SCOTUS RULING STRIKES DOWN BAN ON SCANDALOUS AND IMMORAL TRADEMARKS

For decades the U.S. Patent and Trademark Office (“USPTO”) has refused to register trademarks consisting of words or symbols deemed “immoral’ or ‘scandalous’, in accordance with Section 2(a) of The Lanham Act.  In recent weeks, however, the Supreme Court of the United States struck down this long-held prohibition when it ruled that the refusal to register such trademarks violates the First Amendment to the U.S. Constitution, namely free speech of the trademark owner. For additional information on this ruling, see this National Law Journal article.

What exactly is an “immoral’ or ‘scandalous’ trademark?

Generally speaking, trademarks are used by an individual or business to brand and sell goods or services. Trademarks create identity, brand recognition and goodwill to the consumer. The previously banned scandalous or immoral trademarks typically contain profanity, are lewd, sexually explicit, or relate to drug use, religion or terrorism. So, why would a business owner want to brand their goods or services with a trademark that is “immoral’ or ‘scandalous’?  The answer to this question depends on the individual trademark owner, what goods or services they are selling, and most importantly, who their target market is. For example, a business who wishes to market their product to a younger group of consumers may use profanity to appeal to the rebellious side of their target consumer, which may shock most other groups of people, but the shock factor can be a very useful marketing tool.

Undoubtedly, there are individuals who are wholly unoffended by what the USPTO constitutes ‘immoral’ or scandalous’.  In fact, there are many generations of consumers who even resonate with the “offensive” terms or message.  Apparel and related goods is an industry often heavily impacted by the prior “immoral’ or ‘scandalous’ trademark ban.  Many apparel businesses have attempted to create brands consisting of terms that violate Section 2(a), only to have their applications rejected.  An example consists of four-letter word trademarks or logos depicting of  drug paraphernalia or sexuality used on clothing, hats or handbags.  Indeed, we have counseled many clients in the past seeking to trademark such brands.  The Court’s ruling allows businesses to move forward with these trademarks and seek federal protection.

What does this mean?

This 180 degree change in the law is likely to open the floodgates of applicants seeking to register trademarks once banned.  In fact, there have been hundreds of recent filings at the USPTO and this will continue to grow.  How will this affect businesses and consumers?  Businesses are now free to create and define a brand that best represents their message, profane or not, and they will be able to seek the broadest protection in their trademark with a U.S. registration. On the other hand, consumers will be exposed to bold trademarks and branding that appeals to some and which is highly offensive to others.  There is no doubt that this ruling will affect branding on a whole new level.     

Conclusion

Gehres Law Group, P.C. can provide assistance with determining if your creative work is eligible to be trademarked or if you should use an alternate approach, such as filing a patent or copyrighting your work product. Our legal team will also guide you through the formal process of applying to register your trademark, which can be a difficult process that begins with choosing the correct application. Just give us a call at 858-964-2314 or contact us online to find out how we can help; we offer free consultations for new clients. Learn more about our trademark flat fee packages here.

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WHERE TO INCORPORATE YOUR SMALL BUSINESS

Introduction

Many California business owners have heard and read that Delaware is the best state in which to form their entity due to their business-favorable laws. In particular, Delaware has historically offered:

• the most favorable franchise tax rules and been the most pro-management from a legislative and judicial perspective;

• broader protection for board members against derivative suits (lawsuits initiated by shareholders on behalf of the corporation);

• less legal protection for minority shareholders than California (e.g., cumulative voting is not required and staggered boards are allowed); and,

• limited statutory protection against hostile takeovers.

However, despite the ease and potentially favorable factors that point to Delaware as a destination for business formation and incorporation, there are some factors that California business owners, especially those who own small businesses, should consider before jumping on the Delaware bandwagon.

Cost Comparison Between California and Delaware

It currently costs $89 to file articles of incorporation in Delaware. The required annual report filing fee for all non-exempt domestic corporations is $50, plus taxes. The minimum Delaware corporation tax is $175 for corporations using the Authorized Shares method, and a minimum tax of $350 for corporations using the Assumed Par Value Capital method.

In contrast, the fee for filing articles of incorporation in California is $100. There is also a requirement to file an initial report within 90 days of incorporation which provides detailed information about your company and includes a fee of $25. In addition, the state requires the filing of an annual report along with a filing fee of $25. Most corporations will also pay a minimum annual franchise tax of $800 to the California Franchise Tax Board.

