LPS Law Blog

DFI PUBLISHES QUARTERLY DATA ON CALIFORNIA COMMERCIAL BANKS

The California Department of Financial Institutions has just issued its Quarterly Report. The Quarterly Report presents summary statistics for DFI licensees, which include banks, credit unions, offices of foreign banks and trust companies with a one-year comparison.  According to DFI, the situation for commercial banks based on  the latest data available is as follows:

For the one-year period ending June 30, 2008, the number of state-chartered banks increased by 5.4% to 216 at the quarter end, compared to 205 a year previous.  Assets were up from $214.6 billion to $230.5 billion, an increase of $15.9 billion, or 7.4% over the same period, while loans were up 10.4%, from $152.0 billion to $167.8 billion.  Total equity capital decreased $1.0 billion, from $27.9 billion to $26.9 billion at the end of the quarter, causing the equity capital to total asset ratio to decline from 13.00% to 11.69%.  Deposit growth did not keep pace with loans, increasing 4.3% to $158.7 billion, which caused the loan to deposit ratio to increase to 105.73% from 99.89% at the close of the Second Quarter 2007.
 
For the first half of 2008 state-chartered banks reported $406.7 million in losses, off $1.7 billion or 130.9% from the $1.3 billion in net income reported at the close of the Second Quarter 2007.  This was due in part to the increase in loan loss provisions, from $163.1 million to $1.2 billion, an increase of 619.6%.

The net interest margin was down from 3.62% to 3.38%.  Loan loss reserves were up 68.0% from $309 million at midyear 2007 to $519 million at the close of the current quarter; however, noncurrent loans more than doubled going from $853.8 million to $3.3 billion, which caused reserve coverage of noncurrent loans to decrease from 205.53% to 75.60%.  Other real estate owned also more than doubled, going from $43.1 million to $255.3 million. 

Additional information is available on the DFI website under the Financial Statistics page and the financial data published by the Federal Reserve Bank, Federal Deposit Insurance Corporation and National Credit Union Administration.  

 

Nina P. Kwan, Esq. is the author of this post and may be contacted at nkwan@lpslaw.com Ms. Kwan counsels business clients and financial institutions on corporate and regulatory matters.

A BRIEF PRIMER ON THE WAIVER OF SUBROGATION

             The right of subrogation is the right to pursue someone else's claim as if it were your own.  For example, if a landlord's building burns down due to the negligence of a tenant, without a waiver of the right of subrogation, the insurance company could pay the landlord for the value of the building, and then sue the tenant to recover the amount it paid to the landlord.  The insurance company is subrogated to the landlord's claim, meaning it may pursue the landlord's claim against the tenant. The tenant is not protected by the landlord's insurance policy and the tenant's own insurance may be inadequate to cover the loss to the building. The tenant will end up having to pay the insurance company out of pocket for the loss. 

 

             This scenario could also arise with the landlord at fault and the tenant as the injured party. For example, a landlord's negligence which starts a fire in the common area could result in the destruction of a tenant's expensive computer equipment.  The landlord would have the same problem of having to pay the tenant's insurance company for the loss if there is no waiver of subrogation.

 

             However, leases frequently contain a waiver of subrogation provision, which limits this right to pursue someone else's claim.  A typical waiver of subrogation provides that if either the landlord or tenant suffers loss or damage which is caused by the other, but which is covered by the injured party's insurance,

 

                          1) the injured party waives any claim it might have against the other to the extent that it is compensated by an insurer, and

                          2) each party agrees to obtain from its insurer a provision acknowledging this waiver and agreeing that the insurance carrier will not be subrogated to the rights of the injured party to the extent that these rights have been waived.

 

             Thus, the waiver actually deals with the subrogation claim and also the basic liability between the parties. 

 

             For example:

 

"8.6 Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby."  (from AIREA Lease form)

 

             In the example above, a waiver of subrogation provision would mean the insurance company would not be able to subrogate to the landlord's claim and sue the tenant.  Likewise, the injured landlord would not be able to sue the tenant to recover damages for a loss that is insured by the landlord's insurance company. 

 

             The waiver is in effect so long as it does not violate any of the terms of the insurance policy. If the policy does not permit a waiver and a waiver is included in the lease, the policyholder may be in danger of losing its insurance coverage.

