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And now, for something completely different:

I ride my bike to work, whenever possible – preferably 5 days/week. I can take the short route which is only about a mile, or I can take a longer route, which is closer to 4 miles, and more scenic. Either way, if I drive, the car barely gets warmed up, so it’s hardly worth it. I used to commute 10 miles each way, but since I moved, I don’t have to do that, but I enjoyed that route too. Occasionally, people ask me why I do this and they usually assume I have some larger motivation. Mainly, though, I do it because I enjoy it and I think its good for me, physically and mentally.

There is, however, a very strong case for promoting bike commuting as a mainstream transportation mode. I recently wrote an op-ed piece in the Washington Post on the benefits of cycling, and how they should be welcomed regardless of party affiliation. For more, you can check out this, this or this.

The gist is: The economic benefits of cycling — not just for cyclists, but for the community at large, are staggering. Lower health-care costs benefit all of us. Having fewer cars on the road, especially at peak hours, reduces the need for expensive new roads and parking lots, and it means fewer deaths and injuries from vehicle-related accidents. Bike infrastructure projects create jobs too – more than 11 jobs per million dollars vs. 8 jobs per million for highway projects.
A safe bike-commuting environment can help people get to work even if they don’t have a car or can’t drive for any reason.

In Richmond, some 18 percent of households can’t afford a car, and 60 percent of households share a single car among several adults. Bikes can help them get and keep jobs. Right now, biking and walking make up 12 percent of all trips in the United States and cost about 2 percent of transportation dollars.

I’m not suggesting everyone can or should bike to work – it’s a matter of personal choice. But it seems to me that anyone who wants to should be able to do so in safety and without having to take elaborate detours or ride on sidewalks just to avoid becoming a traffic statistic.

When you consider how little of the transportation budget goes to meet the needs of this healthy and practical means of getting to work, fairness and common sense would seem to demand that we address the needs to cyclists in planning our streets and intersections, and accord the bicycle, one of the most elegant and efficient inventions ever devised by man, its rightful place on the roads, which we all pay for with our taxes, whether we drive, ride or walk.

How did you get to work today? Now, wouldn’t you feel better on a bike?

Of course this stuff is hard to read! So is quantum physics, but that’s because quantum physics is, in fact, hard, no matter how well you write it (even for quantum physicists). Contracts, however, should be easy to read – clear declarative sentences organized into paragraphs arranged in a logical order.

Contracts are like computer programs. They set some initial conditions (names of parties, date, etc.). Then they list a series of basic directions and “if…then” statements which, if properly thought through, should cover most any eventuality governed by the agreement. That’s what computer code does.

You can run computer code on a computer processor and you will know pretty quickly if the code runs smoothly or if it hangs. The problem with contract language is that for now, there is no contract processor to run the code, except the gray matter of the reader, who may be a judge, another attorney, or just a contract party.

Here are some tricks I use to make sense of contracts.

If you have the electronic file (in Word or something similar), do these simple “search and replace” operations. Your altered contract may not read perfectly, but it will be improved and more understandable.

After this, your contract will be shorter and reading it may seem less daunting. More importantly, it will be dramatically clearer and more understandable. I actually have a software tool that will do all of this automatically in one pass, which is very helpful.

All of these legalisms have crept into the language of contracts over the years, and now most lawyers just accept them, and even feel uncomfortable without them. Some actually think that adding them is chargeable work. This does not make them necessary or even helpful. In many cases, they are just crutches for sloppy drafting, which is often a symptom of sloppy thinking.

In particular, I despise “For the avoidance of doubt……” followed by anything. I was taught that a good drafter says things once and says them clearly. If you have to repeat it, you need to rewrite it. “For the avoidance of doubt” is the legal equivalent of “I mean, you know, it’s like, blah, blah, blah……..right?” Repetition of the same idea with different wording merely opens up cracks for ambiguity to seep into the contract. If litigators get a hold of that language, they will pry those cracks open with industrial strength jackhammer arguments and corrosive cross-examination leaving your “iron clad” agreement in a pile of rusty rivets and crumbling boilerplate. It’s worth knowing that an infamous case not so long ago turned on the presence or absence of a comma, and millions were at stake. Clarity matters.

So, if you have to read a contract, you can either mentally make these adjustments, or let your word processor do it for you – either way, you will find the contract much more understandable and less soporific. Your eyelid muscles will thank you. And of course, it goes without saying, (but I will say it anyway, for the avoidance of doubt ), you can send me or any of our Virginia business attorneys your contracts and we will be happy to interpret them for you!

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In previous posts we’ve dealt with “boilerplate” clauses such as waiver, jurisdiction and venue, and integration. Today we will talk about two related clauses: the “assignment” clause and the “binding effect” clause. Both of these clauses relate to the question of who may enforce a contract at a later date.

Let’s start with binding effect. The binding effect clause typically reads something like this:

Binding Effect. This Agreement shall be binding upon and shall inure to the benefit of the heirs, personal representatives, successors, and assigns of the parties.

It almost seems redundant. Why would you need a paragraph saying that the contract is binding? After all it’s a contract right? Well not so fast. Judge Richard Posner, a noted federal judge and scholar on the topic of contracts recently decided a case in which he explained why not every document which expresses a mutual understanding is or should be enforceable as a contract, especially when that document includes language that specifically disclaims the intent to form a contract. Judge Posner is known for his clear and direct writing and you can read that case here. 

It’s worth noting that the converse is not necessarily true. Just because you say something is a contract, does not make it a contract if it is missing the essential elements such as offer, acceptance, mutuality, consideration (meaning exchange of value) and a legal purpose. Those are all topics for entire first-year Law school contracts course, but it is sufficient for this topic to note that it is easier to disclaim the existence of a contract than to create one. However, if you include a “binding effect clause” you certainly have reinforced the idea that you intend the document to be binding to some extent.

So what does the “binding effect” clause really do? It simply defines the parties to whom the benefits and burdens of the contract apply. Under common law, with some exceptions, a contract is an intangible right that can be freely transferred. One of those exceptions, however, is for personal service contracts. When you contract with someone for their personal services, they may not simply sell that contract and transfer their obligation to another party with whom you have had no prior contact. In the same way, if you are performing an obligation under a contract for a specific person, you may not want to continue to have that obligation if the original party substitutes a new one for any reason. But the most likely application of the binding effect language is when an individual party dies, or becomes disabled, or when a business is sold. In those cases it is critical for the other party to know whether it can expect a contract to survive.

Which brings us to the assignment clause. An assignment clause might read something like this:

Assignment. Neither party shall assign any rights or obligations under this Agreement, which are personal to the parties, without the prior written consent of the other party, which consent shall not be unreasonably withheld. No assignment of this Agreement by the Company shall operate to release the Company from any of its obligations hereunder.

