In the employment arena, the firm negotiated substantial settlements in two employment termination actions: (1) a whistleblower case, and (2) a case alleging violations of the Family Medical Leave Act brought against a major international investment bank.  Finally, the firm successfully negotiated a settlement of an employment harassment case, alleging harassment of the employee on the basis of his Arabic ancestry.

Stephen M. Politi is a Boston Tax Attorney and Adjunct Assistant Professor, (SALT), Bentley University Graduate School. He is former Chief Counsel, Massachusetts Department of Revenue and former Counsel, Massachusetts Joint Legislative Committee on Taxation. He may be contacted at spoliti@engelschultz.com.

COPYRIGHT 2010

This article explores, from a ten year Massachusetts perspective, state responses to one or more of the following challenges: declining state tax revenues; the political inability, or unwillingness, to raise tax rates or enact new taxes; and limited tax administration resources triggered by budget cuts, hiring freezes, early retirement programs, and employee furloughs.

For example, the Massachusetts Department of Revenue (“MDOR”) reported that tax collections for fiscal year 2009, totaling $18.259 billion, were $2.6 billion less than the fiscal year 2008 collections of $20.9 billion. According to the Commissioner of Revenue (“Commissioner”), more than 123 MDOR positions were eliminated in fiscal year 2009 either through attrition or retirement and MDOR sustained a budget reduction of $9.5 million.

Massachusetts Responses:

I. Implement New Technologies

MDOR announced in 2006 that employing the latest technology is one of its key objectives and a key response to the question: How to do more with less?

Legislation enacted in 2002 authorized the Commissioner of Revenue to specify the method of filing tax returns and other documents and specifically included the authority to require that any return, document or tax payment be filed with or transmitted in such manner, format, and medium as the Commissioner shall prescribe. Within three months, the Commissioner began to exercise that authority to require employers, operators, and vendors collecting taxes above certain annual thresholds to file their returns and pay their taxes by electronic means for tax returns due on or after January 1, 2003. On July 1, 2003, the Commissioner further expanded electronic filing requirements, by (1) imposing electronic filing and/or tax payment requirements on third party bulk filers, certain new businesses and existing businesses applying for an additional tax registration, purchasers of cigarette excise tax stamps, and payers of motor fuels excise tax, and corporation, partnerships, and certain fiduciaries and (2) by lowering the electronic filing threshold announced in 2002 for employers, operators, and vendors. In 2004, in a continuing effort to take advantage of new technology as a tool to improve tax administration, the Commissioner prescribed new or expanded electronic filing for certain filers, including requiring certain personal income tax return preparers to use electronic means to file all personal income tax returns (unless a taxpayer specifically directed on the paper form that filing be on paper); postponed electronic filing requirements for other filers; and changed some previously mandated electronic filing requirements. In 2005, the Commissioner expanded and clarified the electronic filing and payment requirements for certain corporations and partnerships. In 2009, the Commissioner again expanded electronic filing and payment requirements for corporate combined groups, composite filers, and certain pass-through entities. In fiscal year 2009, approximately 91% of personal income tax returns were filed via commercial software, a professional tax preparer, or with a 2-D bar coded return .

In June 2002, MDOR launched Discovery Tax, a $6 million system that mines more than 60 electronic databases, including IRS, wage reporting systems, driver’s license and vehicle registrations, and home ownership records, to identify business entities and individuals who did not file tax returns or who under-reported income. Other technological initiatives have included the mandatory use of WebFile for Business, an online application, to register with the MDOR ; the optional online filing of Applications for Abatement ; the optional online requesting of Certificates of Good Standing and/or Tax Compliance ; and other online services for filing personal income tax return extensions; checking the status of an individual income tax refund, and for viewing a business account history.

MDOR has also used its investments in technology to reach out to other state tax agencies to “share data in order to locate non-filers and under-reporters”. MDOR’s pilot Clearinghouse project netted more than $300,000 owed to Massachusetts by reviewing personal income tax data provided by the State of Connecticut and helped MDOR secure support for a multi-state data sharing initiative. According to MDOR, by the end of fiscal year 2006, nine tax agencies in the northeast had signed on to use the program to assist in locating individuals not paying taxes to their respective states. The success of the Clearinghouse project earned MDOR the Federation of Tax Administrators’ 2007 award for outstanding compliance program. Additionally, in fiscal year 2006, MDOR tested a new tool for conducting audits, named Audit Workbench. Audit Workbench, a Web-based application, is an electronic audit file containing taxpayer records, auditor work papers and MDOR notices and is designed to “promote better accountability” at the auditor level.

II. Enact Revenue Enhancements; Loophole Closers; And Clarifications

In Massachusetts, it may be possible to determine whether tax related legislation was enacted during a Democratic or Republican administration just by reference to the name by which the legislation is known. Tax changes known as revenue enhancements are likely to have been enacted during Democratic administrations while tax changes enacted during Republican administrations are likely to be known as loophole closers.

There are several examples, during the past decade, of revenue enhancers; loophole closers; and legislative clarifications including but not limited to, the following:

1. The Massachusetts corporation excise tax did not specify basis adjustment rules. Massachusetts closed this loophole with legislation providing detailed basis adjustment rules to account for differences in basis arising from differing Massachusetts and federal tax laws.
2. When the federal taxable income of an individual or corporation is finally determined by the federal government to be different from that originally reported, the federal change must be reported and, if a taxpayer owes additional tax to Massachusetts as a result of the federal change, that tax must be paid with interest. In 2003, Massachusetts closed a perceived loophole by specifying that a final federal determination includes a change in federal taxable income resulting from a closing agreement, an offer in compromise or similar agreement whether or not any audit or other review is complete with respect to issues not addressed in the agreement and without regard to whether the agreement results from a formal deficiency assessment. In 2005, Massachusetts “enhanced” the reporting requirements of tax adjustments, based upon final determinations of tax due, to include adjustments based on certain final determinations of tax due by any other state, territory, or possession of the United States or Canada.
3. In 2004, Massachusetts “clarified” existing sales/use tax law by providing:
   • that a company shipping goods to a Massachusetts customer may not avoid the application of drop shipment tax collection rules through contractual provisions governing passage of title ; and
   • that the tax exemption for direct and cooperative direct mail promotional advertising materials is restricted to individual discount coupons or promotional booklets or circulars of six pages or less that incorporate coupons and does not include mail order or department store catalogs or telephone directories.
4. In 2004, Massachusetts enacted legislation providing for the allocation of certain “non-apportionable” income to Massachusetts when the income is realized by an in-state domiciliary corporation and “clarifying” existing law to the effect that in the case of the licensing of intangible property the “income-producing activity”, for purposes of the sales factor apportionment provision, will be deemed to be performed in Massachusetts to the extent that the intangible property is used in Massachusetts.
5. Massachusetts law imposes personal and individual liability upon certain officers and, employees of a corporation and certain partners and employees of a partnership for the unpaid withholding tax, sales and use tax, including meals tax, and room occupancy excise tax of corporations and partnerships. When this law was first enacted, limited liability companies were unknown entities. In 2005, Massachusetts acted to close another perceived loophole, extending the rules of personal and individual liability to members of limited liability companies. In 2010, Massachusetts “enhanced” the application of its responsible persons provisions to include personal and individual liability for unpaid cigarette excise tax.
6. Legislation enacted in 2005 closed both corporate tax and sales and use tax “loopholes”. First, corporations exempt from taxation under Internal Revenue Code section 501 were made subject to tax on their unrelated business taxable income as defined under Internal Revenue Code section 512. Second, the sales and use tax law was amended to impose tax on prewritten computer software delivered electronically or by “load and leave” transactions. Prior to this amendment, tax was imposed only on sales of prewritten software delivered in tangible form such as a disk. Third, the legislation added two significant restrictions to the “small business exemption” which exempts, from sales tax, sales of gas, steam, electricity or heating fuel for use by qualifying small businesses having five or fewer employees. The two restrictions include an income requirement, i.e. the business must have had gross income of less than one million dollars for the preceding year and must reasonably expect gross income of less than one million dollars for the current year, and a requirement that otherwise qualifying purchases, such as management companies, may claim exemption for energy purchasers, solely for their own consumption but cannot claim the exemption if any portion of the energy purchased is provided to or for the benefit of other entities, such as tenants.
7. In 2008, Massachusetts removed the broad sales tax exemption for sales of pesticides and lawn chemicals and limited the exemption only to sales to farmers and licensed applicators and projected a $3 million annual tax revenue increase . That same year, Massachusetts directed the Registry of Motor Vehicles to begin registering “Low Speed Vehicles” and “Limited Use Vehicles” thereby making transfers of these vehicles no longer eligible for the sales and use tax exemption for casual and isolated sales and requiring that tax on these vehicles be directly paid to the Registry of Motor Vehicles (instead of being paid by the purchaser to the vendor).
8. Massachusetts adopted legislation in 2008, joining at least 45 other states, requiring that the filing status for business entities in Massachusetts must conform to their filing status for federal tax purposes. This conformity to the federal check-the-box rules resulted in many state filing changes, including the repeal of the separate taxation provisions that formerly applied to corporate trusts, and was projected to generate $99 million annually in increased tax revenue.
9. Federal Public Law 86-272 generally prohibits a state from imposing a net income tax on income derived from interstate commerce if the only business activities conducted within the state are limited to the solicitation of orders for sales of tangible personal property and where (1) orders are sent outside the state for approval or rejection, excepting orders solicited by an independent contractor, and (2) if approved, the orders are filled by shipment or delivery from a point outside the state. In 2008, Massachusetts enacted legislation providing that corporations protected from the income measure of the Massachusetts corporation excise tax by reason of Public Law 86-272 may, nevertheless, be subject to the greater of the non-income measure or the Massachusetts minimum excise tax of $456.00 . Aside from generating new revenue attributable to the non-income measure and minimum $456 excise, taxpayer compliance with this new law will identify, at no cost to the Department of Revenue, corporations that have nexus with Massachusetts but which claim Public Law 86-272 protection from the income measure of the corporation excise tax. What great audit leads!
10. In 2009, Massachusetts enacted legislation “clarifying” that the refundable earned income credit applies only with respect to that portion of earned income of nonresidents that is derived from Massachusetts sources.
11. In 2010, Massachusetts enacted legislation “clarifying” how a partner’s distributive share of income and their tax items are determined if the partnership agreement does not have substantial economic effect or does not provide for the determination of distributive share.

