LIMITED LIABILITY COMPANIES--THE BEST OF ALL WORLDS?

A limited liability company (LLC) is a business structure that combines some of the best features of sole proprietorships, partnerships and corporations. LLC owners, like their counterparts for partnerships or sole proprietorships, report profits or losses on their personal income tax returns. Like a corporation, however, the owners of an LLC have "limited liability," that is, they are shielded from personal liability for debts and claims arising from the business.

Limited Liability

The limited liability for LLC owners is not absolute. Owners still can be held liable if they (1) personally and directly injure someone; (2) personally guarantee a loan or business debt on which the LLC defaults; (3) fail to deposit taxes withheld from employees' wages; (4) intentionally commit a fraudulent or illegal act that harms the company or someone else; or (5) treat the LLC as an extension of their personal affairs rather than as a separate legal entity. The last exception to limited liability is the most significant. It carries the potential for complete removal of the protections for individual owners. If the line between LLC business and personal business becomes too blurred, a court could find that a true LLC does not exist, leaving the owners personally liable for their actions.

Ownership

Most states allow a single individual to be the sole owner of an LLC. An LLC makes the most sense in circumstances where there is a concern about personal exposure to lawsuits stemming from operation of the business. Most laws prohibit establishment of an LLC in the banking, trust, and insurance fields.

Unlike corporations, LLCs can carry on their business without holding regular ownership or management meetings. Of course, formal meetings backed up by written minutes still may be advisable to document important decisions, such as a change in membership or a major expenditure.

Formation

Setting up an LLC is relatively simple. Articles of organization must be filed with the appropriate state office, usually the Secretary of State. The articles of organization include the name and principal office for the LLC, the names and addresses of its owners, and the name and address of the person or company that agrees to accept legal papers on behalf of the LLC.

Even if it is not legally required, the owners should prepare an operating agreement that spells out the owners' rights and responsibilities. The absence of an operating agreement will mean that state statutes will govern the operation of the LLC by default. An operating agreement acts as a guide for resolving common issues that an LLC will face, and thereby helps to avert misunderstandings between the owners. It also underscores the authenticity of the LLC itself, which can be helpful when a judge is deciding whether the owners are protected from personal liability.

A standard operating agreement includes the members' percentage interests in the business; the members' rights and responsibilities; the members' voting power; allocation of profits and losses; how the LLC will be managed; rules for holding meetings and taking votes; and "buy-sell" provisions that control what happens when a member wants to sell his interest, becomes disabled, or dies. Although it is frequently overlooked when an LLC is created, a buy-sell agreement is important as a sort of "premarital agreement" among the owners. The buy-sell provisions can clarify and ease the transition when the inevitable changes come to the members of the LLC.

Taxes

Since an LLC is not considered separate from its owners for tax purposes, the LLC pays no income taxes itself. Like a partnership or sole proprietorship, an LLC is a "pass-through entity." Each owner pays taxes on a share of profits, or deducts a share of losses, on a personal tax return. The IRS regards each member as a self-employed business owner, not an employee of the LLC. There is no tax withholding, and owners must estimate taxes owed for the year, then make quarterly payments to the IRS.

Conversion

By converting to the LLC business structure, sole proprietors and partnerships can gain the protection afforded to LLC owners without changing the way their business income is taxed. Conversion usually can be accomplished either by filling out a simple form or filing regular articles of organization. Federal and state employer identification numbers will have to be transferred to the name of the new LLC, as will such items as sales tax permits, business licenses, and professional licenses or permits.

The process for creating an LLC is streamlined and free of highly technical considerations. However, there is an important place for professional advice concerning such matters as choosing an LLC over other business structures, preparing or reviewing the operating agreement, and setting up accounting systems.

NO PRIVACY FOR HOME COMPUTER

An insurance services company bought two computers for use by Robert, one of its employees. One computer was used at the office, and one was used exclusively at home. Robert signed a policy statement in which he agreed that he would use the computers for business purposes only and not for various inappropriate purposes, including accessing obscene material. He also consented to having his computer use monitored "as needed" by employer personnel and agreed that his communications by computer were not private.

When Robert's employer determined that he had used the home computer to view sexually explicit material, it fired him, despite Robert's protests that he had not intentionally accessed the pornographic sites. Robert sued for wrongful discharge, contending that the real reason he was let go was the fact that three days after the termination some of his stock options were going to vest. Since the company contended that the home computer was likely to contain evidence that Robert was deliberately accessing pornography, it demanded that the computer be produced, with nothing deleted from the hard drive. Robert refused, arguing that he had an expectation of privacy when using a computer at home, even a computer supplied by his employer.

The court ordered Robert to turn over the computer under the terms required by his employer. It rejected the argument that the home computer was a "perk" for senior executives that could be used for personal purposes. In Robert's case, the home computer was, in fact, primarily used by him and his family for personal matters. Information on the computer included his family's financial information and personal correspondence. Robert and his family had been treating the home computer as a personal computer at their own risk.

