What happens when a small company backed by a big investor is “kicked to the curb” by the Phone Company?  Throw in a multiple-year courtship of that company gone bad along with a preemptive suit by the Phone Company to squash the company’s major customer and you can get the kind of facts that can lead to a multimillion dollar jury verdict.  That is exactly what happened in a recent jury trial in the Norfolk Division of the Eastern District of Virginia where a small company, ActiveVideo Networks, Inc. (“ActiveVideo”), sued several Verizon entities claiming the Phone Company infringed a series of ActiveVideo’s interactive video technology patents.  The result was a message that even the non-4G T-Mobile® girl could hear and understand: a historic $115 Million verdict against Verizon. 

So what exactly happened that led Big Red to see red? San Jose based ActiveVideo (formerly ICTV) pioneered certain technology central to offering interactive services over cable systems in the early 1990’s.  The technology is used in the delivery of certain interactive applications like video-on-demand and interactive TV.  Over the course of the next decade, ICTV sought to interest the industry, including Verizon, in this technology and, in the process, lent Verizon two systems to study.  Repeated questions, technical assistance and demonstrations of the technology unfortunately led to no business.  Years passed and finally, after repeated requests for the return of the systems, Verizon sent back the systems, one in total disrepair, claiming it was not interested in the technology any more.  In the interim, however, Verizon had developed its own “similar” technology along with others and launched this technology as part of its FiOS interactive services. In addition, because ActiveVideo’s largest and only current customer of the time controlled strategic parts of the New York City market, Verizon launched an attack against Cablevision in the International Trade Commission seeking to shut it down.

ActiveVideo filed suit against Verizon in May 2010, alleging that the Verizon FiOS system infringed four patents covering technology created and owned by ActiveVideo.  Prior to trial, the Court invalidated certain patents asserted by Verizon in its counterclaim against ActiveVideo.  At the end of the three and a  half week trial that spanned July into August, the Norfolk Federal Court jury found that Verizon had infringed all asserted claims of the ActiveVideo patents through its deployment of Verizon’s FiOS interactive services.  By ruling in the company’s favor, the jury affirmed ActiveVideo’s rights as the inventor of the technology in question.  ActiveVideo also has filed a motion seeking a permanent injunction to prevent Verizon from continued use of the company’s technology.  Verizon has filed an appeal.   Stay tuned.

Stephen E. Noona is the head of Kaufman & Canoles’ Trial Section and Co-chair of its Intellectual Property Law and Franchising Practice Group.  He has been counsel in over ninety (90) patent cases in the Eastern District, is Fellow in the American College of Trial Lawyers and has appeared before the judges in all four Divisions of the Eastern District on patent and intellectual property matters. Stephen served as co-counsel for ActiveVideo in its successful case against Verizon.  –Stephen E. Noona

The Department of Labor issued a final rule implementing Executive Order 13495, Nondisplacement of Qualified Workers Under Service Contracts. The Executive Order establishes a general policy of the federal government concerning service contracts and solicitations for service contracts for performance of the same or similar services at the same location. This policy mandates the inclusion of a contract clause requiring the successor contractor and its subcontractors to offer those employees employed under the predecessor contract, whose employment will be otherwise terminated as a result of the award of the successor contract, a right of first refusal of employment under the successor contract in positions for which they are qualified. The effective date for this final rule is pending, and the Department will publish a notice in the Federal Register announcing the effective date once it is determined. –David J. Sullivan

Buy-Sell Basics
Buy-sell agreements funded by life insurance are a popular tool in planning for the succession and longevity of a business upon the death of a business owner. Through buy-sell agreements, business owners can agree to a predetermined disposition of each owner’s interest in the business upon his or her death or upon other events. The two main buy-sell planning scenarios generally involve an agreement among the business owners under which: 1) the business entity will buy back the deceased owner’s share upon death (referred to as a “redemption agreement”), or 2) the other owners will directly buy out the deceased owner’s share upon death (referred to as a “cross-purchase agreement”). As one might imagine, the unexpected death of a business owner can quickly create the need for liquidity to fund these obligations under a buy-sell agreement, and accordingly, life insurance on the lives of business owners is frequently used to provide this needed liquidity.

