Thursday, April 2, 2015

Key Legal Documents for Startups and Entrepreneurs

Earlier this week I went to a really useful workshop conducted by the Venture Law Project and David Salmon entitled "Key Legal Docs Every Entrepreneur Needs." I decided to attend because I wanted to make sure that I’m on target with what I am teaching in Business Associations, and because I am on the pro bono list to assist small businesses. I am sure that the entrepreneurs learned quite a bit because I surely did, especially from the questions that the audience members asked. My best moment, though was when a speaker asked who knew the term "right of first refusal" and the only two people who raised their hands were yours truly and my former law student, who turned to me and gave me the thumbs up.

Their list of the “key” documents is below:

1)   Operating Agreement (for an LLC)- the checklist included identity, economics, capital structure, management, transfer restrictions, consent for approval of amendments, and miscellaneous.

2)   NDA- Salmon advised that asking for an NDA was often considered a “rookie mistake” and that venture capitalists will often refuse to sign them. I have heard this from a number of legal advisors over the past few years, and Ycombinator specifically says they won't sign one.

3)   Term Sheets- the seminar used an example for a Series AA Preferred Stock Financing, which addressed capitalization, proposed private placement, etc.

4)   Independent Contractor Agreement- the seminar creators also provided an IRS checklist.

5)   Consulting Agreement- this and some other documents came from  Orrick's start-up forms page and ycombinator. FYI, Cooley Goddard also has some forms and guidance.

6)   Employment Agreement- as a former employment lawyer, I would likely make a lot of tweaks to the document, and vey few people have employment contracts in any event. But it did have good information about equity grants.

7)   Convertible Promissory Note Purchase Agreement- here's where the audience members probably all said, "I need an attorney" and can't do this from some online form generator or service like Legal Zoom or Rocket Lawyer.

8)   Stock Purchase Agreement- the sample dealt with Series AA preferred stock.

9)   IRS 83(b) form- for those who worry that they may have to pay taxes on "phantom income" if the value of their stock rises.

10) A detailed checklist dealing with basic incorporation, personnel/employee matters, intellectual property, and tax/finance/administration with a list of whether the responsible party should be the founders, attorney, officers, insurance agent, accountant, or other outside personnel.

What’s missing in your view? The speakers warned repeatedly that business people should not cut and paste from these forms, but we know that many will. So my final question- how do we train future lawyers so that these form generators and workshops don't make attorneys obsolete to potential business clients?

 

April 2, 2015 in Business Associations, Corporate Finance, Corporations, Entrepreneurship, Law School, LLCs, M&A, Marcia Narine, Teaching, Unincorporated Entities | Permalink | Comments (4)

Thursday, March 19, 2015

This I Believe: On Corporate Purpose and the Business Judgment Rule

Prof. Bainbridge yesterday posted about The Modern Corporation Statement on Company Law.  The statement has ten fundamental rules, of which number ten is:

Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximise profits for their shareholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as a separate entity, even if this does not entail seeking to maximise short-term shareholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist shareholders, the threat of a hostile takeover and/or stock-based compensation schemes.

Prof. Bainbridge is with Delaware Chief Justice Strine in that profit maximization is the only role (or at least only filter) for board members.  As he asserts, “The relationship between the shareholder wealth maximization norm and the business judgment rule, . . . explains why the business judgment rule is consistent with the director's  "legal obligation to maximise profits for their shareholders." 

CJ Strine has noted that the eBay decision, which I have written about a lot, says that if “you remain incorporated in Delaware, your stockholders will be able to hold you accountable for putting their interests first.”  I think this is right, but I remain convinced that absent self-dealing or a “pet project,” directors get to decide that what is in the shareholders best interests.

I have been criticized in some sectors for being too pro-business for my views on corporate governance, veil piercing law, and energy policy.  In contrast, I have also been said to be a “leftist commentator,” in some contexts, and I have been cited by none other than Chief Justice Strine as supporting a “liberal” view of corporate norms for my views on the freedom of director choice. 

When it comes to the Business Judgment Rule, I think it might be just that I believe in a more hands-off view of director primacy more than many of both my “liberal” and “conservative” colleagues. Frankly, I don’t get too exercised by many of the corporate decisions that seem to agitate one side or the other.  I thought I’d try to reconcile my views on this in a short statement. I decided to use the model from This I Believe, based on the 1950s Edward R. Murrow radio show.  (Using the Crash Davis model I started with was a lot less family friendly.) Here’s what I came up with [Author's note, I have since fixed a typo that was noted by Prof. Bainbridge]:   

I believe in the theory of Director Primacy.  I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies.  I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions—such as closing on Sundays—and that a corporation can make worker-based decisions—such as providing top-quality health care and parental leave—but I believe both such bases for decisions must be rooted in the directors’ judgment such decisions will maximize the value of the business for shareholders for the decision to get the benefit of business judgment rule protection. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability.  I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views—from CVS Caremark and craigslist to Wal-Mart and Hobby Lobby—without necessarily violating any shareholder wealth maximization norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter because liberal and conservative business leaders have both been responsible for massive long-term wealth creation.  This, I believe.      

March 19, 2015 in Business Associations, Corporate Governance, Corporate Personality, Corporations, CSR, Delaware, Joshua P. Fershee, LLCs, M&A, Social Enterprise | Permalink | Comments (5)

Thursday, February 12, 2015

“We Just Can’t Get Enough of Business Associations”

My seventy business associations students work in law firms on group projects. Law students, unlike business students, don’t particularly like group work at first, even though it requires them to use the skills they will need most as lawyers—the abilities to negotiate, influence, listen, and compromise. Today, as they were doing their group work on buy-sell agreements for an LLC, I started drafting today’s blog post in which I intended to comment on co-blogger Joan Heminway’s post earlier this week about our presentation at Emory on teaching transactional law.

While I was drafting the post, I saw, ironically, an article featuring Professor Michelle Harner, the author of the very exercise that my students were working on. The article discussed various law school programs that were attempting to instill business skills in today’s law students. Most of the schools were training “practice ready” lawyers for big law firms and corporations. I have a different goal. My students will be like most US law school graduates and will work in firms of ten lawyers or less. If they do transactional work, it will likely be for small businesses.  Accordingly, despite my BigLaw and in-house background, I try to focus a lot of the class discussion and group work on what they will see in their real world.

I realized midway through the time allotted in today’s class that the students were spending so much time parsing through the Delaware LLC statute and arguing about proposed changes to the operating agreement in the exercise that they would never finish in time. I announced to the class that they could leave 10 minutes early because they would need to spend at least another hour over the next day finishing their work. Instead most of the class stayed well past the end of class time arguing about provisions, thinking about negotiation tactics with the various members of the LLC, and figuring out which rules were mandatory and which were default. When I told them that they actually needed to vacate the room so another class could enter, a student said, “we just can’t get enough of business associations.” While this comment was meant to be a joke, I couldn’t help but be gratified by the passion that the students displayed while doing this in-class project.  I have always believed that students learn best by doing something related to the statutes rather than reading the dry words crafted by legislators.  My civil procedure students have told me that they feel “advanced” now that they have drafted complaints, answers, and client memos about Rule 15 amendments.

