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The Top Seven Things For Which A Business Owner Can Be Held Personally Liable

By: Doug Bend & David Nied This article first appeared on Forbes. In general, the owner of a legal entity cannot be held personally liable for the liabilities of their business. That being said, business owners should be wary of the following seven items that they can still be held personally liable for: 1. Bank… Read More

By: Doug Bend & David Nied

This article first appeared on Forbes.

In general, the owner of a legal entity cannot be held personally liable for the liabilities of their business. That being said, business owners should be wary of the following seven items that they can still be held personally liable for:

1. Bank Loans

Most bank loans for new business owners require a personal guarantee. If a business owner provides that personal guarantee and the company is unable to meet the loan obligations, the bank can hold that owner personally responsible for the loan.

2. Security Filings

When raising a round of capital, it is important to make sure that any required security filings are made in each state in which there is an investor.

If the proper security filings are not made and the company does not do well, the investor can have their investment rescinded and the owner of the company can be held personally responsible for the investment amount.

3. Contracts

Business owners should make sure that they sign all contracts on behalf of their legal entity and not themselves as an individual. In the first paragraph of each contract, it should be clear that the agreement is being made on behalf of the company.

Similarly, in the signature line, the owner should sign the agreement on behalf of the company and not themselves as an individual.

4. Government Taxes

The government can sometimes come after the business owner for any unpaid taxes. In particular, when a corporation fails to withhold proper payroll taxes, the person responsible for withholding those taxes — in many cases, the owner of the business — can be held personally liable for the unpaid taxes.

5. Wages

At least in California, owners of a business can be held personally responsible for any unpaid employee wages plus late payment penalties. This includes liability for failing to pay minimum wage, failing to pay overtime, failing to provide mandatory meal and rest breaks and other wage violations.

While officers and directors may have a claim for indemnification for such personal liability, that safety net does not apply to the owner of the business.

6. Entity Maintenance

A court is more likely to pierce the corporate veil and allow an aggrieved party to go after the personal assets of an owner if the legal entity is not being properly maintained, such as having annual shareholders and board of directors meetings.

Even though courts weigh many factors to assess alter-ego liability, failing to maintain current, accurate and complete books and records that document required meetings and events is a surefire way to get a judge to look askance at your plea for limited liability.

7. Co-Mingling Funds

In addition, a court may pierce a company’s corporate veil if the business owner is co-mingling personal and business funds. Do not be tempted to use your corporate credit card for personal, non-business related expenses — it may open the door for a creditor to march into your personal bank account.

If properly maintained, a legal entity can provide a business owner with a great deal of legal liability protection. By being wary of the above pitfalls, a business owner is more likely to prevent their personal assets from being put in jeopardy by the activities of their business.

This article was co-authored by David Nied of Ad Astra Law Group, LLP and a member of Forbes Legal Council.

The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.

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Can Shareholders Waive Directors’ Fiduciary Duties?

By Luthien Niland In California, directors and officers have fiduciary duties, or legal obligations, that they must adhere to when making decisions for the corporation and the shareholders. If they do not fulfill their fiduciary duties, the directors and officers can be sued. Therefore, in order to minimize their risk, directors and officers may try… Read More

By Luthien Niland

In California, directors and officers have fiduciary duties, or legal obligations, that they must adhere to when making decisions for the corporation and the shareholders. If they do not fulfill their fiduciary duties, the directors and officers can be sued. Therefore, in order to minimize their risk, directors and officers may try to convince shareholders to release them of these duties, but such efforts are illegal under California law.

Background on Fiduciary Duties

Fiduciary duties imposed on directors and officers of corporations generally fall into one of two categories: duty of loyalty and duty of care. The duty of loyalty requires directors and officers to always act in the corporation’s best interest and forbids them from engaging in “self dealing,” or taking advantage of their position in the corporation to benefit their own interests. The duty of care obligates directors and officers to carry out their duties as a normal prudent person would do under the circumstances, including making sure that they are completely informed before making decisions.

