Law Blog

Having money is great.  What’s even better is getting that money for free (though some would argue being born with it versus winning it is one in the same).  With news of yet another record-breaking lottery winner who is not my father – despite the fact that he’s played it for the past 30 years and still hasn’t seen more than a few dollars in winning (please Dad, please, please stop), the shared thought in everyone’s head is “how long before this new guy ends up in financial ruin?”

Now to be fair, possessing a winning lottery ticket isn’t an automatic Monkey’s Paw.  The vast majority of lottery winners have held on to their money and walked quietly off into the sunset, living their lives in ways that all of us only wish we could.  However, there have been a lot of lotto winners who couldn’t quite seem to keep it together.  And let’s face it: those are the interesting stories because like everyone else who reads these articles, people can’t help but wonder how it’s possible to lose millions in so short a period of time.   Aside from the government taking a huge chunk of it right off the bat and the numerous family and friends that inevitably spring out of nowhere to borrow a little somethin’ somethin,’ the answer is that a lot of these winners seem to squander their winnings away in failed businesses.

From construction companies to personal record labels, these lottery winners seem to love risking it big in the hopes of earning a little more.  Personally if it were me, I’d be happy just walking off into said sunset because I’m so sick of working…ahem…

Anyway, enough about me.  One of the biggest failings for these temporarily lucky few isn’t necessarily a lack of knowledge in the business they’re attempting to pursue (though you should really, really know your industry), it’s that they didn’t properly incorporate their business to protect their assets.

Starting a business is no doubt a difficult, risky, and expensive venture.  Folding and closing up shop on a failed business often means more than just a loss dream; what usually accompanies it is a string of creditors looking to seize your assets in order to make themselves financially whole again.  Now on the one hand, this is great news for the creditor who gets to cut up your business and personal property to make good on a defaulted loan.  But on the other hand, well, I don’t really need to spell it out, huh?

Establishing your business as a corporation rather than a sole proprietorship or partnership has a number of advantages.  Most important of these is the protection against liability you are given when you incorporate your business.  Corporations are treated almost like an individual.  If it falls, you as a shareholder are only liable for the money that you’ve put into it, which means your personal assets are safe, theoretically.  Furthermore, unlike a sole proprietorship, corporations live on forever as long as the business remains viable.  Corporations allow you to control the amount of income you receive and may also allow you to defer your taxes to a later time, and may even give you certain tax deductions not possible as a sole proprietor.

Last year, LegalMatch received thousands of new clients looking for business attorneys to help them incorporate their small business.  But don’t be too gung ho about incorporating your business.  Aside from the paperwork, there are some real disadvantages, too, such as the ineligibility for personal tax credits and the costs to incorporate.  Sitting down with a good business lawyer is the best way to see if incorporating your business is the right move for you.  It definitely would’ve probably helped a lot of those lottery winners.

And remember, sometimes even the best financial lawyers and advisors can’t save you no matter how much money you may have.

Apparently thousands of Americans are not heeding dire warnings that Obama’s tax plan is going to ruin small business owners. (End sarcasm). Last year LegalMatch.com received thousands of requests for business formation lawyers. Our respondents told LegalMatch they were looking to create the following types of businesses:

• LLC (limited liability company): 45%
• Corporation: 17%
• S Corporation: 15%
• Nonprofit: 9%
• Partnership: 8%
• LLP (limited liability partnership): 3%

Don’t they realize there is an impending war on the rich and on business owners?! That this country is going to be socialist before the year is over?!?! (OK, now I am really ending the sarcasm, I promise…)

All jokes aside, LegalMatch.com statistics support the conventional wisdom that LLCs are the most popular type of new business in the country. Limited Liability Companies are a relatively new invention, but a powerful tool if one wants to limit their exposure while running a business.

Are lawyers helping this increase? Lawyers typically operate LLCs when they form their own small firm. The tanking economy is affecting everyone, attorneys included, and more and more attorneys are looking to go it alone. Newly minted attorneys, thousands of whom are regularly churned out every year, are facing stiff competition in a vastly shrinking field. Business is so bad (or is it good?) that an online university offering courses on how to build and run a solo practice has recently opened. Because clearly, the best thing a recent law graduate can do is spend more money on school. (I thought I stopped being sarcastic?)

Obviously new grads aren’t the only ones going it alone; the vast majority may be experienced lawyers or attorneys with a year or two already under their belt. As more and more biglaw firms collapse, we may be seeing more and more fragmenting in the legal community. This could be good thing for clients and attorneys. More lawyers competing may mean lower fees for our services, and more new lawyers getting out of their biglaw basements and acting like real attorneys means more experience and possibly more options down the line. In every crisis there is an opportunity; is now the time for a change?

GM, Ford, and Chrysler are all clamoring to be next in line to receive billions of dollars of taxpayer money. Should they get it? If they don’t, will bankruptcy lead to the economic catastrophe recently forecasted by Big 3 executives on Capital Hill?

Absent a bailout, the Big 3 are looking at Chapter 11 bankruptcy. Chapter 11 is a corporation-specific type of bankruptcy that calls off the dogs and gives a company breathing room to restructure. In the case of the big 3 automakers, most experts agree that Chapter 11 bankruptcy would cut jobs, gut costly labor contracts with unions such as UAW, eliminate pension obligations to current and future retirees, and close unproductive factories.

