New York Small Business Law

All you Need to Know About: The LLC Operating Agreement

The LLC Operating Agreement is a key document for a business organized as a New York Limited Liability Company, especially if that business has more than one owner (the owners are "Members" in LLC terminology). If an LLC business was like a marriage, the LLC Operating Agreement would be like a prenup, parenting agreement and divorce settlement all in one.

Why you should have an LLC Operating Agreement:  

While the New York limited liability company law provides for some default rules applicable to LLC businesses that do not have an LLC operating agreement in place, the members of the business are well advised to craft their own rules by way of an LLC Operating Agreement (which is actually required by law in New York, Section 417).  The members of the LLC business are given great flexibility to regulate their rights and responsibilities with respect to the LLC, management of the LLC and pretty much everything else that concerns the LLC and the LLC Members. Only very few rules in the NY LLC law cannot be modified by an Operating Agreement.

The LLC Operating Agreement sets forth the rules that apply to the members of the LLC and the management of the LLC.   It should give answers to the following questions:

Who owns what of the LLC business?  Who contributes what to the business of the LLC?  Who gets how much of the business profits of the LLC?  When are LLC business profits to be distributed?

See:  Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

How are the members to manage the day to day affairs of the LLC business?  Are there specially appointed Managers to manage the LLC business, rather than management by the LLC members?  Who can vote on non day to day, monumental business decisions affecting the LLC business?  

See: Management Provisions in an LLC Operating Agreement

Who has which responsibilities regarding the business of the LLC?  What other obligations do the LLC members have to the business and to the other LLC members?

See: LLC Member Obligations in an LLC Operating Agreement

What happens if an LLC member wants to leave the LLC Business or sell his or her membership interest?  How can new LLC members join the club?  Should the LLC members be allowed to force someone to leave the LLC Business?

See: Buy Sell Provisions in an LLC Operating Agreement

How can the LLC be dissolved?  What happens upon dissolution of the LLC and how are the assets to be distributed?

All these and more are questions to be addressed in an LLC Operating Agreement.  Ideally, you should hire a business attorney who specializes in startup matters and LLC operating agreements to draft your LLC operating agreement.  However, an educated client is the best client and knowledge of the key issues in an LLC Operating Agreement is key for efficient cooperation with a business attorney.

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 **This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**

Buy Sell Provisions in an LLC Operating Agreement

While many LLC Operating Agreements are silent on this point, it is a good idea to include so called Buy Sell provisions in the LLC Operating Agreement.

Buy Sell provisions set forth what is going to happen when an LLC Member wants to leave the LLC, dies, is unable to continue his or here duties, declares bankruptcy,  wants to sell his or her interest to an outsider, or when the LLC members are hopelessly deadlocked in the management of the LLC.  All of these scenarios could seriously harm the LLC or the remaining members.

The most common buy sell provision is probably the so called right of first refusal, which would provide that an owner can sell his LLC membership interest to an outsider if he or she has first offered it to the LLC or the remaining LLC members and such members declined.

Then there could be provisions forcing a buy out of an LLC member if such member has committed a serious breach of his obligations against the LLC.  Or, in case of a professional LLC, if any member has lost his license to practice the profession of the LLC.

In each buy-out situation it is important to have terms that provide the exact mechanism of a sale and exit of an LLC member as well as the method of determining a price for the LLC membership interest.  

It is also common to limit the price being paid for an LLC membership interest under certain circumstances.  For example, if a member decides to leave before the expiration of a certain period after formation of the company, he may not be able to get much if anything for his interest, since he or she hasn't put in enough effort to have earned it.
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Related Posts:

All you Need to Know About:  The LLC Operating Agreement

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

Management Provisions in an LLC Operating Agreement

LLC Member Obligations in an LLC Operating Agreement

**This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**

LLC Member Obligations in an LLC Operating Agreement

These days, LLCs are often founded around a brilliant idea which requires a lot of development, creation and "sweat equity."  As a consequence, it is a good idea to include certain obligations of the LLC members in the LLC Operating Agreement.

