Authored by Thomas Harvey; originally published in The Recorder, September 22, 2016.

Brand owners and their attorneys are grappling with an important question: how to disclose their connections to luminaries like PewDiePie.

If you haven’t heard of PewDiePie, don’t worry—he’s a 26-year-old Swedish college dropout who likes to sit at his computer, play video games and shoot movie clips. But he also happens to operate the most popular YouTube channel in the world. He has nearly 50 million subscribers, and his commentary wields huge influence over the success of a video game release. Marketers pay him to exercise it. Last year, PewDiePie’s production company reported an operating profit of about $8.1 million.

Brands have long valued “native advertising,” promotional content that is similar to the news, articles and entertainment that surrounds it. But they are increasingly spending their dollars on the particular subspecies known as influencer marketing, in which individuals—ranging from stars (LeBron James) to quasi-stars (Kim Kardashian) to everyday people (a little-known blogger)—endorse products with messages that are personal, direct and authentic. The dollars at stake are substantial. According to a recent report, the most popular influencers (three to seven million followers) command an average of $187,500 per YouTube post, $75,000 per Instagram or Snapchat post, and $30,000 per Twitter post. Even lesser influencers (between 50,000 and 500,000 followers) command average payouts of $2,500, $1,000 and $400, respectively.

The proliferation of social platforms has created many new marketing opportunities for brands. But in these formats it is often impossible to distinguish between products that influencers happen to like and those that they are paid to endorse. Today, brand owners struggle with how to harness their authenticity without deceiving customers or falling afoul of federal disclosure requirements.

The Federal Trade Commission is watching carefully. Guided by Section 5 of the FTC Act, which prohibits “unfair or deceptive acts or practices in or affecting commerce,” the FTC has increasingly focused on influencer marketing. Last December, it updated its guidance with a policy statement on deceptively formatted advertisements. In its long-held view, messages not identifiable as advertising are deceptive if they mislead consumers into believing that they are independent, impartial or not from the sponsoring advertiser. It explores this principle in the context of influencer marketing.

Click here to continue reading a PDF of the article.

Authored by Scott Hall; originally published in the Daily Journal, August 16, 2016.

The Federal Aviation Administration’s recently announced rules for commercial operation of small Unmanned Aircraft Systems (UAS or drones), set to take effect later this month, provide long-awaited guidance to drone operators and manufacturers and open the floodgates of opportunity to many businesses that hope to utilize drone technology in various ways in coming years. Indeed, with reports predicting that the expansion of commercial drones could generate more than $82 billion for the U.S. economy and add 100,000 new U.S. jobs over the next decade, numerous companies are evaluating how they can capitalize on the greater availability of drones across many industries, including aerial photography and filmmaking, real estate, precision agriculture, infrastructure monitoring and surveillance and scientific research.

The FAA’s new rules are expected to spark a significant expansion in the commercial use of drones primarily by removing the previously burdensome hurdles needed to obtain FAA approval for nonhobby/non-recreational drone use. Under the new rules, anyone can operate drones for commercial use as long as they do so in accordance with the FAA’s stated rules and conditions. The rules, which restrict drone operation to daytime or twilight hours, impose weight and speed limits (drones must weigh less than 55 pounds and travel no faster than 100 miles per hour), and require that drones not fly over people and stay within the visual line of sight of the operator (who must have, or be supervised by someone having, a remote pilot’s certification), are far less onerous than the previous requirements for obtaining specific FAA authorization for commercial drone use through airworthiness certifications, exemptions or certificates of waiver or authorization.

While the new rules are certain to foster increased use of drones in many industries, they are also notable in terms of what they say (and do not say) about the ongoing struggle — between federal, state and local governments — over who has responsibility and enforcement power over drones. Interestingly, the FAA’s new rules emphasize the necessity of compliance with certain state and local laws in addition to abiding by federal rules and regulations. For example, the rules explicitly inform drone operators that “state and local authorities may enact privacy-related laws specific to [drone] operations.” Additionally, while the FAA’s new rules permit operation of a drone from a moving land or water-borne vehicle in certain circumstances, the rules note that state and local laws, including laws prohibiting distracted driving, may prohibit or otherwise restrict such drone operation. The FAA’s rules unequivocally instruct that drone operators “are responsible for complying with all applicable laws and not just the FAA’s regulations.” Such a statement is in stark contrast to proposed legislation passed by the Senate earlier this year, which would have preempted all state and local laws relating to the design, manufacture or operation of drones. Such preemption language was not included in the version of the FAA Reauthorization Act passed into law last month, but the precise division of federal or state responsibility over drones remains unclear.

