Thursday, July 1st, 2004
Virginia Lawyer, June/July 2004
The full article is available in pre-formatted PDF format by clicking on the “Associated File” link below.
Introduction
For attorneys practicing health law, consulting the Privacy Standards of the Health Insurance Portability and Accountability Act (“HIPAA”) is almost an everyday event. Since these extensive and complicated rules were published in December of 2000, we have been advising health care providers and health plans (“covered entities” under HIPAA) on the steps they should take to become compliant. For other attorneys, however, HIPAA has become a roadblock to patient information that used to be much more accessible.
Monday, June 7th, 2004
W. David Paxton
In a combination of reports released, the federal government has made an effort to revive the debate regarding the disparity in pay and position between many men and women which is frequently referred to as the Glass Ceiling phenomenon. [1]
- GAO Report. In November, 2003, the General Accounting Office reported that women earn only about $.80 for every $1.00 paid to a man, which is the same pay gap that has persisted for nearly 20 years. The report entitled Women’s Earnings: Work Patterns Partially Explain Differences Between Men and Women’s Earnings. According to this report, several key work patterns explain most, but not all, of this earning gap:
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- Men work on average 2,147 hours per year vs. 1,675 hours for women.
- Men average 16 years of work experience while women average 12.
- Approximately 88% of men work full-time, while only 67% of women work full time.
- Women spend three weeks out of the labor force per year on average while men are out of the work force an average of only one week per year.
These statistics confirm the common sense assessment that many businesses experience where women employees trade off career advancement or higher earnings for jobs that offer greater flexibility in order to better manage work and family responsibility. Nonetheless, the report contains troubling suggestions that this series of logical trade-off between work and home may not be the whole story. The report notes the following:
On the other hand, an earnings difference may result from discrimination in the work place or subtler discrimination about what types of career or job choices women can make…
Nonetheless, it is difficult, and in some cases may be impossible to precisely measure and quantify individual decisions and possible discrimination.
Businesses should expect that this study will be used to spark a more careful analysis of the payroll practices of larger organizations.
- EEOC Reports March, 2004.Continuing this renewed focus is a report issued by the Equal Employment Opportunity Commission on March 5, 2004. In the past several years, the EEOC has become much more focused on gathering and analyzing statistical information from the EEO-1 reports that larger employers are required to submit. An EEO-1 report is required to be filed by every private sector employer that employs 100 employees, as well as those businesses with government contracts that exceed $50,000, and employ at least 50 employees. The most recent statistics (for 2002) were released, and the report noted significant differences. The report is based on data compiled from 39,000 employers employing nearly 52 million workers. The study entitled Glass Ceilings, the Status of Women as Officials and Managers in the Private Sector is accessible on the EEOC’s website at https://www.eeoc.gov. There are several notable findings from this report:
- Women represent 48% of all jobs listed in EEO-1 employment, but only hold 36.4% of positions within the officials and managers category. In contrast, the EEOC pointed out that women make up 80.3% of the office and clerical workers category.
- The report went on to note that women now occupy 51.7% of professional jobs – compared to the low number of officials and managers. Professionals include accountants, airline pilots, artists, designers, dieticians, editors, engineers, lawyers, mathematicians, registered nurses, HR specialists, social sciences teachers and surveyors.
EEOC Chairman, Cari M. Dominguez specifically noted while more women are shattering the proverbial glass ceiling, and many more are chipping holes in it, unfortunately, the gains are not across the board. Disparities exist in the work force participation of women by industry. Some industries are doing a better job than others. We hope this study will assist employers and employees alike in identifying barriers to the opportunities for access and advancement.
While there are a number of specific findings, the primary contribution of these analyses is the ability to raise important problems and questions about gender based discrimination given the wide variations and the types of firms and industries in the American economy… while it is difficult to specify the precise causes, it seems evident that management recruitment patterns in blue collar industries differ substantially from management recruitment patterns in service industries.
The EEOC has identified the Top 10 List of those having the best opportunity for women as follows:
- the healthcare sector;
- retail sales;
- legal services;
- insurance industry;
- property management; and
- financial institutions.
Among those businesses in the Lowest 10 tend to be:
- architectural, engineering and related services;
- general freight trucking industries (a/k/a PJAX, Inc.);
- automotive parts industry;
- plastics product manufacturing;
- converting paper product manufacturing; and
- metal fabricating manufacturing.
- Local Statistics. It is interesting to compare these statistics compiled at the national level to the local MSAs. In the Lynchburg MSA, there were only 153 EEO-1 reports submitted, and in the Roanoke MSA, there were 292 reports submitted. These two reports cover 94,655 employees who work in our region.
- Lynchburg MSA (34,348 employees). In contrast to the national average (48%), the work force in the Lynchburg MSA is comprised of 45 % women, and only 24% of women hold officials and manager positions (compared to 36.4% nationally). Consistent with the national trends, however, women comprised 50.6% of the professional category. Other statistical information of note in the Lynchburg MSA are as follows:
- 74.3% of the Lynchburg workforce is Caucasian (compared to 70% nationally) and a 25.7% minority workforce
- Roanoke MSA (60,307 employees). In the Roanoke MSA, the statistical information shows a slightly different picture. Women make up 49% of the workforce (slightly more than the national average), however, women comprise only 30.8% of all officials and manager positions (as opposed to 36.4%). Women hold 58.6% of the professional category (compared to 52.1%), and 52% of the sales workforce (compared to 55% nationally). Most interesting is the Technicians category, which applies to those occupations requiring basic scientific knowledge and manual skill obtained through two years of post high school education which includes computer programmers, drafters, engineering aids, practical or vocational nurses, photographers, technicians (medical, dental, physical science and other assistants). In Roanoke, 59% of the Technicians are female, compared to 46% nationally.
- The Roanoke workforce is less diverse than Lynchburg as Caucasians comprise 83.9% of the Roanoke workforce and minorities only 16.1%.
