Are Your Contractors Actually Employees? Are You Sure?

The misclassification of an employee as an independent contractor can have several serious consequences.  The employer may be liable for years of unpaid federal, state and local income tax withholdings and Social Security and Medicare contributions, unpaid workers’ compensation and unemployment insurance premiums, and even unpaid work-related expenses and overtime compensation. These liabilities, plus interest and penalties, can potentially be huge for businesses that make substantial use of independent contractors.  Another liability risk arises if misclassified employees who are otherwise entitled to coverage under employee benefit plans have not been provided with health, pension, and other employee benefits.  This could lead to litigation, possibly including class action litigation, brought by or on behalf of misclassified employees who were deprived of benefits to which they claim they were entitled.  Finally, the determination of whether an employer is required to provide health insurance coverage under Obamacare depends on whether the employer has over 50 full-time equivalent (FTE) employees.  If an employer does have over 50 FTE employees and does not provide heath care insurance, the employer must pay a per-month “Employer Shared Responsibility Payment” on its federal tax return beginning with the return for 2014.  While the federal government has not expressly so stated, it is reasonable to assume that independent contractors who are determined to have been misclassified employees will be added into a new calculation of the 50 FTE threshold.  In years to come, some employers may find that they are liable for retroactive  “Employer Shared Responsibility Payments”.

There are different routes to a state or federal determination that an employee has been misclassified as an independent contractor.  One way in which regulatory agencies discover independent contractor misclassification is through the unemployment and workers’ compensation claims process. Local claims offices are more frequently issuing initial determinations of “employee” status in benefit claims filed by workers, including individuals who have signed independent contractor agreements or are receiving compensation on a 1099 basis. As a result of the prolonged recession, many workers who previously regarded themselves as independent contractors are nonetheless applying for unemployment benefits – and more claims examiners are finding that such workers have been misclassified and are entitled to unemployment benefits as “employees.” If a business has not paid unemployment contributions to a state fund on behalf of that worker, the initial determination that the worker had been misclassified as an independent contractor, if upheld by an administrative law judge or referee, can have the same effect as an adverse audit. And once a single worker is found to have been misclassified, the business is then often charged for unpaid contributions for “all similarly situated” workers, along with costly penalties and interest.

Twenty-one states have adopted legislation designed to discourage employee misclassification, and most of these state laws include significant penalties. Eighteen other states have proposed bills intended to limit the use of independent contractors or make misclassification more costly.  In addition, the U.S. Department of Labor has hired several investigators to “detect and deter” companies from misclassifying employees as independent contractors and failing to properly pay overtime or afford statutory benefits to workers.   The DOL has also initiated a “Misclassification Initiative” in which it has entered into memorandums of understanding with 13 states to coordinate enforcement efforts and share information between the state and federal agencies about non‑compliant companies.

Another way the issue can be raised is through IRS Form SS-8.  Individuals paid as independent contractors or businesses may file Form SS-8 to obtain an IRS determination of their status as an employee.  If the IRS finds that the individual was misclassified as an independent contractor, it can issue an agreement that would state the individual is responsible for paying only the employee’s part of employment taxes.  This would entitle the individual to a refund, assuming the individual has paid taxes on the basis that he or she was self-employed, and the employer would then be responsible for the employer’s portion of the taxes (and possibly interest and penalties).  It is not hard to see why an independent contractor, if his or her contract was coming to an end, would file a Form SS-8 to obtain a determination of status as an employee in order to, among other things, recover the employer portion of the FICA/Medicare/Social Security tax.   If reclassified as an employee, the individual might then also seek unemployment benefits and sue the company for unpaid employment benefits.

Last but not least, the issue of employee misclassification can also arise during an IRS audit.

So when is an independent contractor actually an employee?  That question is often very difficult to answer.  Even the GAO, in a 2006 report, said, “the tests used to determine whether a worker is an independent contractor or an employee are complex, subjective, and differ from law to law.”  (GAO Report- Employment Arrangements)

Two things are clear, however. First, many state laws that address misclassification of employees as independent contractors create a presumption that an individual is an employee unless the business paying the individual establishes that he or she is not an employee.  And second, the determination of employee misclassification is often made by an administrative agency, which makes it more difficult to challenge the decision because courts often give governmental agencies wide latitude in interpreting their regulations.  With that background, court cases and state laws offer some guidance, but the issue of employee classification remains very subjective.   The U.S. Supreme Court has identified certain factors that should be considered in determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA), which, among other things, establishes a Federal minimum wage and requires that certain employees receive overtime pay at 1-1/2 times the regular wage for hours in excess of 40 in a work week. In general, the Supreme Court held that a worker who meets the FLSA definition of employee is one who is economically dependent on the business he or she serves. In contrast, an independent contractor is one who is engaged in a business of his or her own.   Many state laws describe employment status as a situation where the hiring party has the “right to control the manner and means” by which the worker accomplishes the end product of his or her work.  While these standards are FLSA or state law specific, they do give a point of reference.  The question, then, is what specific factors will a court look at to economic dependency or employer control?    The IRS has stated that it will consider “all information that provides evidence of the degree of control and the degree of independence.”  (IRS Form 15-A- Employer’s Supplemental Tax Guide)  Here are some factors to consider:

