DAVID VOLK, Esq.: Smart Entrepreneurs Plan Ahead With Prenuptial Agreements

Business Spotlight

Multiple owners of a corporation or limited liability company should have an owner agreement that sets forth rules of what happens if someone dies, becomes disabled, leaves, or wants to leave the business. 

Smart business owners think about the future. The best way to think about the future is to anticipate potential issues before starting the business and then engage in risk reduction by planning for how to manage the future problems that may arise.

Your first risk management step is to choose a business structure. Sole proprietorships and general partnerships can expose you to liability for the debts and wrongs of the business.

A corporation has what is called the corporate veil that generally shields owners from the debts of the business. Limited liability companies, also called LLCs, have similar protection for owners.

There are exceptions. If you sign a personal guarantee of a company’s debt and the company defaults, you can be sued personally for that debt. If you engage in personal wrongdoing while conducting business activity, you can be sued personally. An example is when you are driving a company vehicle and hit someone.

You and the company can be sued, just as if you committed fraud through the business. Negligence and fraud exception examples are called torts. 

Corporate owners are called shareholders. They own shares of stock in the corporation. Limited liability company owners are called members. They own units in the company.

Multiple owners of a corporation or limited liability company should have an owner agreement that sets forth rules of what happens if someone dies, becomes disabled, leaves, or wants to leave the business. 

A corporate owner agreement is called a shareholders agreement. A limited liability company owner agreement is called an operating agreement. Florida has default laws that regulate relationships in entities when no agreement exists.

However, a signed agreement among partners is advisable, as it allows owners to discuss and agree on what will happen if an owner dies, becomes disabled, leaves, or wishes to leave the business. 

A major risk with limited liability companies is that they have statutory rules that can cause dissolution of the limited liability company if an owner dies, becomes disabled, or quits the business. Unlike the general rule of corporations allowing transfers of interest, a member departing can dissolve the limited liability company. 

A major risk with corporations and their generally free transfer of ownership interests is that if a shareholder dies, their heirs could inherit their stock, and now you have a co-owner that may not be a good fit.

Assume two people own a corporation. One dies. Soon, the widow or widower of that deceased person shows up and is your co-owner. And, he or she has always hated you because the deceased got along much better with you than they did with their deceased spouse. Or, the co-owner dies and his idiot son shows up demanding a new Corvette convertible as his company car.    

LLCs are the most used business entity for small business owners. The remainder of this article will focus on LLC operating agreements.

The operating agreement defines the LLC’s management structure, describes how the LLC’s profits are allocated and distributed, and sets out the agreements among the LLC’s members. It is similar to a combination of a corporation’s bylaws and a shareholders’ agreement.

When preparing the operating agreement, parties should consider member rights, including rights to share in the LLC’s profits and losses; receive distributions from the LLC; and vote and participate in the LLC’s management.

The LLC’s management can be member-managed, which is the management structure of most small business LLCs, with each member typically having the inherent authority to act on the LLC’s behalf and execute contracts or manager-managed, which is generally more appropriate where there are passive members in the LLC, such as investors who are not actively involved in the direct management or day-to-day activities of the LLC, with managers governing the LLC like a corporation’s board of directors and officers.

The operating agreement should state how an initial capital contribution will be made, whether by cash, tangible or intangible property, services rendered, promissory notes, or other obligations.

The operating agreement may also address a member’s liability or penalty for failing to make a contribution. The operating agreement should specify if all, or just certain, members are required to make an initial contribution and the form and amount of that initial contribution.

Unless otherwise provided by the operating agreement, profits, losses, and distributions are allocated among the members based on the agreed value of each member’s contributions to the LLC as stated in the LLC’s records. 

The operating agreement should specify the terms and conditions of admitting new members and any transfer restrictions on the membership interests. The operating agreement can specify events or circumstances that cause dissolution as well as how the LLC will be wound up. 

An operating agreement generally governs the relations among the members and between the members and the LLC, the rights and duties of the LLC’s managers if member managed is not chosen, and the LLC’s activities and affairs and the conduct of those activities and affairs.

Most of Florida’s statutory provisions are default provisions, meaning they only apply if the applicable subject is not otherwise addressed by an operating agreement.

However, the following is a sample of statutory rules that the operating agreement may not eliminate the duty of loyalty or the duty of care with limited exceptions.

For example, suppose the conduct does not involve bad faith, willful or intentional misconduct, or a knowing violation of law.

In that case, the operating agreement may, if not manifestly unreasonable, alter or eliminate aspects of the duty of loyalty, identify activities that do not violate the duty of loyalty, alter the duty of care, but may not permit any willful or intentional misconduct or a knowing violation of law, and alter or eliminate any other fiduciary duty, such as common law duties of loyalty and care.

