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Legal Alert

January/February 2004

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In this issue . . .

• How to avoid FMLA disputes
• A legal audit can prevent costly legal woes
• Letter of intent: prelude to buying a business
• Recent Developments Concerning Family Limited Liability Companies

How to avoid FMLA disputes

In 2000, a maintenance worker who had worked at a hospital for 25 years asked for unpaid leave under the Family & Medical Leave Act (FMLA) to care for his ailing father. The hospital granted the leave, but fired the worker while he was out because he rated poorly on a new performance-review program based on the amount of work completed each month.

The worker sued the hospital in federal court, alleging that he couldn’t possibly have completed the same amount of work as others while he was out. A jury, in Schultz v. Advocate Health, decided that the hospital had illegally retaliated against him for taking time off and awarded him more than $11 million in damages. The hospital’s appeal is pending.

Although the appellate court could reduce (or increase) that award, the jury sent a clear message: The FMLA’s purpose — to help employees balance work and family responsibilities — is important in our society, and employers must not penalize workers who take advantage of the law.

More FMLA claims

Enacted in 1993, the FMLA gives qualifying employees the right to take up to 12 weeks of unpaid, jobprotected leave in any 12-month period to care for their (or an immediate family member’s) serious medical condition. As U.S. life expectancy continues to rise, more and more workers are caring for aging parents, their growing children and themselves. We can expect more FMLA requests and more disputes and lawsuits.

How can you protect your company from FMLA claims and lawsuits and promote your workers’ health and job satisfaction? By becoming familiar with the law and taking steps to ensure that your managers and supervisors comply with it. This article summarizes your and your employees’ FMLA rights and responsibilities — and how to avoid disputes.

Employee rights and obligations

Your company is covered by the FMLA if you employ 50 or more employees — counting both fulltimers and part-timers — working within 75 miles of the worksite. To be eligible for unpaid FMLA leave, an employee must have worked for you for at least 12 months and for at least 1,250 hours within the past 12 months before requesting leave. But you don’t have to count vacation time or previous medical leave when totaling the number of hours worked in the past 12 months. If you rehire a former employee, you can’t deny a leave request because the worker took previous FMLA leave.

Each qualified employee is entitled to take up to 12 weeks of unpaid leave during any 12-month period. But if a husband and wife both work for you, you may limit their combined total to 12 weeks to care for a newborn, a newly adopted child, or a child or a parent with a serious medical condition.

Serious medical conditions

To be considered “serious,” a medical condition must involve a physical or mental illness, injury or impairment — and any later related incapacity — that requires a health-care professional’s continued treatment. But the birth or adoption of a child qualifies under FMLA.

Employees with a serious medical condition qualify for leave if they can’t perform any one of their essential job functions because of the health condition. And you must grant time off for them to receive medical treatment.

Suppose an employee asks for leave to care for a sick family member. You have to grant leave if its purpose is to provide for the family member’s physical or psychological care or basic comfort. The family member can be a parent, spouse, child under 18 — including foster children, stepchildren, and legal wards — or a disabled older child.

Timing

Your employees must give 30 days’ notice when they apply for FMLA leave, if the health condition is foreseeable, or as soon as possible if not foreseeable. In an emergency, another adult may request leave for an employee unable to do so. You may delay the start of leave by up to 30 days if an employee fails to give 30 days’ notice for a foreseeable health condition.

Employees don’t have to specifically mention the FMLA to assert rights under the act. But they must supply enough information about the illness or injury so that you can determine whether the request for leave qualifies under the FMLA. Employees must make an effort to schedule hospitalizations, treatments and doctor visits so that their absence doesn’t disrupt company business.

An employee can take all 12 weeks of leave at once — or intermittently — for a single qualifying condition. But check with our attorneys to see what special conditions employers must meet to qualify for intermittent leave.

Employees returning from FMLA leave are entitled to the same or equivalent job (one with similar duties and responsibilities) with the same pay and other employment terms and conditions as before. You must continue to maintain their group health and dental insurance while they’re on FMLA leave. Some exceptions exist, of course. For example, if you lay off an entire department, the FMLA may not protect the job of a department member on family medical leave.

Employer rights and obligations

When an employee applies for leave, it’s up to you, the employer, to determine if the leave’s purpose qualifies under the FMLA. Of course you may grant paid or unpaid leave regardless of whether it qualifies — you’re the boss. But if it does qualify under FMLA, you must grant leave.

If leave requests meet FMLA requirements — whether or not the employees specifically mention FMLA — you must notify them in writing that the granted time off counts against their annual FMLA entitlement. This is important. Failing to notify can lead to costly disputes and claims. For example, you may be forced to grant an additional 12 weeks of leave to an employee if you failed to record previous leave as FMLA related.