This clause sets limits on either party’s ability to transfer its rights and obligations. Some assignment clauses are very permissive, and some are very restrictive. Just as the binding effect clause deals with transfers caused by unexpected events, such as death, or sale of a business, the assignability clause is more focused on voluntary transfers of rights and obligations. In the assignment clause, either party may restrict the right of the other party to transfer its obligations and benefits. This is very important. For example, what if you enter into a contract with a business, and the contract requires you to provide confidential information about your business to the other party? If that party were then allowed to simply sell that contract to your competitor, your information would be compromised. That’s just one of many examples. Another is where you contract for the services of a specific person because of their expertise, connections, reputation or your pre-existing relationship. If that person could then simply sell the contract to a 3rd party with whom you had no prior dealings, you may not receive the benefit of your bargain.

So as I hope you can see, both the binding effect clause and the assignability clause can have critical implications for your business. However, the circumstances in which they matter are usually not presented immediately. If you sign a contract and everything goes well, the job is completed and payments made, then they really never come into play. It’s only after you are in contract with someone, and the unexpected happens that they become relevant, and often critical.

If you are tempted to try crafting your own contracts, beware of the pitfalls of removing or neglecting these boilerplate terms. How happy will you be with the apparent cost saving when you later have trouble keeping the other party to the agreement true to its requirements? If you have questions or comments, just note them below and one of our Virginia business lawyers will get back to you.

Related articles

• When Acceptance Is Not (thecontractanalyst.wordpress.com)

Don’t be so fast to discard it, or to assume that only lawyers care about the “fine print.” Let’s look at another term. Frequently, contracts will have a clause called a “no waiver” clause. This language says that just because a party waives its rights in one situation, does not imply or require them to waive those rights in another similar or even identical situation. You could say it’s protection against the “no good deed goes unpunished” rule.

In the absence of this clause, if a customer typically accepted late shipments, the vendor might try to claim that this “course of dealing” modified the written terms of the agreement, and that they were permitted to ship late without penalty anytime they wanted. Your behavior would have “waived” your contract terms. This argument would fail if the contract had a “no waiver” clause.

In future posts, we will continue our discussion of boilerplate contract clauses, such the venue and jurisdiction provisions. I’m sure you’re on the edge of your seat waiting, but in the meantime, you may want to be sure that your contracts have the standard boilerplate that you need. I’m going to recommend (big surprise) that yours be reviewed by an attorney to make sure that the boilerplate properly protects you. At least as much as the other party. Seriously – have your lawyer look at your agreements before you sign, or better yet, get them to help in preparing them. Don’t let something as simple as a “waiver” clause leave you high and dry.

Isn’t protecting your rights and those of your business a good reason to have a Virginia business lawyer look over the contracts you prepare yourself?

We greatly appreciate the trust and confidence Equity Concepts has placed in our Virginia business attorneys. What improvements are you making in your business client service? How are you providing added value to your profesisonal relationships?

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In the last post we talked about boilerplate clauses, specifically, the “integration clause.”

There are lots of other boilerplate sections that might seem to just be boring and unnecessary text, something you might drop if you didn’t know why they exist. Let’s look at two more.

Example one is the jurisdiction and choice of law clause. The fundamental purpose of a contract is to be able to enforce your rights if there is a dispute. You might assume that you can sue on your contract in the city and state where you made the deal, but that might not be the case. If the other party is in another city or state, they may have asked their attorney to specify that all disputes be resolved in the courts of that city in that state. If they did, it’s also likely that they specified that their local state law would apply.

The contract that requires you to cross several time zones just to make your case is a lot less useful. If your contract requires you to sue in Nevada applying Nevada law and you’re in New Hampshire, it’s going to be a very expensive lawsuit. You’ll probably be hiring a new attorney in another state, who doesn’t know you or your business or anything about the deal. That’s not a good way to start a lawsuit. But the other side will certainly take that all into account in any settlement offer. They will know that your settlement calculations will be more favorable to them because your legal costs will be higher than if you sue in your home court. See how the boilerplate works?

The law of the other state may not be favorable to your case. Although the Uniform Commercial Code (UCC) has been enacted in all 50 states, the case law can vary significantly in the rules of interpretation of the Code. What’s more, there are large areas of law, like employment, that are not covered by the UCC. Some states are “employment at will”, others give employees greater rights to maintain their jobs. If you are preparing an employment agreement, you would certainly want to control whether a California court would interpret a noncompete clause or whether a Virginia court would. I bet the interpretations would be different.

Example two is the “assignment” clause, another boilerplate clause that can dramatically affect your rights. This is not about homework. The assignment clause determines whether or not you or the other party can assign the benefits and obligations of your contract to a third party. Many contracts are designed to be assignable, and for commercial reasons, they have to be. Bank loans are a good example. On the other hand, if you contract with a company because of its specific expertise you may be disappointed to learn that they have assigned it to another company, whose standards are not as high. Sometimes it’s appropriate for one party to be allowed to assign its rights, while the other is restricted. The main point is that there is no single rule, and it’s always better to be clear in advance by using the proper boilerplate.

How will you be sure your contract protects your interests? Well, that’s what a good Virginia business lawyer is for. And all that boilerplate that some might think just increases your cost may eventually save your business, wouldn’t it?

So what is boilerplate anyway? The term originally meant exactly what it said. Boilerplate was standard, high-strength steel plate used to make boilers. Nothing fancy – just flat and strong to keep the boiler from exploding. Later, the term took on a meaning in the printing industry when blocks of text that were reused frequently were sometimes cast in steel as opposed to lead to make them more durable. Over the years, the word acquired a more general meaning, connoting anything highly standardized and commonplace. Lawyers adopted the term to refer to the language at the end of the contract that doesn’t seem to change very much from deal to deal.

It’s true that contract boilerplate language doesn’t change much, but the changes, while subtle, can be important. Boilerplate language is just as much part of the contract as the price, the delivery date or the description of the goods or services. What’s different about boilerplate is that it mostly matters when there’s a dispute. Of course, that’s when you really want the contract to be clear, unambiguous and, ideally, drafted in your favor.

Let’s look at one typical boilerplate term that most business people gloss over. It’s called the “integration clause.” The integration clause says that the written contract embodies all agreements of the parties with respect to the subject matter.

