Author: Chris Swiecicki

by Chris Swiecicki

What is “Lifting the Corporate Veil” in Company Law?

Founders set up LLCs and other corporations to protect themselves from personal legal liability. The personal assets of members of an LLC are separate from their business assets. However, courts sometimes end the limited liability protection for owners, directors, and shareholders, an action called the lifting the corporate veil or piercing the corporate veil. 

“Veil” refers to the protection from legal liability provided by LLCs and corporations.  When a court lifts the corporate veil, it removes the shareholders’ protection from legal liability. Their personal assets will be included in any orders to repay creditors and other litigants.

Owners, directors, and shareholders need to do all they can to protect themselves from a court piercing the corporate veil—and the personal consequences that follow.

When Do Courts Lift the Corporate Veil?

Courts use caution when considering lifting the corporate veil because the principle of limited liability is a key part of corporate law. However, in cases where there is straightforward evidence of an egregious act of misconduct, courts are willing to pierce the corporate veil and impose personal liability. The misconduct may include fraud, wrongdoing, or abuse of the corporate form. In Missouri and in most other states, three factors must be present for a judge to pierce the corporate veil:

1. The owner dominated finance, policy, and business practices around a transaction and the corporate entity did not have a “separate mind.”
2. The owner’s control was used to defraud, violate a statute or other legal duty, or commit a dishonest or unjust act that hurt the plaintiff.
3. The control is believed to have caused the injury or loss.

A Missouri appeals court reaffirmed the three requirements for lifting the corporate veil in a 2014 case, Hibbs v. Berger.

Can Minority Members Ask Courts to Pierce the Corporate Veil?

The Hibbs ruling is also known for the court’s decision on whether minority members may file claims against majority owners. Plaintiff Steve Hibbs claimed that Brian Berger, his former employer, owed him money. Hibbs owned 5% of one of Berger’s businesses. When the company started having money problems, Hibbs stopped getting paid.

The Missouri Court of Appeals ruled Hibbs, a minority member of an LLC, had a right to pierce the corporate veil. Then, the court considered whether the case met the three requirements for removing the protection offered by an LLC. The court decided there was not enough evidence to pierce the corporate veil.

Examples of Courts Piercing the Corporate Veil

Two high-profile examples of a court piercing the corporate veil took place in Florida:

• In Ocala Breeders’ Sales v. Hialeah, Inc., the court lifted the corporate veil to investigate reports of the corporate officers of Hialeah, Inc., unlawfully running a subsidiary. The look behind the corporate veil revealed the subsidiary was no more than an instrument of the parent company. Hialeah, Inc., did not have enough capital and thus could not meet its obligations.
• In Broward Marine, Inc. v. S/V Zeus, the court lifted the veil of a yacht company to reveal the dominant shareholder’s evasive moves to avoid paying the plaintiff the money he owed him. The court found the defendant transferred all the company’s assets to another business he owned and hid the transaction. A judge ruled the dominant shareholder and his other company both were liable for the debt.

Florida courts followed the same guidelines for piercing the corporate veil as Missouri courts do.

Bad Business Practices Leading to Lifting the Corporate Veil

Courts are more likely to strip protection from legal liability–pierce the corporate veil–of companies guilty of one or more of these bad business practices:

• Commingling funds. When members of an LLC do not keep their own money separate from their business funds, they risk losing protection from legal liability. In the view of the courts, a business owner who does not treat their business as a separate entity does not qualify for limited liability protection.
• Sharing assets. Owners of LLCs who own more than one business need to keep separate financial records and lists of assets for each business. For example, if they list an expensive piece of equipment as an asset for one business, they cannot list the same equipment on their other business’s Schedule C.
• Illegal activities. If a corporation is used as a vehicle to defraud creditors, shareholders, or other third parties, a court may disregard the corporate form and hold the individuals responsible for the corporation’s actions. This can occur when the corporation is used to conceal illegal activities or to evade legal obligations.
• Lack of corporate formalities or recordkeeping. Corporations must follow certain formalities such as holding regular meetings and tracking finances. They also must keep a clear separation between the corporation and its owners.
• Undercapitalization. The courts consider whether a business is undercapitalized when a creditor or other litigator asks for lifting of the corporate veil. The court wants to know whether the business has enough money to run. If the court decides the LLC or other business entity is undercapitalized, it is more likely to pierce the corporate veil.

How to Avoid Piercing of the Corporate Veil and Personal Legal Liability

If you ever face piercing the corporate veil, you will have a better chance of convincing a court you keep your business and personal assets separate by adhering to best practices:

• Follow formalities for your business structure. Corporations need to have annual meetings, file reports, and more. LLCs and LLPs need to file reports to the state, have operating agreements, and keep records of votes on big decisions.
• Save business documents for at least seven years. When you do this, you can prove you run your business following the law.
• Have separate business and personal accounts at the bank and for other accounts.
• Capitalize your business to the extent you can always pay your bills, employees, and contractors.
• Use your business name on everything including contracts, signage, business cards, and other official documents.

Corporate lawyers have advice specific for maintaining the veil for different industries and fields.  Whether you are starting a business or tweaking an existing corporate structure, a conversation with an experienced corporate attorney is a valuable use of your time. Swiecicki and Muskett, LLC, advises business owners and corporate leaders based on decades of legal experience. Contact us today if you have any questions about piercing the corporate veil!

