Corporation, Securities
& Business Law Forum
June 2000 Vol. 45, No. 3
Statements or expressions of opinion or comments appearing herein are those of the editors or contributors, and not necessarily those of the association or section.
Contents
* Arbitration of securities industry employment disputes in flux
* Early stage venture finance: sources of data for the "angel" round
| * | Seventh Circuit applies Illinois Survival Statute to bar shareholders' claims |
| * | Minutes of the Corporation, Securities and Business Law Section Council |
This edition of the newsletter has several interesting articles, including a discussion of arbitration issues in the securities industry, and an informative analysis of "angel" funding for start-up companies. We also feature a review of the Seventh Circuit's recent discussion on shareholder claims, as well as our regular column, "Case law update." This edition also includes Business Law FlashPoints (also available at IICLE's Website www.IICLE.com).
As always, we look forward to your comments and suggestions. We also welcome your submissions to the newsletter.
Robert C. Knuepfer, Jr.
Baker & McKenzie
130 East Randolph Drive
Chicago, Illinois 60601
312/861-8913
robert.c.knuepfer.jr.@bakernet.com
By David E. Doyle
The interplay of the Illinois Securities Law and the validity of arbitration clauses
In Aste v. Metropolitan Life Insurance Company, MetLife Securities, Inc. and Anthony M. Williams, Docket No. 1-99-2574 (First District, March 28, 2000), the First District Illinois Appellate Court handed down a decision that may cause brokerage firms to examine the validity of the arbitration clauses in their customer contracts. In this case, the plaintiff, an executor of an individual's estate, sued the defendants out of dealings relating to investment services that the defendants provided to the plaintiff. The defendants' representative contacted the decedent for the purpose of soliciting the use of their estate planning services. After a few meetings, the parties executed a customer profile that contained the decedent's investment objectives, and this profile stated that the decedent's investment objectives matched those of the fund being considered. The customer profile also contained an arbitration clause. The parties then transferred $212,000 of the decedent's funds from a Merrill Lynch account to accounts with the defendants, at least some of which were then invested.
The plaintiff sued the defendants on grounds that included breach of fiduciary duty, constructive fraud and negligence. The defendants argued that the claims were subject to arbitration due to the arbitration clause in the customer profile. The lower court agreed, and the plaintiff appealed. The plaintiff claimed that because the representative that executed the customer profile on behalf of the defendant was not a registered salesperson at the time it was executed, it violated the Illinois Securities Law ("ISL"), and the arbitration clause was invalid.
The appellate court stated that the ISL made it a violation for an unregistered salesperson to sell, offer to sell or solicit an offer to purchase a security. The court also noted that there was very little Illinois case law defining what constitutes an "offer" under the ISL, but it stated that analogies to the Federal securities laws and Uniform Securities Act suggest that the term "offer" should be liberally construed. The court went on to hold that because the customer profile identified the decedent as the "purchaser of shares," it described the investment objectives of the decedent and it noted that they matched those of the investment fund, the profile constituted a solicitation of an offer to purchase securities. The court held that the contract created by execution of the customer profile was void because it was in violation of the ISL and contrary to public policy.
The defendants asserted that claims under the ISL are arbitrable and should be settled by arbitration. The court found that since the only substantive provision of the customer profile was the arbitration clause, the courts (not an arbitrator) had the authority to determine whether the clause was valid. Accordingly, the appellate court remanded the case back to the trial court for proceedings based on plaintiff's claims.
Recovery of lost profits and liquidated damages for breach of employment agreement
In Med+Neck and Back Pain Center, S.C., v. Noffsinger, Docket No. 2-99-0699 (Second District, March 9, 2000), the defendant, a podiatrist, resigned from his employment after less than half of his term of employment was finished. The plaintiff and defendant had entered into an employment agreement that provided for a two-year term of employment, and it contained a liquidated damages provision in the event of early termination by the defendant. It also provided for attorney fees for the prevailing party in any dispute. The plaintiff attempted to recover lost profits from the defendant's breach, as well as liquidated damages, training costs and attorney fees.
