More On Limited Liability Companies' Fiduciary Duty

Now that we have an Indiana Court of Appeals decision describing the fiduciary duty of an LLC to its members, I almost thought to scratch this post. However, Chicago Business Litigation Lawyer Blog's Respected Law Professor's Insights on Corporate Freeze-Out Litigation may still have some benefit to you.

"In Fairness and Good Faith as a Precept in the Law of Corporations and Other Business Organizations, 36 Loy.U.Chi. L.J. 551 (2005), Murdock addresses the fiduciary duty of good faith and fairness that controlling interests of a business owe to minority interests. Noting that this internal duty is a fairly recent legal phenomenon, he surveys caselaw on the subject from around the country that applies to closely held corporations, public corporations and LLCs. Noting that the Uniform Limited Liability Company Act (ULLCA), a model law adopted by several states, doesn't include language that gives members of an LLC fiduciary duties to one another, he praises Illinois for modifying that language to protect members in the updated Limited Liability Company Act."

Indiana Case law: LLC Fiduciary Duty to Former Member

The Indiana Court of Appeals decided that Indiana Liability companies have a continuing fiduciary duty to a former shareholder or member to accurately report the company's fiscal results to the IRS for a year in which the former member held stock or was still a member of the limited liability company. That is Mike A. Abdalla, et al. v. Raed I. and Hani I. Qadorh-Zadin. This is how the Court of Appeals got to that conclusion.

The Court of Appeals started with this legal basis:

Limited liability companies, such as the ones at issue here, were not available in Indiana until the enactment of Indiana‟s Business Flexibility Act in 1993. Ind. Code § 23-18-1-1 et seq. The popularity of LLCs has forced courts nationwide to address traditional business issues in terms of this statutory creation. In Indiana, there is little case law regarding LLCs and hardly any case law concerning fiduciary duties in the LLC context. In light of this limitation, we decided in Purcell v. Southern Hills Investments, LLC, 847 N.E.2d 991, 997 (Ind. Ct. App. 2006), that “common law fiduciary duties, similar to the ones imposed on partnerships and closely-held corporations, are applicable to Indiana LLCs.”

Shareholders in a closely-held corporation, such as Q Realty, owe each other fiduciary duties. G&N Aircraft, Inc. v. Boehm, 743 N.E.2d 227, 240 (Ind. 2001). In such a corporation, “[t]he fiduciary must deal fairly, honestly, and openly with his corporation and fellow stockholders. He must not be distracted from the performance of his official duties by personal interests.” Id.

Against which there was this law:

With regard to the assignment of membership in an LLC, Indiana Code section 23-18-6-4.1(e) provides that “[u]nless otherwise provided in a written operating agreement, a member who assigns the member‟s entire interest in the limited liability company ceases to be a member or to have the power to exercise any rights of a member when an assignee of the member‟s interest becomes a member with respect to the assigned interest.” Despite the option included in the statute to deviate from the provision on assignment of interest, the companies‟ operating agreements clearly state that a member who assigns all
of his interest in the LLCs “shall no longer have any rights or privileges of a Member . . ..” (Appellants‟ App. p. 82). As such, it would appear that the Zidans relinquished their fiduciary duties on August 4, 2006 and thus no longer have a course of action concerning the K-1 Schedules which were drawn up in the Fall of 2007.

The former members argued this:

On the other hand, the Zidans focus our attention on Thompson v. Central Ohio Cellular, Inc., f.k.a., Cellwave Inc., et al., 639 N.E.2d 462 (Ohio Ct. App. 1994). In Thompson, after the plaintiff sold his shares to Cellwave in late 1991, the corporation had tax returns prepared for the 1991 tax year. Id. at 464. On April 1, 1992, Cellwave provided Thompson with a K-1 Schedule that reflected an allocation to him of more than $6 million in long-term capital gains for 1991. Id. Although Thompson claimed that the K-1 Schedule improperly shifted a significant tax burden to him, Cellwave refused to provide a corrected K-1 Schedule. Id. Thompson filed a complaint, alleging breach of fiduciary duty and fraud. Id.

***
Analyzing the character of the „shareholder termination rule,‟ the Cellwave court emphasized that the rule is not absolute. Id. at 470. The court specified that “[t]ermination of the fiduciary relationship does not shield the fiduciary from its duties or obligations concerning transactions which have their inception before the termination of the relationship.” Id. Because the reporting to the IRS of Cellwave‟s financial results for the year 1991 was based on transactions which had their inception before the termination of the fiduciary relationship, the court concluded that Cellwave owed a fiduciary duty to Thompson. Id.