 

by Chris Swiecicki

What is a “Poison Pill” in Corporate Law?

When a larger company tried to take over the company owning the St. Louis Post-Dispatch in 2022, corporate lawyers showed Lee Enterprises how to fight back. They crafted a poison pill defense, or shareholders rights plan, to kill the unsolicited offer from Alden Global Capital. The defense worked, and Lee still owns the Post-Dispatch and 22 other papers.

Corporate lawyers often recommend poison pills for defense against corporate raiders.  Sometimes the acquirer backs off. Other times, the targeted company and the acquirer reach a favorable agreement.

How Do Poison Pills, Shareholder Rights Plans, Work?

Poison pills reduce the appeal of a takeover by either making the deal too expensive for the bidder or by creating negative side-effects of a takeover.

As corporate raiders begin buying up shares, corporate lawyers work closely with the targeted company to determine the specifics of the poison pill and when to launch it. For example, a  board may stipulate that a shareholders rights plan take effect when the acquiring entity gains 20% of the company’s shares.

Most shareholders rights plans include a stipulation that they can be changed or negated by the board. Thus, the board is forcing the acquirer to negotiate directly with them, which will have a positive position for bargaining.

Corporate lawyers use a variety of ways to launch poison pills including:

1. Preferred stock plan: A company issues a dividend of preferred stock to shareholders. These shareholders may use special voting rights when a company tries to takeover by buying a large quantity of shares.
2. Flip-in: Many companies include a provision in their charter or bylaws establishing a threshold for buying stock. Before the acquiring entity nears the ceiling, usually between 20 and 50%, the targeted company starts selling stock at a discount to its existing shareholders. This dilution of the company’s stock may prevent the hostile takeover.
3. Flip-over: When a company employed a flip-in poison pill and was not able to avoid a hostile takeover, there is another defense mechanism to try: A flip-over poison pill.  The shareholders of the targeted company buy up stock at a discount. In doing so, they dilute the shares of the acquiring company’s existing shareholders. This is only possible if a section of the bylaws spells out the legality of the maneuver.
4. Back-end plan (also known as a note purchase rights plan): A back-end plan gives shareholders of the targeted company the opportunity to exchange their stock for either cash or other securities at a higher value if the acquiring company gains a majority of the company stock. This strategy may diminish the acquiring company’s interest in purchasing the existing shareholders’ stock.
5. Golden handcuffs: Corporate lawyers also may recommend a golden handcuffs poison pill. Many executives have lucrative deals rewarding them when they hit goals and/or stay with the company for a certain period. The “handcuffs” often include deferred compensation and employee stock options. A golden handcuffs poison pill defense removes the vesting and performance requirements. Then, the executives may cash out and leave the company. This often makes the target less desirable to the acquirer who need the executives to lead the company after they take over.

Pros and Cons of Poison Pill Defense Strategies

The ultimate success of a poison pill defense strategy reveals itself years down the road. Boards will consider whether the goals of both companies were met and whether they are still being met when analyzing the success of the shareholders rights plan.

For many companies, the poison pill is a negotiation tactic that succeeds in either 1) preventing a hostile takeover or 2) laying the foundation for a favorable merger. While developing the shareholder rights plan, or poison pill, the company finds a way to dictate the terms of the takeover. The poison pill’s benefits may include:

• The targeted company identifies potential acquisitions.
• Higher premiums for shareholders.
• Slowing the speed of a corporate raid.

In the short term, a poison pill can hurt the valuation of many shares. The decrease in value will affect the company’s constituencies in different ways:

• Shareholders may receive a financial loss when the value of their shares declines.
• Corporate executives who also own part of the company may or may not lose their position, power, or money during a takeover.
• Lower and mid-level employees may be laid off.

Corporate Lawyers Guide Companies Threatened by a Takeover

If another company is positioning itself to get majority ownership in your company, contact the Swiecicki-Muskett law firm. Managing partner Christopher Swiecicki will guide you in developing a poison pill, or another strategy, to lead your company through a hostile takeover proactively and cost-effectively.

Christopher developed his expertise in corporate law as both in-house and outside legal counsel. Today, he provides senior-level counsel to C-suite executives, in-house legal teams, and business owners. He is on the faculty of Washington University in St. Louis School of Law where he teaches business acquisitions (M&A) courses.

Contact the Swiecicki-Muskett law firm at 636-778-0209 or email [email protected].

  

by Chris Swiecicki

What is a Merger and Acquisition Lawyer? When Do You Need One?

Merger and acquisition lawyers help companies that are at a crossroads. They facilitate deals and advise owners who are looking to sell their business, buy another business, or combine assets and resources to create a new entity.

The merger and acquisition (M&A) branch of law brings together multiple disciplines, including accounting, tax law, real estate, government and industry regulations, and more. M&A lawyers must have a diverse skill set (or the ability to assemble a team of people with the appropriate expertise) to handle all of a transaction’s moving parts.

When Should a Business Hire a Merger and Acquisition Lawyer?

Buying or selling a company, or merging with another one, is not something that a business owner should attempt on their own. Even their corporate counsel might not be equipped to handle the transaction. An attorney with merger and acquisition expertise is necessary, and it’s a good idea to get them on board as soon in the process as possible.