Length of Contract.   A contract with an independent contractor typically has a fixed term or it terminates upon completion of a specified project.    An open-ended contract (or no written contract) suggests employment.   Moreover, a contract with an independent contractor, even if it has a fixed term, can suggest employment status if it is renewed many times, thereby creating a long-term relationship with expectations of an indefinite number of contract renewals in the future.

Nature of Work.  An independent contractor typically performs tasks that the company needs to have performed only at certain times or for a special reason, not tasks that are performed by employees of the company as part of the company’s core business.  Moreover, a contractor’s performance objectives are usually described in detail in a written agreement, whereas a vague scope of work, such as “responsibilities as assigned” suggests an employment contract.

Supervising Employees.  Independent contractors typically do not supervise employees.  Such supervision, whether required by the contract or de facto, would suggest employee status.

Hours worked.  Who decides what hours the individual works?  An independent contractor typically sets his or her own hours, even if paid by the hour.  In contrast, an employee must be “at work” during specified periods on specified days.

Exclusivity.  Can the individual do work for other companies?   If not, this would suggest employment, although prohibiting an independent contractor from working for competitors during the term of the contract would not be unusual if trade secrets or technology are involved.

Marketing.  If the individual is an independent contractor, then one would expect the individual to be marketing his or her services so that new work can be found to provide other sources of income when the current contract ends?  Does the individual have a website, business cards and marketing materials?  Has the individual received other requests for work and how has he or she responded?

Expenses.  Does the individual have insurance, at his or her expense, to protect the employer against errors or malfeasance?  Does he or she pay for professional training, conferences and membership in professional organizations?  Who pays for equipment such as laptops, cell phones, tablets, and storage devices that are used off the company’s premises?  An independent contractor would typically pay all or most of these expenses whereas an employee would not.

Reports.  What reports does the individual file?  An independent contractor will typically file periodic progress reports describing tasks performed or progress achieved.  Employees are not usually required to file such reports because they are more closely supervised and their accomplishments are known to their supervisor.

Other.  Can the individual engage subcontractors?  If the individual unilaterally terminates the contract before the end of the term, must the individual pay a penalty to cover the cost to the company of finding another contractor to complete the work?  If the work performed is not satisfactory to the company, must the individual do the work again without additional compensation?  Are there incentives for early completion and penalties for late completion?   Each of these questions, if answered “yes”, would be indicative of independent contractor status.

These are only some of the factors an administrative agency or court might consider and, unfortunately, there is no way to predict how many factors, and the weight given to each, will tip the balance one way or the other.  Suffice it to say that the written contract between the individual and the company is a very important part of the analysis.  If doubt exists as to whether a contract with an independent contractor will survive scrutiny, companies should contact an attorney with a view to possibly amending the contract to add provisions, or clarify existing provisions, in order to reduce the risk of reclassification of the individual as an employee.

The Corporation Secretary

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2013 in review

The stats helper monkeys prepared a 2013 annual report for this blog.

Here’s an excerpt:

The concert hall at the Sydney Opera House holds 2,700 people. This blog was viewed about 20,000 times in 2013. If it were a concert at Sydney Opera House, it would take about 7 sold-out performances for that many people to see it.

Click here to see the complete report.

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The Importance of Entity Management

The link below provides access to a brief article on entity management from CT Corporation, a leading provider of registered agent and other services for legal entities.  We could not have said it better ourselves.  While the advice from CT Corporation applies to both public and private companies, it is small privately held companies that tend to neglect entity management.  It’s not important until it is, and then it is usually too late.

Entity Management



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Who We Are

Roger Wiegley, founder and CEO of The Corporation Secretary, is a corporate lawyer with over 30 years of experience.  He started The Corporation Secretary three years ago because he felt that there was a gap in both the knowledge and administration of small businesses.  Every day hundreds of new companies are formed as entrepreneurs launch new ideas.   In many cases—perhaps most cases–the founders and managers of these small business do not understand the legal issues surrounding the organization that they have created or plan to create.  Where do they turn for help?  Some seek advice from law firms.  This often proves to be a very expensive alternative.   Another source of guidance is the Internet.  This route is particularly dangerous because the advice is generally too general, too simple, too esoteric or just self-serving.  The companies that will incorporate a business for $99 do not have the resources to try to understand the circumstances of a potential buyer.  They just want the $99.  What happens after that is not their concern.  It is fair to say that many owners of start-ups, despite their original objectives, have not protected their personal assets from liability through the business organization they formed.