 

Neil Taxy, Esq. is the author of this post and may be contacted at ntaxy@lpslaw.com Mr. Taxy counsels a variety of business clients in real estate transactions, commercial and residential.

CALIFORNIA PROHIBITS GRADUATED FILING FEES IN PROBATE ADMINISTRATION

Prior to March, 2008, the California courts imposed a graduated filing fee for petitions to administer decedents' estates.  For the smallest estates (under $250,000), the filing fee was $320.  For the larger estates (over $3.5 million), the filing fee was $3,635 plus 0.2 percent of the amount over $3.5 million.

In March, 2008, this system of graduated filing fees was declared unconstitutional.  Estate of Claeyssens (2008) 161 Cal. App. 4th 465.  The court found that the graduated filing fees amounted to an estate tax, which impermissibly amended the California initiative prohibiting estate taxes. 

Since the issuance of this case, as a practical matter, courts have generally stopped imposing the graduated filing fees.  There are bills winding their way through the California legislature that will likely set the filing fees at a flat $330 or $355. 

 

 

Molly F. Jacobson, Esq. is the author of this post and may be contacted at mjacobson@lpslaw.com Ms. Jacobson counsels individuals and business clients in estate planning and small business matters.

VENTURE FUND ORGANIZATIONAL ISSUES FOR NON-U.S. PERSONS: A BRIEF CHECKLIST

Below is a brief, general overview of certain basic venture fund organizational issues, and related tax planning issues applicable to foreign investors:

 

Organization

A typical venture fund (“Fund”) is organized as a limited partnership (“LP”). Most LPs are established under the laws of the State of Delaware due to (1) the comprehensive nature of Delaware corporate law, and (2) the history and predictability of such jurisdiction.  A Fund is ordinarily sponsored through the efforts of one or more key individuals (the “Principals”). The Principals ordinarily organize and own an entity, often a limited liability company, to serve as the general partner of the Fund (the “General Partner”). The General Partner can also function as the manager or investment adviser of the Fund (the “Manager”). Alternatively, the Principals can organize another “sister” limited liability company for this purpose. Investors subscribe for interests in and become limited partners of the Fund (“Limited Partners”).

Funding

Under the terms of the Fund’s partnership agreement (the “Partnership Agreement”), the General Partner and the Investors would each have commitments (“Commitments”) to make capital contributions (“Capital Contributions”) in specified maximum amounts to the Fund. Typically, the General Partner is expected to make a Commitment of at least 1% of the total Capital Contributions, and the Limited Partners agree to provide the remaining 99%. This traditional allocation is derived from prior legal requirements, but today it usually varies between 1% and 5%. Capital Contributions are used by the Fund, under the exclusive control of the General Partner, to pay Fund expenses (“Fund Expenses”) and make investments (“Portfolio Investments”) in a manner consistent with the investment strategy or guidelines established for the fund (the “Investment Guidelines”).

The common practice is to schedule an initial closing of the sale of interests in the Fund once a specified minimum level of Capital Commitments has been achieved. The Fund then retains the ability to add investors in one or more subsequent closings.  In most cases, the period ranges from three to twelve months. Later investors are then required to retroactively contribute pro rata to the expenses of the Funds.

Management

The Manager is responsible under the terms of the Partnership Agreement (or, under the terms of an investment advisory or management agreement, as applicable) for identifying and evaluating prospective Portfolio Investments, monitoring Portfolio Investments on behalf of the Fund, and recommending sales or other exit strategies (“Exits”).

In return for these services, the Manager is paid an annual management fee (“Management Fee”). The Management Fee is expected to cover salaries of the Principals and other operating costs (collectively, “Management Expenses”). A typical annual Management Fee ranges between 1.5% and 3.0% of the size of the Fund. A smaller Fund tends to charge a higher Management Fee and vice-versa a larger Fund.  Most venture funds begin operating with a Management Fee based on the total value of the Commitments, and then transition to a formula combining Commitments and Contributions.

