Engel & Schultz, LLP

Getting Paid In Stock, Options Or Promissory Notes: Negotiating Terms of Non-cash Payment for Consulting

admin — Fri, 04 Jun 2010 15:48:41 +0000

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.

Negotiating Compensation, Employment and Severance Contracts

admin — Fri, 04 Jun 2010 15:24:00 +0000

Ø Is an Employment Contract Necessary?

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. 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

2. Job Search and reputation

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

3. Releases

Mutual release
Legal rights
Rights to enforce settlement

4. Enforcement
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.

Making Effective Contracts: To Advance Organizational Success in a Changing Competitive Marketplace

admin — Tue, 13 Apr 2010 16:18:36 +0000

¨ Selling Products or Services

¨ 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?

What makes a contract enforceable? Do I need a signature? Can we use fax or e-mail? Can we use click-though?
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?
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?
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?
Are you buying or selling equipment or products? What warranties offered on quality, service or performance? Against IP infringement? Remedies?
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?
Are you hiring or offering services? What warranties exist on experience, standards compliance? Reports, deliverables? What restrictive covenants – confidentiality? nonsolicitation? Noncompete? Scope and Considerations?
Are you doing software development? Who owns IP? What specifications what payment milestones, what protections against changes asked?
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

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

Subcontractor / Service Provider Agreements

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

Software Development Agreements

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

Dealer and Distributor Agreements

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

Sales Representative Agreements

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

Value Added Reseller Agreements

Scope of License
Pricing and Payment Terms
Value Added contributions
Exclusivity; multiple channel issues
Product delivery; Source code
Protections of Proprietary Rights
Non-competition
Termination, Warranties and Other standard Supplier/Distributor issue

Product Licensing

Types: Use Manufacture, Distribution, Trademarks, Licenses, OEM, VAR Agreements
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
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.

How To Maximize Your Return, As Owner, From Your Business

admin — Fri, 02 Apr 2010 17:39:01 +0000

How To Maximize Your Return, As Owner, From Your Business:

Techniques to allow owners of S and C Corporations to take profits out of the business for owner’s benefit; Merits of S and C Corporations and Change from C to S Corporation

By Robert A. Adelson, Esq.

1. Taking Money out of S Corporation

S Corp Distributions in lieu of CEO Salary

i. Single level taxation

ii. S Corp dividends not self-employmt earnings

iii. Avoidance of 15.3% payroll taxes

iv. IRS can re-characterize dividends

v. 9 Factors on reasonable compensation

vi. Cases and Treasury Study

vii. Documents to support determination and reasonableness

Pass-through gains on asset sales
Pass-through losses

2. Taking money out of C Corporation

Maximize salary/bonus compensation

i. Avoid double taxation of large profits (though not so severe)

ii. Same issues on unreasonable compensation

Pay dividends, if profit is small or retained

i. Utilize skinny graduation of Corp . rates

ii. Utilize retained earnings to payout dividends at current low capital gains rates

3. Taking money out of both S & C Corporations

Income splitting with family members

i. Utilize their low tax brackets

ii. Limited by Kiddie tax

Lease of business assets to corporation
Coordinate andmaximize entertainment, travel and conference expenses
Vehicle, home office and equipment reimbursement
Age weighted profit sharing plans
Other Employee Benefit or Fringe Benefits plans
Thinning new corporation by use of debt and corporate loans to owner
Stock redemptions of owners
Employee stock ownership plans
Tax free separations and divisions of the business
Charitable trusts on sale of stock

4. Avoidance Constructive Dividends Red Flags in Audits

Payment of benefits to owners
Payment of debts, personal expenses of owners
Bargain sales of property to owner
Bargain use of company property
IRS determined unreasonable compensation

5. Which is better: S Corp or C Corp?

Merits of S Corporation

i. Single level of taxation

ii. Pass through of tax gains/losses

iii. No accumulated earnings tax

iv. Avoidance pay roll tax

v. Single level tax on sale on liquidation of business

vi. Ability to allow future acquirer a favorable Section 338(h)(10) election

Merits of C Corporation

i. Accumulation of income without immediate shareholder tax

ii. Ability to have complex capital structure (i.e. preferred stock)

iii. Ability to have foreign shareholders

iv. Ability to be a public company (i.e. unlimited number of shareholders)

v. Ability to use fiscal year

vi. Ability to use Section 1202 stock

6. Change from C to S Corporation

BIG – Built In Gain Rule

i. Asset sales – tax gains on corporate level for 10 years after change

ii. Taxed at highest corporate rate

iii. Need for valuation in connection with change

LIFO inventory recapture tax
Excess Net Passive income tax

i. If accumulated E &P

ii. Over 25% gross receipts passive income

iii. Loss of S election if 3 consecutive years

About The Speaker

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, commericial 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 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 Bonnie Gorbaty for the invitation to speak to the CEO Forum program of The Commonwealth Institute on the topic of “How To Maximize Your Return, As Owner, From Your Business”, at the offices of corporate sponsor Citizen Bank, 53 State Street, Boston, MA, March 10, 2010.

Business Formation and Early Stage Tax and Legal Issues

admin — Wed, 03 Mar 2010 17:43:02 +0000

¨ Liability Risks and Protections in Business

¨ Choice of Entity – Tax /State law Structures

¨ Patents, Trademarks & Proprietary Rights

¨ Contracting for Employees, Subcontractors

¨ Product, Sales and Finance Arrangements

¨ Nonprofit Corps – Organization, Tax Status

By Robert A. Adelson, Esq.

EXAMPLE (Hypothetical and Fictitious)

FREEDOM TRAIL TECHNOLOGIES – ENTITY CHOICE /OTHER ISSUES

FREEDOM TRAIL TECHNOLOGIES

Waltham, MA

Founded 2008

Founders Financials

Paid in

P. Revere, d, Pres 10,000 P/L (FY 09 -Projected)*

J. Adams, d, VP/Sec 10,000 Revenue 500 Expenses 500

H. Knox, d,Treas 10,000 Balance Sheet (12/31/09)*

J. Hancock, director [10,000] Assets Liabilities

P. Henry – employee A/R, Equip, A/P, Loans – 275

F. Marion – employee Cash, Other Shareholders

T. Paine – employee Equity 40

Total – 8 – 6 employees 300 Accum Deficit (15)

2 contractors (*,ooo omitted)

Freedom Trail Technologies was founded in 2008 by techies P. Revere, J. Adams, and H. Knox, three former employees of giant Bay Colony Scientific Inc. Each contributed cash, equipment and know-how, and Knox also advanced additional funds as needed to fund the company. So far, most of revenues come from consulting often work bundled into big projects. The economy hasn’t helped. Lots of work they thought they’d get didn’t come in. They’ve retooled. They’ve lost assignments because they aren’t incorporated and had some collection problems. Most of the clients have been satisfied but there are two problem accounts which raise some concern with the founders. Though no suit has been filed, Knox is concerned about protecting his new home “Ft. Knox” in Weston. In any case, the group wants to spend more time developing e-Revolution™ a new product they feel can make an impact in B2B e-commerce.

A colleague of Revere, J. Hancock who led Tea Party Inc. and other successful companies in the past, has likewise expressed desire to see the group spend more time in development and has said he’d like to invest $10,000 to match contributions by the founders. Besides his own willingness to invest, Hancock introduced Revere to A. Hamilton the wealthy managing partner of Below-Zero Stage Investments, a Cambridge-based VC fund. Hancock also suggests meeting M. Gandhi, a US resident with key contacts in Banglapore India (Gandhi, Nehru & Mountbatten). Hancock says she may be helpful raising funds off-shore (and Revere thinks… in providing additional programmers if and as needed.)

In the meantime, Adams has interested G. Washington, CEO of First-In-War Co. a nationally known VAR out of Arlington, VA, in e-Revolution™, so much so that Washington asked for detailed product specifications, information on where it’s been marketed, revenues and prospects to this point. Adams is gathering information to send Washington who just sent his 20-page standard Exclusive License. Revere likes FIWC. It’s marketed other e-products and is well known, so he’s tempted to sign.

Both Adams and Knox have pushed Revere to form a corporation or LLC for financing reasons. He just wants to get the work out. Unfortunately, that’s gotten harder of late since B. Arnold, a valued employee since launch, quit FTT recently and joined the competition. Arnold felt he wasn’t appreciated enough. Meanwhile, other recruits, P. Henry, F. Marion & T. Paine have also asked for equity. Revere particularly doesn’t want to lose Patti or Frances or even vociferous Tom. Time has been short since the move to a bigger space in Waltham. However, the founders have decided it’s time to attend to paper work – to consider some form of business “entity”, whether to sign the VAR contract, whether to get a costly patent of e-Revolution and other “legal stuff”. Time and money are short. What will we recommend?

IS IT REALLY NECESSARY

TO INCORPORATE?

… and Other Questions to help you tell -

Is a Corporation the best choice for me?

¨ What are your motives? What are your goals and objectives in choosing an entity (new entity) under which to conduct business?

¨ Have you lost business because of concern over lack of incorporation, “continuity of existence” or lack of commitment to the enterprise?

¨ Are you selling products or services now? What potential liabilities do you face? Were you sued? What assets do you want to protect?

¨ Does your business have sufficient capital? Have you borrowed? offered loan guarantees? collateral? What are your expected capital needs in the near future? expected capital sources? Is any offshore?

¨ Is your business capital intensive? Does it involve substantial investment in real estate, oil, gas, cattle or other investment assets?

¨ Do you expect to encounter substantial losses? Is immediate pass-through of losses or differential pass-thru to investors important?

¨ Is your business people intensive? Is employee and executive recruitment important? Do you want to offer equity incentives?

¨ Is your business family held? Do you seek to keep in the family ownership? Management? What other family goals are sought?

¨ Are you a life-style company? If not, what is your exit or harvest strategy? Is planning for that important to you now?

¨ Do you have important concerns over timing /fiscal year? Cash basis vs. Accrual accounting? Fringe benefits? Deduction of expenses?

STATE LAW CHOICES OF BUSINESS ENTITY

(MASS. STATE LAW)

Organizational Legal Structures	Limited Liability	State Filing	State Tax
1) Sole Proprietorship	–	–	–

2) Partnership
►General	–	–	–
►Limited	GP— LP√	√	No ann Fee after orig filing
►Limited Liability Partnership (“LLP”)	√	√	ann.Fee $500/yr

3) Limited Liability Company (“LLC”)	√	√	ann. Fee $500/yr

4) Corporation (for Profit)
►Business or Professional	√ √	√ √	√ √
►Domestic or Foreign (Del.)	√ √	√ √	√ √
- ► “C Corporation”	√	√	√
► “S Corporation”	√	√	Minimum Frchise Tax $456/yr; Tax if>$6m GrossRcpts

ADVANTAGES of Incorporation over

Partnership or Sole Proprietorship

1) Limited Liability (without insurance)

exceptions: professional malpractice
limited partnership/LLC and LLP also provide limited liability
Single member limited liability in corp.

2) Ease of Transfer of Interests & Financing

Sale Securities/IPOs
Potential ease in liquidity to investors
Debt Financing – lender confidence however, personal guarantees may still be required

3) Continuity of Enterprise

Sale confidence, credibility in business dealings
Familiarity of corporations,
Rules established by case precedent & Structure to dealings
Security of structure and rights to employee recruits
Security of structure to strategic allies

DISADVANTAGES of Incorporation

1) Complexity and Paperwork

Organizational documents,
Minutes, annual meetings, notices, upkeep . . .
Tax returns, bank accounts, separate financial records
Corporate form – operating in corporate form

2) Cost

Professional Fees, Accts. Lawyers
State Taxes, Filing fees, Ann Reports
Separate Capital maintained for corporation/ no shell

3) Taxes

Profits and Capital Apprec. potentially Taxed Twice

- exceptions: S Corps and many offsetting issues (see Taxation)

TAXATION OF BUSINESS ENTERPRISE

Merits of Structure Entity Tax Issues	C Corp	S Corp	Pship	LLC
Second Level Tax	Yes	Mainly No	No	No
Profits over $50,000 Profits under $50,000	Bad Good	OK OK	OK OK	OK OK
Personal Service Co.	Bad	OK	OK	OK
Corp AMT	Bad	N/A	N/A	N/A
Accum Erngs Tax	Bad	N/A	N/A	N/A
Pers Holdg Co Tax	Bad	N/A	N/A	N/A
Pass Thru Losses Loss Carryovers	Bad Good	OK OK	Good OK	Good OK
Sale on Liquidation Assets sale	Bad	OK	Good	Good
Sale of Stock	OK	OK	OK	OK
Sale of §1202 Stock held 5 years Rollover on shares sale	Good Good	N/A N/A	N/A N/A	N/A N/A
Flexibility in Allocating income, loss, expense	Bad	OK	Good	Good
Social security taxes	OK	Good	Bad	Bad
Cash Method	Bad if > $5mil rev	Good	Good	Good
Fiscal Year	Good	N/A	N/A	N/A
Interest expense for auto, other bus. Items	Good	N/A	N/A	N/A

PATENTS, TRADEMARKS AND

PROPRIETARY PROTECTION

Patent - Strongest protection for proprietary technology but also hardest to attain

