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Cannabis Licenses and Due Process Protection

Cannabis Licenses and Due Process Protection

Cannabis Licenses and Due Process Protection

Cannabis Licensing and Due Process

Cannabis Licenses and Due Process Protection

A cannabis license is a legal document that allows the licensee to engage in business in the legal cannabis industry of the state for which the license was granted.

Nowadays, such licenses are a highly valued commodity, with application fees costing tens of thousands of dollars, and in some cases, being able to sell them for millions of dollars.

In this sense, it is important to make a question about the type of rights that people have over these licenses. Specifically, the aim of this post is to answer whether a cannabis license can be considered a property interest, and thus, whether it can receive procedural due process protection.

What can be defined as property interest.

Property interest can be defined as the extent of a person’s or entity’s rights in property. The word “property” signifies a legal relationship between a person and an object.

To put it in even simpler terms, property interest is the right that a person has to control, sell, and/or transfer a property. 

Further, according to the U.S. Supreme Court, property interests are “created and defined by existing rules or understandings that stem from an independent source such as state law rules or understandings that secure certain benefits and support claims of entitlement to those benefits.” A constitutionally protected property interest must be an interest that is securely held, so that it is more than a mere expectation of an interest.

Attributes of property

Generally speaking, we can narrow down the attributes of property to three:

  1. Exclusive rights to determine the use of a resource.
  2. Exclusive rights to the services of the resource.
  3. Rights to exchange the resource at mutually agreeable terms.

However, determining whether a cannabis license can be considered property can be difficult. Like a tobacco or a liquor license, a cannabis license can’t be considered property right away, like a car or a house would be.

And, as mentioned above, property interests are defined by “existing rules or understandings that stem from an independent source such as state law rules or understandings that secure certain benefits and support claims of entitlement to those benefits.”

In other words, whether a license is a property interest or not, will depend solely on the characteristics of the interest granted by a license in a particular state. 

For this, we will focus on a slightly different set of attributes using the same model other authors have used to characterize an analogous commodity: liquor licenses. In this sense, liquor license has four attributes which delineate its property characteristics:

  1. Right to obtain
  2. Right to alienate
  3. Right to renew
  4. State’s right to revoke

These attributes will guide us on whether a cannabis license constitutes a property interest for purposes of procedural due process or takings challenges.

The right to obtain

The substantive conditions established in a state’s statutory framework for issuing licenses give birth to the right to obtain them. A license is not a property interest when a legislation lacks substantive criteria for determining when a license must be given. When the legislative framework establishes specific standards for choosing whether to issue a license, leaving the issuing authority with limited discretion, it establishes a constitutionally protected property interest.

When it comes to awarding licenses, states typically adopt one of four methods:

  1. The state issues a license to any applicant who meets the statutory qualifications. The statute clearly specifies that the license must be granted whenever the qualifications are met. In this case, the applicant’s expectations of receiving a license may create property interest. However, the mere application for a license does not create a property interest if the statute specifies that the license may be denied if certain qualifications are not met.
  2. The state has discretion determining how many licenses should be issued. Due to the limitations on the issuance, the licenses under this scheme have more property characteristics.
  3. The state limits the number of new licenses to a fixed statutory quantity. The numerical limits placed, tend to have more property characteristics than the two mentioned before.
  4. The state operates and/or does not license the private sector. 

The right to alienate

This right is manifested when a state licensing legislation enables licensees to transfer licenses, and license holders can enter the market and earn fair market value for the property interest.

Federal courts have looked at the transferability and market value of licenses in determining whether state-created interests constitute property to which a federal tax lien attaches:

“[A] liquor license will constitute property, within the meaning of federal law [for I.R.S. purposes], if the license has beneficial value for its holder, and is sufficiently transferable.”

A transferable license possesses “intrinsic worth that is subject to bargaining and sale in the marketplace.” As a result, federal courts have considered transferable liquor licenses to be personal property in the past.

Different jurisdictions interpret the element of alienability and the related property interest in the license differently. This variation exists because a license might be deemed an asset for a variety of reasons. Some courts, for example, consider the license as a privilege in cases concerning the licensee’s connection with the government and as property in cases involving the licensee’s relationship with other parties such as creditors or heirs.

However, the monetary value created when a state allows the transfer of a license for compensation does not necessarily justify treating the license as property for all purposes.

The right to renew

The third attribute, the right to renew, may also create a property interest in the license.

The renewal process varies by state, and most licenses are only good for one year. Some states enable licensees to renew without submitting a formal reapplication.

These types of legislation provide strict standards for renewal and allow for renewal rejection only for “good cause.” In these jurisdictions, the licensee comes to assume that his or her license will be renewed automatically. The perpetual renewal procedures allow for shortened and accelerated review processes, as opposed to the strict procedures necessary for initial license granting.

In this sense, a perpetual license may be characterized as property due to the licensee’s entitlement to renewal.

Other states have a renewal system that requires holders to reapply for renewal each year. These statutes forbid the licensee from expecting automatic renewal. As a result, the licensee is denied the claim of entitlement required to elevate the license to the level of constitutionally protected property.

In jurisdictions that use a provisional renewal process, license holders have no reasonable expectation that their license would be recognized as property.

The state’s right to revoke

The fourth and final characteristic, the state’s authority to revoke, is derived from the limitations imposed by legislation on government activities in revocation proceedings.

Some states apply different due process standards for the issuance procedure and the revocation procedure. To cancel or suspend a license in Illinois, for example, due process requirements such as proper notice and an opportunity to be heard are required.

However, in this situation, no property right exists prior to the issue of a license in Illinois, and the application procedure should not be subject to any procedural due process protection.