- Significance of Reports. The EEOC has made it clear by the issuance of this latest Glass Ceiling report and the accompanying statistics, which also includes an analysis of these same statistics over the previous five years, that it is carefully examining businesses that have employment and hiring patterns that fall outside the norm for what would be expected given these overall trends. It is important that every organization, but especially those that file EEO-1 reports carefully analyze their own statistical data and compare to that of the national and local MSA data to determine if they are significantly out of step. Manufacturers need to be especially concerned if a charge of discrimination is filed by an individual working in one of the industries where the EECO believes there is a statistical problem, and your workforce is out of line with general statistics. The EEOC is taking a much more heightened interest in evaluating the situation. It must be remembered that the EEOC can use the complaint by one employee to justify a more extensive review of your hiring and promotion practices and will not be limited solely to gathering information just based on the one individual who has filed a complaint, particularly if the individual complaining suggests that there are other similarly situated individuals who experience this same thing. As noted in the enforcement section, the EEOC is looking for opportunities to make cases into class actions in order to maximize their recovery. We think that there is no coincidence that the EEOC’s Baltimore office which oversees Virginia targeted a trucking company for a significant enforcement action after only one employee complained. The investigation into that complaint led to a second complaint being filed by the terminal manager who claimed that he had opposed certain practices, and this opened the door for a multi-million dollar settlement.
[1] The term Glass Ceiling is commonly used to describe those artificial, invisible barriers that are based solely on attitude and organizational bias which prevent qualified individuals from advancing upward into management level positions. Typically it refers to barriers to women, but can also apply to racial and ethnic minorities.
Friday, May 21st, 2004
HIPAA’s Impact on Litigation
J. Rudy Austin
Robyn Smith Ellis
Congress enacted the Privacy Standards of the Health Insurance Portability and Accountability Act (HIPAA) to protect patients from unauthorized disclosure of their medical records. HIPAA regulations require healthcare providers to establish policies and procedures that comply with the Privacy Standards. One of the many questions raised by HIPAA is the effect of the Privacy Standards on statutes in many states, including Virginia, that allow lawyers defending claims or lawsuits brought by patients against their own physicians or others, under certain proscribed circumstances, to have ex parte (without the patient or the patient’s lawyer being present) conversations with the patient’s treating physicians. One United States district court has now answered this question.
A federal court in Maryland has ruled that in the absence of a court order, ex parte conversations with treating physicians are barred by the HIPAA rules, even when a state law, in this case a Maryland statute, specifically authorized such contact. In Law v. Zuckerman, 307 F. Supp. 2d 705 (D. Md. 2004), the defendant’s lawyer conducted ex parte discussions with treating doctors in a medical malpractice case. The patient sought a declaration from the court that such contacts were in violation of HIPAA. The court held that the lawyer’s contacts with the doctors violated HIPAA because the state statute specifically permitting such conversations was preempted by HIPAA. The court ruled preemption was appropriate because the Maryland statute was less stringent in terms of protecting the privacy of the patient’s medical records than the HIPAA regulations. Although a violation of HIPAA may result in civil penalties imposed by the Secretary of the Department of Health and Human Services, HIPAA does not direct a court as to how to impose penalties for a violation during the course of discovery or trial. The court, in its discretion under rules of court procedure, did not sanction the lawyer because he had acted in good faith under the mistaken belief that state law permitted his ex parte discussions.
Virginia’s statute regarding ex parte contacts with treating physicians by lawyers, Va. Code º 8.01-399 is different from Maryland’s law, and very narrowly circumscribes the opportunities for counsel to have such ex parte contacts with treating physicians. It is our view that strict compliance with the Virginia statute is in accord with the HIPAA requirements, and contacts made pursuant to Virginia law should not be found to violate HIPAA. In March 2004, the Virginia House of Delegates and Senate directed the Joint Commission on Health Care to study how Virginia medical records privacy laws can be coordinated with HIPAA and the degree to which the laws should be made consistent. Hopefully this study will lead to some clarification as to which Virginia laws have been preempted by HIPAA.
For more information on HIPAA or how Virginia law applies in this context, please contact Rudy Austin at (540) 983-9401.
Wednesday, April 28th, 2004
Robyn Smith Ellis
On April 7, 2004, the U.S. Department of Labor’s Employee Benefits Security administration released Field Assistance Bulletin 2004-1 which provides enforcement guidance to field investigators on health savings accounts (“HSAs”). The guidance is intended to facilitate the adoption of health savings accounts by employers. The Department of Labor believes that HSAs will lead to more choices and lower health care costs for American workers and their families.
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“Act”) permits eligible individuals to establish HSAs effective January 1, 2004. Generally, eligible individuals are those who are covered under a high deductible health plan; are not also covered by any other health plan that is not a high deductible health plan; are not entitled to benefits under Medicare; and are not claimed as a dependant on another person’s tax return. Since the Act was signed into law, a number of questions arose regarding whether HSAs constitute employee welfare benefit plans under the Employee Retirement Income Security Act (“ERISA”).
Field Assistance Bulletin 2004-1 clarifies that while employer-sponsored high deductible health plans in the private sector or group health plans are subject to ERISA, HSAs are generally not covered. Specifically, employer contributions to HSAs are not covered by ERISA where the establishment of the HSA is completely voluntary on the part of the employee and the employer does not: (1) limit the ability of eligible individuals to move their funds to another HSA beyond restrictions imposed by the Internal Revenue Code (“Code”); (2) impose conditions on utilization of HSA funds beyond those permitted under the Code; (3) make or influence the investment decisions with respect to funds contributed to an HSA; (4) represent that the HSA is an employee welfare benefit plan established or maintained by the employer; or (5) receive any payment or compensation in connection with an HSA. The mere fact that an employer imposes terms and conditions on contributions that would be required to satisfy tax requirements under the Code or limits the forwarding of contributions through its payroll system to a single HSA provider does not affect whether an HSA funded with employer or employee contributions is covered under ERISA, unless the employer or the HSA provider restricts the ability of the employee to move funds to another HSA beyond those restrictions imposed by the Code.
Thursday, March 11th, 2004
W. David Paxton
While neither the Fourth Circuit nor Virginia courts have yet addressed the issue, the California Court of Appeals has held that current or former employees who post defamatory statements about a business on the Internet can be held legally accountable for such false statements. In Varian Medical Systems, Inc. v. Delfino, H024214 (Cal. Ct. App. 2003), two former employees posted numerous derogatory messages about Varian and two of its executives. A jury found the defendants liable for defamation, invasion of privacy, breach of contract and conspiracy, awarding $425,000 in general damages and $350,000 in punitive damages.
