What triggers a “technical termination” of a business for tax purposes according to the IRS?

If more than 50% of the interests in a partnership or a multi-member LLC is transferred within a 12-month period, the entity technically ceases to exist under federal tax law. That’s true even if the business continues to operate as normal for all other intents and purposes.

A technical termination can occur even where partial sales occur in different calendar years. So if 25% of a business’s interests is transferred in September 2014 and another 25% are transferred in July 2015, this would still count as a sale of 50% of the business in a year.

A termination can also occur if a multi-member LLC becomes a single-member LLC – even if less than 50% is transferred. So if an LLC has two members, one with an 80% interest and one with a 20% interest, and the majority owner buys out the other owner, that’s still a termination according to the IRS.

This “technical termination rule” is not the end of the world for a business, but it’s something to be consider and address with proper paperwork. For example, a special tax return is due within a few months after the “termination” occurs. Recently, according to public IRS cases, one family business was hit with more than $12,000 in IRS penalties and interest because the family did not realize they needed to file their “special return.”

The partnership or LLC undergoing a transfer or sale must also make new federal tax elections and start over with new depreciation periods – which can significantly reduce tax write-offs. And if the business operates on a fiscal year, the owners might end up having to report more than 12 months’ worth of taxable income in the year the termination occurs.

So, the obvious lesson here is be sure to consult with your CPA before closing on a sale or transfer of a portion of your business.

Prescriptive Easement Issue Arises Against Kind Neighbor

NO GOOD DEED WILL GO UNPUNISHED, and that is certainly the case in the law of prescriptive easements.  Here, a well-meaning property owner invited her neighbor onto her property to perform some clean-up.  She quickly realized that her offer of entry put her squarely in the sights of a future easement claim.  Her posting on AVVO.COM follows, as well as my response:

“A neighbor cut a road across our property. a sheriff has given me an incident number. I think I need a lawyer… help!  We live in the forest, in SugarPine. Neighbor refuses to repair the damage. We granted access for him to clean up his needles, and now there is a 150′ Road!! Please advise what I should do next THANKS!! “

This question raises issues of trespass, prescriptive easement and others. Based upon the facts you stated here, the neighbor appears to have exceeded the rights of use you granted him; however, there could be more to this than offensive behavior. The action hints at an intention to set up prescriptive rights on your property. In order to establish a prescriptive easement in California, a claimant must take action on your property that is “open and notorious,” continuous and uninterrupted for a period of at least five (5) years (occasional use could establish the prescriptive use right for the same frequency, e.g., on weekends), adverse, and subject to a “claim of right” (i.e., not consented to). The holder of a “servient estate” (you) must have actual knowledge of the prescriptive use in order for such use to be “open and notorious.”

While situations like these appear on their surface to constitute simply rude and offensive behavior, the statutory requirements for prescriptive easements actually warrant such behavior in order for the offender to succeed(!) Thus, while the two suggestions of Mr. Martz (consulting a lawyer and writing a letter) are good initial considerations in your strategy to address the matter, the manner in which you or your attorney communicate with this claimant is of equal importance. For example, your attorney may consider whether the demand letter should be sent via certified mail, return receipt requested, in order to satisfy legal requirements and ensure you can meet your evidentiary burden. The lawyer may consider a lawsuit for quiet title or other relief. If the matter can be resolved, the attorney might consider whether a settlement agreement should be recorded to ensure that the resolution runs with the land. The bottom line is that consulting with qualified counsel here is an especially good idea because taking the “wrong” action could end up being tantamount to taking no action at all. This is particularly true in light of the 5-year statutory deadline.

Church Owner’s Charitable Business Threatened by Slanderous Statements

“My husband is a pastor one of the members left the church to start his own church”

“He left upset and has been visiting and calling other members saying false things about my husband and telling them to join his church what can I do ? by the way I recorded our meeting I have proof that he is lying (we have a sign) but no one knows of recording. 
How can I help my husband we already lost a lot of people who believed his lies? My husband reputation is being attacked”

The issue of unfair competition is unfortunately something we see quite often in business litigation.  If the allegations are true, the claims here would not be founded upon “business fraud,” but slander and unfair competition.  The claimants posted the above issue on AVVO.COM recently, and this is how I responded:

The issue regarding the Church member communicating false information about your husband may amount to actionable slander, which would be addressed in the civil courts. You should consult with an attorney for an assessment as to whether the statements satisfy the elements of slander. If the communications include statements that your husband has committed a crime or other such behavior, the allegations would be addressed with a claim of “slander per se,” a claim which places an even higher burden upon the defendant. If there is good reason to believe the communications will continue, consider discussing injunctive relief with your attorney. There are other important torts to consider in this situation as well, to the extent that these statements may be adversely affecting the Church’s income. I have a blog coming out shortly about interference with business income.

