Ohio Practical Business Law

Bankruptcy Stats for Columbus, Ohio Over the Long Haul

Teri Rasmussen — Thu, 17 Feb 2011 10:06:32 -0500

When Keith Brown, the Deputy Clerk of our Bankruptcy Court here in Columbus, spoke at a recent meeting of the Columbus Bar Association Bankruptcy Committee, he brought statisitics about bankruptcy filings in Columbus, Ohio over the last 25 years with him. Because this roughly spans my career as a creditors' rights lawyer (I started two years earlier in 1984), this was especially interesting to me.

So what do these stats show? Well, for one thing, I'm thinking that our Bankruptcy Judges must be working even harder now than they always have. We've had three bankruptcy judges in the Eastern Division of the Southern District of Ohio, seated in Columbus, Ohio, since I started practicing law in 1984 (and probably for a while before that). However, there are THREE TIMES the number of filings now as compared with 25 years ago - 5,191 filings in 1986 versus 15,324 filings in 2010.

Other interesting observations:

>>> Chapter 11 cases have actually decreased slightly - only 30 last year as compared with cases numbering in the thirties, forties or fifties many years. You can also see an interesting bump in the 1989-93 period with 274 cases filed in 1990. This takes me down memory lane a bit as most of these were connected to the bankruptcy of Cardinal Industries and were various affiliated real estate limited partnerships operating apartment complexes and Knights Inn motels. This was my "coming of age" case in many respects as I was exposed to all variety of bankruptcy and lending law issues and was trusted with progressively more responsibility representing secured lenders in the case over its four year pendency..

>>> Chapter 12 for farmers was quite popular from 1987 to 1993, but with the exception of one year since then, was not been utilized much.

>>> Chapter 7 cases peaked at 23,425 in 2005 before falling to 5,018 the next year, their lowest number in nearly fifteen years. Of course, this was probably the product of BAPCPA (aka Bankruptcy Abuse Prevention and Consumer Protection Act) in which many people accelerated their filing knowing that when the law became effective, there would be a "means" test making it more difficult to file Chapter 7 in several cases.

>>> The total number of filings was roughly the same betwwen 2009 and 2010 - 15,475 to 15,324 - but increased 20% between 2008's total of 12,991 and 2009. Most of that increase occurred in Chapter 7 filings.

You Gotta Sweat the Small Stuff When Preparing Mortgages in Ohio!

Teri Rasmussen — Sun, 13 Feb 2011 10:15:48 -0500

Finding new and different ways to invalidate a mortgage has been the consummate "cottage industry" for Ohio bankruptcy trustees over the last few years. Typically, these involve the use of sections 544(a)(3) and 551 of the Bankruptcy Code by a Chapter 7 Trustee to attempt to avoid the mortgage as defective and preserve the winnings for the bankruptcy estate

A while back I wrote a post about what could happen if a mortgage accidentally failed to include a legal description and only identified the mortgage property by street address. Happily for lenders, the answer there was that it still works, at least in urban settings where a street address probably really is enough to identify real property.

Since then, in representing various lenders, I've had occasion to learn about all the different ways there are to screw up a mortgage in Ohio and render it ineffective. In other words, the smallest, most insignificant, discrepancy or mistake in a mortgage can result in a lender going from worrying about whether the value of the property is enough to pay off the full amount owed to wondering how they're going to get paid anything at all.

Mortgage Acknowledgements "By the Book" -

Ohio Rev. Code 5301.01(A) sets out the requirements for a valid mortgage. It requires that a mortgage

be signed by the mortgagor
have the signing of the mortgage acknowledged by the mortgagor before a notary public
have the notary public certify the acknowledgment
have the notary public subscribe his or her name to the certificate.

Ohio law provides a suggested form of acknowledgement, which if used, guarantees the effectiveness of the acknowledgement. According to Ohio Rev. Code 147.55(A) an acknowledgement of an individual signing in the following form makes you "golden":

State of

County of

The foregoing instrument was acknowledged before me this (date) by (name of person acknowledged)

(Signature of person taking acknowledgement)

(Title or rank)(Serial number, if any)

Slightly different forms - all using the language "acknowledged" -- are set out for corporations and partnerships. However, Ohio Rev. Code 147.54 also provides that an acknowledgement is acceptable if it contains the words "acknowledged before me" or their "substantial equivalent". In addition, Ohio Rev. Code 147.55 itself specifically states "[t]he authorization of the forms in this section does not preclude the use of other forms." And of course that's where all the legal action is.

The Problem Children -

There are two main problem areas, namely forgetting to write the name of the mortgagor in at all and not completing the acknowledgement properly.

No-No #1 - Blank Acknowledgements : One of the favorite targets for bankruptcy trustees has been to focus on mortgages with notary acknowledgements failing to even mention the name of the folks signing the mortgage. See, e.g. In re Nolan, 383 B.R. 391 (BAP 6th Cir. 2008); In re Leahy, 376 B.R. 826 (S.D. Ohio 2007). Under no circumstances should the notary acknowledgement clause leave blank the NAME of the MORTGAGOR. It's easy to see how this happens - over and over and over again. But as a lender, you've ABSOLUTELY POSITIVELY have got to make sure this doesn't happen, or if it does, make everyone re-sign EVERYTHING, or at the very least the mortgage, before any $$$ go anywhere.

No-No #2 - Sufficiency of Acknowledgement: Then there are all sort of other cases focusing on the specific language used in the acknowledgement. Ohio Rev. Code 147.53 requires that the person taking the acknowledgment certify that

the person acknowledging actually appeared before them
that person acknowledges executing the subject document
the person taking the acknowledgment either knew that person or received satisfactory evidence that the person acknowledging was the person referenced in the acknowledgement

These cases are much more fact dependent and often turn on the presence or absence of particular words. Now pending in the United States Sixth Circuit is a case (Drown et al. v. Citifinancial, Case No. 09-4448) which may shed some light on this category of cases. The case involves two consolidated cases (Hardesty v. Citifinancial, Inc. (In re Roberts), Adv. Pro No. 08-2171 (Bankr. Case No. 08-51945) and Drown v. Citifinancial, Inc. (In re Friesner), Adv. Pro No. 08-2207 (Bankr. Case No. 08- 54576)), originally before Judge Preston, which focused on the limited issue of whether use of the words "executed before me" instead of "acknowledged" renders a mortgage defective. Judge Preston granted summary judgment for the lender in both cases with the opinion being issued in the Roberts case - see 402 B.R. 808 (S.D. Ohio 2009) and this decision was affirmed by the U.S. Sixth Circuit B.A.P., 419 B.R. 20. Oral argument was heard on the pending appeal in the Sixth Circuit in early December 2010. Several other cases which present similar facts are being held in abeyance pending this ruling.

"Bad Boy" Guarantees and the Coming Commercial Real Estate Crisis

Teri Rasmussen — Sat, 05 Feb 2011 11:59:00 -0500

Soaring foreclosures of residential mortgages have somewhat obscured what many believe will soon be a similar collapse in commercial real estate. Which means we'll all be talking more about "bad boy" guarantees before too long. Indeed, just recently, Julie Satow of the NYT wrote that such provisions are hobbling restructuring of commercial real estate loans in her article "'Bad Boy' Guarantees Snarl Billions in Real Estate Debt".

"Bad Boy" Guarantee Defined

Before we get too far, let's make sure we all know what we mean by "bad boy" guarantee, sometimes also called a "springing" guarantee. In commercial real estate - unlike the small business world - loans are typically extended to borrowers on a "nonrecourse" basis. This means the principals of the borrower neither expect, nor have been required, to be personally liable for the borrower's obligation by way of a guarantee or otherwise. Instead, the promissory note (and often the mortgage granted to secure repayment of the loan) contain "exculpatory" clauses. These provisions state that if there is a default on the loan, the lender agrees to look only to the real estate to satisfy the debt and will not seek to collect from the principals - or for that matter, the borrower - personally. A "bad boy" guarantee changes that.

Originally, personal liability was imposed on guarantors of commercial real estate loans - typically the principals of the borrower - only for truly egregious sorts of conduct bordering on fraud, gross negligence, willful misconduct, and the like. Gradually, the nonrecourse "carve-outs" became more extensive and began including such things as the filing of bankruptcy by or against the borrower. For an interesting discussion of some early cases enforcing these sorts of covenants, read Andrew Levy's July 2003 article entitled "'Bad Boy' Guarantees - Courts Are Enforcing Non-Recourse Carve-Outs". A more recent survey of cases and some practical advice for borrowers and guarantors can be found in "Distressed Times Call for Ordinary Measures: Revisit Your Loan Covenants to Avoid Springing Recourse Liability"

Are "Bad Boy" Guarantees Responsible for Commercial Real Estate Crisis?

Ms. Satow's recent NYT article takes a decidedly pro-borrower slant towards the enforceability of "bad boy" guarantees. Her lead:

The commercial real estate market is being hobbled by billions of dollars in distressed debt, and some experts are pointing to a provision in many loans - a so called bad-boy guarantee - that they say is to blame for a large part of the backlog.

Further on in the article, she continues:

Since the market crash, some lenders have engaged in a game of "extend and pretend" with troubled developers, where they extend their loan agreements past the maturity dates to keep them from defaulting in the hope that the economy will improve and the loans will be repaid. As a consequence, the loans are not recorded as distressed though they may be in fact.

