Negative Covenants in Loan Agreements – Think Through What You Really Want To Add

By: Serge Filatov, Esq.

When documenting a loan, lenders often have to determine which negative covenants they want to add to their loan agreement. Before determining which negative covenants to add, it is important to understand the purpose of negative covenants.

What Are Negative Covenants?

Negative Covenants are restrictions in a loan agreement which are inserted for the following reasons: (i) to help establish guidelines for business operation, (ii) assess continued creditworthiness, (iii) identify problems before an event of default occurs, and (iv) ensure that the borrower can repay its loans to the lender.

What are examples of Negative Covenants? Examples of commonly used negative covenants include the following:

Indebtedness Limitations . These provisions restrict the ability of the borrower to take on additional debt other than the loans made under the loan agreement. The purpose of such a covenant is to ensure that the borrower does not take on more debt than it can repay and to restrict the borrower from having other creditors who will compete for repayment.

Lien Limitations . These provisions restrict the borrower’s ability to encumber any of its assets other than the lien put on by the lender or other approved third parties. The provisions protect lenders against other creditors by restricting who can be a secured creditor.

Fundamental Change Limitations . These provisions restrict the borrower’s ability to enter into any transactions that fundamentally change the borrower’s business, such as mergers, sales of substantially all of the borrower’s assets or liquidations. The restrictions ensure that the borrower maintains the same business during the life of the loan and that the borrower does not incur indebtedness or become subject to liens as a result of a transaction such as a merger.

Material Agreement Change Limitations . These provisions often restrict the borrower from amending the terms of any material agreements, such as a sales contract with a significant customer or borrower’s underlying governing documents. The restrictions helps ensure borrower continues to maintain a business which is similar to the business that existed at the time when the lender made its credit decision about the borrower.

Sale of Asset Limitations . These provisions restrict the borrower’s ability to sell, transfer or dispose of its assets outside of the ordinary course of its business. The restrictions ensure that the borrower’s assets remain substantially the same during the life of the loan. This is especially important for loans which are collateralized by the borrower’s assets.

Equity Payment Limitations . These provisions restrict the borrower from making payments to its equity holders, for example including making any distributions and equity redemptions or repurchases of the borrower’s equity. The restrictions ensure that the borrower will repay the lender prior to making payments to its equity holders.

Investment Limitations . These provisions restrict the borrower’s ability to make investments, including any loans, advances, equity purchases, note purchases, and asset acquisitions. The restrictions help ensure that the borrower will use its cash to pay down its debt to the lender rather than using it for investments.

Affiliate Transaction Limitations . These provisions restrict the borrower from entering into transactions with affiliates, or require that any such transactions are at least on an arm’s length basis and on terms no less favorable to the borrower than it could obtain if the transaction was with a third party. The restrictions help ensure that the borrower does not transfer its assets to a party which is not part of the loan and also ensures that the borrower does not enter into sweetheart deals which are not favorable to it.

Capital Expenditure Limitations . These provisions restrict the borrower from making capital expenditures, usually not exceeding a certain amount in any fiscal year. Since the funds used to make the capital expenditures could otherwise be used to repay the loan, lenders often put in restrictions to limit cash flowing out of the borrower.

Prepayment Limitations . These provisions often restrict the borrower from prepaying its loan early. Sometimes prepayments are not allowed at all while other times lenders will allow prepayments but will add prepayment penalties if a borrower tries to repay principal early. These restrictions help ensure that the lender will meet certain earnings targets on the loan.

Material Adverse Effect Limitations . These provisions often are used as default triggers so that if a borrower suffers any change which could cause a material adverse effect to its business, it is automatically in default under the loan. The provisions are often broad and provides the lender a catch-all provision to use in a problem loan scenario.

The above list of negative covenants is just a sample of the various restrictions that can be used to protect a lender. Additionally, each of these covenants can be written with exceptions and carve outs to accommodate a borrower based on a borrower’s unique situation.

If you are an institutional lender, don’t just rely on “stock” covenants. If you are a private lender, think hard about whether you want to add covenants to your loan. Either way, carefully consider what restrictions you want to put on the borrower based on the borrower’s risk profile and use restrictions that work for the specific deal.

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.