Subjects: Process, Machine, Manufacture of Composition, but not naturally occurring.
Patentable Only if New, Useful, Unobvious
Time Bars: U.S.: 1-Year from invention;Foreign: 1-Year from US filing if not disclosed
Prior Art@ search on novelty, publication
Patent Application required with US PTO, Claims (coverage)Review, approval or appeal
Inventorship, Documentation, Ownership

Advantages – Limited Monopoly, covers Ideas, upheld against innocent users, reengineering

Disadvantages – High Threshold to achieve, cost, time, claims may be limited/circumvented. Policing

Copyright - protection for expression, against reproduction of proprietary matter, easier to attain

Subjects: Original works of Authorship, Fixed and Tangible medium or expression
Copyright Coverage? Only if Expression, Reproduction or Derivative of the same Does not cover Ideas or concepts
Registration, deposit with Copyright Office, Notice (c Name Year) useful, not required

Advantages – Long Duration, low cost/threshold

Disadvantages – Not protect ideas, only copying, not against independent devlpt or innocent use

Trademark - word or symbol describing product or service protection available with use in commerce

Mark cannot be descriptive or generic Prior search advisable
“Likelihood of Confusion” test for registration or infringement
Common Law marks or Federal or State registration,
Proof of use in commerce (state or interstate) normally required in one or more of 42 international classes of goods or services
Federal filing allowed with Intent To Use in 6 months (extendable)
U.S. Priority based on First Use (or ITU filing date), Federal filing establishes use in all 50 states
Foreign priority generally based on 1^st to file; Paris convention Federal filing date gives 6 month window to foreign filing
Use of Ô (state or common law) or Ò (federal), other protections Affidavit of Use required after 5 years

Trade Secret – Broadest subject matter. Protection for business Competitive advantages, easy to gain, difficult to maintain

Covers: Information used in trade or business Giving advantage over Competition, and not generally known Can include customer lists, market info, sources of supply, as well as new inventions
Applies based on nature of secret, action to preserve it, no formal filing
Must show value or cost in development
Must show reasonable efforts to preserve

–Internal security – employee confidentiality

–External security – plant / computer security

–Document control, visitor non-disclosure agmts

Not lost due to disclosure in violation of confidentiality agreement; however, gives no protection against independent discovery

CONTRACTS FOR EMPLOYEES AND SUBCONTRACTORS

Employment Agreements – Executives and key Employee contacts

1. Founder and Key Employees, both for loyalty and to secure key human assets

2. Duties, Outside Affiliations, Board Control

3. Salary Compensation, Benefits

4. Confidentiality, New Inventions, Non-compete and restrictive covenants

Employee Manual – Employment terms of other salaried employees

Company policies including Confidentiality

Service Contacts – independent contractor

1. Description of Services, milestones, reports

2. Fees, flat, formula, segment; Expenses

3. Warranties, indemnification, Confidentiality, non-disclosure

4. Independent Contractor status

Cash Compensation and Benefits

Salary, Incentive Income (limited for start-up)
Deferred Compensation
Insurance/Benefits, Expense Reimbursement

Equity Incentives / Participation

Stock Purchase Plan
- Income Tax on Value over Amount pai Tax paid when no substantial risk of forfeiture,
Repurchase for Vesting / ‘83(b) Election
Attraction for 93 Tax law & 97 law rollover
Stock Option – ISO, Incentive Stk. Option Plan
- Strike price is original FMV, limits on amount, exercise
- Capital Gain on sale of stock, subject to AMT
Stock Option – Non-Qualified
- No IRC limits on strike price, terms or exercise
- Income Tax on Value over Amount paid
- Tax paid when option is exercised – ordinary tax not CapGain
Equity Based Compensation
- Phantom Stock
- Stock appreciation Rights (SARs), Tax Gross-Ups

Shareholder / Share Purchase Agreements

Founders Buy-Sell Agreement
- Goals: stabilize management, ownership provide liquidity, valuation of share
- Means: restriction on share transfer
- Involuntary transfer – death, disability, by legal process (divorce) – redemption/ cross sale
- Funded Plans – via insurance – co-sale for step-up, avoid AMT
- Voluntary Transfers – right of 1st Refusal
Employee Stock Restriction
- Company Repurchase Rights
- IRC §83 election; standoff
Investor Stock Purchase
- Warranties and Information covenants
- Registration Rights or exemption
- Tag Along and Cash-out rights

CONTRACTS FOR PRODUCTS -MANUFACTURE & MARKETING

Production Contracting Arrangements

1. Supply contracts and Purchase Orders – Battle of Forms

Delivery, Risk of Loss
Warranties: patent, copyright infringement, express of implied product warranties
Remedies and Damages

2. Payment and Credit Terms

3. Equipment Leasing

4. Service Contracts

5. Manufacturing Arrangements

Delivery, Risk of Loss

Distribution of Products or Services

1. Identification of Company=s market niche,

2. Distributor and Dealer Agreements

a. Territory, Exclusive or Non-Exclusive

b. Sales levels, Pricing, Credit Terms

c. Product, Parts, Supplies, Service

3. Sales Agent / Representative

Agreements – where customized services / products

4. Sales Contract Terms

5. Marketing and Promotional Arrangements

Product Licensing

1. Types: Use, Manufacture, Distribution, Trademarks, Licenses, OEM, VAR, Agreements

2. License Terms

a. Grant, Exclusivity Back Licenses

b. Royalties and Audit Reports

c. Intellectual Property Protection

d. Warranties, Liabilities, Expert Controls

3. Software Licensing Issues

a. Source Code, Object Code, Escrows

b. Shrinkwrap

c. Boxtop licenses, Enhancements

Strategic Technology Alliances and Joint Venture Arrangements

Alliance of type listed above, contributions, mutual benefit
Can include formation of Joint Venture partnership or LLP

CONTRACTS FOR MONEY:

Raising Capital and Securities Law Compliance

Venture Capital Finance

1. Development of Financing Strategy

2. 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

3. Valuation – from Company’s pre-money worth

4. Presentation, negotiation, commitment, then Venture Capital Due Diligence

NONPROFIT CORPORATIONS:

PLANNING

Different Purpose of Nonprofit from Business Corporation

Civic, charitable or other public purposes
Not formed for personal, pecuniary gain
Can engage in limited commercial activity but profits used for organizational purpose and not distributed for private benefit
Funding largely from contributors, grants, dues, merchandise sales, admissions

Planning for Nonprofit entity

Goals and mission statement
Nature and number of participants
Operational weeds – employees, financing
Regulating requirements
Exposure to liability
Tax considerations

NONPROFIT CORPORATIONS:

ORGANIZATION

Articles of Organization (M.G.L. Ch: 180)

Filed with Secretary of State
Nonprofit purposes: civic, educational, charitable, religious, social clubs, chambers of commerce, business league
Limiting assets to qualify purpose and other terms for tax exempt status

By-Laws

Regulation and management of corporation
Management by Board of Directors or Board of Trustees
Meetings, treasurer, elections, committees
Include or not include members

Registration with Division of Public Charities

Office of Attorney General
Before engaging in charitable work or raising funds

Annual State Filings

Filed with Secretary of State

NONPROFIT CORPORATIONS:

TAX EXEMPT STATUS

Application for Federal Tax Exemption

IRS Form 1023
Enables tax deductible contributions to corporation
If filed within 27 months of incorporation (15 months plus 12 month extension) tax exempt shares retroactive to filing date of incorporation

Annual Tax Reports

IRS Form 990

Application to Mass. Department of Revenue (DOR)

Application for Original Registration as Exempt Purchaser
Exempt for State Sales taxes

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, Massachusetts 02110, (617) 951-9980, fax: (617) 951-0048. His e-mail addresses 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 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 2000. Mr. Adelson is specialized in corporate, taxation, finance, commercial and technology contracting law. In those areas, he frequently represents startup and smaller companies in software, and other technology-based fields. He also represents executives or consultants in executive 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, 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 family, probate, real estate and litigation matters.

Mr. Adelson is a frequent speaker at business forums. Additional information on the subjects on which he speaks is shown at www.engelschultz.com/index.php/category/publications/ Further information on Mr. Adelson’s background and his past published articles is available at his law firm website www.engelschultz.com/index.php/attorneys/partners/robert-adelson/

The speaker thanks Artem Efremkin, for the invitation to speak to Young Entrepreneurs of Tufts (YET) on the topic of “Business Formation and Early Stage Tax and Legal Issues” at the YET meeting in Medford, Massachusetts, on March 3, 2010.

The examples on page 1 of these Materials are hypothetical and fictitious in their entirety (although the questions on page 2 are drawn from actual client questions). The purpose of the examples 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 choice of business entity and issues in the structure of start-up and early stage businesses including issues of finance, executive and employee recruitment, 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.

Negotiating Your Employment Agreement While on the Job

admin — Tue, 19 Jan 2010 16:29:16 +0000

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By Robert A. Adelson

1. Cash Compensation and Benefits

«Cash Compensation

Base Salary
Deferred Compensation
Bonus Income

«Fringe Benefits

Medical and Pension Benefits
Insurance coverages
Vacation, Leave, Company Prerequisites

2. Equity Incentives, Tax Benefits and Structuring

« Equity Incentives: Based on Tax Structuring

Restricted Stock, 83(b) Election
Stock Options – Qualified (ISOs), Non-Quals
Equity Based Compensation Plans
- Phantom Stock & Stock Appreciation Rights (SARs)
- IRC §409 Deferred compensation rules
LLC Capital Interest
LLC Profits Interest

« Key Terms in Executive Equity Negotiations

Vesting and Change of Control
Valuation and Anti-Dilution
Stock Option Terms and Exercise
Purchase Terms & Shareholder Agreements

3. Position, Platform, and Launching Pad

Title and Position
Duties and Support
Outside Affiliations
Terms of Agreement & Exit

4. Relocation and Expense Reimbursement

Temporary Living and Travel
Permanent Relocation
Tax Gross-Up
Business and Professional Expenses
Other costs including contract costs

5. Change of Control

Form and Amount of Benefits
IRC 280G, 4999. 409A issues
Parachute exceptions / Caps
Tax Gross-up

6. Termination and Severance

Cause, “Good Reason”, Cure, Notice
Severance – relation to surviving covenants

7. Non-Competes and Restrictive Covenants

Confidentiality & Assignments
Non-Solicitations – Customers, Employees
Non-Compete

8. Opportunities for Negotiation

When you are on the job

Changes in your Employer
Changes in your responsibilities
Achievements, establishing yourself

9. Preparing for the negotiation

Keeping records of your accomplishments
Showing how you added value to company
Independent support for your position
Bargaining tactics
Setting proper stage for negotiation

10. Understanding your Employers BATNA

(Best alternative to Negotiated Agreement)

Employer’s alternatives if you weren’t there
Are you unique – do they really need you?
What cost? How long to get replacement?
Would operations suffer – what cost to employer?

11. Knowing your own BATNA

Do you have attractive alternative options
Could you easily get better job, rate, conditions?
Would you be happier elsewhere – job evaluation
Could you go an extended period without a new job?

12. If main goal is salary increase and

Company has freeze policy,

other approaches to take

Seek non-cash benefits, items in lieu of salary
Negotiate next year’s salary or set time for review
Seek deferred compensation (if non-violative of freeze)

13. Negotiation is worth the effort

Employer rarely makes best offer – need to seek it
You appear stronger, negotiating in constructive way

14. How to Negotiate, How to succeed

Engage counsel, be prepared to negotiate from beginning
Maintain flexibility; even if you don’t at first succeed,

there may be a future occasion to “revisit” the issues

About the Presentation

1. The outline was prepared for the webinar, arranged by Taariq Lewis, for MIT Sloan CEO Network with focus on employees / executives on the job. This seminar also represents a portion and overview of the detailed seminar outline and presentation materials Robert Adelson prepared at the request and for national publication by ExecSense Webinars (formerly Reed Seminars) www.reedlogic.com/ of San Francisco, CA, a recognized leader in seminars for executives and attorneys. These materials also offer a preview of the full seminar materials.

The full seminar materials include numerous case studies, discussion of why the topic is important and how and when to negotiate, things to watch out for , pitfalls and ramifications of failing to follow suggestions made, a dozen frequently asked questions and a sample employment agreement. The materials include a 60-minute presentation by Mr. Adelson.

More information on this seminar is available by ExecSense Webinars under the title What to Know Before Negotiating Your Next Raise, Compensation Plan and/or Employment Agreement. The CD is available from ExecSense Webinars at http://www.execsense.com/details.asp?id=412

The author also welcomes executives desiring representation in the areas of employment and equity agreements, termination, severance, change of control, relocation and restrictive covenants. Contact information to reach the author, Robert Adelson is on the next page.

About the Speaker

Robert Adelson brings over thirty years of experience to his work representing executives negotiating employment agreements, compensation and equity arrangements. He began as an associate at major New York law firms Dewey Ballantine and Weil Gotshal & Manges, before returning home to Boston in 1985 where he has since been a partner in small and medium sized firms before joining his present Boston law firm in 2004. He holds degrees from Boston University, B.A., summa cum laude, Phi Beta Kappa, Northwestern University (Chicago), J.D., Law Review, New York University, LL.M. in Taxation. He is a member of the bar in Massachusetts and New York.

Robert Adelson is a frequent speaker and author of numerous published articles in the areas of employment agreements, non-competes and restrictive covenants, compensation, stock, options, phantom stock and executive equity terms and arrangements.

Robert Adelson has represented a wide range of executives: CEOs, COOs, CSOs, CTOs, CMOs, CFOs and numerous Vice Presidents, taking or changing positions in Massachusetts and across the US.

