If the summer whizzed by too fast and you are still using your old Circular 230 disclaimer on emails and correspondence, it is time to fix that.
In June, the U.S. Treasury Department finalized Circular 230 regulations which replaced the covered opinion rules with one standard for written advice under Circular 230 section 10.37. The Director of OPR was quoted in Tax Notes Today, June 17, 2014 as follows: “ if a disclaimer says 'The Internal Revenue Service says' or 'I am required under Circular 230,' I can promise you that you will get a letter from my office asking you to cease and desist using that kind of language because I don't want taxpay-ers to be misinformed. We do not require that language after last week."
Many attorneys, CPAs and Enrolled Agents are simply removing the disclaimer and not replacing it with any specific language. Some are using more generic language to say that nothing in the email message constitutes a tax opinion.
This is a good opportunity to caution employees about communications via email mes-sage given security issues with unsecured emails and potential privilege issues. And it will certainly shorten some email threads, especially those between tax professionals, which were often piled high with back and forth Circular 230 disclaimers.
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A Massachusetts Land Court judge has ruled certain e-mail communications sent by coun-sel to a real estate development company’s independent contractor were protected by the attorney-client privilege and not subject to disclosure in discovery or use at trial. The ruling broadens the application of the attorney-client privilege to a client’s consultants under Mas-sachusetts state law and has significant implications for attorneys communicating with their clients in transactional matters, as well as litigators seeking to obtain or prevent discovery of communications between attorneys and non-employee consultants of clients.
The ruling in One Ledgemont LLC v. Town of Lexington Zoning Board of Appeals, et al., addressed a discovery dispute in litigation arising from a business transaction. At the time of the underlying transaction, counsel for one of the defendant real estate development company sent a number of e-mails to the company’s employees, with copies to a consult-ant working with the company on the transaction. The parties did not dispute the consultant was neither an officer nor paid employee of the defendant.
Nor did the defendant claim the consultant was a necessary agent of the company whose involvement was needed to enable effective communication with counsel, such that the e-mails would remain protected by the attorney-client privilege, as articulated in the Supreme Judicial Court’s decision in Commissioner of Revenue v. Comcast Corp., 453 Mass. 293 (2003). Originally, instead, the defendant argued the Land Court should adopt the “functional equivalent” doctrine recognized in federal courts, according to which the court does not distinguish, when applying the attorney-client privilege to a corporation, between an employee and an independent contractor who is the functional equivalent of an employee. (cont. page 2)
Communications and Privilege: Circular 230 Reminder by Elizabeth J. Atkinson, Esq.
CALIFORNIA | COLORADO | CONNECTICUT
MARYLAND | MASSACHUSETTS | MICHIGAN
NEVADA | NEW JERSEY | NEW YORK
PENNSYLVANIA | TEXAS | VIRGINIA
Attorneys’ E-mails to Client’s Independent Contractor May Be Protected by Attorney-Client Privilege by Ben N. Dunlap, Esq.
The Land Court adopted and applied the functional equivalent doctrine, reasoning the independent contractor’s “position and role in the business life of the [defendant company] [were] the functional equivalents of those which would be held by someone getting a paycheck from the entity directly.” The Court considered the consultant’s “unusual role” which gave him “exclusive leasing and advisory opportunities and responsibilities with the [defendant company] that were of long duration, highly deferen-tial, and made him a key decision leader for the most senior man-agement.” The Court noted the consultant “garnered a large amount of his compensation from the [defendant company] alone,” the company had “veto power” over his ability to serve other clients, and “[n]o other broker or advisor had any real role in how [the company] acquired, ran, leased, improved, developed, and disposed of its real estate assets.” For those reasons, the Court determined the consultant was “the same as” a “high level principal or employee” of the defendant company, and concluded that without his involvement, “the lawyers’ advice may have been deficient, and based on less than the best input from the client.”
The Court cautioned against broad application of the functional equivalent doctrine, however, emphasizing the atypical nature of the consultant’s role with the defendant company: “Where the relationship with the company is one the non-employee has with many other clients or customers; is single-purpose and limited in scope, duration, and responsibility; or does not put the non-employee in a high-level, trusted decision-making or guiding role, equivalent to that of an employee, the non-employee does not hold the status necessary to keep communications involving him or her privileged.”
