ITEMS OF NOTE
Actual resolution of legal issues depends upon many factors, including variations of facts and state laws. This information is not intended to provide legal advice on specific subjects, but rather to provide insight into legal developments and issues that we feel could be useful to our clients and friends.
Employer/Employee
EMPLOYMENT LAW GUIDEBOOK
The U.S. Department of Labor has published a guidebook to provide businesses with general information on the laws and regulations that the Department enforces. The guidebook describes the statutes most commonly applicable to businesses and explains how to obtain assistance from the Department for complying with them.
The authority of the Department of Labor extends to many statutes, but the following are several that affect most employers: Employee Retirement Income Security Act (ERISA); Occupational Safety and Health Act (OSHA); Fair Labor Standards Act (FLSA); and Family and Medical Leave Act (FMLA).
The Employment Law Guide: Laws, Regulations and Technical Assistance Services can be accessed on the Internet at:
www.dol.gov/asp/programs/guide.htm
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ADA AND SMALL BUSINESSES
The Americans with Disabilities Act (ADA) prohibits disability discrimination in employment for employers with 15 or more employees. The prohibition is far-reaching and covers hiring, firing, and everything in between, such as promotions, benefits, and harassment in the workplace. The smallest of businesses are not affected by the ADA because of the 15-employee threshold for coverage. The ADA does apply, however, to many of the roughly 25 million small businesses in the nation.
Who Is Protected?
The ADA protects three categories of individuals: those with a physical or mental impairment that substantially limits one or more major life activities (like sitting, standing, or sleeping); those with a record of such an impairment, such as a person who had debilitating cancer but is now in remission; and those who are regarded by employers as having such an impairment, even though the individuals otherwise are not so impaired as to be 'disabled' under the ADA. Regardless of the category, the ADA protects only persons who are qualified, that is, they meet job-related requirements and can perform essential functions for the job, with or without a reasonable accommodation.
Hiring
While an employer can ask an applicant a wide range of questions concerning job qualifications, the ADA does not allow medical examinations or questions about disability until the employer has made the applicant a conditional job offer. An exception is recognized for questions directed to an apparently disabled applicant about whether a reasonable accommodation will be required.
After a job offer is made, an employer can ask any disability-related questions and require medical examinations, so long as these requirements apply to everyone in the same job category. For example, if, during a medical examination required of all employees in a job involving the use of dangerous machinery, it is revealed that an applicant has frequent and unpredictable seizures, the employer can withdraw a job offer to that individual.
Medical Information
Once a person is on the job, the ADA allows required medical examinations or questions about a disability only where there is a reasonable belief, based on objective evidence, that a particular employee will not be able to perform essential job functions or will pose a direct threat because of a medical condition. As an example, if a normally reliable employee has told her employer that a new medication she takes makes her lethargic, and she begins to make many mistakes, the employer can ask her how long the medication can be expected to affect job performance.
Reasonable Accommodation
The ADA differs from most other employment discrimination laws in imposing an accommodation duty on employers. If a disabled person needs a reasonable accommodation in order to apply for, or perform, a job, the employer generally must provide it unless to do so would create an undue hardship. An undue hardship means significant difficulty or expense, based on an employer's resources and operations.
Most accommodations are not expensive or burdensome. A diabetic employee may need regular breaks to eat properly and monitor blood sugar and insulin levels, or a blind employee may need someone to read information posted on a bulletin board. If more than one accommodation will work, the employer may take the option that is less costly or easier to provide.
In addition to the undue hardship defense, an employer need not provide an accommodation which:
* assists an individual off the job;
* removes or alters the essential functions of a job;
* lowers production or performance standards; or
* excuses violations of rules on good conduct.
Helpful Handbook
The Equal Employment Opportunity Commission, which is charged with enforcement of the ADA, has issued a new handbook to help small businesses comply with the ADA. The handbook provides many examples of factual situations with which small businesses could be confronted. The ADA primer can be accessed online at www.eeoc.gov.
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SEXUAL HARASSMENT IN EMPLOYMENT
When sexual harassment by a supervisor creates a hostile or offensive environment in the workplace but results in no disciplinary action, an employer can avoid liability by showing: (1) that the employer exercised reasonable care to prevent and correct promptly any sexually harassing conduct; and (2) that the plaintiff employee unreasonably failed to take advantage of any preventive or corrective opportunities provided by the employer or to avoid harm otherwise.
An important part of the first element of the defense is the preparation and distribution of a well-drafted policy prohibiting sexual harassment. In fact, as a recent case illustrates, a policy that is unclear or is not comprehensive could damage or destroy an employer's ability to assert the second element of the defense.
In that case, Elizabeth was promoted to the position of a team leader at a bank. Shortly thereafter, she began to report to a male supervisor. He made Elizabeth's life miserable at work for over two years, until she finally complained to management about his behavior. While the supervisor's harassment did not involve sexual overtures or other sexually provocative comments or actions, it was driven by the supervisor's hostility toward women, generally, and Elizabeth in particular. The supervisor's conduct was offensive and sometimes threatening, ranging from stereotypical remarks about the deficiencies of women as managers to an apparent reference to the O.J. Simpson trial when the supervisor told Elizabeth that he could 'see why a man would slit a woman's throat.'
The presence of a policy against sexual harassment and a victim's lengthy delay before complaining will often help shield an employer from liability. In Elizabeth's case, however, the bank's policy against harassment described only sexual advances, requests for sexual favors, and other actions of a sexual nature. Although the conduct Elizabeth was enduring was unlawful sex discrimination, the bank's narrowly worded policy led her to think otherwise. The deficient policy would not support a defense for the employer, and its incomplete definition of prohibited harassment excused Elizabeth's delay in complaining.
Although Elizabeth's case shows the importance of having an accurate and complete policy against sexual harassment, that is only part of a policy of prevention that will minimize the risk of employer liability. Also contributing to the liability of Elizabeth's employer was the inadequacy of its investigation after receiving the complaint. The bank basically ignored the allegations of harassment, focusing instead on the supervisor's objectionable management style. No one at the bank actually asked the supervisor whether he had made any of the sexually harassing remarks, nor did anyone follow up on an allegation that another bank employee had left because of sexual harassment from the same supervisor. The only consequences for the supervisor had been a 90-day probation period and a directive to improve his management style and 'smile more.'
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NEW OVERTIME REGULATIONS
The Department of Labor recently issued sweeping new regulations on the eligibility of workers, especially 'white-collar' employees, for overtime pay. Federal law requires that overtime be paid for nonexempt employees at a rate of one and one-half of regular pay for all hours worked over 40 hours in a week. To be 'exempt' is to be ineligible for overtime. Employers should update their employee handbooks to reflect the new law on overtime pay.
Salary Tests
Since 1975, workers paid a salary of less than $155 per week ($8,060 per year) have been eligible for overtime, regardless of their job duties or how they are paid. Now that threshold has been raised considerably, to $455 per week ($23,660 per year). The 'highly compensated employee' test will make workers with an annual salary of at least $100,000 exempt, if they perform office or nonmanual work and 'customarily and regularly' perform one of the duties of either an exempt executive, administrative, or professional employee. The exempt duty need not be the employee's 'primary duty.'
Manual laborers, other blue-collar workers, licensed practical nurses, and 'first responders,' such as police officers and firefighters, will be eligible for overtime regardless of salary.
Executive Exemption
In the middle ground of compensation, between $23,660 and $100,000 per year, individuals will be exempt as executives if their primary duty is management of the enterprise or one of its departments or subdivisions, and if they 'customarily and regularly' direct the work of at least two full-time employees. A new requirement is that would-be executives must either have the power to hire and fire or at least their recommendations in such matters must be given 'particular weight.' This tighter focus on hiring and firing is a change from the former regulations in which employees could fall within an executive exemption because of their general managerial authority. The term 'particular weight' invites differing interpretations, but courts can be expected to look at factors such as whether hiring and firing recommendations are part of an employee's regular job duties and how frequently such recommendations are made. An employee who owns at least 20% of a business and is actively engaged in managing it will also be exempt, without regard to salary thresholds.
Administrative Exemption
For employees in the same mid-range of compensation used for the executive exemption, but whose primary duty is 'the performance of office or non-manual work directly related to the management of the general business operations of the employer or [its] customers,' the administrative exemption will apply. The employee's primary duty must also include work that involves the 'exercise of discretion and independent judgment with respect to matters of significance.' These criteria are too broad to allow an exhaustive list of 'administrative' positions, but some examples from the new regulations include insurance claims adjusters, financial service employees, policymaking human resource managers, and team leaders for major projects.
Professional Exemption
'Learned professionals' earning between $23,660 and $100,000 will continue to be exempt from overtime as long as their primary duty is the performance of work requiring advanced knowledge in a field of science or learning that is customarily acquired by a 'prolonged course of specialized intellectual instruction.' The learned professional's work must include work 'requiring the consistent exercise of discretion and judgment,' as opposed to routine mental, manual, mechanical, or physical work.
Safe Harbor
Coming into compliance with the new regulations could be a daunting task, given their length, complexity, and lack of specific terminology. Ironclad advice that applies across the board is also in short supply because applying the new rules correctly is highly dependent on the facts and circumstances of each case. But balancing the difficulty of compliance is some leniency in enforcement. A 'safe harbor' in the new regulations protects employers who make improper salary deductions. Employers with clear policies and procedures for addressing salary deduction errors will not lose an exemption for a class of employees unless the employer continues to make improper deductions after receiving complaints.
