A defendant is liable for contributory copyright infringement if it knows of a third party's infringing activity  and "induces, causes, or materially contributes to” the infringing conduct. For example, the designer and distributor of an electronic file sharing system was found liable by the United States Court of Appeals for the Ninth Circuit as a  contributory infringer because users of that system utilized it to exchange massive quantities of copyrighted music. A&M Records, Inc. v. Napster, Inc. The Supreme Court similarly imposed contributory liability arising from the distribution of similar software that allowed for the exchange of copyrighted music on a peer to peer, rather than a centralized, basis. MetroGoldwinMayerStudios, Inc. v. Grokster, Ltd.

 ©2009 Clark & Trevithick. A Professional Corporation. All Rights Reserved.

A relatively new statute exists under Illinois law that all businesses should be aware of going forward. Known as the Citizen Participation Act (CPA), it is commonly referred to as an anti-SLAPP statute. SLAPPs, or “strategic lawsuits against public participation,” are filed to discourage individuals from speaking out or otherwise communicating with government in opposition to the interests of the plaintiff—most often a corporate entity.

As an example, assume that ABC Development Company intends to build and develop an eight-story senior citizen center in the town of Suburbia. A group of residents oppose the project, purportedly because of its location. The citizens band together and begin to work against the project by creating literature that identifies supposed problems with the development and by attending public meetings to lobby against it. Angered by this conduct, ABC Development Company believes that certain statements being made by the group are not accurate and wants to sue the citizens for defamation in order to stop their actions. Before doing so, ABC Development Company needs to give serious consideration to the Citizen Participation Act.

A Defendant-Friendly Statute

In essence, the CPA is intended to provide immunity from liability for any acts made “in furtherance of the constitutional rights to petition, speech, association and participation in government.” Importantly, the acts are immunized “regardless of intent or purpose,” except when they are not “genuinely aimed at procuring favorable government action, result or outcome.” Therefore, even if ABC Development Company believed that one of the individuals involved in the group had a financial incentive to see the development fail, that would not negate the applicability of the act.

If ABC Development Company were to file a defamation suit against the group, and the group asserted that the lawsuit is a SLAPP, the CPA would come into play and trigger procedural rules that are not otherwise known in Illinois law. For example, the trial court would be required to hold a hearing and render a decision on the applicability of the act within 90 days after the plaintiff was served with notice of the motion asserting that the lawsuit is a SLAPP. During that 90-day period, no discovery could be taken, with limited exception.

Further, the circuit court would be required to grant the motion and dismiss the lawsuit unless the plaintiff produced “clear and convincing evidence that the acts of the moving party are not immunized from, or are not in furtherance of acts immunized from liability” by the CPA.  In other words, the burden essentially shifts at the earliest stage of the litigation to the plaintiff to produce clear and convincing evidence that the defendants’ actions in lobbying against the project are not immunized under the CPA. Therefore, ABC Development Company would have to produce evidence that the citizens’ acts were not genuinely aimed at procuring favorable government action. This is a very difficult standard to meet, particularly if the evidence must be produced without the benefit of discovery.

Even if ABC Development Company produced such evidence and survived the motion to dismiss, the defendants would still have a right to seek immediate review by the appellate court. Although ordinarily the appellate court could not be asked to review the denial of a motion to dismiss until after the conclusion of the entire litigation, the CPA permits an immediate appeal. The act also directs the appellate court to expedite the appeal in order for the defendants to obtain a review of the trial court’s decision as expeditiously as possible.

Clearly, the provisions of the CPA are intended to favor the defendant. This is also evident in the attorneys’ fee provision of the act. Specifically, the CPA contains a mandatory provision requiring that attorneys' fees and costs be awarded to a defendant that prevails on a motion brought pursuant to the act. If the defendant is required to obtain an order from the appellate court finding that the CPA applies, the defendant would likely seek recovery of all attorneys' fees and costs associated with the proceedings in both the trial court and the appellate court. In our example, this could result in a significant payment by ABC Development Company to the citizens group if it is determined that their conduct was immunized under the act.

The CPA can be a great tool for an individual being forced to defend against a SLAPP. Unfortunately for businesses, it can also create liability for an entity that files a defamation action. If a trial court finds that the act applies to the case at hand, the plaintiff is required to pay the defendants' attorneys' fees and costs. Accordingly, whether you are contemplating filing a defamation action, or faced with being a defendant in a defamation suit, it is wise to consider the CPA and consult with your attorney to determine its applicability.

