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Supreme Court Rules that Claims for Wrongful Foreclosure Must Be Filed Prior to Trustee Sale

By | Articles, Real Estate

The recent Arizona Supreme Court case, Zubia v. Shapiro, 243 Ariz. 412 (2018), reminds homeowners to obtain early legal counsel when facing foreclosure, while bolstering lenders’ affirmative waiver defenses. Particularly, the Supreme Court ruled that borrowers waive claims to damages concerning the validity of a trustee’s sale when they first fail to obtain injunctive relief to prevent the trustee’s sale.

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Choosing The Correct Business Entity

By | Articles, Business

Societies have conceived new business structures since time immemorial. Fundamentally, joining together with business partners spreads the demands of capital and limits risk.

Italians made family firms, compagnia, where fathers, brothers, and sons would pool their labor and capital. Fittingly, the name compagnia derives from the Latin phrase for the act of sharing bread, cum panis. Then, companies granted by royal charter arrived, like the East India Company, an import-export business who received special privilege from the Crown to pursue a monopoly on trade between London and Asia, with offerings varying from pepper to textiles to tea. The East India Company, the mother of the modern multinational corporation, pioneered the joint stock mechanism. That innovation allowed for separation of investors and managers, broadening the pool of capital; it also spread risk and provided limited liability, and it allowed the enterprise to trade on its own account, rather than in the names of the individual owners.

Now, with a few clicks and an electronic signature, anyone can form a business entity, securing the same limited liability separation between an entity and its owners as employed by corporate giants across America.

But which form of entity is right for your business?

For many business owners, the choice-of-entity decision is driven purely by tax considerations. But the two most prevalent forms, the corporation and the limited liability company (LLC), also offer sought-after advantages of: (i) limited personal liability, (ii) easy transfer of ownership, and (iii) management separation from ownership.

Certainly, the tax benefits are relevant, like the incentive to avoid double taxation or the substantial restrictions on entities under subchapter S of the tax code — but don’t miss the legal distinctions and historical context. The LLC is structurally different than a corporation. Today, many owners form LLCs, almost by default, without considering their unique attributes, such as: (1) the primacy of the operating agreement, and (2) the application of fiduciary duties.

First, owners should consider that the LLC is as much a creature of contract as of statute. As a result, once an LLC comes into existence and has a member, the LLC necessarily has an operating agreement, whether written, oral, or implied by law. The operating agreement plays a vital role, as it establishes the fundamental rules for the relationships between the LLC, its members, and any manager.

Even so, many business owners select the LLC form but never draft an operating agreement — or perhaps worse, draft one, but neglect to sign it.

On the other hand, a corporation is not driven by private contract between individuals. Rather, there is a body of statutory and common law that, in some ways, cannot be displaced. A corporation has been judicially defined as “an artificial being, existing only in contemplation of the law; a legal entity, a fictitious person, vested by law with the capacity of taking and granting property and transacting business as an individual. It is composed of a number of individuals, authorized to act as if they were one person. The individual stockholders are the constituents or component parts, through whose intelligence, judgment, and discretion the corporation acts.”

Second, the owners should consider the obligations they intend to impress on themselves and management; for example, owners should consider whether they can limit their fiduciary duties to simultaneously pursue other ventures.

Granted, the topic of fiduciary duties raises many of the most complex questions in the law of business organizations.

For the LLC, the primary issue is to what extent the members can privately agree in the operating agreement to vary or eliminate those duties. Although a contract cannot completely transform an inherently fiduciary relationship into a merely arm’s length association, the operating agreement has substantial power to “reshape, limit, and eliminate fiduciary and other managerial duties.” For example, the classic fiduciary “duty of loyalty” means: (i) not “usurping” company opportunities or otherwise wrongly benefiting from the company’s operations or property; (ii) avoiding conflict of interests in dealing with the company (whether directly or on behalf of another); and (iii) refraining from competing with the company. Members can agree, however, to tailor those limitations and allow a member or manager to engage in other business or compete with the company. On the other hand, corporate directors and officers are not free to contract out of their duties to shareholders.

The law of business organizations has continually modernized, providing us with accessible tools to limit personal liability. But, whether your company is in real estate or technology, simply holds investments or engages in long-distance trade voyages around the Cape of Good Hope, building upon the right legal structure is critical to its long-term success. If you or someone you know has questions about how to structure their business or investments, please call our office today to schedule a consultation with Andy Anderson.

Andy Anderson is an Attorney with Provident Law®. He serves businesses and individuals, counseling them as they form, operate, and protect their companies. He is a member of the State Bar of Arizona Subcommittee tasked with revising the Arizona Limited Liability Company Act. He also serves on the Board of Directors of the Christian Legal Society and he is a graduate of the James E. Rogers College of Law at the University of Arizona and the W.P. Carey School of Business at Arizona State University. Andy can be reached at andy@newnewprovidentlawyers.mystagingwebsite.com or 480-388-3343.