III. Shift Tax Administration Costs From MDOR Onto Taxpayers

Since 2002, the Massachusetts personal income tax return has had a line for consumers to report use tax on items that they may have purchased out of state or from Internet or mail order sellers who did not collect Massachusetts sales or use tax. In 2004, to further facilitate the self-reporting of use tax, Massachusetts enacted legislation permitting taxpayers to use a schedule to report a “safe harbor” amount of use tax (but excluding purchases of items having a sales price of $1,000 or more) based on their Massachusetts adjusted gross income. The efforts of Massachusetts in this regard reflect a recognition that auditing individual consumers for unpaid use tax is not generally an effective use of audit resources.

The Massachusetts Legislature authorized the Commissioner of Revenue, effective August 9, 2004, to require persons other than employers to (1) deduct and withhold taxes from payments made by such persons to residents, nonresidents and part-year residents of Massachusetts; (2) to file withholding returns as prescribed by the Commissioner; and (3) to pay over the taxes so required to be deducted and withheld. The legislation also lowered the threshold for withholding upon winnings from $5,000 to $600, effective December 1, 2004. Pursuant to this legislative authorization, the Commissioner, effective January 1, 2005, required promoters and other persons making payments for events in the Commonwealth to register online for withholding tax and to withhold and remit income tax from the entertainer, athlete, or other event participate and, for tax years beginning on or after January 1, 2009, the Commissioner required pass-through entities that maintain an office or engage in business in Massachusetts to deduct and withhold Massachusetts tax, as a general rule, from the pro-rata share of the entity’s Massachusetts source income attributable to non-resident shareholders, partners, or other non-resident members . In 2010, the Commissioner required motion picture production companies to withhold personal income tax on payments to independent contractors and loan outs for services rendered in Massachusetts .

Additionally, the Commissioner has considered, but has not yet implemented, using the authorization provided by St. 2004, c. 262, s. 21, to require withholding of tax on sales of Massachusetts real estate by non-residents.

Other examples of shifting tax administration costs onto taxpayers have included the increased use of administrative summons and the increased use of questionnaires, including both domicile and nexus questionnaires.

IV. Enact Laws Changing Taxpayer Favorable Court Decisions

If there has been a political unwillingness to enact new tax laws or to increase tax rates, that unwillingness has not extended to the enactment of laws changing the result of taxpayer favorable court decisions, most notably in the area of nonresident taxation.

For example, the term “Massachusetts source income”, as applied to nonresidents, has been judicially construed in several different factual contexts. More specifically, under prior law, the reference to income derived from or effectively connected with any trade or business, including employment, carried on by the nonresident was interpreted as not permitting the taxation of nonresident income connected with past Massachusetts employment or business where the nonresident had not carried on any business in Massachusetts during the taxable year of receipt. Similarly, under prior law, the reference to income derived from or effectively connected with the ownership of any interest in Massachusetts real or tangible personal property was interpreted as not permitting the taxation of gain derived from a nonresident partner’s sale of his partnership interest even where the assets of the partnership consisted exclusively of Massachusetts real or tangible personal property, absent the application of a sham transaction or step transaction doctrine .

Legislation enacted in 2005, however, redefines the term “Massachusetts source income” in a fashion that prospectively overrides most of this taxpayer favorable case law during the past 15 years . As a result, nonresidents are now subject to tax on all income that results from, or is attributable to, a Massachusetts trade or business, including income from a covenant not to compete; separation, sick or vacation pay; and deferred compensation that is received after the nonresident ceases to do business or be employed in Massachusetts. Income from a Massachusetts trade or business now also includes income that results from the sale of an interest in a business and, generally, applies to the sale of an interest in a sole proprietorship, general partnership, limited liability partnership or limited liability company.

In 1984, the Massachusetts Supreme Judicial Court ruled that the Commissioner lacked statutory authority to employ the unitary business approach of combining income of all affiliated corporations in determining a corporation’s Massachusetts taxable net income. In 2008, for tax years beginning on or after January 1, 2009, the Legislature instituted unitary combined reporting for multi-state corporations, changing Massachusetts from a separate company reporting state, and accompanied this change with phased-in corporate tax rate reductions. The positives of unitary combined reporting were summarized by the Massachusetts Study Commission on Corporate Taxation as including (1) increased economic efficiency by reducing distortions from tax avoidance practices; (2) simplification particularly when combined with check the box conformity; and (3) preservation of the corporate tax base from further erosion through income shifting and other practices. On the other hand, in a letter to the Legislative Committee on Taxation dated April 26, 2004, the Commissioner acknowledged that the definition of unitary business is “inherently gray” and predicted, if adopted, that “protracted audits and litigation would ensue”.

In 2003, Massachusetts enacted legislation “clarifying” that dividends received from a Regulated Investment Company (RIC) by a financial institution or a corporation are excluded from the definition of dividends eligible for the dividends received deduction.

In 2003, the Legislature reacted to the Supreme Judicial Court’s decision in The Sherwin-Williams Company v. Commissioner, 438 Mass. 71 (2002), rehearing denied (Feb. 28, 2003) which evaluated deductions for inter-affiliate trademark royalty expenses. The 2003 legislation requires that a taxpayer add-back to net income related member interest and intangible expenses and costs, including losses incurred in connection with factoring or discounting transactions, subject to certain exceptions generally predicated on the ability to show by clear and convincing evidence that a particular add-back would be unreasonable and was intended to protect the operation of the state’s tax laws to ensure against abusive tax avoidance measures.

The Legislature reacted in 2004 to the following three decisions:

• The decision of the Appellate Tax Board in Combustion Engineering v. Commissioner of Revenue, 25 Mass. App. Tax Bd. Rep. 758 (2000) to provide that the target corporation, in a transaction involving an Internal Revenue Code Section 338(h)(10) election, shall be treated as having sold its assets for sales factor purposes and not its stock as the Appellate Tax Board had concluded.
• The decision of the Massachusetts Appeals Court in Greenery Securities Corp. v. Commissioner of Revenue, 58 Mass. App. Ct. 70 (2003), by adding a new and specific definition of securities for purposes of determining qualification for the preferential corporation excise tax provisions available to security corporations.
• The decision of the Massachusetts Appeals Court in Morton Buildings, Inc. v. Commissioner, 43 Mass. App. 441 (1997) which held that where goods are purchased out of state and significantly altered before being brought into the Commonwealth, the use tax did not apply when the components are used in Massachusetts. The legislative response changed the use tax statute to explicitly provide that use tax is due on manufactured, fabricated, or assembled items when used in Massachusetts.

V. Decouple From Taxpayer Favorable Federal Tax Law Changes

For both business corporation excise tax and for financial institution excise tax purposes, Massachusetts defines gross income and net income with reference to the Internal Revenue Code, as amended in effect for the taxable year with certain adjustments. For personal income tax purposes, applicable to individuals, unincorporated entities and pass-through entities, Massachusetts defines gross income, adjusted gross income, and taxable income with reference to the Internal Revenue Code as amended and in effect on January 1, 2005, again with certain adjustments and with the caveat that the current Internal Revenue Code, and not the 2005 Code, is adopted in certain instances including, but not limited to, trade or business expenses, travel expenses, meals and entertainment expenses, Roth and education IRAs, exclusion for gain on sale of a principal residence, and medical and dental expenses.

For tax years ending after September 10, 2001, state law was amended to decouple it from the adoption of Internal Revenue Code Section 168(k) for purposes of “bonus” depreciation and, effective for tax years beginning on or after January 1, 2005, state law was amended again to decouple it from the adoption of Internal Revenue Code Section 199 for purposes of the production activity deduction.

With respect to estates of decedents dying on or after January 1, 2003, Massachusetts decoupled its estate tax from the federal estate tax, as modified by the federal Economic Growth and Tax Relief Reconciliation Act of 2001.

In 2009, the Massachusetts Legislature enacted an appropriations act for Fiscal Year 2010 which included provisions decoupling Massachusetts tax law from certain federal tax law changes made by the American Recovery and Reinvestment Act of 2009. Specifically, corporate excise and personal income taxes were decoupled from the discharge of indebtedness provisions of Internal Revenue Code Section 108(i), effective for discharges in taxable years ending after December 31, 2008, and were also decoupled from the federal treatment of high yield discount obligations under Code Sections 163 (e)(5)(F) and 163(i)(l), for obligations issued after August 31, 2008. Additionally, effective July 1, 2009, corporate excise and financial institution excise taxes were decoupled from the special rules for certain built-in losses due to change in ownership provisions of Code Section 382(n).

VI. Enact New Statutes Cutting Back Taxpayer Rights

In 2002, the Legislature voted to disallow the personal income tax deduction for charitable deductions which was first recognized for the 2001 tax year and also repealed the personal income tax rate reduction from 5.3% to 5.0% approved by Massachusetts voters and scheduled to go into effect in 2003 .

Many taxpayers have heard of the sham transaction and step transaction doctrines and understand that a taxing authority which seeks to invoke such a doctrine to disallow the asserted tax consequences of a transaction generally carries the burden of proof. Not so in Massachusetts. In 2003, Massachusetts enacted legislation authorizing the Commissioner, in his discretion, to disallow the asserted tax consequences of a transaction by asserting the application of the sham transaction doctrine or any other related tax doctrine, in which case the taxpayer has the burden demonstrating by clear and convincing evidence, as determined by the Commissioner, that the transaction possessed both: (1) a valid, good-faith business purpose other than tax avoidance; and (2) economic substance apart from the asserted tax benefit . In all such cases, the taxpayer has the additional burden of demonstrating by clear and convincing evidence, again as determined by the Commissioner, that the “asserted non tax business purpose is commensurate with the tax benefit claimed .

Also in 2003, Massachusetts enacted legislation imposing new limitations on the payment of refunds on certain late filed returns .

The Fiscal Year 2004 Budget Act enacted tax law changes described by Massachusetts as reducing the amount of interest paid on overpayments of tax, permitting MDOR to operate more efficiently by making corrections to returns during processing based on third party information or MDOR records, and eliminating duplicative hearings.

