BizLawBuz …. The Power of Know

This week’s featured topic is provided courtesy of Wright Penning & Beamer client and friend Tom Buck. Thanks, Tom, for sharing this insightful piece.

Eight Practices to Protect Your Corporate Cash

by JT (Tom) Buck
an old entrepreneur

Recently, a very good friend had the unfortunate situation of an employee embezzling funds from his company. This was not sneaking an extra $20 onto an expense report. It was a concerted effort over a long period of time to steal and hide the misappropriation of large sums of money.

The employee had literally stolen several thousand dollars per month over several years. The embezzlement was hidden in legitimate looking, duplicate vendor invoices, checks which were signed by an authorized signer; which then were altered on the payee line. The volume of checks and invoices handled on a monthly basis obscured the false transactions. My friend was shocked at the behavior of this trusted employee. He was fortunate that insurance provided a partial recovery and that the company’s long-term prospects for success were not harmed once this was discovered. However, the loss, the effort for recovery, and the damage done to their culture of trust was extreme.

My friend is a very smart and trusting man. This led to the success of the thief for many years, yet, following this experience, several financial procedures in his company were changed to prevent a future occurrence of this type of theft. This story and the following practices were gathered from a review of best practices as recommended by two leading CPAs in Southeast Michigan and are shared for the benefit of other business owners. If implemented, these practices will greatly reduce the probability of your company having a similar experience.

Practice Number 1 – Disbursement Review
These best practices start with a complete review of all funds going out of the company. This particular practice would have, most likely, prevented the embezzlement at my friend’s company. An owner must review every disbursement item on the bank statement, comparing each item to the related invoices or originating transaction, every month.

Practice Number 2 – Review Endorsements on Checks
For every check written, read the endorsements on the back to ensure they are going where intended. Some banks do not return the paper checks in efforts to become more paperless. This may require viewing the backs of checks on-line.

Practice Number 3 – Review Cash Transfers
Some of your transactions may be through automatic transfers or pre-authorized withdrawals. This practice requires a specific review, every month, of all other transactions involving cash transfers including but not limited to: ACH, Tax, 401k transactions and other payments. Make sure these amounts match the expected payments and originating documents.

Practice Number 4 – Enter all Debits and Credits into the Accounting System
Many times smaller credits or debits can go unnoticed in the busy activity of a month. These can be in the form of a refund on a vendor invoice, or a discount for early payment, or perhaps even a small expense item paid for out of petty cash. These transactions are often not tracked well in the accounting system because they are small or seem unimportant. These debit memos and credit memos must be entered into the accounting system to have accurate accounting and to prevent the possibility of the funds they represent being misappropriated.

Practice Number 5 – Enter all Payables into Accounting
A bill, which arrives the first of the month and is due within the month, may be placed into the payments file and just entered into accounting as an expense opposite a cash payment. To track these fully, they should be entered as an expense opposite (increasing) the payable account, then cash opposite (decreasing) the payable account. Otherwise, payables records will be incomplete.

Practice Number 6 – Follow the Rules
Create a culture of following the financial rules. Contrary to a world where we want to see ‘out of the box’ thinking to improve our products, our services and our relationships with customers, the financial reporting and management arena is one where following the rules keeps bad things from happening. Any deviations from these particular rules should be well understood and documented.

Practice Number 7 – Background Investigations
Establishing the practice of performing background checks on employees who work with the accounting system, financial payments and financial receipts is a way to insure that the people handling these transactions do not have a history of malfeasance. As intrusive as this may feel, it is incumbent on owners, for the success of the enterprise to employ talent with the highest ethics for work in finance and accounting.

Practice Number 8 – Enforce Vacation Policy
The discovery of the malfeasance in my friend’s company occurred while the employee was on vacation and another employee was covering their responsibilities. This points out the wisdom of enforcing a minimum of a one-week vacation per year, with another employee stepping in, for those with financial responsibilities in the organization.

If these eight practices are followed, the likelihood of an employee escaping with corporate funds is greatly reduced. Owners often find having a personal focus on sales and operations to be of the greatest satisfaction as they apply their time and energy in their organization. While delegation of financial responsibilities seems prudent, regular time allocated to these practices will improve the results and security of the company’s resources. The embezzler from my friend’s company is serving time in jail as of the timing of this writing. While this prospective consequence deters most employees from stealing, without the above practices it is possible they could escape.

Thanks to Jim Bauters of UHY Advisors, Inc. in Southfield, Michigan, and to Kevin McKervey of Clayton McKervey, P. C. also of Southfield, Michigan, for their suggestions and contributions to the creation of this article. Thanks also to my friend for being willing to share a terrible experience to help others avoid the problem.