At first glance this seems obvious, and superfluous. Trust me, it’s not. The reason for this language is that, if it is not present, either side may be able to introduce evidence of subsequent agreements, side agreements, understandings, interpretations or other factors that could dramatically change the meaning of the agreement. If the language is present, then the person trying to prove something other than exactly what the agreement says has a high burden of proof. The only surefire way to prove that the terms of the agreement as written are not binding would be to have another written document amending the agreement and referring to it specifically. So the real purpose of this boilerplate clause is to enhance the certainty for both parties.

In this way, the language performs its boilerplate function exactly, holding the contract together despite pressures that might blow it apart. What common terms are you skipping over in your DIY contracts?

Virginia has topped the charts as the number one state in the nation for doing business according to CNBC.  When it awarded Virginia first place this year, CNBC remarked:  “we are starting to detect a pattern here.”  This is the second time that Virginia has run away with the award for top state for business since 2007 when CNBC started the awards.  Virginia has been either #1 or #2 every year since the awards began. 

 See the full survey results at  http://www.cnbc.com/id/41666602/

 This year, Virginia seized the top spot once again with the best overall score in the history of the CNBC study — 1,660 out of 2,500 points.  CNBC‘s Senior Correspondent, Scott Cohn quipped:  “we couldn’t have planned it this way, and if we could have, we might have mixed things up a bit.”   The annual study, measures all 50 states on 43 different metrics in ten key categories of overall business competitiveness.   They weight the categories based on how frequently the states themselves use them as selling points to attract business.   This method holds the states accountable to their own standards of performance and provides insight into the credibility of their sales pitch.

 The ten categories for selection criteria and weightings are:

 1.  Cost of Doing Business (350 points)

 2.  Workforce (350 points)

3.  Quality of Life (350 points)

 4.  Infrastructure & Transportation (325 points)

 5.  Economy (300 points)

 6.  Education (225 points)

 7.  Technology & Innovation (225 points)

 8.  Business Friendliness (200 points)

 9.  Access to Capital (100 points)

 10.  Cost of Living (50 points)

 According to CNBC Virginia is a perennial favorite because of its strategic location, friendly business climate and diverse economy. It moved back to the top this year thanks to marked improvements in a couple of key areas. 

Virginia’s tax burden improved considerably, helping the state move up five places to number 21 in the all-important “Cost of Doing Business Category.”  In the “Education Category,” a critically important factor for businesses looking for an educated and motivated workforce, Virginia jumped seven points to number 6, reflecting the Commonwealth’s efforts initiated in 2009 to reduce class sizes.

Virginia did what it does best each year in the study:  it shows a solid all-around performance by finishing in the top 10 in a number of key categories.  In 2011 it finished in the top 10 in five categories (“Infrastructure & Transportation” at number 10, “Economy” at number 8, 6th place in “Education,” 2nd in “Business Friendliness” and 10th in “Access to Capital”).

 Foreign and domestic enterprises should take note.  Virginia deserves to be on your short list for headquarters and operations in your future development plans.

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It seems that internet and social media titans Google and Facebook have once again, to no one’s surprise, gotten themselves in some hot water with the FTC and some privacy watchdogs again. They just can’t seem to get the hang of this “privacy” thing. Hence the start of this post.

Google has settled with the FTC over a little faux pas concerning its fabulously fizzled BUZZ service. Trying to combine the best of Facebook and Twitter, they announced BUZZ with typical Google style and fanfare, and just to be hip, they phrased their sign up options thusly:

“Sweet! Check out Buzz”

Or

“Nah, go to my inbox”

Minor problem: The “Sweet!” option gave less than a full and transparent statement of the degree to which users’ information would become public. In essence, Buzz capitalizes on all those emails you never deleted, scanning them for connections that you have or might want to make, or something like that. In other words, they use your private information to build a public social network. I’m sure they studied the 2009 Facebook Privacy policy fiasco in detail, but apparently concluded that Google and BUZZ were somehow “different” as in not subject to the same rules and regulations as their competitors. When folks started to realize that their private information was being shared far more than the casual “Sweet – Check out Buzz” message indicated, they were less than amused, but then, as they dug further they discovered that checking the “Nah” box did not have the effect one might have expected either. Notwithstanding a clearly checked “Nah” box, Google dutifully went right ahead and collected all sorts of information about the non-subscribers, perhaps with the thought that they would be pleased to see all that information stored and ready to go once they finally decided to join the flood of ecstatic BUZZ users, now measuring in the hundreds, or even thousands.

For its thoughtful and condescending violation of its users’ privacy expectations, Google was invited to discuss their philosophy of privacy with the FTC in court, leading to a proposed consent order that requires Google to submit to rigorous FTC audits for the next 20 years.

Facebook’s latest gaffe was to introduce its facial recognition capability as an “Opt Out” feature in June. Described by PC Magazine as “Creepy” and “terrifying,” Facebook’s tool works in the background scanning and analyzing the 200 million or more pictures uploaded every day by its 600 million users. By comparing faces in the pictures in its database with pictures in which your friends have “tagged” you, or you have tagged yourself, Facebook develops an incredibly powerful capability to analyze your movements, your activities, and your associations. Of course, by participating in Facebook in the first place, you already give them a lot of raw material, but this new tool goes one step farther. And it’s a big step.

Even if you opt out, how can you know whether Mr. Zuckerman’s elves won’t continue to analyze your photos with this capability. Or, having opted out, what if being tagged in one photo with one “suspect” and in another with a different “suspect” might provide a link that law enforcement officials would just about do anything to know. Did I say ‘suspect”? Sorry – I meant “subject.” Facebook is not a government agency of course. But then, what, if any, new surveillance capability has not eventually been commandeered by law enforcement, with or without a warrant? I’m not sure I would want to count on Facebook not to give up the goods if the FBI or Homeland Security brought enough pressure to bear. In fact, their privacy policy pretty much makes it a foregone conclusion:

6. How We Share Information

 

 Facebook is about sharing information with others — friends and people in your communities — while providing you with privacy settings that you can use to restrict other users from accessing some of your information. We share your information with third parties when we believe the sharing is permitted by you, reasonably necessary to offer our services, or when legally required to do so. For example:

……..

To respond to legal requests and prevent harm. We may disclose information pursuant to subpoenas, court orders, or other requests (including criminal and civil matters) if we have a good faith belief that the response is required by law. This may include respecting requests from jurisdictions outside of the United States where we have a good faith belief that the response is required by law under the local laws in that jurisdiction, apply to users from that jurisdiction, and are consistent with generally accepted international standards. We may also share information when we have a good faith belief it is necessary to prevent fraud or other illegal activity, to prevent imminent bodily harm, or to protect ourselves and you from people violating our Statement of Rights and Responsibilities. This may include sharing information with other companies, lawyers, courts or other government entities.

