Current Developments in Estate Planning and Business Law: September Review

A bankruptcy attorney sues Square, Inc. for discrimination; a Florida law firm learns an expensive lesson on negligent drafting—last month saw a few cases offering cautionary tales. So you can stay abreast of these legal developments, we’ve highlighted three recent cases and analyzed how they may impact your estate planning and business law practice.

The perils of negligent draftsmanship

Gulfport OB-GYN, P.A. v. Dukes, Dukes, Keating & Faneca, P.A., No. 2018-CA-00514-SCT, 2019 WL 4071721 (Miss. Aug. 29, 2019)

This case attests to the damage that can be wrought by a seemingly minor drafting error. In Gulfport OB-GYN, P.A. v. Dukes, Dukes, Keating & Faneca, P.A., medical practice Gulfport OB-GYN (“Gulfport”) sued law firm Dukes, Dukes, Keating & Faneca, P.A. (the “Firm”) for malpractice due to the inclusion of negligent language in a noncompetition covenant, which caused substantial financial losses for Gulfport when one of its doctors left to establish her own practice. 

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In 2008, Gulfport hired the Firm to assist in the hiring of Dr. Donielle Daigle, including drafting an employment agreement between Gulfport and Dr. Daigle. Diagle’s employment agreement contained a noncompetition covenant which, unbeknownst to Gulfport, contained what it would later assert to be negligent language: 

“Employee agrees that for a period of three (3) years following termination

of her employment by the Employer, regardless of cause (subject to

Section 7(d)), she will not engage in any medical practice or perform

any service directly or indirectly in competition with the medical

practice of Employer, to include hospital staff positions, or have any

interest in any capacity whatsoever in any enterprise that engages in

such medical practice within a radius of fifty (50) miles from the

Memorial Hospital at Gulfport, without the express written consent of

the Employer.”

Because the covenant only referenced the termination of the employee by the employer, when the employee later left voluntarily to start her own practice, the noncompetition covenant was for all intents and purposes—unenforceable. 

Gulfport agreed to pay Dr. Diagle $425,000 for unpaid compensation and subsequently filed this legal malpractice suit against the attorney who drafted the employment agreement, Blum, and the Firm. Gulfport argued that the language, “termination of [Dr. Daigle’s] employment by the Employer” was negligent because it allowed Dr. Diagle to compete with the clinic after Dr. Daigle’s voluntary resignation. 

Ultimately, the Court held that Gulfport failed to prove that Dr. Diagle would have accepted the more comprehensive noncompetition covenant, and was thereby unable to demonstrate that the attorney's negligence caused any damage.

Takeaways: While Blum and the Firm escaped liability, they still faced the disruption and inconvenience of defending a malpractice claim in court. Attorneys are required to adhere to reasonable standards of conduct when representing clients. Many attorney malpractice cases arise due to drafting errors. Transactional attorneys are required to follow client instructions when drafting contracts; otherwise, the client could face unnecessary financial and legal consequences. While the standard for legal negligence varies by state, it must generally be demonstrated that, were it not for an attorney’s actions, a client would have reached a more favorable outcome in a subsequent dispute. Attorneys must therefore be cognizant throughout the drafting process of their client’s objectives. An attorney must also ensure that their clients understand the import of all material provisions. It can sometimes help to focus a client’s attention by sharing cautionary tales of contractual misunderstandings, such as Gulfport’s unfortunate outcome.

Attorneys looking to minimize the risk of drafting errors should consider using automated drafting software, such as Wealth Docx® for estate planning and Business Docx® for business planning. As comprehensive drafting solutions, Wealth Docx and Business Docx, automate the drafting process, reducing data entry (and the risk for error) and streamlining the drafting process. Learn more about the drafting features here. 

