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Editor’s note: The following are hypothetical case studies, with fictional managers and fictional businesses, as a way for executives to learn more about some of the situations they or their companies may face. reporter Jeanne Graham wrote the hypotheticals, and legal experts familiar with the kinds of problems described offered suggestions to remedy the situations. Their opinions are not intended to be legal advice. To submit suggested hypotheticals for “Case in Point,” go to www.executivelegaladviser.com . Vincent Slusheris a shareholder in Davis Munck in Dallas and heads its business and financial reorganization section. He is a member of the State Bar of Texas and the Louisiana State Bar Association. His practice includes representing debtors, official committees, lenders and major creditors in workout and reorganization matters. Steve Stapletonis a shareholder in and section head of the corporate and business law section of Cowles & Thompson in Dallas. His practice is concentrated in bankruptcy and commercial litigation. Valerie C. Glassis a partner in Atlas & Hall in McAllen. She sits on the Council for the State Bar of Texas Labor and Employment Section and represents employers in all facets of the employment arena. Amy Dashiellis a partner in the Austin firm of Scott, Douglass & McConnico. She is board certified in labor and employment law by the Texas Board of Legal Specialization and represents employers in employment litigation and consultation.
Bankruptcy Blues at Trakstuff Inc. Samantha Ducat fears the worst. No matter how many times she re-runs the spreadsheet analysis, the answer is the same. Trakstuff Inc. is burning money faster than it is able to obtain commitments for sales and faster than it is able to obtain a third round of financing. Ducat is chief financial officer for the 2-year-old start-up that designs software programs that track and re-order inventory for retail operations. The software not only counts items as they are sold, but also notes which products are most popular and then re-orders an inventory mix that emphasizes those products that sell fastest. It’s a great product. Unfortunately, due to the economy and many failed technology ventures, investment capital is not as easily obtainable as it was just two years ago. Based on the reputation of the company’s founders, three well-known and successful hi-tech entrepreneurs, investors have poured $56 million into the company. The company’s president and one of its founders, Bill Calhoun, said the company’s 57 employees would receive a bonus this month equal to 20 percent of their annual salaries. Calhoun suggested the bonus during a monthly dinner he hosted for the company’s management team. Calhoun said that if the company met a particular customer’s deadline, all employees would receive a bonus. The employees worked feverishly for the past three months and completed the project two days prior to the customer’s deadline. As a consequence, the customer placed a $1.2 million order for product. But even with that $1.2 million sale, Ducat estimates that the company only will survive another 16 weeks. Ducat thinks Calhoun should renege on the promised bonuses. It’s not a contract with the employees, is it? If the bonus is paid, the company will be bankrupt within 10 weeks. Ducat is worried that since the company is facing insolvency, creditors will claim that the bonus payout was an extravagance and an example of poor judgment by company officers. Should Trakstuff pay the bonuses? What other steps, if any, should the company take as it prepares for bankruptcy? Answer No. 1 By Vincent Slusher Trakstuff Inc. is off track and faces a bumpy ride in the near future. The most immediate problem facing Trakstuff is the prospect of angry employees. Starting with the obvious, is the company legally obligated to pay its employees the 20 percent bonus because they met the client deadline? In Texas, it is a pretty close call. To be enforceable, the unilateral promise, like the one made by the company president here, has to be definite as to its terms, and the president must have the authority to bind the company. The promise must be more than the president’s encouragement of his employees to do a good job and thereby make Trakstuff profitable. Dealing with those issues separately, it would appear that the unilateral promise was sufficiently definite. There was a term for performance, this month based upon the successful and timely completion of the customer’s order. There was an amount promised, 20 percent of each employee’s salary. Where the issues start to gray a little is how the offer was communicated to the employees and how much authority Calhoun had to make it in the first place. It does not appear that the offer was made directly by Calhoun to the employees. Calhoun “suggested” the bonus at a “monthly” dinner Calhoun hosted for Trakstuff management. It would be pertinent to determine how that suggestion was in turn communicated to the employees. Additionally, there is no indication whether Calhoun had the authority, as Trakstuff president, to authorize and pay the bonuses. If he did not have that authority, if it rested with Trakstuff’s board of directors for instance, then the company may have a defense to any attempt by an employee to enforce the promise. However, Trakstuff’s legal obligation to its employees is not the be-all and end-all in this hypothetical. The immediate problem facing the company is difficult from another perspective. A start-up software venture’s greatest asset is its employees and their accumulated know-how. For this company to survive, in or out of bankruptcy, these key assets have to be preserved. Should the company elect not to pay the bonuses, they are going to have an active employee crisis on their hands that is going to have to be resolved. An explanation of the current crisis facing the company along with a promise to “make up” the deferred or foregone bonus might be all it takes. Paying the bonuses seems likely to drive Trakstuff straight into bankruptcy. Not paying them may cause an open revolt and mass defection among the employees thus crippling Trakstuff’s potential. Tough call, but I would advise not paying the bonuses absent a real threat of mass defection. Assuming Trakstuff survives its immediate crisis, what’s next? Of primary importance is for Trakstuff to get a handle on its cash burn rate. Ducat needs to work with her management to determine who the company’s critical vendors are. The company must develop a budget that cuts expenses down to the bare minimum. Calhoun may want to eliminate the monthly management dinners, for example. All non-essential debt payment should be suspended or delayed while