More specifically:

• Effective July 1, 2003, Massachusetts reduced the interest rate paid on tax overpayments from the federal short-term rate plus four percentage points compounded daily to the federal short-term rate plus two percentage point, simple interest. No, Massachusetts did not similarly reduce the interest rate it charges on tax underpayments!
• The Commissioner was given the authority to change the tax shown on a return, without first giving notice to the taxpayer of the Commissioner’s intent to make a deficiency assessment, based on information from third party sources or MDOR records. Prior to this law change, the Commissioner’s authority to change a self-assessment without prior notice to the taxpayer was limited to the correction of an arithmetic or clerical or other obvious error apparent upon the face of the return. In a related amendment, for purposes of calculating interest on a refund of an overpayment of tax, a return that requires, in MDOR’s judgment, correction of the tax liability based on third party sources or MDOR records is no longer considered filed, and thus no interest will be paid on any refund following the correction.
• Taxpayers were stripped of their long standing statutory entitlement to both a pre-assessment hearing, with respect to any proposed assessment, and an abatement hearing, unless they can establish that there is new factual information or new legal precedent that was not available at the time of the pre-assessment hearing or raise a new issue not considered at the pre-assessment hearing.
• MDOR was authorized to deny what it considers an incomplete abatement application if a taxpayer fails to supply information requested by MDOR within thirty days and, if a taxpayer appeals a denial of an incomplete abatement application and prevails on the merits of the claim, no interest will accrue during the period prior to the decision or judgment in favor of the taxpayer and interest will only commence from the date of the decision or judgment.

In 2010, Massachusetts enacted legislation giving the Commissioner the authority to audit pass-through entity return items at the level of the partnership, S corporation, or other pass-through entity, rather than at the level of the partner or member although the partner or member is allowed to opt out of the unified audit process.

Taxpayers used to be entitled to interest on tax overpayments if refunded within 45 days after the last day prescribed for filing the tax return. In 2002, the Legislation restricted the interest on tax overpayments to refunds not issued within 120 days after the last day prescribed for filing the tax return . Twofold immediate effect: (1) Massachusetts is given cost free additional use of monies belonging to taxpayers and (2) MDOR workload processing demands are lessened. Although the Legislature reduced the 120 day period to 90 days in 2009, the time is still twice the time prescribed in 1998.

VII. Grant Amnesty

Massachusetts has enacted four Amnesty Programs in the past decade to encourage, on a cost effective basis, the voluntary disclosure and/or payment of delinquent tax obligations.

The first of these four Amnesty Programs authorized a two-month amnesty period in 2002. This Program was quickly followed by a two month extended Program in the first two months of 2003 on substantially the same terms but also providing a limited look-back period for unpaid use tax liabilities and payment by the installment method for certain taxpayers. In 2008, the Legislature authorized a third amnesty program which the Commissioner implemented for a two month period in 2009. This third program was limited to individuals with existing personal income tax, existing personal use tax and existing cigarette excise tax liabilities for tax years or periods ending on or before December 31, 2007 and it brought in $32 million, well in excess of projected receipts of $10 to $20 million The most recent Amnesty Program was implemented for a two month period in 2010 and it was limited to taxpayers with certain specified existing business or trustee tax liabilities for tax years or periods ending on or before December 31, 2009. The most recent Amnesty Program generated over $32.6 million from 8,495 amnesty eligible taxpayers, exceeding MDOR’S $20 million projection.

On a related topic, legislation enacted in 2003 authorized the Commissioner to compromise and settle the inheritance tax that would have been owed on the transfer of any future interest before such transfer occurs.

Additionally, the Commissioner:

• Announced, in 2009, a voluntary compliance and enforcement initiative pertaining to employers that either have failed to file Massachusetts withholding or wage and information returns or have misclassified workers that should have been classified as employees.
• Announced, in 2008 and 2009, a look-back policy applicable to business corporations that have failed to file Massachusetts returns as required by state law pertaining to the in-state ownership and use of intangible property or state law creating a presumption regarding “engaged in business in the commonwealth” because of in-state lending and ancillary loan activity .

VIII. Strengthen Tax Collection Tools

In 2005, the Legislature amended tax administration law to provide that certain payments by MDOR “in error”, including erroneous tax refunds”, may now be collected like a tax and that the failure to repay a payment in error may result in the imposition of interest and penalties .

Legislation enacted in 2008 expands the Commissioner’s authority to revoke or suspend licenses, including professional licenses, issued by Massachusetts agencies and, provides that the Registry of Motor Vehicles shall revoke or suspend a driver’s license, learner’s permit, right to operate a motor vehicle, or certificate of motor vehicle registration for nonpayment of taxes upon notification from the Commissioner. In its first year, this driver’s license suspension program generated $9.1 million in delinquent tax payments.

Additionally, the 2008 Legislation:

• Increased the one-time demand for payment fee from $5 to an amount not more than $30;
• Increased the rate at which late pay penalties accrue from one-half of one percent a month to one percent a month; and
• Extends the statue of limitations for collection of taxes from 6 to 10 years.
• Legislation enacted in 2010:
• Accelerates the Commissioner’s authority to begin collection action, except where the taxpayer has filed for an abatement, within 60 days after an assessment, instead of 90 days after an assessment.
• Accelerates the due date for payments from taxpayers in cases where MDOR assessments are sustained at the Appellate Tax Board, moving the required payment date such that it is the 30th day following the date when the Board issues its initial decision (without deferring to such later time as the Board may issue written findings and a report with respect to its initial decision.) ; and
• Provides for an increase in tax, consistent with federal law, on certain taxpayers who defer payment of income tax through use of the installment sale method.

IX. Enact New Penalties To Discourage Certain Taxpayer Conduct

Legislation enacted in 2010, changes the penalty for failure to report a federal change or other state change from the lesser of $100 or 10% of the tax due to 10% of the tax due (thus increasing the amount of the penalty in cases where the tax due is greater than $1,000.00).

Legislation enacted in 2005 imposed the following four new categories of penalties (each of which is, in substantial part, derived from Internal Revenue Code provisions imposing like penalties with respect to federal returns) that apply in the following circumstances :

1. A taxpayer substantially understates a tax liability or underpays taxes due to negligence or disregard for Massachusetts laws, including public written statements of the Commissioner;
2. A preparer with respect to a tax return or claim for abatement or refund knows or reasonably should know that the return or claim reflects a position or positions unsupported by Massachusetts law, and the position was not disclosed or was frivolous; or a preparer willfully attempts to understate tax liability or demonstrates a careless, reckless or intentional disregard of Massachusetts tax laws or written public statements issued by the Commissioner;
3. A taxpayer takes a tax return reporting position on an issue in Massachusetts that is inconsistent with a position taken in another state and the governing law relating to that issue is the same in all material respects in Massachusetts and the other state, and;
4. A person organizes, assists in the organization of, or sells (or assists in the sale of) any plan or arrangement, and makes or furnishes, or causes another person to make or furnish, a false, fraudulent or deliberately misleading statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit, including the avoidance of a filing requirement.

X. Enact New Taxes and Increase Tax Rates

Last year, the Legislature and Governor decided that new taxes and increased tax rates were needed in addition to the nine responses of new technologies; loophole closers; shifting of administrative costs; the enactment of laws changing taxpayer favorable court decisions; decoupling from federal tax law changes; the enactment of laws cutting back taxpayer rights; tax amnesty programs; strengthened tax collections tools; and new penalties.

2009 Legislation enacted a 25% increase in the rate of sales/use tax from 5% to 6.25% on sales at retail of tangible personal property and telecommunication services and removed the sales tax exemption for beer, wine and alcohol effective August 1, 2009. Without this 25% sales tax increase, fiscal year 2010 Massachusetts tax collections would have been less than fiscal year 2009 collections. Also, in 2009, the Legislature adopted a Local Option Meals Excise which authorizes accepting cities and towns to impose a local .75% sales tax on the sale of restaurant meals in addition to the 6.25% state sales tax on meals . As of May 26, 2010, 103 of 351 Massachusetts cities and towns adopted the new .75% local option meals tax, generating $11.3 million in revenue (as of May 3, 2010). The legislation also increased the maximum rate of the local option room occupancy excise from 4% to up to 6% (from 4.5% to 6.5% in Boston) provided that each city or town votes to accept the increase rate . And in 2009, Massachusetts enacted a 5% excise on the gross revenues of a provider from the sale of direct broadcast satellite service to a subscriber or customer in Massachusetts.

The excise tax on cigarettes was increased in 2008 from $1.51 per pack of 20 cigarettes to $2.51 per pack ($25.10 per carton) and from $1.8875 per pack of 25 cigarettes to $3.1375 per pack. Additionally, the definition of “cigarette” was expanded to include “little cigars”.

In 2002, Massachusetts enacted a personal income tax increase which increased the tax rates on all categories of long term capital gains with respect to transactions completed on or after May 1, 2002. (The effective date of this tax increase was later changed to January 1, 2003.)

Conclusion

More than 300 years ago, Jean-Baptiste Colbert, French Minister of Finance (1665-1683) under the rule of King Louis XIV, defined taxation as “the art of so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing.” Is it fair to conclude that Massachusetts has now elevated Massachusetts taxation from an art form to a science? You decide.

COPYRIGHT 2010

          • Steps to launch a product business               

          • Legal Aspects of startup companies

          • Steps to launch a service business

          • Consulting to get a job

          • Joining a startup venture

By Robert A. Adelson, Esq.

Entrepreneurial Profile: Do you have what it takes?

