Hiding is Dropping the ball

This case was recently decided by the Superior Court of New Jersey (Appellate Division).

The petitioner, Fayette Fair Trade, Inc. (“Fayette”), which is wholly-owned by a shareholder, Rosario, appealed from a final determination of the Director of the Division of Alcoholic Beverage Control (“ABC”) suspending its license based on a finding of an undisclosed business interest in the license, and the licensee’s failing to disclose that interest in the application, or providing false, misleading or inaccurate information about it. The question on appeal: whether the licensee’s employee, Jerez, who runs the day-to-day operations of the licensed premises with little or no oversight from the owner of the corporation licensee and who shares in the licensee’s profits, but is not a shareholder, holds an impermissible, undisclosed beneficial interest in the liquor license in violation of state law.

This type of issue arises not infrequently in closely held companies. In the typical scenario, partners A, B and C wish to open a nightclub or restaurant, but, for whatever reason (e.g., C’s felony conviction, or “tax issue”), C wishes to remain off the books. Whether C elects to disclose her personal tax affairs to the government, C must disclose her business affairs for the business in the process of applying for an alcoholic beverage license. Failure to do so usually creates an undisclosed “front,” “farm out,” or “lease out” (as the opinion teaches), which is a big no-no in the alcohol license scene.

Indicia of a front include: a licensee’s lack of knowledge regarding the financial affairs of its business; the purchase of a license using commingled funds [and the wife sharing the profits thereof in the joint enterprise with her criminally disqualified husband], or funds contributed by a spouse; authorization of a non-licensee to pay bills, sign checks and retain profits; holding oneself out to the public as the owner; a husband authorized to withdraw business funds; the licensee visiting the premises once a month, having no knowledge of the business, and receiving no salary; or apparent control by an undisclosed party.

Fayette argued what it could: numerous companies offer their employees an “ownership” interest without necessarily issuing “stock” to them. But that argument didn’t go far. As the court held:

Any arguments [Fayette] has to Jerez’s non-shareholder status in the licensee corporation are irrelevant to this charge. Question 9.3 of the liquor license application unambiguously requires disclosure of “anyone not having an ownership interest in the license [who] receive[s] . . . (by way of rent, salary, or otherwise) all or any percentage of the gross receipts or net profit or income derived from the business to be conducted under the license . . . .” [Fayette] expressly answered Question 9.3 in the negative in its application filed on June 6, 2000. [Fayette] filed its 2002-2003 renewal application in May 2002, and on August 13, 2002, subsequent to the July 1, 2002 contract with Jerez, it submitted an amendment.[Fayette] admits it failed to amend its answer to Question 9.3 and disclose Jerez’s profit-sharing interest at that time, nor do so in any of its subsequent annual renewal applications. See N.J.A.C. 13:2-2.14 (requiring a licensee to file an amendment regarding any change to its current license application not more than ten days after the change occurs).

The bottom line, as the court saw it, is that Fayette delegated a controlling interest in the operation to Jerez:

In the present case, Jerez admitted control over virtually every aspect of the day-to-day management and operation of the licensed facility — opening and closing the business each day, handling all receipts and disbursements, making general operating decisions, making all entries into the books of account, and using personal funds or credit to purchase liquor or supplies for the business. She acknowledged Rosario’s unavailability due to other business commitments; he testified he only checks on the business once or twice a week. Rosario admitted to relying heavily on Jerez regarding the operation of the business, accepting her word as to weekly profits and never questioning her claims for reimbursement of business expenses. Jerez referred to Rosario as her “partner,” her July 1, 2002 written agreement provided for compensation by profit-sharing, and both she and Rosario testified they have shared all business profits at least “50-50″ since that time. Based on Jerez’s profit-sharing in the licensed premises, over which she exercised a large degree of unsupervised control, the Director found that Jerez, a non-shareholder, held an impermissible undisclosed interest over the liquor license, in contravention of N.J.S.A. 33:1-26 and N.J.S.A. 33:1-25.

Because the Director’s determination had a statutory and regulatory basis (and was supported by the law and the facts of the case), ABC’s deicsion is AFFIRMED.

The moral of the story: think locally, act globally, not the other way around.

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