What have we learned in three years?  More people than we expected have come to The Corporation Secretary for the formation of business entities.   This is a service that we do not even promote on our website ( because there is so much competition and, to do the task properly (covering all the steps, discussing all the issues and alternatives, and providing personal service), we are more expensive than the “corporation in can” Internet services (although much less costly than a law firm).   The second thing we discovered is that our clients often need follow-on advice because state governmental agencies show up when they discover a new business in their jurisdiction–tax, labor, etc.  (It’s actually worse if they don’t show up but their requirements apply nonetheless.)  The Corporation Secretary can help with these matters because it knows the business of its clients.  And finally, we have been doing a substantial amount of Internet research for our clients to examine and describe specific laws and regulations in various states.

While The Corporation Secretary does not provide legal services, we are sometimes asked for advice that involves the practice of law.  For this we use an affiliated law firm, The Law Offices of Roger D. Wiegley (   We know that our clients want quality legal services at a reasonable cost.  With that in mind, our law firm affiliate will undertake assignments for a fixed-fee, approved by the client in advance.


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Our Delaware Franchise Tax is WHAT ?!?

Delaware has been preeminent as the place for businesses to incorporate since the early 1900s.  Close to a million business entities are domiciled in Delaware, including more than one-half of the corporations that make up the Fortune 500.

Why do corporations choose Delaware?  There are several reasons. First, the Delaware General Corporation Law is one of the most comprehensive, advanced and flexible corporation statutes in the nation.   Second, Delaware’s corporations court, the Court of Chancery, is highly respected because its judges are very knowledgeable and their decisions are well reasoned.  The accumulated body of Delaware court decisions provides clarity and guidance in many of the situations that might arise in the realm of corporate governance or shareholder rights.  Third, the state legislature is diligent about keeping Delaware’s corporation statute current.  And fourth, the Secretary of State’s Office is not at all bureaucratic.  Quite the contrary, it is efficient, helpful and courteous.  As one small example, Delaware was among the first states to accept corporate filings by fax.

Delaware’s large body of corporation laws, including both statutes and court cases, allows a company to avoid lawsuits through better planning.   The law is often much less clear in other states.  Moreover, most corporate attorneys are familiar with Delaware  corporation law in addition to the laws of the particular state where they are admitted to practice. A typical engagement letter from a law firm will say something like, “our practice is limited to the laws of [home state] and the Delaware General Corporation Law.”

For all these reasons, many venture capital firms are more willing to invest in Delaware corporations, and entrepreneurs want to make their new businesses attractive to venture capital firms from the outset.

What are the disadvantages of incorporating in Delaware?  There are two.  First, the Delaware annual filing fee and annual franchise tax is an added expense because most corporations (i.e., those located outside Delaware) must still register as a “foreign” corporation in the state where they are located and and pay annual fees to that state. And second, the annual franchise tax in Delaware can come as a shock if the corporation is formed without adequate planning.

The Delaware annual franchise tax is calculated as follows (this is somewhat over-simplified—the exact calculation can be found at

If the authorized shares have no par value, the franchise tax is $75 for up to 5,000 authorized shares; an additional $150 for the next 5,000 authorized shares; and an additional $75 for each additional 10,000 authorized shares above the first 10,000 authorized shares.  The maximum annual franchise tax is $180,000.

If the authorized shares have a stated par value, the corporation must calculate the “assumed par value”, which is determined by dividing total gross assets of the corporation by the total number of issued shares.  If this assumed par value is greater than the stated par value (which it almost always is), the assumed par value is multiplied by the number of authorized shares.  The result is rounded up to the nearest million, then divided by a million, and then multiplied by $350.  The minimum annual franchise tax is $350 and the maximum is $180,000.

Many entrepreneurs like to start their corporations with a huge number of authorized shares, hoping that they will need these shares for several rounds of future issuance:  founders, new employees, family and friends, angels, venture capital investors and then the IPO.  The problem is that a huge number of authorized shares, if not issued, can result in a very high annual franchise tax for a Delaware corporation, and the tax gets even higher as the gross assets of the corporation grow.  The attached spreadsheet shows the annual franchise tax for a Delaware corporation with 30 million authorized shares (page 1), 10 million authorized shares (page 2) and 1 million authorized shares (page 3), at different levels of gross assets and issued shares.

Delaware Franchise Tax Examples

The lesson here is that it can be very expensive for a Delaware corporation to authorize shares and not issue them.  In most cases it would be better to start out with a small number of authorized shares and then later amend the certificate of incorporation to increase the number of authorized shares when a new issuance is planned.

