February 2018 Update
The California Capital Access Program (CalCAP) (see Health & S C §§44559–44559.12; 4 Cal Code Regs §§8070–8078.21), which is run by the California Pollution Control Financing Authority, is a form of loan portfolio insurance that covers up to 100 percent of the risk of banks and other financial institutions that make loans to California’s small businesses. See generally http://www.treasurer.ca.gov/cpcfa/calcap/. Special parts of the CalCAP program are intended to assist small businesses with financing the costs to alter or retrofit existing facilities to comply with the requirements of the federal Americans with Disabilities Act of 1990 (ADA) (42 USC §§12101–12213) (see 4 Cal Code Regs §§8070.8–8070.14) and to assist California small businesses and residential property owners with financing the costs for seismic retrofits (see 4 Cal Code Regs §§8078.15–8078.21). See §1.18.
Written business plans are developed and prepared by both startup and existing businesses for various purposes. See §§2.2–2.4. Chapter 2 details the recommended contents of business plans. In view of the urgent need for businesses of today to maintain active cybersecurity programs, business plans should address cybersecurity (the technological measures that the company has in place to protect sensitive customer information as well as the company’s own trade secrets) and disclose whether the company has cyber-risk insurance coverage. See §2.15.
In McGill v Citibank, N.A. (2017) 2 C5th 945, the California Supreme Court held that a provision in a predispute arbitration agreement that waived the right to seek public injunctive relief (i.e., injunctive relief that has the primary purpose and effect of prohibiting unlawful acts that threaten future injury to the general public) in any forum is contrary to California public policy and therefore unenforceable. Citing 9 USC §2, the court also held that the Federal Arbitration Act does not preempt this rule of California law or require enforcement of the waiver provision. The public injunctive remedies sought to be waived in McGill were those available to private plaintiffs under California’s unfair competition and false advertising laws, as well as the Consumers Legal Remedies Act (CC §§1750–1784). See §3.10A.
In People v Black (2017) 8 CA5th 889, the court held that promissory notes that the defendant offered for investment in a real estate development were not securities within the meaning of the Corporate Securities Law of 1968 because the investment was a one-to-one transaction, there was no indication that the notes could have been traded publicly, the agreement bound the defendant’s separate property for purposes of enforcing payment, and the terms of the agreement provided for repayment regardless of whether the deal succeeded. See §5.20.
The board of directors should consider whether the founders or certain key management personnel should sign a restricted stock purchase agreement providing for certain restrictions on transfer, ownership vesting of the shares held by such persons, and the corporation’s (or it designee’s) right to purchase such founder’s or person’s shares on cessation of employment by the corporation. See Business Buy-Sell Agreements §§3.48–3.73 (Cal CEB) for an example of such an agreement, which includes a provision for optional purchase on termination of employment. See §5A.13.
A sample form of Board Resolutions Approving Private Placement Memorandum and Employment of Brokers has been added to Chapter 5A. See §5A.17A.
Chapter 5A includes forms of “bad actor” questionnaires. See §§5A.42–5A.43. Shareholders that will own 20 percent or more of a corporation’s shares should complete one of the two forms of “bad actor” questionnaire, as applicable, to ensure the corporation’s present and future ability to rely on Rule 506 under Regulation D (17 CFR §230.506). See §5A.26.
Effective January 20, 2017, Rule 504 (17 CFR §230.504) was amended to disqualify certain “bad actors” from participation in Rule 504 offerings. Specifically, Rule 504(b)(3) provides that the Rule 504 exemption is not available for the securities of any issuer if that issuer would be subject to disqualification under Rule 506(d) (17 CFR §230.506(d)) on or after January 20, 2017. Disclosure of “bad actor” events that occurred before January 20, 2017, is required in accordance with Rule 506(e) (17 CFR §230.506(e)). See SEC Release No. 33–10238 (Oct. 26, 2016). See §6.17.