If a director or officer makes decisions for the shareholders or the corporation in a manner that does not meet these obligations, then the shareholders can bring a lawsuit against the director or officer for breach of a fiduciary duty. Additionally, in small, non-public corporations, majority shareholders can generally control the corporation by electing themselves as directors and officers, thereby “freezing out” minority shareholders. Therefore, directors and officers of small or close corporations are generally held to a higher standard for fiduciary duties.

Waiver of Fiduciary Duties is Void

California statutory law and common law expressly prohibit the waiver of fiduciary duties for directors and officers. In particular, section 204(a) of the California Corporations Code states that a corporation’s Articles of Incorporation may not “eliminate or limit the liability of directors” for acts or omissions that violate the directors’ fiduciary duties to the corporation and shareholders. Furthermore, section 1668 of the California Civil Code provides that any contracts (such as a shareholders agreement) that “exempt any one from responsibility for his own fraud, or willful injury to the person or property of another” are against public policy. Based on these statutes and prior court cases, the California Court of Appeals in Neubauer v. Goldfarb held in 2003 that “waiver of corporate directors’ and majority shareholders’ fiduciary duties to minority shareholders in private close corporations is against public policy and a contract provision in a buy-sell agreement purporting to effect such a waiver is void.” As a result, directors and officers cannot limit or avoid their fiduciary duties through the company’s incorporation documents or another contract.

Minimizing Risks for Directors and Officers

Although directors and officers cannot obtain a waiver from shareholders of their fiduciary duties, there are a number of ways to minimize the risk of a shareholder lawsuit:

  1. Fulfill duty of loyalty – Directors and officers should make sure that all decisions made are in the best interests of the corporation and the shareholders, not just one or a small number of shareholders. Robust, detailed written board and/or shareholder resolutions or minutes documenting the reasons for a decision are recommended so these reasons can be provided to the shareholders and also as evidence in the event of a lawsuit.
  2. Fulfill duty of care – Directors and officers should obtain and review all information necessary for making a decision and, when helpful, either include this information in board resolutions or refer to it. Again, the more detailed the board and shareholder resolutions or minutes, the better the historical and legal record that is created. All shareholders, even minority shareholders, have the right to request information from and about the corporation with reasonable cause. Therefore, while directors may not want to include confidential company information in a resolution that is being freely circulated, otherwise it is prudent to add whatever supporting information was used for a decision to a resolution since it is open to shareholders anyway.
  3. Sign indemnification agreements between the company and the directors – In the event that a director acts in good faith and is still sued, the company is then agreeing to pay for the lawsuit.
  4. Provide E&O (“Errors and Omissions”) insurance for directors – The financial viability of this option generally depends on the size of the company and can be discussed with a business insurance broker.

In conclusion, although shareholders cannot waive their right to sue directors and officers for breach of fiduciary duties, directors and officers can protect themselves from such a lawsuit by making all decisions in the best interests of the corporation, being properly informed before making any decisions, and documenting all decisions and reasoning in writing thoroughly.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article

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Preparing an Employment Agreement

By Alex King When a small business or startup considers offering an employment position to a candidate, it’s common practice to create an employment agreement, or offer letter, which stipulates the general terms of the relationship. Before presenting such an agreement to a candidate, make sure you consider a couple of key provisions: • The… Read More

By Alex King

When a small business or startup considers offering an employment position to a candidate, it’s common practice to create an employment agreement, or offer letter, which stipulates the general terms of the relationship. Before presenting such an agreement to a candidate, make sure you consider a couple of key provisions:

• The position and title, including whether the offer is for full time employment, and the expected days and hours the candidate should fulfill
• Whether or not the position is considered exempt or non-exempt, as defined by the Fair Labor Standards Act
• The rate of pay and if the offer includes any equity compensation
• The term of employment. The law presumes the relationship is “at will” (See Cal. Labor Code 2922) unless specifically changed within the agreement.
• The statement of benefits being offered, if any

To help highlight the “at-will” nature of the relationship, many employers will bold or place the at-will provision in all caps. Speaking generally, if the employer provides a clear at-will provision within an employment agreement or offer letter, it hinders the ability for the employee to later claim there was an inferred agreement that the employee could only be terminated for cause (See Guz v. Bechtel Nat. Inc., 24 Cal.4th 317 (2000)).