Time will tell whether Facebook and Google use these powerful capabilities for good or evil, but they are here to stay, and growing everyday. Even if there is little you can do to block their intrusive reach, you owe it to yourself to actually read the privacy policies of Facebook and any other site to which you submit personal information.

How carefully are you reading the Terms of Service and Privacy Policies of the online sites you frequent?

Related articles

• The FTC’s Proposed Settlement With Google Over Buzz Privacy Breaches (ericgoldman.org)

 NPR recently did a story about Grand Rapids, Michigan’s inspiring response to a Newsweek article listing Grand Rapids as one of America’s “dying cities” with a “bleak” economic outlook. Many small and medium business owners can empathize with what the people of Grand Rapids felt in the face of such a stark prediction, as business owners have been hearing from the media for years about how many businesses are failing with more hard times ahead.

Yet, the town of Grand Rapids did something inspiring in response. A small group of filmmakers, business people, and politicians rallied with a downtown production of hundreds of the town’s citizens, including prominent business leaders, students, government officials, and local news personalities, lip syncing to Don McLean’s hit, “American Pie.”

Watch the video here:

The video went viral fast, with over a million views on a holiday weekend. What is so inspiring about a town lip syncing?

1. It is quintessentially American. To respond to bad news by having a town-wide sing-along of “American Pie,” featuring cheerleaders, a pillow fight, a Nerf battle, the mayor riding in a convertible, and that plucky, small town, everybody-knows-everyone-else-and-we-can-all-pull-together-and-do-something-great . . . well, that is what the indomitable American spirit is all about. 
2. There is a time for grieving and a time for fun. “American Pie” is a perfect sing-along song, but it is also about overcoming grief and sharing that sadness with the entire community of Americans. As much as the song is about the literal death of musicians, it also stands as a powerful metaphor for the grief a lot of Americans are experiencing in this tough economy, from the loss of a job, a house, or a dream of graduating and getting started on a family. Yet, it also inspires a togetherness that leaves most people with a smile on their faces. The song “American Pie” is a great lesson in how to turn grief into community.
3. Cooperation. A lot of Americans seem fed up with partisan politics and the division in the country. It is refreshing to see a group of people react to a bad economic outlook not by playing party politics, but by banding together, regardless of ideology, and working to solve the problem by improving the image of their town.
4. Maybe there really is no such thing as bad press. The average American is tired of hearing about bleak economic forecasts and how there is no hope for the future. We, as a country, seem ready to face depressing headlines in the press and get outside and enjoy our towns, our neighbors, and have fun this summer, whatever lies ahead. And maybe, just maybe, that “Eh, whatever, let’s go have a pillow fight, then kayak down the river!” attitude in response to tough economic forecasts is just the thing that will prevent them from coming true. Getting out there in response to bad press and inspiring others to do the same certainly got more eyes on Grand Rapids than the hundreds of struggling towns that weren’t on Newsweek’s 10 Worst list.
5. Great use of social media.One lesson that the millions of people who watched the video may not have been realizing they were learning is that this is a fantastic use of social media to promote a “brand.”Too often social media marketing messages are too clearly “pitch” and not enough about the heart and soul of a brand. Small business owners looking to use YouTube or other types of social media to gain eyes (and hearts and minds) through a direct dialog to potential customers can learn a lot from Grand Rapids’ approach. Make your content fun, interesting, inspiring, and tell ‘em what is really at the heart of your brand and you will win new fans.

The Grand Rapids approach has a lot of great lessons for business owners looking for a creative solution to a tough economy. How will you apply these lessons to your own economic challenges?

If nothing else, sharing this video with your staff and colleagues may be a great way to spend 10 minutes energizing your employees and building a sense of community at your workplace.

Guest author Erin McNeill is a co-editor of Sands Anderson’s Risk Manager blog and is a second year associate at Sands Anderson specializing in general litigation, liability defense, and easements.

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The trademark geeks lawyers at Sands Anderson have been debating how far a company should go to “police” its trademarks.  Entrepreneur Media  (publisher of Entrepreneur magazine and owner of Entrepreneur.com) got us thinking about it:  in attempts to protect its Entrepreneur brand, it sent cease and desist letters to EntrepreneurOlogy.com for workshops, EntrepreneurPR, a firm that had a newsletter called Entrepreneur Illustrated, and 3Entrepreneurs, which  sold T-shirts, sweaters and hats with the phrase “Entrepreneur Generation”.

While it is never too soon to protect your company’s valuable trademark, registration alone is not enough. The owner of a trademark has to stop people from infringing its marks, known as policing the mark. 

It is a difficult line to walk. If you don’t police, you could be deemed to have abandoned your mark or have allowed infringing uses to go unchecked.  Too much (or inappropriate) policing can make your company look like a bully and generate bad PR. 

It is important to remember that a trademark registration protects the use of the brand name in connection with the goods and services provided in the registration only.  So if your registration is for ENTREPRENEUR.COM for “downloadable podcasts in the field of business, current events, lifestyle issues, and developments in science and technology”, is a Tshirt with “ENTREPRENEUR GENERATION” on it likely to cause confusion with your service?  Entrepreneur Media thought this was justified, because it had produced clothing with its “entrepreneur” logo.

The first step in policing is to find other people who are using your mark or something substantially similar that is likely to cause confusion in the marketplace. This can be done through search engine alert services or by hiring “watch” companies. Then you need to send a cease and desist letter, demading that the infringing use stop.  After that, there are a number of ways to maintain control of the mark from liecensing  the use to seizing and destroying infringing material. 

In addition to policing, maintaining a trademark after registration also includes making occasional post-registration filings. 

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Most lawyers who practice business law have relatively little experience in pricing their services.  They are used to billing by the hour, because that’s what they were trained to do.  Nonetheless, you can use the new openness in your favor by agreeing to your legal fees in advance, signing an agreement, and gaining more control over the value of your legal expenditures.

How do you raise the topic?  It’s easy.  Just say “I’d like to consider paying you for your services in a way that does not depend on the hours you expend.”    If it’s just a contract that you need drafted, a single flat fee is usually appropriate.  If it’s a negotiation over a contract, you can still agree to a flat fee, but you should expect it to be higher than the fee for the drafting alone. If you are entering into a complex legal situation, you may need to propose that the attorney give you fixed fees for specific stages or portions of that project.  Don’t be shy.  If your attorney does not readily propose a fee in response to your request, there’s nothing stopping you from proposing one to the attorney.  They can either accept it or reject it.  It’s a simple matter of doing business and agreeing to a price. 