Nonetheless, if adopted by other Massachusetts trial and appel-late courts, the functional equivalent doctrine may have potentially far-reaching effects. In the right circumstances, corporate counsel may share advice freely with clients’ high-level, long-term consult-ants without fear that such sharing will waive the attorney-client privilege. Companies relying substantially on independent con-tractors to perform work may be emboldened to involve them in legal decision-making as well as business matters. In litigation, counsel may be precluded from obtaining certain documents and taking testimony from non-employee consultants of their oppo-nents.
Because the application of the functional equivalent doctrine is highly fact-specific, however, its scope will likely be defined in future litigation where companies invoke the attorney-client privi-lege to avoid disclosure of attorney communications sent or copied to consultants.
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Independent Contractor cont.
New York Appeals Court Decision Allows Predecessor Counsel to Place Equal Blame on Successor Counsel in Legal Malpractice Action by Elitza V. Miteva, Esq.
In two consecutive slip opinions, Rehberger v Garguilo & Orzechowski, LLP, 118 A.D.3d 765; 118 A.D.3d 767 (June 11, 2014), a New York Appeals Court affirmed a trial court’s decision allowing a defendant law firm in a legal malpractice matter to main-tain third-party contribution claims against the plaintiff’s subsequent counsel, even in the absence of any allegations of wrongdoing by the plaintiff.
The plaintiff, through its law firm Dollinger, Gonski & Grossman (“Dollinger”), commenced the legal malpractice action to recover damages arising from misconduct allegedly committed by Garguilo & Orzechowski, LLP and Jerry Garguilo (“Garguilo”) while representing him in a declaratory judgment action to enforce the buy-out provi-sion of a stock agreement. The plaintiff alleged that Garguilo failed to serve a notice required by the stock agreement upon the individual shareholders, which resulted in a judgment dismissing them from the action.
Garguilo filed a third-party complaint for contribution and common-law indemnification against Dollinger, alleging that as successor counsel during the relevant time period, Dollinger had sufficient opportunity to fully protect the plaintiff’s rights when it took over the case. Garguilo claimed, if the plaintiff were able to establish that Garguilo committed malpractice, then Dollinger was culpable for essentially the same conduct because it too failed to serve notice on the individual shareholders and to take action against those share-holders to enforce the buy-out provision of the stock agreement.
(The trial court denied Garguilo’s motion for summary judgment as to its third-party contribution and indemnification claims against Dollinger, as Garguilo’s negligence could not be determined as a matter of law. The trial court also denied Dollinger’s motion for sum-mary judgment as to Garguilo’s third-party claim for contribution, reasoning Dollinger had failed to establish that it did not breach a duty owed to the plaintiff that contributed to or aggravated his alleged damages. The trial court, however, ruled Dollinger could not be held liable for indemnification as a matter of law, because any liability of Garguilo to the plaintiff would be based on actual wrongdoing by Garguilo, and not on vicarious liability for the conduct of Dollinger.
In light of this Appeals Court decision, both predecessor counsel and successor counsel may benefit from employing certain risk manage-ment practices. For example, upon turn-over of the litigation file to successor counsel, predecessor counsel should include a memoran-dum highlighting, among other things, any approaching deadlines, tasks requiring completion, and weaknesses to be addressed. Like-wise, successor counsel should approach the new engagement as more than just a new case. As successor counsel, a law firm does not have the benefit of a “clean slate” and the file may contain issues that predecessor counsel neglected. Successor counsel ought to identify those mistakes and work with the client to determine the best manner in which to fix them.
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In a recent decision, Mark G. DeGiacomo, Tr. of the Est. of Inofin Inc. v. Raymond C. Green, Inc. (In re Inofin Inc.), 512 B.R. 19 (Bankr. D. Mass. 2014), the United States Bankruptcy Court for the District of Massachusetts held the parties’ course of perfor-mance can modify the scope of the collateral secured in a written security agreement.
