Preparing Board Meeting Minutes: Necessary Evil and Corporate Drudgery?

For many entrepreneurs, the idea of preparing minutes of board meetings seems like a thankless chore, especially when there are only two or three directors. It may be tempting to skip this corporate formality if the purposes for it are not understood. Also, many entrepreneurs wonder what magic language should go in them to make them “legal.” This article clarifies the reasons for preparing minutes and identifies the components that should be included in them.

Reasons for Preparing Board Meeting Minutes

There are several reasons for preparing good corporate minutes:

State Law Requirements and Corporate Bylaws. State laws generally require corporations to prepare and keep minutes of board meetings. According to Delaware state law (a state where many companies are incorporated), “one of the officers shall have the duty to record the proceedings of the meetings of the stockholders and directors in a book to be kept for that purpose.” The Wisconsin Statutes do not require corporations to take board minutes unless requested by a director, but most corporation bylaws require the corporation to maintain adequate minutes of board meetings.
Reduce Personal Liability Exposure. Preparing and maintaining proper corporate minutes may help reduce the risk of personal liability. Directors have a fiduciary duty of care, meaning that they have to show that they sufficiently analyzed the alternatives before making a decision. They also have a fiduciary duty of loyalty, meaning that they must act in the best interest of the corporation and its shareholders, above any of his or her own interests. Maintaining good corporate minutes can help to establish that the duties of care and loyalty have been fulfilled. Also, by having good corporate records, there may be less chance of a third party “piercing the corporate veil” by claiming that the corporation is nothing more than a sham of the owners who disregard the separateness of the entity and should not receive the benefits of limited liability protection.
Third Party Requirements. Another reason to keep minutes is to provide evidence of approval of transactions involving third parties (e.g., banks, investors, and strategic partners). In addition to being a state or bylaws requirement to approve significant transactions, some third parties require evidence of such approval as a condition of closing.
Reduce Likelihood of Certain Types of Litigation. In a 2006 case, the Supreme Court of Delaware described best practices for approval of an action by a board committee and concluded that the company could have avoided decade-long litigation if proper minutes had been recorded for every meeting with detail regarding the information that was used to make the decisions.
Creation of a Historical Record. A bonus of preparing minutes is that the company will accumulate a searchable, historical record of all of the significant actions taken by the company. By either gathering signatures electronically or by scanning and combining the final, signed minutes into a searchable PDF binder, they will be easily searchable and ready for delivery to future investors, bankers, and auditors who require them for a transaction or audit.

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Wide Adoption of Electronic Signatures and Electronic Contracts Overdue

Many laws establish the validity of electronic signatures, but adoption has been mainly in e-commerce. With heightened awareness of the efficiency and security of current e-signature software spurred by Adobe’s recent free beta release of its eSignatures product, electronic contracts may become more popular.

While almost a decade has passed since the federal Electronic Signatures in Global and National Commerce Act (ESIGN Act) became law, most companies have yet to take advantage of the opportunities that the act affords. Other than online click-wrap license agreements and Internet sales terms and conditions, most companies are still entering into most of their agreements on paper. Having moved beyond faxing in most cases, the norm these days for most businesses is to print, sign, scan, and email the contract. In large or important agreements, companies typically also exchange multiple sets of originals, so that each side (and their legal counsel) have original copies. In most situations, this elaborate process is unnecessary. For a variety of reasons, we often encourage clients to go paperless with their contracts when appropriate.

Software and Internet Services that Assist with Electronic Contracts

There is some encouraging news that going paperless in the contracting process may become more prevalent. Adobe recently released a free beta version of its online eSignatures software-as-a-service (SaaS). The SaaS offering is easy to use and may spur more adoption of e-signature technology. Low cost competitive products from DocuSign, Arx, and AlphaTrust are also worthy of consideration. These and other e-signature vendor products offer the following benefits:

E-signatures speed up the contracting process. The extra steps of printing for signature, scanning, preparing a cover letter/fax, and mailing/faxing are removed.
E-signature service can be accessed virtually anywhere. All that the parties need is a computer with an Internet connection. No need for the traveling executive to find a printer and scanner/fax or have the hotel staff print the document, prepare a coversheet and fax the signed document back.
Electronic contracting saves paper. There is no need to print the agreement, so it supports the virtually paperless office, such as ours.

In addition, traditional concerns over security have mostly been allayed. The e-signature vendors typically offer one or more security measures to authenticate the sender and verify that the document has not changed since it was signed. Many e-signature vendor offerings are SAS 70 Type II compliant and upload and download over an SSL encrypted channel. Audit trails show when and by whom documents were sent, viewed, and signed. After signing and downloading, with most of the products, the party sending the contract typically has the ability to delete the electronic contract from the cloud.

