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Managing Legal Risk in the Citrus Industry1 Kristen Gunter, Abel Putnam, and James Stricker2 1. This is EDIS document FE 201, one of nine papers in the 1999 Citrus Risk Management Series, a publication of the Department of Food and Resource Economics, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL. Published October 2000. Please visit the EDIS website at http://edis.ifas.ufl.edu. 2. Kristen Gunter and Abel Putnam, attorneys, 500 South Florida Avenue, Suite 200, Lakeland, FL; and James Stricker, extension agent IV in economic development, University of Florida, Polk County Cooperative Extension Office, Bartow, FL. The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide research, educational information and other services only to individuals and institutions that function without regard to race, color, sex, age, handicap, or national origin. For information on obtaining other extension publications, contact your county Cooperative Extension Service office. Florida Cooperative Extension Service/Institute of Food and Agricultural Sciences/University of Florida/Christine Taylor Waddill, Dean. Introduction To effectively manage legal risks, citrus growers should first understand the source of legal risk. Growers can benefit from understanding the source of legal risk. Knowing the source of risk allows one to avoid "stepping into it", so to speak. Another way to think of legal risk is to think in terms of liability. "Liability" is an obligation to do or refrain from doing something. The word is also used in the law to refer to one's responsibility for his own conduct. Sources of Liability Legal liability will not attach unless a legal duty exists. Where do you find these legal duties? They come from three primary sources. Contract. In a contract, the parties voluntarily take on duties relative to each other. Everyone is familiar with contracts. They can be fruit contracts, lease agreements, or promissory notes. Inherent in a contract is the imposition of obligations, or duties, by both parties to the contract. Contract duties should be easy to pinpoint because most contracts are in writing. Before a contract is signed, it should be read. If you consult a lawyer, there may be ways to limit your liability by placing certain duties on the other party. For example, if you are buying critical services from a vendor, you may need to require a performance bond. In a fruit contract, you may want a provision that would allow you to terminate the agreement in the event you sell your grove or pay a fixed rate per box if you elect to not deliver under the contract. Generally, if you meet your obligations under your contracts and receive what you contracted for, you should be able to minimize the risks associated with contracts. If you breach a contract, you may find yourself owing the other party money for damages. Tort. A second source of liability exists in torts. A tort is a civil wrong where the law provides a remedy in the form of damages. The law of torts is concerned with the allocation of losses arising out of all the things we do as humans, whether it is driving cars, owning property, or growing citrus. There is a long and growing list of torts. Examples you are familiar with include the torts of negligence, libel, slander, nuisance, and trespass. The common thread woven into all torts is the idea that liability will attach to conduct that is socially unreasonable. Someone who commits torts is called a "tortfeasor". If you want to manage risk in this area and escape the ugly label of "tortfeasor", then conduct your activities as a
Managing Legal Risk in the Citrus Industry 2 reasonable man or woman and apply a reasonable standard of care to all things you say and do. This advice is not meant to be flippant. Managing risk in the area of torts is very tricky because what you consider reasonable conduct, your neighbor or employee may not. Unfortunately, a judge or jury may agree with your neighbor or employee. Statutory. The third source of liability is based upon statutory law. When the public as a whole requires protection, a legislative or governmental body passes a law or adopts a regulation that limits or prohibits activities and usually attaches a penalty for violation. Statutory law, including regulations by governmental agencies, is, for the most part, codified. This means you should be able to find the law "in black and white" in a book. Statutes include things like the Florida citrus maturity standards in Chapter 601 of the Florida Statutes and in the American Disability Act in the U.S. Code. Statutes describe crimes such as murder and theft. One caveat: Although you can go find a statute or a rule, finding the government's or a court's interpretation of the statute may be more problematic. Lawyers are trained to help you figure these things out and to advise you on compliance with statutory obligations. To manage risks for contract, tort, and statutory duties, you need to establish within your business a systematic, company compliance program. Although every business is unique, activities associated with citrus production that lend themselves to a formalized compliance program include adhering to pesticide and chemical laws, engaging in lawful employment practices, meeting contractual obligations, keeping licenses and permits current, etc. In a systematic plan, you force your business to identify the duties imposed by contracts, statutes, and tort law. Such a discipline makes you examine your practices for compliance with the law. Your Extension agents and grower associations can provide you with a wealth of assistance in many of these areas, but, at some point, you should consider professional advice. No matter what it costs, you and your employees cannot afford to be ignorant of your duties under the law. Compliance programs can come in all shapes and sizes. Ideally, they should include employee training, document and records control, and documentation of practices and equipment maintenance. Programs should include systems for failure investigation and corrective actions. The benefits of a company compliance program are many. It should help keep you out of trouble, but the discipline should also help you improve your product quality and customer service. Remember that your customers are not just consumerscustomers also include your employees, regulators, packers, and processors. Even with a compliance program in place, there is still risk and exposure. A compliance program will hopefully reduce your risk. Understanding Risk Exposure Stated below are two generally accepted maxims that, when taken together, frequently lead to unfortunate results: Risk must be taken to expand and succeed in the business world, and Bad things happen to good people. It is essential to understand your exposure to risk so that you may accept that risk and manage it as closely as possible. The risk which we are discussing here is civil monetary risk, which generally takes the form of a court judgment. The judgment itself is, for the most part, meaningless. When it does become an issue is when the Sheriff is knocking on your door to seize and sell your property to satisfy a judgment. Business Entities: Exposure of the Owners When speaking of liability that may arise from your business operations, personal exposure to the liability and risk depends upon the legal entity under which your business operates. Legal entities include (1) Individuals and Sole Proprietors, (2) Judgments Against General Partnerships, (3) Limited Partnerships/Family Limited Partnerships, and (4) Corporations.
