Limited Liability Companies – The Best of All Worlds?

A limited liability company (LLC) is a business structure that combines some of the best features of sole proprietorships, partnerships and corporations. LLC owners, like their counterparts for partnerships or sole proprietorships, report profits or losses on their personal income tax returns. Like a corporation, however, the owners of an LLC have “limited liability,” that is, they are shielded from personal liability for debts and claims arising from the business.

Limited Liability

The limited liability for LLC owners is not absolute. Owners still can be held liable if they (1) personally and directly injure someone; (2) personally guarantee a loan or business debt on which the LLC defaults; (3) fail to deposit taxes withheld from employees’ wages; (4) intentionally commit a fraudulent or illegal act that harms the company or someone else; or (5) treat the LLC as an extension of their personal affairs rather than as a separate legal entity. The last exception to limited liability is the most significant. It carries the potential for complete removal of the protections for individual owners. If the line between LLC business and personal business becomes too blurred, a court could find that a true LLC does not exist, leaving the owners personally liable for their actions.

Ownership

Most states allow a single individual to be the sole owner of an LLC. An LLC makes the most sense in circumstances where there is a concern about personal exposure to lawsuits stemming from operation of the business. Most laws prohibit establishment of an LLC in the banking, trust, and insurance fields.

Unlike corporations, LLCs can carry on their business without holding regular ownership or management meetings. Of course, formal meetings backed up by written minutes still may be advisable to document important decisions, such as a change in membership or a major expenditure.

Formation

Setting up an LLC is relatively simple. Articles of organization must be filed with the appropriate state office, usually the Secretary of State. The articles of organization include the name and principal office for the LLC, the names and addresses of its owners, and the name and address of the person or company that agrees to accept legal papers on behalf of the LLC.

Even if it is not legally required, the owners should prepare an operating agreement that spells out the owners’ rights and responsibilities. The absence of an operating agreement will mean that state statutes will govern the operation of the LLC by default. An operating agreement acts as a guide for resolving common issues that an LLC will face, and thereby helps to avert misunderstandings between the owners. It also underscores the authenticity of the LLC itself, which can be helpful when a judge is deciding whether the owners are protected from personal liability.

A standard operating agreement includes the members’ percentage interests in the business; the members’ rights and responsibilities; the members’ voting power; allocation of profits and losses; how the LLC will be managed; rules for holding meetings and taking votes; and “buy-sell” provisions that control what happens when a member wants to sell his interest, becomes disabled, or dies. Although it is frequently overlooked when an LLC is created, a buy-sell agreement is important as a sort of “premarital agreement” among the owners. The buy-sell provisions can clarify and ease the transition when the inevitable changes come to the members of the LLC.

Taxes

Since an LLC is not considered separate from its owners for tax purposes, the LLC pays no income taxes itself. Like a partnership or sole proprietorship, an LLC is a “pass-through entity.” Each owner pays taxes on a share of profits, or deducts a share of losses, on a personal tax return. The IRS regards each member as a self-employed business owner, not an employee of the LLC. There is no tax withholding, and owners must estimate taxes owed for the year, then make quarterly payments to the IRS.

Conversion

By converting to the LLC business structure, sole proprietors and partnerships can gain the protection afforded to LLC owners without changing the way their business income is taxed. Conversion usually can be accomplished either by filling out a simple form or filing regular articles of organization. Federal and state employer identification numbers will have to be transferred to the name of the new LLC, as will such items as sales tax permits, business licenses, and professional licenses or permits.

The process for creating an LLC is streamlined and free of highly technical considerations. However, there is an important place for professional advice concerning such matters as choosing an LLC over other business structures, preparing or reviewing the operating agreement, and setting up accounting systems.

Should You Incorporate Your Business?

Following fast on the heels of a decision to go into a particular kind of business is the decision about what kind of legal form it should take. The most common options are a sole proprietorship, a partnership, or a corporation. You may lean toward the corporate route because you like the sound of having “Inc.” after the company’s name, but there are some more practical, business-like considerations to take into account.