On appeal, the court considered whether the fact that defendants’ messages appeared on the Internet affected the character of the messages for purposes of defamation law. The defendants argued that “typical Internet hyperbole” could not be considered defamatory. The court rejected this challenge on three grounds: (1) the Internet would never achieve its potential as a viable source of information unless it is subject to the law, (2) the fact that readers might not believe the content of the postings did not change the fact that the statements damaged Varian’s business reputation, and (3) the postings at issue were not typical anonymous and outrageous postings, as alleged by the defendants.
The court also considered whether defamatory communications posted on the Internet should be considered slander, which requires proof of special damages, as opposed to libel, for which damages are presumed. The court noted that the messages were composed and published as written words, “just like newspapers, handbills, or notes tacked to a conventional bulletin board,” ultimately holding that defamatory statements posted on the Internet are properly characterized as libel. Consequently, it was not necessary for the plaintiffs to prove damages.
What Does this Mean for Employers?
Prior to this decision, it was unclear whether Internet speech would be held to a different standard under defamation law. Employers now clearly have the option to respond to false statements affecting a company’s reputation with a defamation suit. Employers must also carefully consider the practical realities of choosing to sue current or former employees. Among other things, determine whether you are able to identify who posted the defamatory postings and whether you are willing to spend the time and financial resources necessary to pursue litigation.
For more information about this topic, please contact W. David Paxton at (540) 983-9334 at Gentry Locke Rakes & Moore, LLP.
Copyright, Gentry Locke Rakes & Moore, March 2003
This article is provided for informational purposes only. It is not intended as legal advice nor does it create an attorney/client relationship between Gentry Locke Rakes & Moore, LLP and any readers or recipients. Readers should consult counsel of their own choosing to discuss how these matters relate to their individual circumstances. Reproduction in whole or in part is prohibited without the express written consent of Gentry Locke Rakes & Moore, LLP.
Tuesday, February 24th, 2004
Introduction
The new Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“Act”) permits eligible individuals to establish Health Savings Accounts (HSAs) starting January 1, 2004. HSAs are similar to Archer Medical Savings Accounts (“Archer MSAs”) as well as Individual Retirement Accounts (“IRAs”). They offer tax-sheltered savings like an IRA, and withdrawals for qualified medical expenses are tax-free. After a beneficiary attains the age of 65, withdrawals for anything other than qualified medical expenses (which continue to be tax-free) are treated the same as distributions from traditional IRAs.
Like an Archer MSA, an HSA is established for the benefit of an individual, is owned by the individual, and is portable. Therefore, an employee who establishes an HSA while working for one employer takes the account with him when he switches employers or leaves the workforce. Archer MSAs have not been used extensively because eligibility is limited to the self-employed and employees of small businesses.
The Act permits an employee to make pre-tax contributions to HSAs through a cafeteria plan as well as after-tax contributions outside a cafeteria plan which are deductible “above-the-line” when a covered beneficiary is covered under a high-deductible health plan. Employers may also contribute to HSAs, and such contributions are excluded from the employee’s gross income and deductible to the employer. HSA funds may be accumulated over the years or distributed on a tax-free basis to pay or reimburse qualified medical expenses.
Why Should Employers Care About HSAs?
HSAs may help reduce health care premium costs and give employees the ability to manage their own health care and health care costs.
HSAs are portable and owned by the individual; they go with the employee when the employee leaves. As such they can be viewed as a benefit, especially for those who do not have significant, current health problems.
Employees receive tax-free treatment on contributions, investment growth, and withdrawals for “qualified medical expenses.”
Employers do not have to determine whether HSA funds are used for “qualified medical expenses.” The determination is the employee’s responsibility.
HSAs will be more attractive to employees than Flexible Spending Accounts (“FSA”) which also allow employees to make pre-tax contributions to pay for medical expenses. FSA contributions do not earn interest, and employees must “use them or lose them.”
HSAs will be attractive to employees because they offer a variety of investment options, including savings accounts and mutual funds.
Unlike Archer MSAs, no limit on group size exists. HSAs are available to the self-employed as well as individuals covered under a large group plan.
Who May Establish an HSA?
An “eligible individual” can establish an HSA. An “eligible individual” means an individual who:
- Is covered under a high deductible health plan (“HDHP”) on the first day of the month in which contributions are made;
- Is not also covered by any other health plan that is not an HDHP (with certain limited exceptions);
- Is not entitled to benefits under Medicare (has not reached the age of 65); and
- May not be claimed as a dependent on another person’s tax return.
What Is a “High Deductible Health Plan”?
Definition: An HDHP is a health plan that satisfies certain requirements with respect to deductibles and out-of-pocket expenses.
Self-only coverage: An HDHP has an annual deductible of at least $1,000 and annual out-of-pocket expenses required to be paid (deductibles, co-payments and other amounts, but not premiums) not exceeding $5,000.
Family coverage: An HDHP has an annual deductible of at least $2,000 and annual out-of-pocket expenses required to be paid not exceeding $10,000. For family coverage, a plan is an HDHP only if, under the terms of the plan and without regard to which family members incur expenses, no amounts are payable from the HDHP until the family has incurred annual covered medical expenses in excess of the annual deductible.
Preventive care: A plan is not an HDHP merely because it has no deductible (or a small deductible) for preventive care. Except for preventive care, a plan may not provide benefits for any year until the deductible for that year is met.
Network plans: A network plan is a plan that generally provides more favorable benefits for services provided by its network of providers than for services provided outside of the network. In the case of a network plan, the out-of-pocket expense limits for services provided within the network are the only limits that count towards the maximum annual out-of-pocket expense limits allowed for an HDHP. Further, the annual contribution limit is determined by reference to the deductible for services within the network.
Other health coverage that makes an individual ineligible: Generally, an individual is ineligible for an HSA if the individual, while covered under an HDHP, is also covered under a health plan (as individual, spouse, or dependent) that is not an HDHP.
Other health coverage that does not affect individual eligibility: The following types of insurance are called “permitted insurance” and do not affect individual eligibility: coverage under insurance for workers’ compensation, tort liabilities, liabilities relating to ownership or use of property, as well as insurance for a specified disease or illness, and insurance that pays a fixed amount per day (or other period) of hospitalization. Accident, disability, dental care, vision care and long-term care insurance coverage likewise does not affect individual eligibility.