That being said, Mr. Hirsch’s admonition about recording conversations is well taken. While a number of States are considered “one party” states, permitting recording of conversations without notice to the other party, California is not one of them. Furthermore, California’s law on the matter is not the only law that regulates recording conversations. The Federal Law also regulates the area, through the Federal Communications Commission (“FCC”) under Title 47 of the Code of Federal Regulations. Any person considering recording a conversation in ANY State should become well acquainted with these rules before surreptitiously recording conversations.

WEARABLE TECHNOLOGY? Workers’ wearable technology will create new headaches for business

Over the next few years, we’ll see the very rapid adoption of wearable technology – smartwatches, Google Glass, and other miniaturized connectivity devices. 

It’s not hard to imagine how employees carrying and using such devices could create problems for businesses.  Think of a service employee whose smartwatch displays inappropriate text messages or images, an accounting worker whose Google glasses capture salary data and automatically uploads it to social media, or a home health aide whose smart bracelet updates the world on her location – even though the home addresses of her clients are supposed to be confidential. How should a business owner deal with these issues?

It’s not too soon for business owners to think about updating cellphone, social media and other policies to take these new devices into account.  For example, cell phone policies that ban phone use in certain times and places could be adjusted to apply to devices that place calls or send messages without the physical use of a phone. Appearance policies could be extended to cover wearable devices that make noise, light up or display data.

Policies providing that employees have no “right to privacy” when using the company’s Internet connection could clarify that this applies as well to wearable devices. Driving policies that prohibit cell phone use could now apply to other communication methods.

It could also be a good idea to clarify that employees do not have the right to secretly record communications or secretly take photos or videos at work. (You’ll need to be very careful with this one, however, because federal labor law does allow workers to document their working conditions for certain purposes, and a company policy cannot prohibit them from doing so.)  In California, we have a “two party” system, wherein anyone wishing to record conversations of another must obtain the consent of the other party to the communication, or if recording multiple parties, obtain the consent of each person participating in the communication.

Amendment or modification of the employee manual is a good place for a business owner to start when initiating policies designed to deal with “wearable technology.”  Thereafter, regular meetings and/or office memos reminding employees of amended or modified policies are a good way to ensure the new policies are observed.

A Lesson for Landlord Attorneys: Mind the Details

The recent case of Bank of New York Mellon v. Preciado (2014 S.O.S. JAD14-06) serves as a good reminder to commercial landlords to pay close attention to details when dealing with residential evictions.  When commercial lenders take properties back by way of foreclosure, they often must deal with the unfortunate remaining task of doing an unlawful detainer on the property.  Many such lenders and their property managers are not accustomed to the rigorous detail required by the statutes in such situations.  The case by New York Mellon against Preciado is a good example of such a “trap for the unwary.”  

California’s legislative branch has taken extensive measures to protect tenants from wrongful and improper evictions.  The rules for residential landlords are rigorous.  While this blog is generally dedicated to commercial lease issues, the following lessons serve as important reminders to commercial lenders and owners when dealing with residential tenants.

Lesson number one for landlord counsel in this case appears to be: never underestimate the resolve of your adversary.  This case, while apparently a quick post-foreclosure eviction, turned out to be a matter that proceeded all the way through trial and up to the Court of Appeal.  The trial court ruled in favor of the landlord, but the tenant did not stop upon the issuance of that ruling.  The tenant’s appeal was unusual and was in fact a far more extensive step than most tenants take in residential cases.  But therein lies the lesson.  The fact that a tenant may be destitute should never be mistaken for a lack of resolve.  Landlord counsel should always expect a tenant to seize upon legal opportunities.

Lesson number two for landlord counsel arising out of the New York Mellon case: hire competent process servers.  Here, the Court ruled that service of process was ineffective where the process server posted notice and made no mention in his declaration that he at least ATTEMPTED personal service.  Where service is carried out by a registered process server, Evidence Code section 647 applies to eliminate the necessity of calling the process server as a witness at trial.  Landlord attorneys usually do not call their process servers as witnesses, and why should they?  If the presumption protects them, why open up Pandora’s Box and put the case in a position of unnecessary risk?  Well, the rule may be generally helpful to the landlord in presenting the case, but it is most certainly another trap for the unwary.