Reverse Veil Piercing: Another Reason to Pay Your Bills

By: Tamara B. Pow, Esq .

A recent California Court of Appeals case ( Curci Investments, LLC v. Baldwin ) means California LLC assets could be at risk for a member’s personal liability. Baldwin borrowed $5.5 million from an investment firm, as a predecessor to Curci Investments Inc. (“Curci”). Fast forward three years to the due date and Baldwin does not repay his debt. Curci files a lawsuit to collect the debt, but agrees to stipulate to an extension to allow Baldwin to pay his debt over time. At the end of that extension in 2012, Baldwin still does not pay back the investment firm, so the trial court in California files an Entry of Judgment against Baldwin for $7.2 million, including prejudgment interest and attorney fees and costs. In 2014, Curci files a motion seeking charging orders against some of the business entities that Baldwin may have invested in or been involved in some way. The court grants this motion for 36 entities which then made no distributions. The court then rules against Curci when Curci tries to access Baldwin’s assets through Baldwin’s LLC, in what is known as “reverse veil piercing.” The court was concerned with the possibility of harming innocent shareholders and corporate creditors, allowing judgment creditors to bypass standard judgment collection procedures, and using an equitable remedy when legal remedies are available. Most of all, however, the court ruled against Curci because it believed that reverse veil piercing was not available in California.

Here is the interesting part. Baldwin had previously formed and held interests in hundreds of corporations, partnerships, and LLCs, 36 of which were included in Curci’s motion seeking charging orders. The business in question is JPBI LLC, a Delaware LLC used for the exclusive purpose of holding and investing Baldwin and his wife’s cash balances. From 2006 to 2012, JPBI distributed roughly $178 million to Baldwin and his wife, (during which time Baldwin borrowed money, agreed to the stipulation to extend the date to pay the investment firm and was ordered by the court to repay Curci). To top it all off, Baldwin owned 99% of JPBI LLC, while his wife owned the remaining 1%.

All of that would mean nothing, however, without the applicability of reverse veil piercing, the inverse of traditional veil piercing. The trial court thought it to be unavailable in California, based on the decision of another case, Postal Instant Press, Inc. v. Kaswa Corp. (2008), which ruled that the veil of a corporation could not be pierced under certain conditions. However, in the timely appeal filed by the plaintiff, the California Appeals Court was able to differentiate that case from this one, ultimately remanding the case back to the trial court, with instructions to determine whether JPBI’s veil should be pierced. While the Appellate Court did not rule whether JPBI’s veil should be pierced, it did make clear that reverse veil piercing, which is the act of a collector satisfying the debt of an individual through the assets of an entity of which the individual is an insider, is available in California for several reasons:

First, the facts of this case allay any concerns the trial court had based on the previous case. Since Baldwin and his wife owned the entire company, and were in charge of when JPBI distributed money, there were no innocent shareholders involved. Additionally, Curci explored all avenues, and pursued other legal remedies, before filing the motion seeking charging orders. This satisfied the court’s concern that creditors bypass standard judgment collection procedures or other legal remedies.

Second, the previous case applied only to corporations, whereas JPBI is an LLC. Per the trial court, in reading the decision from the previous case, “A third party may not pierce the corporate veil to reach corporate assets to satisfy a shareholder’s personal liability.”

Third, Corporations Code § 17705.03, which Baldwin had used to argue his case, was read by the Appellate Court as the exclusive remedy for reaching the judgment debtor’s “transferrable assets,” not referring to his LLC’s assets.

Fourth, the Revised Uniform Limited Liability Company Act, from which the previous statute came from, included comments that the charging provisions “were not intended to prevent a court from effecting reverse veil piercing where appropriate.”

Next the trial court will have to determine whether Curci can in fact pierce JPBI LLC’s veil to use Baldwin’s assets to satisfy his debt. The court will have to determine this by evaluating the same factors that are applied in a traditional veil piercing case, as well as whether Curci has any plain, speedy, and adequate remedy at law.

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.

By Reading This Blog, You Are Agreeing To…

By: Robert V. Hawn, Esq.