Dirk A. Beamer

A recent update from the State Bar Business Law Section addresses a recent decision out of the Oakland County Circuit Court, where Judge Colleen O’Brien granted a preliminary injunction requiring an auto supplier to keep shipping parts even though the customer was delinquent in payments and, as a result, in breach of the purchase order. To the extent you work in the auto sector, be aware of what could be an ongoing bias in favor of OEMs and larger tier suppliers. The hopes were this would lessen with the shake-up in the industry, but this case suggests otherwise.

Appended below is an Opinion and Order from Judge Colleen O’Brien in Oakland County Circuit Court in Metavation LLC v. Grede LLC, Case No. 11-116105-CK granting a preliminary injunction in a supplier dispute, provided by Adam Kochenderfer of Wolfson Bolton PLLC.

In the Metavation action, the Court granted Plaintiff’s motion for a preliminary injunction after Defendant refused to produce component parts under supply contracts between the parties. Among other things, Defendant claimed that alleged late payments entitled Defendant to unilaterally terminate the contracts. Defendant further argued that the shutdown of Plaintiff’s assembly operations, and consequent employment losses, would not constitute “irreparable harm” under Michigan law. The Court disagreed, holding that

1. the terms of the parties’ contracts control and “[d]e minimus delays in payment do not permit a party to unilaterally terminate a contract;”
2. the factor regarding irreparable harm weighs in favor of Plaintiff because Plaintiff relied on frequent shipments of parts from Defendant, and, if Defendant ceased shipments, “Plaintiff’s manufacturing business would come to a halt;” and
3. “the prevention of job losses serves the public interest.”

Therefore, the Court issued a preliminary injunction ordering Defendant to continue producing and shipping the component parts to Plaintiff in accordance with the parties’ contracts.

Dirk A. Beamer

While the changes are mainly technical in nature, some are substantive and worth noting. Changes to the Michigan Limited Liability Company Act (”LLCA”) took effect on December 16, 2010.

The LLCA now:

• Enables corporations to easily convert into limited liability companies (”LLCs”) and vice versa. This represents one of the most important changes to the LLCA. Prior to the amendment, it was necessary to go through a formal merger of a corporation and an LLC to make the conversion. There are several reasons, such as tax implications and corporate governance, that may make it desirable to change the form of an existing business entity, and this process will make such a change much simpler.
• Clarifies how a person is admitted to an LLC as a member. Previously, the LLCA indicated that a person could only become a member of an LLC at the time of formation if the person signed the initial operating agreement, but LLCs are not required to have operating agreements. Now, a person will be admitted as a member if he or she signs an operating agreement, or if the person’s status as a member is reflected in the LLC’s records. Additionally, a person can be admitted by the other members in any other writing.
• Provides processes and guidelines for the approval of transactions with interested managers or agents (i.e., the transaction was fair, material facts of transaction were disclosed, and disinterested managers/members approved the transaction);
• Explicitly authorizes LLCs to provide broad indemnification of members, managers, and others, subject to some exceptions. The former LLCA seemed to some to only permit indemnification of managers, not members and agents.
• Explicitly authorizes LLCs to purchase errors and omissions (D&O) insurance for members, managers, and others. Like indemnification matters discussed above, the former LLCA was interpreted to prohibit LLCs from purchasing errors and omissions insurance on behalf of any person other than a manager.
• Limits the rights of an LLC member’s creditor. As a result of the amendments, a creditor cannot take the member’s membership interest in the LLC and either sell it or become a member itself; creditors receive only a charging order and the right to distributions that would be payable to the member. Under the prior version of the LLCA, creditors were attempting to go beyond attaching the economic rights of their debtors and attempting to participate in management of the LLC or sell the membership interest.
• Clarifies that members and managers of LLCs may be entities rather than natural persons.

For additional information regarding changes to the LLCA and how they affect your business, please contact an attorney at Wright Penning & Beamer.

Julie Pfitzenmaier

Since the economic meltdown of 2008, commercial loans for small businesses have been harder to find than a four-leaf clover. Would-be borrowers need every bit of luck available to find cash from traditional sources, despite the fact that many lenders enjoy surplus liquidity. I have personally worked with a number of clients who have been both surprised and frustrated by the difficulty in getting loan approval for profitable businesses. Manufacturers, professional practice groups, pharmaceutical companies: no one is exempt from the onerous new rules and new world of commercial lending. Fortunately, some welcome assistance may be on the way.

