Issue 23  September 7th 2024

CrowdStrike IT outage: wave of business interruption claims expected

It was hard to miss the TV coverage of hundreds of travelers stranded as a result of last month's tech outage.

In what has been called one of the largest and worst cyber events in recent history, many businesses that were taken offline are expected to have suffered heavy losses.

As a result, insurers are bracing for a tsunami of claims, as policyholders look to recover their business interruption losses.

Although specific outcomes are unknown, a couple things seem certain:

1) There is going to be renewed scrutiny over cyber insurance policies relating to limits, exclusions, and conditions. Gaps in coverage or ambiguous language may lead to potential disputes between insureds and insurers.

2) There will be a wave of business interruption claims requiring complex damage analysis to support claims.

Has your client been impacted? Let's talk.

jdsupra.com  

Court interprets share valuation mechanism on exercise of call option

This is an intriguing case recently decided by the High Court of Justice of England and Wales.

Should the valuation of shares under a call option should take into account restrictions that would apply to the company’s business if the option were actually exercised?

A shareholder agreement gave the right of one party to exercise a call option to acquire an interest in the shares of Viva, a provider of financial and payment system solutions.

But exercising the call option would effectively make the company a regulated entity in the eyes of the United States, barring it from expanding its existing business lines there.

Yet, the controlling shareholder agreement stipulated that the valuation must overlook the financial impact of exercising the call option and assigned value to a hypothetical buyer rather than a specific buyer who might activate the regulation.

Consequently, the High Court determined that the valuation should exclude the regulations that would be triggered.

I think it safe to surmise that the buyer neither anticipated nor appreciated this outcome.

The decision underscores the critical need for precision when formulating valuation clauses in commercial contracts and buy-sell agreements.

Shameless plug: it often makes a lot of sense for the parties to consult with a business valuation specialist when drafting an agreement to minimize the risk of unintended consequences.

macfarlanes.com  

S corporation did not lose its status due to misappropriated distributions, leaving shareholder liable for taxes on income he never received

Do disproportionate distributions terminate a company's S corporation status?

Spoiler alert: nope.

The issue came up in a recent U.S. Tax Court decision, Maggard vs. Commissioner.

Maggard, a shareholder in an S corporation, accused two other shareholders of misappropriating funds and making disproportionate distributions to themselves, leaving out Maggard.

As the S corporation is a pass-through entity, Maggard was liable for years of income tax for his share of company earnings, even though he had not received any of that income.

Maggard tried to convince the tax court that the lopsided distributions violated the "one single class of stock" rule of an S corporation -- effectively terminating the S corporation status. Which in turn meant Maggard would not owe all those pass-through taxes.

Sorry, said the Tax Court; that's not the way the rules work. According to the Tax Court, and despite the history of disproportionate distributions, the corporation did not formally change its governing documents or authorize or create a second class of shares. Thus, the governing provisions continued to provide for identical rights to distributions and liquidation proceeds. So, no termination of S corporation status. Meaning the Treasury rules look to not what the corporation actually does with its distributions, but what the governing provisions say.

The Tax Court said: "[o]ne cannot help but sympathize with a taxpayer caught in this situation. But it is a situation that we've seen before."

And proceeded to play the world's smallest violin.

What are the takeaways here, other than life can sometimes be brutally unfair?

Disproportionate distributions will not sink a company's S corporation status, though conferring non-identical rights in the governing language will.

Also, this case highlights a real risk of owning a non-controlling interest in a pass-through entity. An unscrupulous controlling shareholder could cause some serious financial damage, in more ways than one.

ey.com