How many times have you registered or signed up for something online and came across a Terms of Service agreement? The answer is a lot, because vendors want to make sure we agree to their terms before providing a product or service. These days every app we use, every service we enroll in online, and every time we make a one-time online purchase, we are made to enter information about ourselves and our credit card before clicking that button that completes the entire process. And that process almost always comes with some form of notice warning that by clicking that button, you agree to the “Terms and Conditions”.

Whether these terms are enforceable or not depends, in large part, on whether they are conspicuous on the site and whether the user is required to agree to them before getting the product or service ordered. Meyer v. Uber Technologies, Inc. , decided by a Federal Appeals Court in August of this year, illustrates the need for properly designing the process by which the user agrees to terms. Although the case was heard in New York, it was decided under California law.

The plaintiff filed a class action lawsuit against Uber, specifically former CEO Travis Kalanick, although Uber was later joined as a defendant, in the U.S. District Court for the Southern District of NY. The plaintiff alleged that Uber’s ride-sharing application allowed drivers to illegally fix prices individually. The defendants filed a motion to compel arbitration under Uber’s Terms of Service agreement. On appeal, the defendant argued that the Terms of Service was unenforceable.

The primary issue around enforceability was whether the Terms of Service was visible and noticeable enough, or reasonably conspicuous, so that the user knew it was entering into an agreement. If so, the agreement will be enforced against the user even if the user didn’t read the agreement. “While it may be the case that many users will not bother reading the additional terms, that is the choice the user makes; the user is still on inquiry notice,” wrote Judge Chin in the decision of this case.

Although the determination of whether the Terms of Service is “reasonably conspicuous” requires considering many factors, the analysis focuses primarily on the design of site where the contract is formed. The three appellate judges reviewed the screen size of the plaintiff’s Samsung Galaxy S5 and how the screenshot of the final step of the registration process appears on that screen, the presence of words and other things in close proximity to the “agree” button, and the appearance, location, and interpretive function of the agree button itself. “Clarity and conspicuousness are a function of the design and content of the relevant interface,” wrote Chin.

The court noted a number of aspects of the design. To open an account, a user must click a button marked “Register”. Underneath this button, the screen states “By creating an Uber account, you agree to the TERMS OF SERVICE and PRIVACY POLICY,” with hyperlinks on them, which the user can click if they want to enjoy a little light reading. The court noted that payment screen was uncluttered. There were only fields for the user to enter his or her credit card details, or a button to click in order to use different payment options, and a warning that the user was agreeing to terms when clicking “Register.” The entire screen is visible on one page, with very little scrolling required and no additional pages to review before creating the account. The warning itself is in small font, but is also in bold font, with the hyperlinks in light blue and underlined. As a result, the Court ruled that the design of the screen, and the language used, was reasonably conspicuous.

Notwithstanding, Meyer declared that he was not on actual notice of the hyperlink, that when he was signing up he was not aware of the existence of the Terms of Service. There is no evidence that Meyers had actual notice of the Terms of Service, and the defendants did not point to any evidence from which a jury could infer otherwise. According to Judge Chin, however, California contract law measures assent by an objective standard that takes into account both what the person or entity seeking service said, wrote, or did, and the transactional context in which the person or entity verbalized or acted. California contract law is clear that “an offeree, regardless of apparent manifestation of his consent, is not bound by inconspicuous contractual provisions of which he is unaware, contained in a document whose contractual nature is not obvious.”

Using California’s concept of measuring assent by an objective standard, Judge Chin introduces the notion of a reasonably prudent smartphone user: “Precedent and basic principles of contract law instruct that we consider the perspective of a reasonably prudent smartphone user”. Because of the nature of the design of the contract formation process, the Appeals Court held that “a reasonably prudent smartphone user would understand that the terms were connected to the creation of a user account.” Even if a reasonably prudent user was indeed not aware of the conditions that would be set forth by their clicking of a button, the court held that the user would be “still bound if a reasonably prudent user would be on inquiry notice of the Terms of Service.”

In explaining his decision, Judge Chin further observed “inasmuch as consumers are regularly and frequently confronted with non-negotiable contract terms, particularly when entering into transactions using the internet, the presentation of these terms at a place and time that the consumer will associate with the initial purchase or enrollment… from which the recipient benefits at least indicates to the consumer that he or she is taking such goods or employing such services subject to additional terms and conditions that may one day affect him or her.”