Robert lacked a reasonable expectation of privacy in the home computer, in part because he had notice of and had consented to his employer's policy allowing only business use of the computer. Another factor weighing against his position, however, was "accepted community norms." He could not argue forcefully that there had been an invasion of privacy given that, according to the court, over three-quarters of major firms in the country monitor, record, and review employee communications and activities on the job.

BEWARE OF PREDATORY HOME LOANS

At a time when stock prices have tumbled, so have interest rates on home equity loans and mortgages, and many homeowners are borrowing against their homes to generate cash. As a result, more people are at risk of being victimized by "predatory" lenders. A predatory loan occurs when a company misleads, tricks, or even coerces someone into taking out a home loan with excessive costs and without regard to the homeowner's ability to repay. The consequences of such a loan can be especially severe since the defaulting borrower could lose the home itself.

For the most part, predatory lending has been associated with companies that specialize in marketing to people with poor credit histories or who are simply strapped for cash. Typical targets are elderly people with high medical bills or overdue home repairs, middle-class individuals swamped by credit card debt, and lower-income consumers with less access to reputable lenders.

A typical consumer may not know the terms for predatory practices, but the borrower will recognize some of these behaviors. In a "bait and switch" scheme, the lender promises one thing but offers something different at closing, when it really matters. "Equity stripping" results from encouraging heavy borrowing from home equity, beyond the consumer's ability to make payments. "Loan flipping" is multiple refinancing, to the point that fees, and possibly higher rates, become unmanageable. When a lender engages in "loan packing," it has added charges to the loan contract for overpriced or unnecessary items.

There are federal laws designed to protect consumers from some of the predatory lending practices. The Truth in Lending Act requires lenders to give timely information about loan terms and costs, and it allows borrowers on loans secured by a home to cancel the loan up to three business days after signing the contract. The Home Ownership and Equity Protection Act requires providers of "high cost" refinancing or home equity loans to give the borrower key information about the loan three days before closing. It also prohibits the making of a home equity loan without regard to a borrower's ability to pay it back. These laws play an important role, but the best deterrent to predatory lending is informed and vigilant consumers.

Some of the most effective preventive measures are only common sense, but in practice they are too often ignored: (1) think through the decision to borrow before taking the plunge, and be wary of a lender who hurries you; (2) select a lender with a good reputation in your community, and steer clear of home improvement contractors or loan brokers who contact you out of the blue; (3) compare quotes from at least three lenders, then negotiate for the best possible deal. And remember, the loan with the lowest monthly payment is not necessarily the best loan; and (4) read and make sure you understand the loan documents before signing them, keeping an eye out for discrepancies between what may have been discussed previously and what is in the fine print.

AN EXPENSIVE TEE SHOT

For some, golf courses are like outdoor board rooms. The emphasis is as much on conducting business as it is on lowering handicaps. But if business transactions have taken priority over the game itself, there is a risk that an injury caused by someone's negligence can have repercussions for the firm's bottom line.

A member of a golf club invited a guest for a round of golf and a sales pitch as to why he should come to work for the member's family business. The guest was new to golf, and his host did not fill him in about basic golf etiquette. The guest teed off on the first hole when another golfer on the same hole was only about 70 yards down the fairway. The tee shot struck the golfer in the eye, causing permanent partial loss of vision and a scar.

The injured golfer sued the club member for negligence for not controlling her guest, as required under the club's rules. She argued that the member did not meet her duty of stopping her guest from teeing off before the fairway was clear. In fact, the member had hit first, giving her uninitiated guest the impression that he could do the same.

Before the case could get to a jury, it was settled for a substantial amount. Most of the settlement cost was borne by the club member's family business, because the golf outing was as much for recruiting an employee as for recreation. This case suggests the need for company policies requiring employees to supervise their guests when entertaining on a golf course, including a basic review of golf etiquette and safety for novice golfers.

IS IT TIME FOR AN ESTATE PLANNING CHECKUP?

Even the most detailed and carefully crafted estate plan should be revisited periodically to make sure that it is in line with changing laws and life circumstances.