On the heels of a Securities and Exchange Commission investiga-tion and eventual “cease and desist” order from the Massachu-setts Division of Banks, in 2011, several creditors filed an invol-untary petition against Inofin Incorporated (“Inofin”) under Chap-ter 7 of the Bankruptcy Code. Inofin was a financing company specializing in purchasing and servicing sub-prime automobile loans from dealerships. After the sale of an automobile to a con-sumer, the dealerships would sell or assign the installment contract to Inofin. Private lenders, such as Raymond C. Green, Inc. (“RCG”), provided Inofin with the capital to purchase the installment contracts from the dealerships.
Inofin and RCG commenced their relationship in 1996, when RCG and a predecessor to Inofin entered into a $500,000.00 secured loan. In connection with the 1996 loan, Inofin and RCG entered into a written security agreement (the “1996 Security Agreement”) that defined the secured collateral as: “all of [Inofin]’s rights in and to chattel paper…and…installments sales contracts [sic] purchased by [Inofin] with the proceeds of loans from [RCG] and assigned and delivered to [RCG].” (emphasis added). RCG also filed a UCC-1 financing statement with the Massachusetts Secretary of State’s Office in April, 1996, perfect-ing RCG’s security interests in the secured collateral.
Over the course of the next fifteen years, the parties’ conduct did not conform to the express language in the 1996 Security Agree-ment, requiring Inofin to purchase the installment contracts with funds from loans provided by RCG. Instead, Inofin comingled RCG’s funds with those of other lenders, making it impossible to determine which installment contracts Inofin had purchased with proceeds from RCG’s loans and which were purchased with pro-ceeds from other private lenders.
Given RCG’s inability to establish which installment contracts Inofin purchased using the proceeds from RCG’s loan, the Bank-ruptcy Trustee argued that RCG’s security interest failed to attach. The Bankruptcy Court disagreed, finding the 1996 Security Agreement was only partially integrated and, therefore, merely supplemented the parties’ course of performance. During the adversary proceeding, there was testimony from Inofin and RCG that, on a weekly basis during the parties’ fifteen year relation-ship, Inofin assigned and delivered to RCG installment contracts with an attached allonge, stating: Inofin was assigning to RCG all of its rights, title, and interest to the installment contracts at-tached thereto. Inofin and RCG testified the allonges were intend-ed to be additional grants of security, supplementing those given under the 1996 Security Agreement. The Bankruptcy Court agreed and found the assignment language in each allonge, together with the parties’ course of performance, constituted the “security agreement”.
Although not the intended effect, this holding opens up the possi-bility of collusion between a debtor and creditor (to the detriment of other creditors), claiming their course of performance supple-mented their written security agreement. Whether other courts follow this decision or limit it to its facts remains to be seen. It would be premature and foolhardy, however, for lenders and other secured parties to rely on this decision expecting the same result. Instead, the better and more prudent course of action would be for a secured lender to re-review its written security agreements to ensure the parties’ conduct thereafter conforms to the written language.
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Bankruptcy Court Rules that a Security Agreement May be Modified by Parties Course of Performance by Jessica N. Kennedy, Esq.
In Greenbaum v. Holian, MICV201303793A, 2014 WL 2743141 (Mass. Super. Mar. 26, 2014), the Superior Court held a legal malpractice claim against an attorney’s estate was not time barred despite being filed outside the one-year statute of limitations. The Court found the client was excused from compliance with the limitations period because the client had shown an absence of “culpable neglect” in failing to discover the attorney’s nondisclosure within one year following the attorney’s death. Thus, the client was entitled to equitable relief pursuant to M.G.L. c. 190B, §3-803 from the general prohibition against commencing such an action more than one year after the attorney’s death.
The plaintiff Greenbaum filed suit on November 29, 2012 assert-ing a legal malpractice claim against attorney Charmoy who died, more than two years earlier, on July 12, 2010. In deciding wheth-er the plaintiff was entitled to equitable relief under M.G.L. c. 190B, §3-803, the Court found that prior to his death, Charmoy had served for more than thirty years as legal counsel to Green-baum. Over the years, Charmoy occasionally presented Greenbaum the opportunity to make secured loans to Charmoy’s clients. In those transactions, Greenbaum relied on Charmoy to describe the borrowers and the loan terms to him. Greenbaum would not communicate directly with the borrowers. Based on Charmoy’s representations, Greenbaum understood and expected the loans would be secured by adequate collateral and used exclusively for business, not personal purposes. Charmoy prepared all docu-mentation for the loans and handled the closings.