Thank you,

Robert Adelson

ROBERT A. ADELSON, ESQ.

Engel & Schultz, LLP

265 Franklin Street, Suite 1801

Boston, MA 02110

(617) 951-9980 EXT. 205

FAX: (617) 951-0048

E-mail: radelson@engelschultz.com

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

Webpages -

http://www.engelschultz.com/index.php/attorneys/partners/robert-adelson/

http://www.engelschultz.com/index.php/category/publications/

Substantal Settlement of Whistleblower and Disability Cases

admin — Thu, 19 Nov 2009 20:42:25 +0000

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Engel & Schultz announced that in the same week, it has settled two long standing employment cases. One case involved a wrongful termination of an alleged whistleblower. The second case involved the alleged failure to accommodate an individual with a physical disability. While the terms of the settlements are confidential, the defense attorney in one case described the settlement as “substantial”. In the other case, which the office had pursued for the past three years, in settlement discussions, defense counsel stated, “You were not dealt a strong hand, but you played every card right. It’s time for you to cash in your chips.” Both plaintiffs are extremely decent people, and Engel & Schultz is happy to have worked on both of their behalfs.

Brief to Massachusetts Supreme Judicial Court Successfully Arguing that Implied Warranty of Habitability Attaches to Sale of Condominium (Condo)

admin — Tue, 17 Nov 2009 21:11:22 +0000

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MASSACHUSETTS SUPREME JUDICIAL COURT

____________________

SJC – 08647

_____________________

STEPHEN BERISH, ANTHI TSAMTSOURIS, SIDNEY PARLOW, IRVING LYON AND ANGELO MASSA, TRUSTEES OF THE TRUST OF THE COTUIT BAY CONDOMINIUM,

Appellant/Cross-Appellee/Plaintiff

vs.

STUART BORNSTEIN, ET. AL.

Appellant/Cross-Appellee/Defendants

___________________________________

APPEAL FROM THE

BARNSTABLE SUPERIOR COURT

BEING HEARD ON DIRECT APPELLATE REVIEW

___________________________________

BRIEF OF APPELLANT/CROSS-APPELLEE/PLAINTIFF

STEPHEN BERISH, ANTHI TSAMTSOURIS, SIDNEY PARLOW, IRVING LYON AND ANGELO MASSA, TRUSTEES OF THE

TRUST OF THE COTUIT BAY CONDOMINIUM

____________________________________

Stephen Schultz, Esq.

BBO # 447680

Engel & Schultz, P.C.

125 High Street, Suite 2601

Boston, MA 02110

(617) 951-9980 (Tel)

(617) 951-0048 (Fax)

Table of Contents

Statement of the Issues…………………….. -1-

Statement of the Case: Nature of Case,
Course of Proceedings & Disposition Below
…………………………………….. -1-

Statement of Facts…………………………. -8-

Summary of Argument……………………….. -14-

Argument…………………………………. -17-

Conclusion……………………………….. -47-

Table of Authorities

Cases

American Tower Owners Assoc. v. CCI Mechanical, 930 P.2d 1182 (Utah 1997) -21-

Apahouser Lock & Sec. Corp. v. Carvelli, 26 Mass. App. Ct. 385 (1988) -33-

Armbruster v. Hayden Company-Builder Developer, Inc., 622 S.W. 2d 704 (Mo. App. 1981)……………………………………. -20-

Aronsohn v. Mandara, 484 A. 2d 675 (N.J. 1984)…… -20-

Assoc. of Apartment Owners v. Child, 1 Haw. App. 130, 615 P. 2d 756 (1980) -20-

Barclay v. DeVeau, 384 Mass. 676 (1981)…………. -41-

Barnes v. Mac Brown & Co. Inc., 342 N.E. 2d 619 (Ind. 1976) -20-

Bay State-Spray v. Caterpillar Tractor, 404 Mass. 103 (1989) -29-

Beachwalk Villas Condominium Association v. Martin, 406 SE2d 372 (S.C. 1991)……………………………………. -30-

Berg v. Stromme, 79 Wn. 2d 184, 484 P.2d 380 (1971).. -21-

Berman v. , Watergate West, Inc., 391 A.2d 1351 (D.C. Ct. App. 1978) -20-, -25-

Blagg v. Fred Hunt Co., 612 S.W. 2d 321 ( Ark. 1981)
………………………………………… -20-

Board of Managers of the Fairways at North Hills -41-

Bolkum v. Staab, 346 A.2d 210 (Vt. 1975)…… -20-, -25-

Boston Hous. Auth. v. Hemingway, 363 Mass. 184 (1973)
……………………………… -21-, -22-, -23-

Boston Symphony Orchestra v. Commercial Union Ins. Co., 406 Mass. 7 (1989) -28-

Brewer v. Poole Construction Co., 2001 Mass. Super. LEXIS 151 -24-

Brown v. Fowler, 279 N.W. 2d 907 (S.D. 1979)…….. -20-

Butler v. Caldwell & Cook, Inc., 122 A.D. 2d 559, 505 N.Y.S. 2d 288 (1986) -20-

Callaway v. City of Reno, 993 P.2d 1259 (Nev. 2000).. -21-

Cigal v. Leader Development Corporation, 408 Mass. 212(1990) -29, 37-

Clevert v. Jeff. W. Soden, Inc., 241 Va. 108, 400 S.E. 2d 181 (Va. 1991) -21-

Coburn v. Lenox Homes Inc., 567 A.2d 599 (CT 1977)
………………………………………… -20-

Commonwealth v. Kapsalis, 26 Mass. App. Ct. 448 (1988)
………………………………………… -36-

Commonwealth v. Pope, 354 Mass. 625 (1968)………. -36-

Compass Point Condominium Owners Ass’n v. First Fed. Sav. & Loan Ass’n, 641 So. 2d 253 (Ala. 1994)……………………………. -20-

Condominium v. Fairway at North Hills, 603 N.Y.S. 2d 867 (App. Div., 2^nd Dept.)…………………………………… -41-

Council of Co-Owners Atlantis Condominium, Inc. v. Whiting-turner Contracting Company, 517 A.2d 336 (Md. 1986)… -32-

Council of Unit Owners of Breakwater House Condominium v. Simpler, 603 A.2d 792 (Del. 1992)……………………………….. -20-

Dixon v. Mountain City Construction Co., 632 S.W. 2d 538 (Tenn. 1982) -20-

Dunant v. Wilmock, Inc., 176 Ga. App. 48, 335 S.E. 2d 162 (1985) -20-

East River S.S. Corp. v. Transamerica Delaval, 476 U.S. 858 (1986) -29-

Elden v. Simmons, 631 P.2d 739 (Okla. 1981)……… -20-

Elderkin v. Gaster, 447 Pa. 118, 288 A.2d 771 (1972)
………………………………………… -20-

Eliker v. Chief Indus., Inc., 242 Neb. 275, 498 N.W.2d 564 (1993) -20-

Fretschel v. Burbank, 351 N.W. 2d 403 (Minn. App. 1984)
………………………………………… -20-

Gable v. Silver, 258 So.2d 11 (Fla.App.), cert. discharged, 264 So. 2d 418 (Fla. 1972)……………………………………. -20-

Gailunas v. SPQR Management Assoc., Inc, 1997 Mass. Super. LEXIS 579 -27-

Gaito v. Auman, 327 S.E. 2d 870 (N. Car. 1985)…… -20-

Gateway Condominium Trust v. Clinton, 1996 Mass. Super. LEXIS 409 -27-

Glickman v. Brown, 21 Mass. App. Ct. 229 (1985), rev. den., 396 Mass. 1106 (1986)…………………………………… -37-

Gupta v. Ritter Homes, Inc., 646 S.W. 2d 168 (Tex 1983)
………………………………………… -20-

Kennedy v. Columbia Lumber and Manufacturing Co., 384 S.E. 2d 730 ( S.C. 1988) -20-

Keyes v. Guy Baily Homes, Inc., 439 So. 2d 670 (Miss. 1983) -20-

Kirk v. Ridgway, 373 N.W. 2d 491 (1985)…………. -20-

Lempke v. Dagenais, 547 A.2d 290 (N.H. 1988)…….. -20-

Libman v. Zuckerman, 33 Mass. App. Ct. 341(1992). -9-

Loch Hill Construction Co. v. Fricke, 284 Md. 708, 399 A.2d 883 (1979) -20-

Marcil v. John Deere Indus. Equip. Co., 9 Mass. App. Ct.625 (1980) -27-

McCann v. Brody-built Construction Co., 197 Mich. App. 512, 496 N.W. 2d 349 (1992)………………………………………… -20-

McDonough v. Whalen, 365 Mass. 506(1974)……. -19-, 26-

McMahon v. M&D Builders, Inc., 360 Mass. 54(1971)
………………………………………… -18-

Meadowbrook Condominium Association v. South Burlington Realty Corp., 565 A.2d 238,(Vt. 1989)…………………………….. -19-

Moransais v. Heathman 744 So. 2d 973(Fla. 1999). -30-

Moxley v. Laramie Builders, Inc., 600 P.2d 733 (Wyo. 1979)
………………………………………… -20-

Multi Technology v. Mitchell Management Sys., 25 Mass. App. Ct. 333 (1988)………………………………………… -36-

Nader v. Citron, 372 Mass. 96(1977)……………. -28-

National Academy of Sciences v. Cambridge Trust Co., 370 Mass. 303,(1976)………………………………………… -42-

Nichols v. R.R. Beaufort & Assocs., 727 A.2d 174 (R.I. 1999) -20-

Petersen v. Hubschman Constr. Co., Inc., 76 Ill. 2d 31, 389 N.E.2d 1154, 27 Ill. Dec. 746 (Ill. 1979)………………………… -19-

Real Estate Marketing v. Franz, 885 S.W. 2d 921 (Ky. 1994)
………………………………………… -20-

Redarowicz v. Ohlendorf, 441 N.E. 2d 324 (Ill. 1982)
………………………………………… -20-

Richards v. Powercraft Homes, Inc. , 678 P.2d 427 (Ariz. 1984) -20-

Rogers v. Scyphers 161 S.E.2d 81 (S.C. 1968)…. -23-

Rothberg v. Olenik, 262 A.2d 461(Vt. 1970)…… -24-

Saltis v. Lakes Heating & Air Conditioning, 2001 Ohio App. LEXIS 1279. -21-

Samuelson v. A.A. Quality Constr., 749 PO. 2d 73 (Mont. 1988) -21-

Schipper v. Levitt & Sons, Inc., 207 A.2d 314, ( N.J. 1965) -25-

Seal Harbor III Condominium Trust v. Kaplan ,1997 Mass. Super. LEXIS 126………………………………………… -28-

Sewell v. Gregory, 371 S.E. 2d 82 (W. Va. 1988)…… -20-

Shisler v. Frank, 582 N.W.2d 504,(Wisc. Ct. App. 1998)
………………………………………… -19-

Sutton Corporation v. Metropolitan District Commission, 38 Mass. App. Ct. 764(1995)…………………………………. -9-

Sylvia v. Johnson, 44 Mass. App. Ct. 483 (1998)…… -33-

Tusch Enters. v. Coffin, 113 Idaho 37(Idaho 1987)…. -19-

Utz v. Moss, 503 P.2d 365 (Colo. 1972)………….. -20-

Wimmer v. Down East Properties Inc., 406 A.2d 88 (Me 1989)
………………………………………… -20-

Yepsen v. Burgess, 269 Or. 635, 525 P.@d 1019 (1974 (en banc) -20-

Statutes and Regulations

780 CMR 101.4…………………………….. -22-

780 CMR 118.1…………………………….. -22-

Mass. Gen. Laws c. 231 § 6C………………… -45-

Other Authority

Hyatt and Rhoads, Concepts of Liability in the Development and Administration of Condominium and Home Owners Associations, 12 Wake Forest L. Rev. 915, 973 (1976)……………………. -41-

Restatement (Second) of Torts, § 385………… -32-

Restatement (Second) of Torts, § 424………… -31-

Uniform Condominium Act Section, 3-103(a). -40-, -41-

Statement of the Issues

! Whether there is an implied warranty of habitability in the sale of a completed dwelling by its builder-vendor.

! Whether the economic loss rule prohibiting the bringing of a negligence claim applies where (1)a builder has violated a legal duty imposed by the building code, (2) the result of the negligence is the creation of a dangerous condition, (3) where there is consequential property damage to the same dwelling caused by the defect or (4) where the parties are not in contractual privity.

! Whether the court improperly limited plaintiffs’ M.G.L. c. 93A claims.

! Whether the Court improperly limited plaintiff’s recovery of damages relating to defendant’s breach of fiduciary duties.

! Whether the lower court improperly applied interest to plaintiffs’ contract claim from the date of the complaint rather than from the date of the breach.

Statement of the Case: Nature of Case,

Course of Proceedings & Disposition Below

This is a case in which the Trustees of a condominium unit owner’s trust is seeking recovery from the condominium developer/vendor for shoddy construction of the condominiums.

The plaintiffs in this case are the successor trustees of the Trust of the Cotuit Bay Condominium (hereinafter “the Association Trust”) established pursuant to M.G.L. c. 183A. App.(Vol 1), A479, ¶ 1.