Laws Related to Electronic Contracts

Numerous laws in the United States and abroad recognize the legitimacy of electronic signatures. The federal ESIGN Act and Uniform Electronic Transactions Act (UETA) serve to establish generally the legal equivalence of electronic records and signatures with paper writings and manually-signed signatures, removing barriers to electronic commerce. Forty-seven states have adopted the UETA, a model law for states to enact to cover contracts governed by state law; the remaining states, New York, Illinois, and Washington, have each adopted their own statutes governing electronic transactions. Under the UETA, an electronic signature is attributable to a person if it was the act of the person, which can be shown by the effectiveness of the security procedures for signature authentication and the context and surrounding circumstances at the time of the document’s creation. No one can be required to use a digital signature or to accept a digital signature. Besides the United States, the European Union has adopted the Electronic Signature Directive (1999/93/EC) and numerous countries have adopted electronic signature laws.

How Electronic Signatures Work

These are the basic steps to send a document for signature using an electronic signature solution. The initiator sets up a password-protected account, uploads a document, types the email addresses of the recipients, composes a short cover note (if desired), clicks to sign (or chooses to sign last), and sends. Recipients receive an email with the customized message and a link to a document to sign. Recipients are not required to pay to use the electronic signature service, but they may need to set up an account. After completing any required authentication checks, they click on the link, review the document, and click to sign and send. After the document is fully signed, all parties receive an email with a link to the document with digital signature stamps from each signing party. In the case of Adobe’s eSignatures SaaS offering, Adobe will apply a certifying signature, appearing as a blue ribbon, indicating that the document has not changed since it was signed.

Additional E-Signature-Based Offerings that Facilitate the Electronic Contracting Process

E-signature vendors with low-cost software or services offer many of the following additional features (some of which Adobe may incorporate into later versions):

Signatures in multiple places and on specific lines (whereas Adobe’s eSignatures SaaS offering just appends a signature page to the end with all the electronic signatures)
Fill-in-the-blank forms and agreements, guiding receiving parties through the document with signature flags, initial flags, and instructions, and preventing a party from signing a document with an incomplete blank
Ability to compare the signed document to the encrypted hash captured at document signing to confirm that the signature is valid and the document has not been modified (whereas Adobe’s blue ribbon indication is immediate)
Signing parties other than the sender do not need to subscribe to the service (free)
Folders to deliver multiple documents in logical groups
Workflow processes for internal approvals
Access via mobile devices
Optional multi-layered authentication, such as passwords, ID checks administered by third parties with questions from public and private databases, security fobs, etc.
Integration with business enterprise software
Server-based as well as hosted solutions
Custom branding and instructions
Optional behind-the-scenes digital signature cryptology

Using Digital Signatures for Additional Security

A subset of electronic signatures, digital signatures provide more checks to ensure security, but more time and cost can be involved in administering them. Digital signature technology can also be used to control who has access to a document or who can sign or certify it. Digital signature technology is the gold standard of security in terms of validating the authenticity of the signature and preserving the integrity of the document. This is due to the secure method of locking and unlocking the signatures on the document. A digital signature, also known as a digital ID, requires a private key of the signer and a public key for the receiving party to validate the signature. Many large organizations implement a public key infrastructure to issue, authenticate, and revoke digital IDs used for digitally signing documents. Most receiving parties require that a certificate authority, such as VeriSign or GlobalSign, validate the authenticity of the public key. There are fees in the hundreds to thousands associated with using a Certificate Authority. While it is not difficult to establish a digital ID or validate another party’s digital IDs, some education and administration is involved.

When to Use Handwritten Signatures vs. Electronic Signatures on Contracts

Although electronic signatures are in most cases recognized as being equally valid as handwritten signatures, there are occasions when handwritten signatures may be more appropriate. When doing a substantial deal with a party in a more formalistic country, such as Japan, China, Spain, and Italy, a personal signing ceremony can be a culturally sensitive choice. Parties might also prefer to sign in person or exchange wet ink signatures when stakes are high or emotions run deep, as with the sale of a business. In addition, under law, there are certain types of agreements that cannot validly be signed electronically. For example, in many places, wills, testamentary trusts, family law documents, and U.C.C. documents must be signed by hand. If in doubt as to whether a contract may validly be signed electronically, check with your attorney first. Also, government regulators in some highly regulated industries such as pharmaceutical and financial services regard the use of digital signature technology favorably for regulatory and legal compliance.