Confidentiality

Each member should be obliged to keep all LLC business confidential.

Non- Competition

Members should be restricted from competing with the business of the LLC or soliciting employees, vendors or customers away from the LLC to another business venture.  Note though, that restrictive covenants like non compete provisions and non solicitation provisions have to be reasonable to be enforceable in court. 

Intellectual Property

If the LLC members are creating intellectual property on behalf of the LLC (software, designs, innovative methods of doing anything), the LLC Operating Agreement must set forth that all such intellectual property has to be immediately assigned to the LLC and is not and will not be the property of the individual LLC members.

Participation in the LLC Business

The LLC Operating Agreement could  set forth that certain members have distinct responsibilities with respect to the operation of the LLC.  For example, it could provide that A is responsible for research and development and B for sales and marketing.  If the agreement was silent, you could potentially have the situation that A works 24 hours a day to make things happen and B sits around and does nothing.  Without obligations in the LLC Operating Agreement, A could do nothing about B's inactivity.  

 

Related Posts:

All you Need to Know About:  The LLC Operating Agreement

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

Management Provisions in an LLC Operating Agreement

Buy Sell Provisions in an LLC Operating Agreement

**This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**

Management Provisions in an LLC Operating Agreement

Management provisions in the LLC Operating Agreement deal with the management of the LLC business, which basically means decision making for the LLC business. There are ordinary business decisions (think: buying copy paper at Staples, landing another customer, paying employees....) and extraordinary business decisions, such as obtaining financing for the LLC business, selling major equipment, taking in a new owner, i.e. a new LLC member, merging with another business, and so forth.

Default NY LLC law Rules: Management by Members

As per NY LLC Law, by default, the LLC is managed by its Members (Section 401) and each Member has authority to make ordinary business decision for the LLC and bind the LLC (i.e. enter into contracts in the name of the LLC) in connection with such ordinary type decisions. Extraordinary business decisions, however, require a formal authorization by the LLC Members (Section 412). The formal authorization can be by majority vote of the LLC Members in a meeting or by written consent.

Management by Managers

If you set forth in the LLC's Articles of Organization (the document that was filed with the Secretary of State in Albany in connection with the formation of the LLC), that the LLC shall be managed by Managers, New York law has a second set of default rules applicable to the management of the LLC. In that case, the Manager(s) have the authority to make ordinary business decision for the LLC and bind the LLC (i.e. enter into contracts in the name of the LLC) in connection with such ordinary type decisions. Extraordinary business decisions require a formal authorization by the Manager(s). If there is more than one Manager, a majority vote or written consent constitutes such formal authorization.  In that case, the LLC Members do not have any authorization to manage the day to day business affairs of the Company.

However, some extraordinary business decisions still require the consent by the LLC Members. The law has a list of such extraordinary events (admit a person as a Member, dissolve the LLC, and so forth, look in Section 402 (c) and (d)).

Drafting your own Rules

When you read the NY LLC law, it almost always states “except as provided in the operating agreement…). This is your ticket to draft your own rules with respect to the management of your LLC.

Here are common matters written into LLC Operating Agreements with respect to the management of the LLC business:

No required Annual Meetings

By default, under NY LLC Law, meetings of LLC Members must be held annually. In order to keep administration of the LLC lean and mean, many LLC founders decide to NOT require annual meetings of the LLC members and state as much in the LLC Operating Agreement.

Board of Managers

LLCs with many Members or Members who are not involved in the day-to-day management of the LLC can provide for a Board of Managers, similar to the structure in corporations.

LLCs can establish committees with responsibilities designated by the Board of Managers, Officers with special titles, such as President, Vice President and others.

In that context, you can provide how many people should be on the Board of Managers and who are the initial persons to serve on the Board of Managers.

You can provide for special veto rights by certain people, how Managers are to be elected, how they should be replaced or fired, if necessary.

In LLCs with only a few involved LLC Members and no Managers, you would also set forth who of the Members has authority to decide about day-to-day LLC business decisions and bind the LLC in contracts and agreements.  You could also provide for certain areas of responsibilities assigned to each managing LLC Member, like Joe is responsible for the LLC's marketing and Jack for sales and distribution of the LLC.

