Articles Posted in Contracts

Last week, we reported about an important event for startups: Title II of the Jumpstart Our Business Startups Act or JOBS Act took effect last Monday and it lifted the ban on general solicitation, allowing startups to publicly advertise that they are seeking investments. General solicitation means “to publicly advertise the opening of an investment round in a private company by utilizing mass communication.” As reported by Forbes magazine, “under Title II of the JOBS Act, entrepreneurs will be permitted to publicly advertise that they are fundraising for their businesses, something that was previously illegal for the past 80 years under Rule 506 of Regulation D and Rule 144A of the Securities Act of 1933.” As promised, this week, we will discuss several important steps startups must take to comply with the regulations of Title II if and when they choose to generally solicit their fundraising efforts.

Under Regulation D Rule 506(c), the rule allowing for general solicitation, the first thing you must do if you are a startup choosing to engage in public fundraising or general solicitation is ensure that only accredited investors are permitted to enter the funding round. This requirement differs from private fundraising, which is regulated by Regulation D Rule 506(b), and which allows you to have in your funding round up to 35 non-accredited investors with whom you have had a pre-existing relationship.

So what is an “accredited investor?” According to Regulation D Rule 506(c), an “accredited investor” is one generally having earned $200,000 for the past two years, or $300,000 if married, or having a net worth of $1 million not including a personal residence. Of course, it is not as easy as simply asking a potential investor if they meet this threshold. The JOBS Act requires startups to verify the status of investors and provide official documentation to confirm that each investor meets the “accredited investor” threshold. Because some investors may not feel comfortable providing such personal information (including tax returns, relevant bank statements, brokerage account statements, credit reports etc.) directly to startups, the SEC has allowed third-party services to undertake this necessary due diligence. This service protects a potential investor’s proprietary information and also relieves the startup of the burden of verification. A third-party service can be a registered investment advisor, a broker-dealer, an attorney, or a certified public accountant.

Last week, we discussed the Sarbanes-Oxley Act and what startups should know about it. We noted that shortly after the Sarbanes-Oxley Act was enacted, critics argued that it restricted innovation and suffocated the growth of startups and small companies because the cost of compliance was too great for them. In response to these concerns, the government, on April 5, 2012, enacted the Jumpstart Our Business Startups Act or JOBS Act. The purpose of the JOBS Act is to encourage funding of small businesses and startups by easing certain securities regulations. For example, the JOBS Act extends from two to five years, the time that certain small companies and startups have to begin complying with the requirements of the Sarbanes-Oxley Act, i.e., certifying the accuracy of financial information. It also provides an exemption from the requirement to register certain public offerings with the Securities and Exchange Commission.

According to Forbes magazine, Title II of the JOBS Act takes effect today, and it lifts the ban on general solicitation, allowing startups to publicly advertise that they are seeking investments. General solicitation means “to publicly advertise the opening of an investment round in a private company by utilizing mass communication.” As reported by Forbes, “[b]eginning today, September 23, 2013, under Title II of the JOBS Act, entrepreneurs will be permitted to publicly advertise that they are fundraising for their businesses, something that was previously illegal for the past 80 years under Rule 506 of Regulation D and Rule 144A of the Securities Act of 1933.” The only restriction under Regulation D 506C is that all investors must be accredited, generally having earned $200,000 for the past two years, or $300,000 if married, or having a net worth of $1 million not including a personal residence (see more on compliance next week).

What Does Removal of the Ban Mean for Startups

Last November, Google began providing one-gigabit-per-second fiber optic internet service to homes in Kansas City, Kansas. These residents will be the first people in the world to test out Google’s new service. When Google first announced its nationwide Google Fiber project three years ago, over 1,000 cities and towns across the country applied for the chance to get the service, and Kansas City won. The new high-speed service carries data at speeds more than 100 times faster than the average American internet connection. One of the reasons Google chose Kansas City is because the city is home to many startups and tech-friendly organizations, such as the Ewing Marion Kauffman Foundation, the world’s largest foundation dedicated to entrepreneurship, which develops and generously supports numerous efforts to provide entrepreneurs the knowledge, skills, and networks they need to start and grow businesses.

Not surprisingly, entrepreneurs have taken notice of the high-speed connection and Kansas City has become the epicenter of a thriving startup community. Three things make the high-speed connection so attractive to startups: (1) it is relatively inexpensive; (2) engineers are able to upload large sequences of data almost instantaneously; and, (3) startup founders and executives are able to easily and seamlessly video chat with investors and partners all over the world. And one neighborhood in particular has become a hub of startup activity. Hanover Heights, part of a the community that has been called the Kansas City Startup Village (KCSV), was the first neighborhood in Kansas City to receive access to Google’s high-speed internet, and the influx of startups and entrepreneurs that followed the installation has spawned what one venture capitalist has termed the “Homes for Hackers” program. The program offers serious entrepreneurs and their startups a rent-free home equipped with Google Fiber. Some startups have even purchased their own homes in KCSV in order to take advantage of Google’s high-speed internet connection and to foster an environment of collaboration.

