California strictly prohibits noncompete agreements with three very narrow exceptions involving partners, LLC members, and sale of a business (Business and Professions Code section 16600).  Any agreement that limits the ability of an employee or independent contractor from engaging in the work of his or her choosing is void under California law.

Here are some examples of provisions that would be void under California law:

Employee shall not directly or indirectly solicit any current customers to transfer any account or relationship from Employer to any business other than Employer.

For 18 months after termination of employment Employee shall not render services, directly or indirectly, to any competitor in which such services could enhance the use or marketability of a competing product.

These kinds of provisions are very common in employment and independent contractor agreements even though they are unenforceable.  An employee should not sign an agreement that contains a clause like this.  Even though it’s unenforceable, a new employer might refuse to hire an employee that has signed such an agreement unless the former employer releases its rights under this agreement.  Why?  The new employer does not want to take a chance that the former employer will litigate the issue even though the chance of success is basically nil.

While employers should not put any non-solicitation or non-compete provisions into their agreements, they can and should include provisions to protect any secret information such as a prohibition on employees and former employees from revealing company secrets to any third party.

The following is excerpted from Michael’s letter of support for the Maryland B Corp legislation (HB-1009):

First, it rewards companies that affirmatively serve the public interest in the state. The proposed legislation effectively creates and strengthens a brand for good corporate behavior.  The B-Corporation label recognizes companies that are committed to undertaking their business with high labor, environmental, and community standards, even if this commitment reduces its profitability.  HB-1009 effectively rewards a company embracing these goals by helping consumers also motivated by these values to find and selectively purchase their goods and services.  It similarly rewards socially responsible businesses by attracting like-minded investors.

Second, it increases market efficiency. Some argue that whenever companies sacrifice profits for other goals like high labor or environmental standards, efficiency is lost.  This, however, springs from an incorrect definition of efficiency, since it focuses exclusively on whether or not consumers are being offered the cheapest goods and services.  A better definition of efficiency focuses on whether consumers are getting the best value for goods and services. Value includes quality of the product and quality of the company, and decisions about value depend entirely on consumer choice.  It is an axiom of a market economy that it functions more efficiently when consumers have the best information possible to make their market choices.  The B-Corporation label does this, effectively matching consumers and investors committed to improving the state’s public interest with companies that share these values.

Third, it boosts the state economy. In addition to the benefits that flow from greater market efficiency, the legislation will tend to drive more Maryland residents to buy goods and services from local companies and drive more investors to place money in local companies.  Local purchasing and local investing boosts local jobs.

Fourth, it supports the broad objectives of economic development. There is a growing body of evidence that locally owned companies, compared to absentee owned businesses, generate for every dollar spent in them higher economic multipliers.  That means more income, wealth, jobs, tax receipts, and charitable contributions for the state.  Additionally, the evidence also suggests that these businesses are particularly good a promoting smart growth, tourism, entrepreneurship, and low-carbon footprints—all goals officially embraced by the state of Maryland.

Finally, it accomplishes all these worthy objectives at virtually no cost. All that is required by the bill is voluntary action by companies who wish to apply and comply, and minor administrative declarations and paperwork by the state.  It would be difficult to identify another proposed measure that would deliver as much “economic stimulus” at as small a cost.

The only reservation I have about this bill—a minor one—is that I would like to see it go further.  I would like the bill explicitly to embrace the carefully nuanced criteria for social performance designed by B-Lab (the architects of the B-Corporation label).  And I would like to see explicit preferences in state procurement and in disbursement of economic-development incentives for B-Corporations.

The California Medical Marijuana Program Act states that “Qualified patients, persons with valid identification cards, and the designated primary caregivers of qualified patients and persons with identification cards, who associate within the State of California in order collectively or cooperatively to cultivate marijuana for medical purposes, shall not solely on the basis of that fact be subject to state criminal sanctions under Section 11357, 11358, 11359, 11360, 11366, 11366.5, or 11570.”

The sections of the Health and Safety Code listed include sanctions for possession (11357), cultivation (11358), possession for sale (11359), transportation or furnishing marijuana (11360), maintaining a location for unlawfully selling, giving away, or using controlled substances (11366), managing a location for the storage or distribution of any controlled substance for sale (11366.5), and nuisance caused by selling, storing, manufacturing, and distributing a controlled substance (11570).

In People v. Urziceanu (2005), the California Court of Appeal said that this section of the MMPA “indicates it contemplates the formation and operation of medicinal marijuana cooperatives that would receive reimbursement for marijuana and the services provided in conjunction with the provision of that marijuana.”

But is this the same thing as selling?

Los Angeles City Atty. Carmen Trutanich has said that state law authorizes collectives only to grow marijuana and recover their actual costs, not to sell it.

This sounds like splitting hairs to me – what is the difference between selling and recovering costs when it is clear in the MMPA that this all needs to be done without profit?