Ms Satow's thesis is that "bad boy" guarantee provisions deter bankruptcy filings in which debtors might be able to take action without the consent of lenders. Instead, according to Ms. Satow, distressed real estate situations result in foreclosures and lengthy court battles. She quotes a developer as saying:

If lenders are logical and would rather resolve issues instead of litigate, then they will consider ways to modify the constraints that their borrowers may have originally agreed to.

To emphasize the point that lenders are the problem, Ms. Satow briefly discusses the case of ING Real Estate Finance (USA) LLC v. Park Avenue Hotel Acquisition LLC, Case No. 2010-50276 (February 24, 2010) (unpublished). In that case, the borrower was 19 days late in paying approximately $279,000 (Ms. Satow incorrectly says millions, not thousands) in taxes on real estate securing $133 million in debt. Applying basic principles of contract law, the judge refused to enforce the nonrecourse carve out in this case. And if you read the case, it's a fairly easily reached (and in my view, correct) decision under the facts presented there.

Now maybe it's all my years as a creditors' rights attorney showing, but it seems to me that we are not dealing with unsophisticated people here when it comes to real estate developers taking out loans in the multi-millions. Which is why it makes a lot of sense to me that, as Ms. Satow also reports, for the most part courts have been enforcing "bad "boy" guarantees, often relying on basic contract law principles, even when they are fairly expansive.

Do "bad boy" guarantees constrain a developer's ability to "walk away" from a project heading "south"? In some cases, you bet! And for my part, I don't necessarily see anything wrong with that. If the net result is that everyone involved has to stay engaged to reach a resolution, that does seem like an overall favorable outcome in general.

I do, however, agree with the very last quote in Ms. Satow's article from a lawyer representing both lenders and borrowers: "We either need an alternative way to properly incentivze borrowers or get clarity that servicers can waive guarantees without risk of getting sued." If the combination of "bad boy" guarantees and a servicer's inflexible obligations to the lenders employing them mean that borrowers won't file bankruptcy AND servicers won't budge, that would not be a desirable state of affairs, However, that is an entirely different problem and has much more to do with the relationship between lenders and servicers than being a consequence of the enforcement and enforceability of "bad boy" guarantees.

Ohio Weighs In

In the real world of course, everything is more complicated than a simple matter of enforcing a contract as written. An Ohio case recently argued in the United States Sixth Circuit illustrates the complexity of facts that may exist in these situations. In 111 Debt Acquisition, LLC v. Six Ventures, LLC, Case No. C2-08-768, 2009 WL 414181 (Feb. 18, 2009) (S.D. Ohio), there are allegations that the party filing the prohibited bankruptcy "bad boy" trigger on behalf of the borrower was not reallly authorized to do so. Against that backdrop, the countervailing arguments as to proper contract interpretation of a "bad boy" guarantee provision are interesting to read. For those with PACER access, the Case No. in the U.S. Sixth Circuit is 09-4436 with the oral argument having occurred in December 2010. For those wanting to get directly to the pleadings, here are the Appellant Borrower's inital brief and Reply brief, as well as the Appellee lender's brief.

Interestingly, both briefs make reference to a 2009 article by James H. Wallenstein entitled "'Springing Recourse' Guaranties Enforced in Recent District Court Opinions: Will the Trend Continue? Should In Terrorum Provisions Be Enforced?" For those interested in the subject, this is indeed an article worth reading.

Clearly we have not heard the last about these provisions and their effect.

Tight Drafting is Everything in Preparing Contracts - Lessons of the Bluffton Bus Incident

Teri Rasmussen — Tue, 01 Feb 2011 20:42:42 -0500

When I first heard about the recent Ohio Supreme Court decision in Fed. Ins.Co. v. Executive Coach Luxury Travel, Inc., 2010-Ohio-6300, I didn't pay it much mind. After all, how could a case about insurance coverage have much of anything to do with my business, commercial amd creditors' rights practice here in Central Ohio? After some gentle prodding from a loyal reader of this blog. I realized that the case is really an object lesson about how important good drafting always is.

The underlying case of course involves a terrible accident of a bus carrying members of the Bluffton University (located in Ohio) baseball team.in Georgia. Five people, including the bus driver, were killed and several others were severy injured. The University had contracted with Executive Coach Luxury Travel, Inc. to transport the team. At issue in the case - presumably because the University's insurance had higher limits than that of the bus company -- was whether the bus driver, an employee of the bus company, was an "insured" within the language and meaning of the insurance policy.

For the Ohio Supreme Court, the case really came down to something rather unremarkable - the LANGUAGE OF THE CONTRACT. Here's the relevant provision, referred to as the "omnibus clause", defining an "insured" as:

[a]nyone else while using with your permission a covered 'auto' you own, hire or borrow.

The majority held:

The [insurance companies] contend that they never intended to provide coverage for someone like [the bus driver] whom they consider an unforeseen third party. We consider this contention disingenuous. The omnibus clause is broad. It applies, with the above exceptions [found inapplicable], to "anyone else." We are not persuaded by the contention that the driver of a bus that Bluffton rented from a company in the business of renting buses is an unforseen third party, when a clause in the insurance policy covers "anyone else" driving a hired auto. ...

On its face, it is clear to us that the ;clause applies to the case before us; Bluffton hired the bus from [the bus company] and granted permission to [the bus driver] to drive the bus. Whether the insurance company intended the clause to apply is immaterial because the language of the policy supports a conclusion that [the bus driver] is an insured. We consture insurance policies liberallly in favor of the insured.

A dissent in which two justices joined found just as unambiguous an interpretation:

The omnibus clause... does not apply to the facts of the case because Vluffton did not "hire" a bus or give "permission" to [the bus driver] to drive. Instead, as the trial court found, the evidence demonstrates that Bluffton contracted with [the bus company] for transportation services -- and a bus and driver were incidental to the contract. [The bus company] chose a bus to provide Bluffton with transportation, and [the bus company] hired [the bus driver] to drive. Although [the bus company] worked to accomodate the requests of its client, ultimately, [the bus company] was responsible for assigning a bus and driver to provide transportation services to Bluffton. Thus, [the bus driver] was nit an insured under the omnibus clause.

And here is the lesson for business and other transactional attorneys - it really does matter what you put in documents. Personally, I find the majority's decision a rather strained interpretation in search of a result of providing insurance coverage. I rather doubt that the bus driver would have said that he believed he was covered by the University's insurance had anyone asked him before the trip began. But the point is that now there will probably be a specific exclusion in new policies to prevent liability of this nature in the future. And had there been such language in this contract, the result might have been different.

In the next couple of posts I will examine some particular situations in which results really are turning on how one little word is interpreted,

Ohio Statutory Exemption Amounts Increased in 2011

Teri Rasmussen — Mon, 31 Jan 2011 14:56:19 -0500

Applicable exemptions from execution, garnishment, attachment, or sale - or most importantly - in consumer bankruptcy - have increased with respect to judgments or orders entered after April 1, 2010..

One of the useful things about being involved in bar association activities is the way it keeps you current with developments in your practice area. And, if you haven't been paying attention to everything, it's a good way to catch up. So it was that I was reminded that Ohio state law exemptions are now making an effort to keep up with inflation.

In my creditors' rights world, exemptions seem to come up most often in the context of individual consumer bankruptcy. Section 522 of the Bankruptcy Code lets a debtor keep specific property up to a certain value. It also lets each State decide whether to use the federal exemptions found in secion 522 or require debtors residing in its state to use state law exemptions. Ohio has chosen to "opt-out" of the federal exemptions and requires debtors to avail themselves of the exemptions provided by Ohio Rev. Code 2329.66.

For many years, nothing was done about the amount of exemptions allowed, thus making them less and less meaningful. That changed in 2008 when the General Assembly updated all of the amounts. In addition, Ohio Rev. Code 2329.66(B) also required the amounts to be updated every three years beginning April 1, 2010 "to reflect the change in the consumer price index for all urban consumers, as published by the United States department of labor." Although the original leglislation failed to specify which state agency was responsible for this task, it has now been assigned to the Ohio Judicial Conference. Click here to see the new amounts which will remain in force until April 1, 2013.

Learning M&A Strategy and Tactics Through Abercrombie & Fitch's Corporate Activities

Teri Rasmussen — Thu, 23 Dec 2010 17:42:38 -0500

As I was catching up on my Google Reader entries from out here in the heartland of Iowa where my folks reside (Xmas break), an article in the NYT's Deal Book by Steven Davidoff entitled "Abercrombie's Ohio Express" caught my eye. According to the article, Abercrombie & Fitch is MOVING ITS STATE OF INCORPORATION FROM DELAWARE TO OHIO!! As well as making several other corporate governance changes. (Apparently all the stuff I've been hearing about how hard my government officials have been working to make Ohio friendlier to businesses must be paying off - yeah, right.)

Davidoff links to the preliminary proxy statement filed with the SEC yesterday (December 22, 2010). According to the preliminary proxy statement, Abercrombie & Fitch is making this move because

Operational Benefits and Commitment to Ohio - the vast majority of A&E employees and the company headquarters are in Ohio - New Albany (an upscale suburb on the outskirts of northeast Columbus) to be exact
Reduction of State Tax Liability - it'll save $180,000 a year
Address Corporate Goverance Matters "in a manner that we believe appropriately protects and benefits the Company and its stakeholders"
Enhancement of Ability to Attract and Retain Qualified Directors because "Ohio law affords directors a clearer balance of corporate governance rights and responsibilities than Delaware law"

OK, so does anyone really believe some of these reasons? I find myself rather skeptical that a corporation the size of A & F would make such a fundamental corporate change just to save less than an amount likely to have been some A & F upper managment type's bonus for the year. And, like Davidoff, I find it unpersuasive that this change will substantially enhance the ability to draw top shelf directors - I've just never thought of Ohio corporate of a public (or for that matter, private) corporation. As for the "we're so committed to Ohio" argument - well, I've rarely seen that as a standalone reason for making this sort of corporate decision. So, as Davidoff points out, it's really all about the corporate governance matters.