Retained Voting Rights of LLC Members

You can set forth a list of LLC business decisions that are so important to your LLC that they always require a vote by the LLC Members, despite management of the LLC by Managers or a few select Members.  In that respect, you would also provide the level of consent that is required (majority, super majority, or unanimous consent) for such decisions.

Voting Requirements

How many votes does each LLC Member or Manager have when it comes time to take a vote? The default rule for member managed LLCs under NY LLC Law: The Members vote in proportion to each Member’s share of profits.  Example: Joe gave $10,000 as startup capital to the LLC and Jack gave $90,000.  Joe gets 10% of all the profits of the LLC and Jack gets 90%.  Joe gets 10% of the votes and Jack gets 90%, i.e. in matters requiring majority consent, Jack would always have the last word.

You can change voting requirements for the LLC in numerous ways.  There can be special groups of LLC Members who have voting rights different from other LLC Members and independent of their economic interest in the Company.  There can even be LLC Members who have no voting rights at all.

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Related Posts:

All you Need to Know About:  The LLC Operating Agreement

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

LLC Member Obligations in an LLC Operating Agreement

Buy Sell Provisions in an LLC Operating Agreement

**This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**

 

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

The LLC Operating Agreement will have provisions stating what the LLC members have contributed upon formation of the LLC.  Contributions can be in the form of money, property or services.  While not a contribution per se, the Operating Agreement can also provide that the LLC members may have the right to grant loans to the LLC.

Read more about Capital Contributions in Funding the Company.

The LLC Operating Agreement further has to address the economic ownership rights of its LLC members.  (Economic ownership rights are usually distinguished from the voting and management rights of the LLC members.)

There is equity ownership in the LLC which represents the LLC member's right to share in what is left over of the company upon its dissolution or if it were to be sold as a whole to another person or entity.  

Then there is the right to receive distributions of the LLC's profits as it goes along and makes money.  LLC members have a right to receive their share of profits, i.e. money left over from the revenues of the LLC's business after expenses.

In the most common scenario, LLC members share equity ownership and profit distribution rights equally.  For example, if A and B each own 50% of the LLC and nothing else is stated in the Operating Agreement, A and B would each have a right to 50% of the equity ownership and the profit distribution rights.

But it is the beauty of the LLC, that the Operating Agreement can provide otherwise.  For example, if A contributed $50,000 to the starting capital of the LLC and B nothing, they could agree that they both own 50% of the equity ownership of the LLC, but that A will initially receive ALL the profit distributions of the LLC until he has received back his initial capital investment.  

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Related Posts:

All you Need to Know About:  The LLC Operating Agreement

Management Provisions in an LLC Operating Agreement

LLC Member Obligations in an LLC Operating Agreement

Buy Sell Provisions in an LLC Operating Agreement

**This post is for informational purposes only.  For actual legal advice contact a business lawyer, business attorney or business law firm**

S-Corporations and the Old Low Salary Trick

Some people are in love with the s-corporation, because they think they can save a bunch on Medicare and Social Security tax (aka self-employment tax).  Here is how that "trick" goes:

Working owners of "flow-through" entities (such as s-corporations and LLCs) are responsible for 12.4% social security tax on the first $106,800 and 2.9% medicare tax on all income paid to them.

The owner of an s-corporation can theoretically save on these taxes by structuring the distribution of the s-corporation's income partly as profit distribution and partly as salary paid to the owner.  As a consequence, the owner will only pay self-employment tax on the part he called "salary."  Obviously, you can save a lot by paying yourself only a very low salary.  

This strategy (paying a low salary) is promoted by many accountants and given as the main reason to chose an s-corporation rather than an LLC when starting a business. But does it work?  Not, if the salary is too low.

The IRS, of course, may challenge this approach in an audit and claim that the salary that was paid to the owner was too low and thus depriving the government of self-employment tax.  As the Wall Street Journal reports, it happened to this accountant and he lost the fight against the IRS.