Notice that this differs in several ways from the Illinois case reported by Chicago Business Litigation Lawyer Blog in LLC Members Owe Company, Manager No Fiduciary Duty, Appeals Court Rules.

Limited Liability Companies - Get the Operating Agreement

Nothing from Why You Need Professional Advice and an Operating Agreement for Your LLC differs greatly from what I advise people wnating to start a limited liability company, so pay attention.

Absent an operating agreement, many critical issues will be determined by statute. Let’s say, hypothetically, that a business person establishes an LLC, coming up with the business plan and strategy and contributing the capital to start the business. Further assume that she decides that a trusted assistant should have a small equity interest in the business, both as a reward and an incentive to perform. Thus, the founder files the LLC paperwork listing herself and the assistant as the two members.

In Indiana . the same surprise awaits the unwary creator of a LLC:

The founder may be surprised to find at a later date that, because there is no written operating agreement, she and the assistant are, by Georgia statute, entitled to equal votes in managing the business. O.C.G.A. § 14-11-308(a)(1). In addition, the founder and the assistant are entitled to equal profit distributions. O.C.G.A. § 14-11-403. The founder will also find, as a consequence, that the assistant has the legal right effectively to block anything the founder wants to do with the business.

Which is why I suggested last week to a potential client that an LLC would not do what he wanted to do - maintain control.

I like the sense of hope given in this paragraph but I would not want to rely on anyone's altruism in a business situation.  As Cindy Lauper once sang, money changes everything.

It may be possible, if the assistant is a reasonable person, to clean this up at a later date by adopting an operating agreement that makes the assistant the minority equity holder and that allocates voting rights and profit distributions as was originally intended. However, if there has been a falling out between the two members, or if they simply honestly disagree on what their respective rights should be, it can lead to a very difficult dispute.

Pay attention to this paragraph:

Of course, if the founder had consulted a lawyer in establishing the LLC, this scenario would have been avoided. The issues would have been addressed in an operating agreement, making the founder the manager, establishing the percentages for profit distributions, and dealing with many other issues.

I spoke wiht another person this past week who is looking to litigate a business set up problem.  When I asked if the business had been incorporated, I was told that the other people decided a lawyer was too costly.  Thiose same people will now be paying more to defend a lawsuit with a likelihood of paying damages.  So much for saving money on lawyers.

Limited Liability Companies: Treating the LLC as Subchapter S Corp

San Diego Small Business Law Blog has a good post on this subject - S-Corporation Election For Your Limited Liabiliy Company (LLC)?

o why would you make the election to treat your LLC as an S-Corp? If you find the flexibility and ease of corporate governance for LLCs attractive, yet find that the tax advantages of S-Corps applies to your company, you can go ahead and combine the two.

Of course, you will still have to satisfy the requirements of S-Corporation:

1. Domestic corporation or eligible domestic entity (LLCs are)
2. No more than 100 shareholders
3. Shareholders must be individuals, estates, certain trusts and exempt organizations
4. No non-resident alien shareholders
5. Only one class of shares
6. Cannot be: A bank or thrift institution that uses the reserve method of accounting for bad debts under section 585, An insurance company subject to tax under subchapter L of the Code, A corporation that has elected to be treated as a possessions corporation under section 936, A domestic international sales corporation (DISC) or former DISC.
7. Tax year ending 12/31, a natural business year, an ownership tax year, a tax year selected under section 444, 52-53 tax year based on any of the above, or any tax year for which the corporation establishes a business purpose
8. Each shareholder consents in writing

Remember, if you want more information about retaining me for a case, please give me a call at 765-641-7906.

Start Ups: Subchapter S or C-Corporation Status

For a long time I have debated with an accountant friend whether Subchapter S is really necessary for a new corporation. My starting point has been that the tax savings for a Subchapter S do not exist unless you have a C-Corporation paying dividends. Let me now add

Venture Capital investments in C-Corporations from LearnVC.com to the mix:

In most circumstances, a company must be a C-Corporation when taking investments from venture capital firms. There are a few reasons for this:

1. VC Limited Partners (LPs) contractually obligate the VC General Partners (GPs) to avoid any pass through tax liabilities that may result in an investment into a portfolio company that wasn’t a C-Corp.
2. Even if the company was a non pass-through tax entity (like an LLC with an election to be treated as a non pass-through entity), the governance of the company would be non-standard as compared to a C-Corporation. VCs focus on C-Corps, and even though it is possible to invest in an entity like an LLC, they don’t to avoid complexity.
3. Lastly, if the company was an S-Corp, the company would immediately be converted to a C-Corp when a VC invests, as the fund is a non-person. See this post for more information.