Just as signing and emailing documents became prevalent with widespread adoption of PDF files and improvements in scanners, so, too, are electronic signatures likely to become more mainstream as people discover the increasing efficiency and security of e-signature technology.

The NDA, CDA, PIA, and Other Confidentiality Agreements

Sometimes they are called Nondisclosure Agreements (NDAs), Confidential Disclosure Agreements (CDAs), Proprietary Information Agreements (PIAs) or Secrecy Agreements, but for the most part, they each are the same thing trying to accomplish virtually the same objective: limit the disclosure and use of one’s confidential information. This post examines the details of an NDA.

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Because of the frequency of which they are used, one of the first forms that we automated at AlphaTech was the Confidentiality Agreement. Sometimes they are called Nondisclosure Agreements (NDAs), Confidential Disclosure Agreements (CDAs), Proprietary Information Agreements (PIAs) or Secrecy Agreements, but for the most part, they each are the same thing trying to accomplish virtually the same objective: limit the disclosure and use of one’s confidential information.

So, if they are all trying to do the same thing, why are there so many forms out there? The answer is that it often comes down to legal limitations, the one-way versus two-way (or mutual) nature of the agreement, and exceptions or limitations to the disclosure and use limitations. For example, many states consider when employees sign a Confidentiality Agreement it is a restrictive covenant (or noncompete). As such, to be enforceable in most states, the agreement must have “reasonable” limitations on variables such as duration. These legal restrictions are not typically the same for two businesses entering into an NDA.

The balance of this post examines the details of an NDA.

Definition of Confidential Information

Most NDAs define “Confidential Information” very broadly. There are commonly carve-outs for things like information that ends up in the public domain, information already in the possession of the recipient, and information conveyed to the recipient from someone else who was not under an obligation to keep it confidential. It is also common to see trade secrets carved out of the confidential information definition if the NDA imposes more strict obligations on use and disclosure of trade secrets. Sometimes one sees a carve-out for information that is “independently developed” by the recipient without the use or benefit of the confidential information provided by the discloser. This last carve-out is appropriate in some contexts, but not in others. Regardless, if the “independently developed” provision is incorporated, be sure that it does not permit “reverse engineering” of confidential information.

A controversial provision that one sometimes sees in NDAs is a requirement that in order to be considered within the definition of confidential information, the information must be marked “confidential” or confirmed in writing as confidential if communicated orally. This limitation is fine for arrangements that are very limited in scope and have a specific set of documents that are considered confidential. However, companies should be wary of such a limitation for continuing relationships or arrangements in which many people are exchanging a lot of confidential information. The process of marking and communicating what is confidential (consistently) can get unwieldy very quickly. A failure to follow just once this “simple” procedure of marking something confidential, can lead to disastrous results.

Use and Disclosure of Confidential Information

An important but sometimes overlooked provision is the scope of the permitted use of confidential information. The scope of use should be broad enough to accomplish the intended purpose of the disclosure (e.g., to enable the consultant to perform under a consulting agreement or explore the possibility of entering into a strategic partnership with another company), but not overly broad to enable shenanigans. The use provision should be tailored to the specific context of the intended use. Also, it is common to see a provision that enables disclosure if the recipient is legally compelled to do so (e.g., under a court order or subpoena).

No License or Warranty

It is common to have a provision in an NDA that disclaims any license or warranty being conveyed when delivering the confidential information. Sometimes, when something is delivered, there can be an implied warranty or license associated with the item being delivered (that the information is accurate, that it works, that it doesn’t infringe on the rights of others, that the recipient can use it, etc.). This type of provision typically disclaims those.

Duration of the NDA

NDAs typically have two elements of duration. The first element is the period during which disclosures can be made that are covered under the NDA. For example, for employees or consultants, this is typically the period during which the employee or consultant is engaged by the company. The second element is the period during which confidentiality and use restrictions apply after the agreement comes to an end. A common restriction one sees for employees is that the duration lasts for a period of two years following the end of the employment.

Governing Law, Jurisdiction, Forum/Venue

Most NDAs address which state’s (or country’s) law applies when interpreting the NDA. Many NDAs also address where a dispute will be resolved. The provision is less important when the two parties are located in the same area. It becomes more important (and often negotiated) when the parties are not located near one another or are located in different countries. Common compromises are to (i) choose one party’s state’s law (or country’s law) to govern the contract and the other party’s location as the forum/venue, (ii) delete the provision altogether, making it unclear which state’s law applies and where disputes are to be settled, or (iii) in a two-way NDA, choose a neutral but relevant state’s law to govern the agreement (e.g., Delaware, if both companies are incorporated there) and require the discloser (the company enforcing) to use the recipient’s location in the event the discloser would like to sue the recipient.