Property Owners Waive All Claims And Defenses Against Lender After Foreclosure

By | Articles, Real Estate

Pursuant to Arizona’s deed of trust statutes, if a borrower defaults on her mortgage obligations, the lender may foreclosure non-judicially by recording its Notice of Trustee Sale with the County Recorder’s Office. See generally, A.R.S. § 33-801, et seq. Importantly, if the borrower believes that she has any claims or defenses against the lender concerning the loan, those claims must be filed before the non-judicial foreclosure takes place.

There are generally only three ways to stop a trustee sale:

  1. reinstate the loan by paying the outstanding balance or otherwise curing the default;
  2. file for bankruptcy protection; or
  3. file a lawsuit and seek an emergency temporary restraining order (TRO).

To be clear, reinstating the loan or filing for bankruptcy are the only guaranteed strategies to postpone a trustee sale; the filing of a lawsuit, on the other hand, is only successful if the Court:

  1. grants the request for a TRO; and
  2. enters the TRO sometime prior to the date and time of the trustee sale.

Based on recent history, it generally takes the Court about five business days to consider and enter a TRO. (Importantly, any lawsuit and request for TRO must have a good faith basis and is subject to sanctions pursuant to Rule 11, Arizona Rules of Civil Procedure.)

Pursuant to Madison v. Groseth, 279 P. 3d 633, 636 Ariz. Add. Rep. 23 (App. 2012), the failure to obtain a TRO prior to the trustee sale waives all claims against the lender (and the new owner), including any allegation that the lender failed to provide the borrower with proper notice of the trustee sale.

At first blush, the above holding appears inequitable and even unconstitutional – after all, how can the borrower object to lack of notice if the borrower doesn’t discover the wrongdoing until after the fact? In Madison v. Groseth, the Court of Appeals observed this potential paradox:

Under other circumstances, [requiring a borrower to obtain a TRO to halt the trustee sale] may apply to deprive borrowers of due process if the borrower does not receive sufficient notice of the trustee sale to obtain an injunction of the sale.

Id. at 635. The Court noted that in the present case, however, the borrower admitted that she received notice of the trustee sale yet failed to apply for a TRO to halt the trustee sale. Indeed, the borrower not only received notice of the trustee sale, but the borrower actually filed a lawsuit against the lender prior to the trustee sale and did not allege that she received inadequate notice of the sale. Consequently, the Court held that this waiver requirement did not deprive her of due process.

In conclusion, if a lender initiates the foreclosure process and the borrower believes that she has claims or defenses against the lender regarding the foreclosure process, the borrower must immediately file a lawsuit against the lender and request a TRO to halt the trustee sale or else the borrower will waive all claims against the lender regarding the alleged wrongful foreclosure.

Mr. Charles regularly represents lenders and borrowers in foreclosure matters. If you or someone you know has questions regarding foreclosures or buyer/lender disputes, please call or email today to speak with Mr. Charles.

You’re Not in Kansas Anymore: A Cautionary Tale Concerning Real Estate Transactions in Arizona

By | Articles, Real Estate

This article was written by Christopher J. Charles, Esq. and Eric L. Walberg, Esq.

With interest rates hovering at historic lows and prices generally stable, many experts agree that now is still a good time to purchase real estate in Arizona. Everyone appreciates a good deal.  But some buyers approach that goal with the wrong strategy. For example, some buyers aim to keep “one foot in and foot out” in case a better deal comes along prior to close of escrow.  We refer to this as “buyer’s leverage.” Arizona is not unique in experiencing this phenomenon. But two of Arizona’s key contract interpretation rules could result in unintended consequences for the unwary buyer.

The first of these two unique rules is that the court cannot rewrite contract terms. On the other hand, the second rule allows the court to consider oral or other extraneous evidence outside the “four corners of the contract” in interpreting an agreement (i.e., a broad interpretation of the “parole evidence rule”). This article explores these Arizona-unique contract interpretation rules and their relationship to each other in the context of real estate agreements.

The ready, willing, and able buyer cannot maximize his leverage without an appreciation and impact of these two Arizona-unique rules on the following “boiler plate” contract provisions:

This agreement constitutes the entire agreement of both parties, and all previous communication between both parties whether written or oral with the reference to the subject matter of this agreement is canceled and superseded.

In the event that any provision of this agreement is deemed vague or unenforceable, the parties agree that the [judge/arbitrator] shall rewrite the provision to be enforceable and/or to reflect the intent of the parties.

Including the latter contract provision in an effort to insert “flexibility” and maximize “buyer’s leverage” could have the unintended consequence of bogging the buyer down in litigation, thanks to the above contract interpretation rules.