In essence, my first concern with a business that wants to be a corporation is with structure and tax issues revolve around the issue of structure. Accountants think first of taxes. Bottom line is that the business needs to know what it wants so that the best structure with the best tax consequences can be created by the accountant and the lawyer.

Business Prenup

I wrote about business prenups in More prenuptials for businesses and now I have found another writer on the same subject with Got a Business?Get a Prenup:

Business owners look forward to "prenups"--whether with a spouse or a business partner--with about as much eagerness as a rectal exam. Sure, it's necessary, but it's often unpleasant and something you'd rather skip. Some people do-- avoiding the doctor for that reason.

But those exams can uncover serious health situations that, if left untreated, could wreak terrible damage. Same goes for not having a prenuptial agreement. If there's a divorce and you haven't worked out how to handle your assets, the damage inflicted on your company could be devastating.

The article nails the difficulty of getting business owners to think about break ups and then goes into all the good points favoring putting a buy-out agreement into the corporate by-laws or limited liability company's operating agreement.

Contested divorces rarely bring out the best in people. Some will be ruthless, just to spite the soon-to-be ex-spouse. It's not unheard of for a spouse to fraudulently claim that he or she has a stake in the other spouse's business, which could be hard to disprove if you've not kept appropriate records. A prenup offers protection against predatory challenges in the following ways:

It can define your company as an asset acquired before marriage.

It can provide for who controls the company post-divorce.

It identifies who owns the stock in the company.

It can set out a fair method for valuing the business or its stock at the time of divorce (which could refer back to the formula contained in the company's ownership agreement).

It can address all present and future property, assets and income, both during the marriage and in the event of divorce.
Like an ideal relationship, a successful prenup has the following qualities:

It's fair.

There's full disclosure of financial (and other) issues.

The parties entered into it freely (e.g., you're not forcing your intended to sign while you're on your way down the aisle).

If you are operating a business with someone besides yourself but do not have a buy-out agreement, you need to ask yourself why you are in this position. Then you need to get this potentially expensive problem fixed.

Starting a Business with a Partner?

Let me say I am not using partner in its technical sense. I know of small corporations where they speak of one another as partners. I do not know many lawyers who like the idea of a partnership compared with a corporation or a limited liability company. Partnerships lack the liability protections of a corporation or a LLC.

With all that in mind, I still think

Contemplating a Business Partnership? from BusinessWeek makes very good points about starting a business.

In their book Beer School, Steve Hindy and Tom Potter, who founded Brooklyn Brewery in 1987, described the importance of defining a partnership from the outset and formalizing it on paper with a set of parameters that could be referred to when questions or troubles arise. To underscore their point, the pair wrote: "Even a dog can shake hands."

"One important thing that we did at the beginning," Hindy explained to BusinessWeek in a 2005 interview (BusinessWeek.com, 11/18/05), "was to draw up a partnership agreement that defined it financially and also defined a buy-sell agreement, in case one of us wanted out or in case of disputes. Over the years, I saw many partnerships dissolve into chaos. They had shaken hands at the beginning, but there was nothing on paper to define what that meant." The two parted ways amicably when Potter retired in 2004

***
According to Dushnitsky, the early stage of the business relationship is the time to determine what each person can bring to the partnership

in terms of capital, contacts, level of engagement, as well as to see
how each views their commitment to the venture, their vision, and the time line they see for its development. In other words, Dushnitsky says, "early on, it is easy to have an honest conversation." Moreover, it will become apparent rather quickly if the parties are on the same page to be able to move forward successfully.

***

It's not that Dushnitsky is opposed to formalizing a partnership
agreement eventually. "I do think a document is extremely important," he says. "But [it's] just like a marriage. You don't [bring] a ring in one hand and the prenuptial in the other."

Get the understanding about the business and everyone's earlier rather than later. then get that understanding into a LLC operating agreement or corporate by-laws.

Newsday's Guidelines to making a partnership work covers some of the same territory but this only reinforces the major point here - get things understood at the start of the relationship.

