Boulder Business Law Advisor

I just read Inc.com's Norm Brodsky's The Right Way To Approach A Start-up - a short but insightful article on a recent experience he had with one of his startups.  What I found to be the most interesting item in his story was that among his business partners, he retained "a veto over the location" of the business (Kobeyaki Restaurants in NYC). 

This brings up a great question: "How does one get a veto in a startup?" Well, like anything else you agree on with your partners, you negotiate.  But then what do you do? ... Write it down!  Yesterday, we wrote about some things all startups should not avoid doing early on.  Number one on the list was choice of business entity.  It is during this process that you will best be able to make and memorialize agreements as to how the business will be run.  In a Limited Liability Company (LLC), for example, it will come in the form of an Operating Agreement.  An operating agreement is the governing document of the company, which, while similar in many respects to a stock corporation’s by-laws, contains the agreement of the members as to how the LLC will conduct its day-to-day business.  It is in the operating agreement you could include a provision providing for a "veto" much like Mr. Brodsky had in his startup. 

Q: How does one get a veto in a startup?

A: Negotiate.

It is best to memorialize any (and all) such agreements early on in the startup to avoid (or at least minimize) disputes at critical points.  An agreement for a veto may not be necessary in your situation, but there may be something else you want - or are asked to give.  In Mr. Brodsky's situation, the location of the business was a critical decision to him - so much so that he used his veto a couple of times.  I would venture a guess that when Mr. Brosky exercised his veto power, his business partners were at least a little annoyed.  But having a solid agreement will help in such situations as reasonable minds can simply point to the agreement and move on. 

Certainly, agreements are always up for interpretations, so be as clear and forthright when drafting them.  Drafting an operating agreement should be done by a lawyer or even lawyers depending on its scope and the parties involved.   If you are asked to give something up, it is always a good idea to consult your own lawyer - i.e., one who represents you and your interests, not the business itself.

Laszlo & Associates' Boulder StartUp Lawyers provide legal counsel to businesses on a variety of business needs including startup and corporate formation, employment law, risk management, corporate protection and legal compliance.

The Eleventh Circuit, in Farias v. Mr. Heater, et al., 2012 WL 2354359, No.11-10405 (June 21, 2012), held that the defendant manufacturer of a propane gas heater that caused a home fire after being improperly used by the plaintiff indoors was not required to include Spanish language warnings for its heaters. 

The case involved a plaintiff who purchased two infra-red portable heaters from Home Depot, manufactured by Enerco and Mr. Heater.  According to the plaintiff, because the warnings were inadequate, as they were only in English, she used the two propane heaters indoors which led to her home catching fire, causing $300,000 in damages. However, despite the plaintiff's claims as to the adequacy of the warnings, the district court held as a matter of law that the warnings were in fact adequate.

Additionally, despite alleging in her complaint and summary judgment arguments that defendant manufacturers had a duty under Florida law to provide Spanish language warnings, the plaintiff “did not challenge the district court’s conclusion that Florida law does not automatically impose a duty to provide bilingual warnings on consumer products.”  

Instead, plaintiff presented two issues for appeal: 1.) “the district court erred in concluding that the English-language written warnings and graphic depictions, which were provided, can be deemed ‘adequate’ as a matter of law because she asserts they are inherently contradictory, inaccurate and ambiguous”, 2.) the lack of bilingual warnings was inadequate because the defendants' marketing was directed towards the Hispanic community.

Regarding the first issue, the Eleventh Circuit held “[h]aving considered the totality of the written warnings and graphic depictions, we find that the Defendants adequately notified consumers of the ‘apparent potential harmful consequences’ of the indoor use of the [defendant’s] propane gas heater, including the risk of fire.”  The court was not persuaded that the picture illustrations and written warnings were ambiguous “as to whether the heater could be used inside a person's home and whether the heater posed a fire hazard if used inside a person's home.”  The warnings contained several references that the heater should not be used indoors and also warned of the risk of fire.

As to the second issue, the court was also unpersuaded by plaintiff’s arguments.  There was no evidence that the defendants “regularly and actively” marketed the heaters on Hispanic television or radio stations or Hispanic newspapers.  Prior Florida case law found a duty on the part of the manufacturer to provide bilingual warnings if such a circumstance in marketing and advertising was present.