The court held that the general rule is that an employer may not collect lost profits from a breaching employee. It may collect the costs of obtaining a replacement for the breaching party, but in this case it found that evidence of such costs was not presented. Therefore, it held that the plaintiff was not entitled to lost profits or damages for the cost of finding a replacement. Moreover, it found that the liquidated damages provision was a penalty and thus unenforceable. The court stated that liquidated damages may not be used as a penalty to punish nonperformance or as a threat to secure performance. The plaintiff contended that the liquidated damages were intended to reimburse the plaintiff for the costs of training the defendant. The court held that the damages formula bore no relation to the training costs, as it was drafted to be a high penalty on the first day of employment, and then it gradually reduced to almost nothing at the end of the term. Accordingly, it was found to be a penalty that would not be enforced. Finally, the court upheld the lower court's finding that neither party was entitled to attorney fees, as both parties prevailed on parts of their case. The court agreed that the defendant did breach the employment agreement, but he prevailed on the damage counts. Thus, the court found that the lower court did not abuse its discretion in not awarding any attorney fees.
By Donna J. Cunningham, Cunningham & Colleagues, P.C., Barrington
Author's note: Lots going on this month, so this will be a longer than usual newsletter. However, many of this month's cases have not yet been posted. If a link does not work, try again later.
February, 2000
1. OSHA withdraws home workplace rules, extends comment time for proposed ergonomic standards
Facing a business community furious over its proposal to hold employers liable for the workplace safety of employees who work at home offices, including 20 million or more telecommuters, OSHA withdrew its proposal, and in testimony prepared for a Senate committee hearing, advised that it will not inspect home offices, after all. Assistant Labor Secretary Charles Jeffress said the agency does not expect employers to inspect home offices, either, and will not hold them liable for home office accidents. However, OSHA will enforce safety regulations for other kinds of home workplaces, especially involving hazardous materials or equipment, or piecework done at home for manufacturers. OSHA has also extended its public comment period regarding its proposed new Ergonomic Standards. A hearing scheduled for April 11, 2000, in Chicago will go ahead as planned.
2. D&O policy pays for "pureheart, but empty head"
Although the head of Plaintiff's trust department invested in highly speculative securities, and Plaintiff suffered losses as a result, Plaintiff was entitled to coverage under its directors and officers liability policy. The appeals court found that the record amply supported the district court's finding that the head of the trust department had a "pure heart, but empty head," and therefore, the bad-faith exclusion to coverage under the policy did not apply. . Citizens First National Bank of Princeton v. Cincinnati Ins. Co., Nos. 98-3534 et al. Cons. (1/14/00). Appeal, N.D. Ill., E. Div. Aff'd and vac'd in part and rem'd.
3. First impression: administrative order issued by state environmental agency is not a "suit" triggering duty to defend.
Applying California law, the Illinois Appellate Court ruled that the issuance of an Administrative Order by a state Environmental Protection Agency triggered the insurer's duty to defend. However, in a case of first impression, the California Supreme Court has ruled that no duty to defend exists, since the order is not a "suit" under the terms of the policy. Moreover, the law of the case doctrine is inapplicable, and the decision applies retroactively, so that insurer is entitled to summary judgment. W.C. Richards Co., Inc., v. Hartford Accident and Indemnity Co., No. 1-99-1014, 1st Dist., Cook Co., Aff'd (12-30-99).
4. Farmland conversion of wetlands results in loss of farm subsidies.
District court correctly granted government's Motion for Summary Judgment in action under the Food Security Act, 16 USC §3801for the return of $92,703 in farm subsidies because of defendant's conversion of wetlands on farm lands. Although Defendant claimed that he was only a renter with no control over wetlands, and that wetlands were converted by his father, record disclosed that Defendant listed himself as operator of farm on benefit forms, and failed to provide any evidence showing opposition to his father's alleged conversion of wetlands. U.S. v. Dierckman, No. 98-4131 (1/11/00). Appeal, S.D. Ind., New Albany Div. Aff'd.
5. New network solutions dispute policy effective January 1, 2000
Effective January 1, 2000, Network Solutions, Inc., formerly the exclusive Registrar of Internet Domain Names, has adopted a new Uniform Domain Name Dispute Resolution Policy. Under the new policy, neutral and accredited dispute resolution service providers will resolve disputes. In addition, some of the differences between the new policy and the old one are: a) domain names formerly placed on "hold" will be released; b) the new policy applies to all state and common law trademarks, as well as to nationally registered trademarks, and applicants are responsible for ensuring that their chosen domain names do not infringe on any other names or marks; c) Complainants may include any domain name that is confusingly similar to their trademark--as well as identical to their trademark.
