Corporate Compliance: Avoiding and Preparing for a Lawsuit

A business should always be prepared for a lawsuit, and the best time to prepare for one is before any possible legal claims arise.  Corporate compliance can go a long way in preparing for and avoiding a lawsuit.  If a business has a self-monitored corporate compliance plan and audits its own practices consistently, it will not only avoid potential lawsuits, but have self-preserving support in the case of a lawsuit.

Organization

Organization is the most important way to prepare for a lawsuit against your business. By cataloging documents and maintaining an accurate calendar, a business can help prove lawful dealings and interactions. For example, in some cases it may be necessary to prove how much work was performed and when it was performed. An accurate calendar could help evidence meetings, timelines, and transactions.  If you keep your documents and calendar on your computer or in the cloud, it is advised that you back it up several times a month to ensure it is not lost or destroyed

Minutes

Minutes or some other kind of notes should be kept for not only business meetings regarding organization or formation, but for all business dealings. Many business lawsuits involve alleged misrepresentations, disclosures, broken promises, or misunderstandings. If a company makes it a practice to train employees on taking minutes, it will be easier to prove certain positions or agreements in court. All business employees should be encouraged to record general subjects of discussion, who was present at a meeting, discussions about risks or concerns, and whether there was an agreement or disagreement.

Contracts

In addition to keeping all business contracts, you should also keep all contract drafts. Businesses go back and forth, and sometimes one side may not track a change in an agreement. To help resolve a contract dispute, you may be able to prove the intent of the parties from deleted or added provisions to an agreement.

These are a few suggestions to be prepared, whether as a plaintiff or as a defendant in case of a business lawsuit. Depending on the type of business practice, there may be state or federal regulations requiring certain additional compliance measures. Corporate compliance measures from similar industries can also be helpful guidelines in establishing your own business policies.

What is an S Corp?

An S Corporation (“S Corp”) is known as a pass-through tax entity because business profits are only taxed at one level: the owner’s personal tax returns. Partnerships and LLCs may elect to be taxed as an S Corp, but corporations’ profits are taxed pursuant to the owner’s personal tax returns and the corporation pays its own taxes. This feature makes an S Corp an attractive business entity for those considering formation.

S Corp

An S Corp is an entity formed under California civil law. An S Corp generally offers the same liability protections to shareholders as any other business entity. The actual liability of the owners for debts and obligations of the business will depend on what type of entity the S Corp is formed under, as will the entity’s  management structure.

To form an S Corp in California, an entity must file a California Form 100S, a California S Corporation Franchise, or an Income Tax Return. Prior to this, the entity will have to be properly formed, meaning that all required documents were filed with the California Secretary of State.

Once an entity’s directors or shareholders have approved the election of S Corp status, it is usually necessary to prepare the minutes over one or two weeks, and then send them to all the directors or shareholders for their signature.

S Corp Taxation

A business entity that elects to be taxed under Subchapter S for federal tax purposes will also be treated as an S corporation for California tax purposes. After deducting its business expenses, an S Corp passes through all of its net income to its shareholders as profit distributions. The S Corp is not itself taxed at the federal level, like a corporation is taxed. At the state level, California does require an S Corp to pay a 1.5% tax on net profits, subject to an $800 annual minimum.

Residential vs. Commercial Leases

California law treats residential and commercial leases very differently. Generally, commercial tenants receive less legal protections than residential tenants. It is therefore critical for both landlords and tenants to be very familiar with the terms of a commercial lease, and not just assume that the same standard provisions are provided in each agreement.

Residential Lease Agreement

For starters, a residential lease agreement is a contract between a tenant and a landlord to use property for living. The agreement is usually a standard form, and the rental property is generally a house, townhouse, apartment, or condominium. Residential leases generally contain a provision that the tenant may not use the property for commercial purposes, or for the purpose of earning a profit. The rent is usually a set amount every month, and the term of the lease is generally a year.

Since a residential lease involves somebody’s future home, federal, state, and local laws provide specific tenant protections to ensure safe and secure housing. Most importantly, a landlord is required to provide safe and habitable housing. To further ensure that tenants are protected, California law allows a tenant’s attorney to collect fees for habitability violations of a residential unit.