* Be sure that estate assets are held in such a way as to minimize estate taxes at death and to avoid overfunding or underfunding of post-death trusts;

* Review the powers of attorney for health care and property to confirm that they reflect current wishes;

* Make adjustments to reflect the death or disability of a beneficiary, or a significant change in a beneficiary's needs;

* Update or prepare a living trust, which allows an estate plan to be carried out with minimal court involvement;

* Retitle assets in your name as trustee of your living trust if you want to avoid probate upon disability or death;

* Review how you hold title to assets (i.e., payable on death, joint tenancy, tenancy by the entirety, etc.);

* If you have not already done so, name appropriate guardians for minor children in your will;

* If you have included a marital gift or a marital trust upon the death of one spouse, consider making the provisions more or less restrictive;

* Examine the scope of "powers of appointment" that allow a survivor to redirect where assets will eventually pass;

* Confirm that the timing as to when a beneficiary will receive or have the right to demand principal is compatible with current wishes;

* Make any revisions suggested by changes in the family such as disabilities, births, deaths, or changed marital status;

* Reassess how title to your home is held;

* Consider the different options for designating beneficiaries for IRA accounts, pension plans, and other assets related to retirement;

* Possibly make annual gifts to children and others free of estate and gift taxes (up to $11,000 per person per year in 2002);

* Consider setting up separate trusts or Section 529 education funding plans for children or grandchildren.

In addition to these considerations, there is a broad range of estate planning options, one or more of which may be desirable based on current circumstances. Among these devices are charitable trusts, irrevocable life insurance trusts, family limited partnerships, family foundations, self-canceling installment notes, and qualified personal residence trusts. A qualified professional can help you sort through the possibilities and arrive at an estate plan that keeps up with changing conditions.

IRS MAKES IT EASIER TO SETTLE TAX DEBTS

The Internal Revenue Service has published new regulations that will make it easier for taxpayers to negotiate settlements of their tax debts. The regulations expand the "offer in compromise" program, under which settlements can be reached with taxpayers who cannot pay their entire tax debts.

Under the old policies, the IRS could accept a taxpayer's offer of settlement only if there was a doubt about whether the taxpayer was liable or the debt could ever be collected. These bases for compromise remain in effect, but the new regulations add flexibility, making the IRS decision to accept or reject a compromise offer dependent on the taxpayer's particular circumstances. The bottom line is that a taxpayer is eligible for a compromise where collection of the entire tax debt would create economic hardship or where there are compelling public policy or equity considerations favoring a settlement.

It may be evidence of hardship if a taxpayer cannot: (1) earn a living due to a long-term illness or disability, and it is foreseeable that resources will be exhausted; (2) pay basic living expenses if assets are liquidated to pay the tax debt; or (3) borrow against equity in assets, and seizure or sale could make it difficult for the IRS to collect the tax debt.

Even with loosened-up rules, the IRS will only come so far to meet a taxpayer in a settlement. The new rules do not allow a compromise that "would undermine compliance with the tax laws." The burden is on the taxpayer to make the case for compromise. Absent exceptional circumstances, the IRS will presume that an uncompromising application of the tax laws gives a fair and equitable result.

THEY SAID IT

The following things were actually said by people in courtrooms across the country.

Q: Doctor, did you say he was shot in the woods?

A: No. I said he was shot in the lumbar region.

Q: Are you married?

A: No. I'm divorced.

Q: And what did your husband do before you divorced him?

A: A lot of things I didn't know about.

Q: Did you blow your horn or anything?

A: After the accident?

Q: Before the accident.

A: Sure, I played for ten years. I even went to school for it.

COURTS BEGIN PUTTING THE BRAKES ON "TAKINGS"

The power of government to take private property for a public use, with payment of fair compensation, has been nearly unassailable in our legal system. In most condemnation cases, the right to take the property is a foregone conclusion, and the parties litigate only the amount of compensation. Courts generally have deferred to the government's articulation of a public purpose for the taking, even when private parties also benefit.

In recent years, there has been a trend toward closer scrutiny of a proposed condemnation to find a paramount public purpose, and even to stop the proceedings where one is lacking. Property owners targeted for a taking are receiving a more sympathetic hearing when they contend that the true beneficiary of the proceedings is not the public but simply another private party with designs on the property.

Although they were largely unsuccessful, challenges to takings as lacking a public purpose first arose in urban renewal cases. The government would condemn blighted property so that it could be redeveloped, usually by private developers. The government could point to the overriding public benefits from such revitalization of property and could successfully argue that benefits to private parties were incidental.

In successful attacks on use of the condemnation power, it is harder to find the public use and easier to see private profit as the motivation for the taking. For example, in one case, the developer of an automobile racetrack wanted some neighboring land for a parking lot, but the company that owned the land did not want to sell it. The developer reached an agreement with a regional authority that had condemnation powers, by which the developer would pay for proceedings to condemn the land in return for getting the property from the authority immediately after the condemnation. A state supreme court found that this transparent arrangement to take land so that it could benefit the racetrack developer was a misuse of the eminent domain power. As the court put it, that power "is to be exercised with restraint, not abandon."

In another successful challenge to a condemnation, a city tried to take land owned by a church in order to turn the land over to a major discount retailer. The property had been vacant for a decade, despite having been declared a blighted area. The city tried to use blight removal and redevelopment of the property to justify its actions. This reasoning was undermined by the city's denial of permits sought by the church for more church buildings on the property, even though such a use would have eliminated blight just as well as the commercial use favored by the city.

