Economic Developments Impacting Businesses, Employers and Private Investors
A Q&A with Sherman & Howard's Changing Markets Practice Group

Recent U.S. and worldwide economic developments have pushed many businesses onto new playing fields, practically overnight. Resulting historic legislative and regulatory responses will impact businesses and individuals in ways that were not imagined only weeks ago and won't completely be known until years from now. Sherman & Howard's attorneys discuss a few of the questions raised by these recent developments and ways in which we are assisting clients:

Is my money safe?

The recent headlines questioning the safety of money market funds and depositary institutions have caused many of us to ask this question. The answer depends on several factors that we have been analyzing for our clients. Our analysis has included a review of recent legislation and regulatory action that has enhanced the safety of various types of accounts.

The Emergency Economic Stabilization Act of 2008, enacted October 3, 2008, temporarily increased the standard maximum deposit insurance amounts under the Federal Deposit Insurance Act and the Federal Credit Union Act to $250,000. This temporary increase is effective until December 31, 2009.

The Temporary Guarantee Program for Money Market Funds, opened by the U.S. Treasury Department on September 19, 2008, guarantees investors that they will receive $1 for each money market fund share held in any publicly offered eligible money market mutual fund that applies for and pays a fee to participate in the program. While the program protects the accounts of investors, each money market fund makes its own decision to sign up for the program. Investors should contact their money market fund directly to determine if it is participating in this program.

We have also analyzed various custodial arrangements and cash management programs established by financial institutions to help assess the relative risk of such arrangements.

Have we just experienced a Material Adverse Change?

This is a question that we have been hearing lately, in light of the pressures on today's credit and capital markets. Why is it relevant? Well, in the context of mergers and acquisitions, buyers and sellers often negotiate a definition of "Material Adverse Change" or "Material Adverse Effect." A Material Adverse Change is a change in circumstances that has a material adverse effect on the target's assets or business, and sometimes on the ability of one or both parties to consummate the transaction. There are generally three ways that Material Adverse Change is relevant in the context of a purchase agreement:

• The seller's representations and warranties may be qualified by Material Adverse Change. For example, "the target has not received notice of any pending litigation that would constitute a Material Adverse Change."


• The seller may give an express representation that there has been no Material Adverse Change since the date of the most recent financial statements or some other fixed date. This representation may or may not be re-asserted at closing.


• The buyer may condition its obligation to close upon there being no Material Adverse Change since the agreement was signed or some other fixed date.

An acquisition transaction may be impacted if a Material Adverse Change occurs and either the seller is unable to re-assert its representation at closing or the buyer has a "no Material Adverse Change" closing condition. Whether changes to the credit and capital markets will constitute a Material Adverse Change will depend, in part, on the negotiated definition of the term. If you are a party to a transaction that has been signed but has not closed, it is probably time to review the purchase agreement to evaluate the risk of not closing (if a seller) or the right to refuse to close (if a buyer). If you are currently negotiating a purchase agreement, focus carefully on the definition of Material Adverse Change and negotiate one that will best suit your needs and protect your expectations.

What retirement plan issues should I be considering now?

Recent stock market declines raise various issues with respect to retirement plans of all types. Plan fiduciaries should evaluate the performance of their portfolios to be certain that prudent procedures are in place. The funding status of defined benefit plans should be assessed for ways to address under funded status. At this time fiduciaries should reevaluate fiduciary liability insurance policies, indemnification of fiduciaries and assess the fiduciaries who may be at risk. A full legal checkup may be in order.

Investment options under defined contribution plans, and default investment options in particular, should be reevaluated to assure they remain appropriate.

How will these developments impact our workforce?

• Many businesses may reduce the size of their workforces as a result of current conditions. Sherman & Howard employment law attorneys can help businesses create and implement systems to assess their employees in an objective manner, make reduction-in-force selection decisions, and avoid claims that the decisions discriminatorily targeted (or had a disparate effect on) persons in legally-protected classes. If such claims are asserted, notwithstanding such planning, the Firm will vigorously defend businesses in such cases.


• Employers that conduct mass layoffs and plant closings have duties under federal and state laws, such as the Worker Adjustment and Retraining Notification Act ("WARN"), to give advance notice to affected employees and state labor departments. Typically, these laws require at least 60 days' advance notice, and require employers to pay terminated employees for the entire 60-day period. However, one exception is when the plant closing or mass layoff is caused by business circumstances that were not reasonably foreseeable as of the time the notice would have been required. This exception is scrutinized closely and litigated vigorously, because it operates to relieve obligations that the employer would otherwise bear. Sherman & Howard attorneys regularly advise employers with regard to such notice laws. Further, in light of the recent and rapidly-developing credit crisis, the Firm's employment law attorneys are available to defend employers that are unable to give the full, required notice.