LLCs in Delaware are a little different. LLCs are $90 to form and are not required to file an annual report. However, they are required to pay an annual tax of $300.

LLCs in California do pay less than corporations in most cases. The formation fee is $85 and the 90 day Statement of Information fee is $20. Unlike California corporations, LLC’s must file a report with the state every other year rather than every year, along with a fee of $20. And the annual minimum tax payable to the Franchise Tax Board remains at $800.

While it may appear, from the outset, that Delaware is the preferable place to form your business based on a cost analysis, if your company does business in or from California, it must be registered in California whether it was formed in another state or not. This means that companies who conduct any business in or from California will remain subject to the filing fees charged by the California Secretary of State’s office, and must pay the minimum franchise tax of $800. Furthermore, a Delaware corporation operating in California must maintain a registered agent in Delaware (in addition to having one in California), which generally costs a minimum of $100 per year.

As you can see, if your company does business in or from California, incorporating in Delaware substantially increases the costs of formation and annual reporting. Click on the following links for the Secretary of State’s office of California and Delaware, respectively https://www.sos.ca.gov/business-programs/business-entities/ and https://corp.delaware.gov/.

Corporate Laws

The corporate laws of Delaware are very well developed and, as mentioned previously, business friendly, especially for businesses that have a national customer base and also for venture capitalists. However, it is important to consider how your business will be structured before determining the optimal state in which to incorporate. For example, if your business is structured as a single-member LLC, the business-friendly laws of Delaware are unlikely to be of any benefit to your business.

Other factors to consider are your business goals, where you will conduct business, and where you will bank. If you plan to bank and do the lion’s share of your business in California, then the decision is usually fairly straightforward, you would be better off ,in most cases, to incorporate in California. And, as previously discussed, if your business will generate California source revenue, or is operated from California, it must be registered in California.

If a California based business is incorporated in Delaware, lawsuits against the business may be filed and litigated in Delaware. While the outcome of such lawsuits could potentially be more favorable in a Delaware court, there is no guarantee that will occur. And, if your business is located outside of California, litigating a lawsuit in Delaware obviously becomes more expensive and inconvenient for a California based business owner since there will be significant costs associated with that scenario, like traveling to and from Delaware. As a result, you may incur extensive expense without any real benefit.

The good news, and another reason to choose the California versus Delaware option for forming your business, is that California has now incorporated a large portion of the Delaware General Corporations Law into its statutes and regulations thereby bringing many of the benefits of filing in Delaware to California.

Conclusion

With some exceptions, large corporations, not small or medium-sized businesses operating in California, will typically benefit from incorporating in Delaware or another state outside of California. When you are considering the type of business entity or structure to utilize for your business, or the most favorable state in which to incorporate, contact our trusted Business and Corporate Attorneys at the Gehres Law Group for a complimentary consultation. We’re confident that you’ll be glad you did.

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CALIFORNIA EMPLOYMENT LAW UPDATE 2019

Even though we are well into 2019, it is important for employers to be aware of and understand the importance and ramifications of the changes to California’s employment law landscape, which can affect their day to day operations. Some highlighted changes in California law are discussed below. The experienced employment law attorneys at Gehres Law Group are ready to assist employers in navigating the sometimes confusing and ever-changing employment laws in this State.

Wage Law Changes

First up is a reminder that California’s minimum wage went up to $12.00 per hour for employers with 26 or more employees, and $11.00 per hour for employers with 25 or fewer employees.  Minimum wage increases will continue at the rate of $1.00 per hour until January 1, 2022 for larger employers, and January 1, 2023 for smaller employers. See California Labor Code Section 1182.12. Higher rates may be in effect for employers located in certain cities which have enacted their own minimum wage rates.

Exemptions for agricultural workers relating to overtime and other working conditions have been repealed or changed.  Beginning January 1, 2019, agricultural employees must receive overtime at one and a half times the employee’s regular rate of pay for all hours worked in excess of nine and a half hours in one workday or 55 hours in one work week.  The overtime threshold is reduced by one-half hour per day or five hours per week every year until January 1, 2022 when the threshold matches the eight hours per day/40 hours per week requirements applicable to most other workers. The double-time threshold will be set at 12 hours per day beginning January 1, 2022. The timeline for compliance is delayed by three years for small employers–those with 25 or fewer employees.