The Corporation Secretary





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Obamacare: Required Notice to Employees

Under Obamacare, employers subject to the Fair Labor Standards Act must provide a “Notice of Coverage Options” to each employee, whether full-time or part-time and regardless of whether the employer is covered by an employer health care plan.  The purpose of this Notice is to inform employees that they may obtain health insurance through their state’s Health Insurance Marketplace. With respect to employees who are current employees before October 1, 2013, employers are required to provide the notice not later than October 1, 2013.  For each new employee hired on or after October 1, 2013 the notice must be given at the time of hiring.  For 2014, the Department of Labor will consider a notice to be provided at the time of hiring if the notice is provided within 14 days of an employee’s start date.

Employers Subject to the Requirement

Generally, the Fair Labor Standards Act applies to employers that have annual sales or receipts of $500,000 or more.  More information is available through the Department of Labor Wage-and-Hour Division’s FLSA compliance tool.

Content of the Notice

The Department of Labor (“DOL”) published temporary guidance on May 8, 2013  (Technical Release 2013-02) describing the content of the required Notice.

The Notice must inform each employee of the existence of a new Marketplace as well as contact information and a description of the services provided by the Marketplace. The notice must also inform the employee that the employee may be eligible for a premium tax credit under section 36B of the Code if the employee purchases a qualified health plan through the Marketplace; and a statement informing the employee that if the employee purchases a qualified health plan through the Marketplace, the employee may lose the employer contribution (if any) to any health benefits plan offered by the employer and that all or a portion of such contribution may be excludable from income for Federal income tax purposes.

The Department of Labor proves a model Notice for employers that offer a health plan   (Model Notice With Employer Plan)  and a model Notice for employers that do not offer a health plan (Model Notice without Employer Plan).    Employers may create there own version of the Notice provided that it meets the content requirements described above.

Delivering the Notice

The notice must be provided in writing, free of charge, in a manner calculated to be understood by the average employee. It may be provided by first-class mail. Alternatively, it may be provided electronically if the requirements of the Department of Labor’s electronic disclosure safe harbor are met.  Generally, those requirements are:

  • actual receipt of transmitted information (e.g., using return-receipt or notice of undelivered electronic mail features, conducting periodic reviews or surveys to confirm receipt of the transmitted information);
  • protection of the confidentiality of personal information relating to the individual’s accounts and benefits (e.g., incorporating into the system measures designed to preclude unauthorized receipt of or access to such information by individuals other than the individual for whom the information is intended);
  • the electronically delivered documents must be prepared and furnished in a manner that is consistent with the style, format and content requirements applicable to the particular document (e.g., attaching a PDF version of a document to an email); and
  • notice must be provided to the employee, in electronic or non-electronic form, at the time a document is furnished electronically, that apprises the individual of the significance of the document when it is not otherwise reasonably evident as transmitted (e.g., the attached document describes changes in the benefits provided by your plan) and of the right to request and obtain a paper version of such document.

Typically, electronic notices would be provided via the company email system.

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Officers of a Company can be Personally Liable for the Company’s Failure to Collect or Remit Sales Taxes

Under most state tax laws, the tax authority of the state has the option to pursue collection of unpaid sales taxes against any individual who has the authority within a company for the collection and remittance of the tax.  These so called “corporate officer liability” statutes have been in existence for many years but, for the most part, were rarely enforced.  Most states have re-labeled these statutes as “responsible party” statues to make it clear that owners and others can be personally liable even if they are not officers of the company.

Generally, states use “responsible party” laws to impose personal liability on individuals only if they cannot collect from the company itself.  The most frequent cases involve insolvency or dissolution of the company before all sales taxes are paid.  With many states now experiencing revenue shortfalls, some state tax authorities are now aggressively pursuing responsible parties when they cannot collect from the company.  This issue is also more important today because the Internet has raised some difficult questions on when sales taxes must be collected for Internet sales.

A recent Tax Appeals case in New York demonstrates this problem of responsible-person liability very well.   New York Tax Law states that “every person required  to  collect any [sales] tax  imposed by this article shall be personally liable for the tax imposed, collected or required to be collected.” Thus, liability may include not only those taxes actually collected, but also those taxes the company was obligated to collect but did not.  In other words, the requirement to remit sales tax applies whether or not the tax was ever collected.  Moreover, a responsible party is anyone with a duty to act, not just the person who was assigned the responsibility to remit the taxes.