Despite the proliferation of limited liability companies and the various benefits of that structure, many businesses today still operate as corporations. As you know, a corporation is owned by its shareholders, who elect the directors who run the company. The directors, in turn, elect the officers, including the president, to oversee day-to-day operations. The directors are generally elected once a year either at a shareholders' meeting or by written consent according to the rules and procedures set forth in the corporate bylaws. Thus, the bylaws establish where and when the annual meeting will take place, how many directors will be elected, when the directors will meet, who can call special meetings, how those meetings will be called, what powers the directors and officers have, and so on.

While virtually every corporation has bylaws, many of the provisions are regarded as boilerplate and are often ignored or not even read at all. Treating bylaws this way, however, is never good corporate practice, and two provisions in particular should be afforded more respect since they are often pivotal when disputes arise over control of a company: (1) the number of directors and (2) whether and how the bylaws can be amended.

Ignoring these provisions can have negative consequences, as a shareholder learned in a recent Illinois Appellate Court case, Kern v. Arlington Ridge Pathology S.C. When a dispute arose between shareholders over control of a corporation, one of the shareholders filed suit to prevent the directors from amending the corporate bylaws, claiming that the directors did not have a quorum. The bylaws required four to nine directors, yet only three had been in place for the prior six years. The bylaws also stated that three directors were not sufficient to constitute a quorum or to amend the bylaws. Despite these straightforward provisions, the Illinois Appellate Court denied the plaintiff's petition, allowing the directors to proceed with the meeting and amend the bylaws.

How did this happen?

The answer is simple. The court ruled that, since the corporation had for six continuous years operated with only three directors, it had in effect waived or abrogated the provision that required four to nine directors. In other words, since the corporation did not "use" or act on that provision for an extended period of time, the court treated that bylaw as if it had already been amended to require only three directors. "Non-use," the court said, resulted in the removal of the requirement for four to nine directors.

Implications for Corporations

What are the implications for anyone who is operating a business as a corporation? For starters, you should not take your bylaws for granted, especially if you are not the sole shareholder in your company. If you are not operating with the required number of directors and you attempt to hold an election to fill the vacancies in an effort to resolve a dispute, you may not be able to do so. At the very least, such a situation can create confusion, if not litigation.

But there are other common provisions that should be followed as well, such as how your bylaws are amended. If you fail to amend them as required, then it is possible that the bylaws themselves—the governing document of your organization—will be rendered absolutely meaningless in the eyes of the courts.

Therefore, every business operating as a corporation should take the time to review its bylaws and make sure that this important document accurately states your organization’s intended policies. If not, the bylaws should be properly amended—now, not later. But having the bylaws say what you want is only half the battle. The second half is to follow them. As the Kern court made very clear to the plaintiff, with corporate bylaws, you have to use them or lose them.

The U.S. Supreme Court recently confirmed that employee benefit plans are governed exclusively by federal law and the plan documents. In Kennedy v. Plan Administrator for DuPont Savings & Investment Plan, et al., the Supreme Court unanimously held that a plan's payment of benefits to a designated ex-spouse beneficiary was proper, despite the ex-spouse's purported waiver of plan rights upon divorce.

What does this mean for plan participants? For starters, it is important to understand that the federal Employee Retirement Income Security Act of 1974 (ERISA) requires every employee benefit plan to specify how benefits are to be paid. ERISA also states that the plan administrator must act in accordance with the plan documents insofar as they are consistent with federal law. As evidenced by the Supreme Court's ruling in the Kennedy case, these requirements can create a particularly unfavorable situation for plan participants who fail to change their beneficiary designation following a divorce.

While many state laws automatically revoke the designation of a spouse as beneficiary upon dissolution of marriage, ERISA preempts such statutes and requires that plans be administered—and benefits be paid—in accordance with the plan documents, irrespective of state laws. In the Kennedy decision, the Supreme Court went so far as to hold that even where a divorce decree specifically divests the non-participant spouse of his or her interest in plan benefits, in the absence of an executed plan document removing the non-participant ex-spouse as a beneficiary, the plan benefits are properly payable to the non-participant ex-spouse. The only exceptions, according to the Court, are when the waiver is part of a special “Qualified Domestic Relations Order” presented to the plan administrator, or when the waiver is consistent with the plan documents (i.e., the plan itself provides that benefits are automatically waived by the non-participant spouse in the event of divorce or that a divorce decree is a proper method of waiver).

While the Kennedy case holds that the plan administrator properly paid the benefits to the ex-spouse, the issue of whether the deceased participant’s estate had any valid claims for payment over from the ex-spouse was not litigated. However, even if such claims could have been successful for the estate, the associated litigation would likely have been very costly.

Lessons Learned

What should participants in employee benefit plans do now to avoid a similar outcome?