In holding for the defendant, the Appeals Court noted that the “registration process allowed Meyer to review the Terms of Service prior to registering, included a reasonably noticeable hyperlink, and expressly warned the ‘reasonably prudent smartphone’ user that by creating an Uber account, the user was agreeing to be bound by the linked terms.”

This case is very helpful for operators of ecommerce websites, particularly those in California, because it clearly outlines the design parameters required of a website enabled contract formation process. For those creating click through agreements, these guidelines are invaluable.

Big Changes Are Happening to California Tax Law

By: Tamara B. Pow, Esq.

As of July 1 st , important changes are now being implemented regarding the administrative side of California tax law. The state Legislature has restructured the Board of Equalization (BOE) into three separate entities: the BOE, the California Department of Tax and Fee Administration (CDTFA), and the Office of Tax Appeals (OTA). This change is a result of the recently enacted Taxpayer Transparency and Fairness Act of 2017, signed into law by Governor Jerry Brown during the last week of June.

The reason for this new look, as described in the bill itself, came from a review by the Attorney General, the California State Auditor’s Office, and the State Personnel Board, which determined that the BOE’s workplace culture and practices severely hindered its ability to report exact and reliable information to the public, the administration, and the state Legislature.

Under the new law, the CDTFA will assume the BOE’s administrative and regulatory duties for managing programs involving sales and use taxes, and other business taxes and fees. The CDTFA will be housed within the Government Operations Agency, where the BOE used to be operated, and taxpayer and fee payer account information services and deadlines will remain the same until further notice. Governor Brown has appointed David Botelho, of San Leandro, as the Acting Director of the CDTFA. The BOE, on the other hand, will continue to administer property taxes, alcoholic beverage taxes, and insurance taxes as an independent agency.

The other important change is the creation of the OTA, which will hear tax appeals from the Franchise Tax Board, the BOE, and other tax collecting agencies. The OTA, which will be formed as an independent entity, has also been established as of July 1 st , 2017, but will not begin full operation and hearing appeals until January 1 st , 2018. In the meantime, a Director for the organization will be appointed from within the OTA and the governance structure will need to be established. Stakeholder meetings will be scheduled as the OTA takes form and prepares to take over cases for which the BOE will no longer have jurisdiction after December 31, 2017. The OTA will set up numerous three-member panels of Administrative Law Judges to hear tax appeals in Sacramento, Fresno, and Los Angeles. The number of panels set up within each city will depend on the volume of cases occurring in each geographical location.

More transition information can be found for the new department on its website, and on .

Cannabis Cash – Green Industry’s Troubles with Greenbacks

By: Robert Hawn, Esq.

Being a business lawyer in Silicon Valley, I have seen new industries develop and bloom overnight. Last November, California voters created the State’s newest green industry by adopting the Control, Regulate and Tax Adult Use of Marijuana Act of 2016. The initiative is California’s attempt to follow the leads of Colorado and Washington and allow for the recreational use of cannabis. Although voters were certainly motivated by reasons other than revenue, the pro-use campaign argued that cannabis taxes could contribute to the state’s coffers.

The problem with cannabis is that while states have legalized medical, and increasingly, recreational use, the federal government continues to characterize cannabis as a Schedule 1 drug. This means that cannabis is included in a category that includes such drugs as heroin, Quaalude, and GHB (often referred to as the “date rape” drug). These types of drugs are thought to be so dangerous and lacking in medical efficacy that federally licensed, or chartered, institutions can’t have anything to with them. These institutions include banks, whether they exist on the national level, or for the benefit of a small community on Main Street. As a result, banks cannot process any payments that arise out of the sale of cannabis. It is no surprise that much of the cannabis business, whether you are a purchaser or a business advisor, is done in cash.

So, what is a law abiding grower in the Emerald Triangle (the name used for the growing regions within Mendocino, Humboldt and Trinity Counties) to do? The poor grower can’t just write a check to pay their taxes. Banking large amounts of cash when you are trying to pay taxes is often impossible due to bank reporting requirements concerning cash deposits. The amounts required to be paid are not insignificant. It was recently reported by the general counsel of the California Cannabis Industry Association that some cannabis businesses can run up tax bills of up to $1,000,000. What’s worse, cultivation often occurs in rural areas, far from the government infrastructure and agencies that can accept large amounts of cash payments. Transporting large amounts of cash is not only inconvenient, it can be conspicuous and subject a poor farmer to theft or worse.