Profits by the Fund are generally divided according to a formula that provides the General Partner with a share (typically 20%) of the profits (the “Carried Interest”) attributable to the investors’ Capital Contributions.  The timing of the distribution of the Carried Interest, as well as the order in which it is paid first, can vary. For example, the Carried Interest may apply to incremental profits in excess of a base rate of return (i.e. 8%) (“Hurdle Rate”). Or in case where early investments generate profits and later investments do not, payment of the Carried Interest to the General Partner can be subject to an obligation to restore some of those profits to investors (“Clawback”).

Tax issues for offshore investors

Normally, a foreign Limited Partner is not subject to U.S. federal income tax, so long as the Fund operates in such a way that it is not deemed to be “engaged in a trade or business in the United States” and its income is “not effectively connected with the United States.”^[1]

A Fund is typically not deemed to be “engaged in a trade or business in the United States” solely as a result of acquiring or disposing of investment and the ancillary activities associated with that. However, as a precaution with foreign Limited Partners, it is very important for the Partnership Agreement to either (1) prohibit the Fund to invest in activities that would make the Fund be deemed to be “engaged in a trade or business in the United States” (i.e. investments in operating companies classified as partnerships), or (2) permit the foreign Limited Partners to organize an alternative investment vehicle.

Likewise, so long as the Fund invests in stock and does not invest in activities associated with real estate or real property holding corporations, the income would normally be “not effectively connected with the United States”^[2]. An important point in this respect is that income from advisory activities (i.e. advisory services to Portfolio Companies) would, however, be deemed to be “effectively connected”. As such, to reduce the risk of U.S. tax exposure to the foreign Limited Partners, the Fund ought to be structured in such a way that either (1) prohibits the provision and remuneration of advisory services, or (2) has the Manager, and not the Fund, earn those advisory fees, possibly crediting them back against Management Fees, as permitted by law.

One exception to the general exclusion from U.S. federal income tax for foreign Limited Partners is for dividend and interest income received by the Fund. Tax on this type of income would be withheld in the U.S. on account of the foreign Limited Partners.

Finally, it is important to note that regulatory concerns and tax planning for investors outside the United States, in their jurisdictions, could also affect the basic structure outlined above and, if necessary for the investors, lead to the creation of multiple entity fund structure, grouping investors into “feeder” entities, each created in accordance with the tax preferences of the investors. These entities can be other limited partnerships, tax-haven corporations, offshore business trusts or other entities.

***

Specific tax and organizational planning, including an analysis of the applicable securities law offering exemptions, will be possible once the target fund size, number and jurisdiction of the investors have been defined.

 

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.com Mr.Daste counsels a variety of technology startups and entrepreneurs in capital raising and operational matters.

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[1] See Treas. Reg. Section 1.864-2(c)(2)(ii). Scottish American Investments Co. v. Commissioner 12 T.C. 49 (1949).

[2] See I.R.C. Section 897

BREVI NOTE IN MATERIA COSTITUTIVA PER UN VENTURE FUND AMERICANO

• Un venture fund e' tipicamente costituito come una "limited partnership" in Delaware. Cio' e' dovuto al fatto che le normative del Delaware non solo permettono questo tipo di veicolo, ma anche garantiscono un livello di trasparenza e affidabilita' di prim'ordine.

• Il venture fund viene gestito da una "managing company", solitamente costituita come "limited liability company" (in Delaware o California) e controllata dagli organizzatori del fondo.

• La managing company funge da "general partner", mentre gli investitori diventano "limited partners" nel fondo. La principale differenza tra le due categorie di partners e' che il general partner svolge un ruolo attivo di management. E' fondamentale preservare questa divisione, in quanto grazie alla struttura di limited partnership, i profitti realizzati dal fondo vengono assegnati direttamente agli investitori, senza dover "passare" attraverso il fondo come entita' legale separata e, quindi, venire tassati in entrata.

• La raccolta di capitali per il fondo avviene generalmente in due fasi: nella prima fase, il fondo raccoglie "commitments" dagli investitori; nella seconda fase si passa alla raccolta di fondi diretta. Questa seconda fase a sua volta puo' avvenire in due tempi: il fondo fissa una data iniziale per la raccolta di un certo numero di commitments, dopodiche' stabilisce un periodo (variabile, dai 3 ai 12 mesi) durante il quale altri investitori hanno la possibilita' di partecipare.