In contrast, several jurisdictions apply the same due process criteria to both the issuing and revocation procedures. This amount of procedural protection afforded to the licensee during a revocation hearing is a strong indicator of whether the state views the interest as a vested property right or just an expectation of ongoing entitlement.

Although none of the aforementioned characteristics are required for a court to conclude that the license is a property right, their presence helps courts to conclude that the licensee’s interest in the license has reached to the level of a constitutionally protected property interest. These qualities may also have an impact on the due process protection necessary for any state action. The level of constitutional protection afforded to the applicant or licensee grows as the degree of property-like features increases.

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Types of due process

Due process under the Fifth and Fourteenth Amendments can be broken down into two categories: procedural due process and substantive due process. Procedural due process, based on principles of fundamental fairness, addresses which legal procedures are required to be followed in state proceedings.

Relevant issues, as discussed in detail below, include notice, opportunity for hearing, confrontation and cross-examination, discovery, basis of decision, and availability of counsel.

Substantive due process, although also based on principles of fundamental fairness, is used to evaluate whether a law can be applied by states at all, regardless of the procedure followed.

Substantive due process has generally dealt with specific subject areas, such as liberty of contract or privacy, and over time has alternately emphasized the importance of economic and noneconomic matters. In theory, the issues of procedural and substantive due process are closely related. In reality, substantive due process has had greater political import, as significant portions of a state legislature’s substantive jurisdiction can be restricted by its application.

Procedural Due Process Protection

According to the Fourteenth Amendment, no state may “deprive any person of life, liberty, or property without due process of law.” The Due Process Clause entails procedural due process, which ensures proper notice, hearing, and an unbiased decision maker before the government deprives a person of certain protected interests.

Because licensing is regulated under statutory or constitutional provisions, a state or local agency’s refusal to issue licenses, or decisions to revoke or to transfer a license, is a state action which may trigger a claim that the licensee has been deprived of procedural due process.

However, due process protection against state action requires that the action impair a constitutionally protected “liberty” or “property” interest.

For those states which have not yet determined the level of due process required for licenses, an examination of the four property attributes discussed above will help determine the due process protection the state should provide the licensee, or potential licensee, either by judicial decision or legislative action.

There are three circumstances we need to have in mind regarding the extent of the procedural due process protection, namely:

1. Procedural Due Process Required Because the License is a Property Interest

If the licenses are considered property, then the states must offer complete constitutional protection. In this sense, a pre-deprivation hearing and chance to be heard must be provided whenever a licensee’s interest in the license is jeopardized.

To establish whether the license is a property interest, we must consider the four property interest attributes listed above. 

2. Procedural Due Process Required by Type of Licensing Action at Issue and By Legislative Mandate

The majority of states give some due process protection by enacting legislation outlining the procedures that licensees must follow and distinguishing between various licensing acts such as issuance, renewal, and revocation.

Licenses may not reach to the degree of property necessary for the purposes of due process rights to be given. Many jurisdictions, however, provide limited due process protection for some license acts, such as renewal or revocation, by legislation or decision.

In the liquor industry, Georgia and Alabama are examples of states that provide due process protection by legislation. The legislature in Georgia established due process rules for the granting, rejection, suspension, or revocation of a liquor license, but declined to acknowledge the existence of a property interest in the license.

States may also grant limited due process protection through judicial decision. This protection may extend to some, but not all licensing actions.

A liquor license, for example, is not considered property under New Jersey law. This legislative declaration is supported by New Jersey case law, which holds that a liquor license is neither a contract or a property right, but rather a licence or privilege to engage in an otherwise illegal profession. Nonetheless, due process has been required in judicial judgments addressing federal matters. 

3. Procedural Due Process Not Required Because License is Not a Property Interest

When a governmental action impacts a licensing interest, most states require licensees to be given some due process consideration. However, a state that refuses to offer such constitutional protection typically will do so because it refuses to recognize the license as a constitutionally protected property interest for the activity in question.

Determining when procedural due process rights are violated

Procedural due process is breached when a legislative procedure describing the process necessary for a licensing action is not followed, or when a court decides that appropriate notice and hearing have not been provided for an action affecting a protected property interest. Challenges to referendum procedures or local-option elections may likewise violate due process unless the court decides that the action is legislative in nature.

To determine when a procedural due process right has been violated, a court must first evaluate whether the license is a constitutionally protected liberty or property interest under the Fourteenth Amendment, and then assess whether the licensees have received the appropriate level of procedural due process.

Substantive Due Process

The presence of a property right is not required for substantive due process or equal protection. As a result, deciding whether a license is property is not required for assessing constitutional protection under these principles.

As applied to state or municipal regulatory activities, substantive due process guards against state action that is “arbitrary and unreasonable or without proper relation to the legitimate legislative purpose.” There must be a real and significant link between the rules imposed and the prevention of harm to the public’s moral, social, or economic well being.

In other terms: substantive due process is the notion that due process not only protects certain legal procedures, but also protects certain rights unrelated to procedure.

In this case, there are two major things you must look for: 

  1. Did the government pass legislation?
  2. Does that legislation ban rights previously enjoyed by citizens?

If the answer to both is “yes”, we have a substantive due process problem. The resolution of that problem is that no law can be arbitrary. Any law that offends substantive due process must be analyzed by either:

  1. Strict scrutiny
  2. Rational basis test

Choosing which one to apply is based upon the nature of the right. If the right is a fundamental right, you must apply strict scrutiny, any other rights will be analyzed with the rational basis test.

In substantive due process actions, once the plaintiff proves that there is a law that is banning their rights, it is the government’s burden to prove that, if in fact it is interfering with a right, the law is necessary to achieve a compelling government interest.

Main difference between substantive and procedural due process

Substantive due process asks the question of whether the government’s deprivation of a person’s life, liberty or property is justified by a sufficient purpose, while procedural due process asks whether the government has followed the proper procedures when it takes away life, liberty, or property.

