Corporate Matters: Series Limited Liability Companies

Read Publication

Clients frequently tell us they have heard of series limited liability companies but are unsure what they are and when they should be used. In this issue we will briefly explain the series limited liability company (“Series L.L.C.”) and outline some of the pros and cons, with respect to its formation and use.

SERIES L.L.C. ESSENTIALS

Delaware and a handful of other states have allowed the formation of Series L.L.C.’s since the mid-1990’s. A Series L.L.C. is a limited liability company (“L.L.C.”) composed of an individual series of membership interests where the L.L.C. is essentially subdivided into many separate series, each series holds distinct assets, and obligations with respect to the assets designated as being in a series. The creation of the series must be included in the Certificate of Formation and the management and operation of each series must be set forth in the Series L.L.C. agreement. The Delaware statute provides that “a limited liability company agreement may establish or provide for the establishment of one or more designated series of members, managers, limited liability company interests orassets” and that each series may have a separate business purpose or investment objective. This allows, in theory, for each series to have its own management structure and distinct business purpose.

The feature that most piques the interest of our clients is the ability of the assets of each separate series to be protected from the creditors of another. An owner of an L.L.C. that holds real estate assets, for example, that comprises both ownership and management could hold each business in a separate series of the same L.L.C., and a suit against the ownership series could not attack the assets of the management series.

Corporate Matters: Covering Your Partner's Tax Tab

Read Publication

A district court, affirming a bankruptcy court decision, recently held that a partner can be secondarily liable for a partnership's unpaid employment taxes and that the I.R.S. could proceed with collection without having commenced specific individual action against the partner.

Case History

In Pitts v. U.S., Wendy K. Pitts, a California resident, was a general partner of DIR Waterproofing (“DIR”), a California general partnership. On March 1, 2012, Pitts filed a Chapter 7 bankruptcy petition in the U.S. Bankruptcy Court for the Central District of California. As of that date, DIR had unpaid Federal Insurance Contribution Act taxes and unpaid Federal Unemployment Tax Act taxes for various quarters in 2005, 2006, and 2007. It also had unpaid penalties.

Commencing in 2007, the I.R.S. recorded a number of tax liens naming DIR and Pitts as the taxpayers for the unpaid amounts. The I.R.S. identified Pitts as a DIR partner on the liens. At the time of the district court proceeding, the liens still encumbered the property of Pitts.

On June 21, 2007 and August 7, 2007, the I.R.S. issued Notices of Federal Taxes Due naming DIR as the taxpayer and Pitts as a partner.

As of the time of the summary judgment proceeding in June 2013, DIR still owed at least $114,859 in tax debt, plus unassessed interest. However, the I.R.S. never assessed DIR's taxes against Pitts or brought a judicial action against her.

Corporate Matters: Delaware or New York L.L.C.?

Read Publication

When a client is considering commencing business operations in New York, we are often asked whether it is preferable to form a limited liability company (“L.L.C.”) in New York or in Delaware. As we have mentioned in a previous issues, Delaware is generally the preferred jurisdiction for incorporation and the jurisdiction we typically recommend.

We thought it might be helpful to set out a short summary of issues that one will encounter in choosing between a New York or a Delaware L.L.C. and the relevant advantages and disadvantages of using either state.

Filing Fees

The fee for filing the articles of organization for a New York L.L.C. is $200, while the fee for filing a certificate of formation in Delaware is only $90.00. However, if the Delaware L.L.C. intends to conduct business in New York, it must file an application of authority for a foreign limited liability company, accompanied with a certificate of good standing from Delaware.

The determination of whether the Delaware L.L.C. is conducting business in New York is largely fact specific. The filing fee for the application for authority is $250, and the Delaware fee for a certificate of good standing can range from $50 (for a short form certificate) to $175 (for a long form certificate).