For example, a common issue addressed in real estate contracts is the financing contingency. The ready, willing and able buyer might wish to keep its “options open” by requiring that the financing contingency language be drafted in such a manner that he can “escape” the deal if another more advantageous deal comes along. The buyer can demand and may receive a rather vague financial contingency provision that on its face places little or no parameters on the source or terms of financing it might be required to pursue, believing that negotiating such vague terms might prevent the buyer providing more information about its efforts than it might want to divulge to the seller. By insisting on this “flexibility,” however, the buyer may unwittingly open itself up to litigation in Arizona because the seller is able to press the buyer to provide more detail about its efforts to secure financing than the buyer is accustomed to providing in other states. lf the buyer balks at providing this information, the unique contract interpretation rules in Arizona can provide the leverage to the seller against the buyer by asserting that either the brokers or parties involved in the negotiation of the agreement envisioned that the buyer would pursue a certain type of financing. In the end, the seller can claim that although the explicit terms of the agreement do not set forth what efforts the buyer must undertake or agree to, the parties cannot release the buyer from its contractual obligations by claiming a failure to obtain acceptable financing for the purchase of the real estate.

In the example above, the next move by the buyer might be to point out to the seller that the financing contingency language in the contract is so broad that the buyer need only claim the inability to obtain “acceptable” financing, and the contract is terminated. The problem with this approach is that it opens the door to the second Arizona-unique rule of contract interpretation: that court cannot rewrite the contract, notwithstanding inclusion of a contract provision expressly providing to the contrary. The seller will counter that the buyer is simply trying to insert certainty into a contract that did not contain certainty, something an Arizona arbitrator or judge cannot do. This would require the court to delve deeper into the “real intentions” of the parties, and to look to oral or other evidence outside the “four corners” of the contract. Ultimately, this results in a potentially vicious cycle of investigation into the contract that the buyer may never have envisioned at signing. Because the Arizona court cannot re-write the contract, there is no clear end game for either side.

The buyer’s leverage is a function of how many deals it can be involved with at any one time, and how motivated the seller is to close the deal to possibly become the ready, willing and able buyer himself. The dynamics of the real estate deal are rarely known by the parties and can change quickly. But often the parties (including brokers) fool themselves by believing they understand these dynamics. For example, the respective brokers or other agents (including legal counsel) can be fully informed of the motivations of both parties in entering the deal. But in the course of due diligence, the seller or buyer might be introduced to a totally unrelated alternative deal that they simply cannot pass up, making the closing (or failure to close) so important that they are willing to risk the relationship by killing (or forcing) the deal.

The moral to this story? Draft clear and complete contracts (including well-drafted amendments or addenda) to maximize the chance of smooth transactions and to reduce the risk of disputes or litigation.

If you or someone you know has questions regarding real estate contracts, please call today to speak with Mr. Charles.

Whose Business Is It Anyway? Considerations For Dividing Assets In A Divorce

By | Articles, Estate & Trust

Community Property

Sadly, according to recent statistics, roughly half of marriages end in divorce. When “irreconcilable differences” occur, one of many important considerations is how to equitably divide marital assets.

Arizona is a community property state. Absent other contracts or agreements, when a couple resides in a community property state, when they marry, everything that each of them earns from the day they get married belongs to both spouses.

In most cases, the assets a person had before marriage remain that person’s sole and separate property, as do any gifts or inheritances received after marriage. If one chooses to combine his or her sole and separate property with the couple’s community property, generally speaking, the property that is combined then becomes community property.

These legal principles apply to real estate and businesses that a husband or wife has an ownership interest in. In the context of divorce proceedings, as with all other community property, after receiving evidence submitted by the parties, the judge will determine the value of the asset, and then equitably divide the community property interest in the assets between the spouses.

Business Valuation

If the ownership of the business predates the marriage, the judge will examine what the community invested in the business by time and money during the marriage. The judge will also look at the value of the business on the date of the marriage and on the date the Petition for Dissolution was served. In order to present such evidence to the court, the spouse can hire a forensic accountant and obtain the businesses’ financial records for the past 5 years (or longer in some cases).

For some businesses, it may be necessary for the judge to assign a value to the intangible assets of the business as well as the tangible assets of the business. Intangible assets may include patents, trademarks, contracts, and goodwill. The courts recognize two types of goodwill, personal goodwill and enterprise goodwill. Personal goodwill is also known as professional goodwill and attaches to a particular individual such as a REALTOR®, surgeon, or a lawyer, rather than the business the individual owns. Enterprise goodwill or business goodwill comes from the attributes of the business itself.

