by Steve LewickyGovernment Employees Receiving Notices of Termination: Now What?
Our firm has been contacted in recent days by many US Government employees that have received letters informing them that their employment will be terminated “for cause” in thirty days. Most of these have been accompanied by separate letters putting the employee on administrative leave for the intervening thirty days. Situations vary by agency, by status of the employee, and by other factors, but in all cases it’s important for these employees to understand their rights.
US Government employment is not “at will” – the type of employment relationship that is common in the private sector. Termination of government employment is subject to and controlled by federal statutes that establish Civil Service employment protections. If a federal employee is terminated or disciplined without cause or reason, those employment actions may be appealed to the Merit Systems Protection Board (MSPB), an independent agency of the government. The Merit Systems Protection Board hears appeals when the government takes adverse employment actions like removals and terminations, suspensions of more than 14 days in length, reductions in pay or grade, or performance-based employment actions. It can award remedies that include back pay accruing after the date of termination, reinstatement in the position, and sometimes reimbursement of attorneys’ fees.
An employee’s appeal rights are greatly affected by whether they are still in a probationary period. The government can remove a probationary employee subject only to limited rights of appeal. Outside of probationary periods, government employees have broad rights of appeal from a termination or removal decision.
While some agencies appear to be terminating large numbers of employees at the same time by alleging “cause” for removal, some agencies may also try to reduce head count using established workforce reduction programs, such as: (a) voluntary separation incentive payments (VSIPs), (b) voluntary early retirement authority (VERA), or involuntary separations by a reduction in force (RIF). Agencies also appear, in some cases, to be attempting to reduce their workforce by reassigning employees to a different office location, often at great distance, and then terminating employment if the employee refuses to relocate.
Federal employees receiving an offer of voluntary separation incentive payments (VSIPs) and/or an offer of voluntary early retirement (VERA) should closely examine the proposed terms of these offers, and will benefit from having legal counsel review any such proposals. Reductions in force (RIFs) can only be undertaken in conformance with government regulations on RIFs, and the government should be held to these requirements.
Lewicky, O’Connor, Hunt & Meiser helps current and former US Government employees navigate the current upheavals in federal employment. Every person’s situation is different, but in most cases it is very important for a government employee receiving notice of termination or of other adverse employment action to promptly provide a written objection response to the agency, and to file an appeal to the Merit Systems Protection Board within the fixed time period for doing so. We guide our clients in taking these steps. Equally important, recent government actions and pronouncements suggest that the government may be contemplating employment actions that are not in compliance with applicable laws. This makes it even more important to have legal counsel to analyze and explain new or unprecedented developments, as the occur.
by Steve LewickyYou received a stop-work order from the Government – What do you do next?
The Trump Administration, during its first weeks in office, has suspended or terminated a large number of federal contracts, and an even larger number of contracts may now be at risk of suspension or termination. The General Services Administration (GSA) also has been taking steps to terminate leases for government offices and facilities. Government contractors need to understand their rights in this challenging environment.
Procurement contracts are subject to the Federal Acquisition Regulations (the “FAR”), and almost always include standard FAR clauses that allow the Government to terminate or freeze the contract for the Government’s own convenience, without any default by the contractor.
A stop-work order is a written order from the contracting officer that requires a contractor to stop all or part of the work on a government contract for ninety days (or longer, if the parties agree to an extension). A contractor receiving a stop-work order has to immediately comply with the terms of the order, and take reasonable steps to mitigate costs related to the work covered by the order. If the stop-work order is not canceled within ninety days, the contracting officer will either cancel the stop work order or terminate the contract. After the stop-work order is cancelled or expires, the contractor then has thirty days to request an equitable adjustment or submit a claim for payment for costs incurred based on the stop-work order. If the contract is terminated, the contractor is entitled to reasonable costs in any termination settlement agreement.
A contracting officer also may suspend work and freeze a contractor’s performance on a procurement contract. Suspensions of work can suspend, delay, or interrupt all or part of the work for a period of time that is determined by the contracting officer. A suspension of work order may be in writing, but does not have to be. If a contracting officer constructively suspends work without a written suspension order, it is important for the contractor to memorialize the suspension in writing to the Government within a short period following the onset of the suspension.
When terminating a contract for its convenience, the Government has to provide written notice to the contractor that the termination is for convenience, and the notice must state the effective date of the termination. Although the Government cannot act in bad faith in making a decision to terminate a contract for convenience, it is a very high burden for the contractor to overcome a legal presumption that the Government took its action in good faith.
Even if the contractor does not allege bad faith by the Government in exercising its right to termination, the contractor still has a right to receive fair compensation for work performed and for preparations made for the terminated portions of the contract, including a reasonable allowance for profit. To pursue a remedy, the contractor must submit a “termination settlement proposal” within one year of the effective date of termination – unless an extension is granted by the contracting officer. The parties will then try to negotiate the terms of a termination settlement, which may include reasonable profit for work that has been completed. Contracting officers have discretion to take fairness considerations into account in settlement negotiations, but a termination settlement agreement must adhere to cost principles and procedures set forth in FAR Part 31. If the parties are unable to reach agreement, then the contracting officer will issue a final decision, which can be appealed to the agency’s contract review board or to the U.S. Court of Federal Claims.
The Contract Disputes Act establishes the process by which contract disputes are resolved with the Government. Under this law, a contractor must submit a claim, in writing, to the contracting officer within six (6) years after accrual of the claim. The written claim must demand payment of a sum certain – which in some circumstances is a surprisingly difficult exercise. Claims exceeding $100,000 must be certified by an individual authorized to bind the contractor. Under most circumstances, the contracting officer has sixty days to issue a final decision on a filed claim — unless the contracting officer notifies the contractor within those sixty days of a different time period for issuing the decision. The contracting officer’s decision can be appealed to the particular agency’s appeal board within ninety days, or to the U.S. Court of Federal Claims within twelve months. If the contracting officer fails to issue a final decision within sixty days (or within such other time period the contracting officer previously established), the claim is considered to be a “deemed denial,” allowing the contractor to appeal the denial.