The labor code was also amended to clarify that an employer may ask applicants their salary expectations for the position applied for. The law also authorizes employers to make compensation decisions based on employees’ current salaries, only if any wage differential is justified by one or more specified factors, including a seniority system or a merit system. See California Labor Code Sections 432.2 and 1197.5.

Under the State’s paid family leave law, employers are now allowed to require employees to take up to two weeks of earned, but unused, vacation leave before, and as a condition of, employees receiving paid family leave benefits.

Although not set into effect yet, beginning January 1, 2021 California’s existing paid family leave program will expand to employees who request time off related to their own active duty military service, or that of a close family member.  Current law only provides partial wage replacement to employees who take off due to the serious illness of themselves or a family member, or to bond with a new child.

Finally, employers are now required to provide copies of an employee’s payroll records within 21 days of the employee’s request. This new law involves a change in the language to ensure that employers understand they are required to make and provide the copies itself, as opposed to making the records available for the employee to copy.

Sexual Harassment

A new law in California requires employers with five or more employees to provide sexual harassment training to their employees by January 1, 2020, and then every two years after that. Specifically, employers must provide supervisors with two hours of training and nonsupervisory with one hour of training. Previously, only employers with 50 or more employees were required to provide the training. The new law also requires the Department of Fair Employment and Housing to develop compliant sexual harassment training courses.

An amendment to the FEHA made clear that a single incident of harassing conduct is sufficient to create a triable issue of hostile work environment, if the conduct interfered with an employee’s work performance or, otherwise created an intimidating, hostile, or offensive work environment.  The law explicitly overrides the prior standard for hostile work environment set by the 9th Circuit in Brooks v. City of San Mateo, 229 F.3d 917 (9th Cir. 2000), which held that a single incident of sexual harassment did not support a cause of action.

Also, as a part of the amendments to the FEHA, California Government Code §§12900 – 12996, employers are now clearly liable for any unlawful harassment by non-employees, not just sexual harassment as was the previous case. Non-employees include applicants, unpaid interns or volunteers or persons providing services pursuant to a contract in the workplace. With few exceptions, employers are now prohibited from requiring or inducing employees to release a claim or right under FEHA or require employees to sign non-disparagement agreements which prevent the employee from disclosing information about unlawful acts in the workplace, including sexual harassment.

Finally, FEHA now authorizes courts to award prevailing parties in civil actions, under the FEHA, reasonable attorney’s fees and costs including expert witness fees. It restricts courts’ ability to award reasonable attorney’s fees and costs to prevailing defendants to only those times when the court determines the action was frivolous, unreasonable, or groundless when brought, or that the plaintiff continued to litigate after it clearly became so.

Other Discrimination and Accommodation Issues

Lactation accommodation rules were also modified for 2019. Existing law requires employer to provide a location, other than a toilet stall, to be used for lactation (or at least make reasonable efforts to do so). The location should be permanent, unless the employer is unable to provide a permanent location and the temporary location is private and not used for other purposes while being used for lactation.  There is some flexibility for agricultural employers, allowing them to comply by providing an air-conditioned cab of a truck or tractor. See California Labor Code Section 1031.

The statutes governing employee criminal background checks and hiring/employment decisions under The Fair Chance Act were also amended. Except in specific situations, employers have previously not been permitted to use in hiring or employment decisions, information disclosed an employee concerning the employee’s participation in a pretrial or posttrial diversion program or concerning a conviction that has been judicially dismissed or ordered sealed. The new law makes changes to the specific situations when the general prohibition does not apply. These exceptions to the general prohibition include situations where (1) the employer is required by law (State or Federal) to obtain information regarding the particular conviction of the applicant, regardless of whether the conviction has been expunged, judicially ordered sealed, statutorily eradicated, or judicially dismissed following probation, (2) the applicant would be required to possess or use a firearm in the course of his or her employment, (3) an individual with a particular conviction is prohibited by law from holding the position sought, regardless of whether the conviction has been expunged, judicially ordered sealed, statutorily eradicated, or judicially dismissed following probation, or (4) the employer is prohibited by law from hiring an applicant who has that particular conviction, regardless of whether the conviction has been expunged, judicially ordered sealed, statutorily eradicated, or judicially dismissed following probation.

If your business is in need of further clarifications, updates or just a review of your employment practices and policies, please contact our experienced Employment and Business Law attorneys at the Gehres Law Group PC for a consultation.

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HOW DOES PAGA EFFECT EMPLOYERS IN CALIFORNIA?

