the sordid purpose
to earn money for stockholders."
The court concluded, "the bar, which is an institution of the highest usefulness and standing, would be degraded if even its humblest member became subject to the orders of a money-making corporation. . . ."
In the District of Columbia, similarly, the practice of medicine could "not lawfully be subjected to commercialization and exploitation," as would be the case if practiced by a corporation which "employs licensed physicians to treat patients, itself receives the fee, and the profit object is its main purpose, the arrangement being such as to divide the physician's loyalty and destroy the well recognized confidential relation of doctor and patient." United States v. American Medical Association, 110 F.2d 703 (D.C. Cir. 1940).
Objections such as these might have been addressed by ethical rules, like the conflict of interest rule, that would require a professional to sever an association that impinged on his professional judgment.
The District of Columbia Code, §29-502, enumerated some of the professions that could not be rendered by a corporation before December 10, 1971, including lawyer, architect, CPA, engineer, physician, and a variety of other health professionals. Not long before, however, courts struggled to define the "learned professions," as two mid-century cases illustrate. In Silver v. Lansburgh & Bro., 111 F.2d 518, 518-519 (D.C. Cir. 1940), the Court of Appeals for the D.C. Circuit held that optometry was "a mechanical art" which was "not a learned profession comparable to law, medicine, and theology." (It seems that the last one, theology, is regularly practiced on behalf of one of two corporate institutions, the church and the university, but so be it.) In Alabama Bd. of Optometry v. Eagerton, 393 So. 2d 1373, 1377 (Ala. 1981), a state board of optometrists sought to escape taxation of eyeglasses by arguing that optometry is a "learned profession." Apparently, even in 1981, it was not - at least not in the sense that of the learned professions recognized by the Alabama Supreme Court, which were law, medicine, the ministry, and of course, "the profession of arms."
The "profession of arms?" Leaving aside why anyone without a subscription to Soldier of Fortune would think of the military profession as one that might be practiced through a corporation, or subject to regulation at the level of state government, the inclusion of "the profession of arms" in a list with law, medicine and the ministry merits a brief digression. In the case State ex rel. Laughlin v. Wash. State Bar Ass'n, the court denied reciprocal admission to the Washington State Bar to one Colonel Laughlin because he had joined the military and spent 30 years, in the court's words, "practicing as a judge advocate general throughout the world." According to the court, Col. Laughlin, as a young man, had made a choice: "Colonel Laughlin had chosen his profession in 1920 when he left the practice of law and took up the profession of arms. He remained in the military profession until 1946. It might truly be said that he was actually and actively engaged in the business of being an officer in the United States army, for this is the profession to which he has devoted his entire time and attention in various parts of the world for more than a quarter of a century." Laughlin, 26 Wn.2d 914, 930 (Wash. 1947). An Army officer, true - practicing law in the military justice system. We have had the privilege of practicing among veterans of the Judge Advocate General's Corps. from time to time. They have always been outstanding practitioners on the whole. But Apparently the "profession of arms" is not only a "learned profession," as the Supreme Court of Alabama believed, but one so consuming as to eclipse 30 years of litigation practice in the military justice system. Barring some ground-breaking development, this will be the last mention of the "profession of arms" in our discussion.
Objections to the corporate practice of professions have also been based on the inability of a corporation to sit for a proficiency examination, or to possess good moral character. It was clear to the Supreme Court of Kentucky, 1943, that, "while a corporation is considered a person for many purposes, it is recognized that one cannot be licensed to practice a learned profession, which can only be done by an individual who has received a license to do so after proving his qualification and knowledge of the subject. Kendall v. Beiling, 295 Ky. 782, 789-790 (Ky. 1943). The same, however, was true of a partnership. See Cincinnati Ins. Co. v. Wills, 717 N.E.2d 151, 158 (Ind. 1999). The Kentucky Supreme Court also recognized that a corporation cannot "possess in its corporate name the necessary moral character required" for the practice of law. American Ins. Ass'n v. Kentucky Bar Ass'n, 917 S.W.2d 568, 571-573 (Ky. 1996).
The parallel development of the doctrine of the "corporate practice of medicine" emphasized the need to preserve physicians' autonomy. However, its earliest proponent, the American Medical Association, guilelessly expressed its concerns over maintaining "reasonable competition among the physicians of a community" (Principles of Medical Ethics, 1912), condemning "contracts that create more than 'reasonable competition' " and promote "underbidding to obtain contracts" (1933), creating conditions of "unfair competition" (1934). The FTC ultimately found that these restrictions were anticompetitive (n.7).
In Parker v. Board of Dental Examiners, 216 Cal. 285, 14 P.2d 67 (1932), the California Supreme Court held that the practice of dentistry within a corporate structure was unlawful because only "persons" were permitted to engage in the practice of dentistry, and a corporation could not possess consciousness, learning, skill, and good moral character.