The defendant Stuart Bornstein (hereinafter “the developer”)is an individual, who was (i) an original trustee of the Association Trust, (ii) a trustee of the Cotuit Bay Condominium Trust (hereinafter “the Nominee Trust”), the entity that acquired the property on which the Cotuit Bay Condominium (hereinafter “the Condominium”) was constructed and that financed the construction, and (iii) the president of the defendant Cotuit Bay Condominium, Inc., the general contractor that constructed the Condominium. Id., A479, ¶ 2.

The defendant Jamila Bornstein is Stuart Bornstein’s wife and was from October, 1981, until June, 1985, a trustee of the Association Trust. Id., ¶ 3.

The defendant Paul Bornstein is Stuart Bornstein’s brother and was from October, 1981, until July, 1984, a trustee of the Association Trust. Id., ¶ 4.

The defendant Morris Bornstein is Stuart Bornstein’s father and was from October, 1981, until July, 1983, a trustee of the Association Trust. Id., ¶ 5.

On January 28, 1987, plaintiffs filed the Complaint in this action in the Land Court.

On April 21, 1988, the Land Court ordered the case transferred to the Barnstable Superior Court.

On or about October 26, 1988, plaintiffs filed a Third Amended Complaint (hereafter “the Complaint”). Id., A91-A119.

On December 21, 1993, the Superior Court (O’Neill, J.) granted Stuart Bornstein’s and Cotuit Bay Condominium Inc.’s motion to dismiss Counts I and II of the Complaint, sounding in negligence. Id., A183-A186. Judge O’Neill declared that “[b]ecause the plaintiffs’ complaint fails to assert any damage other than the allegedly defectively designed and constructed condominium itself, this claim is barred by the ‘economic loss’ doctrine, and shall therefore be dismissed. Id. A184. Judge O’Neill also dismissed Count X, a claim that the developer had breached the implied warranty of habitability, ruling that “[u]nder the current state of the law in this Commonwealth, such a cause of action arises only in situations involving the rental of residential property, and does not extend to the purchase of a house or condominium.” Id. A185.

On January 19, 1994, plaintiffs filed a Petition for Interlocutory Relief Under G.L. c. 231 § 188 (First Paragraph) seeking review of the Superior Court’s granting of the Motion to Dismiss on the negligence and implied warranty of habitability claims. Id. A198-A205.

On February 4, 1994, Justice Dreben denied the Petition for Interlocutory Review without stating reasons for the denial. Id. A 221. She noted, however:

Since the evidence on the counts remaining in this matter is for the most part relevant to the dismissed counts (I, II and X), it is suggested that any additional otherwise admissible evidence, if any, which is only relevant to the dismissed counts also be admitted. This procedure may preserve the issues without the necessity of a new trial in the event that the issues are appealed and the appellate panel disagrees with the decision of the motion judge. Id.

Forty one days of hearings were held before a master (Charles Sabatt) between January 3, 1994 and January 24, 1995. Thirty eight witnesses were called by the plaintiffs, while the defendants called only one witness. Id., A483, ¶ 21. Defendants did not call a single witness asserting that the condominiums were constructed in accordance with the provisions of the Massachusetts Building Code or a single witness disputing the amount of damages claimed by plaintiffs relating to their claims that the condominium was defectively constructed.

On December 20, 1994, Mr. Sabatt, ruling from the bench, dismissed all but one of Plaintiff’s claims that Mr. Bornstein violated M.G.L. c. 93A. App.(Vol 10), A5100B-A5100H.

On May 1, 1996, a Master’s Report was filed with the Court. App.(Vol 1), A391-A455. Among other findings, the Master found that the wording of Count XI of the Complaint required that the breach of fiduciary duty claim against Stuart Bornstein must be construed as a claim only against him individually for his acts as trustee of the Association Trust. Id., A395, ¶ 17. Nevertheless, the Master found that Stuart Bornstein had breached his fiduciary duties owed to the plaintiffs by failing to replace certain defects in construction and awarded plaintiffs $295,562.77 in damages (prior to the addition of interest) for the breach of fiduciary duty. Id., A449, ¶¶ 296-298. In addition, the Master found that Stuart Bornstein had breached a contract with the Association Trust by failing to pay $36,223 in common area fees due. Id., A411-A412, ¶¶ 106, 108. However, he concluded that plaintiffs had suffered no damages relating to the breach of contract claim, because Mr. Bornstein through the defendant Cotuit Bay Condominium Inc. had paid for certain expenses and maintenance costs which he was not otherwise obligated to pay and which offset his failure to pay the common area fees due. Id., A412, ¶ 109.

On February 28, 1997, Judge O’Neill issued a Memorandum and Order ruling on (1) Defendants’ motion to modify and confirm Master’s Report or In the Alternative to Recommit, (2) Defendants’ Objection to Master’s Report and Request for Further Findings and (3) Plaintiffs’ Objections to Master’s Report. Id. A468. Judge O’Neill remanded the case to the Master, declaring that the Master’s findings that Bornstein failed to insure that units admitted were constructed in accordance with the State Building Code to be inconsistent with his ruling that the breach of fiduciary duty claim was brought against Bornstein solely in his role as trustee of the Association Trust. Id., A471. He ordered the Master “to make findings of damages limited to Bornstein’s failure to ‘maintain, repair, and replace’ common areas from October, 1981 to July, 1985 (the dates during which Bornstein was a trustee of the Association Trust), in breach of his fiduciary duty as Trustee of the Association Trust.” Id. A472. In addition, Judge O’Neill held that Bornstein, as an owner of a number of the condominium units, could not set-off expenditures he made as the developer, against his contractual duty to pay common fees, and, thus, awarded plaintiffs $36,233 in damages on its breach of contract claim. Id. A469-A470.

On September 14, 1999, the Master issued his second Master’s Report (hereafter “Master’s Report II”). Id. A478. Master’s Report II reduced plaintiffs’ damages on its breach of fiduciary duty claim from $295,562.77 to $104,022.70. Id., A529, ¶¶ 267-269. The Master interpreted Judge O’Neill’s February 28, 1997, Order as requiring him to limit his findings of breach of a fiduciary duty to defects in the common area of which Stuart Bornstein had actual notice during his tenure as a Trustee of the Association Trust. Id. A533-A534, ¶¶ 295-296. He concluded that Bornstein only had actual notice of damage resulting from defective construction which would cost $104,022.70 to repair or replace. Id. A534, A529, ¶¶ 296, 267-269. He expressed his personal opinion that Judge O’Neill was wrong in so limiting him, Id., A533-A534, ¶ 295, n. 2, and he filed as an Appendix “Alternative Findings and Conclusions of Law – Other Common Area Defects” indicating that if not restricted by the Court’s order he would have continued to award plaintiffs the additional $191,605.00 he had awarded them in his first report. Id., A542-A550.

On May 1, 2000, Justice O’Neill issued a Memorandum of Decision and Order on Defendant Bornstein’s Objections to Master’s Report, and Motion to Modify and Adopt the Master’s Report. Id., A563. The court affirmed the Master’s Report II in all respects.

On August 22, 2000, judgments were issued reflecting the findings in the Master’s Report II. Id., A567-A569.

Statement of Facts

On October 30, 1981, the Cotuit Bay Condominium was created by the defendant Cotuit Bay Condominium Trust. App(Vol 1),A508 ¶ 149 , App.(Vol 2), “Master Deed”, A751-A878.

The Cotuit Bay Condominium Trust was a Nominee Trust for which Stuart Bornstein was the trustee and principal beneficiary, App.(Vol 1), A479, A508, ¶¶ 2, 151. All building permits required for the construction of the condominium were issued to the Nominee Trust. Id., A508, ¶ 152. The Nominee Trust owned every condominium unit from the date that it was admitted to the Condominium until it was sold to a third party purchaser. Id., A495, ¶ 88.

Construction of the Condominium occurred between 1981 and 1985. Id., A508, A511, ¶ 154, 176. In total, 62 units were constructed. Id., A512, ¶ 177. Construction was undertaken by the defendant Cotuit Bay Condominium, Inc., a company for which Stuart Bornstein was either the sole stockholder or the majority stockholder. Id., A508, ¶¶ 155, 156. In fact, all of the entities that constructed and developed the Cotuit Bay Condominium were legal entities within which Stuart Bornstein or members of his immediate family held beneficial interests, within which Stuart Bornstein exercised exclusive control, or within which Stuart Bornstein was the sole director or officer. Id., A509, ¶ 159.

The plaintiff Association Trust (the unit owners’ organization) was formed by means of a declaration of trust dated October 30, 1981. Id., A509, ¶160. The original Trustees of the Association Trust were the defendants Morris Bornstein, Paul Bornstein, Jamila Bornstein, Stuart Bornstein and Ronald Schmidt (an employee of Cotuit Bay Condominium, Inc.)(collectively referred to as “The Defendant Association Trustees”). Id., A510, ¶ 163. Stuart Bornstein admitted retaining control of the Trust until June, 1984, and remained a trustee until 1985. Id., A510, ¶ 170.

All of the members of the Bornstein family supposedly acting as Association Trustees abandoned their trustee responsibilities owed to the unit owners. Stuart Bornstein conceded that his family members played no role in the administration of the trust. App.(Vol 5), A2425-A2426. In fact, Maurice Bornstein (Stuart Bornstein’s father) testified that he did not even know that he was a trustee. App.(Vol 6), A2890. Stuart Bornstein further conceded that he was “more involved as the President of Cotuit Bay Condominium, Inc.” (the construction company) and that his “role as Trustee was a very passive one at most.” Id. A2721. He stated that the only time he “even thought as a trustee was at an annual meeting when we had it” and that he “was trustee for one day a year.” Id. A2721-A2722, A2724.

The construction of the condominium units were replete with deficiencies and defects.

During the tenure of the defendants as Trustees of the Association Trust, the following common areas experienced water leaks and required maintenance, repair or replacement: sliders, chimneys, skylights, decks and flat roofs. App.(Vol 1), A512-A513, ¶ 182. In all cases in which the water leaked from the structural components of the units, namely from the chimney enclosures, roofs, skylights and sliders, there was consequential damage to the sheet rock and other interior elements. Id., A514, ¶ 190. None of the skylights, chimneys or sliders which leaked were installed with the appropriate flashing required by the State Building Code. Id., ¶¶ 191-195.

During the tenure of the defendants as Trustees of the Association Trust, there was also evidence of rotting and deterioration of the outside decks. Id., A515, ¶ 202. The supporting columns for the outside decks were not constructed of pressure treated wood and were built directly into the ground causing them to decay or rot. Id., A516, ¶ 204. None of the decks at the Condominium were constructed in accordance with the Massachusetts Building Code nor were they constructed in a good and workmanlike manner. Id., ¶ 207. While decks constructed in accordance with the State Building Code and good building practices would be expected to have a life of 15 to 20 years, none of the decks at the Cotuit Bay Condominium survived for longer than ten years and in some cases they survived for far fewer than even ten years. Id., A517, ¶ 216-217.

Other “latent” defects [FN1] existed in the construction of the

____________________________________________________

FN1 The Master concluded that Stuart Bornstein, in his role as Association trustee, did not have notice of these defects during his tenure. App. (Vol 1), A534, ¶ 297. To reach this conclusion, the Master felt compelled by the Court’s remand to “ignore” Stuart Bornstein’s knowledge “derived from his multiple roles as builder and developer”. Id. Moreover, the Master acknowledges that in fact an architect had advised Stuart Bornstein that the attics were not vented in accordance with code. Id., A531, A534, ¶¶281, 298. Nevertheless, the Master somehow concluded that because the inadequate ventilation had yet to manifest itself in actual damage to the attics that Mr. Bornstein was not under sufficient notice to obligate him to undertake repairs.

_________________________________________

condominiums during the tenure of the Association Trustee Defendants. These included improper bathroom ventilation, improper attic ventilation, and improper fastening of the chimneys to the roofs of the buildings. Id., A529, ¶ 271.

The bathroom exhaust venting system did not provide for any ventilation to the outside of the buildings and violated the Massachusetts State Building Code. Id., A530, ¶ 273, 274. Over time, the lack of adequate bathroom ventilation will cause decay to the wooden rafters and sheathing in the condominium buildings. Id., ¶ 275.

In none of the condominium buildings were ridge vents installed nor baffles provided as required by the Massachusetts Building Code. Id., A531, ¶ 278. In some cases, the eaves vents were stuffed with insulation, which also violated the Massachusetts Building Code. Id., ¶ 279. Over time, the above described violations of the Building Code relating to ventilation of the attics will result in the decay of the timbers, rafters and plywood. Id., ¶ 280.

The several hundred pound chimneys were attached to the roofs with nothing other than eight penny nails banged into the sheathing. Id., A532, ¶ 287. Not surprisingly, several of the chimneys have fallen off of the roofs. Id., ¶ 289.

Summary of Argument

The lower court improperly dismissed plaintiff’s claim that there is an implied warranty of habitability in the sale of a completed dwelling by its builder-vendor. Courts in a vast majority of states now hold that an implied warranty arises in the sale of new homes by their builder-vendor. The same rationale employed by the Supreme Judicial Court in the case of Boston Hous. Auth. v. Hemingway, 363 Mass. 184, 191-97 (1973) supporting the proposition that there is an implied warranty of habitability in every lease supports the conclusion that in the modern world the primary interest of the purchaser of a home is not in the land conveyed but in finding upon it an objectively habitable home, i.e. one complying with all relevant building codes. There is particularly no meaningful distinction between the mass production and sale of manufactured goods and the mass production and sale of condominium homes. See Section II, infra at 18-25.