California has recently sought to address these concerns. Senate Bill 148, the Cannabis Safe Payment Act, introduced by Senators Wiener and Atkins, seeks to allow county agencies to collect cash tax payments on behalf of the State. The bill specifically authorizes the State Board of Equalization, or a country agency, to collect cash payments owed by a cannabis-related businesses to a state agency that administers any fees, penalties, or other charges for these types of businesses. This allows the green business person to make their payments at their local county office without having to schlep thousands of dollars of greenbacks to the appropriate state office in a major urban area or Sacramento. As State Board of Equalization Fiona Ma said recently in a prepared statement, “Driving around the State with bags of cash is not the safest method of paying your taxes, but it’s generally the only way the cannabis industry can pay what they owe until we can bank the industry.”

The take away from all of this is that the State, and the movers and shakers of California’s newest legal industry, will be constantly searching for solutions to solve the cash management problem faced by cannabis businesses. It is likely the legislature will do everything it can to make tax payment easy. The final solution, however, to the cash problems facing the industry will remain elusive until a suitable banking structure is found which circumvents existing federal restrictions.

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.

Crowdfunding: Are you the Right Investor?

If you have always wanted to invest in a start-up business , whether a high tech emerging growth company or a low tech products company, you have no doubt heard of the new SEC rules allowing crowdfunding. Part of the excitement comes from being able to make investment opportunities available through crowdfunding internet portals, and part of the excitement comes from more relaxed investor standards. Let’s take a look at the new regulation, which the SEC has title “Regulation Crowdfunding”. You can find it at . My last blog regarding crowdfunding ( click here to read ) focused on the requirements for an issuer. In this blog, I’ll focus on the requirements concerning investors.

Crowdfunding is generally thought of as the use of the Internet by small companies to raise modest amounts of funds from investors. The new regulation allows investments to occur online. Only a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority (“FINRA”) or other national securities association registered with the SEC, however, is allowed to offer and sell securities to the investing crowdfunding public. A company can’t offer a crowdfunding opportunity directly. To see if a broker-dealer is properly registered with FINRA, check , and to check if a portal is properly registered under FINRA, check .

Although Regulation Crowdfunding relaxed investor suitability standards, some still exist. The standards limit the amount that can be invested. During any 12 month period, an investor can invest up to:

  1. the greater of either $2,000 or 5% of the lesser of the investor’s annual income or net worth IF the investor’s annual income or net worth is less than $100,000; or
  1. up to 10% of the investor’s annual income or net worth, whichever is less, but not to exceed $100,000, IF both the investor’s annual income and net worth is each more than $100,000

There are some important caveats when looking at these limitations, and investors should familiarize themselves with these limitations through their own research or discussion with their advisors. First, net worth can NOT include the positive value of an investor’s personal residence. An investor can, however, include the income or net worth of an investor’s spouse even if the income or net worth is not jointly owned. Second, if the investor consolidates his or her spouse’s income or net worth to satisfy the above criteria, the investment amount limitations are still determined based on the individual investor’s income or net worth.

Investors need to be careful. Crowdfunded securities are not like public company stock. There are limits on reselling crowdfunded securities. An investor may not sell these securities for one year after purchase except to the original issuer, to an accredited investor, as part of a registered public offering, to a family member or trust created for the benefit of a family member, or in connection with the death or divorce of the purchaser. Each of these classes of persons have specific definitions under the securities laws. Although Regulation Crowdfunding doesn’t state this, transfers of the crowdfunded securities after the one year holding period can’t be done unless the transfer complies with applicable federal and state securities laws. Because of this, crowdfunding securities will be extremely illiquid. Investors will have to be prepared to hold the stock indefinitely, or at least until the issuer goes public or is sold to another company in exchange for cash or publicly tradeable securities.

Crowdfunding provides opportunities for both issuers and investors. Investors needs to carefully evaluate the risk of investing in the issuer, and need to be prepared to hold their investment for a long period of time, or lose it altogether.

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.

New California LLC Statement of Information Forms – Don’t be caught unaware!