1. Introduction

          • High Rate of Startup Failures

          • Hard to Succeed

          • Don’t start for wrong reasons

2. Passion for your business

          • Commitment, sacrifice, confidence

          • Optimism, reasons why it will work

          • Resilience

3. Knowledge of your market and place

          • What is really unique about your business

          • Need: Selling morphine, not vitamins

          • Business Model

           • Where are you playing: dominance over your market

           • Recurrent Revenue-fixed cost leverage

           • Competitive advantage

4. Working with others, Facing Change

          • Sharing, fairness, team building

          • Adapt and change-learn and grow from your mistakes

          • Scaling the business-including when to fire yourself

5. Putting yourself out there, on the line

          • Giving of yourself

          • Networking

          • Relationship building, nurturing

Launching a Successful Product Business

1. What is a Successful Business

          • Producing good return to you and your stockholders

          • More money coming in than you are putting out

2. Have a Plan: How will you create value for others

          • Find a “pain” in the market – providing a solution

          • You can’t create demand-  you want to fill supply

          • Establish your brand based on filling a compelling need

3. Know your customer, know your market

          • Start local and build – small, fast, cheap

          • Keep testing-figure out what works and doesn’t

          • Keep your database, access it

          • Develop a sellable model/market and test product

4. Build a company

          • LLC a corporation- entity, limited liability, credibility

          • Stock for others

5. Build a team

          • Equity and fairness; share success

          • Convince others to join you – seek good fit

          • Build a Board of Advisors or Directors – Key resource for you

6. Build a prototype, sell something

          • It doesn’t have to be perfect

          • Selling-feedback and gets $ coming in

          • Establish further proof points of viability, credibility

7. Develop and protect your IP

          • What you can protect and what you can’t

          • Strategize IP protection- IP assets

8. Bootstrapping and Commercial Contracts 

Legal Aspects of Launching a Product Business

1.  Choice  and Formation of Business Entity

          • Business Merits of Corporation (S or C), LLC, LLP

          • State of Formation, Qualification of foreign entity

2.  Taxation of Business

          • Double v. Single Level taxation; payroll taxes

          • Pass Through of losses / income;  1202 stock opportunity

          • Complexity of capital structure

3.  Intellectual Property and Proprietary Protection

          • Patents  – Provisional and full utility patent

          • Trademarks – ITU and use based filings

          • Copyrights and Trade Secrets

          • Assignment of rights and NDAs

4.  People – Contracts among Service providers and Owners

          • Employees / Contractors, consultants, “Virtual Companies”

          • Board of Advisors / Board of Directors

          • Equity Participation – Options, Restricted, Phantom stock

          • Shareholder Agreements – Share transfer, management, succession

5. Products and Markets

          • Production Arrangements / Supply contracts

          • Sales / Distribution – Dealer contracts, sales terms

• Product and IP licensing

6. Money:  Raising Capital and Securities Law Compliance

          • Bootstrapping, family and government grants

          • Angel and Venture Capital Finance / Securities law compliance

          • Loans, collateral, guarantees and debt finance

7. More:  Other important legal aspects of your business

          • Home;  Office / facility and store leases

          • Zoning and environment regulations

          • Regulatory compliance for your products

          • Business insurance

Launching a Service or Consulting Business

1. Your Market: Research and Determination

          • Self Skill assessment (“looking in mirror”)

          • Who are your customers? Finding them…

          • Listening to customers/match skills to need

2. Selling Service and Selling Yourself

          • Selling Payback you can deliver customer

          • Promotions – articles, talks, advertising …

          • Lead Generation, building your network

3. Building a Trade Name and Identification

          • Name, Logo for Recognition / Distinction

          • State, Federal trademarks as bus. Assets

4. Compensation, Pricing & Collection Planning

     • Fees- By Rate, Commission, Lump sum

     • Payment Installments – Periodic, Milestone

     • Security – deposit, Security Interest, Penalty                              

     • Reimbursement or Payment of Expenses

     • Currency of Payment – Cash, Stock, Other

5. Production, Costs and Delivery of Services

     • Quality Control; Repeat Bus, best marketing

     • Cost Control, start small

6. Sales and Limitations on liability to customers

     • Sales Terms to limit commitment, Forms Battle

     • Upfront Liability Bar: Corp, LLC in operation

     • Backend Liability protection via insurance

7. Staff, Subcontracting & Handling Overflow

     • Staff & contractors to expand capacity, reach

     • Subcontracting work Terms & Non-poaching

Consulting as Tool to Secure, Evaluate Full-time Jobs

1. Leave Firing Range (rejection bullets) to talk payback to CEO

2. Expanding your Window of Opportunity with cash from consulting: added staying power

3. Expansion to Deal Flow via added flexibility to take part-time or try-out situations (employer’s chance to sample the milk..)

4. Paid Due Diligence – your chance to learn more before you commit to full-time offer

5. Keeping offers open – delay for alternatives or sweeten offer; employer still gets work

6. Add to Skill-set; Keep current, sharpen skills

7. Something new to talk about – recent, current work experiences to relate in interviews

8. Fall Back – a consulting practice is your own to which you can return as jobs shift

9. While consulting is not for every executive or may be no substitute for a full-time job in many cases it can offer a stop-gap and add to your options as you seek that job.

   Joining a Startup Company

1. Knowing the score

          • Low odds of success

          • Other Alternatives

          • Valuing your Money & Time

          • Non-Monetary Benefits

2. Picking a Winner

          • Team: Knowledge, Experience, Contacts

          • Marketing Plan: Addressing real Need

          • Business Model / scalable

          • Barrier to Entity

          • Likelihood of Finance; Exit strategy

3. Doing your Homework

          • Website & Marketing materials

          • Resumes and Interviews

          • Reference Checks

          • IP Due Diligence

4. Protecting Any $ Investment you make

          • Private Placement memorandum

          • Financial Statements

          • Preferred Stock position

          • Investor Protective terms

5. Protecting Employment / the services you provide

          • Signup Bonus

          • Meaningful Equity

          • Defined Responsibilities

          • Coverage of your Expenses

          • Severance Terms

ABOUT THE SPEAKER AND PRESENTATION

            These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801, Boston, MA 02110, (617) 951-9980.        Fax (617) 951-0048. Email:radelson@engelschultz.com  Website:  www.engelshultz.com  

Blog:  http://robadelson.wordpress.com/

            Mr. Adelson is a graduate of Boston University, Phi Beta Kappa and Northwestern University Law School in Chicago where he was a member of  Law Review.  He also has an LL.M. degree in Taxation from New York University and is a member of the Massachusetts, New York and US Tax Court Bars.

Robert Adelson began his legal career in 1977 as an associate at major New York City law firms, first Dewey Ballantine and later Weil Gotshal & Manges, before returning home to Massachusetts in 1985, where he has been a partner at several Boston firms before joining his present firm as senior business law partner in 2004.  Mr. Adelson is specialized in corporate, taxation, contracting, employment and intellectual property law.  In those areas, he frequently represents entrepreneurs, startup and smaller companies. He also represents executives and consultants in employment, contracting, liability and severance matters, and family business with phantom stock and succession planning.

Mr. Adelson’s law firm, Engel & Schultz, LLP, is a small but broad service law firm of 6 attorneys in Boston.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in litigation, real estate, family and probate matters. 

Mr. Adelson is a frequent speaker at business forums and Chairman of IEEE Boston Entrepreneurs Network www.boston-enet.org and a Board member at 128 Innovation capital Group www.128icg.org .  Further information on Mr. Adelson’s background and his past published articles is available at the Engel & Schultz LLP  law firm website.  To view many of Mr. Adelson’s past articles, see http://www.engelschultz.com/index.php/category/publications/ 

Mr. Adelson has been a member of Temple Shalom for 14 years.  His son William and daughter Kathryn were bar and bat mitzvahed at the Temple.  The speaker wishes to thank Allan Cole and the Brotherhood of Temple Shalom of Newton, MA for the opportunity to speak on  “Entrepreneurship 101:  Starting a Successful Business” at Temple Shalom, 175 Temple St., Newton, Massachusetts, on January 24, 2011.

The purpose of these materials is to offer an outlines on the subject matter of the Entrepreneurship for those considering forming or joining a startup company or advising others on that prospect. Thus, it is hoped these materials will be informative to those in attendance.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case.

Finally, after lengthy discovery and the defeating of a motion for summary judgment filed by the employer, Engel & Schultz negotiated a settlement for the benefit of a whistleblower who had objected to filing false documents to the government.

By Robert A. Adelson, Esq.

Why you, as Consultant, are worse off If work unpaid, than if never done…

1.    Business obligations of Independent Consultant  exceed company employee – tasks beyond work

• Marketing & Sales – finding your consultant work
• Maintaining currency in your field
• Producing work once assignment given
• Delegation of work and development of Subcontracting relations with other consultants
• Keeping home or rented office facilty and equipment
• Billing and collection – assuring your revenues & payment

2.    Time = $$$.  Unpaid work steals time from other business tasks also essential to consultant business 

3.   Respecting the Value consultants bring to the client – value that should be timely paid for

• Just in Time management – to fill need
• No lingering obligation, termination when use ended
• Hired for expertise & experience – no training cost
• No pension, medical, vacation or other benefits
• No permanent office or support
• Self-insured, liability insurance typically required 

4.    Exception to rule – When you are not worse off… When you, as Consultant, can afford not to be paid

• When cash is not only currency for your payment…for example…
• Assignments in new field, little prior experience – learn on client
• Access to technology or markets, back license of technology
• Face time with valued contacts; “free” exposure for your work
• Work in desired location, other “perks” or benefits for doing work

5.         Though you benefit, client’s work shouldn’t be free 

 If your client is cash-strapped, and You want to do the work…

How to structure billing to get paid?

1.     Installment payments – fixed time-table

 2.     Debt obligations – promissory note

• Unconditional promise to pay sums owed
• Interest on outstanding debt
• Warrants in client stock – Equity “kicker”
• Collateral security for debt
• Perfection of security interests
• Defining “events of default” & consequences
• Collection costs & Attorneys fees

 3.       Payment of your out-of-pocket costs –

• Separate from your consultant fees – Not income to you
•  Reimbursement /direct payment – so you’re not out of pocket

 4.      If cash pay unlikely…what else can you get?

 5.      Payment in Client’s Equity (a piece of the business)

• Since you share risk… you deserve share of client’s upside
• Get it now – if your work adds value… that shouldn’t penalize you
• Types of Equity:  Stock, Options, Phantom Stock
• Different tax treatments – seek tax favored equity
• Valuation – balancing debtor’s current status & the prospects
• Vesting of stock & options
• Exercise period of options – termination issues
• Anti-dilution protections; Cash-out, reporting, retention rights

 6.      Non-cash benefits to Consultant from Client work 

• Be sure you’re timely obtaining these benefits in quality expected
• When non-cash objectives achieved – be ready to terminate

What pro-active steps can you take? To improve chances of timely payment …

1.   Get cash advance – especially from 1^st time clients

• Eliminate “window shoppers” – establish payment expectation
• Assure that client has “skin in the game” – stake in your work

2.   Valid and Good Contract – before starting work

• Real parties to agreement, addresses, personal guarantees
• Mutual assent – signed agreements
• Clear mission – defined scope, performance obligations
• Clear conditions, variables, contingencies on performance
• Enforcement terms – governing law, consent to jurisdiction
• Once again, right to collection costs, attorney’s fees (often done that prevailing party get attorneys fees – need this provision)

