Last week’s post was about the differences between the internal documents of bylaws and operating agreements, and what their purpose is as opposed to the Articles documents.  This week and next, I will take a closer look at the in-depth documents, bylaws and operating agreements, separately and mention a couple things that startups and small businesses should know about bylaws.

Adopting Bylaws are Required along with Certain Provisions

Recall last week that I mentioned as opposed to a LLC’s operating agreement, that a corporation’s incorporators or board of directors MUST adopt initial bylaws for the corporation.  However, what is also required are certain provisions that control how shareholders and directors behave with regard to the corporation.  Further, there are provisions that the owners of the company may consider.

*The Difference Between “May” and “Shall”

I don’t normally give grammar lessons on my blog, but when it comes to business law, especially corporate documents, many people get bored, confused, (sometimes angry), at the tedium of the words we use.  Thus the need for clarity in the matter.

Without getting into the mechanical linguistics of it all, when “shall” is used it is something that you MUST do, whereas “may” gives you the option of doing the act.  I am going to use an example when it comes to Annual Meetings.

You Must Have Annual Meetings, but You May or May Not State the Place of the Meetings

What does that mean?  Let me show you the relevant statute and break it down:

(a)  A corporation shall hold a meeting of shareholders annually at a time stated in or fixed in accordance with the bylaws.

(b)  Annual shareholders’ meetings may be held in or out of this State at the place stated in or fixed in accordance with the bylaws.  If no place is stated in or fixed in accordance with the bylaws, annual meetings shall be held at the corporation’s principal office.  Notwithstanding the foregoing, the bylaws may authorize the board of directors, in its sole discretion, to determine that the annual meeting shall not be held at any place, but may instead be held solely by means of remote communication as authorized under subsection (c).

So notice in section (a) it states that a corporation shall hold a meeting of shareholders each yeah and that the bylaws shall state that time.   However, notice in section (b) it states that these shareholders’ annual meetings may be in Hawaii or not, and that the bylaws may state this place. However, if you do not state a place it shall be the corporation’s principal office.

Please note that is just part of the “Meetings” statute as it is to the Hawaii Business Corporation Act.   What you should take away from it is that there are some provisions required in bylaws and there are others that you have flexibility with.

Why is this Relevant for People Starting a Business?

Yes, paperwork is tedious, but it also creates accountability and a method of controlling your business.  More often than not with a start-up there is the idea person, the money person, and the person who can engineer/produce/implement the idea.  With three people involved there has to be a way to control how the interact.  Further, once the business develops, the goal may be to seek more investment, and thus new additional owners of the corporation (shareholders) join the entity.  Thus the need for bylaws to dictate how this all operates.

Some Other Typical Provisions that Appear in the Bylaws

These other provisions are in no particular order, and some may or may not appear in the bylaws.  Further some of them may be required, and others just appear as it is customary.  The point for a business owner using a corporation should know that some of these things appear in your bylaws, the way you govern your business.

Sample Subjects of Bylaw Provisions:

  1. Special Meetings (as opposed to the Annual Meetings)
  2. Required Officers, Duties of Officers
  3. Record Date (this refers to what date a record reflects what shareholders are entitled to notice of a shareholders’ meeting)
  4. Number if Directors, Director qualifications and Duties
  5. Notice (how notice is given for certain circumstances)
  6. Stock Certificate Signatures
  7. Restriction on Transfer of Stock
  8. Shareholder Agreements

There are other provisions that more often than not appear in bylaws, but this is just meant as a sample.  Finally, please take heed you should consider seeking an expert’s help when drafting your bylaws, as this is a foundational document of your corporation.  I have seen many founders wanting to start fast and adopting poor or wrong bylaws, and then requiring “cleanup” work, which is often more costly and time-consuming after the fact of initial adoption.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

 

Quick reminder before I dive into this week’s Draw the Law, I have a talk under Pacific New Media on Social Media and that Law.  Check out the info here.
So last week I talked about Articles of Incorporation versus Articles of Organization.  Recall, that the former were for corporations, and the latter was for LLCs.  In addition, remember that these series of posts are meant to deal with a startup person’s guide to all the paperwork they have to deal with when forming a company.

This week is all about bylaws and operating agreements, which are internal documents as opposed to last week’s documents, where are what get filed with a state agency, so become a matter of public record.  One of the easiest analogies to get is that if the Articles are the birth certificate, then the bylaws or operating agreement represents the skeleton of the company.

Are these Documents Public?