By: Tamara B. Pow

Will your LLC be suspended for failure to file the Statement of Information because you use an outdated form?

In May of 2016 the California Secretary of State published a new form of Statement of Information for Limited Liability Companies (LLCs) . Filing the correct form, on time, is critical if you don’t want your LLC to be suspended.

The Secretary of State does not revise its forms often, but when it does, it is critical that business owners be made aware of the changes and file the correct forms. The Secretary of State will reject outdated forms, potentially causing delays and additional expenses. In May of 2016 the California Secretary of State revised the LLC Statement of Information form which had been in use since January of 2014. Here are some things you should know about LLC Statement of Information Requirements and the new forms:

  • There are two different LLC Statement of Information Forms – the LLC-12 for the initial filing and follow up filings that include changes to the last filing, and the LLC-12NC form which is a much more simplified form for LLCs that need to satisfy the filing requirement but do not have any changes to make to the information on the previous filing.
  • The new LLC-12 only has room to list one manager or member. If the LLC is managed by more than one manager or member, the LLC must include attachment pages.
  • You should always obtain a copy of the filed Form LLC-12 when you file it. The cost of obtaining a copy of the face page is $1.00, plus each attachment page increases the cost by $0.50.
  • The initial filing is due 90 days after the entity’s registration date.
  • The periodic filing is due every two years based on the LLC’s registration date. If the LLC was registered in an even year, it is due the next even year. If it was registered in an odd year, it is due the next odd year. The filing period includes the month of registration plus the immediately preceding five months.
  • The filing fee is $20. There is no fee to file a Statement of Information outside the normal filing period in order to update information changes for the LLC, such as changes to the address or the agent for service of process.
  • The Agent for Service of Process listed on an LLC’s Statement of Information should be aware their name and address is a public record, open to all, and listed on the Secretary of State website. The addresses of the LLC, and its managers or members listed in the filing are also public record.
  • The form can be rejected if the details are not correct. Make sure the company name, filing number, jurisdiction and other details are exact, including each comma.
  • The penalty for failing to file a Statement of Information by the due date is $250.00.
  • You can mail the form to the Secretary of State for filing, but if you need proof of filing any time soon, you should deliver it in person to the Sacramento office. To avoid the trip to Sacramento, the company can send the form and the check for copies to a filing agent in Sacramento to delivers it on the LLC’s behalf.

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 formations, operations, sales, conversions and dissolutions. Her consistent and extensive work with LLCs keeps her up to date when advising owners of LLCs and other business entities of Secretary of State updates and other changes in the legal requirements of maintaining business entity liability protection.

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.

Crowdfunding – Is this the deal for you?

By: Robert Hawn

If you are an emerging growth high technology start-up , or a closely-held small business, you’ve heard of crowdfunding. Crowdfunding is commonly used to describe an approach to fund raising over the internet, often characterized by small investment amounts by large numbers of people. Recently, the Securities and Exchange Commission enacted its Regulation Crowdfunding. You can find all 685 pages of the release discussing the Regulation, and the Regulation itself, at . In this blog, we’ll focus on the requirements concerning issuers.

Under the Regulation, an issuer can raise a maximum of $1,000,000 through crowdfunding in any 12-month period from any person. The offering can’t be conducted by your company directly, however. Instead, it has to be conducted through a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority, or FINRA, or other national securities association registered with the SEC. To see if a broker-dealer is properly registered with FINRA, check , and to check if a portal is properly registered with FINRA, check .

There are some eligibility requirements that can disqualify an issuer. These include, among others, companies that don’t have a specific business plan (or whose plan is to engage in a merger or acquisition with an unidentified company), issuers that violate so called “bad boy” rules, and companies that have failed to satisfy annual reporting required by Regulation Crowdfunding.

One major requirement facing issuers under the Regulation is the need to prepare a disclosure statement. Although not as extensive as the type of statement required for an SEC registered offering, the requirements are significant. Items that must be disclosed pertain to the offering itself as well as the issuer. Offering related items include, among other things, the desired amount of the offering, the deadline for reaching it, whether investments over the desired offering amount will be accepted, the price of the securities, how the proceeds will be used, and material risks associated with the investment. Issuer related items include, among other things, a description of the business and its financial condition, information about 20% owners, members of the Board of Directors of the issuer, and officers, information concerning transactions between the issuer and related parties, and a description of the issuer’s ownership and capital structure.