In a recent newsletter, the State Bar of Michigan’s Business Law Section reported that recent changes in federal legislation will ease the qualification requirements for companies seeking Small Business Administration (SBA) financing. As part of the Small Business Jobs Act of 2010, Congress modified the definition of a “small business company” to allow previously ineligible businesses to qualify. Businesses with a tangible net worth of $15 million or less, as well as annual profits of $5 million or less, now meet the size requirements of a would-be SBA borrower. This change significantly expands the pool of businesses eligible for SBA funding.

Before you get too excited, keep in mind that the SBA loan approval process has itself become painfully slow, in part due to the flood of new applicants. The change in eligibility requirements will likely exacerbate the delay. That said, any change that promises to increase the working capital available to smaller businesses is a welcome change given the stand-offish attitude of most private lenders. If your organization needs to borrow, or if it has recently tried unsuccessfully to obtain a loan, you should ask your lender or CPA about potential options under this recent piece of legislation. For more information, do not hesitate to give me a call.

Dirk A. Beamer

Still wondering how the federal Patient Protection and Affordable Care Act (”PPACA”) will affect you or your business? Not sure what changes you may need to implement to avoid penalties? You’re not alone. While the nation attempts to navigate the overhaul of the health care system, here are a few key points to help you understand some aspects of this complex law:

Dependent Coverage
For all employer-sponsored health care plans that provide coverage to dependent children of covered employees, PPACA will now require that the dependents’ coverage continue until the dependents turn 26 years old. This requirement is effective for all plan years beginning on or after September 23, 2010.

Penalties for Individuals
Starting January 1, 2014, individuals will incur a penalty for each month that they do not have health insurance coverage. In 2014, that penalty cannot exceed $95 for the year. In 2015 and 2016, the maximum penalty increases to $325 and $695, respectively, for each year.

Penalties for Large Employers
PPACA defines a “large” employer as one that employs 50 or more full-time employees working 30 or more hours per week. Large employers must offer “acceptable” health care insurance to employees starting January 1, 2014, or face penalties. “Acceptable” coverage means coverage that is affordable to the employee.

If a large employer does not provide any coverage, and for that reason an employee qualifies for a subsidy (or “premium credit”), the employer faces a monthly penalty, calculated as follows:
No. of full-time employees – 30 x $166.66 = Monthly Penalty
The $166.66 represents 1/12 of $2,000.

If a large employer does not provide “affordable” health insurance coverage, the monthly penalty assessed for each full-time employee that qualifies for a subsidy because of the lack of affordable coverage is 1/12 of $3,000. This penalty is not based on the number of full-time employees; only the number of employees that qualify for a subsidy.

It is still unclear whether the penalties imposed by PPACA might still be less than the cost of providing acceptable health care insurance, as some critics of the law have suggested.

Julie Pfitzenmaier

Talking Business on Social Networking Sites

Whether you personally post or tweet, chances are good your company’s employees participate actively on any number of social networking websites. According to the Pew Research Center, adult use of such sites accounted for almost fifty percent of the internet activity in America in 2009. Aside from its personal and entertainment value, social networking can be a valuable tool for fostering successful business relationships. The blurry line between personal and business use, however, can create unforeseen risks for your company, including the risk that posted comments by your employees will be treated as official statements from the company.

Consider the case of an overzealous sales representative who proudly brags about the company’s products online (so far, so good) but in the process decides to talk trash about a competitor. Does the competitor now have a libel or slander case against your company? Or how about a company supervisor who offers the following recommendation on LinkedIn for a subordinate who is also pursuing an approved sideline business: “I have worked with Sally for five years and have always found her to be hard working and high performing.” If the company later lets Sally go for poor performance, can the supervisor’s post be used as evidence that Sally’s performance was fine and that she is being discriminated against because of gender? In both instances, the answer is probably “yes.”

Employers must be careful in monitoring or regulating employees’ personal, online activity too closely. If you track employee use regularly, you are bound to learn information that you would have preferred not to know and that may actually limit your ability to supervise and discipline the employee. Nonetheless, when it comes to employee comments about workplace activities or relationships, serious thought should be given to updating the company’s handbook or policy manual to provide some basic “dos and don’ts” governing this category of online statements.

Questions? Give me a call … or just post them here on our blog.

Dirk A. Beamer

The New Michigan Statewide Smoking Ban: How it Affects Us

On May 1, 2010, the “Dr. Ron Davis Smoke-Free Air Law” went into effect in Michigan. Smoking is now banned in most public buildings in Michigan and in outdoor areas where food or beverages are served, such as restaurant patios and porches.