The following scenarios will trigger the need for a merger and acquisition lawyer:

• Some small business owners grow their companies with the specific goal of one day striking a lucrative deal to sell it to a larger entity. They should consult with a good attorney early to ensure that their company, and their own compensation, is structured appropriately.
• Whether or not it was planned, potential buyers may start to show interest in a company. Consulting with a merger and acquisition lawyer can be helpful to assess the options, and whether or not it makes sense to entertain offers at all at that particular time. They can also advise on “poison pill” options to prevent hostile takeovers.
• Hiring a merger and acquisition lawyer is a good idea during succession planning if there is no plan to pass the company on to heirs or partners. The attorney can get the ball rolling to find potential buyers.
• When a company finds itself ready to expand and add to its portfolio by acquiring another business, a merger and acquisition lawyer can get the necessary resources lined up and begin to search for suitable candidates.
• A competitor or a company that fits well with a business may go on the market. A merger and acquisition lawyer can structure a viable offer.

Regardless of the circumstances of a sale, purchase, or absorption of a company, it is best to have an M&A lawyer at the earliest stages of the deal. Ideally, they should be the ones obtaining a valuation and crafting the agreement. These transactions are complex and have both internal and external consequences for all of the entities involved. Waiting until a deal is on the table and contracts are already drafted is too late.

M&A Attorney Responsibilities—The Basics

A merger and acquisition lawyer’s job is to advise and negotiate for their client. Throughout the course of the transaction, they will draft and file agreements that pertain to the business assets, employees, debt, and stock. The attorney will work with various accountants, real estate brokers, bankers, and opposing counsel as needed to set up the deal and see it through to completion.

First and foremost, M&A attorneys need to understand their client’s business objectives in order to craft a transaction that benefits the owners, stockholders, and employees. They will map out steps and a timeframe (which typically will take several months) and keep their client informed of the status and progress of the case.

Once the merger or acquisition is complete, the attorney will help to set up any new entities and continue to guide their client as they carry out the integration of assets, staff, and policies.

When the client is the target of a merger or acquisition, the M&A attorney will review the offer and help the company decide whether to accept it, refuse it, or negotiate further.

Skills That Merger and Acquisition Lawyers Bring to the Table

Lawyers who specialize in mergers and acquisitions must wear many hats and understand a wide array of legal and business accounting topics. Those who routinely work in multiple disciplines can offer their clients the level of expertise necessary to reach the best outcome. Swiecicki & Muskett Attorneys at Law, for example, combine the practice areas of corporate law, taxation, and contract negotiations.

This type of multi-faceted firm can tackle the necessary parts of a corporate merger or acquisition. Whether these services are performed by the firm or outsourced, a skilled M&A lawyer is able to interpret the information and how it affects the proceedings.

Accounting and Business Valuation. Knowing what a company is worth through a business valuation is an essential part of any merger or acquisition. In addition, mergers and acquisitions require expert analysis of financial records and tax returns.

Tax Implications. Buying or selling a company can have a big impact on tax liability. It is necessary to understand the transaction’s tax implications and structure the deal accordingly.

Regulatory Obstacles. Government or industry regulations can prevent a merger or acquisition from moving forward. Antitrust, security, and investment laws are just some of the things that a merger and acquisition lawyer will need to navigate, to make sure their clients are in compliance.

Real Estate. The purchase or sale of a business can include the transfer of land, buildings, and other assets. Knowledge of real estate law and property valuations will help this part of the deal go smoothly.

Intellectual Property. Merger and acquisition contracts need to be clear about who owns or holds the rights to intellectual property. Placing a value on these items is important too.

3rd Party Contracts. Quite often, a company has contracts with lenders and other parties. An M&A attorney can obtain the necessary consent from those entities and deal with their concerns about how the business relationships will be affected by the transaction.

Human Resources. A merger and acquisition lawyer can make sure the agreements adhere to any applicable employment, compensation, and benefits laws. They will handle how various aspects are treated, such as payouts, employee stock options, retention agreements, terminations, and consolidation of offices.

Negotiations. A large part of the merger and acquisitions lawyer’s role is negotiating all aspects of the agreement between the entities. This can include the sales price, terms and payments, and any of the other items on this list.

Due Diligence. One of the most important jobs of a merger and acquisition lawyer is conducting due diligence. Private companies are not under the same scrutiny as publicly held ones, so this means conducting an in-depth investigation into the other company to ensure that things are as they claim. They will study their financial statements and other corporate documents, and assess the company’s obligations, litigation risks, and potential growth, among other things. They will look for evidence of sandbagging and ensure that everyone is holding to the implied covenant of good faith and fair dealing.

Finding the Right Merger and Acquisition Lawyer

When a company embarks on a merger or acquisition, it will need representation who can ensure that they meet the intended goals of the transaction. The terms should be clear to all entities and result in a legally binding agreement and a smooth transition for all involved.

At Swiecicki & Muskett, LLC, you will find relevant legal expertise with the breadth of knowledge necessary for a purchase, sale, or consolidation of companies. The firm’s unique combination of practice areas brings more to the negotiating table than the typical corporate counsel. In fact, Christopher Swiecicki teaches Business Acquisitions (M&A) and Corporations as an adjunct professor at Washington University School of Law.