Under CA law, certain information must be given to employees at the time of hiring. For non-exempt employees, the employer must give specific information about pay rates and paid sick leaves (See Cal. Labor Code Section 2810.5). Any changes to this information must be provided in writing to employees within seven (7) days of implementing the changes. For employees whose compensation includes commission, the employer must provide a written commission agreement stating the method for computing and paying the commission (See Cal. Labor Code Section 2751).

Finally, it should be noted that as a CA employer non-compete agreements are generally unlawful. However, a prudent employer can create some indirect non-compete provisions, such as including proper non-disclosure and confidentiality clauses within the employment agreement or offer letter. Furthermore, employers can also include non-solicitation language that would prohibit an employee from recruiting co-workers after the employee leaves.

The information provided above is far from an exhaustive list. Employers should work with an attorney to ensure they are properly following state and federal rules to avoid costly mistakes down the line. If you’re interested in speaking to an attorney at Bend Law Group, please reach out at info@bendlawoffice.com, or give us a ring at 415 633 6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Is GOOGLE Too Generic To Be A Trademark? Well, Let’s “Google it!”

By: Vivek Vaidya and Nidhi Kaushal Can I get some Kleenex please! Do you have any Aspirin? How about a Q-Tip? Can you Xerox this for me? We often use and refer to popular brand names in our daily life to buy certain products or services. While it may be a company’s dream to turn its… Read More

By: Vivek Vaidya and Nidhi Kaushal

Can I get some Kleenex please! Do you have any Aspirin? How about a Q-Tip? Can you Xerox this for me?

We often use and refer to popular brand names in our daily life to buy certain products or services. While it may be a company’s dream to turn its trademark into a household name, it could also could result in the death of a brand.

A trademark provides protection to the names, slogans and logos that distinguish a company’s goods and services from others. However, trademarks that become “generic” lose their distinctiveness, and in turn lose their trademark protection. A trademark becomes generic when the general public start identifying similar products or services through that single name. For instance, Kleenex have become a generic term for tissues, and Xerox has become generic for photocopying devices. When the product or service with which the trademark is associated acquires a substantial market dominance or mind share of the public, it can become victim to “genericide.”

Google faced a situation where two individuals, David Elliot and Chris Gillespie, filed a request for cancellation of the GOOGLE trademark on the grounds that it is generic. They claimed that the word GOOGLE has become synonymous with “search the Internet,” and Google should lose its trademark protection.

In May 2017, the case was heard by United States Court of Appeals for the Ninth Circuit. The court ruled that the plaintiffs were unable to show that there is no other way to describe “internet search engines” without calling them GOOGLE. The court reasoned that “not a single competitor calls its search engine a GOOGLE and because members of the consuming public recognize and refer to internet searches engines using other terms, the plaintiffs have failed to show that there is no available substitute for the word google as a generic term”. However, the court of appeals recognized the possibility that over the time a valid trademark becomes the victim of genericization when the name has become an exclusive descriptor that makes it difficult for the competitors to compete unless they use that name.

The case was submitted to the Supreme Court for review. However, in October 2017, the Court declined to hear the plaintiffs petition.

Companies spend large amounts of resources to protect and maintain their trademarks. With this victory, it is surely a celebration for GOOGLE and other companies that could fall into the “genericide” trap. However, this issue is on-going, and this case likely marks the beginning of many challenges to the trademark rights of widely used global technology companies.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.  