The more believable motive for the city was its desire to generate more revenue by putting a taxable business on what had been tax-exempt church property. But the city had other ways to generate revenue. As to both of the city's ostensible goals--blight removal and generation of revenue--the city was "using a sledgehammer to kill an ant." In issuing an injunction against the condemnation proceedings, the court characterized the condemnation as resting only on "the desire to achieve the naked transfer of property from one private party to another."

CASE BY CASE

Long-Arm Jurisdiction Falls Short

Robert found just the excavator he wanted advertised on an Internet auction site. Before making the successful bid, he contacted the seller through e-mail and received assurances from her that the product was in good condition. Robert then traveled to the seller's home, which was several states away, and bought the excavator. When the equipment did not perform as expected and the seller did not respond to Robert's request for a partial refund, Robert sued the seller in his home state.

Robert's lawsuit failed because the seller was not subject to the jurisdiction of the courts in Robert's home state. For a nonresident to bring herself within the reach of a state's "long-arm" jurisdiction, she must purposefully have benefited from the privilege of doing business in that state. Perhaps the seller could have foreseen that residents of any state might bid on the excavator, but that was insufficient to bring her into the courts in Robert's state. She had no control over who would ultimately be the winning bidder, nor could she exclude bidders from particular jurisdictions.

Also weighing against subjecting the seller to litigation was the isolated nature of the transaction and the fact that she was not a commercial seller and was using a third party's site. A different result might have been achieved against a business that used its own website to advertise itself and make transactions across state lines.

Liability for Independent Contractors

In another case, a manufacturing company contracted with a security firm to provide a security guard. The guard shot and killed an individual who was trespassing, but not for criminal purposes, on company property, after the person had obeyed the guard's order to lie on the ground. The company argued that it could not be held liable for the negligent acts of an independent contractor, but a state supreme court ruled otherwise.

The court agreed that the security firm and its guard were independent contractors. The manufacturing company's downfall was an exception to the rule of no liability for acts of independent contractors. If the work to be performed is inherently dangerous, the work can be delegated to an independent contractor, but the duty to use reasonable care cannot be avoided by the employer. Work is inherently dangerous when it involves a foreseeable risk of physical harm to others and requires special precautions.

In the case of the trigger-happy security guard, who was armed and instructed to "deter" thieves and vandals, dangerous confrontations between the guard and persons entering the property were contemplated. In the context of such danger, the independent contractor status of the guard became a mere legal technicality that did not shield the manufacturing company from liability.

ADA AND SMALL BUSINESSES

The Americans with Disabilities Act (ADA) prohibits disability discrimination in employment for employers with 15 or more employees. The prohibition is far-reaching and covers hiring, firing, and everything in between, such as promotions, benefits, and harassment in the workplace. The smallest of businesses are not affected by the ADA because of the 15-employee threshold for coverage. The ADA does apply, however, to many of the roughly 25 million small businesses in the nation.

Who Is Protected?

The ADA protects three categories of individuals: those with a physical or mental impairment that substantially limits one or more major life activities (like sitting, standing, or sleeping); those with a record of such an impairment, such as a person who had debilitating cancer but is now in remission; and those who are regarded by employers as having such an impairment, even though the individuals otherwise are not so impaired as to be "disabled" under the ADA. Regardless of the category, the ADA protects only persons who are qualified, that is, they meet job-related requirements and can perform essential functions for the job, with or without a reasonable accommodation.

Hiring

While an employer can ask an applicant a wide range of questions concerning job qualifications, the ADA does not allow medical examinations or questions about disability until the employer has made the applicant a conditional job offer. An exception is recognized for questions directed to an apparently disabled applicant about whether a reasonable accommodation will be required.

After a job offer is made, an employer can ask any disability-related questions and require medical examinations, so long as these requirements apply to everyone in the same job category. For example, if, during a medical examination required of all employees in a job involving the use of dangerous machinery, it is revealed that an applicant has frequent and unpredictable seizures, the employer can withdraw a job offer to that individual.

Medical Information

Once a person is on the job, the ADA allows required medical examinations or questions about a disability only where there is a reasonable belief, based on objective evidence, that a particular employee will not be able to perform essential job functions or will pose a direct threat because of a medical condition. As an example, if a normally reliable employee has told her employer that a new medication she takes makes her lethargic, and she begins to make many mistakes, the employer can ask her how long the medication can be expected to affect job performance.

Reasonable Accommodation

The ADA differs from most other employment discrimination laws in imposing an accommodation duty on employers. If a disabled person needs a reasonable accommodation in order to apply for, or perform, a job, the employer generally must provide it unless to do so would create an undue hardship. An undue hardship means significant difficulty or expense, based on an employer's resources and operations.