Find out how Swiecicki & Muskett, LLC can help you navigate your merger or acquisition.

by Chris Swiecicki

Selling Your Business? Find Out About Section 1202 to Avoid Taxes on Your Capital Gain

Investing in emerging fields like tech and software can have enormous tax advantages. When entrepreneurs sell their businesses, they may be able to exclude up to 100% of capital gain under Section 1202—up to $10 million or 10 times their investment, whichever is more. Both founders and their investors qualify for the exclusion after they have owned the company for five or more years.

If you want to position yourself for the Section 1202 gain exclusion when you sell your business, you may need to change the structure of your business to make an easy sale.  

Requirements for Claiming a Section 1202 Gain Exclusion

When selling a business or stock, having the wrong structure can be incredibly costly. For example, selling a business after changing the organizational structure from a C Corporation to a trust disqualifies the seller from the Section 1202 gain exclusion.

To qualify for the exclusion, a small business must meet the following requirements:

1. Its aggregate gross assets did not exceed $50 million at any time on or after August 10,1993, and before the issuance.
2. Its aggregate gross assets do not exceed $50 million after the issuance.
3. It is a U.S. C Corporation and will continue to be so when its stock transfers to a buyer.
4. The owner bought its stock with cash, property, or services.
5. Its stock must be stock as defined in the federal income tax code. Non-vested stock, stock options, and warrants are not Q.S.B.S.

While corporate stockholders are ineligible for Section 1202’s gain exclusion, stockholders of other business entities may qualify for the gain exclusion. This includes individuals, trusts, and pass-through entities.

Which Business Investments Qualify for Capital Gain Exclusions?

The capital gain exclusions in Section 1202 were designed to stimulate the economy. Thus, qualified trades or businesses are those creating jobs and/or knowledge including manufacturing, technology, research and development, and software.

Investments in service industries are not qualifying stock purchases. Section 1202 lists the following fields as not qualified for the capital gain exclusions:

A. Accounting, actuarial science, athletics, brokerage services, consulting, engineering, financial services, health, law, performing arts, or any other profession in which the main asset is the reputation or skill of employees.

B. Banking, financing, insurance, investing, or other financial services.

C. Farming.

D.  Oil and gas production covered under Section 613 or 613A.

E. Operation of hotels, motels, restaurants, or similar businesses.

In addition, property management is not a qualified business (Section 1202(e)(7)).

When you are structuring a business for easy sale and positioning yourself for capital gain exclusions, stay focused on its qualifying mission. You need to invest at least 80% of the corporation’s assets (by value) in qualified business activities to receive the Section 1202 exclusion.

How the Section 1202 Exclusion Became So Lucrative

The federal government sweetened the deal for investors following the Great Recession. Before 2009, Section 1202 allowed certain small businesses and start-ups to exclude 50% of capital gain in their gross income. The 2009 Recovery Act increased the exclusion to 75% of the capital gain of the sale of qualified small business stock (Q.S.B.S.) purchased between February 18, 2009, and September 27, 2010. The exclusion expanded to 100% of capital gain after September 27, 2010. Today, those selling a qualifying business receive:

• 100% exclusion from U.S. federal capital gain tax. (Sometimes the exclusion is a lower percentage. See below.) 
• 100% exclusion from the alternative minimum tax 
• Exclusion from the 3.8% net investment income tax

When you sell a business that does not qualify for Section 1202 exclusions, you probably will be responsible for paying the taxes on gains related to selling small business stock at the maximum rate of 28.7%.

Section 1202 Considerations for the Easy Sale of a Business

When you are ready to cash out on the successful launch of your business, pay close attention to whether your business is structured for easy sale AND for keeping you eligible for Section 1202 gain exclusions. To qualify for the exclusions, you must sell stock, not assets (deemed or actual). However, most buyers want to buy your company’s assets, not your stock. When you offer stock, and the other party is buying most of the shares, they will likely demand a discount. In this scenario, you may benefit from rolling over 20% to 30% of your equity as part of a structured deal. You will be allowed to defer gain, and be positioned to claim a Section 1202 gain exclusion, when the buyer eventually sells the rollover equity.

Many other ways to structure a business for easy sale are buried in the tax code. Here at Swiecicki & Muskett, we are experts at uncovering the opportunities lying just under the surface of the mountains of rules enforced by the I.R.S. and the court system.

Moves for When You Don’t Qualify for Section 1202 (Yet)

Suppose you want to take advantage of the Section 1202 exclusions but can’t because you have the wrong business structure. If you expect significant appreciation of your company’s stock and plan to sell your business or stock, changing your structure from an S corporation to a C corporation is a wise move. Capital gain after the conversion will qualify for exclusion on Section 1202.

The corporate tax team at Swiecicki & Muskett has many other solutions for structuring your business for an easy and lucrative sale. Based in St. Louis County, Christopher Swiecicki and his team serve growing businesses of all structures and sizes. Contact him at 636-778-0209 or email [email protected].

 

by Chris Swiecicki

What Business Legal Fees are Tax Deductible?

As a small business owner, you know how important it is to seek legal advice and services when needed. From drafting contracts to resolving disputes, legal fees can quickly add up. However, many types of legal fees are tax-deductible, potentially saving you money come tax season. Just which legal fees are eligible for tax deductions? And are there any tax advantages of legal services worth exploring?

