Online Agreements: Size Matters!

By: Robert Hawn, Esq.

I recently had the opportunity to speak on a panel at the State Bar of California Annual Meeting to discuss doing business online. As a technology lawyer practicing in the San Francisco Bay Area, I constantly advise clients on their online activities. One of the most common issues is creating terms of use, or terms of service, that are enforceable.

Many of us engage in day to day business online. Everything from ordering a shirt to buying the latest pop release are performed from our desktop, pad, or phone. As part of this, we often enter into agreements, often called terms of use, terms of service, or just licenses, which govern our activities. People like me want to make sure that these online agreements can be enforced.

For a long time, the court wrestled with the notion that providing sufficient notice of the terms under which someone could use a website would result in an enforceable agreement. So, if you want to make your online agreements are enforceable, you have to make sure you provide enough notice to make sure that someone knows they are entering into an agreement. Sounds simple, right?

Unfortunately, it’s not. Where trouble often occurs is in making sure the user knows they are entering into an agreement. The challenge faced in creating enforceable agreements lies not in the words that are used in the agreement, but, in many cases, the manner in which the user becomes aware of the agreement. This makes enforceability not necessarily a legal problem, but a website design problem. And this problem becomes even more acute when you are dealing with the reduced display of your average cell phone.

Two recent cases, each decided in July of this year and each dealing with the Uber ride service, illustrate the problem. In Cullinane v. Uber Techs., a Massachusetts court had to decide the enforceability of an online agreement to determine if a dispute had to be decided through arbitration. The court describes the account creation process as follows:

“below the credit card information input box, and above the keyboard, appear the words “By creating an Uber account, you agree to the Terms of Service and Privacy Policy”. . . . If a user clicks the button that says “Terms of Service & Privacy Policy”, the Terms of Service then in effect are displayed on the phone.”

In looking at the enforceability issue, the court went back to contracting basics: notice and consent. First, the court held that users were on notice. The language clearly says that “By creating an Uber account, you agree.” Second, the court held that, by clicking on the button, the users manifested intent.

By contrast is Meyer v. Kalanick, a New York case applying California law that was decided less than three weeks later. Same issue as in Cullinane, but different result. Why? Well, remember what I said about notice being important? Let’s look at the contracting process. On the screen where a user keyed in their credit card information, there was a “Register” button in the form of a banner spanning the entire screen. Underneath, in a size similar to the Register button, were buttons enabling payment by PayPal or Apple Wallet. The court goes on to say:

“Beneath these two buttons, in considerably smaller font, are the words “By creating a User account you agree to the “Terms of Service & Privacy Policy” …. “While the Terms of Service & Privacy Policy is in all caps, the key words “By creating a User account you agree to” are not in any way highlighted and, indeed, are barely legible…. A potential user may click on the Register button and complete the User registration process without clicking on the hyperlink.”

The court basically said because the notification of user account creation was “not in any way highlighted” and “barely legible”, the user was not put on notice they were entering into an agreement. Same language as the Cullinane case, but different result. The takeaway: Size Matters!

There are a number of other factors that lead to enforceability. Recent cases show, however, that the design of the contracting process is critical toward making online contracts enforceable.

Bob Hawn is a founding partner of Strategy Law, LLP in downtown San Jose, California. His practice focuses on emerging growth technology companies, technology licensing, angel and venture capital financing, business entity formation, corporate governance, mergers and acquisitions, and U.S. market entry. He speaks regularly on technology law related issues and was the 2014-15 Chair of the Business Law Section of the State Bar of California.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

California Conforms to New Tax Due Dates – Update your Agreements!

By: Tamara B. Pow, Esq.

On December 8, 2015 I published a blog about new federal partnership tax return filing deadlines . At that time, the IRS had just announced that partnership and S corporation returns will be due 2 ½ months after year end, or on March 15 th if the partnership is on the calendar tax year. C corporation returns will be due 3 ½ months after year end, or on April 15 th for calendar year corporations. California has now conformed to these due dates (AB 1775, Ch. 16-348). (Note: California has not conformed to the federal delay in changing the due date for C corporations with fiscal years ending on June 30 th .)