You may require an employee who requests FMLA leave to provide a heath-care provider’s medical certification confirming the condition’s nature and seriousness. If leave is for the employee’s own illness or injury, you can require a doctor’s opinion (in some cases at your expense) of the employee’s inability to perform essential job functions. You may also require a fitness certification before the employee returns to work. But you generally shouldn’t dispute a doctor’s opinion about the seriousness of the condition or the employee’s fitness for work.

Some special rules apply when leave is requested for the birth or adoption of a child or for leave to care for a family member with a serious health condition. For example, sometimes you can require an employee to substitute paid leave — such as vacation or personal time — for FMLA leave. If in doubt about when you may require a substitution, please ask us.

Here are more steps that can help you stay out of trouble with the Department of Labor, whose Wage & Hour Division administers the FMLA and processes employee claims:

• Post a notice that summarizes FMLA provisions (you can download one in PDF format from this Web site: www.dol.gov/esa/regs/compliance /posters/pdf/fmlaen.pdf).
• Keep detailed, accurate records of FMLArelated requests, grants, rejections, notices, confirmations, medical records, dates and duration of leave, and disputes.
• Never discriminate or retaliate against an employee (or former employee) on the basis of an FMLA-leave or request for leave.

Also, our attorneys can help you comply with the act.

Look at the bright side

Although the FMLA can add to your company’s administrative burden, it also helps to keep families healthy and happy. This can improve their morale and productivity. If you have questions about how to apply the FMLA in your business, we can answer them.

Federal vs. state FMLAs

Eleven states and the District of Columbia have enacted their own family and medical leave statutes: California, Connecticut, Hawaii, Maine, Minnesota, New Jersey, Oregon, Rhode Island, Vermont, Washington and Wisconsin. Some of these state statutes provide more generous benefits than the federal FMLA. If the statutes — or any of their provisions — differ from the FMLA, the employee is entitled to the greater benefit.

A legal audit can prevent costly legal woes

Preventive medicine means visiting your doctor once a year or so for a checkup, even if you’re not sick or injured. Preventive maintenance means taking your car to a mechanic for a tune-up every 15,000 miles, even if it seems to be running smoothly.

And preventive law means doing something now instead of waiting until you get sued, fined or indicted. That something is conducting a legal audit to prevent disputes from becoming lawsuits, to comply with current rules before you’re hauled into court and to correct a minor ethical breach before it mushrooms into a front-page scandal.

An ounce of prevention

Prevention usually costs much less than remediation. Curing a serious disease in its advanced stages can cost a lot more than curing it while it’s still a minor problem. And paying your doctor for advice on how to prevent disease costs even less.

Large corporations have general counsel, some with a team of lawyers on the payroll, who continuously review the company’s operations and plan strategies to minimize legal risks. Smaller companies look to outside counsel. Though they’re not on the payroll, familiarize your outside lawyers with your operations, long-term goals and corporate culture, so they can regularly review and advise you on how to minimize your legal risks.

A pound of cure

Don’t wait until you’re in hot water to begin the legal-audit process. Your first step is to conduct a comprehensive legal audit with your attorney’s guidance. Then he or she can conduct preventive legal reviews for as little as a few hours each month.

Your attorney may have a set of review guidelines or a “risk list” of items to examine or both. But no two legal audits are the same, because every business has different procedures and different kinds of risks. Prepare your own list to make sure the audit misses nothing.

You can divide your list into four categories.

1. Documents

You probably store thousands of documents in various files and archives. Out of this jungle of records — and keeping an eye out for problems and potential risks — here’s what your lawyer should review:

• Both “standard” and customized business forms,
• Invoices, purchase orders and collection letters,
• Licenses and permits necessary to do business and provide professional services,
• Entity formation records, such as incorporation articles, partnership agreements and limited liability corporation documents,
• Insurance policies,
• Patents, trademark and copyright registrations, confidentiality agreements, and noncompete covenants,
• Employee benefit brochures, handbooks, posted employment policies and regulations,
• Asset titles and deeds to real property,
• Employment and work-for-hire contracts,
• Leases and rental agreements,
• Supplier and customer contracts,
• Loan documents,
• Document retention policies (including e-mail and electronic files),
• Documents and correspondence related to pending legal action, and
• External publications such as newsletters, white papers and seminar materials.

2. Memoranda

Before your attorney begins the audit, write brief memos describing these policies and procedures: e-mail and Internet monitoring and usage policies, government rules that cover your specific operations (other than employment and environmental rules that cover all businesses), and a short description of training programs for managers and supervisors — including Americans With Disabilities Act and Title VII training.