Limitations of Traditional Buy-Sell Planning
Despite the many benefits of the traditional buy-sell strategies, there remain significant limitations that prevent widespread implementation among many businesses that could greatly benefit from buy-sell planning. Below are a few of the frequently cited limitations of traditional buy-sell planning:

1. The cash value and death benefit of the life insurance policies often can be reached by creditors of the business (under a redemption agreement) or creditors of the individual business owners (under a cross-purchase agreement).
2. Under a cross-purchase buy-sell agreement, the number of policies required to carry out the plan can become difficult to manage depending on the number of business owners, as each owner must own a policy on the life of each other owner. For example, in a business with three owners, six policies are needed.
3. The success of a buy-sell plan can be largely dependent on the responsibility and oversight of the individual owners and the plan can be compromised if the individual owners fail to pay the premiums on their policies or if they refuse to pay over or use the death benefits pursuant to the buy-sell agreement.
4. The financial burdens of the premiums may be allocated disproportionately if younger owners have to own policies on older owners, which carry higher premiums and vice versa.
5. Undesired income tax consequences can be triggered by the “transfer for value” rule when remaining policies are transferred between owners, as will be necessary at the death of an owner, as well as other times during the plan.

The Benefits of Using an LLC
A recent advancement in buy-sell planning is the use of a limited liability company (LLC) separate from the underlying principal business entity to own the buy-sell insurance. Under this approach, the business owners would still execute a “cross-purchase” agreement, but would form an LLC to own a life insurance policy on the life of each owner. Using an LLC to own and administer the insurance policies can combine the benefits of “redemption” and “cross-purchase” agreements, while eliminating the disadvantages of both. The use of an LLC can lessen the administrative burden, make use of tax benefits, afford flexibility in structure, and provide numerous other benefits as discussed below.

1. Avoids Numerous Policies: Typically, a cross-purchase buy-sell agreement requires each business owner to own a policy on the life of each other business owner. However, by using an LLC to own the buy-sell insurance, the LLC owns all the policies, so only one policy per shareholder is needed.
2. Protection from Creditors: In a typical buy-sell agreement situation, if the policy is owned by the principal business entity, the policy may be subject to the creditors of the business. Similarly, if the policies are owned by the business owners in their individual capacities, the policies may be subject to the reach of creditors of the individuals. However, by using a separate LLC whose main purpose is to own the buy-sell insurance, the policies generally are protected from the reach of creditors of the principal business and creditors of the individual business owners. Further, IRS guidance supports the valid business purpose of such an LLC used solely to own insurance.
3. Tax Benefits: Typically in buy-sell planning, unwanted income tax consequences are often triggered as a result of the “transfer for value” rule under Internal Revenue Code §101 which treats as income any valuable consideration received in exchange for the transfer of any right to receive life insurance proceeds. This situation can arise in numerous scenarios during traditional buy-sell planning. For example, in traditional cross-purchase buy-sell planning, when any owner dies, the surviving owners typically purchase the life insurance policies owned by the deceased owner at his death (which the deceased owner owned on the other owners). This can trigger the “transfer for value” rule requiring income to be recognized. However, when using the LLC structure the transfer of policies generally is not necessary, and one of the exceptions to the “transfer for value” rule is the transfer to or from a partnership in which the insured is a partner, so this exception applies when transfers are necessary. Finally, IRS guidance provides that, so long as properly structured, insurance proceeds payable to the LLC would not be includable in the estate of a deceased owner.
4. Transferability: The use of an LLC to own buy-sell insurance allows much easier transitions by permitting new owners to join the LLC and participate in the existing insurance framework, while also allowing current owners to exit the LLC prior to death, without triggering the “transfer for value” rule. At the death of an owner, his or her death benefit is used to buy the deceased owner’s interest in the principal entity and to cancel his or her interest in the LLC, eliminating any ongoing obligations.
5. Economics: The use of an LLC allows for flexibility in structuring how the premium costs for insurance policies are borne by the owners. Among numerous other options, the LLC can be seeded with income producing assets to fund the premiums. Another option is that the principal entity can pay the premiums indirectly through presumably equal distributions, dividends or compensation to the members or shareholders of the principal entity, who then contribute the funds to the LLC for payment of the premiums.
6. Ease of Administration: The use of an LLC in buy-sell planning provides a centralized vehicle to administer the policies, rather than leaving the responsibility and oversight up to the individual owners.