Davidoff sees the move as a possible effort to benefit from stricter anti-takeover statutes in Ohio and does a great job of explaining the possible implications of this unheralded (there was no press release and, as Davidoff notes, filing something this time of year does seem like you're hoping no one notices) corporate move. Davidoff concludes:

The move allows Abercrombie to greater manage the acquisition process to a preferred bidder and without fear of new shareholders interfering. Shareholders will gain a bit by perhaps being allowed to call special meetings and remove directors if they approve next year the elimination of Abercrombie’s staggered board. But the question is whether Abercrombie’s shareholders and Institutional Shareholder Services and other proxy governance services will think it is enough to justify Abercrombie’s move.

In addition to reading Davidoff's article, you should take a look at the preliminary proxy statement itself if you are remotely interested in either

this unusual move by Abercrombie & Fitch
learning more about how M&A works in Ohio

The preliminary proxy statement references pertinent Ohio statutes, as well as Delaware law, and compares the provisions of Ohio and Delaware law where applicable. It is extremely well written and provides a fairly accessible explanation of important elements of key M&A and related corporate law in Ohio.

This is an interesting development both with respect to Abercrombie & Fitch itself and as an object lesson to be played out in the nuances of Ohio corporate law. According to the Columbus Dispatch article on this development, the SEC has ten days to comment. Something worth following in the winter months ahead.

LLC Membership Interests as Securities?

Teri Rasmussen — Tue, 21 Dec 2010 15:34:03 -0500

Finding capital for a new venture is always a challenge and many an entreprenuer looks to solve this problem by swapping membership interests in the new limited liability company formed to run the business in exchange for funds. However, in the excitement of the moment, the entreprenuer may not even think about the fact that those membership interests might actually be "securities" whose sale must be done in compliance with state and federal securities laws.

Both state and federal law cast an extremely wide net in defining what constitutes a "security"; indeed Ohio Rev. Code 1707.01(B) specifically mentions membership interests in its definition.

In the case of federal law, there are three basic approaches to determining if something is a "security" subject to regulation.

Landreth Timber Test
Reyes Family Resemblance Test
Howery Efforts of Others Test

In Landreth Timber Co. v. Landreth, 471 U.S. 681, 687,690 (1985), the instrument in question was in fact called “stock” and possessed the usual characteristics associated there with – i.e., (i) the right to receive dividends contingent upon an apportionment of profits; (ii) negotiability; (iii) the ability to be pledged or hypothecated; (iv) the conferring of voting rights in proportion to the number of shares owned; and (v) the capacity to appreciate in value – was determinative.

For promissory notes, the “family resemblance” test for determining if something is a “security” was enunciated in Reves v. Ernst & Young, 494 U.S. 56 (1990). The test is designed to ascertain the “economic realities” of the transaction. It has been explicitly adopted as also governing Ohio securities law in Perrysburg Twp v. City of Rossford, 103 Ohio St.3d 79, 2004-Ohio-4362 (2004). The test focuses on:

Motivations – if for investment, then security; if commercial, then not a security
Plan of Distribution – common trading for investment v. one-on-one negotiated transaction
Reasonable Expectations –would a reasonable member of public consider it an “investment”

When it comes to LLC membership interests, the Howery test is the most applicable in determining if a LLC membership interest is a "security". In SEC v. W.J. Howery , 328 U.S. 293, 299 (1946), the United States Supreme Court defined an “investment contract” for securities law purposes as:

[A] contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.

For purposes of analysis, the Howery test can be broken down as follows, with the last element being the most difficult to analyze in practice:

Investment of Money
Common Enterprise
Expectation of Profits
Profits Solely from the Efforts of Others

In Ohio and eleswhere, arguments have been made that at least in the case of member-managed LLCs, a membership interest should not be considered a security. Although there doesn’t appear to be any Ohio caselaw directly addressing this question, some courts in other jurisdictions have concluded that LLC membership interests are not securities. See e.g., Nelson v. Stahl, 173 F. Supp.2d 153, 165 (S.D.N.Y. 2001) (“Because the LLC agreements grant their members direct authority over management of the entities, their structure precludes” a finding that LLC membership interests are securities.); Great Lakes Chem. Corp. v. Monsanto Co., 96 F. Supp.2d 376,392 (D. Del. 2000).

Logically, this makes a fair amount of sense to me. If - as is the case in most smaller member-managed LLCs - the members themselves are all an integral part of the operation and success of the business, it is hard to see how a membership interest truly fits the definition of a secuiryt. And harder still to see how the underlying policy of essentially making sure people ge enough enough information to make decent investment decisions about what to do with their $$ is really served inthese instances.

You might think that's all very well, but what about that explict reference to LLC membership interests in Ohio's statutory defintion of "security"? It doesn't differentiate between member-managed and manager-managed LLCs. However, from time to time, despite this seemingly rather large obstacle, the argument is made that membership interests in at least member-managed LLCs ought not to be treated as a “security”. The idea is that LLCs are a hybrid between partnerships and corporations and that member-managed LLCs are much more like partnerships than corporations and afford the member with managerial control. This argument relies upon Perrysburg Township v. City of Rossford, 149 Ohio App. 3d 645, 653, 778 N.E.2d 619, 624-25 (2002) in which the Court stated:

despite the fact that a particular instrument may be included in the list of transactions constituting securities, that inclusion is not conclusive proof that an instrument is a security…. The determination of whether a particular instrument must be made on a case-by-case basis with the primary emphasis on the economic realities of the instrument.

Furthermore, in a case involving a partnership interest, the U.S. District Court for the Northern District of Ohio opined “in determining whether an investment qualifies as a security under §1707.01, Ohio courts uniformly require that an investor not have received the right to exercise managerial control over the enterprise invested in.” J & S Enter. v. Warshawsky, 714 F. Supp. 278, 281 (N.D. Ohio 1989)

So perhaps the door is still ever so slightly ajar....

Using Exemptions from Registration of Securities

Teri Rasmussen — Fri, 03 Dec 2010 08:26:17 -0500

Whether its LLC membership interests or more traditional corporate stock being offered to potential investors, there are certain rules that need to be followed to stay out of trouble with state and federal authorities. Most importantly, a "security" such as stock or possibly a membership interest must either be "registered" with state and federal agencies OR an exemption from reigstration must exist. Because registration is an extremely expensive time consuming process, if at all possible an exemption from registration should be found.

Accredited and Unaccredited Investors

One of the keys to staying out of trouble is identifying prospective "accredited" and "unaccredited" investors and understanding the difference between the two, together with the proper marketing approach to each. An Accredited Investor is an investor able to bear the investment’s economic risk and who already has access to type of information normally contained in a prospectus. Specifically, an accredited investor is further defined as an institutional investor or person with, in the case of entities, at least $5 million in assets and, with respect to individuals, having a:

(1) Net worth (including spouse) of individuals greater than or equal to $1 million, or

(2) An annual income of greater than or equal to $200,000 (or $300,000 when considering jointly with spouse) for the current year and the two previous years.

An unaccredited or Non-accredited Investor is simply any person or entity who is not an “accredited investor”.

Here's how it works for a company looking for new investors. Accredited investors are typically required to complete Subscription Agreements and Investor Questionnaires to demostrate they meet the requirements of being an accredited investor. How the company goes after prospective investors depends on how much capital a company wants to raise in the next 12 months.

Rules for Raising Capital

It is important to be careful about compliance with both federal and state securities regulations because a violation with respect to even a single investor can invalidate the entire transaction. In addition if investors are sought in more than one state (e.g. Ohio and Kentucky), the issuing company must be in compliance with the laws of every state from whence investors are coming. Here are some of the major federal exemptions from reigstration; state exemptions often mirror federal exemptions

Less than $1 Million. For a privately held company - this exemption is not available to public companies - wishing to raise less than $1 million in any twelve consecutive month period, no specific form of disclosure is required nor is there any restriction on the sort of investors permitted. However, general solicitation and advertising is permitted only with respect to accredited investors unless the offering is registered or exempt under state law. Re-sales do not need to be restricted if the offering is registered under state law (otherwise it must be restricted for 2 years).

General solicitation and general advertising include, but are not limited to, any advertisement, article, notice, or other communication published in any newspaper, magazine, or similar media; or broadcast over television, radio, or the Internet (or other communications devices); and any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. The prohibition on advertising and solicitation may be difficult to apply in practice – what if media does story on product of new company? In addition, putting blanket information on company website with “click here” option to invest is a particularly bad idea.