For advice on how you can protect your cannabis license, feel free to contact us, and also, visit our blog, Cannabis Industry Lawyer.

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Fiduciary Duty Litigation

Fiduciary Duty Litigation

Fiduciary Duty Litigation in Corporate Law

 

Fiduciary Duty LitigationA fiduciary duty is an obligation that exists in a relationship in which one of the parties has the best interest when acting on the other party/es behalf. 

There are multiple types of fiduciary duties. Some examples can be the obligations between lawyers and clients; shareholders and directors; between business partners; and many others where special trust is part of the nature of the relationship, or a reliance on the one party exists to exercise its expertise or discretion on behalf of the others. 

Breaches to fiduciary duties are extremely common, especially in corporations. Here are all the details you should know about fiduciary duties and what to do when you have to appeal to litigation because a breach has occured.

 

Fiduciary Obligations

A fiduciary duty consists of two main fiduciary obligations.  

  • Duty of loyalty, the fiduciary prefers the beneficiary’s interests to his or her own 
  • Duty of care,  the fiduciary acts as a reasonably careful person would act under the same or similar circumstances safeguarding the beneficiaries’ interests.

Depending on the state’s legislation other duties such as the duty of good faith and the duty of acting according to law can also be considered. The failure of either of these duties may result in fiduciary duty litigation.

 

Who Is Part Of This Relationship

 

  • Fiduciary: The person who holds the obligation that exists in the relationship, Fiduciary Duty Litigationhaving best interest when acting on the other partiy/es behalf
  • Principal: The person to whom the fiduciary owes the duty

Who has fiduciary duties?

 

These are the persons the law denominates as fiduciaries, keep in mind states may differ in these considerations:

  • Partners: Business partners in a partnership owe each other a fiduciary duty. Some of these duties are to account for profits, property, opportunities, or other benefits derived by the partner, and to abstain from competing with the partnership.
  • LLC Managers: A duty to account to the LLC, and hold any property, profit or LLC benefit, as a trustee for the LLC; and, A duty to abstain from competing with the LLC; to refrain from negligent or reckless conduct, intentional misconduct, or knowingly violating the law.
  • Corporate Directors: The board of directors of a corporation owes duties to the corporation itself, and the shareholders. Directors must act in the best interest of the corporation and the shareholders
  • Corporate Officers: the fiduciary duty requires officers to apply their best business judgment, to act in good faith, and to promote the best interests of the corporation.
  • Controlling Stakeholders: As Someone who has a legitimate interest in serving the company so that the company performs well overall their duties are similar to the corporate officers one, as they may take decisions in the name of the company.

Breach of Fiduciary Duty Fiduciary Duty Litigation

Breaches of fiduciary duty happen when a binding fiduciary relationship is in effect and actions that are counterproductive to the interests of a specific client are taken, to benefit the fiduciary’s interests or the interests of a third party instead of a client’s.

A breach can also come from a failure to provide critical information that may lead to misunderstandings, or misinterpretations. Identification or disclosure of any potential conflicts of interest is important in fiduciary relationships because all types of conflicts can be a source for undesired intentions.

Elements Of a Breach Fiduciary Duty 

To be sure you have a case of breach of fiduciary duty, you must look for three essential elements: 

  • A duty existed, You must determine if the specific relationship in question created a fiduciary duty under the law
  • A breach of the duty occurred: You must prove that a breach occurred and that the defendant acted on his own behalf instead of in the best interests of the other parties. 
  • Damages were suffered: You must prove that the breach caused harm and compensation is available. 

Most common breaches of fiduciary duty

There are many ways in which fiduciaries may breach their duties. The most common breaches of fiduciary duty include:

  • Self Dealing, through conflict of interest business, transactions for personal gain or personal economic profits.
  • Usurpation of business or corporate opportunity
  • Misappropriation of corporate funds and property.
  • Neglect, business imprudence, or lack of necessary business skill.
  • Deficiently acting in the business owners, shareholders, or members best interest.
  • Failure to provide accurate corporate information.
  • Breach of confidentiality.
  • Misuse of superior knowledge.
  • Giving inappropriate advice or counsel 
  • Abusage of superior or influential position.

Fiduciary Duty Litigation

When a fiduciary duty has been breached, those affected can consult with a corporate litigation attorney about filing a lawsuit. 

If you believe you have a case for breach of fiduciary duty,  you should really know all your options, don’t forget litigation could worsen the situation.

While these types of disagreements need to be resolved, there are other alternatives, such as mediation. Be sure you consult it with an expert before making a final decision. 

Going to court can be time consuming, stressful and expensive and private disputes will become a matter of public record. All litigation processes are complex, and fiduciary duty litigation is not the exception.

You do not want to spend time and money going to court only to be unable to prevail and obtain the legal remedy you seek because you were unprepared, a fiduciary duty litigation attorney could make a difference in the result.

 

Key Points Of Fiduciary Duty You Should Know

  • A fiduciary is legally obligated to put their client’s best interests ahead of their own.
  • Fiduciary duties appear in a range of business relationships, including a trustee and a beneficiary, corporate board members and shareholders, and executors and legatees, but also in many civil relationships.
  • You may have heard the term investment fiduciary before, and it is anyone with legal responsibility for managing someone else’s money.
  • Fiduciary duties are both ethical and legal. 
  • A fiduciary must avoid any conflicts of interest between his own interests and the interests of the principal, as well as to avoid any conflicts that may arise between different clients of the fiduciary.

If you are looking for a Fiduciary Duty Attorney don’t hesitate to contact us.

 

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What Is an Accredited Investor?

What Is an Accredited Investor?

What Is An Accredited Investor

accredited investor

What is an accredited investor?