1. 1. 1. Even if you are not divorced, review your current beneficiary designations to make certain you have named your intended beneficiary. If the designated beneficiary is an ex-spouse (or another individual whom you no longer consider appropriate), make sure to execute the proper change of beneficiary forms to name the beneficiary you desire.
          
      2. Review your plan documents. If your plan does not provide for an automatic waiver of benefits by a non-participating spouse in the event of divorce, the plan should be amended to provide that a non-participant ex-spouse is automatically divested of his or her interest in plan benefits, and that the designation of an ex-spouse is automatically revoked upon the entry of a divorce decree, regardless of whether that decree meets the requirements of a Qualified Domestic Relations Order.

The Worker, Retiree and Employer Recovery Act of 2008 was recently passed to provide financial flexibility in these tough economic times. A primary component of this new law is the suspension of Required Minimum Distributions (RMDs) from retirement plans in 2009. This provision is designed to prevent retirees from having to sell retirement plan or IRA assets at distressed values in order to generate the cash needed to make their RMDs.

What the Act Means for Participants

Qualified retirement plans and IRAs are subject to various rules regarding Required Minimum Distributions. Generally, participants must begin taking annual distributions from their plans once they attain age 70½. The first RMD, however, may be deferred until April 1 of the following year. The amount of each annual RMD is generally determined by dividing the account balance at the end of the prior year by a distribution period published by the IRS. Distributions are taxed as ordinary income (unless the participant made nondeductible contributions). Furthermore, failure to take an RMD will subject the participant to a 50% excise tax.

The Worker, Retiree and Employer Recovery Act of 2008 suspends the RMD requirements for 2009, which means that the next RMD for IRA owners and qualified defined contribution plan participants will be for calendar year 2010. The act does not, however, affect the RMD requirement for participants who attained age 70½ in 2008 but chose to defer their distribution until April 1, 2009.

For participants who attained age 70½ in 2009, no RMD is required for 2009. However, these participants will need to take an RMD for 2010, which must be done by December 31, 2010. Unfortunately, it cannot be deferred until April 1, 2011, even though it is technically the first RMD.

Inherited IRAs and Qualified Plans

Beneficiaries of inherited plans must also take Required Minimum Distributions. While Roth IRAs are not subject to RMD rules during the owner's lifetime, there are post-death requirements that apply. The relief provided by the Worker, Retiree and Employer Recovery Act of 2008 extends to beneficiaries of inherited IRAs and retirement plans, similarly waiving the RMD requirements for 2009. Under the act, beneficiaries of an IRA, Roth IRA or other qualified plan may skip taking the RMD in 2009. Furthermore, if you are following the Five-Year Rule to comply with the RMD requirements and if tax year 2009 falls within the five-year period following the retirement account owner's death, the act automatically extends the payout period by one year (thus making it a six-year payout period).

Benefits of the RMD Suspension

By suspending RMDs for 2009, the Worker, Retiree and Employer Recovery Act of 2008 offers tax relief to participants and beneficiaries of IRAs and other defined contribution plans who would not otherwise take withdrawals (e.g., participants that do not rely on their RMDs for living expenses). By not taking a 2009 RMD, the participant or beneficiary will decrease his or her taxable income for 2009 and will keep more assets within the tax shelter of the retirement account. In addition, if IRA or defined contribution plan assets have declined in value, the waiver of 2009 RMDs will provide an opportunity for the investments to recover before having to be sold to make withdrawals.

In today's turbulent economic environment, gifting assets with depressed values can provide significant transfer tax benefits. However, care must be taken to avoid inadvertently causing the loss of income tax benefits.

A beneficiary receiving an asset from a decedent upon his or her death generally receives an income tax basis for the bequeathed asset equal to its fair market value as of the decedent's date of death. Unlike testamentary transfers, a beneficiary receiving a lifetime gift from a donor generally receives an income tax basis for the gifted asset equal to the donor's basis. However, if at the time of the gift the value of the gifted asset is less than the donor's basis, a special rule applies: For purposes of determining loss on a subsequent sale of the gifted asset, the beneficiary’s basis is the lower fair market value of the asset as of the date of the gift.

If you are contemplating a gift of an asset with a current fair market value that is less than the donor’s basis, and if the asset may be sold shortly after the gift is made, a better strategy may be for you (the donor) to sell the asset and realize the loss for income tax purposes. That approach would enable you to take full advantage of your basis, followed by a gift of the net proceeds to the donee.

When contemplating a gift, care must be taken in determining what asset to give, so as not to cause loss of income tax benefits. Prior to making a gift, it is important to determine not only the value of the asset, but also what the basis would be.

