Internet Sales Tax Law Struck Down In Illinois

Statute providing for Internet sales tax on out of state sales and sales through affiliates struck down in Illinois.

Link: Performance Marketing Association, Inc. v. Hamer (Illinois Supreme Court)

Amazon.com Logo
Amazon.com is typically the primary target for state Internet sales tax laws.

Like many states, Illinois desperately wants to collect an Internet sales tax when its citizens buy stuff over the Internet.  Generally, a state cannot impose duties to collect taxes on out of state retailers and must rely on people to report their own purchases and pay the sales taxes directly to the state.  Good luck with that.

In order to get to the Internet sales, Illinois changed its sales tax law to change the definition of “maintaining a place of business in this state” to include:

“a retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link of the person’s Internet website.”

In other words, Illinois can get to Amazon and its sales if someone in Illinois signs up for their affiliate program and includes an Amazon ad on their website.

The performance marketing industry has been fighting these laws across the United States and made it to the Illinois Supreme Court.

The court noted that the statute does not require tax collection by out-of-state retailers who enter into performance marketing contracts with offline and over-the-air broadcasters.  As a result, the amended statute is targeted solely at “online” performance marketing.

The plaintiffs argued that the federal Internet Tax Freedom Act (the “ITFA”) preempts the Illinois statute and that the Illinois statute violates the commerce clause of the U.S. Constitution.  The ITFA prohibits a state from imposing discriminating taxes on e-commerce.  This includes revenue raising measures and the imposition of obligations to collect sales taxes.

The court concluded that the statute uses performance marketing over the Internet as the basis for imposing a use tax collection obligation on an out-of-state retailer.  However, national, or international, performance marketing by an out-of-state retailer which appears in print or on over-the-air broadcasting in Illinois will not trigger an Illinois use tax collection obligation.  As a result, the statute imposes a discriminatory tax on electronic commerce within the meaning of the ITFA. Accordingly, it is expressly preempted by the ITFA and is therefore void and unenforceable.

Because the court made its decision based on preemption, it did not make a decision based on the alternative argument that the statute violates the commerce clause of the Constitution.

Contracts and the Law – Beer Contracts in Mergers & Acquisitions

Labatt distributor shows why contracts must work with the law and can’t just change it.

Link:  Esber Beverage Company v. Labatt USA Operating Company (Ohio Supreme Court)

Labatt Light Lime - Yum - Terminated Contract in InBev and Anheuser Busch MergerIs this still a thing? Terminated Contract in InBev and Anheuser Busch Merger

Every now and then I get a request to draw up an agreement that does not jive with the law.  I’ll get suggestions such as, “Just call it something else, like “Consulting Agreement.’”  I have to say, “It doesn’t work that way.  The contract has to work within the framework of the law.  Sorry.”

How is this relevant to anything?  Well, because when a manufacturer sell its rights relating to a particular brand of alcohol to a successor, the new owner can terminate any distributor’s franchise without cause.  At that point, the new owner’s obligations are notice and compensation.

We learn this because Esber Beverage Company was a long-time distributor of Labatt for InBev.  InBev went on to merge with Anheuser-Busch.  Because easy is cheap, the U.S. Department of Justice would not allow this merger to proceed without some sort of obstacle.  With no consideration at all of the good folks who distribute Labatt, the Justice Department forced the merged company to divest itself of all assets relating to Labatt.  A new company backed by private equity firm KPS Capital Partners, L.P. purchased the rights to Labatt and terminated Esber.

Esber sued claiming that the statute only applied when there was no written agreement.

The court didn’t buy it.

Pursuant to the statute, every manufacturer of alcoholic beverages must offer its distributors a written franchise agreement specifying the rights and duties of each party. If the parties do not enter a written franchise agreement, a franchise relationship will arise as a matter of law when a distributor distributes products for 90 days or more.  So far so good.

The statute also sets forth how to cancel or terminate a franchise.  There are three situations:

  • With prior consent and 60 days’ notice
  • With “just cause,” and the statutes explains what this means.

In addition, in either case, the manufacturer must repurchase all of the terminated distributor’s unsold inventory and sales aids.

However, the statute also provides for terminating a franchise when the manufacturer sells a particular brand or product of alcoholic beverage to a successor manufacturer. If a successor manufacturer acquires all or substantially all of the stock or assets of another manufacturer, the successor manufacturer may give written notice of termination, nonrenewal, or renewal of the franchise to a distributor of the acquired product or brand.  On termination of the franchise, the successor manufacturer must repurchase the distributor’s inventory and must compensate the distributor for the diminished value of the distributor’s business that is directly related to the sale of the terminated product, including the appraised market value of the distributor’s assets devoted to the sale of the terminated product and the goodwill associated with that product.