Most accommodations are not expensive or burdensome. A diabetic employee may need regular breaks to eat properly and monitor blood sugar and insulin levels, or a blind employee may need someone to read information posted on a bulletin board. If more than one accommodation will work, the employer may take the option that is less costly or easier to provide.

In addition to the undue hardship defense, an employer need not provide an accommodation which:

* assists an individual off the job;

* removes or alters the essential functions of a job;

* lowers production or performance standards; or

* excuses violations of rules on good conduct.

Helpful Handbook

The Equal Employment Opportunity Commission, which is charged with enforcement of the ADA, has issued a new handbook to help small businesses comply with the ADA. The handbook provides many examples of factual situations with which small businesses could be confronted. The ADA primer can be accessed online at www.eeoc.gov.

SOLO 401(K) RETIREMENT PLANS

As a result of recent tax law changes, a new retirement savings account is now available for "owner-only businesses." An "owner-only business" is either a business that employs only the owner and immediate family members or a business that employs only the owner and employees who by law may be excluded from participation in retirement plans. Excludable employees include employees under age 21, employees with less than a year of service or who work less than 1,000 hours per year, certain union employees, and certain nonresident alien employees.

The new plan, sometimes called an Individual (k) plan, can be set up both by incorporated businesses or unincorporated businesses such as sole proprietorships and partnerships. When compared with other types of business retirement plans, an Individual (k) plan allows more flexibility in its funding and larger contribution amounts.

The two components of an Individual (k) plan are a profit-sharing contribution from the employer (up to 25% of compensation) and an employee salary deferral (up to $12,000 in 2003). Combining those two components, the maximum contribution on behalf of any one business owner is a whopping $41,000 in 2003. Contributions are discretionary each year.

The maximum salary deferral amount will increase by $1,000 per year through 2006. In addition, for individuals who are age 50 or older, the Individual (k) plans, like 401(k) plans for larger businesses, allow "catch-up" contributions in amounts that will increase annually through 2006. For 2003, the maximum catch-up contribution is $1,000.

Business owners are eligible to take personal loans from Individual (k) plans, so long as the plan document allows for plan loans. They may borrow as much as $50,000 in cash, or 50% of the balance in their account, whichever is less. Borrowing from an Individual (k) plan carries the same downside as with conventional 401(k) plan borrowing, however, making this move a last resort for many. Aside from undermining the accumulation of a large balance growing tax-free in the account, a loan, if not paid back on time, will be considered a distribution by the IRS, triggering income taxes and a 10% penalty.

CREDIT REPORTING AGENCY HELD ACCOUNTABLE FOR ERRORS

Judy discovered that her credit report from a large credit reporting agency erroneously included about a dozen accounts for a different person, also named Judith. The report identified Judy as using that person's name as an alias. Unfortunately, the "other" Judith, who did exist, had a checkered debt-paying history that was erroneously presented as Judy's in the credit report.

Judy's own spadework revealed that the credit reporting agency had merged her information with that of the second Judith because they had similar first names, were born in the same year, were from the same part of the country, and, most importantly, their Social Security numbers differed by only one digit. This initial computer mistake was bad enough, but what ultimately led to a very large damages verdict for Judy was the inadequate response of the reporting agency once Judy had brought the errors to its attention.

The agency deleted some of the accounts that did not belong in Judy's report, but it kept most of them after supposedly verifying them with creditors. This "verification" was very superficial and did not convey to the creditors the information Judy had provided. In effect, the agency simply asked each creditor, "Is this what you reported?" Fully three years after Judy notified the reporting agency of the erroneous information in her report, some of it remained, and the undeserved stain on her credit was as obvious as ever. To add insult to injury, some of the deleted information from the second Judith even reappeared on Judy's report.

The situation came to a head when the erroneous credit report caused Judy to be denied a mortgage. By supplying still more information to the agency, including a supportive letter from the "other" Judith, and contacting creditors herself, Judy eventually cleaned up her credit report and got out from under the shadow of a stranger's unpaid debts. By then, however, she was a wreck emotionally, and the damage to her credit reputation was only beginning to be restored. A jury verdict made the credit reporting agency pay for these injuries, but sent an even louder message in a large award of punitive damages.

The success achieved in Judy's lawsuit was largely due to her own diligence. The steps she took are practically a blueprint for what someone should do when credit reporting errors are made and then left uncorrected by an agency. It took years in her case, but Judy prevailed in the end by making telephone calls, keeping notes and documents, contacting creditors directly, and even enlisting the aid of the debtor whose poor credit history had appeared in Judy's credit report.

ONLINE BANKING

Banks that rely on the Internet and other low-cost ways to provide service, as opposed to "bricks and mortar" branch offices, can save on expenses and pass the savings along to customers in higher returns on deposits and lower interest rates on loans. Online banking also gives customers the convenience of being able to monitor their accounts and complete transactions around the clock, without waiting for mailed statements or being limited by office hours.