First of all, it is a little unclear how the English warnings were “inherently contradictory, inaccurate and ambiguous” if they could not be understood in English—which would be the entire point of arguing that the warnings should be bilingual to begin with.  Second, the court upholds the district court’s decision that the warnings were adequate as a matter of law here, but this decision could easily be interpreted to be limited to the facts of this case.  While the court did NOT say there was a duty for a manufacturer to automatically include bilingual warnings, there may be circumstances where it would find such bilingual warnings necessary—particularly, where there is evidence that the product manufacturer directed its advertising and marketing at a particular ethnic community.

The Boulder Business Lawyers at Laszlo & Associates, LLC provide legal counsel for businesses on a variety of business needs, including products liability, risk management, corporate protection, and legal compliance.  

The UK’s The Guardian broadly reviews the on-going debate surrounding nanotechnology—namely, whether the benefits offered by nanotech materials outweigh the risks to the environment and to humans.  The article juxtaposes the uncertainty surrounding the risks of nanotech materials with its positive potential.  For instance,“[i]n the medical arena, nano-robots could be programmed to repair damaged cells and mimic our own natural healing processes,” or for the environment, “the effects of man on the environment could be halted and reversed through nano filters designed to remove carbon dioxide from the atmosphere.”

As The Guardian notes, the properties that make nanotechnology beneficial may be the exact properties that create the risk: "[a]s chemical substances get smaller, their behaviours and characteristics may change, with certain nanomaterials possessing properties not found in their bulk counterparts… the novel properties that nanomaterials can possess give rise to new forms of risk."  It is the uncertainty that makes the nanotechology debate important at this time, particularly since there are already "1000 nanotechnology enhanced products on the market" currently:

Potential risks from nano are both unknown and unknowable.  Unknown because little risk assessment has take place to date (less than 2% of the money being poured into nano research is devoted to risk analysis) and unknowable because scientific expertise in chemical assessment has not kept pace with scientific expertise in nanotechnology. Put simply, we are not currently capable of testing all of the inherent properties of all nanomaterials.

For this reason, comparisons between asbestos and nanotechnology run rampant.  According to the article, the first asbestos mines opened in Quebec in 1874.  Asbestos was widely used by various industries by the 1950’s.  While some concerns about the safety of asbestos were first noted as early as 1900, it was not for many years until asbestos came under any real scrutiny for being connected to any health concerns.  The uncertainty of the risks surrounding nanotechnology will most likely lead to increased government regulation in the very near future—particularly, if the government does not believe that the nanotech industry is proactively assessing the risk of its own products.

The article ends with an open question to consumers:

Simply ask yourself this question: when was the last time you ever picked up your body wash in the shower and scrutinised the ingredients list? And, even if you did notice "(nano)" next to an ingredient, what would that mean to you: a warning as to possible side effects? A selling point as to unique properties? Something else?

The Boulder business lawyers at Laszlo & Associates, LLC provide legal counsel to businesses on a variety of business needs including products liability, risk management, corporate protection and legal compliance.

Non-disclosure agreements or “NDAs” are agreements common in the early days of startups wherein parties agree to keep certain information confidential.  NDAs make sense and are necessary where one or multiple parties party seeks to share an idea with multiple potential investors and business partners.  NDAs are generally limited in duration and "bridge the gap" so to speak between an initial meeting and a later final agreement. 

When drafting an NDA, here are some key points to keep in mind:

• Is the NDA a “one way” or “two way” agreement?  This is important to determine who is sharing the information and who is agreeing to keep it confidential?  If both parties are sharing information, you’ll need a two way NDA.
• Like any agreement, be sure your NDA sets forth the goals and objective of the agreements and represents the positions of the parties.
• Be sure your NDA adequately protects the information you seek to protect, i.e., using a broad term like “all confidential information” may not protect your IP as it may simply not be “confidential information.”  Be specific and spell out what it is you seek to protect.
• Be reasonable and realistic in the NDA.  A requirement that all information must be stamped “CONFIDENTAL” may be over burdensome and not be realistic – and might ultimately hurt you if some information slips through the cracks and is left unmarked. 
• NDAs should have a termination date or event.  For example, an NDA is a transitional agreement that would expire once a fully executed final agreement is reached.
• NDA provisions that call for the return of protected material should reflect applicable document retention rules and laws.  Certain return provisions may not be practical.
• If you are considering crowdfunding to raise capital, an NDA is probably not workable as your ideas and information will necessarily need to be shared with countless individuals.