A business valuation expert is essential to assigning a value to the intangible assets of a business to present to the court. Enterprise goodwill is recognized as a community asset of the business in all states, including Arizona. Some states have declined to include personal goodwill as a part of the community assets of a business. Arizona continues to include personal goodwill as a community asset of a business in a divorce.

SIDS (Sudden Income Deficiency Syndrome)

One spouse is often unfamiliar with a business that has been started and managed by the other spouse. This lack of knowledge leaves that spouse vulnerable to pre-divorce financial maneuvering that has become so common that it is known as “SIDS” (sudden income deficiency syndrome).

Example: A business that has been supporting the family for years that suddenly has little or no income or value. Clues that the sudden lack of income from the business is a result of improper financial maneuvering include correlating the drop in income with a time when the couple began having serious marital difficulties. Other clues include:

  1. when the spouse operating the business begins having the business pay his personal expenses; or
  2. when one spouse’s involvement in the business is reduced.

The more that one spouse performs work or provides services for the business, the stronger her claim is for an partial ownership of the business and the more likely the spouse is to have knowledge of the value of the business.

To prove to the court that the value or income of the business is not what it seems, an attorney will need to call upon a forensic accountant to assist in gathering evidence of manipulation to present to the court.

Prenuptial Agreements, Management and Operating Agreements

In Arizona, the laws regarding community property can be limited by contracts, such as prenuptial agreements. A “prenup” is the most common contract to limit or modify the application of community property law in a divorce. A prenuptial agreement can clearly state whether a business becomes community property after a marriage and which spouse will get to keep the business after a divorce. If a business is created after the marriage, the prenuptial agreement can determine whether that business is community property. In order to be a valid contract, the prenuptial agreement must be fair to both sides, and each party must fully disclose their financial condition. Each party should have their own attorney review and attest to the fairness of the prenuptial agreement and that their client was not coerced into signing the prenuptial agreement.

Absent a prenuptial agreement that establishes ownership and management of the business, the business should have a management agreement and operating agreement that restricts stock transfers to anyone without the consent of all partners. The operating agreement should define who would manage the business if a Petition for Dissolution is filed and served.

Conclusion

The equitable division of assets, especially business-related assets can be difficult. This article briefly summarizes the basic principles of how the business interests of a couple going through a divorce are treated by the courts in Arizona and the steps that can be taken to simplify the division of business interests in a divorce. Each situation is unique. If you or someone you know has questions concerning a specific situation, please contact us for a case strategy session.

HUD Says Screening Based on Arrest Record May Violate Fair Housing Act

By | Articles, Real Estate

As many as 100 million U.S. adults – or nearly one-third of the population – have a criminal record. The U.S. Department of Housing and Urban Development (HUD) recently issued a warning and compelling statistics that reveal that certain protected classes are being disproportionately impacted by their criminal history.

The Fair Housing Act prohibits discrimination in the sale, rental, or financing of dwellings and in other housing-related activities on the basis of race, color, religion, sex, disability, familial status or national origin. 42 U.S.C. §3601 et seq.

Although criminals are not a protected class under the Fair Housing Act, criminal background-based restrictions may violate the Act if, without justification, the restrictions negatively impact one race more than others (known as “discriminatory effects liability”). In addition, where two or more applicants have similar criminal backgrounds, the Act is violated if the housing provider prefers one race over another (known as “disparate treatment liability”).

HUD warns that a housing provider violates the Fair Housing Act if the provider’s policy or practice has an unjustified discriminatory effect, even if the provider had no intent to discriminate. This is noteworthy because under this standard, an ostensibly neutral policy or practice that has a discriminatory effect violates the Act if it is not supported by a legally sufficient justification. And according to the statistics quoted by HUD, housing decisions based on criminal records conclusively result in a discriminatory effect on certain races of people.

HUD does, however, mention the following safe harbor: the policy or practice may be lawful notwithstanding its discriminatory effect as long as the decision is supported by a legally sufficient justification. For example, safety. Some landlords and property managers site the need of protecting other residents and their property as legal grounds for denying applicants based on their criminal background. For sure, ensuring resident safety and protecting property are among the fundamental responsibilities of a housing provider, and courts may consider such interests to be both substantial and legitimate, assuming they are the actual reasons for the policy or practice.

But a word to the wise: denial of housing opportunities based on past history of criminal arrests (without proof of conviction) will not likely satisfy this test. Indeed, according to the U.S. Supreme Court, “[t]he mere fact that a man has been arrested has very little, if any, probative value in showing that he has engaged in any misconduct. An arrest shows nothing more than someone probably suspected the person apprehended of an offense.” Schware v. Bd of Bar Examiners, 353 U.S. 232, 241 (1957); see also United States v. Berry, 553 F.3d 273, 282 (3d Cir. 2009) (“[A] bare arrest record – without more – does not justify an assumption that a defendant has committed other crimes and it therefore cannot support increasing his/her sentence in the absence of adequate proof of criminal activity.”); United States v. Zapete-Garcia, 447 F.3d 57, 60 (1st Cir. 2006) (“[A] mere arrest, especially a lone arrest, is not evidence that the person arrested actually committed any criminal conduct.”). Thus, a housing provider who denies housing to persons on the basis of arrests alone (without proof of conviction) cannot prove that the exclusion actually assists in protecting resident safety and/or property.