Introduction

This article provides guidance to employers in understanding and defending against claims brought under California’s Private Attorneys General Act of 2004 (“PAGA), Labor Code § 2699 et seq. Under PAGA, aggrieved employees are allowed to step into the State’s shoes, specifically California’s Labor & Workforce Development Agency (LWDA), to bring legal actions against employers for alleged violations of California Labor Code that would otherwise, absent this statute, be limited to the LWDA. It is a unique mechanism through which employees can file suit on behalf of other similarly situated “aggrieved” employees without bringing claims as class actions, which can be a very unwieldy and difficult legal process.

PAGA Claims and Penalties

The potential recovery in a PAGA claim can be mindboggling. PAGA divides Labor Code violations into three categories: 1) Serious Labor Code Violations; 2) Health and Safety Violations; and 3) Other Labor Code Violations. If the Labor Code provision underlying the PAGA claim already provides for a civil penalty, then an employee may seek to collect that penalty for themselves and, on behalf of other aggrieved employees. In cases where the underlying Labor Code section does not already provide a civil penalty, the PAGA penalty is equal to $100 for each employee per pay period for the initial violation, and $200 for each employee per pay period for each subsequent violation, of which an aggrieved employee may keep 25% of the penalties recovered.

Moreover, PAGA provides for the recovery of costs and attorney’s fees, which are often a significant percentage of a judgment in such cases, so there is an incentive to settle such claims promptly if they have any merit. While the statute of limitations period is only one year, that merely dictates what the timeline for filing suit is, and doesn’t limit the damages, which continue to run for any violation that is continuing after suit is filed. In other words, if a wage and hour violation continues to run throughout the course of the litigation, then the recovery will be based on the full period starting from when the violation began to when the finding on behalf of the plaintiff is entered. See Williams v. Superior Court of Los Angeles, CASC, DAR p. 6879.

The legislative intent behind the law is to allow employees to bring to light blatant and broad violations of labor laws by unscrupulous employers. The result though has been to punish employers who may not be aware of their requirements under California Labor Code and regardless of how small, technical, or short-lived the alleged violation. All hope, however, is not lost as there are some technical, in addition to factual, defenses available to employers in a PAGA claim.

Defenses to PAGA Claims

Over and above any factual defense the employer may have, PAGA requires employees to notify the LWDA (and the employer) describing the specific provision alleged to have been violated, including the facts and theories to support the alleged violation.  Then, only if LWDA chooses not to pursue a Labor Code violation claim, or issue a citation against the offending employer, is the employee allowed to proceed with the PAGA suit. Because the notice is required before bringing the PAGA claim to court, a PAGA claim can be dismissed outright if the notice is deficient. In other words, if an employee fails to provide proper notice to the LWDA or fails to file the PAGA claim within the one-year statute of limitation period, then the PAGA case will fail. Additionally, although no specific defenses to this statute are set forth in the law itself, normal defenses to claims of underlying alleged violations of the Labor Code are available. Click here for the notice requirements.

Unfortunately, both the California Supreme Court and the Ninth Circuit Court of Appeals have ruled that PAGA claims may not be waived as a part of an employment arbitration agreement. See Smigelski v. PennyMac Financial Services, Inc., CA3. On the positive side, it is settled in the California courts that the nonparty employees who were included as other “aggrieved” employees, as well as the State (LWDA), are bound by judgments in PAGA claims. In other words, if the original plaintiff settles or obtains a judgement, or there is a dismissal with prejudice, the facts may not be re-litigated by any of the parties. See Amalgamated Transit Union, Local 1756, AFL-CIO v. Superior Court (2009) 46 Cal. 4th 993.

Conclusion

It is imperative, though, that an employer consult our experienced Employment Litigation Defense Attorneys if they have any questions about compliance with California Labor Code or if they receive notice of a PAGA claim in any form. By far, an employer’s best defense in avoiding significant exposure under a PAGA claim is to regularly review and update internal policies, handbooks and procedures, to ensure their business practices comply with the ever-changing California employment and labor laws. The sooner our experienced Attorneys at Gehres Law Group get involved, the more likely we will be successful in assisting your Company in avoiding the worst possible outcome. Contact us today for a complimentary consultation.

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Corporate Leaders’ Duty of Loyalty and Conflicts of Interest in California

This article outlines the duty of loyalty imposed on corporate leaders, how the business judgment rule provides protection against liability for directors if they act with reasonable care, and how conflicts of interest should be handled by corporate leaders.

