Report From Counsel - Summer 2002

Report From Counsel

SUMMER 2002 ISSUE

WIDER SUIT ON CARBON MONOXIDE IS SOUGHT

MOUNT LAUREL When an alarm sounded in Beverly Duchon's condominium late one night in December 1998, she thought it was her fire alarm.

But the high-pitched warning came from a carbon-monoxide detector installed just two weeks earlier by the condo association in Laurel Place, where Duchon and her husband have lived for nine years.

While firefighters used oversize fans to air out her home, Duchon spent five hours in the hospital being treated for carbon-monoxide exposure.

She was lucky. Nine months earlier, Mount Laurel firefighters had to break down a door to rescue a disoriented and unresponsive man who had been exposed to high levels of the odorless, invisible gas.

The Duchons and their neighbors were just then learning that "design defects" in their condo floor plan may have led to a risky carbon-monoxide buildup in the utility room, which houses three gas-burning appliances, according to a pending lawsuit filed in December.

This month, lawyers for area residents filed a motion for class-action certification, which would allow them to include all residents of Orleans-built multifamily homes, with gas appliances, constructed in the last 10 years in Mount Laurel.

Last week, the township prepared to petition Superior Court in Burlington County to join as a separate plaintiff in the suit against Orleans Homebuilders, the developer of Laurel Place, the Lakes, and neighboring communities.

Representing Orleans, lawyer Lawrence Dugan said: "We believe that most, if not all, the homes were constructed in accordance with the Uniform Construction Code and, indeed, certificates of occupancy were issued by Mount Laurel Township for all of these homes. We are continuing our investigation."

He would not comment further on the matter.

After the initial filing by lawyers Philip Fuoco, Norman Shabel and Steve DeNittis in late December, the state instructed the township to investigate the allegations.

In February, the building inspector cited about 120 violations in Orleans multifamily homes, contending the builder "failed to provide sufficient combustion air for the fuel-burning appliances as set forth" in the state building code, which requires a certain amount of space and ventilation for rooms with gas-burning appliances. The citations were intended as a blanket compliant against about 700 units in the Lakes neighborhood.

Orleans has appealed the violations to the Burlington County Construction Board of Appeals, which is scheduled to hear the matter May 21.

In its letter of appeal, sent Feb. 21, Orleans lawyers wrote: "Orleans is hopeful that this request will prove to be solely of a technical nature inasmuch as our client believes, at this juncture, that it should be able to reach an amicable resolution of this matter with the township and address the issues."

The township contends that as many as 3,000 multifamily homes that have utility rooms containing more than one gas-burning appliance could be at risk.

In addition to violation of the building code, lawyers contend danger lies in the size of the utility rooms. Like most of their neighbors' utility rooms, the Duchons' is 5 feet by 7 feet with an 8-foot ceiling. It contains a washer, dryer, furnace, and hot-water heater.

Lawyers representing residents also say poor dryer maintenance can cause the furnace to malfunction and produce carbon monoxide.

If the plaintiffs can prove the utility rooms are poorly designed, they want Orleans to make amends, possibly by adding more ventilation.

The problem dates to the 1980's, when development was booming in Mount Laurel. Residents and township officials say the area was in such a hurry to promote growth that plans including those for several Orleans developments now in question were approved without proper oversight.

In 1989, the plans were approved by a fire subcode official who is no longer employed by the township, township solicitor Mike Mouber said.

"He made a mistake. He made it a lot of times," Mouber said.

"If the township had some fault, then it did. But that's not going to prevent the township from saying it should be corrected," he said.

FAIR LABOR STANDARDS ACT

The Fair Labor Standards Act (FLSA) is the source of minimum wage, overtime pay, recordkeeping, and child labor standards affecting over 100 million private sector and governmental workers. To be covered by the FLSA, an enterprise must have employees whose work has at least an indirect connection to interstate commerce. In most cases, a firm must do at least $500,000 in business annually to be covered, although some entities, including hospitals, schools, and governmental agencies, are subject to the FLSA regardless of volume of business.

The FLSA is far-reaching, but it does have its limits. For example, it does not require pay for vacations, holidays, severance, or sickness, nor does it mandate meal or rest periods, holidays off, or vacations. When an employee is fired, the FLSA does not require a discharge notice, a reason for the discharge, or immediate payment of final wages. Assuming the employee is at least 16 years old, the FLSA also does not limit the number of hours in a day, or days in a week, that an employee may be scheduled to work.

