Archive for November, 2013

WHEN NORTH CAROLINA’S NEW LIMITED LIABILITY COMPANY (LLC) STATUTE GOES INTO EFFECT JANUARY 1, 2014, DO I NEED TO REVISE MY CURRENT OPERATING AGREEMENT?

Friday, November 22nd, 2013

By:  Rick Jackson

On January 1, 2014, Chapter 57D of the North Carolina General Statutes goes into effect (“New LLC Statute”) and Chapter 57C is repealed (“Old LLC Statute”).  The New LLC Statute will apply to all LLC’s, even those formed before January 1, 2014.

So is it time to make an appointment with your attorney to review your operating agreement?  Perhaps, but not for the reasons you may think. 

As three of the most significant changes to the Old LLC Statute, the New LLC Statute (1) introduces and emphasizes the concept of “company officials” as an alternative to managers, (2) introduces and emphasizes the concept of “economic interest owner” as distinguished from members, and (3) provides that the New LLC Statute (other than seven enumerated exceptions) may be “supplemented, varied, disclaimed, or nullified” by the operating agreement.

1.  New Definition:  “Company Officials”

The New LLC Statute provides that “company officials”, such as directors and officers, can be used by LLCs as the decision makers for the LLC in lieu of managers.  But the use of directors and officers in an LLC is not new to the New LLC Statute.  The New LLC Statute simply places greater emphasis than the Old LLC Statute on its use as a possible alternative to managers.

The ability to use directors and officers in lieu of managers underscores just how flexible the governance of LLCs can be.  In determining the appropriate decision-making structure of your LLC, it is important to consider whether the use of directors and officers in lieu of managers is, in practice, more efficient (or burdensome) in carrying out your day-to-day management.  Even more important is determining the decision-making authority of the members of your LLC in relation to that of its managers (if manager-managed) or directors and officers, as the case may be.  For example, are there major decisions that should require member approval instead of manager approval?

2.  New Definition: “Economic Interest Owner”

Similar to the definition of “company officials”, the definition of “economic interest owner” is new to the New LLC Statute, but the concept is not.    Under the Old LLC Statute, this concept was referred to as an “assignee”.  Like an assignee, an “economic interest owner” only has the economic rights of a member but not the non-economic rights, such as management rights, derivative action rights, and rights to information.  In contrast, a “member” has both economic and non-economic rights in the LLC.

The concept of “economic interest owner” is most relevant in the context of the buy-sell provisions of your operating agreement.  In general, involuntary events may cause a transfer of a member’s interest in the LLC (e.g. the death of member).  Your operating agreement hopefully provides an efficient way to address these situations, often referred to as buy-sell events.  As a related matter, your operating agreement in general should provide that any recipient of the transferred membership interest is merely an economic interest owner, not a member of the LLC (unless admitted pursuant to the member substitution or permitted transferee provisions of the operating agreement).

3.  Use of Operating Agreement to nullify New LLC Statute 

The phrase “except as otherwise provided in . . . a written operating agreement, . . .” was used throughout the Old LLC Statute.  This meant that the section of Old LLC Statute that this ubiquitous phrase preceded would apply to your LLC, unless your operating agreement contained express language to prevent or otherwise modify its application to your LLC.  In lieu of the repeated use of this phrase, the New LLC Statute more-succinctly and comprehensively provides that the New LLC Statute (other than seven enumerated exceptions) may be “supplemented, varied, disclaimed, or nullified” by the operating agreement.  Here again, this is not a concept that is new to the New LLC Statute.

More importantly, you need to understand those instances in which you do not want the New LLC Statute to apply to your LLC and draft your operating agreement accordingly.  For example, you generally want the bankruptcy of an individual member to automatically trigger that member’s withdrawal from the LLC but there are instances in which you may not want this to automatically happen.  Your operating agreement needs to account for these situations.

In summary, you do not need to make an appointment with your attorney to review your operating agreement solely based on the New LLC Statute, but if you have not addressed the issues described above with your attorney to assure that your operating agreement properly fits your business, now is the time to do so.   

Please contact me if I can assist you in any way with your North Carolina LLC  (rjackson@mwbavl.com; 828-254-8800).

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Rick Jackson is an Attorney with the law firm of McGuire, Wood & Bissette, P.A.   He works primarily with small to mid-size businesses: technology and manufacturing companies; property owners, developers, and homeowner associations; medical and dental practices and hospitals; restaurants and breweries; agricultural and natural product businesses; and nonprofits.  http://tinyurl.com/myoclkw

 

 

 

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BUSINESS ISSUES AND SUCCESSION OF THE FAMILY BUSINESS

Thursday, November 7th, 2013

By Harris M. Livingstain

There is no greater confluence of legal issues than those that are involved with the transitioning of a family-owned business to the succeeding generation. Whether the business is passive in nature (for example, rental real estate), service oriented or a manufacturing concern, a myriad of issues face the senior generation whose wealth, financial security and sense of accomplishment are tied closely to the business.