More than $1 Million. If a company wants to raise more than a million, different rules apply. First unaccredited investors must be given a private placement memorandum (PPM). A PPM is a lengthy stand-alone document disclosing everything prospective purchaser needs to know about the company, as well as the company’s plans and prospects, to make an informed decision to invest in the company. The PPM will generally include a Subscription Agreement which acts as the “sale contract” for the ownership interests being offered. In addition to providing required information to prospective investors, a PPM can also serve as protection against securities fraud claims by establishing a record of what information was provided potential investors. A PPM includes:

Cautionary Language regarding investment risks
Summary of Offering terms – often in a table format
Description of issuing company, its organizational structure, management team, capitalization, and history
Business Plan and selected financial data
Specific risk factors
Disclosure of potential conflicts of interest
Subscription procedures

If PPM has stated maximum or minimum duration of the offering or level of investment to consummate the operation of the company, the issuer cannot change those unilaterally – all investors must sign off. Anti-fraud provisions are still applicable and the burden still on issuer to demonstrate offering qualifies for exemption from registration.

Less Than $5 Million. A further disitinction is made between companies wishing to raise more or less than $5 milllion in a 12 month period. A public or privately held company wishing to raise $5 million or less in any twelve consecutive month period may use another exemption to make sales to an unlimited number of accredited investors. However, sales to non-accredited investors are limited to 35 such investors and they must all be given audited financial statements of the issuer. Resales are restricted for at least two years and no general solicitation or advertising is permitted at all.

Safe Harbor Rules. Companies wishing to raise more than $5 million or which otherwise do not fit within the other exemptions may use another exemption sometimes known as the "safe harbor" eexemption to raise an unlimited amount of capital. This exemption requires all non-accredited investors (limited to 35 in number) – either alone or through the advice of a purchaser representative – to have knowledge of the subject issuer without disclosure, as well as have sufficient knowledge and experience in financial and business matters (called “sophisticated”) to make them capable of evaluating the merits and risks of the prospective investment.

Intrastate Exemption. . A company seeking investors only from its own state is eligible for an exemption from registration of the securities being offered. under this exemption, the issuing company must be incorporated in the state in which securities will be offered (e.g. company incorporated in Ohio offers shares to Ohio residents). In addition, the issuing company must carry out a significant portion of its business in the selected state. There is no limit on the size of the offering or the number of purchasers.

Source of Receiver's Ability to Sell Real Property

Teri Rasmussen — Tue, 30 Nov 2010 17:35:51 -0500

In my last post, I discussed the most prominent Ohio case law regarding the authority of a court-appointed receiver to sell real property out of the receivership, free and clear and without encumbrances of course. But where does the receiver's authority to do anything with the property come from in the first place?

We need to start with the statutory authorization for a lender to have a receiver appointed. Ohio Rev. Code 2735.01 explains in relevant part:

A receiver may be appointed by ... the court of common pleas or a judge thereof in his county... in the following cases:...

(B) In an action by a mortgagee, for the foreclosure of his mortgage and the sale of the mortgaged property, when it appears that the mortgaged property is in danger of being lost, removed, or materially injured, or that the condition of the mortgage has not been performed, and the property is probably insufficent to discharge the mortgage debt;...

(F) In all other cases in which receivers have been appointed by the usages of equity

Thus, by statute, if property is deteriorating in value, has deferred maintenance issues, or other undesirable consequences may result from allowing the present situation to persist, a court is going to be inclined to appoint a receiver.

Furthermore, nearly all commercial mortgages/assignments of rent are going to have a clause pursuant to which the borrower explicitly agrees to the appointment of a receiver. The following is a fairly typical example:

Appointment of Receiver. Mortgagee shall be entitled (without notice and without regard to the adequacy of any security for the indebtedness secured hereby) to the appointment of a receiver of the rents and profits of the Property, and such receiver shall have, in addition to all the rights and powers customarily given to and exercised by such receiver, all of the right and powers granted to Mortgagee contained herein.

So, even apart from the statutory basis, virtually all lender mortgagees will have the contractual right to have a receiver appointed in the event of a default.

The question then becomes what exactly can the receiver do once appointed. Here is where the debate is waged. Ohio Rev. Code 2735.04 is extremely broad in describing the permissible powers of a receivers, stating simply:

Under the control of the court which appointed him, as provided in section 2735.01 of the Revised Code, a receiver may bring and defend actions in his own name as receiver, take and keep possession of property, receive rents, collect, compound for, and compromise demands, make transfers, and generally do such acts respecting property as the court authorizes.

So the fundamental question is whether the deafening silence as to the specific right of a receiver to sell real property should be taken as permission or prohibition. The trend, especially recently, as been to see the lack of any restriction as enabling. And of course it doesn't hurt that those provisions in mortgages authorizing appointment of a receiver are very broad themselves with respect to the rights granted the prospective receiver.

Authority of Foreclosure Receivers to Sell Real Property - Yes, EVEN in Cuyahoga County!

Teri Rasmussen — Sat, 20 Nov 2010 14:28:33 -0500

UPDATED NOVEMBER 30, 2010 >> I KNEW this day would come one of these days - I write a perfectly good post on a useful topic and then mere days later some court issues a ruling which completely changes the gist of what my remarks should be.

From a lender's standpoint, foreclosures in Ohio (and probably elsewhere as well) take SOOOO long. And if we're talking commercial property which generates revenue (or at least could), there's the added irritation that those funds may not be coming the lender's way on their own. So what's a lender to do?

By this time a lender (or perhaps the borrower) has already rejected a deed-in-lieu arrangement in which the borrower conveys the property over to the mortgagee lender in exchange for all, or a portion, of the indebtedness being satisfied. In addition to a borrower not being willing to go this route, lenders may not find this an effective solution if, for example, there are junior liens encumbering the mortgaged property.

As a lender, you could of course pray for the borrower to file bankruptcy where at least (1) you can control and direct the use of "cash collateral", i.e. any rents and other monies being generated by the operation of the property; and (2) you might be able to force one of those famous "363 sales" and get the property sold. 'Course bankruptcy - especially of the Chapter 11 kind - comes with its own set of headaches for a lender and may not be much, if any, improvement.

What about using state court procedures which may be less expensive to accomplish the same objective? Yes, I'm talking about getting a receiver appointed who can then market the commercial property and consummate a sale with an interested purchaser.

Most lenders are familar with the concept of getting a receiver appointed in commercial foreclosures to protect, preserve, and maintain the property until a foreclosure. In Ohio - as in many other states - receivers are commonly and relatively easily appointed in these situations, particularly when the terms of the mortgage itself authorize such an appointment. Read my Source of Receiver's Ability to Sell Real Property for more on this.

No Authority for Receiver to Sell Free and Clear. However, in Ohio, as elsewhere, it has been and to some extent remains, a bit unclear as to whether an appointed state court receiver may sell real property free and clear of liens and encumbrances.

In Indiana, a recent case – decided on extremely bad facts from the lender perspective in my opinion --.found that such a sale by a state court receiver was not permissible. However, when read closely, the case really turns on due process concerns arising from the fact that the receiver tried to sell the property without returning to the court for additional specific authorization to sell the property.

Similarly, Ohio Director of Transp. v. Eastlake Land Dev. Co., 177 Ohio App.3d 379, 894 N.E.2d 1255, 2008-Ohio-3013 (8th App. Dist.), is misread by many as limitation on the authority of a court-appointed receiver to sell real property. In this respect, the Court's reliance on the unreported Richland County case of Au v. Au Rustproofing Ctr., Inc. (July 3, 1984), Richland App. No. CA 2227, 1984 WL 4959 is important. Even though liens on the real property were to attach to a fund created by the sale in the Au Rustproofing case, the Ohio Fifth District Court of Appeals reversed the trial court's approval of a sale by the receiver, saying, "[W]e believe the courts do not have the power in receiver proceedings to take away lien rights in property which were vested by contract or by operation by law without the consent of the lienholders." In Eastlake, after quoting this passage with approval, the Court of Appeals said:

The trial court did not have authority to authorize the receiver to convey the property free and clear of AFF's contractual lien rights in the property without AFF's consent or notice to AFF that the property would be sold free of its lien. The trial court's order authorizing the receiver to do so effectively resulted in a denial of AFF's due process rights and, accordingly, was erroneous as a matter of law. (emphasis supplied)

However, key elements leading to the appellate court's reversal of the trial court order permitting the sale included the fact that the receiver did not provide any evidence concerning the value of the property and the trial court failed to provide appropriate due process for the lienholder to assert its rights. And interestingly, unlike the Au Rustproofing court, the Eastlake Court seemed most vexed by the lack of due process, rather than just termination of lien rights, stating:

the procedures mandated by foreclosure are more than statutory "hoops" though which one must jump; they embody real concepts of due process. Notice, opportunity to be heard, independent appraisal, and public sale are designed to protect the interests of all parties; due process is a notiion embedded in all court action.

At least two Cuyahoga County Common Pleas cases have apparently taken Eastlake as an absolute prohibition on permitting any sale free and clear of liens by a receiver under any circumstances.

>>>>>>>>>> UPDATE >>>>>>>>>>> UPDATE >>>>>>>>

SO NOW we have the Ohio Court of Appeals for the Eighth Appellate District (that's Cuyahoga County, i.e. Cleveland) issuing an opinion on November 24, 2010 in Huntington National Bank v. Motel 4 Baps, Inc., 2010-Ohio-5792, Case No. 95107 dissing Eastlake and gong along with the cases discussed below in upholding the ability of a court appointed receiver to sell real property under certain circumstances. (Hat tip to my friend Carole Weiss for calling my attention to this case)

And if ever there were a case making it easy to shred the perceived purported holding of Eastlake that receivers had no such authority to sell real property, this case was certainly the poster child for it. Whereas the receiver in Eastlake apparently took some illadvised shortcuts resulting in rather questionable due process, in the Motel 4 Baps case, we have due process all over the place.