This was not enough for Esber, which asserts that the statute does not permit a successor manufacturer to terminate when the successor manufacturer has itself entered into or assumed a written contract with the distributor. The court disagreed and quoted another case for the proposition:

“When a statute’s language is clear and unambiguous, a court must apply it as written.”

It continued:

“The plain language of the statute allows the successor manufacturer to terminate a franchise.  The definition of “franchise” includes both written franchise agreements and franchise agreements that have arisen by operation of law.”

As a result, the new owner can terminate Esber and Esber is entitled to compensation.  However, the contract does not trump the statute.

SEC Rolls Out Market Structure Website

It is actually a part of their sec.gov website, but it is a new part.

MIDAS Website here.
SEC Press Release here.

The SEC released its new MIDAS site to “promote better understanding of our equity markets and equity market structure through the use of data and analytics.”  This is a fancy way of saying that you can make charts of market info that you usually don’t see in traditional stock tickers rolling across your t.v. screen.

I am still combing through it to see what it does and how it can be useful.  It seems to provide some very detailed information relating to trading activity.  We are not talking about mere buy-sell-bid-ask information for stocks, but information that generates pretty charts purporting to show how the market functions.

It seems aimed at understanding (or providing the premise for going after) the high frequency trading (HFT) crowd and flash crashes.

The SEC believes it will help it to monitor and understand mini-flash crashes, reconstruct market events, and develop a better understanding of long-term trends.  To this end, MIDAS collects:

  • posted orders and quotes on national exchanges;
  • modifications/cancellations of those orders;
  • trade executions against those orders; and
  • off-exchange trade executions.

The SEC’s new website will be making available broadly:

  • ratios related to the number and volume of orders that are canceled instead of traded;
  • percentage of on-exchange trades and volume that are not disseminated on the public tape (odd-lot trades);
  • percentage of on-exchange trades and volume that are the result of hidden orders; and
  • quarterly distributions analyzing the lifetime of quotes ranging from one millionth of a second to one day.

The website can be used to:

  • compare and contrast data series according to the type of security, market capitalization, volatility, price, and turnover; and
  • explore detailed quote-life distributions, and download data series and quote-life distributions.

It is not immediately clear to me how this will be used as a policy-making tool, but you can expect charts generated from MIDAS to be displayed in some very exciting Congressional hearings.

Can Open Market Stock Purchases Resulting In Majority Control Constitute A Breach Of Fiduciary Duty?

How about the board’s granting of the right to engage in those purchases?

Answer:  No.

Link:  In re Sirius XM Shareholder Litigation

Background

In 2009, Sirius was hurting.  Liberty Media was nice enough to provide $530 million for a 40% interest, some board seats and some consent rights.  The agreement included a standstill provision preventing Liberty from gaining majority control for three years.  Following the standstill period, the agreement prevented Sirius from using a poison pill or charter or bylaw amendment to interfere with additional purchases of Sirius stock by Liberty.  The investment and agreement were disclosed publicly.

At the end of the standstill period, Liberty announced it would obtain a controlling position through open market purchases.  Sirius opposed it, and even opposed the FCC approval that Liberty would need in order to obtain majority control.  However, Liberty was able to get its majority stake.

Plaintiffs sued claiming breach of fiduciary duty on the part of Liberty and the Sirius board of directors.

Fiduciary Duty Claims Against Sirius Board

The court initially noted that the time period for fiduciary duty claims ran from the time of the agreement in 2009, and thus their claims were time barred.  The plaintiffs also argued that the board should have instituted a poison pill to prevent Liberty’s additional purchases, the court said this was not the wrongful act.  The plaintiff’s complaints arise out of the initial agreement in 2009, and the plaintiffs did not have a good reason for waiting to file a lawsuit.  The terms of the deal were fully disclosed in 2009, and the board’s inability to stop Liberty’s purchases were based on the 2009 deal.

Anything the board did that is subject of the plaintiffs’ complaint was based upon 2009 activity and, therefore, the statute of limitations ran from 2009.  As the court said, “[u]nder Delaware law, a plaintiff’s cause of action accrues at the moment of the wrongful act – not when the harmful effects of the act are felt – even if the plaintiff is unaware of the wrong.”

Fiduciary Duty Claims Against Liberty

The Plaintiffs also argued that Liberty had a fiduciary duty even if it was a non-controlling shareholder when it initially invested in 2009.  This duty of fairness would preclude Liberty from buying additional shares in the open market unless the Sirius board approved the terms.

