Timely Insights for Businesses, Individuals and Private Investors
A Continuing Q&A with Sherman & Howard's
Changing Markets Practice Group

Ongoing U.S. and worldwide economic developments continue to impact the playing field for businesses, individuals and private investors. In December 2008 and October 2008 Changing Markets Client Advisories, Sherman & Howard's attorneys discussed some of the initial issues raised by these developments. In this Client Advisory, Sherman & Howard's attorneys continue their discussion of questions raised by these recent developments and ways in which we are assisting clients:

What steps should I take if a customer appears to be in shaky financial condition?

If you have a right to liens, such as mechanics' liens, be sure they are timely and accurately noticed and filed. Insist on payment in advance for future deliveries, if possible. Try to collect amounts due. Although payments received within 90 days of a bankruptcy are vulnerable to "preference" recovery, it is far better to have the funds and try to defend, such as with an "ordinary course of business" defense. And your customer may not file bankruptcy within 90 days of your receipt of the payment. Review your form of agreement or purchase order form, and add language providing you with a right to costs of collection and interest if payments are not made when due.

What are the first steps I should take when I learn of the bankruptcy of a customer?

If you delivered goods within 45 days before the bankruptcy, you must demand "reclamation" (return of the goods) in writing within 20 days of the bankruptcy petition or your rights arising from reclamation will be lost. (There are severe limitations on the remedies for reclamation, but since the right is easily asserted and quickly lost, you would want to provide the notice quickly, if the reclamation rights might be available.)

Mechanics' liens can still be perfected after a bankruptcy is filed. You would want to do this in a timely fashion. You need to file a notice with the bankruptcy court.

Consider whether your claim is large enough to want to serve on a creditor's committee; this can be time consuming, but is the source of the best information about the bankruptcy.

My company is getting more internal complaints from shareholders, partners or employees as a result of the recession. What should I do?

Some companies have experienced an uptick in management complaints by their own shareholders, partners or employees, in response to the economic downturn. Unfortunately, ignoring internal allegations of a legal violation or breach of management duties, in order to preserve resources during the downturn, can prove costly down the road. Managements who ignore legitimate complaints, or who undertake a review or investigation by the very same officers or directors against whom allegations have been made, may expose the company and themselves to substantial liability. Qualified counsel, audit committee members and knowledgeable personnel should be charged with promptly, confidentially and independently investigating such claims. Ordinarily these individuals will determine the relevant facts and whether any violation has occurred. They will then make appropriate recommendations to management for rejection of the claims or for corrective action that should be taken. An independent, internal investigation oftentimes is a strong defense by itself to an internal complaint, because it demonstrates management's judgment and diligence in responding to issues raised. Don't be penny-wise and pound-foolish during the recession - promptly investigate internal complaints through qualified personnel.

Will insurance cover claims asserted against me arising from the downturn in the economy and, if so, what should I do to maximize my coverage?

The proper handling of internal and external complaints and allegations of wrongdoing can also have insurance coverage implications. To the extent that the complaints will result in insurance claims, it is important to know that insurance companies are scrutinizing claims very carefully, looking at all aspects of an insured's conduct - from application for coverage to the reporting of a claim - in determining whether to extend coverage to a particular claim.

Companies should pay very close attention to applications for new or renewed insurance coverage, particularly for questions asking about knowledge of claims or potential claims. Company representatives and employees responsible for disclosing information in the application should err on the side of caution, working closely with the company's broker and counsel when completing the application. If an insured fails to disclose in an application circumstances which may give rise to a future claim, an insurer may seek to rescind the policy due to the insured's failure to disclose, leaving the insured to bear the cost of the claim out-of-pocket.

Insurers also scrutinize the timeliness of any claim made by the insured. Thus, if you receive an actual claim - in the form of a demand letter, lawsuit, or arbitration demand -- you should notify your insurer or your insurance broker immediately. If you fail to provide the insurer with timely notice of a claim, the insurer may seek to deny coverage for failure to comply with the policy's late notice provision. It may be tempting when a claim first comes in to focus energies entirely on understanding the claim and preparing a strategy to address the claim. However, it is very important to provide notice to the company's insurers right away.

Could treating workers as "independent contractors" or as exempt put my company at risk?