An accredited investor is a person or legal entity with a special status under financial laws, who is allowed to participate in non-registered investments, since being considered an individual with the experience and means to participate in riskier investments and bear any potential losses.

The Securities and Exchange Commission (SEC) concedes companies and private funds the opportunity to not register certain investments as long as the firms sell these assets to accredited investors exclusively.

Who Is an Accredited Investor? 

In order to qualify as an accredited investor, a person must meet certain criteria involving his annual income and net worth.

  • Annual Income: The investor must have an annual income that exceeds $200,000 or $300,000 for joint incomes, for the last two years. The individual must also expect the same or higher revenue in the current financial year.
  • Net worth: The investor must have a net worth of $1 million or higher, either as an individual or jointly if married, at the time of purchase.  In the case of an entity, assets must be valued at $5 million or higher or have an owner who is considered an accredited investor.

However, entities formed for the sole purpose of purchasing unregistered securities will not be allowed accredited status. 

 

How do I become an accredited investor?

There’s no formal process of certification offered to prove you’re an accredited investor. There is no government agency to review an investor’s credentials, and no exam or certification exists stating that a person has become an accredited investor. Instead, it is on the companies selling the non-registered investments to verify the qualifications of the buyers. 

Typically, the investor is required to fill out a questionnaire that requires details of their annual income and their net worth attaching supporting documents like financial statements, account information and tax return. It is possible some companies require additional information, like letters from financial advisors and attorneys or credit reports.

 

Why do accredited investors exist?

The Securities and Exchange Commission (SEC) created this distinction to refer to individuals considered “sophisticated investors”, who are not in need of the same levels of financial protections the common investor does. 

Allowing only accredited investors to participate in offerings of non-registered securities has the purpose of:

  • Regulating companies against advertising to or soliciting investments from non-accredited investors.

 

  • Protecting the regular investors from getting into riskier projects, especially because they may not have the fund reserves to handle a loss

 

  • Making sure that those who meet the qualifications have the financial sophistication necessary to evaluate a private investment and potentially riskier opportunity 

 

  • Assuring that the risk of losing their investment falls on those who financially prepared to bear the situation.

Amendment to the Accredited Investor Definition

The SEC announced the adoption of amendments to the definition of “accredited investor,”. In efforts to “simplify, harmonize, and improve” the rules governing the private offering of securities while maintaining investor protections by adding new categories of qualifications, including

  • Individuals with professional certifications, designations or credentials issued by an accredited educational institution, which the SEC may designate from time to time; 

 

  •  Individuals who are “knowledgeable employees” of private funds;

 

  • Limited liability companies (LLCs) with $5 million in assets;

 

  • Entities, such as Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries, that own investments, in excess of $5 million

 

  • Family offices with at least $5 million in assets under management and their family clients; and

 

  • Spousals may pool their finances for the purpose of qualifying as accredited investors, describe as “spousal equivalent”

Here is the full text of the amendment  

The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.

The amendments to the accredited investor definition in Rule 501(a):

add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.  In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.  This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future.  Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;

include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;

clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;

add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;

add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and

add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

The amendment to Rule 215 replaces the existing definition with a cross-reference to the definition in Rule 501(a).

These amendments were announced on August 26, 2020, and they will take effect 60 days after publication in the Federal Register. 

If you are interested, here you can find SEC’s official Press release And if you have any questions about how accredited investors work, do not hesitate to contact us

 

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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What are valuation caps?

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Subscription Agreements

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Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens

 

Why Do You Need a Buy Sell Agreement Lawyer

Why Do You Need a Buy Sell Agreement Lawyer

Buy Sell Agreements

Buy Sell Agreement Lawyer

Why Do You Need a Buy Sell Agreement Lawyer?

A buy-sell agreement is a legally binding contract between the owners of a business where they agree on what happens to a partner’s shares in the event of life-changing situations that may result in chaos that could potentially ruin the business and bankrupt its owners, assuring the remaining owners that the business will carry on successfully.

A Buy Sell Agreement Lawyer Helps Transition the Business Ownership.

The Buy Sell agreement is also heard of as a buyout agreement, a business will, or a business prenup. Comparing a buy sell agreement with a prenuptial agreement is the most accurate comparison: In a prenuptial agreement, you can get out of the marriage under certain conditions. 

At the same time, you can protect your financial operations. A buy sell agreement offers the same rights, just with one small difference. In a Buy Sell agreement you can cover all the financial transactions between the business partners. This makes a buy sell agreement more reliable and more effective in terms of financial stability.

A buy sell agreement defines your rights when it comes to difficult situations.

Your partner can fall ill or become unable to operate the business the right way. In that case, a buy-sell agreement lowers your financial risks of bankruptcy or debt. You can protect yourself by signing an agreement that will keep your business intact.

Two Common Types of Buy Sell Agreements Are:

 

  • Cross-purchase agreement, and
  • Redemption agreement
  • A cross-purchase agreement happens when the remaining owners decide to purchase the shares of the business that is for sale. In this matter, it is important to know that the mechanism relies on a life insurance policy.
  • A redemption agreement is another form of a buy sell agreement. Here, we have a situation when the business entity buys the shares of the business. With a redemption agreement, the contract limits the ability of business owners to sell or transfer their ownership stakes in the business.

Some businesses decide on a mix of the two forms of agreements, with some portions available for purchase by individual partners and the remainder bought by the partnership. The importance of a buy sell agreement covers most of the financial risks that may occur in the business.

How to Know If a Buy Sell Agreement Is Right for Me

If you plan to start a business with a partner, a buy sell agreement can offer many protective points that can change your business perspective.

Many life situations are inevitable and we can rely on this kind of contract when the official regulations are necessary for business operations.