In connection with new Rule 506(c) (17 CFR §230.506(c)), the SEC has revised Form D to add separate boxes for issuers to check to indicate whether they are using general solicitation and general advertising in a Rule 506 offering under Rule 506(c), or whether they are conducting the offering without general solicitation and general advertising in compliance with Rule 506(b). See §6.19B.
Additional comparative discussion of Rule 147 (17 CFR §230.147) and Rule 147A (17 CFR §230.147A) has been added to Chapter 6. Rule 147A is not subject to the statutory limitations of §3(a)(11) of the Securities Act and does not constitute a safe harbor under §3(a)(11). Nevertheless, Rule 147A is similar to Rule 147, with two principal distinctions:
Under Rule 147, offers and sales may be made only to persons resident within the same state or territory in which the issuer is resident and doing business. Rule 147A has no restriction on offers, requiring only that the issuer be resident and doing business within the state or territory in which all sales are made. Because Rule 147A does not restrict offers, in general the issuer or any person acting on its behalf may use any form of general solicitation and general advertising in connection with the offering, including unrestricted websites and other forms of mass media.
Under Rule 147, an issuer that is a corporation, limited partnership, limited liability company, trust, or other form of business organization that is organized under state or territorial law may make offers and sales only in the jurisdiction in which such entity is organized. In contrast, Rule 147A is available to entities that are organized in a jurisdiction other than the jurisdiction in which the securities are sold. So, for example, an issuer incorporated in Delaware could conduct a Rule 147A offering in California.
The Fixing America’s Surface Transportation Act (FAST Act) (Pub L 114–94, 129 Stat 1312) made several changes to the federal securities laws, including the addition of a new exemption from registration for private resales of securities. The FAST Act added §4(a)(7) to the Securities Act (15 USC §77d(a)(7)), which is essentially a safe harbor for the §4(1½) exemption. To qualify for the §4(a)(7) exemption, a transaction must meet the following requirements:
The seller may not be the issuer or a subsidiary of the issuer of the securities being sold under the exemption;
Each purchaser must be an accredited investor (as that term is defined in Rule 501(a) of Regulation D; see §6.6);
Neither the seller nor any person acting on its behalf may engage in any general solicitation or general advertising;
If the issuer of the securities being sold under the exemption is not subject to the periodic reporting requirements of the Securities Exchange Act, subject to certain limited exceptions, the seller must provide certain specified information to each prospective purchaser about the issuer and the securities being offered (including financial statements of the issuer);
Neither the seller, nor any person being paid a commission or other remuneration for participating in the sale, is subject to an event that would disqualify an issuer or other covered person as a “bad actor” under Rule 506(d)(1) of Regulation D (see §6.19) or is subject to statutory disqualification under Section 3(a)(39) of the Securities Exchange Act;
The issuer must be engaged in business and may not be in the organizational stage, in bankruptcy or receivership, or be a blank check, blind pool, or shell company that has no specific business plan or purpose, or have indicated that its primary purpose is to engage in a merger or business combination with, or the acquisition of, an unidentified person;
The securities being sold may not constitute all or part of an unsold allotment to, or a subscription or participation by, a broker or dealer as an underwriter of the securities or a redistribution; and
The class of securities being sold must have been authorized and outstanding for at least 90 days.
Securities sold under the §4(a)(7) exemption are “restricted securities” within the meaning of Rule 144 and may not be further transferred unless registered, except pursuant to an applicable exemption from registration. Securities sold under the §4(a)(7) exemption are also “covered securities” under §18 of the Securities Exchange Act and are therefore exempt from certain registration and qualification requirements under state securities laws. See §6.30.
In City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v Align Tech., Inc. (9th Cir 2017) 856 F3d 605, the Ninth Circuit noted that “the three standards for pleading falsity of opinion statements articulated in Omnicare, Inc. v Laborers Dist. Council Constr. Indus. Pension Fund (2015) ___ US ___, 135 S Ct 1318, … apply to Section 10(b) and Rule 10b-5 claims” (856 F3d at 609), and also noted that “to the extent that the Ninth Circuit’s prior standard permitted plaintiffs to plead falsity by alleging that ‘there is no reasonable basis for the belief’ under a material misrepresentation theory of liability, the prior standard was ‘clearly irreconcilable’ with Omnicare, and was therefore overruled” (856 F3d at 616). See §6A.2.