The court disposed of this claim as well.  First, they are time-barred because they were still the product of the arms-length negotiations and deal in 2009 when Liberty was not even a stockholder, much less a controlling stockholder.  Second, open market purchases after disclosing the intent to make such purchases do not involve any control over Sirius’ board or misuse of Sirius’ resources by Liberty.  There was no allegation of insider trading or an attempt to effect a going private transaction.  To the contrary, even the plaintiffs conceded that Liberty’s purchase announcement would result in the market price for the Sirius shares to increase prior to purchase.  As a result, what the plaintiffs are really claiming is a repackaging of their opposition to the 2009 deal.

The only real complaint of the plaintiffs is that the board did not institute a poison pill, which was not only prohibited by contract but is not actionable under Delaware law without additional bad acts (recall the Landry’s case, Louisiana Municipal Police Employees’ Retirement System v. Fertitta, 2009 WL 2263406 (Del Ch. July 28, 2009)).

The court finished with its adherence to basic corporation law and contracts:

“There are many situations when corporations enter into contractual arrangements that have important implications for corporate control in conceivable future situations; for example, debt instruments commonly give creditors rights that, if used, may result in their assuming control.  The use of such rights to obtain control in the situations specifically contemplated by those contracts does not constitute a fiduciary breach.  As this court has explained, even “[a] controlling shareholder is not required to give up legal rights that it clearly possesses; this is certainly so when those legal rights arise in a non-stockholder capacity.””

Domain Misdirected – Now Fixed

I learned yesterday that the domain for this blog was misdirected and attempts to reach it ended up on some random landing page with popup ads.

I contacted HostGator, which hosts this blog as well as the Underdisclosed.com blog and my law firm site, DougBermanLaw.com.  The domain was directed to the wrong HostGator server.  There is no indication of why, how or when this happened since the site was working fine through last week.

In addition, the DougBermanLaw.com site was down due to a glitch on the HostGator side involving the site builder tools.

Anyway, its fixed now.  HostGator customer service did a great job in getting them back up and running.

In the Freelance Economy, you never know what kind of problems you’ll face day-to-day, including IT issues.  Get a good service provider.

I Was Quoted In An Article

. . . on the MyCorporation blog regarding LLCs vs. Corporations.  I was one of the experts weighing in on this issue.

While it may seem pedestrian to practitioners, considering the amount of ink spilled over this issue, it is an ongoing item of concern for entrepreneurs.

Here is my excellent contribution:

“7. “The short answer is “it depends.” However, I have found that an LLC will often provide more flexibility in terms of division of rights and responsibilities from the default rules in many business entity statutes. There is more flexibility in terms of pass-through tax treatment with LLCs vs. corporations, even with a Subchapter S election.”

– Doug Berman, Corporate Attorney, Law Office of Douglas M. Berman

Sage advice, indeed.

SEC To Remain Open During Government “Shutdown”

The SEC has assured the markets that it “will remain open and operational in the event the federal government undergoes a lapse in appropriations on October 1.”

Any changes to the SEC’s operational status after October 1 will be announced on www.sec.gov.

If you want more juicy details of the SEC’s operational plan in the event of a government shutdown, enjoy this link:

Plan of Operations During an SEC Shutdown

Where I Add to the Pile of Opinion Regarding Corporations vs. LLCs for Startups

I got another (non-client) question about whether I prefer corporations or LLCs for startups.

Short Answer:

It depends.

Long-Winded Answer:

I have found that an LLC will often provide more flexibility in terms of division of rights and responsibilities from the default rules in many business entity statutes.  In addition, there is more flexibility in terms of pass-through tax treatment with an LLC than with a corporation, even with a Subchapter S election.

If there are a small number of owners, or it is owned by a single person, they can usually get to the same result regardless of the entity type.  In that case, the most important thing is to have some type of limited liability entity in place, and a corporation and an LLC are similar enough that the same results can be achieved through a variety of strategies.

Many people suggest a corporation because it is easier to attract investors, but that is not necessarily the case.  Only a small portion of small businesses attract the type of institutional investors (such as venture capital firms) that would require the company be organized as a corporation.  Investors in some industries may expect specific organizational forms for their investment.  For example, real estate or natural resources investors may expect the company to use a limited partnership.

If an entrepreneur is in discussions with, or knows it may want to approach, an investor prior to organization, the investor’s concerns can be met up front.  However, in the beginning the organizational form should be driven by the entrepreneur’s and business’ needs.  Unless the entrepreneur knows who will make the investment and what their criteria is, there is no way to predict the terms up front as every situation is different, and there is likely to be some required restructuring done prior to the investment in any case.

The Risk Of Bitcoins

Cross-posted at Underdisclosed.com.