One thing that further muddies the water is that the Attorney General’s medical marijuana guidelines seem to urge collectives to pay sales tax.  But if they are not selling and just recovering their costs, why do they have to pay sales tax?  This puts collectives in a difficult position – if they pay sales tax, are they admitting they are selling which is not clearly legal?  And if they don’t pay sales tax, will the Board of Equalization come after them?

One possible solution is to pay sales tax but submit a letter to the BOE stating that the collective is paying under protest because it does not believe that a collective set up by patients to share marijuana is selling anything.

Summarized from a memo by Christen Lee, Esq.

The following are characteristics that will make it more likely that a court will consider an instrument to be a security, and therefore subject to securities regulations:

1. the right to receive dividends contingent upon an apportionment of profits;
2. negotiability (i.e., transferability);
3. the ability to be pledged or hypothecated (i.e. used as collateral);
4. the conferring of voting rights in proportion to the number of shares owned;
5. the capacity to appreciate in value;
6. the motivations of the seller and buyer – the seller’s purpose is to raise capital and the buyer’s purpose is to earn a profit;
7. the plan of distribution - there is “common trading for speculation of investment” and the instrument is offered and sold to a broad segment of the public;
8. public perception – the public reasonably perceives the instrument as an investment;
9. the instrument poses a risk to the investing public.

On April 7, California DLSE released an opinion letter addressed to a program called Year Up.  Year Up places young people in internships in for-profit businesses as part of a year-long educational program.  The internships are unpaid, though the interns do receive a small stipend for living expenses.

Even though the private for-profit businesses get some benefit from the work the interns do, the state approved the unpaid internship program.

Coincidentally, this opinion was released just five days after the publication of a New York Times article called “The Unpaid Intern, Legal or Not.”

Apparently, there has been a recent proliferation of unpaid internships and the federal and several state governments are taking notice.  Generally, all people who work for for-profit businesses must be paid at least minimum wage.  While there is an exception for interns (aka trainees), the exception is very narrow.

There are six criteria for unpaid interns that must be adhered to:

1. The training, even though it includes actual operation of the facilities of the employer, is similar to what would be given in a vocational school or academic educational instruction;

2. The training is for the benefit of the trainees;

3. The trainees do not displace regular employees, but work under their close observation;

4. The employer that provides the training derives no immediate advantage from the activities of the trainees, and on occasion the employer’s operations may actually be impeded;

5. The trainees are not necessarily entitled to a job at the conclusion of the training period; and

6. The employer and the trainees understand that the trainees are not entitled to wages for the time spent in training.

According to the New York Times article, there are many incidences of paid workers being displaced by unpaid interns, interns being assigned non-instructional, menial labor, and much of the work being unsupervised.

Many employers argue that the DOL criteria need updating because they are based on a 1947 Supreme Court decision (a time when many internships were for blue collar production work).

Guest Post by Gabrielle Lessard, Esq.

The recently enacted health insurance reform legislation includes a tax credit that helps many small businesses provide coverage for their employees.  Many tax-exempt non-profit organizations can also receive the health care tax credit, although at a reduced level.

To qualify, small businesses and exempt organizations must:

• Have fewer than  25 full-time equivalent (FTE) employees
• Pay average annual wages below $50,000, and
• Cover at least 50% of their workers’ health insurance premium costs.

Small businesses can receive a credit up to 35% of their 2010 employee premium costs.  This amount increases to 50% in 2014.  The non-profit credit starts at 25% in 2010, increasing to 35% in 2014.

The credit is effective January 1, 2010.  Eligible small businesses can claim the credit as part of the general business credit starting with the 2010 income tax return they file in 2011. For tax-exempt employers, the IRS will provide further information on how to claim the credit.

For more information click here.

When a group of people forms a cooperative to work together, they have to decide whether to treat themselves as employees of the co-op or as producers that contract with the co-op to provide products or services through the co-op.

A prototypical producer co-op is made up of farmers that each work independently on their own farms.  They each contract with the co-op to provide a certain amount of produce that the co-op will market for them.  Patronage dividends are paid based on the amount of produce each member markets through the co-op.

Imagine a different scenario: a group of bookkeepers gets together to form a bookkeepers’ co-op.  Should the co-op be a worker co-op or a producer co-op?  Note that in California and in many other states, there is not a separate statute for a worker co-op versus a producer co-op.  So the co-op would form under the same statute in either case.  The important question is whether the bookkeepers would treat themselves as employees or independent contractors with respect to the co-op.

Co-op members will often prefer to treat themselves as independent contractors to avoid the compliance issues that come with having employees.  Whether they are co-op members or not, (in most cases) employees must be paid minimum wage, have workers compensation insurance, have employment taxes withheld from their pay, etc.  But co-ops should be careful about choosing this route.  Before treating co-op members as independent contractors, the co-op should consider whether the members comfortably fall within the IRS’s definition of an independent contractor (for example, how much control does the co-op have over the day-to-day activities of the members? are the members free to work for others? do the members purchase their own supplies and equipment? etc.).

The IRS, as well as other regulatory bodies, is very concerned about workers being misclassified as independent contractors.  The penalties for misclassification can be harsh.  So do some careful thinking before treating co-op members as independent contractors!