On January 9, 2009, federal legislation (HR 436) was proposed that, if enacted, would eliminate valuation discounts relating to transfers of closely held business interests to the extent of the entity's non-business assets. This legislation especially affects estate planning with regard to family limited partnerships holding cash, bonds, marketable securities and/or real estate (with an exception for real estate activities where more than 750 hours of services are rendered during a taxable year).

The proposed legislation would only be effective for transfers made after the date of its enactment.
 
While there are many reasons for creating closely held entities and transferring interests to family members, individuals who are contemplating estate planning with family limited partnerships—particularly gifting or sales to Grantor Trusts—should consider promptly implementing their plans. Otherwise, if the proposed legislation is enacted, the tax savings benefits of such planning will be lost.

The combination of recent volatility and depressed values in the financial markets, historically low interest rates, and the deepening recession have created an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis. Hopefully, values will increase again. When they do, the opportunity to leverage and reduce—or even eliminate—your transfer taxes on such favorable terms may be gone.

In the meantime, there are a number of techniques worth considering to make the most of this perfect storm.

Annual Exclusion Gifts and the Lifetime Gift Exemption

As the value of stock, real estate and other assets has generally been declining, now may be a good time to use such assets to make gifts as a means of reducing estate taxes. Currently, individuals can give $13,000 annually to each of any number of donees without incurring any gift tax ramifications. Gifts in excess of this amount are generally taxable, but the first $1 million is shielded by the Lifetime Gift Exemption (in essence using a portion of the exemption available at death to transfer assets free of estate tax). The tax savings are magnified when you factor in future growth, which inures to the benefit of the donee.

A husband and wife with three children, for example, might make gifts of “depressed value stock” using their annual exclusions and Lifetime Gift Exemptions, expecting the stock to recover by 25% over the next three years. If the value of the stock gifted in 2009 was $2,078,000, no gift tax would be due. At the end of three years, the value of the assets that the children then owned would be $2,597,500—an estimated $269,000 in estate tax savings if the parents died that year. However, if the parents survived for an additional 15 years and the stock continued to grow 5% annually, it would be worth approximately $5 million, with an estimated $1.53 million in estate tax savings.

Minimal Interest Intra-Family Loans

An intra-family loan is a simple but attractive estate planning technique that can be executed independent of other strategies and without adverse gift tax consequences. In order to avoid gift taxes, the loan must be made at the Applicable Federal Rate (AFR), which is currently quite low. As of March 2009, the AFR is 0.72% for a loan of three years or less, 1.94% for a three-plus to nine-year loan, and 3.52% for a loan exceeding nine years. Although your family member/borrower will owe you interest on the loan, wealth is transferred on a tax-free basis as long as the funds are invested with a return in excess of the AFR.

Refinancing Existing Loans

Many parents may have made loans to their children or trusts for their benefit, including outright loans and loans issued in connection with sales of assets. The interest rate being charged on the loans may be significantly higher than the current AFR. If the loans can be prepaid without penalty, and if the parent/lender does not need the cash flow, consideration should be given to refinancing the loans at the lower current interest rate. This will reduce the child’s cash outflow, allowing the wealth to grow for his or her benefit outside the transfer tax regime.

Grantor Trusts and Installment Sales

If a person creates a trust and includes certain Grantor Trust provisions, the income tax laws treat the trust and the creator as one (i.e., the existence of the trust is ignored). The creator, not the trust, then reports the trust income and pays the tax thereon. In essence, this allows the creator to make tax-free gifts to such a trust benefiting the trust beneficiaries. As the creator is required to pay the income tax on the trust’s income, the Grantor Trust grows tax free while allowing the creator’s assets that would otherwise be subject to transfer taxation to be reduced by the amount of the income taxes. The tax-free compounding of the Grantor Trust may create the greatest of all estate tax leveraging.

A parent can establish a Grantor Trust and sell appreciating assets to that trust for an installment note bearing interest at the AFR, which is currently very low. Under the Grantor Trust rules, no gain or loss on the sale would be recognized. Although the Grantor Trust would be required to make payments on the note, the growth on the asset sold would inure to the trust beneficiaries. In essence, the parent would be freezing the value of the transferred assets. The sale to the Grantor Trust produces transfer tax benefits when the assets sold appreciate more than the rate of the promissory note, which is likely given the low current AFR and the probability that an asset with a severely depressed value will recover.