Picking the right partner, though, takes careful consideration, say experts. The wrong union can spell trouble for you and your small business and end as messy as a bad divorce.

"Getting involved in a partnership is like getting married," says Ira Nottonson, a Boulder, Colo.-based attorney and author of "Forming a Partnership: And Making It Work" (Entrepreneur Press; $32.95). "The problem is some marriages last and some don't."

***

Not having a partnership agreement: A partnership agreement outlines the terms of the partnership. Think of it almost like a prenup. "It's an ounce of prevention," explains Marilyn K. Genoa of the law firm of Genoa & Associates Pc in Old Brookville, who's also on the board of directors of the Nassau County Bar Association. It should lay out such critical issues as partners' expectations, responsibilities and roles, exit strategies (i.e. if a partner wants out or wishes to sell), and ownership interest of each partner, says Genoa. "Who's putting in what and who's taking out what are the two biggest questions," adds Ralph Warner, co-author of "Form a Partnership: The Complete Legal Guide" (Nolo; $39.99) and president of Nolo, a Berkeley, Calif.-based provider of legal information.

Not considering the business structure: A general partnership can be formed on "a hug and a handshake," says Nottonson. But there are other types of partnerships, including limited partnerships, which can offer different liability and tax consequences. See sba.gov /smallbusinessplanner/start /chooseastructure/START_ FORMS_OWNERSHIP.html. Consult with your accountant and attorney to see which one best fits your business. "You need to think through what your potential liabilities are and what your tax consequences are going to be," says Zankel.

If you are looking to start an Indiana business and need legal counsel, please give me a call.

Why Does a Business need a Buy-Sell Agreement?

My first, smart-alecky answer to my question is for the same reason as for getting a prenuptial agreement before a marriage. Except that no want to consider the failure of a marriage while business failures occur daily. Some failures occur because of no buy-sell agreement.

TLD's General Counsel Blog's Business Divorces has a good description why a business needs a buy-sell agreement and how they should operate:

A buy-sell agreement is a way for two partners beginning a business to decide when, how and at what price their "business divorce" will play out. We recently drafted a buy-sell agreement for a group of individuals beginning a cellular accessories distribution business. The three individuals were equal shareholders, all were on the Board of Directors, and all three were employees of the corporation.

One of the shareholders decided he could get a better business opportunity by taking business leads from the company and diverting them to himself for his own personal gain. The other partners found out about what was going on and wanted this partner out of the corporation. Without a buy-sell agreement in place, this partner could be fired as an employee, but the re-purchase of that individual's shares is generally not possible. The law does not provide for a requirement of non-employee shareholders to sell their shares either to the corporation or to the other partners.

With the Buy-Sell Agreement in place, these shareholders were able to compel the repurchase of the shares, give a price for the re-purchased shares, and gave them a significant bargaining power

As the post goes on to state, the best time for creating a buy-sell agreement comes at the start of the business relationship but if not done then get one as soon as possible.

And something for those of the DIY crowd, take a look at what you are doing by yourself and see if it includes a buy-sell agreement.

LLCs must have attorneys in federal court

This came down last month and LLC owners who do not want to hire a lawyer need to think again.

LLCs must have attorneys in federal court:

"Owners of limited liability companies must be represented by an attorney to appeal a decision in federal court, ruled the 7th Circuit Court of Appeals today. Because a company and its president appealed a District Court's decision without an attorney, the appellate court dismissed the appeal.
In United States of America v. Derrik Hagerman and Wabash Environmental Technologies, LLC, No. 08-2670, Wabash and its president, Derrik Hagerman, appealed the District Court's dismissal of the government's petition for relief after Wabash agreed to start paying restitution and furnish specific financial information. The defendants were convicted of criminal violations of the Clean Water Act and ordered to pay $250,000 in restitution and placed on five years of probation.

In United States of America v. Derrik Hagerman and Wabash Environmental Technologies, LLC, No. 08-2670, Wabash and its president, Derrik Hagerman, appealed the District Court's dismissal of the government's petition for relief after Wabash agreed to start paying restitution and furnish specific financial information. The defendants were convicted of criminal violations of the Clean Water Act and ordered to pay $250,000 in restitution and placed on five years of probation.


The 7th Circuit dismissed Hagerman's appeal because he wasn't a party to the probation-violation proceeding and no order naming him was entered, wrote Judge Richard Posner. Wabash's appeal also must be dismissed because they are proceeding pro se with the appeal, which can't be done in a federal court.