On the other hand, denial of a housing-related opportunity based a criminal conviction is likely okay. But the housing provider must still prove that such policy or practice is necessary to achieve a substantial, legitimate, nondiscriminatory interest. A blanket ban on anyone with a conviction record – no matter when the conviction occurred, regardless of the crime, or what the person has done since then – will be unlawful.

According to HUD, a blanket ban against anyone with a criminal record results in discrimination against certain races of people because of the disparities in the U.S. criminal justice system. As a result, the housing policy should differentiate between various crimes and the date of the convictions. For example: [1] convicted sex offenders need not apply (regardless of the date of conviction); [2] convicted felons guilty of violent crimes, kidnapping, terrorism, drug manufacturing, need not apply (regardless of date of conviction); [3] conviction of any drug-related offenses involving possession only, or alcohol-related offenses where no one was injured or killed, must be at least 2 years old.

To summarize, the Fair Housing Act does not prohibit housing providers from considering an applicant’s criminal background when making housing-related decision. But according to HUD’s recent warning, the Act does prohibit housing-related decisions based solely on the applicant’s criminal history. And the Act may prohibit housing-related decisions based solely on the applicant’s conviction record without evidence of a legally sufficiency justification such as safety concerns. As a result, housing providers should immediately implement thoughtful application policies and practices that consider the type of crime, evidence of a conviction, the date of the conviction, and the person’s behavior since the conviction.

If you or someone you know has questions regarding multi-family housing, landlord tenant issues, or other real estate matter, please call or email today.

Christopher J. Charles is the founder and Managing Partner of Provident Law®. He is a State Bar Certified Real Estate Specialist and a former “Broker Hotline Attorney” for the Arizona Association of REALTORS® (the “AAR”). He is also an Arbitrator and Mediator for the AAR regarding real estate disputes; and he serves on the State Bar of Arizona’s Civil Jury Instructions Committee where he helped draft the Agency Instructions and the Residential Landlord/Tenant Eviction Jury Instructions.

Christopher is a licensed real estate instructor and he teaches continuing education classes at the Arizona School of Real Estate and Business. He can be reached at chris@newnewprovidentlawyers.mystagingwebsite.com or at 480-388-3343.

Vacation Rentals

Governor Ducey Signs Law Approving Vacation Rentals in Arizona

By | Articles, Real Estate

Keeping true to his goal for Arizona to become to the sharing economy of what “Texas is to oil and what Silicon Valley used to be to the tech industry,” Governor Ducey signed SB1350 paving the way for vacation rentals in Arizona. Prior to SB1350, cities such as Scottsdale, Phoenix, and Sedona opposed residential rentals for less than thirty days.

Now state law prevents cities and counties from banning short-term rentals and establishes uniform tax laws for vacation rentals.

Click here, to review an overview of the new law in Arizona. This new law protecting vacation rentals in Arizona is the first of its kind in the nation. Airbnb and VRBO are now lobbying across the country for similar laws in other states.

Although SB1350 prevents cities and counties from restricting vacation rentals, in limited situations HOAs may restrict short term rentals pursuant to CC&Rs.

For more information regarding vacation rentals, call or email Mr. Charles today, to schedule a consultation.

A Reminder To Know Your Local Franchising Remedies

By | Articles, Business

I read two tales of franchise terminations. In both cases, the franchisee had been caught with their hand in the convenience store cash register, using different iterations of register-opening keys to misrepresent sales, from “no sale” and “safe drop,” “cancel age verification,” to “beer non-tax.” Lots of different tricks. The franchisees booked thousands of transactions with unreported or underreported income. In fact, one of the franchisees admitted under oath that he used the cancel age verification modus on as many as 4,000 sales of cigarettes over an 18-month period. But in both cases, the franchisor caught on, by way of detailed audits and surveillance, and notices of franchise termination were served.

Now what?

In these cases, 7-Eleven v. Kapoor Bros [1] and 7-Eleven v. Grewal [2], the franchisor 7-Eleven filed a lawsuit, seeking an immediate order from the court to prevent the franchisees from continuing to infringe its federally registered trademarks and service marks: 7-Eleven®, Slurpee®, and Big Gulp®, as well as to prevent continued operation of the stores in violation of non-competition provisions. The results were surprising. 7-Eleven, a sophisticated franchisor with a well-crafted franchise agreement, achieved an order granting in full a preliminary injunction against the franchisee in Florida — and a lesser result on the same facts in Massachusetts.