Your business partner may go ill or die, and that is when a buy sell agreement comes into effect. Your business capital will be protected and you can continue all the future business operations.

Here are some potential situations that a Buy Sell Agreement would prepare you for:

  1.  Personal Bankruptcy of one of the owners;
  2.  Business owner’s retirement;
  3.  Disability of one of the owners;
  4.  Irreparable disagreement between partners;
  5. Death of one of the owners.

Cross-purchase buy and sell agreements contribute to the rights of the business owners.

As a remaining business owner, you can buy the interests of the selling owner. This applies when a selling owner is no longer capable of maintaining their business obligations. 

Buy and sell agreements are also important in the method of determining the overall business value at the beginning of the business as well as when one of the business owners remains the only owner.

Careful drafting of a buy sell agreement can also eliminate or lower any potential estate taxes that apply at your death.

In the situation when you want to pass your ownership interest to one of your family members at your death, avoiding the estate tax is one of the possible outcomes.

What Can I Get From A Buy Sell Agreement?

A Fair Value Price for Shares

A Buy Sell Agreement is a perfect way to establish the Fair Value of your business individual stake. This agreement sets the figure ahead of time, preventing disagreements between partners about whether a buyout is or not fair.

Facilitates the break up of the partnership 

The Buy Sell Agreement minimizes the stress of the disintegration of the partnership, having designed a legally binding strategy to be followed in the case a partner exits the company 

Lets owners decide on the future of the shares

The Buy Sell agreement specifies who is entitled to your stake if you exist, preventing owners fighting over shares or third parties deciding on the future of your company. The uncertainty can be avoided with a well-crafted agreement.

Do I Need a Buy Sell Agreement Lawyer?

A buy sell agreement lawyer is necessary if you want to avoid state taxes and protect your business capital and operations. With a buy sell agreement, you will be able to buy shares of the business and prolong your business perspective.

A good buy sell agreement lawyer can help you draft the buy sell agreement that protects both your business partner’s interests and your interests. You will have the right to continue the business operations even in the case of illness or death of your partner. 

It is possible to stay protected and define a new business strategy with a buy sell agreement. A good buy and sell lawyer can help you craft and improve the right contract that protects you in the case of inevitable circumstances.

 

When Should I Make a Buy Sell Agreement?

The perfect moment to create a Buy Sell Agreement is way before the ownership transition, when all the owners are equally involved and an orderly transition can be planned for. 

Since at the time the buy sell agreement is being executed the owners may not even know who would be bought out, when and why. Hence, relationships between the owners would be presumably good so they would most likely come to an objective consensus on the terms.

If you wait for the triggering events to occur, relationships may be strained, and not having a solid buy sell agreement may result in conflict, potentially becoming extremely expensive for all the parties. 

Making sure that the terms of the buy-sell agreement are in writing and having the owners agree to those terms beforehand helps to eliminate the potential conflict. 

The buy sell agreements doesn’t need to be a separate document. It could be included in the company’s shareholders agreement or in the partnership agreement. 

The important thing is not to assume that you have one, and always make sure to keep it updated and clear in what your specific intentions are, amending the existing agreement or creating a new one if necessary. 

Do I Need a Buy Sell Agreement if I Am the Sole Proprietor of My Business?

Even if you are the only shareholder in your business, you should still consider to have a Buy Sell agreement to make sure your assets are protected in the face of any eventuality. 

The Buy Sell Agreement is a clear outline of your intentions for the future of your company that will be taken into consideration once you no longer have the power to voice it. You certainly would be saving your heirs, and employees unnecessary trouble.

What Important Things Should I Consider in My Buy Sell Agreement?

Avoid the use of Ambiguous Language

Since the purpose of your Buy Sell Agreement is to prepare for any possible eventuality involving one of the owners, you should make sure the statements in the agreement are the clearest possible so you prevent conflict between the stakeholders the moment the sale is executed. 

Unclear language in contracts tends to represent further conflict between the parties involved, which can only mean negative financial repercussions for you.  

Worst Case Scenarios Must be Considered

It doesn’t matter if probabilities are very low, you should have a Buy Sell Agreement that takes into consideration all the possible scenarios. You want to have every precautionary clause possible to assure you the best outcome.

Set the Objectives Of Your Business Straigh

All of the owners should not only understand, but also agree with the short and long term objectives of the company. If this concordance doesn’t happen and the owners have varying objectives it may be difficult to outline a good Buy Sell Agreement.

Beware of Taxes

You should get assessment on the tax consequences of shares exchanging, to prevent you and your business from losing a lot of money. A good Buy Sell Lawyer can guide you to make the right moves when it comes to avoiding getting wrecked by taxes.

If you are looking for a Buy Sell Agreement Lawyer don’t hesitate to contact us.

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What are valuation caps?

A valuation cap is a term of a convertible note or a SAFE. It is also a great way to attract investors to any startup, providing them with an incentive to invest. Starting a successful financing round for your business will expose you to a slew of new terms. It is...

Thomas Howard

Thomas Howard

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Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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Justifiable or Reasonable Reliance Under Section 523 of the Bankruptcy Code

Justifiable or Reasonable Reliance Under Section 523 of the Bankruptcy Code

Exception to Discharge Section 523 of the Bankruptcy Code

Reasonable Reliance Section 523 Bankruptcy

Sometimes a debtor is less than honest, that’s when you bring an adversary action in bankruptcy

Was your reliance justifiable  or reasonable when lending money to a dishonest debtor that. later ends up in bankruptcy. Collateral Base Attorney Tom Howard recently helped our client win a $1.8 million dollar verdict in a bankruptcy case out of the Central District of Illinois. The case, liura v. Brady (In re Brady), concerned several novel issues of law, including the standard for “justifiable” or “reasonable” reliance under §523(a)(2) of the Bankruptcy Code.