After a receiver was appointed in this commercial foreclosure case, the receiver retained the services of a commercial real estate firm to market and sell the subject property. Eventually a public auction of the property was scheduled, but before it could take place, the borrower filed Chapter 11 bankruptcy. At that juncture, a negotiated resolution is reached allowing the borrower sixty days to refinance or arrange for a friendly purchase. After the expiration of this period, a second auction is scheduled after which the receiver files a motion with the trial court seeking authorization to consummate a sale to the highest bidder. A hearing is held on the motion and the trial court approves the sale. Like I said, LOTS and LOTS of DUE PROCESS here.

The borrower apparently relied primarily on the argument that the provisions of Ohio Rev. Code 2329.26 - which by its explicit terms applies to execution sales - must be followed. (Why the borrower didn't just jump up and down yelling "Eastlake - no authority to sell", which would have been a far better argument in my opinion, I don't know.) Anyway, the Court of Appeals wasn't much impressed and easily distinguished execution sales which happen AFTER judgment is taken from receivership sales.

The Court then cited the cases discussed below (without discussing them unfortunately) and pointed out that Ohio Rev. Code 2735.04 - which actually DOES govern receiverships - gives receivers extremely broad powers. It further distinguished Eastlake on the basis that the decision there really revolved around the complete absence of due process - my point exactly.

SO, apparently, even in Cuyahoga County, receivers CAN sell real property prior to the forecosure sale as long as due process is observed. Makes sense to me.

>>>>>>>>>> UPDATE >>>>>>>>>>> UPDATE >>>>>>>>

Receiver Does Have Authority. In contrast, in another recent case, the Warren County Court of Appeals has ruled that a state court receiver does indeed have this power. In Park Nat. Bank v.Cattani, 187 Ohio App.3d 186, 2010-Ohio-1291 (12th App. Dist.), the Court focused on the role of a receiver as an agent of the court, stating:

The Supreme Court of Ohio has interpreted R.C. 2735.04 "'as enabling the trial court to exercise its sound judicial discretion to limit or expand a receiver's powers as it deems appropriate.'" As a result, because R.C. Chapter 2735 "does not contain any restrictions on what the court may authorize when it issues prders regarding receivership property," we find that this includes the power to authorize a receiver under certain circumstancea to sell property at a private sale free and clear of all liens and encumbrances. (citations omitted).

The Court also noted that all parties had been properly served and concurred with the trial court's view that a sheriff's sale would not have brought a higher price.

Quill v. Troutman Ent., 2005-Ohio-2020 (2nd App. Dist.) - we're talking Dayton area here -- decided a few years ago, also approved the ability of a receiver to sell real property in appropriate circumstances and adequate notice and due process procedures.

For those wanting a more detailed and scholarly summary of these cases, read A Model Statute for Free-and-clear Sales by Equity Receivers by Colette Gibbons and Jason Grimes which was published in the ABI Journal

So, the BOTTOM LINE in all this? ~~Unless you're trying to get a receiver authority to sell real property in a case in Cuyahoga County,~~ you should be OK as long as you use common sense in providing notice and due process to interested parties and provide at least some evidence as the the value of the property and/or efforts already undertaken to sell it.

Lender Tips for Smoother Sailing in Navigating Bank Customers' Chapter 11 Cases - Knowing Where You're Starting From

Teri Rasmussen — Thu, 11 Nov 2010 10:17:44 -0500

In the current economic environment. many lenders are getting far more experience with Chapter 11 bankruptcy filings of bank customers than they would like. What do you really need to know to deal with these situations efficiently and effectively? What's the most important thing to do first? LOOK AT THE FILE and figure out where you're starting from. Whenever I am asked to represent a lender in a bankruptcy or workout scenario, this is ALWAYS the very first thing I do. How else can you figure out where you can hope to get to and how best to get there?

Hopefully and most likely, you've known this day was coming for a long time. In fact ,if like most lenders, you have a "blanket" security interest in all business asset of your borrower and your borrower has engaged experienced bankruptcy counsel, you've probably already been involved in negotiations over use of "cash collateral". This is in fact probably a "good" thing. If you haven't yet been contacted about this, then dealing with that should be one of your first priorities >> more on that later.

But we're getting ahead of ourself here. At the moment a lender first recognizes that a loan may be "going south", the most important thing to do is to immediately review the bank's credit and collateral files to determine if there are any vulnerabilities in the lender's position, If you haven't already done this, DO THIS NOW!!! It will determine the strength and leverage of the lender's position and circumscribe the parameters of what a lender can expect as a result of the bankruptcy filing. And if you are fortunate to recognize an issue early enough, maybe even several months before a filing, you may well be able to mitigate the range of consequences through various proactive preventive actions.

Documentation and Perfection. So, what should you be looking at/for in these files? First and foremost, a lender should check to be sure its lien is properly perfected and the loan documentation is in order. If real property is involved, this means making sure there is a recorded copy of the mortgage. If, instead, personal property such as equipment, inventory, or accounts receivable is involved, has a financing statement been properly filed (and if necessary had a continuation statement filed if the loan is more than five years old)? And yes, these mistakes really happen - way way more than you might think.

has the financing place been filed in the right place, i.e. jurisdiction in which debtor is organized or incorporated in most cases - NOT where the collateral is except for crops, minerals, etc.?
Is the financing statement filed in the correct name, i.e. the "official" name shown in the organizational documents on file with the State - NOT a trade name? And the spelling is correct?
has the collateral been adequately described AND not described too narrowly? "All business assets" is no good, but "Bulldozer, S/N1234578" isn't much help either if that particular piece of equipment has been replaced or additional collateral has been acquired by the borrower.
- A subissue here is whether the collateral has been properly described based on the use it has in the hands of the debtor, i.e. is it equipment or inventory?

A lender should also take time to review the underlying loan documentation to be certain it contains the proper signatures, does not have blanks that should have been filled in, or have exhibits that never quite got attached to documents, and the like. In addition, the technical form of the documents can also be important to verify - although this is currently more prevalent in consumer cases, one "hot" area of bankruptcy lien avoidance litigation is attacking the form of the mortgage and the acknowledgments in particular.

Priority and Valuation. After reviewing the basic loan documentation and verifying that the lender is in fact a SECURED creditor, it is equally important to understand your priority position as compared with other creditors and the extent to which you may be undersecured.

if you are in that mythical group of secured creditors who is oversecured by a considerably amount, stop reading right now and go out and buy a lottery ticket as clearly you are blessed beyond all measure and should be applying your talents elsewhere.

WIth real property, obtaining title work is probably key to verifying that your mortgage lien is in fact first. You'll probably also want to check with the office of the County Auditor and/or Treasurer to find out if there are delinquent taxes and if so, how much. (If a foreclosure precipitated the filing, you'll already have this info.) With personal property, a UCC lien check with the Secretary of State, as well as judgment lien searches in appropriate courts are probably in order. Then there are those nasty little exceptions to the general "first filed, first in priority" rule - the dreaded floating lien in receivables cut off by IRS tax liens, purchase money security interests (PMSI) notices (and whether they were or weren't properly sent and what record there is of that now anyway)

Sometimes priority is fairly straightforward and an acknowledged pecking order emerges among multiple secured creditors. However, many other times, it's not nearly as clear as various creditors advance different theories as to why their security interest should have priority over others. Other times the debtor may just not see the issue the same way as the creditor(s). And I'm not even talking about various innovative "equitable" theories for avoiding the lien - that's a whole 'nother kettle of fish.

Once you've determined where you might stand in comparison with other creditors - and the debtor's bankruptcy schedules can be helpful in learning about this - it's also important to have some idea what the collateral securing the loan might be worth, as well as how valuable (or not) alternative collection strategies (such as possibly guarantors) might be. The debtor's bankruptcy schedules can give you an idea of your borrower's or financial statement from your borrower in the file, great! If not, start thinking abut ways to determine some sort of valuation.

Other Concerns. It's also probably not too early to consider whether, and to what extent, the lender has received a payment likely to be considered a preference. There's never an harm in accepting such a payment on the front end, but the possibility of having to give it up depending upon how events unfold cannot be overlooked.

And what about other possible vulnerabilities in a creditor's position? Was the disposition of collateral really handled in a "commercially reasonable" matter, and if there are questions, what will happen? Has the relationship between borrower and lender been tense and adversarial for quite a while and will there be allegations arising from those pre-bankruptcy communications, meetings, and activities? Even if a lender believes it is completely blameless, it is wise to at least consider how a party with a different perspective might be evaluating the situation. Knowledge really is power in these situations.

So what does this Chapter 11 bankruptcy filing really mean for a lender and its borrow? Well, it's probably neither the best of times nor the worst of times. Most importantly, lenders need to be very focused on the credit itself and events as they unfold n the bankruptcy. To be best equipped for this ongoing task, lenders must first have a clear understanding of where exactly they are starting from.

BP, CSR, and the Greening(?) of the Business Judgment Rule

Teri Rasmussen — Tue, 09 Nov 2010 16:27:46 -0500

We hear a lot these days about the importance of "going green" which - while having some varying meanings - essentially comes down to being more "responsible" about the resources, people, and the world around us. As the BP oil spill drama winds down and the inevitable lawsuits unfold, I'm sure we'll hear quite a bit more about how BP's directors and officers were "asleep at the switch" and breached their fiduciary duty to shareholders by allowing dangerous practices to go on which purportedly caused the oil leak. In fact, one such case has already been filed and apparently voluntarily dismissed.