Self-insured medical reimbursement plans: A self-insured medical reimbursement plan sponsored by an employer can be an HDHP.
How Does an Individual Establish an HSA?
An eligible individual can establish an HSA with a qualified HSA trustee or custodian in much the same way an individual establishes an IRA or Archer MSA. Any insurance company or bank can be a trustee or custodian. An eligible individual may establish an HSA with or without the involvement of the employer. The HSA can be established through a qualified trustee or custodian who is different from the HDHP provider. The trustee or custodian may require proof or certification that the account beneficiary is an eligible individual, including that the individual is covered by a health plan that meets all of the requirements of an HDHP.
How Are Contributions to an HSA Made?
Who makes contributions: Any eligible individual may contribute to an HSA. For an HSA established by an employee, the employee, the employee’s employer or both may contribute to the HSA of the employee in a given year. Family members may also make contributions to an HSA on behalf of another family member as long as the other family member is an eligible individual.
How much can be contributed: The maximum annual contribution is the sum of the limits determined separately for each month, based on status, eligibility and health plan coverage as of the first day of the month. For 2004, the maximum monthly contribution for eligible individuals with self-only coverage under an HDHP is 1/12 of the lesser of 100% of the annual deductible under the HDHP or $2,600. For eligible individuals with family coverage, the maximum monthly contribution is 1/12 of the lesser of 100% of the annual deductible under the HDHP or $5,150. All contributions made by or on behalf of an eligible individual are aggregated for purposes of applying the limit. The annual limit is decreased by the aggregate contributions to an Archer MSA. Unlike Archer MSAs, contributions may be made by or on behalf of eligible individuals even if the individuals have no compensation or if the contributions exceed their compensation. If an individual has more than one HSA, the aggregate annual contributions to all the HSAs are subject to the limit.
Catch-up contributions for individuals between the ages of 55 and 65: For individuals (and their spouses covered under the HDHP) between ages 55 and 65, the HSA contribution limit is increased by $500 in calendar year 2004. This catch-up amount will increase in $100 increments annually until it reaches $1,000 in calendar year 2009. The catch-up contribution is also computed on a monthly basis. After an individual has attained age 65 (the Medicare eligibility age), contributions, including catch-up contributions, cannot be made to an individual’s HSA.
Contribution limit for one or both spouses that have family coverage: In the case of married individuals, if either spouse has family coverage, both are treated as having family coverage. If each spouse has family coverage under a separate health plan, both spouses are treated as covered under the plan with the lowest deductible. The contribution limit for the spouses is the lowest deductible amount, divided equally between the spouses unless they agree on a different division.
Form of contributions: Contributions to an HSA must be made in cash.
Tax treatment of contributions by individuals: Contributions are deductible by the eligible individual in determining gross income (“above the line”). The contributions are deductible whether or not the eligible individual itemizes deductions. Contributions made by a family member on behalf of an eligible individual are deductible by the eligible individual in computing adjusted gross income, whether or not the eligible individual itemizes deductions.
Tax treatment of employer contributions: In the case of an employee who is an eligible individual, employer contributions to the employee’s HSA are treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from the employee’s gross income. The employer contributions are not subject to withholding from wages for income tax or subject to FICA, FUTA or the Railroad Retirement Act. Contributions to an employee’s HSA through a cafeteria plan are treated as employer contributions. The employee cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.
Tax treatment of an HSA: An HSA is generally exempt from tax like an IRA or Archer MSA unless is ceases to be an HSA. Earnings on amounts in an HSA are not includable in gross income while held in the HSA.
When contributions may be made: Contributions for the taxable year can be made in one or more payments, at the convenience of the individual or employer, at any time prior to the time prescribed by law for filing the individual’s federal income tax return without extensions (generally April 15). Although the annual contribution is determined monthly, the maximum contribution may be made on the first day of the year.
Excess contributions: Contributions by individuals to HSAs are not deductible to the extent they exceed the applicable limit. Contributions by an employer to an HSA for an employee are included in the gross income of the employee to the extent that they exceed the applicable limits or if they are made on behalf of an employee who is not an eligible individual. An excise tax of 6% for each taxable year is imposed on the account beneficiary for excess individual and employer contributions. If the net income attributable to the excess contribution is paid to the account beneficiary before the last day prescribed by law (including extensions) for filing the account beneficiary’s federal income tax return, then such net income attributable to the excess contributions is included in the account beneficiary’s gross income, but the excise tax is not imposed and the distribution of the excess contributions is not taxed.
Rollover contributions: Rollover contributions from Archer MSAs and other HSAs into an HSA are permitted. Rollover contributions need not be in cash, but are subject to the annual contribution limits. Rollovers from IRAs, health reimbursement arrangements (HRAs) or from FSAs to an HSA are not permitted.
How Are Distributions From HSAs Treated?
When distributions may be received: An individual can receive distributions at any time.
How distributions are taxed: Distributions from an HSA used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents are excludable from gross income. This is true generally even if the individual is not currently eligible for contributions to the HSA. Amounts not used exclusively to pay for qualified medical expenses of the account beneficiary, spouse or dependent are includable in gross income, and are subject to an additional 10% tax, except in the case of distributions made after the account beneficiary’s death, disability or attaining age 65. If the account beneficiary is no longer an eligible individual (i.e., the individual is over age 65), distributions used to pay for qualified medical expenses continue to be excludable from gross income.
Qualified Medical Expenses: “Qualified medical expenses” are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in section 213(d) such as those costs to diagnose, cure, treat or prevent disease which may include nonprescription drugs and over-the-counter drugs, but only to the extent the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established. Health insurance premiums are not qualified medical expenses except for the following: qualified long-term care insurance, COBRA health care continuation coverage, and health care coverage while an individual is receiving unemployment compensation. For individuals over age 65, premiums for Medicare Part A or B, Medicare HMO and the employee share of premiums for employer-sponsored health insurance, including premiums for employer-sponsored retiree health insurance can be paid from an HSA. Premiums for Medigap policies are not qualified medical expenses.
Who determines whether distributions are used exclusively for qualified medical expenses: Employers, trustees and custodians are not required to determine whether HSA distributions are used for qualified medical expenses. Individuals who establish HSAs make that determination and should maintain records of their medical expenses sufficient to show that the distributions have been made exclusively for qualified medical expenses and are therefore excludable from gross income.