These cases teach us that franchisors and franchisees should see their favorably-negotiated agreement as the baseline, the bare minimum. Even more, business owners should plan ahead and know the law of their jurisdiction in connection with pivotal events like termination and renewal.

THE KAPOOR BROS. AND GREWAL CASES

In Kapoor Bros., the Middle District of Florida granted injunctive relief for the franchisor, prohibiting both trademark infringement and operating a competing business. Differently, in Grewal, the District Court of Massachusetts granted injunctive relief, prohibiting trademark infringement, but denying injunctive relief to enforce the non-compete clause. Thus, both courts agreed that franchisor was entitled to preliminary injunction to stop trademark infringement, to prevent harm and preserve status quo through trial. But in Kapoor Bros, the court found that the franchisor would suffer irreparable harm if the franchisee operated a competing business until a trial on the merits could be held, while the court in Grewal found no irreparable harm or balance of harms in favor of the franchisor, denying a preliminary injunction to shut down the franchisee’s operations.

You find at least three key distinctions between these opinions, namely the courts’ consideration of: [1] the franchisees’ continued trademark infringement, [2] the franchisees’ hardship and whether it can be considered in connection with the preliminary injunction, and [3] the economic gap between a large franchisor and an individual franchisee.

First, the Florida court assumed that the franchisee would continue to illegally employ the 7-Eleven trademarks, while the Massachusetts court took as given that the franchisee’s continued competition would be without the use of those marks, assuming that the franchisee would comply with the injunction on trademark infringement. Specifically, the Florida court emphasized that the franchisee was, “operating stores under 7–Eleven’s brand without its permission,” and was “pirating the goodwill associated with 7–Eleven and causing it immeasurable damage.” While the Massachusetts court said that 7-Eleven’s brand would not lose any goodwill in the community because, “Customers would have no reason to associate [franchisee’s] convenience store with the 7–Eleven brand after 7–Eleven’s marks are removed from the premises, assuming [franchisee’s] convenience store continues to operate in accord with this order.” This assumption certainly changes the nature and magnitude of possible harm to the franchisor.

Second, both courts considered a Florida statute, Section 542.335(1)(j), which provides for a presumption of irreparable harm for the violation of an enforceable restrictive covenant. Citing that statute, the Florida court said that a preliminary injunction is, “the common and preferred remedy.” Differently, citing the Kapoor Bros. case, the Massachusetts court found that this Florida law further “prohibits the court from considering individualized economic or other hardship that might be caused to the person against whom enforcement is sought” when determining the enforceability of a restrictive covenant. Massachusetts does not have a similar statute. And so, the Massachusetts court reasoned that the Florida court did not look at the hardship to the franchisee, which was central to the Grewal analysis in Massachusetts.

Third, the courts treated differently the disparate economic strength between a large franchisor and an individual franchisee. The Massachusetts court saw 7-Eleven, who had 50,000 stores, as big enough to absorb any harm that the franchisee could inflict. And the court sympathized with the franchisee, who used “a very significant portion of her personal capital,” testified to be $100,000, to fund the initial franchise fee. Specifically, the Massachusetts court stated:

“[W]hen the value of one (or even two) year(s) of lost profit from one of 7–Eleven’s 50,000 worldwide franchise establishments is viewed in proportion to the company’s total annual profit, the losses would likely be miniscule. Additionally, denying this portion of 7–Eleven’s preliminary injunction certainly would not cause it to lose its indisputably competitive position in the market.”

On the other hand, the Florida court reviewed other facets of harm to the franchisor that the Massachusetts court didn’t consider — recognizing that 7–Eleven “will have difficulty entering the market served by the former franchisees” and also that other 7-Eleven franchisees will take a lack of enforcement as a concession to the breach.

All in all, Florida and Massachusetts law produced two different results on essentially the same facts, with the same franchisor and same franchise agreement. Certainly, 7-Eleven would have sought a premium on its business with franchisees in Massachusetts, had it known that the local court would likely not grant a preliminary injunction to enforce its non-competition provision.

With that context, let’s look at a couple drafting points for franchise agreements.

APPLICATION: FRANCHISE AGREEMENT NUTS & BOLTS

Fundamentally, the first step is to negotiate favorable restrictive covenants in the Franchise Agreement. Generally, franchisors aim to restrict the franchisee, preventing them from competing with the franchisor during the franchise term, plus a period of time after expiration or termination of the franchise agreement. The franchisor will also restrict the franchisee from soliciting employees of the franchisor or other franchisees. Franchisees, on the other hand, try to resist or limit the duration of any competition restrictions, seeking a narrow and precise definition of the restricted activities, as well as the geographic scope of the restriction.