Counsel must make absolutely sure that the Process Server’s proof of service (affidavit attesting to the service) complies with legal requirements.  The proof of service must demonstrate that, even if substitute service is ultimately the basis for the service, the process server at least TRIED to serve the termination notice personally.  No such statement was provided in the proof of service here, so once again, the landlord lost.

Lesson number three for landlord counsel from the New York Mellon case: Be prepared to thoroughly prove up transfer of title.  Post-foreclosure evictions require, as one essential element of proof, that the owner prove he/she/it owns the property.  This really is not a complicated fact.  But the problem arises when there has been, for example, a sale conducted other than by the trustee identified in the deed of trust, and no evidence is put forth showing authority to conduct the sale.  Again, these details are often overlooked, as they were here, and careful attention must be paid on the landlord side to the issue of title, as well as all other issues discussed above.


Transfer disclosure statement required even in mixed use sales!

Richman v. Hartley, 2014 S.O.S. B245052
This is an important recent case dealing with Transfer Disclosure Statements (“TDS”).

California requires its residential property sellers to disclose, in writing, details about the property they wish to sell. The disclosure obligations apply to nearly all California home sellers – whether selling a single family home, condominium or mobile home. Such disclosures are so important that a body of law is dedicated to ensuring the disclosures are made, known as “the Transfer Disclosure Law.” As a general rule, all sellers of residential real property containing “one to four units” in California must complete and provide written disclosures to the buyer. There are a few exceptions, such as properties that are transferred by court order or from one co-owner to another. (See, California Civil Code section 1102.)

The reason these disclosures are so important is that potential home buyers need to know as much as possible about a property in order to evaluate whether to buy it. The “true” condition of the property affects the offer the buyer is willing to make, and the ultimate sales price. The disclosure obligations remind California home sellers that they have a legal responsibility to be open about a property’s condition, and are subject to litigation (or arbitration) if they hide defects.

In this new case, buyer Hartley argued that he was denied a TDS and that seller was obligated to provide one before closing escrow. He contended that a TDS was “required by law” in the transaction because the improvements on the property included two dwelling units. Richman, the seller, insisted that he was not required to comply with the Transfer Disclosure Law, which, he contends, was intended to apply only to transfers of residential real property, not to a mixed-use property such as the one at issue.

The Court of Appeal had no difficulty at all determining that a TDS was required for the sale of this mixed-use property. Neither the original enactment of the Transfer Disclosure Law nor any subsequent amendments has limited its application to transfers of real property that contain only residential units, and no published decision of an appellate court has so limited it. By its language, then, section 1102 applies to any transfer of real property on which are located one to four residential units, regardless of whether the property also has a commercial use.

The result was also supported by other enactments of the Legislature which expressly defined “residential real property” to exclude mixed-use properties. For instance, Business and Professions Code section 11423, adopted in 1992, defines “residential real property” to mean “real property located in the State of California containing only a one- to four- family residence.” (Id., at subd. (a)(3).) The same language was used in section 2954.8, adopted in 1979, governing the handling of impound accounts by financial institutions. That section limits its application to loans made upon the security of real property “containing only a one- to four- family residence.” (Id., at subd. (a).)
The lesson of the Hartley case, then, for all sellers and brokers transacting a sale of “mixed-use” property, is ALWAYS USE A TDS.

BORROWER BEWARE!! Be careful about copyrighted images on websites and sales materials

Graphic designers often like to “borrow” photographs and other artwork in order to create websites, brochures, direct-mail solicitations and other materials. But a business must make sure it has a legal right to use images and designs in its marketing materials.

A company called Dream Communications found this out the hard way recently, when a designer used a photograph without permission in creating an online magazine about luxury homes in Hawaii. The owner of the image sued, claiming that it was entitled to almost $8,000 in licensing fees.  This was only the tip of the problematic iceberg for Dream Communications.  Its problems became nightmares when a court added penalties under the federal copyright law. In the end, Dream was ordered to pay the owner $45,000 in damages, plus almost $7,000 in attorney fees and costs.

There are a number of companies that license “stock art” for business use at a modest cost, as well as websites that offer some artwork for free. This is a safe place to START looking for images and logos, but should not be the end of the analysis.  Business must take every precaution to make sure they are not using images belonging to another company.  


On-line customer harassment and bad Yelp reviews – What’s a business to do?