Hagerman claimed, as president and "member" of Wabash, he can represent the company in proceedings. But corporations aren't permitted to litigate in federal court unless represented by an attorney who is licensed to practice in that court, and the same applies to LLCs, wrote the judge. Even though the appellate court hadn't ruled on whether an LLC can litigate only if represented by a lawyer, the same rule applies.

The right to conduct business confers privileges, and one of those is the obligation to hire an attorney if you want to sue or defend on behalf of the company, Judge Posner wrote.

Limited Liability Companies: What Are They?

Barely Legal Advice Blog's What is a Limited Liability Corporation actually a good job of describing what is a LLC.

The article discusses how they compare to corporations, how they compare to partnerships, and their advantages and disadvantages. (There is another article here that covers about the same territory but I like Barely Legal's article better. Which explains why I am picking on it.)

Some points I agree with:

1. Due to its newness, there are still few statutes governing LLC establishment. It only adopts applicable statutes governing partnerships and corporations.

and

For Limited Liability Corporation Establishment, it is judicious to seek advice from a Business Lawyer who can help you construct the agreement, by-laws, property distribution agreement, rules and regulations, and other complicated administrative matters.

The first point makes every break up of a LLC an adventure - especially as so many people refuse to follow the advice in the second point.

I disagree with the following if these "advantages" trump other business entities:

1. Since the members are taxed at a personal level, double taxation is avoided.

2. It requires less paperwork compared to a corporation.

Most small incorporations qualify as Subchapter S corporations and so (at least) negate the advantage of number 1. As for the second, I am not sure of what paperwork there is less of - I find the LLC's operating agreement a lot of paperwork.

I have other articles here on limitied liability companies and I will have more over the next month or so (jsut follow the "Limited Liability Companies (LLC)" link below). Yes, they are popular. Yes, they are relatively easy to set up. But all that ease creates the opportunity for serious problems. Please get informed before you decide you want to use the LLC format for your business. Then give me a call to help you get the job done right.

Limited Liability Companies: The LLC Operating Agreement

Warning!: Another recurring theme for this blog approaches: the most important thing for a limited liability company (LLC) is its operating agreement.

For what needs to into this agreement I suggest reading Anatomy of a Limited Liability Company Operating Agreement- What Must Be There and Why the Operating Agreement for an LLC is the Most Important Document to Your Business and my own Limited Liability Companies: What Does an Operating Agreement Do For a LLC?.

Indiana Limited Liability Companies and Fiduciary Duties

Reading Chancery Gives Victory to "Freedom of Contract" and Refuses to "Find" Fiduciary Duties in LLC Agreement When Not Clearly Stated from Delaware Corporate and Commericial Litigation Blog gave me a reason to tout Indiana as a place for forming a limited liability company. The Delaware Chancery Court decided that Delaware law imposes no fidicuiary duty other than what is specifiied in the LLC's operating agreement.

Importantly, the court found no provision in the LLC Agreement at issue that: "create[d] a code of conduct for all members; on the contrary, most of those sections expressly claim to limit or waive liability."

Here is the money quote:

"There is no basis in the language of the LLC Agreement for Segal's contention that all members were bound by a code of conduct, but, even if there were, this Court could not enforce such a code because there is no limit whatsoever to its applicability".

The "implied covenant of good faith and fair dealing" claim was carefully examined and dispatched with one of the more lucid and cogent treatments I can recall of this amorphous cause of action.

Finally, the breach of fiduciary duty claim was confronted by first reciting the provisions of the Delaware LLC Act at Section 18-1101(c) that allow for complete elimination of all fiduciary duties as part of an LLC Agreement. The court read the parties' LLC Agreement in this case to eliminate fiduciary duties because it flatly stated that:

"...members have no duties other than those expressly articulated in the Agreement. Because the Agreement does not expressly articulate fiduciary obligations, they are eliminated."

Indiana's Court of Appeals decided in Purcell v. Southern Hills Investments, LLC (pdf format) that an implied fiduciary duty existed for Indiana LLC's. The Court of Appeals relied upon Credentials Plus LLC v. Calderone, 230 F. Supp.2d 890 (N.D. Ind. 2002) (see Purcell at page 9 -10).