According to the New York Tax Regulations, this question of “duty to act” is to be resolved “in every case on the particular facts involved.” The regulation further states that “[g]enerally, a person who is authorized to sign a corporation’s tax returns or who is responsible for maintaining the corporate books, or who is responsible for the corporation’s management, is under a duty to act.”  A 1990 New York Tax Appeals case established that identifying the person under a duty to act requires an inquiry into “whether the individual had or could have had sufficient authority and control over the affairs of the business to be considered a responsible officer or employee.”   The following factors were found relevant in the sales and use tax area: the individual’s status as an officer, director, or shareholder; the individual’s authorization to write checks on behalf of the corporation; the individual’s knowledge of and control over the financial affairs of the corporation; the individual’s authorization to hire and fire employees; whether the individual signed tax returns for the corporation; and the individual’s economic interests in the corporation.

In the recent New York Tax Appeals case, petitioner was the CEO, a director and a shareholder of a public company. He acknowledged that he was responsible for the day-to-day management of the company but said he relied on the CFO and outside accountants to manage the financial affairs of the company. However, he had access to the company books and records and had the authority to write checks. He also had the authority to hire and fire employees. Based on these facts, he was held to be personally liable for payment of sales taxes owed by the company.

Some Practical Advice

  •        Make sure that all “trust fund” taxes (sales and use taxes and payroll withholding) are paid when due. This may seem obvious, but a business may end up with a large tax bill, including penalties, simply because it did not realize that a transaction was a taxable event.  The danger lies in a tax audit, where the tax authority may recharacterize a transaction or relationship as taxable, and this often occurs in the context of sales and use taxes or withholding taxes. For example, independent contractors may be recharacterized as employees, upon whose wages are due state and federal withholding, FICA, and FUTA.
  •        Consult with an experienced tax advisor to ensure that all relevant taxes are being collected and remitted properly.
  •       When entering into a new business venture, determine up front who will be responsible for collecting and remitting taxes. Do so in writing—in a shareholder or partnership agreement, corporate bylaws, or an employment agreement.
  •      Upon discovering a tax problem, take steps to rectify the problem in order to avoid personal liability and do so while the company is solvent.  The worst of all worlds is to ignore the problem, only to find years later that the company does not have enough money to cover past due taxes and penalties.
  • If faced with a responsible person questionnaire, give serious thought to how—and whether—to complete it. The tax department may have its eye on the statute of limitations and want to identify potential responsible parties early in the audit before any statute of limitation period expires. Once these people are identified, the department can ask for statutory waivers.  (In New York, the three-year statute of limitations for companies does not apply in the determination of the personal liability of responsible parties.)
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401(k) Plan Administrators: Be Very Afraid!

A recent decision of the Federal Ninth Circuit Court of Appeals should give pause to anyone who administers a 401(k) plan or other employee benefit plan subject to the Employee Retirement Income Security Act (“ERISA”).  In Tibble v. Edison Int’l, 10-cv-56406, 2013 WL 1174167 (9th Cir. Mar. 21, 2013), the court ruled that 401(k) plan fiduciaries breached their duty of prudence in the selection of investment options because their reliance on a consultant’s advice was unreasonable. The court said that plan fiduciaries must make certain that their reliance on a consultant’s advice is reasonably justified and they cannot “reflexively and uncritically adopt [a consultant’s] recommendations.”   The court did not say how to determine whether such reliance is “reasonably justified”.   Problem is, the issue will only arise when plan participants have suffered losses and, with the benefit of hindsight, a plaintiff’s lawyer will call into question the soundness of the consultant’s advice and the reliance placed on such advice by the plan administrators.

As background, ERISA, a federal law enacted into law in 1974, contains requirements for the administration of employee benefit plans.   Employee benefit plans include pension plans and welfare plans.  A pension plan means any plan, fund or program that provides retirement income to employees or the deferral of income for a period extending to the termination of employment.  The most common employer-administered pension plan is a 401(k) plan.  The term “welfare plan” means a plan that provides benefits such as healthcare benefits or long-term disability plans.

ERISA creates fiduciary duties for administrators of ERISA plans and imposes personal liability for breach of those duties.  In most corporations with 401(k) plans, the plan is administered by a committee consisting of officers of the corporation.  Each member of the committee is an “administrator” of the plan under ERISA and therefore has fiduciary duties.

Among the fiduciary duties of plan administrators, the most subjective is the “prudent man rule”, i.e., a fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity” would act.  While this sounds like an objective standard, it is really quite ambiguous.  There are “prudent men” who male speculative investments every day.  Offering many of those investments to 401(k) participants would probably be a breach of a plan administrator’s fiduciary duty.  Moreover, most plan administrators lack the experience and knowledge to choose among the wide range of investment options available today.  Hence, most plan administrators hire a financial consultant to advise them.  ERISA not only allows this, it expressly requires it:  if a fiduciary lacks the expertise for a certain area then the fiduciary must obtain expert help.  29 U.S.C. §1104 (a)(1)(B).  Typically, a 401(k) plan will offer a range of investment choices to plan participants and the plan administrators will hire a financial consultant to recommend this range of diversified investment options.   A very important issue raised by the Tibble case is the extent to which plan administrators can rely on advice on financial consultants.