One of the major concerns that many businesses have in seeking accounts payable, or even in litigating against other businesses who have breached contracts, is negative press.  A lawsuit never looks good, even when a business is “in the right.” Most businesses seek to appear “above the fray” and not given to litigation.  One serious concern in chasing bad debts is that the debtor may pursue an on-line “hate” strategy, designed to drag down the creditor in the eyes of the public.  Negative customer reviews whether they are placed on Yelp or other search locations can be posted as a means to drag the business down.

Online customer reviews have become a very important part of retail business. In one recent survey, two-thirds of shoppers said they consulted online customer reviews before buying. Of those, 90 percent said their buying decisions were influenced by positive reviews, and 86 percent were influenced by negative reviews. Accordingly, if even a small number of disturbed customers or “haters” who are not paying their debts decide to turn the tables with negative press,and post bad Yelp reviews, this can have a vastly destructive effect on a retailer.

A one-star increase in a restaurant’s Yelp rating led on average to a 5-9 percent increase in revenue, according to a recent Harvard Business School study. And a one-point increase in a hotel’s score on Travelocity and TripAdvisor allowed hotels to increase their rates by up to 11.2 percent, according to an analysis by Cornell University.

With online reviews becoming so important, it’s no wonder businesses are so negatively affected when customers post negative reviews, especially if the business thinks the negative marks were undeserved.  To the same extent that positive on-line reviews boost profitability, the negative reviews can significantly impede it.

Is there anything you can legally do about fraudulent or bad reviews ?

Yes and no. It’s possible to sue someone for posting a bad review, but given the high cost and difficult burden of proof, a business will generally want to sue only in an extreme case or if there’s actual fraud (such as if you suspect a competitor is behind the negative evaluations).

Truth can be a complete defense

Generally, customers have a right to express their own opinions and to state facts. So if a person writes that a plumber was rude and surly, that’s their opinion and there’s not much you can do about it. If a person writes that the plumber showed up four hours late, that’s also protected – assuming the plumber actually was four hours late. (Maybe the plumber stopped to save a child from a burning building, and you can respond to the review by providing that information, but the business cannot sue because the review was technically accurate.)  Truth can be a complete defense.

Lies are a different story but caution is in order

If a customer posts outright lies in a review, then the retailer can probably sue for defamation. But be careful! What may seem like a lie to you might seem to a jury (made up of other consumers) like a simple difference of opinion. And bringing a lawsuit can make the problem worse, by alerting the media and giving the original review more attention than it deserves.

On the other hand, if someone truly has a vendetta against you, and is working hard to spread lies and damage your business, then it’s worth considering bringing a lawsuit to protect your reputation.

And if you suspect sabotage, you should definitely talk to a lawyer.

Is there anything you can do about fake reviews?

Fake reviews, sometimes posted by competitors, are a serious problem. A Harvard Business School study recently suggested that roughly 16% of online reviews are fraudulent. And Yelp, which has a fraud algorithm to try to catch faked appraisals, says it excludes an astonishing 25% of its customer reviews as suspected fraud.

Recently, the Hadeed Carpet Cleaning Company in Alexandria, Va. suffered a rash of negative reviews on Yelp. Hadeed suspected that most of the reviews were fake because they tended to make very similar claims (such as that the final charges were double what was quoted) and Hadeed couldn’t match the details of the complaints to any actual customers.

Hadeed asked Yelp to turn over the identity of the reviewers, and Yelp refused. But the Virginia Court of Appeals ordered Yelp to turn over the data. While anonymity and free speech are important, the court said, Hadeed had made a sufficient case of “dirty tricks” because it could prove that some of the reviews could not have been made by actual customers, and so must have been full of false statements.

Think twice about asking your brother to review your business

By the way, not all fake online reviews are from competitors. The opposite problem is that companies sometimes pose as consumers and post highly favorable, made-up reviews about themselves, in order to boost their own scores.  This is illegal, and it might be a good idea to warn any of your employees who might be tempted to “goose” their review scores not to do so in a dishonest way.  Recently, the New York Attorney General’s office busted 19 companies for posting fake favorable reviews, issuing fines in some cases of almost $100,000. Yelp has also sued at least one firm for allegedly posting fake positive reviews.

If a business suspects that a competitor is posting “false positives,” it should consider reporting the action to the authorities.  Depending upon the degree of harm and the malicious intent, further consideration of options should be reviewed with counsel.

If you suspect your business is the target of fake reviews and/or online customer harassment, please consult with a business fraud attorney to protect your rights or if you are in Orange County, call Stephen Hammers, a business fraud attorney in Irvine, California at (800) 511-6058.