In January 2008, Greenbaum approved a loan of $125,000 to Pisaladis, a client of Charmoy’s. The loan was secured by separate mortgages on Pisaladis’ residence and on a commercial property in Dedham. Consistent with Charmoy’s representations to Greenbaum and Greenbaum’s understanding, the promissory note required the loan proceeds not be used for “personal, family, or household purposes.”
Following the loan closing, in February 2008 Greenbaum received, but did not review, various documents and correspondence from Charmoy concerning the loan. Included was a Settlement State-ment showing a disbursement from the loan to Marie Hodgdon a/k/a Maria Theodurou in the amount of $89,500. Also included was a copy of a check in the amount of $90,850 to Hodgdon/Theodurou, with the notation “Pisaladis.” Mr. Greenbaum testified he did not notice either document indicating proceeds of the loan had been paid to Hodgdon/Theodurou. In January 2010, pursuant to loan modification documents Charmoy prepared, the mortgage on Pisaladis’ residence was released, thus leaving the outstanding balance on the loan secured only by the Dedham property.
Before Charmoy’s death, Pisaladis made timely interest payments directly to Charmoy, who delivered them to Greenbaum. After Char-moy’s death, Pisaladis made timely interest payments directly to Greenbaum until September 2011, when Pisaladis missed a payment. Around that time, Pisilidis told Greenbaum he was negotiating “a debt situation” with another lender, but assured Greenbaum the loan would be repaid. In one conversation around that time, Pisaladis informed Greenbaum that proceeds from the loan had been used to settle a claim arising from an auto accident with Marie Hodgdon a/k/a Maria Theodurou.
Pisilidis filed for bankruptcy on May 12, 2012. Unbeknownst to Greenbaum, another lender held two pre-existing mortgages on the Dedham property at the time it was mortgaged to Greenbaum as security for his loan to Pisaladis. Greenbaum alleged Charmoy knew, but failed to disclose, that the mortgage on the Dedham property was junior to those pre-existing mortgages. Greenbaum further alleged he suffered a loss as a result of Pisilidis’ bankruptcy and the inadequacy of the collateral securing the loan.
Greenbaum relied on Section 3–803(e) to argue he was entitled to equitable relief from the general requirement (under G.L. c. 190B, § 3–803) that actions against an estate must be brought within one year of the decadent’s death. Section 3–803(e) provides an excep-tion to the one-year limitations period if the court finds “that justice and equity require it and that [the plaintiff] is not chargeable with culpable neglect in not prosecuting his claim” within the limitations period. As explained by the Court,“[t]he burden is on the [plaintiff] to show both that justice and equity require recognition of a merito-rious claim and that failure to bring the claim was not due to care-lessness or lack of diligence.” The Court further explained this statutory exception “is remedial in character[; i]ts operation is not limited to cases where the failure to sue seasonably was due to such fraud, accident or mistake as would be ground for equitable relief if there were no statute.”
The Court held Greenbaum satisfied the first prong of the test requiring the plaintiff to show its claims have “substantial merit.” The evidence showed one of Charmoy’s former law partners over-heard Pisalidis tell Charmoy when the loan was made that the proceeds would be used to settle a personal claim against Pisalidis. The evidence further supported that Charmoy knew of the unau-thorized use of the proceeds because his office prepared the Settle-ment Statement and check reflecting payment to Hodgdon.
The Court rejected the Estate’s argument that it would be unfairly prejudiced if the claim were allowed to proceed due to Charmoy’s law firm having dissolved shortly after his death. More specifically, the Estate argued it had limited access to computer files and poten-tial witnesses, in particular, Charmoy’s assistant who died in 2013. The Court acknowledged a showing of prejudice may prevent Sec-tion 3–803(e) from extending the limitations period. The Estate, however, made no particularized showing of any prejudice. As the Court explained, the Estate “points to no specific document that cannot be found”; “offers no evidence as to what witnesses, other than Mr. Charmoy’s assistant, are now unavailable or what these witnesses might know”; and “fails to describe any information the assistant might have had” which is now unavailable.