Separate and distinct from procurement contracts are grants and cooperative agreements by which government agencies make awards to non-governmental entities. These grants and agreements are referred to collectively as “federal financial assistance,” and are governed by Subparts A through F of 2 C.F.R. § 200. “Grants’ do not anticipate substantial involvement of a Government agency to carry out the activity in the agreement, while “cooperative agreements” have agency involvement.
Government grant officers can only terminate a federal financial assistance award for convenience if the terms and conditions of the award permit termination for convenience, and if the “award no longer effectuates the program goals or agency priorities.” Costs associated with a termination or suspension are only allowable if the federal executive agency expressly authorizes them in the notice of termination or notice of suspension. However, suspension costs or post-termination costs are allowable if the arise from financial obligations which were properly incurred by the recipient or subrecipient before the effective date of suspension or termination, and not in anticipation of it; and if the costs would be allowable if the award was not suspended or expired normally at the end of the period of performance in which the termination takes effect. Recipients are typically entitled to termination settlement costs that the recipient is unable to discontinue after the termination date. Each agency has its own process for making objection to terminations of a financial assistance award, and for hearings and appeals
If faced with an actual or anticipated government contract termination, federal contractors need to take these steps:
• Fully understand the contract terms. It is important to understand the type of contract involved, and the contract’s exact terms. This provides the groundwork for how to dispute the Government’s action, or any delay in payment.
• Document termination costs. It’s also very important to obtain and maintain detailed documentation of all costs arising from a contract termination, suspension, or stop-work order – or from delays in payment. A government contractor is going to have to demonstrate to the contracting officer all costs arising from the Government’s action.
• Give clear written notice to the contracting officer. A contractor hit with an adverse action should immediately notify the contracting officer, in writing, that the government contractor believes a stop-work order or suspension of work has given rise to costs, and that the contractor intends to seek and award of those costs in the form of a contract claim, once the suspension ends, the stop-work order is lifted, or the Government formally terminates the contract.
• Follow all required procedures when filing a claim or appeal, and meet all deadlines. The relevant claim submission process and/or appeals process has to be complied with rigorously, including all filing deadlines. Typically, a claim for a stop-work order must be submitted within thirty days of cancelation or expiration of the order.
by Steve LewickyTax Considerations When Buying or Selling a Business in Maryland
When structuring the purchase or sale of a business in Maryland, one of the most important tax considerations is a choice between structuring the transaction as a stock sale or an asset sale. This decision has been covered at greater length in another article that I recently authored, but in very brief summary: A stock sale is typically the structure preferred by sellers, since a seller typically pays the capital gains tax rate on a stock sale, and the buyer retains the existing tax basis in assets. An asset sale is generally preferred by buyers, as asset sales provide a step-up in basis for depreciation purposes. This article will review other tax issues, beyond the “stock sale v. asset sale” question.
Bulk Sales Tax
Maryland applies a 6% tax to tangible personal property that is included in a business sale. The Bulk Sales Tax applies to furniture and fixtures, computer software, business records, customer lists, and non-capitalized goods and supplies. There are exemptions from application of the Maryland Bulk Sales Tax, including the following:
The “Resale Inventory Exemption” exempts from Bulk Sales tax tangible personal property that was purchased for purposes of resale. To benefit from this exemption, a seller must have maintained documentation demonstrating that the subject inventory was held exclusively for resale. The seller also must obtain a resale certificate from the purchaser.
The “Manufacturing Equipment Exemption” exempts from Bulk Sales tax manufacturing equipment and machinery that is used directly in the production process, and that passes a “used directly” test that is established under Maryland state tax regulations.
The “Motor Vehicle and Transportation Equipment Exemption” exempts sales of vehicles and transportation equipment that are required by the State of Maryland to be titled and registered. These are instead subject to excise taxation under the Maryland Transportation Code.
Some types of “Occasional Sales” also are exempt from Bulk Sales taxation, if they are casual and isolated sales that the company does not regularly engage in as part of the business. These must be one-time or isolated transactions that are undertaken no more than three times in any twelve-month period.
The “Affiliated Entity Transfer Exemption” may except from Bulk Sales taxation certain transfers that are between two entities that have common ownership at a level of 80% or greater, as long as the common ownership continues for at least two years after the transfer.
To support any or all of the above exemptions from Bulk Sales taxation, the company must maintain contemporaneous documentation supporting the exemption(s), such as copies of written agreements specifying the exempt assets, as well as resale or exemption certificates where applicable. Failure to properly document exemptions can result in assessment of the tax, with interest and penalties, along with personal liability for responsible parties.
Sales and Use Tax
Maryland has a Sales and Use Tax that may apply to transfers of tangible personal property in the sale of a business. Maryland law provides several potential exemptions from these taxes, which may apply when there is a sale of an entire business.
The sale of an entire business or of a complete business division may qualify for exemption if the sale encompass all or substantially all of the business assets, the assets are sold as a going concern, and the purchaser continues the same type of business operation following the transaction. The following asset classes remain subject to sales and use taxation, however, even if the transaction as a whole is exempt: (1) inventory not held for resale, (2) office equipment and supplies, (3) non-production equipment, and (4) consumable supplies.
The statute also provides an exemption for casual and isolated sales, which may apply to the sale of an entire business when the transaction is properly structured. To benefit from this exemption, the sale transaction may not be of a type that is regularly engaged in by the seller, and it must be infrequent and not part of a series of sales. The seller must not be regularly engaged in the business of selling similar items. No more than three sales may occur within a twelve-month period, and the exemption applies only to sellers not otherwise required to hold a Maryland sales tax license.
Maryland law also provides an exemption for some statutory mergers, consolidations, and other types of qualifying corporate reorganizations. To qualify under this exception, the transaction must qualify as a tax-free reorganization under IRC § 368, must be between qualifying business entities, and proper documentation of the reorganization must be maintained.
Real Property Transfer and Recordation Taxes
If the sale or purchase of a Maryland business includes the transfer of real property, then a county or local Transfer and Recordation Tax will apply, based on the amount of consideration paid for the real property in the transaction. Maryland appellate courts have recently made clear that Transfer and Recordation Taxes are not to be based upon the value of any intangible business assets transferred in the transaction, or on Goodwill, or on the value of transferred business licenses. This makes proper allocation of the purchase price between real and intangible property an important part of any purchase and sale agreement, where real property is a component of the transaction.