3. Interview issues

Don’t try to describe all your policies and procedures in a memo. Rather, use this information as a starting point. And be prepared to discuss with your attorney all pending or potential disputes with suppliers, competitors, customers, and employees, and trade secrets that may need more formal protection.

4. Site visit

List issues to discuss when your attorney visits your office, plant or other facilities, including your:

• Storage and retrieval systems for paper and electronic documents,
• Electronic file backup and storage, and
• Web site disclaimers, potential intellectual property infringement and deep-linking issues.

This list should get your legal audit off to a good start.

Four categories

You may add to or delete items from these lists, but your comprehensive legal audit should cover all four categories. Later audits can focus on narrower lists of items and issues — ask us to help you develop an audit schedule that suits your particular situation.

Letter of intent: prelude to buying a business

Buying another business is one way you can enter new markets, acquire needed technology, subsume a competitor, integrate vertically or simply expand.

A proposed transaction is often initially outlined in a letter of intent. This document broadly outlines the terms agreed on during preliminary negotiations and protects the deal during the last phases: due diligence, formal purchase offer and final negotiations.

A letter of intent typically contains a transaction’s essential terms. Don’t be tempted to compose it hastily or take it less seriously than other documents, such as the formal offer or the sale contract. A properly written letter of intent not only protects your deal, but also helps you establish a strong bargaining position for final negotiations. But it isn’t a contract and doesn’t contractually bind the parties.

Take preliminary acquisition steps

After you decide that buying a business fits into your long-term strategy, the next steps include evaluating potential candidates, meeting with prospective sellers and narrowing the field to a primary candidate. At that point you’ll research the company and its leaders, estimate the company’s value, and — if it still looks promising — hold preliminary negotiations to discuss key purchase terms.

The most important terms include:

• The buyout price or a narrow price range,
• Deal structure — for example, stock vs. asset sale and payment terms,
• Whether the seller will continue to participate in the business — as either an employee or a consultant — or will be required to sign a noncompete covenant,
• List of assets and inventory to be transferred,
• Who will be responsible for liabilities — including taxes,
• Conditions or contingencies each party must meet before closing, and
• Assurances that the seller will make company records available to you on a confidential basis during the due-diligence phase.

And you’ll want to be sure that those records support the seller’s representations about the company.

Write a letter

After you and the seller broadly agree on these and other important terms, compose your letter of intent. Ask your attorney to help you write it — or at least review it before you and the seller sign it. This is especially important because you have to ensure that the letter of intent is not binding.

In addition to summarizing the key agreed-on terms, the letter of intent may restrict the seller from entertaining offers from other prospective buyers for a specified period. In this respect, the letter protects the preliminary agreement while you invest considerable time and professional fees in a thorough evaluation of the company’s operations, books, assets, contracts, pending litigation, insurance coverage, key employees, suppliers and perhaps customers.

Sellers unwilling to be restricted from dealing with other potential buyers (essentially taking the company off the market while you conduct due diligence) should at least give you the right of first refusal in case another buyer makes an offer. Another alternative is that, in exchange for taking the company off the market for a specific period, the seller will be entitled to a partly nonrefundable deposit in escrow.

Include other provisions

Because every case is different, a standard letter of intent doesn’t exist. But here are some provisions that you may want to include in yours:

Introduction. Although the offer to buy and the final purchase agreement should be more formal, your letter of intent can be cordial. You can say, for example, “The purpose of this letter is to confirm our intention to acquire your company, XYZ Corp., according to the general terms and contingencies that we have agreed upon, summarized below.”

Nondisclosure. If you haven’t already signed a confidentiality or nondisclosure agreement, the seller may insist that you do so now, before you peer into the company’s tax returns, payroll, contracts and other sensitive records.

Financing. You may want to reserve the right to obtain part of the purchase price from outside financing sources, using the target company’s assets as collateral.

Due diligence. State that your offer to buy depends on a complete and satisfactory review of such things as the company’s books, records and operations — to be conducted at your expense, completed within a specified number of days and subject to your (and some named advisors’) personal review.

Lease assignations. The seller will assign existing leases or transfer some lines of credit (or both) to the seller.

Continued operation. Until the sale is final, the seller will continue to operate the business as usual, meet all financial obligations, and maintain cash balances and net worth within a specified percentage of current levels.

Notification of changes. The seller will notify the buyer of any material changes in the company’s financial and operating condition.

Binding or nonbinding. State whether the letter of intent — or any individual terms or provisions in it — are binding. If not, you should say, for example, “These terms will be binding only on the execution of a final purchase agreement.” Most litigation in this area results from ambiguities as to what parts are binding.

Termination. State under what conditions either party may withdraw from negotiations.