Managing Legal Risk in the Citrus Industry 3 Individuals and Sole Proprietors When you are operating as a sole proprietor and a judgment is entered against you, no entity-level protection exists and you are personally exposed to the entire judgment. However, having a judgment entered against you may be meaningless. A judgment merely is evidence and an establishment of the dollar amount for which you are responsible to pay to another person or entity. That person or entity must then take the next step and actually attempt to collect upon the judgment through a levy of property, foreclosure sale, garnishment, etc. Florida is a very liberal and protective state with regard to judgment debtors, and a significant amount of the assets of an individual are generally exempt from the claims of creditors. Examples of assets which are exempt from creditors are: Homestead. Under the Florida Constitution, your or your family's homestead is exempt from forced sale under process of court to the extent of one-half acre of contiguous property if located within a municipality, and 160 acres if rural. Note: the exemption is merely based upon size, and the value of the homestead has absolutely no bearing on the exemption. Personal Property and Automobiles. The Florida Constitution also provides an exemption from forced sale of personal property (automobiles, goods, merchandise, etc) up to $1,000 in value. Wages of Head of Household. Absent written agreement to the contrary, the wages of any person who provides more than one-half the support for a child or other dependent are exempt from the issuance of a writ of attachment or garnishment. In order to maintain this protection, it is essential that you maintain the character of these excluded wages and avoid co-mingling these funds with other funds that may not be protected by a like exemption. Marital Property. Perhaps the most significant and easily attained asset protection vehicle is the maintenance of property as joint marital property or "entireties" property. A judgment against one spouse, regardless of its amount, is not a valid lien on property owned jointly by husband and wife. For a judgment to be valid against marital property, the judgment must be against both the husband wife. Life Insurance. Life insurance and annuities payable to third parties, for the most part, are exempt from the claims of creditors, as are disability benefits. However, life insurance annuities or disability insurance taken out to specifically benefit a creditor, such as credit life insurance policies, are certainly payable to the creditor and are not exempt. Retirement and Pension Plans. As a general rule, retirement funds such as 401(k) plans, pensions, and retirement and profit sharing benefits are exempt from the claims of creditors. A major caveat to the above exemptions is the unfortunate and ever-so-frequent instance of divorce, alimony, and child support. The possibility of divorce and marital instability should preferably be dealt with before any marriage. (This can be effectively addressed through the use of both pre-nuptial and post-nuptial agreements.) Additionally, when the business is an entity other than a sole proprietorship, the spouse is bought out (through a buy-sell agreement rather than obtaining an interest in the entity) for a price that can be agreed upon by the business associates as opposed to the business being part of the dissolution process. Judgments Against General Partnerships A partnership arises when two or more people form a business, or a venture, dividing in some manner both the expenses and income from the partnership business. Each partner in a General Partnership is jointly and severally liable for all debts, obligations, and actions of the partnership; the other partners; and the employees, agents, representatives, etc. "Joint and several" means that a creditor may seek payment of the entire judgment from any one of the partners, and is not limited to seeking an equal amount from each partner. For example, if a $100,000 judgment is entered against a partnership that has three partners, but only one of the partners has the present ability to pay, the partner with the ability to pay will likely be pursued for payment of the entire $100,000 amount. That partner may then
Managing Legal Risk in the Citrus Industry 4 seek contribution from the other partners, but, if they have no non-exempt assets, his judgment will likely be worthless. A General Partnership provides little or no insulation from personal liability. In fact, it tends to leverage and increase the risk. This leverage arises from the fact that the very essence of a partnership is to pool resources to invest in a much greater venture than any single partner would have been able to do alone. The greater the chance of a higher reward, the greater the chance of a more catastrophic loss. Although a judgment against the partnership is, in essence, an individual judgment against each of the partners, the converse is not true: a judgment against one of the partners is not a judgment against the partnership or its assets. A judgment creditor of any one partner is entitled to a charging order against that partner's interest in the partnership, but is unable to levy upon the partnership assets or force a sale of those assets in payment of the judgment. A charging order simply provides that distributions, which would otherwise be made to the partner, if any, are to be made directly to that partner's creditors in satisfaction of the debt. Limited Partnerships/Family Limited Partnerships A Limited Partnership or Family Limited Partnership offers distinct and significant liability protections that are not afforded the partners in a General Partnership. A Limited Partnership is an entity wherein the type of ownership is severed into two units: General Partnership units, which maintain control (and maintain 100 percent liability for the obligations and debts of the partnership); and Limited partnership units, which simply represent ownership in