The lower court also erred in dismissing plaintiff’s negligence claim, because of the economic loss rule. The economic loss rule does not apply to this case, because plaintiffs suffered more than the economic loss measured by the need to replace the defective work. In particular, water leaks caused consequential damages to sheetrock and other interior elements. Inadequate ventilation resulted in decay to surrounding elements. The economic loss rule also does not apply as the parties were not in contractual privity. The plaintiff had no opportunity to protect itself contractually, and, thus, should not be limited in its ability to recover under a negligence theory. Finally, the violations of legal duties imposed by the State Building Code dictates against imposition of a court-imposed economic loss rule. See Section III, infra at 25-33.

The lower court should not have dismissed the vast majority of plaintiff’s chapter 93A claims on the basis that the Complaint’s claims did not relate to the common areas which the plaintiff association had standing to protect. The Complaint attached and incorporated plaintiff’s demand letter into the Complaint, and the Court’s refusal to acknowledge the claims set forth in the demand letter was an abuse of discretion. See Section IV, infra at 33-38.

The lower court erroneously limited plaintiff’s damages to $104,022.70 resulting from defendant’s breach of fiduciary duties. Damages should not have been limited to those defects of which defendant had actual knowledge, as defendant had a fiduciary duty to make a reasonable inquiry as to the truth of assertions that the condominiums exceeded all required building codes, as well as a fiduciary duty as a developer to ensure that the condominium units were constructed properly. Moreover, the Court, apparently accidently, undercalculated plaintiff’s damages by $9,500. Finally, the Master below abused his discretion in refusing to allow testimony relating to the cost of repairing the condominium’s duct work, while acknowledging that the testimony was consistent with pretrial disclosures and consumed in the disclosure of the cost of larger repairs. See Section V, infra at 38-45.

The court erroneously applied interest on plaintiff’s contract claim from the date of entry of the judgment rather than from the dates of the breaches of contract. See Section VI, infra at 45-47.

Argument

I. INTRODUCTION

The lower court in this case in essence found that the condominiums built and sold by the defendants were shoddily constructed in flagrant disregard of numerous Building Code provisions. Yet, through the exercise of legal gymnastics and hair-splitting, the court also determined that the plaintiffs were only entitled to $104,022 of the $295,562 in damages that they suffered as the result of this shoddy construction. This simply cannot be the law.

Whether plaintiffs should prevail because the developer’s fiduciary duties must be more broadly interpreted, because the chapter 93A claim should not have been dismissed, because plaintiff’s negligence action is not barred by the economic loss rule or because there is an implied warranty of habitability that attaches to the sale of a dwelling (or at least to the sale of a condominium unit) is of no particular moment to the plaintiffs, so long as they prevail. On the other hand, it is of considerable moment to this Court to establish the exact boundaries of the economic loss rule, the parameters of the implied covenant of habitability, and the duties imposed on a fiduciary in order that future home purchasers, unlike the plaintiffs in this case, will not have to struggle for fifteen years in court in order to enforce their rights.

II. THERE IS AN IMPLIED WARRANTY OF HABITABILITY IN THE SALE OF A COMPLETED DWELLING BY ITS BUILDER-VENDOR.

The lower court erroneously dismissed plaintiff’s claim that there is an implied warranty of habitability in the sale of a completed dwelling by its builder-vendor. In McMahon v. M&D Builders, Inc., 360 Mass. 54, 62 (1971), the Supreme Judicial Court noted the trend in other jurisdictions to impose on the builder-vendor of a dwelling house an implied warranty to the initial purchaser (a) that the house was built in a good and workmanlike manner, (b) that it is suitable for habitation, and (c) that it was built in compliance with applicable building laws, ordinances, regulations or codes. The Court concluded that the issue had not been raised properly in that case and did not need to be reached; however, the court twice described the issue as an “important question” for the Massachusetts courts to decide.

Since 1971, the trend has, if anything, accelerated and even more jurisdictions have concluded that there is an implied warranty of habitability[FN2] in the sale of a completed dwelling by its builder-vendor.

_______________________________________________________

FN2 Plaintiffs have termed the implied warranty as one of habitability. They have done so as that is the term used by Massachusetts appellate courts to describe the implied warranty in the context of residential leases. Some jurisdictions style this implied warranty as one of habitability. See, e.g., Tusch Enters. v. Coffin, 113 Idaho 37, 740 P.2d 1022, 1030 (Idaho 1987). Others call it an implied warranty for fitness of purpose or intended use. See, e.g., Petersen v. Hubschman Constr. Co., Inc., 76 Ill. 2d 31, 389 N.E.2d 1154, 1158, 27 Ill. Dec. 746 (Ill. 1979). Yet, others call it an implied warranty of good quality and workmanship. Council of Unit Owners of Breakwater House Condominium v. Simpler, 603 A.2d 792, 795 (Del. 1992). However, as the court noted in Shisler v. Frank, 582 N.W.2d 504 (Wisc. Ct. App. 1998), “the substance of the warranty is defined in a similar manner: Implied in the contract for sale from the builder-vendor to the vendees is a warranty that the house, when completed and conveyed to the vendees, would be reasonably suited for its intended use.” See, also Meadowbrook Condominium Association v. South Burlington Realty Corp., 565 A.2d 238, 241 (Vt. 1989) (Issue of whether breach of implied warranty in common area not turn on whether area is habitable but on quality of construction).

________________________________________________________

As of today, courts in a vast majority of states now hold that an implied warranty arises in the sale of new homes by their builder-vendor. In fact, forty (40) states plus the District of Columbia have found such an implied warranty to exist. [FN3] In one other state, an intermediate appellate court

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FN3 Blagg v. Fred Hunt Co., 612 S.W. 2d 321 ( Ark. 1981); Richards v. Powercraft Homes, Inc. , 678 P.2d 427 (Ariz. 1984); Council of Unit Owners of Breakwater House Condominium v. Simpler, 603 A.2d 792 (Del. 1992); Berman v. Watergate West, Inc., 391 A.2d 1351 (D.C. Ct. App. 1978); Tusch Enterprises v. Coffin, 740 P.2d 1022 (Ida. 1987); Gable v. Silver, 258 So.2d 11 (Fla.App.), cert. discharged, 264 So. 2d 418 (Fla. 1972)Gable v. Silver, 258 So.2d 11 (Fla.App.), cert. discharged, 264 So. 2d 418 (Fla. 1972); Redarowicz v. Ohlendorf, 441 N.E. 2d 324 (Ill. 1982); Barnes v. Mac Brown & Co. Inc., 342 N.E. 2d 619 (Ind. 1976); Keyes v. Guy Baily Homes, Inc., 439 So. 2d 670 (Miss. 1983); Lempke v. Dagenais, 547 A.2d 290 (N.H. 1988); Aronsohn v. Mandara, 484 A. 2d 675 (N.J. 1984); Gaito v. Auman, 327 S.E. 2d 870 (N. Car. 1985); Elden v. Simmons, 631 P.2d 739 (Okla. 1981); Nichols v. R.R. Beaufort & Assocs., 727 A.2d 174 (R.I. 1999); Gupta v. Ritter Homes, Inc., 646 S.W. 2d 168 (Tex 1983); Sewell v. Gregory, 371 S.E. 2d 82 (W. Va. 1988); Moxley v. Laramie Builders, Inc., 600 P.2d 733 (Wyo. 1979); Utz v. Moss, 503 P.2d 365 (Colo. 1972); Kennedy v. Columbia Lumber and Manufacturing Co., 384 S.E. 2d 730 ( S.C. 1988); Bolkum v. Staab, 346 A.2d 210 (Vt. 1975); Compass Point Condominium Owners Ass’n v. First Fed. Sav. & Loan Ass’n, 641 So. 2d 253 (Ala. 1994); Coburn v. Lenox Homes Inc., 173 Conn. 567, 378 A.2d 599 (1977); Real Estate Marketing v. Franz, 885 S.W. 2d 921 (Ky. 1994); Dunant v. Wilmock, Inc., 176 Ga. App. 48, 335 S.E. 2d 162 (1985); McCann v. Brody-built Construction Co., 197 Mich. App. 512, 496 N.W. 2d 349 (1992); Fretschel v. Burbank, 351 N.W. 2d 403 (Minn. App. 1984); Armbruster v. Hayden Company-Builder Developer, Inc., 622 S.W. 2d 704 (Mo. App. 1981); Butler v. Caldwell & Cook, Inc., 122 A.D. 2d 559, 505 N.Y.S. 2d 288 (1986); Brown v. Fowler, 279 N.W. 2d 907 (S.D. 1979); Assoc. of Apartment Owners v. Child, 1 Haw. App. 130, 615 P. 2d 756 (1980); Kirk v. Ridgway, 373 N.W. 2d 491 (1985); Wimmer v. Down East Properties Inc., 406 A.2d 88 (Me 1989); Loch Hill Construction Co. v. Fricke, 284 Md. 708, 399 A.2d 883 (1979); Eliker v. Chief Indus., Inc., 242 Neb. 275, 498 N.W.2d 564 (1993); Yepsen v. Burgess, 269 Or. 635, 525 P.@d 1019 (1974 (en banc); Elderkin v. Gaster, 447 Pa. 118, 288 A.2d 771 (1972); Dixon v. Mountain City Construction Co., 632 S.W. 2d 538 (Tenn. 1982); Berg v. Stromme, 79 Wn. 2d 184, 484 P.2d 380 (1971); Clevert v. Jeff. W. Soden, Inc., 241 Va. 108, 400 S.E. 2d 181 (Va. 1991); Shisler v. Frank, 582 N.W. 2d 504 (Wes. App. 1998).

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has indicated that an implied warranty may exist, although it required proof of negligence to sustain a claim.[FN4] Only three states have outright

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FN4 Saltis v. Lakes Heating & Air Conditioning, 2001 Ohio App. LEXIS 1279.

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rejected the claim that a builder/developer owes a purchaser an implied warranty of habitability. [FN5] Massachusetts is one of only six states that

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FN5 Samuelson v. A.A. Quality Constr., 749 PO. 2d 73 (Mont. 1988); Callaway v. City of Reno, 993 P.2d 1259 (Nev. 2000); American Tower Owners Assoc. v. CCI Mechanical, 930 P.2d 1182 (Utah 1997).

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has apparently not ruled on this “important issue”. [FN6]

________________________________________________

FN6 Alaska, California, Kansas, Massachusetts, New Mexico, and North Dakota.

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In Boston Hous. Auth. v. Hemingway, 363 Mass. 184, 191-198 (1973) this Court inferred from a landlord’s statutory duty to comply with the Commonwealth’s Sanitary Code a legislative intention that tenants should only pay rent for habitable premises, and concluded that the caveat emptor doctrine had outlived any purposeful use. The Court thus implied in all residential leases a warranty of habitability. 780 CMR 101.4780 CMR 118.1Ingalls case, 156 Mass. 348, supra; Rogers v. Scyphers 161 S.E.2d 81 (S.C. 1968);Rothberg v. Olenik, 262 A.2d 461(Vt. 1970); Brewer v. Poole Construction Co., 2001 Mass. Super. LEXIS 151,** 16-17; Berman v. Watergate West, Inc., 391 A.2d 1351 (D.C. App. 1978) (There is no meaningful distinction between the mass production and sale of automobiles and mass production and sale of homes); Schipper v. Levitt & Sons, Inc., 207 A.2d 314, 325 ( N.J. 1965) (same).

Count X of the Complaint, alleging a breach of the implied warranty of habitability, names Stuart Bornstein, both individually and as he was trustee of the Nominee Trust, as the defendant. Defendants in this case have spent much of their time seeking to divide up Mr. Bornstein legal existences in order to avoid liability. However, a number of courts have found that the implied warranty of habitability applies to developers regardless of the legal structures they have created to attempt to separate the builders of the dwellings from the sellers of the dwellings. See Bolkum v. Staab, 346 A.2d 210, 211 (Vt. 1975).

A. The Economic Loss Rule Does Not Apply to this Case Because Plaintiffs Suffered More than Economic Loss.

In this case, the Master found two types of defects in construction: (1) those defects related to inadequate flashing which had already caused consequential property damage,(2) those defects related to inadequate ventilation which over time would cause consequential property damage, and (3) those defects, such as construction of the decks and the improper fastening of the chimneys, which would require only replacement of the original work itself. Specifically, the Master found that in all cases in which the water leaked from the structural components of the units, namely from the chimney enclosures, roofs, skylights and sliders, there was consequential damage to the sheet rock and other interior elements. App.(Vol.1), A514, ¶ 190. In addition, the Master found that the failure to adequately vent the bathrooms and attics over time would cause decay to the wooden rafters, timbers, plywood and sheathing in the condominium buildings. Id., A530, A531, ¶¶ 275, 380.