Summary
Careful tax planning in Maryland business sales transaction can yield significant savings for both parties. During the due diligence process prior to consummation of a business sale, it is important for the due diligence team to review past tax returns and filings, to ensure compliance with bulk sales requirements, and to assess any transfer tax obligations. It is good practice to model the tax impact of different deal structuring options, and to consider both parties’ tax objectives during negotiations. It’s also important to comply with bulk sales notice and payment requirements, where applicable to a particular transaction. The optimal structure and transaction terms depend on specific circumstances of a particular transaction, and may require balancing competing tax objectives.
None of the information provided in this article constitutes legal advice or tax advice. Every situation is different and should be thoroughly reviewed by and discussed with your legal and tax advisors. Please do not rely on the contents of this article as the basis for making decisions regarding your particular situation. If you are contemplating the purchase or sale of a business in the State of Maryland, Lewicky, O’Connor, Hunt & Meiser stands ready to provide legal support for your contemplated transaction.
by Steve LewickyStructuring the Purchase or Sale of a Business: Asset Sale vs. Stock Sale
There are three ways to structure the purchase or sale of a business: As a sale of a corporation’s stock or of a limited liability company’s member interests (generically referred to as a “stock sale”), as a sale of some or all of the company’s assets, or through a merger. Each of these approaches offer its own advantages and considerations for Buyers and Sellers, including tax implications, liability exposure, and the relative complexity of the transaction. Liability exposure can be a very important consideration, but in this article I will be discussing only the tax implications of selecting between an asset sale and a stock sale.
Tax Advantages to Buyers in an Asset Sale
Beyond gaining protection from assuming the liabilities of the acquired business, a significant benefit for the Buyer in an asset sale is the ability to step up the tax basis of acquired assets to their fair market value. This can yield substantial and ongoing financial benefit to the Buyer. The stepped-up basis mechanism allows Buyers to reset the tax basis of acquired assets to their purchase price, rather than inheriting the Seller’s existing tax basis. As an example, let’s consider a piece of manufacturing equipment:
In a stock purchase, if the original owner purchased the equipment for $200,000, claimed $150,000 in accumulated depreciation, and the equipment at the time of the acquisition has a fair market value of $120,000, the Buyer would inherit a tax basis of $50,000 ($200,000 – $150,000), would have limited future depreciation deductions, and would have a potential taxable gain of $70,000 if the asset is later sold at its $120,000 fair market value. In an asset purchase, however, the Buyer would receive a new tax basis of $120,000 (the current fair market value), would gain access to fresh depreciation deductions calculated from the stepped-up basis, would minimize or eliminate taxable gain on any future sale at fair market value, and would generate higher annual tax deductions, thereby improving cash flow. Stepped-up basis extends across various asset categories, including physical assets (buildings, equipment, and furnishings), intangible assets (patents, trademarks, and customer relationships), and goodwill.
For corporations in the 21% corporate tax bracket, the tax savings from stepped-up basis can be substantial. If a transaction includes $500,000 in stepped-up basis, the Buyer could realize tax savings of $105,000 over time, through increased depreciation deductions. These tax advantages often influence acquisition negotiations, since Buyers may be willing to pay a premium for assets due to the long-term tax benefits of stepped-up basis. This benefit has to be weighed against the Seller’s potential need for a higher purchase price to offset its increased tax burden in an asset sale.
Another benefit for the Buyer in an asset sale are opportunities for enhanced depreciation and amortization deductions, thanks to the step-up in basis. Depreciation applies to tangible assets such as buildings, equipment, and vehicles, while amortization applies to intangible assets (patents, customer relationships) and goodwill. Both mechanisms allow companies to deduct the cost of assets over their prescribed useful lives, reducing taxable income and generating tax savings. As an example, let’s consider a transaction involving manufacturing equipment valued at $500,000, customer relationships valued at $250,000, and a commercial building valued at $1,000,000. In a stock purchase, the Buyer will inherit the Seller’s existing tax basis. If the Seller has already claimed significant depreciation, the Buyer’s future deductions would then be limited. For instance, if the equipment has a depreciated basis of $100,000, the Buyer could only claim future depreciation on that amount, even though the Buyer presumably paid market value for the equipment in the acquisition transaction. In an asset purchase, however, the Buyer can claim depreciation and amortization based on the full fair market value of the assets. In the above example, the manufacturing equipment (valued at $500,000, with a 7-year depreciation schedule), would have annual depreciation of about $71,428, with an annual tax savings of about $15,000 at a 21% corporate tax rate. That would be a tax savings over the depreciation period of $105,000. The customer relationships (valued at $250,000 in this example, with a 15-year amortization schedule), would result in an annual amortization of $16,667, and annual tax savings (at a 21% corporate rate) of $3,500, for a total tax savings over the amortization period of $52,500. The commercial building (valued at $1,000,000 in this example, with a 39-year depreciation schedule), would have annual depreciation of about $25,641, yielding annual tax savings of $5,285 at a 21% corporate rate, resulting in aggregate tax savings over the depreciation period of $210,000.
The tax code may provide further opportunities to accelerate these benefits through its bonus depreciation provisions. Current tax law allows for 100% first-year bonus depreciation on many qualifying assets, enabling immediate write-off of their entire cost. While this provision doesn’t apply to buildings or to most intangibles, it can significantly accelerate tax benefits for eligible assets.
The parties may state, in their purchase-sale agreement, an agreed upon allocation of the purchase price, which can affect the timing of tax benefits. Buyers often benefit from allocating more of the purchase price to assets with shorter recovery periods. Any agreed-to allocation must be reasonable and supportable, however, in order to pass muster with the IRS.
Enhanced depreciation and amortization can create temporary differences between book and tax income, resulting in deferred tax liabilities. These enhanced deductions represent a significant financial advantage of asset purchases, often justifying higher purchase prices or providing additional negotiating leverage. The present value of accelerated tax savings can materially improve the Buyer’s return on investment and provide additional cash flow for debt service or business reinvestment.
Another significant financial advantage to an asset purchase is the ability to amortize goodwill for tax purposes. This is not available in a stock purchase. Goodwill emerges when a Buyer pays more than the fair market value of identifiable assets, reflecting the additional value attributed to intangible factors such as brand reputation, customer relationships, employee expertise, market position, and potential synergies. This premium often represents a significant portion of the purchase price in business acquisitions. Goodwill can be amortized over a 15-year period, generating substantial tax savings for the acquiring company.