 **This post is for informational purposes only,  For legal advice contact a business lawyer**

New York LLCs and Privacy Concerns

Some people are very concerned about their privacy and don't want the public to be able to determine their ownership of a New York Limited Liability Company.  No worry, this can be arranged and nobody needs to know who is the owner of a New York Limited Liability Company.

The only document that is filed with the New York Division of Corporations, and thus publicly available, is the articles of organization.  The articles do have to give an address where process has to be served, in case the LLC is being sued.  However, this address can be the address of your lawyer who formed the LLC or a registered agent.  Your name does not have to appear anywhere on the articles of organization.

The operating agreement of the limited liability company will have to state your name, because unless you are stated as a member in such operating agreement, you are, in fact, not a member and don't own any piece of the LLC.  However, this document is private and only in your records.  Unless you are forced to disclose it (tax audit, legal action), you will not have to show it to anyone.

 

 

**This post is for informational purposes only,  For legal advice contact a business lawyer**

Do you have to date a written Contract? - and other burning New York contract questions

Do you have to date a written contract?

No.  You should date the contract as a matter of fact, but if you don't, you still have a valid and enforceable contract.

Can you predate or postdate a contract?

Yes.  If you do so, by stating something like "agreement between x and y, dated as of ____", it means that the contract will be effective, i.e. in effect/enforceable, as of that date.

Do you have to notarize a contract?

No.  In any event, the notary would not notarize the contract, but only attest that the signatures on the contract are the signatures of the person named as a signatory to the contract.  You could require (i.e. it is optional) notarization of signatures, if you want to have super solid evidence that the person claiming to sign the contract is really that person.  But it is really uncommon to do that, unless you are dealing with million dollar contracts.

Speaking of signatures, what is that exactly?

A “signature” can be any mark, stamp, writing (and so forth) on a document, as long as it was put there with the intent to execute such document.  An “electronic signature” is an electronic sound, symbol, or the like, connected with an electronic record, which was implemented by a person with the intent to execute or sign the electronic record.  

In most cases, regular signatures and electronic signatures are valid for contract executions.

What if the contract hasn't been signed by the parties?

An unsigned contract may be enforceable, provided there is objective evidence establishing that the parties intended to be bound.  Exception:  Where the parties to a contract make actual signing a condition to the effectiveness of the contract, there is no contract until they have signed, although all the terms have been agreed on.  

Do I have to keep an original copy of the contract?

No, a scanned copy of the contract with the signatures on it should be fine. 

 **This post is for informational purposes only,  For legal advice contact a business lawyer**

Corporate Record Keeping - Company Records Explained

Filing a certificate of incorporation  in New York is the beginning point of a corporation (or articles of incorporation in Delaware).  Unfortunately, this is where it often ends for many small business owners.  Too many neglect the additional paperwork that is needed to keep the corporate house in order and keep the corporate shield of limited liability intact. I have written about corporate books before (as I had almost forgotten), but this is a new take on it and a much needed update, since I suspect there are still many small business companies out there that have nothing of this set up properly.  If you don't want to learn how to do it, have a business lawyer explain it to you, or better, make a business lawyer keep your records as a secretary of the corporation.  The lawyer or his or her assistant can do this very quickly and efficiently.  

While no fancy leather bound binder and seal is required, one should have some sort of binder with the following tabs and papers:

1. Articles/Certificate of Incorporation

Under this tab, in New York, one files the certificate of incorporation, in Delaware, the Articles of Incorporation, usually a certified copy of the one registered with the Department of State, Division of Corporations.  This is a public document and anybody can order a copy to look at it.  Along with with the certificate of incorporation, you should file the filing receipt, which you received from the Division of Corporations right after filing the certificate or the articles.

2. Bylaws

Each corporation must have by-laws, which are the rules that govern the inner workings of the corporation; how many officers/directors are allowed, how are they elected/removed; how are meetings of shareholders to be conducted...and so forth.   The by-laws of a corporation are not public, but they must be in your corporate binder.  If, against my advice, you used a non attorney formation service, they may have sent you a set of standard by-laws, which may or may not be all you need.  