In Kapoor Bros. and Grewal, the 7-Eleven covenant not-to-compete provision prohibited the franchisee for one year after termination from “maintain[ing], operat[ing], engage[ing] in, or hav[ing] any financial or beneficial interest in, adverts[ing], assist[ing], mak[ing] loans to, or leas[ing] a Competitive Business” located at the leased premises or at the site of any former 7-Eleven store within two years of it being operated as a 7-Eleven store. The term “Competitive Business” was defined as, “any business that is the same as or similar to a 7-Eleven Store…, including a convenience store or other store not designated as a convenience store in which the product mix is fifty percent (50%) or more of goods or services substantially similar to those then-currently offered by a 7-Eleven Store.”

Further, the 7-Eleven agreement stated that, “[A]ny breach of any of the terms of the [non-compete provision] will result in irreparable injury to us and that we are entitled to injunctive relief to prevent any such breach.” And the franchisees agreed that the restriction, “contains reasonable limitations as to time, geographical area and scope of activity to be restrained and does not impose a greater restraint than is necessary to protect our goodwill or other business interests.” And the franchisees agreed that its claims against 7-Eleven would not be a defense to enforcement of the non-compete clause.

All of those terms favored 7-Eleven, the franchisor, and those terms are commonly found in franchise agreements.

Therefore, Kapoor Bros. and Grewal demonstrate that, even with the right contract language, whether and how a court grants immediate relief for injunction against franchisee could turn on specific state statutes and body of common law.

What’s at stake?

In the context of restrictive covenants and injunctive relief, it is the franchisor’s ability to immediately shut down franchisee operations and use of its trademarks, post-termination of the franchise agreement. Without it, litigation could stretch out for years before the franchisor receives a judgment, and the franchisor could be exposed to significant harm in the meantime. Overall, business owners should consider how relevant state laws will apply in critical situations. A comprehensive franchise agreement might not be enough. If the law in your jurisdiction is unclear or unfavorable, you might seek additional protection or compensation to bear the legal risk.

[1] 7-Eleven, Inc. v. Kapoor Bros. Inc., 977 F. Supp. 2d 1211 (M.D. Fla. 2013).

[2] 7-Eleven, Inc. v. Grewal, 60 F. Supp. 3d 272 (D. Mass. 2014).

Vacation Rentals

Breaking News! State Senate Votes to Protect Vacation Rentals

By | Articles, Real Estate

Due in part to the convenience of our new “Sharing Economy” through websites like VRBO and airbnb, vacation rentals are booming. Short-term rentals, however, are under attack by certain cities and HOAs. Some cities such as Sedona, Arizona and Coronado, California, have passed legislation to expressly prohibit rentals for less than 30 days. And other cities including Scottsdale and Phoenix have recently taken the controversial position that although their codes and zoning ordinances do not expressly prohibit vacation rentals, any rentals for less than 30 days in residential districts are illegal as “commercial use.”

In an effort to clarify owners’ property rights in Arizona, the State Senate recently voted to pass SB1350 sponsored by Senator Debbie Lesko. SB1350 prevents cities from restricting vacation rentals and clarifies taxation issues. The bill is currently pending before the House of Representatives.

Governor Doug Ducey endorsed vacation rentals in his State of the State address: “Arizona should be to the Sharing Economy what Texas is to oil and what Silicon Valley used to be to the tech industry.”

If you or someone you know has questions regarding vacation rentals, please call our office today to schedule a consultation.

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Arizona Crowdfunding

By | Articles, Business

I have a soft spot for freebies – giveaways, handouts, complimentary gifts, whatever you prefer to call them.

Since 2013, I’ve participated in a medley of musical “crowdsourcing” projects, which have netted me quite the bounty, including, but not limited to: pre-release digital downloads, vinyl (which, according to the Journal, will outsell CDs this year), coffee mugs, autographed posters, VIP parties and private shows, and something one artist named “The Musical Kitchen Sink,” a collection that included his entire discography.

And a majority of the population would say that I’ve been a part of “crowdfunding.” But this isn’t the case. And there is a big difference in the law between what I described as “crowdsourcing” and “crowdfunding.”

While crowdsourcing is about donations in exchange for small tokens or perks, crowdfunding, on the other hand, is all about harnessing the capital of crowds as investment, issuing an equity stake in your company. Starting a Kickstarter or Indiegogo crowdsourcing fundraiser is a relatively simple endeavor that you can launch over the weekend. Crowdfunding, on the other hand, is a technical project that needs legal acumen. If you aim to raise money through crowdfunding, get good advice from your attorney and avoid the risks of that project, including civil and criminal penalties.