If a Buyer acquires a business for $5 million, but the identifiable assets have a fair market value of $3.5 million. The $1.5 million difference represents goodwill. The tax treatment of this goodwill varies dramatically between asset and stock purchases. In a stock purchase transaction, the Buyer receives no tax benefit from the goodwill premium. While the goodwill is recognized for accounting purposes, it cannot be amortized for tax purposes, resulting in no tax deductions over the life of the asset. In an asset purchase transaction, however, the tax treatment can be far more advantageous. In the above example where there is $1.5 million in goodwill, there would be an annual amortization deduction of $100,000 ($1.5 million over 15 years), which would yield annual tax savings of $21,000 at a 21% corporate tax rate, and total tax savings over 15-year period of $315,000. This tax treatment not only converts what otherwise would be a non-deductible purchase premium into tax-deductible amortization over the amortization period, but also allows companies to forecast tax benefits with certainty. The present value of goodwill amortization tax savings often justifies paying a higher purchase price.
To secure these tax benefits, Buyers must ensure that the allocation to goodwill stated in the purchase-sale agreement is reasonable and supportable, is based on proper valuations, documented in the purchase agreement, and is reported consistently on tax returns. While tax treatment allows for straight-line amortization, accounting rules require periodic impairment testing, which requires separate tracking systems, deferred tax accounting, regular monitoring and reporting, and compliance with tax and accounting requirements.
The goodwill amortization benefit represents one of the most compelling reasons Buyers generally prefer asset purchase structures. The ability to generate substantial tax savings over a 15-year period often influences both deal structure and purchase price negotiations.
Advantages to Sellers in an Asset Sale
Although the asset sale structure generally favors Buyers, Sellers potentially can receive a higher purchase price in an asset sale, to offset tax implications, and an asset sale gives a Seller the ability to retain particular assets or intellectual property. If some but not all of the business assets are sold, then the Seller has the option of continuing to operate with its retained assets (if not prohibited from doing so in the purchase-sale agreement), and the Seller may have some flexibility in handling remaining liabilities of the business.
Tax Advantages to Sellers in a Stock Sale
Stock sales typically provide Sellers in corporate acquisitions with more favorable tax treatment than do asset sales, and Sellers therefore often prefer this transaction structure. Tax advantages come in the form of lower effective tax rates and simplified tax treatment. The fundamental tax benefit of a stock sale lies in its single-level taxation at preferential capital gains rates. When corporate shareholders sell their stock, they pay tax only once, on the difference between the sale price and their basis in the stock. Current federal long-term capital gains rates max out at 20%, but with additional state taxes that vary by state. Let’s take the example of a C-Corporation sale with a sale price of $5 million, and a tax basis of $3 million, resulting in a capital gain of $2 million. With an asset sale, this transaction would result in double taxation. First, the C-Corporation would recognize the $2 million gain that would be taxed at the federal corporate tax rate of 21%, resulting in a corporate tax liability of $420,000, and net proceeds to the corporation after this tax of $4.58 million. Thereafter, if or when the proceeds are distributed to shareholders, the federal capital gains rate of 20% will be applied to this $4.58 million, resulting in shareholder tax liability of $916,000. The combined tax burden at both levels of taxation in this example would be $1.08 million, resulting in an effective tax rate on the gain of about 67%.
The same transaction structured as a stock sale would result in a single level of taxation at the shareholder level. In the above example, the $2 million gain would be taxed at the 20% federal capital gains rate for a total tax liability of $400,000, for an effective tax rate on the gain of 20%. In this example, there would be a tax savings for the Seller of $935,000, comparing the tax sale scenario to the asset sale scenario.
Capital gains rates present a substantial advantage over ordinary income tax rates, of course. While ordinary income tax rates can reach 37% at the federal level, long-term federal capital gains rates are typically 20% for high-income Sellers, with additional state tax rates varying by jurisdiction. To secure capital gains treatment, stock must be held for more than one year to qualify for long-term capital gains rates, the transaction must represent a genuine sale or exchange of a capital asset, the Seller must maintain proper documentation of their basis in the stock, and the sale must be properly structured and executed.
C-Corporations benefit most dramatically from stock sale treatment, as a stock sale eliminates the double taxation inherent in the C-Corporation structure. The avoidance of corporate-level taxation represents a pure tax savings that flows directly to shareholders’ bottom line. The above example considered a C-Corporation, but tax treatment depends on entity type.
S-Corporations also benefit from stock sale treatment, though the advantage is more nuanced. While S-Corporations generally avoid double taxation even in asset sales, stock sale treatment ensures the entire gain receives capital gains treatment, rather than having portions potentially taxed as ordinary income depending on the character of underlying assets.
Limited Liability Companies and partnerships, when selling membership interests or partnership interests, typically receive treatment similar to stock sales, providing comparable tax benefits to their owners — but asset sales for partnerships may result in ordinary income treatment for certain assets, and there may be complexity in allocating gain among partners.
In addition to having advantage in applicable rates of taxation, stock sales also eliminate concerns about depreciation recapture that may occur in asset sales, where equipment and machinery gains may be taxed as ordinary income, real estate depreciation may be recaptured at 25% rates, and other asset classes may trigger different tax rates. Stock sales also eliminate the need to characterize gain on an asset-by-asset basis, thereby reducing complexity in state tax compliance, simplifying tax reporting and compliance, and providing greater certainty in tax outcome. Stock sales also can avoid multiple state tax filing requirements, reduce exposure to state transfer taxes, and simplify compliance across jurisdictions.
Advantages to Buyers in a Stock Sale
While the stock sale structure typically favors Sellers, a stock sale gives the Buyer a simpler transaction structure, with fewer formal requirements, along with automatic transfer of contracts, licenses, and permits. There is no need to retitle individual assets, as there would be in an asset sale. A simpler transaction structure results in reduced transaction costs and complexity. A stock sale also allows seamless continuation of business operations, preserves existing contracts and relationships of the business, maintains existing permits and licenses, and retains the corporate entity and tax attributes.