The disclosure statement must also include financial statements prepared in accordance with generally accepted accounting principles as applied in the US. The financials must cover the shorter of the immediately preceding two fiscal years or the period since inception. The review the financials have to undergo depends on the amount of the offering:

  • If the current offering plus previous offerings under the Regulation are $100,000 or less, the financials must be certified by the principal executive officer and accompanied by certain information from the issuer’s tax returns (but need not include the tax returns themselves.
  • If the current offering, plus previous offerings under the Regulation, are more than $100,000 but less than $500,000, the financials must be reviewed by a CPA.
  • If the current offering, plus previous offerings under the Regulation, are over $500,000, the financials must be audited. If, however, the issuer has not previously sold securities in reliance under the Regulation, the financials must be reviewed by a CPA.

Keep in mind that there are no exceptions to these requirements, even for very early stage companies. So, if your company has just been formed, and you want to raise over $500,000, you’ll need to provide audited financials.

The amount the issuer can sell to an individual investor is limited. My next blog will discuss the specific investor limitations.

Advertising the offering is, not surprisingly, very limited. An issuer can publish a notice advertising the offering terms similar to “tombstone” ads. The notice must include the address of the funding portal or broker-dealer who is assisting with the offering.

In addition to the initial disclosure documentation, an issuer must file annual reports with the SEC and provide them to investors. The annual reports must contain much of the same information required under the initial disclosure document. Once the issuer becomes a reporting company under the Exchange Act, there is no further need to provide the annual reports required by the Regulation. The rules under which a crowdfunding issuer becomes subject to the reporting obligations under the Exchange Act have been relaxed if the issuer is current on its annual reporting obligations, uses a registered transfer agent, and has less than $25 million in total assets.

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.

Business Contracts – Beware of Third Party Beneficiaries -They May Not Be Missing Persons

By: Robert Hawn

As a business attorney with a Silicon Valley practice, I create a lot of contracts for many different kinds of companies. It never gets boring! One of the issues we sometimes worry about is whether there are any other parties that might have rights under these contracts. This concept, which lawyers refer to as a “third party beneficiary right,” is often disclaimed in the agreement. Job done, right? Well maybe not.

In January of this year, a Ninth Circuit Court of Appeals looked at whether third party rights exist where they have been expressly disclaimed in an agreement and decided that, the facts need to be examined further. Whether this case will expand third party rights, or will just be limited to its particular facts, remains to be seen. It does, however, caution business people to make sure of the deals they cut so that only the parties with whom they deal with in the contract will be the parties they have to deal with in court if the deal goes sideways.

For you fans of 80s Rock, this case involved the lead singer of the band, Missing Persons. The facts, however, are not just a simple case of walking in L.A., so pay attention.

Dale Bozzio, the lead singer of the band, brought suit against Capitol Records, and its corporate parent, EMI, to collect royalties based on what was argued to be a mischaracterization of the source of the record company’s revenue for the band. Like many bands, Missing Persons had created a “loan-out corporation.” This is a corporation that is used to cut deals with, among others, record companies. Under the contract, Bozzio, along with her other band mates, agreed that they would not bring any claims for royalties individually against the record company, but only against the loan out corporation. Problem was, the corporation was suspended when the band broke up and therefor had no standing to sue. So, a lower court looked at the contract and said no corporation, no lawsuit, and besides you agreed not to sue, so go away. Bummer. Bozzio appealed.

The Ninth Circuit looked a bit closer at the contract, and said not so fast. To make a long song into radio format, the Ninth Circuit looked at some other parts of the law and the contract and said that Bozzio could have her day in court. They were swayed by prior case law that seemed to imply that the fact that the corporation could not sue did not necessarily mean that someone claiming third party beneficiary rights under that corporation could not sue. They were also swayed by a clause, presumably created to protect the record company, that said that if the loan out corporation could not provide Bozzio’s services, that she would provide them directly. In addition, the Agreement provided for royalty payments individually under certain circumstances, which allowed the court to conclude that the record company may have accepted the concept of individual rights for Bozzio under the agreement, and that her standing as a third party beneficiary of the loan out corporation’s rights against the record company existed, notwithstanding her promise not to sue the record company directly.