The flip side of online banking is that, if a problem arises, you cannot sit down face-to-face with someone from the bank to resolve it. There is also a premium on doing research to check out the legitimacy of an unfamiliar and remote institution before you entrust it with your money and private information. A good place to start is the "About Us" section of a bank's website, which should at least give basic contact information. If it does not, that in itself should raise suspicions. Other warning signs include names or websites that are only slightly different from those of well-known institutions and rates of return that are far out of line with what other banks are offering. It is a good idea to confirm that an institution is federally insured by contacting the Federal Deposit Insurance Corporation or searching its "Institution Directory" at www3.fdic.gov/idasp.

Like any bank customer, users of online banking institutions are well-advised to safeguard private identification information, keep good records, and monitor transactions and balances regularly. Online banking customers also have the protection of federal laws such as the Equal Credit Opportunity Act, the Truth in Lending Act, and the Truth in Savings Act. Those who decide to do their banking solely in front of a computer screen especially should know about the Electronic Fund Transfer Act, which deals with consumer rights involving electronic banking transactions.

FEDERAL ADVERTISING GUIDELINES FOR BUSINESSES

The Federal Trade Commission Act prohibits advertising that is untruthful, deceptive, or unfair, and it requires advertisers to have evidence to back up their claims. There are also other federal laws applicable to advertisements for specific types of products and state laws that apply to ads running in particular states.

Unfairness

An advertisement is unfair if it causes "consumer injury." The Federal Trade Commission (FTC) uses a three-part test to determine if a consumer injury has occurred or is likely to occur as the result of an advertisement: (1) the injury must be "substantial"; (2) the injury must not be outweighed by any offsetting consumer benefits; and (3) the injury must be one that consumers could not reasonably have avoided. An injury may be substantial because of monetary harm or unwarranted health and safety risks. More subjective effects, such as offending the tastes or opinions of consumers, generally will not constitute a substantial injury. The FTC will also consider whether a challenged practice violates established public policies and whether the conduct is immoral, unethical, oppressive, or unscrupulous in deciding whether it is unfair.

The Act recognizes that, in general, the government expects the marketplace to be self-correcting, with informed consumers making purchasing decisions without regulatory intervention. The FTC may step in, however, when sellers use practices that distort free market decisions, such as by withholding critical information from consumers or pitching questionable products to highly susceptible and vulnerable classes of purchasers such as the terminally ill.

Deception

An ad is deceptive if it contains a statement or omits information that is material and is likely to mislead consumers. Information is material if it is important to a consumer's decision to buy or use a product. Examples include representations about a product's performance, features, safety, price, or effectiveness.

The FTC will scrutinize an ad for deceptiveness from the point of view of the typical consumer who sees it. The focus is on the whole context of an ad, rather than whether certain words are used. Sometimes what an ad does not say is most important. If the ad is for a collection of books, it is deceptive to withhold from consumers the fact that they will receive only abridged versions of the books. An ad that says "this product prevents colds" and one that says "this product kills germs that cause colds" both claim to prevent colds, but the first claim is expressed, and the second is implied. The FTC expects an advertiser to be able to back up both types of claims with proof and to have such proof before an ad runs.

Backing It Up

Substantiation of a claim in an ad means that there must be a reasonable basis for the claim in the form of objective evidence. The kind and amount of evidence depend on the claim, but at the very least the advertiser must have the level of evidence it purports to have. If the ad boasts that "two out of three doctors" recommend a product, the advertiser must be able to produce a reliable survey to prove the claim. For more general representations, the required level of proof is determined by factors such as what experts in the field think is necessary. Health and safety claims, in particular, must be supported by competent and reliable scientific evidence. As flattering as they may be, testimonials from satisfied customers usually are insufficient to substantiate a claim requiring objective evaluation.

Comparative Ads

The policy of the FTC actually is to encourage the naming of or reference to competitors, so long as there is clarity and such disclosure as may be needed to avoid deception of the consumer. Even ads that disparage the competition are permitted if they are truthful and not deceptive. The FTC requires neither less nor more substantiation for comparative ads than for other advertising.

Enforcement

The FTC marshals its resources in order to pay closest attention to ads that make claims about health or safety ("Acme water filters remove harmful chemicals from tap water"), and ads that make claims that consumers would have difficulty checking out for themselves ("ABC hairspray is safe for the ozone"). The FTC also concentrates on national rather than regional or local advertising, patterns of deception rather than isolated disputes, and cases that pose the greatest threats of widespread economic injury.

Depending on the nature of the violation, the FTC or the courts can choose from a variety of remedies. These include cease and desist orders, civil penalties, orders to make refunds to consumers, and informational remedies such as running a new ad to correct misinformation in the original ad. Other federal legislation allows businesses to sue competitors for making deceptive claims in advertising.