Although the FAA asserts broad federal authority over drone operations, it appears to recognize that states have the power to enact — and may be in the best position to address — laws dealing with privacy, trespass, zoning and other areas consistent with a state’s police powers, that involve drones. But such distinctions may not prove workable in the context of the countless anticipated uses of drones, including remote delivery and aerial photography or mapping, to name just a few.

Numerous companies, for example, are currently developing businesses focused around the transportation or delivery of products or objects by drones. Certain states, however, such as Oregon, have passed laws prohibiting drone operation over private property. Such state laws will obviously prove problematic to any attempts by businesses to deliver products by drone, given that drones will almost certainly need to fly over private property to complete their deliveries. Other companies hope to use drones for aerial photography, mapping and other imaging and data collection purposes. But such use may conflict with state laws, including California’s AB 856, that prohibit the use of drones to capture images or other data associated with private property. Moreover, any number of other state or local laws restricting drone operation in some way — based on public safety, zoning, privacy or other areas typically within the power of state governments to regulate — may hinder planned commercial drone businesses. Having to navigate through such a patchwork of inconsistent state laws may deter companies from investing in or expanding commercial drone operations.

Ultimately, where to draw the line in terms of federal and state responsibility over drones may not be as easy as carving out categories such as “privacy” or “public safety” since drone use is certain to raise questions as to the scope and applicability of traditional areas of law that have never been answered before. The FAA’s new rules, while giving a nod to the validity of certain state and local drone laws in combination with federal rules and regulations, continue to leave open the questions that will ultimately need to be confronted regarding preemption. Thus, while the rules are sure to expand commercial drone use, some companies may hold back on fully pursing drone ventures until more of these questions are answered.

Fortunately, the FAA’s new rules maintain flexibility for dealing with drones going forward, which is essential to foster current and anticipated commercial use of drones, while also determining how to most effectively police such use. While the rules for small commercial drones are a positive development for the industry, they are clearly only the first step towards comprehensively regulating the expectedly rapid expansion of the commercial drone industry.

Click here to view a PDF of the article.

On August 2, 2016 the U.S. Treasury Department issued proposed regulations addressing transfers between family members of interests in family-controlled entities (e.g., corporations, partnerships and LLCs).  If enacted, these rules will eliminate most valuation adjustments for lack of liquidity and marketability (i.e. “minority interest discounts”) for gift and estate tax purposes.  Hearings on the proposed regulations are scheduled for December 1, 2016, and the final regulations may be effective thirty days later.

Background

Currently, a taxpayer might hold a business, marketable securities or real estate in an entity (e.g., a partnership, LLC or corporation).  A gift or sale of the taxpayer’s non-controlling interest in the entity to his children or grandchildren, or a trust for their benefit, is typically appraised at a value that reflects minority interest discounts.  These discounts arise from the recipient’s inability to control the entity and to freely transfer or “cash out” of the transferred interest.  Under the proposed regulations these minority interest discounts would be largely disregarded for gift and estate tax purposes.

Examples

1. Outright Gifts: Spouses previously formed an LLC with $20 million of assets.  They gift a 20% LLC membership interest to a separate trust for the benefit of each of their 3 children and their descendants.  An independent appraiser applied a 30% minority interest discount to each of the gifted interests in the LLC.Under current law, each gift would be valued at $2.8M (instead of $4M if undiscounted).  Similarly, the remaining 40% held by Spouses would be included in the survivor’s taxable estate at $5.6 million (instead of $8M if undiscounted).  Thus, the total value of the LLC that is subject to gift and estate tax is $14M, which is $6M less than the undiscounted value of the LLC assets.

   This results in a savings of $2.4M in gift and estate tax compared to the tax if no gifting had been done.  Further tax savings may occur as the appreciation and growth on the gifted assets is outside of the Spouses’ taxable estates.

2. Sale: Another way that this transaction can be accomplished is by the sale of each Spouse’s LLC membership interests to a trust in exchange for a promissory note.  In that transaction, the sale would be at the discounted value and the note could be repaid at a low interest rate (e.g., currently as low as 1.18% for a 9-year note).  Spouses may retain the cash flow from the assets in the LLC as the interest and principal is repaid on the note.Again, the potential estate tax savings to the family could be as much as $2.4M.  In this example all of the appreciation and growth above the interest rate on the note will also be outside the Spouses’ taxable estates.

Under the proposed regulations, the minority interest discounts would essentially be disregarded under both examples.  The resulting gifts, or the sales price, would be at the full $20M undiscounted value, and the potential $2.4M in gift and estate tax savings would be unavailable.

