Category: Business Entity Restructuring

CORPORATIONS SHOULD ACT NOW TO AVOID THE FRANCHISE TAX

By , February 28, 2014 9:59 am

The attached e-mail and the article attached to it may interest readers of this post who practice in Oklahoma or who have clients that do business there. Tim Larason is a first-rate Oklahoma business lawyer, LLC lawyer and tax lawyer.

To My CPA friends: Corporations with a significant asset base in Oklahoma should act now to convert to LLC status by June 30, 2014, to avoid return of the corporate franchise tax. If done properly, taxable gain can be avoided and current income tax filing status as a C corporation or S corporation can be continued without interruption. To see the two page summary, click here.  – Timothy M Larason

 

LLC CONVERSIONS

By , February 24, 2014 9:54 am

This excellent blawg post concerns pending LLC conversion legislation in the state of Washington.  It should greatly interest readers of this post who practice in that state.

Conversions of corporations to LLCs are often useful to obtain pick-your-partner and charging order protections for corporate shareholders, and, in a few states, they can protect business owners from state taxes.  By my rough count, about 35 states already have the conversion legislation that is pending in Washington.  And even in states that don’t, conversions can often be accomplished by mergers into “foreign” (i.e., out-of-state) entities followed by conversions under the laws of those foreign states.  Conversions of corporations to LLCs are a complex, challenging and sometimes lucrative practice area for LLC lawyers.

NORTON V. K-SEA–A DELAWARE LIMITED PARTNERSHIP CASE RELEVANT TO LLC PRACTICE NATIONALLY

By , January 7, 2014 9:42 am

Because of the prestige of the Delaware courts and the pervasive influence of the Delaware Limited Liability Company Act on the drafting of non-Delaware LLC acts, any competent LLC lawyer must follow on a current basis significant Delaware decisions affecting LLC practice.  These include decisions concerning other Delaware “alternate entities,” such as limited partnerships.

An easy way to do so is to subscribe to the Delaware Corporate and Commercial Litigation blog.  A very recent post in that blog sought to identify the ten most important corporate and commercial decisions of the Delaware courts in 2013.  You can access here the discussion in that post that is most relevant to LLC practice—namely, the discussion of the Delaware Supreme Court’s May 28, 2013 decision in Norton v. K-Sea Transportation Partners, L.P.  This case concerned the validity of waivers of fiduciary duties in Delaware limited partnership agreements and the scope of the implied contractual covenant of good faith and fair dealing as applied to those agreements.

STATUTORY CONVERSIONS

By , January 6, 2014 9:01 am

Because LLCs provide statutory charging order and pick-your-partner protections and corporations don’t, it often makes sense for business asset protection purposes (and sometimes also, as in New Hampshire, for state tax purposes) to convert corporations to LLCs.  The easiest way to accomplish these conversions is under statutory conversion provisions in corporate and LLC acts.  My Wolters Kluwer LLC book discusses in great detail the law and tax rules governing statutory conversions.  Statutory conversion provisions provide that converting business organizations will be the same legal entities after the conversion as before.  They thus simplify the conversion process and protect against transfer taxes.  However, the issue whether, in a statutory conversion, the converting business has the same internal arrangements among the members and managers after the conversion as before is sometimes unclear.

The attached post in the Delaware Business Litigation Report blog discusses a statutory conversion case recently decided by the Delaware Chancery Court with regard to the duty of an LLC to advance litigation expenses to an LLC manager.  The case holds, in essence, that the matter must be resolved on the basis of the governing LLC agreement.

“BEST PRACTICES IN LLC FORMATIONS” (Post #4) – My LLC Formation Checklist

By , February 4, 2012 4:48 pm

The most basic “best practices” in forming LLCs are:

  • To create or acquire a checklist that tells you all of the legal and tax tasks that should be performed for clients who need comprehensive LLC formation services; and
  • To use this checklist whenever you form an LLC.

When you form an LLC for a client, you should, ideally, perform all of the tasks on your checklist that are within your professional expertise; and you should help your client find other professionals who can handle LLC formation tasks that are beyond your expertise.

I’ve been forming LLCs since 1993. I still find that after I think I’ve done all I should do for a particular LLC formation client and I look at my checklist, I find yet additional tasks to perform. Unless you look at your checklist, you always forget something.