Economic hardship has also induced many businesses to give "creative" treatment to the people who work for them. While this "creativity" might have provided a quick short-term solution, it could mean substantial liability for those businesses over the long run. To stop the accumulation of liability, prudent businesses, under the cloak of the attorney-client privilege, are auditing (and if necessary, changing) their practices.

For instance, some businesses are improperly treating workers as "independent contractors," often at the workers' request, thereby putting themselves at risk for non-withheld employee income taxes, FICA payments, penalties, unemployment and workers' compensation taxes and premiums, overtime pay, minimum wage payments, civil rights claims, benefits under collective bargaining agreements, and ERISA non-discrimination rule violations. Also, multi-million dollar overtime pay liability is mounting for many employers because they wrongly designated employees as "exempt" under the wage and hour laws.

Necessity may be the mother of invention. But, according to Robert Byrne, so is "getting caught." It's wise for a business to detect problems with and fix its "creative" solutions before "getting caught."

Are there proactive steps I can take to minimize my company's exposure to risk?

Yes. Clients work with our attorneys not only to identify current internal misconduct but also, increasingly, to drive business planning that will reduce the risks and potential liability of any future internal misconduct. We advise clients proactively on a wide range of related business matters, including corporate governance, risk assessment, exploration of potential merger and/or acquisition targets, research on board of director candidates, and evaluation of current and potential borrowers.

Are any changes to estate planning laws expected in 2009? If so, what?

It is likely that Congress and the President will change the estate tax law in 2009, and while none of the exact changes are yet known, a few of the issues that Congress is considering include:

Unified Credit Equivalent Amount. Most commentators assert that Congress and the President will make the $3.5 million unified credit equivalent amount permanent. This amount may be indexed for the cost of living. The result of permanency will be no repeal in 2010 and no reduction of the amount to $1.0 million in 2011.
Rate. The effective rate for the federal estate tax is 45 percent. Estate planning professionals believe that Congress and the President will make the current maximum rate of 45 percent permanent.
Portability. Every US citizen has a maximum $3.5 million unified credit equivalency amount. With sophisticated wills and trusts, a couple may eventually transfer $7.0 million to the second generation free of estate tax. In other words, currently a specialized estate plan is required to ensure that both spouses' credit amounts are available. Congress is considering a change in the law that will permit the surviving spouse to utilize both spouses' credit amounts automatically.
Discounting. Family Limited Partnerships are used widely by individuals with significant estates. Estate taxes are reduced when the value of the limited partner's share of the partnership is discounted. The IRS believes that family limited partnerships and the associated discounts they produce are inappropriate. Some members of Congress agree and bills have been proposed to restrict the use of discounting. Click here for a more detailed discussion of how family limited partnerships work.

As an example of the use of a family limited partnership, consider a husband and wife who create a partnership to hold an asset worth $1 million. The wife is the general partner with all control and holds a 10 percent interest. The husband is the limited partner with no control and holds the remaining 90 percent interest. It is widely asserted that, because as a limited partner the husband has no control over the partnership and a limited market in which to sell his interest, the value of his interest is not $900,000 (90 percent of $1 million), but a reduced or discounted amount, perhaps $600,000. A gift or testamentary transfer at the $600,000 discounted amount reduces the associated gift tax or estate tax.
Grantor Retained Annuity Trusts (GRATs). These irrevocable trusts are designed to transfer future appreciation at no (or nominal) gift tax cost. They are also often used by individuals with significant estates and are ideal for people who own an asset with potential for significant future appreciation.

While options for restricting the use of GRATs have been discussed since President Clinton was in office, and President Obama has also indicated his support for changes to GRATs, many commentators believe that GRATs are unlikely to be changed in any bill that Congress finalizes in 2009.

A GRAT is an irrevocable trust. The grantor establishes the GRAT and contributes an asset (such as an interest in a company). The grantor may be trustee of the GRAT. The grantor retains the right to receive an annual annuity back from the GRAT for a period of years (commonly between two and five years). Any value remaining in the GRAT at the end of such period passes (free of transfer tax) to designated beneficiaries, typically the grantor's children.