As stated above, these documents are internal. That being said the government and institutions may require you to reveal them in order to do business.  Certain trades or industries a regulating agency may require the filing of your bylaws or operating agreement to do business. For example, to obtain a liquor license in the City and County of Honolulu a LLC must submit its operating agreement.  In addition, financial institutions, like banks (this is just an example of one local bank and is NOT an endorsement of them) will require you to submit your bylaws or operating agreement in order to open a business account.  Finally, for startups venture capital firms, potential investors, etc . . . will definitely want a look at your business structure and may even require you to change them to protect their interest.

So What are These Documents Used For?

Both bylaws and operating agreements are internal documents that guide the behavior among shareholders and members, respectively, as well as officers, directors, and managers.   The documents are contract, agreed upon by the owners at the onset of the company.   Therefore, if the rules are not abided by an offending shareholder, member, officer, director, or manager a breach of contract claim may exist for them not following the rules.

Do I Need to Have these Documents?

This question should show how LLCs are more flexible whereas corporations are more formal.  You must adopt an initial set of bylaws for the corporation you form if you are an incorporator or part of the board of director.  However, with the LLC you may enter an operating agreement with fellow co-members, if you don’t you will have the statute as your default rules for guiding the LLC.  This is one of several differences between the corporate structure versus that of a limited liability company.  As stated in previous posts and my law talk, corporations tend to be more formal, but sought after for startups due to investment and tax benefits whereas LLCs are used for their flexibility and ability to be less formal (thus less administrative costs), and that these differences can be seen when drafting these internal documents.

A Word on Negotiating and Drafting these Documents

Many times, startups and small business co-members like to create their own bylaws or operating agreement without an attorney.  What should be realized about this is that in both cases there are certain provisions that are not waivable.  Further, due to the formality of the corporation and the flexibility of the LLC the distribution of ownership, allocation of profit and losses, etc . . . is not necessarily something that should be done without advice and consulting.

In addition, many of people try to only use one attorney to draft a document that reflects the interest of people coming together for an endeavor. What they don’t realize is that is basically intended to be a long-term business deal and sometimes genuine disagreements amongst the starting owners of the company may force each of them to get an individual attorney to negotiate on their behalf.  Another misconception many people have is that they must adopt Robert’s Rules to guide their meetings in their bylaws or operating agreement because they see it on television or see another organization using them.  Remember I said that these documents are a contract?  Consider that if you fail to live up to your own agreed upon rules you are in breach of the company’s internal guiding document.  Finally, consider that these documents are NOT set in stone and operating agreements and bylaws usually have a method to amend them. Whether the process to amend them is easy or not is up to you.

On a personal note, I would like to impart I have dealt with several companies where the people started out friends and thought they could have an informal situation and ignored their own bylaws or operating agreement.  Then a falling out occurred, and well let’s just it was ugly. Others have tried to draft them on their own with disastrous results not realizing further legal work needs to be done when they want to sell the business or attract investors.

So next week, I will tackle bylaws, and some specifics about them, and the following week after that I will tackle operating agreements.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So this is continuing the trend I started two weeks ago, as I realized Startup Weekend Honolulu was approaching, and a lot of first time startup people have frequent questions.  By the way, other fun events are coming up in Honolulu (with me speaking or people who are more entertaining because it is not with legalese speaking), so check out my calendar later this week for information on them.
Anyway, I spoke about the differences of trade names, trademarks, and trade secrets as it is a source of constant confusion for people starting up their business.  I’ll be honest, it actually is still confusing even for people who have been in busy for a long time and should know the difference.

Today’s topic is one that I discuss during my business entity formation talk.  Today’s post is much more abbreviated, but it’s goal is to clear confusion about all that paperwork we attorneys like to make for you when you start a business.  So frequently, when a person gets an idea in their head they know they have to protect it and themselves, so they know to set-up a business entity.  Remember that very first Draw the Law on Limited Liability?  (If you don’t remember or know, go ahead click the links.)  So the only way you get to have a legal entity is by filing information with the state you plan on doing business in.  Therefore, in the State of Hawaii you turn to the Department of Commerce and Consumer Affairs to file your Articles of Incorporation OR Articles of Organization.

What’s the Difference between the Documents?

Articles of Incorporation are filed for a corporation whereas Articles of Organization are filed for a limited liability company.  They are similar documents, but the wording indicates what the entity is which for let’s say transfer of ownership, buying-selling the business, matters for tax consequences and other important aspects of a business deal.  I always tell people it’s like your business’s birth certificate. Once filed and registered with the state your company is born and can do business.