Item 402(1) of Regulation S-K allows an issuer that is a “smaller reporting company” to provide the scaled down executive compensation disclosures set forth in Items 402(m)–(r) of Regulation S-K. A “smaller reporting company” is defined in Rule 405 under the Securities Act (17 CFR 230.405), Rule 12b-2 of the Exchange Act (17 CFR 240.12b–2), and Item 10(f)(1) of Regulation S-K (17 CFR 229.10(f)(1)) to mean an issuer that had (1) a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter; (2) in the case of an initial registration statement, a public float of less than $75 million as of a date within 30 days of the date of the filing of the registration statement; or (3) a public float of zero and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available. 17 CFR §229.10(f)(1). The SEC recently proposed amendments that would increase the financial thresholds in the smaller reporting company definition. Under the proposed amendments, the $75 million public float threshold would be increased to $250 million and the $50 million revenue threshold would be increased to $100 million. See Amendments to Smaller Reporting Company Definition, SEC Release No. 33–10107 (June 27, 2016), 81 Fed Reg 43130. See §6A.30.
The dollar limits on capital that may be raised under Regulation Crowdfunding (17 CFR §§227.100–227.503) and the dollar limits on investors in offerings under Regulation Crowdfunding have been raised incrementally. See §§6B.2, 6B.42–6B.43.
In Beechum v Navient Solutions, Inc. (CD Cal, Sept. 20, 2016, No. EDCV 15-8239-JGB-KKx) 2016 US Dist Lexis 129782, the federal district court declined to look beyond the face of the transaction and consider whether a nonexempt lender that purchased loans from an exempt lender (a bank) was the “real” lender for purposes of the usury laws. The Beechum court cited WRI Opportunity Loans II LLC v Cooper (2007) 154 CA4th 525 for the proposition that a court “must look solely to the face of a transaction to determine whether an exemption applies.” 2016 US Dist Lexis 129782 at *28. Because the lender was a bank exempt from the usury limitations under Cal Const art XV, the loans made by the bank were exempt from California’s usury prohibition as a matter of law. 2016 US Dist Lexis 129782 at *29. See §8.16.
Most promissory notes and loan agreements provide that a borrower is required to pay a higher rate of interest following an event of default. The Ninth Circuit Court of Appeals has ruled that such provisions are enforceable in the context of a bankruptcy reorganization even if the default has been cured. In Pacifica L 51 LLC v New Invs., Inc. (In re New Invs., Inc.) (9th Cir 2016) 840 F3d 1137, the court overruled its prior decision in Great W. Bank & Trust v Entz-White Lumber & Supply, Inc. (In re Entz-White Lumber & Supply, Inc.) (9th Cir 1988) 850 F2d 1338. Because New Investments’ reorganization plan proposed to cure a default under the promissory note (the underlying agreement), the plan was governed by Bankr C §1123(d). The court found that the underlying agreement provided for higher post-default interest and that applicable nonbankruptcy law (Washington state law) allowed for a higher interest rate on default when provided for in the underlying agreement. Therefore, New Investments was required to pay interest at the higher post-default interest rate specified in the underlying agreement in connection with its cure of the default. The court did not specify whether the default rate applied for the remainder of the loan or only until cure was achieved. See §8.18B.
In Nautilus, Inc. v Yang (2017) 11 CA5th 33, the court analyzed the “good faith” defense, which allows a transferee to avoid liability for a fraudulent or voidable transfer if it can establish that it acted in good faith. The court held that the good faith defense is not available if the transferee (1) had fraudulent intent, (2) colluded with a person who was engaged in the fraudulent conveyance, (3) actively participated in the fraudulent conveyance, or (4) had actual knowledge of facts showing its knowledge of the transferor’s fraudulent intent. The court emphasized that the mortgage lender to the transferee was not subject to inquiry notice of facts that would have given it knowledge of the fraudulent intent. The court also held that the transferee has the burden of proof in establishing its good faith. See §8.20A.