The term “family business” is often associated with a business owned by a single family unit, but many such businesses are owned by two or more family units, related or unrelated, and the succession issues in those businesses present more difficult challenges to the owners.  Seventy percent of family businesses do not survive to the second generation, and less than fifteen percent survive to the third.  Those failure rates illustrate the difficulty of business succession planning.

Threshold questions may include when should the senior generation begin the process of transitioning? Are there family members able and willing to take the business into the next generation?  If not, what steps should be taken to ensure the business retains its value for the benefit of the descendants of the owners?  If there are family members able and willing to assume control, what steps have been taken to prepare for the transition to the next generation?  How does the senior generation’s estate plan dispose of control of the business and to whom (that is, those involved in the business vs. those not involved in the business)? Should management position and authority be transferred to the next generation during life so that the senior generation can provide sufficient guidance? If so, how does the senior generation retain sufficient financial security given that the majority of the wealth of such individuals is directly related to the value and cash flow of the business?

What about senior non-family management?  If there is no family member ready, capable or interested in maintaining the business, how does the senior generation insure that these individuals remain with the business to preserve value for possible sale to third party or to the employees, or provide guidance to future family members who may be interested in succeeding but are not yet ready to assume leadership?   Are these non-family employees secured by “golden handcuffs,” or financial incentives (that is, phantom equity plans, life insurance, non-qualified deferred compensation plans)?  Does the business have in place any protections to minimize the threat that such employees may leave and compete either alone or with another business competitor (employment agreement with noncompetition, non-solicitation and non-disclosure of trade secrets)? 

In many situations, the majority of the senior generation’s wealth and financial security is tied directly to the business and this can make it difficult for transition during life.  The benefit of such lifetime transition is the senior generation’s ability to provide much needed guidance, and can often provide gift and estate tax benefits.  In fact, with the current gift tax exemption amount at $5,250,000 per person (increasing to $5,340,000 in 2014), there is great incentive to encourage transition now as Congress may reduce that amount in the future. Employment agreements and post-retirement salary continuation plans or consulting agreements can reduce the concerns over the loss of financial security. If the business is operated on property owned by the senior generation, a long-term lease between the business and the owner can provide post-transition cash flow. If such property is owned by the operating entity, consideration should be given to distributing the property to the senior generation prior to transition, albeit income tax consequences of such a distribution  should be carefully reviewed and weighed against the long-term benefit.  The senior generation can retain a position on the Board of Directors and be paid a director’s fee.  Also, the senior generation can sell his/her business interests to the succeeding generation for a small down payment and the balance paid with a promissory note containing favorable interest rates based on the Applicable Federal Rate (link to current rates http://tinyurl.com/p96bzeh).  There are also techniques to minimize the income tax consequences attributable to such a sale.

The role of a well-thought-out stockholder’s agreement (for corporations), operating agreement (for limited liability companies) or partnership agreement (for partnerships) cannot be overstated. In a single family unit business where less than all of the succeeding generation is involved in the business, such agreements can solve concerns the senior generation may have that passing control of the business to only one member of the succeeding generation may be unfair to the non-involved member(s). These agreements can provide the non-involved (and minority owner) with a “put right” to require the business entity or other owner to purchase his or her interest based on certain trigger events tied to financial performance of the business.  To alleviate the potential financial strain on the business (which will often be the source of funds even if the other owner is the purchaser), the “put” can be based on favorable payment terms and/or only for certain percentages over a period of time.  If there is life insurance on the senior generation, the business can be named as beneficiary (and in certain instances, the business can acquire the policy) and the “put” trigger can be the death of the senior generation and the business or the other owner(s) will have the proceeds (generally, free of income tax to the beneficiary of the policy) to fund the purchase. These agreements can also provide the business entity or family member to whom control of the business has been passed an “option” to acquire the interests of the other family members, also on favorable purchase terms so as to ease the financial strain. If the business is owned by more than one family unit, these agreements can also facilitate the transition and also ensure that the members of the non-participating family unit receive fair value for their share.  

In my experience, emotional and psychological issues of “letting go” have been the major impediments to effective succession planning.   Dealing with one’s mortality is difficult enough without the added burden of the transition of a successful business, often associated with one’s legacy.  However, the “head in the sand” or “let my kids deal with it” approach is what generally defines those businesses that do not last for the succeeding generation and are a major contributor to family discord. Granted, the process can be expensive and time consuming, but it is time and money well-spent.

 

–  Harris Livingstain is a Partner at McGuire, Wood & Bissette, P.A., and has extensive experience in estate planning and probate matters, including estate tax reduction techniques, and succession planning involving owners of closely-held businesses http://tinyurl.com/ofl7lxc . 

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