the company examines its options. Should Trakstuff have to file for Chapter 11, the cash it has on hand on the date it files may make the difference in a successful reorganization. If Trakstuff has a substantial intellectual property portfolio, it should examine that portfolio and ensure that it does not cut or defer costs that impact the value of that portfolio. While examining Trakstuff’s vendor relationships, management also should review any lending arrangements it has with its banks and/or investors. Trakstuff must clearly understand the terms of those arrangements and what assets secure the debts to its lenders. The company’s directors must understand that in a Chapter 11 a great deal of internal information must be disclosed in court filings and that the information is then a matter of public record. Once a company files a Chapter 11, it is in play. The debtor has the exclusive right for 120 days to propose a reorganization plan and then an additional 60-day period to have a plan confirmed. Should the creditors reject that plan or should the exclusivity be terminated by the court, then creditors or other interested parties can submit a competing plan. Moreover, a highly agitated and motivated creditor constituency, feeling the company has been mismanaged (the bonus issue alone is not sufficient), might engage in a fight with Trakstuff to have a trustee appointed, thereby ousting current management from Trakstuff’s day-to-day operational control. Chapter 11 is a great tool for many companies that have a product and a plan. Trakstuff seems to be on the brink of either disaster or profitability. Chapter 11 may provide Trakstuff with a haven from which it can emerge and resume operations in a profitable manner. However, it is a direction that should not be taken lightly. Answer No. 2 By Steve Stapleton As a tech start-up that has blown through $56 million and whose survival depends on a sluggish retail environment, the prospects for Trakstuff seem dire. If Calhoun’s promise of a 20 percent bonus is typical of his decisions, it is not surprising that the company is in financial straits. As to Ducat’s initial concern, in determining whether such a promise is to be enforced, courts generally must distinguish between carefully developed employer representations and platitudes. The first may be enforced; the second will not. If Calhoun’s promise was one the employees relied upon, the company should be straight with them about their continued prospects for employment; they should be told that the company cannot afford to pay the bonuses. As a final measure, the cookie jar should be wrenched away from Calhoun, and Ducat should be cognizant of this sobering fact: Only a small minority of the bankruptcy cases filed result in a restructured company; the vast majority are ultimately liquidated or sold. In considering bankruptcy, the company must weigh the possible consequences to each of its constituencies: employees, investors, vendors and customers. It must decide which contracts to keep (assume) and which to reject (terminate). It must review its software agreements carefully. The company must be realistic about its prospects for putting a plan together that has long-term viability. Most importantly, the company must focus its efforts on obtaining financing that will get it through the bankruptcy proceeding and on obtaining financing that will ensure its survival after bankruptcy. First, the company should understand that bankruptcy is a public forum. Everything the company does will be subject to public scrutiny. Second, approaching the current investors would be the next task since they most likely would be the source of financing. Since their equity interests are the last to get paid in a bankruptcy proceeding, an infusion of new money may be the only way the investors can salvage their investment and the only way for the company to survive. Third, the company must advise its employees generally, but forcefully, of the company’s financial condition. It must deal straight with them, reminding them of their at-will status (e.g. employment that can be terminated by employee or employer at any time); advising that some may be laid off. It must in good faith formulate a plan for cost savings that has their support. If the company is sued over the bonuses, that suit would be postponed with the filing of bankruptcy and may be subject to estimation, and ultimately payment, as an unsecured claim. The company must ensure a loyal customer and vendor base. Where contracts are involved (e.g., equipment or real property leases, a variety of customer and vendor agreements), Trakstuff may assume (keep) those contracts or reject them. If a contract is assumed, its obligations are an administrative expense that must be paid first and in full; if rejected, a contract is deemed breached. Any claim arising from the rejection is merely an unsecured claim, which is substantially lower in priority of distribution and need not be paid in full. Intellectual property, including software licenses, is treated differently, however. Assumption of those contracts may depend on the consent of the other party (such as a customer) in the contract. The company also must be cognizant of transactions occurring prior to bankruptcy. Transfers to a creditor within 90 days prior to bankruptcy (and up to a year if such creditor is an insider) may be voided by the bankruptcy court if the creditor received more than it would have received in a liquidation. Similarly, transfers of property to anyone, whether a creditor or not, made within a year of the bankruptcy filing (or up to four years if state law is applied) may be voided by the bankruptcy court as fraudulent, if Trakstuff received less than reasonably equivalent value and was insolvent or if the transfer was made to hinder, delay or defraud any creditor. One of the most remarkable (and most surprising) aspects of bankruptcy is its cost. A Chapter 11 proceeding typically involves a huge phalanx of legal and financial professionals. Additional constituencies, such as creditor committees, may employ their own professionals. The services rendered by those so employed are entitled to an administrative priority. Thus, without appropriate financing, the company’s prospects may be short-lived. Regardless, all Trakstuff’s constituencies will be affected by the disposition of the company’s assets and the contractual obligations associated with those assets. Disposition could be affected by a sale, by the confirmation of a plan of reorganization or, most egregiously, through liquidation. Thus, the construction of a viable business plan providing for the disposition of the company by way of a sale or a plan of reorganization, properly funded, is always the end game.