To summarize the facts, Edison International, a California utility, offered its employees investment options in the company’s 401(k) plan, including three retail-class mutual funds. Edison’s 401(k) investment options did not include lower-fee institutional-class funds available from the same investment firm.  The trial court found that the Edison plan fiduciaries did not properly investigate the alternative of offering these institutional-class funds. The Ninth Circuit affirmed.

The court did not accept the plaintiffs’ argument that retail-class mutual funds are an imprudent investment option for an ERISA plan, despite the fact that institutional-class funds charge lower fees.  The court emphasized that retail-class mutual funds have certain advantages, such as participant familiarity and the ready availability of public information on the fund’s performance.  However, the court found that it was imprudent to not consider the option of institutional-class funds.  There was no evidence that Edison or its adviser had investigated the option of institutional-class funds.  Edison argued that it had acted prudently because it based its decision on advice received from Hewitt, which had been retained to provide advisory services to the plan. The Ninth Circuit rejected this argument, stating that expert advice does not absolve a fiduciary of responsibility: “Just as fiduciaries cannot blindly rely on counsel . . . or on credit rating agencies . . .  a firm in Edison’s position cannot reflexively and uncritically adopt investment recommendations.”

Edison also argued that it was not liable because the plan participants who suffered losses had made their own investment decisions.  This defense was based on Section 404(c) of ERISA, which precludes breach of fiduciary duty claims in situations involving decisions made by plan participants.  The Ninth Circuit rejected this argument, saying that section 404(c) only protects fiduciaries from losses that are a “direct and necessary result” of a participant’s action. In other words, if the plan fiduciaries act imprudently when they create the investment options, they cannot later argue that they not liable for the participants’ losses because the participants made the wrong choices.

The Ninth Circuit opinion in the Tibble case, although 50 pages long, is not very helpful on the issue of how plan administrators should ‘investigate’ the investment options recommended by a financial consultant.  What does it mean to say that a fiduciary cannot ‘reflexively and uncritically’ rely on a consultant?  Presumably, it means asking questions.  But does a non-expert know what questions to ask of an expert, apart from “Have you presented all the available options?” and “What else do we need to know to make an informed decision?”  Of course, it will now be common to ask about institutional-class funds and other investment choices with more favorable fee structures, but that is only one issue out of many that a fiduciary could ‘investigate’.  At a minimum, plan administrators should require the financial consultant to thoroughly document its advice, including reference to all the criteria that might be important to plan participants.   Perhaps the company’s legal counsel should prepare a list of the challenges that have been raised by plaintiffs’ lawyers in the many published cases that have been brought against plan adminsitrators, and to question the consultant on how these challenges are address in company’s plan.  Of course, all of this should be part of a written record that can later be used, if necessary, to show that a proper ‘investigation’ was conducted by the plan administrators.

To repeat a point made earlier, ERISA plan administrators have personal liability if they breach their fiduciary duty and plan participants suffer a loss as a result.  If you are on the committee that administers your employer’s 401(k) plan, it would be a good idea to check the company’s indemnification provisions for officers and directors. A “prudent man” would do no less.

Law Offices of Roger D. Wiegley




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Ten Things to Consider When Forming a Joint Venture

1.         Know your partner.    This is obvious.  Go beyond the obvious.  Do as much research as you can so that you understand the corporate culture of the party you will be partnering with.  Do not assume that the individuals you have been talking to at your prospective partner have the same values and vision as the organization they represent.  Has the organization done joint ventures before?  What were the results?  Can you talk to someone at their former partners?  There is more at risk than the hoped for financial results.  Your reputation can be adversely affected by the acts of your partner, even acts that are not directly related to the joint venture itself.

2.         Know your partner’s national culture.  If your partner is located in a country other than your own, invest the time to learn how your partner’s national culture could affect your joint venture.  Learn business etiquette in your partner’s country.  Learn how contracts are perceived, how problems are solved and how partners are expected to behave in your partner’s culture, even if the location of the joint venture operations is elsewhere.  Cultural values and perspectives shape the way people think and act, and the only certainty is that every culture is different.  The more diverse the cultures of the two partners, the more likely it is that unexpected disagreements will develop. This is not a simple undertaking but it is worth the effort.

3.         Decide on the respective roles in detail at the start.   Do not assume that a general description of a partner’s role implies that all related tasks are included in the role.  Create a list of tasks—both expected and those arising in the event of possible contingencies—and assign them to the respective partners.  If there are tasks that neither partner can or will perform, choose the third-party contractors for those tasks before the venture is formed or at least have a clearly defined selection procedure.  This list of assigned roles should include less-than-obvious responsibilities such as risk management and emergency planning.  If the management team of the joint venture is responsible for these areas, this should be clearly delineated and written policies should be required.  Shared management responsibility sometimes results in circular finger pointing when things go wrong.