6. Intellectual property: use of "first choice of doctors" does not require majority; survey results cannot be used to define terms
Plaintiff was not entitled to a preliminary injunction under the Lanham Act, 15 USC §1125 (a)(1), in its action seeking to prevent defendant from using "1st Choice of Doctors" phrase on label of its baby formula. Majority support not required to be "first." Phrase was not misleading where level of preference for defendant's product was high, and difference in support between defendant's product and any other similar products was substantial. Also, Plaintiff's survey results cannot be used to define terms. Mead Johnson & Co. v. Abbott Laboratories, No. 99-2215 (1/5/00). Appeal, S.D. Ind., Evansville Div. Rev'd.
7. Illinois sues online pharmacies for failure to obtain Illinois license
Joining only two other states, Kansas and Missouri, Illinois Attorney General has sued several online pharmacies under the state's consumer protection laws. The lawsuits charge the defendants with violating Illinois' Consumer Fraud & Deceptive Business Practices Act, the Illinois Medical Practice Act, and the Illinois Pharmacy Practice Act, by, among other things, practicing medicine without a license. In a typical case, a consumer logs on, agrees to a "Waiver of Liability," answers limited medical questions, chooses a dosage level and number of pills desired, and then the consumer's credit card is charged for the medication plus a $75 "consultation fee."
8. Stock options may increase overtime pay, or, no good deed goes untaxed
Under another controversial Department of Labor proposal, employee stock options given to workers who are eligible for overtime pay may have to be included in the calculation of that employee's overtime pay, according to the another Department of Labor Advisory. If not amended or withdrawn, the advisory would make stock option programs for non-professional workers more expensive and complex for employers, or non-existent for employees. Washington Post.
9. Insurers may limit total payout for AIDS-related insurance claims to amount less than for other conditions
Without comment, the U.S. Supreme Court let stand a decision of the Seventh Circuit Court of Appeals permitting Mutual of Omaha to set a $25,000 lifetime coverage limit for AIDS claims, but a $1 million limit for other conditions. Plaintiffs had contended that the practice was discriminatory under the Americans with Disabilities Act. John Doe and Richard Smith vs. Mutual of Omaha Insurance Company, No. 98-4112 (June 2, 1999)
10. A host of proposed new Illinois legislation
Corporate names, fictitious addresses. HB 2991. Amends the Business Corporation Act of 1983, General Not For Profit Corporation Act of 1986, Limited Liability Company Act, Uniform Partnership Act, and similar laws, and Assumed Business Name Act. Provides that foreign persons and foreign entities subject to these Acts may not intentionally misrepresent the geographic origin or location of the person or entity (i) with their assumed or fictitious name or (ii) with an Illinois or toll-free telephone number that is transferred to a business location outside Illinois. Subjects violators to certain penalties.
Business organizations; name use after dissolution. HB 3943. Amends various Acts relating to business organizations. Changes registration requirements for limited liability partnerships. Changes the requirements for certificates filed to form a limited partnership. Changes a provision permitting mergers of limited partnerships with limited liability companies to permit mergers of limited partnerships into one limited partnership. Changes requirements for executing articles of merger between a corporation and a limited liability company. Changes the effect of administrative dissolution of a business organization (including corporations, not-for-profit corporations, and limited liability companies) and revocation of a business organization's certificate of authority to permit that organization to retain exclusive right to use of its name for 30 days. Makes other changes.
Business organizations; registration denial criteria. HB 3944. Amends the Illinois Securities Law of 1953 by revising criteria for denial, suspension, or revocation of registration under the Law; and amends violations of Act to include violations by investment adviser representatives. Amends certain loan broker and business broker statutes. Amends the Business Opportunities Sales Law of 1995 by revising definition of "business opportunity" and the exclusion of certain sellers or offerers. Makes other changes.
Franchise disclosure statement. SB 1330. Amends the Franchise Disclosure Act of 1987. Requires copies of a disclosure statement and proposed franchise sale agreements to be given to a prospective franchisee at least 14 days before the prospective franchisee executes a binding franchise or other agreement or at least 14 days (rather than 14 business days) before any consideration is received. Effective immediately.
Corporate childcare credit. SB 1441. Amends the Illinois Income Tax Act. Provides that for taxable years 2000 through 2004, each corporate taxpayer is entitled to an income tax credit in an amount equal to (i) 30% of the start-up costs to provide a child care facility for the children of its employees and (ii) 5% of the annual amount paid or expenses incurred in providing the child care facility for the children of its employees. Provides that a corporate taxpayer may provide and operate a child care facility independently or in partnership with other corporations. Allows an excess tax credit to be carried forward and applied to the tax liability of the five taxable years following the excess credit year. Effective immediately.