I have been getting my share of Bitcoin-related inquiries lately.  Here are some thoughts regarding the risk of engaging in Bitcoin-denominated transactions.

In my view, the biggest risk of Bitcoins is the regulatory issue.  This risk exist whether you conduct Bitcoin-denominated business or trade Bitcoins like you would with any other currency.

There has been a lot of news lately about the efforts of a variety of U.S. regulators to understand Bitcoin, and these regulators are not in the business of exempting financial products that compete with government issued currencies or act outside of the established financial regulatory environment.

Governments in general, the U.S. government in particular and state governments particularly are wary of alternative financial vehicles.  The U.S. government does not have a particularly good track record even where the law would seem to be on the side of the financing vehicle.  For example, the U.S. and state governments went after Paypal while it was in its IPO process.  In addition, there have been several “e-gold” currencies in the past that have failed for a number of reasons, from criminal behavior on the part of the principals to allegations of the currencies being used for fraud or money laundering.  There has also been a crackdown on activities of banks and financial institutions that attempt to evade U.S. laws by locating offshore or on Indian reservations.

In addition, there are the governmental concerns with tracking financial transactions for purposes of combating money laundering, drug trafficking and terrorism, and I cannot imagine that the government would exempt Bitcoin from these extensive regulatory obligations.  However, I am not sure Bitcoin would be in a position to comply with them.  This would make Bitcoin difficult to use in the U.S. or by U.S. persons and subject the creator(s) of Bitcoin to substantial risk, even as secretive as they are, as the head of founders of PokerStars, Full Tilt Poker and Absolute Poker could tell you.

As a result of all of the above, there is substantial expense and risk in using and accepting Bitcoins, as there should be a risk premium attached due to the very real possibility that the U.S. and other governments could shut them down.

 

A Simple Question: What Does “Annual” in “Annual Meeting” Mean?

According to the Massachusetts Supreme Court, the answer isn’t quite so simple.

Link:  Brigade Leveraged Capital Stuctures Fund, Ltd. v. PIMCO Income Strategy Fund

 

“Annual” means “annual,” right?  How hard could it be.  Let’s allow some ambiguous drafting, course of dealing and New York Stock Exchange regulations make it complicated.

Background

PIMCO is a big fund company and Brigade is an investor in two of its funds, each of which is a Massachusetts business trust.

The funds sent notices to investors of their intent to hold annual meetings as usual.  Brigade sent notice that it was going to nominate a trustee for election at the annual meetings.  PIMCO rescheduled the meetings to the last day of its fiscal year.

The funds’ declarations of trust require annual meetings at least 15 months after the first sale of shares and thereafter as specified in the bylaws.

The funds’ bylaws provide that annual meetings shall be held, so long as common shares are listed for trading on the NYSE, on at least an annual basis.

The NYSE requires listed companies to hold an annual shareholders’ meeting during the fiscal year.

Brigade filed suit seeking an injunction requiring PIMCO to hold the annual meeting as soon as practical and a declaration that the bylaws require an annual meeting at least once within any twelve month period.

Brigade contends that the rescheduling to nineteen months after the last annual meeting does not count as “annual,” which means within twelve months of the last annual meeting.  PIMCO says “annual” means “during the fiscal year.”

What the Court Says “Annual” Means

    Interpretation of Governing Documents

The court noted that the reference to the NYSE clearly means that an annual meeting must be held, at the very least, once every fiscal year, even though the bylaws do not explicitly say that.

However, the court reviewed the bylaw provision for shareholder notices together with the annual meeting requirement.1  It also noted that the bylaws provided for a special meeting in lieu of annual meeting, which may take place outside of the “annual period,” a thirty day window following the anniversary of the previous year’s annual meeting, which is not an “annual meeting,” but a “special meeting.”

The court also noted that this interpretation is consistent with how PIMCO historically scheduled its meetings and the usual meaning of “on an annual basis.”

There is more going on here than contract interpretation, and you may already know this if you have ever dealt with this issue before a court.

    The Real Issue

Many courts don’t come out and say it, but the Brigade court did.  Where the bylaws are ambiguous, it will construe them against the drafters, in other words, the company.

The upshot is that courts do not like it when companies try to escape the wrath of a shareholder vote.  As the court said,

“Moreover, where “bylaw provision are unclear, we resolve any doubt in favor of stockholders’ electoral rights.””

The court went on to quote a variety of shareholder friendly cases for the proposition that voting in corporate elections is a fundamental right of shareholders, and the court will not interpret ambiguous governing documents to allow the company to postpone an election.

________
1Bylaws Section 10(c):

“To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty- five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior year’s annual meeting; … provided, … however, if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an “Other Annual Meeting Date”), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10th) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed” (emphasis added).