Here are some of objections you might hear, along with some suggested responses:

 1.         Lawyer says, “I’d like to do that but I don’t know how long it will take.”  You can simply respond: “Well, I assume you’ve done many of these projects before, and you must have some idea, even if it’s just an educated guess.  I’m willing to agree to a reasonable number, and you, as a professional, should have some idea of what your services are worth.”  You, as the client, have every right to your opinion on the value of the services that you require.  There is nothing so unique about the practice of law that mandates billable hour arrangements.

 2.         Lawyer says, “I’d like to do that, but our firm is not set up to do business that way.”  You can say: “Well, here’s an opportunity to try something new.  You and your firm might find it very beneficial.  And my company and I like to do business with attorneys who think in terms of solutions, rather than activities.”

 3.         Lawyer says, “I can give you an estimate, but every case is different and I might lose money if I commit to a fee that turns out to be too low.  On the other hand, if I estimate too high, you might pay more than you would on hourly basis.”  Your response: “I don’t want an estimate, I want an agreement.  I’m willing to accept the fact that it may be higher than what I might pay based on your hours, but that’s okay, because I want the certainty.  This way we share the risk, and you have the same incentives I do, namely, to handle this in the most expeditious way that is consistent with my objectives.” 

 Another way to get an attorney’s attention and interest them in a flat fee is to offer to pay a significant portion of the fee in advance.  You can agree to pay the balance on the project is complete.  Of course you have to define “completion”, but that’s a good practice anyway, ensuring your attorney is clear on your objective.  It’s possible that you may find that the larger the firm, the less willing your attorney may be to consider an AFA.   That may simply be a reflection of the fact that the attorney is managed and rewarded based on the billable hour system.    He or she may not have the authority to make such an arrangement or the incentive to ask for permission.   Still, it never hurts to ask, and if you tell the attorney that you really would like to do business with their firm, you can certainly ask them to take it up with their management.

You could also direct your attorney to the many resources now available on the topic of AFAs.  Two good places to start are www.verasage.com, and www.clientrevolution.com. Finally, if your attorney is still unwilling to propose or consider AFAs, talk to some other Virginia business lawyers.  I have written and commented extensively on the topic as well, and I would be happy to direct you (or your attorney) to the blogs where you can find my comments and the articles I’ve written.

Seriously. I know it sounds like a pitch, but I am sincere. Of course we hope that you will hire North Carolina corporate attorneys and Virginia business lawyers from Sands Anderson, but even if you don’t, make sure that you find an attorney who has experience in these matters. I can give you several good reasons.

First, if your business is worth investing in, then you probably have your hands full – or you are excess baggage. You should either be closing your next sale, getting your next-generation prototype to work, or hiring a replacement for the engineer who left suddenly, leaving a critical project is completed. You need to delegate.

If you’re capable of getting a venture capitalist interested enough to give you a term sheet, you’re probably bright enough to learn all the ins and outs of VC financing structure. But that doesn’t mean that you should. As we discussed in Point Number 8, the VC capital structure model, while elaborate, really doesn’t change much from deal to deal. The parameters may change, e.g. the pricing, compensation levels, vesting schedules, liquidation preference factor, etc., but the essential structure of the deal follows a tried and true path. If you really want to reinvent the venture capital business model, you’ll have a lot more luck after you have successfully IPO’d your company. Until then, you will be wasting your time trying to reinvent a wheel that’s already round enough.

Another reason you should hire a good lawyer, is that no right-thinking VC will invest in the company that is not represented by competent counsel. It raises too many questions. It also puts an extra due diligence burden on the VCs and their lawyers. They need to know that everything is where it needs to be, the corporate records are up to date, patents have been filed, and all of the outstanding stock has been properly authorized and issued. In answering these questions, they get lots of comfort from having a law firm on the other side of the deal issue a legal opinion. Even if you could give such a legal opinion, it wouldn’t be worth much unless you have a legal malpractice policy of your own.

Good venture capital lawyers, with many of these transactions under their belt, are more likely to pick up on subtle cues or wrinkles in the deal. They may be able to anticipate where a venture capital firm will give way on one point, and use that to your advantage to protect you on another point. If you or your attorney haven’t done these deals before, you won’t know where the trade-offs are. You could easily give away too much to obtain something that the venture capital firm didn’t really care that much about. In other words, there’s no substitute for experience. Related to that is that a good venture capital lawyer will stay up to date on “market” deal terms. If the VC is asking too much, your lawyer should know that. If they haven’t done enough deals, they would have nothing to compare to. Depending on the state of the economy, the scarcity of capital, the state of the market for IPOs or strategic acquisitions, venture capital deal terms will change, just like the price of the stock fluctuates in the public market. The difference is that with private companies, it’s not a simple as a quoted price. Take a look again at the term sheet referred to in Point Number 8. There are many knobs to turn and switches to flip.

Finally – you will need good counsel. Issues may arise that you cannot or should not discuss with your employees. You may question why the VCs are asking for a specific term or a piece of information, and your partners or employees will not know the answer. You will want to know if the VC is being too aggressive, or if their body language suggest that you can get better terms. Here again, experience is the key. Good venture lawyers have a “sense of the deal” that develops only with time and deal flow. They can also come up with creative solutions that you would not think of. Almost every deal threatens to run aground over some issue in the process between term sheet and funding – but there is almost always a solution. In negotiating deals, as in navigating rivers – It’s good to have an experienced pilot who knows the shoals, the rocks and the currents.

No matter how smart, committed, persistent, motivated, talented, indomitable and attractive you may believe yourself to be, no one can do it all. And even if you could – what if you get hit by a bus? VC’s are said to be risk takers, but in a larger sense they are risk managers. Risk is a given in start-ups and high-tech – it’s just table stakes. It’s how the VC manages the inveitable risk that matters.

One way they manage risk is by investing in a portfolio or “team” of companies. Before there was such a thing as modern portfolio theory – even squirrels knew it wasn’t smart to put all your acorns in one tree. Pretty good for a rodent with a knack for getting run over because it can’t make up its mind which way to run…but I digress.

So if you are a VC and you like the product, the market, the timing and the “space” as they like to call it – you really don’t want to put all your chips on Red 21. Not even Reggie Jackson could win the World Series alone. Successful companies are companies first, then they are successful. Any endeavor that progresses beyond the “Eureka” moment in the shower quickly becomes a multi-dimensional enterprise.

It stands to reason that the same person who thinks up the idea may not he best person to make it cheaper, better, faster, or to sell it, let alone to sell it into markets the inventer didn’t even know existed. And then there is the boring stuff and sometimes the ugly stuff – the blocking and tackling, ordering parts, returning parts, re-ordering parts, negotiating prices, hiring people (and firing them), buying furniture, negotiating leases and on and on ad infinitum.