There are a few exemptions to the new law. Individuals still may smoke in cigar bars, tobacco specialty retail stores, and on the gaming floors of Detroit’s casinos. The exemption for the casinos is automatic. Cigar bars and tobacco specialty retail stores, on the other hand, must meet certain requirements and file an affidavit with the Michigan Department of Community Health by June 1, 2010, in order to be exempted. Tribal casinos are not covered by the new law, so their operators are free to permit smoking wherever they like.

Most any other indoor space used by the general public is subject to the ban, even bingo halls, private clubs, and the indoor common areas of multi-unit apartment buildings and condominium buildings. Some examples of the places in which smoking is now prohibited are hotel/motel guest rooms, malls, restaurants, arenas, concert halls, and places of employment that are not otherwise exempted.

Owners and operators of spaces covered by the smoking ban are required to take several steps in order to comply with the new law. Briefly, those steps are:

1. Post “no smoking” signs or the international “no smoking” symbol at each entrance and in each area where smoking is prohibited.
2. Remove ashtrays and smoking paraphernalia from areas where smoking is prohibited.
3. Ask people who are smoking in smoke-free areas to stop smoking.
4. Refuse service to those who are smoking in violation of the law, and ask them to leave if they refuse to comply.

More information, including “no smoking” signs and affidavits for exemption, can be found at www.michigan.gov/smokefreelaw.

Lee Flaherty

Paying your competitor’s attorney fees in Non-Compete Cases

After seventeen years practicing law, I find that most business clients appreciate the services I have to offer and are willing to pay a fair fee for them. But I have yet to meet a client who feels at all inclined to pay the legal bill of a competitor who has just sued. That’s like being thirteen and kissing your sister. Yet when corporations sue each other over the alleged theft of a valuable employee, the dispute can quickly become a fight over attorney fees.

Any time you hire a competitor’s current or former employee (or independent contractor), you face the risk of a lawsuit from the competitor alleging improper interference with a contract, or some other form of unfair competition. If the employee had a written agreement not to compete with the former employer, the risk of such a suit is all the greater. Risk assessment needs to be part of the hiring decision so you can decide whether the potential employee’s attributes justify the risk. In performing that assessment, you have to consider the possibility of paying not only damages but also the cost of your own – and even your competitor’s – legal fees.

If the competitor goes to the trouble of suing you, it will probably bring every plausible claim available against you. In non-compete cases, this usually involves a claim that the employee and you have conspired to steal the competitor’s trade secrets and proprietary information. In most lawsuits between business competitors, each side pays its own legal expenses – win, lose or draw. But under Michigan’s version of the Uniform Trade Secrets Act, a prevailing plaintiff can recover attorney fees if it shows that the defendant willfully and maliciously stole a trade secret.

Just as I have never met a client anxious to pay a competitor’s lawyer, I have also never met a client (whether a corporation or an individual business person) who believes he acted maliciously in his business dealings. Unfortunately, there is scant case law in Michigan clearly defining willful and malicious conduct under the Uniform Trade Secrets Act. As a result, in virtually every non-compete case brought naming you as a defendant, you will face the argument – and the risk – that you did act maliciously.

Most non-compete cases start with a request for an immediate injunction to stop the alleged unfair competition. This requires the judge to conduct a hearing that resembles a mini-trial at the outset of the lawsuit. The judge’s decision whether or not to grant the injunction will be widely viewed as a barometer of the ultimate merits of the case. Consequently, many cases settle once the judge grants or denies the injunction requested, if not before. In the mean time, the parties – and the suing party in particular – will have incurred substantial legal bills in a short amount of time. (In one case I defended, the opponent racked up about sixty thousand dollars in fees in the one month between filing and settling the case.) With the judge’s decision on the injunction having effectively resolved the merits of the claim, the parties are left to fight over who should foot the bill for having brought the matter to court.

Obviously, the judge’s decision on the injunction will either strengthen or weaken the suing party’s claim that you acted maliciously. Either way, both sides will need to consider carefully how much more legal expense they are willing to incur solely to fight over who should pay the fees to date. If the case appears ready for settlement even before the judge rules on the request for an injunction, you still may face a fight over attorney fees. I have seen plaintiffs with no real damages become all the more insistent that they recover attorney fees as a matter of principle to ensure that the perceived misconduct does not go unpunished. If you are defending, do you buckle and pay some portion of the other side’s fees, or do you hold ground as a matter of principle? If you hold fast, you may end up paying far more money in the long run, albeit to your own attorney rather than to your competitor’s. As a colleague once told me, “It is perfectly appropriate to stand on principle, once you have acknowledged that principle is expensive.”

