Fall 2008 Issue

REPORT TO COUNSEL

Henningson & Snoxell, Ltd. congratulates our colleagues on their selection as Super Lawyers.

2008 SUPER LAWYERS

You represent the firm's commitment to our principles of honesty, integrity, professionalism, and service.

Jeffrey A. Berg is the chair of the firm's Family Law Department. He represents clients in all areas relating to family law including custody, parenting time, property settlements, ante-nuptial agreements, and post-divorce issues. He helps clients through the difficult process of divorce with compassion and integrity. He is also an experienced mediator.

Craig T. Dokken practices in the areas of commercial and construction litigation in both federal and state court. Craig is active in local and state Bar Association activities and presently serves on the General Assembly and the Elections/Appointments Committee of the State Bar. He is a frequent lecturer at professional seminars and is an adjunct professor at Hamline University.

Steven M. Graffunder is the chair of the firm's Real Estate Department. He practices in the areas of commercial and residential real estate, construction law, mechanic's liens and banking law. He is an MSBA Board Certified Real Property Law Specialist and works closely with sellers, buyers, lenders, developers, investors and contractors concerning all of their real estate needs. He is a frequent lecturer at professional seminars.

James E. Snoxell is the chair of the firm's Business Law Department. He works primarily with business and corporate clients advising them about corporate law issues, and advising nonprofit organizations about their special legal concerns. He works with clients to prevent and resolve employment law problems, helps protect intellectual property rights and advises clients about business succession and personal estate planning needs.

Mark V. Steffenson is the chair of the firm's Litigation Department. His litigation practice includes contract disputes, employment law, ERISA matters, insurance coverage disputes and product liability claims. He works with clients on environmental and land use matters, shareholder, partnership and franchise disputes and represents clients in arbitration and mediation.

LANDOWNER GETS SETTLEMENT FOR "TAKING"

When the government takes aim at private property to be taken for some public purpose, more often than not any resulting litigation is a contest over how much the property owner should be paid, rather than whether the exercise of the power of eminent domain was appropriate in the first place.

From the landowner's standpoint, it is important to realize that adequate compensation is not determined simply on the basis of the current use of the property. Instead, the landowner is entitled to the value of the property based on its "highest and best" use (whether that use already exists or is only in the eye of a developer), so long as such a potential use is not too speculative or otherwise foreclosed by applicable laws and regulations.

The importance to a property owner of negotiating compensation on the basis of a best-case, but realistic, development scenario for the property is illustrated by a recent case in which the owner of a vacant, 22,000-square-foot lot settled with a town for compensation in an amount that was about 27 times higher than the amount initially offered by the town.

The lot was zoned for residential use, although at the time of the condemnation action the owner had no building or development plans. Appraisers hired by the town offered an opinion that the vacant lot's best use was only as open space, or as a buffer for an abutting lot. They reasoned that compliance with the town's lot area and frontage requirements, as well as with its road standards for improving the dirt road on which the lot was located, would be so burdensome as to make any development of the property prohibitively expensive. They also indicated that extensive development costs would preclude development even if the lot was considered to have grandfathered status that would protect it from certain town requirements.

For its part, the landowner retained experts who opined that the lot was, in fact, suitable for residential purposes and should be valued as such when arriving at a compensation figure for the taking. As the town's experts had noted, there were various requirements on the books that, in theory, could be costly to comply with. However, an examination of past rulings by the town's zoning and conservation officials showed that the lot was likely to be exempted from some of the requirements. Moreover, improvement of the dirt road, which would have been an especially big-ticket item, was not likely to be required.

Both sides were necessarily looking into the future to some extent, but the landowner was able to depict a scenario for the lot that was optimistic enough to bring about a favorable monetary settlement with the town.

CYBER INSURANCE FOR BUSINESSES

Businesses have been dependent on computerized information for some time now, but it has been only relatively recently that insurance companies have devised and offered insurance policies specifically tailored to the potential losses from a variety of problems that can affect a computer system.

An early impetus for cyber insurance was anticipation in the late 1990s of losses associated with the coming of "Y2K." That concern turned out to be overblown, but the threats that have spurred cyber insurance offerings since then are real enough, including viruses, hackers, and legal injuries to others from information on a company's website. One study has found that the average annual technology- related financial loss for United States companies more than doubled just from 2006 to 2007.

Another development that prompted more cyber insurance policies was the realization, which sometimes came as a surprise to insured businesses, that general liability policies did not cover computer problems. Cyber insurance is a good idea for all of the usual reasons associated with insuring against business losses. But it also makes sense because of the particular costs associated with responding to a computer data breach, especially now that many states have adopted data breach notification laws.

This kind of postmortem after a breach could include such measures as notifying affected customers, paying for credit monitoring for those customers, replacing compromised credit or debit cards, and undertaking forensic analyses of affected databases. All in all, there are some expensive scenarios to insure against.

Categories of Losses

The losses covered by cyber insurance generally fall into two categories: first-party losses, meaning those affecting the business itself; and third-party losses, meaning incidents mainly affecting outside parties, including the customers of a business. Of course, the same underlying problem can cause both kinds of losses, such as when unauthorized access to a computer system shuts down the computer system of a company whose customers or clients rely on that system through an extranet.