3.   Achieve value – meet your milestones

• Show & evidence clear consideration – what you did for him
• Potential case in equity – quantum meruit – value conferred
• Defense to counterclaim – you didn’t perform and it cost client

4.   Establish lien on work accomplished / deliverables  

• Contract should provide right to lien on unpaid amounts
• Again, depends on value achieved
• Fear rescission & action on lien potent weapon on bundled product

5.   Dunning clients within Bounds of law

• Calling clients in arrears – law’s latitude on commercial debtors
• Threatening pre-litigation letters
• Collection costs (collection agency) & attorneys fees 

6.   Exception to Rule – When oral contract enforced

• Party seeking enforcement acted in reliance on clear oral contract
• Party denying enforcement received benefits from oral deal
• Doctrines in equity: “Implied Contract” & “Unjust Enrichment”

If pre-litigation actions fail, what’s next? Legal strategies to achieve bill collection…

1.   What collection attorney needs before taking case?

• Prerequisite #1:   Enforceable legal case
• Prerequisite #2:   “Deep Pocket” to pay verdict for plaintiff
• Different types of contingency fee cases
• Size of case needed to merit contingency / or hourly legal work

 2.         What you need to do to have enforceable case

• Evidence of contract – copy of signed contract or alternative
• Evidence of work performed and debt owed
• E-mails or conversations – reflecting defense to debt or its acknowledgement & collection efforts
• Determine merits of client position vs. potential defense claims and defense counterclaims if any
• Obtaining jurisdiction over debtor – address in state, ss# for skip-trace if needed

 3.         What you need to show a deep pocket to pay

• Bona fide defendant – if early stage company, preferable to have personal guaranty, so person can be sued as well as company
• Identify and quantify assets covered by lien or which may be reachable in pre-judgment attachment actions

 4.   Plan /Implementation: 1^st (asset) stage of legal action

• Preparation of complaint, plaintiff affidavit & proper service
• Coordinated action against assets (“low lying fruit): reach & apply
• With event of default occurred & realization on any collateral

5.   Plan /Implementation:  2^nd (motion) stage of action

• Motion for summary judgment if appropriate
• Motion for expedited discovery – interrogatories / depositions
• Defense against same, if any from debtor
• Settlement or trial – at each stage, both parties weighing costs 

ABOUT THE SPEAKER AND PRESENTATION

These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Boston, MA 02110, (617) 951-9980.  Fax (617) 951-0048. E-mail: radelson@engelschultz.com  Website:  www.engelshultz.com   Mr. Adelson is a graduate of Boston University, Phi Beta Kappa and Northwestern University Law School in Chicago where he was a member of  Law Review.  He also has an LL.M. degree in Taxation from New York University and is a member of the Massachusetts and New York and US Tax Court Bars.

Robert Adelson began his legal career in 1977 as an associate at major New York City law firms, first Dewey Ballantine and later Weil Gotshal & Manges, before returning home to Massachusetts in 1985, where he has been a partner at several Boston firms before joining his present firm as senior business law partner in 2004. 

Mr. Adelson is specialized in corporate, taxation, finance, commercial and technology contracting law.  In those areas, he represents four main types of clients:

• Startups, smaller companies and entrepreneurs in software, and other technology-based fields, including issues of building management team, IP protection, strategic and commercial contracts, shareholder issues, M&A and capital finance; 
• Consultants ad service providers in issues of client contracting and contract enforcement; subcontracting work; trademarks and trade identification, copyrights and trade secret protection; liability, regulatory issues, entity choice incorporation;
• Executives and key employees in negotiation of employment terms, compensation, stock, options and phantom stock, termination, severance and relocation;
• Family businesses including those in transition with issues of succession planning, recruitment and retention of non-family members and other issues of business.   .

Mr. Adelson’s law firm, Engel & Schultz, LLP, is a small but broad service law firm of 6 attorneys in Boston.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in litigation, real estate, family and probate matters. 

Mr. Adelson is a frequent speaker at business forums and author of numerous articles published in Boston Business Journal, Mass High Tech and elsewhere. He is Vice Chair of the Boston Entrepreneurs Network and a board member of 128 Innovation Capital Group.  Further information is available at his law firm website  www.engelschultz.com .

The speaker thanks Nathan Sokal (who delivered a presentation from the consultant’s viewpoint), for the chance to join him speaking on the legal viewpoint, on topic:“Consultants: How to make sure you get paid”, for the IEEE Consultants’ Network at Waltham, Massachusetts, on October 22, 2008.   These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case.

(c) 2008 by Robert A. Adelson

EQUITY COMPENSATION ARRANGEMENTS FOR HIGH TECH CONSULTANTS

EXAMPLE  (Hypothetical and Fictitious)

SuperpowerSoft Co. 

                                                                           Employees: 5 (3 being part-time)

                                                               Shares        Sales: -0-; Developmental State

Edison Pres., CEO                            40%           Assets: 250k    Liabilities:       10k

Kwertzberg, VP Operations        40              Cash:   50        A/P      10

Other Part-Time Employees       2                 Equipment       50

Investor Stocks (FFF)                   10               Technology 150 Sh/h Equity: 240k

Mansey, VP Mrktg (if vested)    8                   P/L: (30k)

Part-Time Consulting for High Tech Start-Up Company

            Tim Mansey was a senior officer at software giant, Zen Development Corp. in Cambridge until Zen’s acquisition by an even larger out of state computer corporation.

            After leaving Zen, Mansey decided that, rather than job search for a full-time position, he would seek job assignments from different companies, selling his engineering, marketing skills from 15 years at Zen and other known companies on Mansey’s resume.        

             Over the last year, Mansey developed a consulting business for software companies under the name, “CEO Strategies”. He has an ongoing 1-day a week assignment and completed job assignments with large and smaller companies, including assistance in marketing , product design, technology validation and some software development work.  One company has asked Mansey to join its board of directors.

             Most clients have paid on time, and with one or two exceptions, the work of CEO Strategies has been very well received.  Originally, Mansey’s assignments came from colleagues at established firms, but now he also approaches start-up and emerging companies, even though most cannot pay Tim’s daily consulting fees.

              Recently, Tim discussed a part-time spot in one such startup: SuperpowerSoft Co., newly founded by Tom Edison who invented the SSC proprietary technology, and Mitch Kwertzburg, who was with Tom at DEC and with family, etc. contributed the cash capital.

              Formed 6 months ago, SSC now has 3 other techies part-time, leases space in Burlington, and has a product nearing completion.  SSc still has funds from investment by Mitch, family, friends, etc., but no one takes a salary.  So, Tom and Mitch thought it time to recruit a “sales guy” to help market the product.  Enter…Time and CEO Strategies.

               Tim believes SSC has a breakthrough technology with ready markets.  With his industry background, Tim believes that he can attract licensing & strategic alliance partners (he sees ChyBase as likely 1^st match) to speed SSC market entry but Tim needs authority.

               Tom and Mitch like Tim, but don’t want him taking over and are not sure how much stock to give him.  They have several questions on compensation, terms and pitfalls.  

IS EQUITY FOR PAY A GOOD DEAL?  

OPPORTUNITIES AND… PITFALL

QUESTIONS OF THE CONSULTANT:

• When does taking equity as your pay make the most sense?
• What are the types of equity? Stock options

Or other arrangements a client can offer you?

• How do we value the stock or options you get?
• What taxes does the Consultant pay?
• How do you avoid dilution
• What other structuring issues should you ask about to protect your equity stake?

QUESTIONS OF THE COMPANY:

• When does offering equity make sense to a Company?
• Can this equity be paid based on performance? Or loyalty? Can we measure performance?  How much stock to give?
• What if things don’t work out: Can we get the stock back? What if Consultant dies? Quits? What if we sell the Company?
• Is stock (or options) paid deductible by the Company?
• Will giving stock now hurt us later? In seeking financing? In morale with current staff? In recruiting new talent?

Equity Compensation for Services

1. Forms of Equity

• Common Stock: voting or non-voting
• Preferred Stock:

Preferences in liquidation

Dividends, cumulative or not, management

• Warrants or Options
• Convertible Debt
• Phantom Stock/ other deferred comp

1. Vesting Schedule

• Acceleration on change in control
• Buy-back rights on Termination

1. Stock Purchase Agreement

• Investment warranties by purchaser
• Company disclosure, business plan
• Anti-dilution protections, pre-emptive rights
• Company covenants, reports
• Registration rights
• Cash-out Rights

1. Stock Option Agreement

• Grant Date & Option Period
• Exercise Price and Method
• Company Plan, restrictions if qualified
• Enhanced flexibility, if non-qualified.  

Valuation of Company Equity

1. Current (Tax) Fair Market Value

Rev. Rul 59-60: Assets, Indus, History, Comps.

Discounts for Illiquidity, blockage, minority

1. Forward (Investor) Value from Business Plan

a.       Product, Technology, Uniqueness, Edge

b.      Market, Competitive Strategy, Penetration

c.       Management Team, motivation, track record

d.      Financial forecast, underlying assumptions

e.       Capital Sought, financing stage, funds use

1. Blend Valuation with our without Services

- Entrepreneur’s investment, upside potential

-Present value of future using 35% ROI

Stockholder Agreements related to Equity

1.      Goals:        stabilize management, ownership, provide liquidity, valuation of shares

2.      Means: share transfer restrictions, voting agreements

3.      Involuntary transfers

4.      Voluntary transfers – 1^st Refusal to Co., Shhs

5.      Control Change Co-Sale: Drag & Tag-along 

Taxation of Equity (in lieu of cash compensation)

1.      Stock Issued – Purchase Plan

• Not restrictive; open to Consultants
• Tax Paid when no subst’l risk of forefeiture & stock has readily ascertainable FMV
• §83 Ordinary Income Tax
• §83(b) Election can accelerate the Tax

2.      Stock Option – ISO (Incentive Stock Option)

• Restrictive Plan – FMV, limits on amount, exercise
• No Tax on Exercise; Capital gain on sale
• Limited to current company employees

3.      Stock Option – Non-Qualified Plan

• Restrictive Plan NOT IRS Required

Tax Paid on Exercise of option

• Capital gain on Later Apprec. Paid on Sale
• Not limited to current employees

4.      Equity Based Compensation Plans

• Phantom Stock; Stock Apprec. Rights (SAR)
• Tied to co. growth, no equity but payment rates
• Not restrictive; open to Consultants
• Taxed as Paid; All §83 Ordinary Income Tax

Payment by Promissory Note

1.      Installment payments – fixed time-table

2.      Debt obligations – promissory note

• Unconditional promise to pay sums owed
• Interest on outstanding debt
• Warrants in client stock – Equity “kicker”
• Defining “events default” & consequences
• Collection of costs & Attorneys fees
• Collateral security for debt
• Perfection of security interests

3.      Installment taxation on payments received

4.      Benefits of note for enforcement

ABOUT THE SPEAKER AND PRESENTATION

            These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801, Boston, MA 02110, (617) 951-9980, fax: (617) 951-0048, e-mail: radelson@engelschultz.com

            Mr. Adelson is a graduate of Boston University, Phi Beta Kappa, and Northwestern University Law School in Chicago where he was a member of Law Review. He has an LL.M. degree in Taxation from New York University, and is a member of the Massachusetts, New York and U.S. Tax Court Bars.  He began his legal career in 1977 as an associate at major New York City law firms, first Dewey Ballantine and later Weil Gotshal & Manges, before returning home to Massachusetts in 1985, where he has been a partner at several Boston firms before joining his present firm as senior business law partner in 2004.