CASE BY CASE

Bait-and-Switch Credit Card Offer

In a variation on the typical "bait-and-switch" scheme, a bank made a promotional offer of a "no annual fee" credit card, then changed the terms mid-year to require such a fee. A credit card holder sued the bank under the federal Truth in Lending Act (TILA). She alleged a violation of the requirement in TILA that an issuer of a credit card disclose the terms of the card accurately and without misleading statements. A federal court allowed the lawsuit to continue.

Both the advertisement soliciting customers for the credit card and the card holder agreement stated that no annual fee would be charged, but the agreement also stated more generally that the bank had the right to change any of the terms at any time. The bank maintained that the latter provision gave it the right to impose an annual fee whenever it wanted.

In ruling for the credit card holder, the court found that a reasonable consumer was entitled to assume that the issuer of the credit card would refrain from imposing an annual fee for at least one year. Given the apparent intent of the bank to begin an annual fee after the "bait" had been taken, the statement of "no annual fee" was misleading and in violation of TILA. If the bank had wished to reserve the right to impose an annual fee later, notwithstanding the "no annual fee" solicitation, further clarification would have been necessary to comply with TILA.

Casino Cheats Gambler

Steven was a multimillionaire businessman with a fondness for high-stakes gambling. His reputation as a high roller led a Las Vegas resort to recruit him to gamble at the grand opening of its new casino. The enticement from the casino was a $2 million line of credit.

When Steven was just getting warmed up in what figured to be a long stretch of gambling, casino officials informed him that he had used up the line of credit, plus several million dollars of his own money. Steven had been gambling not with chips but with a "player card," and cameras had been recording his betting results. He strongly disputed how much in the red he really was, but the casino made him leave the premises.

Steven sued the gaming company that operated the casino, and a jury added more millions to his net worth. He convinced the jury that the casino's goal on opening night was to improve its bottom line by forcing him to quit while he was in the hole. The casino officials knew that an experienced gamer like Steven could recoup his losses, and then some, in the same night, so they created the conflict over the amount of the gambling debt as an excuse to ask Steven to leave. This breached the agreement between the parties.

Evidence of underhanded tactics of the casino no doubt made an impression on the jury. Steven produced gambling debt invoices that the casino had generated even before he began to gamble. The videotapes from the night in question, which were key to proving just how much gambling debt Steven had incurred, had been destroyed by the casino. These tactics cast a cloud of suspicion over the casino's version of the events.

ARBITRATION CLAUSES IN EMPLOYMENT CONTRACTS

The Federal Arbitration Act requires courts to enforce clauses in commercial contracts that require arbitration of disputes. The U.S. Supreme Court has ruled that transportation workers engaged in interstate commerce are exempt from the Act. For other types of workers, the effect of the Supreme Court ruling was to reaffirm the enforceability of mandatory arbitration provisions in agreements entered into by workers engaged in interstate commerce.

Interstate Commerce Requirement

The Act's requirement that workers be engaged in interstate commerce is not especially difficult to meet, given the interconnectedness of the economy. When a nurse at a hospital tried to avoid binding arbitration of her wrongful discharge claim by arguing that her employment agreement had no impact on interstate commerce, the argument failed. The court pointed out that the nurse's employment depended on the constant use of supplies purchased from other states and that the hospital treated many out-of-state patients. More often than not, similar connections can be made between most jobs and the flow of interstate commerce, especially for large employers.

Level Playing Field

To say that employers and employees generally may bind themselves to arbitration is not to say that there is no judicial oversight. In the time since the Supreme Court cleared the way for mandatory arbitration, courts have been occupied with creating a level playing field when employers make the signing of an arbitration agreement a condition of employment. If its terms weigh too heavily in favor of the employer, the agreement, or at least the offending part, may be ruled invalid.

Finding that an arbitration agreement was "utterly lacking in the rudiments of evenhandedness," one federal court refused to enforce an agreement that allowed only the employer to choose the panel from which an arbitrator would be selected. Supposedly the parties were to achieve a fair result by using an alternate strike method to arrive at one arbitrator, but, given that the whole pool was selected by the employer with no constraints, "an impartial decisionmaker would be a surprising result." It may be possible to avoid this particular defect by stating in the agreement that the parties will use an arbitration service that takes measures to find an unbiased arbitrator having no potential conflicts of interest.

Paying the Costs

Splitting the costs of arbitration evenly between the parties may seem reasonable on its face, but some courts have invalidated such clauses as being too burdensome for individual employees. Aside from considering the respective abilities of the parties to pay what can sometimes be substantial up-front costs for arbitration, there is a concern that the prospect of shouldering those costs has a "chilling effect" on employees' rights to have their grievances heard. Alternative approaches include payment of all costs by the employer, waiver of the employee's share on a case-by-case basis if it is beyond the employee's means, or capping an employee's share at the level of costs that would be incurred in court.