Section 338(h)(10) Election
In some circumstances, Section 338(h)(10) of the Internal Revenue Code provides a sophisticated mechanism that allows C-Corporations to combine the legal benefits of a stock sale with the tax advantages of an asset sale. This election represents a hybrid approach, where the transaction is legally executed as a stock purchase while being treated as an asset purchase for federal tax purposes. To qualify for this election, the purchasing entity must be a corporation (not an individual or partnership), the Buyer must acquire at least 80% of the target company’s stock in a taxable purchase, the target must be either an S corporation or a subsidiary member of a consolidated group, and both Buyer and Seller must formally agree to make the election.
When a Section 338(h)(10) election is made, the transaction is treated as a hypothetical asset sale followed by a liquidation of the target company. The target company is deemed to have sold all its assets to a new corporation at fair market value, and the Buyer receives a stepped-up tax basis in the acquired assets. For S corporations, shareholders experience a single level of taxation. The transaction avoids double taxation typically associated with C corporation asset sales.
The Buyer obtains stepped-up basis in assets for enhanced depreciation and amortization, benefits from the legal simplicity of a stock acquisition, avoids need to transfer individual assets or obtain third-party consents, and preserves valuable contracts and permits that might be non-transferable. The Seller achieves potentially higher purchase price due to the Buyer’s tax benefits, maintains transaction efficiency of stock sale, avoids the complications of an asset-by-asset transfer, and might receive more favorable overall tax treatment compared to straight asset sale. The election process involves specific timing and procedural requirements, however. The election must be filed by the 15th day of the 9th month following the acquisition month, requires formal agreement between Buyer and Seller, and is irrevocable once made. In addition, the purchase price must be allocated among assets according to IRS rules.
While potentially advantageous, a Section 338(h)(10) election may result in state tax treatment that differs from federal treatment, and there are complex valuation and allocation requirements. The election may result in higher taxes for the Seller when compared to a straight stock sale.
Summary
The choice between an asset sale and a stock sale requires careful consideration of a number of factors, including the tax implications discussed above, as well as liability exposure, transaction complexity, and circumstances that may be applicable to the particular business involved. Asset sales generally favor Buyers due to tax benefits and for reasons of risk management, and stock sales often appeal to Sellers due to tax efficiency and transaction simplicity. The optimal structure depends on the specific circumstances of the transaction and the priorities of the parties.
The availability of Section 338(h)(10) elections adds another layer of sophistication to the structure decision, potentially offering a beneficial hybrid approach that combines the advantages of both asset and stock sales. However, this option requires careful analysis and consideration of all parties’ circumstances and objectives.
None of the information provided in this article constitutes legal advice or tax advice. Every situation is different and should be thoroughly reviewed by and discussed with your legal and tax advisors. Please do not rely on the contents of this article as the basis for making decisions regarding your particular situation. If you are contemplating the purchase or sale of a business in the State of Maryland, Lewicky, O’Connor, Hunt & Meiser stands ready to provide legal support for your contemplated transaction.
by Steve LewickySubcontractors Can Make a Project Owner Pay for Services and Materials Provided by the Subcontractor on a Construction Project, When Payment is not Received from the General Contractor
Construction projects almost always involve framers, carpenters, plumbers, electricians, drywall installers, and other subcontractors contracting with a general contractor to supply services and materials to the building project (unless the property owner directly contracts with tradesmen). If the framers, carpenters, plumbers, electricians, drywall installers, or other subcontractors are not paid for their work in a timely manner, they can sue the general contractor for breach of contract. Separate and in addition to bringing a lawsuit for breach of contract against the general contractor, subcontractors also can seek to establish a mechanic’s lien — to make the owner of the property pay for the provided services or supplies if the general contractor refuses to pay, or is no longer able to pay. This gives contractors and subcontractors on construction projects a powerful tool to obtain payment for materials and services – and it is something that property owners need to aware of.
Through a mechanic’s lien, a person or company that provides labor or materials on a construction project can place a lien against improved real property for the value of unpaid labor or materials – but only if the requirements of the mechanic’s lien statute are strictly adhered to.
Maryland’s mechanic’s lien statute is complicated, and this article provides only a general summary, without addressing all of the requirements and nuances. Generally speaking, any person or company that furnishes work or materials to a construction project in Maryland pursuant to a contract may establish a mechanic’s lien if they are owed money on a project. Contractors, subcontractors and suppliers can all claim such a lien, regardless of whether they have a contract directly with the owner of the property, as long as the labor was performed for or about the subject building, and as long as the materials were for the building project.
A mechanic’s lien is only available for certain types of construction projects in Maryland. Newly constructed buildings are subject to mechanic’s liens, though what exactly constitutes a “building” is sometimes a contested issue, because not every type of structure on land constitutes a building for these purposes. For construction projects that involve repair or renovation of existing buildings, a mechanic’s lien is only available in Maryland if the project involves the repair, re-building or improvement of the building to the extent of 15% of its value. Condominium units and the common elements of condominiums are also subject to mechanic’s liens, but there are special notice requirements apply to condominiums.
An important aspect of Maryland mechanic’s liens is a requirement to give written notice of an intention to seek a lien in some circumstances, and strict time limitations for giving notice and bringing suit.
Anyone seeking a mechanic’s lien who does not have a direct contractual relationship with the property owner – for example, subcontractors, and in many cases material suppliers – must comply with notice provisions set forth in the mechanic’s lien statute. When this type of notice is required, it must be mailed by the lien claimant to the property owner within 120 days after the claimant performed the work or furnished the materials. There are nuances regarding when this 120-day period begins to run, and numerous court cases address this issue.
Separate and apart from giving any required notice of an intention to claim a mechanic’s lien, a petition seeking to establish the mechanic’s lien must be filed in the appropriate Circuit Court no later than 180 days after the work has been finished or the materials furnished. The correct parties must be named as defendants in the suit, and there are detailed requirements for what must be included in the petition that is filed with the court.
After a petition is filed with the court, there is a two-step process whereby the court first reviews the papers that have been filed, and holds an initial show-cause process and proceeding to determine if there is sufficient cause to establish an interim mechanic’s lien. The court typically will set a bond for entry of an interim lien. If an interim lien is established, then in a second stage the court will later hold a trial on the merits of whether the mechanic’s lien should continue thereafter until satisfied. At any time after a petition to establish a mechanics lien is filed, the property owner can file a petition to have the property released from the lien upon the filing of a bond sufficient to protect the lien claimant. Once a lien is established, the lien claimant then has one year to file a petition to enforce the lien.