What happens upon death: Upon death, any balance remaining in the account beneficiary’s HSA becomes the property of the individual named in the HSA instrument as the beneficiary of the account. If the surviving spouse is the named beneficiary, the HSA becomes the spouse’s HSA. The surviving spouse is subject to income tax to the extent distributions from the HSA are not used for qualified medical expenses. If the beneficiary is someone other than the surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary’s death.
Are There Any Other Special Rules With Respect to HSAs?
Discrimination rules for employers: If an employer makes HSA contributions, the employer must make available comparable contributions on behalf of all “comparable participating employees,” those with comparable coverage, during the same period. Contributions are considered comparable if they are either the same amount or same percentage of the deductible under the HDHP. If employer contributions do not satisfy the comparability rule during a period, the employer is subject to an excise tax equal to 35% of the aggregate amount contributed by the employer to HSAs for that period.
Cafeteria plan: Both an HSA and an HDHP may be offered as options under a cafeteria plan. An employee may elect to have amounts contributed as employer contributions to an HSA and HDHP on a salary-reduction basis.
COBRA: HSAs are not subject to COBRA continuation coverage.
Tuesday, February 24th, 2004
A HIPAA Checklist and Authorization for Release of Protected Health Information is available in pre-formatted PDF format under the Additional Reading section.
Friday, February 13th, 2004
BUSINESS VALUATIONS IN LITIGATION 101: A BASIC GUIDE
James C. Joyce, Jr.
Kevin W. Holt
The need for business valuations arises in a variety of types of litigation from domestic relations to minority shareholder suits, from disputes over the sale of a business to taxation and estate litigation. In all such cases, the basic issue is the same—how much is the business or an ownership interest in it worth and how do you measure it.
This article discusses business valuations in litigation. The article explores general expert witness issues in the specific context of valuations for purposes of litigation. The article reviews the different types of valuations and the methodologies of performing them. Finally, the article explores some of the more difficult and interesting issues associated with business valuations including valuing intangible business assets, such as goodwill and professional degrees, and valuing interests in not-for-profit corporations.
This article is by no means a comprehensive treatise on business valuations. Accounting manuals and other sources provide far greater detail about the accounting and financial intricacies of business valuations. Rather, the article is intended to be a basic guide for lawyers who increasingly are encountering the need to value businesses in litigation.
GETTING THE DOCUMENTS
Placing a value on a business is as much an art as it is a science. Valuing a business depends on a number of factors: the business’ financial history, the nature of the industry or trade and the business’ location, among other considerations. [1]
As an initial matter, the lawyer must obtain information about the company’s financial history, whether by obtaining financial documentation from the client or from the opposing party through discovery.
Determining a business’ financial history requires basic financial documentation, including the company balance sheets, income statements and cash flow statements. Relevant documentation also includes the most recent income tax returns, statements of partners’ capital accounts (if applicable), inventory lists, aged accounts receivable and accounts payable lists, employment agreements, customer agreements, loan agreements, copies or descriptions of employee benefit plans, leases, equipment lists and depreciation schedules. [2]
Particularly in the case of a closely held company, however, the most recent financial statements alone may not be sufficient to determine the business’ current value. The most recent financial documents may need to be updated in order to reflect accurately the company’s current value. For example, since the last financial statements, the company may have received a significant insurance or litigation settlement or other unusual one-time payment. Conversely, the company may have incurred sizeable research and development costs or unusual payroll expenses (such as wage increases) since the most recent financial statements. [3] The financial documentation must be supplemented with information about these payments or liabilities.
Additional information beyond that reflected in the company’s financial statements also should be gathered by the lawyer in preparing for a valuation. Of particular importance is information about the experience and skill level of the business’ management and key personnel. Obviously, a company with proven, veteran management personnel is worth more than comparable business with untested leadership. A company’s intangible assets such as its intellectual property, including patents, trademarks and copyrights, or its proprietary manufacturing processes also can be of high value and must figure into any valuation. [4]
The nature of the industry or the future economic prospects of the geographic area in which the business is located also affect a company’s value and are not found in the company’s financial documentation. Relevant industry information frequently can be found in the annual reports or securities filings of publicly traded companies similar to the one being valued. [5] Economic or economic development information can be obtained by contacting the municipal government offices or a college or university in the area in which the business is located. Such reports, filings and information should be obtained by the lawyer prior to the valuation being performed.
HIRING THE EXPERT
Regardless of the type of case, the next step in valuing a business for litigation purposes is hiring an expert business appraiser. As in hiring other types of experts, the lawyer hiring an expert business appraiser first and foremost should consider the prospective expert’s credentials. The important factors, as with would-be experts generally, are: his or her degrees, experience, publications, speaking engagements, testimony experience and references. Frequently, the lawyer should consider hiring an appraiser as a consulting expert to assist in discovery and in researching economic data or damages, such as lost profits.
Very early in the relationship, the lawyer should carefully define the appraisal assignment to the expert. Specifically, the lawyer must inform the appraiser about the business or business interest to be appraised, the effective date or dates of the valuation and the applicable valuation standard and methodology. The statutes and case law concerning the type of litigation at issue generally will dictate the valuation’s standards and methodologies.
Additionally, the appraiser’s fee amount and terms of payment will need to be worked out early in the relationship, as is the case with experts generally. The amount of the appraiser’s fee should not be (or appear to be) dependent on the result of his or her valuation. Thus, the appraiser should be compensated on a flat-fee or hourly basis to negate any suggestion by opposing counsel in a deposition or at trial that the expert has an interest in the outcome of the litigation. [6]
TYPES OF VALUATION
In valuing a business, the fundamental question being determined is what is the business (or an ownership interest in it) worth. Measuring the value of a business or the financial benefit of owning an interest in it can be done in several ways by the expert appraiser. For example, value can be determined by looking at earnings or cash flow (either from operations or investment dividends or interest), the liquidation of assets or the sale of an ownership interest in the company.
Two of the principal standards of valuation are “fair market value” and “fair value.” As mentioned above, the lawyer will need to clearly communicate to the appraiser the standard which applies in the particular case.