From the middle of the 20th Century, professionals sought the ability to incorporate their practices. Corporate tax rates were historically lower than individual rates through most of the last Century, in part because of the "double taxation" of corporate income (at the corporate and shareholder level) . For example, in 1964, a corporation would pay at the rate of 22% on the first $187,000 (today's dollars) or 50% for amounts over that threshold. For the same time period, a married couple earning the same amount paid tax at the marginal rate of 37.5% (compared to today's 28%), and faced marginal tax rates up to 77% for greater earnings (n. 8). Still, there were perceived advantages in paying tax on corporate income while shifting personal income to future years. In addition, a variety of techniques enhanced the financial advantages to doing business in the corporate form. Chief among these was corporate sponsorship of tax advantaged retirement plans. Some scholars have observed that the once ubiquitous "partnership of professional corporations" was designed primarily to allow the owners of a firm to design individual corporation sponsored retirement plans to meet the individual needs of each principal, to enable the individual professional corporation of each principal to sponsor generous retirement plans and other fringe benefits, while employing their subordinates under an umbrella partnership, denying them the same benefits without violating former participation rules (n. 9).
Other benefits included compensating shareholders by dividend (thereby avoiding the payroll or self-employment tax), lower capital gains rates, loans to shareholders, and deductibility of corporate vehicles, travel, meals and entertainment.
Traditionally, in both sole proprietorships and partnerships, all tax effects were passed through to the individual partners, as if doing business in their personal capacities, who also bore full liability for the actions of their business entities. Professionals coveted the benefits available from doing business in the corporate form.
The earliest professional corporation statutes were enacted in 1960-61. By 1970, all but Iowa, New York and Wyoming had enacted a professional corporation or association law. New York's statute was enacted that year, Wyoming's in 1971, and Iowa's in 1975. At that point in time, all states had some form of professional corporation statute.
The IRS resisted recognizing corporate tax treatment for professional corporations, however, contending that the corporate form was antithetical to the practice of professions because it depended upon a set of criteria including limited liability, centralized management, perpetual existence, and transferability of ownership. By their nature, professional businesses generally could not have limited liability (because of ethical concerns) and, because of the highly personal nature of their primary activities, were not susceptible of centralized control. However, on August 8, 1969, the Internal Revenue Service conceded, after suffering a long line of court defeats, that professional service corporations and associations were corporations for tax purposes. T.I.R.-1019 (n. 10).
Large law firms and other professional firms began reorganizing as partnerships of professional corporations, in which, as noted above, owners would incorporate their individual practices in order to gain tax advantaged benefits as "employees" of their corporations; these entities would in turn form partnerships that would employ subordinates and staff, effectively excluding them from the more generous benefits reserved for the owners. The partnership of professional corporations served another, more mundane purpose, however - it enabled a professional firm to engage in a multi-state practice while still obtaining the benefits of incorporation for its owners. This is because a feature of virtually all professional corporation statutes has been that the shareholders and officers of the corporation must be licensed to practice the relevant profession, which normally means being licensed in the specific jurisdiction in which the corporation is chartered. The District of Columbia provides a good example of this. D.C. Code §29-502 defines "License" as a "license, certification, certificate, or registration, or other legal authorization required by law as a condition precedent to the rendering of professional service within the District," and "Professional corporation" as "a corporation organized under this chapter solely for the specific purposes provided under this chapter and which has, as its shareholders, only individuals who themselves are duly licensed to render the same professional service as the corporation." According to these definitions, all owners of a D.C. professional corporation must therefore be licensed to practice the same profession within the District of Columbia.
New York's law is similar. It begins, "Notwithstanding any other provision of law, one or more individuals duly authorized by law to render the same professional service within the state may organize . . ." N.Y. CLS Bus. Corp. §1503(a).
This requirement may have served a rational governmental purpose by in effect insulating the regulatory machinery from the subtle business of resolving questions such as when a professional may ethically share fees with a non-professional, whether a professional can exercise independent professional judgment if she must share management responsibilities with a non-professional, whether professional firms can cross state boundaries, and the like. The traditional corporate fiction - that the corporation is a person - was served by requiring the "corporate person" to be "licensed" to the same degree as would a natural person practicing in the field, by requiring all of its constituent members to be so licensed. Even advocates for the enactment of professional corporation statutes asserted that practice by such corporations would be confined to an individual state. E.g. Jones, H., The Professional Corporation, Fordham L. Rev. (Autumn 1958), at 362 ("No creeping corporate monster could cross state lines, as many professional partnerships (e.g., national accounting firms) now do.")