I am certainly no expert on how to engage law students, but I do recommend reading the article that Joan posted, and indeed the whole journal (15 Transactions: Tenn. J. Bus. L. 547 (2014). Finally, please share any ideas you have on keeping students interested in the classroom and prepared for the clients that await them. 

 

February 12, 2015 in Business Associations, Business School, Conferences, Corporations, Delaware, Joan Heminway, Law School, LLCs, Marcia Narine, Negotiation, Teaching, Unincorporated Entities | Permalink | Comments (1)

Wednesday, January 7, 2015

BA/Corporations -- New Media Teaching Resources

I had very limited time at AALS this year (unfortunately) but I still walked away with some great ideas (and a chance to say hello to a few, but not enough, friendly faces).  I am borrowing from many ideas shared in the panel cited below, as well as a few of my own.  As many of you prepare to teach BA/Corporations for the spring (or making notes on how to do it next time), here are a few fun new resources to help illustrate common concepts:

  • HBO's The Newsroom.  A hostile takeover, negotiations with a white knight-- all sorts of corporate drama unfolded on HBO's Season 3 of The Newsroom.   I couldn't find clips on youtube, but episode recaps (like this) are available and provide a good reference point/story line/hypo/exam problem for class.
  • This American Life-- Wake Up Now Act 2 (Dec. 26, 2014).  This brief radio segment/podcast tells the story of two investors trying to reduce the pay of a company CEO.  The segment discusses board of director elections, board duties, board functions and set up some large questions about whether or not shareholders are the owners of the corporation and their profit maximization is the ultimate goal for a company.  This could be followed with Lynn Stout's 2012 NYT Dealbook article proposing the opposite view.
  • HBO's Silicon Valley.  For all things tech, start up, entrepreneurship and basic corporate formation, clips (you will want to find something without all of the swears, I suspect) and episode recaps from this popular show illustrate concepts and connect with students.  Again, great for discussion, hypos, and exam fact patterns.
  • The Shark Tank!.  I have to thank Christyne Vachon at UD for this idea.  There are tons of clips on youtube and most offer the opportunity to talk about investors bringing different things to the table, how to apportion control, etc.  Here is an episode involving patent issues. I think that I am going to open my experiential Unincorporated/Drafting class with a Shark Tank clip on Monday.  
  • Start Up Podcasts.  These 30-minute episodes cover a wide range of topics. Here is one podcast on how to value a small business.   At a minimum, I will post some of these to my course website this spring.  (Thank you Andrew Haile at Elon for this recommendation.).
  • Planet Money.  The podcasts are a great resource, but what I love is the Planet Money Twitter page because it is a great way to digest daily news, current events and topical developments that may be incorporated into your class.
  • Wall Street Journal--TWEETS.  (that felt like an oxymoron to write). Aside from the obvious, I find the Twitter feed to be the most useful way to use/monitor the WSJ.  I will admit it, I don't "read" it every day, but this is my proxy.

Special thanks to the participants in the Agency, Partnership & the Law's panel on Bringing Numbers into Basic and Advanced Business Associations Courses: How and Why to Teach Accounting, Finance, and Tax

Moderator: Jeffrey M. Lipshaw, Suffolk University Law School
Speakers:
Lawrence A. Cunningham, The George Washington University Law School
Andrew J. Haile, Elon University School of Law
Usha R. Rodrigues, University of Georgia School of Law
Christyne Vachon, University of North Dakota School of Law
Eric C. Chaffee, University of Toledo College of Law
Franklin A. Gevurtz, University of the Pacific, McGeorge School of Law

And Happy New Year BLPB Readers!

-AT

January 7, 2015 in Anne Tucker, Business Associations, Corporations, Current Affairs, Entrepreneurship, LLCs, M&A, Unincorporated Entities | Permalink | Comments (3)

Tuesday, January 6, 2015

Larry Ribstein Being Right Doesn't Make Anyone Else Wrong

Over at The Conglomerate, Usha Rodrigues says, "Larry Ribstein was wrong." Usha argues that she's right to teach LLCs at the end of the course, and Larry was of the mind that LLCs should play a more prominent role in the business entities course.  

For my teaching, I'm with Larry on this, though I am also of the mind that Usha (and other teachers) may have different goals, so taking another tack is not wrong.  I'm pretty sure we're all better teachers when we are true to ourselves and our thinking.  For me, anyway, I am, without a doubt, at my worst in the classroom (and probably out) when I try to mimic someone else. 

So here's how Usha explains her thinking:

I don't leave LLCs til the end of the semester because I think they're unimportant.  It's because the cases are so damn thin.  It's still such a new form, I just don't see much there there.  Most of them wind up being trial courts who read the statute in completely stupid ways.  Blech.

 

So I teach corporations and partnerships emphasizing fiduciary duty, default vs. mandatory rules, and the importance of the code.  In fact, one semester I confess that I would ask a question and then intone, "Look to the code!" so often I felt like a Tolkien refugee.  By the time I get to the LLCs cases, which are pretty basic, the class is ready for my message: the LLC is a new form.  When dealing with something new, judges look both to the organizational statutes and to the organizational forms they know as they shape the law.  Plus the LLC is such an interesting mix between the corporate and partnership form, it just makes sense to get through them both before diving in.

It's hard to argue with Usha's rationale.  Like Larry, she's smart, and this is a reasonable take.  For me, though, it doesn't work toward my goals, so I have a different point of view.  I think it's more in line with where Larry was coming from, though I admit I don't know.  

Here's why:  I want students (and lawyers and courts) to treat LLCs as unique entities.  Leaving them to the end of the course reinforces the idea that LLCs are hybrid entities the combine partnerships and corporations.  I just don't think that's the right way to think about LLCs.  

Certainly, it is true that LLCs share characteristics of partnerships and corporations.  But partnerships and corporations can have similarities, too. We can, for example, refer back to the partnership case of Meinhard v. Salmon when discussing corporate fiduciary duties and corporate opportunity.

In my experience, teaching LLCs at the end of the course seemed to frame the LLC as an entity that is just pulling from partnership or corporate law.  As such, it seemed the students were thinking that the real challenge for LLCs was figuring out whether to pull from partnership law or corporate law for an analogy.  Part of the reason for that, I think, is that so many of the LLCs cases seem to think so, too.  See, e.g., Flahive.  As Usha would say, "Blech."

The LLC is prominent enough in today's world that I think it warrants a more prominent role in the introductory business organizations course.  If we don't bring the LLCs more to the fore, we allow courts to continue to misconstrue the entity form, in part because we aren't giving students the tools they need to ensure courts understand the unique nature of the LLC. 