The Delaware blog finds no problem with this situation while I have serious qualms. My qualms fall into two categories. First, having been involved in cases where the mistreatment of an LLC's minority members amounted to a breach of fiduciary duty and with an implied fiduciary duty there was no protection for the minority. Secondly, I see too many people relying on do-it-yourself sites to create their operating agreements and those can lead them into the first category.

All of which means one thing for the non-lawyer: get a lawyer to draft or review your LLC agreement.

LLC Uniform laws

Not too often do I write about theory rather than practice, but reading A model for LLC laws (Thanks to Delaware Corporate and Commercial Litigation Blog for its Ribstein on LLCs that lead me to Professor Ribstein's article).

I do not know that our General Assembly has given any thought to revising our LLC statute. If there is any movement in Indiana towards changing the LLC statute, I say reading Professor's Ribstein's article should come first.

Do Corporate Governance Procedures Apply to Indiana Limited Liability Companies?

Not a question that has come up in Indiana but has in Delaware. See LLC Not Subject to Corporate Governance Standards of Corporations.

From the description of Delaware law given in this post, I do not think there is any great difference with Indiana law. Which is why I when I have written here about limited liability companies I have emphasized the importance of the operating agreement.

If you are trying to start a LLC in Indiana, I am taking on new clients at this time.

Indiana Law on Judicially Dissolving a Limited Liability Company

Indiana has no case law on dissolving a limited liability company. The statute setting the procedure for judicially dissolving a LLC is IC 23-18-9-2:

On application by or for a member, the circuit or superior court of the county in which the limited liability company's principal office, or if there is none in Indiana, in which the registered office is located, may decree dissolution of the limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.

Which made Judicial Dissolution of the Unprofitable LLC from New York Business Divorce Blog very interesting. New York's statute parallels Indiana's 23-18-9-2 without any significant differences and there is case law interpreting the statute.

Thinking over the argument regarding profitability as grounds for dissolution, I can see why the New York judges considered lack of profitability as grounds for dissolution but I think the argument against this position is the better one. I cannot think of any judges I am acquainted with having any experience in business. I can see them thinking that an unprofitable business equates to a failure of the operating agreement.

I see here a reference for us in Indiana for litigation purposes and a bit more. I read the following as something for us to think of when drafting a LLC operating agreement:

Profitability or the lack thereof, by itself, clearly is no basis to grant or deny dissolution, assuming the operating agreement itself does not set forth some measure of financial distress as ground for dissolution.

Piercing Liability Protections of a Limited Liability Company - Some Ideas by Way of North Carolina

Wilmington North Carolina Business Law and Litigation Attorney Blog has a multi-part article on getting past the personal liability protections of a LLC. This article bears paying attention to for Indiana limited liability companies.

I have yet to see a case from Indiana on the subject but it is one that interests me both from the perspective of creating limited liability companies for clients and also because I may be suing a limited liability company. North Carolina might have some ideas for Indiana. In Piercing the LLC Veil in North Carolina - Part II, the North Carolina statute is quoted:

The North Carolina Limited Liability Company Act protects LLC members from liability for the actions of the LLC. N.C.Gen.Stat. § 57C-3-30(a) provides:

A person who is a member or manager, or both, of a limited liability company is not liable for the obligations of a limited liability company solely by reason of being a member or manager or both, and does not become so by participating, in whatever capacity, in the management or control of the business.

Indiana's has a similar statute:

IC 23-18-3-3 Personal liability of members, managers, agents, or employees
(a) A member, a manager, an agent, or an employee of a limited liability company is not personally liable for the debts, obligations, or liabilities of the limited liability company, whether arising in contract, tort, or otherwise, or for the acts or omissions of any other member, manager, agent, or employee of the limited liability company. A member, a manager, an agent, or an employee of a limited liability company may be personally liable for the person's own acts or omissions.

If anything, Indiana offers wider protection to limited liability companies. Neither North Carolina nor Indiana defines the acts or conduct or omissions that might lead to personal liability.

Apparently, North Carolina lawyers have attempted to use the traditional, veil-piercing factors from corporations law as a guide to piercing the liability protections of the LLC. I must agree with this paragraph:

Of course, such an approach misses the obvious: an LLC is not a corporation. They are different types of business entity altogether. Just because the courts can look past a corporation's liability protection under certain circumstances, it does not automatically follow that those exact same circumstances should cause an LLC member to lose liability protection.