The use of an LLC to own life insurance in conjunction with a properly structured buy-sell agreement can provide the ideal structure for a smoother transition and more security for small businesses upon the death of individual business owners. –Will Holt

Stay tuned for updates from our newest blog, Trusts & Estates Law.

Shipments of defense articles by and to United States government facilities or personnel in foreign countries are generally not exempt from adhering to the International Traffic in Arms Regulations (“ITAR”) because such shipments constitute “exports,” for ITAR purposes.  However, ITAR provides some exemptions for shipments involving the Government.  22 CFR § 126.4 states that “[a] license is not required for the temporary import, or temporary export, of any defense article, including technical data or the performance of a defense service, by or for any agency of the U.S. Government (1) for official use by such an agency, or (2) for carrying out any foreign assistance, cooperative project or sales program authorized by law and subject to control by the President by other means.”

This exemption applies only when all aspects of the export transaction are affected by a United States Government agency or when the export is covered by a United States Government Bill of Lading.  This exemption, however, does not apply when a United States Government agency acts as a transmittal agent on behalf of a private individual or firm, either as a convenience or in satisfaction of security requirements.  Furthermore, in the majority of cases, the Office of Defense Trade Controls must issue approval before defense articles previously exported pursuant to this exemption are permanently transferred.

Another ITAR exemption provides that “[a] license is not required for the temporary import, or temporary or permanent export, of any classified or unclassified defense articles, including technical data or the performance of a defense service, for end-use by a U.S. Government Agency in a foreign country under the following circumstances:

1. The export or temporary import is pursuant to a contract with, or written direction by, an agency of the U.S. Government; and
2. The end-user in the foreign country is a U.S. Government agency or facility, and the defense articles or technical data will not be transferred to any foreign person; and’
3. The urgency of the U.S. Government requirement is such that the appropriate export license or U.S. Government Bill of Lading could not have been obtained in a timely manner.

It is important to note that if you export pursuant to one of the above exemptions, you must present a Shipper’s Export Declaration (SED) and a written statement certifying that these requirements have been met at the time of export to the appropriate District Director of Customs or Department of Defense transmittal authority.  In addition, you must provide a copy of the SED and the written certification statement to the Directorate of Defense Trade Controls (“DDTC”) immediately following the export. 

The DDTC tends to narrowly construe these exemptions, so your company should conduct a thorough analysis to ensure the applicability of a particular exemption.  If you would like more information on these ITAR exemptions, please feel free to contact me at recoley@kaufcan.com.
–R. Ellen Coley

In addition to its provisions undercutting patents on tax avoidance strategies, the patent reform legislation just passed by Congress (S.23/H.R. 1249) — now called the “America Invents Act,” formerly the “Patent Reform Act of 2011” — includes provisions that will make it more difficult to enforce any business method patent “that claims a method or corresponding apparatus for performing data processing operations utilized in the practice, administration, or management of a financial product or service…”  The effect of this section of the Act when it becomes law (which is a virtual certainty) will be to help banks and other financial institutions deal with accusations of patent infringement, particularly in the area of electronic payment processing, by allowing them to institute review proceedings in the U.S. Patent and Trademark Office with regard to the patents they are accused of infringing.  Whether this provision (Section 18 of the Act) is viewed as special interest legislation to help big banks, or as a well-intentioned impediment to patent troll activities, it will shift the balance in future legal battles between financial institutions and holders of patents arguably infringed by them.  It is also indicative of the dual nature of the Act – some genuine patent reform, but also some help for particular industries and constituencies. –Robert E. Smartschan

As this blog discussed in early July, the National Labor Relations Board has been working on a rule that would require all employers to notify employees of their rights under the National Labor Relations Act.  The Final Rule has been issued and will require employers to provide such notification as of November 14, 2011.