The amount of the annuity payment frequently is set so that the grantor receives back assets with value equal to the value of the assets contributed plus an interest factor. The result is that the transfer to the GRAT is not a gift. (This technique is called a "Walton GRAT," after the Wal-Mart heirs who successfully fought for approval of the no gift GRAT.) The interest rate charged in relation to a GRAT is a rate prescribed monthly by the IRS and currently is 2.8 percent. In other words, a GRAT created today is effective if the assets contributed to the GRAT appreciate at an annual rate of more than 2.8 percent because any appreciation in excess of 2.8 percent passes tax-free to the beneficiaries of the GRAT.

What should taxpayers do in light of possible changes to estate planning laws?

There is no "one size fits all" conclusion for clients. Once new law is enacted, clients should review their estate plan with their estate planning attorneys to ensure that no changes are needed, but should do so with the knowledge that changes likely are unnecessary. Clients who have no estate plan or an outdated estate plan should consider implementing an estate plan in coordination with the forthcoming change in the law.

High net worth clients ($3.5 million for individuals and $7.0 million for married couples) may be impacted more by possible changes to the discounting of family limited partnerships or the handling of GRATs. If Congress restricts the ability to discount, clients' assets will be valued at higher amounts, which will result in a more significant estate tax burden. If Congress restricts the use of GRATs, the result will be a more significant estate tax burden. Thus, high-net-worth clients should consider whether a family limited partnership or GRAT should be implemented (a) while values are lower because of the current economic downturn, (b) while interest rates are low, and (c) before Congress implements a law that may restrict these techniques.

For more information please contact your Sherman & Howard relationship attorney or one of the attorneys in our Changing Markets Practice Group.

Sherman & Howard has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the Firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation.

Circular 230 Notice

This advisory contains provisions concerning a federal tax issue or issues. This advisory is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on any taxpayer by the Internal Revenue Service. For information about this statement, contact Sherman & Howard L.L.C. or visit our website at www.shermanhoward.com/PrivacyPolicy/Circular230/.