A partnership, on the other hand, might be able to practice across state lines. According to the ABA, "virtually every jurisdiction that has examined the issue allows its attorneys to divide fees with out-of-state lawyers or law firms, provided that the in-state ethics requirements are satisfied" (n. 11).
The New York Bar's Committee on Professional Ethics, for example, observed:
"DR 3-103(A) prohibits lawyers from entering into law partnerships with non-lawyers. While on its face the
rule might appear to prohibit affiliations with persons not licensed to practice law in New York, that
interpretation is tempered by DR 2-102(D) which provides that if a partnership is formed between lawyers
of different jurisdictions, the partnership's letterhead must clearly state the jurisdiction in which each lawyer
is licensed to practice law. DR 2-102(D) thus contemplates the formation of partnerships between lawyers
of different jurisdictions."
In time, the tax code and regulations were revised to eliminate much of the tax benefit from professional practice in the corporate form. In 1980, legislation required that any "affiliated service group" be treated as a single employer for purposes of retirement plan structure and non-discrimination rules. Beginning in 1983, incorporated professional practices (“personal service corporations”) have been taxed on all taxable income at the corporate tax rate applicable to the highest income bracket (n. 12). A series of cases in the 1990s-2000s greatly circumscribed the ability of personal service corporations to pay substantial compensation to their shareholders in the form of dividends which would escape payroll taxation (n. 13). And Still, some tax benefits remain, and limited liability for ordinary business activity (but not professional errors) has increased in importance with the expansion of liability (in areas such as intellectual property and employment) and growth of damage awards.
With the growth of multi-jurisdictional practices, and the continued popularity of incorporation, the question whether a professional entity with limited liability may practice across state lines remains highly relevant, even apart from the short-lived tax benefits that were dismantled over the past 30 years. Some of the benefits remain. For example, a professional corporation may still generate revenue through activities other than services performed by its shareholder-employees, and thus can argue for more favorable treatment of some distributions to owners, as dividends, capital gains, and return of capital. Corporations that elect to be C corporations (subchapter C, chapter 1, of Title 26 of the U.S. Code) can deduct, and pay tax-free, certain fringe benefits to owner-employees. (Note 14.) Apart from tax benefits, limited liability for ordinary business activity (but not professional errors) has increased in importance with the expansion of liability in areas such as intellectual property and employment.
Perhaps the single greatest complicating factor for incorporated practices today stems from the vestiges of the corporate practice of the professions doctrine, and the confusion over the inherent attributes of the corporation (e.g., that of being a "person" that is incapable of possessing good moral character), and those attributes that can be addressed through statute, regulation or ethical rule.
A survey of the professional corporation laws of the five largest states and the District of Columbia reveals that it is nearly impossible to organize a professional corporation to conduct business across state lines unless all of the shareholders, directors and officers are licensed in the relevant profession in at least one of the states. After 50 years' experience with the regulation of incorporated professional practices, significant barriers remain for firms that would pursue a genuine multi-state practice (without the need to organize multiple entities and group them under the umbrella of a partnership, unincorporated association, Swiss Verein, or the like).
Examples of more restrictive statutes governing professional incorporation and the grant of authority to foreign professional corporations are found, surprisingly, in the District of Columbia, New York and California.
In the District of Columbia, shareholders and officers of a professional corporation must all be licensed to practice the relevant profession in the District. D.C. Code §29-502(2) provides, " 'Professional corporation' means a corporation organized under this chapter solely for the specific purposes provided under this chapter and which has, as its shareholders, only individuals who themselves are duly licensed to render the same professional service as the corporation, and sub-section (1) defines "License" as a "license, certification, certificate, or registration, or other legal authorization required by law as a condition precedent to the rendering of professional service within the District." Thus, the District of Columbia will not recognize a professional corporation owned by professionals, some of whom are licensed in the District, and others elsewhere. See also §29-508. While the D.C. Code contains a definition of a professional limited liability company, the code contains few provisions expressly governing such entities. We will discuss this further, below.
The D.C. Code contains no express authority for foreign professional corporations to register to do business in the District of Columbia. D.C. Code §29-105.02 provides that "a foreign filing entity or foreign limited liability partnership shall not do business in the District until it registers with the Mayor under this chapter." Section 29-105.03 provides for the filing of a registration statement by a foreign corporation; and Section 29-101.06 provides for penalties for doing business in the District of Columbia without authority, including, "If a foreign filing entity, does business in the District of Columbia: (A) Without having obtained a certificate of registration under §29‑105.02; or (B) After its certificate of registration has been terminated under §29‑105.11." D.C. Code §29-101.06(4). These are general provisions applicable to business corporations. There are no corresponding provisions for foreign professional corporations, nor any reference to these provisions in Chapter 5 (governing professional corporations specifically). The former D.C. Corporation Code provided expressly for the issuance of certificates of authority for foreign professional corporations to transact business in District, D.C. Code §29A-414 (2001), but that statute is now repealed, and a comparable provision does not appear in the 2010 Act.