Exceptions to Bankruptcy Discharge under Section 523 –

Bankruptcy discharge is the value most debtors that petition for relief under the Bankruptcy Code are after.  The discharge of their debts can wipe away thousands or millions of dollars of debt holding down a debtor in order to give him or her a fresh start.  But not all debtors are honest but unlucky – some are lying about their debts, which is why you can file an action to except certain debts, usually obtained fraudulently, from discharge. Section § 523(a)(2) of the Code is the authority for such adversary proceedings, which provides, in relevant part:

  • (a) A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
  • (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—
  • (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;
  • (B) use of a statement in writing—
  • (i) that is materially false;
  • (ii) respecting the debtor’s or an insider’s financial condition;
  • (iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and
  • (iv) that the debtor caused to be made or published with intent to deceive[.]
  • 11 U.S.C. § 523(a)(2)(A), (B).

Pliura v. Brady – Justifiable or Reasonable Reliance under Section 523

The case concerns the Chapter 7 Bankruptcy of Bob Brady (Debtor), a prominent home builder in Central Illinois. After earning his MBA and spending several years in banking, Bob Brady joined Brady Homes, the family business. Brady Homes has built over 1,500 homes in the Bloomington/Normal area, and has also built and managed apartments and condominiums. The Debtor also participated in several other real estate businesses, including Pinehurst Development (Pinehurst) and Brew of Illinois, LLC (Brew). In other words, the Debtor was a very experienced and sophisticated real estate professional, and knew all about holding and transferring title of property.

As our Central Illinois readers might know, the Debtor is the brother of State Senator Bill Brady. At the time of the loan, Senator Brady was running for Governor of Illinois as the Republican Party nominee (he went on to narrowly lose the race to incumbent Governor Pat Quinn). Bob Brady needed the loan to pay subcontractors, who were threatening to file liens and go public with the Bradys’ ongoing financial woes. Naturally, this would have been embarrassing for Senator Brady’s campaign.

In 2010, Dr. Thomas Pliura (a lawyer and a physician) and his wife loaned Brady and his brother $1,000,000 at an interest rate of 6%. The note was accompanied by a Security Agreement, giving the Creditors security in several properties own by Brady and identifying each property, including the address and tax identification number. The Security Agreement stated that the Bradys were the “sole, legal and equitable owners” of the properties. In the interest of Brady’s political ambitions, Dr. Pliura agreed not to record a mortgage against the properties which secured the $1,000,000 Note. He simply relied on the promises and written representations of the Brady Brothers, whom he had known for twenty years.

In fact, all of the properties were owned by Pinehurst and Brew, not by Brady and his brother. Additionally, all of the properties were encumbered by mortgages to Busey Bank. The properties had actually been cross-collateralized to other loans, and the Bradys were underwater on their various loans by approximately $3 million dollars.

The Bradys made one payment to Dr. Pliura- a check that bounced. They never tendered any additional payments. Dr. Pliura retained an attorney to look into collecting on the Note, and discovered that the Properties were not owned by Brady, and were further encumbered to Busey Bank. Soon, Brady filed for bankruptcy, and Dr. Pliura filed his lawsuit.

Section 523: Two Ways to Recover

Normally in bankruptcy, a debtor’s outstanding debts are discharged, and creditors have their rights to collect curtailed or outright eliminated. Under Section 523 of the Bankruptcy Code, there are a few ways to prevent this, or have a debt declared “non-dischargeable.” Section 523(a)(2) again provides:

(a) A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or

1328(b) of this title does not discharge an individual debtor from any

debt—

. . .

(2) for money, property, services, or an extension, renewal, or

refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud,

other than a statement respecting the debtor’s or an insider’s

financial condition;

(B) use of a statement in writing—

(i) that is materially false;

(ii) respecting the debtor’s or an insider’s financial

condition;

(iii) on which the creditor to whom the debtor is liable for

such money, property, services, or credit reasonably

relied; and

(iv) that the debtor caused to be made or published with

intent to deceive[.]

  • Under 523(a)(2)(A), the Pliuras had to show “(1) the Debtor made a false representation or omission; (2) the Debtor knew the misrepresentation was false or made the representation with reckless disregard for the truth; (3) the Debtor made the misrepresentation with intent to deceive; and (4) they justifiably relied on the misrepresentation in making the loan.”
  • In contrast, under 523(a)(2)(B) the Pliuras were required to prove that the Debtor submitted to them, as part of their loan transaction, a written statement “(1) that was materially false; (2) that included information respecting the Debtor’s financial condition; (3) that they reasonably relied on in extending the loan; and (4) that the Debtor made or published with intent to deceive.”

The two sections have previously been held to be mutually exclusive. Under the recent Supreme Court case of Lamar, Archer & Cofrin, LLP v. Appling, the reasonable reliance bankruptcyCourt found that “a statement about a single asset” could be a “statement respecting a debtor’s financial condition.” That is, if the Bradys made a statement about a single one of their assets, the Pliuras would be in Section 523(a)(2)(B) and the “reasonable reliance” standard. The Court briefly addressed this issue, and found that Brady had made written representations about his financial condition, so the Pliuras would have to recover under 523(a)(2)(B).

Was There Reasonable Reliance?

There was no real dispute that Brady knowingly made materially false statements about his ownership of the Properties, and that the money was, in fact, owed to the Pliuras. There was a mountain of evidence that Brady knowingly and intentionally deceived Pliura to induce him to make the loan. But the bigger question was: did Dr. Pliura reasonably rely on Brady’s representations?

