Negligent hiring and/or retention of employees: urban legend or state law?

In 2009, a Wachovia (now Wells Fargo) teller searched through the bank’s customer information until she found a customer with a name similar to her husband’s name. The Wachovia teller than used the customer’s identity and credit to spend approximately $600,000.00 on vehicles, jewelry, and a trailer for her husband’s business.

The customer, a Georgia firefighter and emergency technician, did not take the teller’s actions lying down. Instead, he filed suit against Wells Fargo, alleging that the bank was liable for the actions of the teller, its employee. The lawsuit is now before the Georgia Supreme Court, which must decide whether the customer has a claim against Wells Fargo based on the Gramm-Leach-Bliley Act, which provides for the regulation and protection of consumer information.

While the Gramm-Leach-Bliley Act may not apply to every Georgia employer, the concept that a Georgia employer can be liable for the actions of its employees does apply to all employers. Georgia law requires employers to exercise ordinary care in selecting employees, and likewise requires employers not to retain employees the employers realize are “incompetent.” An employer will be liable for negligent hiring or retention if the employer either knew, or by exercising ordinary care should have known, that the employee was incompetent and that the employee’s incompetency hurt the plaintiff during the employee’s working hours.

For example, if an employer hires or retains an employee that employer knows is a habitual drunk driver, and if that individual becomes drunk and injurs another while driving the employer’s delivery truck, the employer will quite likely be held liable.  Of course, if the individual got drunk and injured another while driving the his or her personal vehicle on his or her own time, then the employer would not be liable.

The bottom line: because employers may be held liable for the actions of their employees during working hours, it is vitally important for employers to have a hiring and review procedure in place that allows the employer, while complying with state and federal anti-discrimination law, to ensure that it is hiring dependable, trustworthy employees.

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Coming soon: the crowdfunding you already think exists (part 1)

You may have heard that crowdfunding is already on its feet and on its way to becoming the next big thing.  In fact, the crowdfunding you may think already exists… doesn’t.  Not yet, anyway.  The average investor and the small business owner are both standing by, like participants waiting to jump into a game of double dutch, but the time has not quite come.  Here’s a quick primer.

Businesses need to raise capital.  One of the main ways they do so is by selling equity, or shares of ownership (also known as “securities”).  As a general rule, if a business wants to sell securities, it has to register on the federal level with the SEC (Securities and Exchange Commission) and often on the State level, too.  Registration is time consuming and expensive.  Businesses, especially small businesses (which employ half of the private workforce in America), often need to raise capital for growth but don’t want to deal with registration.  These businesses can raise capital from accredited investors (primarily people who make more than $200,000 per year or have more than $1 million in assets) without having to register, but they cannot currently raise capital from non-accredited investors without registration. This is an issue for a couple of reasons.

According to the New York Times, the median household income in the United States is about $52,000 per year.  That means that most Americans are non-accredited investors.  With certain exceptions, small businesses cannot sell to these non-accredited investors without first registering.  Accredited investors, who make up a relatively small minority of the population, may be more difficult to find (though perhaps easier to find now that the ban on general solicitation has been lifted (see Facebook Friend Seeks Funds: Title II of the Jobs Act (part 1)).  This cuts off a major potential source of funding for small businesses. The system is designed to protect unsophisticated investors from risky investments.  After all, according to the Wall Street Journal, three out of every four start-ups will likely fail, and about three quarters of them never return investors’ capital. On the other hand, many small investors feel that it is fundamentally unfair that the law deprives them of many opportunities to invest in local businesses or benefit from successful non-registered start-ups in the way that “rich people” can. All of this may cause you to wonder, “Well how can a business “crowdfund” if it cannot raise equity capital from the majority of people… from the crowd?”  That’s a great question, and that’s why the crowdfunding you think exists, doesn’t (yet).

Crowdfunding, at its core, is the ability to raise money directly from a large pool of everyday investors with minimal hurdles, using technology and social media to facilitate the fundraising.  Crowdfunding became law in 2012 through Title III of the Jobs Act, with the purpose of providing a relatively simple way for entrepreneurs and small businesses to gain access to more capital in order to grow the economy. Although crowdfunding is now legal, for the most part, it doesn’t yet exist.  The reason is that while the Jobs Act tells us what the law is, the SEC must then promulgate rules to tell us how the law works in practice.  The SEC hasn’t yet issued final rules to inform us how Title III will be implemented, but the SEC has recently issued proposed rules, which is a first big step (see Crowdfunding – SEC Proposes Rules on Title III of the Jobs Act).  So, we still wait, but we are getting closer!

As it stands, under federal law, businesses cannot yet raise equity capital from the majority of Americans (from the “crowd”).  This may confuse you, and you may be thinking, “Well what about Kickstarter, that’s crowdfunding, right?”  Good question.  There is an important distinction between equity-based funding and rewards or donation-based funding.  This distinction is explored in detail in part 2 of this post.