The above are simply general points of consideration when formulating your NDA.  Some NDAs are simple, and some require more thought, detail and specificity.  As with any agreement, be sure you know exactly what your goals are and what you are trying to protect. 

Laszlo & Associates' Boulder lawyers provide legal counsel to for-profit and non-profit businesses on a variety of business needs including startup and corporate formation, employment law, risk management, corporate protection and legal compliance.

While there are many forms your startup can take, in reality, there are only three forms a startup will consider: C Corp, S Corp, or LLC.  Deciding what corporate form a startup should take is one of the most critical early decisions a startup will make.  But, making an informed decision and laying the proper foundation will save many headaches down the road. 

The C Corp:  The C Corp is a separate legal entity and is a separate tax payer, i.e., it pays its own state and federal taxes and if it distributes dividends to shareholders, those dividends are taxed (and paid by the shareholders).  This is commonly referred to a “double taxation.”  But does it make sense for a startup to organize as a C Corp?  Maybe … maybe not.  The most important scenario for startups to organize as a C Corp is where it plans on raising venture capital – in this instance it has to be a C Corp.  Another reason to be a C Corp would be where the startup plans to retain money in the company.

The S Corp: If you are not sure whether your startup will need to be a C Corp down the road, but it remains a possibility, the S Corp offers very good flexibility and can be easily converted to a C Corp should the need arise.  Perhaps the most attractive feature of the S Corp is the pass through taxation and ease with which it can be converted back to a C Corp (I say “back” because you first organize as a C Corp, then elect S status by filing Form 2553 with the IRS).  There are key drawbacks to the S Corp however.  An S Corp must adhere to all C Corp formalities including recordkeeping, shareholder meetings, file annual reports, etc.  Also, S Corps cannot have more than 100 shareholders – which would essentially eliminate the possibility of crowdfunding – LLCs cannot be shareholders and all individual shareholders in an S Corp must be US citizens or permanently reside in the US.  Finally, the S Corp is far less flexible in terms of division of profits and classes of stock – for example, as an S Corp, your startup cannot have common and preferred classes of stock. 

The LLC: Which brings us to the darling of the small business world – the LLC.  If your startup does not plan to raise venture capital and seeks flexibility in ownership structure, the LLC is a very desirable corporate form.  Like the S Corp, the LLC provides for pass through taxation and will protect personal assets from liability (when corporate formalities are observed).  One of the most convenient aspects of the LLC is that owners of an LLC operate the business pursuant to an “Operating Agreement.”  Please do not mistake this to mean an Operating Agreement is a simple document – generally, they are not.  However, LLC Operating Agreements can be drafted to address very specific items unique to a given business’ needs.  Further, division of profits and losses are easily dealt with in the LLC – whereas in an S Corp, any division must strictly conform with one’s percentage ownership of the company.  It is important to note that not all states permit conversion of an LLC to a C Corp – thus, an LLC may not be the best option if you need to be a C Corp down the road.

The above is a very general overview of the three main types of corporate structures utilized by startups.  It is paramount that any startup fully understands its current position with an eye toward the future when deciding what form to take.

The Boulder Business Lawyers of LaszloLaw provide legal counsel to startups, for-profit and non-profit businesses on a variety of business needs including corporate formation, risk management, corporate protection and legal compliance.

In 2003, Cervelo, the maker of high end road bicycles, voluntarily, and in conjunction with the U.S. Consumer Product Safety Commission, recalled 317 Wolf all carbon road bicycle forks.  In April 2012, a Massachusetts man riding on a bike fitted with the recalled forks crashed and died.  Police stated that the rider was on a Cervelo Soloist and that it appeared a "mechanical failure" causing the forks to separate from the bike led to the crash.  An investigation is currently underway, but let us assume, for purposes of this article, that the recalled Cervelo forks caused the accident and ultimately the man’s death.

Most punitive damage awards stem from evidence that the manufacturer knew or should have known about a post-sale problem but failed to take adequate remedial measures to prevent accidents.

In the Cervelo case, the recalled Cervelo forks were sold from April 2003 until July 2003 - with a recall announced July 31, 2003.  It would appear that Cervelo worked swiftly to recall the defective forks.  But with only 300 forks sold in such a short period of time, how was it that Cervelo was unable to reach all owners of the forks?  The bottom line is no one should have been riding on those forks.  In its latest Consumer Product Safety Commission Recall Handbook, the CPSC lists dozens of ways to inform consumers of a product hazard and recall.  Of note is the social media aspect, perhaps the most efficient way to reach your consumer:

The Commission encourages companies to be creative in developing ways to reach owners of recalled products and motivate them to respond ... As new or innovative methods of notice and means of communication become available, such as social media, the staff encourages their use. ...  use of a firm’s social media presence to notify consumers of the recall, including Facebook, Google +, YouTube, Twitter, Flickr, Pinterest, company blogger networks, and blog announcements.

