Litigation


In my last newsletter I offered some tips on issues to consider when buying a business.   The ink well isn’t dry yet…so here are a few more:

3. Ask the Seller to stick around.

When you buy a business, you are not just buying the Seller’s assets, you are buying their relationships, their goodwill, and a part of their life.  Having the Seller stay involved in the business for some time as a consultant or employee (a few months or even a year after the purchase) can be invaluable in ensuring a smooth transition.  The Seller may be the only one who knows where to find the extra set of keys to the cash register, or the Seller may be the key to keeping several big customer relationships.  These are the kinds of issues that can’t be completely addressed in the purchase documents and require continued cooperation from the Seller.  Of course, the Seller will expect to be paid for this service, but this is usually negotiated as part of the purchase price, so the Seller’s continued involvement is an integral part of the deal.  Often the Seller welcomes the opportunity to stay involved; they may seek the continued interaction with employees and customers and they will certainly want the business, their pride and joy, to continue to succeed.

 

4.  Watch out for surprise liens or judgments.

If bank financing is involved in your purchase, you can rest assured that your attorney will be required to make sure that the assets are free and clear of liens.  However many transactions these days do not involve bank financing and in those cases it is important  to have your attorney do a basic lien and judgment search as part of your due diligence.  If your Seller has a bank equity line of credit, the bank may have a UCC lien filed against all the Seller’s assets and unless that lien is released at closing it will follow the assets even though you as Buyer may have nothing to do with that equity line.   There are also possibilities of tax liens or other judgments which the Seller may have “forgotten” about.  Don’t rely simply on the representations and warranties given by your Seller in the purchase documents; those provisions are not binding on a third party creditor and will not help you when you are trying to get a release from the creditor so that you can get your own equity line in the future.

 

5.  LLC vs Corporation.

As you are making plans on a business purchase, you’ll have to decide the type of entity you want to use.  I don’t have space here to give you a full comparison of the options, but generally you will be looking at using either an LLC or a corporation.  If real estate is an asset in the business then an LLC will almost always be the preferred choice; remember my general rule – never put real estate in a corporation – if you need a refresher see my Nov 09 Newsletter on my blog.  A corporation is still the most common form of entity for operating businesses and can occasionally offer some tax savings opportunities.  Your best resource on this decision will be your CPA, since they will be handling your tax filings.

 

Give these issues consideration before you get too far into negotiations and don’t be afraid to call your attorney; your attorney can advise on these and other things to consider before you ever start discussions with the Seller and will save you time and expense in the long run.

 

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Hopefully many of you remember Vitameatavegemin from the classic “I Love Lucy” show.  How in the world does this relate to a limited liability company (LLC) you say?  Well is your LLC tired, run down, listless?  Has it fallen out of good standing and is it failing to follow corporate formalities?  If so, you may need to pep it up a little.  I touched on this topic briefly in an earlier newsletter addressing limited liability protection.  To make sure you are taking the necessary steps with your LLC, consider these tips:

A common question I hear is whether LLCs are required to have annual meetings.    The answer is “No.”  One of the benefits of the LLC as compared to a corporation is that many of the traditional legal requirements are relaxed; thus the LLC form is more flexible and more suited for many small businesses.  However the LLC should have some form of minutes or consent action signed by the managers or members to approve any major transactions within the LLC as they occur (such as a change in ownership, change in manager, or sale of business).  This does not mean you need a consent action when your LLC buys a new coffee machine, though this may be one of the most important purchases you make!  If you are not sure what transactions require approval of the members, check your operating agreement.  Whenever the LLC borrows money from a bank, the bank will require the LLC members or managers to approve the loan transaction through a similar form of consent action or minutes.  All of these documents evidence official legal action of the members or the managers and should be maintained along with the other LLC records.

The ownership records for an LLC should not be taken for granted.  Most LLCs that we organize don’t issue ownership certificates.  Again this is a distinction from corporations which usually have stock certificates.  Instead the LLC ownership is recorded and maintained on a schedule in the LLC’s operating agreement.  Whenever there is a change in ownership, such as upon death of a member or sale of an interest, this ownership schedule should be updated.  Some LLC owners prefer to rely on the LLC tax returns and their CPA to keep track of the LLC ownership, but this is a mistake and it can lead to problems later if there is any inconsistency in the tax records versus the LLC documents.  The better practice is to update the LLC ownership schedule as needed and then send a copy of the updated schedule to the LLC’s CPA or tax professional for use in the income tax reporting.

Finally, one of the most important items for an LLC is to keep the annual reports current with the NC Secretary of State.  In North Carolina an LLC must file an annual report by April 15 of each year together with a $200 annual filing fee.  These reports require very basic information about the LLC and its managers or members and can be filed online.  From time to time the Secretary of State conducts audits of its LLC filings and initiates administrative dissolution of LLCs which don’t have their reports current.  If you receive a notice from the Secretary of State along these lines, be sure to give that filing attention.