 

What Information do these Documents Contain?

Your articles contain information about your company that is accessible by the public.  It’s things like your mailing address, who owns the corporation, if there is corporate stock, or if your limited liability company is managed, and if there is a registered agent for the company.  All things you have to discuss with your co-founders, and usually with an attorney, before you set-up.   Sometimes your articles may also need to contain certain purpose statements like that for a nonprofit corporation OR a B-corporation.

What’s the Difference for between Articles and Bylaws/Operating Agreements?

Articles of Incorporation or Organization, depending on your entity, MUST be filed with the state you are transacting business in (*note it is not the same department or agency as it depends on your state, so check with your local government).  Therefore, you can kind of think of it as an external record, your business exists and the whole world now knows it.  However, bylaws and operating agreements are INTERNAL documents. You do NOT need to file them with the state. They are your agreements with fellow co-founders and how you operate internally.  I will follow-up next week about their differences between each other, and then individualized posts on each document.

So that is a good place to leave off for this week.  Next week, I will focus in on those internal documents, the bylaws and the operating agreement and the differences between the two and addressing some of the more frequently asked questions about them.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

Congratulations to all winning teams at this past weekend’s Startup Weekend Honolulu.  I look forward to meeting you all. Good job by The Box Jelly for hosting a great event!
So last week was trade name versus trademark.  Today is another area that a lot of startups get confused.  They find a programmer, designer, consultant, and other similar professions to help them bring their idea to reality, but want them only as an independent contractor, and if they have enough capital, possibly an employee.  However, no ownership, thus how do they protect their most sacred moneymaking idea that they slaved over a weekend trying to pitch?

Make them sign a nondisclosure agreement (NDA), is usually the first conclusion, then when a Client comes to me to draft them a NDA. I then ask them what they want to protect with the NDA, and they then to proceed to tell me everything including the kitchen sink . . . isn’t everything internal a trade secret?

No, just because you don’t want your competition to know does not make it a trade secret.

So What IS a Trade Secret?

Where we start off with trade secrets is the legislative definition, which is found in Hawaii at HRS §482B-2. This is the definition section under the Uniform Trade Secrets act and it states the following:

“Trade secret” means information, including a formula, pattern, compilation, program device, method, technique, or process that:

(1)  Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(2)  Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

So right off the bat, the definition indicates why a lot of business owners feel they have a trade secret.  Their information is precious (to them), they created a “new” “method” or “technique” (which was tried already and the market doesn’t think it is valuable), etc . . . . As you can tell by my commentary in the parentheses a trade secret has to be more.

Let’s use the famous example of a trade secret The Coca-Cola Company’s formula for coca-cola. First, it satisfies the first element. It’s a formula.

Second, the formula must have an independent economic value from not being known. In this case, it is clear that it does. No one has successfully replicated Coke’s formula AND it’s major rival Pepsico does not have the same formula.  Through its distribution deals and keeping the formula unattainable by normal means (such as experimenting) they have built a beverage empire.

Lastly, Coke has kept this secret for so many years, which supports the last element, which is the efforts to maintain secrecy.  At this point it may be beyond reasonable, but the efforts by Coke to maintain the correct amounts to the formula are legendary.  From bank vaults, to shopping around to different suppliers, etc . . . you name it, they have probably created an elaborate strategy to foil would be corporate spies.

What does this Mean for a Startup?

If you want to make a sound NDA, then you need to know what your company is all about.  Before, you think that is easy, remember you have gone around itching the idea to get investors, employees, etc . . . what have you told them?  Remember it’s a balancing act of trying to sell the idea without giving up the process, the secret has to be generally not know.

This brings me to another situation where people rely on public data, government information, etc . . . I will give them they have come up with a clever way to put disparate knowledge together, but if someone can readily replicate that “cleverness” on their own their really isn’t anything to protect.

Finally, the shotgun approach to NDA use should not be your method of maintaining secrecy.  Medium and large companies go overboard and have their janitors sign them when the have no intention of enforcing it against them and they aren’t privy to the company’s core secrets.  So for you, don’t make everyone you come in contact sign it, especially investors. They aren’t going to do it.