The most common standard of valuation is the “fair market value” standard. “Fair market value” has been defined by the Supreme Court of Virginia as “the price the property [or business] will bring when offered for sale by a seller who desires but is not obliged to sell and bought by a buyer under no necessity of purchasing.” Board of Supervisors v. Telecommunications Indus., Inc., 246 Va. 472 (1993). Similarly, the Internal Revenue Service (“IRS”) has described fair market value as:
The amount at which property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts. [7]
The “fair value” standard of valuation applies most often in the context of fixing the value of a dissenting shareholder’s stock under a state’s business corporation act, such as Virginia Code Ann. § 13.1-730. Under the statute, a shareholder is entitled to dissent from, for example, the sale of the corporation and obtain payment of the fair value of his or her shares. “Fair value” is the stock’s intrinsic value. In determining the stock’s fair value, the stock’s market value, net asset value, investment value and earning capacity are relevant considerations. Lucas v. Pembroke Water Co., Inc., 205 Va. 84 (1964). Evidence of the price at which stock recently was sold will be instructive whether or not the company is publicly listed. Id.
METHODS OF VALUATION
There are several valuation methods and approaches an appraiser can employ. The most recognized methods are those which measure value by looking to earnings or cash flow capitalization, book value, capitalized excess earnings, comparable companies and the peculiarities of the particular industry.
Valuation based on a company’s earnings (current or historical) or cash flow capitalization essentially involves an annuity calculation. The value of a company’s expected future earnings is calculated and reduced to present value based an expected rate of return. The rate of return is variously called the discount rate, the interest rate or the capitalization rate. [8]
Book value is the information shown in a company’s books of account. The business’ net worth is calculated from that information. This valuation method does not give a true value of the business because it fails to take account of a business’ intangible assets not shown on the books. [9] The book value approach, for this reason, tends to underestimate a company’s worth.
The capitalized excess earnings method accounts for these intangible assets. The value of assets not disclosed on company books can be substantial, particularly going concern value, goodwill, leaseholds and intellectual property rights. This value is added to the value of the company’s disclosed assets and the total value represents the value of the business as a whole. [10]
The values of comparable companies can be found, in the case of publicly traded companies, in SEC filings. Particular industries have developed rules of thumb concerning rough approximations of value. For instance, service businesses are often valued at a multiple of their gross receipts. A client knowledgeable in his or her business, will be able to tell the lawyer or the lawyer’s expert what those rules of thumb in the specific industry are. [11]
PREMIUMS AND DISCOUNTS
In the case of valuing shares of stock or other ownership interests in a business, premiums or discounts may need to be applied to determine the shares’ true value. The premiums and discounts reflect the degree of control (or lack of control) that the stockholder or other company owner has. As well, discounts take account of the difficulty a minority shareholder would have selling his or her ownership interest in the business.
The principal premium is the “control premium.” The two main discounts are the “minority interest discount” and the “discount for lack of marketability.”
It is no surprise that a controlling ownership interest in a company is more valuable than a minority interest. This is the case because with a controlling ownership interest come the prerogatives of electing directors, determining officers’ compensation, declaring and paying dividends and setting overall business policy and direction. [12]
The two discounts, the minority interest and the discount for lack of marketability, reflect that a minority owner in a business has less control over its management. The stock’s value is initially discounted to account for the lack of control. Because minority ownership interests are generally more difficult to sell or transfer, the value of such an interest is further reduced for its lack of marketability. Typically, business appraisers employ a combined 40% discount for the minority interest and lack of marketability. In other words, the value of the stock is determined and then reduced by 40% to reflect the minority ownership position. [13]
DIFFICULT CASES: VALUING INTANGIBLE ASSETS
Some of the more challenging cases of business valuations occur in the context of equitable property distribution in divorce cases. This is particularly the case when intangible assets, such as professional degrees, licenses and goodwill are concerned.
Beginning in the 1970s, spouses in numerous cases sought a share of the professional degrees and licenses obtained during marriage by their soon-to-be former spouses. [14] The majority of cases decided have held that professional degrees and licenses are not marital property. A minority of jurisdictions, however, have determined that degrees and licenses are marital property subject to equitable distribution in a divorce proceeding.
The seminal case of O’Bryan v. O’Bryan, 489 N.E.2d 712 (N.Y. 1985) held that a medical degree and license acquired during marriage is marital property subject to equitable division. The cases which have followed O’Bryan over the years and adopted its rationale have held that virtually any career advancement or degree obtained during marriage is marital property subject to division upon divorce. [15]
Another intangible asset difficult to value in the property distribution context is goodwill. Virginia has adopted the majority position that goodwill is an asset of a professional practice, subject to valuation as marital property upon divorce. Russell v. Russell, 11 Va. App. 411 (1990). For such purposes, professional goodwill has been defined by the Virginia Court of Appeals as “the increased value of the business, over and above the value of its assets, that results from the expectation of continued public patronage.” Marion v. Marion, 11 Va. App. 659, 667 (1991). More recently, the Virginia Supreme Court has defined professional goodwill as “the difference between the price a business would sell for and the value of its non-goodwill assets.” Advanced Marine Enterprises, Inc. v. PRC, Inc., 256 Va. 106, 120 (1998).
From an accounting perspective, there are two methods used to value goodwill. The first method involves the capitalization of either net profits or excess earnings. The second method measures goodwill at the time a business is sold as the difference between the sales price and the market value of the business’ tangible assets. [16]
OF PARTICULAR CONCERN TO LAWYERS: GOODWILL IN THE CONTEXT OF A PARTNERSHIP AGREEMENT
Many law firms operate under partnership agreements. Valuing a law firm’s goodwill in a divorce proceeding presents especially thorny issues.
Many partnership agreements prohibit partners from receiving payment for goodwill upon their withdrawal or retirement from the firm, their disability, their death or the firm’s dissolution. When, however, a partner’s divorcing spouse seeks the equitable distribution of the partner’s partnership interest, including the partner’s interest in the firm’s goodwill, courts have tended to look beyond the partnership agreement and award some measure of payment for goodwill.
In a recent opinion, the Supreme Court of Virginia did just that. In Howell v. Howell, 31 Va. App. 332 (2000), the court looked beyond a law firm’s partnership agreement to award a divorcing spouse a share of the partner’s interest in the firm’s goodwill. The firm’s partnership agreement provided that a partner would receive only the balance in his or her capital account and a share of the firm’s net income upon the partner’s termination or death.