Take-Away

Clients who have an appropriate asset profile, and have contemplated lifetime gifts or sales to descendants, or trusts for descendants, should accelerate their consideration of this planning.  The favorable valuation principles under current law may be unavailable as early as the end of 2016.  Several months are often required to properly consider, document and implement such gifts.

Note:  This article is only intended as an information alert, and a general summary of how the new proposed treasury regulations could impact estate planning opportunities.  The application of these proposals in a particular client situation will vary, and should be discussed with qualified advisors to determine if further action is appropriate.

Authored by Scott Hall and David Anderson; First published in the California Real Property Journal, a quarterly publication of the Real Property Law Section of the State Bar of California.

Combined with powerful state-of-the-art cameras and communications technology, drones are capable of efficiently and economically photographing, videotaping, and gathering other information for applications and in manners previously undreamed of. This impressive technological leap forward, however, has been accompanied by numerous documented instances of blatant misuse, which in turn, have prompted calls for state and federal lawmakers—including those in California—to spring into action. The legislative response to drones, however, has struggled to keep up with the technological capabilities and ever-expanding uses of drones. Additionally, lawmakers have failed to provide necessary clarity regarding the rights and restrictions of drone operation in the context of property rights in airspace above private property.

Instead, the limited legislative solutions enacted in response to drones have thus far focused on protecting privacy rights rather than establishing clear property rights. In October 2015, in response to public outcry over growing incidents of drone invasions of privacy, California enacted a widely-applauded law—AB 856—that directly addressed privacy concerns associated with drone use by prohibiting any knowing entrance into the airspace above the land of another person without permission in order to capture images, sounds, or other physical impressions of private activity. While this so-called “Anti-Paparazzi” law may give celebrities additional legal recourse against snooping paparazzi drones, it does little to protect the privacy of non-celebrities who may not have the financial resources or individualized incentives to pursue legal remedies for potential violations. Moreover, despite being technically couched as expanding the scope of unlawful “trespass,” AB 856 focuses on intentional conduct that invades privacy rather than clarifying the parameters of airspace property rights, and, in so doing, fails to provide needed guidance to both property owners and drone operators about what rights each possess when it comes to drone operation above private property.

Indeed, at the same time AB 856 was signed into law, Governor Jerry Brown vetoed other drone legislation that would have created a bright-line rule to protect airspace rights over private property by allowing property owners to prohibit drones from flying below a certain height over their property without their consent. In the wake of these legislative and executive decisions, the continuing lack of clarity regarding the scope of airspace property rights (including where drones may and may not operate) is likely to result in increased confusion about those rights. It may even lead to increased occurrences of property owners taking the law into their own hands. Various incidents around the country involving property owners shooting at drones, or otherwise attempting to prohibit drones from entering airspace above their property, suggest that many believe that the protection of such airspace is as important to the reasonable use and enjoyment of their property as the land itself.

Whether current laws are sufficient to deal with the new and unique issues presented by drones, or whether new drone-specific laws and regulations should be enacted—and what those laws should look like—is currently the subject of heated debate in California and throughout the country. Determining a workable resolution to these issues requires considering both the origins and shortcomings of current laws as applied to drones, as well as the unique capabilities and applications for drones now and in the future. This article briefly reviews the history of airspace property rights and how previously unresolved issues are being raised again in response to expanding drone use. The article then examines whether drone regulation is properly a federal or state issue before discussing recent California drone legislation. The article concludes by proposing that legislation beyond existing law is needed to create bright-line rules for protecting airspace rights up to a specified height above private property. This type of bright-line rule will not only give needed assurances to property owners about their airspace rights, but also facilitate greater support for, rather than opposition to, further development and application of drone technology across a variety of industries.

To continue reading, click here.

By now, anyone who works in the real estate industry is likely to have heard of Basel III and the new requirements for HVCRE Loans.  But you may be asking: what is Basel III; what constitutes an HVCRE Loan; and what is the impact to a borrower in real estate deals?  The alert below answers these questions.

What is Basel III?

The Basel Committee on Banking Supervision (the “Committee”) is an international committee focused on the importance of adequate capitalization in a stable international banking system.  To improve regulatory oversight and risk management in the banking sector following the 2008 financial crisis, the Committee adopted a new capital accord commonly referred to as “Basel III”. Congress mandated the adoption of Basel III in the United States when it passed The Dodd–Frank Wall Street Reform and Consumer Protection Act.  The final rules implementing Basel III took effect on January 1, 2015.