The rule of thumb is what your trying to protect your core strength and are you deriving that strength because no one else has figured it out.  This includes things like next year’s marketing plan, your competition not knowing how you will expand your product lines is a) valuable b) it is not known and c) if you are keeping it under lock and key, encrypted files, etc . . .  then you do have a trade secret. Obviously, it will no longer be a secret as to when you role out these new product lines, but before that time you need they are worth protecting. Then on the NDA side you only make people sign one if they can make use of your idea on their own (i.e. an engineer who knows the process to make a new material).

Anyway, the lucky winners from Startup Weekend Honolulu will get this information in a lecture and more regarding contracts, HR, Internet laws, and organizing their company as part of their winning package as provided by my firm.  So I urge you participate in Startup Weekend, as you may be the one asking, can I protect my business idea?

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.


Last week, I discussed equitable remedies in breach of contract situations.  I would like to shift gears for a while and do some information specifically aimed at startups, as this upcoming weekend is Startup Weekend Honolulu at the Box Jelly, coworking space.  If you have not signed up, you can check out the info here, and recommend trying it once as it is a very unique experience and you meet a lot of people.
My goal with the next month’s worth of posts is to deal with frequent misconceptions by people who are starting up their business.

Anyway, this post and the next one is aimed and clearing up some of the notions about the various “trade” legal aspects. Namely, I will be discussing the difference between trade names and trademarks, and what is a trade secret. I frequently run across clients and people who are very confused when they first start out their business and it is crucial for your legal protection of your business that you get the differences.

Trade Name vs. Trademark: Explaining the Difference

A trade name is NOT the same as a trademark.  While, both are definitely a part of trade and business they both operate and serve different roles.  Let’s use an example to walk through the way these two legal concepts are different.

Let’s say Mr. Joey Nakamura wants to sell his specialty brand of shave ice.  Let’s say Mr. Nakamura ignores my very first Draw the Law post, and does not want to create some kind of business structure with limited liability.  Therefore, he is a sole proprietor, but he does not want to sell his specialty brand of shave ice under his personal name.  So he registers a trade name and does business as JN Specialty Shave Ice.  This is his trade name.

While, developing his shave ice Joey then decides to create several unique flavors that are his signature products.  So he creates the Joey Jabuticaba and Nakamura Nectarine and begins packaging and labeling the bottled flavors as such.  These products in the marketing world are his brand names, which are advertising and marketing terms, but in the legal world these are his trademarks.

Thus the difference is a trade name functions to identify the particular business, and for a lot of people they know this as “doing business as”, but the concept actually includes corporate, llc, partnership, and fictitious names.  It is simply the name you are using to identify your business.

Trademarks, are any words, names, symbols, or devices (or a combination of those things) that are used to identify and distinguish your goods from those of others and to indicate the source of the goods (or services for service marks), even if the source is unknown.

Where the Confusion Comes In

Why do people mix these two up?  Well, it is very easy because many businesses use their name to identify their goods and services, for instance here in Hawaii, “American Savings Bank” and “Hawaiian Airlines” both are a trade name and trademark.  Your name can function both as a trade name and as a trademark, so long as it does not infringe on the rights of another.  Furthermore, a single business can own dozens of different trademarks to identify their various brands.

Why is the Distinction is Important?

Well, for some starting businesses they start out and register a business, then want to use another name.  Therefore they register a trade name thinking they are protected from trademark infringement.  As shown above, they are different and function so.  Further, when you start using your trade name you may be giving rise to trademark infringement on your part.  That’s right your name may be causing confusion in the marketplace because it may exist as someone else’s registered trademark.   At that point you would have to get a new name, which as experienced marketers will tell you is a blow to your marketing strategy and will force a costly re-branding.

So be careful when choosing your business name and be careful on how you market your product or service. See you next week, when I talk about trade secrets.  Startup competitors I’d definitely say you might want to check that one out as well.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So last week I rounded out the discussion about what you can expect in terms of damages from a lawsuit. Just a brief recap, there will be no punitive damages via a penalty clause in the contract and it is possible other statutory damages may be available based on what the situation is for the breach (was there any fraud or misrepresentation?).
This week I will focus on what are known as equitable remedies.  The prior discussions on damages are legal remedies.

What’s the Difference between Equitable and Legal Remedies?

My goal is not to turn you into a legal expert, but you should understand there is a distinction between the two. I will be brief. Generally, legal remedies provide for monetary damages as was discussed in the prior posts.  However, equitable remedies deal with the notion of equity or “fairness”. Equity remedies were created to deal with situations where the rule of law’s answer was too harsh (i.e. monetary damages were not enough). Therefore, equitable remedies care more about a particular person’s knowledge and their state of mind and motive. These things go to whether or not a court will grant an equitable remedy.