3.  Minutes

The tab called minutes should contain all records relating to shareholder meetings or consents and director meetings or consents.  At a minimum, at the start of the corporation, it should have papers documenting the "organizational meeting."  This is where the "incorporator", the person who signed the certificate of incorporation and filed it in Albany does certain things:  Adopts By-laws of the corporation and appoints the first director(s) of the corporation.  This "meeting" can be done in writing and be a one page document signed by the incorporator, See example here.

Then there should be minutes of the first meeting of the directors, where the directors approve the actions of the incorporator, decide to open a bank account, authorize the issuance of shares...and so forth.   See this example.

As the corporation lives on, this tab will also hold all annual shareholder and director meeting minutes and any other meetings where the corporation made certain decisions through its directors and shareholders.

4. Stock Certificates 

In most cases, if you don't have a stock certificate showing your name on it, you don't any piece of the corporation.  No matter what anybody told you how much of the company you own, you must have a share certificate showing it.  If you are the sole owner of the company, you can put your stock certificate here.  This tab will also hold blank certificates that can be issued to new shareholders at a later time.

5. Stock Transfer Ledger

 A Stock Ledger is a register that tracks any issuance of stock, by listing the number of shares issued, date of issuance or transfer, the name and address of the shareholders and so forth.   

 

**This post is for informational purposes only,  For legal advice contact a business lawyer**

Getting Paid - Debt Collections

I don't need to tell you that getting paid by your customers for whatever your small business is offering for sale should be your number one concern.  Here are some pointers for handling this most important aspect of your small business.

Prevention, Prevention, Prevention

Ask for money in advance, whenever possible.  Ask for periodic advance payments, whenever a mile stone has been reached or come up with other periodic payment dates after partial performance.  Send invoices as soon as possible.  Have an agreement with your customer that clearly, unmistakably, sets forth WHEN and HOW MUCH your customer has to pay.  More on that below.

As soon as your customer is late on payment, follow up and start the collection process.  Resend the original invoice periodically, which then, under certain circumstances (check with your lawyer), can become an "account stated" and makes it easier to ultimately collect in court.

But don't harass the customer and consider having someone else make the reminder call in order to protect your relationship with the customer.

Investigation

Once a debtor is unresponsive to all your preliminary debt collection attempts (repeated invoices, calls), do some intelligence work to find out if your debtor has money or assets to pay his or her debt.  You can get a credit report on them (Permissible Purpose to get Credit Report).  

Find out if the debtor has litigation pending by checking the available court resources: For example, Civil Court of New York City, Supreme Court.  Many other courts have ways to check online whether your debtor is already a defendant in any court case.

You do this investigation to avoid spinning your wheels where a debtor is judgment proof, i.e. it would be a waste of time and money to go after them, because they have essentially nothing.

Collection

At this point, you could hire a collection agency to collect the debt for you.    They will usually charge a percentage of the debt.  If the debt is less than 90 days old, the charges may be less.  See here for one debt collection agency's rates (no affiliation, whatsoever).  This goes to show again, that making collecting your outstanding invoices a priority as soon as a customer is late, can mean a difference in actual dollars.

Going to Court

I am sorry, if you actually have to go this far.  In court, you will have to present hard facts, in particular, a legal basis for your claim for money.  In most cases, this will be an enforceable contract between you and your debtor.  As I stated above, it is crucial that you have valid and enforceable agreements with your customers.  This doesn't always mean a lengthy written agreement, it can be the terms and conditions on your website, if the customer is aware of them and agreed to them; the writing on your order forms and so forth.  Most important is that you can show that your customers agreed to your terms.  A signature is best, a click on something on your website that states "by clicking on this you agree......." may work, but this is an area where you can really use a lawyer to make sure that your customer arrangements will hold up in court.  

Aside from the legal implications, for customer relations and avoidance of surprises and disputes, it is also crucial that your customers KNOW what and when they owe you money.  So make whatever agreements or terms you have, very clear and visible.