Obviously, if your client wants comprehensive LLC formation services:

  • You and any professionals you associate yourself with should perform all of the tasks on your checklist;
  • You should perform each of these tasks thoroughly; and
  • You should perform each in accordance with the applicable best practice. (This means, of course, that first you have to determine this best practice.)

Obviously, if your clients want only a portion of the services on your checklist—i.e., they want only intermediate or basic services—that’s all you should provide; and you may have to provide some of these services less than thoroughly. But if this is the case, you should be clear about it in telling your client the scope of your representation—and I would argue that Rule 1.2 of the ABA Rules of Professional Conduct as in effect in most states so requires. Otherwise you might face a malpractice suit for what you didn’t do. And you should always begin by offering your client all of the services on your checklist.

Over a period of many years, I’ve spent scores of hours compiling my own LLC formation checklist, and I’ve asked a lot of other LLC lawyers to review my checklist. The resulting checklist is attached here. This checklist is the backbone of the third edition of Drafting Limited Liability Company Operating Agreements, my Wolters Kluwer LLC formbook and practice manual, on which I’m currently at work. The table of contents of the third edition as I currently envision it is here.

I’ll be quite grateful for any comments that, on the basis of your own LLC formation experience, you may have on either of the attached documents.

“BEST PRACTICES IN LLC FORMATIONS” (Post #3) – “Best” Practices vs. “Sound” Practices

By , January 21, 2012 10:58 am

As I mentioned in my first post in this blog on the subject of best practices in forming LLCs (published on January 16, 2012), it seems to me that authors of LLC formbooks and practice manuals worth their salt ought not merely to propose to their readers the practices these authors favor for use in forming LLCs or even to recommend these practices for this use.  Rather, they should provide their readers with what they believe to reflect LLC formation best practices; and they should explain to their readers why they believe them to be best practices.

The reason, obviously, is that this is what, if they reflect on the matter, readers clearly want.  Obviously, if you ask these readers whether, in forming LLCs for their clients, they want do so as well as they reasonably can–i.e., at a high level of competence–their answer (even if they have not previously focused expressly on the question) will be a resounding yes.   But this means that what they want from such a book is not merely recommended or even clearly sound practices.  Rather; they want best practices.

But validly classifying specific LLC formation practices specifically as best practices is no easy task.  This is because, in almost all cases, the best LLC lawyers and law firms—i.e., the ones most likely to be using the best LLC formation practices—cloak these practices (and all of their other legal practices) in secrecy.  In my experience, they almost never disclose them in any detail in law journal articles, in practice manuals, in CLE outlines or in any other source.

So what can be done by a person such as myself–a person intent on writing the best possible LLC formbooks and practice manuals—to overcome this cloak of law firm secrecy?

Above all:

  • We can scour the legal literature in the hope that the best law firms or the most skillful LLC formation lawyers have disclosed their secrets in these sources (even though we know in advance they probably haven’t done so);
  • We can test our own considered ideas about best practices by seeking evaluation of them by other LLC lawyers we believe are forming LLCs for their clients with a high degree of competence; and
  • We can test our ideas in blogs like this one and elsewhere on the Internet and in other public media–e.g., bar seminars–in the hope of receiving useful feedback from the community of LLC formation lawyers.

Indeed, if we want to write good books about LLC formation practice, we must do all these things.

“Best Practices in LLC Formations” (Post #1)—Introduction

By , January 16, 2012 1:00 pm

I’m currently preparing a third edition of Drafting Limited Liability Company Operating Agreements, my Wolters Kluwer LLC formbook and practice manual. The purpose of the Third Edition is to comprehensively and systematically implement in the book the concept of LLC formation best practices.

As you no doubt know, “best practices” is a concept in wide use in medicine, manufacturing and other non-legal fields, but not in the law. It is a concept that I want to be express, pervasive and unifying in my book.

In a series of posts in this blog, I will be presenting, as succinctly as I can, my key thoughts on the subject of LLC formation best practices as I develop them in drafting and revising the Third Edition. I’ll be very grateful for any comments you may have on these posts.

HOLDING LLC MEMBERSHIPS THROUGH SINGLE-MEMBER LLCs—A TRAP FOR THE UNWARY?

By , January 11, 2011 8:50 am

In my LLC practice, I often run across LLCs whose ultimate owners hold their LLC memberships through single-member LLCs.  They do this because they think that they are obtaining two significant benefits—greater anonymity as LLC owners and an extra layer of statutory liability protection.