More so than with some of the other structures for a business, starting a corporation means complying with formalities required by state laws. Once the shareholders (owners) of the business agree on some basic matters, such items are embodied in articles of incorporation that must be filed with the appropriate state agency. These essentials usually include:

a corporate name;
the number of shares that can be issued;
the number of shares each owner will buy and for what contribution of cash or property;
the nature of the corporation’s business; and
the identity of the directors and officers of the corporation who will handle day-to-day operations.
the fledgling corporation will also need bylaws, which constitute a procedural rule book for the company.

Decision making

The bottom line here is that whoever holds a majority of the shares of a corporation has ultimate control over it. Usually it takes a majority of the shares to elect the board of directors, which is charged with making the “big picture” decisions. If a decision is momentous enough for the company’s future, such as a change in the articles of incorporation or whether or not to merge with another company, the shareholders usually have a more direct role in that they themselves must approve the decision by a certain margin of votes.

The board elects the officers of the corporation, typically including a president, vice-president, secretary, and treasurer. The officers may or may not be salaried employees or shareholders, and in some cases one person may hold more than one office.

Accountability

At or near the top of the list of characteristics favoring the corporate structure is the fact that, since the corporation is treated as a legal “person” separate from the people who own and run it, the shareholders as a rule are not personally liable for the corporation’s debts. Instead, their risk is confined to their investment in the company. To every rule there is an exception, however, and here the exception has the colorful legal name of “piercing the corporate veil.” If the owners do not comply with the statutory requirements for running a corporation, or if they blur the lines too much between corporate and personal finances, the legal fiction of the corporation as a separate entity is ignored and the owners are on the hook for the corporation’s losses.

Transitions

As a separate entity in the eyes of the law, a corporation does not go out of existence if one or more of its owners dies. Instead, a corporation stays alive until its owners decide otherwise. Transfer of the ownership of the corporation is accomplished by selling its stock. New owners are added either when existing owners sell some of their stock or the corporation itself sells more shares of stock. The smaller the enterprise, the more likely it is that the owners, for whom the corporation may be both their property and their employer, may agree to restrict the sale of the stock in order to maintain control.

The particular circumstances of each new business and the differences in the governing laws of the states make generalities difficult. That said, the factors on the debit side of the ledger for corporations include the costs of setting up the corporate entity, the need for a separate tax return, and the burden of “double taxation.” Double taxation means that the corporation is taxed on its profits, and the shareholders are then taxed on their dividends. On the credit side are limited liability for the owners and easy transfer of ownership.

Making the appropriate choice for a business form is one of the first, and one of the most important, decisions a new business will make. Whether choosing a corporate structure or some other form, make sure to consult with a qualified attorney.

Financial Planning for Disaster

Beware the Automatic Update!

Here at New Options, we manage several websites for our customers on the WordPress platform. It is stable, easy to use, and our clients find that they can add new informative posts quickly.

WordPress is updated frequently with new features and to fix nagging small issues. But the last update, 4.8.1, has wreaked havoc on many a website. Fortunately, our preferred web hosting company, Network Solutions, takes frequent “snapshots” of hosted websites, allowing customers to restore data back seven days.

So…even though you might be able to recover from disaster, here are a few tips for updating your version of WordPress:

Update any “plugins” that you actively use on your site. Be sure that the plugin details indicate that it will be compatible with the new version of WordPress.
Backup, backup, backup! If things get wacky, you will want to restore your website to the same condition it was in before it imploded.
After a successful update, check those plugins again. You may need to do a little tweaking to be sure they are active and functioning properly.
Check each major page of your website, i.e., the homepage and the major menu pages.

Running your own website can be fraught with danger! Fortunately, there are New Options consultants ready to help you. If you need a new website, or just need to get out of a jam, give us a call!

Pay Day’s Coming: Don’t Forget the Sick Leave!

California Assembly Bill 1522, signed by Governor Brown last September, went into full effect on July 1st. The law requires all California employers to provide paid sick leave to their employees. The new law includes any employee who works at least 30 days within a year in California, including part-time, per diem, and temporary employees, with some specific exceptions.

An employee qualifies for paid sick leave by working for an employer on or after January 1, 2015, for at least 30 days within a year in California and by satisfying a 90 day employment period (which works like a probationary period) before an employee can actually take any sick leave.