I. Duty of Loyalty

California law imposes certain fiduciary duties on officers and directors of a corporation, duties which are owed to the corporation’s shareholders and to the corporation itself. One such duty is referred to as the duty of loyalty, which requires that officers and directors act in the best interests of the corporation and its shareholders. Any breach of this duty by corporate leaders exposes them to civil liability, and can expose them to criminal charges as well, depending on the circumstances.

Guidance on how to interpret this duty of loyalty is provided by the California Corporations Code, which provides, in part, that a director of a corporation operating in California has a duty to act “in good faith…in the best interests of the corporation and its shareholders,” with a level of care, “including reasonable inquiry, that an ordinarily prudent person in a like position would use.” Cal. Corp. Code § 309(a). See also Small v. Fritz Companies, Inc., 132 Cal.Rptr.2d 490, 499 (2003).

II. Conflicts of Interest

Self-dealing, such as when an officer or director has a conflict of interest with the corporation and acts in his or her own interest, and against the corporation’s interests, is a frequent example of a breach of the duty of loyalty. California law states that an interested director can avoid violating the Corporations Code if he or she discloses to the other directors the material facts of any transaction in which they have a conflict of interest, and a majority of the non-conflicted directors approves the transaction. Cal. Corp. Code § 310. It is important to note that the fact that a conflict of interest is present does not prevent a director from fulfilling his or her obligations to the corporation, but the director should act with the utmost candor concerning the facts of such transactions and abstain from voting on such matters.

III. Business Judgment Rule

Where a conflict of interest is alleged to have occurred, the business judgment rule will often come into play as well. Courts will not typically intervene in corporate decisions if the decision-makers acted in good faith and with the reasonable belief that their actions were in the corporation’s best interest. However, pursuant to long-standing legal precedent, this protection is NOT extended to corporate officers, who must act with a higher level of prudence and should carry adequate insurance to protect against the possibility of civil liability being imposed for their business decisions. See Gaillard v. Natomas Co., 208 Cal.App.3d 1250 (1989)

For further discussion on the business judgment rule, both statutory and common law, see our article:How Does the Business Judgement Rule Protect Corporate Executives?

Summary

In determining whether a decision-maker has violated his or her duty of loyalty or otherwise engaged in conduct for which legal action may be instituted, the interplay between the various legal duties and protections often involves a complex analysis in applying the law to the facts of each case. As such, it is important to reach out to an experienced business attorney to assess such situations. The trusted team of lawyers at Gehres Law Group, P.C. has the expertise to advise corporations of all sizes on such matters. Contact us today for a complimentary consultation.

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PROTECTING PERSONAL ASSETS AGAINST LIABILITY FOR BUSINESS DEBTS IN CALIFORNIA

Although no business owner ever wants to consider the likelihood of being sued for unpaid business debts, breach of contract, or damages caused by their employees, business activities, or the like, these events do happen. What’s more, if businesses do not plan properly, owners may become personally liable for the debts of the business. This article discusses some ways to avoid personal liability in the unfortunate case that a business’s activities results in litigation.

The business attorneys at Gehres Law Group often recommend a three-pronged approach to aid clients in ensuring they are protected from personal liability for their company’s debts. The first step is to make sure that the business itself is structured as a business entity that protects and separates personal assets/liability from business assets/liability. The second step is to enter into agreements in a manner which will limit a business owner/officer/director’s personal liability. As a final step, obtaining appropriate insurance coverage, over and above what is required by law, that covers common business risks in the company’s specific industry, is also important in controlling personal liability exposure.

BUSINESS ENTITY CONSIDERATIONS

If you’re operating a business as a sole proprietorship, you and your business are, from a legal perspective, the same entity. That means that you personally, in addition to being entitled to the income of the business, are liable for all of your business debts. It also means that all, or most, of your personal assets can be attached, or considered for collection, by your creditors. Likewise, in a general partnership each partner is personally liable for 100% of the business’s debts. Therefore, if there aren’t enough business assets to pay the partnership’s debts, and your partner is broke, creditors can come after your personal assets to pay all of the business’s debts, not just your pro rata share of the debts.