Private-sector employers (including labor organizations) whose workplaces fall under the National Labor Relations Act will be required to post the employee rights notice where other workplace notices are typically posted. Also, employers who customarily post notices to employees regarding personnel rules or policies on an internet or intranet site will be required to post the Board’s notice on those sites. Copies of the notice will be available from the Agency’s regional offices, and it may also be downloaded from the NLRB website. 

The notice, which is similar to one required by the U.S. Department of Labor for federal contractors, states that employees have the right to act together to improve wages and working conditions, to form, join and assist a union, to bargain collectively with their employer, and to refrain from any of these activities. It provides examples of unlawful employer and union conduct and instructs employees how to contact the NLRB with questions or complaints. 

A fact sheet with additional information about the rule is available here. –David J. Sullivan

On September 8, 2011, the U.S. Court of Appeals for the Fourth Circuit dismissed two lawsuits challenging the constitutionality of the individual mandate provision contained in President Obama’s healthcare reform overhaul (“Obamacare”).

The three-judge panel declared that the Fourth Circuit does not have jurisdiction, citing the Tax Anti-Injunction Act as preventing the court from hearing a challenge to the constitutionality of Obamacare.

Therefore, the appellate court dismissed the two lawsuits—one filed by Virginia Attorney General Ken Cuccinelli and one filed by Liberty University—without ruling on the constitutionality issues presented.

The Fourth Circuit is the third appellate court to hear lawsuits challenging Obamacare, which includes the individual mandate provision requiring individuals to buy health insurance or pay a penalty.  The Sixth Circuit ruling upheld the constitutionality while the Eleventh Circuit declared the individual mandate provision to be unconstitutional.  The D.C. Circuit is yet to rule on the appeal pending in its appellate court.  This latest decision from the Fourth Circuit further paves the road heading toward the Supreme Court.
–Christopher L. McLean

There are many risks associated with the acquisition of real property. Risks include the existence of liens on the property, the person or entity conveying the property not actually having authority to convey the property, previously granted use restrictions, errors in the legal description, and boundary descriptions that are inconsistent with areas actually being used or thought to be the boundaries of the property. The acquirer relies on the conveying party to disclose any issues, and for an examination of the public records to disclose everything. However, errors and oversights occur, and in some instances there are prior agreements that are not recorded, or are not correctly recorded, among the public records. To minimize the risks that may occur due to errors, oversights, and risks associated with unknown agreements, acquirers purchase title insurance.

Title insurance is a contract that obligates the insurer to indemnify the purchaser of the insurance (the “insured”) from loss incurred due to loss of use and enjoyment of the property occasioned by the existence of liens, defects and encumbrances that are not identified as being excluded from coverage. A standard coverage title policy will contain special and standard exceptions. Special exceptions are property specific and arise from matters discovered in an examination of public records (recorded liens, easements, leases, life estates, restrictions, etc.); the title policy, unless addressed with an endorsement, will exclude from coverage any loss occasioned by someone exercising a right pursuant to an identified easement, lease or other instrument. The standard exceptions contained in title policies are (1) unfiled mechanic’s and materialmen’s liens (the “M/L Exception”); (2) rights of claims of parties in possession of the property (or portion thereof) (the “Possession Exception”); (3) easements or claims of easements not shown in the public records (the “Easement Exception”); (4) any encroachment, encumbrance, violation, variation, or adverse circumstance that would be disclosed by an accurate and complete land survey of the property (the “Survey Exception”); and (5) taxes or assessments (the “Tax Exception”). Title policies that include standard exceptions exempt from coverage losses arising from unknown issues (e.g., someone claiming the right to drive through the middle of the property based on an unrecorded document or past actions that are not revealed by an examination of the public records), are the issues that the insured wants to be insured against.

To address these unknown risks, the insured, when purchasing title insurance, should consider obtaining an extended coverage title policy that minimizes the exceptions from coverage and offers affirmative coverage. Such coverage insures the insured against loss occasioned by defects ascertainable, but undiscovered or unreported, by an examination of the public records (e.g., land records, tax bills, and court records, etc.), and from defects that are not ascertainable from the public records (e.g., parties in possession, unfiled mechanic’s liens, encroachments, boundary line issues, and other matters that would be disclosed by an accurate survey).