A qualifying employee begins to accrue paid sick leave beginning on July 1, 2015, or if hired after that date on the first day of employment. Employees will earn at least one hour of paid leave for every 30 hours worked. Although this might total as much as eight days a year for someone who works full time, employers can limit the amount of paid sick leave to 24 hours (three days). Employers may also limit the number of accrued hours “carried over” into the following year of employment.

Sick leave may be taken for care of the employee or a family member for preventive care or care of an existing health condition or if the employee is a victim of domestic violence, sexual assault or stalking.

Like vacation pay, employees may not “cash out” accrued sick leave when they leave their job unless the employer’s policy provides for a payout. But if an employee leaves and is laterrehired by the same employer within 12 months, they may reclaim the prior balance of their “leave bank”.

Employment issues in California are complex–an up-to-date employee handbook is a must! Let the experts at New Options Business guide you. Call us today!

Buy-Sell Agreements for Small Business

The transfer of ownership interests in a small business should take into account all of the considerations that make each business, and especially a family-owned business, unique. The vehicle for accomplishing the transfer is usually called a buy-sell agreement. Its name barely begins to describe the buy-sell agreement’s various purposes. With professional advice, the agreement can be tailored to meet the objectives of each small business, whether the business is in the form of a close corporation, partnership, limited liability company, or some other structure.

By creating a market for the ownership interest of a shareholder who has retired, become disabled, or died, a buy-sell agreement insures that such an interest can be converted into cash when cash is more important than having shares in the company. Since small businesses often pay out most or all of their profits in salaries, an equity interest in the business would be much less valuable if its owner was not assured of being able to sell that interest back to the business or to other shareholders.

Valuation of the Business

When a triggering event in a buy-sell agreement causes the interest of one owner of a business to be purchased by other owners, or by the business as an entity, a critical issue is placing a dollar value on that interest. It is difficult to set a market value for shares in closely held corporations, whose stock by its nature has little or no liquidity. An agreement can set the price for shares according to a predetermined formula, value as shown on the company’s books, an appraisal by a third party, or some other method. In any event, it is important that the provisions on the valuation and purchase price of shares in the company be kept current.

Orderly Transition of Ownership

A buy-sell agreement also may serve as an orderly method for maintaining control over the company despite a change in the composition of its owners. In a family-owned business, this may mean a clause in the agreement effectively keeping the business in the family by allowing remaining family members to buy the interest of a departing owner. For children who decide not to carry on in the business, cash, perhaps generated by life insurance on a senior owner, might be an alternative to inheriting part of the business.

A typical buy-sell agreement for a family business provides that, on the death or departure of one shareholder, the remaining shareholders have the right to purchase his or her shares. Those participating in the buyout usually acquire those shares in an amount commensurate with their holdings. An alternative could give the corporation itself the right to purchase the shares. However, this option may bring into play laws for the protection of creditors that limit the power of corporations to purchase their own shares. A hybrid approach sometimes used in buy-sell agreements allows the business to buy its own shares, only to the extent permitted by relevant statutes, but the remaining shareholders could then purchase any shares not acquired by the corporation.

Avoid Conflicting Terms

Since one of the triggers for application of a buy-sell agreement is a shareholder’s death, shareholders should avoid conflicts between the terms of the agreement and their estate plans. When the terms of an agreement and a will cannot easily be reconciled, the odds increase for litigation, rather than the smooth transition for which the agreement was designed. If a will predates the agreement, it may be necessary to draft a new will that is consistent with the agreement. A less-complicated approach is to amend the will with a codicil providing that business interests are to be disposed of according to the buy-sell agreement.

Consistency between an estate plan and a buy-sell agreement is important not only as to disposition of shares, but also as to voting or management rights in the company. A shareholder should determine whether his estate or heirs should have such rights, and then be sure that the documents accurately reflect the shareholder’s wishes. Similarly, a shareholder should consider whether limits on his executor’s voting rights are desirable, so as to avoid the possibility that the executor will act to frustrate the shareholder’s intent.

One purpose of any contract is to avoid future disputes between the parties by establishing rights and duties for future contingencies. Aside from dealing with the substantive issues raised by transferred ownership, a buy-sell agreement also can head off conflict, or at least help solve it, by providing for a form of alternative dispute resolution or mediation.