 

 

 

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Catch 22: Founders Must Pay Themselves Even Before Their Company Earns Revenue

By: Luthien Niland It’s a common scenario for start-up founders: a few friends join together to build a company, each working long hours without pay in exchange for a promise – or at least a hope – that the company will be successful and they will be paid back tenfold for their initial time and… Read More

By: Luthien Niland

It’s a common scenario for start-up founders: a few friends join together to build a company, each working long hours without pay in exchange for a promise – or at least a hope – that the company will be successful and they will be paid back tenfold for their initial time and sacrifices. However, even though this is common practice, it may violate California law and has the potential to be very costly for the company and the directors personally if things turn sour.

Minimum Wage Requirements and a Minor Exception

All employees in California must be paid at least minimum wage, at the rate set either by the state or the city where the employee is working. While there are various factors for classifying a worker as an independent contractor versus an employee, generally someone who is working full-time or more for a company on a long-term basis is considered an employee, and so the minimum wage requirement applies to many founders.

In addition to the minimum wage requirement, which can be paid on an hourly basis or salary, employees may also be entitled to be paid overtime and receive meal and rest breaks. These additional requirements depend on if the employee is classified as “exempt” (no overtime or breaks required) or “non-exempt” (overtime and breaks required). Employees are considered “non-exempt” unless they meet certain requirements to be considered “exempt” (this blog post describes the most common exceptions to wage and hour requirements)1 and are paid a salary that is at least equal to double the minimum wage for full-time employment. For California employers with 25 employees or less, this is currently $41,600 per year, and for California employers with over 25 employees, the minimum salary amount for exempt employees is $43,680. Therefore, unless founders meet the criteria for an “exempt” employee, additional penalties can be imposed for not paying them for overtime or meal or rest breaks.

One additional exception to the non-exempt classification is that employees who own at least 20% of the company and are involved in management of the company may be classified as exempt employees. However, whether a founder is classified as a non-exempt or exempt employee, she or he must still be paid at least minimum wage or a salary equal to the applicable state or city requirements, so this exception does not release companies from paying founders that fall under this exception.

Where Things Can Go Wrong

While anyone who is starting a company likely knows about minimum wage, it is important to understand that this is an absolute requirement for any company that has employees. It is not a defense to these requirements that the company doesn’t have money to pay its employees. Further, any agreement to contract around minimum wage requirements is unenforceable, so a founders agreement or other contract waiving a founder’s right to payment or deferring compensation is useless.

While the California Department of Labor could bring a proceeding against a company for not paying its employees in accordance with wage and hour laws, the more likely scenario is that a disgruntled founder will decide to leave the company and sue for unpaid wages – and if the founder was working normal start-up hours of 60+ hours per week, between unpaid minimum wage and overtime, missed meal and rest breaks, and penalties for all of these violations (plus the time and expense of a lawsuit), the amount of money claimed by the founder can add up very quickly, especially for a start-up that still hasn’t generated much or any revenue. Additionally, if the start-up is planning to approach investors to raise capital, not only will a lawsuit look terrible during due diligence, but the investors will likely be turned off by the prospect of their investment money being used to pay the debt of the company from the lawsuit.

Personal Liability of Directors

One reason why we recommend forming a corporation is to protect the people involved from personal liability for the actions of the corporation. However, California statute specifically carves out an exception from such personal liability protection for officers and directors for wage and hour violations. Section 558.1 of the California Labor Code states that any employer, or any person acting on behalf of the employer, which includes any owner, director, officer, or managing agent of the employer, may be held liable for the employer’s violations of any provision regulating minimum wages and other directives in Wage Orders, such as unpaid overtime and denied meal or rest breaks.