(cont. page 5)
Late-Filed Legal Malpractice Claims Against Deceased Attorney’s Estate Allowed to Proceed
by David A. Slocum, Esq.
Late-Filed Legal Malpractice Claim cont.
Massachusetts Attorneys Must Be Wary of Constructive Waiver of An Affirmative Defense by Lauren A. Appel, Esq.
As to the “culpable neglect” prong of the analysis, the Court ex-plained a plaintiff “must establish that failure to file suit within the one-year limitations period was not due to carelessness or to any lack of diligence for which [the plaintiff] might properly be censured or blamed.” The Court was not persuaded by the Estate’s argument that Greenbaum reasonably should have inquired further about the collateral, and/or reviewed the loan documents in 2008, which would have put Greenbaum on notice that the proceeds were used for personal purposes. Key to the Court’s determination was Char-moy’s fiduciary status. As explained by the Court: “[t]he problem with [these] contentions is that they ignore the fiduciary duty owed to the [client] .... Greenbaum ... [is] not culpable for relying upon Charmoy fully to disclose the terms of the transaction and the known uses of the loan proceeds.” The evidence showed Greenbaum re-lied upon Charmoy as his trusted legal advisor to handle all aspects of the loan. As a fiduciary, Charmoy had an obligation “fully to dis-close” to his client the facts of the transaction, and “[m]erely sending the client the documents relating to the closing of the loan with no explanation as to the reason for the payment from the loan proceeds to Hodgdon, and no description of the mortgages received by the [client], fail[ed] to satisfy that duty of disclosure.”
In applying the “culpable neglect” standard, the Court held the ques-tion was whether Greenbaum had notice of his claim within one year following Charmoy’s death. Even though Greenbaum did not bring suit until fourteen months after the time he had become concerned (September 2011 when Pisalidis missed a payment), the absence of culpable neglect during the 12-month period imme-diately following Charmoy’s death was satisfied for purposes of Section 3-803(e). Thus, Greenbaum was entitled to relief under Section 3-803(e).
The Probate bar should take note of this decision, as it has potential-ly broad application going forward. The decision makes it clear that a legal malpractice claim survives the statute of limitations where the client does not know of the basis for the claim until more than a year after the attorney’s death. The decision also provides an important reminder to all lawyers regarding their fiduciary obligation of “full disclosure” to the client; sending a client a document without expla-nation as to its significance does not satisfy this obligation.
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The Massachusetts Supreme Judicial Court (“SJC”) recently re-affirmed that, in certain circumstances, a party’s subsequent conduct in litigation can negate an affirmative defense of lack of juris-diction. While the SJC’s ruling is in line with prior state appellate court rulings and federal court decisions considering the constructive waiver issue, the holding serves as a reminder to defense counsel to act promptly to preserve a client’s defense.
In American Int'l Ins. Co. v. Seuffer GMBH & Co., 468 Mass. 109 (2014), a products liability case, the defendant asserted a lack of personal jurisdiction defense in its answer to the complaint. Approxi-mately twenty months later, after the defendant had participated in significant discovery, the defendant moved for summary judgment on its affirmative defense of lack of personal jurisdiction. The trial court denied the motion, finding the defendant had waived its affirm-ative defense of personal jurisdiction by participating in extensive litigation. The SJC agreed.
In affirming the trial court’s decision, the SJC examined the following three factors: (1) the amount of time that had elapsed, as well as the changed procedural posture of the case, in the period between the party’s initial and subsequent assertion of the defense; (2) the extent to which the party engaged in discovery on the merits; and, (3) whether the party engaged in substantive pre-trial motion prac-tice or otherwise actively participated in the litigation. Applying these factors, the Court found the long delay of twenty months between the filing of the answer and the defendant’s summary judgment mo-tion, together with the extent of discovery the defendant conducted -- served and responded to written discovery and took four depositions -- constituted a waiver of its personal jurisdiction defense.
While the notion that a previously asserted defense may be lost based on such broad factors is certainly troubling for defense attor-neys, the holding must be viewed in light of the circumstances surrounding the case. In a footnote, the SJC noted that the statute of limitations on the plaintiff’s claim likely would have run in the proper jurisdiction -- Wisconsin -- if the defendant prevailed on summary judgment. Accordingly, it appeared the defendant had delayed filing its motion to dismiss for lack of personal jurisdiction as a tactic to prevent the plaintiff from re-filing in the correct state court. The SJC’s ruling serves both as a reminder to promptly move for dismissal on jurisdictional grounds and a warning not to delay a dispositive motion on an affirmative defense as a means to gain an tactical advantage in a litigation.