Why are Equitable Remedies Important for Delaware Corporations?

In general, most states in the US have granted their courts merged powers over equitable and legal remedies (that is you can go to court and ask for both where appropriate). However, of significant note to startups, Delaware’s Court of Chancery remains separate as a court of equity, therefore you would go there to receive equitable remedy. This is significant and why some people suggest that when you intend to go the startup corporation route seeking to do a public offering you incorporate in Delaware due to the significant experience and knowledge that this court of equity provides.

The Equitable Remedies for Contract Situations

Since we are focusing on a contract matters I am only going to talk about 3 equitable remedies, but know that for the variety of situations that a lawsuit might arise out of there are more.  The 3 are as follows: (1) specific performance; (2) rescission; and (3) rectification.

Specific Performance: Make the Wrongdoer do What was Agreed Upon!

Specific performance is as it sounds. The court will order the wrong party to do something. Typically, in contracts this becomes an appropriate remedy when the subject it in question is unique and no other remedy is available.  For example, if the seller fails to deliver a valuable painting by a specific artist.  What you should note is that this almost a goods-specific remedy, as a court will almost never force a person to do what was agreed upon in a personal services contract.  For example, forcing a singer to sing when they ditch out on a concert.

Rescission: Banish this Bad Contract to the Void!

This remedy is basically terminating the contract and putting the parties back in the position they were before the contract was agreed upon.  Basically, it is kind of like those time-travel alternate reality type of movies.  We treat the situation as if it never happened (in legalese this is known as void ab initio).  Common situation is where insurers will rescind an insurance policy due concealment, material misrepresentation, or breach of warranty.  In this scenario, the insurer will send the insured a notice and send a check in the amount for the premium paid back to the relevant policy period.

Rectification: Judge, Fix the Contract!

Rectification (more commonly known as Reformation) basically is the court rewriting the contract to reflect what a written document should have said in the first place. Typically, there is a situation which is known as unilateral mistake where one party mistakenly believes a term or provision is in the contract, and the other party is aware of this mistaken belief and the mistake is to the benefit of the second party knowing the error.

Bottom line: Remedies of Last Resort

Understand that equitable remedies are not the court’s first position.  We place significant value on parties of full capacity to bargain out their contracts.  Therefore, to force someone to do something (which goes against the theory of “efficient breach”) or for a judge to tear up the contract or edit it is not taken lightly.  In most contract breaches, your first stop will be damages, and you only get to equitable remedies if that is not enough and unfair.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So last week I discussed about the main types of damages that you would likely ask for in a breach of contract lawsuit. While that post covered compensatory, consequential, and liquidated damages there are few other types of remedies in a lawsuit that you should be aware of when you enter into the calculus of whether to sue or not, or if you are entering into a shaky contractual relationship that may expose you to the risk of a lawsuit.  So let’s get to it for this week!

Penalty (Punitive) Clauses: Don’t Hide Masquerade Them as a Liquidated Damages Clause

So remember last week that I mentioned that a often times in sophisticated contracts that the parties know what is the value of the deal, and would like to prevent the other side from non-performing.  Many times this clause is a Liquidated Damages clause that says if Party A does not perform it will owe Party B X amount of dollars because of non-performance.  Sometimes, overzealous business owners, fearful that a valuable deal will go under try to turn a Liquidated Damages Clause into a penalty provision.  They would rather punish the other side for their non-performance. Penalty (also known as punitive) damages are virtually NEVER enforced.

Let me say this in all caps to be clear: A LIQUIDATED DAMAGES CLAUSE THAT IS ACTUALLY A PENALTY CLAUSE WILL NOT BE ENFORCED UNDER HAWAII STATE LAW. Kona Hawaiian Assocs. v. Pacific Group, 680 F.Supp. 1438, 1449 (D.Haw.1988). Furthermore, under Hawaii law, liquidated damages contained in a contract can only be enforced if there is a “reasonable relation” between the liquidated damages and the amount of the party’s actual damages. Shanghai Inv. Co. v. Alteka Co., 92 Hawai’i 482, 993 P.2d 516, 528 (2000),

Bottom line: when calculating how much the deal is worth to you and reducing it to a written agreement be “reasonable” in your assessment of what the other side will owe you in non-performance, as you don’t want to pay for an expensive contract that is not going to be enforced. Also don’t let emotions get the better of you, as you trying to put the hurt on the other side because they broke the deal and it will hurt your honor is not something that is a part of contract law.

