Suing For Convoluted Profits - A Proving Procedure

Transcription

1 Business Associations and Intro to Federal Securities Law Abe Cable Fall 2011

2 Derivative Claims A procedure for owners to sue management (corp and LLCs) Derivative claims brought through and by the corporation/llc Others brought directly by shareholders We ll focus on later

3 Limited Partnerships Chapter 2 Section 7

4 Holzman v. De Escamilla

5 How It Was Supposed to Work Russell (LP) Passive Share profits/losses Escamilla (GP) Active Share profits/losses Andrews (LP) Passive Share profits/losses Hacienda Farms, Limited Who is personally liable for partnership obligations if they stick to the plan?

6 Limited Partnership Basics After filing with the state for LP status: Passive limited partners not personally on hook for partnership liabilities Active general partner (and you need at least one) is personally on hook for partnership liabilities GP can be a limited liability entity Financially, limited partnership the same as general partnership Under CA statute, name must include: limited partnership, LP, or L.P.

7 How It Was Supposed to Work Russell (LP) Passive Share profits/losses Escamilla (GP) Active Share profits/losses Andrews (LP) Passive Share profits/losses Hacienda Farms, Limited Why do creditors of Hacienda Farms, Limited s think Russell and Andrews are personally liable?

8 How It Worked Russell (LP) Escamilla (GP) Andrews (LP) Active Share profits/losses Active Share profits/losses Active Share profits/losses Hacienda Farms, Limited Andrews & Russell: Selected crops Overruled E Signed checks Removed manager

9 Limited Liability Partnerships

10 LLP Basics Requires a filing with the state All partners have rights of general partners, but limited liability Some states limit liability for torts only (not contracts) Generally only available for professional services (e.g., accountant, lawyer, architect)

11 LLCs Chapter 4

12 Intro to LLCs (overview) Tax advantages of partnership Limited liability of corporation Management structure somewhere in between

13 Intro to LLCs (history) Introduced in the late 70s Tax status settled in the 90s

14 Intro to LLCs (tax) Profits not subject to double taxation C-corps pay at up to 35% federal rate plus C-corp shareholders pay federal tax on dividends (though sometimes at lower appx 15% rate) State taxes too LLC profits and losses flow through to owners That s less tax (up to 35% federal rate for individuals) Owner may need to pay tax even if LLC hasn't distributed $ Losses are a good thing for tax purposes Capital gains (sale by LLC of appreciated assets) flow through, often at lower rate than ordinary profits

15 Intro to LLCs (more tax) Generally no negative tax consequence for transfers of assets between owners and LLC C-corp, in contrast, is like a lobster trap (assets generally can t be pulled out w/o tax consequences) This means LLCs are a more flexible starting point than C- corps If only one member, disregarded entity for tax purposes (just like sole proprietorship)

16 Compare S-Corp S-corp is just a regular corporation under state corporation act A corporation elects S-corp status with IRS Unlike C-corp (the IRS default), operating profits, losses, and gains flow through to shareholders Generally only suitable for small business Limit of 100 shareholders Shareholders generally can t be entities, so no venture capital No preferred stock allowed, so no venture capital Negative tax consequence for transfers of assets between owners and corporation (details of rules are above our pay grade)

17 Intro to LLCs (formation) LLC formation process similar to corp File articles (of organization) Prepare operating agreement, much like a partnership agreement & bylaws

18 Intro to LLCs (members) Owners referred to as members Financial rights similar to a partner Capital account Allocation of profits & losses» ULLCA has equal sharing default rule; most states (CA) make proportionate to capital account

19 Intro to LLCs (management) Must elect in articles whether: Member-managed Manager-managed

20 If member-managed: Intro to LLCs (management) Unless OA says otherwise, each member has equal rights in management If disagreement, most matters decided by majority vote (ULLCA 404(a)(2)) A few extraordinary matters (merger, dissolution, etc.) require unanimity These rules often changed in OA

21 Intro to LLCs (management) If manager-managed: May have multiple managers Default is that each manager has equal management rights If disagreement, most matters settled by majority vote (ULLCA 404(b)(2)) A few extraordinary matters (merger, dissolution, etc.) require member unanimous vote (ULLCA 404(c)) Managers sort of like officers; sort of like board Managers don t have to be members

22 Intro to LLCs (transferability) Default rules similar to partnership Assignment of economic interest allowed But admission as member requires consent of other members OA usually includes buyout and buy-sell provisions

23 Intro to LLCs (fiduciary duties) Manager-managed LLCs: Managers have duty of care and loyalty Members usually don t have duties in role as members Member-managed All members of member-managed LLC have duty of loyalty and care

24 Intro to LLCs (limited liability) ULLCA 303(a): A member or manager is not personally liable for debts, obligations, or liabilities of the company solely by reason of being a member or manager Stay tuned to learn about veil-piercing

25 Intro to LLC (name requirements) ULLCA 105: LLC name must include: limited liability company, limited company, or related abbreviations (MBCA 4.01: Corporate names must include: corporation, incorporated, company, limited, or abbreviations)

26 Westec v. Lanham

27 Westec v. Lanham Member: Lanham Member: Clark Managers: Lanham, Clark Preferred Income Investors, LLC If PII signs a lease in PII s name and then defaults, who is liable?