Just this week, bike manufacturer Specialized issued a recall due to hazardous break levers. However, the company has not yet announced the recall on Twitter - where it has more than 60,000 followers.  Others have tweeted about the recall but nothing from the Specialized company itself (as of the writing of this blog post). This is such a missed opportunity - Specialized can immediately reach 60,000+ consumers who will immediately get the information it provides (not to mention there are more likely than not some affected consumers following on Twitter.)

In the Cervelo case, a question will certainly be asked whether Cervelo did everything it reasonably could have done to ensure all forks were replaced.  How did (if at all) Cervelo try to inform the man that his bike was one that had the defective forks? Twitter was not around in 2003, and it is doubtful the company had policies and procedures in place to notify customers via social media at that point. But times have changed.  It is 2012, and there is simply no excuse not to use social media to inform consumers of hazards and recalls associated with your products.  And keep in mind that many (if not most) of your jurors will use and understand Twitter, Facebook and the latest social media - and wonder why you did not use it to let them know they could get hurt.

The Boulder lawyers at Laszlo & Associates, LLC provide legal counsel to businesses on a variety of business needs including products liability, risk management, corporate protection and legal compliance.

Yesterday, a New York Supreme Court Judge (In New York, Supreme Courts are the state's trial courts) granted Sirius XM Radio Inc.'s motion for summary judgment in a $300 Million + case brought against it by Howard Stern. Stern v Sirius.pdf In the lawsuit, Howard Stern and agent Don Buchwald claimed that Sirius failed to honor its agreement to pay them "Sirius Subscriber" based bonuses totalling over $300 million.  Sirius took the position that the subscriber number "triggers" were only met after Sirius and XM Radio merged in 2008 and therefore did not trigger the "Sirius Subscriber" language in the contract.

The dispute ultimately boiled down to what a "Sirius Subscriber" was.  The agreement did not define "Sirius Subscriber" and Stern argued the term included all subscribers to the new Sirius XM Radio, regardless of whether they subscribed to Sirius Radio or XM Radio.  Siruis took the position that the contract terms were unambiguous and that Sirius and XM subscribers were not the same.  The New York court agreed with Sirius. 

Perhaps the most relevant term of the agreement in favor of Sirius' position was the "XM Merger" clause providing:

In the event Sirius merges with XM Satellite Radio, Sirius shall pay you [Howard Stern] a fee of $25,000,000 , whereupon the HS [Howard Stern ] Programs may be broadcast to all subscribers of the surviving company.

This term, Sirius argued, made clear that Sirius and XM subscribers were different and that the agreement contemplated as much. 

Legally it makes sense.  When Howard Stern and Sirius were negotiating the agreement years ago, both sides were hedging their positions against the unknowns of the future - something we all try to do in any contract.  At the time, it was not clear whether Sirius and XM would merge or be permitted to merge.  The affect of a Sirius/XM merger, Sirius argued, was treated separately in the agreement as evidenced by the $25 million merger payout.  The court agreed - but look for an appeal of the decision by Stern in the near future.

The take away from the Stern v. Sirius case is that smart contract drafting is critical at any level.  In reality, when the agreement was drafted, Howard Stern and his team along with Sirius were not blind to the ambiguities upon which this lawsuit was based.  These types of "unknowns" provide wiggle room down the road, but are very risky.

Laszlo & Associates, a Boulder Law firm, provide legal counsel to for-profit and non-profit businesses on a variety of business needs including startup and corporate formation, employment law, risk management, corporate protection and legal compliance.

Two recent articles tout the benefits of Colorado’s liquor laws to craft brewers.  The articles, by Eric Wallace of the Vail Daily and Dan Frosch of the New York Times, can be read by clicking the respective links.

After reading the above articles, I thought I would take a moment to expand on the key Colorado liquor laws that make Colorado so attractive for the craft brew industry. 