HVCRE Loans

Recent attention on Basel III has focused on the increased risk weighting of certain High Volatility Commercial Real Estate Loans (or “HVCRE Loans”), and the corresponding increase in reserve requirements for banking organizations making such HVCRE Loans.  A typical commercial real estate loan has a risk weighting of 100% and a capital requirement of 8%.  This means that a bank must reserve at least $8 million in capital to make a $100 million loan.  An HVCRE Loan is assigned a risk rating of 150%.  This means that a bank must reserve at least $12 million in capital to make a $100 million HVCRE Loan (i.e. $4 million more in reserves).

An HVCRE Loan is any loan from a banking organization that finances the acquisition, development or construction of real property, which is not considered to be “permanent financing,” and specifically excludes: (1) loans on 1-4 unit residential properties; (2) community development loans; (3) agricultural loans and (4) commercial real estate loans which satisfy the following requirements:

1. The loan-to-value ratio is less than: (a) 65% for raw land; (b) 75% for land development projects; (c) 80% for commercial, multi-family, or other non-residential construction projects; or (d) 85% for already improved property;
2. The borrower has contributed capital in the form of cash or unencumbered readily marketable assets of at least 15% of the project’s “as-completed” value; and
3. The borrower’s contributed capital and all of the project’s “internally generated capital” is contractually required to remain in the project until the project is sold, or until the loan is either paid off in full or converted to permanent financing.

The HVCRE regulations currently only apply to banking organizations, although there is some speculation that this could change to also include loans from insurance companies. Mortgage REITs and private equity funds that originate commercial real estate loans are not currently subject to HVCRE regulations.

“Permanent financing” is not defined in the regulations, but based on an FAQ published in April 2015 by the relevant federal banking agencies: (1) a loan does not constitute “permanent financing” if it will have future advances and the underwriting is based on the “as-completed” value of the project and (2) “permanent financing” requires, at a minimum, that the loan satisfy the lender’s “normal lending terms” and “underwriting criteria” for permanent loans.

Borrower Impact

Increased Pricing: If a loan is classified as an HVCRE Loan, the lender will face a lower return on its capital as a result of the higher capital reserve requirement.  This will likely lead to increased pricing on the loan, including a higher interest rate, for the borrower.  If possible, lenders will want to ensure that a loan is not classified as an HVCRE Loan.  Borrowers should expect to see loan provisions addressing that the exemptions to being classified as an HVCRE Loan have been satisfied.

Required Capital: In the HVCRE Loan analysis, the loan-to-value requirement is a relatively straightforward calculation that is standard for all commercial real estate loans.  The requirement that a borrower will be required to have contributed capital in the form of cash or unencumbered readily marketable assets of 15% of the project’s “as completed” value is more complicated.  Since such capital must be contributed prior to the disbursement of any loan proceeds, this requirement may create obstacles to disbursement of loan proceeds at closing.

Borrowers should first understand what may be included as “capital” in the form of cash or unencumbered readily marketable assets.  “Capital” includes cash paid to purchase land and out-of-pocket development expenses.  It does not include: (1) the value of any contributed land (including any increase in land value that may result from improved market conditions or a project’s entitlements) or (2) any borrowed money or other collateral pledged in support of the loan, such as a second mortgage or an unsecured loan.  It is unclear whether proceeds of a mezzanine loan or debt of a borrower’s parent entities may be included as “capital”, but a conservative lender would likely exclude such proceeds. This may cause certain joint venture structures to look more attractive.  Furthermore, the capital contribution requirements are based on the “as-completed” value of a project rather than a project’s cost, which is a change from conventional underwriting practices, and may increase the required capital contribution for any given project.

Capital Must Remain in the Project: Borrowers must also be aware of issues related to the requirement that a borrower’s contributed capital and internally generated capital remain in the project until the project is sold, or the loan is paid in full or converted to permanent financing.  This requirement prohibits a borrower from making distributions of any contributed equity and traps net operating income in the project, in each case, during the life of the loan. It is unclear whether income generated by the project can be applied to cover a project’s expenses. Borrowers should therefore expect to see increases in required reserves to cover a project’s carrying costs.

Cost Provisions: Borrowers may be tempted to let the lender focus on the details of ensuring a loan satisfies the requirements necessary to avoid classification as an HVCRE Loan; however, it is in a borrower’s best interests to focus on this issue as well.  If a loan is determined after closing to constitute an HVCRE Loan and the lender faces higher reserve requirements and capital costs as a result, the lender may attempt to pass these costs onto the borrower through the general cost and indemnification provisions that are standard in most loan documents. Borrowers should also be on the lookout for any new or special provisions specifically related to such costs.

The attorneys at Coblentz Patch Duffy & Bass are well-versed in the nuances of the new Basel III regulatory requirements.  Should you have any questions or require additional information, or are interested in counseling on a specific project, please contact Kyle Recker.