Mechanic’s liens can be an important method for contractors, subcontractors and suppliers to ensure payment, but they are complicated and are subject to strict time constraints. The Maryland mechanic’s lien statute differs from those of other states in many ways. If you are a contractor, subcontractor or supplier seeking payment for labor or materials provided in Maryland, or if you are a Maryland property owner that has received notice that someone intends to assert a mechanic’s lien, or has already petitioned the court for a mechanic’s lien, I encourage you to promptly consult with an attorney who is knowledgeable about this area of law. Very strict limitations apply to these claims.
Mechanic’s liens are not available for government construction projects, but somewhat similar protections are provided to subcontractors on government construction projects through the bonding requirements in the Miller Act (for federal government construction projects) and the Maryland Little Miller Act (for state government construction projects). Other laws also protect subcontractors, such as the Maryland trust fund statute and the Maryland Prompt Payment Act.
Steve Lewicky
(410) 489-1996
by Steve LewickyProtection of Shareholders in Family Businesses and Close Corporations
Family businesses often organize themselves as “close” corporations. The benefits of doing so include: (1) a Maryland close corporation cannot issue or sell stock without the affirmative approval of all of its shareholders (who typically are members of the same family); (2) shareholders cannot transfer their stock unless all shareholders give prior approval; and (3) any merger or transfer of assets also requires unanimous shareholder approval. A Maryland corporation may elect to be a “close corporation” by including a statement of this election in its corporate charter, or by amending its corporate charter through a unanimous vote of all shareholders.
Close corporations typically do not have boards of directors, and instead are managed directly by the family members/shareholders themselves. When there is no board of directors, the shareholders are responsible for taking actions (by shareholder vote or resolution) that more typically would be handled by directors, in non-close corporations. Shareholders in a close corporation may (and often do) enter into written shareholder agreements to regulate the affairs of the corporation, which may place restrictions on the transfer of stock, the payment of dividends, the division of profits, or the allocation of shareholder voting power. Courts enforce these unanimous shareholders agreement by injunctive relief, or in some circumstances by ordering dissolution of the corporation.
Each shareholder in a Maryland close corporation has a statutory right to receive an annual statement of corporate affairs, and a right to inspect key corporate documents such as bylaws, meeting minutes, the stock ledger, and books of account. Once a year, every shareholder in a Maryland close corporation has a right to receive, within twenty days of request, a statement of corporate affairs that sets forth the corporation’s assets and liabilities in reasonable detail, verified under oath by a company officer.
By their very nature, if majority interest holders are willing to use oppressive tactics, a minority shareholder can effectively be frozen out of decision making, or even from the economic benefits of ownership. Since there is a limited market for shares in closely held corporations, especially for the purchase of a non-controlling interest in a closely held corporation that is experiencing dissention among the shareholders, a minority shareholder’s interest can effectively be held hostage by the controlling shareholder(s).
The only remedy for oppressive shareholder conduct expressly stated in Maryland statutory law is involuntary dissolution by judicial action, but the Maryland appellate courts in recent years have held that, before ordering dissolution of a corporation, trial courts should first consider whether equitable remedies are available to rectify the oppressive conduct. The appellate courts have suggested equitable remedies such as ordering corporate dissolution at a specified future date, to become effective only if the shareholders fail to resolve their differences by that date. They also have suggested appointment of a receiver to operate the corporation for the benefit of the shareholders until differences are resolved, or retention by the court of jurisdiction over the case for the protection of minority shareholders. Other judicial options include injunctive relief to prohibit oppressive conduct or to require the declaration of dividends; or ordering the corporation or the majority shareholders to purchase the stock of minority shareholders at a fair and reasonable price; or an award of damages to minority shareholders as compensation for injuries suffered as a result of oppressive conduct by the majority shareholders. These court decisions have expanded the “toolbox” of remedies available to Maryland trial courts when confronted with majority interest holders in close corporations oppressing their fellow shareholders.
Under Maryland law, conduct is considered oppressive if it defeats objectively reasonable expectations that were central to the minority shareholder’s decision to join the corporation. Courts are not required to match a remedy to the subjective expectations of a particular minority shareholder, however. For example, a minority shareholder that is also an an-will employee of a closely held corporation typically will not be successful in asking a court to order the company to reinstate terminated employment, even if the shareholder/employee had a subjective expectation that the company would continue to employ him indefinitely into the future.
Although a minority shareholder’s at-will employment status does not create a legal right to ongoing employment, he or she can still ask the court to craft appropriate equitable relief to overcome oppressive conduct by the majority, and the court must consider not only the defeated expectations of the terminated shareholder/employee, but also the interests of other shareholders, company management, employees and customers. For example, if a closely held corporation terminates a minority shareholder’s employment, and stops distributing profits to the minority shareholder through dividends at the same time that majority shareholders receive high salaries and/or valuable personal use of company assets, the minority shareholder can seek equitable relief from the court.
The same situation may also give rise to a cause of action under Maryland law for breach of fiduciary duty by the majority shareholders. Although there is a statutory presumption that a majority shareholder acts in good faith, in a manner that the director reasonably believes to be in the best interests of the corporation, and with the level of care that an ordinarily prudent person would exercise in the position of a corporate director would use under similar circumstances – this presumption may be overcome by contrary evidence. Overcoming the presumption requires more than simply showing that the company refused to authorize a dividend to shareholders during periods when the company was profitable. It requires circumstances more akin to a majority shareholders looting the company, either by directly taking corporate funds for personal use or by paying themselves excessive compensation. Typically, an action for breach of fiduciary duty must be brought on behalf of the corporation in a corporate derivative action, and not directly by one shareholder against another – though there are circumstances where a direct action will be permitted if majority shareholders or directors have breached a duty owed directly to the minority shareholder, causing the minority shareholder to suffer an injury that is separate and distinct from any injury suffered by the corporation. Claims of excessive compensation to majority shareholder/employees or other misuses of corporate funds belong to the corporation, and not to individual shareholders, and must be brought through a derivative action.