Illegal Workers at CoCo Construction CoCo Construction is having a great year. Company owner and president Tommy Cooning is looking at $12 million in revenue � a company high. CoCo specializes in laying concrete foundations for general contractors working for mid- and large-sized companies. It’s a competitive industry, and CoCo has built a reputation for delivering quality foundations on time and on budget. The company recently won the bid for a $1.2 million project for a nationwide retail chain’s newest site in San Antonio. As CoCo grows, so do Cooning’s questions about his labor force. Like other Texas companies in the construction business, CoCo hires many employees for labor crews, estimating job costs and developing architectural drawings. He suspects that some of his employees are working illegally in the country. CoCo’s construction foreman, George Baker, insists that the company will not be able to bid competitively for projects if it doesn’t hire any “illegals.” The company requires all employees � full-time, part-time and temporary � to provide Social Security information and a photo I.D. with each job application. The company is current on all its payroll taxes. But Cooning is worried. He wants to assess his legal risks. Is the company’s policy of requiring Social Security information and a photo I.D. for each employee enough to protect it from prosecution if it mistakenly hires an illegal worker? Should CoCo be requiring more documentation from employees? What kinds of penalties does the company face if it mistakenly, or worse knowingly hires an illegal worker? Answer No. 1 By Valerie C. Glass Cooning is right to be concerned about Baker’s statement. It is against the law to hire an individual who is not legally authorized to work in the United States and the penalties for doing so are tough. In 1986, Congress passed the Immigration Reform and Control Act; it hoped that by requiring employers to check the employment eligibility and identity of their employees, the flow of illegal immigration would be reduced. The Form I-9 was developed as part of that statutory scheme. The act shifts the responsibility of verifying an employee’s identity and work eligibility onto employers and imposes heavy fines if the forms are not filled out correctly. With a few exceptions, an employer is required to ask for and examine documents that establish a person’s identity and his eligibility to work in the United States. The Form I-9 consists of three sections, each with particular timing requirements and employer obligations. The employee must complete Section 1 at the time he begins working. The employer never should write anything in Section 1. An employer also should not type the information in the boxes and should not try to write in or correct anything after the fact. The wording above the signature block in Section 1 makes whoever fills out the section legally responsible for the truth of everything in this section, so adding something later can put the employer in a bad situation. Most important, an employer should be sure an employee has checked the box indicating his immigration status. No check mark is considered a substantive violation and can cost the company. Section 2 requires the employer to review and record the original employment authorization and identity documentation presented by the employee within three business days of the date the employee begins work. An employer must verify two things � the person’s authorization to work in the United States and his identity. Acceptable documents are listed on the back of the form itself. An employer should examine and make copies of only enough documents to meet the needs of the form. If the employee gives the employer a document that fulfills both requirements, the employer should stop there. If the employee gives the employer two documents that establish identity, the employer should accept only one. And the employer certainly should not accept documents, such as a credit card, that do not meet either requirement. Cooning explains that he uses two documents to satisfy the I-9 � a Social Security card and photo I.D., but an employer needs to be careful never to ask for or insist on specific documents. While an employer is forbidden from asking for specific documents to complete an I-9 form, the employer must insist on original or certified copies of documents. That means no faxes, copies or promises that the document is coming. The employer should make a good-faith effort to determine if the document is real. The employer should look at the quality of the document and the clarity of the picture, and rely on his knowledge of what a document is likely to look like. If the employee’s documents appear to be genuine and appear to relate to the employee, the employer may not refuse them or request more documentation; requesting either more or specific documents could violate the discrimination provisions of the act. If the documents presented appear to be forged or not representative of the employee, the employer is obligated to inquire further, although the employer is not required to undertake an extensive investigation of the documents to ensure their authenticity. The employer should fill out Section 2 by the end of his third day on the job. An employee who cannot provide the documents by the third day can provide a receipt that shows that he has applied for and is awaiting replacement documents. He then has 90 days to show the replacement documents. An employer must be sure to follow up. If the employee cannot present satisfactory documents or receipts, the employer must fire him by the end of the third day. The fines for violations of the act are serious. Immigration officers, who can demand to see the forms with just 72 hours’ notice, can impose fines starting at $250 for technical violations (such as a missing date in certain locations) and