Non-recognition of foreign professional corporations is underscored by D.C. Code §29-512, which provides that a D.C. professional corporation may merge only with another domestic professional corporation, or a domestic limited liability company. Finally, nothing contained in Title 17 of the D.C. Municipal Regulations, governing business organizations, appears to authorize foreign professional entities to do business in the District.
A possible exception for law firms is recognized by ethical rule. Rules of Professional Conduct: Rule 5.4(b) would permit non-lawyers to be shareholders in a professional law corporation provided that they perform services that support the corporation's law practice, and submit to the Rules of Professional Conduct. It remains unsettled whether the ethical rule would be held to supersede the requirement of the D.C. Professional Corporation Act (as it should, because the bar traditionally is regulated by the courts, not the legislature, Note 15). However, it would be anomalous, at least, if a foreign licensed professional (a psychologist or engineer, for example) were permitted to own shares in a D.C. professional law corporation, while a foreign lawyer were not.
The regulations of the accounting profession recognize the right of a foreign professional accounting corporation to transact business in the District of Columbia. DCMR §17-2542.2 provides that "The Board shall register a sole proprietorship, partnership, limited partnership, limited liability partnership, or professional corporation if it finds . . . (a) That applicant has organized and exists as . . . (1) A professional corporation pursuant to D.C. Official Code § 29-401 et seq. (2001); (2) A foreign professional corporation possessing a valid certificate of authority to render professional services in the District of Columbia pursuant to D.C. Official Code § 29-414 (2001) . . ." This section, however, makes reference only to the former Business Corporations Code, now repealed.
Florida's statute is also restrictive. In Florida, a foreign corporation may not transact business until it obtains a certificate of authority from the Department of State. Fl. Code 607.1501(1). Like the District of Columbia, Florida's statute does not appear to authorize issuance of a certificate of authority to a foreign profession corporation or limited liability company. For instance, Section 607.1503, governing a foreign corporation's application for a certificate of authority, contains no provisions to determine whether the corporation is a validly existing professional corporation under the laws of its jurisdiction of organization, or the laws of Florida.
To qualify to do business in New York, a professional corporation from out of state must be able to certify that it is authorized to practice the relevant profession in the jurisdiction where it is incorporated, N.Y. C.L.S. Bus. Corp. §1530(a)(3), and identify "each person . . . who is licensed to practice the profession or professions" in New York, §1530(a)(4). If health services are to be offered, New York takes a restrictive view, consistent with the corporate practice of medicine doctrine, requiring the foreign corporation to certify "that each shareholder, officer and director of the foreign professional service corporation is licensed to practice said profession in this state." N.Y. C.L.S. Bus. Corp. §1530(b)(3). According to the New York statute, and excluding health services, a foreign corporation authorized to offer professional services in its home state should be eligible to qualify to do business in New York so long as the members who will practice the profession in New York are licensed there.
Notwithstanding the seemingly liberal wording of its statute, in practice, New York requires that all owners of a foreign professional corporation be licensed in the jurisdiction of origin. In this way, New York imposes greater requirements on the activities of the corporation outside of its borders than within. In New York, the practice of professions is regulated generally by the New York State Education Department, or, in the case of law, the relevant courts. N.Y. Bus. Corp. Law §1532(b). New York requires foreign professional corporation applicants to submit to the New York State Education Department, "satisfactory evidence of licensure in the original jurisdiction for each shareholder, officer and director of the corporation." This requirement appears nowhere in the corporation statutes, nor, indeed, anywhere in any New York statute or administrative rule; rather, it is found on the website of the Department of Education. See www.op.nysed.gov/corp/pcorpforeign.htm (viewed August 5, 2014). The only possible authority appears in section 8 NYCRR §59.10, relating to the issuance of a certificate pursuant to Business Corporation Law, section 1503(b)(ii): "(a) Applications to the State Education Department for the issuance of a certificate pursuant to Business Corporation Law, section 1503(b)(ii), shall be made by submitting to the department a fully executed certificate of incorporation which complies with the provisions of such section and of section 1512 of such law, and which sets forth or has annexed to it an affidavit of one of the original officers, directors or shareholders of the corporation setting forth the name of each individual who is to be one of the original shareholders, directors or officers of the corporation. Notably, this rule contains no requirement of licensure in the corporation's home jurisdiction.