Maryland’s “close” corporation structure can have real benefits for family businesses, and may be the best way to structure this type of company. While the inherent risks of this structure must always be considered, the Maryland appellate courts in recent years provide a means to protect minority shareholders’ rights and expectations when majority owners try to oppress minority shareholders.
by Steve LewickyMaryland Law Requires Compensation Transparency In Job Postings & Allows Employees To Discuss Their Compensation With Fellow Employees
Effective on and after October 1, 2024, Maryland has updated its Equal Pay for Equal Work Law. The revised statute contains important requirements for companies that employ people in the State of Maryland.
Disclosure of Compensation
Employers may not prohibit their employees in Maryland from inquiring about, discussing, or disclosing their compensation, or the compensation of another employee. Employers cannot take adverse employment action against an employee for asking a fellow employee about compensation, or for disclosing his or her own compensation to others. The law does not require an employee to disclose his or her compensation to anyone, nor does it permit an employee to disclose compensation information to a competitor of the employer.
If an employer knew or reasonably should have known that its actions violate the above requirements, an affected employee can sue the employer for injunctive relief and to recover up to two times the amount of actual damages suffered as a result of the violation. If the employee prevails in the suit, the court is required to also award to the employee a reasonable amount of attorneys’ fees incurred by the employee in bringing the successful legal action. An employee may bring a lawsuit on behalf of the employee and other employees similarly situated. Lawsuits to enforce these provisions may be brought up to three years after the end of an employee’s employment by the company.
Publication of Rates of Compensation in Job Postings; Prohibition Against Requiring Job Applicants to Reveal Past Compensation History
Employers are required to include in all job postings (internal or public), for positions that will physically perform work within the State of Maryland, the compensation range for the position and a general description of benefits or any other compensation offered for the position. An employer may not retaliate against (or refuse to interview or hire) an applicant because the applicant declines to provide his or her compensation history, or asks for the compensation rangeinformation that the employer is required to publish. Only after the employer has made an initial offer of employment (including an offer of compensation) may the employer then seek information about an applicant’s compensation history in order to evaluate whether to negotiate a higher compensation offer based on that history.
Violations of this part of the law may be enforced by the Maryland Commissioner of Labor through the issuance of orders compelling compliance, and at the discretion of the Commissioner also by imposing monetary fines for violations occurring after a first violation.
Equal Pay
Maryland employers are prohibited from paying compensation to employees of one gender at a lower rate than paid to other employees, if they work in the same Maryland county and if they perform work of comparable character. This does not necessarily mean that employees of different genders with similar jobs cannot be paid different rates of compensation in all circumstances. Differences in compensation rates may be permissible if based on a non-discriminatory seniority or merit system, or if the jobs require different abilities or skill sets, or have different duties. Differences in rates of compensation also may be allowed if there are non-discriminatory distinctions between the employees, such as in levels of education, training or experience. An employer that is paying a wage in violation of these provisions is not permitted to reduce another employee’s compensation to comply with these requirements.
If an employer knew or reasonably should have known that its actions violate the above requirements, an affected employee can sue the employer for injunctive relief and to recover the difference between the compensation paid to employees of one gender and the compensation paid to employees of another gender. Here, again, if the employee prevails in the suit, the court is required to award a reasonable amount of attorneys’ fees to the employee.
by Steve LewickyIf You Have An Ownership Interest In A Business, You May Be Required To Register Your Ownership With The Federal Government
Congress passed the Corporate Transparency Act in 2021, establishing an affirmative reporting requirement if you hold a “beneficial ownership interest” (“BOI”) in many types of companies. Exempt from this reporting requirement are ownership interests held in publicly traded companies, nonprofit organizations, and certain large operating companies. This new federal government reporting requirement is often referred to by the acronym “FinCEN.” The government has created a BOI e–filing website where owners of companies can satisfy the reporting requirement by uploading their ownership information: https://boiefiling.fincen.gov.This federal government reporting requirement is separate and distinct from any filing requirements your company may have with state governments or tax authorities.
Companies established before 2024 have until the end of 2024 to file their BOI report. Acompany established during 2024 must file its BOI report within 90 calendar days after receiving (from the state of its incorporation or organization) actual or public notice that the company’s creation or registration is effective. After 2024, the registration period will shrink to 30 days aftera new entity’s creation.
More information about the reporting requirements under FinCEN can be found athttps://www.fincen.gov/boi, with an FAQ page at https://www.fincen.gov/boi-faqs#B_1
Also, be aware that scammers sometimes send out letters or emails that purport to be from the “United States Business Regulation Department,” or something similar, asking the recipient to pay them a filing fee under the Corporate Transparency Act, or be subject to severe penalties or imprisonment for noncompliance. These letters and emails are a scam. Actual reporting under FinCEN is free and is done through the https://boiefiling.fincen.gov website.
by Steve LewickyOperating a Church or Religious Organization in Maryland and Handling Disputes
Religious organizations in Maryland, including churches, synagogues, and mosques, are typically structured as “religious corporations,” which is a special category of corporation that has been authorized by the State of Maryland. Certain hierarchical religious denominations, such as the Roman Catholic Church, the United Methodist Church, the United Presbyterian Church, and the Episcopal Church, have their own unique treatment under the Maryland Corporations Code. All other churches, religious societies, or congregations – regardless of sect, order or denomination — are subject to the provisions that I will summarize below.
To form a religious corporation, the adult members of the organization must elect at least four trustees to manage the affairs of the religious organization and prepare a written plan for the governance of the organization. Among other things, this plan document has to set forth the time and manner for the election and succession of trustees, and the qualifications for individuals to be eligible to vote in elections, and to be elected to office in the organization. It must then be acknowledged by a majority of the trustees. Once the written plan is in place, the trustees have to file articles of incorporation with the State of Maryland in order to establish the religious corporation, and the articles of incorporation must contain the written plan of the organization, in addition to other required information.
Once the religious corporation is established with the State of Maryland, the board of trustees manages the worldly functions of the organization, leaving theological matters and pastoral duties to the clergy or to the members themselves. The trustees manage the financial activities and assets of the organization in a similar manner as a for-profit corporation’s board of directors manages a business corporation. It is important to understand that it is the trustees (acting as a board) that own and manage all of the organization’s property and assets – not the clergy. However, unless the written plan provides otherwise, the senior minister of the church also serves as one of the trustees of the religious corporation, in addition to those trustees that were elected by the congregation.