	Contact Us Services Attorneys News and Events Publications About the Firm Diversity Careers In the Media Events and Registration Press Releases Speaking Engagements Articles Client Advisories Subscriptions History Offices Pro Bono Interlaw Contact Us Culture Legal Opportunities Summer Associates Support Staff Publications Client Advisories Home > Publications > Client Advisories > View Timely Insights for Businesses, Individuals and Private Investors A Continuing Q&A with Sherman & Howard's Changing Markets Practice Group Ongoing U.S. and worldwide economic developments continue to impact the playing field for businesses, individuals and private investors. In December 2008 and October 2008 Changing Markets Client Advisories, Sherman & Howard's attorneys discussed some of the initial issues raised by these developments. In this Client Advisory, Sherman & Howard's attorneys continue their discussion of questions raised by these recent developments and ways in which we are assisting clients: What steps should I take if a customer appears to be in shaky financial condition? If you have a right to liens, such as mechanics' liens, be sure they are timely and accurately noticed and filed. Insist on payment in advance for future deliveries, if possible. Try to collect amounts due. Although payments received within 90 days of a bankruptcy are vulnerable to "preference" recovery, it is far better to have the funds and try to defend, such as with an "ordinary course of business" defense. And your customer may not file bankruptcy within 90 days of your receipt of the payment. Review your form of agreement or purchase order form, and add language providing you with a right to costs of collection and interest if payments are not made when due. What are the first steps I should take when I learn of the bankruptcy of a customer? If you delivered goods within 45 days before the bankruptcy, you must demand "reclamation" (return of the goods) in writing within 20 days of the bankruptcy petition or your rights arising from reclamation will be lost. (There are severe limitations on the remedies for reclamation, but since the right is easily asserted and quickly lost, you would want to provide the notice quickly, if the reclamation rights might be available.) Mechanics' liens can still be perfected after a bankruptcy is filed. You would want to do this in a timely fashion. You need to file a notice with the bankruptcy court. Consider whether your claim is large enough to want to serve on a creditor's committee; this can be time consuming, but is the source of the best information about the bankruptcy. My company is getting more internal complaints from shareholders, partners or employees as a result of the recession. What should I do? Some companies have experienced an uptick in management complaints by their own shareholders, partners or employees, in response to the economic downturn. Unfortunately, ignoring internal allegations of a legal violation or breach of management duties, in order to preserve resources during the downturn, can prove costly down the road. Managements who ignore legitimate complaints, or who undertake a review or investigation by the very same officers or directors against whom allegations have been made, may expose the company and themselves to substantial liability. Qualified counsel, audit committee members and knowledgeable personnel should be charged with promptly, confidentially and independently investigating such claims. Ordinarily these individuals will determine the relevant facts and whether any violation has occurred. They will then make appropriate recommendations to management for rejection of the claims or for corrective action that should be taken. An independent, internal investigation oftentimes is a strong defense by itself to an internal complaint, because it demonstrates management's judgment and diligence in responding to issues raised. Don't be penny-wise and pound-foolish during the recession - promptly investigate internal complaints through qualified personnel. Will insurance cover claims asserted against me arising from the downturn in the economy and, if so, what should I do to maximize my coverage? The proper handling of internal and external complaints and allegations of wrongdoing can also have insurance coverage implications. To the extent that the complaints will result in insurance claims, it is important to know that insurance companies are scrutinizing claims very carefully, looking at all aspects of an insured's conduct - from application for coverage to the reporting of a claim - in determining whether to extend coverage to a particular claim. Companies should pay very close attention to applications for new or renewed insurance coverage, particularly for questions asking about knowledge of claims or potential claims. Company representatives and employees responsible for disclosing information in the application should err on the side of caution, working closely with the company's broker and counsel when completing the application. If an insured fails to disclose in an application circumstances which may give rise to a future claim, an insurer may seek to rescind the policy due to the insured's failure to disclose, leaving the insured to bear the cost of the claim out-of-pocket. Insurers also scrutinize the timeliness of any claim made by the insured. Thus, if you receive an actual claim - in the form of a demand letter, lawsuit, or arbitration demand -- you should notify your insurer or your insurance broker immediately. If you fail to provide the insurer with timely notice of a claim, the insurer may seek to deny coverage for failure to comply with the policy's late notice provision. It may be tempting when a claim first comes in to focus energies entirely on understanding the claim and preparing a strategy to address the claim. However, it is very important to provide notice to the company's insurers right away. Could treating workers as "independent contractors" or as exempt put my company at risk? Economic hardship has also induced many businesses to give "creative" treatment to the people who work for them. While this "creativity" might have provided a quick short-term solution, it could mean substantial liability for those businesses over the long run. To stop the accumulation of liability, prudent businesses, under the cloak of the attorney-client privilege, are auditing (and if necessary, changing) their practices. For instance, some businesses are improperly treating workers as "independent contractors," often at the workers' request, thereby putting themselves at risk for non-withheld employee income taxes, FICA payments, penalties, unemployment and workers' compensation taxes and premiums, overtime pay, minimum wage payments, civil rights claims, benefits under collective bargaining agreements, and ERISA non-discrimination rule violations. Also, multi-million dollar overtime pay liability is mounting for many employers because they wrongly designated employees as "exempt" under the wage and hour laws. Necessity may be the mother of invention. But, according to Robert Byrne, so is "getting caught." It's wise for a business to