Collaboration and sharing physical office space is particularly important to startups. While many businesses have been started and run successfully from anywhere in the world, startups are more likely to succeed in an environment where employees and/or founders are able to meet and interact in person. Google, Twitter, and Groupon are prime examples of startups that began in such a way. Risks of working remotely include, employees missing interaction with colleagues, employees becoming drained by extensive travel, and thus unhappy with their employment situation and more likely to be recruited by other companies.

This week, New Zealand voted to ban software patents, and the impetus for New Zealand’s decision seems to be the practice of patent trolling; the Chief Executive of New Zealand’s Institute of IT Professionals commented that the country would no longer tolerate “the vexatious practice of ‘patent trolls.'” Why does this decision matter to California start-ups and should the United States follow New Zealand’s lead? Answers to these questions will be discussed in the following article.

Coincidentally, New Zealand’s decision to ban software patents comes on the heels of a report issued by the Government Accountability Office (GAO) (“Assessing Factors that Affect Patent Infringement Litigation Could Help Improve Patent Quality”), which was discussed in an earlier blog article (“Patent Trolls Targeting Software Companies and Start-ups”) and which essentially concluded that patents on software do not work. Why don’t patents on software work? There are several reasons, including the sheer number of patents and poorly issued patents. In the past 20 years, the number of software patents has grown tremendously. In 1991, software patents made up less than a quarter of all patents issued by the U.S. Patent and Trademark Office (PTO); however, in 2011, the PTO issued more software patents than any other category of patents. Software patents also produce more litigation than any other category of patents because software is used so widely and because the patents issued by the PTO are often overly broad, unclear, and vague. The GAO points out in its report that another problem with software patents is that their complexity and rapid development cycle make researching patents impractical. This problem is particularly relevant to start-ups; because granted patents are often poorly crafted, it is impossible for entrepreneurs to search through them in order to determine whether or not they are infringing on another’s patent. The GAO interviewed representatives from software start-up companies, who confirmed this problem, explaining that “searching for relevant patents before developing new products is unrealistic and diverts already scarce resources, particularly because their product development process can be as short as two months.” The start-ups also advised the GAO that “they do not always apply for patents until their companies are well established because patents attorneys are expensive, and the process is time-consuming…. [T]he cost of [research and development] is low relative to the cost of applying for a patent, so there is minimal incentive in the software industry to patent in order to recoup [research and development] costs.”

Some experts believe that the United States should follow New Zealand’s lead and ban software patents because they do not promote innovation but in fact hinder it, as explained above. The difficulty with this proposal, however, is that while the patent system does not work well for software, it works well for other industries such as the pharmaceutical industry, where chemical patents are indexed and searchable by formula. These same experts point out that the United States Supreme Court’s decision this summer in Association for Molecular Pathology, et al. v. Myriad Genetics, et al., hints at the possibility that the high court may not be particularly fond of software patents. In that case, the Court ruled that human genes may not be patented because the patent included “well-understood, routine, conventional activity previously engaged in by researchers in [the] field.”

Starting tomorrow, August 29, 2013, Engine, a non-profit connecting startups and government (according to its website, “the voice of startups in government”), is kicking off Startup Across America Day. Forty-four members of Congress will meet with technology startups in their home states and districts in order to discuss policy issues that impact their businesses. Events will take place in Atlanta, Austin, Baltimore, Boulder, Cambridge, Chicago, Cincinnati, Dallas, Grand Rapids, Jeffersonville, Kansas City, Long Island, Memphis, Phoenix, and Seattle. The goal of this event is to establish “the first step in creating a lasting dialogue between Members and their startup communities; [to] allow Members to meet with job creators in their district; [to] discuss the importance of entrepreneurship and innovation to the American economy; and [to] embark on conversations about the policy issues that matter to these dynamic businesses.” One subject that is certain to be discussed by both parties is “patent trolling,” and it is an important issue in California because many startup companies, particularly those in the technology industry, rely heavily on patents. The issue has also become a hot topic in Washington.

Patent trolls are shell companies that exist solely for the purpose of asserting that they should be reimbursed because they hold patents that are being infringed upon, mostly by an electronic process or software, hence the reason California’s technology industry is particularly concerned with the practice of patent trolling. Patent trolls essentially threaten to file lawsuits against alleged patent infringers, and their threats seem to be real: Between 2010 and 2001, the number of patent infringement lawsuits increased sharply, up by a third, compared to the previous decade. It is estimated that the practice of patent trolling has cost small and medium-sized companies an estimated $29 billion per year in litigation and/or settlement fees, and it is alleged that the practice has become more popular over the last few years because the Patent and Trademark Office (PTO) has been unable keep up with the demand for patents, issuing many that were too broad or poorly documented. For its part, the government is looking for ways to curb the practice. In June, President Obama issued five executive orders and seven legislative recommendations designed to protect innovators from frivolous litigation and to ensure the highest-quality patents in our system. In addition to the President’s actions, several members of Congress introduced legislation aimed at changing the way patents are considered, awarded, and litigated.