Corporate Matters: Convertible Note Financing

Read Publication

We have seen an increased number of term sheets for convertible note financings lately and thought it might be helpful to discuss some of the terms and conditions of these notes. In an earlier issue of Insights, we discussed angel investing and the risks (and rewards) of that strategy. Convertible note financings are used for seed financing and are a very economical and efficient way for start-up companies to obtain seed capital without losing control of the early-stage company.

CONVERTIBLE NOTE

A convertible note financing is short-term debt that automatically converts into shares of preferred stock upon the closing of a Series A financing round. This method of financing is favored by company founders because it can be completed very quickly, is somewhat simple, and is relatively inexpensive in terms of legal costs. A convertible note purchase agreement and note can be a few pages long and prepared and closed in a few days.

While start-up companies can issue common stock to early investors, there are a variety of reasons why the founders may be reluctant to do so. These include the difficultly in putting a value on an early stage company and potential tax issues for founders issued stock at nominal values. Because convertible notes are debt not equity, their issuance puts off the valuation matter until the later round of financing – by which time the company may have developed to an extent where more and better information is available on which to base a valuation.

Corporate Matters: Professional Limited Liability Companies and Professional Corporations

Read Publication

In our March issue we discussed incorporation basics and entity selection. We focused on limited liability companies and corporations, as they are the most common entities used. We thought it might be helpful to follow up on that article with a brief discussion on professional limited liability companies and professional corporations.

PROFESSIONAL LIABILITY COMPANY

A professional limited liability company (“P.L.L.C.”) is organized for the sole purpose of providing professional services by licensed professionals. Generally, states don’t allow L.L.C.’s for businesses where a license is required. Licensed professionals who want the benefits of an L.L.C. must form a P.L.L.C. instead. A P.L.L.C. must be organized solely for the purpose of engaging in either a single licensed profession, or in two or more that can be lawfully practiced together. The name of the business must include the words “professional limited liability company,” or the abbreviation “P.L.L.C.” Generally, any person who is licensed to practice in a state under a designated profession may organize a P.L.L.C. A professional is a person licensed in a field such as health, law, engineering, architecture, accounting, actuarial science, or another similar field. However, licensing requirements may vary state by state. Therefore, one must thoroughly review the applicable statute for the state in which the P.L.L.C. will conduct business.

A professional or group of professionals considering incorporation would consider a P.L.L.C. for the favorable pass-through tax treatment and limited liability – a member of a P.L.L.C. is not liable for acts of another member or the entity’s debts. Note, however, that members remain personally liable for their own professional misconduct or malpractice. So, even if you practice a profession through a P.L.L.C., it is a good idea to carry malpractice insurance.

Corporate Matters: Breaking Up Shouldn't Be So Hard to Do

Read Publication

We have found that clients typically have to be persuaded to think about what will happen if a commercial relationship does not work out. In this issue we will discuss break up provisions and what you should look for when entering a business relationship or other form of contractual obligation.

The problem of what happens if a relationship does not work out as planned can arise in many different legal contexts: (i) Landlord/Tenant – in some instances matters concerning lease renewal are not determined when the lease is signed, but rather, they are negotiated at the expiration of the term; (ii) Joint Venture/Partnerships – many joint ventures or partnership are set up in ways that make deadlock a distinct possibility; (iii) General Contracts – either party to a contract can breach the terms and conditions; (iv) Marriage Contracts – apparently 50% of these are breached by one of the parties (the cleanest resolution of these breaches one governed by a pre-nuptial agreement). When everyone is in a good mood the assets are divided, even when the last thing on anyone’s mind is the division of assets.

Corporate Matters: Angel Investing, An Introduction

Read Publication

Bette Davis once said that growing old is not for sissies. If she were she alive today, she would no doubt be an accredited investor and may well add angel investing to the potentially long list of activities not for sissies.