Commercial Lease Agreement

A commercial lease, on the other hand, is a contract between a business tenant and a landlord for use of commercial property. Commercial leases are usually uniquely designed for the particular commercial tenant, unlike standard residential lease agreements. The property is intended to be used in a way that will generate a profit, and there is no right of habitability. The property is generally a business space such as a warehouse or office space. The rent is usually based on the amount of square footage occupied by the tenant, and may require the tenant to pay a percentage of their profit earned on the property. Commercial lease agreement terms are usually a set number of years, which sometimes include option rights that must be exercised within a certain period of time before the expiration of the lease.

A commercial tenant, usually a business entity, is presumed to be on equal footing with his or her or its landlord in negotiating a commercial contract, which means that there are fewer laws that specifically protect commercial tenants.

Landlord and Tenant Issues: Mandatory Disclosures

California law requires landlords to make certain mandatory disclosures to tenants, most of which are usually found in the lease or an addendum to the lease, and generally concern the health and safety of potential building inhabitants. It is important for both landlords and tenants to be aware of the mandatory disclosures. If a landlord does not make a required disclosure, or fails to disclose dangerous conditions on the property, the landlord can later be found liable for damages the tenant suffers.

MANDATORY LANDLORD DISCLOSURES IN CALIFORNIA

  1. Registered Sexual Offender Database

    The California Civil Code provides the exact language landlords must put in a lease about the online registered sexual offender database. (Cal. Civ. Code § 2079.10a)

  2. Paying for Utilities of Others

    Before a tenant signs a rental agreement, the landlord needs to let the tenant know if gas or electric service to the tenant’s unit also serves other areas that are not used by the tenant. If it does, the landlord must disclose how costs will be allocated. (Cal. Civ. Code § 1940.9)

  3. Toxic Mold

    The landlord needs to let the tenant know in writing if there is toxic mold that exceeds permissible exposure limits or poses a health threat in the residence. (Cal. Health & Safety Code §§ 26147, 26148)

  4. Ordinance Locations

    If there is a former federal or state ordinance within one (1) mile of the rental property, the landlord must inform the tenant. (Cal. Civ. Code § 1940.7)

  5. Pest Control Service

    If the rental property is serviced for pest control, the landlord needs to tell the tenant about any disclosures the landlord received from the pest control company. This could include what kind of pest is being controlled, what pesticides are used and their active ingredients, whether the pesticides are toxic, and how often the property will be treated. (Cal. Civ. Code § 1940.8, Cal. Bus. & Prof. Code § 8538)

  6. Intent to Demolish

    If a landlord has applied for a permit to demolish a rental unit, he or she must give prospective tenants written notice before accepting any deposits or screening fees. (Cal. Civ. Code § 1940.6)

  7. No Smoking Policy 

    If a landlord prohibits or limits smoking on the rental property, the lease needs to specifically describe the areas where smoking is limited or prohibited. (Cal. Civ. Code § 1947.5)

OTHER MANDATORY DISCLOSURES

On top of California’s mandatory disclosures, there may be additional mandatory disclosures outlined by federal law and local ordinances. For example, federal law requires that landlords disclose if they know about any lead-based paint hazards in the rental premises.

Are Ridesharing Apps Like Uber and Lyft Breaking California Law?

Consumers love the convenience of new ridesharing startup companies such as Uber, Lyft, and Sidecar offer. With a few taps on your smartphone, you can have a car waiting for you within minutes. State and local governments, however, are less in love with these companies, and have been trying to halt their services around the country. Most recently, the California Public Utilities Commission sent letters to all three companies informing them that their ride-share services violate state law.

The three letters specifically address the illegality of the ridesharing companies’ newest service, which matches up strangers going the same way, then charges each individual a reduced fare. Lawmakers are worried that, for obvious reasons, this option could negatively impact the transportation industry. They are not far off the mark, as a recent study shows that ride-sharing services have the potential to reduce the total amount of miles driven by taxis by up to 40 percent.