4.         Discuss contingencies before the agreement is signed.  The only constant in this world is change.  Discuss the “what if’s” with your prospective partner and try to determine how the joint venture will respond to the various changes that might be encountered:  changes in market conditions, competition, personnel or equipment shortages, new regulations, loss of key customers, etc.  This type of discussion serves two purposes.  First, it may lead to adaptive processes and procedures in the joint venture’s structure that allow for greater flexibility when needed.  Equally important, it can give you a better understanding of how easy it will be to get your prospective partner’s cooperation when you believe that changes will be needed.

5.         Create a detailed joint venture agreement.   There are certain areas that should always be covered:

  • Structure of the joint venture (ownership, voting rights, governing body)
  • Objectives (or a reference to a business plan)
  • Financial contributions each will make (up-front and callable or contingent)
  • Composition of the management team and any key individuals to be assigned
  • Contributions of intellectual property to the joint venture and ownership of      intellectual property created by the joint venture
  • Allocation of profits and losses.
  • Liabilities of partners to each other and indemnities.
  • Rights to business opportunities found by but not suitable for the joint venture
  • Distributions
  • Dispute resolution procedure

This list is just a beginning.  Leave as little as possible “to be worked out later.”  More likely than not, later will be harder.

6.             Clear performance indicators.  Establish clear performance indicators for each party to the joint venture.  What if the projections in the business plan are not met? It is not uncommon for the two parties to have different expectations about what the joint venture can achieve at different times in the future and if those expectations are not met, how it will affect the respective contributions of the parties.  For example, if one party is providing the financing and the other party is providing expertise, will the former feel that its financial commitments should be reduced if there are delays in achieving the profit targets?  Performance indicators will provide both parties with a better understanding of what each can expect from the other and it will also probably raise important questions about the changes that should occur if the performance indicators fall short.

7.         Establish an open dialogue.  Generally speaking, unless there is a problem joint ventures do not generate as many meetings or senior-level discussions as would be the case if the joint venture project were simply a project of one of the partners.  Perhaps this is because there is usually travel involved or because the collegial environment inside a single organization is missing.  Or perhaps it is because discussions may disclose differences of opinion and such differences, while easy to resolve within a typical corporate organization, are not so easily resolved in a joint venture.  Whatever the reason, it is important for the joint venture partners to meet regularly face-to-face to discuss progress and to discuss openly all of the issues either party may wish to discuss.  This type of regular dialogue not only mitigates the risk of misunderstandings but also brings attention to matters that, if not discussed, can grow into serious disputes.  It can also foster personal relationships between individuals that prevent the parties from becoming suspicious of each other.

8.         Keep good records.   Who keeps the financial, operational and other records?  Which records are kept and where are they kept?  Who has access?   What records are required by regulations in the location of the joint venture’s operations and in the country of each partner?  How are the records protected?   It is easy to underestimate the importance of the answers to these and similar questions.  The advantages of good record-keeping are of course well known but there is an additional advantage in the case of joint ventures: If a key person who was assigned to the joint venture by one of the parties leaves his or her employer, it will be harder for the person’s replacement to reconstruct the “corporate history” of the joint venture by “asking around”.  The records will have to speak for themselves.  One approach might be to store all the records in a cloud that is accessed through the Internet independently of either party’s IT network.  The access could be controlled through assigned user names and passwords, and permissions could be assigned for adding, deleting and editing documents.  In addition, interested parties could be notified when documents are added and the storage system could have an access log showing who logged-in and when.

9.         Select advisers carefully.   Again, this seems obvious but it should not be considered routine.  Select legal, accounting, tax and strategic advisers who are practical, creative and knowledgeable about the reasons joint ventures can go awry.  Advisers that a company has used in the past with good results may not be the right choice if they lack experience in joint venture planning.  In addition, it is useful to think about who will act as legal counsel to the joint venture after it is formed.   Often, neither partner wants the other partner’s regular counsel to be giving advice to the joint venture because of the potential for a conflict of interest.