running well into thousands of dollars for substantive violations (such as failing to verify documentation). Fines are per error, not per form, so one badly filled out form easily can cost an employer. If an employer properly completes a Form I-9 and later discovers the employee is not actually authorized to work, the employer will not necessarily be charged with a verification violation; however, the employer cannot knowingly continue to employ the individual. That is why Baker’s comment is disconcerting. If Baker has knowledge that some of the individuals he is hiring are illegal, the company cannot continue to employ them. The act authorizes civil monetary penalties for violations and lists factors to be considered when imposing such penalties. Civil penalties can be imposed by the Immigration and Naturalization Service, the Department of Labor, the U.S. Department of Justice and/or the Employment Standards Administration. The factors include 1. the size of the business; 2. the good faith of the employer; 3. the seriousness of the violation; 4. whether the individual was an unauthorized alien; and 5. any history of previous violations. The act provides penalties of not less than $100 and not more than $1,000 for each person regarding whom the employer committed a violation. Answer No. 2 By Amy Dashiell Cooning must first and foremost make it clear to his construction foreman that CoCo Construction will not hire any “illegals.” Any short-term benefit from such practice can quickly result in costly penalties and litigation for the company and its executives and even jail time for the execs. By way of example, federal officials recently raided a large retail chain because its cleaning contractor allegedly hired illegal workers. Federal officials alleged that executives and store managers for the retailer knew of the contractor’s immigration violations. Not only did the retailer face a federal investigation with potential fines and even prison time, but it also was sued by the illegal workers employed by the contractor for violations of the Racketeer Influenced and Corrupt Organizations Act, the federal racketeering statute, because the workers alleged that their employment relationship with the retailer and its contractor constituted ongoing criminal activity. Several other suits have been filed and successfully prosecuted against companies and their individual owners alleging that the practice of knowingly hiring illegal workers constitutes criminal activity and violates the RICO statute. Finally, an Executive Order signed in 1996 provides that contractors that are found to violate immigration laws will be barred from obtaining government contracts for a period of one year. To protect himself and his company, Cooning needs to ensure that CoCo Construction complies with the requirements of the Immigration Reform and Control Act of 1986 (IRCA). The IRCA requires employers to complete a Form I-9 for each employee, which is available on the Web site of the U.S. Citizenship and Immigration Services (formerly the Immigration and Naturalization Service). The employer and employee must complete and sign this form within three days of employment. The employer must certify that it has verified the employee’s identity and employment eligibility by reviewing documents from the “List of Acceptable Documents” found on the back of the form. To comply with the IRCA, CoCo Construction must change its policy of requiring a photo I.D. and Social Security card for each employee, for the IRCA prohibits any employer with four or more employees from “committing document abuse” by requiring an employee to produce a specific document, or more or different documents that are required by the Form I-9. An employer, therefore, cannot require that an employee provide a specific document, such as a Social Security card, or provide more documents than are required by the I-9 to verify identity and eligibility. Instead, the company should provide the employee with a copy of the “List of Acceptable Documents” and allow the employee to choose which document(s) to present. Although it is not required, it is good practice to photocopy the documentation presented by the employee and keep the copies with the I-9 Form in the employee’s file. The form requires the employer to verify that the documents “appear to be genuine and relate to the employee named “; therefore, the company should question the employee if the documentation does not appear to be genuine. It also is important to remember to update and re-verify the employee’s eligibility by completing Section 3 of the I-9 Form if the employee’s verification documentation expires during employment. Many companies use a commercial software program that tracks their employees’ status and flags the company when the eligibility must be re-verified. Employers must retain completed Form I-9s for their employees for three years after the date of hire or one year after their employment ends, whichever is later. Employers who hire aliens not authorized to work in the United States are subject to fines ranging from $250 to $10,000 for each unauthorized alien. Additionally, employers who demonstrate a pattern of knowingly hiring unauthorized aliens may face up to a six-month prison term. Perhaps informing the construction foreman that he could face prison time for employing aliens would temper his insistence on violating the law. Finally, the company should be aware that the IRCA and other federal statutes prohibit discrimination against individuals based on their national origin or citizenship status. Concerns regarding immigration status should not prevent the company from hiring employees able to present documentation sufficient to satisfy the I-9 requirement, for such practice may expose the company to liability for discrimination.

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