Many of the same types of issues and disputes that confront for-profit corporations can also arise in a religious corporation, but in addition, religious corporations often seek advice in three areas that are somewhat unique to this sphere: (1) disputes over how elections are organized or held within the religious organization, (2) controversies over hiring or dismissing clergy, and (3) members of the congregation wishing to leave and form another church, synagogue, or mosque.
Disputes over congregation elections always have unique facts, but a central issue in such a dispute often is determination of who the members of the organization are that are permitted to cast ballots in an election. Although the statute mandates that the written plan set forth the qualifications for individuals to be eligible to vote in elections and to be elected to office in the organization, many plans are vague on this point. That can lead to uncertainty as to which of two or more rival church membership rosters of eligible voters is correct. The statute requires that, if a contest arises over the voting rights or the fair conduct of an election, those questions must be submitted to arbitration by a panel of three arbitrators, to be selected in accordance with the statute, who are members of neighboring churches of the same religious persuasion. There is no appeal from the decision of this three-arbitrator panel.
Controversies over hiring or dismissing members of the clergy are governed by the written plan of the organization, but as in the case of elections, some written plans lack precision on how this is to be done. Sometimes factions in the congregation are pitted against each other for or against the retention of a particular member of the clergy, and depending on the terms of the plan, this can lead to a decision by the board of trustees, or in some cases to a contested election of the congregation.
When members of a congregation decide to break off and form a new congregation, the act of leaving one congregation is relatively straightforward, but disputes can arise over ownership of real property or financial resources. Although the statute specifically allows members of a congregation to separate and form a new congregation, that does not mean that the splinter group will have any right to take real property or financial resources of the original organization with them.
Our firm can answer questions and provide legal guidance to churches, synagogues, mosques and other religious organizations related to their governance, legal rights and obligations. We also can assist those who wish to form a new religious organization, whether resulting from a division of an existing congregation or as a completely new organization. Please contact us at [email protected] or (410) 489-1996.
by Steve LewickyDue Diligence in the Purchase or Sale of a Maryland Business
The term “Due Diligence” refers to a process by which someone contemplating the purchase of a business investigates that business in connection with the anticipated transaction. The seller in the transaction also may engage in some amount of seller-side due diligence when a sale is contemplated, though the seller’s efforts are typically far more limited than the buyer’s efforts, since the seller already has detailed knowledge about the finances and operations of its own company. The potential buyer’s due diligence efforts often are coordinated by an attorney representing the buyer, but it is common and advisable for the buyer to form a team of accountants, managers, consultants and sometimes outside experts, to participate with the attorney in the due diligence process. The scope of due diligence is dependent on the particular company and situation, but the goal must be to gather enough information about the acquisition target to make informed decisions about the contemplated transaction.
Due diligence is intended to identify problems with an acquisition target and the risks associated with going through with a transaction, but should also involve evaluation of the positive attributes of a contemplated transaction. If the acquiring company is interested in purchasing another company in order to fit a particular need or enter a new business area, then one area of due diligence should be to focus on whether the contemplated addition meets this need, and to what degree the desired outcome will be achieved by the transaction.
Comprehensively discussing all aspects of due diligence would fill an entire book, and this article is not intended to cover all aspects of an adequate due diligence process. Questions of scope and depth of due diligence depend on the particular transaction, on the nature of the seller’s operations and financial condition, and on the contemplated transaction terms. A central consideration in determining the extent of due diligence is thinking through the allocation of risk between buyer and seller. Both sides of a transaction will weigh the amount of risk each is willing to take, and a number of things will go into that assessment, including the sale price and the nature and strength of representations and warranties that will be included in the transaction documents. For example, a buyer might insist on a lower purchase price – all things considered – if its opportunity to conduct thorough due diligence is limited, and may be willing to pay more for a company if it is able to thoroughly conduct extensive due diligence. Likewise, the negotiated sale price may depend, in part, on whether the buyer receives strong and extensive contractual representations and warranties in the purchase contract. The converse also is true, from the seller’s perspective.
The nature of due diligence in a particular transaction is also strongly influenced by whether the deal is structured to be an asset sale, stock sale, merger, or sale of LLC member interests. The scope also depends upon whether the transaction is structured to have all due diligence completed prior to the parties signing the transaction documents with a simultaneous closing of the transaction, or to have the transaction documents signed first, followed by continued due diligence prior to closing to verify the accuracy of representations and the satisfaction of conditions for closing.
In the course of conducting due diligence, the buyer side of the transaction typically will issue an often-lengthy list of documents and data that it wishes to review, and also will seek access to the seller’s management, accountants, and perhaps key third parties. The produced documents and data are reviewed by the buyer’s due diligence team, which under almost all circumstance should contain buyer representatives in the areas of legal, accounting, and business operations. Within the legal area, often a senior attorney in a law firm representing the buyer will organize and coordinate the due diligence efforts, with less-senior attorneys and/or paralegals in the law firm doing much of the legal work. A similar allocation of workload also is often used with outside accounting firms representing the buyer for the accounting aspects of the due diligence review.
Purchasing or selling a business is not a simple process, even when the buyer and seller are relatively small companies. Acquiring a $1 million company is far less complicated than acquiring a $100 million company, of course, but I am sometimes surprised when the contemplated buyer or seller of a small- or mid-size company discusses a potential acquisition with me and has an expectation that its attorney can quickly read through a few documents and thereby adequately cover all the bases. In fact, even the simplest acquisitions of small companies require a significant amount of legal and accounting work. Having said this, there can be wide variations in cost depending on many factors, including the size and complexity of the acquisition target, the transaction terms, and selection of the right law firm to thoroughly perform all legal work necessary in an acquisition while still keeping costs manageable.
If you are contemplating the purchase or sale of a Maryland business, whether through asset sale, stock sale, or transfer of limited liability company member interests, our firm has the background and skills necessary to guide you through this process. Please contact Lewicky, O’Connor, Hunt & Meiser at (410) 489-1996 or [email protected].
