E-SIGNATURE ATTRIBUTION

             Aerotek, Inc. hires hundreds of thousands of employees to work, globally, as contractors. To keep hiring efficient, Aerotek worked with a software developer to build an online-only hiring application. Aerotek uses the computerized hiring app exclusively to guide candidates through the hiring process.

            We recognize this system as “onboarding.”

            The hiring app sends a welcome email to the candidate, which email includes a hyperlink for the candidate’s use to navigate the online account-registration page. At that point a unique user ID and PW is created, and the candidate supplies answers to several personal security questions.

            At each subsequent log-in the candidate must correctly enter the user ID, PW, and answer the security question.

            If successfully navigated, the hiring app presents the candidate with employment information and various contracts to e-sign. First up is the Electronic Disclosure Agreement. By agreeing to the terms of the EDA, the candidate consents to “be bound” by Aerotek’s e-docs “as though . . . signed . . . in writing.” The next set of docs ask for the candidate’s personal info. Each successful completion unlocks the ability to continue deeper into the employment app.

            Included in the docs is a Mutual Arbitration Agreement.

            Trojuan Cornett, Michael Marshall, and Lerone Boyd each remotely completed Aerotek’s computerized hiring app; Jimmy Allen completed his in Aerotek’s office by going through the same computerized online app procedure. Aerotek hired all four to work on a construction project for Aerotek’s client. All four were terminated not long after starting work; all four sued Aerotek and others for racial discrimination and retaliation.

            Aerotek moved to compel arbitration, which dispute resolution mechanism was contained in the MAA. All four employees opposed the motion. Each submitted a sworn declaration acknowledging that he had completed the online hiring application but denying that he had ever seen, signed, or been presented with Mutual Arbitration Agreement.

            Aerotek responded with a time-stamped MAA and EDA, along with database records showing the timestamp for every other action taken by each of the four employees in completing the hiring application.

            At trial, Aerotek’s program manager testified that no employee could have completed the procedure without executing the MAA, and that the records could not have been altered or manipulated after submission. The four employees, unmoved by the program manager’s testimony, countered with their declarations.

            Based on the evidence presented, the trial court denied Aerotek’s motion to compel arbitration. The court of appeals affirmed.

            Aerotek appealed to the Supreme Court.

            To compel arbitration, a party must prove that a valid arbitration agreement exists. For the MAAs to be valid, the employees must have consented to them. The employees argue they did not consent to the MAAs because the e-signatures are not theirs.

            Texas law provides that if parties to a transaction have agreed to conduct it by electronic means, then a standard for attributing e-signatures is applied. That standard requires the showing of a security procedure to determine if the e-record or e-signature is valid. Adequate security procedures include the use of algorithms or other codes, identifying words or numbers, encryption, or callback procedures.

            A record that cannot be created or changed without unique, secret credentials, can be attributed to the one person who holds those credentials.

            The Supremes sifted through the evidence and came to a different conclusion, finding that each of the employees signed and therefore consented to the MAAs and as a consequence, each agreed to arbitration. Aerotek wins. See Aerotek, Inc. v. Lerone Boyd, Michael Marshall, Jimmy Allen, and Trojuan Cornett; Case No. 20-0290; Texas Supreme Court; May 28, 2021: https://law.justia.com/cases/texas/supreme-court/2021/20-0290-0.html.

            Lessons / Questions / Observations:

1. Lesson: My surmise is that the use of e-contracts already exceeds the use of paper contracts. This case is a great tutorial on how to be sure e-contracts are valid, and also how to challenge e-contracts.
   

2. Observation: This case comes to us from the world of employment law. However, it seems to have equal application to all areas of law including mine – real estate.
   

3. Questions: Do you use software to create e-contracts? Do you have a contract with the software supplier certifying that the supplier’s products comport with law, so you have recourse if your e-contracts are successfully challenged?
   

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

CONVERTING DEBT TO EQUITY [INVOLUNTARILY]

             10 years ago Lisa Skye Hain was a Manager at WeWork in NYC, where she met Joel Schreiber, one of the original investors in WeWork. Joel was also the founder of Waterbridge Capital, a real estate investment firm in NYC.

            Lisa decided to start her own shared office space – Live Primary, LLC – in 2015, and Joel agreed to invest $6 million in exchange for a 40% membership interest. Lisa received 30%, and another member received the final 30% interest.