Right to Equitable Remedy

Many NDAs will include a provision that states if the recipient breaches the agreement, the discloser will be entitled to equitable or injunctive relief. In the NDA context, equitable or injunctive relief refers to getting a court order to stop the recipient from using or disclosing the confidential information. Sometimes, this type of relief can be more difficult to obtain than monetary damages. However, in most contexts involving an NDA dispute, the discloser’s top priority is to prevent the recipient from continuing to use or disclose the confidential information. As a result, the purpose of the provision is to attempt to stipulate that the requirements to get an equitable or injunctive remedy have been met.

Entitlement to Attorneys Fees in the NDA

Many NDAs contain a provision covering attorneys’ fees. Sometimes they are structured as a prevailing party obligation—the winner gets the loser to pay the winner’s attorneys’ fees. Other times, especially in one-way NDAs, the attorneys’ fees provision requires the recipient to pay the discloser’s attorneys’ fees in enforcing the terms of the NDA.

Return of Confidential Information and Materials

Most NDAs address the situation of what happens at the end of the term of the NDA with regard to materials that contain confidential information. Most NDAs require that materials containing confidential information either be returned or destroyed. Some NDAs require that if the recipient destroys the materials, the recipient is required to certify that the materials have been destroyed.

Sometimes NDAs contain a provision that entitle the recipient to retain a copy of all confidential information for record keeping purposes. Query whether maintaining a single copy for recordkeeping purposes on a server that everyone has access to is consistent with the expectations of most companies disclosing confidential information. If retaining a copy for recordkeeping purposes is included, be sure that type of issue is addressed. Similarly, sometimes the NDA will contain a provision that enables people within the recipient organization to retain the “residual” information in their memory. Of course, regardless of the presence of this particular provision, people cannot readily “delete or destroy” information in their mind without collateral grave implications. However, be sure to understand what people can do with that residual confidential information under the terms of the agreement.

Other Provisions in the NDA

Depending on the industry or substance of the disclosure, there can be additional provisions included within the NDA. For example, there can be some export limitations for certain types of information. The NDA can address those limitations. The NDA can also cover certain disclosures and limitations that are applicable to insider trading restrictions under federal securities laws. These and other issues should be considered when developing an organization’s NDA forms and when reviewing those received from another company.

Understanding the United Nations Convention on Contracts for the International Sale of Goods

Background on the CISG

The United Nations Convention on Contracts for the International Sale of Goods (“CISG”) is an international treaty that governs most sales of goods between a buyer and seller that reside in different countries, if those countries have adopted the CISG. It has been adopted in the US and more than 70 other countries. In fact, signatory countries account for more than two-thirds of all goods moving in international trade and encompass a majority of the world’s population. Significant trading partners that have adopted the treaty include Mexico, China, Japan, South Korea, Singapore, most of Western Europe (excluding Great Britain) and Canada.

In the United States, the sale of goods between businesses is generally governed by state-adopted versions of Article 2 of the Uniform Commercial Code (“UCC”). When contracting parties in the U.S. agree to terms, the UCC serves as a backdrop, filling certain gaps that the parties may have failed to address, establishing certain standards on warranties and disclaimers, etc. The CISG performs a similar role in an international transaction, but differs from the UCC in important ways. Set forth below is a brief summary of some of the key aspects of the CISG, as well as differences between the UCC and the CISG.

When the CISG Applies

As noted above, the CISG applies to the sale of goods between parties residing in different jurisdictions that have adopted the CISG. The CISG, however, does not apply to sales (1) of consumer goods; (2) by auction; (3) of securities or negotiable instruments; (4) of ships, vessels, or aircraft; or (5) electricity. The CISG is also not applicable to so-called “assembly contracts” where the party that orders goods to be manufactured supplies a substantial part of the materials necessary for such manufacture or production of the goods.

It is important to note that when applicable, the CISG is likely to apply unless expressly disclaimed in the contract. Case law suggests, for example, that if you are selling equipment to a Canadian buyer and your contract says something to the effect of, “the parties agree that the laws of Wisconsin will govern this transaction, except the conflict of law provisions therein,” the CISG will still likely trump Wisconsin law unless the contract goes on to state expressly that the CISG does not apply.