• La raccolta, essendo svolta da un'entita' del Delaware operante in California, e' soggetta alle normative federali e statali americane riguardanti appunto l'emissione quote di partecipazione da parte del fondo. La raccolta in un venture fund solitamente avviene nell'ambito di queste normative, sfruttando regole che permettono la raccolta di capitali senza bisogno di prospetto o di approvazione formale da parte degli organi regolatori americani.

• La tipica struttura di un venture fund costituito in Delaware e concentrato in investimenti in startup companies permette la partecipazione da parte di investitori stranieri, individualmente, e senza che essi debbano essere soggetti al fisco americano nel caso di distribuzione dei profitti.

• L'investitore straniero resta ovviamente soggetto alle normative fiscali in vigore nella sua giurisdizione per quanto riguarda la propria quota di profitti/capital gain.

 

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.comMr.Daste counsels a variety of technology startups and entrepreneurs in capital raising and operational matters.

CONSEGUENZE FISCALI NEL PORTARE I SERVERS IN CALIFORNIA

Recentemente un imprenditore italiano mi ha posto una domanda interessante, la cui risposta vorrei condividere in questo spazio:  la semplice migrazione dei servers in California da parte di un'azienda non altrimenti domiciliata in California attiva la sales and use tax?

Come regola in generale, lo stato della California puo' imporre la sales and use tax (IVA italiana) se il retailer ha una sufficiente presenza fisica nello stato ("nexus") da risultare "engaged in business". Se pero' l'unico aspetto di presenza fisica sono i servers, cio' non e' sufficiente a stabilire il contatto minimo per essere considerati "engaged in business". C'e' proprio una normativa specifica in merito, di cui ne riporto un riassunto qui sotto.

 

The use of a computer server on the Internet to create or maintain a World Wide Web page or site by an out-of-state retailer will not be considered a factor in determining whether the retailer has a substantial nexus with California. No Internet Service Provider, On-line Service Provider, internetwork communication service provider, or other Internet access service provider, or World Wide Web hosting services shall be deemed the agent or representative of any out-of-state retailer as a result of the service provider maintaining or taking orders via a web page or site on a computer server that is physically located in this state.

 

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.com Mr. Daste counsels a variety of technology startups and entrepreneurs in capital raising and operational matters.

 

LLCs AND TECHNOLOGY STARTUPS: FOUNDERS FAQs

Limited liability companies (LLCs) are generally advantageous to hold (A) real estate, (B) closely held businesses; and (C) portfolio of stock investments (holding companies for startup founders or VCs)  In the last instance, founders of technology startups often utilize an LLC as the holding vehicle for their interests in the newly formed corporation. Some frequently asked questions are:

1. Why an LLC? The main conventional reasons for this are: (A) pass through taxation; (B) limited public filing information; (C) operating agreement flexibility

2. What is pass through taxation? Pass through taxation means that the entity is generally disregarded as a taxpayer. Yet, note that the LLC is still subject as an entity to state tax requirements. This link to the California Franchise Tax Board explains you those requirements in summary.

3. What about limited public information? The LLC operating agreement (detailing company ownership, among other things)  remains private. The articles of the organization are the only public filing, and these do not state the capital ownership of the LLC. For more information, see the CA Secretary of State website.

4. What is the operating agreement? The operating agreement is the governing document of the LLC, which sets forth the rights and preferences of its members.  Members can customize the operating agreement to suit to the circumstances. For example, with two or more members, you will always see a right of first refusal/cross purchase right. This is necessary in order to prevent transfers of LLC interests to third parties. An exception to this are permitted transfers, such as transfer to trusts, family members or other types of transfer that do not alter beneficial ownership. See the sample LCL Operating Agreement that is attached.

5. Why not just use an LLC for my technology startup? Corporations are the entity of choice. Unfortunately, LLCs are not so flexible for structuring multiple rounds of capital raising, since the law by default does not provide for different classes of interests with special rights, as stock corporation have. See for example the California LLC law, codified in the California Corporations Code Section 17000 et seq Beverly Killea Act.

6. Is Delaware better than California as the state of LLC organization? With regard to choice of state of organization, one view is as follows: (A) CA makes sense for LLCs holding local real estate and closely held businesses, (B) DE makes sense for LLCs holding a portfolio of stock investment of a portfolio of real estate in multiple states (in this last case there is a special type of LLC called Delaware Series LLC that allows multiple series of interests to hold different properties in away that insulates them one from the other for purposes of liability and yet maintains a single holding company). There are of course exceptions that make it preferable to use CA LLCs even as stock portfolio holding companies and viceversa.