While the battle against patent trolls gained significant momentum over the summer, a report issued by the Government Accountability Office last week may “put a spoke in the wheel.” According to the report, the increased number of lawsuits in 2011 was most likely influenced by the anticipation of changes in the Leahy-Smith America Invents Act, which significantly changed our patent system, including limiting the number of defendants in a lawsuit, thus resulting in many plaintiffs breaking up one lawsuit against multiple defendants into several lawsuits. The report further concluded that companies that make products brought the majority of patent infringement lawsuits, while patent trolls only brought a fifth of lawsuits. However, as anti-troll groups point out, the GAO report also shows that patent trolls are very active in software cases, which accounted for 65 percent of defendants between 2007 and 2011.

Buying property can be a difficult task. Unless you know exactly what you want, just figuring out where to start can be overwhelming. It can be a harder task even after you find a property you prefer because it can be difficult to make sure you have enough information to make a good decision. This is where real estate agents, brokers and attorneys come in. Any of these people can be a great asset when searching for a property. The relationship between a buyer or seller and their chosen real estate person can vary and it is important that both sides are clear with their needs and expectations in order for a sale to be completed smoothly. Buyers and sellers enter into real estate transactions with various level of experience, therefore the duty of the real estate person may also vary.

Take for example the case of Salahutdin v. Valley of California, Inc. In this case, David Seigal (Seigal) is appealing a previous case against him, which he lost, regarding his actions as a real estate agent. Shaucat and Jeannie S. Salahutdin (the Salahutdins) sued Seigal because they believed he misrepresented a property which they ultimately purchased based on his recommendations. The Salahutdins wanted to purchase a home and land with the specific purpose of later separating the property and providing equal proportions to their two children. When searching for new property the Salahutdins explained their goal to Seigal and he in turn explained that the property had to be at least one acre in size for the Salahutdins purpose. The parties agreed to focus only on properties one acre and larger and Seigal soon found a property, Black Mountain, he felt fit the Salahutdins needs.

When the Salahutdins asked questions regarding the size of the property, Seigal affirmed that it was over an acre and therefore subdividable. Seigal received his information from the listing from the sellers’ real estate agent. At no point before the sale of the property did Seigal independently verify the size of the property or inform the Salahutdins that he did not verify the information. There were no obvious indications the sellers’ representation was incorrect. Also, at the time the property was placed on the market it was surrounded by a perimeter fence enclosing more than one acre. Therefore the Salahutdins took his word regarding the size of the property and chose to purchase it.

According to a recent article in P-V Tech, real-estate investment trusts (REITS) are growing across the country, and California is no exception. Earlier this month, a large land sale indicated that REITS are also beginning to have a hold in the solar industry. Near Fresno, the New York-based company Power REIT purchased approximately 100 acres of land that will support over 20MW of utility-scale projects in the area.strip mall.jpg

This recent land acquisition is likely to have implications for commercial solar energy solutions in California. If you have questions about commercial real estate and renewable energy, contact an experienced commercial lawyer today.

REITS and Commercial Real Estate

Purchasing real estate is a difficult process. Finding a place that you like, which fits your needs and is within your budget is not always easy. There is a lot of work to do to find the perfect piece of real estate, but it is important to remember that the work doesn’t end when the property is chosen. Before purchasing property, it is the buyer’s responsibility to make sure the property is acceptable for his or her uses, is generally safe and sound and overall a good purchase. Sometimes sellers are genuinely unaware of issue with the property or title, and in those situations the buyer is stuck with any problems he or she could have found, but did not. But what about those instances when the seller does something intentionally wrong? That depends on the situation. If you can prove the seller did something wrong intentionally, often the buyer will be allowed to cancel the contract or can adjust the selling price. In some cases, however, that is not enough.

Take for example, the California case of Utley v. Smith. In this case, Charles Utley (“Utley”) is suing for specific performance to force the sale of a piece of property, which Utley believes he rightly owns. In this case, Jewell Smith (“Smith”) owned a piece of property, which he offered sell to two buyers. Smith offered Utley the option to purchase the property and promised to keep the option open for a few weeks with a down payment. During the period of time that Utley had the option to purchase the property, Smith sold it to Lewis and Desch, who are also a part of this case. The option agreement was entered into before the purchase agreement occurred, however, Smith ended up executing the documents for both agreements on the same day. This is important because, when purchasing a property, it is the buyer, or his or her agent’s, responsibility to check the physical property as well as the title in many jurisdictions. While Utley had a valid option agreement with Smith, both agreements were written up on the same day, therefore regardless of whether or not Lewis and Desch did their research there was no evidence that someone else had a claim to the property.