What Types Of Legal Fees Are Tax-Deductible?

Certain legal fees incurred by you in the operation of your business are tax deductible, such as:

Startup Costs

Legal fees incurred during this process can be deducted up to $5,000 in the business’s first year if you’re creating or buying a business. This includes fees associated with creating legal documents or paying state incorporation fees. Any remaining startup costs must be amortized over time. This is important to remember when starting a new business, as the costs of creating or buying a business can quickly increase.

Defense Costs

Legal fees for defending or protecting your business from lawsuits can be deductible. This includes fees for attorneys, court costs, and other related expenses.

For instance, if a customer sues your company for a defective product or a supplier sues you for breach of contract, the legal fees for defending yourself in court can be deducted. (That said, this significant expense can often be avoided by having proper legal documentation in place—specifically, contracts and agreements.)

Tax Advice or Preparation

Legal fees related to tax advice or tax preparation are also deductible. This includes fees for tax attorneys, accountants, and other professionals who provide tax advice or prepare tax returns. This is a critical deduction to remember, as tax preparation and advice can be essential in ensuring your business complies with tax laws and regulations.

How Much Can You Deduct?

The amount a business owner can deduct in legal fees in a year depends on the type of legal expenses incurred.

Business expenses are defined as costs incurred “while operating a necessary and ordinary business.” These expenses are typically fully deductible on a business’s tax return. Examples of business expenses include rent, salaries, supplies, and utilities. The IRS allows businesses to deduct the total cost of these expenses from their taxable income, reducing the amount of tax owed.

The 2% rule applies to miscellaneous itemized deductions, meaning you can only deduct a portion of an expense if it exceeds 2% of your adjusted gross income (AGI). However, recent changes to tax rules have impacted which expenses qualify as miscellaneous deductions.

While some fees are fully deductible, such as startup costs, others may limit the amount you can deduct. This can make navigating the deduction process complex and time-consuming, which is why many businesses turn to professionals to ensure they maximize their deductions.

For startup costs, the IRS allows a deduction of up to $5,000 in the business’s first year. Any remaining startup costs must be amortized over time. You can deduct a portion of the startup costs each year until you’ve deducted the full amount. The amortization period typically lasts for 15 years, but there are exceptions for certain types of businesses.

There’s no limit to the legal fees you can deduct for defense costs. However, it’s important to remember these fees must be directly related to defending or protecting your business from lawsuits. Legal fees related to personal matters aren’t deductible.

For tax advice or preparation, the amount of deductible legal fees vary depending on the type of service provided. For instance, legal fees for tax preparation and advice are deductible in full. However, legal fees for tax planning, such as setting up a tax shelter or tax avoidance scheme, may be subject to limitations.

It’s important to note the IRS has strict rules about what legal fees are tax deductible. So, working with a tax professional or accountant is always a good idea to ensure you’re deducting the correct amount.

Additionally, documentation of legal fees is essential for tax purposes, so keep accurate records of all legal expenses incurred throughout the year.

Which Legal Fees Are Not Tax Deductible?

It’s important to note legal fees related to personal matters, such as divorce or estate planning, can’t be deducted. Additionally, legal fees that aren’t directly related to your business aren’t deductible. This includes legal fees for personal lawsuits or disputes unrelated to your business.

For example, if a former employee is suing you, but the lawsuit has nothing to do with your business, you can’t deduct the legal fees for defending yourself against this suit.

However, these fees are deductible if the suit relates to a business dispute (such as an employee suing for unpaid wages).

The IRS also does not allow you to deduct legal fees for the following:

• Personal lawsuits or other legal disputes unrelated to your business.
• Legal fees for divorces, child custody issues, and similar matters.
• Legal expenses related to criminal activities.

Final Thought

Keeping track of your legal fees throughout the year is essential, as working with a tax professional or accountant to determine the tax advantage of legal services for your business. Deducting legal fees is a small but important way to keep your business financially healthy. For more on the intersection of legal help and tax law, contact us.

by Chris Swiecicki

Can Disasters Be Tax Deductible? Tax Implications of a Corporate Lawsuit

A day barely goes by without a news report about some corporate entity making a serious misstep that has them facing fines and penalties. Several cases of corporate litigation come to mind: Lawsuits against the tobacco industry and big pharma are probably the most publicized. And there are cases of environmental harm by manufacturers, public utilities, or most recently, railroad accidents impacting both the land and the communities that live there.

While most of these companies do not mean to cause harm, there is little argument that they do bear some responsibility for their part in certain outcomes. It is no surprise when a government entity like the EPA imposes fines, or when a trial results in a court-ordered settlement for compensatory or punitive damages.

When a company makes a mistake (or breaks the law,) the CFO and the rest of the C-Suite understand that they must pay the penalty imposed. There can be a silver lining though: Some portions of the payment may be tax deductible. But the ability to take advantage of the deduction depends on the structure and wording of the settlement agreement. This is why it is essential to bring in skilled counsel like Swiecicki & Muskett Attorneys at Law early in the process. A combination of expertise in both taxation law and corporate litigation is necessary to make the best of a bad situation.