detect problems with and fix its "creative" solutions before "getting caught." Are there proactive steps I can take to minimize my company's exposure to risk? Yes. Clients work with our attorneys not only to identify current internal misconduct but also, increasingly, to drive business planning that will reduce the risks and potential liability of any future internal misconduct. We advise clients proactively on a wide range of related business matters, including corporate governance, risk assessment, exploration of potential merger and/or acquisition targets, research on board of director candidates, and evaluation of current and potential borrowers. Are any changes to estate planning laws expected in 2009? If so, what? It is likely that Congress and the President will change the estate tax law in 2009, and while none of the exact changes are yet known, a few of the issues that Congress is considering include: Unified Credit Equivalent Amount. Most commentators assert that Congress and the President will make the $3.5 million unified credit equivalent amount permanent. This amount may be indexed for the cost of living. The result of permanency will be no repeal in 2010 and no reduction of the amount to $1.0 million in 2011. Rate. The effective rate for the federal estate tax is 45 percent. Estate planning professionals believe that Congress and the President will make the current maximum rate of 45 percent permanent. Portability. Every US citizen has a maximum $3.5 million unified credit equivalency amount. With sophisticated wills and trusts, a couple may eventually transfer $7.0 million to the second generation free of estate tax. In other words, currently a specialized estate plan is required to ensure that both spouses' credit amounts are available. Congress is considering a change in the law that will permit the surviving spouse to utilize both spouses' credit amounts automatically. Discounting. Family Limited Partnerships are used widely by individuals with significant estates. Estate taxes are reduced when the value of the limited partner's share of the partnership is discounted. The IRS believes that family limited partnerships and the associated discounts they produce are inappropriate. Some members of Congress agree and bills have been proposed to restrict the use of discounting. Click here for a more detailed discussion of how family limited partnerships work. As an example of the use of a family limited partnership, consider a husband and wife who create a partnership to hold an asset worth $1 million. The wife is the general partner with all control and holds a 10 percent interest. The husband is the limited partner with no control and holds the remaining 90 percent interest. It is widely asserted that, because as a limited partner the husband has no control over the partnership and a limited market in which to sell his interest, the value of his interest is not $900,000 (90 percent of $1 million), but a reduced or discounted amount, perhaps $600,000. A gift or testamentary transfer at the $600,000 discounted amount reduces the associated gift tax or estate tax. Grantor Retained Annuity Trusts (GRATs). These irrevocable trusts are designed to transfer future appreciation at no (or nominal) gift tax cost. They are also often used by individuals with significant estates and are ideal for people who own an asset with potential for significant future appreciation. While options for restricting the use of GRATs have been discussed since President Clinton was in office, and President Obama has also indicated his support for changes to GRATs, many commentators believe that GRATs are unlikely to be changed in any bill that Congress finalizes in 2009. A GRAT is an irrevocable trust. The grantor establishes the GRAT and contributes an asset (such as an interest in a company). The grantor may be trustee of the GRAT. The grantor retains the right to receive an annual annuity back from the GRAT for a period of years (commonly between two and five years). Any value remaining in the GRAT at the end of such period passes (free of transfer tax) to designated beneficiaries, typically the grantor's children. The amount of the annuity payment frequently is set so that the grantor receives back assets with value equal to the value of the assets contributed plus an interest factor. The result is that the transfer to the GRAT is not a gift. (This technique is called a "Walton GRAT," after the Wal-Mart heirs who successfully fought for approval of the no gift GRAT.) The interest rate charged in relation to a GRAT is a rate prescribed monthly by the IRS and currently is 2.8 percent. In other words, a GRAT created today is effective if the assets contributed to the GRAT appreciate at an annual rate of more than 2.8 percent because any appreciation in excess of 2.8 percent passes tax-free to the beneficiaries of the GRAT. What should taxpayers do in light of possible changes to estate planning laws? There is no "one size fits all" conclusion for clients. Once new law is enacted, clients should review their estate plan with their estate planning attorneys to ensure that no changes are needed, but should do so with the knowledge that changes likely are unnecessary. Clients who have no estate plan or an outdated estate plan should consider implementing an estate plan in coordination with the forthcoming change in the law. High net worth clients ($3.5 million for individuals and $7.0 million for married couples) may be impacted more by possible changes to the discounting of family limited partnerships or the handling of GRATs. If Congress restricts the ability to discount, clients' assets will be valued at higher amounts, which will result in a more significant estate tax burden. If Congress restricts the use of GRATs, the result will be a more significant estate tax burden. Thus, high-net-worth clients should consider whether a family limited partnership or GRAT should be implemented (a) while values are lower because of the current economic downturn, (b) while interest rates are low, and (c) before Congress implements a law that may restrict these techniques. For more information please contact your Sherman & Howard relationship attorney or one of the attorneys in our Changing Markets Practice Group. Sherman & Howard has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the Firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation. Circular 230 Notice This advisory contains provisions concerning a federal tax issue or issues. This advisory is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on any taxpayer by the Internal Revenue Service. For information about this statement, contact Sherman & Howard L.L.C. or visit our website at www.shermanhoward.com/PrivacyPolicy/Circular230/. © 2009 Sherman & Howard L.L.C. June 18, 2009 Copyright 2000-2010 Sherman & Howard L.L.C. All rights reserved. Privacy Policy \| Terms of Use

Timely Insights for Businesses, Individuals and Private InvestorsA Continuing Q&A with Sherman & Howard's Changing Markets Practice Group

Timely Insights for Businesses, Individuals and Private Investors
A Continuing Q&A with Sherman & Howard's
Changing Markets Practice Group