Not knowing the facts of the North Carolina cases, I am left with some guesswork about the reason for using corporations law. Either it is a sign of how conservatively our lawyer's brains work or it is a sign of laziness or both. I would think the better analogy would be to limited partnerships. Whether such an argument gets one any further in piercing a LLC's liability protection is a question for another time but I doubt this argument would be any more successful.

I also suggest reading Piercing the LLC Veil in North Carolina - Part 3. In this part, the argument appears to be that creating a LLC for the purpose of defrauding creditors might lead to a piercing of the veil. I find this appealing as an equity style argument but I keep thinking the evidence had better be pretty and prepare for an appeal if successful.

Limited Liability Companies: A Very Good FAQ from New Jersey

Yes, New Jersey. The New Jersey Lawyers Blog published Limited Liability Company – Questions and Answers. I see little disagreement with Indiana law and some common-sense answers to the questions.

I thoroughly agree with this (see my post "More about do it yourself LLC Operating Agreements"):

Question 5: I know that I can form an LLC online by myself. Why do I need a professional advisor such as an attorney?

Answer: True, you can form the company online, but the mere existence of the LLC offers little protection. A professional can draft the Operating Agreement to include the provisions you want and need and can monitor activities that may cancel statutory protection. You need good documents and procedures to benefit from the statutory protection. Further, you may get significantly more protection from an LLC formed in a different state or country. An advisor familiar with the options can help you make the right decision.

I will admit that the post raises a point for favoring LLC's over corporations that I had never considered:

Question 6: What is the difference between an LLC and a corporation?

Answer: The sole remedy of a creditor of a debtor/LLC member is the charging order against distributions. The creditor of a debtor/corporation shareholder may attach and gain ownership of the shares, thus giving the creditor significant management rights. For asset-protection purposes, the LLC is a better structure.

Yet, I do not see this as a major concern in Indiana. Corporate stock falls within the category of intangible personal property. Indiana's exemption law keeps stock with a fair market value of less than $200.00 in the hands of the owner/debtor. A closely held corporation's stock has no fair market value because of the lack of a market. I think this is an interesting idea but ultimately a wash.

If you are thinking of starting an Indiana LLC, remember that I am taking on new clients.

Partnership Gone Bad

Here is a situation that would give business lawyers a nightmare.

Partners open one business site and then decide to open another site. One partner stays to operate the original location and the other goes out to open the new site. The partner opening the new site drains the bank account, enters into a lease, and generally increases the business' debt without any counterbalancing profit.

What the partner who stayed with the original site does not know is that there are major problems ahead. Think Titanic and iceberg sort of problems.

So long as the other partner had the apparent authority for the lease, then both partners are on the hook.

If the other partner incurred debt for the business, then both partners are liable for the debt.

Liability here means that both partners' personal assets - as well as any partnership assets - are on the table to be taken by the partnership's creditors.

True, the partner who did not sign the lease or run up the bills can seek contribution from the other partner. I presume that the relationship has soured to the point that any contribution will only come after the one partner sues the other for payment of the debts they incurred.

Litigation between partners means that the business is in meltdown mode. The business stops functioning as source of profit. What money there is goes to lawyers.

I do not mean to imply that setting up as a corporation or a limited liability company (LLC) would have solved all the problems of the business. I mean only to say that some problems could have arisen and others would have been minimal.

Remember that if you are looking to start a business in Indiana or have business litigation, I am taking on new cases at this time.

Breaking Up The Business

Be prepared for what can go wrong with a business. You start a business with other people. You do not want to think about the business ending but most people do not want to think about their marriage coming to an end, either.

The New York Times published Making the Breakup Much Easier and I think it gives a non-lawyer perspective on business relationships falling apart. For a more lawyerly post on the same subject follow this link.

"When he tried to cash out, they argued that the business had hit hard times and wasn’t worth anything. (Both restaurants have since closed.) Mr. Ayoub, 51, who now owns Fornino, an upscale pizzeria in the Williamsburg section of Brooklyn, said he walked away from the feud with just enough to pay his lawyer."

Such tangles and many others can be avoided with a buy-sell agreement — basically a business prenup or a postnup, depending on when owners draw it up. In a buy-sell, partners (the process is the same for corporations and limited liability companies) decide what will happen to their interest in the company if events like death, divorce and personal bankruptcy occur.