Federal extensions (based on requests) of time to file partnership returns have changed – from five months to six months, same as S corporations. C corporation extensions depend on the taxable year, with some being reduced from six months to five months. California (automatic) extensions of time to file may change as well from the current six months for partnerships and seven months for corporations to six months for both ( Spidell’s California Taxletter, Volume 38.10, p.4).

Don’t forget to update LLC operating agreements and LP and LLP partnership agreements, as well as corporate shareholder agreements if necessary to make sure the requirements are in line with these new deadlines. Often these agreements have particular time periods for management to provide tax reporting documents to owners, which may need to be changed. For example, the partnership tax return deadline for a calendar year partnership is now March 15 th . If your partnership agreement still says the managing partner shall prepare tax information by the 90 th day of the tax year, it should be changed to the 60 th day (or thereabouts) to meet the new requirements.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including limited liability company and other business entity formations, operations, transfers, conversions and dissolutions. Her tax background, including time as a tax consultant at Price Waterhouse, LLP, as well as her MBA and real estate brokers license help her stay apprised of these items when advising owners of LLCs and other business entities.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

LLC Operating Agreements – Failure to Contribute, Part II

By: Tamara B. Pow, Esq.

What do you do if your LLC needs capital and a Member fails to contribute their share?

The question of “What if the Company needs more money?” was addressed in Part I of this blog . If it is at all possible that the LLC will need additional funds in the future, the operating agreement should provide both for the right to borrow on prescribed terms from insiders, and the right to require members to contribute their share of the additional capital needed. This Part II addresses potential provisions to include in your LLC operating agreement to deal with the situation where the members are required to contribute additional capital and a member defaults in this obligation. The operating agreement can provide that either the managers or the non-defaulting members may elect one or more of the following remedies:

Advance the Funds for the Defaulting Member

The non-defaulting members may advance funds to the Company to cover those amounts which the defaulting member failed to contribute and then treat that sum as a loan to the defaulting member at a high interest rate (such as 10% per annum). The terms of the advance could include a mechanism for all cash distributions from the LLC that would normally go to the defaulting member to be paid to the advancing member instead until the advance, including interest, is paid in full. It is a good idea to include a form of promissory note as an attachment to your operating agreement if you plan to include this remedy. You may also want to provide that the defaulting member automatically grants a security interest in his or her membership interest to secure the promissory note.

Adjust Percentage Interests

Another alternative may be to simply adjust the percentage interests of the members after the additional capital contributions are made so that the defaulting member is diluted by the additional capital contributions of the other members. If you plan to use this remedy, your operating agreement should provide a formula or other methodology for adjusting the percentage interests so that an appraisal is not required.

Dissolve the Company

This may be considered the nuclear option. If a member does not contribute additional capital when required, the other members may simply not want to continue doing business with the defaulting member and can choose to dissolve the Company. This could be decided by a majority of the non-defaulting Members (or a supermajority, but not less than a majority of the LLC members), or by all of the non-defaulting Members. The method for dissolution should be set forth in the operating agreement.

Buy Out the Defaulting Member

The operating agreement can provide a right in favor of either the Company or the non-defaulting members to buy out the defaulting member’s membership interest. Terms and conditions should be set forth in the agreement. Because this is supposed to be a penalty for the defaulting member’s failure to contribute funds when needed, the purchase price could be less than fair market value as long as the discount is agreed to in advance (by inclusion in the operating agreement).

Preferred Distributions to Non-Defaulting Members

The operating agreement could include a provision giving non-defaulting members preferential distributions in the amount of their additional capital contributions plus a preferred return thereon so that the non-defaulting members get all of their additional contributions back plus more before the defaulting member gets any distribution.