The Court began its analysis by noting that usually, reasonable reliance is determined based on the lender’s lending standards. However, “[h]ere, of course, the Pliuras are not traditional lenders and have no standard practices or any relation to the lending industry; it would be unfair and inappropriate to evaluate their reliance as though they were commercial bankers.” As the court further explained, while “reasonable reliance does not generally require creditors to conduct an investigation prior to entering into agreements with prospective debtors[.]” In re Morris, 223 F.3d 548, 554 (7th Cir. 2000). But, at the same time, creditors cannot ignore “obvious red flags.” Harris N.A. v. Gunsteen (In re Gunsteen), 487 B.R. 887, 902 (Bankr. N.D. Ill. 2013).

The Court looked at the various statements made by parties to the Note. However, at the end of the day, it was not just that the parties has discussed ownership of the properties, but that “Dr. Pliura put the information they were relying on in writing, and the Debtor signed that writing.” It was unrebutted that Brady read the representations in the Note at closing, and did not raise any objections at the time. The court also relied on Dr. Pliura’s personal relationship with the Bradys in assessing his reliance. “He knew that William Brady was a state senator and a candidate for governor and, apparently, he held Sen. Brady in high regard. He knew the Bradys as successful businessmen in the community, and, despite also knowing of their current financial distress and urgent need to borrow money, he had no reason to think that any of the Bradys, including the Debtor, would look him in the eye and lie.”

This case provides significant guidance for creditors who are proceeding under 523(a)(2)(B). Even sophisticated individuals can be misled and lied to by people they know and trust. This case clarifies that for debtors who are betrayed by people close to them, the law is still on their side.

The full opinion of the Court is available here.

David Silvers

David Silvers

Regulatory Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

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What are valuation caps?

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Stock Warrant Purchase Agreements What is a stock warrant? According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is...

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How Do You Perfect a Security Interest in Agriculture?

How Do You Perfect a Security Interest in Agriculture?

agricultural security interests

A “security agreement” is defined by the Uniform Commercial Code (UCC) as “an agreement that creates or provides for a security interest.” 810 ILCS 5/9-102(a)(74). A security agreement is “effective according to its terms between the parties, against purchasers of the collateral, and against creditors.” 810 ILCS 5/9-201(a). Or, put simply, a security agreement gives a creditor some form of legal right over the property of a creditor. To have an enforceable security agreement, creditors need to meet a series of strict requirements.

Problem Ag Loan

How Do You Perfect A Security Interest in Agriculture?

A “security agreement” is defined by the Uniform Commercial Code (UCC) as “an agreement that creates or provides for a security interest.” 810 ILCS 5/9-102(a)(74). A security agreement is “effective according to its terms between the parties, against purchasers of the collateral, and against creditors.” 810 ILCS 5/9-201(a). Or, put simply, a security agreement gives a creditor some form of legal right over the property of a creditor. To have an enforceable security agreement, creditors need to meet a series of strict requirements.

The Basics

For a security interest against collateral to be enforceable against the debtor and third parties, 810 ILCS 5/9-203(b) requires that the following three conditions be met:

1. Value has been given.

2. The debtor has rights in the collateral or the power to transfer rights in the collateral to the secured party.

3. One of the following conditions has been met:

a. The debtor has authenticated (signed or otherwise executed) a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned.

b. The collateral is not a certificated security and is in the possession of the secured party under 810 ILCS 5/9-313 pursuant to the debtor’s security agreement.

c. The collateral is a certificated security in registered form, and the security’s certificate has been delivered to the secured party under 810 ILCS 5/8-301 pursuant to the debtor’s security agreement.

d. The collateral is deposit accounts, electronic chattel paper, investment paper, or letter-of-credit rights, and the secured party has control pursuant to the debtor’s security agreement.

These are the minimum requirements that must be satisfied to enforce a security interest. In re Duckworth, 776 F.3d 453, 462 (7th Cir. 2014).

Common Pitfalls: Mistaken Identification

Lenders must properly identify the debt to be secured, because §9-203 does not provide a mechanism for rescuing a lender from mistakenly identifying the debt to be secured. In Duckworth, the court held that the mistaken identification of the debt cannot be corrected against the bankruptcy trustee by using parol evidence to show the intent of the parties to the original loan. Id.

In Duckworth, the bank brought an action against the bankruptcy trustee and others asking the court to determine that the bank had a first priority security interest in proceeds from the sale of certain farm products, equipment, and crop insurance. After the farmer filed a Chapter 7 petition, the trustee was holding $22,284.27 in post-petition sales of farm equipment and $586,740.38 in crop proceeds.

The debtor obtained a loan from the bank by a promissory note dated December 15, 2008, in the amount of $1.1 million. On page 2 of the 2008 note, in a paragraph labeled “collateral,” it stated that the borrower acknowledged that the note was secured by a security agreement dated December 13, 2008. The debtor did sign an agriculture security agreement dated December 13, 2008, that described the collateral as all inventory, farm products, farm equipment, and crop insurance, among other property. However, in the definition of “note,” the principal amount was left blank and the note was referenced as being dated December 13, 2008; there was no cross-collateralization clause.

The trustee and another creditor argued that the security interest was invalid because the security agreement provided that its security debt was evidenced by a note dated December 13, 2008, even though that note did not exist. The bank provided the declaration of the loan officer who prepared the loan documents and personally closed the loan. The loan officer explained that the discrepancy was a “clerical error.” The bank further maintained that the error was correctible by means of parol evidence, because Illinois adheres to the principle that documents executed as part of a single transaction are interpreted as one contractual agreement. The bankruptcy court agreed. So did the district court on appeal. However, the Seventh Circuit Court of Appeals reversed, declaring that bankruptcy trustees “are entitled to treat an unambiguously security agreement as meaning what it says, even if the original parties have made a mistake in expressing their intentions.” 776 F.3d at 463.