When Noncompetition Agreements Cross State Lines

It is a common practice for an employer to require an employee to sign an agreement preventing the employee from competing with the employer for a certain period of time and in a designated geographic area. For many years, interpretation and enforcement of these noncompetition agreements or covenants not to compete, as they sometimes are called, have led to lawsuits. When an ex-employer attempts to enforce an agreement in another state, which happens more often in today’s economy, special issues arise because of the variations in how receptive or hostile the different states are to the anticompetitive effects of these agreements.

Dueling Lawsuits
When Mark was hired in Minnesota to work for a manufacturer of medical devices, he signed an agreement not to compete with the employer, for two years after leaving, and in any area where the employer marketed its products. In a typical “choice-of-law” clause, the agreement also said that it was governed by the laws of the state where the employee last worked for the employer.

After five years, Mark resigned and moved to California to take a job with a company that was competing head-to-head with his ex-employer. Correctly anticipating a fight, and wanting to reach the courthouse first, Mark and his new employer sued his former employer in a California court on the same day he started his new job. Except in limited circumstances, California law prohibits anticompetition agreements, so Mark asked for a declaration that the agreement he had signed was void and unenforceable against him in California. More than that, he also asked the court to prohibit the ex-employer from taking any action outside of the California court to enforce the agreement. At about the same time, the former employer did, in fact, sue in a Minnesota court, which issued a preliminary order to enforce the terms of the agreement.

A stalemate ensued, with each side having obtained a ruling in its favor, and purporting to prevent pursuit of the litigation in the other state. When the California case was appealed to that state’s highest court, it ruled against any interference with the pending litigation in Minnesota. At the same time, the court recognized California’s aversion to noncompetition agreements and allowed Mark’s California case to proceed unless and until any Minnesota judgment became binding on the parties. In short, the race to a favorable judgment continued.

Georgia on His Mind
In another similar case, James signed a noncompetition agreement with a company in Ohio that gave computer support services to providers of wireless communications. Later, he left and relocated to Georgia, which does not prohibit noncompetition clauses outright but does subject them to close scrutiny. The agreement had provided that Ohio law was controlling.

Like Mark in the California case, James went to work for a competitor in his new state and sued there to invalidate the covenant not to compete. Unlike the California case, however, there were no dueling lawsuits in different states because James had misrepresented to his first employer that he was leaving to become a stockbroker.

James’s lawsuit in Georgia to rid himself of the agreement was partially successful. The agreement was too broad and restrictive to pass muster under Georgia law, so it could not be enforced there, even though the agreement itself referred to Ohio law. James was relieved of the agreement, but only while working in Georgia, because, as the court put it, “the public policy of Georgia is not that way everywhere.”

Lost Database is Not Insured

“If you can’t reach out and touch it, it is not insured.” That was the gist of a court’s ruling in a lawsuit brought by a company that lost a large amount of electronically stored data when an employee inadvertently pressed the “delete” key on a keyboard. The company looked to its insurer to cover the expenses for restoring the data and to recover lost income caused by the disruption. The insurer denied coverage on the basis of policy language that limited coverage to a “direct physical loss of or damage to” covered property.

The language from the policy was meant to be interpreted in its ordinary and popular sense. Thus, “physical” means “tangible” or capable of being touched. The information in a computerized database, in and of itself, has no material or tangible existence, unlike a storage medium for information, such as a disk, tape, or even papers in a file cabinet. The court concluded that when the employee sent the data into thin air with an unintended keystroke, there was no direct physical loss within the meaning of the insurance policy. (The court distinguished this case from another case in which the loss of a computer tape and the data on it were covered under a policy covering “physical injury or destruction of tangible property.”)

Recognizing that the dictionary was not on its side, the company that lost its data also argued that public policy should weigh heavily in favor of insurance coverage. After all, loss of information in the same manner as occurred in this case is common, and our economy unquestionably is highly dependent on computers and the intangible information that they contain. However, the court declined to use public policy as an “interpretive aid.” There are plenty of useful legal principles for construing insurance contracts, but using public policy to redefine the scope of coverage agreed to by parties to a contract is not one of them. The lesson: Questions of insurance coverage are to be answered solely in the language of the policies and, therefore, careful drafting of policy language is critical.