Bank director immunity. House Bill 3405 (Persico, R-Glen Ellyn; Hassert, R-Romeoville) immunizes bank directors for alleged failure to perform their obligations as directors if they relied in good faith on the advice, information, or opinions of bank officers, professional advisors, or other bank committees. It has been referred to House Judiciary I Committee for a hearing.
Computer information transactions. Senate Bill 1309 (Dillard, R-Downers Grove) creates the Uniform Computer Information Transaction Act. Among other things, the bill proposes rules for memorializing contracts using electronic records, and governs the commercial licensing of computer information and network access contracts. SB 1309 has been referred to the Senate Executive Committee.
March, 2000
1. New IRS rules require lawyers and accountants to report corporate tax avoidance. New rules issued by the Treasury Department and the Internal Revenue Service require attorneys and accountants who promote tax shelters to their corporate clients to report any transaction where the "significant purpose" of the transaction is tax avoidance. Also under the new rules, businesses are required to report to the IRS whenever their book income (earnings reported to stockholders) significantly exceeds their taxable income, and report every payment to a tax shelter promoter that exceeds $100,000. In addition, the Clinton administration has introduced legislation that would make the "economic substance" doctrine a part of the tax code, so that the IRS does not have to attack each tax shelter on a case by case basis. As we go to press, we are unable to locate the rules online; rules may not yet be posted.
2. Small businesses take it on chin because of new tax law.
Based on a law which took effect on December 17, 1999, taxes on the proceeds from the sale of the assets of a business using the accrual method of accounting must be paid all at once, even if the proceeds are to be received in installments over several years. Previously, an exception existed for asset sales of such businesses. The new provision was part of a much larger tax bill, so it went largely unnoticed. Under the new law, the lump sum tax payment can be avoided if the buyer purchases the seller's stock rather than seller's assets, but that would mean buyer also purchases seller's liabilities--and his cost basis in the stock. A coalition of business groups have asked Treasury Secretary Lawrence Summers to repeal the "onerous" law.
3. First impression: "additional insured" covered only if written agreement.
A subcontractor allegedly agreed to name the general contractor as an additional insured under its comprehensive general liability policy, pursuant to an oral agreement. In a case of first impression under Illinois law, the First District has interpreted the typical policy language for "additional insureds" under such policies to require a written agreement. Following a similar California case, and rejecting Hartford's argument that the phrase, "include as an insured any person or organization with whom you agreed, because of a written contract or agreement or permit, to provide insurance such as is afforded under this policy," was to be read in the disjunctive, so that "written" applied only to the first word, "contract," the court found that the injured party was not an additional insured based on the parties' oral agreement. U.S. Fire Insurance Co. vs. Hartford Insurance Co., No. 1-00-1847 (2-23-00) Cook County. Aff'd.
4. Insured corporation by definition cannot have "family members"
Insured corporation maintained a business auto insurance policy, under which an endorsement provided coverage for any family member. When the president's son was injured, corporation made claim under policy, contending that insureds included owners of company and their families. Refusing to follow cases in Connecticut and other states which granted coverage in such circumstances to the shareholders of closely held corporations, the First District Appellate Court held that "insured" under the policy meant corporation, not president, and a corporation by definition cannot have family members. Rohe v. CNA Insurance Co., No. 1-99-1350 (2/8/00). 1st Dist. Cook Co. Aff'd.
5. Requirement of cash collateral violates Truth-In-Lending Act.
A loan agreement which requires cash collateral violates the Truth-in-Lending Act, 15 USC §1601. The only effect of cash collateral is to reduce the amount of the loans, which makes the annual percentage interest rate listed in the agreement inaccurate. Even though the loan agreement provided that cash security would be repaid with interest when the loan was repaid, the cash collateral was not a "deposit" under the Act, which would negate defendant's liability, since the cash deposit was not placed into an interest bearing, segregated account at federally recognized financial institution as required by the Act. Williams v. Chartwell Financial Services, Ltd., Nos. 99-2258 & 99-2287 Cons. (2/8/00). Appeal, N.D. Ill., E. Div. Rev'd and rem'd.
6. From the European Union: EU investigates Microsoft for possible violation of EU competition laws. EU Competition Commissioner Mario Monti announced the European Union's investigation of Microsoft's