I figure Usha can get students where she needs to on this regardless of how she teaches business associations.  She is a lot smarter than I am.  Given my goals and how I think about the LLC, though, I'll keep starting my class with an introduction to LLC formation, and I'll keep teaching LLC cases and issues throughout the semester.  

January 6, 2015 in Business Associations, Corporations, Joshua P. Fershee, LLCs, Partnership, Teaching | Permalink | Comments (2) | TrackBack (0)

Tuesday, December 30, 2014

Courts and the LLC, End of the Year Edition

I continue to document how courts (and lawyers) continue to conflate (and thus confuse) LLCs and corporations, so I did a quick look at some recent cases to see if anything of interest was recently filed. Sure enough, there are more than few references to "limited liability corporations" (when the court meant "limited liability companies."  That's annoying, but not especially interesting at this point.  

One case did grab my eye, though, because because of the way the court lays out and resolves the plaintiffs' claim.  The case is McKee v. Whitman & Meyers, LLC, 13-CV-793-JTC, 2014 WL 7272748 (W.D.N.Y. Dec. 18, 2014).  In McKee, theplaintiff filed a complaint claiming several violations of the Fair Debt Collection Practices Act against defendants Whitman & Meyers, LLC and Joseph M. Goho, who failed to appear and defend this action, leading to a default judgment. After the default judgment was entered, defense counsel finally responded.  

This case has all sorts of good lessons.  Lesson 1: don't forget that all named parties matter.  Get this: 

Defense counsel admits that he was under the mistaken assumption that default was to be taken against the corporate entity only. See Item 17. However, default was entered as to both the corporate and individual defendants on July 3, 2014 (Item 9). Defense counsel did not move to vacate the default and in fact did not respond in any way until the default judgment was entered on September 17, 2014. Item 12. Even then, the defense motion was framed as one for an extension of time in which to file an answer (Item 14), rather than a motion to vacate the default or default judgment. Inexplicably, in his papers, defense counsel states that a default judgment has not been entered. See Item 17. Since good cause is to be construed generously and doubts resolved in favor of the defaulting party, see Enron Oil Corp., 10 F.3d at 96, the court will accept the explanation of defense counsel as evidence of a careless lack of attention to procedural detail rather than an egregious and willful default on the part of defendant Goho [the individual and apparent owner of the LLC].
McKee v. Whitman & Meyers, LLC, No. 13-CV-793-JTC, 2014 WL 7272748, at *1 (W.D.N.Y. Dec. 18, 2014).  A link to a free version of the case is here.
 
Wow.  I concede there are some procedural details here, but this sure sounds substantive to me, as well.  
 
Lesson 2: if you name someone in the caption, you probably want to have some allegations about them as a defendant.  Fortunately for defense counsel, the plaintiff's counsel was not on the ball, either.  Though Goho was named in the caption, the complaint did not describe Goho as a party or contain allegations about Goho's individual liability for the FDCPA violations. The defendant's Prayer for Relief also only sought judgment from the Whitman & Myers, LLC. (The court conveniently skips the fact that court probably should have noticed these deficiencies the first time around, before entering default judgment against Goho.)  

Finally, the moment regular readers (see, e.g.,  here, hereherehere, and here) saw coming:
 
Lesson 3: You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One.  The plaintiff argued that "the court should pierce the corporate veil and hold defendant Goho personally liable." The court's response: "[T]here is nothing on the face of the complaint or in the record that would support individual liability for defendant Goho on the basis of corporate veil-piercing . . ."  
 
The court is, of course, correct. However, the sentence should be followed by one that says, "This is because there is no corporation named as a party to this case, so there is no corporate veil to pierce."  Obviously, the court could have gone on to note that even if the plaintiffs meant for the court to pierce the limited liability veil of the LLC, the allegations were insufficient for that, too.
 
As a side note, it would have been interesting to see how the court would have dealt with the argument that Goho and his LLC were so intertwined that they share legal counsel and that even his own counsel did not immediately recognize the individual and the entity as separate until after default judgment was entered.  (I don't see that as a winning argument, but it's better than what was argued.) 
 
Moving forward, I'd like to see courts tell plaintiffs that a request to "pierce the corporate veil" of an LLC amounts to a failure to state a claim.  The court should allow counsel to amend the complaint to get the language right. Until there is a consequence, even a minor one, for merging LLCs and corporations, attorneys and courts will continue to get it wrong.  
 
Thus, a New Year's Resolution for Courts:  "We will treat corporations and LLCs as separate entity types."  And, please, after making sure to always call LLCs "limited liability companies," move on to creating separate veil piercing language.  

December 30, 2014 in Business Associations, Corporations, Haskell Murray, Joshua P. Fershee, LLCs, Unincorporated Entities | Permalink | Comments (2)

Tuesday, December 9, 2014

LLC Loophole Is Not Clearly a Loophole

The New York Times reports that LLCs have the ability to do things in New York politics that corporations cannot do: 

For powerful politicians and the big businesses they court, getting around New York’s campaign donation limits is easy.

. . .

Corporations like Glenwood are permitted to make a total of no more than $5,000 a year in political donations. But New York’s “LLC loophole” treats limited-liability companies as people, not corporations, allowing them to donate up to $60,800 to a statewide candidate per election cycle. So when Mr. Cuomo’s campaign wanted to nail down what became a $1 million multiyear commitment — and suggested “breaking it down into biannual installments” — the company complied by dividing each payment into permissible amounts and contributing those through some of the many opaquely named limited-liability companies it controlled, like Tribeca North End LLC.

It may appear unseemly to allow LLCs to do things corporations cannot do, but (as usual) I bristle at the implication that LLCs should be treated like corporations just because they are limited-liability entities. Perhaps LLCs and corporations should be treated the same for campaign purposes (and I am inclined to think they should be), but there are lots of reasons to treat LLCs differently than corporations, and it is not inherently "a loophole" when they are treated differently.

A loophole is an ambiguity or inadequacy in the law.  Here, the different treatment is not an ambiguity, though it is inadequate to limit funding in campaigns. However, it is not at all clear that the intent was to limit funding through LLCs.  The law was likely passed so that the legislature could say it did something to reform finance.  It did -- it closed the door for corporations and opened the door for LLCs.  Playing entity favorites is permissible, even if it's not sensible.  

LLCs and corporations are different entities, and different rules for different entities often makes a whole lot of sense.  And even when it doesn't make sense, the idea that different entities should have different rules still does. Let's not conflate the two concepts, even when decrying the impact. 

December 9, 2014 in Business Associations, Corporations, Current Affairs, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Tuesday, December 2, 2014

The Beginning of the End of Limited Liability?

Okay, so limited liability is probably not going away, though it appears that some would have it that way. "Eroding" is probably a better term, but that's less provocative.  