the partnership and entitlement to any distributions. The General Partner (the owner of the General Partnership units) of a Limited Partnership is wholly liable and exposed without limitations to the Liability Partnership. (A planning possibility would be to establish a corporation to act as the general partnership so that the maximum personal exposure would be the assets owned by this general partner). The Limited Partners are not personally liable for partnership debts and obligations, thus the only exposure of a Limited Partner is that partner's investment or share of the partnership assets. As with a General Partnership, a creditor of one partner cannot attach the partnership's property to satisfy its judgment, but must simply rely upon a charging order, which gives that creditor the right to income distributions made from the partnership, if any. A creditor has no right to force distributions to Limited Partners, cannot participate in management (as a general rule), and has no right to inspect partnership books and records. Corporations A properly formed and maintained corporation (either a C-corporation or an S-corporation) provides protection for its owners from entity-level liability. A judgment against the corporation may only be collected from corporate assets, and the "corporate veil" protects shareholders from personal liability for corporate debt. This veil of protection may be pierced if the corporation is not properly formed, is administratively dissolved when the liability arises, or if someone is able to prove that the corporation is a mere "alter ego" of its shareholders. To maintain the formality of a corporation, you should, at a bare minimum, maintain separate books and records for the corporation, stock certificates should be issued, and annual meetings held. Provided these basic steps are taken, it is difficult for a successful argument to be made piercing the corporate veil and attaching individual liability to shareholders. Practical Suggestions for Reducing Risk Avoid Voluntary Exposure to Entity Liability. The most common action taken by an Individual, Limited Partner, or Shareholder to expose himself to personal liability is an action that is done voluntarily such as entering into loans or agreements as an individual or giving personal guarantees for entity responsibility. Once you sign the agreement or a personal guaranty, you and your personal assets are subject to that creditor's claims. (Subject to the exemption described above). Additionally, the most common personal guarantees call for joint and several liability, which means (as explained above) that you may end up paying the entire judgment amount and then be left pursuing your former
Managing Legal Risk in the Citrus Industry 5 partners and co-owners. When dealing with institutional lenders, especially if your entity is newly formed or does not have significant assets, it may be impossible to avoid the giving of personal guaranties. An institutional lender, however, will frequently consent to each partner or owner giving a limited guaranty, guaranteeing only a certain percentage or dollar amount of the entity's debt. Non-institutional lenders, such as equipment sales or leasing, are on a very competitive posture and are frequently willing to waive a personal guaranty requirement to close a deal. Never assume that the documents presented to you for signature must be signed on a "take it or leave it" basis. Liability Insurance. The importance of adequate liability insurance cannot be overly emphasized. In a litigious society such as ours, liability insurance is an essential component to business planning. Read the policy, do not just assume you know what the coverage is. Notify the insurance company promptly regarding any incidents. Also, take advantage of any employee safety seminars or inspections offered by your insurance company. Risk Management from an Estate Planning and Tax Planning Point of View When discussing this topic, the risk faced is the failure of accomplishing any of the following goals: an orderly transfer of assets at your death, disability, or retirement; minimization of taxation (both estate taxation and income taxation); and the avoidance of immediate dissipation of the estate by your heirs ("protecting Junior from himself"). Transfer of Assets For an orderly transfer of assets to occur, communication and planning are essential. The deathbed is not the appropriate place to begin your estate planning process. When dealing with crops such as citrus, a prompt transition of control is essential to keep the business operating in a productive manner. Even if there will be no continuity of the business, to maximize liquidation value, some plan should be in order to manage the property and protect its value. Property may be transferred directly to the recipient during your lifetime; it may be transferred into a trust for the benefit of the ultimate recipient; or you may hold the property until your death, whereupon it will be disposed of in accordance with your will, assuming you have one. The preferred manner of transferring your property will depend upon many factors such as your marital and family status, the age of your children, the size of your estate, the health and level of maturity of your children, etc. Estate and Income Planning and Taxation Discussions dealing with continuity and transfers upon death naturally lead to estate planning and income tax issues. Estate planning addresses the disposition or transfer of your estate, minimization of taxes owed by virtue of death, and, to the extent such taxes are owed, providing funds for the payment of these taxes to avoid having to sell the proverbial farm. As previously stated, assets may be distributed in any number of ways, depending upon the entity in which the assets were held. Assets may be distributed outright to the heirs during your lifetime through the gifting of fractional interests, partnership interests, or stock; transferred through some type of a trust arrangement, providing benefits to your heirs while placing another individual or entity in control of the management of the business; or use any combination of these devices. The taxability of your estate, obviously, will dictate to a great extent just what actions may be necessary to protect your estate in the greatest manner possible. Each individual is currently allowed a $675,000 credit equivalent which means that, if your gross estate is $675,000 or less, you will not be subject to taxes. (The Taxpayer Relief Act of 1997 provided a shelter amount of up to $1.3 million for qualified family-owned businesses. This provision has multiple technical requirements, which will not be discussed here.) If you find yourself in a