• As employers implement reductions in force, attorneys in our employee benefits group are available to prepare and implement ERISA-compliant severance pay plans in conjunction with separation programs. Sherman & Howard tax attorneys also regularly advise employers so that their severance pay plan programs are in compliance with Internal Revenue Code, Section 409A.


• We anticipate that the current turmoil will likely spark new legislation intended not only to protect consumers in the financial markets, but also to provide further regulation of the employment relationship, from the CEO to the most junior employee in an organization. We are on the verge of what could be some of the most profound changes to labor and employment laws in the last several decades, fueled, at least in part, by the growing perception that American workers are in need of additional laws to ensure their ability to redress complaints against their employers. We are monitoring this closely, so that we can work with our clients to stay abreast of new initiatives and laws and help to manage these anticipated changes most effectively.

How can a seller continue to do business with a troubled buyer on credit and protect itself against having to return the payments made within 90 days of a bankruptcy by the buyer?

The bankruptcy code requires return of payments made to a creditor within 90 days of the filing of a bankruptcy if the payment was for an antecedent debt and the buyer was insolvent at the time that the payment was made, unless the payment was made in the ordinary course of business or made according to ordinary business terms; was made as a contemporaneous exchange of money for goods (e.g. COD shipment); or made under other circumstances set out in the bankruptcy code. Thus, changes in credit terms or credit limits within this time, or not structuring the credit to comply with the bankruptcy code, could result in the court requiring repayment of the amounts received within this 90-day period to the debtor for division among all the creditors. We can help assess your accounts receivable policies and procedures to enhance your ability to retain payments received from bankrupt clients and customers.

How do I unwind a securities contract, a forward contract, a commodity contract, a master netting agreement, a swap or repurchase agreement with a bankrupt company, such as Lehman Brothers, and then what do I do?

If you are a party to a swap agreement, a securities contract, a forward contract, a commodity contract, a repurchase agreement or a master netting agreement, you may liquidate, accelerate, offset (under a master netting agreement) or terminate these contracts even though the other party is in bankruptcy. You may then file a claim for the damages that you have suffered, if any, because of the action which you took. The damages are measured on the date of the action taken, unless there are not any commercially reasonable determinants of value on that date, and then measured on the first date thereafter.

Our corporate office space is more than we need. Is there a way to reduce our overhead?

One way that companies can reduce overhead is to assign their leases or to sublet all or a part of their premises. Sometimes landlords will allow for releases of the assigning tenant's liabilities, but not often. Given the current economic climate, it is unlikely a release can be obtained, and it will be important to protect against future defaults by any subsequent assignee or subtenant. We have prepared agreements whereby assigning tenants and sublandlords are able to protect against future defaults by subsequent tenants, including recapture rights, non-disturbance agreements from prime landlords, and other mechanisms.

We are currently a purchaser in a purchase contract that we regret having executed. Do we need to close, and do we have any exit rights?

Some contracts for the purchase and sale of real estate will include a specific performance clause, meaning that a seller can require the buyer to perform. (Generally, a buyer will always have a right to specific performance.) Whether such a clause is specifically enforceable against a buyer is uncertain and may depend on the specific facts of a transaction and the applicable contract provisions. Many agreements, however, contain a liquidated damages provision serving to limit damages against a buyer. We have advised buyers in troubled contract situations about their rights and remedies and any possible exit strategies and limitations of losses in such agreements. Similarly, we routinely advise sellers about their rights to enforce a contract against a buyer or in negotiating concessions.

We are unsure whether the contractor is staying on budget and whether he is paying his subcontractors. How can we avoid the possibility of mechanics' liens being filed for monies previously paid to the contractor?

There are various mechanisms available to lenders, owners and landlords to protect against mechanics' liens from subcontractors and others. We have advised many clients on how to structure payments and budget provisions to provide for safeguards to minimize or avoid liens in such circumstances. For example, we are advising landlords about posting Notices of Non-Responsibility, advising lenders regarding loan administration to ensure loan advances pay lienable items, and advising homeowners about safe harbor provisions for payments to contractors.

Our company needs a new loan, or needs to refinance an existing loan on our corporate facility/campus. In the current climate, will we be able to obtain such a loan or refinance with our current lenders?

We have advised clients on negotiating enforceable loan commitments and reasonable loan covenants. Given the current economic climate, it is more important than ever to be represented by counsel who can 1) negotiate fair and reasonable loan covenants that are not overreaching or overly burdensome and 2) take the necessary steps to close a loan even with a difficult lender.

We are a lender and have an overwhelming number of defaulting borrowers and/or borrowers who seem on the brink of default. We are uncertain whether we should modify the loan and grant an extension of time. Would we lose our priority in such a situation? Alternatively, how would we go about foreclosing and protecting the business on an ongoing basis?