28 ULLCA 303(a) Liability Rule A member or manager is not personally liable for debts, obligations, or liabilities of the company solely by reason of being a member or manager

29 Westec v. Lanham Larry Clark PII [Lanham s/pii s address] How did this business card cost Lanham $9,000+?

30 Westec. V. Lanham Clark negotiated and approved services by Westec Per Clark s instructions, Westec sends agreement to Lanham, but never signed Services relate to PII business, but Westec doesn t know Westec sues Company, Lanham, and Clark for unpaid bill

31 What body of law (agency, partnership act, corporation act, LLC act) does court look to in considering Lanham s personal liability?

32 Westec v. Lanham Agents liable for acts of undisclosed principals Agents not liable for acts of disclosed principals Lanham says he is PII s agent Does filing of articles serve as constructive notice of PII as principal under CO statute?

33 CO Notice Statute Filing articles is notice that the LLC is an LLC and is notice of all other facts set forth in the articles

34 What does court hold, and why?

35 Westec v. Lanham [T]he statutory notice provision applies only where a third party seeks to impose liability on an LLC s members or managers due to their status as members or managers of the LLC. Where a third party sues a manager or member of an LLC under an agency theory, the principles of agency law apply notwithstanding the LLC Act s statutory provision.

36 Westec v. Lanham [O]nce the limited liability company s name is known to the third party, constructive notice of the company s limited liability status has been given, as well as the fact that managers and members will not be liable simply due to their status as managers or members.

37 Advising Choice of Entity

38 Choice of Entity C-corporation S-corporation LLC Limited liability Yes Yes Yes Flexibility: complicated allocations of profits/losses Flexibility: Ability to remove assets/convert Yes (preferred stock allowed) Lobster trap No (common stock only) Lobster trap (though conversion to C- corp okay) Yes (OA allocates profits & losses) Tax Double tax Single tax Single tax Venture capital & IPO: Available? Yes No (b/c of SH limitations) Yes No (no IPO; venture capital is rare but possible) Formalities: Important Important Less important/fewer?

39 Livelihood business (goal is current income for owners working in business) High-growth startup: (goal is to raise capital and make $ for founders and venture capital through IPO) Real estate projects: (goal is long or short term returns to outside investors, but not through IPO) Joint venture (two established entities collaborate for current income or to raise venture capital) Choice of Entity (Cheat Sheet) C-corporation S-corporation LLC No (double tax) Yes (preferred stock and lack of ownership restrictions good for venture capital and other outside investors; IPO allowed) No (double tax) Yes (if goal is to raise venture capital for joint business) Yes (if client can follow formalities, S-corp is easiest; but hard to change directions or take out assets later) No (common stock only and ownership restrictions difficult for outside investors) No (common stock only and ownership restrictions difficult for outside investors) No (entities can t own S- corp stock) Yes (but partnership economic rights/tax are complicated) Infrequently (venture capital investors don t like for complicated tax reasons) Yes Yes (if goal is to generate current income or if parties are willing to convert to C- corp later for venture capital)

40 Practice Tips for Client Communications

41 Client Communications Look good Even in , presume formality (consider using titles until client uses first name) Capital letters and punctuation Have someone (ideally a supervisor) review Print and proofread it s amazing how much better it works

42 Client Communications Choose your words carefully You lay out options and explain strength & weakness; client makes informed decision Everything you say can and will be used against you in a court of law See next slide for examples

43 Client Communications Don t over-sell your advice: forming a corporation means that you will not be personally liable But don t be hysterical: if you don t hold annual meetings, you have not respected formalities and are therefore personally liable for the debts of the corporation Try: The corporate statute requires you to follow certain formalities, such as holding annual meetings to elect directors and officers. In the relatively rare instances in which courts have held shareholders personally liable for debts of a corporation, the courts cited failure to follow corporate formalities as one factor in favor of personal liability.

44 Client Communications Know your audience For most clients, citations to legal authorities won t be meaningful Plain English examples reflecting those authorities can be useful

45 Choice of Entity Exercise Fairway Technologies, Inc. ( FTI ) wants to start joint venture with Ready Apps LLC ( Ready Apps ) Purpose is to develop and sell edrive app that analyzes a golfer s swing using FTI clubs Each has agreed to contribute $25K and to receive 50% of profits from edrive sales Both actively involved