Loss of Rights

A defaulting member could lose her voting and approval rights, either permanently or until the default is cured. A defaulting member could also lose her ability to participate in management or operations, as applicable, either permanently or until the default is cured.

There could be many other potential remedies depending on the type of business of the LLC. For instance, if the additional contribution required is actually for certain property or services by the member, the Company could choose to require the defaulting member to contribute cash equal to the fair market value of the property or services not contributed. Or the Company could simply require specific performance.

Regardless of which remedies are right for a particular LLC, it is critical that the options for enforcement be included in the operating agreement so that each member acknowledges and agrees that the remedies are fair and reasonable at the time the operating agreement is signed, well in advance of any default.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including limited liability company and other business entity formations, operations, transfers, conversions and dissolutions. Her tax background, including time as a tax consultant at Price Waterhouse, LLP, as well as her MBA and real estate brokers license help her spot issues like these when advising owners of LLCs and other business entities.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Strategy Law is sponsoring C2SV

Strategy Law is proud to be a sponsor of Creative Convergence Silicon Valley (C2SV) , a cutting edge conference bringing together business disrupters and technology luminaries along with established and emerging musical artists for two days of forward looking discussions and three nights of music and parties. C2SV is taking place this weekend (October 6-8) in Downtown San Jose.

LLC Operating Agreements – Failure to Contribute, Part I

By: Tamara B. Pow, Esq.

Don’t get caught with an underfunded LLC. Plan ahead in your LLC Operating Agreement.

The question of “What if the Company needs more money?” is often not addressed by an LLC until it is too late, the LLC is in need of cash, and has no ability to borrow and no way to force the members to contribute additional funds. This issue could arise in an operational business limited liability company of any type due to cash flow needs. It can also arise in real estate limited liability companies where the members fund the company initially to provide capital to purchase the real estate, and then additional funds are needed later for capital improvements, repairs, or even operating cash if the tenants leave or are not paying their rent. If the members of an LLC unfortunately used some standard form of LLC agreement found online or copied from a friend, the agreement is probably silent on this matter.

Although investors generally do not want to enter into an agreement whereby they can be forced to contribute additional funds, LLC managers do not want to have their hands tied when a cash flow situation arises. Providing for members to make additional capital contributions is especially common in closely held and family entities, where the intent is not to allow for additional outside investors. Here are some ideas to consider when drafting your LLC operating agreement, to make sure you have a plan to deal with cash flow crunches.

The Right to Borrow from Insiders:

The biggest problem arises when the Company cannot force the members to contribute additional cash and also cannot obtain financing from a third party or institution. In this case, it is incredibly helpful to have a provision in your operating agreement providing for the managers to act on behalf of the Company to authorize a loan from a manager or member to the Company on reasonable pre-agreed terms. In particular, this provision should spell out what interest rate is considered acceptable, and that interest rate should be high enough to entice the manager or member to loan to the cash-strapped LLC. The operating agreement should also set forth the rules for paying back the loan, and whether it must be paid in full before any distributions may be made to members. Keep in mind that members are taxed on profits of the LLC, not distributions they receive, so you may want to provide for minimum tax distributions for the members while the loan is being paid down.

Default:

If no manager or member wants to loan funds to the Company, and the LLC operating agreement provides that members must make additional capital contributions in certain circumstances (usually either by the majority vote of the members, or a decision by the managers), then the operating agreement should clearly state that a failure to contribute such funds is a default by that member. Usually the agreement provides for the managers to give written notice to the defaulting members, with a period of time during which the member can cure the default by making the required capital contribution. However, the agreement must also provide options for the managers or the Company to take action once it is clear the member is in default.

Several options for dealing with a member default for failure to contribute capital are covered in part II of this blog.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including limited liability company and other business entity formations, operations, transfers, conversions and dissolutions. Her tax background, including time as a tax consultant at Price Waterhouse, LLP, as well as her MBA and real estate brokers license help her spot issues like these when advising owners of LLCs and other business entities.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.