Say you’ve got a real game changing, paradigm shifting idea – do you really want to spend your time trolling used office furniture stores and placing employment ads? Maybe not – but somebody has to. When I was the VP of Corporate Development for a start-up, we had some extremely talented engineers we hired from the likes of Motorola and EG&G. But we were on a really tight budget – still in the angel finance mode. The COO and I had offices that overlooked a parking lot, and on the other side was an old motel that was being remodeled. We each kept an eye out for furniture that was set out by the dunpsters, and when we saw something usable – we went and got it.

But you can bet we didn’t pull the engineers away from their $30K Broadcom development kits to help us – we did it because it allowed those wizards to keep working. So in a way, the more that you believe you really are the reincarnation of Thomas Edison or the next Steve Jobs, the more you should want a team around you so you can focus on the amazing things that only you can do.

Venture capitalists, as our Virginia business lawyers know, want you to have a robust team of talent. What are you doing to start building your team, before your competition drafts all the best players?

If you’re serious about raising venture capital, you must be prepared to accept virtually all of these terms, if you expect to close. In the process, it’s crucial that you be honest with yourself. If you really cannot get comfortable with the standard terms, you would be better off bootstrapping your company. Otherwise, talking to VCs — let alone getting into extended negotiations with them over terms that are pretty much nonnegotiable — is a waste of your time and theirs.

So here are some of the biggies.

1. The stock you own may be “reverse vested.” What does this mean? It means that even though you issued stock to yourself when you formed your company (or LLC membership interests, as the case may be), the deal terms may require you to put substantial amounts of your equity at risk. This is the VCs way of making sure you stick around. In effect, you have to earn your equity back. The period over which you earn, the equity back may be from 3 to 5 years, and it may affect all or maybe just a portion of the equity. But you can pretty much count on subjecting a significant portion of your ownership to this mechanism.
2. The VCs will not buy common stock or its LLC membership equivalent. They will have what is known as a liquidation preference. Simply put, they get their money back before you get any of yours. When venture money is especially scarce, or IPO conditions are unfavorable, the VCs may even ask for a multiple liquidation preference. This is a way of extracting a decent return even if the company’s performance is mediocre.
3. You will sign an employment agreement that will enable the VCs to fire you if you’re not performing. There is significant flexibility in terms of compensation, perks, etc. But the bottom line is, if you’re not getting the job done, the VCs can and will replace you. The employment agreement may grant you termination benefits, which can be either generous or downright stingy. These are some of the areas where you can negotiate successfully, as long as you stay within the framework.
4. The VCs will have the right to participate in any public offering of stock. They will also have the right, under certain conditions to demand that you register their stock for sale with the Securities Exchange Commission, even in the absence of an IPO. At the same time, you may have to agree not to sell your stock in the IPO and for some time thereafter. Investors generally think it’s a bad thing to see founders cash out at the IPO. This demonstrates a certain lack of confidence in the company’s future, and of course the price of the IPO is based almost entirely on the company’s future. So even though you will look wealthy on paper the day after the IPO, you may be no more liquid than the day before.
5. VCs do not have infinite patience. They have to answer to their investors, and they expect to invest and recover their funds over period of 5 to 10 years, but the sooner the better. That is why they require redemption rights. Redemption rights allow them to turn in their stock for a return of the original capital plus all accrued dividends. This protects the VCs in case the company makes progress, but is not able to arrange an IPO or acquisition, whether due to market circumstances or less than stellar company performance. By maintaining the right to get their money back, the VCs can have greater assurance that they can close out a fund, clearing the decks for them to raise another. Bear in mind, the VC’s job depends entirely on their ability to both invest and recover capital within a reasonable timeframe. Most of their investors are institutional (insurance companies, pension funds, sovereign wealth funds, etc.) and all of them desire some degree of predictability.

These are just a few key points that often pose problems for founders. Founders tend to be self-reliant, control oriented, highly confident (sometimes to a fault) and utterly convinced that they have the right idea, and the unique ability to bring it to fruition. These same factors that make entrepreneurs successful can also get in their way in the venture capital process. As a founder, you have to realize that the VCs assume that you possess all of those attributes, otherwise they probably wouldn’t even be talking to you. But from their experience, they know that they have to control founders for their mutual benefit. The faster a company grows, the sooner it outgrows the management capabilities of the founders, requiring installation of “professional” management. The mentality of the professional managers can be quite at odds with the entrepreneurial mindset, and clashes are the rule rather than the exception, so be prepared.

For a complete overview of the terms of venture capital deals, look at the NVCA model documents. By downloading these documents, you can at least be forewarned, and forearmed before entering into negotiations. It’s no secret that these terms can be tough. But at least you can anticipate them and make your decisions accordingly.

“Nothin’ from nothin’ leaves nothin’.” Billy Preston

“42.7 percent of all statistics are made up on the spot.” Stephen Wright

Know your ownership position. In our last post, we discussed being prudent about what you say to the venture capitalist or fund management. This post, however, is about being careful about how the raising of capital affects share of ownership and business success.

Don’t sacrifice your start up to the false god of majority ownership. It’s a common mistake to view ownership and control in a one-dimensional framework. What could be simpler, there are hundred percentage points and if you have more than 50 of them, you’re the boss, right? And that’s a good thing, right? To which I respond: “no” and “maybe.”

The venture capitalist’s model capital structure is not based on a simple division of ownership (we’ll talk about that next time). There are plenty of good reasons for this, and it’s mutually beneficial to investors and entrepreneurs. For example, you might own 51% of common stock, but when you take into account anti-dilution rights, preemptive rights, adjustments to conversion rates, participating versus nonparticipating preferred, clawback’s, vesting schedules and other parameters, it’s very hard to know what your share of the ultimate pie might be. Furthermore, owning 51% of the fully diluted common stock does not guarantee control. With the VC investment will come new board members, and rights to take control of the board if the company misses milestones. That’s not to say percentage is not relevant, just that it’s not simple. All things being equal, (which never happens), a higher percentage is better than a lower one, but when the bargaining starts it is easy to make too much of that.

Entrepreneurs need to keep in mind that the fundamental economics of venture capital funds constrain VCs in setting the terms and size of their investments. Based on the size of the fund, they have to allocate a certain amount of money to initial investments, another chunk to follow-on investments in successful companies, and still a third for “problem children” i.e., the companies that still show promise, but can’t seem to keep momentum. The size of the VC fund’s staff is also a factor. There are only so many deals that one person can successfully monitor, manage and contribute to. Remember part of what you are getting with the venture capital money is the knowledge and experience of the fund principals. If your contact with the venture fund has too many pots to watch, you may not get your full measure of advice.