EXAMPLE.  Arthur Able and Bill Baker are equal members of AB, LLC.  AB, LLC, in turn, holds real estate with a fair market value of $1 million.  Arthur holds his AB membership directly in his own name.  Bill holds his through a single-member LLC named “Cosmic Holdings, LLC,” of which he is the sole member.

I think the above ownership structure creates a serious trap for Bill.  One of major benefits of holding property in an LLC is that all U.S. LLC acts except that of Pennsylvania provide LLCs and their members with statutory charging order protections.  (And I understand that Pennsylvania case law provides charging order protections for Pennsylvania LLCs and their members.) 

I will write about charging order protections at greater length in future posts.  However, in essence, LLC statutory charging order provisions provide that if a creditor holds an unsatisfied judgment against a member of a multi-member LLCs on the basis of a claim unrelated to the LLC’s business:

  • The creditor may obtain a lien (a “charging order”) against the LLC on the debtor-member’s right to receive distributions of LLC profits, requiring the LLC to distribute to the creditor any LLC profits it would otherwise distribute to the member to the extent of the judgment.
  • However, the creditor may not levy on the debtor-member’s voting rights or other management rights in satisfaction of the claim.

In my view, the fact that LLC statutes provide for charging order protections and that corporations do not is the single greatest business organization law advantage of LLCs over corporations.    

To explain:  In the above example, Bill, as noted, holds his ownership in AB through a single-member LLC.  What this means as a practical matter is that if Bill accidentally but negligently runs over and kills a brain surgeon on business unrelated to the LLC and the brain surgeon’s estate obtains a $20 million judgment against him, the estate can levy on his single-member LLC membership; it can obtain Bill’s voting rights; and, by exercising deadlock voting power, it can force the LLC to sell its assets and distribute Bill’s share of the proceeds to the estate.  This is because charging order protections only protect LLC members; they do not protect the members of single-member LLCs that are members of multi-member LLCs.

By contrast, assume that Arthur is the AB member accidentally killing the brain surgeon.  In this situation, charging order protections will enable the estate to obtain a charging order against AB, LLC; but, because Arthur holds his membership in AB directly, the estate cannot obtain Arthur’s voting rights and thus cannot force AB’s dissolution.

In short:  Think long and hard before advising your LLC formation clients to hold their memberships in multi-member LLCs through single-member LLCs.  First, your client will thereby lose charging order protections.  Second, as a practical matter, he won’t need a second liability shield; so why bother with a single-member LLC?  Third, in any law suit, the “anonymity” he thinks he will obtain through his single-member LLC will quickly turn out to be worthless.

WHAT SHOULD BE YOUR GOALS IN DRAFTING THE OPERATING AGREEMENT OF A “SUBSIDIARY SINGLE-MEMBER LLC”?

By , December 22, 2010 9:13 am

In the last post in this blog, dated November 27, 2010, I discussed the potential business asset protection value for many privately owned companies that presently hold their assets and conduct their business through a single entity of adopting a new two-entity parent/subsidiary structure. In this restructuring, the subsidiary should be a single-member LLC taxable as a “disregarded entity.”

In implementing this restructuring, what should be your goals in drafting the operating agreement between the parent and the single-member LLC? I suggest you should have the two main goals summarized below:

1. You should draft the operating agreement so as to provide the parent company and its owners and relevant employees with a clear and comprehensive statement of the legal and tax structure of the single-member LLC, including, especially, its financial and management structures. This statement will be indispensable to the single-member LLC’s managers in administrating and operating the LLC. It may also be indispensable in dealing with third parties that deal with the single-member LLC, such as federal and state tax auditors and potential lenders.

2. To minimize the risk of veil-piercing, you should make clear in the operating agreement the essential separateness of the parent and the single-member LLC. The operating agreement can do much to accomplish this goal—e.g., by documenting the compliance of the LLC with the anti-veil-piercing “adequate capitalization” requirement and by providing in its management provisions that all day-to-day decisions of the single-member LLC will be made by its own internal managers and not by the parent.

However, it may be also be useful for this anti-veil-piercing purpose to formalize, in the operating agreement or in separate intercompany agreements, all other arrangements between the parent and the single-member LLC—e.g., arrangements, if any, for centralized accounting and marketing.