Small Business – Maintaining a Safe Workplace

In theory, and often in practice, the safety of the workplace is a top priority for any business. But while large companies may have personnel devoted exclusively to the subject, safety is but one of many responsibilities for the owners of small businesses. In some cases, the matter of keeping workers safe slips down the list of priorities. There to make sure the issue is not neglected is the federal Occupational Safety and Health Administration (OSHA).

OSHA has written very detailed standards for maintaining workers’ safety. It also has an expansive mandate to enforce those standards and the various provisions of the Occupational Safety and Health Act. Removing dangerous conditions is only common sense from any point of view, including employer-employee relations and a calculation based solely on dollars and cents.

The first step for any small employer is to be informed and educated as to workplace dangers, not all of which may be obvious. OSHA maintains an extensive website (www.osha.gov) that includes information that is especially pertinent to small businesses and guidance about specific threats to safety. Insurance companies provide another good source of information, since these companies have a vested interest in enhancing workplace safety and thereby minimizing insurance claims.

While exotic threats such as anthrax or Legionnaires’ disease may capture headlines, the leading causes of serious workplace injuries are more ordinary. They include overexertion, such as excessive lifting, pushing, pulling, holding, carrying, or throwing an object; falls on the same level (as distinct from falls from a height); and “bodily reaction,” which covers injuries from bending, climbing, slipping, or tripping without falling. Regular inspections and repairs, not to mention a vigilant workforce, can head off many such injuries.

Apart from monetary penalties that may follow an OSHA investigation, many billions of dollars each year are paid by employers in medical costs, wage payments, and insurance claims management as a result of workplace injuries. Small businesses get some breaks from OSHA, in the form of smaller monetary penalties and some exemptions from recordkeeping requirements for employers with 10 or fewer employees. Still, given their smaller financial reserves, small businesses, in particular, are well advised to live by the truism that an ounce of prevention is worth a pound of cure.

The Dangers of Employee Internet Use

By some accounts, a large majority of employees access the Internet on company computers for personal reasons while at work. The obvious adverse effects of this on productivity are only the tip of the iceberg with regard to the potential headaches that such activities can cause for employers. Personal Internet activity by employees can pose security risks to the company’s computer network itself, such as by exposing a network to a computer virus.

Less immediate but just as serious is the threat of legal liability of the employer to injured third parties. Some scenarios are not difficult to imagine. An employee uses his computer as a tool for sexually harassing fellow workers by visiting pornographic websites. Or, an employee embroiled in a bitter domestic dispute uses his office computer to communicate threats to his spouse, and the employer fails to take action.

In a recent case, one such nightmare scenario was all too real for an employer that had to defend itself against the alleged victims of an employee who used a workplace computer for conduct that was criminal, not just indicative of poor judgment. This case may be the first reported decision on the matter of an employer’s liability to a third party for having failed to take action to stop an employee from using a company computer in a manner that harmed the third party. It most certainly will not be the last such case.

The case involved an employee who used his company’s computer at work to visit pornographic sites, including some relating to child pornography. Over a period of time, a supervisor and some coemployees became aware of this activity and complained to management. Eventually, the offending employee was confronted and was told to stop such use of the computer, but, a few months later, he was again discovered to have accessed pornographic sites.

Eventually, the employee was arrested on child pornography charges, including allegations that he had transmitted nude pictures of his 10-year-old stepdaughter over his office computer to a child pornography site. The employee’s wife, who divorced him, sued the employer for failing to investigate and for failing to report the employee’s viewing of child pornography. The case was settled, but not until a precedent was set when the lawsuit survived attempts to have it dismissed before trial.

There are limits to what companies can or should do to prevent improper use of company computers, but it is only prudent to take at least some basic measures. It makes sense to have a written e-mail and Internet use policy that clearly informs employees of what, perhaps, they should already know–that the employer has and reserves the right to monitor employees’ use of the company’s computers and to discipline violators. In addition, there needs to be even-handed enforcement of the policy. Even the best written policy will do little to convince a jury, if it comes to that, that a company has done all it reasonably could have done, if the evidence is that the policy was toothless or rarely enforced.

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