It doesn’t take much to maintain an LLC, but it is easy to let some of these simple items fall through the cracks.  If it has been a number of years since you have focused on your LLC corporate records, you should dust them off and see what you have and what you may be missing.  And if all else fails join the thousands of happy peppy people…watch I Love Lucy and you’ll understand.

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Now that we are in recovery (hopefully) from the great banking flu of 2008-2009, it has become clear that doing business with banks has changed quite a bit.  Gone are the days of quick loan approvals and business loans secured only by the underlying business.  Even more than ever, banks now look for personal guarantees from well-heeled individuals to secure a business loan, and if you are the guarantor, you need to consider several details.

 For any of you who needs a refresher on the basics of a personal guarantee, refer to my July 2009 newsletter.  The first thing you need to understand is that most guarantees are a guarantee of payment not collection.  This means that if there is a loan default the bank can show up at your door and demand payment; it doesn’t have to try to collect from the business, or other guarantors, or even foreclose on property first.  Banks are also regularly requiring guarantors to pledge liquid assets (e.g. a marketable securities account) as security for the guarantee.  This makes it even easier for the bank to recover from the guarantor immediately on default.  It also means that as a guarantor you will be required to tie up these liquid assets often for the full duration of the loan.

 If you have been asked to sign a guarantee, there are several things to watch out for.  How long is the guarantee?  Usually it will run for the duration of the loan but the guarantee will likely provide that the loan (and the guarantee) can be extended by the business without your approval.  The business can likely also agree to a higher interest rate or make other changes in the loan without your approval.  Most importantly, is the guarantee limited to a specific amount? Look carefully….it probably isn’t and that could expose you to a lot more liability than you expect.  If you have other deposit accounts with the bank, the guarantee will often provide that the bank can hold those accounts if it needs to collect from you.    The bank may be willing to negotiate some or all of these items, so make sure you ask and by all means have your legal counsel review the document before you sign.  Also it is very important that you stay informed about how the business is doing and whether it maintains the loan in good standing; the bank is not obligated to let you know if the loan falls behind.

 Many loan guarantees involve several individual guarantors which helps share the pain if the bank ever enforces the guarantee.  However the bank is usually not required to collect from all guarantors; if one guarantor has sufficient collectible assets the bank can pursue that person alone.  For this reason, many guarantors enter into an indemnity agreement to ensure that if one guarantor is required to pay more than their fair share of a loan, then all the other guarantors will reimburse them.  If you are in a transaction with several guarantors, you should also consider their personal assets and make sure you can recover from them if you get stuck paying the bank.  For example, if they have much of their wealth in retirement assets or  joint real estate with their spouse, you may have a difficult time collecting on the indemnity.

 This all  reminds me of the old poker saying….if you cant’s tell who the sucker is at the poker table, it is probably you.  Don’t be the sucker when it comes to your guarantee.

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Many of you have heard about the benefits of owning real estate in a limited liability company (LLC) to provide protection from liability arising out of your ownership of the real property.  See my June 2009 newsletter for further discussion.  This is pretty standard advice that you will hear from most advisors, including me.  However there is one area where the decision to re-title real estate into an LLC is not so clear: real estate owned by husband and wife, particularly where one of them is in an occupation that is exposed to professional liability.

In North Carolina real estate owned by husband and wife as tenants by the entireties is protected from each spouse’s individual creditors.  This means that if one spouse has a judgment entered against them individually, the judgment creditor cannot enforce the judgment against any real estate as long as the real estate is owned by husband and wife as tenants by the entireties.  This can be important, for example, where one spouse is a doctor and subject to potential malpractice liability.        

If real estate is re-titled into an LLC as per the typical advice, then the husband and wife will lose this special protection which only applies to real property; their ownership interest in the LLC will be subject to their individual creditors.  Some of you may be thinking….but doesn’t owning an LLC interest provide some protection against collection from creditors?  Yes it does…but not nearly the protection afforded by the special tenancy by the entireties rule.  Now I am not saying that a husband and wife should never use an LLC for real estate; many of my married clients do.  My point is simply that there are some circumstances where re-titling real estate into an LLC may not be the best choice.  You’ll need to consider the decision on a case-by-case basis.

A few imporant qualifications to note….

1.  This special rule only applies to real estate owned by husband and wife as tenants by the entireties; that is the default type of joint ownership for a husband and wife in NC, but the real estate can also be titled as “tenants in common” which does not afford the special protection.  You need to check your deed to be sure.  Also, if one spouse owned the property before marriage then it is not in tenants by the entireties unless it is re-titled after the marriage.

2.  I am only speaking about NC law.  If you have property in another state, the discussion above is irrelevent for that property, though there may be similar laws which apply in the other state.

3.  The IRS takes the position that it is not bound by this special exception, so it may enforce an individual claim against any property owned by husband and wife.

4.  The protection only applies to individual claims; if both husband and wife are liable for a claim the protection is not applicable.

If you are married and considering an LLC for real estate, make sure you ask about the tenancy by the entireties rule.

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