            Mr. Adelson is specialized in corporate, taxation, business and technology transactions.  In those areas, he frequently represents (1) small companies with their various business needs, including shareholder and employee issues, financing, commercial contracts, intellectual property, joint ventures, mergers and acquisitions, succession planning (2) senior executives, in negotiations over severance, employment, relocation, stock options, compensation and stockholder arrangements, and  (3) consultants – in liability protection, intellectual property protection, trade identification, vendor, client and subcontractor arrangements.

            Mr. Adelson’s firm, Engel & Schultz, LLP, is a small but broad service law firm of 6 attorneys in Boston’s Financial District.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in family, probate, real estate and litigation matters. 

            Mr. Adelson is a frequent speaker at business forums and Chairman of IEEE Boston Entrepreneurs Network www.boston-enet.org .  Further information on Mr. Adelson’s background and his past published articles is available at his law firm website.  To view many of Mr. Adelson’s past articles, see http://www.engelschultz.com/index.php/category/publications/  or http://robadelson.wordpress.com/

The speaker thanks Ron Goodstein and Tom Vaughan for the invitation to speak for IEEE Consultants’ Network on the topic of “Getting Paid in Stock, Options or Promissory Notes:  Negotiating the terms of on-Cash payment for Consulting Services” at the Emerging Enterprise Center, Waltham, Massachusetts on May 26, 2010.   

The example on page 1 of these Materials are hypothetical and fictitious although the questions on page 2 are drawn from actual client questions.  The purpose of the example is solely to illustrate contracts issues, strategy and planning concepts and stimulate meeting discussion.  The remainder of these materials are to offer rough outlines of broad areas of major contracting situations for technology based business. It is hoped that these materials will inform discussion and be useful reminder of topics covered for the attendees.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case.

©2010 By Robert A. Adelson

As an engineer, marketer or senior executive, you may be offered stock or options  or a promissory note to cover part or all of your pay.

1.  Is Equity for Pay a Good Deal?  Whether you are taking a new position or re-negotiating your current job, whether you work full-time or as part-time consultant, whether the company is early stage or well established, questions often come up -

●  When does taking equity instead of cash make sense?

●  What types of equity can a company offer you?

●  How do you value the stock?

●  What taxes are paid?  How to avoid taxes?

●  When does taking a promissory note make sense?

●  What terms should a note include?

If you are an employer or starting your own company and thinking of paying stock, you ask – can we get the stock back, if things don’t work out?

2.  Valuing Stock Received.  If the stock is traded on an exchange or OTC, value is published in The Wall Street Journal.  But where the company is not public, there is no set answer on how to judge stock value. What investors paid is the best barometer but your stock remains illiquid (who knows when, if ever, you can sell) and investor stock may be different than yours.

Often, taking stock makes the most sense when you believe in the management team and marketing/business plan, or when you have other motives.  If this work gives you new contacts, or skills, or access to a new technology, the job may be worth it, even if the stock proves a bust.

3.  Stock Choices and Taxes Due. Cash investors typically receive preferred shares and service providers common.  This means if the company goes bankrupt, investors will have their money out first.  However, even with just common shares, there are often choices, e.g. between S and C stock, or qualified and non-qualified options.

Stock choices can have important tax consequences to watch out for.  If stock is issued below fair market value, that difference is taxable when the shares issue.  Options are normally not taxed until you exercise the option (and ISOs not until you sell).  Yet, obtaining stock also makes you eligible for lower capital gains tax on sale.

4.  Vesting, Dilution, Contract Protection.  When you receive stock or option documents you should also be careful to review the equity terms for such issues as -

►  When do shares “vest” – when do you own the shares? 

   When can you exercise the options?

►  What protections do you have against more shares being

   given out?  new shares diluting your share value?

►  What happens if there is a change in control of the company?

►  Do you have an ability to “cash out” your shares?

5.  Promissory Note to Evidence Payment. Taking a promissory note is an alternative to stock that makes the most sense if there is a strong sense that payment will be made after a delay. Unlike stock, the promissory note is an unconditional promise to pay a sum certain either on demand on at a fixed time.  The note should bear interest typically at the Wall Street Journal prime rate or one or more points above, can be secured or unsecured, include collection terms and might also include an equity “kicker” or stock or warrants added as part of the consideration.

The author and speaker is Robert A. Adelson, Esq., partner at the Boston law firm of Engel  & Schultz LLP.  Mr. Adelson is a graduate of Boston University, Phi Beta Kappa, and Northwestern University in Chicago, where he was a member of Law Review.  He has an advanced LL.M. degree in Taxation from New York University.

Mr. Adelson has been an attorney since 1977, specialized in business, tax and contract law.  His work includes legal issues of executive compensation, incorporation and finance, trademarks, licensing and intellectual property.  He represents startup and emerging corporations, and individual consultants and executives.  His 6-attorney law firm offers full service in litigation, family law, probate and real estate.  Engel & Schultz  is located at 265 Franklin Street in Boston.  Mr. Adelson may be reached at (617) 951-9980 ext 205 or radelson@engelschultz.com.

Copyright © 2010 Robert A. Adelson

    Ø      Platform, Position, Launching Pad

    Ø      Cash Compensation and Benefits

    Ø      Equity: Corporate/Tax Structure

    Ø      Termination, Severance, Non-Compete

    Ø      Good Vibrations      

By Robert A. Adelson, Esq.
EXAMPLE (Hypothetical and Fictitious)

Engineer Bradee                                                            MicroscopicSoft, LLC

Employee Offer Sheet:                                              Company Profile:

Salary: $225,000 plus bonus                                                         Bus: Software

Benefits: HMO Med/NoDent/                                                         HQ: Eugene, OR

401K, Life/Dis insur  Perqs: blackberry               Assets: $2 mil net (12/31/09)

Term:  At Will                                                                   Sales: $10 mil FY ‘09

Severance: 3 mos                                                           P(L): ($0.5 mil)

Expns : Relocation                                                         Stock : 20 mil o/s LLC units

Pos: EVP COO                                                                                      Exchange: Private

Outside Bds:  None                                                                            Employees : 50

Equity : 100,000 units (NQ)                                                         Est.: 2002  

Full-time Employment with Emerging Hi-Tech Company

            Thomasina Bradee, PE of  Wellesley, MA, is an executive considering a job move.  She is now VP Sales with the Harris Graphics Division of ZEN Development Corp. a local software company recently acquired by giant Big Blue Machines, Inc. (BBM)

            Bradee recruited the sales team and developed marketing and channel strategy for Footnotes, Zen’s top sales product, and has been offered the EVP & COO spot with MicroscopicSoft, LLC, a young Oregon software company.  Founded by Gyl Bates, Microscopic focuses on products similar to Footnotes and has backing from Bates who head a large company also located in the Northwest with a similar name.  Microscopic still has $3 million in assets (including a Company facility in Eugene) net of long term liabilities.  It has experienced recent losses from operations this past year, its burn rate increasing, but it also believes itself well positioned for a possible liquidity event next year.

            The package offered to Tom includes $225,000 salary (50k deferred) with 20% bonus, plus relocation expenses and options for 100,000 units vesting over 5 years.  Fair market value is now estimated at $0.50 per unit which would be Tom’s strike price.

            Bates is anxious for Tom to start.  Bates particularly wants her to attend a big trade show for Microscopic in Chicago sponsored by Alex Blue, showcasing Microscopic among Blue software clients.  As Tom packs for Chicago, she does have some concerns about uprooting her family and sale of her home purchased at the height of the market.  She is also concerned about recent sales results, reception of Microscopic’s latest product offering, and some articles in trade literature mentioning Bates’ frustration and listing Microscopic as a potential takeover target for others in the footnotes market.  But Tom is unsure of her position with Zen, now part of BBM, she likes the challenge, and with more information she thinks she can help Microscopic’s market position.

            Tom just gave her current boss BBM’s Gertner Louis, notice of her plans.  She never had an employment contract before, and it occurs to her, she ought to have someone look over the “term sheet”.  Gyl e-mailed and asked her to sign and return.  Hence, on a friend’s referral, we have received Tom’s car phone call on the way to the airport. 

BEYOND THE HANDSHAKE . . .

IS AN EMPLOYMENT CONTRACT

REALLY  NECESSARY?

QUESTIONS OF THE EXECUTIVE:

¨     When does asking for a contract make the most sense?

¨     How and When to ask for a contract if not offered?

¨     Will raising this now kill the job offer?

¨     How and When to uses a lawyer or advisor?
(Won’t a Lawyer kill the deal for sure?

¨     Who negotiates and how does it proceed?

¨     What documents are involved?

¨     What will this cost?

¨     What if the Company won’t change anything?

QUESTIONS OF THE COMPANY:

¨     When does offering a contract help the Company?

¨     Will a contract open the company to liability?
(Isn’t at-will employment best for all?)

¨     Will a contract’s terms cause Company problems -
with Existing Employees? . . . with Investors?