The Series LLC

There are still a number of old postings knocking around the internet that say that the LLC is a new and untested form of business entity.  Not so any more.  The LLC has been around in the US for more than thirty-five years and is the entity of choice today for many if not most small businesses and many larger ones, too.

As the law of corporations and business entities evolves, however, there are a number of new types of LLC that have that slightly raw, cutting-edge flavor of opportunity, salted with risk, that the LLC itself had back in those heady frontier days of the late nineteen seventies.  One such entity is the Series LLC.

Let’s think for a moment about why we have an LLC or corporation in the first place.  Business risks should always be segregated from personal assets, but there are often good reasons for segregating distinct business enterprises or major business assets from one another, too.  From a liability standpoint, ideally, if you owned 10 rental properties, you may wish to own each in a separate LLC, placing each into a separate “risk basket.”

Some entrepreneurs in this position begin to consider a holding company structure, a tried and true mechanism for separating risk and still retaining certain tax advantages of a single entity.  Still, this can become administratively inconvenient, not to mention very costly, when administrative costs and government fees must be paid for each LLC.

One solution, originating from the insurance industry and investment trust business (where investment trusts often own multiple portfolios in protected cells within a single entity such that the investment liabilities of one cell do not spill over and involve the holdings in other cells) is to provide for a single, broad, limited liability company structure that contains separate “risk baskets,” each operating like a distinct entity in itself, to hold each of these assets.  Each of these cells or baskets is called a “series.”

Certainly, not all states are yet able to organize Series LLCs; however, of the nine states that currently permit the formation of some type of Series LLC (DE, IL, IO, NE, OK, TN, TX, UT, and WI), Delaware and Nevada are among the leaders in establishing the basis for stability and longevity that the form will require if it is to become as widespread in years to come as the plain vanilla LLC is today.  Of course, just because you are doing business in Georgia, for example, this does not mean that your LLC–or your Series LLC–cannot be organized in, say, Nevada or Delaware.

At its core, then, the Series LLC principle provides a mechanism for the creation of separate series within an LLC such that the debts and other liabilities with respect to each series are enforceable against that series alone.  While the articles of organization indicate that the LLC is a Series LLC, in Nevada and Delaware, only the LLC operating agreement is required to detail the actual number of series and the assets each owns.  The operating agreement, of course, is not a public document but is simply maintained with the corporate records.  The assets of each series are contained in a schedule, and the schedule is amended each time a property is bought, sold or transferred.

The Delaware and Nevada LLC Acts further allow the LLC operating agreement to provide different members and managers for each series (for example, Series A may be wholly owned by the principal member of the LLC, Series B may be a partnership with the LLC member and an equity investor, etc.).  If the various series within an LLC do have different members or different membership rights, each series may be treated as a separate LLC for tax purposes (maintaining flexibility, but perhaps eliminating some of the administrative advantage of the series LLC in terms of its pass-through taxation potential).

Though each series must have its own “business purpose,” it is enough for this that each series owns a separate property.  To maintain the separation of liability, however, it is vital that each series is treated for all intents and purposes almost as if it were a separate company.  Best practice suggests that this means keeping a unique set of books and records for each series, a separate bank account, and taking care to enter into contracts in the name of the series, not the LLC (even though the LLC holds title to the property).

As noted above, the series LLC is a relatively new concept, and there a number of risks associated with its use.  This is just one reason why this is an entity choice that should be made in consolation with a business attorney and not by clicking through a series of online forms at Legal Wizz, or the do-it-yourself, online, business incorporation company-of-the-month.  Nine states permit the formation of such an entity, and while many other states (including Georgia) may have discussed doing so, the law in those states which may be considering permitting organization of series LLCs is still in various stages of development.  A separate question is whether a state (like Georgia) that does not yet permit the organization of series LLCs will respect that structure when a series LLC organized properly in an other state does business in a state that has not yet come onboard with the concept, a thorny issue that brings the Full Faith and Credit Clause of the Constitution into dialogue with state law.   If a court were not to accept the validity of the structure, a judgment against one series might be applied across the various series, dissolving the barrier conceived to protect such assets in the first place.

Similarly, while the IRS stated in a private letter ruling as far back as 2008 that the Federal tax classification (i.e., disregarded entity or partnership or taxable association) is determined for each series independently, and proposed Treasury Regulations should soon make this absolutely clear, individual states may choose not to respect this classification for state tax purposes, which may lead to unforeseen difficulties if states attempt to tax all the income across a multi-state series instead of just the income attributable to the series operating in that state.

No company, and certainly not a series LLC, should be organized and maintained by someone without the training and knowledge to do so.  It may be true that sometimes with great risk comes great reward, but anyone contemplating a business venture of any sort should nonetheless talk it over with an attorney accustomed to corporate structures, both simple and complex.  Not to do so is to invite the likelihood that with a particular great risk comes… well, just great risk.  The business lawyers at Briskin, Cross & Sanford are always ready to help companies and entrepreneurs weigh their options as they form or grow their business.

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