Given these findings, the first two types of defects, which either caused or will cause consequential damage, are clearly not barred by the economic loss rule as currently articulated by this Court. In Marcil v. John Deere Indus. Equip. Co., 9 Mass. App. Ct.625, n.3 (1980); Gateway Condominium Trust v. Clinton, 1996 Mass. Super. LEXIS 409, *5 (Welch, J.);Gailunas v. SPQR Management Assoc., Inc,1997 Mass. Super. LEXIS 579(Cowin, J.); Seal Harbor III Condominium Trust v. Kaplan ,1997 Mass. Super. LEXIS 126,(Hinkle, J.) [FN7]

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FN7 Justice O’Neill dismissed the Complaint “[b]ecause the plaintiffs’ complaint fails to assert any damage other than the allegedly defectively designed and constructed condominium itself. . .” In fact, the Complaint does not seek to set forth the exact damages suffered, but notes that there will be “substantial expense” to “correct said defects and deficiencies”. App.(Vol 1), A106-A107, ¶¶ 72, 75. The defects specifically noted in the Complaint include the lack of flashing and the inadequate ventilation. Id.,A99-A100, ¶ 30(l)&(p).

In dismissing the Complaint, Justice O’Neill failed to apply the proper standards for reviewing a Motion to Dismiss. “[A] complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim.” Nader v. Citron, 372 Mass. 96, 98 (1977). “The process is not one of looking at the legal theory enunciated by the pleader but of ‘envisaging what kinds of losses may be proved as lying within the range of the allegations of the complaint . . .’” Boston Symphony Orchestra v. Commercial Union Ins. Co., 406 Mass. 7, 12-13 (1989). In this case, the court certainly could have and should have envisioned that inadequate flashing will result in consequential water damages and that inadequate ventilation will result in deterioration of surrounding structural elements. In fact, in its Opposition to the Motion to Dismiss, plaintiffs specifically argued that “the defective work has resulted in damage to property”. App.(Vol 1), A134, n.3. At a minimum, plaintiff should have been afforded the opportunity of amending the complaint rather than having its complaint dismissed.

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In fact, none of plaintiffs’ negligence claims should be barred by the economic loss rule. At a minimum, the economic loss rule should not apply where the parties are not in contractual privity.

The underlying rationale for applying the economic loss doctrine is that “when a product injures only itself the reasons for imposing a tort duty are weak and those for leaving the party to its contractual remedies are strong”. East River S.S. Corp. v. Transamerica Delaval, 476 U.S. 858, 871 (1986). As the Court stated in Bay State-Spray v. Caterpillar Tractor, 404 Mass. 103, 109-110,

The commercial user can protect himself by seeking express contractual assurances concerning the product (and thereby perhaps paying more for the product) or by obtaining insurance against losses. A person physically injured by a defective product generally had neither the bargaining power nor the opportunity to bargain with its manufacturer or seller and so could not reasonably provide himself with the same kind of protection that a purchaser of goods could.

In this case, the plaintiff had no opportunity to protect itself contractually against the defendants’ defective construction and therefore should not be held to the limitations of the economic loss rule. The plaintiff in this case is the unit owners’ Trust. The Court noted in Cigal v. Leader Development Corporation, 408 Mass. 212, 217-218 (1990), that the unit owners’ association must act as the exclusive representative for unit owners in litigation alleging negligent construction of common areas. The Court concluded that such litigation “is not governed by contract principles”. Id.

The common areas were in essence foistered upon the unit owners’ association by the developer, who had one or more of his family sitting on the Association Trust for the first four years of the trust’s existence. The plaintiffs never purchased any of the common areas and never had the opportunity to bargain for any express contractual warranties; there are thus no alternative remedies weakening the reasons for imposing tort duties on the defendants. See Beachwalk Villas Condominium Association v. Martin, 406 SE2d 372 (S.C. 1991) (”economic loss rule” limited to those cases where duties are created solely by contract); Moransais v. Heathman 744 So. 2d 973, 983 (Fla. 1999)(the economic loss rule was primarily intended to limit actions in the product liability context, and its application should generally be limited to those contexts or situations where the policy considerations are substantially identical to those underlying the product liability-type analysis).

C. The Economic Loss Rule Does Not Apply As Defendants Violated Clearly Established Legal Duties Owed to the Plaintiffs.

The Master found that the condominiums were built in direct contravention of numerous building code provisions. See App.(Vol 2), A882-A907 for excerpts of sections of the Building Code violated by defendants. Even if the lack of a contractual relationship between the plaintiff and defendants does not render the economic loss rule inapplicable to this case, the independent violation of a legal duty dictates that the court-imposed economic loss rule not be applied in this case.

The Restatement (Second) of Torts, § 424 is clear:

One who by statute or by administrative regulation is under a duty to provide specified safeguards or precautions for the safety of others is subject to liability to the others for whose protection the duty is imposed for harm caused by the failure of a contractor employed by him to provide such safeguards or precautions.

At least one court has held that the economic loss rule does not apply to defects potentially affecting the safety of the homeowners. Council of Co-Owners Atlantis Condominium, Inc. v. Whiting-turner Contracting Company, 517 A.2d 336 (Md. 1986). The Maryland court relied on the provisions of Section 385 of the Restatement (Second) of Torts, which provides:

One who on behalf of the possessor of land erects a structure or creates any other condition thereon is subject to liability to others upon or outside of the land for physical harm caused to them by the dangerous character of the structure or condition after his work has been accepted by the possessor, under the same rules as those determining the liability of one who as manufacturer or independent contractor makes a chattel for the use of others.” Id. at 341.

The court concluded that “the determination of whether a duty will be imposed in this type of case should depend upon the risk generated by the negligent conduct, rather than upon the fortuitous circumstance of the nature of the resultant damage.” Id. at 345.

In this case, at a minimum, defendants must be held liable for (1) their defective construction of the decks, whose supporting columns for the outside decks were not constructed of pressure treated wood and were built directly into the ground causing them to decay or rot and (2) the defective fastening of the chimneys. These defects, which could have resulted in the decks collapsing and the chimneys falling to the ground, clearly potentially endangered the health and safety of the homeowners. See testimony of plaintiff’s expert Robert Brandon re. dangerousness of defendant’s construction. App.(Vol 9), A4547-A4548.

IV. THE COURT SHOULD NOT HAVE DISMISSED PLAINTIFF’S 93A CLAIMS ALLEGING MISREPRESENTATIONS AND FAILURES TO DISCLOSE RELATING TO THE COMMON AREAS OF THE CONDOMINIUMS.

Paragraph 107 of the Complaint alleges that Stuart Bornstein in developing and marketing the condominium violated M.G.L. c. 93A as follows:

by failing to disclose his knowledge as to defects and deficiencies with the design and construction of the Condominium;
by failing to correct defects and deficiencies after representing such would be cured and/or corrected; . . .
c. by failing to provide various features, components and elements of the Condominium after representing the same would be provided; . . ..
generally, by failing to deliver the Condominium as represented.

App.(Vol 1) A112.

Paragraph 112 of the Complaint incorporated by reference the allegations contained in plaintiff’s 93A Demand Letter, which was attached to the Complaint. Id. A113-A114. The Demand Letter alleged, among other things, that Bornstein had represented that (1) the condominium would have a heated pool when it in fact had an unheated pool, (2) a satellite and cable television system would be installed when in fact a satellite system with no cable was installed, (3) hand-carved front doors would be installed when in fact standard, common doors were installed, and (4) the condominium would be constructed in conformity with state building code requirements. App.(Vol 2), A602-A603. [FN8] The Letter further alleged that the above

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FN8 Plaintiffs introduced into evidence a brochure which specifically included all of the above misrepresentations including a representation that “Cotuit Bay Condominiums have been built to last. Its structural design and materials exceed all currently required building codes and fire laws.” (Emphasis in original). App.(Vol 2), A599. Mr. Bornstein admitted that this brochure was provided to prospective purchasers of condominium units. App.(Vol 6), A2670-A2672.

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misrepresentations and failures to disclose had led to, among other things, improperly built decks, improper installation of flashing, improper ventilation and inadequate television reception. Id., A604-A606.

On December 20, 1994, Mr. Sabatt, ruling from the bench, limited Count XIII against the developer to the allegation that he had violated M.G.L. c. 93A by failing to pay common area charges when due. App.(Vol. 10), A5100C-A5100H. He dismissed the allegations made in subparagraphs 107(a)(b)(f) and (h) noted above, concluding that these claims were “held by individuals” and that “these individuals were not clearly identified as claimants”. Id. A5100F.

On August 22, 2000, judgment was issued dismissing plaintiff’s 93A Count. App.(Vol 1), A567.

In his December 20, 1994, ruling, the Master gives no explanation of why allegations of (i) failing to disclose knowledge as to defects and deficiencies with the design and construction of the Condominium, (ii) failing to correct defects and deficiencies after representing such would be cured and/or corrected, or (iii)failing to provide promised features after promising they would be provided are allegations only relevant to individual units and not relevant also to the common areas. This Court has indicated that only notice pleading is required to support a 93A Claim. Multi Technology v. Mitchell Management Sys., 25 Mass. App. Ct. 333, 335 (1988). Even without the incorporation by reference of the Demand Letter, the pleadings are sufficient to state a claim going to the common areas as well as to the individual units in the Condominium. With the incorporation by reference of the Demand Letter (which specifically notes problems in the common areas), there is no question but that defendant has been placed on sufficient notice of claims going to the common areas. [FN9]

_____________________________________________________

FN9 In prefatory remarks to dismissing the 93A Count, the Master noted that he is a “strict constructionist” and “guess[ed] that my philosophy will be tested in the appeals court”, and concluded that incorporation of the demand letters by reference was not “magic enough to say that we are alleging that everything in those letters is hereby an allegation in this count”. App.(Vol 10), A5100C-A5100E. In fact, the courts in Massachusetts have made it clear that matters incorporated by reference should be reviewed in analyzing the sufficiency of a Complaint. See Commonwealth v. Kapsalis, 26 Mass. App. Ct. 448,454(1988) (information incorporated by reference sufficient for defendant to know nature of accusation against him); cf Commonwealth v. Pope, 354 Mass. 625, 629 (1968) (complaint attached to warrant becomes a part therof).

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The association trust, and not the individual unit owners, is the proper plaintiff for a 93A action alleging misrepresentations and nondisclosures involving the common areas. In Glickman v. Brown, 21 Mass. App. Ct. 229 (1985), rev. den., 396 Mass. 1106 (1986).

A. The Lower Court Improperly Narrowed The Fiduciary Duties Owed by The Defendants to The Plaintiffs.

1. The Court Improperly Limited Defendant’s Fiduciary Duties to the Duty to Maintain, Repair and Replace Common Areas.

In his Memorandum of Decision issued on February 28, 1997, Judge O’Neill ordered the Master to limit his findings on Count XI to “Bornstein’s failure to ‘maintain, repair, and replace’ common areas from October 1981 to July, 1985, in breach of his fiduciary duty as Trustee of the Association Trust.” App.(Vol 1), A472. In fact, as trustee of the Association Trust Bornstein also owed the Unit Owner’s Association a duty to ensure that the condominium units were constructed properly.

Because Bornstein personally directed and controlled the work on the condominium, App.(Vol 1), A508-A509, ¶¶ 155, 156, 159, controlled the admission of newly constructed buildings in the condominium for his own profit motivated interests, App.(Vol 2), A765-A768, sec. 8, while contemporaneously acting as the controlling trustee of the association trust, App.(Vol 1) A510, ¶ 170, he owed heightened fiduciary duties to the unit owners association to assure that the construction on the units being admitted into the condominium was proper. As a trustee who is also the developer it was incumbent upon Bornstein to assure that economic decisions made as the developer to cut costs or corners not be made at the expense of the unit owners’ association.

Section 3-103(a) of the Uniform Condominium Act provides that “[i]n the performance of their duties, the officers and members of the executive board [of a unit owner’s association] are required to exercise (i) if appointed by the declarant, the care required of fiduciaries of the unit owners.” Comment 1 to Section 3-103 notes that “[t]his provision imposes a very high standard of duty . . . because there is a great potential for conflicts of interest between the unit owners and the declarant.” On point is the case of Board of Managers of the Fairways at North Hills Condominium v. Fairway at North Hills, 603 N.Y.S. 2d 867, 868-869 (App. Div., 2^nd Dept.), in which the court found a breach of fiduciary duty by the trustees of the association trust in their failure to correct the deficient construction of the units. The court, relying upon the Governors Grove Condominium Ass’n v. Hill Dev. Corp, 414 A.2d 1177 (CT Super. Ct. 1980)

As noted in the prior section, Judge O’Neill ordered the Master to limit his findings on Count XI to “Bornstein’s failure to ‘maintain, repair, and replace’ common areas from October 1981 to July, 1985. . .” For inexplicable reasons, the Master interpreted this order as requiring him “to confine findings of damages only to those items for which there is evidence that Stuart Bornstein had actual notice . . .” Master’s Report II, ¶ 295.

The law in Massachusetts is clear that a fiduciary must make reasonable efforts to ascertain the true state of facts it has represented. National Academy of Sciences v. Cambridge Trust Co., 370 Mass. 303, 309 (1976). Mr. Bornstein represented that the structural design and materials of the Cotuit Bay Condominiums exceeded all currently required building codes , whether or not he had actual knowledge of all of the building code violations, he was under a fiduciary obligation to make a reasonable inquiry to determine the truth of his assertions. [FN10]

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FN10 The Master indicated that if not restricted by the Court’s order to finding damages related to defects of which Mr. Bornstein had actual notice, he would have awarded plaintiffs an additional $191,605.00 in damages.

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B. The Master Understated The Fair And Reasonable Cost to Repair The Fastenings on the Chimneys.