Section 1503 governs the formation of a domestic professional corporation "to render the same professional service within the state," and provides in relevant part, "(b) The certificate of incorporation of a professional service corporation shall meet the requirements of this chapter and (i) shall state the profession or professions to be practiced by such corporation and the names and resident addresses of all individuals who are to be the original shareholders, directors and officers of such corporation, and (ii) shall have attached thereto a certificate or certificates issued by the licensing authority certifying that each of the proposed shareholders, directors and officers is authorized by law to practice a profession which the corporation is being organized to practice and, if applicable, that one or more of such individuals is authorized to practice each profession which the corporation will be authorized to practice." The language "a profession" and "each profession" allows for the possibility that a professional corporation may engage in more than one licensed profession, as in the case of design professionals.
The professional corporation statute of Texas is relatively liberal in form. Domestic and foreign professional entities are addressed together in Title 7 of the Texas Business Organizations Code. Only persons licensed in Texas may provide services through the professional corporation or LLC (§301.006), but Texas recognizes that a foreign entity may be owned or managed by a combination of persons licensed in Texas or in another jurisdiction. §301.003(5) ("professional individuals," §301.003(5), or "authorized persons," §301.004). Texas, like California, expressly authorizes joint practice by professionals in related healthcare disciplines. §301.012.
The Texas statute governing registration of foreign corporations allows a foreign professional corporation to register to do business in Texas upon a representation that "the entity exists as a valid foreign filing entity of the stated type under the laws of the entity's jurisdiction of formation" and "is authorized to pursue the same business or activity" under the laws of that jurisdiction, "regardless of any differences between the law of the entity’s jurisdiction of formation and of this state applicable to the governing of the internal affairs or to the liability of an owner, member, or managerial official." Texas Bus. Org. Code, Title 1, Ch. 9.
A foreign professional corporation or LLC may not receive authority to transact business in Texas if its home jurisdiction does not permit "reciprocal admission" of a Texas entity. §301.005. This would appear to preclude the registration in Texas of a D.C. professional corporation.
Illinois allows foreign professional corporations to receive authority to transact business within the state if ownership and control are exercised by persons licensed to practice the profession in the state of domicile, or in Illinois. As in Texas, Illinois will not deny authority to a foreign corporation by reason of the fact that the laws of its state of organization differ from Illinois law. Il. Comp. Stat. Ch. 805, §13.05.
California's professional corporation statute is the most peculiar of those surveyed: it is highly restrictive in some respects, liberal in others, and (of course) detailed in all. California's Corporations Code §13401(b) defines "professional corporation" as "a corporation organized under the General Corporation Law or pursuant to subdivision (b) of Section 13406 that is engaged in rendering professional services in a single profession." Perhaps in keeping with California's seeming obsession with the corporate practice of medicine doctrine, but mitigating its application to a degree, Cal. Corp. Code §13401.5 provides in detail for exceptions to the "single profession" restriction, for 16 enumerated healthcare disciplines. For example, so long as a majority of the shares are held by licensees in the main profession, the stock of a marriage and family therapy corporation may be held by physicians, psychologists, clinical social workers, RNs, chiropractors, acupuncturists, naturopaths, and licensed clinical counselors. Cal. Corp. Code §13401.5(g). Similarly, Cal. Corp. Code §13401 liberalizes the procedure to obtain authority to practice for professional corporations, domestic or foreign, "rendering professional services by persons duly licensed by the Medical Board, . . . the Osteopathic Medical Board . . ., the Dental Board . . ., the California State Board of Pharmacy, the Veterinary Medical Board, the California Architects Board, the Court Reporters Board of California, the Board of Behavioral Sciences, the Speech-Language Pathology and Audiology Board, the Board of Registered Nursing, or the State Board of Optometry. These corporations are not required to obtain a certificate of registration as a prerequisite to doing business in California.
California's statute is liberal, also, in its eligibility requirements for foreign professional corporations. Cal. Corp. Code §13406(a) provides, without differentiation between domestic and foreign corporations, that "shares of capital stock in a professional corporation may be issued only to a licensed person or to a person who is licensed to render the same professional services in the jurisdiction or jurisdictions in which the person practices, and any shares issued in violation of this restriction shall be void."
California's statutes contain extensive provisions governing the conduct of professional corporations outside of California. Cal. Corp. Code §13405(a) provides that "a professional corporation may render professional services outside of this state, but only through employees who are licensed to render the same professional services in the jurisdiction or jurisdictions in which the person practices. Nothing in this section is intended to prohibit the rendition of occasional professional services in another jurisdiction as an incident to the licensee's primary practice, so long as it is permitted by the governing agency that regulates the particular profession in the jurisdiction. Nothing in this section is intended to prohibit the rendition of occasional professional services in this state as an incident to a professional employee's primary practice for a foreign professional corporation qualified to render professional services in this state, so long as it is permitted by the governing agency that regulates the particular profession in this state. Section 13405(b) provides that a foreign professional corporation qualified to render professional services in this state may lawfully render professional services in this state, but only through employees who are licensed persons, and shall render professional services outside of this state only through persons who are licensed to render the same professional services in the jurisdiction or jurisdictions in which the person practices.