And - intermixed with the corporate argument of a breach of fiduciary duty -- is a newer theory starting to gain ground. Namely that BP (and, necessarily, its directors, officers, and other top management) also broke its obligations to all of the rest of us affected by the huge amount of oil flowing into the Gulf. In the parlance of the day, it shirked its corporate social responsbility - CSR as it is sometimes referred to.

I came across this whole controversy while preparing to teach the "business judgment rule" -which really is one of my favorites - to my current round of undergraduates. As I menitoned in my last post on "constituency" statutes, more than 30 states -though not Delaware - have some sort of law making it permissible for directors to look beyond simple increase in shareholder value.

When I learned about these "constituency" statutes , it made me think more carefully about what the scope of a director's duty really oght to be. Traditionally, the "business judgment rule" has protected directors (and officers) in corporations (and their counterparts in publicly held LLCs) from liability for just making a "wrong" decison - as long as they exercised sufficient care in arriving at that "wrong" decison. And the concept makes enormous sense in the abstract! None of us want directors so petrified with fear when faced with crucuial decisions that they won't do anything, or at least not without so much back-up that it's way too late when they do finally make that decisions. It's not good economically and its not good logically.

However, as attractive and "politically correct" as it might be to endorse a growing expansiveness of stakeholders that should be considered in making decisions for a company, I am concerned we may ultimately arrive at place in which we have inadvertently had "too much of a good thing" Whether it's a public or privately held corporation, the ACTUAL OWNERS of the company are in fact the SHAREHOLDERS. At "the end of the day", they are the folks who have actually invested cold hard cash in the financial futre (and hopefully profitability) of the company.

In saying this, I am not overlooking the importance of the contributions of many employees to the success of the company. Nor am I belittling the crucial role of many a company in the life and vitality iof their individual commmunties. Certainly, these are critical factors.

But the bottom line is that it is the company OWNERS that should matter most. Now hopefully a sufficient number of shareholders understand and appreciate the value of looking beyond next quarter's financial results. Because for s compsny to survive and prosper over the long term, there must be some foresight.

ANd if too many shareholders are concerned only about short-term economic results, then they may well reap what they have xowed.

Business Judgment Rule and the Role of "Constituency" Statutes: Are Shareholders the Only Stakeholders?

Teri Rasmussen — Wed, 27 Oct 2010 08:19:55 -0500

Traditionally, the "business judgment rule" has protected directors (and officers) in corporations (and their counterparts in LLCs) from liability for just making a "wrong" decison - as long as they exercised sufficient care in arriving at that "wrong" decison - such as relying on advice and reports from experts.. ( A couple of years ago around this time, when I was also preparing to teach the concept to Capital University students, I posted about the "business judgment rule" in the context of the delay in installing lights in Wrigley Field - and the possible connection with the Cubs unfortunate perennial "Wait til next year!!" chant.) While more often used in conjunction with unhappiness of shareholders of PUBLIC corporations, the rule also applies to privately held companies.

Ohio has an especially director-friendly statute (Ohio Rev. Code 1701.59) which is not unlike statutes in several other states:

(B) A director shall perform the director’s duties as a director, including the duties as a member of any committee of the directors upon which the director may serve, in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would use under similar circumstances...

(C)(1) A director shall not be found to have violated the director’s duties under division (B) of this section unless it is proved by clear and convincing evidence that the director has not acted in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation, or with the care that an ordinarily prudent person in a like position would use under similar circumstances, in any action brought against a director...

(D) A director shall be liable in damages for any action that the director takes or fails to take as a director only if it is proved by clear and convincing evidence in a court of competent jurisdiction that the director’s action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or undertaken with reckless disregard for the best interests of the corporation. (emphasis supplied)

In other words, you the shareholder are going to need some awfully good evidence to even remotely have a chance of prevailing in any lawsuit claiming a director failed to perform his responsibilites with sufficient care, diligence, and loyalty.

Lately, while preparing for teaching the "business judgment rule" to my current drop of undergraduate students, I learned about "constituency statutes". Basically, a constituency statute is an effort to make it "O.K." for corporate directors to move beyond just considering the "bottom line" in making the decisions for a corporation. Ohio's "constituency" statute (Ohio Rev. Code 1701.59(E) is representative. It says:

(E)... a director, in determining what the director reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation’s shareholders and, in the director’s discretion, may consider any of the following:

(1) The interests of the corporation’s employees, suppliers, creditors, and customers;

(2) The economy of the state and nation;

(3) Community and societal considerations;

(4) The long-term as well as short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.

So, in addition to shareholder value, directors of Ohio corporations can consider the interests of the following other stakeholders:

Employees of the company
Suppliers of the company
Customers of the company
Creditors of the company
Ohio's economy
the national economy
Community/societal considerations
Worth of continued independence of the company
Long-term interests of shareholders

So, is there any other possible concern somehow left out? I can't think of any.

Many of these "constituency statutes" were enacted in the '80's as a response to the takeover battles occurring then. The idea was that companies MEANT something to the communities in which they were located. In addition, the thought was that there are other "stakeholders" affected by these decisions and that it is important to consider this as well.

More than 30 states now have some form of "constituency" statutes. Interestingly, Delaware - the mecca of corporate incorporation - has no such statute. So what's next? Will consideration of these other stakeholders become not only permissible, but mandatory?

As a shareholder in some of America's largest corporations, I DO want directors and officers to look out for increasing shareholder value. And I admit, I am sometimes quite focused on the short term gain or loss or ROI. But stepping back from it and trying to be objective, it IS important that other things come into play.

But how far should this really go? It's one thing to provide some cover for directors to make more long term decisions. It's quite another to start mandating consideration of these other stakeholders.

In my next post, I'll probe the ramifications of asking directors to think about stakeholders beyond the shareholder owners and explore the scope of stakeholders that should be taken into account.

Ruminations and Reflections on Legal Blogging Three Years In to It

Teri Rasmussen — Wed, 20 Oct 2010 11:21:04 -0500

Recently, Above the Law had an interesting post about whether the whole legal blogging thing is even worth the effort. I think the consensus is that it may or may not result in new clients easily traceable to the blog; some seem to have been more successful than others in this area. For my part, I would say that I've gotten a few clients I wouldn't have otherwise gotten (especially lately), but it hasn't really been a juggernaut in this area.

However, there are a few other quantifiable (or at least semi-quantifiable) benefits to doing my blog these last three years:

VISIBLITY. Especially for a small firm -which I now am - it's invaluable for visibility purposes. If you do a Google search for "Columbus business attorney" or "Dublin business attorney", my law firm web site doesn't yet show up in the Google "Top 10" results - but my Ohio Practical Business Law blog sure does. This was true even when I WAS at a big firm - my blog showed up higher in search results than my law firm bio, In addition, I frequently get unsolicited compliments from business and legal acquaintances which at the very least means they are at least paying attention to my existence - which as we all know is a major part of getting to consideration for a referral or being retained.

COMMUNICATION. It's a terrific communication vehicle for clients and prospective clients, as well as referral sources. There's been any number of times I've sent a link to a post relevant to some question I've been asked or to a concern that might exist. While I can't directly quantify how much REVENUE this has produced, I DO know that it has been universally very well received (and I am judging from comments received separate in time from any mention of the blog) .

KNOWLEDGE. It makes me a better lawyer. For those who already blog, this comes as no surprise. Blogging DOES keep you more alert to what's happening in your practice area. As many already know, it's only when you have to teach it or write it down clearly, that you really understand a concept. And I've started to build myself an incredible easily searchable reference library of WHAT I DO KNOW about topics important to my practice >>> which I actually do consult on occasion.

HAPPINESS. It makes me feel good. O.K. this isn't really quantifiable, but whether you work in (and especially) BigLaw, or you've escaped to (or never left) the burbs, none of us ever get enough compliments or postive reinforcement in the normal course of the practice. Having even strangers comment positively (without any prompting on my part) on my work reminds me that I really do know what I'm doing and helps gird me for whatever the next battle is. It's a natural performance enhancer!

Maybe the bottom line is you either ARE or ARE NOT a law blogger. To keep on with it, I think the quantifiable results help, but ultimately you either enjoy doing this or you don't. If you are among those who find the experience fulfilling, you already know WHY you do it and WHAT IT MEANS to you. If you don't really get it, there's not much I or anyone else can really say to convince you.

I am reminded of a recent lunch I had with another attorney friend who I've known since we were "baby lawyers" at BigLaw (Columbus, Ohio style). We chit-chatted about our personal activities and respective, now small firm, practices in a desultory way. But then something happened - I'm not sure how - and suddenly my friend was telling me about her real passion at this point, and it wasn't Law. She talked excitedly about a novel she had written and steps she had taken towards getting it published. And not in a naive "I really want this" way. She was completely realistic about what a long shot this was, but also impressively eloquent about the real life steps she had taken to make it a reality. .

She felt a compulsion - an almost physical need - to keep writing. Now maybe my friend will become a best selling novelist; I really hope she does. But if that never happens, I don't think she will have felt her efforts were a waste of time and effort. Why? Because the process itself has made her feel more alive than anything in her already quite successful law practice.