The net effect of all these factors is that venture funds typically invest from one to five million dollars in an early round, and generally receive anywhere from 25 to 75% of the equity of the company on a fully diluted basis, that is, assuming all options, conversion rights and other equity interests are fully exercised. However, even if you maintain 51% of this magic fully diluted number, if your company does not perform, there will undoubtedly be adjustments or subsequent rounds of financing that might dilute you down to single digits.

And single digits aren’t necessarily all that bad either. If your share declines because of follow-on investment rounds at increasing prices, then the value of your seemingly small 9%, may far exceed the value of 90% of an earlier round. Just remember, it’s all about the money. I doubt Bill Gates thinks about what his percentage of Microsoft was when he first received venture capital money. All he really cares about is what it’s worth right now.

Our Virginia and North Carolina business lawyers know quite a bit about how ownership agreements and funding structures work. Use the comments below to share your observations and questions about ownership in your start-up company.

The Act’s title of “small business” is somewhat of a misnomer. Its provisions have a significant impact on businesses of all sizes, not simply small ones. In addition, the new law includes some retirement savings incentives for individuals and other provisions unrelated to small businesses jobs creation.

Over the next few weeks we will be featuring a series of articles on this important law and discussing the elements of the SBJA that all businesses should be aware of.

Bonus Depreciation

The Bonus Depreciation needs to be our first topic because it is an expense deduction that can be taken immediately for certain qualifying property but, in order to be eligible for 2010 tax benefit, the equipment must be placed in service now before year’s end.

The SBJA extends the 50-percent additional first-year bonus depreciation for the 2010 tax year. Under this law, all businesses, regardless of size, can immediately depreciate an additional 50-percent of the cost of specified property purchased and placed in service in 2010. This is in addition to the IRS Code Sec.179 expensing (allowing expense deductions for capital investments), which was also extended by the SBJA through 2011. The effect of this is to enhance significantly the deductions for capital purchases and thus reducing corporate taxes.

Bonus depreciation is allowed only for: (1) tangible property to which Modified Accelerated Cost Recovery System (“MACRS”) applies that has a recovery period of 20 years or less, water utility property, certain computer software, and qualified leasehold improvement property. Except for certain computer software, the depreciation is not usable for other intangible property.

The bonus depreciation deduction is calculated by multiply the unadjusted depreciable basis of the property by 50-percent. This is the amount of depreciation the business can deduct in the first year in addition to the regular depreciation. If your business purchases a machine in 2010, for example, for $50,000 and it qualifies for the bonus deduction, your business would be allowed to deduct $25,000 in first-year depreciation. In addition, the remaining cost of the machine is available for the normal deduction under MACRS. This is a significant acceleration of the cost recovery business expense.

In order to take the deduction for the 2010 tax year, however, your business must put the equipment into service in 2010. We don’t advise doing deals based on tax impact alone, but if your business was otherwise in the market for that qualifying capital equipment, now is the time to buy.

Stay with us for this series on the new Small Business Jobs Act. We will keep you informed of other important provisions of the SBJA. This law, if understood and used, will have a significant impact on your businesses after-tax cash flow. If you have any questions please contact us here at Sands Anderson.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with IRS requirements, we inform you that any tax advice contained in this communication was not intended or rendered, and cannot be used to: (i) avoid penalties under the Internal Revenue Code; and/or (ii) promote, market or recommend to anyone else anything the communication addresses.
This article is distributed with the understanding that Sands Anderson is not providing legal, or other professional advice. Facts and circumstances differ among taxpayers and you should contact our firm to discuss the specifics of your situation and how they may apply to information presented here.

Last time, we focused on having a plan. As a corollary to presenting that plan in your conversations while seeking venture capital, here are some things you should never ever say (or at least do your best to avoid saying) to a venture capitalist:

This is really several tips in one post. It’s a nonexclusive list of statements and phrases that will not help you, and may even hurt you in your quest for investors.

1. “If we can capture just one percent of the market, we will…” This phrase is bad in two respects. First, it is naïve, because it implies that in a large market, almost anyone can grab a small percentage. This may be true in economics textbooks, where they describe “perfect competition” but it’s definitely not true in the real world. The other problem with the phrase is that it may give the listener the impression that you’re not thinking big enough. Venture investors don’t want to invest in bit players and also-rans, they want winners. By definition, you cannot achieve extraordinary returns on investment with ordinary performance.
2. “We have no competition.” In other words, there is no market for your product? If you don’t have obvious competition, then your product is competing against pre-existing solutions to the same problem that your product purports to solve. Plus, without acknowledging competition, you are really asking investors to make a double bet: the first that is that a market for your product will emerge, and the second bet is that you have the winning solution.. Venture investors are not in the habit of compounding their risks.
3. “The rest is easy!” If only this were true! Even if the steps after your “breakthrough” appear simple, it’s never good to underestimate the challenges you face. At every step in the process of bringing your product to market and making it succeed, there are real-world obstacles. People make mistakes, lose motivation, fight with other team members, etc. Circumstances can conspire against you in, totally unforeseen ways. In my venture company, some of the most painful delays we experienced were caused by the most mundane issues or quirk events.
4. “We guarantee you X. percent return on your money.” If you could do that, you wouldn’t need venture capital, you could borrow the money. This is beyond naïve. Enough said.
5. “It’s not about the money.” If it’s not about the money, why should they give you any of theirs?
6. “XYZ Co’s solution is pathetic.” In other words, don’t denigrate your competition. If they are already up and running and especially if they have raised capital, they may know something you don’t know. Plus, it’s bad form. Worst case, one of the investors in your audience may have invested in the company, when they were with the different fund, or even pitched them internally to their partners just last week. After all, if they are interested in your market enough to talk to you, how do you know they haven’t already talked to your competition? Oh, and by the way, check their website before sending your plan just to make sure that they haven’t made a competitive investment.

I could go on, and there are numerous other examples on the many websites that deal with the topic of raising venture capital. You can be sure that the venture fund, partners that you talk to will have their own pet peeves for the best general advice I can give you is to be circumspect and professional about your opportunity in your plan to capitalize on it. Bold statements alone will not carry the day, and actions speak louder than words.

Have you ever said something you’ve lived to regret? How did it affect your chances for business success?

In venture capital deals, there is a highly standardized corporate structure. A venture backed company has common stock, owned by founders and employees, and preferred stock, owned by the investor VCs. There may be several series or classes of preferred stock, depending on the number of rounds of investment. Each series or class will have specific rights of priority, rate of return etc. Within the standard model, the actual deal terms can vary widely, but market conditions tend to restrict them to a fairly narrow range at any given time.