Paying a Corporate Settlement for a Mishap

Disasters like the collapse of the Taum Sauk Reservoir in Missouri in 2005 or the Norfolk Southern derailment in Ohio in 2023 result in environmental issues and incur large settlements paid to government entities. While a corporation will negotiate to reduce the amount of their fines and penalties, if possible, they have no choice but to pay up once everything is settled.

But consider this: Say a settlement calls for payment due to the government of $10,000,000. But what if that amount is tax deductible at a 35% tax rate? This means a tax deduction of $3,500,000, or in other words, a net cash outflow of $6,500,000 instead of the full $10,000,000.

This is still a very large number, of course, but the reduction is significant. And for a smaller company, the difference between paying the full amount of a settlement with or without a tax deduction can mean the ability to make payroll, or even keep the doors open.

It is extremely unlikely, if not impossible, that an entire settlement would be tax deductible as in the example above. There are strict requirements for which portions are, and which are not, deductible. Furthermore, the settlement must be structured properly from the start; there is no going back to claim a deduction after the fines are paid.

Any company finding itself subject to fines and penalties can improve its outcome with a corporate tax attorney who understands the IRS rules and can structure the settlement appropriately.

What is Deductible After a Catastrophe?

Understanding the tax treatment of fines and penalties paid by corporations requires in-depth knowledge of Internal Revenue Code Section 162(f). A typical accounting department or even corporate counsel might not have the experience in both tax and litigation to unravel the complex rules surrounding the topic.

IRC Section 162(f) dictates that in general, a tax deduction is not allowed if the company violated any law. The exceptions to this are compensatory amounts paid for “restitution, remediation, or to come into compliance” with a law.

This means that if the taxpayer (the corporation that paid the fine or penalty) can establish that the money paid went toward correcting or remedying the situation, it might be able to be claimed as a deduction. So, if the money is restitution to those who were harmed, remediation of damaged property, or helps the company come into compliance with the law, it could be eligible.

Some examples:

• Repayment of embezzled funds, for example, falls under the category of restitution, so could be claimed as a tax deduction.
• If the corporation must reimburse the government for the costs to investigate or litigate, those amounts are not restitution, remediation, or to come into compliance, and are therefore not allowable as a deduction.

There are many other compensatory amounts involved in a corporate settlement that a corporate litigation attorney may or may not be able to make an argument for as deductible. This is why finding someone who specializes in these cases is so important.

Structuring the Settlement for the Best Outcome

A tax deduction is not just an accounting trick; it is cash back in the pockets of a corporation after paying a large sum. That cash can help lessen the blow to a company and its shareholders after a disastrous and expensive event.

In order to maximize the tax benefits of a settlement with a government entity, corporations must act fast to bring in legal counsel to help draft the agreement. The calculations and verbiage built into the document will determine the end result.

An experienced tax attorney will be able to differentiate the funds paid into different “buckets.” There are amounts that will be clearly either compensatory or non-compensatory. Then there are dollars that are subject to interpretation. It is here where a firm like Swiecicki & Muskett excels, finding ways to categorize expenses that will present a viable argument for the IRS.

The IRS can and typically will dispute claims that are not clear-cut. Settlement agreements that are drafted properly with the correct legal language and phrasing can stand up to the challenge.

No corporation is happy about making a mistake that causes damage or hurts people or the environment. And when accidents happen, they understand that there will be a price to pay. But understanding the tax implications of a corporate lawsuit can lessen the blow.

by Chris Swiecicki

How to Find a Corporate Tax Lawyer

Creating a tax strategy takes teamwork among legal, finance, and accounting professionals. Many companies trust an independent corporate tax lawyer as an advisor to the tax strategy team. When you are ready to add a corporate tax lawyer to your team, how do you find one? The search starts the old-fashioned way and ends with a list of interview questions. 

Ask for a Referral to a Corporate Tax Lawyer

This is a case when “Googling it” is not a good first step. You will not see many listings for “corporate tax lawyer.” You probably will have better success by asking your professional network if they will refer you to a corporate tax lawyer. Inquire with your banker and accountant, and the lawyers you work with on other matters. Most of us trust recommendations from respected colleagues, which is why this is the best way to find a lawyer you will trust from day one. 

If you do not get a referral from someone you know, check with the bar associations in your area; for Missouri, those include the Federal Bar Association and the Eighth Circuit Bar Association, the bar for the St. Louis area. (You can also learn about our own Taxation Law capabilities here at Swiecicki & Muskett.) 

Check Their Credentials for Practicing Taxation Law

The practice of taxation law requires a minimum of a Juris Doctor degree, known as a J.D. The attorney also must be licensed by the state bar. Many corporate tax lawyers expand their expertise and earn a Master of Laws in Taxation degree, known as an L.L.M.. Some are certified public accountants and others have served in corporate finance positions.

Christopher Swiecicki, founder and managing attorney at Swiecicki & Muskett, L.L.C., practices taxation law with the insight of decades of experience in law, finance, and accounting. During his career he has:

 

• Earned a J.D. in 1990 and an L.L.M. in 2005, both from the Washington University School of Law, one of the top law schools in the nation.
• Taught a course in Business Acquisitions as an adjunct professor at the Washington University School of Law since 2011. 
• Worked as a tax accountant at one of the Big Four accounting firms.
• Served as inside tax counsel to a Fortune 500 Company.
• Worked as inside tax counsel to a regional financial institution.
• Served as a chief financial officer and general counsel for a $40 million private company. 
• Been recognized as an expert in the field by the Association of Corporate Counsel and the American Bar Association. 