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Recent Appeals Court Ruling Highlights Important Qualifications to the Work Product Doctrine by Catherine A. Bednar, Esq.
In a recent decision, Cahaly v. Benistar Property Exchange Trust Co., 85 Mass. App. Ct. (2014), the Massachusetts Appeals Court vacat-ed the Superior Court’s denial of a motion for sanctions against a Boston law firm for withholding documents in connection with a 2002 trial. In the underlying action, the law firm defended a major investment firm that handled the accounts of the primary defendant, a trust company. The plaintiffs contracted with the trust company to hold their funds in escrow while they engaged in tax-advantaged "like-kind" property exchanges under Internal Revenue Code, 26 U.S.C. § 1031. Instead of holding the plaintiffs’ funds in escrow, however, the trust company deposited the funds with the law firm’s client and other investment companies, losing more than $8 million of the plaintiffs’ funds.
At issue were documents which the law firm obtained during discov-ery and prior to trial showing that an employee of the investment company visited the trust company’s website and, in particular, visit-ed the § 1031 pages of the trust company which revealed that the trust company was an intermediary holding third-party funds. Previ-ously, the law firm filed a motion for summary judgment on behalf of the investment company, arguing that at no time was the invest-ment company aware that the funds in the trust company’s invest-ment accounts were in fact escrowed funds belonging to third parties. The investment company continued to maintain this defense through trial.
The law firm reasoned the employee who visited the § 1031 pages was a compliance specialist, who generally acted under the direction of the investment company’s in-house attorneys. Accordingly, the law firm determined the documents were prepared in anticipation of litigation and, thus, were protected from disclosure under the work product doctrine. The law firm also prepared supplemental answers to interrogatories disclosing the employee viewed the subject website pages but, ultimately, decided not to serve these supplemental responses in light of its decision the work product doctrine applied to the documents. During a second trial in 2009, the investment company was represented by new counsel, who produced the documents. The plaintiffs then moved for sanctions on the grounds that the original law firm had improperly withheld the documents.
In its decision, the Appeals Court held the law firm could not with-hold evidence that the investment company’s employee viewed the pages while at the same time assert, as part of its defense, that no employee was aware of this information. Although the trial judge correctly cited the principle of Commissioner of Rev. v. Comcast Corp., 453 Mass. 293 (2009), that the work product doctrine may protect documents that a party’s nonlawyer representative obtained in anticipation of litigation, the trial judge failed to address two important qualifications to the work product doctrine set forth in Comcast.
The first qualification was whether the plaintiffs had made a show-ing of substantial need for the work product material and an inability to obtain its equivalent by other means. The Appeals Court found they did. A substantial need was shown because the work product at issue was central to the parties’ substantive claims. The second qualification was consideration of the distinction between fact work product and opinion work product. As discussed in Comcast, fact work product is entitled to less protection than opinion work product involving an attorney’s mental impressions, opinions, or legal theo-ries. The Appeals Court determined the law firm was not justified in withholding the fact that an investment company employee had viewed the § 1031 pages. The Appeals Court further held, even if one assumed the law firm was reasonable in its belief that the mate-rials revealed the attorney’s mental impressions and, therefore, con-stituted opinion work product, the documents were nonetheless discoverable because the investment company and its counsel had put their knowledge “at issue” in making out their defense; they withheld evidence which “ran directly counter to the heart of [the investment company’s] defense that it had no such knowledge.”
Consequently, the Appeals Court vacated the trial judge’s decision that the materials were protected from disclosure under the work product doctrine. The Appeals Court remanded the matter for a de-termination by the fact finder as to whether the law firm’s miscon-duct was the result of “genuine, professional judgment” or if, in-stead, the law firm unfairly sought a tactical advantage warranting sanctions.