On the other hand, if your business is formed as a corporation or LLC, you and your business are separate legal entities. As such, assuming that you do not otherwise expose yourself to personal liability, and your corporation or LLC is properly formed and maintained, you would have no personal liability for the debts of the business, even if the business can’t pay them. Our highly experienced San Diego Business Attorneys can assist you in determining not only the best type of entity structure for your specific needs, but also in preparing your corporate and other legal documents in a manner which provides you with maximum protection against personal liability for business obligations.

Maintaining corporate compliance once an entity is formed is also critical, such as preparing annual corporate minutes, ensuring the entity is adequately capitalized as required by the California Corporations Code, as well as addressing other compliance issues is also critical to ensure business owners are well protected. See our related articles on this topic here and here.

ENTERING INTO AGREEMENTS ON BEHALF OF YOUR BUSINESS

Once you have settled on the proper structure of your business ventures, it is important to also be cognizant of potential situations where your actions might undermine the protection you have tried to maintain by that formation against personal liability for the business’s debts.

One way that you may inadvertently waive your right to personal liability protection is to sign a personal guarantee for a business loan or line of credit. Any debt that you obtain using this method is yours personally should your business assets not be sufficient to satisfy the debt.

The next way that you might unknowingly expose your personal assets to attachment for business debts is by signing a contract or agreement in your personal name versus on behalf of the Company. For example, John Smith, who is President of ABC Corporation, would need to sign John Smith, President, on any documents related to the business/corporation when he is representing that business. If he simply signs John Smith, without including his capacity as an officer or agent of the Company, he may have just set himself up for personal liability for that debt. Seems harmless, but it could be an expensive mistake.

An additional way for a business owner/officer to subject themselves to personal liability is to use personally owned collateral or credit cards (not in the business’s name) to underwrite or accumulate debt on behalf of the Company. It is very important to remember not to comingle personal assets and debts with business debts.

Finally, along these same lines, if a business owner personally misrepresented or lied about any facts when applying for a loan or credit on behalf of the corporation or LLC, they could be held personally liable for the debt, as well as potential personal exposure for fraud, both civil and criminal. Also, as touched on previously, if a business fails to maintain a formal legal separation between the business’s and the owner/officer’s personal financial affairs, creditors will likely try to have a court hold those owners/officers personally responsible for the business’s debts under a theory known as “piercing the corporate veil.”  

INSURANCE CONSIDERATIONS IN PROTECTING THE ASSETS OF THE BUSINESS AND THE OWNERS/OFFICERS

Over and above the necessity to ensure that a business entity is complying with both statute and contract by maintaining the required insurance coverage, such as workers compensation, vehicle coverage, general liability, including “acts and omissions” when appropriate, and property (real and business). An umbrella policy is often a good choice when underlying liability insurance may not be enough to cover a catastrophic loss or claim. This provides an added layer of protection for your company, and potentially the owners/officers if there is an attempt to obtain personal liability against them for the company’s debts.

Along those lines, obtaining a management liability policy could be invaluable for the following types of situations: 1. Directors and officers — basically this protects directors and officers, as well as the business entity, when there are allegations that their decisions resulted in the mismanagement of the company, causing a loss to others. 2.  Employment practices liability —coverage that protects the directors, officers and the entity when there are allegations of discrimination, harassment and failure to promote and similar employment legal issues. 3. Fiduciary liability — If an officer or director acts in a role for example, the entity’s investment advisory board and there is a loss for the investors or employees, as in the case of a 401(k) plan, this type of insurance generally operates to protect the plan fiduciaries when there are allegations that they failed to fulfill their duties to the plan participants, assuming that there was no fraudulent intent or gross negligence.

In summary, taking steps to limit personal liability when starting and running a business provides peace of mind for a business owner and it is vital to consider at the beginning of the business cycle. Our San Diego Business Attorneys can discuss your concerns and options with you as well as assist you in setting up and maintaining your business entity in a manner designed to ensure the least amount of personal financial exposure possible in your circumstance. Contact us today for your complimentary consultation.

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ISSUES OF FRAUD IN BUSINESS CONTRACTS

Contracts are the foundation that businesses, small or large, depend on daily to carry out their mission.  Most businesses exist by virtue of contracts, agreements of mutually dependent promises and obligations such as partnership agreements, articles of incorporation and shareholder agreements, limited liability operating agreements, service agreements, licensing agreements, and many others.  Businesses hire their employees by contract, or quasi contract, either in writing or orally.  And, of course, business suppliers and customers supply and purchase in conjunction with purchase and sales orders/contracts.  So, it is not surprising that business litigation, for the most part, is centered on the interpretation and enforcement of these agreements, and the recovery of damages for alleged breaches of contract, issues of their formation, or execution of the duties under these agreements. 