So what is the takeaway? First, just excluding a person as a third party beneficiary might not do the trick. You need to look and see if there are any other provisions affecting those shareholders that might allow them to assert rights sufficient to allow them to sue you. This case is particularly interesting because a clause that was, in my opinion, created to help the record company (i.e., the clause that allowed the record company to get Bozzio’s services when the loan out corporation would not provide them) was used against the record company. Second, and probably most important, you need to keep in mind that the law in this area is fuzzy and fact dependent, and you have to consider these types of rights as you evaluate the risk of any deal.

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.

Doing Online Business With Europe? New Shield to Replace Your Safe Harbor?

By: Robert Hawn

As a business attorney practicing in the San Francisco Bay Area working with start-up companies , I often represent companies which are pursuing market opportunities in the European Community. Many of these companies, especially “software as a service” companies, offer apps and other services which process data and personal information of individuals who live in Europe. As a result, these companies are required to comply with European Union directed privacy laws. Up until recently, complying with these laws was possible by taking advantage of a “safe harbor” that allowed US companies to process personal data of individuals in EU member countries.

Last October, a European Union Court threw into disarray this “safe harbor,” and invalidated this relatively long standing information sharing framework. Since then, many companies receiving information from EU country citizens have operated in an uncertain environment regarding privacy matters. A ray of hope arose, however, in the last few weeks with the adoption of a new approach to enable U.S. companies to gather European originated personal data.

A Little History

The European Community has traditionally been highly protective of the personal information of the citizens of its member states. This has often clashed with the relatively more business oriented approach taken in the United States. This conflict, and the highly protective privacy rules of the EU, made it almost impossible for US companies to comply with EU related rules when dealing with personal data of EU citizens. In the early 2000’s, the United States and the EU agreed on a self-certification framework, referred to as the “ Safe Harbor Privacy Principles,” to allow personal data to be transferred to US companies. The Safe Harbor allowed a U.S. company to self-certify that its privacy practices satisfied certain enumerated standards.

Last October, the European Court of Justice held that the Safe Harbor was invalid because, among other things, the revelations by former National Security Agency contractor Edward Snowden showed that U.S. authorities could access EU citizen data in the U.S., and that there was no means for redress. Without the Safe Harbor, only expensive and time-consuming approaches under the EU directives were available for those U.S. companies that wanted to comply. Most commentators believe these alternate approaches may be available to larger companies, but won’t be available, at least quickly and economically, to smaller emerging growth companies. They fear that lack of easy compliance will prevent small and emerging growth companies from expanding their operations into Europe.

On February 2, 2016, a new framework was announced by the U.S. and European Union to replace the Safe Harbor. The announcement released by the European Commission states that the new framework, referred to as the “EU-US Privacy Shield” will provide stronger obligations on companies in the U.S. to protect the personal data of Europeans. It also requires stronger monitoring and enforcement by the U.S. and increased cooperation with European Data Protection Authorities. Access to European citizen data will be subject to clear conditions, limitations, and oversight to prevent “generalized access”, according to the announcement. The U.S. will also be required to appoint an Ombudsperson to receive inquiries or complaints from European citizens. Formal adoption by the EU, and implementation by the U.S., will likely occur over the next few months.


There are a number of implications, particularly for smaller companies. First, the Privacy Shield will likely be more difficult to comply with than the Safe Harbor, resulting in relatively more resources being devoted to protection of personal data from European citizens. Second, the trend of companies maintaining servers in the EU to manage European citizen data will probably continue, if not accelerate. Third, more companies will explore anonymizing their EU-originated data before it is transferred to the US. Fourth, until the Privacy Shield is implemented, there will continue to be a great deal of uncertainty over how personal data can be transferred to the U.S.

What’s a small U.S. company to do?

Pending clarification from our friends in the European Union, there are two actions that can be taken now. First, from a legal standpoint, make sure your privacy policy is updated, i.e., it reflects your current practices. Second, from a practical standpoint, make sure that you consider all of your privacy practices and ask yourself whether you would be irritated if your own personal information were treated in a similar manner.

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.