Nevertheless, Uber and Lyft firmly believe that their use of ridesharing technology is better for the environment and more convenient for consumers. The companies have agreed to work with the state to resolve the issue, but neither intends to change its practices in the meantime.

The California Public Utilities Commission says that only certain buses may legally pick up more than one person, drive them around, and then charge each person an individual fare. In its letters, the California Public Utilities Commission suggested that the ride-share companies should petition lawmakers to modify the state code if they think it is outdated. Until then, the Commission intends to enforce the state law prohibiting ridesharing.

Landlord and Tenant Disputes: Normal Wear and Tear

One of the most dreaded parts of renting a place to live is moving. Tenants generally bank on the fact that they will not see their security deposit again. This does not necessarily have to be the case, and tenants as well as landlords should stay informed about their rights to know how much of their deposit they are entitled to receive back from the tenant’s perspective, and how much can be held back from the landlord’s perspective. For one thing, damages for “normal wear and tear” cannot be deducted from a tenant’s deposit. Naturally, this raises the question of what exactly normal wear and tear actually is.  A landlord may legally only use a tenant’s security deposit for unpaid rent, cleaning the rented premises, repairing damages other than normal wear and tear, and replacing or restoring furniture, furnishings, or other items of personal property.

Naturally, this raises the question of what exactly normal wear and tear actually is.  The can be law vague in addressing head-on what constitutes “normal wear and tear,” but a fair and good faith approach can establish what is and what is not normal wear and tear. For example, simple wearing down of carpet and drapes because of normal use or aging would constitute normal wear and tear. A few spots and moderate dirt are also probably normal wear and tear. However, massive rips or permanent stains will likely exceed a reasonable definition of the term, and would justify a deduction from the tenant’s security deposit.

When it comes to walls, minor marks or nicks are normal wear and tear, and are the landlord’s responsibility to fix. On the other hand, several holes that require filling, patching, and repainting could justify withholding the cost of repair from the tenant’s security deposit.

Deciding whether something constitutes normal wear and tear generally involves subjective discretion. If you think you have been charged for normal wear and tear though, you should fight to have that portion of your security deposit returned.

The Difficulty of Challenging a Variance

Challenging a variance in California can be very difficult.  In the recent case of Eskeland v. City of Del Mar, 224 Cal. App. 4th 936 (4th Dist. 2014), a property owner purchased a home with a pre-existing non-conforming structure. His front lawn was shorter than 20 feet, violating the city’s zoning ordinances. On top of that, he wanted to build a new house on the same, non-conforming footprint as the house he bought, because the steep elevation on one side of his property made it unfeasible to remodel in a way that did meet the zoning requirements. He applied for a variance, which was conditionally granted.  His neighbors tried to prevent him from going through with the remodel,  arguing that his plans were in violation of the city’s municipal codes. Earlier in the year, a court ruled that he could keep the house’s footprint as it was when he bought it, and build a new house on the footprint too. This case provides valuable guidance for California property owners regarding variances and non-conforming structures.

 

For one thing, if a property owner has the City Council’s approval for a variance, it will be very difficult for neighbors to successfully fight it. As the California Supreme Court has affirmed, administrative decisions are given a strong presumption of correctness, so successfully appealing such a decision to the courts will be difficult.

Furthermore, when an administrative board approves a non-conforming structure, those opposed to it will have the burden of showing an abuse of discretion on the part of the administrative body. This is a difficult burden to overcome, because it will require proving that the structure is objectively unworthy of being granted a variance.

Also, even if the neighbors were able to prove that the administrative board could have ruled another way which was just as reasonable or more reasonable, that is not enough to overcome the burden of proof.  The neighbors will have to prove that the administrative board’s finding was unreasonable given the circumstances.

Finally, it is important to understand that variances are granted based on a balancing test of feasibility and hardships. In this case, the city council determined that although it was technically feasible for the property owner to remodel in a way that met the zoning requirements by re-leveling the entire area, re-leveling would be an unreasonable hardship. In the end, this was one of the main reasons why the Court of Appeals denied the neighbor’s challenges to his plans.