Today, Christopher Swiecicki provides personalized service to business owners and executives at major corporations. He keeps his client roster small enough to respond quickly to every client. When he meets with clients, he has in-depth knowledge of their needs. (To begin a conversation, you can find his contact information here.)

Ask If the Corporate Tax Lawyer Has Applicable Experience

A corporate tax lawyer might have impressive credentials but lack experience related to your situation. Ask them about it before signing a contract with them. In some cases, you may need to meet with them to explain your situation. If you learn they are not experienced in the area you need help with, ask them for a referral to another corporate tax lawyer. 

Learn What the Corporate Tax Attorney Will Do for You

When hiring a corporate tax attorney, find out what they will do for you. Christopher Swiecicki has decades of experience advising companies on the federal tax-related aspects of acquisitions and dispositions, mergers and financial structures and products, and corporate governance. If you are seeking counsel in one of these areas, contact Swiecicki to discuss your situation and see if there is a good fit.

In other situations, consider asking the following questions, or variations of them, depending upon your business:

 

1. What is your experience with a business like ours?
2. How do you see our business interests intersecting with tax law?
3. How will you apply your knowledge of taxation law to help us manage our business functions more effectively?
4. Will you help us decide whether to set up a C-Corp or an LLC?
5. What skills and resources do you have to help our company manage tax exposure and risk?
6. How does your team stay current on IRS rulings and government programs affecting business taxes?
7. Will you advise us on the tax ramifications of current operational and business decisions?
8. Do you provide counsel related to e-commerce and cloud-based services?
9. Do you have experience litigating cases before the IRS?

 

At Swiecicki & Muskett, we serve businesses in many industries with varied structures and sizes. We are constantly gaining new insights, thanks to the diversity of our clientele.  

When you are ready to increase profits with a sophisticated tax strategy, contact us. We will serve you with the strength of our experience combined with constant attention to changes in taxation law. Contact Christopher Swiecicki at 636-778-0209 or email [email protected].

by Chris Swiecicki

Understanding Sandbagging in M&A Transactions

In the context of buying a business, a “sandbagging” Buyer is one who is (or becomes) aware that a specific representation or warranty made by the Seller is false—but instead of telling the Seller this fact, the Buyer completes the transaction. The Buyer then seeks post-closing damages against the Seller for the breach.

Sandbagging is a frequent occurrence in acquisitions. It happens so often that transactional planners have made a “sandbagging playbook” that tells people how to handle the issue, depending on which side of the deal they’re on and whether the state law governing the agreement is “pro-sandbagging” or “anti-sandbagging.” 

Competing Interests When it Comes to Sandbagging Clauses

More importantly, the Buyer and Seller in a deal have different competing interests, and so each has their ideas on handling the sandbagging clause.

So, while there are many different ways to prepare for sandbagging, most strategies boil down to three essential elements:

1. Including a clause in the acquisition agreement that says the Buyer can seek a claim even if the Buyer knew ahead of time that the Seller’s representations and warranties were false (i.e., sandbagging is permitted)..
2. Including a clause in the acquisition agreement that says the Buyer can’t seek compensation for a breach of the Seller’s representations and warranties if the Buyer knew the representations and warranties were false ahead of time (i.e., sandbagging is explicitly forbidden).
3. Saying nothing about the issue. In this case, the contract defaults to whatever state law says.

When the Buyer wants a sandbagging clause, and the Seller wants an anti-sanding clause, a typical compromise is to leave both clauses out of the purchase agreement. However, in certain states, if the agreement makes no mention of a sandbagging clause, sandbagging is permitted. So from the Seller’s perspective, mentioning the clause is only sometimes considered an equal compromise. 

As seen in Arwood v. AW Site Services, LLC In the Court of Chancery of Delaware, the state respects contracting parties’ right to enter into good and bad contracts. The Delaware Supreme Court has yet to decide if a party can win a settlement for a broken promise if both parties knew some of the promises weren’t true at the time of signing.

Sandbagging in the Context of Due Diligence

Due diligence is expensive, so parties to contracts in mergers and acquisitions often try to ensure a Buyer doesn’t have to check every detail of a Seller’s business. 

Pro-Sandbagging

A pro-sandbagging clause enables a buyer to pursue compensation for a violation of a representation or warranty even if the Buyer had previous knowledge that the statement was untrue. The right to a remedy, for instance, is not affected by any knowledge acquired (or capable of being acquired) before or after the execution and delivery of the agreement or the closing date with respect to the accuracy or inaccuracy of such representation [or] warranty. 

In the Buyer’s eyes, a pro-sandbagging clause helps assure that it will benefit from its bargain. Based on the Seller’s promises and warranties, the Buyer assumed that its target had a particular worth. Buyers claim that if the statements are untrue, they overpaid and should receive compensation. Additionally, buyers contend that pro-sandbagging agreements give the parties more assurance. They eliminate obstacles to recovery, for instance, a protracted and expensive argument over the Buyer’s prior knowledge during the indemnification process.