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DISABILITY GUIDANCE FOR EMPLOYERS
The Americans with Disabilities Act (ADA) prohibits an employer from asking applicants and employees disability-related questions or requiring them to undergo medical examinations, unless such requirements are 'job-related and consistent with business necessity.' The Equal Employment Opportunity Commission (EEOC) previously issued guidelines that were only applicable to job applicants, but recently the EEOC issued a 'Guidance' that shifts the focus to questions and medical examinations during employment. Employers should make sure that their policies and handbooks are consistent with the Guidance. Questions or medical exams that are not allowed by the Guidance may lead to liability under the ADA's enforcement provisions. Even if questions are illegally asked of, or exams illegally required for, employees who are not disabled, an employer is exposed to liability under the ADA.
The Guidance gives some examples of disability-related inquiries that are not permitted: Do you have a disability? Have you ever sought workers' compensation benefits?; questions about genetic backgrounds; and any broad questions about an impairment that are likely to elicit information about a disability. Unless it is shown to be job-related, an employer cannot ask all of its employees about their use of prescription medications. On the other hand, questions that relate to job performance and the necessities of the business are more likely to be acceptable. For example, an employer can ask about an employee's current illegal drug use or drinking; whether the employee can perform certain job-related functions; and the employee's general well-being.
The Guidance sets forth situations in which an employer can ask for information about an employee's medical condition. Such questions are permitted when (1) an employer reasonably believes that an employee either will be unable to perform essential job functions or will pose a direct threat to others due to a medical condition; (2) an employee has requested a reasonable accommodation for a disability; (3) federal laws or regulations require that an employer obtain the information; (4) an employer offers voluntary programs for treatment of certain health problems; or (5) the information is to be used to further affirmative action programs.
When an employee requests a reasonable accommodation for a disability, if the employee does not provide necessary medical information, the employer can request a medical exam to be conducted by its doctor. First, however, the employer must have given the employee an opportunity to provide the information in a timely manner. In somewhat ambiguous language, the Guidance further states that an employer 'should consider consulting with the employee's doctor (with the employee's consent)' before requiring an in-house exam.
An employer's right to require submission to a medical exam is also triggered by the employer's reasonable belief that an employee poses a direct threat. If the opinions of the employer's and the employee's doctors are in conflict, the employer must evaluate them according to the doctors' areas of expertise, the kind of information provided, and the employer's first-hand observations of the employee. In the case of employees who balk at questions or requests for exams, the Guidance states that any resulting disciplinary actions should relate to performance problems (the inference being that the employee should not be punished for insubordination).
Some tests and procedures commonly used by employers are not medical exams, although they may be intrusive. Thus, neither the Guidance nor the ADA limits the use of tests for current illegal use of drugs, physical agility tests, psychological tests measuring personality traits, and polygraph examinations. The ADA requires employers to treat any medical information, whether voluntarily disclosed by an employee or obtained from an inquiry or a medical examination, as a confidential medical record. Only in limited circumstances may employers share such information with supervisors, managers, first-aid and safety personnel, medical personnel, and certain government officials.
You can read or download the Guidance online at www.eeoc.gov/docs/guidance-inquiries.html.
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EMPLOYEE OR INDEPENDENT CONTRACTOR?
Classifying a person as an employee rather than as an independent contractor has wide-ranging legal consequences. For example, an employer generally must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes, while hiring an independent contractor requires no such duties. Likewise, an employee might be entitled to benefits such as pensions, insurance, sick leave, and vacation pay while an independent contractor would have no such expectations.
How do you determine whether a worker is an employee or an independent contractor?
In answering this question, our courts focus on the relationship between the worker and the business, generally, and issues of control and independence, in particular. Even these issues get broken down into narrower inquiries relating to behavioral control, financial control, and the type of relationship the parties have.
Behavioral control refers to the when, where, and how of working. A court is more likely to find an employer-employee relationship when it finds that the employer controls factors such as: what tools or equipment will be used, what workers are hired to assist with the work, where supplies or services are purchased, who will perform specific tasks, and in what sequence the work will be done. Training a worker to perform services in a particular manner also indicates an employer-employee relationship.
Financial control entails the right to make decisions on the business aspects of a job. Employees are more likely than independent contractors to have expenses reimbursed and are less likely to have a significant investment in facilities used in the work. Employees have less freedom to seek out personal business opportunities. Guaranteed payment of a regular wage for a specified time period is usually a sign of employee status, while only an independent contractor will be in the position to realize a profit or a loss.
Other aspects of the worker's relationship with a business can also help to separate employees from independent contractors. Of course, how the parties themselves describe the relationship in any written contracts carries some weight. Employees are more likely to receive benefits like insurance, a pension plan, vacation pay, and sick leave. Hiring a worker with an expectation of carrying on a relationship indefinitely, instead of for a specific project, is evidence of an employer-employee relationship. If a worker's services go to the heart of the business's activity, as opposed to being at the periphery of the business, it is more likely that the arrangement will have the kind of direction and control that characterize how employers and employees operate.
What the parties call themselves is a factor, but courts are not bound by such labels if the facts point to a different conclusion. The substance of a relationship is most important when determining whether a worker is an employee or an independent contractor.
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BUSINESS
BUSINESS ENTITY BASICS
Before even the most promising business can put down roots and prosper, its owners must make the threshold decision about what kind of legal entity it will be. Different options are available, with each option having strengths and weaknesses. Legal requirements may vary by state depending on the business form chosen. Following are some general characteristics of the most prominent business entities. As the variety of choices indicates, competent legal advice is necessary to make the proper decision.
Sole Proprietorship
The greatest virtue of a sole proprietorship is its simplicity. From a legal standpoint, the business and its owner are the same. This allows the proprietor to avoid most of the formalities required for some other business forms. For example, business income is reported on the proprietor's personal tax return. One significant drawback is that a sole proprietor has personal responsibility for all business debts and court judgments.
General Partnership
A partnership is a business run by two or more persons, but the 'persons' can be individuals or business entities. In a general partnership, all partners are 'general partners,' which essentially means that their business fates are closely intertwined. Each general partner has unlimited personal liability for partnership debts, can incur obligations on behalf of the partnership, and acts as an agent for the other partners and the partnership. The partners usually share equally in managing the business and dividing the profits, but they may set their own terms for these and other matters in a written partnership agreement. Tax liability on partnership income is 'passed through' to the individual partners so that each partner pays taxes on his or her individual share of the profits.
Limited Partnership
In a limited partnership, there are general partners and limited partners. General partners run the business's day-to-day operations and have personal liability for partnership obligations. Limited partners are usually passive investors in the business. They are not personally liable for partnership debts and the most they can lose is the amount invested in the partnership. A limited partnership allows money to be raised for the business from the limited partners, but the general partners do not have to share with them day-to-day decisionmaking or comply with requirements for creating a corporation and issuing stock.
In contrast with a corporation, a partnership dissolves and is liquidated upon the death or withdrawal of a partner unless the partnership agreement provides otherwise. For example, the agreement may allow a buyout of a deceased or withdrawn partner, election of a new partner, and continuation of the business. As a general rule, a limited partnership carries on unaffected by the loss of a limited partner.
Corporation
A corporation is an entity that is separate from its owners, with its own legal rights and responsibilities. The owners (the corporation's shareholders) are not personally liable for debts of the corporation. The shareholders elect a board of directors to supervise the corporation and the board hires officers to manage day-to-day matters. The major drawback for the corporate model is having its income taxed twice: first on the corporation's income and then on any dividends paid to the individual shareholders.
The S corporation, a hybrid creature of the Tax Code, has some characteristics of corporations and some of partnerships. If specific tax rules are satisfied, income in an S corporation is taxed only when it is passed through to the owners. Also, the owners retain their insulation from personal liability for corporate debts.
Limited Liability Company
An increasingly popular form of business entity is the limited liability company (LLC), another hybrid combining some of the best traits of the other entities. The owners, called members, are not limited in number or type, as are shareholders in an S corporation. While LLC members generally have the kind of limited personal liability associated with limited partners, they have flexibility to participate in the management of the business if the governing document, called 'articles of organization,' so provides. The earnings of an LLC are given the same advantageous passed-through treatment as are earnings of a sole proprietorship or partnership, thereby avoiding double taxation. Please consider the next article.
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LIMITED LIABILITY COMPANIES--THE BEST OF ALL WORLDS?
A limited liability company (LLC) is a business structure that combines some of the best features of sole proprietorships, partnerships and corporations. LLC owners, like their counterparts for partnerships or sole proprietorships, report profits or losses on their personal income tax returns. Like a corporation, however, the owners of an LLC have 'limited liability,' that is, they are shielded from personal liability for debts and claims arising from the business.
Limited Liability
The limited liability for LLC owners is not absolute. Owners still can be held liable if they (1) personally and directly injure someone; (2) personally guarantee a loan or business debt on which the LLC defaults; (3) fail to deposit taxes withheld from employees' wages; (4) intentionally commit a fraudulent or illegal act that harms the company or someone else; or (5) treat the LLC as an extension of their personal affairs rather than as a separate legal entity. The last exception to limited liability is the most significant. It carries the potential for complete removal of the protections for individual owners. If the line between LLC business and personal business becomes too blurred, a court could find that a true LLC does not exist, leaving the owners personally liable for their actions.
Ownership
Most states allow a single individual to be the sole owner of an LLC. An LLC makes the most sense in circumstances where there is a concern about personal exposure to lawsuits stemming from operation of the business. Most laws prohibit establishment of an LLC in the banking, trust, and insurance fields.
Unlike corporations, LLCs can carry on their business without holding regular ownership or management meetings. Of course, formal meetings backed up by written minutes still may be advisable to document important decisions, such as a change in membership or a major expenditure.
Formation
Setting up an LLC is relatively simple. Articles of organization must be filed with the appropriate state office, usually the Secretary of State. The articles of organization include the name and principal office for the LLC, the names and addresses of its owners, and the name and address of the person or company that agrees to accept legal papers on behalf of the LLC.