Differences between the CISG and the UCC

Should you care if the CISG applies? It depends. But you should know what you are agreeing to so you can make a reasonable choice.

CISG Applies to Oral Contracts

One significant difference between the CISG and the UCC is that the UCC limits the enforceability of oral contracts. The CISG states that a contract of sale need not be evidenced by writing and is not subject to any other requirement as to form. A contract may be proven by any means, including witnesses. Furthermore, in the absence of a specific clause to the contrary, the CISG generally permits oral amendments or modifications to contracts.

Battle of the Forms

The CISG and UCC also differ in their approaches to the “battle of the forms.” Under the UCC, a final form that is not intended specifically as a counteroffer will act as an acceptance, even though it contains different or additional terms to those contained in the prior form. The additional terms are considered as proposals for additions to the contract and, as between merchants, become part of the contract, unless (1) the offer expressly limits acceptance to the terms of the offer; (2) the terms materially alter the offer; or (3) notification of objection to the terms already has been given or is given within a reasonable time after notice has been received.

The CISG departs from the UCC approach and, instead, says a reply to an offer that purports to be an acceptance but contains material additions, limitations or other modifications is a rejection of the offer and constitutes a counteroffer. Thus, at least prior to performance, either party may be able to claim successfully that no enforceable contract exists under the CISG. After delivery and acceptance, a contract will undoubtedly be deemed to have existed. Although the terms of the contract may be subject to dispute, the CISG generally favors the last party to submit materially different terms.

Disclaimer of Warranties Less Formal Under the CISG

The UCC and the CISG have similar provisions for warranties, but the requirements to disclaim warranties differ. The CISG contains no provisions comparable to the disclaimer procedures that sellers may use under the UCC. For example, under the UCC, an effective disclaimer of the implied warranty of merchantability generally must mention “merchantability” and must be in conspicuous writing. Similarly, an effective disclaimer of an implied warranty of fitness must be in writing and conspicuous. The CISG is less formalistic and appears to permit disclaimers of warranties as long as the “parties have agreed” in writing or orally.

UCC Follows the “Perfect Tender” Rule

Under the UCC, a buyer is generally entitled to reject goods that fail in any respect to conform to the contract. This is known as the “perfect tender” rule. Under the rule, generally speaking, a buyer may in good faith reject goods and cancel the contract, even if a defect in tendered goods is not serious and the buyer would have received substantially the goods for which it bargained. The CISG departs from the perfect tender rule and makes rejection or cancellation more difficult. The buyer may void a contract only if the failure by the seller to deliver goods constitutes a fundamental breach. Under the UCC, the buyer has a reasonable opportunity to inspect the goods. However, under the CISG, the buyer must inspect the goods within as short a period as is practicable under the circumstances.

CISG Has a “Self-Help” Remedy

The CISG allows for many of the same damage remedies as those available under the UCC. Generally, a buyer may claim damages if the seller fails to perform. Under the CISG, damages typically equal the loss suffered as a consequence of the breach, including the loss of profit. These types of damages are similar to the direct, incidental, and consequential damages available under the UCC. However, the CISG includes a novel unilateral price reduction remedy: if the goods do not conform with the contract, the buyer may reduce the price. This self-help remedy is not available if the seller is able to cure non-conformity without causing unreasonable delay or inconvenience to the buyer.

Conclusion

Whether you will be helped or hurt by the CISG depends on the circumstance. In the ever-increasing world of global trade, however, buyers and sellers should be aware that it will likely apply unless expressly disclaimed and it will impact how their contract for the sale of goods is enforced. Detailed information about the CISG can be found at the website of the Institute of International Commercial Law at Pace University School of Law.

Effective Contract Management

Effective contract management can save time and money and mitigate risk. Depending on the company’s current and anticipated needs, the solution may be a simple spreadsheet, a database, a licensed software application, or a web-based hosted service. Equally important as choosing an appropriate contract management tool is designating a qualified administrator.

Effective contract management can save a company time and money and mitigate risk. Even so, often after companies painstakingly negotiate agreements, they frequently file them away and move on to the next business negotiation without giving them much further thought. Getting control of contracts then can become a fire drill after deadlines are forgotten or when a potential strategic partner or acquirer wants to look at a company’s contracts.