In G&W Warren’s, Inc. v Dabney (2017) 11 CA5th 565, the court of appeal, citing CC §2856(b), held that when a guarantor has agreed in its guaranty agreement that its obligations will secure amounts owing by a borrower following modifications to payment amounts or payment terms in the borrower agreements that are consented to by the borrower, “no particular words or references to statutory provisions are required to effect a guarantor’s waiver of defenses.” 11 CA5th at 583. The fact that the waiver provision in the guaranty agreement did not include the words “waive” or “waiver” was irrelevant. The court found that the guarantor had consented to modifications of the payment terms and therefore expressly waived the exoneration defense. The court also noted that a guarantor will not be held liable beyond the express terms of his contract. See §8.20E.
In Tidwell Enters., Inc. v Financial Pac. Ins. Co. (2016) 6 CA5th 100, the court of appeal confirmed the existing broad standards governing an insurer’s duty to defend. It held that an insurer “‘bears a duty to defend its insured whenever it ascertains facts which give rise to the potential of liability under the policy,’” that a “‘third party plaintiff cannot be the arbiter of coverage,’” that “‘[a]ny doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured’s favor,’” and that an insurer “‘need not defend if the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage.’” 6 CA5th at 106 (citations omitted). See §11.41.
In Advent, Inc. v National Union Fire Ins. Co. of Pittsburgh, Pa. (2016) 6 CA5th 443, an insurer that had funded a settlement sought contribution from an insurer that refused to participate. The court held that “‘where [the non-participating coinsurer’s] duty to defend is undisputed, and where by law the settlements are presumptively reasonable[,] the burden of proof is on [the nonparticipating coinsurer] to establish that there was no coverage (and not on the [settling coinsurer] to prove the opposite).’” 6 CA5th at 455. See §11.42.
Patent exhaustion limits the extent to which a patent holder can control an individual patented product after authorized sale. Patent exhaustion extends to sales that occur outside of the United States. Moreover, the domestic sale of a patented product exhausts all patent rights regardless of any post-sale restrictions that the patent holder may try to impose on the product through a license agreement. As long as the sale is authorized, the patent rights are exhausted on that product. Impression Prods., Inc. v Lexmark Int’l, Inc. (2017) ___ US ___, 137 S Ct 1523. See §12.11.
In a design patent, the patent owner is entitled to either lost profits or $250 for infringement if the design patent is applied to an article of manufacture. 35 USC §289. However, the relevant “article” of manufacture for arriving at a damages award need not be an end product, but may be only a component of the end product. Samsung Electronics Co. v Apple, Inc. (2016) ___ US ___, 137 S Ct 429. See §12.12A.
If an item has a useful function, then copyright protection, if any exists at all, is available only for the features that can exist separately from the useful item. With regard to useful items such as clothing, expressive elements of an item can be protected if two conditions are met: (1) it can be perceived as a two- or three-dimensional work of art, separate from the useful article, and (2) it still qualifies as protectable expression when “imagined separately from the useful article” into which it is incorporated. Star Athletica, L.L.C. v Varsity Brands, Inc. (2017) ___ US ___, 137 S Ct 1002, 1016. See §12.18A.
Title 15 USC §1052(a) contains a provision that a trademark cannot be registered if it disparages persons, institutions, beliefs, or national symbols. However, the United States Supreme Court has ruled that that provision is unconstitutional as a violation of the First Amendment. Matal v Tam (2017) ___ US ___, 137 S Ct 1744 (USPTO’s refusal to register mark “THE SLANTS” for an Asian American rock band violated First Amendment). The Supreme Court’s ruling calls into question the continued viability of a ban against registration of “immoral” or “scandalous” trademarks, although that ban was not at issue in that case. See §12.36.