Statutory Damages: The Government is on Your Side

Statutory damages are legal penalties . . . I know what you are thinking, he just wrote that you can’t get punitive damages.  Yes, that is absolutely right under contract law.  However, in many instances the breach of contract is not the only claim that is brought in a lawsuit.

A good attorney gave me a great analogy for the way the court system works.  The goal of the plaintiff’s attorney is to throw a plate of spaghetti at the wall, this represents the claims that the injured party (the plaintiff) is making against the other side.  The goal of the defendant’s attorney is to take the spaghetti off the wall, that is defend from each claim and argue why they should not “stick” to the defendant.  Let me add to this analogy, imagine that the noodles represents certain kinds of claims (in this case contracts) and the meatballs are another set (torts).  Without getting into further legalese, suffice it to say each claim works in a different way, and if the plaintiff’s claims remain successfully “stuck” on the defendant’s wall, they must pay.

For contract claims, we have already gone through the four.  However, as I just said you will likely not just see a breach of contract claim in an expensive lawsuit.  A plaintiff will likely bring in other claims, such as fraud, misrepresentation, interference of contractual relationship, etc . . . . All of these claims are not ones directly on the contract, but the surrounding facts that could be argued that the defendant owes the plaintiff more.  You see the government has created some of these laws (statutes) to deter certain kinds of behavior. The government, for the sake of business health, it would rather not see people lie or intentionally damage the other side’s reputation. Therefore, statutory damages represents a deterrence and compensation.

Bottom line: the facts in a breached contract situation may give rise to statutory claims due to the other side’s misdeeds,but these are NOT a part of the contract law. Notice, that for all the contract damages you can only recover so much (as they are stipulated under the contract), but non-contractual claims are not bound by the agreement, and may give the non-breaching side greater damages.

That’s it for this week. Next week we will cover another set of remedies, such as can you make the court force the breaching side to actually perform under the contract as originally agreed upon?  See you then!

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So the contract has been broken and you have gone through all the prior posts on this subject matter: ADR is not working, the threat of nonpayment won’t get the other side to perform, and they stopped talking to you. So you are left with a lawsuit to try and recover, but what can you recover in terms of damages? Today’s post is all about the types of damages that you may be awarded in a breach of contract lawsuit. So seeing as Draw the Law has been a long vacation, let’s dive right into it.

General: Damages

In general, damages are awarded in a lawsuit to the party that brings a claim and successfully makes that claim under the facts of the case. The most typical type of award is money.  The rules vary based on the type of the claim, and as exemplified by the recent ruling in the Apple v. Samsung case the assessment of damages can be complicated (see the sheet the presiding juror had to fill out here).  If you are curious how the breakdown of that patent infringement case came out here is a helpful link.

For today’s discussion, I am only focusing on a breach of contract claim.  There are other claims and types of damages, which I will follow-up with in Part II, but for today it is all about the other party did not live up to what was in the agreement and what it will cost the other party for breaking its promise.  Therefore, the most common damages we are concerned about are compensatory, consequential, and liquidated.

The Most Common: Compensatory

Compensatory (also called expectation) damages are the most commonly awarded in a breach of contract suit. The concept is simple: what amount of money would put the nonbreaching party in the position it would have been if the breaching party had performed under the contract?  The rationale behind it could not be more simple as well, we want to give the nonbreaching party the benefit of the bargain, therefore we make the breaching party pay for not living up to the promise.

Example: Let’s say Ron accountant contracts with Annabel web marketer and consultant to do his web marketing and drive his SEO up for fifty-hours at a favorable rate of $50.00 an hour for 1-month. Therefore, he owes her $2,500 for her web marketing services.  If Ron breaches the agreement, Annabel would expect $2,500 as her compensatory damages, which is the economic loss she suffered.

Now, let’s reverse the situation, if Annabel breaks the contract and Ron has to get a new web marketer. To replace her and the new person costs $70.00 an hour for a total amount of $3,500. In this case, Mavis would owe Aaron $1,000. Why?  It is the difference from the benefit of their bargain, $2,500 and the amount he had to spend to deal with her breach, $3,500.  Therefore, a $1,000 from her would put him in the position of the original bargain where he was only going to pay to Annabel $2,500.