When multiple buyers claim to have a right to one property, the order in which agreements occur becomes very important. Generally in these situations, it is not enough to be the first person to sign the paper work. If the information is readily available and you could have found that someone else has a claim to the property, such as an option contract, then you cannot legally purchase the property. In this case, the agreements occurred on the same day and the option contract was not record and filed for a week. Therefore there was no way for Lewis and Desch to find out about the option before purchasing the property. There was also no evidence that they were told and had any knowledge before signing the agreement of the option agreement. Therefore the court found that Lewis Desch were the rightful owners of the property.

Contracts are agreements, written or oral, which bind people to complete a set of actions. It is expected that when you enter an agreement, you intend to follow through with it and complete what is asked of you. This, however, is not always the case. Breaches of contract happen, but how you deal with it will impact future decisions.

Take for the example of the California case of Whitney Investment Company v. Westview Development Company. In this case Whitney Investment Company (Whitney) is appealing a lawsuit where it previously sued Westview Development Company (Westview) for breach of contract. Whitney and Westview had an agreement where Westview hired Whitney as its broker to sell a parcel of land.

This was supposed to be an exclusive listing, so that regardless of who sold the property during the life of the agreement, Whitney would still receive a commission off of the sale. In return, Whitney agreed to pay monthly rentals on two existing highway advertising signs then leased by Westview, to operate a tract office located on the premises, to pay one hundred dollars a month rental to Westview for the tract office, to pay one-half the cost of bringing electricity to the tract office, to maintain an adequate sales force, and upon Westview’s request to expend at least $2,000 for advertising.

Commercial real estate transactions can differ from residential real estate transactions in a variety of ways. For example, commercial lease tend to last longer than residential leases and multiple months of rent is often paid months in advance. While there are benefits to this method, this can also lead to complications later if a company were to go out of business or need to move before the lease has terminated. One way to alleviate this issue is to allow the party leasing to sublease or assign the contract to another party, giving the space and related responsibilities to someone else in a position to afford and maintain the property. This allows a tenant to be flexible in the case of a business change during the term of the lease. However, this option can complicate future issues because multiple subleases and assignments can run together.

Take for example, the California case of Vallely Investments v. BancAmerica Commercial Corporation. In this case, Vallely Investments (Vallely) sued for a declaration that BancAmerica Commercial Corporation (BACC), the assignee, was bound by the lease. Vallely owned a parcel of property, which it leased to Balboa Landing L.P. (Balboa). The lease allowed Balboa to transfer or assign its interest freely, or to get a mortgage. Any assignment had to be in writing, with notice to the Vallely. The person taking over contract was required to expressly accept and assume all of the terms and covenants of the lease. Balboa got a loan from BA Mortgage to develop the property using the deed of trust on the lease with Vallely as collateral, and then it defaulted on the loan. To avoid liability and to make sure the property was properly maintained, the lease was assigned to BACC, a wholly owned Bank of America subsidiary which would manage the property pending a nonjudicial foreclosure. BACC’s goal was to hold the property only for the short period before the foreclosure sale. At the foreclosure sale, BA Mortgage was the successful bidder and it managed the property until selling the lease to Edgewater Place, Incorporated (Edgewater). Eventually, the contract with Edgewater was terminated early because it failed to pay the rent. Vallely then sued BACC for the rent because BACC took the lease over from Balboa.

The main issue in this case is whether foreclosure of a leasehold mortgage extinguishes the duties owed to the lessor, in this case Vallely, by an assignee, BACC, who assumes the lease. While BACC intended to be liable for the property only until the foreclosure, the contract that it signed did not make that specification. When it took over the lease, BACC also assumed the obligations of the prime lease, with the consent of the landlord, and came into privity of contract with the landlord, which allowed Vallely to enforce the assumption agreement as a third party beneficiary. This means that while foreclosure extinguished BACC’s assignment, it did not have any impact on Vallely’s rights. Vallely’s right to enforce BACC’s assumption agreement, as a third party beneficiary, occurred due to the foreclosure. Thus, the foreclosure terminated the privity of estate and privity of contract between BACC and Balboa, but it did not reach the privity of contract between BACC and Vallely. BACC assumed the lease obligations without qualification, and those contractual duties did not end with the foreclosure. It could have structured the transaction so that it shed all liability with the foreclosure, by taking the assignment without assuming the lease. But that is not what occurred in this instance. Therefore, the court found that BACC was liable for the rent on the remainder of the lease.