Colorado brewers are permitted to operate as “Alternating Proprietors” or “tenant manufacturers” who, by way of written agreement, take possession of a host manufacturer's licensed premises for use as an alternating proprietor licensed premises to brew their own beer.  This provides start-up craft brewers the ability to save capital and rent production space.

Further, Colorado law permits Colorado licensed manufacturers of malt liquors (beer) to share brewing space and to sell beer of their own manufacture directly to retail.

C.R.S. § 12-47-402(1) (b) permits brewers

To sell malt or vinous liquors of their own manufacture within this state. Brewers or winers licensed under this section may solicit business directly from licensed retail persons or consumers by procuring a wholesaler's license as provided in this article; except that any malt liquor sold at wholesale by a brewer that has procured a wholesaler's license shall be unloaded and placed in the physical possession of a licensed wholesaler at the wholesaler's licensed premises in this state and inventoried for purposes of tax collection prior to delivery to a retailer or consumer. …

Finally, Colorado liquor law prohibits two critical things:

1) Grocery and convenience stores from selling wine spirits and “full strength” beer (as opposed to 3.2% beer);

and

2) Retail liquor stores from holding more than one liquor license – thus eliminating chain retail liquor outlets. 

These Colorado liquor laws work to prevent national stores such as Trader Joes, Safeway, Wholefoods and Target, for instance, to sell wine, spirits and beer at all Colorado locations.  By law, they are permitted to obtain a retail liquor license for a single Colorado location.  This, craft beer advocates say, provides small brewers (and vintners and distillers) with the opportunity and shelf space to market their products - shelf space that would be otherwise unavailable when competing with national “big” brands.  Despite numerous attempts to change the above Colorado liquor laws, they remain the same with no change in sight.

Laszlo & Associates, a Boulder, Colorado based law firm, provides legal counsel to brewers, distillers and wine makers on a variety of business needs including corporate formation, liquor licensing, employment law, risk management, corporate protection and legal compliance.

Starting a business with friends can be an exciting thing.  However, the excitement and anticipation of jumping in and getting the business off of the ground often overshadows the little details that are necessary when forming your company and, when starting a new business, it is the “little things” that become very big things later!

In Colorado, there are two popular forms of doing business: the stock corporation (“Inc.”) and the limited liability company (“LLC”).  Both forms, if properly formed and administered, limit the liability of the shareholders or members—often the most critical reason to choose one of these forms of doing business. The LLC does offer a degree of flexibility that makes it an extremely popular choice for new businesses.

Once organized, an LLC’s affairs are governed by an operating agreement, which, while similar in many respects to a stock corporation’s by-laws, contains the agreement of the members as to how the LLC will conduct its day-to-day business.  Think of an LLC’s operating agreement as its constitution—the operating agreement governs the rights, duties, limitations, qualifications, and relations among the members, the members' assignees and transferees, and the limited liability company.  The operating agreement may also contain provisions concerning its enforcement, interpretation, construction, and application.  Importantly, however, the operating agreement is a “contract” between the members – an “agreement” as to how the LLC will operate.

Colorado courts have consistently held that the provisions of an LLC’s operating agreement control over any provision of the Colorado state statutes governing limited liability companies to the contrary, subject to some exceptions.  The intent of the Colorado Limited Liability Company Act is to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements.

While some companies may seldom find it necessary to have to refer to the LLC’s operating agreement, the reality is that most businesses with multiple members will need to consult the operating agreement to answer a question or solve disputes – questions such as: what becomes of the LLC if a member (or, the sole member) dies? What do you do when a member decides to exit the LLC or retire?  What if the LLC decides to bring in a new member?  How to go about winding up the operations of the LLC and closing the business – how are the assets to be distributed?  A well drafted operating agreement should answer all of these questions and serve as the roadmap by which your LLC conducts business.

Laszlo & Associates, a Boulder, Colorado based lawfirm provides legal counsel to for-profit and non-profit businesses on a variety of business needs including corporate formation, risk management, corporate protection and legal compliance.

Khalik v. United Air Lines (10th Cir. Feb. 6, 2012) involved a Colorado Arab-American who made numerous claims of discrimination and retaliation because of race, religion, national origin, and ethnic heritage against United Air Lines.  The court found that Khalik’s claims were “conclusory” recitations that were insufficient to meet federal pleading requirements.

The court stated that under Twombly/Iqbal “Twiqbal” (we have preciously written about Twiqbal) while a plaintiff is not required to establish a prima facie case in a complaint, the elements of an alleged cause of action help to determine whether a plausible claim has been set forth.  Where allegations are entirely conclusory, they are not entitled to the assumption of truth.  A plaintiff does not need specific facts, however, cannot make mere conclusions in a complaint.   