How do you avoid the distasteful dilemma of paying some portion of a competitor’s attorney fees? While no answer is full proof, there are steps you can take to minimize the risk:

1. Fully assess the risk going in. When interviewing potential employees, have them confirm in writing as part of the interview process whether they have obligations under an existing non-compete agreement. If they answer “no,” it will be harder for a competitor to show you acted willfully and maliciously in the hiring process. If the answer is “yes,” then you know you face a greater threat of a lawsuit and, consequently, may not want to hire the individual. (One caveat: if you do hire the individual notwithstanding his written admission of an existing non-compete, you may strengthen the argument that you have acted with malicious motives.)
2. Avoid trade secrets. If you do hire a competitor’s current or former employee, be extremely vigilant in instructing the new employee and all who work with him that you will not condone any using or sharing of the competitor’s proprietary information and trade secrets. Monitor the situation for compliance. This will make it harder for your competitor to seek fees under the Uniform Fair Trade Practices Act.
3. Assess your risks again. If you do find yourself in a lawsuit, make sure your initial assessment of your potential liability includes a proper allowance for attorney fees. It rarely makes sense to hold fast to an unreasonably low settlement position, only to spend far more in defense than what you could have resolved the case for early on.

By their nature, non-compete cases force the parties to spend considerable legal fees early in the process, often before either side has a solid understanding of the damages suffered. Many times, the actual damages a suing competitor is able to prove will be far smaller than the fees incurred. Given the attorney fee award provisions under the Uniform Trade Secrets Act, you could find yourself fighting to avoid a fee award against you, even in a case where you have caused no measurable harm to your competitor. Try your best to understand your risks before making the hire. That doesn’t mean you won’t make the hire if the employee is worth the risk. After all, most thirteen year olds would kiss their sister — for the right price.

Dirk A. Beamer

Over the last several years, Michigan has experienced extraordinary job loss. One fruit of those job losses has been an unusual number of business start-ups. All over the state, laid off workers have “reinvented” themselves, sometimes going back to school to pursue a different or more advanced degree, and sometimes going into business for themselves doing either the kind of work they have always done or something entirely new.

Online Resources
The federal government continues to develop online resources for the benefit of business owners. Among the recent resources posted by the Internal Revenue Service is a virtual small-business tax workshop that you can access at http://www.tax.gov/virtualworkshop. The virtual workshop consists of a series of nine videos covering a number of topics of interest to small business owners, particularly those who are just getting started. Lessons cover topics such as how to set up and run your business, how to file and pay your taxes using your computer, how to set up a home office or a retirement plan and how to manage payroll.

Taking Advantage of SBA Loan Programs
The U.S. Small Business Administration also has a number of online resources for small business owners. Several videos and podcasts can be accessed at http://www.sba.gov/training. Among the topics covered by the SBA are how to develop a business plan, how to survive in a down economy, and how to take advantage of SBA loan programs and federal government contracting opportunities.

The Need for Tax or Legal Counsel
These online tools don’t replace the need for tax or legal counsel, but they can help you make better and more efficient use of both your time and our office, which in turn can save you money. If you are considering a new business venture or you need our assistance with a legal matter affecting your ongoing business, please contact any of the attorneys at Wright Penning & Beamer. We would be pleased to help you!

LeClair L. Flaherty

Unpaid receivables cost your business money. Late paying customers may force you to resort to your business’ line of credit in order to satisfy your own cash flow obligations. You are, of course, paying interest on that line of credit.

If you expect to recoup interest from your customer, you need to make sure that an agreed, commercially reasonable interest rate is included as part of your purchase order, contract, or some written document that has been signed by the customer. If your customers are consumers as opposed to business entities, you have to make sure that the interest rate does not exceed the maximum permitted by the controlling state’s usury laws.

Absent a written agreement calling for interest, you will have difficulty recovering interest on the unpaid balance for any point in time prior to filing a lawsuit to collect the unpaid balance. In Michigan, if you do file suit and ultimately obtain a judgment for the amount owed, you will be able to include in your judgment statutory interest calculated from the date you filed the lawsuit. If your claim is based on a contract or written document, the interest will be computed based on any specific amount agreed to in the contract. If no amount was set forth in the contract, interest will be computed at 13% per year, compounded annually.

If there is no written agreement underlying your company’s claim, interest on any judgment you obtain will be limited to a variable amount, calculated at six month intervals, at a rate equal to 1% plus the average interest rate paid on five year United States Treasury Notes. As of January 5, 2010, that amount equals 3.48%. Obviously, a written agreement allows you to recover a much higher rate of interest.

In order to protect your ability to recover interest on unpaid balances, you should make sure that sales or services are provided pursuant to a written contract and that the contract specifically provides for the imposition of interest at a specified rate on any past due balance.

Dirk A. Beamer