To Arbitrate or Not?

Even before an arbitration clause is agreed to, and perhaps later scrutinized by a court, the parties need to consider some distinctions between mandatory arbitration and litigation. Since it is easier to request arbitration than to file a formal complaint in court, use of arbitration may mean an increase in disputes to be resolved. A decisionmaker in arbitration, if he or she is familiar with the industry in question, could understand complex issues better than a jury would. In arbitration, the dispute itself and the terms of any award frequently are kept confidential, affording the parties more privacy than a trial in open court. Finally, some of the same features that make arbitration a simpler and more streamlined approach, like limited factfinding and having no right to appeal, could weigh in one party's favor and against the other, depending on the circumstances of the case.

EMPLOYMENT LAW GUIDEBOOK

The U.S. Department of Labor has published a guidebook to provide businesses with general information on the laws and regulations that the Department enforces. The guidebook describes the statutes most commonly applicable to businesses and explains how to obtain assistance from the Department for complying with them.

The authority of the Department of Labor extends to many statutes, but the following are several that affect most employers: Employee Retirement Income Security Act (ERISA); Occupational Safety and Health Act (OSHA); Fair Labor Standards Act (FLSA); and Family and Medical Leave Act (FMLA).

The Employment Law Guide: Laws, Regulations and Technical Assistance Services can be accessed on the Internet at:

www.dol.gov/asp/programs/guide.htm

LIFE INSURANCE CAN BE PART OF YOUR ESTATE PLAN

Even if you have a relatively modest estate, life insurance can be an important aspect of estate planning for the obvious reason that it can substantially increase the value of your estate. Where the death of a person is premature and a young family is in need of support, life insurance may be the primary means for the family's financial survival.

Even in larger estates, life insurance can be useful by providing the liquidity necessary to pay estate taxes and expenses without the necessity of selling off assets that a family would prefer to keep intact. Additionally, life insurance, unlike many other assets, does not have to go through a time-consuming administrative process before it becomes available to beneficiaries. Therefore, life insurance can be an immediate source of funds for a surviving family.

Estate Taxes and Life Insurance

As is true of any aspect of estate planning, one objective is to minimize the federal estate tax effect that life insurance can have. The primary tax issue that arises is whether the insurance proceeds are included in the estate for federal estate tax purposes. Including the proceeds would generate additional estate tax liability and reduce the amount of the proceeds that are available to the decedent's heirs.

The fundamental rule is that the gross estate will include the value of life insurance proceeds if (1) the proceeds are payable to the decedent's estate and are thus receivable by the executor, or (2) the proceeds are payable to other beneficiaries, but the decedent possessed at his or her death any of the "incidents of ownership" with respect to any policy.

The term "incidents of ownership" is defined more broadly than to be limited to the legal ownership of the policy. The term includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy or pledge it for a loan, and to obtain a loan from the insurer against the surrender value of the policy. There are other indirect ways that the decedent can be found to possess incidents of ownership. For instance, if the decedent is the controlling shareholder of a corporation that possesses an incident of ownership, such possession is attributed to the decedent.

Another scenario that will result in the inclusion of life insurance proceeds in the decedent's estate arises under certain circumstances where the decedent was the initial owner of the policy but transferred such ownership to another person or entity within three years of his or her death. Thus, even where the decedent has rid himself or herself of all incidents of ownership in the policy, there is still the possibility of inclusion under this three-year rule.

Keeping Life Insurance Proceeds Out of Your Estate

A common device for handling the life insurance aspect of an estate plan is the life insurance trust. Typically, a person would initiate the life insurance coverage by acquiring the policy. He or she would then transfer all incidents of ownership of the policy to a previously created irrevocable trust, which would be the named beneficiary on the policy. Assuming that the person survived until at least one day more than three years after the transfer of the policy to the trust, there would be no inclusion of the proceeds in the settlor's estate. If a policy is transferred within three years of death, the proceeds are included in the estate.

If the trust itself acquired the policy, the person would never be the owner and the three-year rule would not apply. The problem would be that the person could neither direct nor require the trust's acquisition of the policy without risking the possibility that he or she would be regarded as the original owner of the policy for purposes of applying the three-year rule. Therefore, it is important that the trustee be completely independent of the decedent.

An insurance trust can also have the practical effect of serving as a means of coordinating the collection, investment, and distribution of the proceeds of several policies. An insurance trust can hold other assets that the decedent transferred to it during his or her life. The trust can also receive assets "poured over" to it by the decedent's will.

If life insurance is to be an element of your estate plan, it should be carefully integrated with the other aspects of the plan. Be sure to seek the guidance of a qualified professional to assist you.