I think legal blogging is sorta like that. Those of us who do it would really like it to produce quantifiable ROI directly traceable to particular posts on our blog, and are incredibly happy when that happens. But that is only partly WHY many, if not most, of us do it. The real reason is that we feel something akin to what my friend was experiencing from her writing. The process of writing itself MATTERS. And the respect and recognition of our efforts from the blogosphere doesn;t hurt either.

And you either understand that - or you don't. If you don't, I understand and yes, I DO feel sad that you can't fathom how wonderful/special this can be. If you already get it, there's nothing else I need to say except WRITE ON!

Anniversary!!

Teri Rasmussen — Tue, 05 Oct 2010 16:33:06 -0500

We are fast approaching the third anniversary of this blog which technically occurs next week. While I haven't yet attained "rock star" status either actually or even in the world of law bloggers (Cf. Francis Pileggi and his Delaware Corporate and Commercial Litigation Blog, for example ), it's still been a good run so far and definitely worth celebrating!

Recently I was nominated (along with about 70+ other blogs) for the Lexis-Nexis Communities Top 25 Business Law Blogs of 2010. While I'm not sure how excited I should be about this nomination (I have noticed some of the other nominated blogs trumpheting this news), it's always nice to be noticed and I would in fact really appreciate your vote and endorsement. Act quickly as the comment period only lasts through October 8. To vote, you must go to one of the websites shown below, sign in if you are already a LexisNexis Community member or become a registered Community member first (it's free), and then leave a comment saying how wonderful I am. :-)

Top 25 Business Law Blogs 2010 – Corporate & Securities Law Community

Top 25 Business Law Blogs 2010 – UCC, Commercial Contracts & Business Law Community

Yeah, it's a ploy for LexisNexis to get you on their list, but then isn't that just about anything these days?

When I started this blog, I wrote about the Purpose and Goals for this Blog and said that I wanted to "provide information which will allow readers to make better legally informed business decisions." That hasn't changed.

I started this blog at WordPress because I wasn't absolutely sure I'd have the discipline and motivation to do this over the long haul. For others just starting out (and may not be certain they can really commit), I highly recommend this host for your blog - there were plenty of choices for me as a newbie and some ability to upgrade should I have chosen to do so.

After about six months I KNEW this was for me - and switched to LexBlog as the host for my blog. While this does cost me some $$, as opposed to WordPress which is free, LexBlog provides important benefits beyond just being a place to put my blog.

This anniversary seemed like an appropriate time to revisit my most popular posts, together with some commentary by me:

363 Bankruptcy Sale FAQ: What You Need to Know to Understand What's Going On with Chrysler and GM
Guess this is more accessible (and perhaps more credible(?)) than my post about GM and the Mirage of a Lightning Quick 363 Sale - Even Theoretically It's a Tough Sell which discusses the process in greater detail.

How Prepackaged Bankruptcy REALLY Works
This one seems to becoming more and more relevant as the number of prepacks seems to have soared, if my Google Alerts on the subject are any guide.

Cognovit Promissory Notes Explained
This one I sorta did expect to be pretty popular and may be the post I actually get the most phone calls about. Which prompted me to write several other posts on the topic which can be found by searching "cognovit" on this site

Adverse Possession and How Good Fences May Not Make Good Neighbors
The popularity of this one really surprised me, but apparently there's a lot of fence disputes out there.

All's Fair in Love and War... and Business? Tortious Interference with Contract or Business

Obviously an important concern
Ohio Foreclosure Proceedings Roadmap Part II: From Complaint to Sheriff's Sale

With Ohio one of the national leaders in foreclosures, it's not hard to see why this post is popular

Buying a Business by Asset Acquisition or Stock Deal - What's the Difference?
This is actually one of my favorite posts and addresses a question I often get from clients

Ohio Foreclosure How Longs FAQ
Again the state of the economy makes the popularity of this post no surprise. It too addresses a question I often get from lenders about foreclosures I might be handling for them

Ohio Judgment Interest Rate ALERT
Maybe it's the "ALERT" part that's made this post more popular than my earlier Determining Interest on Ohio Judgments post

The Long and Winding Road of Chapter 11 Bankruptcy: A Typical Timeline
This is a really long, but very specific, explanation of the Chapter 11 process.

I am very proud of all these posts and glad that they have been the most read of everything I've written. I've also had a couple of sports related posts about the risk you're taking that I'm just a wee bit disappointed didn't make it into the Top Ten. I know they don't really have that much to do with Business Law, but they were a nice change of pace I thought.

And finally, my FAVORITE post so far

Why Every Client Should Want an Attorney Who Blawgs:

>>> NEXT TIME: some thoughts and reflections on this whole legal blogging thing THREE years into it..

Staying Perfected Through Changes in Debtor Name or in Location of Debtor or Collateral

Teri Rasmussen — Thu, 30 Sep 2010 10:33:38 -0500

Borrowers change - their name, their physical location, and perhaps even their state of organization or incorporation. And then there's always the possilbity that a debtor will sell or otherwise transfer collateral subject to a security interest to a third party. What's a creditor to do?

While your loan documents undoubtedly say your borrower is supposed to tell you about these sorts of things, probably in advance, what happens if they don't get around to it? Just how often does a creditor need to check in to be sure it's adequately protected its collateral position? The answer depends upon what sort of change we're talking about AND what sort of collateral you're worried about.

Changes in Debtor

>>>>>> Let's start with the basic change of name situation. (ORC 1309.506; 1309.507) Suppose your debtor Raztigger Enterprises, LLC, a LLC formed in Ohio, changes its name to TGR Industries, LLC. Well, because the "standard search logic" used by the Secretary of State's Office (i.e. computerized alphabetical search) under the newly correct name of TGR Industries would never find any financing statement filed under the old Raztigger Enterprises name, your existing financing statement has become "seriously misleading". As a result

It's still good to perfect a security interest in the stuff the Debtor owns at the time of the name change (assuming you'll later be able to prove which stuff the Debtor got when). So if your collateral is equipment with a serial number, no worries, you're still perfected
Existing financing statement in Raztigger Enterprises name also still good to perfect a security interest in any collateral the Debtor acquires in the four months AFTER the name change.
BUT, no good with respect to property acquired by the Debtor more than four months after the name change UNLESS you file an AMENDMENT to the existing financing statement showing the new name.

>>>>>> Suppose the Raztigger Enterprises decides to store and use your equipment or other collateral in a different state, say Kentucky, on a more or less permanent basis. Doesn't matter. It's the Debtor's location (i.e. state of incorporation or organization) that matters - not the collateral. (ORC 1309.301;1309.307) .

>>>>>> Suppose Raztigger Enterprises decides to become a Nevada LLC maybe for tax reasons. (ORC 1309.316) When the Debtor's state of organization or incorporation changes, you the creditor have the LESSER of (A) the amount of time you would have remained perfected in the old state; OR (B) four (4) months after the change occurs to file a NEW financing statement in the new state (e.g. Nevada). Note it must be an official legal change in the location of the debtor - just moving the cheif executive office to another state IS NOT going to affect anything. If the new financing statement isn't timely filed in the new state, the creditor becomes unperfected retroactively to the date of the location change.

Transfer of Collateral to Third Party

>>>>>> Now suppose Raztigger Enterprises sells equipment collateral to Jones Corporation who then sells it to XYZ, Inc. As long as the creditor has not consented AND the transferree was formed in the same state, the security interest remains valid and enforceable - assuming of course that you can find the collateral at that point.

>>>>>> But what if Raztigger Enterprises, an Ohio LLC, sells the collateral to a company incorporated in Michigan without the consent of the lender? (ORC 1309.316) (Remember, the perfection issue exists even if the physical location of the collateral remains the same.) Here the creditor must file a NEW financing statement in the correct name of the transferee in the new state within the EARLIER of whenever perfection would have lapsed in the old state; OR (B) one (1) year after the transfer of the collateral. If the new financing statement is timely filed, perfection continues uninterrupted. But if the new financing statement is not properly filed within the prescribed time, then perfection lapses retroactively to the time of the transfer as to purchasers for value.

>>>>>>>>>>>>>>>>>>>>

So, bottom, line, if you check about every 3 or 4 months, you're pretty much covered for all eventualities and you have longer than that in some cases. If your collateral doesn't include after-acquired property and is, say, particular piece(s) of equipmen, hopefully easily identified by serial number, then the transfer/sale to a third party in a different state is the main thing you need to worry about and you have an entire year to figure it out.

Points to Remember About Ohio Limited Liability Companies

Teri Rasmussen — Tue, 28 Sep 2010 10:04:39 -0500

And now, the last of a three-part seres of posts summarizing the basic characteristics ofOhio partnerships,corporations, and LLCs. The thing about LLCs is that most of the important things to know about LLCs are the same as what to understand about partnerships and LLCs. So that's why this is the shortest of the three lists. And if you're trying to understand LLCs, go back to the posts on partnerships and corporations to get the full picture.

SO here goes - what to know about Ohio LLcs:

LLCs are a relatively new business form designed to allow the limited liability of corporations while still participating in management of the company. It does not exist until its Articles of Organizations have been filed with the Secretary of State.

Owners of an LLC are called members and their ownership interest is called a membership interest. An LLC must have at least one member, but unlike an S-Corporation can have an unlimited number of members with no restrictions on their characteristics.

Members of LLCs have limited liability for obligations of the LLC except in rare cases similar in nature to those in which a court will pierce the corporate veil and hold shareholders personally liable.