Brief Background on Arizona’s Crowdfunding Law

Generally, accepting investment dollars from strangers is a highly regulated area of law. It is also a complex area, considering that both federal law and state law may apply. And so, companies need to determine whether they have complied with both.

The JOBS Act is the federal law intended to relieve regulatory burden of Dodd Frank and Sarbanes Oxley, two gargantuan regulatory schemes that overburdened small business, pushing them out of the capital markets.

But the federal government has been unable to successfully implement the JOBS Act. And in the meantime, twenty-two states, including Arizona, have tackled the problem themselves. Specifically, Arizona enacted ARS § 44-1844(D), declaring “crowdfunding” to be a transaction exempt from registration with the Arizona Corporation Commission, if transacted under certain parameters. Examples of other exempt transactions under Arizona law include private placements, stock dividends, and statutory or judicially approved reorganizations.

How Much Money Can I Raise under the Arizona Crowdfunding Law?

In simple terms, the issuer can raise up to $1 million every twelve months, without audited financial statements. That amount increases to $2.5 million every twelve months with GAAP audited financial statements. The legal analysis is more complicated, however, as sales to officers, directors or 10% shareholders do not count towards the total. And, generally, multiple offerings made within the same six-month window are integrated, that is, counted as one offering.

This $1 to $2.5 million cap makes crowdfunding unworkable for companies with high capital requirements. But for a single-owner or micro-business, it may be adequate, considering a study done by the Kauffman Foundation in 2009, estimating that the average start-up cost was approximately $30,000. And according to U.S. Census data, more than 40 percent of all small businesses started up for under $5,000. Those “average start-ups” are home-based businesses with low upfront investment.

Considering the relatively small amount that can be raised through Arizona’s crowdfunding law, there is slim margin for error in your cost-benefit analysis.

Practically, companies should raise enough capital to justify the cost of hiring professionals, namely, an accountant and attorney, along with the cost of ongoing legal compliance. Obtaining an audit for a small or midsize private company might cost between $7,000 and $50,000, depending on the audit firm, geographic location and complexity of the business. And the legal fee could be of similar magnitude. And so, crowdfunding will likely be uneconomical for the “average start-up” mentioned above that aims to raise its initial $30,000.

Limitations of the Arizona Crowdfunding Law

The Arizona crowdfunding law is an intrastate exemption. That means that the company and the investors must be located, generally, in Arizona.

To be intrastate, companies issuing the securities must be formed in Arizona. All investors must be Arizona residents. And at least: (a)  80% of the issuer’s revenues must come from business within Arizona, (b)  80% of the issuer’s assets must be located in Arizona, and (c)  80% of the proceeds raised in the offering must be used in Arizona. And the investors can only resell their shares to Arizona residents within the first nine months after the end of the offering.

Additionally, beyond ARS § 44-1844(D), companies must comply with Section 3(a)(11) of the 1933 Act and SEC Rule 147 in connection with intrastate offerings.

Further, each non-accredited investor — someone who has a net worth of less than $1 million (including spouse) and who earned less than $200,000 annually ($300,000 with spouse) in the last two years — may only contribute no more than $10,000. That comes to 100 non-accredited investors, at $10,000 each, to reach the $1,000,000 cap for companies without audited financials and 250 non-accredited investors, at $10,000 each, to reach the $2,500,000 cap for companies with GAAP audited financials.

Logistics

Anecdotally, there are logistical challenges that have stalled many companies who are interested in crowdfunding. For instance, a web portal and website operator are needed; and the proceeds raised must be deposited into a single escrow account maintained by a bank, credit union or other depository financial institution in Arizona.

Disclosure Requirements

Disclosure is the touchstone of securities law, assuring that competent investors have full and timely information for their investment decisions. In short, companies must disclose all material information to the Arizona Corporation Commission and all potential investors. Crowdfunding is no exemption from full disclosure.

All investors must receive a Disclosure Document comprised of specified topics for mandatory disclosure. And investors receive additional protection through anti-fraud requirements under SEC Rule 10b-5 and Arizona’s counterpart.

Also, companies must file certain items with the Arizona Corporation Commission at least ten days before its crowdfunding offering. Importantly, companies must inform the Commission your Target Offering Amount and the Offering Deadline. They must also provide notice of the offering, a disclosure document, and a copy of their escrow agreement.

Moving forward, companies must provide quarterly reports throughout the offering period and while securities are outstanding. Additionally, companies have an ongoing obligation to preserve books and records prescribed by Arizona Corporation Commission for three years.

Application

Arizona crowdfunding is not one-size-fits-all. The legal exemption under ARS § 44-1844(D) is just one of many ways to raise capital, and your business attorney can determine whether crowdfunding is the proper tool for you.