Federal trademark rights arise when goods are sold or services are provided in interstate commerce, although an intent-to-use application can give rise to a date of constructive use that predates actual use. 15 USC §1057(c). The definition of “interstate commerce” is broad and includes “all commerce which may lawfully be regulated by Congress.” 15 USC §1127. The amount of use in interstate commerce can be minimal. Even the sale of a few items across state lines will qualify as “use in commerce.” Christian Faith Fellowship Church v Adidas AG (Fed Cir 2016) 841 F3d 986. See §12.61.
The Computer Fraud and Abuse Act (CFAA) (18 USC §1030) has been applied to address “password sharing.” In U.S. v Nosal (9th Cir 2016) 844 F3d 1024, the court found a violation of the CFAA’s prohibition on unauthorized access when an ex-employee with revoked privileges asked a current employee for login information to gain entry to the former employer’s database. See §13.3.
In Facebook, Inc. v Power Ventures, Inc., supra, Power Ventures accessed Facebook users’ data and initiated form e-mails and other electronic messages promoting its website. Initially, Power Ventures had implied permission from Facebook, but Facebook sent Power Ventures a cease and desist letter and blocked its IP address; nevertheless, Power Ventures continued its promotional campaign. The Ninth Circuit held that Power Ventures did not violate the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (CAN-SPAM Act) because the transmitted messages were not materially misleading; however, Power Ventures did violate the Computer Fraud and Abuse Act (CFAA) and Pen C §502 (see §13.16) after it received Facebook’s cease and desist letter and continued to access Facebook’s computers without permission. See §13.5C.
Businesses in the technology and manufacturing industries should be aware of the Cybersecurity Information Sharing Act (CISA) (6 USC §§149, 151, 1501–1510, 1521–1525, 1531–1533), intended (among other things) to improve cybersecurity in the United States through enhanced sharing of information about cybersecurity threats. The law allows the sharing of Internet traffic information with the U.S. government and creates a system for federal agencies to receive threat information from private companies. It also provides safe harbors from liability for private entities that share cybersecurity information in accordance with the CISA. See §13.14.
Effective January 1, 2017, Pen C §523 was amended to make the use of ransomware a form of criminal extortion and therefore a felony punishable by up to 4 years in prison. See §13.16A.
On October 25, 2016, the Federal Trade Commission (FTC) released a helpful guide on data breach response, titled Data Breach Response, A Guide for Business, available at https://www.ftc.gov/system/files/documents/plain-language/pdf-0154_data-breach-response-guide-for-business.pdf. The guide sets forth a series of steps that a company is advised to take for a quick and appropriate response when the company suspects a data breach has occurred. See §13.22.
Chapter 15 has been revised to reflect the changes in federal income tax law made by the Tax Cuts and Jobs Act (Pub L 115–97, 131 Stat 2054). See §§15.1, 15.4–15.6A, 15.12–15.13, 15.26.
Practitioners should be aware that as a result of final regulations issued on December 13, 2016, domestic disregarded entities that are wholly owned by a foreign person are required to comply with reporting and recordkeeping obligations under IRC §6038A. See Treas Reg §301.7701–2(c)(2)(vi). Such reporting and recordkeeping obligations include obtaining an employer identification number (EIN) in order to file IRS Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, the requirement to file IRS Form 5472, and the requirement to maintain adequate books and records with respect to IRS Form 5472. See §15.22.
In Swart Enters., Inc. v Franchise Tax Bd. (2017) 7 CA5th 497, the court held that passively holding a minority LLC membership interest, with no right of control over the business affairs of the LLC, does not constitute “doing business” in California. Following that decision, the Franchise Tax Board issued FTB Notice 2017-01 indicating that it will not appeal the decision to the California Supreme Court and will follow the decision in situations with the same facts. Therefore, corporate taxpayers who previously filed and paid California corporate franchise tax based on holding a passive, minority LLC interest should consider filing a claim for a refund with the FTB. See §15.22.