7. How do I capitalize an LLC? Finally, with regard to funding an LLC, it is capitalized thought he sale of LLC Interests. Important Note: - unless an LLC is member managed, the LLC Interests are deemed "securities" and thus are subject to securities laws.

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.com Mr.Daste counsels technology startups and entrepreneurs in capital raising, strategy and operational matters.

RIGHT HOLDERS BEAR THE PRINCIPAL RESPONSIBILITY TO POLICE THEIR TRADEMARKS

On July 14, 2008, in Tiffany Inc. v. eBay, Inc., 2008 WL 2755787 (S.D.N.Y.) a New York District Court ruled in favor of defendant eBay and against plaintiff jeweler Tiffany & Company.  This decision ended a four year lawsuit where Tiffany sued eBay alleging that eBay allowed hundreds of thousands of counterfeit silver jewelry to be sold on its website.  Tiffany argued that eBay knew a problem existed and that eBay had an obligation to investigate and control these illegal activities.  Tiffany wanted eBay to refuse to post any listing offering five or more Tiffany items and to immediately suspend sellers upon learning Tiffany's belief that the seller had engaged in potentially infringing activity. 

The court held that it is the trademark owner's burden to police its mark and companies like eBay cannot be held liable for trademark infringement based solely on their generalized knowledge that trademark infringement might be occurring on their websites.  The court looked favorably on the fact that eBay made substantial investments in several anti-counterfeiting initiatives and took appropriate steps to remove listings and suspend service when it knew of counterfeit items listed.  While the court held that Tiffany failed to prove its claims against eBay, the court stated that it made no finding as to whether Tiffany might prevail against any individual eBay sellers.

CHANGES IN DOMAIN NAME TECHNOLOGY AND HOW THIS COULD IMPACT YOU

New technology is now in the hands of "domainers," those who acquire domain names without the bona fide intent to use them, generally for re-sale.  The legal turf is now growing between trademark holders against the domainers. Below is a brief overview of activities that may hurt your online intellectual property. 

 

1.          DOMAIN NAME "TASTING."  One can register a domain name and return the domain name within five days for a full refund.  Domainers acquire names and view the traffic that is generated over a five-day period.  This is called "domain name tasting."  Domain name tasting allows the domainer to conduct a free "market survey" into the ways in which Internet users are mis-typing a bona fide trademark that is used as a website address.

 

Domain names that generate traffic are then purchased and held, and non-trafficked domain names are returned.  Those that are purchased and held are re-routed to advertisers or others for a "pay for click" fee.

 

Domain name tasting has become rampant.  For example, in March 2005, nearly 43,000,000 dot-com and dot-net domain names were registered.  Only 2.5 million such names were deleted that same month.  In contrast, only one year later, in April of 2006, 35,000,000 names were registered and 32.7 million were deleted within the five-day grace period.

 

2.          DOMAIN NAME KITING.  A domainer will set up two companies, Company A and Company B.  Company A will taste domain names in bulk and then reject all of them.  Simultaneously, Company B will then sign up the same domain names immediately after Company A has rejected them, so that Company B now gets to taste the domain names for an additional five days.  Companies A and B engage in this repetitive tasting (domain name kiting) over and over.  To the legitimate domain-name holder, this will tie up related domain names that may be desired.

 

3.          FRONT-RUNNING.  Also known as "domain name spying," when a person inquires about the availability of a domain name, but does not sign up for the domain name that instant, the registrar will "register" the domain name itself, thereby preventing the person from registering it later.  Most typically, the registrar holds the domain name awaiting the user to come back to that registrar, thereby forcing the user to sign up with that particular registrar.  This is annoying but generally does not cause any harm other than preventing one from keeping all domain names consolidated with one registrar.

 

Legal remedies exist but the solutions require creativity given that in these instances trademark law often intersects shifting technology and novel forms of infringement. 

 

Neil Taxy, Esq. is the author of this post and may be contacted at ntaxy@lpslaw.com Mr.Taxy counsels a variety of business clients in trademark and online intellectual property protection strategies.