Managing Legal Risk in the Citrus Industry 6 situation where your assets exceed $675,000, then, at that point, it is essential that you structure your estate to take full advantage of this credit and minimize the taxes that may be owed by your estate. This exemption amount is increasing, and will be $1,000,000 per person in the year 2006. Theoretically, the easiest way to avoid estate taxes is to make sure that your estate does not exceed $675,000. This can be accomplished through lifetime gifting, an appropriate use of discounts on your estate values, and charitable contributions. The benefit of lifetime fractional gifts of the business is that the gift amount may be leveraged through fractional interest and marketability discounts. The Internal Revenue Service recognizes the fact that closely held or jointly owned assets frequently cannot be sold on the open market for an easily determined fair market value. With a closely held business or real estate, where a fractional share is gifted, you are dealing with a limited number of individuals with whom few other people but you would be willing to deal or would have a desire in owning partial interest. The benefit to the person who made the gift is also compounded. Not only is the total value of the taxable estate reduced by the amount gifted, but now the estate is also entitled to a discount because your estate no longer is the 100 percent owner of the asset or property. (Keep in mind, however, that when you make lifetime gifts, the recipient takes your tax basis in the property. If the property passes through your estate, the basis becomes the fair market value at date of death. As a general rule, attempt to gift high basis property.) Formation of a corporation or a limited partnership lends itself to the ease of lifetime and testamentary transfers, as you are then dealing with shares or units of a limited partnership interest that are being transferred, as opposed to actually deeding a portion of real estate or somehow transferring personal property or an operating business. You also protect the recipient of these gifts from personal liability as they are then only exposed up to the value of their respective ownership interest. As an aside, the particular problems facing holders of significant qualified assets such as 401(k) plans or IRAs should be briefly mentioned. It is not uncommon to find that a significant percentage of a married couple's estate is represented by one of the spouse's qualified assets. (Qualified assets are assets where the payment of income taxes has been deferred.) Whether or not the estate is taxable, you are dealing with significant deferred income taxes. The marginal tax rate in a taxable estate with significant qualified assets could well exceed 60 percent. If you have significant qualified assets making up your estate, then it is essential that you speak with your attorney and/or accountant, if you have not already done so. Another word of caution deals with computing the total credit equivalent for you and your spouse. By doubling the current equivalent amount of $675,000, couples generally assume that so long as there is not in excess of $1,350,000 in their joint estate, they will not be subject to taxation at either one's death. Unless your estate is properly planned and administered, this is likely not the case, and you may end up with a horrendous tax bite at the death of the second spouse if either spouse's credits are wasted. Again, this needs to be looked at closely by your attorney or tax advisor to insure that you are protected to the maximum extent possible. Dissipation of Estate by Heirs The final topic to be touched upon is the protection of your estate, subsequent to death, from wasteful dissipation. Health reasons, dependency, laziness, or just plain stupidity sometimes dictate that your heir has absolutely no business inheriting your estate and must be protected from himself, so to speak. This can be accomplished in many ways, while still providing assets to be available for their care and welfare. You may also be dealing with minors, whether it be children or grandchildren, who legally cannot hold and handle assets. A handicapped child or elderly beneficiary may dictate that a special needs trust is required, which will allow that person to have the highest value of life possible. If one of your heirs has significant judgments against him, then you may wish to establish a spendthrift trust for that beneficiary's benefit to protect those assets from the creditors. This is perfectly legal to do and is not a fraudulent conveyance because the creditors are your beneficiary's creditors, and not your creditors. You have no duty to see that those creditors are paid.
Managing Legal Risk in the Citrus Industry 7 Conclusion In conclusion, this information is intended to give a general overview of certain issues and concerns, which the authors see as important, interesting, and valid. Each person's particular situation differs, and this is not to be construed as specific advice for you in your estate, taxation, or business planning. Hopefully, as intended, this information has raised more questions than it has answered, and will generate thoughtful discussions with your co-workers; family members; and your business, tax and estate planning professionals.