Self-Canceling Installment Notes and Private Annuities

Two variations of a promissory note transaction are a self-canceling installment note (SCIN) and a private annuity. A SCIN is simply an installment note that is canceled if the seller/lender (parent) dies. The buyer/borrower (child) receives a windfall if the parent dies prior to the end of the note term, as no further payments will need to be made. This can also result in substantial estate tax savings, as the balance that was due on the note immediately before death is not included in the parent’s estate. However, the parent must be compensated for this self-canceling feature, generally by an increased interest rate on the note. Thus, while there may be substantial estate tax savings if the parent dies while the note is outstanding, additional assets will have been paid to the parent if he or she survives the note term.

In the typical private annuity transaction, a parent transfers property to a child in return for an unsecured promise to make a fixed, periodic payment to the parent for life. If the fair market value of the property transferred equals the present value of the annuity actuarially determined by the Section 7520 Interest Rate, there is no gift tax due. Similar to the SCIN, a private annuity produces a benefit when the parent dies prior to his or her life expectancy, and a disadvantage if the parent outlives his or her life expectancy. Both the SCIN and the private annuity are even more beneficial when interest rates are low.

GRAT: Grantor Retained Annuity Trust

A GRAT is a Grantor Trust whereby the trust pays the creator a predetermined annuity for a given term in exchange for the creator’s contribution of property to the GRAT. At the expiration of the term, the GRAT assets pass to the named beneficiaries (e.g., descendants or trusts for their benefit). The creator would be making a gift at the time of the creation of the trust equal to the value of the transferred property less the value of the retained interest. If the creator survives the term, any assets remaining in the GRAT pass to the named beneficiaries without further gift taxation—regardless of the value. However, if the creator dies during the GRAT term, the assets are fully included in the creator’s estate (in essence unwinding the transaction). A lower interest rate increases the value of the annuity retained by the grantor and thus reduces the value of the gift of the remainder in a GRAT. The GRAT produces transfer tax benefits when the return on the assets transferred exceeds the 7520 Rate—2.4% for March 2009.

Many  factors affect the value of the gift upon creation of a GRAT: the creator’s age, the 7520 Rate, the value of the property being transferred, the term of the GRAT and the annuity percentage. Because the creator can control the term and annuity rate, the GRAT can even be structured to produce no taxable gift (e.g., a two-year term with an annuity equal to 51% of the value of the property contributed). Such a “zeroed out” GRAT would allow appreciation of the assets in excess of the 7520 Rate to pass to descendants free of any transfer tax. Again, with a very low current 7520 Rate, along with the probability that an asset with a severely depressed value will recover, this tax-free scenario can likely be accomplished. However, the clock may be ticking on this “zeroed out” GRAT technique as there has been talk of Congress changing the law to limit the annuity amount and require a minimum remainder/gift value (e.g., 10% of the value of the GRAT).

CLAT: Charitable Lead Annuity Trust

A CLAT is similar to a GRAT, but with the term annuity being paid to a charity. At the expiration of the CLAT term, the remaining assets pass to the named beneficiaries (e.g., children). Not only would the value of the charitable lead interest pass free of any transfer tax, but a CLAT can also be structured to provide the creator with a current income tax deduction. The creator would be making a gift to the remainder beneficiary at the time of the creation of the CLAT equal to the value of the remainder interest (actuarially determined, but with an option to use the 7520 Rate for the month of the transfer or either of the prior two months.) The annuity payment is typically designed to offset the value of the contributed property, so that there is little or no taxable gift upon creation of a CLAT. A lower interest rate results in a larger gift or estate tax deduction for the annuity interest going to the charity and a smaller value for any gift of the remainder interest going to the descendant. A CLAT produces transfer tax benefits when the return on the assets transferred exceeds the 7520 Rate.

QPRT: Qualified Personal Residence Trust

A QPRT is a trust whereby an individual transfers a personal residence to family members at a reduced transfer tax cost. Typically, a parent transfers the residence in trust and retains the exclusive right to occupy the residence for a term of years. Upon expiration of the QPRT term, the residence would pass to children (or other named beneficiaries) without further transfer taxation. The parent is making a current gift of the residence, but the value is reduced by his or her retained interest. While lower interest rates generally mean a lower value for the retained interest and thus a larger gift, the dynamics of a QPRT should not be ruled out. If the current state of the economy has significantly depressed the value of the residence, and if the value is expected to recover, then this technique can render a significant benefit. In essence, the QPRT would freeze the current value of the residence for transfer tax purposes and allow the growth to inure to the benefit of the remainder beneficiaries without further transfer taxation.

• • •

Although the confluence of recent economic events has created a rare opportunity for proactive estate planning, low interest rates and depressed asset values hopefully will not last long. Therefore, it may be important to act now in order to leverage these estate planning techniques while the conditions are ripe.