The Master found that “Plaintiffs’ expert testified that the fair and reasonable cost for labor and materials to make the repairs for each chimney is $875.00 per chimney and the total cost is $16,625.00.” In fact, plaintiffs’ expert, Robert Brandon, testified that the fair and reasonable cost to make the repairs for each chimney is $1,375.00 per chimney. App.(Vol 9), A4553-A4554, A4558-A4570. As the Master found that 19 chimneys needed to be repaired, App.(Vol 1), A532, ¶290, the total cost to make the repairs is $26,125.00 and not $16,625.00.

C. The Master Abused His Discretion in Precluding Damage Testimony Related to the Condominium’s Duct Work.

The Master precluded plaintiff from presenting expert testimony relating to the damages flowing from the defective duct work in the condominiums. App.(Vol. 9) A4960-A4974. He precluded the testimony because of supposed lack of disclosure during discovery of the amount of damages claimed as the result of the defective work. Id.

The Master abused his discretion in precluding this testimony. There had been ample disclosure that there would be expert testimony relating to the inadequate duct work. App.(Vol 1) A166-A168. There was disclosure of the cost of replacing the heating system (including the duct work). App.(Vol 1) A309-A310. The Master acknowledged that the proposed testimony was “consistent” with the disclosures. App.(Vol 9) A4970. He nevertheless precluded the testimony, because the cost of replacing the duct work “appears almost as a subnote” to the overall cost presented for repairing the entire heating system, as it was not broken down separately from an overall cost of replacing the entire system. App.(Vol 9), A4971. At the time of trial, plaintiff was no longer seeking replacement of the entire heating system, but was only seeking replacement of the duct work. App.(Vol 9), A4969-A4970. As defendant had ample opportunity during discovery to seek to break down the cost of replacing the entire system to determine what percentage of that cost was attributable to the replacement of the ductwork, and was certainly not caught by surprise that plaintiff was claiming that the duct work was inadequate, plaintiff should not have been precluded from offering testimony relating to the cost of replacing the duct work.

VI. THE LOWER COURT ERRED IN AWARDING INTEREST ON PLAINTIFF’S CONTRACT CLAIM FROM THE DATE OF THE FILING OF THE COMPLAINT.

The Court entered judgment on behalf of the plaintiffs in “the sum of $36,223.00 with interest of 12% as provided by law from January 28, 1987, on Count XII.” App.(Vol 1), A567. January 28, 1987 is the date that this case was commenced. In Count XII, plaintiffs alleged that the defendant Stuart Bornstein had breached his contract with plaintiffs by failing to pay condominium fees on the units owned by him. App.(Vol 1), A111, ¶ 105.

Mass. Gen. Laws c. 231 § 6C provides in relevant part:

In all actions based on contractual obligations, upon a verdict, finding or order for judgment for pecuniary damages, interest shall be added by the clerk of the court to the amount of damages, at the contract rate, if established, or at the rate of twelve per cent per annum from the date of the breach or demand. If the date of the breach or demand is not established, interest shall be added by the clerk of the court, at such contractual rate, or at the rate of twelve per cent per annum from the date of the commencement of the action . . .

Plaintiff in this case clearly established the dates of the breach of contract. Plaintiffs introduced the Trust of the Cotuit Bay Condominium (hereafter “the Contract”) which provided that condominium fees were to be paid within thirty days and were to be issued no later than 30 days prior to the commencement of the fiscal year, except for the first bill which was to go out within 30 days of the execution of the Contract. App.(Vol 2) A636, Art. V, § 2B. The Contract was executed on October 30, 1981. Id., A628. The fiscal year was established as beginning on July 1. Id. A643.

The Master found that defendant in fact failed to issue bills to himself for condominium properties which he owned. App.(Vol 1), A495 (¶ 91), A498 (¶107). Thus the dates of the breach are the dates that condominium bills should have been paid if issued in a timely fashion (i.e. January 1, 1982, July 1, 1982, July 1, 1983, July 1, 1985 and July 1, 1985).

Plaintiff introduced into evidence a chart from which it can be determined the amount of condominium fees which defendant failed to pay on each day of its breach of contract. App.(Vol 2), A932-A933. Specifically, the chart indicates the date each unit of the condominium was incorporated (i.e. the date that the unit began to owe condominium fees), the date each unit was sold by the developer to a buyer (i.e. the date on which the developer stopped owing condominium fees) and the amount of fees assessed per unit during each year. From this chart, it can be established that of the $36,223.00 of condominium fees that the Court found that the developer failed to pay, $7,150 was due and unpaid on January 1, 1982, $10,893 was due and unpaid on July 1, 1982, $10,767 was due and unpaid on July 1, 1983, $5,321 was due and unpaid on July 1, 1984, and $2,090 was due and unpaid on July 1, 1985. See Appendix to this Brief for chart of condominium fees due.

Conclusion

For the reasons stated in this Brief, judgment should be issued in plaintiff’s favor on Counts I (Negligence), II (Negligence), X (Breach of Implied Warranty of Habitability), XI (Breach of Fiducairy Duty) and XIII (93A) in the amount of $305,062.77. In addition, the case should be remanded for the trial court to determine (i) whether defendants are liable under Counts I, II, X, XI and/or XIII for defective construction of the duct work, and, if so, the amount of damages suffered by plaintiff, (ii) whether defendants are liable for multiple damages under Count XIII, and (iii) the amount of attorneys fees to which plaintiff are entitled for defendant’s violations of M.G.L. c. 93A. Finally, judgment for plaintiff should be affirmed on Count XII in the amount of $36,223, with the case remanded to the lower court to enter interest on $7,150 of the $36,223 judgment from January 1, 1982, $10,893 of the $36,223 judgment from July 1, 1982, $10,767 of the $36,223 judgment from July 1, 1983, $5,321 of the $36,223 judgment from July 1, 1984, and $2,090 of the $36,223 judgment from July 1, 1985.

BY PLAINTIFF/ APPELLANT/CROSS-APPELLEE’S ATTORNEY,

_________________________

Stephen Schultz, Esq.

BBO # 447680

Engel & Schultz, P.C.

125 High Street, Suite 2601

Boston, MA 02110

(617) 951-9980 (Tel)

(617) 951-0048 (Fax)

Date: ______________________

Brief to Massachusetts Supreme Judicial Court in Tax Appeal Challenging Constitutionality of Changing Capital Gains Tax in Middle of Year

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MASSACHUSETTS SUPREME JUDICIAL COURT

____________________

SJC – 09096

_____________________

E. JOEL PETERSON, CARL E. PETERSON, NAUTILUS MOTOR INN, INC., CYRIL GAUM, THOMAS WINKLER III, ALVIN KRAKOW, JOEL DUNSKY, VANGEL ZISSI, NOVAL REALTY, BETTY’S NECK FARM MASSACHUSETTS BUSINESS TRUST, BETTY’S NECK FARM, INC., IRIS H. CANNATA, LISA E. CANNATA AND TOWN AND COUNTRY REALTY, LLC.

Appellants/Plaintiffs

vs.

COMMISSIONER OF REVENUE

Appellee/Defendant

___________________________________

REPORT FROM THE

SUPREME JUDICIAL COURT

FOR SUFFOLK COUNTY

___________________________________

BRIEF OF APPELLANTS/PLAINTIFFS

E. JOEL PETERSON, CARL E. PETERSON, NAUTILUS MOTOR INN, INC., CYRIL GAUM, THOMAS WINKLER III, ALVIN KRAKOW, JOEL DUNSKY, VANGEL ZISSI, NOVAL REALTY, BETTY’S NECK FARM MASSACHUSETTS BUSINESS TRUST, BETTY’S NECK FARM, INC., IRIS H. CANNATA, LISA E. CANNATA AND TOWN AND COUNTRY REALTY, LLC.

____________________________________

Stephen Schultz, Esq.

BBO # 447680

Stephen M. Politi, Esq.

BBO # 402180

Engel & Schultz, P.C.

125 High Street, Suite 2601

Boston, MA 02110

(617) 951-9980 (Tel)

(617) 951-0048 (Fax)

Table of Contents

Statement of the Issues

Statement of the Case: Nature of Case,
Course of Proceedings & Disposition Below -1-

Statement of Facts -2-

Summary of Argument -8-

Argument -11-I.

SECTION 32 OF CHAPTER 186 OF THE STATUTES OF 2002, BY TAXING PLAINTIFFS’ LONG TERM CAPITAL GAINS REALIZED ON OR AFTER MAY 1, 2002 OF ANY TAXABLE YEAR BEGINNING ON OR AFTER JANUARY 1, 2002 AND BEFORE MAY 2, 2002 CONTRAVENES ARTICLE 44 OF THE CONSTITUTION OF THE COMMONWEALTH. -11-

Conclusion -19-

　Table of Authorities

CASES

Barnes v. State Tax Comm’n, 363 Mass. 589, 296 N.E.2d 510 (1973)-12-,-14-

Commissioner of Revenue v. Lonstein, 406 Mass. 92, 546 N.E.2d 157 (1989)-13-

Daley v. State Tax Comm’n, 376 Mass. 861, 383 N.E.2d 1140 (1978)-8-,-10-,-11-,-13-,-14-

Ingraham v. State Tax Comm’n, 368 Mass. 242, 331 N.E.2d 795 (1975)-12-

Massachusetts Taxpayers Foundation, Inc. v. Secretary of Administration, 398 Mass. 40, 494 N.E.2d 1311 (1986)-13-

Opinion of the Justices, 266 Mass. 583,(1929)
-13-,-14-,-15-

Opinion of the Justices, 425 Mass. 1201,681 N.E.2d 857 (1997)-1-,-9-,-10-,-12-

Salhanick v. Commissioner of Revenue, 391 Mass. 658, 661-664, 463 N.E.2d 1163 (1984)-8-,-13-

Tax Comm’r v. Putnam, 227 Mass. 522, 116 N.E. 904 (1917)-12-

Tax Equity Alliance v. Commissioner of Revenue, 423 Mass. 708, (1996)

-17-

Aronson v. Commonwealth, 401 Mass. 244, 516 N.E.2d 137 (1987)cert. denied, 488 U.S. 818, 102 L. Ed. 2d 36, 109 S. Ct. 58 (1988) -12-　

STATUTES

St. 2002, c. 186, § 6 -3-M.G.L. c. 62, § 2(b)(3)(1994)(St. 1994, c. 195, § 10)-4-

M.G.L. c. 62, § 4 -2-,-3-CONSTITUTIONAL PROVISIONS

Article 44 of the Amendments to the Constitution of the Commonwealth -1-,-8-,-9-

Section 14 of the Revenue Enhancement Act -2-

Section 32 of the Revenue Enhancement Act -3-

Whether Stat. 2002, ch. 186, § 32, violates Article 44 of the Amendments to the Constitution of the Commonwealth because it imposes different rates of taxation during the 2002 calendar year on income derived from the same class of property.

　

This is a case seeking a declaration that Stat. 2002, ch. 186, § 32, which makes the provisions in Stat. 2002, ch. 186, changing the taxation of capital gains taxes, effective on May 1, 2002 of any taxable year beginning on or after January 1, 2002 and before May 2, 2002, violates Article 44 of the Amendments to the Constitution of the Commonwealth.

A Complaint was filed in the Supreme Judicial Court for Suffolk County on or about March 25, 2003.

On July 2, 2003, plaintiffs filed a Motion to Report the Case to the Full Supreme Judicial Court, arguing that:

1. The facts in this case are not in dispute.

2. This case raises important constitutional issues.

3. The outcome of this case affects whether or not the plaintiffs must pay over $1.9 million in taxes and whether the Commonwealth can collect potentially millions of other dollars in taxes. It is not only in the plaintiff’s interest to receive refunds of such substantial tax payments as soon as possible, but it is also in the Commonwealth’s interest to know whether it must generate alternative revenue sources or make needed spending cuts as soon as possible.

On July 22, 2003, the defendant Commissioner of Revenue filed a Response to Plaintiff’s Motion for Report of Case indicating that he agreed with plaintiffs that the case should be reported to the Supreme Judicial Court for the Commonwealth.

On September 3, 2003, Justice Sosman reserved and reported the case without decision for determination by the Supreme Judicial Court for the Commonwealth.

On July 23, 2002, the House of Representatives and on July 24, 2002, the Senate in General Court enacted into law chapter 186 of the Statutes of 2002, a statute entitled “An Act Enhancing State Revenues” (hereafter “the Revenue Enhancement Act”). Section 14 of the Revenue Enhancement Act amended Mass. Gen. Laws ch. 62, § 4 to provide that Part C taxable income (hereafter “capital gains”) shall be taxed at the same rate as Part B income (hereafter “ordinary income”). In 2002, ordinary income was taxed at 5.3 %. G.L. c. 62, § 4.Section 6 of the Revenue Enhancement Act defined Part C income as “capital gain income which equals the gains from the sale or exchange of capital assets held for more than 1 year”. St. 2002, c. 186, § 6. Section 32 of the Revenue Enhancement Act (hereafter “the bifurcation clause”), which was added to then H.B. No. 5250 in conference committee, see State House News Service, July 16, 2002, appended to this Brief as Exhibit # 1, provides that sections 2, 6, 7, 8 and 14 of Stat. 186, “shall be effective for tax years beginning on or after May 1, 2002, and for the portion that begins on May 1, 2002 of any taxable year beginning on or after January 1, 2002 and before May 2, 2002.” St. 2002, c. 186, § 32.