Besides Compensation . . . Other Key Terms in Negotiating Executive Employment Contracts

«Position, Platform and Launching Pad

1.      Title and Position; Reporting

2.      Board of Directors Membership

3.      Duties and Responsibilities

4.      Support; Budget

5.      Outside Affiliations

6.        Term of Agreement

7.        Renewals; Exit (“rip-cord”)

«Relocation and Expense Reimbursement

1.      Temporary Living and Travel

2.      Permanent Relocation

3.      Tax Gross-Up

4.      Business and Professional Expenses

5.      Licenses, memberships

6.      Other costs including contract costs

«Termination and Severance

1.      Early Termination by act of Company

2.      Early Termination by act of Executive

3.      Cause, Cure, Notice

4.      Severance – relation to surviving covenants

«Change of Control

1.      Form and Amount of Benefits

2.      Parachute Exceptions, Caps, Tax gross-up 

«Non-Competes and Restrictive Covenants

1.      NDA/Confidentiality Agreements

2.      Assignments of New Inventions

3.      Non-Solicitation

4.      Non-compete

«Good Vibrations

     1.      Good Contract can be very valuable, but it does not itself make a good job, nor is it a substitute for good intelligence.

     2.      If your informants and gut tell you it’s a winner be prepared to concede on contact issues.

HOW DO WE STRUCTURE EXECUTIVE

CASH AND EQUITY COMPENSATION

AS A WIN-WIN FOR  BOTH  SIDES?

QUESTIONS OF THE EXECUTIVE:

¨     The Big Boys get signing bonuses – can you get one here?  Can you justify a large salary increase as well?

¨     If you want to avoid taxes, how do you structure deferred salary to avoid the tax hit and still get paid?

¨     How do you protect your bonus and assure it is paid?

¨     When does taking equity as your pay make the most sense?

¨     What types of stock or options can the company offer?�
What’s the value?  How is this equity taxed?

¨     How do you avoid dilution?  What other structuring issues do you need to protect your equity stake?

QUESTIONS OF THE COMPANY:

¨     When is a Company smart to offer equity or bonus pay?

¨     Can this equity be paid based on performance? or loyalty?
Can we measure performance? how much stock to give?

¨     What if things don’t work out:  Can we get the stock back?
What if Executive dies? Quits? What if we sell the Company?

¨     Will giving stock now hurt us later? in seeking financing?
in morale with current staff? in recruiting new talent?

«Cash Compensation

      1.      Signing Bonus

• Evidence Commitment by Employer
• Replace lost benefits (golden key)
• Payable in Cash, Equity, Other

      2.      Base Salary

      3.      Deferred Compensation

• Funded or Unfunded
• Convertible Debt
• Rabbi Trust or Secular Trust

     4.      Bonus Income

• Guaranteed or Discretionary
• Performance Based

«Fringe Benefits

      1.      Medical, Dental and Health Benefits

      2.      401(k), Pension, Profit Sharing Plans

      3.      Life and Disability Insurance

      4.      Vacation, leave; Company Perquisites

«Equity Incentives:  Based on Tax Structuring

     1.      Restricted Stock Purchase Plan

• IRC §83(b) Election

     2.      Stock Option – Qualified (§422) ISO

     3.      Stock Option – Non-Qualified

     4.      Equity Based Compensation Plans

• Phantom Stock & Stock Apprec. Rts (SAR)
• IRC 409A compliance

«Key Terms in Executive Equity Negotiations

     1.      Vesting and Change of Control

     2.      Valuation and Anti-dilution

     3.      Stock Option Terms and Exercise

     4.      Purchase Terms and Covenants

     5.      Transfer Restrictions & Shareholder Agreements  

Negotiating Severance and The Separation Agreement

1. 1.   Severance Pay and Benefits

• Amounts and timing
• Allocations to Emotional Distress, Attorneys fees and medical expenses to save taxes
• Payments for attorneys fees, outplacement and other specific costs to enhance severance
• Medical coverage
• Other Employee Benefits
• Duration of severance

1. 2.   Job Search and reputation

• Outplacement
• Office Space
• Inquiries from contacts and potential employers
• References
• Confidentiality
• Mutual non-disparagement

1. 3.   Releases

• Mutual release
• Legal rights
• Rights to enforce settlement

1. 4.    Enforcement
2. 5.   Cooperation

ABOUT THE SPEAKER AND PRESENTATION . . .

These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801 Boston, MA 02110, (617) 951-9980, fax (617) 951-0048. His e-mail is radelson@engelschultz.com .  Mr. Adelson is a graduate of Boston University, Phi Beta Kappa, Northwestern University Law School in Chicago where he was a member of the Law Review, and New York University with an LL.M. in Taxation.  He is a member of the Massachusetts, New York and U.S. Tax Court Bars.

Robert Adelson began his career in 1977 as an associate at major New York City firms before returning home to Boston in 1985 where he’s been a partner in smaller firms, joining his present firm as senior business attorney in 2004. Mr. Adelson is   specialized in corporate, tax, employment, commercial contracting and intellectual property law.  He frequently represents employees and executives negotiating their employment terms, stock, options, relocation, non-competes, termination and separation agreements.  He also represents startup and smaller companies in software, medical device and other technology-based fields, independent consultants with compensation and stockholder arrangements, incorporation and liability protection, intellectual property protection, and in vendor, client and subcontractor contracting arrangements.

Mr. Adelson’s  law firm, Engel & Schultz, LLP, has 6 attorneys based in Boston.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in family, probate, real estate and litigation matters. 

            Mr. Adelson is a frequent speaker at business forums and Chairman of IEEE Boston Entrepreneurs Network www.boston-enet.org .  Further information on Mr. Adelson’s background and his past published articles is available at his law firm website.  To view articles, see http://www.engelschultz.com/index.php/category/publications/  or http://robadelson.wordpress.com/

The speaker wishes to thank Marg Balcom for the invitation to speak on the topic of “Negotiating Compensation and Employment Contracts” for the Boston Chapter of ExecuNet at Dedham Community Center, Dedham, Massachusetts, on April 12, 2010.

The example on page 2 is hypothetical and fictitious but the questions on page 3 and 6 are drawn from actual client questions.  The purpose of the example and materials, as developed by Robert Adelson, is solely to illustrate planning concepts and stimulate meeting discussion.  The purpose of the remainder of these materials is to illustrate and offer rough outlines of broad areas of corporate, tax, contracts and business law which affect executive employment contracts, stock and compensation in high technology and more traditional fields.  Thus, it is hoped these materials will be informative to those in attendance.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case. 

Copyright (c) 2010  Robert A. Adelson.  All rights reserved.

¨   Developing Custom Software

¨   Licensing Technology

¨   Distribution of Products

¨   Subcontracting other Consultants

By Robert A. Adelson

EXAMPLE (Hypothetical and Fictitious)

DreamSoft Consultants – Making Effective Contracts

Suppliers (Buying)                       DREAMSOFT                   Customers (Selling)

                                                          CONSULTANT

-Service Subcontractor                                                           Licensg/ Software Dev

                                                            Waltham, MA

-Equipment Vendor                  Cambridge, MA                VAR/ Distributor
                                                               

                                          The Team (Producing) – “Partners”        

Stephanie “Steve” Sprielberg formed DreamSoft Consultants several years ago and now has offices in Waltham and Cambridge.  Her software work has picked up lately and contracts questions have arisen. 

To help work flow Sprielberg hired subcontractor Ford Harrison full time, but recently Sprielberg worries Ford might get a fulltime job with one of Ford’s top customers MCA or work for Sprielberg’s rival Georgia Lucas.  Fortunately, Sprielberg got Ford to sign an NDA when he started, but Ford still says he can use what he knows however he wants.  Dreamsoft cash flow problems also worsen their relations.

However, at least Ford does a good job. Sprielberg though is angry about poor performing AI and Minority Report equipment and a threatened infringement suit over the Coming to America program-all bought from shrewd vendor Tomasina Cruz.  Problems have harmed Dreamsoft’s output and reputation.  Tom offers to repair or replace defects or refund part of the purchase price paid, but…“Only if the fault isn’t from your misuse!  Read your PO, Steve: it’s in BOLD face!”

Besides Cruz, Sprielberg has problems with the ever changing demands of MCA as DreamSoft develops Sprielberg’s Indy Jones4, adding first the Connery and now the Flockhart applications, claiming each covered by the original deal.  Dreamsoft is paid against acceptance and MCA is a tough tester, and even threatens to make the changes needed itself (taking the source code from escrow) if Steve can’t meet deadline.

There are also problems with DreamSoft’s longstanding royalties from Jurassic PK program Sprielberg gave over to VAR Jackie Valenti years ago.  Jackie gets 80% on her sales but she doesn’t sell or market much. Per their old handshake deal, the split is 50/50 on royalties from big reseller Paramout Jackie lined up but she threatens to pay Dreamsoft 20% if there’s not renewal of her contract (ends 3 years). Steve wants it over now.

One place Sprielberg is glad she has no contract is with her new “sort of” partner.  Sprielberg talked with Jessie Katzenbarg who had a lucrative job with DizkneeSoft.   Boss CEO Michelle Estner fired Jessie, who never saw her office again.  Despite other offers, a 50-50 partnership with Sprielberg attracted Jessie.  She put time and money into the Cambridge office, neglected since Sprielberg’s last partner Dave Griffin left (who programmed much of pioneer ET and Jaws programs still lucrative to Dreamsoft but Sprielberg dismisses his “work for hire” since nothing formal was signed).  Now, Jessie’s drive, cash and contacts revived Cambridge and Sprielberg is glad they signed nothing.  “OK Jess”, she recently said “I’ll get the lawyers to finish a buy-in for you.  You’ve been doing great managing Cambridge – keep it up.”  Jessie bristles being called a manager since she left Dizknee to be partner not employee, but Sprielberg is happy keeping it oral so if Jess makes trouble, she’ll fire her too.

Sprielberg’s lawyer charged plenty for a “draft” LLC and handled her divorce from hubbie Griffin.   Steve seeks an IP lawyer who knows contracts to: put off/fire Jessie, stop Ford’s poaching, get damages from Cruz, better terms with MCA & speedy end with Valenti.  She’s now arrived at Rob Adelson’s office.

What should I be looking for in my contracts?

What makes for a good and valid contract?

…And Other Questions to ask along with finally –

When is a good time to ask Rob Adelson’s help?