In the divorce proceedings, the husband, a partner in the firm, maintained that the partnership agreement fixed the value of his partnership interest for purposes of equitable distribution. He argued that the agreement expressly precluded goodwill from being included in the value of his partnership interest.
The Supreme Court announced that the terms of the partnership agreement were relevant, but not controlling, in determining the value of the husband’s partnership interest. The agreement was only one factor among many to consider in determining the intrinsic value of a partnership interest. The court commented that intrinsic value “is a very subjective concept that looks to the worth of the property to the parties.” The court then affirmed the trial court’s valuation of the partnership interest which assigned a value to the firm’s goodwill. The trial court had assigned a value to the firm’s goodwill in finding that the husband’s partnership interest had “intangible value.” Thus, the trial court’s finding that the value of the husband’s partnership interest was more than $300,000 (as opposed to the $85,000 in his capital account) was upheld.
INTO THE GREAT UNKNOWN: VALUING NON-PROFIT CORPORATIONS
In rare instances, litigation may necessitate a business valuation of a non-profit entity. Such a valuation is inherently difficult to perform because: (1) by definition and design, non-profit entities do not have ongoing profitable earnings (if they did, the IRS likely would revoke their tax-exempt status); (2) there are no shares of stock or ownership interests in not-for-profit businesses; and (3) the assets of a non-profit cannot be sold or distributed upon dissolution. Under the Internal Revenue Code, at dissolution a non-profit corporation’s assets must go either to another non-profit pursuing the same charitable purpose or escheat to the state. [17]
Our firm was involved in that rare case requiring the valuation of a non-profit corporation. The corporation was sued by one of its directors / officers / employees after the corporation fired him. The plaintiff essentially alleged wrongful termination, but sued in equity to enjoin the business, a musical group, from continuing to perform without him.[18]
During the course of the case, the plaintiff attacked the business’ compliance with certain corporate and legal formalities required of a non-profit corporation. The plaintiff contended that the group had become a de facto for-profit entity. The plaintiff asserted that, as a minority “owner” of a portion of the business, he had been oppressed by the majority “owners,” and was entitled, as a dissenting “shareholder” under the business corporation act, to the fair value of his interest in the business.
A battle between the experts ensued.
The corporation’s expert appraiser opined that no portion of a non-profit, tax-exempt entity can be considered the property of any person simply because he or she is a participant in the operation of the entity. Moreover, the expert concluded that to qualify and continue as a non-profit, the business must demonstrate that it cannot consistently have an excess of revenues over expenses. Rather, non-profits are subsidized by tax-deductible contributions from the public because they otherwise would be money-losing ventures. Finally, the expert noted that at dissolution the assets of a non-profit, by law, go to another non-profit or to the state. In light of these factors, the corporation’s expert determined that the plaintiff’s minority “ownership” interest in the non-profit entity had no value at all.
The plaintiff’s expert performed a capitalized income or cash flow valuation of the corporation (see above). The expert reduced to present value the expected future income of the group, divided that figure by four (there were four members of the musical group) and arrived at the value of the plaintiff’s “ownership interest.” The expert concluded that the present value of the expected future earnings was of the group was well over $1 million.
The fallacy in the valuation performed by the plaintiff’s expert was that most of the income attributed to the corporation was paid to the group’s members individually rather than to the non-profit. The corporate tax returns revealed that the non-profit’s annual net revenue consistently was about 1/25th of the amount attributed to the entity by the expert. The valuation, to us at least, seemed unreliable because it was based on a false premise.
In mentioning the wide disparity between the two valuations, our intent is not to retry the case in this article. Rather, we simply point out that business valuations are inherently difficult and uncertain in the context of non-profit corporations. Traditional methods of valuation must be modified due to the peculiar legal and financial aspects of non-profit business entities.
CONCLUSION
The need for business valuations is increasingly common in litigation. Understanding the methods of valuing a business can give an attorney a leg up in hiring an expert appraiser or in cross-examining the opposing party’s appraiser. Business valuations, particularly in the case of intangible assets like professional goodwill or intellectual property, can significantly increase the worth of a company beyond the assets shown on its books and, thereby, make the value of a case increase correspondingly. Valuation, therefore, is a subject a lawyer ignores at his or her peril.
[1] Horwich, Willard D., Professional’s Guide to Purchase and Sale of a Business: Taxation, Valuation, Law, and Accounting (New York: Panel Publishers, 2001) at 4.1.
[2] Pratt, Shannon P., Valuing a Business: The Analysis and Appraisal of Closely Held Companies, 2nd Ed. (Homewood, Ill.: Dow Jones-Irwin, 1989).
[3] Horwich at 4.4.
[4] Id. at 4.5.
[5] Id. at 4.3.
[6] Poynter, Daniel F., Expert Witness Handbook (Santa Barbara, Calif.: Para Publishing, 1987).
[7] Revenue Ruling 59-60, 1959-1 C.B. 237.
[8] Horwich at 4.6.
[9] Id.
[10] Id.
[11] Id.
[12] Pratt at pp. 55-56.
[13] Id.
[14] Ain, Sanford K., and Jackson, Anne Marie, Professional, Personal & Celebrity Goodwill Valuation: Forecasting An Uncertain Future, American Academy of Matrimonial Lawyers presentation, November 1998, Annual Meeting, Chicago, Illinois.
[15] See, e.g., Savasta v. Savasta, 549 N.Y. S2d 544 (Fam. Ct. Nassau Cty. 1989) (spouse awarded a portion of doctor’s internal medical license’s value though the doctor never actually practiced as an internist).
[16] Partman, Allen, The Treatment of Professional Goodwill and Divorce Proceedings, 18 Fam. L.Q. 213, 214 (1984).
[17] Treas. Reg. § 1.501(c)(3)-1(b)(4).
[18] The case was tried in Pennsylvania state court under Pennsylvania law.