10.       Have an exit plan.   When a couple is planning their marriage, the last thing they want to talk about is how they would handle a divorce.  People planning a joint venture are not much different.  Unlike divorce, however, the process of unwinding a joint venture is not spelled out in the law.  It is a creature of contract and if the contract is silent, the parties must negotiate the terms of separation at the time they want to end their relationship. This is often a time when the partners have widely divergent views on what is “fair” and there may even be ill will between the parties.  One common way of addressing the prospect of “irreconcilable differences” in the future is to have a buy-sell agreement (or incorporate buy-sell provisions in the joint venture agreement).  It is important to create such an agreement at the outset of the joint venture because it can be very difficult to negotiate anything at the time of separation, even the process by which the terms of separation will be decided.  There are two types of buy-sell agreements:  traditional and so-called “guts ball” agreements.  In a traditional buy-sell agreement, the parties agree on an appraisal process to determine the value of the joint venture.  Either partner can initiate this process and the initiating partner agrees to buy the other partner’s interest at the appraised value.  The problem with this approach is that the appraised value, even if it is the average of three valuations by three independent appraisers, might be significantly above the initiating partner’s estimate of the true value of the other partner’s interest or significantly below the selling partner’s estimate.  In contrast, the guts-ball agreement does not require an appraisal.  Either partner can offer to buy the other partner’s interest at any time at a specified price.  The partner receiving the offer has two choices and only two choices:  accept the offer or purchase the offering partner’s interest at the same price.   In other words, the partner receiving the offer must either sell or buy, in either case at the price specified by the offering partner.  If the partner receiving the offer makes no decision, that is deemed an election to sell and the deemed election can be enforced in court.  This process is inherently fair because the offering partner could find itself in the position of either a buyer or a seller.  Therefore, it must offer a price at which it would be willing to buy or sell, as the other partner elects.  What could be fairer?  Speaking practically, such buy-sell arrangements are seldom exercised, but the fact that they could be is an inducement to the parties to resolve their differences through negotiation.

The ten points above are just a starting point.  Every joint venture is different and requires a plan that addresses all its unique aspects.  Still, it is well to remember that joint ventures often either fail or they disappoint one or both partners.  Be skeptical, be cautious and be clear.  Don’t let the excitement of the planning stage foster the assumption that the results will be so beneficial to both partners that the future will take care of itself.


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Obamacare: Proposed IRS Regs Define “Large Employer”

Under the Patient Protection and Affordable Care Act (ACA, often called Obamacare), companies with 50 or more full-time workers are required to provide health benefits to at least 95 percent of their full-time employees or pay a $2,000 per-employee penalty (the penalty excludes payment for the first 30 full-time employees).  This requirement will become effective January 1, 2014.  Some employers have been reducing the hours of some employees in order to avoid the threshold of 50 full-time employees.  The IRS has now proposed regulations that will make many such avoidance measures ineffective. Proposed IRS Regulations.

Under the proposed IRS regulations, a full-time employee for purposes of the 50-employee threshold means any worker who is compensated for 30 hours in an average week. These 30 hours thus include all paid hours whether or not the employee actually works during those hours.  For example, paid hours include paid vacation time, jury duty, sick days and voting.

Even more surprising, the IRS views a “full-time employee” as a full-time equivalent.   That is, the hours of part-time employees working under 30 average hours per week will be combined to determine how many 30-hour-per-week equivalents are created in the aggregate.  Thus, two 15-hour per week workers will count as one full-time employee, and six 20-hour per week employees will count as four full-time employees for purposes of the 50 full-time employee threshold.

The proposed regulations also describe the health care insurance requirements that must be met by companies within the definition of “large employer” to avoid the penalty.  This is an area where careful planning is needed.  To avoid the penalty, an employer must offer “affordable” coverage to 95% of its full time employees.  “Affordable” means that the cost to the employee (or the cost of the cheapest option if more than one option is offered to employees) cannot exceed 9.5% of any full-time employee’s household income.  If this requirement is not met and any one of the employees receives a government subsidy or tax credit intended to allow purchase of coverage on an insurance exchange, the employer must make a $2,000 per-employee “shared responsibility payment.”  The problem with a reference to household income is that an employer cannot know the household income of each full-time employee.  Even if it did know, circumstances change and the employer could suddenly find itself outside the ACA requirement.  Thus, employers choosing to provide health insurance will feel that they must offer at least one coverage option that does not require a premium contribution greater than 9.5% of the lowest-paid full-time employee’s annual compensation.   Note that “low cost” option is a relative term; it may not actually come at a low cost to the employer.  The IRS, in cooperation with the Department of Health and Human Services, proposes that employer coverage must meet a minimum value threshold based on a combination of co-payments, deductibles, and other cost factors, determined through an as-yet undeveloped automated tool employers can use to see if their coverage options qualify.

It is quite possible that some small employers, although “large” under the proposed IRS regulations, that currently provide health care coverage for their employees will drop the coverage and elect to pay the penalty of $2,000 per full-time employee.  This penalty could be significantly less than the employer’s share of the premium under the lowest cost option meeting federal requirements.  Some employers may even drop their current coverage and “share” the savings by increasing employees’ compensation, thereby shifting what was previously the employer’s cost to the government through the subsidies and tax credits that will supplement the cost of insurance purchased through an exchange by lower paid individuals.

The deadline for public comment on the proposed IRS regulations is March 18, 2013.


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