In a piece at Forbes.com Jay Adkisson has posted his take on the Greenhunter case  (pdf here), which I wrote about here. Mr. Adiksson is a knowledgeable person, and he knows his stuff, but he seems okay with the recent development of LLC veil piercing law in a way that I am not. For me, many recent cases similar to Greenhunter are off the mark, philosophically, economically, and equitably, in part because they run contrary to the legislation that created things like single-member LLCs.

One of my continuing problems with this case (as is often my problem with veil piercing cases), is that there are often other grounds for seeking payment other than veil piercing.  Conflating veil piercing with other theories makes veil piercing and other doctrines murkier. More important, they make planning hard.  Neither of these outcomes is productive.  

In Greehunter, Adkisson notes the court’s determination of the “circumstances favoring veil piercing.”  To begin:

+ There was a considerable overlap of the LLC’s and Greenhunter’s ownership, membership (which is really the same thing), and management. Plus, they used the same mailing address for invoices, and their accounting departments were the same folks.

Okay, first, a shared mailing address is a ridiculous test if we're going to allow subisidiaries at all.  Sharing an address or even sharing an accounting department shouldn't really matter for veil piercing.  This is really more of an enterprise liability-type issue, though the vertical nature of the entity relationship admittedly makes that harder.  However, because an LLC doesn't have to follow formalities this is an absurd test.  These facts also don’t, in any way, harm the plaintiffs. Make an agency claim or some other type of guarantor/reliance argument if there is one.  

+ The LLC didn’t have any employees of its own, but instead relied upon Greenhunter’s employees to actually do things, including to pay creditors. 

So what?  Would this be true of a joint venture between partnerships?  How about if there were just two LLC members – two people who never worked as employees the entity? Should veil piercing be okay then?  No. If there is an agency claim, make that.  If there is a guarantor claim, make that one. But this is not enough.  

+ The LLC really didn’t have any revenue separate from Greenhunter, since the LLC simply passed through all the revenue to Greenhunter, and Greenhunter only kicked back enough money to the LLC to pay particular bills.

So the LLC would not have any money at all but for that which was put into it by the corporation.  This was the structure at the time of deal and the set up at all times. If the creditor plaintiff were concerned, they should have raised that issue (and taken appropriate measures) earlier. 

+ Although the LLC contracted with Western to procure services for the benefit of the wind farm, it was Greenhunter that claimed a $884,092 deduction for that project on its tax return.

This is how pass-through tax entities work. If pass-through taxation should not be allowed or single-member LLCs should not be allowed, then fine, but that’s a policy question to be raised with the legislature. 

+ Greenhunter manipulated the assets and liabilities of the LLC so that Greenhunter got all the rewards and benefits (including tax breaks), but the LLC was stuck with the losses and liabilities.

This implies something was improperly taken from the LLC, but that's not really explained.  If there was an improper transfer of value out of the LLC that should have available for the creditors, then the corporation should have to put those funds (that value) back into the LLC for purposes of creditors.  That’s not veil piercing. If there’s not some kind of value that could be transferred back, then the claim doesn’t make sense. 

Mr. Adkisson continues:

If one looks a veil piercing law as fundamentally comprising two elements: (1) unity of ownership, and (2) the entity was used as a vehicle to commit some wrong, then the single-member LLC (and the sole shareholder corporation) starts out with one foot in the veil piercing grave.

This is exactly why single-member LLCs are fundamentally lousy asset protection vehicles, despite the gazillion ads appearing in sports pages and classifieds advertising “Form an LLC for Asset Protection!”

This doesn’t mean that single-member LLCs should never be used; to the contrary, they are frequently and properly used in a number of situations for reasons other than liability protection.

First, I suppose this would be right if the premise were accurate, but I don’t see it this way. I don't think a “unity of ownership” is the first element for veil piercing.  The above explanation is thus incomplete, and if a court follows it, the court would be wrong because it would be skipping the actual first part of the veil-piercing test.  The Greenhunter case explains the proper test:

The veil of a limited liability company may be pierced under exceptional circumstances when: (1) the limited liability company is not only owned, influenced and governed by its members, but the required separateness has ceased to exist due to misuse of the limited liability company; and (2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity. 

The Greenhunter court even quotes another recent Wyoming case in explaining the rule:

Before a corporation’s acts and obligations can be legally recognized as those of a particular person, and vice versa, it must be made to appear that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of such person and corporation has ceased, and that the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.

Ridgerunner, LLC v. Meisinger, 2013 WY 31, ¶ 14, 297 P.3d 110, 115 (Wyo. 2013) (quotation marks and citations omitted). 

Thus, it is more than a unity of ownership.  There needs to be no separate or individual nature for the entity to satisfy the first prong.  It’s not in any way a simple ownership test.  

Second, I agree that LLCs are hardly perfect for asset protection and I agree that LLCs or other separate entities can be useful for reasons other than liability protection.  Still, I find the idea that an LLC – a limited liability company – should be used for something other than “liability protection” to be an odd assertion.  One can more easily set up a general partnership or simply a division of an existing entity to accomplish goals of separateness, if that’s the only point.  Thus, one may choose an LLC for more than just limited liability purposes, but there’s no reason limited-liability protection wouldn't be a reason to choose an LLC.

The outcome of this case is, frankly, far less concerning to me than the rationale being put forth both in the case and some of the following analysis.  I have to admit much of Mr. Adkisson’s analysis is consistent with how many courts see it. I just continue to believe we can do better in the development of veil piercing doctrine, and if we did, we'd see less need for it. 

Creditors working with limited liability entities need to treat those entities as such.  Ask the parent entity (or an owner) for a guarantee, get a statement of guaranteed funding, or seek some other type of reassurance.  

As for courts, if you plan to pierce the veil of an LLC, fine, but please justify the veil piercing using specific reasons through specific application of the facts to the law. It’s more than unity of ownership, and it’s more than an inability to pay. Steve Bainbridge once noted (citing Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519, 524 (7th Cir. 1991): 

As one court opined, “some ‘wrong’ beyond a creditor’s inability to collect” must be shown before the veil will be pierced.

At least, that’s supposed to be the rule.  I hope it still is.  