The most basic extended coverage policy is one in which the standard exceptions have been removed or modified to take exception only for matters arising in the future. To get the standard exceptions removed or modified, the purchaser of title insurance will need to meet criteria established by the insurer for each standard exception. Generally, the insurer requires the following actions and information prior to its issuance of a title insurance policy without the standard exceptions:

1. In order for the M/L Exception to be removed, an indemnifying affidavit must be delivered to the insurer (signed by all existing or prior owners that owned the property during the period of time that a mechanic’s or materialmen’s lien could arise from) stating that (a) no work has occurred on, and no materials have been supplied in connection with, the property in the period of time that would permit a contractor or supplier to file a lien against the property, or (b) work has occurred during the designated period and that all bills have been paid in connection therewith.
2. In order for the Possession Exception to be removed, the current owner of the property must execute an affidavit attesting that no one other than the current owner is in possession of the property, and that the current owner has no knowledge of any facts that would give rise to someone claiming to have title to, or the right to possess, the property. If the insurer has reason to believe others have been in possession of the property, the insurer may require termination agreements to be signed by such prior occupants, or the insurer will take special exception to the specific issues identified.
3. In order for the Easement Exception to be removed, the current owner must deliver an affidavit attesting that its enjoyment of the property has been undisturbed, and that the current owner has no knowledge of any facts that would give rise to a claim of an easement over and across the property. If the insurer has reason to believe an unrecorded easement may exist on the property, based on old plats or other information, the insurer may require termination agreements or quitclaim deeds to be signed by the possible easement holders, and/or the insurer may take special exception for the rights of others to an easement as shown on a specifically identified plat.
4. In order for the Survey Exception to be removed, a recent survey of the property will need to be prepared, and it will need to contain a surveyor’s certificate that states (a) the surveyor has examined the property, (b) the survey depicts all buildings, structures, fences, improvements and encroachments, and (c) the property description is a complete and accurate description.
5. In regards to the Tax Exception, such exception will not be removed by the insurer, but, upon evidence (a review of the taxing records, and payment of taxes at closing) that all property taxes and assessments due and owing have been paid, the insurer will modify the exception to exclude from coverage losses arising from taxes and assessments not yet due and owing.

Beyond the basic extended coverage created by the removal of the standard exceptions, additional coverage against certain risks can be obtained with the addition of endorsements to the title policy. Endorsements modify the provisions of the title policy to provide coverage over specific risks.

There are dozens of standard endorsements. The most common standard endorsements issued in connection with commercial property are the Access Endorsement, Same As Survey Endorsement, Comprehensive Endorsement, Tax Parcel Endorsement, Contiguity Endorsement (if the property is comprised of multiple parcels), and Zoning Endorsement, all of which afford the insured with coverage for loss arising in connection with matters related to whether the specific property can be used as planned. The Access Endorsement, which will only be issued if a surveyor certifies to the insurer that the property does have a means of access, affords coverage to the insured if it is later determined that the property does not have access to a specifically identified street. The Same As Survey Endorsement, which requires a certified survey, protects the insured against losses resulting from inaccuracies in the survey obtained and relied upon. The Comprehensive Endorsement provides coverage from losses due to violations of recorded covenants and restrictions, and from encroachments of existing improvements across the boundary lines of the property. The Tax Parcel Endorsement insures against losses arising from any inaccuracy with the tax parcel identification number identified in the title policy as being applicable to the property. The Contiguity Endorsement, which requires a review of a survey, provides coverage from losses due to a subsequent determination that multiple parcels comprising the property are not contiguous to one another (i.e., there are gaps between the parcels, and such areas are owned by someone else). The Zoning Endorsement, if the improvements on the property are completed at the time the policy is issued, protects against losses suffered as a result of a court order or judgment that the improvements are in violation of the applicable zoning laws and ordinances. The alternative Zoning Endorsement, if the improvements are not yet constructed, insures against losses resulting from a determination that the contemplated use of the property is not permitted by the property’s identified zoning classification (e.g., the insurer and insured believe the property’s zoning classification permits an apartment building, and it is later determined that the zoning classification does not permit an apartment building).