Even if it is not legally required, the owners should prepare an operating agreement that spells out the owners' rights and responsibilities. The absence of an operating agreement will mean that state statutes will govern the operation of the LLC by default. An operating agreement acts as a guide for resolving common issues that an LLC will face, and thereby helps to avert misunderstandings between the owners. It also underscores the authenticity of the LLC itself, which can be helpful when a judge is deciding whether the owners are protected from personal liability.
A standard operating agreement includes the members' percentage interests in the business; the members' rights and responsibilities; the members' voting power; allocation of profits and losses; how the LLC will be managed; rules for holding meetings and taking votes; and 'buy-sell' provisions that control what happens when a member wants to sell his interest, becomes disabled, or dies. Although it is frequently overlooked when an LLC is created, a buy-sell agreement is important as a sort of 'premarital agreement' among the owners. The buy-sell provisions can clarify and ease the transition when the inevitable changes come to the members of the LLC.
Taxes
Since an LLC is not considered separate from its owners for tax purposes, the LLC pays no income taxes itself. Like a partnership or sole proprietorship, an LLC is a 'pass-through entity.' Each owner pays taxes on a share of profits, or deducts a share of losses, on a personal tax return. The IRS regards each member as a self-employed business owner, not an employee of the LLC. There is no tax withholding, and owners must estimate taxes owed for the year, then make quarterly payments to the IRS.
Conversion
By converting to the LLC business structure, sole proprietors and partnerships can gain the protection afforded to LLC owners without changing the way their business income is taxed. Conversion usually can be accomplished either by filling out a simple form or filing regular articles of organization. Federal and state employer identification numbers will have to be transferred to the name of the new LLC, as will such items as sales tax permits, business licenses, and professional licenses or permits.
The process for creating an LLC is streamlined and free of highly technical considerations. However, there is an important place for professional advice concerning such matters as choosing an LLC over other business structures, preparing or reviewing the operating agreement, and setting up accounting systems.
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VIRGINIA STOCK CORPORATION ACT
The Act.
Virginia stock corporations are governed by the Virginia Stock Corporation Act (the 'Virginia Act'), which is based primarily on the American Bar Association Revised Model Business Corporation Act (the 'Model Act'), on which the Delaware Corporate Code is also based. The Virginia Act, however, deviates from the Model Act in certain situations, arguably making Virginia a more hospitable domicile for corporation than Delaware. By way of example, the Virginia Act permits shareholders of closely-held corporations to enter into agreements pursuant to which all or some of the traditional corporate administrative procedures (meetings, minutes, annual election of directors and officers, etc.) are suspended or eliminated.
Management Friendly
. The hallmark of the Virginia Act is the flexibility which it provides both closely held and publicly held corporations. The Virginia Act places very minimal restrictions on the ability to structure rights and preferences of classes of stock, simplifies the incorporation process, eases management’s administrative burdens in routine corporate affairs and dealings with shareholders, and permits many substantive requirements to be further modified in a corporation’s articles of incorporation and by laws or upon agreement of the shareholders.
Officer/Director Identification.
The Virginia Act deals with the areas of officer director liability and indemnity and anti-takeover defenses in a manner which is specifically intended to address the challenge of attracting and protecting top quality corporate officers/directors by expanding good faith business decisions. The objective underlying this approach is to eliminate the second-guessing of decisions of the board of directors by courts or expert witnesses having the benefit of hindsight.
Virginia’s director and officer indemnification provisions compare favorably to those of other states. For example, the Virginia Act explicitly permits a Virginia corporation to indemnify directors before of after an event, whether or not their defense is successful, provided they meet a good faith standard and certain other statutory criteria. This provision tends to remove doubt regarding the payment of claims under directors’ and officers’ liability insurance. The Virginia Act also places a statutory ceiling on the damage recoverable from directors of a corporation in certain cases and allows a Virginia corporation to eliminate altogether the potential liability of its directors for corporate decisions mad in good faith, by including an appropriate provision in its articles of incorporation or, if approved by the corporation’s shareholders, in its bylaws. The only restriction on the limitation of liability for officers and directors is that the limitation does not apply in cases of willful misconduct or a knowing violation of the criminal law.
Anti-Takeover Devices
. The Virginia Act’s 'affiliated transactions' provisions regulate transactions between the corporation and any person ore entity that become the dominant shareholder of the corporation. They preclude a raider from undertaking successive mergers, asset acquisitions or other techniques to oppress minority shareholders by requiring approval of such acts by two-thirds of the voting shareholder interests other that those of the raider and its affiliates (through the special two-thirds vote can be avoided in certain circumstances).
The Virginia Act also contains provisions which support a board’s adoption of a poison pill rights plan if the board concludes that the corporation may be the subject of a non-negotiated takeover attempt that may not be in the best interests of its shareholders. A 'poison pill' rights plan allows existing shareholders to acquire stock of a target corporation or of an acquiring corporation at a bargain price upon the occurrence of certain triggering events. The typical plan allows for the purchase of the bargain shares after a person or entity has acquired a percentage of the target’s shares or announced a tender offer. Because of its ability to redeem the poison pill rights at a nominal price prior to a shareholder acquiring control of the company, parties contemplating a takeover attempt are encouraged to negotiate with the target’s board.
Corporate Fees.
Virginia’s annual franchise or registration fees are significantly lower than fees in other states. The annual registration fee for a Virginia corporation ranges from a minimum of $50 to maximum of $850, depending on the number of authorized shares.
Qualifying To Transact Business in Virginia
. A foreign corporation (i.e., a non-Virginia corporation), may apply to the Commission for a certificate of authority to transact business in Virginia. A foreign corporation may not transact business in Virginia until it obtains a certificate of authority for the Commission.
The Virginia Act contains a non-inclusive definition of what does not constitute transacting business in Virginia. The general rule remains that a foreign corporation maintaining an office or other place of business in Virginia or advertising for business in Virginia should file for authority from the Commission to transact business in the Commonwealth.
Right-to-Work State.
Virginia is a 'right-to-work' state. Virginia’s 'right-to-work' law provides that 'the right of persons to work shall not be denied or abridged on account of membership or non-membership in any labor union or labor organization.' Thus, an employer may not require, as a condition of employment, membership in a union or the payment of union dues. Any agreement (such as a collective bargaining agreement) which would cause an employer to violate the provisions of the right-to-work law also is illegal.
Virginia is friendly to persons seeking to collect debts
. Judges in Virginia are appointed, not elected, and usually demonstrate evenhanded justice. Debts under $15,000.00 may be pursued in a General District Court which offers an inexpensive and streamlined trial process. Any debt over $3,000.00 may, and all debts over $15,000.00 must, be brought in a Circuit Court. Generally, an attorney is not required to prosecute collection cases in General District Court unless the matter is contested; however, representation by an attorney is required if a corporation seeks to pursue remedies in the Circuit Courts. Virginia courts will recognize properly drafted forum selection clauses. Confession of judgment provisions are also allowed so that a judgment can be obtained without a trial. Once a judgment has been obtained, it can become a lien against real estate. Garnishment of wages and other monies due a debtor is also available.
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BUY-SELL AGREEMENTS FOR SMALL BUSINESSES
The transfer of ownership interests in a small business should take into account all of the considerations that make each business, and especially a family-owned business, unique. The vehicle for accomplishing the transfer is usually called a buy-sell agreement. Its name barely begins to describe the buy-sell agreement's various purposes. With professional advice, the agreement can be tailored to meet the objectives of each small business, whether the business is in the form of a close corporation, partnership, limited liability company, or some other structure.
By creating a market for the ownership interest of a shareholder who has retired, become disabled, or died, a buy-sell agreement insures that such an interest can be converted into cash when cash is more important than having shares in the company. Since small businesses often pay out most or all of their profits in salaries, an equity interest in the business would be much less valuable if its owner was not assured of being able to sell that interest back to the business or to other shareholders.
Valuation of the Business
When a triggering event in a buy-sell agreement causes the interest of one owner of a business to be purchased by other owners, or by the business as an entity, a critical issue is placing a dollar value on that interest. It is difficult to set a market value for shares in closely held corporations, whose stock by its nature has little or no liquidity. An agreement can set the price for shares according to a predetermined formula, value as shown on the company's books, an appraisal by a third party, or some other method. In any event, it is important that the provisions on the valuation and purchase price of shares in the company be kept current.
Orderly Transition of Ownership
A buy-sell agreement also may serve as an orderly method for maintaining control over the company despite a change in the composition of its owners. In a family-owned business, this may mean a clause in the agreement effectively keeping the business in the family by allowing remaining family members to buy the interest of a departing owner. For children who decide not to carry on in the business, cash, perhaps generated by life insurance on a senior owner, might be an alternative to inheriting part of the business.
A typical buy-sell agreement for a family business provides that, on the death or departure of one shareholder, the remaining shareholders have the right to purchase his or her shares. Those participating in the buyout usually acquire those shares in an amount commensurate with their holdings. An alternative could give the corporation itself the right to purchase the shares. However, this option may bring into play laws for the protection of creditors that limit the power of corporations to purchase their own shares. A hybrid approach sometimes used in buy-sell agreements allows the business to buy its own shares, only to the extent permitted by relevant statutes, but the remaining shareholders could then purchase any shares not acquired by the corporation.
Avoid Conflicting Terms
Since one of the triggers for application of a buy-sell agreement is a shareholder's death, shareholders should avoid conflicts between the terms of the agreement and their estate plans. When the terms of an agreement and a will cannot easily be reconciled, the odds increase for litigation, rather than the smooth transition for which the agreement was designed. If a will predates the agreement, it may be necessary to draft a new will that is consistent with the agreement. A less-complicated approach is to amend the will with a codicil providing that business interests are to be disposed of according to the buy-sell agreement.