December 2, 2014 in Business Associations, Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Tuesday, November 18, 2014

Good Grief! Courts Can Only Get So Much Right on LLC Law

I’m starting to think that courts are playing the role of Lucy to my Charlie Brown, and proper description of LLCs is the football.  In follow up to my post last Friday, I went looking for a case that makes clear that an LLC’s status as a disregarded entity for IRS tax purposes is insufficient to support veil piercing.  And I found one.  The case explains:

Plaintiff . . . failed to provide any case law supporting his theory of attributing liability to Aegis LLC because of the existence of a pass-through tax structure of a disregarded entity. Pl.'s Opp'n. [50]. Between 2006 and 2008, when 100% of Aegis LLC's shares were owned by Aegis UK, Aegis LLC was treated as a disregarded entity by the IRS and the taxable income earned by Aegis LLC was reflected in federal and District of Columbia tax returns filed by Aegis UK. Day Decl. Oct. 2012 [48–1] at ¶ 37. In the case of a limited liability corporation with only one owner, the limited liability corporation must be classified as a disregarded entity. 26 C.F.R. § 301.7701–2(c)(2). Instead of filing a separate tax return for the limited liability corporation, the owner would report the income of the disregarded entity directly on the owner's tax return. Id. Moreover, determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders. See United States v. Acambaro Mexican Restaurant, Inc., 631 F.3d 880, 883 (8th Cir.2011). Given the above analysis, the undersigned finds that there is no unity of ownership and interest between Aegis UK and Aegis LLC.

Alkanani v. Aegis Def. Servs., LLC, 976 F. Supp. 2d 1, 9-10 (D.D.C. 2013).

 As Charlie Brown would say, "Aaugh!

So the case makes clear, as I was hoping, that it is not appropriate to use pass-through tax status to find a unity of interest and ownership in a way that will support veil piercing.  But the court then screws up the description of the very nature of LLCs.  This is not a “case of a limited liability corporation!” It's a case of a limited liability company, which is a not a corporation. 

Moreover, to use the court’s language, while it is true that “determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders,” the premise of the case has to do with an LLC’s status. Thus, the court should, at a minimum, make clear it knows the difference.  The statement, then, would go something like this:  "Determining whether LLC formalities have been disregarded requires more than just recognizing the tax arrangements between an LLC and its members.” 

It’s worth noting the entity formalities for LLCs are significantly less that those of corporations, so the formalities portion of LLC veil piecing test should be minimal, but that's a different issue.

Anyway, like Charlie Brown, I will keep kicking at that football, expecting, despite substantial evidence to the contrary, that one day it will be there for me to kick. At least I don't have to go it alone.  

November 18, 2014 in Business Associations, Corporations, Delaware, Joshua P. Fershee, LLCs | Permalink | Comments (2)

Friday, November 14, 2014

Wyoming S.C. Makes LLC Veil Piercing Easier, Says LLCs can have "Corporate Assets"

 The Supreme Court of Wyoming recently decided to pierce the limited liability veil of a single-member LLC.   Green Hunter Wind Energy, LLC (LLC), had a single member: Green Hunter Energy, Inc. (Corp). LLC entered into a services contract with Western Ecosystems Technology, Inc. (Western).  The court determined that veil piercing – thus allowing Western to recover LLC’s debts from Corp – was appropriate for several reasons. I think the court got this wrong.  The case can be accessed here (pdf).  

The court provides the following rule for piercing the veil of a limited liability company, providing three basic factors 1) fraud; 2) undercapitalization; and 3) “intermingling the business and finances of the company and the member to such an extent that there is no distinction between them.”  The court noted that the failure to following company formalities was recently dropped as a factor by changes to the state LLC statute.

Here’s where the court goes wrong: 

(1) As to undercapitalization, the court completely ignores the fact that Western freely contracted with the LLC with little to no cash.  If Western wanted the parent Corp to be a guarantor, it could have required that. If Western thought LLC was acting as an agent for Corp, Western should have claimed that.  It seems to me this is directly analogous to an actual parent-child relationship.  Western contracted with adult (but penniless) child.  Child didn't have money when the contract was signed or when the bill was submitted.  Western then calls parent and says, "Pay up." Western is free to call, but parent can say, “No.  You dealt with my kid, not me, and I didn't agree to this debt.”   

(2) There is a better argument this should be different if this were a tort suit where Western did not choose to engage with the LLC, but that's not the case here.  I don't see how Western can claim undercapitalization now when they had the opportunity to ask before the contract was formed.  Western is the least cost avoider here and assumed the risk of dealing with a lightly capitalized company.  It seems to me that should be part of the assessment.  Undercapitalization is, as the court notes, “a relative concept.” The court cites potential abuse of LLC laws if they were to adopt such a rule that motivates companies to ask for guarantees. instead adopting a rule that could incentivize companies like Western actively avoid ask ingfor guarantees. Why? Because if you ask for a guarantee and are refused, it could be used against you later.  But if you don’t ask, you may get to piece the veil and seek a windfall recovery by getting a post hoc guarantee that was not available via negotiation. 

The court’s rationale is as follows:

It makes good business sense for a contract creditor to try to obtain a guarantee  from the member or retainer from the limited liability company itself. But we are mindful of the reality of the marketplace that many businesses are not in a position—competitively or economically—to insist on guarantees. For that reason, we decline Appellant’s invitation to find piercing inappropriate in this case because Western did not protect itself from Appellant’s misuse of the LLC by attempting to obtain a guarantee or other form of security. To do so would invite abuse of entities, as is the case here. 

No way.  If you can’t “competitively or economically” secure a guarantee, then too bad.  If the legislature wants to create guarantees or minimum capitalization requirements for all entities, fine.  Otherwise, this is absurd. 

(3) Further, Court state that "the district court correctly concluded that the LLC 'failed to adequately capitalize the LLC, that LLC was undercapitalized at all times relevant to this suit and the LLC lacks corporate assets."  Wrong.  Again, if Western knew the finances of LLC at the time of contracting (as it could and should have), then it wasn’t undercapitalized.  LLC simply existed and Western did not seek to avoid the risk of dealing with such an entity. 

More important, though LLCs cannot have “corporate assets.” It’s a limited liability company, not a corporation.  Sheesh.  I’ll add this one to my list of courts getting LLC distinctions wrong.  (See, e.g., here, herehere, and here.) I would have loved to see the Supreme Court correct the district court on that, at least.  

(4) The court incorrectly suggests that the tax filings of the parent corporation and a subsidiary LLC can be a factor in the veil piercing analysis.  Sorry, but no.  For a single-member LLC, for federal tax purposes, the LLC will probably be a disregarded entity.  As such, the LLC will usually (if not always) look like part of the parent corporation. To even consider the tax filing necessarily makes one factor weigh toward piercing.  That’s wrong. 

Early in the opinion, the court notes, “Piercing seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled.” (quoting Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89 (1985) (internal quotation marks omitted)).  In this case the court seems to be trying to make veil-piercing law in LLCs more predictable.   I’m concerned they are – they are making is more likely the veil piecing will occur, at least in the single-member LLC context.  To the extent we’re going to allow single-member LLCs, that’s unfortunate. 

November 14, 2014 in Agency, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Thursday, November 13, 2014

What do lawyers and judges need to know about LLCs?

Understandably, business law professors get upset when people who should know better- judges for example- mischaracterize LLCs. I say we should be even more angry at the law clerks drafting the opinions. Many judges had no exposure to LLCs in law school but clerks graduating today certainly have. 
 