In its 2009 Comcast decision, the Supreme Judicial Court noted a party is entitled to opinion work product only, if ever, in rare circumstances and upon a “highly persuasive” showing of need. The Cahaly decision illustrates a situation where opinion work product is discoverable: when a party withholds evidence that controverts its own claims or defenses.
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Massachusetts Now Permits Attorney Conducted Voir Dire and Arguments on Specific Amounts of Damages by Andrew Fay, Esq.
On August 6, 2014, Massachusetts Governor Deval L. Patrick signed into law a bill that will permit attorney conducted voir dire in Massachusetts. The bill was backed by the Massachusetts Bar Association. Until now, voir dire in Massachusetts was conduct-ed almost exclusively by judges. The new law permits attorneys to question jurors in civil and criminal trials throughout the Supe-rior Court, making Massachusetts consistent with 39 other states that permit attorney conducted voir dire. The bill gives discretion to judges to impose "reasonable limitations" on the voir dire pro-cess. Additionally, the new law permits plaintiffs to "suggest a specific monetary amount for damage at trial." View the bill here or online at http://www.leclairryan.com/pubs/xprPubDetail.aspx?xpST=PubDetail&pub=939.
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To Franchise or Not to Franchise? by Thomas Pitegoff, Esq.
Franchising can be a highly successful approach to growing a busi-ness. But entrepreneurs should weigh success stories such as those of McDonald’s, which had $28.1 billion in revenues and $5.6 bil-lion in net income in 2013, or Subway, which now has more than 67,000 shops across the globe, against cautionary tales that tend to reinforce realism. Sbarro and Quizno’s both filed for Chapter 11 bankruptcy protection in March 2014. This highlights the truth that adopting the franchise model is no guarantee of success.
For starters, let’s take a look at the complexity of franchising overall. While franchising evokes thoughts of fast food (the largest franchise sector), the franchise model has been embraced by a broad range of industries, from hotels to gyms to home health care to business ser-vices. The popular conception of the franchise owner as “the little guy” also is an oversimplification. In fact, multi-unit franchise own-ers are commonplace and can be large companies in their own right. Carrols Restaurant Group, for example, owns more than 570 Burger King locations. Multi-unit ownership allows the franchisor to work with a comparatively small number of franchisees whose com-mon ownership promotes economies of scale. It’s no wonder that franchisors like to work with multi-unit owners.
Many new franchise concepts enter the scene every year. Some won’t make it. Others will enjoy moderate success. Still others will succeed fabulously and develop into large companies. To support their rapid growth, a number of companies have turned to public markets or private equity for funding. In the foodservice arena, for example, the long roster of publicly owned franchisors includes such names as McDonald’s, Dine Equity (Applebee’s and IHOP) and Yum! Brands (KFC, Taco Bell and Pizza Hut). Private-equity giants owning franchisors include 3G Capital (Burger King), Bain Capital (Dunkin Donuts and Dominos) and Roark Capital (Cinnabon, Ar-by’s, Auntie Anne’s, Carvel and others).
Franchising, then, truly is “big business.” But this does not negate its potential advantages for startup entrepreneurs. Indeed, franchising continues to be an appealing way for business owners to grow their brands using other people’s money. Opening a new location can entail significant real estate costs. In franchising, these costs are usually borne by the franchisee, along with the cost of labor. Thus, franchisors can clone their businesses many times over through the investments made by their franchisees. Likewise, the owners of res-taurants, carpetcleaning companies or tax firms—the possibilities are endless—can become franchisees and grow their businesses by opening or acquiring franchised outlets with established business models. Typically, franchisees focus on operations and local brand development; franchisors handle concept-development, systems and regional and national marketing. This mix of roles packs a punch. It can be appealing both to single-unit owners and to experienced, multi-unit franchisees. Meanwhile, passive investors (as distin-guished from active franchise owners) like franchising because of its promise of consistent royalty income and lower perceived risk.