Consistency between an estate plan and a buy-sell agreement is important not only as to disposition of shares, but also as to voting or management rights in the company. A shareholder should determine whether his estate or heirs should have such rights, and then be sure that the documents accurately reflect the shareholder's wishes. Similarly, a shareholder should consider whether limits on his executor's voting rights are desirable, so as to avoid the possibility that the executor will act to frustrate the shareholder's intent.
One purpose of any contract is to avoid future disputes between the parties by establishing rights and duties for future contingencies. Aside from dealing with the substantive issues raised by transferred ownership, a buy-sell agreement also can head off conflict, or at least help solve it, by providing for a form of alternative dispute resolution or mediation.
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WHAT IS INTELLECTUAL PROPERTY?
Until recently, it seemed that only authors, inventors, and corporations and their lawyers had any occasion to encounter intellectual property laws. With computer technology and the Internet available to practically everyone, these laws and their protections have become much more relevant, making it worthwhile to have some knowledge of the subject. 'Intellectual property' involves three major areas: patents, trademarks, and copyrights.
Patents
A patent is the grant of a property right by the federal government to an inventor. A patent lasts 20 years from the date on which the application for it was filed. A patent gives 'negative' rights to its owner. Instead of the right to make, use, sell, or import an invention, a patent is the right to exclude others from these activities.
A person who 'invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent.' Collectively, the items that can be patented encompass most man-made products and the processes for making them. 'Usefulness' means having a useful purpose and, in the case of a machine, being operable for the intended purpose. The subject of a patent must be nonobvious. 'Nonobvious' means that the invention is different enough from existing technology and knowledge that it would not be obvious to a person with skill in the field.
Our courts have set the limits on what can be patented, excluding laws of nature, physical phenomena, and abstract ideas. A patent can be granted for a new machine, for example, but not on the idea or suggestion of the new machine. A complete description of the subject matter for which a patent is sought is a required part of the patenting process.
Trademarks
A trademark is a word, phrase, symbol, or design, or a combination thereof, that identifies and distinguishes the source or origin of goods or services. A service mark is like a trademark except that it refers to a service instead of a product. Trademark rights can be used to prevent others from using a confusingly similar mark but not to prevent the making of the same goods or selling such goods under a nonconfusing mark.
The filing of a registration application with the federal Patent and Trademark Office is one way to establish rights in a mark, but rights also can arise simply from the actual use of a mark. There are greater benefits from registration, however, such as a presumption that the owner of the registered mark is, in fact, its owner and is entitled to use it across the country. Unlike patents and copyrights, trademark rights can last as long as the trademark is used to identify goods or services, although the registration must be renewed every 10 years and certain information must be filed with the government to keep the registration alive.
Copyrights
A copyright protects the writings of an author of 'original works of authorship' from unauthorized copying. Published and unpublished works of a literary, dramatic, musical, or artistic nature are protected by copyright law. Copyrights are registered in the Copyright Office in the Library of Congress, but a copyright is secured automatically when the work is fixed in a copy or photorecord for the first time.
Federal law gives the owner of a copyright the exclusive right to do, or to authorize others to do, the following things: reproduce the work in copies or photorecords, prepare derivative works, distribute copies or photorecords to the public, perform the work publicly, display the work publicly, and, for sound recordings, perform the work publicly by means of a digital audio transmission. Generally, any work created after January 1, 1978 is protected for the author's life, plus 50 years.
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WEBSITES AND JURISDICTION
Before a nonresident person or business entity can be sued in a given state, the defendant must have taken some action that indicates a submission to the authority of that state's courts. Traditionally, this has meant 'minimum contacts' with the state. The laws that set these ground rules are called 'long-arm statutes,' a term that describes the reach of the courts into other states. The term, like the body of court decisions on the subject, may need modernizing in the age of the Internet.
The issue of long-arm jurisdiction has been adapted previously to technological advances in business, and courts again are setting new standards for its use when a plaintiff attempts to bring an out-of-state defendant into court on the basis of the defendant's website activity. These cases fall at various places along a spectrum. At one end are 'passive' websites, which are akin to advertisements in national magazines or newspapers. They allow no real interaction between a business and potential customers. By themselves, passive websites will not subject their creators to jurisdiction wherever the site can be seen.
Midway along the spectrum are websites that allow some interaction by permitting the exchange of information between the site owner and users in another state but where the interaction falls short of transacting business. In such circumstances, the nature and level of information exchange will govern the jurisdiction issue.
For example, a New York bank was allowed to sue a competitor based in another state for trademark infringement in a New York court. The defendant's website allowed customers in any state to apply for loans online. Customers also could 'chat' online with a representative or send e-mailed questions to which they would get a response within an hour. It was ruled that this Internet commercial activity brought the defendant within the jurisdiction of New York. However, while this online activity was both significant and clearly commercial in nature, there was some doubt as to whether customers actually could complete transactions online.
In a case at the opposite end of the spectrum from passive websites, a Texas eyewear company was permitted to sue an out-of-state company in Texas because the defendant was effectively carrying on business in Texas by means of its website. This decision was clear-cut because users of the defendant's website could purchase sunglasses on the website with order forms containing credit card and shipping information. The outcome was not affected by the fact that the computers hosting the defendant's website were not located in Texas.
Businesses with websites can limit their susceptibility to the jurisdictional reach of courts in other states by: (1) using a 'clickwrap agreement' in which website customers agree that any litigation will occur in the courts of a designated state; (2) including a disclaimer that the company will not sell its products to customers in a particular state or states; or (3) disabling a website so that it will not handle orders or shipments for such states.
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REAL ESTATE LETTERS OF INTENT
A letter of intent (LOI) reduces to writing a preliminary understanding of parties who intend to enter into a contract, including contracts to purchase real property. The concept falls somewhere on the continuum between the first informal talk about a possible deal and a binding written agreement covering all of the essential terms. By its nature, an LOI does not bind the parties to the transaction, raising the question as to how it can still be useful. An LOI is evidence of some commitment, albeit more moral than legal, to the deal. A potential buyer with an LOI in hand has an edge over others who may have an eye on the property. Having laid a foundation on which a deal could be built, the buyer and the seller can feel more comfortable about putting in the effort, energy, and money that may be necessary to actually close the deal.
LOIs have potential drawbacks and should not be entered into without advice of counsel. First, if an LOI is produced only after extensive proposals and counter-proposals, or if it becomes stuffed with details you would normally expect to find in the fine print of a contract, it may be more trouble than a nonbinding document is worth. All of that work is better saved for the 'main event.'
Second, while it may be appropriate and even desirable to describe the key terms of the subsequent contract in the LOI, it must be made very clear that the terms are not yet binding. In fact, an LOI should state generally that the parties do not intend to be legally bound to consummate any transaction until they have signed and delivered a written agreement in which they agree to be bound. It helps in this regard to avoid using boilerplate contract terms like 'agree,' 'offer,' and 'accept' in an LOI. Language to the effect that an agreement is subject to formal documentation may be helpful, but by itself it may not rule out a conclusion that the parties intended to be bound. Similarly, while it may not settle the issue, calling the document a 'letter of intent' implies a nonbinding expression in contemplation of a future contract.
In an LOI, the buyer and the seller may need to bind themselves to certain preliminary matters leading up to the contract, however, such as access to the property for inspections. In that case, it is essential to distinguish clearly between nonbinding and binding items in the LOI. Even when the language of the LOI is in good order, a party to the LOI should take care to avoid conduct or statements that are at odds with the LOI's preliminary nature. Otherwise, the other party may attempt to argue, in effect, that actions speak louder than even written words, and that both parties meant to be, and are, bound by everything in the LOI.
In a recent case, a court ruled that a 'letter offer' sent by a developer and signed by the owner of undeveloped land was not a binding agreement. The factors that led to the decision are instructive. The language in the letter stating that it 'will serve to set forth some of the parameters for an offer' suggested the setting of negotiating boundaries, rather than final terms. The letter expressly anticipated that a contract of purchase and sale would be executed later.
It was also significant that several key obligations and events concerning the expected sale, such as the beginning of an inspection period, were to be triggered only by the execution of a contract, not by the offer itself. Finally, the letter offer omitted some terms one would expect to find in a multimillion-dollar contract for the sale of property, such as a closing date, warranties, conveyance provisions, responsibility for taxes, and how the parties were to notify each other of contractually significant events.
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ELECTRONIC SIGNATURES
Using electronic signatures will change the way businesses interact with other businesses, how businesses work with their customers, and even how government serves its citizens. Paying bills, applying for loans, trading securities, buying goods, and contracting for services will all be made easier. Encryption technologies will give greater protections to consumers who conduct business with electronic signatures, and those who would seek to defraud consumers with electronic signatures may well leave a trail to their door in the process.
New federal legislation is trying to catch up with this technology by giving electronic signatures and records the same legal validity as those on paper. The law is intended to give businesses and their customers in transactions affecting interstate commerce the legal certainty needed to participate fully in electronic commerce. As of October 1, 2000, no contract, signature, or record may be denied legal effect solely because it is in electronic form. To be legally enforceable, however, such contracts and records must be in a form that is capable of being retained and accurately reproduced for later reference. The law does not favor one form of technology over another.
Consumers who may be unprepared to enter into electronic transactions are protected by a provision in the new statute that requires that the consumer's consent to a transaction be secured in a manner that reasonably shows that he or she can access relevant information in an electronic form. This means that the consumer must confirm a desire to conduct business electronically and attest to having the ability to access pertinent information electronically. The requirement that parties to a contract affirmatively agree to use electronic signatures does not apply to government agencies.