Wages and Overtime

Workers covered by the FLSA currently are entitled to the minimum wage of $5.15 per hour and overtime pay that is at least one and one-half times their regular rate of pay after 40 hours of work in a workweek. Some minimum wage exceptions apply under specific circumstances to disabled workers, full-time students, workers under 20 in their first 90 days of employment, tipped employees, and student-learners. Wages required by the FLSA must be paid on the regular payday for the covered pay period. Employers cannot effectively reduce the wages of their employees below amounts required for the minimum wage or for overtime pay by making deductions from paychecks for such items as shortages, required uniforms, and tools of the trade.

Exemptions

For the FLSA to apply, there must be an employment relationship that is distinct from other arrangements, such as hiring an independent contractor. Even when it does apply, the FLSA contains many specific exemptions. The exemptions may be from overtime pay, from both the minimum wage and overtime pay, or from child labor provisions. Doubts about application of an exemption generally are resolved against the employer. Employers should scrutinize the exact requirements for an exemption before assuming it applies.

Some of the employees exempted from the overtime pay requirement are commissioned sales employees whose earnings average at least one and one-half times the minimum wage for each hour worked and certain computer professionals who make at least $27.63 per hour. Examples of workers exempted from both the minimum wage and overtime pay include employees of certain seasonal and recreational establishments and white collar employees in executive, administrative, professional, or outside sales positions who are paid on a salary basis.

Child Labor

The child labor provisions in the FLSA are meant to protect the educational opportunities of children and to prohibit their employment in unhealthy or dangerous jobs. The FLSA restricts hours of work for those under 16 and lists hazardous occupations that are too dangerous for young workers. The rules vary with the age of the worker and the occupation. At age 18, an employee is no longer covered by federal child labor rules.

Enforcement

For private businesses, the main enforcer of the FLSA is the federal Department of Labor's Wage and Hour Division. Its representatives conduct investigations either on their own initiative or in response to complaints. The Secretary of Labor can sue to force compliance and to recover unpaid minimum and/or overtime wages, plus an equal amount as liquidated damages. If such a suit has not already been filed, an employee can bring a private action for the same remedies, plus attorney's fees and court costs. Willful or repeated violations of the minimum wage or overtime requirements can result in civil money penalties or criminal prosecution. Aiming at the fruit of underpaid or illegal labor, the FLSA has a "hot goods" provision that prohibits anyone from shipping, offering to ship, or selling in interstate commerce any goods produced in violation of the FLSA.

STARTING A BUSINESS? GET AN EIN.

A new business must get a nine-digit employer identification number (EIN) from the Internal Revenue Service if it either pays wages to one or more employees or files pension or excise tax returns. An EIN is like a Social Security number for a business. It is used when filing a federal tax return, as well as for correspondence with the IRS or the Social Security Administration.

IRS Form SS-4 is an application for an EIN, with information on how to apply by mail or by telephone. The IRS now has a toll-free telephone number for getting an EIN: (866) 816-2065. Taxpayers also can download forms from the IRS website at www.irs.ustreas.gov.

LANDLORDS AND CREDIT CHECKS

Landlords are free to use credit reports in evaluating prospective tenants, but they must follow requirements set out in the Fair Credit Reporting Act (FCRA). A new guidance has been issued that describes how the FCRA applies to landlords and what the consequences are for noncompliance. The guidance focuses especially on a landlord's obligation to provide an applicant with an "adverse action notice" when adverse action is taken based on information in the applicant's "consumer report."

A consumer report is a compilation of information about a person's credit characteristics, character, reputation, lifestyle, and rental history. A report is covered by the FCRA only if it was prepared by a consumer reporting agency (CRA). The major credit bureaus are CRAs, as are many tenant-screening services and reference-checking services. If a landlord uses its own employees to verify personal, employment, and previous landlord references, the FCRA does not apply.

The most obvious adverse action that will trigger the notice requirement is outright denial of a rental application. Something short of that can also constitute adverse action so long as it is prompted by information in a consumer report. For example, a notice must be given to applicants who are required by the landlord to: have a co-signer on the lease; pay a deposit not required for other applicants, or an unusually large deposit; or pay rent that is higher than for another applicant.

The essential contents of an adverse action notice are established in the FCRA. The notice must contain the name, address, and telephone number for the CRA that supplied the report, a statement that the CRA did not make the rental decision and that it cannot give the specific reasons for that decision, and notification that the consumer has rights to a free report and to dispute the accuracy or completeness of information in the report. Even landlords for whom a consumer report played only a minor role in the decision to take an adverse action must give the notice to the applicant. A written notice is the best proof of compliance.