Anti-Sandbagging

An anti-sandbagging clause would prevent a buyer from pursuing reimbursement in cases where the Buyer knew (or, depending on the clause’s scope, had cause to know) that a representation was untrue before closing. The contract can provide, for instance, that the Seller is not responsible for “any Losses originating from or attributable to any inaccuracy in or warranty in this agreement if the party claiming indemnification for such Losses had Knowledge of such breach before Closing.” 

The parties may restrict the scope of the agreement to knowledge received by a particular group of people or to knowledge obtained before a particular date.

These days, anti-sandbagging clauses are rare. However, sellers contend that these clauses may encourage collaboration between the sale parties in specific situations. If, for instance, an executive or owner plans to stay with the acquiring company after the acquisition, the persistent danger that the Buyer may sandbag the Seller may result in conflict and distraction. Sellers might also contend that they should be allowed to fix any problems the Buyer learns about before closing.

Key Takeaways

By getting the Seller’s promises, the Buyer puts some risks on the Seller. As a practical matter of business, a Buyer doesn’t have to check and make a provision for every aspect of the company’s finances because it knows it can take legal action against the Seller if the claims turn out to be false. For example, false or misleading statements about the company’s financial health or expectations of future performance. 

A Seller can’t go back on the promises it made because the Buyer’s due diligence didn’t find out they were false. Since the Seller promised in the contract that the Buyer could depend on certain statements, the Seller can’t say that the Buyer was wrong to trust the Seller’s own binding words.

Two General Rules Governing Sandbagging

In general, courts have established two separate rules—the so-called “Modern Rule” and the “Traditional Rule”— In the absence of a sandbagging clause in the M&A agreement, parties to M&A transactions and their counsel should be aware of how various states handle a buyer’s indemnity rights.

The Modern Rule

The modern rule refers to a legal principle that guides the interpretation and application of law in contemporary society. It is based on the principle that laws should evolve and adapt to changing circumstances and new situations. In other words, the modern rule emphasizes the need for a flexible and dynamic approach to law rather than a strict and rigid interpretation of outdated legal principles.

According to “Modern Rule” courts, the Buyer had the right to rely on the representations and warranties because they were negotiated contractual duties. Delaware and, generally speaking, New York are two states that adhere to the Modern Rule (as well as Illinois, Florida, Connecticut, and Indiana). 

The Modern Rule is a “pro-sandbagging” rule and is thus in the best interest of the Buyer. Because purchasers are typically not required to demonstrate reliance in those jurisdictions to pursue an indemnity claim for a seller’s breach of a representation or warranty, buyers are likely to prefer the controlling law of an M&A agreement to be a state that adheres to the Modern Rule.

The Traditional Rule

According to the Traditional Rule, a buyer’s indemnification claim requires that it be proven that they relied on the representation or warranty in some way. 

Most states have adopted this approach, which calls on purchasers to demonstrate that they relied on the representation or warranty that the Seller broke. 

The Traditional Rule is seller-friendly since it prohibits “sandbagging.” Because a buyer would have to demonstrate that they relied on the Seller’s false representation or warranty to succeed in a claim for breach of representation or warranty against the Seller, a seller will likely prefer that a state that adheres to the Traditional Rule serve as the governing law of an M&A agreement. 

The Bottom Line

Some people who disagree with modern rules think sandbagging is bad economics because it makes bargaining more like a punishment. Others believe that sandbagging is unfair or questionable from an ethical point of view. Even though it might be unsettling to let a Buyer wait until after closing to bring a breach claim against the Seller that it knew about before closing, the risk of this kind of litigation can be managed just like any other risk in the deal that the parties make.

A rule that supports sandbagging backs up the idea that representations and warranties are an essential way to share risks. 

When the parties to a contract choose not to (or don’t) divide the risk of sandbagging, the Buyer can rest assured that, as part of the deal, the Seller has implicitly promised to be honest in what it says. This view of “reliance”—that is, it requires nothing more than relying on the express warranty as part of the deal between the parties—reflects the common belief that an action for breach of an express warranty is no longer based on tort but mainly on the contract. 

In other words, the fact that the Buyer questioned whether the Seller would honor their promises should not free the Seller from his obligations when it agrees to do what it said it would do. Reliance, whether a good idea or not, is not a part of breaking a contract.

Practice Pointer

During the due diligence, you should keep in mind the Seller’s promises and any facts you find that goes against the promises. It is best to seek legal advice before entering into any contract. 

Contact Swiecicki & Muskett, LLC for practical solutions to your business and legal issues.

 

by Chris Swiecicki

Understanding Contract Law: The Implied Covenant of Good Faith and Fair Dealing

A legal contract’s basic function is to state the rights and obligations of each party. In addition, the document typically covers what will happen under a variety of possible scenarios. This list of stipulations can be quite lengthy, especially in contracts between corporate entities.

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by Chris Swiecicki

Mergers and Acquisitions: The Perils of Breaking a Stock Purchase Agreement

At Swiecicki & Muskett, LLC, we often litigate interesting cases that illustrate just how important it is to follow the terms of a contract. One recent case involved our appeal of findings in favor of the seller of a business. We aimed to prove that the company breached its Stock Purchase Agreement (SPA) with the buyer, despite the original court ruling in the seller’s favor.

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