Before July 1, 2017, the California State Board of Equalization (BOE) administered the California sales and use tax. Effective July 1, 2017, as a result of AB 102 (The Taxpayer Transparency and Fairness Act of 2017), the BOE was restructured to perform only duties assigned to it by the state Constitution, while all remaining duties, including administration of California sales and use tax, are or will be transferred to the newly established California Department of Tax and Fee Administration (CDTFA). As of October 2017, a seller’s permit may be obtained online at https://www.boe.ca.gov/info/reg.htm. (Although the CDTFA will be performing most tasks formerly performed by the BOE after July 1, 2017, certain activities will continue to be accomplished on the BOE website until they are fully migrated to the CDTFA website.) See §16.8.
Employers must pay a federal unemployment tax (FUTA) of 6.2 percent (through June 30, 2011) on the first $7000 in wages paid to each employee, but are allowed a credit against this tax based on an employer’s state unemployment insurance tax liability. IRC §3301. Practitioners should note that California employers did not receive the maximum credit permitted (5.4 percent) in 2016 due to outstanding federal Unemployment Insurance loans California owes to the federal government. Rather, the 5.4 percent FUTA credit was reduced by 1.8 percent to 3.6 percent, resulting in an increase in FUTA taxes for California employers (up to $126 more per employee). Practitioners should be advised that a decreased FUTA credit is also likely to occur for 2017, resulting in a similar increase in FUTA taxes for California employers. See the EDD website at http://www.edd.ca.gov/Payroll_Taxes/Federal_Unemployment_Tax_Act_Tax_Increases_2016.htm. See §16.24.
In August 2017, S&P Dow Jones Indices LLC announced that companies with multiple share class structures are no longer eligible for inclusion in the S&P Composite 1500 and its component indices (including the S&P 500, S&P MidCap 400, and S&P SmallCap 600). As a result, index funds, exchange-traded funds, and pension funds that invest passively following these indices will not invest in such companies. This limitation applies to multiple classes of listed or unlisted outstanding common equity, regardless of whether any class has limited or no voting rights. Existing index constituents (such as Alphabet and Facebook) are grandfathered in. See https://www.spice-indices.com/idpfiles/spice-assets/resources/public/documents/561162_spdjimulti-classsharesandvotingrulesannouncement7.31.17.pdf?force_download=true. FTSE Russell has also adopted rules requiring constituents of its indices to have greater than 5 percent of the company’s voting rights (aggregated across all of its equity securities, including those not listed or trading) in the hands of unrestricted (free-float) shareholders. Existing FTSE Russell constituents have until September 2022 to change their capital structures. See http://www.ftse.com/products/downloads/FTSE_Russell_Voting_Rights_Consultation_Next_Steps.pdf. Companies considering a multi-class structure could establish one that could be unwound as the company approaches inclusion in the S&P indices. See §17.12A.
An issuer conducting a concurrent exempt offering for which general solicitation is permitted across state lines (e.g., a Regulation Crowdfunding offering) would be unlikely to comply with the in-state offer restriction in Rule 147(b). An issuer relying on Rule 147A, which permits multi-state offers, may conduct a concurrent exempt offering for which general solicitation is permitted, so long as the issuer complies with the legend and disclosure requirements of Rule 147A(f), as well as any additional restrictions on general solicitation imposed by the other exemption on which the issuer concurrently relies. See SEC Release Nos. 33–10238, 34–79161 (Oct. 26, 2016) at 53. See §19.50.
In June 2017, the SEC announced that a company that is not an emerging growth company can submit a draft registration statement for nonpublic review in an IPO, as well as for most offerings made within 1 year of the IPO. This allows companies to delay the public disclosure of competitive information, and to avoid public disclosure altogether if they do not proceed with the offering. The issuer is required to confirm in a cover letter accompanying the nonpublic draft submission that it will publicly file its registration statement and nonpublic draft submission at least 15 days before any road show or, in the absence of a road show, at least 15 days before the requested effective date of the registration statement. The nonpublic review applies only to the initial submission; an issuer responding to staff comments on the draft registration statement should do so with a public filing, not with a revised draft registration statement. The issuer should file the draft registration statement it had previously submitted for nonpublic review at the time it publicly files its registration statement. See https://www.sec.gov/corpfin/announcement/draft-registration-statement-processing-procedures-expanded. See §20.25.