            Joel produced an Operating Agreement for the LLC that described his contribution as a loan, instead of equity. Joel then caused Primary Member LLC to be formed as the vehicle for the Live Primary project.

            Lisa received a salary from Live Primary. Primary Member did not, nor did the other 30% investor. Primary Member had no day-to-day involvement in business matters but retained consent rights related to major decisions.

            Lisa and Joel later formed Primary, LLC. The Operating Agreement for Primary, LLC, stated that Primary Member would make several loans to the entity totaling $6 million, to establish two shared office facilities and fund start-up expenses. Each loan was intended to be formalized with a Loan Agreement and Promissory Note; each of the loans accrued interest at 1% per year; accrued interest and the principal balance were payable only upon a “Liquidity Event.”

            All loans were required to be repaid before distributions to any other members.

            The Operating Agreement provided that the LLC Managers would deliver disbursement requests to Primary Member. If Primary Member failed to fund the request, then Primary Member became obligated to pay a 5% default fee and the LLC could recover portions of Primary Member’s ownership interest in the LLC, diluting Primary Member’s ownership accordingly.

            Although it was Primary Member’s obligation to fund disbursement requests, it never did so. Apparently Primary Member never opened a bank account. Instead, all advances came from Waterbridge Capital, the real estate investment company founded by Joel, even though Waterbridge was legally a stranger to the Live Primary transaction.

            More than 60 disbursements were made through Waterbridge in a three-year period, without issuance of any Promissory Notes or Loan Agreements. Then additional fundings occurred from June 2018 to July 2020, based on emails from Lisa to Joel.

            Live Primary, LLC, filed a bankruptcy petition and Primary Member filed a Proof of Claim stating that it was a lender-creditor and had loaned the debtor $6.4+ million. Live Primary challenged Primary Member’s lender-creditor position and requested that Primary Member’s interest be reconstituted as an equity investment in the start-up company.

            As background, in bankruptcy law creditors of the debtor may have a right to receive payment based on Proof of Claim forms tendered to the court. And bankruptcy courts can use equitable powers to review contested matters – evidently these are different from adversary proceedings – and potentially recharacterize a loan as an equity interest.

            Basically, recharacterization cases turn on whether a debt actually exists. If not, then the claim might be reconstituted as an equity investment.

            Lenders, particularly secured creditors, are entitled to priority treatment in the context of bankruptcy distributions. Equity investors are not. No lender desires to be reconstituted as an investor, and consequently surrender their priority status when distributions are made.

            In analyzing a determination of loan vs. equity, bankruptcy courts examine facts such as: (a) did the same persons or entities control both the transferor and transferee; (b) were funds paid to an enterprise with little or no expectation that they would be repaid; and (c) is an individual or entity merely attempting to thwart the company’s legitimate outside creditors.

            True loans, says this court: (d) are named as such; (e) have fixed maturity dates and payment schedules; (f) provide for a source of repayment; (g) can be secured but it is not a strict requirement; and (h) might involve reserve accounts and sinking funds to provide a source of repayment.

            The ultimate test is to ascertain the intent of the parties. Claims of creditors who were corporate insiders are closely scrutinized.

            Finding a failure to issue promissory notes and loan agreements, the absence of a fixed, realistic date for repayment, the minimal 1% per year interest rate, the lack of any security or requirement that Live Primary fund a reserve account to secure repayment, and the use of the funds for initial operating expenses “. . . all reveal the economic reality that the [purported loan] functioned as equity.”

            Consequently, Primary Member’s funding was recharacterized as equity. See In Re Live Primary, LLC; Case No. 20-11612 (MG), United States Bankruptcy Court, S.D. New York, March 21, 2021: https://scholar.google.com/scholar_case?case=11865234986206902320&q=in+re+live+primary+llc&hl=en&as_sdt=6,44.             

            Lessons / Questions / Observations:

1. Lesson: What do you think this means to Joel Schreiber – did he lose his investment due to the recharacterization of his funding?
   

2. Observation: I am not a bankruptcy lawyer, but some of this was a surprise to me. It seems logical that a bankruptcy court has the equitable power to make this decision to prevent people from gaming the system, but I would have guessed that the initial characterization of the funding as a “loan” would carry more weight.
   

3. Questions: Do you have investors who insist on making loans to avoid being recharacterized as equity? A close read of this case will grant those investors the safe harbors they need to avoid having their contributions be challenged and possibly reconstituted years later by a bankruptcy court.
   

                                                                                    Stuart A. Lautin, Esq.*

 

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.