Contract management is often ignored or relegated to the backburner due to more pressing daily demands or delegated to someone without the time or ability. Plus, for some companies without relevant expertise or time, it can be daunting to select a contract management solution and integrate the company’s contracts into the management tool. The earlier a company develops discipline in managing its contracts, the earlier it will reap the powerful rewards, including the ability to quickly and easily do the following:

anticipate expiration and renewal dates
manage its own deliverables
monitor third party performance
monitor and understand trends within recurring contracts
produce custom reports based on unique search criteria

Having a good contract management system may also speed the due diligence process of a significant business transaction, as the contracts will have already been reviewed for completeness, summarized for searching and reporting purposes, and scanned for ready delivery. With more sophisticated contract management systems, not only are executed contracts managed better, but the contracting process on the front end can become more streamlined and efficient and yield higher quality and consistency among contract terms.

Variables to Consider when Selecting the Appropriate Contract Management System

When selecting a contract management system for an organization, it is important to consider both the complexity of the organization’s contracts as well as current and anticipated future needs of the organization. Here are some considerations:

How many people are involved in contract administration, and how many people need to have read-only access?
Do the users need to have electronic access to the agreements?
Do the users need to have access to agreement summaries?
Is it desirable for the agreement text to be searchable as well as the summary?
Are there certain controls the organization would like to have in limiting access by some people to only certain types of contracts?
How comfortable are the users with spreadsheets, databases and vendors’ applications?
How many contracts, what types of contracts, and what variations in those contracts does the organization have?
What key elements of a contract does the business want to monitor?
Are email reminders of key dates needed?
How important is it to have a turnkey solution that provides customer relationship management and full contract lifecycle management, including a contracting approval process?
Is it desirable to use a hosted solution as a document repository to free up space on the company’s network?
What is the budget?

Depending on the company’s current and anticipated needs and desires, the solution may be a simple spreadsheet, a homegrown database, a licensed software application, or a web-based hosted service. Ideally, the solution should be scalable so it can grow with the business, or at least the data should be easily exportable, in case a different contract management system is more appropriate as the business evolves.

Using Spreadsheets for Contract Management

A simple spreadsheet is better than nothing and may suffice if the business has relatively few contracts or many of a similar, simple standard form. The advantages of a spreadsheet are that it is inexpensive and easy to use. A spreadsheet can also be supplemented by scanning the agreements as text searchable PDFs. However, a spreadsheet has limited or no functionality to provide email reminders, tailored permissions by document or category, multiple non-standard contract elements, advanced searches, and various reports.

Using Databases for Contract Management

If the business has an employee or advisor experienced with creating databases, that person could create a tailored database for the business, with specialized contract clause fields, a user-friendly form interface, and customized searches and reports. Vendors’ database products frequently offer greater functionality, such as the following:

email reminders
tailored permissions
customizable fields
ability to upload agreements and make them searchable
auto extraction of key data
sophisticated searches and reports
an unlimited hosted document repository
customer support
military-grade security

Pricing can be surprisingly reasonable. It depends on the sophistication of the software, the number of users, and whether it is a software license with one-time license fee and annual maintenance fees, or a hosted solution with ongoing subscription fees that include customer support.

Designating a Contract Administrator

Equally important as choosing an appropriate contract management tool is designating one or more qualified administrators to assume the contract administration function. The administrator(s) should (1) be able to interpret and summarize legalese, (2) be comfortable with the contract management system selected, and (3) have the time to dedicate to contract administration. Consistency of data entry wording is also important for helping retrieve data through searches of summaries. As the adage goes: Garbage In-Garbage Out! If the business does not have a qualified contract administrator in-house, a corporate paralegal at a law firm can fulfill that role or train someone within the organization to serve in that role.

While implementing effective contract management takes some planning and resources, for most businesses the benefits are well worth it. The earlier a business commits to contract management, the sooner it will begin reaping the rewards.

Using Placement Agents in Private Offerings

When raising capital, many companies use an intermediary or “placement agent” to assist them in the process of finding potential investors. If a placement agent of an issuer has a pre-existing substantive relationship with an investor, that relationship generally extends to the issuer for purposes of avoiding the advertising restriction imposed on companies in private offerings. A placement agent usually refers to a person or firm that is a registered broker-dealer, but sometimes also includes “finders.”

One of the requirements in a private offering is that the issuer have a “pre-existing substantive relationship” with its investor. Once exhausting contacts with local or regional venture capital firms and angel investor groups, relatively few entrepreneurs seeking equity investments have adequate personal contacts with wealthy people who can provide sufficient money to meet the capital needs of the entrepreneur’s business. For those who don’t, one option is to engage an intermediary or “placement agent” to assist them in the process of finding potential investors. If a placement agent of an issuer has a pre-existing substantive relationship with an investor, that relationship generally extends to the issuer for purposes of avoiding the advertising restriction imposed on companies in private offerings. A placement agent usually refers to a person or firm that is a registered broker-dealer, but sometimes also includes “finders.”