One of the key features of preferred stock is the “liquidation preference.” Liquidation preference is the amount of money per share of preferred stock. That must be paid before the common stockholders can receive any payment for their stock. This typically matters only if the company is sold, merged or liquidated.

Historically, when a venture-backed company experiences difficulty or misses certain agreed performance targets, the preferred stockholders essentially take control. At that point, they may be less interested in getting a return on their investment as they are in just getting as much of their investment back as they can. If the company ends up in a “fire sale” transaction, the preferred stockholders may assume that the common stockholders will be left with nothing after the preferred liquidation preference is paid.

A recent case in the Delaware Chancery Court (the most influential court on corporate issues) may have changed the ground rules in such situations. In that case, In Re Trados Incorprorated Shareholder Litigation, the directors of the company were found to have breached their fiduciary duty to the common stockholders by declining to initiate a “sale process” i.e. an auction, for the company. A majority of the directors had been elected by the preferred stock investors (venture capital funds). The company had experienced major setbacks and generally failed to meet the expectations of the preferred investors, but appeared to be on the rebound, and was not in danger of failure. Nonetheless, the Board approved a merger of the company in a transaction with the result that the preferred investors recovered most of their investment, some officers received bonuses, but the common holders received nothing. Common stockholders brought a class action against the board members who approved the transaction, and the court ruled in their favor.

As in any case, there were numerous factors in the court’s decision, and there is no general “rule of thumb” that can be derived, but the implications for a director’s duties are significant.

The National Venture Capital Association (“NVCA) maintains a set of legal forms regarded among VCs and their counsel as the industry standard templates for VC transactions. In the wake of Trados the Association has modified the documents to provide greater protection for directors in situations where the interests of the preferred investors and the common owners may be at odds. Anyone considering purchase of convertible preferred stock¹ in a private company, and any board member of such a company should be aware of the heightened duties to other shareholders in light of Trados, and should also make certain that their counsel is aware of their concerns and the changes to the NVCA documents. Conversely, company founders seeking investors, and other common stock holders, or holders of options on common stock (e.g. key employees), would also be well advised to understand this case and its implications for corporate structure.

[1] At the “angel round” stage, many companies are formed as limited liability companies under the law of the state where the company was formed. Although these investments often have a structure similar to that used in VC transactions, the LLC statutes and applicable case law are not identical to the Delaware laws that applied to Trados. Even so, the principles of Trados may guide courts in other states when interpreting the LLC statutes as applied to operating agreements and other investment documents of angel round companies.

In our previous posts, we briefly talked about the new Healthcare legislation which was signed into law (H.R. 4872 the Healthcare and Education Reconciliation Act of 2010 (Reconciliation Act, P.L. 101-152)) (the “Healthcare Act”) and described a number of the major individual mandates contained within that Act.

We continue to present a brief overview of some of the key tax changes affecting individuals and businesses in the Healthcare Act. Please call our offices for details of how the new changes may affect your specific situation.

New for Employer-Provided Plans

The Healthcare Act requires certain changes so that in any employer-provided health insurance plan, the child of any covered employee may be included in coverage until such child reaches age 27, even if the child cannot be claimed as a dependent of the employee on the employee’s federal tax return. The same change is also effective for health insurance plans of self employed individuals (effective March 30, 2010, a self-employed individual may take a “for adjusted gross income” deduction of health insurance premiums where the insurance covers the self-employed individual, the individual’s spouse, the individual’s dependants, and the individual’s children who have not attained age 27).

The Healthcare Act further requires that group health plans that cover dependant children must continue to make dependant coverage available for an adult child until the child reaches age 26. Although there is no requirement for a plan or issuer to provide health insurance coverage for anyone, including dependants, if coverage is provided for dependant children then, under the Healthcare Act, the coverage must continue until the child turns 26. (Note that it is unclear why this provision applies to children under age 26 and other provisions described above apply to children under age 27.)

Health Savings Plans Affected

The Healthcare Act makes several significant changes to certain health savings plans, including health savings accounts (“HSA”), health flexible spending arrangements (“FSA”), health reimbursement arrangements (“HRA”), Archer or medical savings account (“MSA”) and other qualified employer health plans. Current law generally allows participants of these plans to set aside funds, pretax, which will be used to reimburse them for certain healthcare expenses. Presently, reimbursement for over-the-counter medicines and drugs have been very liberal (even over-the-counter aspirins and cough medicine would qualify). The Healthcare Act provides that for amounts paid in tax years beginning December 3, 2010, the allowable medicines for reimbursement will be more restricted. Unless a prescription from a doctor is acquired for over-the-counter medicines, only payments for prescribed drugs and insulin will be eligible for reimbursement.

Another significant change regarding health FSAs is that the amount a participant may set aside per year will be restricted. Currently, there is no statutory restriction as to how much an participant may set aside in a health FSA and such amount is usually limited only by the employer. Effective for tax years beginning after 2012, an employee may only set aside $2,500.00 per year in an FSA. For taxpayers who have been setting aside amounts greater than $2,500.00, this will effectively result in a lost deduction and an increase in tax (regardless as to the taxpayer’s current taxable income).

Due to the Healthcare Act there also will be additional reporting required of most businesses. For all payments made after 2011 by any person engaged in a trade or business (a “Payor”) an information return must be filed for all payments made totaling $600.00 or more in a calendar year to a single payee (other than a payee that is tax exempt). Also, payments to corporations, except those made for medical or healthcare services, are not required to be reported on an information return.

Paying for the Healthcare Act

In another effort to raise money to assist in paying for the expense of increasing federal payments under Healthcare Act, individuals will find it harder to deduct medical expenses. Under current law, a taxpayer may only deduct medical expenses to the extent all such expenses incurred during a single year exceed 7.5% of the taxpayer’s adjusted gross income. Starting in 2013, the Healthcare Act generally increases the threshold for claiming an itemized deduction for unreimbursed medical expenses from 7.5% of adjusted gross income to 10% of adjusted gross income.

Beginning in tax years after 2013, a penalty will be assessed against most individuals who did not have minimum essential health coverage for a month. The penalty will be paid with an individual’s income tax return and be based upon a percentage of household income in excess of a threshold amount. The penalty will be lower in 2014 and gradually increase until 2016, when the penalty will generally be 1/12 of the greater of (i) $695.00 per uninsured adult; or (ii) 2.5% of the household income in excess of the threshold amount of income required for filing a return.

Our Virginia and North Carolina tax lawyers are helping clients wrestle with these and other changes that proceed from the Healthcare Act. If you have questions or comments, please post them below and we will try to respond.