“In this case, several of Plaintiff’s allegations are not entitled to the assumption of truth because they are entirely conclusory, including her allegations that: (1) she was targeted because of her race, religion, national origin and ethnic heritage; (2) she was subjected to a false investigation and false criticism; and (3) Defendant’s stated reasons for the termination and other adverse employment actions were exaggerated and false, giving rise to a presumption of discrimination, retaliation, and wrongful termination.”

"But a plaintiff must include some further detail for a claim to be plausible. Plaintiff’s claims are based solely on the fact that she is Muslim and Arab–American, that she complained about discrimination, that she complained about the denial of FMLA leave, and that Defendant terminated her. Without more, her claims are not plausible under the Twombly/Iqbal standard.”

Khalik is important because it demonstrates that courts are not abruptly dismissing claims under Twiqbal, but rather are looking for some details regarding allegations that could be plead to satisfy the plausibility requirement – like when, where, why, by whom, etc.  This case makes clear that without such information claims will not survive.  Plaintiffs should make every effort to include details to ensure their claims survive - while defendants should not assume the Twiqbal will simply save the day but rather seek to poke holes in and draw attention to deficiencies in specific details that would support those allegations against it.

Laszlo & Associates, a Boulder, Colorado based law firm provides legal counsel to for-profit and non-profit businesses on a variety of business needs including corporate formation, employment issues, risk management, corporate protection and legal compliance.

In his Top 12 Security Risks For 2012, Is Your Company Ready?, David Coursey of Forbes.com identifies routine negligence (you know—good ‘ole lack of due care) as a top business threat for 2012.

“Since people tend to be trusting, you and everyone around you are the weakest links in protecting against social engineering. If this isn’t already on your radar, it certainly should be and needs to be included in your overall corporate protection strategy. Social engineering isn’t the biggest threat you face, by far, but it’s an unavoidable one.”

Similarly, according to Wayne Rash in his 12 Security Threats for 2012, “In the case of security . . . the single-worst security issue we have isn’t the Chinese or the Russian Mafia. The single-biggest problem we have is us.”

How often did our parents warn us “look both ways before you cross,” “make sure you put a hat on … it’s cold,” “walk don’t run?” And, while nothing is stopping us from employing a cautionary spirit in the ways in which we conduct our businesses and instilling that same “be careful” spirit in our employees and contractors, at times we do tend to relegate “due care” to a back seat. Too often in our day-to-day business activities we take the exercise of “due care” (or lack thereof) for granted. We just “assume” that our employees, contractors and agents will be careful. Heck—we all have mountains of contracts and documents telling us how careful everyone we deal with is going to be!

Just today, one of our associates has been unable to access his computer for the past few hours because it was attacked by some new virus that our IT department had never seen—we just “assume” that our business computers will be set up and configured correctly—free from viruses and threats;  that access rights to our business hardware and software are enforced; that our threat protections like firewalls, anti-virus software and anti-hacking programs are current and are installed and administered properly.  But protection does not happen by accident.  Businesses need to actively employ appropriate password creation and maintenance techniques and use scrubbing software when transmitting sensitive, private or confidential business documents and records, etc. 

So, with this constant barrage of new and evolving business and security threats, how does routine negligence seem to make the list year in and year out? Are our employees, agents and contractors too busy? Are they too complacent? Are they too preoccupied? Is being careful too expensive? Exercising due care in the conduct of businesses is not a novel concept.  In our personal lives many of us would never be OK with an “ignorance is bliss” attitude toward our checking accounts or locking the doors at night.  Likewise, such an attitude should exist in the workplace.  Instilling a “be careful” attitude in your day-to-day business from the top down can go a long way to warding off threats to your business health and continued viability.  After all, we are our own worst enemies.   

Boulder, Colorado based Laszlo & Associates provides legal counsel to for-profit and non-profit businesses on a variety of business risks, corporate protection and legal compliance.

            Most cases involving the reasonable expectations doctrine arise in one or more of three basic contexts: (1) ambiguity in the terms of a policy, either generally or within the framework of a policy exclusion; (2) policy exclusions that undermine the insured's reasonable expectations of coverage; and (3) situations where, by virtue of the policy being a contract of adhesion, the insurer in essence took advantage of the insured by issuing a policy that was not consistent with the insurer's reasonable expectations of coverage.  