In addition to the standard endorsements, an insurer has the ability to create non-standard, transaction-specific endorsements to address identified risks that may give rise to loss of use and/or title. For example, if the survey reveals that the property’s existing building encroaches across the property line by a few inches, the insured will want to have an endorsement to the policy that provides coverage against loss or damage suffered as a result of the forced removal of the building. Other examples include affirmative coverage endorsements that protect the insured against loss specifically due to (a) an illegible signature on an old document in the chain of title, (b) a vague or indefinite description of an easement burdening or benefitting the property, and (c) a quitclaim deed in the chain of title that, due to a drafting error, is ambiguous and may not effectively release all of the rights intended to be quitclaimed.

Whether or not a specific standard or non-standard, transaction-specific endorsement should and can be obtained depends on the facts and circumstances of a particular transaction. The extended coverage afforded by endorsements shifts the risk of unknown defects to the insurer, and, because of the risk to the insurer, the ability to obtain extended coverage with endorsements is subject to the insurer’s underwriting criteria, and may require the payment of a higher premium. Compliance with underwriting criteria can take time. For example, the Zoning Endorsement, in either form, requires the payment of an additional premium and the delivery to the insurer of a “zoning letter” issued by the locality stating the property’s zoning classification, the permitted uses under the zoning classification, and whether or not, as of the date of the letter, the property is in compliance with applicable zoning laws and ordinances. It can take several weeks to obtain a zoning letter. Accordingly, it is advisable to identify what endorsements are necessary and desired as soon as possible, and request such endorsements from the insurer well in advance of the date that a title policy needs be in place and effective. This will allow time for the insurer and insured to agree on the most comprehensive and affordable extended coverage title policy that can be obtained to minimize the insured’s risk of loss when acquiring property. –Amy L. Harman

The benefits community has been awaiting major changes to the rules governing disclosure of plan-related fees for several years, but it has taken some time for final regulations to take shape. The Department of Labor in 2010 issued provisional regulations that were originally scheduled to go into effect on July 16, 2011, but the compliance deadline was recently extended into the 2012 plan year. It is likely that additional changes to the proposed rules will be made prior to the effective date.

Sponsors of 401(k) plans, 403(b) plans, and other plans that permit individual investment direction should be aware that beginning in mid-2012, several new categories of information relating to plan investments and fees will need to be disclosed for the first time. The required disclosures will most likely be combined into two separate documents, one that is provided at enrollment then annually thereafter, and one that is provided in the form of quarterly statements.

General Plan Information
This disclosure must be provided to participants before they enroll in the plan and at least annually thereafter. This notice:

• describes the method of giving investment directions;
• discloses the investment alternatives and any brokerage windows or similar arrangements;
• describes all applicable administrative expenses and the manner of allocation among participant accounts;
• includes various other pieces of required language; and
• contains a table disclosing detailed fee and performance information related to each available investment alternative.

Quarterly Fee Disclosure
This disclosure must be provided on a quarterly basis (with an annual summary once each plan year) to each participant, disclosing all fees actually charged to the plan in general (e.g., administrative record-keeping fees) or to the participant’s account in particular (e.g., fees to process loans or QDROs), including fees charged indirectly through funds by means such as 12b-1 fees or revenue sharing arrangements.

At present, compliance with these rules would be difficult if not impossible since some of the information required to be included in the notice (such as 12b-1 or revenue sharing fees) is currently hard to come by. Before the participant disclosure rules go into effect, however, the new regulations will require investment companies and other service providers to provide detailed disclosure to plan sponsors containing all required information. This will make the task of drafting these new disclosures much less daunting.

The general compliance deadline for these new disclosure rules has been postponed until April 1, 2012. The initial participant disclosure must be made no later than May 31, 2012, and quarterly statements must commence no later than August 14, 2012. Plan sponsors should plan accordingly as a good deal of effort may be required to produce the first round of disclosures. Specifically, plan sponsors should soon begin the process of inventorying all plan-level fees and expenses; communicating with service providers to ensure receipt of necessary fee information; and drafting form disclosures that comply with the final regulations, with specific data for each fund to be provided as it becomes available.

The members of our Employee Benefits Practice Group stand by to assist with the drafting of these new disclosures and to answer any questions you may have. –Shad C. Fagerland