A comprehensive cyber insurance policy should encompass both kinds of risks. These are the typical categories of coverage:

• First-party business interruption, covering lost revenue experienced during downtime due to accidents or security breaches (but typically not losses due to catastrophic regional power outages);
• First-party electronic data damage, such as the compromise of data from a virus infection;
• First-party extortion, including the demands made by hackers;
• Third-party network security liability, arising from compromise and misuse of data stemming from identity theft and credit-card fraud;
• Third-party network liability in the form of court judgments obtained by persons harmed by problems originating with a business's computer system; and
• Third-party media liability, aimed at the full range of potential liability from matter published in interactive online communications.

LLC RULING FAVORS TAXPAYERS

Anna was the mother of three children and the widow of the man who invented the heart defibrillator implant. In 1992, she created a trust for each of her daughters and gave a portion of her substantial interests in patent licenses to the trusts. In 2001, she created a limited liability company (LLC), to which she made some large transfers. She then gave a 16% interest in the LLC to each of the trusts, keeping a 52% interest to herself. Only four days later, Anna died suddenly and unexpectedly.

The IRS claimed a deficiency of millions of dollars in estate taxes. It pointed to a part of the Internal Revenue Code that provides that all property is to be included in a decedent's estate to the extent that the decedent has transferred an interest in the property while retaining for life the possession or enjoyment of, or income from, the property. There is an exception to this general rule in cases of a bona fide sale for full and adequate consideration in money, but the IRS argued that the exception did not apply in the case of Anna's estate.

In a somewhat surprising decision, given a recent trend favoring the IRS in such disputes, the United States Tax Court sided with the estate and kept the LLC assets out of the gross estate for estate tax purposes. The court ruled that the bona fide sale exception applied, notwithstanding that the LLC activities were not in the nature of a "business." It was sufficient that Anna had "legitimate and significant nontax reasons" for creating and funding the LLC, including joint management of family assets, pooling family assets to maximize investment opportunities, and providing for each of her daughters on an equal basis.

Some practical lessons for minimizing estate tax liability while using family LLCs emerge from the case of Anna's estate. They include the following: (1) document the legitimate and significant motivations, unrelated to estate taxes, for forming such an entity; (2) continue the entity after the decedent's death, to avoid the appearance of an ordinary trust; (3) if, as in Anna's case, the donor dies unexpectedly a short time after the gifts, be prepared to demonstrate that the death was unexpected; and (4) keep sufficient assets outside of the entity to cover the donor's living expenses, to avoid the possibility that the donor will treat the assets of the entity as her own. The planning, drafting, and advice associated with a family LLC entails resolution of complex issues and requires the guiding hand of a knowledgeable professional.

GET IT IN WRITING

When an Internet executive held a meeting with the chairman of a telecommunications company, the agenda was a new business idea that the Internet executive had. The discussion was transformed into a recruitment when the telecommunications executive suggested that the idea should be pursued within the company he headed. For two men in the upper echelons of high-tech businesses, they then chose a decidedly low-tech way to memorialize their agreement. The end result, however, shows how substance can sometimes triumph over form in the law of contracts formation.

At the end of their meeting, the telecommunications executive simply wrote out the agreement by hand on two notebook pages, and both men signed it. The writing included specifics as to how the newly hired executive would be compensated, the terms on which he could quit if he became unhappy, and what would happen if intellectual property involved in the deal could not be transferred to the telecommunications firm. It also included the statement that "[t]he parties will complete formal contracts as soon as possible but this is binding." This would turn out to be pivotal language in the litigation that followed.

Unfortunately, the new arrangement quickly went downhill, and after about six months the new employee was fired. The relationship ended with the "formal contracts" never having been drafted and executed. When the former employee sued for breach of contract and other wrongs, more than six years of litigation ensued, with two trials and two appeals.

Much of the case focused on whether the handwritten agreement that started everything was a valid, binding contract. The telecommunications company argued that it was merely an "agreement to agree." However, a jury eventually ruled that the agreement was valid, and that the telecommunications firm had breached the terms of the contract represented by the two notebook pages.

Four factors are usually considered in determining whether a "preliminary agreement" is binding. In this case, the first two clearly favored the fired executive: There was no explicit reservation of a right not to be bound (in fact, the handwritten agreement said the opposite) and the executive had partially performed the contract. The third factor is whether all of the terms of the alleged contract were agreed upon. On that point, the agreement, although it may have lacked some details, addressed all of the essentials for a binding contract.

The final factor is whether the agreement was a type of contract that is usually committed to writing in a formal manner. When millions are at stake, as was the case here, it may be unusual to seal the deal with a handwritten document, in outline form, and drafted on the spot by one of the principals without benefit of legal counsel. The agreement was not much to look at, barely surpassing in formality the proverbial agreement scribbled on a cocktail napkin. Still, that it was unorthodox did not mean that the method was unprecedented. In the end, this factor, balanced against the other three, was not enough to discard the agreement and deprive the departed executive of the benefits of his bargain.