Wednesday, November 1st, 2000
Virginia’s new Industrial Storm Water General Permit, covering “point source” discharges of storm water “associated with industrial activity” to surface waters of the Commonwealth, became effective June 30, 1999. The general permit mandates the development and implementation of a facility-specific Storm Water Pollution Prevention Plan (SWPPP) for each covered facility, and various monitoring and sampling requirements depending on a facility’s industry sector. Point source discharges are those that flow through any discernable, defined and discrete conveyance (such as, a ditch, channel or swale ), as compared to uncollected “sheet-flow” run-off. Facilities conducting industrial activities required to have registered under the general permit (or to have obtained an individual permit) generally include those within Standard Industrial Classification (SIC) codes 10-14, 20-45, 50 and 51, with many specific exceptions or limitations. A facility may qualify for an exemption from the requirement to obtain a permit if it properly certifies to the Virginia Department of Environmental Quality (DEQ) that storm water is not contaminated by exposure to industrial activity at the facility.
The SWPPP must identify potential sources of storm water pollution, and detail measures to limit contamination of storm water and assure compliance with the other requirements of the general permit such as training, inspections, and maintenance — all of which must be documented in plan. The SWPPP must also contain a certification that the discharge has been tested or evaluated for the presence of non-storm water discharges.
All covered facilities are required to obtain and visually inspect quarterly grab-samples of storm water discharges for obvious signs of contamination. Facilities in numerous sectors (e.g., timber products, chemicals and allied products manufacturing, landfills, automobile salvage yards, scrap/waste recycling, food and kindred products, concrete products, transportation, printing, fabricated metal products, mining and many others) are required to obtain and analyze samples for specified pollutants of concern (POCs) twice a year, during years two and four of the general permit, in order to determine the effectiveness of their SWPPPs. Many facilities are also subject to enforceable numeric effluent limitations under the general permit and must obtain and analyze samples for the limited contaminants annually to verify compliance.
For most covered facilities, the SWPPP, including any revisions required to comply with the new general permit, must have been prepared and implemented no later than March 26, 2000. If construction is required to fully implement measures required by the plan, reasonable interim measures must be taken and full compliance must be achieved as soon as practicable, but no later than June 30, 2002.
If your facility is currently operating under a general permit, you should be conducting quarterly visual monitoring of your storm water discharges and maintaining reports of the observations on-site with your SWPPP. Visual monitoring for the fourth quarter of 2000 may be performed during any storm event occurring any time from October 1st to December 31st.. Facilities subject to numeric effluent limitations should have completed the first annual sampling and analyses of their storm water discharges for the limited contaminants by June 30, 2000, and submitted the results in Discharge Monitoring Reports (DMRs) to the DEQ. For those facilities included within sectors required to conduct semi-annual sampling for POCs in years two and four of the permit, the first semi-annual sampling event must be completed prior to the end of this year and the results submitted to DEQ in a DMR. Check your permit carefully; if you are subject to numeric effluent limitations and/or are required to conduct semi-annual sampling in years two and four of the permit and you miss the deadlines for submitting the data to DEQ, you could be inviting some unwanted attention.
If your permit includes numeric effluent limitations and you exceed those limitations, you could be in violation of your permit and be subject to action by the DEQ. Significant fines may be assessed and other remedies may include additional sampling, review of processes and operations, and changes to the SWPPP.
If your facility is required to conduct semi-annual sampling in years two and four of the permit, the average concentrations of the POCs for the second year sampling events are compared to specified “monitoring cut-off concentrations” (MCOCs). These MCOCs are not enforceable limits; rather, the DEQ utilizes them to assist in evaluating whether the facility’s SWPPP is adequate and being successfully implemented. If an annual average POC concentration during the second year exceeds the MCOC, the DEQ will request that the facility review and improve their SWPPP. The sampling in the fourth year will demonstrate whether the improvements were effective. If the annual average concentrations for the POCs in the second year do not exceed the MCOCs, the fourth year sampling may be waived (on a pollutant-by-pollutant and discharge-by-discharge basis) provided that the facility continues to implement the successful SWPPP.
If either numeric effluent limitations or MCOCs are exceeded, you should be prepared for an inspection by the DEQ. At this point, legal and technical advice is essential. One focus of the inspection will be your SWPPP. If your SWPPP is not up-to-date, or if there is no documentation for the required activities, the DEQ could consider you to be out of compliance with your permit. Regardless, changes to the facility and/or its practices and procedures will be required in an effort to eliminate the exceedances.
Copyright, Gentry Locke Rakes & Moore, November 2000
Monday, January 3rd, 2000
The aging process frequently produces results that are neither expected nor wanted. Such is the case with many former waste disposal sites sprinkled throughout the State. Recent news reports have alerted us to the proposition that in the near future the consequences of earlier unsophisticated, or careless, waste disposal practices are likely to revisit us. Indeed, we have seen that the regulatory authorities such as the United States Environmental Protection Agency and the Virginia Department of Environmental Quality have identified dozens of old disposal facilities that are known to be “leaking.” Many of these facilities when operated were managed in total compliance with existing laws. A large number of these facilities have been closed for years, if not decades, and as memories fade, it becomes easier to forget or ignore the potential risks created by these former landfills or “dumps,” as they were frequently called.
Anyone who owns or otherwise occupies land next to or in the vicinity of an old disposal site is well advised to take note immediately. Failure to identify a problem early can be as dangerous from a business or financial standpoint as the failure to identify a dread disease in its early stages is to one’s health. The law imposes limitations on the assertion of legal rights which may result in a situation where a land owner or tenant may suffer damage for which there can be no recovery. Under the provisions of certain environmental laws, an owner or operator of property may be held responsible for remediation although the contamination did not result from any actions or activities engaged in by the land owner or user. Typically when contamination is found, the first person that remediation is demanded of is the owner of the property, not necessarily the party that caused or contributed to the contamination.
Many of the old leaking facilities were once operated as municipal landfills. The fact that local governments operated these facilities creates additional and more complex problems. Unlike private landfill operators, municipalities may be entitled to the protection of sovereign immunity because of their governmental status. Likewise, municipalities frequently assert the ability to resort to condemnation to resolve or help resolve their problems. In short, we have recently seen an attempt of municipalities to condemn property that it has contaminated in order to avoid or otherwise lessen the cost of clean up. Needless to say, such consequences to the property owners can be profound.
The point is that if it is believed or suspected that land or business operations may be affected by one of these “leakers,” it is strongly recommended that proactivity be the course of action and that immediate determinations be made as to whether or not the property may be the target of leaking contamination. If so, action to protect the property should follow promptly.
Copyright, Gentry Locke Rakes & Moore, January 2000