Through the interplay of the Corporations Code and the Business and Professions Code, California appears to have foreclosed the practice of most professions to limited liability companies. Cal. Corp. Code §17701.04(e) limits the ability of domestic or foreign LLCs to provide the "professional services" enumerated in Cal. Corp. Code §§13401(a) and 13401.3, only "if the applicable provisions of the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act authorize a limited liability company or foreign limited liability company to hold that license, certificate, or registration." A review of the Bus. & Prof. Code reveals that among the numerous professions recognized and eligible for licensure in California, few may practice in the limited liability company form.
The professional limited liability company should become the entity of choice for professional businesses desiring to practice in multiple jurisdictions. In each of the states surveyed but one, the nature of the LLC as an unincorporated entity has been expressly recognized, and the LLC is more in the nature of an unincorporated association than a corporate person. See Cal. Corp. Code §17701.02(j) ("Foreign limited liability company" means an unincorporated entity formed under the law of a jurisdiction other than this state and denominated by that law as a limited liability company); N.Y. C.L.S. §102(k) ("Foreign limited liability company" means an unincorporated organization formed under the laws of any jurisdiction . . . of which some or all of the persons who are entitled (A) to receive a distribution of the assets . . . (B) or to exercise voting rights . . . and are entitled or authorized to have, under the laws of such other jurisdiction, limited liability for the contractual obligations or other liabilities of the organization); Fla. Stat. §605.0102 ( “Foreign limited liability company” means an unincorporated entity that was formed in a jurisdiction other than this state and is denominated by that law as a limited liability company); 805 I.L.C.S. 180/1-5 ("Foreign limited liability company" means an unincorporated entity organized under laws other than the laws of this State that afford limited liability to its owners comparable to the liability under 805 I.L.C.S. 180/10-10. . .); D.C. Code §29-101.02(5) ("Foreign limited liability company" means an unincorporated entity formed under the law of a jurisdiction other than the District which would be a limited liability company if formed under the law of the District).
Because the LLC is an unincorporated organization, there should be no need to apply the tortured analysis that has plagued the corporate practice of the professions for the past 80 years or so. Leaving aside the spurious objection that a corporation was a person that otherwise could not sit for an exam or demonstrate good moral character, the more compelling rationales for imposing limitations on professional entities (beyond the rules of ethics and conduct which govern specific professions) are limitation of liability and separation of ownership and control. Unlike corporation statutes, LLC acts that follow the Uniform Limited Liability Company Act provide for management directly by members (owners). Further, the uniform act defines the limitation of liability as follows: "The debts, obligations, or other liabilities" of the company "do not become the debts, obligations, or other liabilities of a member or manager solely by reason of the member acting as a member or manager acting as a manager." The NCCUSL Comment on this provision makes clear that it is not intended to govern claims seeking to hold a member or manager directly liable for his or her own conduct (a common feature of professional corporation statutes). Taken together with the unincorporated nature of the LLC, these provisions demonstrate that the LLC is more akin to a partnership or association, which commonly have been permitted to practice professions across state lines so long as the individual members are properly licensed.
In the coming weeks we will examine particular state LLC acts and the degree to which they are amenable to multi-jurisdictional professional practice.
Endnotes
1. Schane, "The Corporation is a Person: the Language of a Legal Fiction," 61 Tul. L. Rev. 563, 609 (1987)
2. Thill, D., Corporations Practicing Law Through Lawyers: Why the Unauthorized Practice of Law Doctrine Should Not Apply, 65 Mo. L. Rev. 151 n.44 (winter 2000).
3. In re Bar Ass'n, 55 Haw. 121, 122 (Haw. 1973).
4. See Dow v. Donovan, 150 F. Supp. 2d 249, 253 (D. Mass. 2001).
5. Human beings, not law firms, are bound by the Rules of Professional Conduct. Although law firms are mentioned in the rules, they relate to the way attorneys conduct themselves and their relationship to the firm in which they work. The Rules of Professional Conduct certainly do not govern how a law firm practices law, because law firms do not practice law. Persels & Assoc., LLC v. State Dep't of Banking, 2014 Conn. Super. LEXIS 738, 21 (Conn. Super. Ct. Mar. 28, 2014) (citations omitted).