Given the ubiquity of LLCs now, I was surprised to learn that among the many outstanding CALI (Computer-Aided Legal Instruction) lessons, there are none on LLCs. (Hat tip to co-blogger Steve Bradford- my students love him now). I have volunteered to work on at least one and maybe more in the coming months. I canvassed some colleagues for their must-haves for these LLC lessons. In no particular order, here's the current list:
 

1) Difference between LLCs, corporations and partnerships 

2) Del. and ULLCA coverage of fiduciary duties, and especially the issue of contractual waiver and default 

3) Ease of formation
 
4) Expense of formation
 
5) Ease of maintenance    
 
6) Expense of maintenance
 
7) Restrictions re. business purpose or activity
 
8) Continuity of life/limitations on existence
 
9) Label for/characteristics (incl. transferability) of ownership interests
 
10) Restrictions re. owners (number, type, or other)
 
11) Authority to bind/create liability for the firm
 
12) Personal liability of owners to outsiders
 
13) Form of management/rights to manage
 
14) Existence/characteristics of monitoring managers/board of directors
 
15) Other (additional governance rules, rights, obligations, etc.)
 
16) Entitlement to income and assets
 
17) Liability for taxes and other governmental obligations
 
18) How investors can get money OUT of an LLC
 

19) No right to distributions, and no right to vote for distributions if manager-managed

20) No right to salary or employment

21)  Taxable liability for LLC membership

22) Exit rights—voluntary withdrawals vs. restricted withdrawals, and whether or not that comes with the ability to force the return of an investment or a new status as a creditor of the LLC

23) Liability for improper distributions

24) Veil piercing, particularly given the lack of corporate formalities

I would love some feedback from practitioners as well. What do law students and practicing lawyers need to know about LLCs? What's missing from this list? What should I get rid of? Please feel free to comment below or to email your thoughts to mnarine@stu.edu

 

 

 

November 13, 2014 in Business Associations, C. Steven Bradford, Corporate Personality, Corporations, Delaware, Law School, LLCs, Marcia Narine, Partnership, Teaching, Unincorporated Entities | Permalink | Comments (1)

Friday, November 7, 2014

A Few Law Listservs

 I subscribe to a few helpful law-related listservs:

All of these listservs provide useful information, through the helpful e-mails from the participants. Especially for those of us at business schools, where we do not have many legally trained colleagues, access to the collective wisdom of those on the listserv is invaluable. Occasionally, however, the listservs produce an avalanche of uninteresting e-mails. The LLC listserv allows the option of getting a single weekly digest of the discussion, which I prefer, though the Yahoo! formatting of the digest is unattractive and cumbersome.

What law-related listservs do you enjoy? Any thoughts on the best (free) platform for listservs?

November 7, 2014 in Business School, Haskell Murray, Law School, LLCs, Negotiation | Permalink | Comments (0)

Tuesday, October 21, 2014

Remaining Vigilant: Getting Courts to Recognize LLCs Aren't Corporations

In Business Organizations today, I spent some time reviewing the differences between varying entity types.  I made the point that courts often make mistakes on this front, especially with LLCs and corporations, and it reminded me I needed to follow up on my own pet LLC protection project. 

Over the years, I have taken more than a passing interest in how often courts refer to (and ultimately treat) LLCs. I have this thing where I think LLCs are not treated as well doctrinally as they should. In February of this month, I made the argument,  Courts Should Get the Doctrinal Distinction Between LLCs and Corporations, and I have made other similar arguments (herehere, and here).  

As part of this I committed to noting when courts refer to LLCs as "limited liability corporations" and not "limited liability companies," as they should.  Almost one year ago, I noted this continuing theme, repeating the search I did for a 2011 article, where I found in a May 2011 search of Westlaw’s “ALLCASES” database that there were 2,773 documents with the phrase “limited liability corporation," in describing an LLC. (That article is here.)  Things are not getting much better.  Since Oct. 15, 2013, there have been 410 more cases making that same mistake. Just since my February 4, 2014 post, reference above, there have been 300 of those cases.  

As I read through some of these cases, many of which don't seem to turn on whether the entity is a limited liability company or a corporation, I have noticed that some of the cases may have an entity structure issue that no one is raising.  That's a failure of at least one of the parties, and potentially the court.  I plan to follow up with a few example of such cases, but for now, I'll part with my familiar refrain: as long as courts keeping describing limited liability companies as corporations, I'll keep pointing it out.

 

October 21, 2014 in Business Associations, Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Thursday, October 16, 2014

Comment from the Student Archives- the Real Housewives Make an Appearance in Business Associations

I plan to write a more traditional blog post later if I have time, but I am in the midst of midterm grading hell. I was amused today in class when a student compared the drama of the Francis v. United Jersey Bank case with the bankruptcy, bank, and mortgage fraud convictions of husband and wife Joe and Teresa Guidice from the reality TV hit the Real Housewives of New Jersey.

I had provided some color commentary courtesy of Reinier Kraakman and Jay Kesten’s The Story of Francis v. United Jersey Bank: When a Good Story Makes Bad Law, and apparently Mrs. Pritchard’s defenses reminded the student of Teresa Guidice’s pleas of ignorance. Other than being stories about New Jersey fraudsters, there aren’t a lot of similarities between the cases. Based on my quick skim of the indictment I don’t think that Teresa served on the board of any of the companies at issue--Joe apparently had an LLC and was the sole member, and the vast majority of the counts against the couple relate to their individual criminal conduct. In addition, Teresa is also going to jail, and no one suffered that fate in United Jersey. But luckily, she may see a big payday from a purported book deal and reality TV show spinoff after she’s out, possibly disproving the adage that crime doesn’t pay.

 

October 16, 2014 in Business Associations, Corporations, Current Affairs, Ethics, Law School, LLCs, Marcia Narine, Teaching, Television | Permalink | Comments (0)

Monday, September 29, 2014

More on LLCs as Non-Signatories of Operating Agreements . . .

In recent blog posts, two of my favorite bloggers, Keith Paul Bishop and Steve Bainbridge, have highlighted for our attention Delaware and California statutes providing (differently in each case) that an LLC and, at least in Delaware, its managers and members, are bound by the LLC's operating agreement even if they do not sign that agreement.  Bishop notes in his post that the California "RULLCA creates an odd situation in which LLCs are bound by contracts that they did not execute and to which they seemingly are not parties."  In his post Bainbridge cites to the Bishop post and another post by Francis Pileggi.  Certainly, they all have a point.  For students of contract law, the conclusion that a non-party is bound by a contract does not seem to be an obvious result . . . .

The flap in the blogosphere has its genesis in a recent Delaware Chancery Court decision, Seaport Village Ltd. v. Seaport Village Operating Company, LLC, et al. C.A. No. 8841-VCL.  The limited liability company defendant in that case raised as its only defense that it was not a party to the limited liability company agreement and therefore was not bound.  Unsurprisingly in light of applicable Delaware law, Chancellor Laster found the defense wanting as a matter of law.

