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The Morton Memo - October 2010

What can you do to protect your business when dealing with a customer who is falling behind or appears to be headed toward insolvency?   Does your business have potential liability for the unlawful acts of third parties?  Some answers to those questions are in this issue.  The Morton Memo is for you, so kindly email me those topics of interest to you.

>> Your customer's bankruptcy can cost you money 

>> Don't aid and abet crime on the Internet

Your CUSTOMER'S BANKRUPTCY CAN COST YOU MONEY

gravelBankruptcy filings are on the increase.   Individuals and businesses are filing bankruptcy petitions in record numbers.   That is not a surprise given the state of the economy and the severe cash flow problems that most businesses have.

        These bankruptcies do pose challenges to business owners when their customers or vendors become insolvent and file bankruptcy.  For instance, immediately on filing a bankruptcy petition, the Bankruptcy Court orders an automatic stay of any proceedings against the debtor.   All legal actions are stopped and all collections actions against the debtor must stop, including letters and phone calls.  Furthermore, bankruptcy law has some interesting twists that can be expensive for a creditor.

        Paying money back to the debtor’s estate.  One surprising doctrine in bankruptcy law is called the avoidance of preferences.   The Bankruptcy Act contains statutes that provide that all creditors of the debtor should be treated the same.  If a creditor receives money from the debtor in the 90 days prior to the bankruptcy filing, then the creditor might be ordered by the Bankruptcy Court to return that money to the debtor’s estate if the creditor would receive more than what other creditors would receive.

        The payment of money to the creditor before bankruptcy is called a preference and the order to return that money is called avoidance.  Creditors are often shocked to find themselves sued by the trustee of a bankrupt debtor for monies paid just before the debtor went into bankruptcy.

        Usually, the creditor that is the subject of the avoidance action is owed money by the bankrupt debtor.  The creditor is in the extremely unfair situation of not only losing money due to the insolvency of its customer, but might lose more money in the avoidance action.

        How to work with an insolvent business.  Businesses that are candidates for bankruptcy are usually easy to spot.  They take longer to pay and often go alarmingly past due on their payables.  They also begin to have sales or deep discounts on goods they might sell.

        Creditors of an insolvent debtor will often make the mistake of entering into payment plans for past due receivables.  The creditor will often apply the payments received from the debtor to the oldest receivables first.  This a good way to get set up for an avoidance action (see above).

        A better approach would be to insist that any goods or services provided to a customer that is behind in its payables be COD.  Do this as soon as a customer starts falling past due.  This is actually a good business practice regardless of the insolvency of the customer.  The payment method doesn’t have to be literally “cash on delivery” but a creditor should get a check on delivery or a wire transfer the day before delivery.

        If goods are paid for when they are delivered, those payments fall into an exception of the avoidance rules.  The “contemporaneous exchange” rule is that if the debtor receives goods from a creditor and contemporaneously makes payments to the creditor, then those payments are not preferences subject to avoidance.   So, COD for new goods works.

        For payments of older debt, creditors are advised to get the advice of an attorney.  The area of bankruptcy can be complex and fraught with little known perils such as the avoidance of preferences.  Some timely advice long before bankruptcy can save a creditor a great deal of grief.

If you have any questions about dealing with insolvent businesses, please contact us at emorton@ericmortonlaw.com or (760) 722-6582.

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                                                                                                     don't AID AND ABET CRIME ON THE INTERNET

LaptopIn the past few years, I have had some experience with litigation arising from Internet-based disputes.  A business’ liability for aiding and abetting the unlawful activity of another online is an evolving area law that can be costly.

 

 For instance, I recently represented a company that was sued in a class action for aiding and abetting an illegal lottery on the Internet.  The plaintiffs sued the owners of the illegal lottery and several payment systems providers who were used by the illegal lottery to accept  payments from the victims.  My client provided one of those payments systems and PayPal was another defendant.

 

 My client and PayPal got out of the case because the plaintiffs did not allege that they had the necessary knowledge and intent to substantially assist the illegal lottery.  The court held that without allegations that they knew of the illegal nature of the lottery website, they had merely provided a service and could not be sued.  This lawsuit was decided under California law (in California Superior Court). 

 

 After I no longer represented the company, my former client was sued by the Federal Trade Commission (FTC) for unfair business practices under Federal law, regarding the unrelated fraudulent activity of another third party. The FTC proved that the company knew that its payment services were being used by third parties for illegal purposes and took no effective measures to stop that fraudulent activity. The company, three affiliated companies and the principal owners had a judgment rendered against them to enjoin them from operating their system and to pay hundreds of thousands of dollars. 

 

 The company and the owners had not received this money.  This was money that had been stolen by other persons using the company’s payment system.  But, the court ordered the company and its owners to be liable. 

 

 In essence, the court held that the company and its owners were responsible for the fraud of other persons.

 

 The key fact was that the FTC proved that the payment company knew its payment system was being use for fraud.  It was essentially held vicariously liable for the wrongs of others.

 

 The problem now is that there are all sorts of illegal and unfair business practices on the Internet and the FTC and other public and private parties are taking action against them.  For instance, the use of pre-populated ordering forms has been deemed an unfair business practice and the subject of legal action.

 

 How to avoid be held vicarious liable.

 

         1.     Be careful who you link with.  A very popular form of cross-advertising is to cross-link websites.  “You put a link on your website to mine and vice-versa.”  Unless you are very familiar with the company and its owners, don’t drive traffic blindly to the websites of unfamiliar companies. 

 

         2.     Don’t blindly enter into referral agreements.  Another popular marketing method is to offer payments of money for referrals.  “I’ll give you 10% of the gross of any revenues I make from any referrals you send me” is a common come on.  This might also take the form of the payment of a fee to place a link with a banner advertisement on your company’s website.

 

         If you accept money for helping bring persons to someone who defrauds them or otherwise unfairly takes advantage of them, you might be held vicariously liable. 

 

         3.     If you get any idea that someone is doing something illegal or unfair, stop helping them.  Needless to say, if you get any complaints about another company,  investigate and stop referring persons to that business. 

 

This is an evolving area of law.  The FTC and other Federal and state agencies are continuing to define in and out of the courts what is illegal or unlawful.  Furthermore, companies change and sometimes slip into unfair business practices on the advice of unscrupulous marketing directors.  Be mindful of your internet-based business partners  and their activities before you make referrals to them. 

If you would like more information about this area, please contact me at emorton@ericmortonlaw.com or (760) 722-6582.

 

 

 

 

 

 

 

 

 

 

 

 

 

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