Although shedding billions in health care costs, pension benefits, and operating costs might look good for a company’s balance sheet, the picture is not so rosy for everyone else. The UAW was a major supporter of President-elect Obama and will not be pleased if the democratic government they helped elect turns their back on them. Furthermore, where will they go for health care? Many-especially those who will inevitably lose their jobs-will go to Medicaid.

Then there are pension benefits. What happens when a company like GM can’t make its pension obligations? Under the Pension Benefit Guaranty Corporation, the federal government insures pension plans in the American auto industry; this agency is already $14 billion in debt.

Lastly, one of the most important parts of corporate restructuring under Chapter 11 is debtor-in-possession financing. This allows a bankrupt corporation to take loans to stay afloat, with the creditors of the needed capital jumping to the front of the claims line. With the economy in a tailspin and credit lines essentially non-existent however, economists like Nobel Prize winning Paul Krugman worry that no one will make any loans. No loans means no production; no production means this turns into a Chapter 7 liquidation.

No one wants to see what will happen if the big 3 simply cease to exist. Experts predict that the potential ripple effect would cost 2.5 million jobs in the various industries that depend on companies like GM. Many unemployed would inevitably end up in government unemployment lines.

There is no question that fundamental restructuring needs to be done. Some job loss and benefit cutting is inevitable. A bailout with strict conditions similar to a bankruptcy hearing, however, could prevent a far larger potential catastrophe. The government’s loan would operate similar to debtor in possession financing necessary to keep the production lines rolling and save millions of American jobs. Significant strings could be attached: the Big 3 would need to do major restructuring of their labor contracts, close unproductive plants, get rid of incompetent management, and make fundamental changes to their business model. Some creditors may need to take a significant pay cut or agree to restructure their claims. At the same time, some of the more horrific consequences of liquidation and massive unemployment would be avoided, and at a fraction of the cost to our economy should the big 3 all go bust.

Just like the original bailout, none of the options look good. Sometimes, however, you have to pick the lesser of two evils.

It’s been estimated that companies with annual revenues over $1 billion spent more than $50 million in legal fees last year.  Although electronic discovery (e-discovery) costs have not been pinpointed, they are widely thought to comprise a huge chunk of overall legal fees; in fact, according to a study conducted by Fulbright & Jaworski, lawyers for companies with revenues topping $100 million listed e-discovery costs as their biggest concern.

In response, major companies, including Cisco Systems and Morgan Stanley, have begun outsourcing to India and other offshore countries, where foreign lawyers review documents at a lower cost.  Sure, we all understand the desire to cut costs, but if companies aren’t careful, they may incur costs far greater . . .   

Obvious concerns about outsourcing to foreign jurisdictions include quality control, issues of professional liability, breaches of attorney-client privileges, and facilitating the unauthorized practice of law.  Remember, China, India, and other popular offshore locations lack stringent U.S. data protection and information security laws; moreover, many also lack adequate judicial systems to remedy a problem once it occurs . . .  

Francoise Gilbert, of the Silicon Valley-based IT Law Group, recently commented on this issue in her lecture, The Law of Privacy and Data Security, hosted by the Bar Association of San Francisco.  Ms. Gilbert stressed that U.S. companies need to make sure their outsourcers abide by U.S. law, and U.S. companies need to closely supervise their outsourers.

For example, if an information security breach occurs at a U.S. company’s foreign call center, the U.S. company remains ultimately responsible; this would be true even if the call center signed a contract to adequately screen and supervise its employees.  It’s also important to realize that a breach could occur even if the call center acted in good faith to abide by the contract. 

A further example: a call center that conducts background checks on prospective employees might not discover criminal records due to limited search capabilities.  So, if an employee committed a crime in a neighboring county, this record would not turn up during the search, she would be hired, and if she uses customer credit card information for fraudulent purposes, guess who pays?

According to a recent  report issued by the U.S. Chamber Institute for Legal Reform (IRL), 58% more securities-related class actions were filed in 2007 than were filed in 2006.  Further, according to a recent study conducted by Cornerstone Research and Stanford Law’s Securities Class Action Clearinghouse, 63 class action suits were filed against the financial services sector in just the first six months of 2008.  This number exceeds the total number of filings in 2007. 

The Stanford report also shows that about half of the 110 filings between Jan 1 and June 30, 2008 were related to the U.S. subprime mortgage crisis and global credit crunch; moreover, the increased filings have caused defendant firms’ market capitalization losses to skyrocket. 

Do these securities class action filings threaten average shareholders’ assets?  According to a recent report issued by the Institute for Legal Reform (IRL), compelling evidence shows that such filings are putting U.S. businesses in peril, and threaten the economic health of individual investors.  Lawsuit-related monetary losses in 2007 doubled since 2006, and settlement costs may even exceed litigation costs as more companies hope to salvage some of their stock price and reputation.  The ILR report urges Congress to investigate fraud and abuses in the securities plaintiffs’ bar, and suggests legislative changes.