Tax treatment of inherited partnership interest: same partnership, different taxpayers 

Lipnick v. Comm’r, 153 T.C. No. 1 (2019)

The U.S. Tax Court recently held that, where a taxpayer received partnership shares as a gift and inheritance from his father, interest paid by the partnership on its indebtedness did not pass through to the taxpayer as investment interest, notwithstanding the fact that the interest had passed through to the taxpayer’s father as investment interest. During the elder Lipnick’s (“Dad”) ownership of the partnership interests, the partnerships borrowed money on a non-recourse basis and distributed the proceeds to Dad, who then invested the money and deducted the resulting interest. Following the transfer of the partnership interests to the younger Lipnick (“Son”), Son treated the interest as related to the business of the partnerships (owning and renting real estate) and, therefore, fully deductible on Schedule E against the income distributed by the partnerships. Son’s characterization of the interest was therefore more favorable to himself, since it would enable a full deduction of the interest. Had he considered the interest to be investment interest - like his Dad - his deduction would have been limited to the extent of his net investment income. He had no net investment income; therefore, following his Dad’s tax treatment of the interest would have had negative tax consequences to Son.

The IRS determined that Son underpaid taxes, since the interest should have been treated as investment income, non-deductible by Son. According to the IRS, Son steps into Dad’s shoes, resulting in the interest being treated as investment interest, just as it had been in Dad’s hands. The Tax Court, however, found no support for the IRS’ theory and noted that Son did not receive, either directly or indirectly, any debt-financed distribution from the partnership, and thus did not make any traceable investment expenditure with the funds which would have generated investment interest.  

The Court noted that when the interests were gifted to Son, the debts that were generating investment interest were are on the books of the partnership—thus, Son’s partnership interest was effectively burdened with these debts.  The Court concluded that Son acquired the partnership interest subject to the debt in accordance with Treas. Reg. §1.163-8T(c)(3)(ii). In other words, the substance of the interest payments had changed once the partnership shares passed from Dad to Son. Son did not have the same relationship to the partnership loan as Dad did because no part of the loan proceeds were distributed to Son.

Takeaways: Attorneys should work closely with tax advisors to ensure clients inheriting partnership interests understand the tax consequences, and that they may differ from what a parent or other transferor reported. Clients may believe they simply step into the shoes of the transferor with respect to tax aspects of inherited business interests. As Lipnick illustrates, this is not always the case.

Discriminatory Protections Extended to Visitors of a Business’ Website

White v. Square, Inc., 446 P.3d 276 (Cal. 2019)

California's Unruh Civil Rights Act (the “Act”) provides that “all persons within the jurisdiction of this state are free and equal…[and] are entitled to the full and equal...services in all business establishments of every kind whatsoever” (Civ. Code, § 51, subd. (b)). Traditionally, the Act has only been applied to brick and mortar businesses. However, in White v. Square, Inc., the Court faced the question as to whether any standing under the Act should be extended to someone who intends to transact (but has not yet transacted) with an online business. 

The Court’s answer: yes, it should. 

In October 2015, Robert White, a bankruptcy attorney, sued Square, Inc. for discrimination against bankruptcy attorneys and for being in violation of California's Unruh Civil Rights Act. White alleged that he visited Square’s website with the “strong, definite and specific intent” to use Square’s services. While reviewing Square’s terms of service, White found that the user must confirm that they will not accept payments in connection with “bankruptcy attorneys or collection agencies engaged in the collection of debt.” As he intended to use its services for his bankruptcy practice, White decided he was unable to continue signing up for Square’s services for fear of committing fraud.

In the initial ruling, the District Court for the Northern District of California dismissed White’s complaint on the grounds that White had not attempted to use Square’s services and his “mere awareness” of the business’ discriminatory terms of service did not provide sufficient standing under the Act.

White appealed, and the Court sided with White, concluding: “that a person who visits a business’s website with intent to use its services and encounters terms or conditions that exclude the person from full and equal access to its services has standing under the Unruh Civil Rights Act, with no further requirement that the person enter into an agreement or transaction with the business.” 

Takeaways: The White case brings front and center potential negative implications of poorly drafted website Terms of Service. A website “Terms of Service” is an agreement that - as the name suggests - governs a website visitor’s use of the service provided by that website. Often thought of as boilerplate or fine print, Terms of Service (also referred to as Terms of Use) form an agreement between a company and website visitors. In California, following White, companies must ensure that nothing in the Terms of Service could be construed to exclude any person from full and equal access to the company’s services. Given that California residents access websites for companies nationwide, it is likely the White case will have farther-reaching consequences than California. All businesses with a web presence should ensure their Terms of Service are non-discriminatory to avoid potential liability.

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