Dispute resolution. Describe how disputes arising from the letter of intent should be resolved — for example, by mediation or under the laws of what state. Keep in mind that you don’t necessarily want to include every term and contingency that will appear in the formal offer. You might want to leave some negotiating room. But you do want to remove doubts about issues that could lead to disputes.

Begin final stages

After you and the seller sign the letter of intent, the final acquisition stages begin: due diligence, formal offer, final negotiations, signing the purchase agreement and closing. We urge you to let us review your letter of intent, and other key documents related to an acquisition, before you sign them.

Recent Developments Concerning Family Limited Liability Companies

Many estate planners have recommended that families form and utilize a limited liability company (the “LLC”) as part of their overall estate plan. If formed and maintained properly, the family LLC can successfully pass assets to the next generation, minimize or even eliminate the federal estate tax on the assets contained in the LLC, and still allow parents to retain some control over the assets. However, recognizing the significant tax savings that the LLCs were affording taxpayers who formed such entities, the IRS has attacked the use of family LLCs on a variety of grounds. Many of you considering the creation of a family LLC and those of you who are already members of a family LLC need to be aware of recent developments in this area.

Many clients ask us what exactly is an LLC. An LLC is an entity like a corporation. Instead of stockholders there are members, each of whom own percentage membership interests in the LLC. The LLC is taxed by the IRS as a partnership, meaning that tax attributes “pass through” to the individual members so there is only one tax paid at one level.

Once a client forms his family LLC, we cannot overemphasize the importance that the LLC institute, obey and maintain certain formalities. In brief, some of these formalities include maintaining good standing with the State in which the entity is formed by ensuring all reports, filings and penalties due to it are up to date and paid and that the LLC has a valid, active resident agent. In addition, the LLC should always maintain a bank account separate from any member’s personal accounts. No funds should ever be co-mingled for any reason, any time. Any capital contribution by the members should be deposited into the LLC’s account. Also, the LLC should be adequately capitalized at all times, with sufficient funds to operate the business and pay the LLC’s expenses as they come due. Further, all documents executed by a member, manager or officer of the LLC must clearly indicate that the member, manager or officer is signing on behalf of the LLC.

An LLC is formed by filing Articles of Organization with the State. An Operating Agreement is prepared which contains provisions similar to those utilized in by-laws for a corporation. A Manager is appointed in the Operating Agreement to “operate” the LLC. The purpose of the LLC is broad: To conduct and carry on a business involving generally, but not limited to, the acquiring, owning, holding, operating, managing, mortgaging, leasing, selling and otherwise disposing of personal and/or real property for investment purposes.

The original members of a family LLC are typically husband and wife who initially contribute assets to the LLC. It is wise to contribute assets which are most likely to substantially appreciate in value. The parents then assign part of their membership interests in the LLC to their children, grandchildren or trusts for their benefit. Charities can even be named as members of an LLC. The assignment of membership interests is a taxable gift. However, application of the annual exclusion from the federal gift tax (currently $11,000.00 per donee) coupled with the lifetime gift tax exclusion (currently $1,000,000.00 per donor) can minimize or even eliminate any tax liability.

Membership interests which are assigned (gifted) to family members may be valued at a discount. This is due to the fact that the family members receiving the interests have a lack of control over their interests (they are not the Managers of the LLC). In addition, since there are transfer restrictions and no public market for the LLC interest, there is a lack of marketability. This means you are “getting more bang for your gifting buck”. An appraisal of the LLC is done to determine how much of a discount the assignments can receive. This can be anywhere from 0 - 50%. Therefore, if you were utilizing your annual exclusion in making the gift of the membership interests to your children, if the interest was really worth $20,000 but is allowed a discount for lack of marketability and control of 50%, then you are only making a gift of $10,000; you have successfully transferred an asset worth two times its value without incurring gift tax or diminishing your lifetime gift tax exclusion.

Over the past few years, the IRS has relentlessly attacked the family LLC and, except for specific egregious cases had, until recently, failed to chink the armor of the family LLC. This past summer however, the IRS won an assault against an LLC. The Tax Court recently ruled on a case that suggested that if a contributor (meaning the husband and/or wife) retains input in the management of the LLC (meaning he or she makes decisions when to make distributions, etc.), it is as if the contributor never gave anything up when he made the assignments to the other family members. The IRS claimed that the contributor had a “retained interest” in the assignments and the assets were included in his estate at the time of his death. Although there are many different opinions about the correctness of the case, we have decided to be conservative and recommend that contributors not serve as Managers of the LLC. Instead, a third party should be appointed to serve as Manager (like a trustee). Also, we are now recommending that Operating Agreements be drafted to include two (2) classes of membership interests as well as limiting the right of the contributors to vote on certain issues involving the LLC in order to alleviate the “retained interest” issues raised by the IRS.