Landlords are well-advised to stay in compliance with all FCRA requirements, including adverse action notices, as the consequences for noncompliance can be significant. For lack of required notices, a landlord can be sued by individuals in federal court and made to pay compensatory damages, punitive damages if the violations are deliberate, and attorney's fees. Federal or state agencies can also sue landlords and get civil penalties. An isolated and inadvertent failure to send a notice, however, will not result in landlord liability if the landlord has reasonable procedures in place to assure compliance with the FCRA.

CASE BY CASE

Stolen Customer Lists

Home food service companies sell and deliver food products and appliances to their customers, many of whom later reorder more products. When a home food service company bought a customer list of one of its competitors, what might have been a competitive advantage instead became a legal headache. The list had been stolen and the food service company that bought it knew it was stolen.

The company whose list got into the wrong hands sued the purchaser of the list for misappropriation of a trade secret. Some courts have refused to recognize customer lists as protected trade secrets when they contain information that is readily available from public sources. The essence of a trade secret is that it has value because it is not easily ascertainable. The customer list for the home food service company was protected because of the time and effort that had been expended to identify particular customers with particular needs or characteristics. The defense that the list contained only information that was easily compiled was undercut by the fact that the defendant had paid a lot of money for it.

A state court found a violation of the law governing trade secrets. It ruled that monetary damages should be awarded to the plaintiff based on net profits earned by the defendant from improper use of the list. The court also barred the defendant from ever using the stolen list again.

ESTATE PLANNING WITH THE FAMILY LIMITED PARTNERSHIP

A "family limited partnership," as the name implies, refers to the creation of a partnership business entity among close-knit family members. A family limited partnership does not necessarily have to involve a business. For instance, it can be created for a particular asset, such as real estate or a mutual fund. This structure is a popular estate planning tool because it can provide both tax and non-tax advantages.

Non-Tax Advantages

One obvious non-tax advantage is that when a transfer restriction is made a part of the family limited partnership arrangement, there is assurance that the business will be kept in the family. The structure also allows the operator of the business (presumably a parent) to maintain control of the business assets until retirement or death. This is accomplished by having the parent retain a general partnership interest that includes management control of the business. The children become limited partners. If a particular child were to be groomed to take over the management of the business, the parent could, over time, transfer fractional shares of the general partnership interest to that child.

Another important non-tax advantage is the protection of business assets. Although the personal assets of the general partner can be reached by creditors of the business, the liability of the limited partners is restricted to their interests in the partnership. Also, the assets placed in the partnership by the donor/parent are protected from his personal creditors. His income from the partnership can be reached by creditors, but not the assets.

Federal Income Tax

The primary income tax advantage to be gained from forming a family limited partnership is the deflection of income from the parent, who is typically taxed at higher marginal rates, to the children, who are taxed at lower rates. Where the donor/parent retains control as the managing partner, the strategy is to allocate earned income to the parent at the lowest reasonable level. The unearned income (return from capital investment) is divided among the parent and children as partners in proportion to their capital interests.

Estate and Gift Taxes

An initial federal estate tax advantage derived from the creation of a family limited partnership is that the allocation of income among the children will prevent the accumulation of such income in the estate of the donor/parent. The main focus is on the savings that can be realized on federal estate and gift taxes.

If the donor/parent transfers limited partnership interests to family members, the value of those interests will not be included in the parent's estate at death. However, when partnership interests are transferred to family members, there is potential gift tax liability, which is calculated at the same rates as the federal estate tax. This problem can be alleviated by taking advantage of the annual gift tax exclusion, which for 2002 is $11,000. A fractional interest can be transferred free of gift tax to each donee up to the amount of $11,000 per year ($22,000 if the donor's spouse consents to the transfer).

The two primary features by which federal estate tax savings are achieved are the estate freeze and the valuation discount. The object of an estate freeze is to transfer the future appreciation of the family business to the children. The effect is to prevent the appreciation of the senior family members' interests in order to minimize estate taxes.

The valuation discount feature discounts the value of the fractional shares into which the business is divided so that the total value of the shares will not equal 100% of the predivision value of the business. There are different methods that can be used to discount the value of the shares. These discounts reduce the value of each partner's share for federal estate tax purposes and benefit both the donor of the partnership interests and the donees.

Recently, the IRS has taken the offensive against valuation discounts. One Tax Court case shows that, in order to secure the "lack of marketability" discount, the donee must not be given powers that would allow him to liquidate the partnership.

Another recent Tax Court case indicates that in order to avoid inclusion of the transferred limited partnership interests in the decedent's estate, care should be taken to avoid the appearance of the decedent treating the property as his own. For example, the transferor's residence should not be transferred to the family limited partnership unless the transferor is to pay rent.

Given that the family limited partnership is such a powerful and complicated entity with major business, tax, and personal consequences, anyone considering forming such a partnership should seek qualified legal advice.