Importantly, though, not every type of business is tailor-made for franchising. The first ingredient of a successful franchise is mar-ket acceptance. The concept must be one that is unambiguously successful. This is especially crucial for the startup franchisor. To sell that first franchise, you have to be able to point to the company’s success. Beyond that, the concept must be one that can be dupli-cated. The business format must be easily described in an operating manual and teachable in a training program. Cloning a business is obviously easier to do with, say, a quick serve restaurant (QSR) con-cept than with a high-end restaurant. A chef who enjoys developing creative dishes is not likely to be interested in mass production. In the same vein, a service-oriented business that requires employees with a high degree of expertise will be more difficult to franchise than one operated via simple, automated equipment. An exception would be conversions of existing businesses to franchises, such as real estate brokerage offices, employment agencies, hair salons or tech service shops. The business should also have some feature that clearly distinguishes it from the competition. A strong brand identity is more than just a trademark—brand identity may include the look and feel of the shop, the distinctive way of doing business and even the culture of the business.
But what if a business owner does want to expand and happens to have a simple, replicable format that requires feet on the ground in geographically diverse local markets? In that case, the choice is be-tween being company-owned or franchised. The owner can raise capital by finding sources to invest in the company. Or the investors can be franchisees who invest in their own businesses under the terms of a franchise agreement designed to help preserve the quality and consistency of the brand. Compare Starbucks and Dunkin’ Do-nuts. Starbucks raised capital through equity financing and public offerings. Dunkin’ Donuts grew by franchising. Starbucks devotes a portion of its legal budget to compliance with the securities laws. Dunkin’ Donuts must comply with the federal and state franchise registration and disclosure laws. On closer analysis, though, the distinction between Starbucks and Dunkin’ Donuts as company-owned vs. franchised breaks down. Starbucks does enter into ar-rangements with others to operate its stores. Just look at all of the Starbucks operations in Barnes & Noble stores and in the lobbies of Starwood Hotels and Resorts (like Sheraton and Westin). These and other Starbucks arrangements with third-party owners are done through exemptions to the franchise laws. That requires legal moni-toring to be sure that none of those arrangements crosses the line and requires registration or disclosure. In some countries, Starbucks openly franchises
Starbucks actually began with an aversion to franchising. In Howard Schultz’s book, Pour Your Heart into It, the Chairman and CEO of Starbucks writes that the company initially refused to franchise. Why? He did not want to risk losing control of the all-important link to the customer. To Schultz, franchisees are middlemen who would “stand between us and our customers.” But Dunkin’ Donuts has grown nicely using the franchise model and has a loyal following. Success in managing franchised stores requires
effort, but so does success in managing company-owned stores. They are just two different ways of doing business.
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Quality Control is Key
Whether the brand grows by franchising or through company owned units, quality control is key. The method of exercising that control, though, is different depending on whether the location is owned or franchised. Managing franchisees is quite different from managing employees. Franchise owners can be independent minded. But this is not always a problem. In fact, the best fran-chisees can sometimes be the most stubborn. They may object to franchisor policies they perceive as helping the franchisor’s bottom line but not helping the bottom line of franchisees. But cooperation can be profitable for everyone, and franchisees often innovate in ways that improve the entire franchise system. A franchise should not and need not be an obstacle that keeps the brand owner at arm’s length from the customer. Franchises represent the brand in the same way that company-owned loca-tions do. Accordingly, selecting excellent franchisees is just as important as selecting excellent employees. Moreover, franchisors often maintain some company owned locations. And they should be tracking the franchisee customers and the performance of the franchisee locations just as they do at company locations. Independent franchise owners are motivated to succeed, which helps the brand be successful. Franchisees also know their local markets and will be quick to let the franchisor know what works and what falls flat.
Company stores do have at least one advantage. The brand own-er can place them near one another without fear of encroach-ment claims. Just look at all of the Starbucks stores that are clustered close to one another—a situation that franchisees would do their best to prevent. Likewise, when its business declined, Starbucks closed a large number of its stores. If those stores had been franchised, simply closing them would have been out of the question, and the franchisor would have been forced to deal with hundreds of failing franchisees and possible lawsuits. This underscores how important it is for franchisors to ensure that their franchisees are successful. If the franchisees are not profitable, the system will not succeed. Happy franchisees are the best referral sources and help fuel further growth.
The bottom line is that franchising has advantages and disad-vantages. The decision to franchise involves business questions and personal preferences. If franchising is the path you take, there are many successful people who went before you. You can learn from their successes— and their missteps.
This article has been reprinted from The Franchise Hand-book, (Summer 2014).
Contact the author at email@example.com.