The language in accompanying portions of the Labor Code suggests that such personal liability can only be enforced by the Labor Commissioner during a proceeding, not in a private lawsuit against a company by an ex-founder. However, this limitation is not explicit in the Labor Code and so there is a risk that an ex-founder may still use it as another claim in a private lawsuit brought for other reasons. Otherwise, if the ex-founder knows that the company is insolvent, it may instead opt to bring a proceeding before the Labor Commissioner where this provision can be enforced, and the officers and directors of the company may be forced to personally pay for the unpaid wages, penalties, and violations of the ex-founder.

What You Can Do

California has a reputation for being an employee-friendly state, and has crafted its wage and hour laws so that people get paid for the work that they perform. Unfortunately, no exception or defense has been created for the broke start-up that is formed with all of the founders voluntarily agreeing not to be paid until the company can generate revenue. Thus, the options to avoid the risks of a wage and hour lawsuit or proceeding are limited.

First, companies can pay their workers at least minimum wage and pay careful attention to whether the workers are non-exempt employees to whom overtime and meal and rest breaks are owed. At the very least, founders can limit the number of founders or other employees who are working for the company without pay to minimize the risk that someone will become disgruntled and pursue a suit for unpaid wages.

Second, the founders can wait to incorporate their company until they are further along in building the company’s product or services. While there may be an argument at some stage of a project that someone working on an unincorporated venture is an employee of that venture, at least initially two friends working towards building an idea together is likely not seen as creating an employer-employee relationship and so wage and hour laws would not yet apply. However, incorporation has many important tax and liability benefits, plus attracting investors and additional talent requires an established legal entity, so this strategy may only be viable in the initial stages of an idea. Additionally, a legal entity owns the IP and other work that the founders are creating, rather than each founder individually owning the IP that they create and therefore could take with them if they decided to leave the venture.

Founder compensation is seldom discussed until it is too late and the wage and hour violations have already occurred, giving a departing founder significant leverage to demand a large pay-out or equity stake in the company. Such risks should be weighed by founders when starting a company and should impact decisions about how money is allocated, how many hours are worked by each employee, and how to best expand the team.

The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.

1 Anthony Zaller, “Five Exempt Employee Classifications All California Employers Should Understand,” 2015.

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Five Key Questions To Ask When Creating Law Firm Equity Agreements

This article first appeared on Forbes. When drafting an equity agreement, partners need to be prepared for many different issues and eventualities. That’s why it is necessary to carefully consider the terms of the agreement, from the allocation of profits and losses to the systems in place when it comes to removing a partner. We… Read More

This article first appeared on Forbes.

When drafting an equity agreement, partners need to be prepared for many different issues and eventualities. That’s why it is necessary to carefully consider the terms of the agreement, from the allocation of profits and losses to the systems in place when it comes to removing a partner.

We have helped set up several law firms, and these are the five key questions that we find partners should consider:

1. How will the profits and losses of the firm be allocated?

Many law firms equally split the profits and losses. An advantage to this approach is that the partners equally enjoy the ups and downs of the firm. For example, if the firm wins a big contingency case, all of the partners benefit.
Other firms use an “eat what you kill” system where each partner gets their net profits, but is also responsible for their losses. A pro to this approach is it may lead to less friction over time between the partners who want to work 70 hours a week and those who want to spend more time with their families, traveling or on the golf course. An eat-what-you-kill item might also create a framework that leads to less resentment if a partner decides to take off more time with a newborn child, to help a sick family member, or if they have expensive spending habits.

2. How will decisions be made?

Partners also need to decide what decisions will require a majority vote of the partners, a supermajority vote (anywhere from 67-90%) of the partners or the unanimous consent of the partners.
For example, if a majority of partners want to promote an associate attorney to be a new partner, is that sufficient?
It is important to be very clear which items require which voting threshold so there is no dispute over whether an item requires a supermajority or unanimous vote, as opposed to merely a majority vote.