What Flows from the Breach: Consequential

Consequential damages are what would be received from all the harm caused by the breach in the contract.  One way to understand this concept is think that the original breach as the starting point of the damages (compensatory), but as many of you business owners know you order product and services in-turn to drive your own business goals. You order parts to build machines, you use web marketers to deliver your message, etc . . .  in order to make a profit.  If there is a delay in your goods or services you are expecting it causes more loss down the line.  These losses stemming from the breach are consequences of the breach, thus they are the consequential damages.

Example: Let’s continue with Aaron and Mavis as the example situation.  Aaron has told Mavis that he needs her services because he will be rolling out new services, in time for filing income tax returns, and he knows these service will generate an additional $3,000 in revenue. If Mavis breaches, and Aaron cannot announce his message on services in time, she will owe in addition to the compensatory damages, $3,000.00 in consequential damages.

Built-in: Liquidated

Liquidated damages is a very simple concept, what is the the amount of money built into the contract in the event of a breach?  That amount represents liquidated damages.

Example: Aaron and Mavis agree that Aaron’s assessment that he will receive $3,000 in additional revenue thanks to the new web marketing campaign over a 30-day period.  Therefore, Aaron makes Mavis agree to a damages clause, stating each day late from the day she is to deliver is $100.00 a day. Therefore, if she is delayed in implementing the web marketing campaign by 5 days, she owes Aaron $500.00 in liquidated damages as stated in the agreement.

Last Word: Limiting Damages

With consequential damages and the ability to build in some sort of formula into a written agreement there is definitely a way to limit damages for a breach.  This is sometimes an effective tool in allowing parties to purposefully breach and pay a known quantity for breaching.  In addition, with consequential damages no party wants to be responsible for everything that happens if they fail to live up to the agreement.  Contractors are keenly aware of this as someone who installs your electricity, water, and the like does not want to be on the hook for loss goods that need be refrigerator, damaged carpets from leaky points, and other nightmarish scenarios.  So usually, there is a warranty in the contract that specifically excludes consequential damages.

The way damages are calculated are always of concern in a business deal because you always should have in the back of your mind, what if this doesn’t work out or what if something more lucrative comes along, should I breach?  If you have a firm calculation it might pay to breach the contract and pay the damages or in negotiating you feel that the value of the benefit is too low or too high based on the risk of a breach.  As always, seek expert help or outside information when calculating for these things.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So talking it out has not work, denying payment isn’t getting them to perform, the mediator cannot get you two to sit down and compromise, your last stop is suing for breach of contract.  Before I go any further, the importance of this topic cannot be misunderstood for small business owners and startups.  For those two groups, my main target audience, you are almost always in precarious position, as many times you do not have the resources to pursue costly litigation, and if the other party is a big company (they usually almost always realize this to be the case).
So let me be clear, today’s post, as all my post have been, is filled with general legal information.  Nothing here in this post is specific advice, your situation should be reviewed with an attorney, and when it comes to considering a lawsuit they can render specific advice to your situation to allow you to think about the pros and cons of such an action.

Does the Breaching Party Even Have Money? Do you have the Time and Money?

One of the first considerations for a lawsuit is it even worth the time for you to pursue a suit?  If the other side did not perform because they are having financial troubles they may be heading to bankruptcy, which means they have bigger headaches to concern themselves than performing under your contract.  In addition, consider that if they are going to enter bankruptcy your contract will not be valid.

As I have done at some of my speaking events, consider the business a box and that box is held up by a series of strings. Those strings are contracts. When a business enters bankruptcy only special creditors will be able to collect (i.e. the strings remain attached to the box). All the other strings are cut. So typically, in your small B2B contracts you are not in the habit of secured financing, therefore it is likely you will be able to collect anything from your now bankrupt breaching party.

In addition, consider the amount of time and money you are expanding for the value of the breached contract? This infographic on Mashable shows how valuable your time is and consider that in a lawsuit: a) you will be dealing with attorneys; b) you may have to produce documents for evidence; and c) you have to be a witness.  All of this takes time and money.

Finally, consider that your situation may be one can be heard by a Small Claims Court. In Hawaii, Small claims are handled in an informal process, where people with small claims can turn to this court for claims valued under $5,000.00 and counter-claims (counter lawsuit) for $25,000.00.  For more information click here.

What does the Contract Say?

Ok, so you determined they got enough cash/assets for you to grab in winning a suit and you have the time and willpower to go after them.  What next? Before you even get there, your attorney is going to ask to see the contract.  Why?  Well, take a look at my Boilerplate Blurbs (as well as if you have attended my talk on Basics of Contract Law), and you will see large time place of suit, how much you can recover, what type of laws govern, etc . . . are already built into the contract.  Therefore, if you pursue in the wrong venue your claim main be dismissed.