LLCs can be either member-managed which are more like partnerships or manager- managed which is more like a corporation.

Managers can be, but are not required to be, members of the LLC. If a manager of an LLC is a member of the LLC, the manager DOES NOT lose his limited liability as a result of participating in the management of the LLC.

Like partnership interests, membership interests are not freely transferrable. If a membership interest is assigned or transferred, ONLY the economic right to receive distributions is conveyed. The assignee will not become a member unless the other members unanimously consent.

Unless otherwise provided in the Operating Agreement, LLC members generally have no right to demand payment of distributions.

Legal principles applicable to partnerships and corporations are also applicable to LLCs.

Key Concepts to Understand about Ohio Corporations

Teri Rasmussen — Sun, 26 Sep 2010 15:51:22 -0500

I suggested in my last post about partnerships that there might be some additional posts derived from my review of business entities for my advanced business law students. And guess what? Here they are. Today is all about CORPORATIONS, and necessarily also about directors. officers, and even shareholders. Here are the highlights of my list of key concepts to understand about Ohio corporations. (For the full version of this list, click here.)

A “foreign” corporation is a corporation which has been incorporated in a state other than the one it is doing business in. For example, a corporation incorporated in Kentucky would be a “foreign” corporation if it wanted to do business in Ohio.

A corporation does not lawfully exist until its Articles of Incorporation have been filed, shares of stock have been issued, Code of Regulations adopted, and directors and officers have been elected.

Shareholders have no right to demand payment of dividends except in extremely rare circumstances. Only directors, acting together as a board with other directors, can declare a dividend.

Unlike general partners, shareholders in a corporation enjoy limited liability and have no liability for obligations of the corporation except in extremely unusual circumstances. If corporate formalities have not been followed, the corporation is undercapitalized, or corporate funds have been intermingled with the personal funds of shareholders, a Court will “pierce the corporate veil” and impose individual liability on the shareholders.

Absent specific restrictions on transfer, shares of stock – unlike partnership interests or membership interests – are freely transferrable, i.e. can be sold or transferred to anyone for whatever consideration is acceptable to the selling shareholder. Unlike the assignment or transfer of partnership interests or membership interests, assignment or transfer of corporate shares of stock conveys BOTH the economic right to receive dividends and other payments AND the governance rights to vote as an owner.

A “close corporation” or “closely held” corporation is a privately held corporation with a limited number of shareholders, most or all of whom are active in the day-to-day affairs of the corporation. A “family business” is often a “close corporation”. A corporation cannot be a close corporation unless it has adopted a Close Corporation Agreement, The advantage of being a close corporation is that it can relieve the corporation and its shareholders from having to observe as many corporate formalities and/or recordkeeping.

Directors can act only as a unit as a Board of Directors and cannot bind the corporation acting individually. Directors vote by headcount with each director having one vote. Directors are elected by shareholders. The Board of Directors sets policy and direction for the corporation and does not manage the day-to-day business and financial affairs of the corporation.

Officers are elected by the Board of Directors and manage the day-to-day affairs of the corporation. Officers act as agents of the corporation in accordance with the instructions of the Board of Directors.

In the event of a merger or stock sale of a corporation, shareholders of the company going out of existence who voted against the transaction have “dissenter’s rights”. This means that they are entitled to be cashed out and receive an amount equal to the fair market value of their shares.

Officers and directors have fiduciary duties to look out for the corporation. Shareholders of close corporations also have fiduciary duties to one another in the same manner as partners in a partnership. The fiduciary duties of the officers and directors include the Duty of Loyalty not to take corporate opportunities for themselves, the Duty of Obedience not to exceed the scope of their authority, and a Duty of Diligence to exercise care in making their decisions. Decisions are protected by the “business judgment rule” to the extent the proper degree of care has been exercised in arriving at the decision.

In the event that directors violate any of their fiduciary duties or otherwise act outside the scope of their authority such as committing an ultra vires act, shareholders are entitled to file a shareholder “derivative suit” in the name of the company against the directors and/or officers alleging negligence in the performance of their duties. If the suit is successful, the damages go to the corporation.

Corporations will be C-corporations unless a specific election is made to be an S-corporation. There are several restrictions on who may be a shareholder of an S-corporation including that there may be no more than 100 shareholders, shareholders generally must be individuals who are U.S. citizens or resident aliens.

Next time, LLCs......

Still Some Important Things to Know About Ohio Partnerships

Teri Rasmussen — Fri, 24 Sep 2010 12:55:29 -0500

I'm winding up my initial unit on business entities for the students in my advanced Business Law class at Capital University School of Management so this seemed a good time to summarize some of the important things to know about the different legal forms in which businesses can operate. Today is PARTNERSHIPS- both general and limited.

I know I've said before that I didn't see much utility in partnerships now that limited liability companies (LLCs) are so well accepted. And I stand by that remark as far as making a conscious selection of a form of business. But the truth of the matter is that lots of folks just start doing business together without thinking much at all about the legal side of the venture. As long as everything is peachy with everyone and with any banks or other creditors, that may be just fine as a practical matter. But sooner or later, in many cases, disputes and problems arise and then what it means to be a partnership from a legal perspective does matter.

So, here's my list of some of the more important characteristics to know about partnerships from a legal standpoint:

General partnerships occur whenever two or more people (or existing business entities) start working together in a common business enterprise. NO writing is required unless otherwise required by statute of frauds.

Any general partner is an agent of the partnership and can act individually to bind the partnership to a transaction.

Limited partnerships REQUIRES a least one general partner and one limited partner (but may have more of each) and specific formal action to be formed. In Ohio that means a written filing with Secretary of State.

In a limited partnership, limited partners are liable only to extent of their paid and unpaid capital contributions. Limited partners CANNOT participate in management of day to day activities of partnership without losing their limited liability. May be able to participate in decisions on whether to admit new limited partner.

A person or business entity can simultaneously hold both a general partnership interest and limited partnership interest in the same partnership.

Absent specific agreement to the contrary, voting, distributions, and allocations of profits and losses will be done by headcount. By agreement, this can be varied in any way desired; it is not necessary that any of these match capital contribution.

Partners CANNOT assign property owned by partnership for their own debts.

If a partner assigns his, her, or its partnership interest (general or limited), the assignee gets ONLY the ECONOMIC aspects of the partnership interest. i.e., will be entitled to receive distributions, allocations of profits. Assignee of partnership interest DOES NOT become a partner and have voting/governance rights unless and until other partners agree.

After partnership assets have been exhausted, creditors of a partnership can reach assets of general partners but not of limited partners. General partners are usually joint and severally liable and have a right of contribution from their fellow partners.

General partner may withdraw from partnership at any time, but is only entitled to liquidation value of its partnership interest.

Limited partners must give six months prior notice before withdrawing from partnership, but are entitled to the fair market value of their partnership interest in most cases.

Withdrawal or other departure of a general partner will cause the dissolution of the partnership which may then be either reformulated or wound up.

Upon dissolution and winding up, partnerships assets go first to secured creditors, then to tax and unsecured creditors, then to limited partners to pay (in the following order) loans, capital contributions, and profits, and finally to general partners to pay (in the following order) loans, capital contributions, and profits.

Commercial Collections Scenarios - Can a Creditor Use a Debtor's Ownership Interest to Run the Company?

Teri Rasmussen — Wed, 08 Sep 2010 13:18:59 -0500

Let’s say your debtor has some ownership interests in a family business which you think might have some value. And if nothing else, the threat that you the creditor might soon be running that business ought to be worth some leverage, right? How can you get to those? The answer depends upon whether the business is set up as a corporation or as a partnership or limited liability company.

Partnerships and LLCs. If the business is a partnership or a limited liability company, the best you can do, whether by way of a charging order or through enforcement of a security interest, is get to the ECONOMIC aspect of the ownership interest. That is, you as creditor CAN start receiving whatever distributions and payments to which your debtor is or becomes entitled.

What you CANNOT do, however, is exercise any control whatsoever on when those distributions or payments are made. Nor can you vote or exercise any other control over the business and financial affairs of the company in which your debtor has the ownership interest. Can’t be a partner or member with anything other than the rights of an assignee unless the other partners or members decide you are. That’s just the way it is - the nature of what it means to be a partnership or a limited liability company.

For the initial creditor, the receipt of payments continues only so long as there is an outstanding amount owed to the creditor. However, if the creditor goes so far as to “foreclose” its charging order or otherwise sell its place as an assignee, any purchaser will continue to receive payments so long as the partnership or LLC is in existence.

Corporations. So what happens if the company in which your debtor has an ownership interest is set up as a corporation? Well, this is a horse of a different color indeed. Whether it’s enforcing a security interest in stock owned by your debtor or proceeding by way of execution or attachment, once that legal proceeding has been accomplished, you the creditor have wound up with ALL the accoutrements of ownership.

What does this mean? Well, you as creditor get the same ECONOMIC aspects of ownership as with partnerships and LLCs which would entitle you to receive dividends. However, unlike the partnership/LLC situation, the creditor also automatically gets the ability to vote as a shareholder. Although that doesn’t give full control of the company – unlike a partnership or LLC, it’s the directors and officers that actually oversee and run the business and financial affairs -- it is a start. In a small and/or closely held corporation, the number of directors and officers is usually small and shareholders have the ability to replace directors.

>>> so, side note to businesses and their owners concerned about “asset protection" - yet another reason to go with a limited liability company aka LLC as your preferred type of entity.