3. How will equity be valued when a partner leaves?

Some law firms value a departing partner’s ownership using a formula in the partnership agreement, such as 1.0-1.5 times the prior year’s gross revenue. Other firms have a business appraiser value the ownership interest of a partner who leaves the firm.
It is important to not only plan for how the fair market value of the equity interest will be calculated, but also how the purchase price will be funded to make sure the payments do not overburden the remaining partners.

4. How can a partner be removed?

Some law firms require a majority vote of the remaining partners to remove a partner whereas other firms have a higher bar for removing a partner.

5. What powers will the managing partner have?

Some law firms like to set checks and balances on the powers of the managing partner. For example, any expenditure above $X requires the approval of a majority of the partners.

There is no one-size-fits-all answer to these questions. The key is partners having a clear equity agreement in place that provides a roadmap when these and other issues inevitably occur.

The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.

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Raising Capital: The Different Investment Stages

You’ve hatched an idea, formed a team and now you’re ready to raise private capital to jump start your new company. One of the keys to success is understanding the general process a startup will go through as it continues to grow and expand its operations. Below you’ll find an overview of the three stages… Read More

You’ve hatched an idea, formed a team and now you’re ready to raise private capital to jump start your new company. One of the keys to success is understanding the general process a startup will go through as it continues to grow and expand its operations. Below you’ll find an overview of the three stages we see most of our startups go through on their way to raising multiple rounds of capital.

Seed Stage

A seed investment in a startup is usually between $100,000 and $1m with the primary investors being friends and family, as well as angel investors. At this stage, the company has little more than a speculative business plan and therefore is primarily selling the founders past experience, vision and long-term plan to those within their network who believe in the talents of the team.

With little operating capital, startups are looking to keep the transaction as cost effective as possible by using instruments such as convertible notes, SAFE and KISS agreements. These are all instruments that will convert to equity at a later date but do not give the holder actual ownership in the company until they do. However, don’t be fooled into think this is not a sale of a “security”, it is, and startups must be compliant at both the state and federal level when closing out this type of transaction.

Early Stage

This is the stage in which the startup actually begins its operations and is looking to raise capital to expand and continue development of its product or service. This is often the startup’s first engagement with an institutional investor (e.g. venture capitalist), and the amount sought is between $1-3m.

At this juncture, a smart startup is looking for more than just cash. No doubt, the capital is needed to fund its operations, but a savvy startup is also looking to form a relationship with an institutional investor to grant access to experts in their field who can advise on financial, strategic and operational issues, and can help lead a growth stage round down the line.

For early stage financing a startup will often sell “preferred stock”, and the investors who invested in the seed stage will convert their convertible instrument into equity during this round.  This round will often cost two to four times as much in legal and accounting as the seed stage but is hopefully offset by the much larger raise.

Growth Stage

The purpose of this round of financing is to expand the product or service to new markets, develop a new line, ramp up the team to scale, or even consider acquiring another startup/small business. While often turning a profit, or trending in that direction, the startup is often incapable of borrowing the funds it needs from a bank as they continue to look for a capital raise through another private placement round of financing.

Like the early stage, the investors tend to be large institutional investors, and the offer is for preferred Series B stock. However, unlike the early stage, the growth stage is often complicated by more complex financials and a greater number of shareholders and investors to consider. Additionally, with a longer operating history, the growth stage company is often viewed as less risky by investors.

Unlike seed or early stage startups, a growth stage company will go through an extensive due diligence process as the new investors investigate and kick the tires on the company. A lawyer familiar with the company who assisted with the first two rounds can typically keep the costs of the growth stage in the same ball park as the early stage round, however, because the overall structure has become more complicated it’s not abnormal for the round to exceed what it costs to complete the early stage round.

Having a sense of the process can aid in your discussions with prospective strategic partners, and investors. If you’re considering raising capital for your venture (big or small) please reach out to carry the conversation forward. You can contact us at info@bendlawoffice.com, or at (415) 633-6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal or tax advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

 

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