Therefore, do not take these clauses lightly. The “Miscellaneous” provisions become the important ones in a breach of contract lawsuit or when one side is considering using a threat of a lawsuit to get the other side to perform. While, I cannot stress enough that an attorney should draft and at least review your agreements – I understand with small business owners and startups that may be too costly.  I still say you should get something in writing, consider turning to Docracy or other sites to have a starting basis for your agreements. In the end, it is better to have something reduced to writing rather than it being a “he said, she said” matter.

The clauses of the contract, your resources (time and money), and their resources (money), and the possibility of suing you back (remember nonpayment may be grounds for a breach by you) are all things you need to consider before suing. An attorney can help you discuss the pros and cons of pursuing a suit. These are not things to take lightly and are a harsh reality of doing business.  You may one day also find yourself in a breach of contract suit situation. Therefore, it’s always good to have an attorney to reach for when building your business as you are bound to make mistakes. Your local bar has a reference resource, and you can find Hawaii’s at this link.

As lawsuits are lengthy affairs, this post is broken into two parts.  So come back next week and I will discuss the type of damages that come under a breach of contract lawsuit, other types of remedies, and a few other things to consider.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

Practice Updates: Business Entity Formation Talk Tomorrow (August 1)

Hey everyone, sorry for the week delay, but the talk on Basics of Contract Law was fun and went well with Docracy. I hope to do this talk again in the future, as it is clear a lot small business owners, startups, and freelancers do not have a firm grasp of what they are getting into in business deals.

Bottomline: You are NOT a consumer, so you do not have the same protections as consumers do when you are a business owner.

Next, thing, I have a talk tomorrow night (August 1st) at the ING Direct Café in Waikiki from 6-7pm. This talk is on Business Entity Formation, and will mainly focus on the differences between LLCs and Corporations. So come learn the pros and cons, and what might be appropriate for your business. This talk is free.

Today’s Draw the Law: Using ADR to Remedy Your Contract Breaches

We all know how costly lawsuits can be, and sometimes the value of the contract is just not worth going toward that direction. Therefore, many times the best way to resolve the breach is to talk it out, but sometimes you are too close to the deal. You need a third-person to look at the situation and come to a decision or help resolve the dispute. This is where alternative dispute resolution (ADR) steps in.

There are two types of ADR: (1) mediation; and (2) arbitration. They are NOT the same process. In addition, you can put in an ADR clause in your contract to determine what the procedure is in a dispute. It can be one or the other, it can be both, or it can be neither. This is a negotiation matter.

Mediation: No Judging, Just Identifying the Problem

In mediation, a mediator does not act like a judge. Nor are they the lawyer for either side. All they do is help both sides resolve disagreement by identifying and defining the items you disagree with. The goal here is cooperation through informal and problem-solving processes, and is NOT adversarial. Generally, this is suitable for divorces and neighbor-to-neighbor disputes, but can work out situations among business partners, customers, and misunderstandings that need clarification.

If you are curious for more information and our in the State of Hawaii, go visit the Mediation Center of the Pacific‘s site by clicking here.

Arbitration: Informal Court

Arbitration functions like an informal court proceeding. On the one hand it is more formal than mediation, but less formal than going to court. It is usually faster and cheaper than a lawsuit because it eliminates many of the processes of formal litigation and trial work. Everything is sped up.  Typically, the arbitrator is a former judge, but has extensive knowledge in your trade and industry.  They will take in witnesses and evidence, and then issue a written decision. More often than not this decision is binding on the two parties; if you lose in arbitration, you may not be able to go to court even if you disagree with the outcome. Usually, to be binding, you and the other party has put in the ADR clause that arbitration will be binding.

Last Word: Partnership Agreements, Operating Agreements, and Bylaws are Contracts!

I think one thing I want this post to impart, and the fact that I did a Basics on Contract Law talk and have a Business Entity Formation talk coming up is that people who join together to start a business is that the internal document that guides the arrangement, whether a partnership agreement, operating agreement, or the bylaws, they are contracts.

Why is this important? Because many times the owners of a business get into arguments or disagree, and sometimes there is a breach of the internal agreement. At that point you have to ask yourself: Do you want to sue your business partner?

Sometimes, the answer is yes, but sometimes the answer is ADR is the better solution and remember you can always use ADR clauses or agreements to force everyone into this less costly route than a suit. You may save money and your business venture.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.