The E-Sign Act, as it is sometimes called, sets forth some specific contracts and other records to which it does not apply. These include wills; family law documents, including prenuptial agreements and divorce decrees; court documents; contracts covered by most parts of the Uniform Commercial Code; and notices relating to termination of utility services, evictions or foreclosures, cancellation of health insurance or life insurance benefits, and recalls of unsafe products.
Electronic transactions remain subject to applicable state and federal laws that prohibit unfair and deceptive acts and practices. The consumer consent requirements in the E-Sign Act are in addition to, not in place of, other statutory requirements with which the parties to the transaction must comply. Other statutes may include a state's own counterpart to the E-Sign Act. However, no state law can restrict the scope of coverage provided for in the federal law.
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CLICKWRAP AGREEMENTS
In the age of online commerce, 'signing on the dotted line' has for many transactions evolved into 'clicking on the 'I agree' box.' But the resulting 'clickwrap' agreement may be just as enforceable in court as if the parties had solemnly written their signatures at the end of a paper contract. As with so many twists on conventional legal concepts that have been ushered in with the Internet, courts are having to adapt time-tested principles on formation of a contract to the computer age.
In one case, a company paid thousands of dollars for sophisticated software. The company claimed that it was entitled not only to use the software but also to receive perpetual upgrades and support. As evidence of such a bargain, the company pointed to the purchase order for the transaction. The seller of the software countered by relying on a later clickwrap license agreement in the software itself that limited its liability to the price paid for the software.
The court ruled that the language in the clickwrap agreement that limited the seller's liability was binding. The buyer clearly had given its assent by clicking 'I agree,' just as if its representative had signed a standard contract. The only issue, according to the court, was whether clickwrap license agreements are an appropriate way to form contracts, and the court held that they are.
The court was aware of and sympathetic to the context in which most clickwrap agreements are created. The typical consumer, having paid a substantial sum for software, rushes it into the computer, clicks on 'install' and scrolls past the fine print in the license agreement. Arriving at the 'I agree' box, the customer clicks on it with hardly a thought. The lesson from this case is that the click of a mouse is the equivalent of the stroke of a pen.
Clickwrap agreements are no less enforceable than conventional contracts, but neither will they be recognized by courts if the basic elements of offer and acceptance are absent. From the early common law of England to American law today, promises become binding only when there is a meeting of the minds. As another court faced with a disputed clickwrap agreement put it, '[a]ssent may be registered by a signature, a handshake, or a click of a computer mouse transmitted across the invisible ether of the Internet.'
That court had to resolve a dispute between visitors to a website who obtained a free software program that makes it easier to download files from the Internet. Someone wishing to download the free program would see at first only a 'download' box but no reference to a license agreement. Only on the second screen was there an invitation to review and agree to a license agreement. A click on that invitation led to an unequivocal statement that the user must agree to the terms in the agreement before installing the software, and another click revealed the agreement in full. In short, visitors to the website were not required to indicate affirmatively their assent to the license agreement, or even to view the agreement, before downloading the software.
Individuals who had downloaded the software sued the provider because they believed that using the software caused private information about their Internet activity to be transmitted to the software provider, which was a violation of federal law. The court ruled that they were not bound by a clause tucked away in the license agreement that required arbitration of disputes in a specific location. From the user's vantage point, the software was like a free neighborhood newspaper at a supermarket counter, there simply for the taking. The provider of the 'newspaper' could not impose contract terms on its taking without clearly requiring assent to the terms before a customer could take the paper.
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LANDLORDS AND CREDIT CHECKS
Landlords are free to use credit reports in evaluating prospective tenants, but they must follow requirements set out in the Fair Credit Reporting Act (FCRA). A new guidance has been issued that describes how the FCRA applies to landlords and what the consequences are for noncompliance. The guidance focuses especially on a landlord's obligation to provide an applicant with an 'adverse action notice' when adverse action is taken based on information in the applicant's 'consumer report.'
A consumer report is a compilation of information about a person's credit characteristics, character, reputation, lifestyle, and rental history. A report is covered by the FCRA only if it was prepared by a consumer reporting agency (CRA). The major credit bureaus are CRAs, as are many tenant-screening services and reference-checking services. If a landlord uses its own employees to verify personal, employment, and previous landlord references, the FCRA does not apply.
The most obvious adverse action that will trigger the notice requirement is outright denial of a rental application. Something short of that can also constitute adverse action so long as it is prompted by information in a consumer report. For example, a notice must be given to applicants who are required by the landlord to: have a co-signer on the lease; pay a deposit not required for other applicants, or an unusually large deposit; or pay rent that is higher than for another applicant.
The essential contents of an adverse action notice are established in the FCRA. The notice must contain the name, address, and telephone number for the CRA that supplied the report, a statement that the CRA did not make the rental decision and that it cannot give the specific reasons for that decision, and notification that the consumer has rights to a free report and to dispute the accuracy or completeness of information in the report. Even landlords for whom a consumer report played only a minor role in the decision to take an adverse action must give the notice to the applicant. A written notice is the best proof of compliance.
Landlords are well-advised to stay in compliance with all FCRA requirements, including adverse action notices, as the consequences for noncompliance can be significant. For lack of required notices, a landlord can be sued by individuals in federal court and made to pay compensatory damages, punitive damages if the violations are deliberate, and attorney's fees. Federal or state agencies can also sue landlords and get civil penalties. An isolated and inadvertent failure to send a notice, however, will not result in landlord liability if the landlord has reasonable procedures in place to assure compliance with the FCRA.
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BUSINESS STARTUP--SHOULD YOU BE A 'FRANCHISE PLAYER'?
Launching a business is a little like walking a tightrope, with any long-term rewards coming only after overcoming some risk. Being well-informed and realistic from the outset is essential. One of the first considerations is the legal form that the business should take. An option that has the potential for achieving a good balance between risk and reward is the franchise.
A franchise is a relationship between the owner of a trademark or trade name (franchisor) and an individual or entity (franchisee) who contracts to use that legally protected identification in a business. The details of the relationship are controlled by a franchise agreement, but most franchises share some common characteristics. Typically, the franchisee sells goods or services that are either supplied by the franchisor or at least must meet standards set by the franchisor. In simple terms, the franchisor provides the ingredients that come from the proven experience of an established line of businesses, while the franchisee provides the elbow grease and all of the other intangibles that are needed if a fledgling business is to get off the ground and prosper.
There are two types of franchises. The simpler version, known as a 'product/trade name franchise,' is the sale of the right to use a business name or trademark. In the more complex form, called a 'business format franchise,' the fates of the parties are tied together more closely and for a longer period of time. In this format, the franchisee trades some of its independence in exchange for various forms of assistance from the franchisor.
Money Matters
One benefit of a franchise is that the prospects for a healthy bottom line are enhanced, since the risks of the investment are reduced by being associated with an established company and its good name. But that boost is not without cost. A would-be franchisee should always be aware of the financial commitment involved, but not be too quickly scared away by the reality that here, as in most business matters, 'you have to spend money to make money.'
It is only prudent to consider carefully a number of likely expenses. There is the initial franchise fee, sometimes nonrefundable and usually at least a few thousand dollars. Costs to rent or build an outlet and to purchase the initial inventory will be significant. The full range of expenses depends on the type of business, but some of the other typical expenses include fees for licenses and insurance, ongoing royalty payments to the franchisor based on income and for the right to use the franchisor's name, and payments into the franchisor's advertising fund.
Who's in Charge Here?
It is the nature of a franchise that, in exchange for getting to hitch its wagon to the franchisor, the franchisee agrees to give up some of the control over how the business will operate. There still should be room for putting a personal stamp on the business, but the franchise business model is not for someone who would have difficulty giving up the decision-making power that comes with starting a business. Owners of a 'Mom and Pop' do not need permission for their store's color schemes, but the franchisee probably will.
As set out in the franchise agreement, the franchisor will usually have the final say about the specific goods and services that may be sold, site approval for the business location, design or appearance standards, as well as authority over an array of operational matters such as hours of operation, signs, employee uniforms, and even bookkeeping procedures. On the larger scale, the franchisor also may limit the franchisee's business to a specific territory.
Parting Company
A franchisee's breach of the franchise agreement, such as by failure to make payments or to comply with performance standards, could result in termination of the franchise and loss of the franchisee's investment. Even without a breach, a franchisee must foresee that franchise agreements generally run for a finite period, such as 15 or 20 years. Of course, if both sides so desire, the agreement can be renewed under the same terms or perhaps even terms more favorable to the now-proven franchise. But the franchisor could decide not to renew, and it usually reserves the right to do so for its own reasons. If there is a renewal, the parties must agree again to all of the terms and conditions. The franchisor may take that opportunity to make changes in the deal to its benefit. In that event, the franchisee would be wise to give a fresh look at whether owning a franchise still makes business sense.
Anyone seriously considering buying and running a franchise needs to do the homework first, and the Federal Government has made that process more organized. The Federal Trade Commission (www.ftc.gov) requires franchisors to prepare a disclosure document, sometimes called a Franchise Offering Circular, that puts in one place a wealth of information about the franchisor, current and former franchisees, and what the franchisee is agreeing to when the franchise agreement is signed. Reading and understanding the disclosure document, not to mention the franchise agreement itself, is essential. One should always seek independent professional advice before making a commitment to a franchise arrangement.
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ESTATE PLANNING
ESTATE PLANNING WITH LONG-TERM CARE INSURANCE
Longer life expectancies and the coming surge in the retirement-age population have increased the demand for long-term care, as well as for insurance as one means of paying for that care. Long-term care encompasses a broad range of services for those with a prolonged illness, disability, or mental disorder. Unlike the focus of traditional medical care exclusively on certain medical problems, the goal of long-term care is the maintenance of an individual's level of functioning.