            Currently before the Supreme Court of Ohio is the question of whether Ohio law encompasses the reasonable expectations doctrine. 

            In Honeybaked Foods, Inc. v. Affiliated Insurance Co., pending in the United States District Court for the Northern District of Ohio, the case will turn on this very question.  In that case, a risk report completed by Affiliated Insurance prior to Honeybaked purchasing the insurance policy in question noted that “[t]he most significant and common hazards exposing the food industry are centered on the susceptibility of food products to spoilage and contamination.”  Honeybaked purchased the policy mindful of the risk assessment. 

            In early November, 2006, HoneyBaked discovered that a sample of its products had tested positive for listeria monocytogenes, a pathogenic bacterium that causes listeriosis, an uncommon but potentially fatal disease.  Further investigation revealed that a risk of contamination affected over one million pounds of product produced from September 5 through November 5, 2006.  Honeybaked suspended operations and recalled tons of contaminated product.

The Affiliated insurance policy contained a contamination exclusion, stating:

"This policy does not insure against loss or damages caused by [contamination, including but not limited to pollution]; however, if direct physical loss or damage insured by this policy results, then that resulting direct physical loss or damage is covered."

Affiliated denied the claim, explaining that the policy excluded the product loss, and because “there is no covered physical loss or damage, any business interruption associated with the listeria contamination is also not covered.”  Honeybaked sued.

            The trial court stated that “a jury could find that HoneyBaked had a reasonable expectation of coverage for losses due to contamination. But the policy, when closely interpreted, excludes losses caused by contamination.  The availability of coverage, notwithstanding the exclusion, turns on the question of whether Ohio law incorporates the reasonable-expectations doctrine and applies such doctrine to this case.”

            A recent Minnesota decision stated that “The doctrine of reasonable expectations does not destroy the insured's obligation to read the policy, but only holds an insured to a reasonable understanding of that policy.” Frey v. United Services Auto. Ass'n, (Minn. Ct. App. 2008).

            Some states allow for use of the doctrine only under certain circumstances while others are less strict on application.  The Reasonable Expectations Doctrine is a "principle [that] pertains to alleged ambiguities within the policy."   Brown v. Indiana Insurance Co., (Ky. Supreme Court, Dec., 2005.)  "Under Arizona law, even unambiguous policy language will not be enforced against the insured if the insured had a reasonable expectation of coverage."   Madsen v. Fortis Benefits Ins. Co., (U.S.D.C. Ariz., Dec. 21, 2006).

            In Honeybaked Goods, the policy excludes losses from contamination. The risk of such loss, a jury could find, motivated HoneyBaked’s purchase of the Affiliated policy, and that Affiliated knew of HoneyBaked’s desire and need for coverage against losses from contamination.  The court stated: “Whether coverage is available in this case depends on whether Ohio law encompasses the reasonable-expectations doctrine.” 

            The Ohio Supreme Court a is very conservative court, but in a recent decision overturned lower courts and extended coverage to victims of a bus crash finding that where a University had hired a bus driver, the bus driver was covered under the University’s policy.  Fed. Ins. Co. v. Executive Coach Luxury Travel, Inc., (Ohio S.Ct., Dec. 28, 2010.)  What is worth noting is that the Dissent in Fed. Ins. Strongly supports the view that intent of the parties is the critical inquiry in such coverage disputes:

“The majority’s narrow interpretation expands the scope of coverage beyond what the parties to the insurance policy intended,” Justice Stratton wrote. “Today’s opinion unreasonably extends coverage to a third party and effectively opens the door for similar claims under other scenarios because the omnibus clause is standard in many insurance policies.”  Fed. Ins. Co. v. Executive Coach Luxury Travel, Inc., 2010-Ohio-6300 Dec. 28, 2010, Stratton, J. and O'Donnel, J. Dissenting.

            In order for Honeybaked to prevail, The Ohio supreme court will have to rule that Ohio either does or does not recognize the reasonable expectations doctrine and the trial court would have to take an Arizona approach and enforce the policy against the insurer based on the position that Honeybaked had a reasonable expectation of coverage despite the exclusionary language. 

            What is the lesson here?  Despite the availability of the reasonable expectations doctrine in some states, the lesson is that care in drafting and an understanding of the law of the state in which the policy is issued are of the utmost importance in insurance policies.