Prior to the enactment of the Revenue Enhancement Act, Part C gross income was defined to include all Part C capital gains. Part C capital gains were long-term (i.e. more than one year) gains from the sale or exchange of capital assets (except collectibles) divided into six classes based on the holding period. Gains from the sale or exchange of capital assets held for more than one year but less than or equal to two years were taxed at a five (5) per cent rate. Gains from the sale or exchange of capital assets held for more than two years but less than or equal to three years were taxed at a four (4) per cent rate. Gains from the sale or exchange of capital assets held for more than three years but less than or equal to four years were taxed at a three (3) per cent rate. Gains from the sale or exchange of capital assets held for more than four years but less than or equal to five years were taxed at a two (2) per cent rate. Gains from the sale or exchange of capital assets held for more than five years but less than or equal to six years were taxed at a one (1) per cent rate. Gains from the sale or exchange of capital assets held for more than six years were not taxed. G.L. c. 62, § 2(b)(3)(1994)(St. 1994, c. 195, § 10).

The Revenue Enhancement Act, by taxing plaintiffs’ long term capital gains realized in the portion of the 2002 calendar tax year after May 1, 2002 at 5.3%, while not taxing long term capital gains realized in the portion of the 2002 calendar tax year prior to May 1 2002 at all or at a lower rate than 5.3%, imposes different rates of taxation on income derived from the same class of property in contravention of Article 44 of the Constitution of the Commonwealth. See Argument, infra, at 11.

Article 44 of the Amendments to the Massachusetts Constitution provides that taxes shall be levied at a uniform rate upon incomes derived from the same class of property. This Court has held on two different occasions that different timing in the acquisition or disposal of an asset cannot justify the imposition of different tax rates on different taxpayers. Salhanick v. Commissioner of Revenue, 391 Mass. 658, 661-664, 463 N.E.2d 1163 (1984); Daley v. State Tax Comm’n, 376 Mass. 861, 383 N.E.2d 1140 (1978). See Argument, infra, at 11-14.

In Opinion of the Justices, 425 Mass. 1201, 1204; 681 N.E.2d 857 (1997), the Court held that different classification of taxes must be based on differences in the “sources of income”. There is no difference in the “sources of income” of capital gains sold on April 30, 2002, and capital gains sold on May 1, 2002. See Argument, infra, at 14-15.

There is no difference in kind between a capital gain sale conducted on April 30, 2002, and a capital gain sale conducted on May 1, 2002. The amount of good judgment and business sagacity required to produce the income is no different in one case than in the other. See Argument, infra, at 15.

Permitting some taxpayers to pay one rate of taxation or no tax at all on the same kind of property for a tax year, while other taxpayers need to pay a different rate on the same kind of property for a tax year, is subject to the type of abuse which Article 44 is intended to prevent. In fact, the General Court did not add the bifurcation clause making May 1, 2002, the effective date of the Revenue Enhancement Act until it met in Conference Committee in July 2002, after a reported lobbying effort by one taxpayer who had sold a $100 million interest in his company in April 2002. See Argument, infra, at 16.

This Court has held on two occasions that it may weigh such factors as habitual practice, custom, or history in determining whether a statute violates Article 44. Opinion of the Justices, 425 Mass. 1201, 1207, 681 N.E.2d 857 (1997); Daley, supra at 866. The bifurcation provision of the Revenue Enhancement Act is unprecedented. A survey of thirty two occasions that the tax laws have been amended since its recodification in 1971 reveals that on no previous occasion has the General Court ever included a provision changing the taxability of income or the tax rate for only part of a taxable year. See Argument, infra, at 17.

Article 44 of the Amendments to the Massachusetts Constitution, ratified in 1915, provides:

Full power and authority are hereby given and granted to the general court to impose and levy a tax on income in the manner hereinafter provided. Such tax may be at different rates upon income derived from different classes of property, but shall be levied at a uniform rate throughout the commonwealth upon incomes derived from the same class of property. The general court may tax income not derived from property at a lower rate than income derived from property, and may grant reasonable exemptions and abatements. Any class of property the income from which is taxed under the provisions of this article may be exempted from the imposition and levying of proportional and reasonable assessments, rates and taxes as at present authorized by the constitution. This article shall not be construed to limit the power of the general court to impose and levy reasonable duties and excises.

The Supreme Judicial Court has upheld the authority of the Legislature to impose different tax rates by distinguishing (a) capital gains from dividends and interest, Tax Comm’r v. Putnam, 227 Mass. 522, 531, 116 N.E. 904 (1917); (b) interest paid on loans made by finance trusts from interest paid on loans made by pawnbrokers, Barnes v. State Tax Comm’n, 363 Mass. 589, 594, 296 N.E.2d 510 (1973); (c) interest earned on in-State bank deposits from that earned on deposits in out-of-State financial institutions, Aronson v. Commonwealth, 401 Mass. 244, 253-254, 516 N.E.2d 137 (1987), cert. denied, 488 U.S. 818, 102 L. Ed. 2d 36, 109 S. Ct. 58 (1988); (d) earned income from unearned (investment) income, Ingraham v. State Tax Comm’n, 368 Mass. 242, 247 n.3, 331 N.E.2d 795 (1975), and (e) money earned in a military retirement system versus money earned in other retirement systems, Opinion of the Justices, 425 Mass. 1201; 681 N.E.2d 857 (1997) .

By contrast, the Supreme Judicial Court has held classifications to be invalid that established different tax rates based on (a) the length of time that the income-generating property had been owned, Salhanick v. Commissioner of Revenue, 391 Mass. 658, 661-664, 463 N.E.2d 1163 (1984); (b) the timing of contributions to a pension fund, Daley v. State Tax Comm’n, 376 Mass. 861, 383 N.E.2d 1140 (1978); (c) the amount of the bank deposit on which interest had been paid, Commissioner of Revenue v. Lonstein, 406 Mass. 92, 94, 546 N.E.2d 157 (1989); (d) the total amount of income received by the taxpayer, Opinion of the Justices, 266 Mass. 583, 586-587, 165 N.E. 900 (1929); and (e) the taxpayer’s income, marital status, and filing status, Massachusetts Taxpayers Foundation, Inc. v. Secretary of Administration, 398 Mass. 40, 494 N.E.2d 1311 (1986).As noted above, two cases have found that different timing in the acquisition or disposal of an asset cannot justify the imposition of different tax rates on different taxpayers. Salhanick v. Commissioner of Revenue, 391 Mass. 658, 661-664, 463 N.E.2d 1163 (1984); Daley v. State Tax Comm’n, 376 Mass. 861, 383 N.E.2d 1140 (1978). In Salhanick, the plaintiff challenged the constitutionality of taxing her capital gains, which had been held for more than six months, at a higher rate than other capital gains which had been held for less than six months. The Court, concluding that different tax rates could not be applied to the sale of iron ore depending on whether the iron ore had been held for more or less than six months, held:

In either event, the royalties derive from holding the iron ore alone. The amount of good judgment and business sagacity required to produce the income is no different in one case than in the other. . . .[A]pproval of a classification of loans according to the distinct nature of the lenders does not connote approval of a classification of royalty income according to how long the taxpayer has held the underlying property. It simply cannot fairly be said that there is a difference in kind between iron ore that is owned for one period of time and the same iron ore that is owned for another period of time.

(emphasis added), supra at 664.

In Daley v. State Tax Comm’n, supra at 866, quoting Barnes v. State Tax Comm’n, 363 Mass. 589, 594 (1973), the Court held that properties are of the same kind unless there are “actual underlying differences” between them. In Opinion of the Justices, 266 Mass. 583, 586-587 (1929), the Court held that although different rates are permitted on income derived from different kinds of property, “nothing in the Amendment authorizes the classification of the owners of property or of taxpayers” for the purpose of establishing different tax rates. In Opinion of the Justices, 425 Mass. 1201; 681 N.E.2d 857 (1997), the Court held that [t]he classification must be based on differences in the ‘sources of income,’ not on characteristics of the property owners or taxpayers”. (citation omitted).

Plaintiffs do not challenge in this litigation the power of the General Court to change the rate of taxation on certain kinds of income for an entire tax year. However, permitting some taxpayers to pay one rate of taxation or no tax at all on the same kind of property for a tax year, while other taxpayers need to pay a different rate on the same kind of property for a tax year, is subject to the type of abuse which Article 44 is intended to prevent.¹This Court has held on two occasions that it may weigh such factors as habitual practice, custom, or history in determining whether a statute violates Article 44. Opinion of the Justices, 425 Mass. 1201, 1207, 681 N.E.2d 857 (1997); Daley, supra at 866.

As the result of the passage of the Revenue Enhancement Act, all of the plaintiffs have needed to or shall need to pay capital gain taxes in calendar year 2002, which they previously would not have needed to pay. Six plaintiffs have already paid $540,015 in capital gains taxes that they would not have needed to pay prior to passage of the Revenue Enhancement Act³. Peterson, E.J. Aff., ¶ 6, App. at 0036; Peterson, C. Aff., ¶ 4, App. at 0060; Zissi Aff., ¶ 7, App. at 0079; Dunsky Aff., ¶ 4, App. at 0097; Krakow Aff., ¶ 4, App. at 0117; Winkler Aff., ¶ 4, App. at 0142. It is estimated that the remaining four plaintiffs will need to pay approximately $1,378,693 in capital gains taxes that they would not have needed to pay prior to passage of the Revenue Enhancement Act. Gaum Aff., ¶ 4, App. at 0115; Cannata, I. Aff., ¶ 7, App. at 0161; Cannata, L. Aff., ¶ 4, App. at 0162; Decas Aff., ¶ 6, App. at 0163-0164. Significantly, all but two of the plaintiffs realized their capital gains after April 30, 2002, but before July 24, 2002, the day the Revenue Enhancement Act was enacted into law. Peterson, J. Aff., ¶ 3, App. at 0035; Peterson, C. Aff., ¶ 2, App. at 0060; Zissi Aff., ¶ 4, App. at 0078; Dunsky Aff., ¶ 2, App. at 0097, Gaum Aff., ¶ 2, App. at 0115; Krakow Aff., ¶ 2, App. at 0117; Winkler Aff., ¶ 2, App. at 0142; Decas Aff., ¶ 4, App. at 0163. But for the arbitrary bifurcation clause setting an arbitrary date after which certain taxpayers realizing capital gains prior to the passage of the act owed taxes, while other taxpayers realizing capital gains prior to the passage of the act did not owe taxes, these plaintiffs would not need to pay the close to two million dollars in taxes that they owe today.

For the reasons stated in this Brief, this Court should issue a judgment declaring that:

1. Taxing long term capital gains realized in the portion of the 2002 calendar tax year after May 1, 2002 at 5.3% while not taxing long term capital gains realized in the portion of the 2002 calendar tax year prior to May 1 2002 at all or at a lower rate than 5.3%, imposes different rates of taxation on income derived from the same class of property in contravention of Article 44 of the Constitution of the Commonwealth.

2. The commissioner shall not enforce any collection from the plaintiffs of any tax on long term capital gains realized in the portion of the 2002 calendar tax year after May 1, 2002 .

BY PLAINTIFFS’ ATTORNEYS,

________________________

Stephen Schultz, Esq., BBO # 447680

________________________

Stephen M. Politi, Esq.,

BBO # 402180

Engel & Schultz, PC

125 High Street

Suite 2601

Boston, MA 02110

(617) 951-9980

(617) 951-0048 (fax)

St. 2002, c. 186, § 32 -1-,-3-

Over $200 Million in Tax Rebates Result from Constitutional Challenge to Capital Gains Tax

admin — Tue, 10 Nov 2009 19:25:09 +0000

Taxpayers across Massachusetts continue to receive rebates as the result of Engel & Schultz’s successful constitutional challenge to the change in the capital gains tax rate in the middle of the calendar year 2002.

In the case of Peterson v. Commissioner of Revenue (Peterson I), Engel & Schultz successfully obtained a ruling from the Massachusetts Supreme Judicial Court ruling declaring that it was unconstitutional to make effective a change in the tax laws in the middle of the 2002 calendar year, thus, taxing some taxpayers, while not taxing other taxpayers, for the same types of transactions.

In response to Peterson I, the legislature passed a law purporting to treat all taxpayers the same, stating that all taxpayers owed capital gains taxes in 2002, but then exempting from that taxation those taxpayers who had already filed their tax returns and paid no capital gains tax for the year 2002. Engel & Schultz challenged the constitutionality of this new legislation. The Commonwealth sought to justify this new legislation by arguing that it was reasonable to exempt persons from taxation who sold their assets prior to May 1, 2002, under the doctrine of “reliance”. The Massachusetts Supreme Judicial Court, at Engel & Schultz’s urging, rejected this argument, and declared the new law, like the first law, to be unconstitutional.

Both houses of the legislature, in response to Peterson II, initially voted for bills which would have established January 1, 2002, as the effective date of the change in the capital gains tax laws, thus, providing rebates to no taxpayers. The governor, through his Commissioner of Revenue, initially argued for the constitutionality of the original tax law, and then requested the court to set January 1, 2002, as the effective date of the change in the capital gain tax.

In response, Engel & Schultz crafted a compromise, eventually adopted by the legislature, providing for a four year payout of the tax abatement, resulting in more than $200 million of tax rebates. Engel & Schultz partner Stephen Schultz was lead counsel in the case.

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