As a major subset of contract law are cases where fraud is alleged, either in the formation of a contract or later in the delivery and execution of the terms of the contract–or, in some cases, where an agreement doesn’t rise to the level of a contract, but fraud in the inducement is present. In essence, “fraud” is present when there is dishonesty or deception at some point in the business relationship which is material to the terms of the contract or transaction. Experienced business litigation lawyers know that, when suing for compensation for breach of contract, the addition of legitimate fraud claims can make their client’s case much stronger, especially from a damages perspective. 

In California, for example, to prove a fraudulent inducement claim, a plaintiff must prove the following elements:

• At least one misrepresentation — false statement — was made or at least one important (material) fact was concealed by the defendant, or their agent;
• The falsity/concealment was known to the defendant, or their agent, at the time it was made;
• The party making the false statement made the false statement in order to induce the other party to enter into the contract;
• There was justifiable or reasonable reliance by the other party; and,
• No contract would have been entered into had the truth been known.

The Law of Damages for Breach of Contract vs Damages for Fraud

Breach of Contract:

When contract disputes cannot be resolved by negotiation, our San Diego business lawyers often find themselves having to file or defend lawsuits for breach of contract.  California Civil Jury Instruction 350, which is used by California courts to instruct juries in such cases, provides a good summary of the types of money damages which may be awarded for breach of contract:

350. Introduction to Contract Damages

If you decide that [name of plaintiff] has proved [his/her/its] claim against [name of defendant] for breach of contract, you also must decide how much money will reasonably compensate [name of plaintiff] for the harm caused by the breach. This compensation is called “damages.” The purpose of such damages is to put [name of plaintiff] in as good a position as [he/she/it] would have been if [name of defendant] had performed as promised.

To recover damages for any harm, [name of plaintiff] must prove that when the contract was made, both parties knew or could reasonably have foreseen that the harm was likely to occur in the ordinary course of events as result of the breach of the contract.

[Name of plaintiff] also must prove the amount of [his/her/its] damages according to the following instructions. [He/She/It] does not have to prove the exact amount of damages. You must not speculate or guess in awarding damages.

Notably, as our contract lawyers or business attorneys can tell you, contract damages are limited to compensating for harm which the parties knew or could reasonably have foreseen.

Damages in Fraud Claims Cases:

There are various types of fraud in law, however the principal statute that applies to business contracts is set California Civil Code section 1572, which provides:  

Actual fraud, within the meaning of this Chapter, consists in any of the following acts, committed by a party to the contract, or with his connivance, with intent to deceive another party thereto, or to induce him to enter into the contract:

1. The suggestion, as a fact, of that which is not true, by one who does not believe it to be true;

2. The positive assertion, in a manner not warranted by the information of the person making it, of that which is not true, though he believes it to be true;

3. The suppression of that which is true, by one having knowledge or belief of the fact;

4. A promise made without any intention of performing it; or,

5. Any other act fitted to deceive.

Fraud is also considered a Tort (a civil wrong that can be found even if a “contract” is not found to exist), and the general “tort” measure of damages is set forth in California Code of Civil section 3333, which provides:

For the breach of an obligation not arising from contract, the measure of damages, except where otherwise expressly provided by this code, is the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.

The difference between alleging a breach of contract or the tort of fraud is significant under California law since punitive damages are allowed under tort law whereas they are not under contract law and, in addition, the damages do not have to have been foreseeable.

See California Civil Code Section 3294, which provides, in part:

Exemplary damages; when allowable, definitions

(a) In an action for the breach of an obligation not arising from contract, where it is proven by clear and convincing evidence that the defendant has been guilty of oppression, fraud, or malice, the plaintiff, in addition to the actual damages, may recover damages for the sake of example and by way of punishing the defendant.

…

(emphasis added).

This opportunity to plead and prove punitive damages, which are typically a percentage of the defendant’s revenue or profits, and meant to punish the defendant, can provide significant leverage for a business litigation lawyer to negotiate a larger settlement on behalf of their client.

If you believe that your business may have been the subject of a fraud, or if you are being sued for fraud, contact our experienced business litigation lawyers today to assist you. There is no charge for an initial evaluation of your case.

The post ISSUES OF FRAUD IN BUSINESS CONTRACTS appeared first on Gehres Law Group.

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