The agreement may not eliminate the obligation of good faith and fair dealing, except that the operating agreement may prescribe standards by which performance will be measured, if not manifestly unreasonable.

You cannot relieve or exonerate liability for conduct involving bad faith, willful or intentional misconduct, or a knowing violation of law or unreasonably restrict the member’s or manager’s duties and rights to inspect and copy LLC records. However, the operating agreement may impose reasonable restrictions on the availability and use of information and define appropriate remedies for any breach of those restrictions.

You cannot vary the grounds for judicial dissolution or vary certain requirements for winding up the LLC’s business, activities, and affairs on dissolution, including discharging or making provision for the LLC’s debts, obligations, and other liabilities, settling and closing the LLC’s activities and affairs, distributing the LLC’s assets; and conducting the wind up under judicial supervision.

You can not unreasonably restrict a member’s right to maintain a direct or derivative action or vary a member’s right to approve a merger, interest exchange, or conversion if the member will have any interest holder liability for any of the LLC’s debts, obligations, or other liabilities arising after the transaction.

You cannot vary the required contents of a plan of merger, interest exchange, conversion, or domestication.

You cannot indemnify a member or manager for conduct involving bad faith, willful or intentional misconduct, or a knowing violation of law; a transaction where the member or manager received an improper personal benefit; personal liability for improper distributions; or a breach of fiduciary duties or obligations except as permissibly restricted, expanded, or eliminated by the operating agreement.

And now, we get to the important functions of an operating agreement when it comes to ownership transfer restrictions, including buy-sell rights. You should consider including the following clauses in the operating agreement that affect the future purchase or sale of membership interests:

■ Right of first refusal: This requires a member receiving an offer from a third party to first offer its membership interests to the other members. 

■ Right of first offer: This requires a member wishing to sell its membership interests to offer the interests to the other members first. 

■ Drag-along provision: This gives a majority member wishing to sell all or a substantial percentage of their membership interests to an unrelated third party the right to force the other members to also sell all or a portion of their membership interests to that third party. 

■ Tag-along (or co-sale) provision: This gives minority members the right to participate on a pro rata basis in any controlling member’s sale of its membership interests to a third party. 

■ Preemptive rights: Preemptive rights give the members the right to buy a pro rata portion (based on their ownership interest) of any future membership interests the LLC issues. 

A well written operating agreement might have language like this and then go in to details about things such as right of first refusal and other mechanisms for managing a departure: “No member may transfer, assign, pledge, or hypothecate all or any portion of the member’s interest in the LLC (including any beneficial or equitable interest therein) at any time without the written consent of all the other members, which consent may be withheld for any reason in the sole discretion of each of the other members. Furthermore, any transfer or assignment of a membership interest must satisfy all the terms and conditions set forth in this section.”

The issues here only scratch the surface of the complexity of LLC law and operating agreements.

Volk Law Offices can help sort out that complexity. The benefit of thinking ahead is that when you think deeply about what can go wrong and manage the risks, you are much less likely to face the LLC divorce nightmare. 

This is general information and not legal advice on which you should rely, especially because this area is so complicated. They say a little knowledge is a dangerous thing. Get quality legal advice in setting up or improving your business. Volk Law Offices can help you manage risk and add efficiencies to your business venture. 

ABOUT THE AUTHOR

David J. Volk, Esq., has conducted approximately 85 trials and more than 800 hearings as sole or lead counsel. Foundational principles such as faith, recognizing the need for mentors, humility, and never giving up is what has led Volk throughout his life and career as a lawyer and business owner.

He has a background of working in family-owned businesses, and this has been helpful in understanding how businesses are run. At the age of twelve, he went to work in his parents’ beverage warehouse with tasks such as sweeping floors, loading, unloading, and cleaning trucks, working in the icehouse, forklift operation, and checking in drivers receipts and money. He continued to stay active in the family business affairs up through graduating law school.

Other activities included helping with leasing, cleaning, and bookkeeping for commercial and residential rental properties; surface coal mining, including operating and servicing trucks and machinery; the sale, delivery, installation, and servicing of manufactured homes; and the construction of a mobile home park and commercial building.

Bar Admissions and Education

Florida Bar, West Virginia Bar, all Florida Federal District Courts, the Eleventh Circuit Court of Appeals, and the United States Supreme Court. Former partner in what was Brevard County’s largest firm Reinman, Harrell, Graham, Mitchell & Wattwood, P.A. and established Volk Law Offices, P.A. in December of 1994. West Virginia University Bachelor of Science degree in business administration (accounting major) 1983 and juris doctor degree from that school’s College of Law 1987. Member: Moot Court Board and Lugar Trial Association. Legal research and writing teaching assistant while in law school. 

For more information, visit VolkLawOffices.com or call 321-726-8338.

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