Types of Care
The two main types of care are skilled care, provided by medical personnel for medical conditions according to a treatment plan, and personal care. Personal care, sometimes called custodial care, is assistance with the activities of daily living that can be provided in many settings, including nursing homes, adult day-care centers, or the individual's own home.
Whether the purchase of long-term care insurance makes sense for a particular individual depends on age, health status, overall retirement objectives, and income. As with any type of insurance, it is critical to understand what is and is not covered among the types of long-term care services that are available. Exclusions and limitations are common. Equally important is knowing where services are covered. Some policies cover care in any state-licensed facility, but others may specifically include or exclude particular types of facilities.
Key Features
Since the amount of coverage is dictated by the type of service, coverage amounts will vary depending on the service. Most policies have a 'total lifetime benefit' for the duration of a policy. In addition, benefits are often payable up to maximum amounts per day, week, month, or year.
A provision on when benefits are payable, sometimes called a 'benefit trigger,' is another key feature that can vary significantly among policies. Some states have legislated benefit-trigger requirements, making it a good idea to check with state insurance departments. Typically, benefits become payable because of the insured's inability to perform a certain number of the activities of daily living. Policy language on mental incapacity also allows for benefits when the insured fails mental functioning tests. Such a benefit trigger is especially important for those afflicted with Alzheimer's, even though most states prohibit the outright exclusion of coverage for that disease.
Although they can add to the cost of a policy, there are optional policy provisions that can help to tailor a policy to individual circumstances. Third-party notification authorizes the insurer to notify a designated third party, such as a relative or friend, if the policy is about to lapse for nonpayment of the premium. A waiver of premium clause allows the insured to stop paying premiums once he or she is in a nursing home and the insurer has begun to pay benefits. Nonforfeiture benefits return some of the investment in the policy if coverage is dropped. If an insured has paid premiums for a certain number of years, some policies allow a death benefit to the estate consisting of a refund of premiums, minus any benefits the company has paid.
Tax Implications
Premiums paid for long-term care insurance are deductible as a medical expense, as long as all medical expenses exceed 7.5% of adjusted gross income. Since premiums on average increase more than tenfold between the ages of 40 and 70, this deduction increases substantially with age. The maximum long-term care premium you can add to your other deductible medical expenses is based on your age at the end of each tax year.
Employer contributions to long-term care insurance for their employees are tax deductible for the employer, and premium payments are not taxable income to the employees. Benefits from a long-term care plan are excluded from income up to the lesser of the actual costs incurred or $63,875 per year. The annual limitation will increase with inflation in future years.
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ESTATE PLANNING WITH THE FAMILY LIMITED PARTNERSHIP
A 'family limited partnership,' as the name implies, refers to the creation of a partnership business entity among close-knit family members. A family limited partnership does not necessarily have to involve a business. For instance, it can be created for a particular asset, such as real estate or a mutual fund. This structure is a popular estate planning tool because it can provide both tax and non-tax advantages.
Non-Tax Advantages
One obvious non-tax advantage is that when a transfer restriction is made a part of the family limited partnership arrangement, there is assurance that the business will be kept in the family. The structure also allows the operator of the business (presumably a parent) to maintain control of the business assets until retirement or death. This is accomplished by having the parent retain a general partnership interest that includes management control of the business. The children become limited partners. If a particular child were to be groomed to take over the management of the business, the parent could, over time, transfer fractional shares of the general partnership interest to that child.
Another important non-tax advantage is the protection of business assets. Although the personal assets of the general partner can be reached by creditors of the business, the liability of the limited partners is restricted to their interests in the partnership. Also, the assets placed in the partnership by the donor/parent are protected from his personal creditors. His income from the partnership can be reached by creditors, but not the assets.
Federal Income Tax
The primary income tax advantage to be gained from forming a family limited partnership is the deflection of income from the parent, who is typically taxed at higher marginal rates, to the children, who are taxed at lower rates. Where the donor/parent retains control as the managing partner, the strategy is to allocate earned income to the parent at the lowest reasonable level. The unearned income (return from capital investment) is divided among the parent and children as partners in proportion to their capital interests.
Estate and Gift Taxes
An initial federal estate tax advantage derived from the creation of a family limited partnership is that the allocation of income among the children will prevent the accumulation of such income in the estate of the donor/parent. The main focus is on the savings that can be realized on federal estate and gift taxes.
If the donor/parent transfers limited partnership interests to family members, the value of those interests will not be included in the parent's estate at death. However, when partnership interests are transferred to family members, there is potential gift tax liability, which is calculated at the same rates as the federal estate tax. This problem can be alleviated by taking advantage of the annual gift tax exclusion, which for 2002 is $11,000. A fractional interest can be transferred free of gift tax to each donee up to the amount of $11,000 per year ($22,000 if the donor's spouse consents to the transfer).
The two primary features by which federal estate tax savings are achieved are the estate freeze and the valuation discount. The object of an estate freeze is to transfer the future appreciation of the family business to the children. The effect is to prevent the appreciation of the senior family members' interests in order to minimize estate taxes.
The valuation discount feature discounts the value of the fractional shares into which the business is divided so that the total value of the shares will not equal 100% of the predivision value of the business. There are different methods that can be used to discount the value of the shares. These discounts reduce the value of each partner's share for federal estate tax purposes and benefit both the donor of the partnership interests and the donees.
Recently, the IRS has taken the offensive against valuation discounts. One Tax Court case shows that, in order to secure the 'lack of marketability' discount, the donee must not be given powers that would allow him to liquidate the partnership.
Another recent Tax Court case indicates that in order to avoid inclusion of the transferred limited partnership interests in the decedent's estate, care should be taken to avoid the appearance of the decedent treating the property as his own. For example, the transferor's residence should not be transferred to the family limited partnership unless the transferor is to pay rent.
Given that the family limited partnership is such a powerful and complicated entity with major business, tax, and personal consequences, anyone considering forming such a partnership should seek qualified legal advice.
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FAMILY LIMITED PARTNERSHIPS DRAW IRS SCRUTINY
A family limited partnership (FLP), like other limited partnerships, is a form of business consisting of one general partner and one or more limited partners. In an FLP, however, the individuals involved usually are members of different generations of the same family. One of the advantages of a well-executed FLP is a reduction in federal estate and gift taxes. Instead of transferring assets directly to beneficiaries, an individual may transfer interests in a limited partnership. Since interest in an FLP is not marketable and since a limited partner does not control management of the enterprise, the value of interests in an FLP usually can be discounted by anywhere from 25% to 50%, with a corresponding reduction in tax liability.
As with many transactions among family members, the IRS has a history of casting a skeptical eye on FLPs. Essentially, the IRS is intent on assuring that the tax advantages of any particular FLP are not the be-all and end-all for its existence. If the FLP is deemed to be a sham, the IRS may challenge the valuation discount and perhaps even the very existence of the partnership.
In one recent case, a federal appeals court found an FLP to be legitimate despite some circumstances that had aroused IRS suspicion. A 96-year-old woman put about $2.5 million into an FLP, keeping $450,000 for her personal expenses. She died two months later. The fact that the transfer included interests requiring active management and that no personal assets, such as a house or car, were involved weighed in favor of the FLP. Also, the person making the transfer into the FLP did not manage the FLP. Perhaps most importantly, oil and gas operations provided an essential legitimate business purpose for the FLP.
In another case that was similar in many respects, including the age of the individual transferring the assets to the FLP, the assets were found to be subject to the estate tax because the FLP had not been formed for a valid business purpose. Transactions made by the FLP never went outside the family circle and amounted to financing the needs of individual family members.
Emerging from the cases are a few rules of thumb for setting up and running an FLP so as to realize its tax benefits without attracting the attention of the IRS:
* Articulate real business reasons for the FLP that can be substantiated by persons outside the FLP;
* Do not let the person transferring assets into the FLP transfer all of his or her assets or use the FLP to pay personal expenses;
* Assign control over the FLP to a general partner who is not the same person who funded the FLP. Often the general partner is an entity, such as a limited liability company;
* Have some 'actively' managed assets in the FLP; and
* Follow the formalities for setting up and operating the FLP, including separate accounts and scrupulous adherence to formal accounting practices.
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LIFE INSURANCE CAN BE PART OF YOUR ESTATE PLAN
Even if you have a relatively modest estate, life insurance can be an important aspect of estate planning for the obvious reason that it can substantially increase the value of your estate. Where the death of a person is premature and a young family is in need of support, life insurance may be the primary means for the family's financial survival.
Even in larger estates, life insurance can be useful by providing the liquidity necessary to pay estate taxes and expenses without the necessity of selling off assets that a family would prefer to keep intact. Additionally, life insurance, unlike many other assets, does not have to go through a time-consuming administrative process before it becomes available to beneficiaries. Therefore, life insurance can be an immediate source of funds for a surviving family.
Estate Taxes and Life Insurance
As is true of any aspect of estate planning, one objective is to minimize the federal estate tax effect that life insurance can have. The primary tax issue that arises is whether the insurance proceeds are included in the estate for federal estate tax purposes. Including the proceeds would generate additional estate tax liability and reduce the amount of the proceeds that are available to the decedent's heirs.
The fundamental rule is that the gross estate will include the value of life insurance proceeds if (1) the proceeds are payable to the decedent's estate and are thus receivable by the executor, or (2) the proceeds are payable to other beneficiaries, but the decedent possessed at his or her death any of the 'incidents of ownership' with respect to any policy.
The term 'incidents of ownership' is defined more broadly than to be limited to the legal ownership of the policy. The term includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy or pledge it for a loan, and to obtain a loan from the insurer against the surrender value of the policy. There are other indirect ways that the decedent can be found to possess incidents of ownership. For instance, if the decedent is the controlling shareholder of a corporation that possesses an incident of ownership, such possession is attributed to the decedent.