Another thing to be aware of is that a corporate officer must always be treated as an employee and not an independent contractor.  So if a co-op member is paid for serving as secretary, treasurer, or some other officer position, those payments must be treated as wages, subject to withholding of employment tax.

I’ve been telling people that as long as a co-op’s members are all in the state where the co-op is located, does most of its business, and is incorporated, there is no need to worry about federal securities law which does not contain an exemption for non-agricultural co-ops.  If you offer memberships in more than one state, I say, you would have to register the offering with the Securities and Exchange Commission.

After I say that, the inevitable response is always “then how does REI do it?”  REI is a cooperative and sells memberships all over the country.

Great question!  I called REI’s corporate lawyer to ask why REI does not consider its memberships to be securities.

He said REI’s memberships are very far from the definition of a security because people don’t join REI to get financial returns.  While REI members do get patronage refunds each year, these are more like a discount on what they buy than a financial return – kind of like the discounts that people pay to get when they join Costco.

REI is so confident in this opinion that it has never requested a no action letter from the SEC.

It also helps that REI memberships are non-transferable and cannot appreciate in value.  It doesn’t hurt that the price of a membership is so low.

Last year, Washington state adopted the community solar project investment cost recovery incentive to encourage communities to develop solar projects.  Unfortunately, the way the legislation was originally written, there could be only one incentive per investor so a group of investors could not pool their resources to build solar projects and each receive the incentive payment.  Recognizing this problem, the legislature planned to allow the incentive to be passed through to individual owners of an LLC that developed a solar project.  Stanley Florek pointed out that cooperatives should also be allowed to receive these passed through incentives.  The legislature listened to him and added cooperatives to the list of types of entities eligible for this pass through treatment.

One benefit of allowing cooperatives to participate is that there is a state securities registration exemption for Washington cooperatives.  So promoters of community energy projects can use the co-op structure to bring in a diverse group of investors without having to register a public offering.

Click here for the bill.

Great job Stanley!

By Cecily Jackson and Jenny Kassan

In a recent Technical Advice Memorandum (TAM), the IRS determined that a major source of revenue for a 501(c)(6) trade association was unrelated business income and therefore taxable.

The trade association’s purpose was to promote a particular sport within a region.  Individuals can only play the sport at sports facilities that charge a fee to play.  The trade association sold discount coupons for use of such facilities.

In the TAM, the IRS listed the requirements for a Section 501(c)(6) organization:

(1)    It must be an association of persons having a common business interest,

(2)    Its purpose must be to promote that common business interest,

(3)    It must not be organized for profit,

(4)    It should not be engaged in a regular business of a kind ordinarily conducted for a profit,

(5)    Its activities should be directed toward the improvement of business conditions of one or more lines of business as opposed to the performance of particular services for individual persons, and

(6)    Its net earnings, if any, must not inure to the benefit of any private shareholder or individual.

The Internal Revenue Code imposes a tax on income to a nonprofit organization derived from any unrelated trade or business regularly carried on.  An unrelated trade or business is any trade or business which is not substantially related to the organization’s exempt purposes.

The trade association argued that the discount coupon program is substantially related to its exempt purposes because it encourages more people to engage in the sport.

The IRS disagreed.  The question turned on whether the sale of coupons promotes general interest and involvement in the sport or if it constitutes the performance of particular services for individual persons or businesses.  The IRS concluded that the sale of coupons only benefited those facilities that chose to participate and not the sport as a whole and therefore the sale of coupons was basically an advertising service for individual businesses.

The IRS states, “Advertising campaigns . . . that name and promote specific businesses rather than the industry as a whole constitute the performance of particular services for individual persons” which is an unrelated trade or business.

We know of many 501(c)(6) organizations that promote their members by maintaining business directories, spotlighting their members on their web sites, etc.  These organizations need to be careful that their activities don’t start to look like the sale of advertising (or else pay tax on the revenue associated with those activities).  (Note that occasional highlighting of members such as for a special event is not a problem because the tax on unrelated business income only applies to a trade or business that is regularly carried on.)

The following are some examples of activities that have been found to be taxable as unrelated business income to a 501(c)(6):

• Advertising of products and services in an association journal, even if those products and services are related to the purpose of the organizations
• Promotions that mention particular businesses
• Promotion of members to the exclusion of non-members in the same industry when members and non-members meet similar standards
• Fee-based services for members and/or non-members that are similar to what might be provided by a commercial business
• Providing discounted parking for patrons of only certain businesses in a downtown area.

The following are some examples of activities that have been found to be substantially related and therefore not taxable as unrelated business income:

• Publication of educational information that incidentally promotes specific businesses
• Providing discounted parking for all visitors to a downtown area
• Sponsorship of tournaments to promote interest in a sport and sale of broadcasting rights to those tournaments
• Promotion of an entire industry or line of business such as Washington apples or the use of plywood as a building material.

Note that a nonprofit can lose its exempt status if a significant amount of its revenue is derived from and/or a significant amount of its resources is devoted to an unrelated activity.