RULLCA: California’s Revised LLC Act

In January 2014, California replaced its Limited Liability Company (LLC) law with the California Revised Uniform Limited Liability Company Act (RULLCA). RULLCA repealed the law that had governed California LLCs for two decades, and provides new provisions governing the formation and operation of limited liability companies.

RULLCA will govern all California LLCs organized on or after January 1, 2014. The new law made several new changes to the formation process of an LLC. For example, if the formation filing information provided to the California Secretary of State is inaccurate, members, managers, and other parties in the LLC formation may now be held liable under certain circumstances.

RULLCA also contains provisions that govern LLCs in the absence of a clear and thorough operating agreement. For example, if an operating agreement specifies management by one or more managers, but is not clear, the LLC will be governed by its members.  Also, the law gives members of a manager-managed LLC the presumptive right to vote on selling, leasing, exchanging, or disposing of all, or mostly all, of the LLC’s property. They also have the presumptive right to approve a merger or conversion, or to amend the operating agreement.

RULLCA does offer LLCs the option to change or eliminate several provisions, but this would require proper formation and a properly drafted operating agreement.  It is advised that anyone looking to form a new LLC work with an attorney to make sure that they take advantage of all the law’s opportunities and are compliant with its requirements. Existing LLCs should review their formation documents and operating agreement to assure that such documents are compliant. Otherwise, the very reason the entity was created, shielding members and managers from liability, could be lost.

California Paid Sick Leave Law

On September 10, 2014, California Governor Jerry Brown signed AB 1522, a law requiring public and private employers to provide their employees with at least 3 paid sick leave days per year. It is very important that employers begin implementing paid sick leave policies to make sure they are compliant with the new law, which goes into effect in July 2015.

Under the new law, most employees will be entitled to one (1) hour of paid sick leave for every 30 hours worked.  Employees will be able to use sick leave for their own illness as well as for preventive care, which includes looking after a sick family member or recovering from certain crimes.

The law creates an accrual option and a lump sum option. Under the accrual option, sick days that go unused during a year will roll over to the next year. However, employers can choose to stop employees from accumulating more than 48 hours, or six (6) days, of accumulated paid sick leave. Under the lump sum option, employers can give all employees a minimum of three (3) days of paid sick leave at the beginning of each year. No accrual or carryover is required.

Employees will not be entitled to pay for unused sick leave at separation of employment. In other words, if an employee leaves his or her job, he or she cannot “cash out” unused sick days in the manner vacation and paid time off can be cashed in.  However, if the employee is rehired by the same employer within a year, he or she can reclaim those unused sick days.

California employers that already have paid sick leave policies that already live up to the requirements of the new law do not need to provide additional leave, but they should make sure they have a way of tracking used and unused leave. California employers who do not have paid sick days need to review the new law and adopt a paid sick leave policy.

Requirements of a Properly Formed Business Entity

There are a number of options when it comes to choosing a business entity for a particular organization or business venture.  Business owners and entrepreneurs can greatly limit their personal liability by forming a business entity or reorganizing a business. Which entity is best suited to a particular owner, organization, or business venture will depend on evaluating which entity is most aligned with their business model and objectives. In California, entity options include a Corporation, a Limited Liability Company (LLC), a Limited Partnership (LP), a General Partnership (GP), and a Limited Liability Partnership (LLP).

Forming a Business Entity

Each business entity offers unique estate planning and tax benefits, as well as different levels of liability and asset protection. However, to take advantage of the protections that each entity offers, all of the statutory requirements must be strictly followed to ensure that the entity is duly and validly formed.

When forming a business entity the following entity-specific documents, among others, must be filed with the California Secretary of State.

  • Corporation: Articles of Incorporation
  • LLC:  Articles of Organization
  • LP: Certificate of Limited Partnership
  • GP:  Statement of Partnership Authority
  • LLP:  Application to Register a Limited Liability Partnership

In addition to these documents, each entity will usually need to elect or maintain an officer, director, member, or partner, as well as conduct an organizational meeting with documented “minutes” of the meeting. Failure to follow the statutory formation procedures could mean that, if sued, a court may find the owners personally accountable for the entity’s obligations and liabilities.