Another scenario that will result in the inclusion of life insurance proceeds in the decedent's estate arises under certain circumstances where the decedent was the initial owner of the policy but transferred such ownership to another person or entity within three years of his or her death. Thus, even where the decedent has rid himself or herself of all incidents of ownership in the policy, there is still the possibility of inclusion under this three-year rule.
Keeping Life Insurance Proceeds Out of Your Estate
A common device for handling the life insurance aspect of an estate plan is the life insurance trust. Typically, a person would initiate the life insurance coverage by acquiring the policy. He or she would then transfer all incidents of ownership of the policy to a previously created irrevocable trust, which would be the named beneficiary on the policy. Assuming that the person survived until at least one day more than three years after the transfer of the policy to the trust, there would be no inclusion of the proceeds in the settlor's estate. If a policy is transferred within three years of death, the proceeds are included in the estate.
If the trust itself acquired the policy, the person would never be the owner and the three-year rule would not apply. The problem would be that the person could neither direct nor require the trust's acquisition of the policy without risking the possibility that he or she would be regarded as the original owner of the policy for purposes of applying the three-year rule. Therefore, it is important that the trustee be completely independent of the decedent.
An insurance trust can also have the practical effect of serving as a means of coordinating the collection, investment, and distribution of the proceeds of several policies. An insurance trust can hold other assets that the decedent transferred to it during his or her life. The trust can also receive assets 'poured over' to it by the decedent's will.
If life insurance is to be an element of your estate plan, it should be carefully integrated with the other aspects of the plan. Be sure to seek the guidance of a qualified professional to assist you.
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CHARITABLE REMAINDER TRUSTS
As the name implies, a charitable remainder trust involves the transfer of assets to a trust with the income going to an individual or individuals (which can include the owner of the assets) and with a charity receiving the assets at the expiration of the trust period. Such a trust device benefits the individuals who are the objects of the property owner's generosity, it transfers assets to the property owner's preferred charities, and it yields tax savings for the property owner.
If the trust is created during the property owner's life, there is a charitable tax deduction equal to the value of the charity's remainder interest, and the transferred property will escape federal estate tax. If the trust is established under a will, the charitable deduction will remove the property from the taxable estate.
There can be other, not so obvious, benefits. Where appreciated assets are transferred, especially where the assets have a low cost basis and there is a likelihood that the property owner would have sold the assets at some point had he not transferred them to the trust, the property owner avoids the capital gains tax that would be imposed upon an outright sale. If the trust sells the assets, it will have no capital gains tax liability because the trust will be a tax-exempt entity. If the property owner has established the trust in his lifetime, the fact that the trust can sell the property tax free maximizes the income base for the income beneficiary, which can be the property owner himself. Moreover, if the trust is a charitable remainder unitrust (CRUT), under which the income is measured as a percentage (no less than 5% of the value of the trust property in a given year), the trust serves as a hedge against inflation for the income beneficiary because as the trust property appreciates in value the income paid out increases. This is not true under the other type of charitable remainder trust, the charitable remainder annuity trust (CRAT), under which a fixed amount of income is paid out each year.
A unitrust can be used as a retirement plan. Although a CRUT usually pays a percentage of the trust's annual value, it can provide that income distributions may not exceed the amount of income actually earned by the CRUT in a given year. Any shortfall in income can then be made up when there is sufficient income. During the property owner's preretirement years, the CRUT can be invested in growth stocks, thus producing little or no income. Upon retirement, those assets can be sold with the proceeds invested in income-producing assets that will yield the agreed-upon income percentage plus a 'make-up' portion to compensate for the earlier shortfalls. Thus, income distributions from a CRUT can be minimized during the preretirement years and then maximized for the retirement years.
It is important to remember that a charitable remainder trust must meet a series of technical requirements and therefore should be drafted only by an experienced professional.
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QUALIFIED PERSONAL RESIDENCE TRUST
Many people's assumption that their estates will escape federal estate tax may be incorrect because they often underestimate the worth of the most valuable asset that they own, their personal residence. Federal estate tax law provides a means for reducing the tax consequences of transferring the family home. The device that is used to accomplish this goal is known as a 'qualified personal residence trust' (QPRT).
Tax Savings Advantage
An individual creates a QPRT by transferring his residence to a trust (usually for the benefit of family members) but retaining the right to use the residence rent-free for a specified period of time. The tax savings occur only if the grantor of the trust survives the period of his retained interest.
Upon the transfer of the residence to the trust, the grantor is regarded as making a gift of the remainder interest in the trust. The value of the gift is the fair market value of the residence less the value of the grantor's retained interest. The gift is taxable, but only to the extent of the remainder interest, and there will be no further tax on the residence at the grantor's death. If a trust other than a QPRT were used, the total value of the residence would be subject to tax, just as it would be if the residence were transferred by will.
Although the grantor must survive the period of his retained interest in order for the tax savings to be achieved, there is no gamble involved. If he fails to survive his retained interest period, the full value of the residence will be taxed, but that is the same result that would be reached if he never transferred the residence to a QPRT. Also, the grantor may continue to occupy the residence once he has survived the retained interest period, but he must pay rent in order to avoid inclusion of the residence in his estate.
Disadvantages
The most obvious disadvantage of creating a QPRT is that the grantor of the trust has a predetermined limit on his right to occupy the residence, after which time he must give up ownership while he is still alive. The remaindermen (normally the grantor's children) then will have ownership of the residence, and the grantor will have to pay rent to them. Since many people may find this to be an awkward situation, the QPRT requires a personal decision that should be given careful consideration.
A second disadvantage concerns the amount of income tax liability that will result if the grantor's children (or other remaindermen) later sell the residence. If no trust is created and the residence passes at the grantor's death, the heirs or beneficiaries get a 'step-up' in basis, meaning that the gain on the sale will be measured against the value of the residence as of the grantor's death. If a QPRT is created, however, there will be no such step-up and the gain will be measured against the price that the grantor originally paid for the property.
Other Considerations
Cash may also be put into the trust, but the trust instrument must limit such additions to amounts needed to pay trust expenses, to make improvements to the residence, and to enable the trust to purchase a replacement residence.
The residence must be used by the grantor as his principal residence, although he may use the premises secondarily for business purposes. A vacation home can qualify for purposes of the QPRT provisions if certain requirements are satisfied.
The trust must prohibit the sale of the residence to the grantor, his spouse, or to an entity controlled by the grantor or his spouse during the period of the grantor's retained interest and thereafter in certain situations.
Conclusion
A QPRT has many technical requirements and establishing one is very complicated. A poorly executed trust has many potential undesirable effects. Anyone considering the use of such a trust should seek qualified legal advice.
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WHEN A GIFT IS NOT A GIFT
The Internal Revenue Code taxes the transfer of property by gift. A donor does not pay gift tax on the first $11,000 of gifts made to any person during the calendar year, but this exclusion applies only to gifts of a present interest in property. A recent federal appeals court decision has held that gift tax was owed on the forgiveness of a corporation's debt because that transaction constituted an indirect gift of a future, not a present, interest to the shareholders of the corporation.
The donor in the case was a family matriarch who had formed a corporation with her five children and two grandchildren. She sold valuable farmland to the corporation to be paid for over 20 years. She then forgave the principal indebtedness on the sale of the land over three successive years. The corporation eventually sold all of the land, converted its assets to cash, and dissolved. When the donor died, the IRS audited her estate and ruled that forgiveness of the debt did not qualify for the gift tax exclusion.
The estate of the donor argued to no avail that when the corporate debt was forgiven the resulting gift was of a present interest in two respects: (1) the net worth of the corporation immediately increased by the amount of the debt reduction, and (2) the shareholders' stock increased in value. However, the shareholders could not individually enjoy these benefits without delay and without the action of others. Under the corporation's bylaws and the law of the state where the corporation was formed, corporate property could be sold only with the approval of two-thirds of the members of the board of directors and the holders of two-thirds of the stock. A majority of the board was required to authorize the declaration of a dividend. Since the gift of forgiveness in this case was a gift of a future interest, the gift tax that the donor's estate had paid under protest would not be refunded.
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MEDICAID AND NURSING HOME BENEFITS
Medicaid is a governmental program that provides health insurance coverage for low-income children, seniors, and people with disabilities. As the baby boomers age, Medicaid's other role, as a source of nursing home benefits, is getting more attention. Each of the states operates its own Medicaid program, subject to some overriding rules set up by Congress and the federal Centers for Medicare and Medicaid Services. The following is an overview of some of those rules. Be aware that the specific requirements can vary from state to state, and must be checked before making decisions.
Asset Rules
An individual may have no more than $2,000 in 'countable' assets to be eligible for Medicaid nursing home benefits. Assets that are not counted in this calculation include personal possessions, one motor vehicle (valued up to $4,500 for an unmarried recipient and of any value for the resident's spouse), a principal residence in the same state where benefits are sought, prepaid funeral plans and a small amount of life insurance, and assets deemed to be inaccessible. To promote the independence of the nursing home resident's healthy spouse, usually referred to as the 'community' spouse, that spouse may keep one-half of the couple's countable assets, up to a maximum of $92,760 in 2004. The least that a state may allow the community spouse to retain in 2004 is $18,552. The couple's assets are totaled as of a 'snapshot date,' which is when a spouse enters a long-term facility in which he or she then stays for at least 30 days.