6. See In re Rhode Island Bar Ass'n, 106 R.I. 752, 760-761 (R.I. 1970).
7. In re Am. Med. Ass'n, 94 F.T.C. 701, 701 (1979), [1979-1983 Transfer Binder] Trade Reg. Rep. (CCH) P 21,955 (1982).
8. Federal Individual Income Tax Rates History, available at taxfoundation.org
9. Bowman, F., The Professional Corporation—Has the Death Knell Been Sounded?, Pepperdine L.R. (spring 1983)
10. See In re Rhode Island Bar Ass'n, 106 R.I. 752, 757 (R.I. 1970)
11. ABA/BNA LAWYER'S MANUAL ON PROFESSIONAL CONDUCT 41:712 (2007)
12. Corporation Income Tax Brackets and Rates, 1909-2002, available at IRS.gov
13. See JD & Associates, Watson v. Commissioner, 107 AFTR 2d 2011-305, (DC IA 12/12/2010), and McAlary LTD, Inc. v. Commissioner, T.C. Summary Opinion 2013-62.
14. Attention must always be given to the special rules for personal service corporations, including the power of the IRS to recharacterize income and deduction items between a corporation and shareholders where an intent to avoid taxes is detected.
15. "The judicial branch of government generally is recognized as having the power to regulate the practice of law," Thill, D., Corporations Practicing Law Through Lawyers: Why the Unauthorized Practice of Law Doctrine Should Not Apply, 65 Mo. L. Rev. 151 n.57 (winter 2000).
The Tricky Business of Business Regulation August 15, 2014
The District of Columbia's regulation of the operations of health spa and massage businesses, DCMR Title 25-D (2009), raises even more questions than do the advertising regulations discussed below (Advertising in the District of Columbia, May 23, 2014). Chapter 2 of the regulations prohibits a licensed massage therapist from performing a "Therapeutic cross-gender breast massage." Section 1702.1. If the intent of this regulation is to discourage sexual misconduct under the guise of therapeutic massage, it is puzzling that only "therapeutic" massage is prohibited. Conversely, same sex breast massage creates no concerns for the apparently ultra-progressive D.C. Council.
The massage of all other erogenous zones, conventionally understood, is, of course, prohibited. All, that is, except the male genitalia. Was the Council supremely confident that no one would think of offering male genital massage services (cross-gender or otherwise)? Or were such activities, even if therapeutic, understood to be so clearly illicit that they required no mention in the regulation? Did the Council debate the applicability of the maxim inclusio unius est exclusio alterius?
If you arrive for a massage appointment and your masseur is armed with an actual weapon, you should be very afraid. Apparently any harm which may be inflicted by the deadliest of weapons will not constitute "injury" under the regulations, which define "injury" as simply "bodily harm resulting from the use of a massage device which requires medical attention." There are narrow definitions in the law, and then there are definitions so narrow that they should not be read by those with even mild claustrophobia. Whatever the reason that the Council chose to write regulations which would apply in the event of injury in a massage business, what possible purpose could be served by limiting the definition to harm caused by a massage device?
Without a doubt, one of the most enlightening regulations is the following, which enshrines the "gross factor" in the spa business:
"Spa – a pool primarily designed for therapeutic use which is not drained, cleaned or refilled for each user."
If the operator cleans the pool after each user, pleasant - and hygienic - though it may be, it is not a "spa." For those who remain undaunted by the District's spa regulations, we recommend arriving early enough to check out the users who will be entering before you. In fact, you may want to be sure you are the first client in line on spa day.
ABC v. Aereo: Supposed Peril for Cloud Computing Fails to Cloud the Issue for SCOTUS June 25, 2014
Today's decision by the Supreme Court in ABC v. Aereo effectively side-stepped any substantive consideration of arguments that a finding of infringement by Aereo would imperil development of the "cloud," and the billions of dollars that have been invested in "cloud computing," or other emerging technologies. The Court's opinion could have ended where it began, with an excerpt from the relevant provisions of the Copyright Act of 1976:
A copyright owner [owns] the “exclusive righ[t]” to “perform the
copyrighted work publicly,” 17 U. S. C. §106(4), including the right to
“transmit or otherwise communicate a performance. . . of the
[copyrighted] work . . . to the public, by means of any device or
process, whether the members of the public capable of receiving the
performance . . . receive it in the same place or in separate places
and at the same time or at different times.” Id., §101.
From these basic principles, the Court methodically explained that a company that offers to thousands of strangers (its customers) content owned by another (not by the customers themselves) cannot avoid liability for the public performance of that content merely by offering a one-to-one connection with each, through technology that is unnecessarily redundant and exists for no purpose except avoiding infringement liability.