The lesson from Duckworth is that special care must be taken to ensure that the security agreement contain a provision for securing future debts. Future advances or dragnet clauses are expressly permitted by the UCC. 810 ILCS 5/9-204(c). A future advances clause must be set forth in writing as part of the security agreement for the security interest to cover debts not expressly identified therein.

See the sample form of an agricultural security agreement in §7.20 below. In the sample form of security agreement, the term “obligations” broadly encompasses all debts existing at the time of execution of the agreement and arising thereafter.

Defining the Collateral

Most security agreements define the “collateral,” but a mistake in the definition can be costly.  Creditors should always use language covering after-acquired property for collateral. There is no protection for creditors who mistakenly assume some kind of “common sense” inclusion applying to things like inventory.

It is important to understand the meaning of terms defined in the Uniform Commercial Code. Some secured lenders define “accounts,” “inventory,” etc. The UCC defines many of these terms, so there isn’t necessarily a need to define them separately in the security agreement. However, it’s important to keep up-to-date on the UUC definitions. For example, some UCC terms changed dramatically when Article 9 was amended in 2001.  Therefore, a provision that incorporates UCC terms can affect the entire agreement.

810 ILCS 5/9-102(a)(34) defines “farm products” to mean “goods, other than standing timber, with respect to which the debtor is engaged in a farming operation” and that are

(A) crops grown, growing, or to be grown, including:

(i) crops produced on trees, vines, and bushes; and

(ii) aquatic goods produced in aquacultural operations;

(B) livestock, born or unborn, including aquatic goods produced in aquacultural operations;

(C) supplies used or produced in a farming operation; or

(D) products of crops or livestock in their unmanufactured states.

“Farming operation” is defined to mean “raising, cultivating, propagating, fattening, grazing, or any other farming, livestock, or aquacultural operation.” 810 ILCS 5/9-102(a)(35).

The term “proceeds” is broadly defined to include whatever property or goods are received upon the sale, exchange, collection, or disposition of the collateral. 810 ILCS 5/9-102(a)(64). A security interest attaches to any identifiable proceeds of collateral. 810 ILCS 5/9-315(a)(2). Determining readily identifiable cash proceeds is a difficult endeavor. See C.O. Funk & Sons, Inc. v. Sullivan Equipment, Inc., 89 Ill.2d 27, 431 N.E.2d 370, 59 Ill.Dec. 85 (1982). The secured party has the burden of identifying its proceeds. Assumptions and speculation are insufficient to meet this burden. See Van Diest Supply Co. v. Shelby County State Bank, 425 F.3d 437 (7th Cir. 2005).

The Grant

According to Article 9 of the UCC, the grant must describe the property and what it secures. 810 ILCS 5/9-203(b)(3). This is a mandatory requirement; the failure to have a document explicitly granting a security interest is fatal. Covey v. Morton Community Bank (In re Sabol), 337 B.R. 195 (Bankr. C.D.Ill. 2006). There are no specific “magic words” required to be included in the security agreement to create a security interest, however no security interest will be recognized without a description of the collateral in a signed or authenticated document or in a separate document incorporated by reference into a signed or authenticated document. 377 B.R. at 202.

Due Diligence and Proper Searches

Before making a loan, a lender must make the following searches to determine whether it has priority:

1. the debtor’s form of organization;

2. the debtor’s principal place of business;

3. the debtor’s predecessors;

4. all names utilized by the debtor; and

5. all locations used for goods.

After the lender relies representations regarding these issues, it still must perform its own due diligence to verify the representations. This includes reviewing an entity’s articles of incorporation, articles of organization, or other organizational agreement and any other reports available to the lender to verify the locations of the collateral.

The lender can confirm whether the borrower is a corporation or a limited liability company and in good standing at the website of the Illinois Secretary of State’s Department of Business Services at www.cyberdriveillinois.com/departments/business_services.

The lender also must conduct a UCC lien search using the precise name of the entity or person. Failure to use the correct name can be fatal. See, e.g., Corona Fruits & Veggies, Inc. v. Frozsun Foods, Inc., 143 Cal.App.4th 319, 48 Cal.Rptr.3d 868, 870 (2006) (financing statement that listed debtor’s name as “Armando Munoz” instead of his correct name of “Armando Munoz Juarez” was seriously misleading and thus invalid). For perfection by filing a financial statement for an individual, the use of a name on a driver’s license and social security card is sufficient. In re Miller, No. 12-CV-02052, 2012 WL 3589426 (C.D.Ill. Aug. 17, 2012); see also 810 ILCS 5/9-503(a)(4).

 

What are valuation caps?

What are valuation caps?

A valuation cap is a term of a convertible note or a SAFE. It is also a great way to attract investors to any startup, providing them with an incentive to invest. Starting a successful financing round for your business will expose you to a slew of new terms. It is...

Thomas Howard

Thomas Howard

Real Estate Lawyer

Whether this is your first land use issue or most recent, our office has helped people and businesses alike.

Thomas Howard was on the ball and got things done. Easy to work with, communicates very well, and I would recommend him anytime.
R. Martindale

What are valuation caps?

What are valuation caps?

A valuation cap is a term of a convertible note or a SAFE. It is also a great way to attract investors to any startup, providing them with an incentive to invest. Starting a successful financing round for your business will expose you to a slew of new terms. It is...

How to add a new member to an LLC

How to add a new member to an LLC

Generally speaking, to add a new member to any LLC, you must first follow the operating agreement or the state law regarding LLCs. Though there are some additional things to take into consideration. Most operating agreements lay out how to add a new partner on their...

Subscription Agreements

Subscription Agreements

A subscription agreement is an investor's request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price...

Need A Business Lawyer?

Call our law offices with your legal questions for help on:

  1. real estate contracts
  2. business contract disputes
  3. Shareholder litigation
  4. cannabis business
  5. fraud actions
  6. mechanic's liens