Transfer Penalty
To avoid giving benefits to those who present a false picture of poverty, there is a transfer penalty that is imposed when people transfer assets without receiving fair value in return. The Government divides the amount so transferred by the average monthly cost of a nursing home in the state in question. The person is then ineligible for Medicaid during the resulting number of months. Several provisions limit the impact of the transfer penalty. First, Medicaid officials can consider only transfers made during the 36-month 'look-back period' preceding the application for Medicaid (or 60 months for transfers made to certain trusts). As a result, it is prudent not to apply for benefits in the three years after a large transfer. Second, the transfer of assets to particular categories of individuals, such as spouses and blind or disabled children, will not bring about a penalty. Finally, a penalty can be completely wiped away, or 'cured,' if the transferred asset is returned, or the penalty may be reduced to the extent that the asset is partially returned.
Treatment of Income
The starting point for dealing with income under Medicaid is that nursing home residents pay all of it, less certain deductions, to the nursing home. The types of deductions are as follows: a $60 per month allowance (subject to some variations among the states) for the resident's personal needs; a deduction for any uncovered medical costs, including premiums for medical insurance; for married applicants, an allowance for the spouse at home if he or she needs income support; and a deduction for any dependent children living at home. Income attributable solely to the community spouse is off-limits. It is not taken into account in determining eligibility and the community spouse will not have to use his or her income to support the spouse receiving Medicaid benefits in a nursing home.
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MEDICAID LOOK-BACK RULES
Both 'Medicare' and 'Medicaid' are programs established by federal law that are intended to assist individuals with the payment of medical expenses. Normally, as a matter of entitlement, Medicare is designed to assist older individuals based on their contributions to Social Security. Medicaid is a medical benefits program only for the aged, blind, and disabled who are in need.
Medicaid covers long-term nursing home costs while Medicare does not. In order to qualify for Medicaid, an individual may own no more than a home, personal belongings, a car, and a small amount of savings and can have an income of only a few hundred dollars per month. The precise levels of income and resources that a Medicaid applicant may maintain and still qualify for Medicaid are set by individual states.
If an individual needs nursing home care and does not already qualify for Medicaid, his assets may be quickly exhausted and his heirs will not receive an inheritance. Given these circumstances, it is understandable that the focus of Medicaid planning has been on the reduction, or 'spending down,' of assets so that qualification for Medicaid is achieved.
The primary obstacle to such an 'impoverishment' strategy is raised by the Medicaid 'look-back' rules. If an asset is given away or sold by the Medicaid applicant for less than its fair market value, the Medicaid administrator must still count the transferred asset along with the Medicaid applicant's other assets if the transfer was made within 36 months (three years) preceding the date of the application. The look-back period is 60 months (five years) for assets transferred to a trust for less than fair market value. When such transfers are added back to other countable assets owned by the applicant, the total will often exceed the maximum level allowable for Medicaid qualification and result in a period of ineligibility.
The rules for calculating the waiting period are complex, but are generally intended to delay the application for Medicaid benefits until the look-back period is free of transfers that were for less than fair market value. The greater the value of the transfers that have occurred during the look-back period, the longer the period of ineligibility for Medicaid benefits. However, the transfer of a homestead for less than fair market value would not be counted if the transfer were made to the individual's spouse, to the individual's child who is under 21 years of age or who is disabled or who provides care to the individual, or to a sibling who has an equity interest in the homestead. Assets other than the homestead are exempt from the look-back/ineligibility period rules if they are transferred to a spouse, to a child who is under 21 or who is blind or disabled, or to a trust for the sole benefit of a disabled person who is younger than 65.
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IS IT TIME FOR AN ESTATE PLANNING CHECKUP?
Even the most detailed and carefully crafted estate plan should be revisited periodically to make sure that it is in line with changing laws and life circumstances.
* Be sure that estate assets are held in such a way as to minimize estate taxes at death and to avoid overfunding or underfunding of post-death trusts;
* Review the powers of attorney for health care and property to confirm that they reflect current wishes;
* Make adjustments to reflect the death or disability of a beneficiary, or a significant change in a beneficiary's needs;
* Update or prepare a living trust, which allows an estate plan to be carried out with minimal court involvement;
* Retitle assets in your name as trustee of your living trust if you want to avoid probate upon disability or death;
* Review how you hold title to assets (i.e., payable on death, joint tenancy, tenancy by the entirety, etc.);
* If you have not already done so, name appropriate guardians for minor children in your will;
* If you have included a marital gift or a marital trust upon the death of one spouse, consider making the provisions more or less restrictive;
* Examine the scope of 'powers of appointment' that allow a survivor to redirect where assets will eventually pass;
* Confirm that the timing as to when a beneficiary will receive or have the right to demand principal is compatible with current wishes;
* Make any revisions suggested by changes in the family such as disabilities, births, deaths, or changed marital status;
* Reassess how title to your home is held;
* Consider the different options for designating beneficiaries for IRA accounts, pension plans, and other assets related to retirement;
* Possibly make annual gifts to children and others free of estate and gift taxes (up to $11,000 per person per year in 2002);
* Consider setting up separate trusts or Section 529 education funding plans for children or grandchildren.
In addition to these considerations, there is a broad range of estate planning options, one or more of which may be desirable based on current circumstances. Among these devices are charitable trusts, irrevocable life insurance trusts, family limited partnerships, family foundations, self-canceling installment notes, and qualified personal residence trusts. A qualified professional can help you sort through the possibilities and arrive at an estate plan that keeps up with changing conditions.
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IRS GETS TOUGH ON ESTATE TAX FRAUD
Prosecutions for filing a false Form 706, the federal estate tax return, have been rare. Recently, a federal prosecutor announced a guilty plea by an individual charged with estate tax fraud. The guilty plea may well be a harbinger of a new 'get tough' policy by the IRS in an area that up until now has not had a reputation for vigorous criminal enforcement.
The defendant in this case was the executor of her mother's estate. She admitted that she intentionally filed a Form 706 that omitted assets worth about $400,000 that should have been included in the estate. The executor could face a term of imprisonment, followed by a term of supervised release, and a large fine.
Individuals who stand to be affected by the new emphasis from the IRS on using a carrot and a stick include executors, tax return preparers, and essentially anyone responsible for the completeness and accuracy of an estate tax return. It is important to remember that old income tax returns and other documents that the IRS can obtain in an audit often will allow it to discover assets that have gone unreported. The recently publicized guilty plea by an executor is a not-very-subtle warning by the IRS that estate tax fraud can have consequences beyond dollars and cents.
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PERSONAL MATTERS
BEWARE OF PREDATORY HOME LOANS
At a time when stock prices have tumbled, so have interest rates on home equity loans and mortgages, and many homeowners are borrowing against their homes to generate cash. As a result, more people are at risk of being victimized by 'predatory' lenders. A predatory loan occurs when a company misleads, tricks, or even coerces someone into taking out a home loan with excessive costs and without regard to the homeowner's ability to repay. The consequences of such a loan can be especially severe since the defaulting borrower could lose the home itself.
For the most part, predatory lending has been associated with companies that specialize in marketing to people with poor credit histories or who are simply strapped for cash. Typical targets are elderly people with high medical bills or overdue home repairs, middle-class individuals swamped by credit card debt, and lower-income consumers with less access to reputable lenders.
A typical consumer may not know the terms for predatory practices, but the borrower will recognize some of these behaviors. In a 'bait and switch' scheme, the lender promises one thing but offers something different at closing, when it really matters. 'Equity stripping' results from encouraging heavy borrowing from home equity, beyond the consumer's ability to make payments. 'Loan flipping' is multiple refinancing, to the point that fees, and possibly higher rates, become unmanageable. When a lender engages in 'loan packing,' it has added charges to the loan contract for overpriced or unnecessary items.
There are federal laws designed to protect consumers from some of the predatory lending practices. The Truth in Lending Act requires lenders to give timely information about loan terms and costs, and it allows borrowers on loans secured by a home to cancel the loan up to three business days after signing the contract. The Home Ownership and Equity Protection Act requires providers of 'high cost' refinancing or home equity loans to give the borrower key information about the loan three days before closing. It also prohibits the making of a home equity loan without regard to a borrower's ability to pay it back. These laws play an important role, but the best deterrent to predatory lending is informed and vigilant consumers.
Some of the most effective preventive measures are only common sense, but in practice they are too often ignored: (1) think through the decision to borrow before taking the plunge, and be wary of a lender who hurries you; (2) select a lender with a good reputation in your community, and steer clear of home improvement contractors or loan brokers who contact you out of the blue; (3) compare quotes from at least three lenders, then negotiate for the best possible deal. And remember, the loan with the lowest monthly payment is not necessarily the best loan; and (4) read and make sure you understand the loan documents before signing them, keeping an eye out for discrepancies between what may have been discussed previously and what is in the fine print.
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FEDERAL PRIVACY RULE PROTECTS HEALTH INFORMATION
Recently, the first-ever federal privacy standards to protect individuals' health-care information went into effect. The mandate for these standards, collectively known as the Privacy Rule, was in the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
The Privacy Rule gives individuals access to their medical records and greater control over the use and disclosure of their personal health information. States are still free to keep or adopt their own policies or practices that are at least as protective as the new federal requirements.
Who Is Covered
Entities subject to the Privacy Rule include health-care providers, health plans (including insurance companies and HMOs), and health-care clearinghouses, such as physicians' billing services. The regulations also apply to 'business associates,' meaning any organization or person (other than a worker for a covered entity) that receives or accesses private medical information on behalf of a covered entity. When a covered entity uses a business associate, the two must enter into a written agreement containing specific protections for the health information used or disclosed by the business associate.
On its face, the Privacy Rule does not directly apply to employers, but that is not to say that employers need not become familiar with its requirements. Employers frequently interact with covered entities and their business associates. In addition, employers administering their own group health plans are effectively brought within the reach of the Privacy Rule.