The Court rejected the argument that Aereo's subscribers were not "the public" because Aereo communicated to each of them, individually, by means of a tiny antenna and digital storage device. The Court's analysis of the meaning of "public" was classic Justice Breyer:
"Neither the record nor Aereo suggests that Aereo’s subscribers receive performances in their capacities as owners or possessors
of the underlying works. This is relevant because when an entity performs to a set of people, whether they constitute “the public”
often depends upon their relationship to the underlying work. When, for example, a valet parking attendant returns cars to their
drivers, we would not say that the parking service provides cars “to the public.” We would say that it provides the cars to their owners.
We would say that a car dealership, on the other hand, does provide cars to the public, for it sells cars to individuals who lack a pre-
existing relationship to the cars. Similarly, an entity that transmits a performance to individuals in their capacities as owners or
possessors does not perform to “the public,” whereas an entity like Aereo that transmits to large numbers of paying subscribers who
lack any prior relationship to the works does so perform."
Explicitly rejecting the argument that thousands of tiny antennae could avoid the purposes of the Copyright Act, the Court held that "when an entity communicates the same contemporaneously perceptible images and sounds to multiple people, it transmits a performance to them regardless of the number of discrete communications it makes."
The opinion is elegant in its practicality, and a relief for those who despair of the ability of modern jurists to apply clear rules of law to new technologies.
Advertising in the District of Columbia (Part 1) May 23, 2014
Advertising in the District of Columbia can be treacherous, far from the free-wheeling business portrayed in AMC's hit series "Mad Men." Consider the health spa. In 2009, the District promulgated some regulations for massage and health spa business (DCMR Title 25-D), including this one:
"No person or facility shall advertise or promote massage therapy or health spa services with . . . images of scantily clad persons. . . or with any sexual overtones."
One might justifiably ask, How are health spa and massage services sold?
In the second clause, we observe a conflict of laws of a sort. The District's massage regulations seem to fly squarely in the face of an "iron law" of advertising. Sex sells, and it is used to sell everything, as long as it is not sex, which the regulated activities are not (if the regulators are doing their jobs). As for the first, prohibiting images of scantily clad persons, it seems obvious that any person pictured enjoying a completely lawful, professional massage would normally be pictured wearing nothing but a towel, and thus, by definition, would be "scantily clad," if clad at all. But the advertiser of massage services is enjoined by another section (1700.6) that "No person or facility shall advertise or promote massage therapy or health spa services that are misleading in any way." Images of patrons enjoying massage or other health spa services fully clothed would be nothing if not misleading.
It bears mentioning that the District government appears to have inadvertently banned the advertisement of any business activity other than message and health spa services with Section 1700.7: "No person or facility shall advertise or promote services that are not massage therapy or health spa services." "Person" is very accurately defined in the regulation as "an association, a corporation, individual, partnership, trustee, government or governmental subdivision, or other legal entity." It does not appear limited to persons engaged in the massage or spa business, at least on its face. And one can search the regulation in vain for a definition of "facility." It is possible Section 1700.7 was intended to apply to "licensees," which are defined in the regulation, and which are probably the only enterprises that should not be advertising services other than the massage and health spa services they are licensed to provide.
It would be difficult to imagine the massage and health spa regulations passing muster under the First Amendment. Under the test in Central Hudson Gas & Electric Corp. v. Public Service Commission, 447 U.S. 557 (1980), laws regulating commercial speech must reflect a substantial governmental interest, and be narrowly tailored to advance that interest directly.
According to the preamble to Title 25-D, the District's interest is in protecting "the public health and safety by preventing and controlling the spread of communicable diseases" and protecting "the environment." A regulation discouraging people who are willing to pay for illicit sex from responding to advertisements by licensed spas that are otherwise clean and in compliance with health department standards hardly seems like it could advance this aim, or, indeed, to be tailored in any way. Many establishments regularly advertise using scantily clad models and sexual overtones. The restrictions placed on legitimate massage and health spa businesses would appear to place them at a distinct disadvantage. As Justice Kennedy wrote for the majority in Sorrell v. IMS Health Inc., __ U.S. __, 131 S. Ct. 2653 (2011), "The State has burdened a form of protected expression that it found too persuasive. At the same time, the State has left unburdened those speakers whose messages are in accord with its own views. This the State cannot do." While it is a painful truth that the District is not a state, we can take some comfort in the fact that it is "the State" - at least in the sense intended by Justice Kennedy.
There are three lessons (at least) in Title 25-D of the D.C. Municipal Regulations. First, it may be axiomatic that "sex sells," but it will not be selling licensed massage or health spa services in the District of Columbia until someone challenges the speech regulations in Title 25-D. Second, drafting regulations can be tricky business, and especially so where speech is involved. Finally, it is not only beneficial, but entertaining, to read one's local regulations carefully. Perhaps it goes without saying that this should be done once or twice before they are enacted.