Broker-Dealers vs. Finders

Broker-dealers are regulated professionals or firms that have passed a series of exams and have gone through a lengthy registration process that includes interviews. Finders, on the other hand, are not generally regulated. According to federal law, a broker-dealer is “any person engaged in the business of effecting transactions in securities for the account of others.”

For purposes of this article, the key language is “in the business of effecting transactions.” A finder is someone not in “the business of effecting transactions.” Rather, finders infrequently bring investors and companies together, but that’s all they can do. By law, a finder is not permitted to pitch for the company, develop deal terms, or negotiate for or represent the investor or the company.

There are likely many finders out there who actually perform the services of a broker-dealer, but have failed to register as one because of either ignorance or the time and cost that it takes to become registered. However, it is a violation of federal and most state securities laws to fail to register if a person or firm is engaging in conduct that constitutes broker-dealer activities. A violation of one of those laws can bring fines, investment rescission, penalties, headaches, and in egregious situations, imprisonment.

Some states place significant restrictions on performing any “finder-related” activities, and take away common blue sky transaction exemptions if an issuer compensates a finder as part of a sale of securities to the particular state’s residents. Moreover, there are regulatory issues of giving transaction-based compensation to finders (e.g., an 8% finder’s fee), which often times is exactly what the company and finder want to do.

Because of these and other regulatory issues and various limitations associated with using finders, it is usually better to work with a broker-dealer rather than a finder. However, there are many more finders that are willing to work with early-stage companies than there are broker-dealers willing to do so.

Selecting a Placement Agent

You may ask, “how does one find a placement agent?” Entrepreneurs can talk with their lawyers, accountants, or other entrepreneurs about their experiences with various placement agents in their area. Generally speaking, for smaller transactions (e.g., under $5 million), placement agents will typically operate on a regional basis (rather than national).

When selecting a placement agent, there are many things to consider. Probably the most important consideration is trust. By using a placement agent, you are putting a lot of faith in an individual or firm. The reverse is true as well from the placement agent’s perspective in that their reputation is affected by the companies with which they work. Below are some other considerations:

Experience generally as a placement agent
Experience and success with companies in similar industries raising comparable amounts of money.
Reputation
Knowledge and experience with securities laws
For broker-dealers, good written policies and procedures
For finders, the impact of using a finder on state Blue Sky exemptions, and potential legal issues with using the particular finder
Pre-existing substantive relationships with prospective accredited investors

Placement Agent Contracts

Contracts with placement agents vary significantly. At the extremes, I have seen handshake deals, which I strongly advise against, and I have seen 25-page agreements. Below is a list of areas that are commonly negotiated in arrangements with placement agents:

Exclusivity
Duration
Compensation amount and type (e.g., retainer/monthly fee versus a transaction-based fee)
Events that give rise to compensation
Ability to terminate and effect of termination
The duration of the “tail” post-termination
Additional services
Indemnity
Representations, warranties, and covenants
Use of affiliates to assist in process

Once a company decides to engage a placement agent, finding the right one(s) under the right terms are essential. The placement agent may not only affect the success of your offering, but the placement agent may also affect (positively or negatively) the reputation of you and your company, expose you to securities law liability and sanctions, and bind you to a long-term, comprehensive, and expensive set of services.

So, if you decide to work with one or more placement agents, choose carefully.

Changing Your Choice of Entity: Cross-Species Mergers and Conversions

With increasing frequency, companies are considering a change in their form of entity. In most states, there are generally two ways to change your type of entity from a legal perspective: merger and conversion. Assuming a change in structure is justified and the tax issues are manageable, this article focuses on the mechanics of converting from one type of entity to another through a merger or a conversion.

With increasing frequency, companies are considering a change in their form of entity. The reasons for the change vary considerably: sometimes companies are underwhelmed by the tax benefits of being a limited liability company and are overwhelmed by its complexities (international tax withholding issues, multi-state K-1’s, profits interests management, phantom income, and employee education regarding equity-based incentives), while other times companies are frustrated by the restrictions on S corporations and desire the flexibility that limited liability companies afford. In other cases still, institutional investors may require a certain form of entity (e.g., a C corporation), while other investors (e.g., active angel investors) are looking to take advantage of pass through losses.