This issue has more history than my brother bloggers point out, some of which is included in the brief Seaport Village opinion.  I probably don't have all the details, but set forth below is some additional background information that may be useful in thinking about the binding nature of LLC operating agreements.  Others may care to fill in any missing information by leaving comments to this post.

Continue reading

September 29, 2014 in Business Associations, Current Affairs, Delaware, Joan Heminway, LLCs, Unincorporated Entities | Permalink | Comments (2)

Friday, September 12, 2014

Delaware Judges and Law Review Articles

In 2007, J. W. Verret (George Mason) and then Chief Justice Myron Steele authored an article entitled Delaware's Guidance: Ensuring Equity for the Modern Witenagemot, which discussed "some of the extrajudicial activities in which members of the Delaware judiciary engage to minimize the systemic indeterminacy resulting from the resolution of economic disputes by a court of equity."

One of these extrajudicial activities is authoring or co-authoring law review articles.  In this post, I am not going to weigh in on whether Delaware judges should be authoring law review articles, but rather, I simply note that there are two recent law review articles and one recent book chapter by Delaware judges that warrant our attention. 

Vice Chancellor Travis Laster - Evidence-Based Corporate Law.

John Maynard Keynes is said to have observed, "When the facts change, I change my mind. What do you do, sir?" In Delaware's Choice, Professor Subramanian argues that the facts underlying the constitutionality of Section 203 have changed. Assuming his facts are correct, and the Professor says that no one has challenged his account to date, then they have implications for more than Section 203. They potentially extend to Delaware's jurisprudence regarding a board's ability to maintain a stockholder rights plan, which becomes a preclusive defense if a bidder cannot wage a proxy contest for control of the target board with a realistic possibility of success. Professor Subramanian's facts may call for rethinking not only the constitutionality of Section 203, but also the extent of a board's ability to maintain a rights plan.

Chief Justice Leo E. Strine, Jr. and Nicholas Walter (Yale), Conservative Collision Course?: The Tension between Conservative Corporate Law Theory and Citizens United.

One important aspect of Citizens United has been overlooked: the tension between the conservative majority’s view of for-profit corporations, and the theory of for-profit corporations embraced by conservative thinkers. This article explores the tension between these conservative schools of thought and shows that Citizens United may unwittingly strengthen the arguments of conservative corporate theory’s principal rival.

 

Citizens United posits that stockholders of for-profit corporations can constrain corporate political spending and that corporations can legitimately engage in political spending. Conservative corporate theory is premised on the contrary assumptions that stockholders are poorly-positioned to monitor corporate managers for even their fidelity to a profit maximization principle, and that corporate managers have no legitimate ability to reconcile stockholders’ diverse political views. Because stockholders invest in for-profit corporations for financial gain, and not to express political or moral values, conservative corporate theory argues that corporate managers should focus solely on stockholder wealth maximization and non-stockholder constituencies and society should rely upon government regulation to protect against corporate overreaching. Conservative corporate theory’s recognition that corporations lack legitimacy in this area has been strengthened by market developments that Citizens United slighted: that most humans invest in the equity markets through mutual funds under section 401(k) plans, cannot exit these investments as a practical matter, and lack any rational ability to influence how corporations spend in the political process.

Because Citizens United unleashes corporate wealth to influence who gets elected to regulate corporate conduct and because conservative corporate theory holds that such spending may only be motivated by a desire to increase corporate profits, the result is that corporations are likely to engage in political spending solely to elect or defeat candidates who favor industry-friendly regulatory policies, even though human investors have far broader concerns, including a desire to be protected from externalities generated by corporate profit-seeking. Citizens United thus undercuts conservative corporate theory’s reliance upon regulation as an answer to corporate externality risk, and strengthens the argument of its rival theory that corporate managers must consider the best interests of employees, consumers, communities, the environment, and society — and not just stockholders — when making business decisions.

Chief Justice Leo E. Strine, Jr. and Vice Chancellor Travis Laster, The Siren Song of Unlimited Contractual Freedom

One frequently cited distinction between alternative entities — such as limited liability companies and limited partnerships — and their corporate counterparts is the greater contractual freedom accorded alternative entities. Consistent with this vision, discussions of alternative entities tend to conjure up images of arms-length bargaining similar to what occurs between sophisticated parties negotiating a commercial agreement, such as a joint venture, with the parties successfully tailoring the contract to the unique features of their relationship.

As judges who collectively have over 20 years of experience deciding disputes involving alternative entities, we use this chapter to surface some questions regarding the extent to which this common understanding of alternative entities is sound. Based on the cases we have decided and our reading of many other cases decided by our judicial colleagues, we do not discern evidence of arms-length bargaining between sponsors and investors in the governing instruments of alternative entities. Furthermore, it seems that when investors try to evaluate contract terms, the expansive contractual freedom authorized by the alternative entity statutes hampers rather than helps. A lack of standardization prevails in the alternative entity arena, imposing material transaction costs on investors with corresponding effects for the cost of capital borne by sponsors, without generating offsetting benefits. Because contractual drafting is a difficult task, it is also not clear that even alternative entity managers are always well served by situational deviations from predictable defaults.

In light of these problems, it seems to us that a sensible set of standard fiduciary defaults might benefit all constituents of alternative entities. In this chapter, we propose a framework that would not threaten the two key benefits that motivated the rise of LPs and LLCs as alternatives to corporations: (i) the elimination of double taxation at the entity level and (ii) the ability to contract out of the corporate opportunity doctrine. For managers, this framework would provide more predictable rules of governance and a more reliable roadmap to fulfilling their duties in conflict-of-interest situations. The result arguably would be both fairer and more efficient than the current patchwork yielded by the unilateral drafting efforts of entity sponsors.

September 12, 2014 in Business Associations, Constitutional Law, Corporate Governance, Haskell Murray, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (0)

Wednesday, September 3, 2014

The March of the Benefit Corporation: Next Up, West Virginia (PART II)

(Note:  This is a cross-posted multiple part series from WVU Law Prof. Josh Fershee from the Business Law Prof Blog and Prof. Elaine Waterhouse Wilson from the Nonprofit Law Prof Blog, who combined forces to evaluate benefit corporations from both the nonprofit and the for-profit sides.  The previous installment can be found here (NLPB) and here (BLPB).)

What It Is:   So now that we’ve told you (in Part I) what the benefit corporation isn’t, we should probably tell you what it is.  The West Virginia statute is based on Model Benefit Corporation Legislation, which (according to B Lab’s website) was drafted originally by Bill Clark from Drinker, Biddle, & Reath LLP.  The statute, a copy of which can be found, not surprisingly, at B Lab’s website, “has evolved based on comments from corporate attorneys in the states in which the legislation has been passed or introduced.”  B Lab specifically states that part of its mission is to pass legislation, such as benefit corporation statutes.