1. What makes a contract enforceable? Do I need a signature? Can we use fax or e-mail?  Can we use click-though?
2. Are there times when I don’t want the contract to be enforceable? What should I say or do so not to be bound?  Can an oral contract bind me?
3. What makes a good contract?  What are you setting out to accomplish? Are you planning ahead?  Are you relying upon any special facts or circumstances to occur? Was there something said you rely on?
4. Are you hiring a subcontractor? Is he or she 1099 or W2? Full-time or part-time?  Who controls the work?  Is risk of payment shared?  Is the project “work for hire”? Are you concerned about contractor “poaching” clients?
5. Are you buying or selling equipment or products?  What warranties offered on quality, service or performance? Against IP infringement?  Remedies?
6. What are your compensation terms? Are you paid by hourly/day or the job?  Do you get an advance/retainer?  Are you paid/reimbursed expenses?  Are non-cash considerations used? Do you get equity or debt?  On what terms?
7. Are you hiring or offering services?  What warranties exist on experience, standards compliance?  Reports, deliverables? What restrictive covenants – confidentiality? nonsolicitation? Noncompete?  Scope and Considerations?
8. Are you doing software development?  Who owns IP? What specifications what payment milestones, what protections against changes asked?
9. Do you have a VAR/ Rep/ Distributor agreement? Is it exclusive? What territories, applications are covered? Royalties determination? What Quotas and what obligations, stocking, customer service? Rights on termination?

MAKING A VALID CONTRACT

►What makes them unenforceable?

• Parties / Subject Matter
• Consideration
• Completion / Finality
• Mutual Assent – normally signed assent
• Electronic Agreement / Elements for valid E-contracts

►When to leave things unenforceable?

• Due Diligence in process
• Playing the field / Other offers in process
• Need based on other factors – Hedge bets, see what happens
• Financing and other contingencies

►Can Oral contracts be enforced too?

• Enforceable elements (see above) need to be met orally
• Party seeking enforcement acts in Reliance upon oral contract
• Doctrine of Implied Contract despite absence of signed document
• Party denying enforcement has received benefits from oral deal
• Doctrine of Unjust Enrichment to force disgorgement of profits

MAKING A GOOD CONTRACT

►Mission – Define mission, Cover the scope of contract

• What do you want to accomplish now? In next several years?
• What else is effected by this service or product

►Conditions – State Variables, Contingencies to performance

• What assumptions are made that would cause a back-out or change deal?
• Hedging your bet on things turning out as you expect & need them to occur

MAKING GOOD ON CONTRACT  (Continued)

►Reliance – State Warranties/representations made each side

• Has there been “touting” some aspect or quality of product or service
• Was there reliance so that if it did not occur you would not have agreed

►Consideration – What each contributes regardless of form 

• What are the motives for this deal – How are you being paid
• Cash – if so what payment terms?  Equity – recite all terms of equity
• Non-cash considerations?  Technology Back-license? Contacts?  Experience?

►Mutuality -  Requiring each party to contract to “ante up”

• The considerations by both parties need to be recited
• These need to be real considerations – new things each offers to other

►Commitment  – Mutual vulnerability & Remedies to default

• Bargaining positions dictate vulnerability in timing of contributions
• Clarity in conditions, contingencies – penalties for breach /failure to close 
• Rights on termination of agreement including surviving covenants

SEEKING GOOD CONTRACT VALUE

►How to cut legal costs to enforce the contract

• Greater the uncertainty – greater litigation risks
• Legal $$ upfront for clear contract save $$$$ in dispute /litigation  

►When should I seek Rob Adelson’s help?

• When you think you have a deal – that terms important to you covered
• Do a businessman’s term sheet – what you think you agree on
• State non-binding – Each side to review – Attorney draft binding contract

Production/ Supply Contracts /Purchase Orders 

1.      Battle of Forms: Buyer PO, Seller Invoice, UCC
2.       Price: changes, adjustments
3.       Payment and Credit Terms
4.       Conditional sales, security interest
5.       Delivery, Orders, Risk of Loss
6.       Second Source v. Requirements contract: Notice of Delay; Right to cover; Ramp-Up; forecasts
7.       Inspection; Acceptance; Repair
8.       Warranties: Copyright/ IP infringement, legal compliance, express or implied product warranties, damages
9.       Liabilities, Remedies and Damages: Incidental (mitigation), Consequential loss, period of time to seek damages
10. Term; termination; Return Buyer’s Property:Information, trade secrets
11. Miscellaneous: Assignment, change orders, integration, arbitration, attorney fees, jurisdiction

Subcontractor / Service Provider Agreements 

1.      Specific Duties: Ongoing Responsibilities,  Particular job, assignment, work excluded
2.       Independent contractor status
3.       Reports and Deliverables: reporting function
4.       Fees/ Compensation: periodic (hr. wk., mo.) Cost plus overhead, project milestone payments
5.       Personnel/ Staffing: qualifications, requirements
6.       Manner of Performance: legal reqs., standards
7.       Ownership of Proprietary Rights: copyrights, work for hire, inventions, new and existing trade sec.
8.       Insurance Coverage/ Independent Contractor
9.       Warranties etc.: Copyright/ IP infringement compliance with law; Express or implied product warranties; Incidental or consequential damages
10. Term; Termination; short notice period; return of client information, plans, materials
11. Confidentiality: proprietary info., exceptions
12. Surviving Restrictive Covenants: No assignments for competitors, no solicitation of client’s customers, no hiring of service provider personnel      

Software Development Agreements

1.     Design Specifications: Function, Response Time, Platform, system compatibility
2.     Deliverables: Code, documentation, components, reports/ tests
3.     Schedule and Performance Milestones
4.     Payment: periodic, cost +, milestone
5.     Ownership of IP Proprietary Rights
6.     Facilities and Cooperation
7.     Files Conversion: Training and Installation Support    
8.     Acceptance and Testing
9.     Warranties etc.: no (known) copyright infringement, compliance with law, regulatory standards, no express or implied product warranties, no incidental or consequential damages
10. Indemnity on infringement
11. Maintenance after Initial Warranty
12. Source Code Escrow
13. Term; Termination; short notice period; return of client information, plans materials
14. Confidentiality: proprietary info., exceptions
15. Surviving Restrictive Covenants: No assignments for competitors, no hiring of service provider personnel
16. Miscellaneous: assignment, subcontracting work, force majeure
17. Other User Issues: Progress reports, response time warranties, staffing, most favored customer

Dealer and Distributor Agreements

1. Territory: Customers, market, geographic division
2. Exclusive or Non-Exclusive
3. Relationship/ Statutory Requirements
4. Sales levels: Minimum, inventory, staffing, best efforts, loss of exclusivity
5. Pricing: Discounts, volume discounts
6. Credit terms
7. Product Availability and Allocation
8. Parts, Supplies, Service
9. Marketing and Promotional Arrangements
10. Order Entry
11. Sales Contract Terms (same issues PO p.5 above)
12. Termination: Supplier Rights: Selling existing inventory , successor buy back
13. Termination: Return Buyer’s Property: information, trade secrets, tools, equipment, materials, no use of trademarks
14. Miscellaneous: Assignment, change orders, integration, arbitration, attorney fees, jurisdiction

Sales Representative Agreements

1. Alternative to direct sales – customized svcs/products
2. Installation, training and other services
3. Paid on commission or discount basis (if stocking rep) Not Agent, no authority to act for supplier

Value Added Reseller Agreements

1. Scope of License
2. Pricing and Payment Terms
3. Value Added contributions
4. Exclusivity; multiple channel issues
5. Product delivery; Source code
6. Protections of Proprietary Rights
7. Non-competition
8. Termination, Warranties and Other standard Supplier/Distributor issue

 Product Licensing

1. Types: Use Manufacture, Distribution, Trademarks, Licenses, OEM, VAR Agreements
2. License Terms
   1. Grant, Field of Use, Exclusivity
   2. Improvement, Back Licenses
   3. Royalties and Audit Reports
   4. Intellectual Property Protection
   5. Warranties, Liabilities, Expert Controls
3. Software Licensing Issues
   1. Source Code, Object Code, Escrows
   2. Manufacture limitations, Modifications
   3. Shrinkwrap, Clickwrap licenses, Enhancements 

ABOUT THE SPEAKER AND PRESENTATION

                 These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801, Boston, MA 02110, (617) 951-9980, fax: (617) 951-0048, e-mail: radelson@engelschultz.com

            Mr. Adelson is a graduate of Boston University, Phi Beta Kappa, and Northwestern University Law School in Chicago where he was a member of Law Review. He has an LL.M. degree in Taxation from New York University, and is a member of the Massachusetts, New York and U.S. Tax Court Bars.  He began his legal career in 1977 as an associate at major New York City law firms, first Dewey Ballantine and later Weil Gotshal & Manges, before returning home to Massachusetts in 1985, where he has been a partner at several Boston firms before joining his present firm as senior business law partner in 2004.

            Mr. Adelson is specialized in corporate, taxation, business and technology transactions.  In those areas, he frequently represents (1) small companies with their various business needs, including shareholder and employee issues, financing, commercial contracts, intellectual property, joint ventures, mergers and acquisitions, succession planning (2) senior executives, in negotiations over severance, employment, relocation, stock options, compensation and stockholder arrangements, and  (3) consultants – in liability protection, intellectual property protection, trade identification, vendor, client and subcontractor arrangements.

            Mr. Adelson’s firm, Engel & Schultz, LLP, is a small but broad service law firm of 6 attorneys in Boston’s Financial District.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in family, probate, real estate and litigation matters. 

            Mr. Adelson is a frequent speaker at business forums and Chairman of IEEE Boston Entrepreneurs Network www.boston-enet.org .  Further information on Mr. Adelson’s background and his past published articles is available at his law firm website.  To view many of Mr. Adelson’s past articles, see http://www.engelschultz.com/index.php/category/publications/  or http://robadelson.wordpress.com/

The speaker thanks Kenneth Glasser for the invitation to speak for APICS – The Educational Society for Resource Management, North Shore Chapter on the topic of “Making Good Contracts: To Advance Organizational Success in a Changing and Competitive Marketplace” at the Bickford’s Grille, Woburn, Massachusetts on April 13, 2010.   

The example on page 1 of these Materials are hypothetical and fictitious although the questions on page 2 are drawn from actual client questions.  The purpose of the example is solely to illustrate contracts issues, strategy and planning concepts and stimulate meeting discussion.  The remainder of these materials are to offer rough outlines of broad areas of major contracting situations for technology based business. It is hoped that these materials will inform discussion and be useful reminder of topics covered for the attendees.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case.

Copyright (c) 2010 Robert A. Adelson.  All rights reserved.