Typically, angel investors provide seed capital to start-up companies or entrepreneurs. When an individual or newly formed closely-held entity seeks financing for a new venture, the most common sources of financing are individuals who have a preexisting relationship with the founders of the venture. With every IPO of a former start-up and the corresponding stories of amazing returns on investment for the few initial investors, angel investing activity, as a whole, and the number of people seeking out such investments has steadily increased over the last decade. The Center for Venture Research at the University of New Hampshire found that the number of active angel investors in 2012 was 268,160. A decade earlier, that number had been approximately 200,000. The dollar amount invested over the same period grew to $22.9 billion from $15.7 billion. There is potential for the numbers to grow further: The Angel Capital Association estimates that there are approximately 4 million potential accredited investors (persons with an individual or joint net worth with a spouse that exceeds $1 million - not counting the primary residence) in the United States who might be interested in start-up and early stage companies.

This increase is despite the fact that approximately 80% of start-ups fail. Many investments made by angel investors end up worthless or sit for long periods in inert companies that buyers have little interest in.

Corporate Matters: Shareholder Agreements

Read Publication

In the first issue of our publication, we discussed the need and relative ease of preparing and entering into an agreement between partners and the consequences of not doing so. We used the recent case of Gelman v. Buehler 2013 NY Slip OP 01991 (March 26, 2013) to illustrate the sometimes expensive consequences of not documenting the initial agreements between partners. Following up on that, we thought it might be helpful to outline in broad terms what one should look for in a shareholders agreement.

While we have stated that it is relatively simple to prepare a shareholders agreement. Careful consideration still must be given to the contents of such an agreement, and it should be tailored to meet the needs of the parties involved. No two shareholders agreements are alike, and one size definitely does not fit all.

When one thinks of a shareholders agreement it is typically in the context of a corporation. Many of the same issues arise between partners when drafting a partnership agreement and members in a limited liability company operating agreement.

SHAREHOLDERS

All of the shareholders should be correctly named and their percentage ownership in the entity set forth. All shareholders that are entities should be in good standing, and individuals should have their complete address inserted.

Corporate Matters: Incorporation Basics

Read Publication

A foreign entity or individual planning on making an acquisition or conducting some other form of commercial activity in the United States must consider what type of U.S. entity to use in that endeavor. We thought it might be helpful to set out the options and answer an even more basic question for those considering activity in the United States: Why should you incorporate?

There are many advantages to conducting business through a properly formed business entity:

• Asset Protection. C corporations and limited liability companies generally allow owners to separate and protect their personal assets in the event of a lawsuit or claims against the business entity.
• Name Protection. Most states will not allow another business to form an entity with the same name as an already existing entity. Once you have filed an organizational document with a State’s Secretary of State another entity cannot be formed with the same name.
• Credibility. In many instances, consumers, vendors and partners may prefer to do business with an incorporated entity.
• Tax Flexibility. Assuming you have no plans to go public, you generally will be able to choose whether your entity will be subject to a corporation income tax or whether profits and losses will be “passed through” to the shareholder, partner, or member.

Corporate Matters: Oral Agreement Can Be Unilaterally Terminated If There Is No Definite Term or a Particular Undertaking

Read Publication

Under New York partnership law (“Partnership Law”), a partnership can be formed orally. Additionally, a partnership may be dissolved unilaterally if “no definite term or particular undertaking is specified” in the underlying agreement.

In Gelman v. Buehler 2013 NY Slip OP 01991 (March 26, 2013, plaintiff (P) and defendant (D) were recent business school graduates who decided to form a partnership in 2007. D had proposed a plan to P aimed at acquiring $600,000 from investors for the purpose of establishing a "search fund" to research and identify and raise any additional funding needed to pay the purchase price of the targeted business. P and D were to manage the business with the goal of increasing its value until it could be sold at a profit (referred to as a "liquidity event") and the investors would share in the profits realized from the sale. P accepted D's proposal and the partnership was formed by oral agreement. P and D expected that the business plan would reach its objective in four to seven years. The partners apparently pursued prospective investors for several months. D withdrew from the venture after P refused his demand for majority ownership of the partnership.