A buy-sell can prevent an assortment of evils, like becoming unwilling partners with an owner’s heirs, or leaving a surviving spouse illiquid because the remaining owners refuse to buy the survivor’s inherited shares. By requiring a sale under certain circumstances, known as trigger events, and specifying the terms beforehand, the buy-sell avoids conflict and protects everyone, said Louis A. Mezzullo, author of “An Estate Planner’s Guide to Buy-Sell Agreements for the Closely Held Business.”

The best time to arrange the details, which can require 20 pages or more, is before you begin a venture, said Robert E. Gregg, a lawyer with Squire, Sanders & Dempsey in Tysons Corner, Va. Still, Mr. Gregg, who has worked with many start-ups, said there was generally no harm in waiting six months or so until you’re sure the business is workable. Either way, there are issues to sort out.

The article goes on a bit about the different options for the content of a buy-sell agreement:

What are the payment terms and financing? A lump-sum payout is often associated with life insurance that is used to finance a buyout when an owner dies, Mr. Redd said. You’ll need fewer policies if the company buys a policy for every owner, rather than if they insure one another individually, he said. The alternative is an installment sale, with payments plus interest over a defined period. These arrangements are common in buyouts where the owners don’t anticipate a ready source of cash, which could happen if one owner gets divorced or wants to quit the business, Professor Donaldson said. The legal bill to prepare a buy-sell agreement can cost $2,500 to $15,000, depending on complexity. If your budget is tight, you can rely on the free buy-sell agreement that many life insurance companies offer policy buyers, but it will probably cover only an owner’s death, not other trigger events.

I wonder if the fees quoted are not New York fees instead of Indiana fees, but I agree on what increases the costs. The more complexity wanted and needed by a client means more work and higher fees. However, I (again) say that the buy-sell agreement must be part of the documents creating the business entity - the Limited Liability Company's operating agreement, the corporation's corporate by-laws and so on.

More about do it yourself LLC Operating Agreements

I read Operating Agreement for LLC? which gives links to forms. I followed these links and now I am reporting back:

A. How To Form An LLC website:

1. Which has this interesting disclaimer:The above is provided for informational purposes only and is NOT to be relied upon as legal advice. This service is not a substitute for the advice of an attorney and we encourage users to have all documents created on our site reviewed by an attorney. No attorney-client relationship is established by use of our online legal forms system and the user is not to rely upon any information found anywhere on our site. THESE FORMS ARE SOLD ON AN "AS IS" BASIS WITH NO WARRANTIES OR GUARANTIES. If you wish personal assistance in deciding whether the document found on our site is right for you or desire representations and warranties upon the legality of the document you are purchasing in the jurisdiction you will be using it, contact an attorney licensed to practice law in your state.
2. The cost? $16.99.
   

B. The Internet Legal Research Group: Indiana Limited Liability Company Operating Agreement (Manager-Managed):

1. You can see the agreement before paying $9.99.
2. The web page offers lifetime updates but offers no explanation of those updates.
3. Reading over the agreement, I do not think it is as bad as it could be. What bothers me is what I do not see. Readers might want to go back to my articles Getting Out of An Indiana Limited Liability Company and Limited Liability Companies: What Does an Operating Agreement Do For a LLC?.)
   
4. I see no explanation of what is meant by a "A Manager-Managed Limited Liability Company".
5. This disclaimer does not appear on the page for Indiana forms but the main page for operating agreements:

   NOTE: THE FORMS AVAILABLE IN THIS ARCHIVE ARE SUBJECT TO OUR TERMS OF USE AND ARE NOT A SUBSTITUTE FOR THE ADVICE OF AN ATTORNEY. LEGAL ADVICE OF ANY NATURE SHOULD BE SOUGHT FROM COMPETENT LEGAL COUNSEL IN THE RELEVANT JURISDICTION. THESE FORMS ARE PROVIDED "AS IS."

C. The last selection is a PDF document from Jian.com. This one does give one a good idea of the complexity of a good LLC operating agreement and its best feature is it is free. The provider also gives these notice to would be users:

1. Do use it "as-is".
2. They will need to make appropriate changes to meet their needs.
3. "You Should Have this Agreement Reviewed and Approved by a Qualified Attorney at Law Before Using It.

Bottom line? Those using any of these forms are on their own if they use them and get a lawyer. No one from these companies is watching the business person's back - until their get an attorney to help them create their own LLC.

If you want to start a LLC, please do yourself a favor and read all of the articles here about limited liability companies. Just click on the links belows next to the word Labels. Even if you are not from Indiana, there may be useful information for you. Read, know what you are getting into, and then get a lawyer.