We advise lenders on how to protect against defaults by borrowers in these uncertain times. It is important for a lender to include remedies that are all-inclusive and provide adequate protections. For example, we routinely provide for the appointment of a receiver without the requirement of notice to the borrower (other than typical default notices) and secure the broadest possible receiver powers tailored to the particular project. We have negotiated workout documents and extension agreements that effectively deal with the effect on priority of the lien of the lender. We have advised clients on ways to maximize the value of real estate security in defaulted loan situations by the creative use of receivers. Whether to continue to work with a borrower or to commence foreclosure remedies is a complicated question, and we are there to analyze the benefits and drawbacks and to draft appropriate documentation to carry out the intent of the parties and to remain flexible in case conditions worsen.

What should you do when you have a non-performing contract and the market crisis is causing a default or preventing performance?

If contractual obligations have not been met, prompt and practical solutions that do not involve years of expensive litigation make the most sense. Sherman & Howard is currently and regularly working with clients in a variety of such circumstances, looking at the best possible options for efficient and effective resolution. In all cases, we bring to bear years of experience counseling and representing clients in real estate and bankruptcy related disputes.

How can we keep our homeowner association healthy in troubled times?

During such times, it is especially important that homeowner associations are vigilant in collecting delinquent assessments, and are proactively protecting their rights by filing liens and delivering appropriate delinquent notices. We have advised associations that need funding not provided by regular assessments on how to borrow against future assessments and the overall affect of doing so. We have also advised various developers and owners in connection with association governance, operational and financial matters.

I have potential losses on investments in CDOs, CMOs or other mortgage loan securities products. Is litigation a realistic possibility for recovery of these losses?

As the effects of the current subprime lending crisis continue to expand, adversely affected people and institutions are increasingly turning to litigation to seek recovery of their losses.

Those suing include mortgage borrowers claiming they were wrongfully manipulated into their mortgage; individual investors; institutional investors; banks; shareholders of companies adversely affected by investments in subprime instruments and their derivatives; pension funds; governmental entities; shareholders of investment banking firms; ERISA Trustees and many others.

Targets of the suits include virtually everyone involved in the origination, packaging, securitization, and sale of these investments. This includes those who made the initial loans, warehousing lenders who financed their operations, packagers who bundled mortgages into packages and securitized them into investment instruments, underwriters of those investments, investment banks, commercial banks, investment fund managers of all sizes and forms, money market managers, stock brokerage houses, insurance companies, ERISA Fund Trustees and others.

Litigation by investors may be the only hope they have of recouping the staggering losses they face.

We have been involved in analyzing the merits of these claims and the prospects for recovery and can help you assess the specific facts of your situation.

Do the recent developments create any estate planning opportunities?

For high net worth individuals, the current low valuations and low interest rates provide excellent opportunities for estate planning techniques designed to shift future appreciation, free of federal gift tax, to the second and third generations. In addition to direct gifts to family members, it is a very good time to explore two mainstream techniques – GRATs (Grantor Retained Annuity Trusts) and Sales to Grantor Trusts.

With a GRAT, the Grantor transfers assets to a Grantor Retained Annuity Trust. Each year, the Grantor "receives back" from the GRAT an annuity (including fair market value interest). At the end of the GRAT term, if there is an asset of value left in the GRAT, that asset passes to the Grantor's children free of federal gift tax. For example, Grantor transfers $6 million of appreciating stock to a GRAT. The Grantor receives an annuity each year of $2 million plus fair market value interest. If, during the three-year term, the GRAT assets grow to $10 million, there will be a transfer of approximately $4 million, free of federal gift tax, to the second generation. Because the GRAT is a "grantor trust" for income tax purposes, there is no income tax triggered on any of these transfers.

With a Sale to a Grantor Trust, the Grantor sells assets to a Trust (typically structured for the benefit of the Grantor's children and grandchildren). The consideration usually consists of a 10 percent down payment and a promissory note. Because the purchasing Trust is a "grantor trust" for income tax purposes, there is no income tax due on the sale. If the assets purchased by the Trust appreciate in value, that appreciation has effectively been transferred to the second and third generations, free of federal gift tax. If, for example, the Grantor sells assets with a value of $5 million to the Trust, and there is subsequent appreciation in the assets to $8 million, there results an inter-generational transfer of approximately $3 million free of federal gift tax.

For more information please contact your Sherman & Howard relationship attorney or one of the attorneys on our Changing Markets Practice Group.

Sherman & Howard has prepared this advisory to provide general information on recent legal development that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the Firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation.

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© 2008 Sherman & Howard L.L.C.                                           October 15, 2008