Today, most states make it fairly easy to change the type of entity or even to change the state of organization of the entity. It is important to keep in mind though that while the mechanics of converting to a new entity from a legal perspective are not typically too complex, the related tax issues can be incredibly intricate, especially for an organization with a long operating history and a complex capitalization structure. While in many situations converting to a different type of entity will be tax-free, that will not always be the case. Your tax advisor and accountants should be consulted early in the process when considering a change in entity form. Assuming a change in structure is justified and the tax issues are manageable, this article focuses on the mechanics of converting from one type of entity to another.

While there are variations among the states, there are generally two ways to change your type of entity from a legal perspective: merging with and into another entity of a different type and effectuating a conversion. The method selected, as well as some of the finer details associated with the particular method selected, is often driven by tax considerations.

Change of Entity Form Through Merger

The more traditional way to change the form of an organization is through a merger. Sometimes people refer to this as a cross-species merger. A merger enables two or more entities to combine into a single entity. The surviving entity can be recently created just to effectuate the change in entity form or it can have an operating history. The surviving entity typically files with the applicable state a plan of merger and a statement that the plan was approved in accordance with applicable law. In most states, the plan of merger identifies the parties to the merger, the surviving entity, and the manner and basis of converting equity interests in each entity into interests in the surviving entity. The plan of merger also includes any applicable amendments to governing documents (e.g., articles) for the surviving entity.

After the merger, only the surviving entity continues to exist and it is responsible for all liabilities of each business entity that is a party to the merger. Subject to certain exceptions and filing requirements, title to assets automatically vests with the surviving business entity.

Change of Entity Form Through Conversion

Within the last decade, most states have adopted statutes that allow organizations to convert their form of entity by just filing the applicable conversion documentation. For example, in Wisconsin, a business that desires to convert to another type of legal entity must submit to the Department of Financial Institutions a certificate of conversion with a plan of conversion and a statement that the plan was approved in accordance with the laws applicable to the pre-converted entity.

Similar to a plan of merger, most states require that a plan of conversion include the name, form of business entity and jurisdiction governing the entity both before and after the conversion. In addition, the post-conversion articles of incorporation or other charter document is an attachment to the plan of conversion. Some states however require a separate filing for the charter document. Like with a plan of merger, the plan of conversion must also include the terms and conditions of the conversion and the manner and basis of converting the ownership interests in the old entity to the ownership interests in the new entity.

Upon conversion, the new entity continues to be subject to the liabilities incurred prior to the conversion. If a business owner had any personal liability by reason of the owner’s position in the entity (such as the general partner of a limited partnership), such liability will continue, but only to the extent accrued prior to the conversion. The new entity continues to be vested with title to all its properties, subject to modest exceptions and certain filing requirements. Any legal proceeding pending against the old entity will be continued against the new entity.

Conducting Due Diligence When Changing Your Form of Entity

Despite the fact that the legal filing requirements for cross-species mergers and conversions are rather straight forward and mechanical, there are a number of due diligence issues that should be considered prior to making the change in entity form. For example, in contracts, a merger is sometimes treated as an assignment of a contract from one entity to another and many contracts prohibit such assignments without prior consent. Businesses should review all their material contracts and consider seeking consent for assignment where necessary. Trademark and patent filings in the U.S. Patent and Trademark Office (USPTO) will need to be updated to reflect new company names in a conversion. Mergers are treated as an assignment that also needs to be recorded with the USPTO. Likewise, regulatory approvals, permits and licenses may need to be updated. Because a conversion, rather than a merger, involves only a single entity, many consider that general contract anti-assignment provisions do not apply to conversions unless conversions are specifically addressed and prohibited. In either case, however, there is frequently a company name change that may need to be reflected on a variety of documents.

In addition to third party contracts and government filings and licenses, there are a number of organizational documents that may need to be created as a result of the merger or conversion. For example, if an entity changes from a limited liability company to a corporation, many of the provisions from the organization’s operating agreement prior to the cross-species merger or conversion will be incorporated into a combination of the new corporation’s bylaws and perhaps a separate shareholders agreement, investor rights agreement or voting agreement. Some of these organizational-related documents can be adopted wholesale with no or modest changes. Others, however, will need considerable changes or even termination because of statutory requirements, efficiency, or custom.

Conclusion

While it would be convenient to have all the facts up front prior to choosing an entity’s form when creating it, even the most diligent and seasoned entrepreneurs experience change in facts or laws that necessitate changing the organization’s form of entity. With proper planning and involvement of your attorney and accountant, the process of converting your form of entity is usually manageable. In the end, like with most things, the decision often becomes a cost-benefit analysis.