As stated by the drafter’s “White Paper, The Need and Rationale for the Benefit Corporation: Why It is the Legal Form that Best Addresses the Needs of Social Entrepreneurs, Investors, and, Ultimately, the Public” (PDF here), the benefit corporation was designed to be “a new type of corporate legal entity.”  Despite this claim, it’s likely that the entity should be looked at as a modified version of traditional corporation rather than at a new entity. 

To read the rest of the post, please click below. 

Continue reading

September 3, 2014 in Business Associations, Corporate Governance, Corporations, Entrepreneurship, Joshua P. Fershee, LLCs, Social Enterprise | Permalink | Comments (1)

Tuesday, August 26, 2014

The March of the Benefit Corporation: Next Up, West Virginia (Cross Post)

West Virginia is the latest jurisdiction to adopt benefit corporations – the text of our legislation can be found here.   As with all benefit corporation legislation, the thrust of West Virginia’s statute is to provide a different standard of conduct for the directors of an otherwise for-profit corporation that holds itself out as being formed, at least in part, for a public benefit.  (Current and pending state legislation for benefit corporations can be found here.)

As WVU Law has two members of the ProfBlog family in its ranks (Prof. Josh Fershee (on the Business Law Prof Blog) and Prof. Elaine Waterhouse Wilson (on the Nonprofit Law Prof Blog)), we combined forces to evaluate benefit corporations from both the nonprofit and the for-profit sides.  For those of you on the Business Prof blog, some of the information to come on the Business Judgment Rule may be old hat; similarly, the tax discussion for those on the Nonprofit Blog will probably not be earth-shaking.  Hopefully, this series will address something you didn’t know from the other side of the discussion!

Part I: The Benefit Corporation: What It’s Not:  Before going into the details of West Virginia’s legislation (which is similar to statutes in other jurisdictions), however, a little background and clarification is in order for those new to the social enterprise world.  A benefit corporation is different than a B Corporation (or B Corp).  B Lab, which states that it is a “501(c)(3) nonprofit” on its website, essentially evaluates business entities in order to brand them as “Certified B Corps.” 

It wants to be the Good Housekeeping seal of approval for social enterprise organizations.  In order to be a Certified B Corp, organizations must pass performance and legal requirements that demonstrate that it meets certain standards regarding “social and environmental performance, accountability, and transparency.” Thus, a business organized as a benefit corporation could seek certification by B Lab as a B Corp, but a business is not automatically a B Corp because it’s a state-sanctioned benefit corporation – nor is it necessary to be a benefit corporation to be certified by B Labs.  

In fact, it’s not even necessary to be a corporation to be one of the 1000+ Certified B Corps by B Lab. As Haskell Murray has explained,

I have told a number of folks at B Lab that "certified B corporation" is an inappropriate name, given that they certify limited liability companies, among other entity types, but they do not seem bothered by that technicality.  I am guessing my fellow blogger Professor Josh Fershee would share my concern. [He was right.]

A benefit corporation is similar to, although different from, the low-profit limited liability company (or L3C), which West Virginia has not yet adopted. (An interesting side note: North Carolina abolished its 2010 L3C law as of January 1, 2014.)  The primary difference, of course, is that a benefit corporation is a corporation and an L3C is a limited liability company.  As both the benefit corporation and the L3C are generally not going to be tax-exempt for federal income tax purposes, the state law distinction makes a pretty big difference to the IRS.  The benefit corporation is presumably going to be taxed as a C Corporation, unless it qualifies and makes the election to be an S Corp (and there’s nothing in the legislation that leads us to believe that it couldn’t qualify as an S Corp as a matter of law).   By contrast, the L3C, by default will be taxed as a partnership, although again we see nothing that would prevent it from checking the box to be treated as a C Corp (and even then making an S election).   The choice of entity determination presumably would be made, in part, based upon the planning needs of the individual equity holders and the potential for venture capital or an IPO in the future (both very for-profit type considerations, by the way).  The benefit corporation and the L3C also approach the issue of social enterprise in a very different way, which raises serious operational issues – but more on that later. 

Finally, let’s be clear – a benefit corporation is not a nonprofit corporation.  A benefit corporation is organized at least, in some part, to profit to its owners.  The “nondistribution constraint” famously identified by Prof. Henry Hansmann (The Role of Nonprofit Enterprise, 89 Yale Law Journal 5 (1980), p. 835, 838 – JSTOR link here) as the hallmark of a nonprofit entity does not apply to the benefit corporation.  Rather, the shareholders of a benefit corporation intend to get something out of the entity other than warm and fuzzy do-gooder feelings – and that something usually involves cash.

In the next installments:

Part II – The Benefit Corporation: What It Is.

Part III – So Why Bother?  Isn’t the Business Judgment Rule Alive and Well?

Part IV – So Why Bother, Redux? Maybe It’s a Tax Thing?

Part V - Random Thoughts and Conclusions

EWW & JPF

August 26, 2014 in Business Associations, Corporations, Entrepreneurship, Joshua P. Fershee, LLCs, Social Enterprise | Permalink | Comments (2) | TrackBack (0)

Tuesday, August 19, 2014

Summer's Over: More On Teaching Business Organizations

At West Virginia University College of Law, we started classes yesterday, and I taught my first classes of the year: Energy Law in the morning and Business Organizations in the afternoon.  As I  do with a new year coming, I updated and revised my Business Organizations course for the fall.  Last year, I moved over to using Unicorporated Business Entities, of which I am a co-author.  I have my own corporations materials that I use to supplement the book so that I cover the full scope of agency, partnerships, LLCs, and corporations.  So far, it's worked  pretty well.  I spent several  years with  Klein, Ramseyer and Bainbridge's Business Associations, Cases and Materials on Agency, Partnerships, and Corporations (KRB), which is a great casebook, in its own right.

I did not make the change merely (or even mostly) because I am a co-author. I made the change because I like the structure we use in our book. I had been trying to work with KRB in my structure, but this book is designed to teach in with the organization I prefer, which is more topical than entity by entity.  I'll note that a little while ago, my co-blogger Steve Bradford asked, "Are We Teaching Business Associations Backwards?" Steve Bainbridge said, "No." He explained, 

I've tried that approach twice. Once, when I was very young, using photocopied materials I cut and pasted from casebook drafts the authors kindly allowed me to use. Once by jumping around Klein, Ramseyer, and Bainbridge. Both times it was a disaster. Students found it very confusing (and boy did my evaluations show it!). It actually took more time than the entity by entity approach, because I ended up having to do a lot of review (e.g., "you'll remember from 2 weeks ago when we discussed LLCs most recently that ...."). There actually isn't all that much topic overlap. Among corporations, for example, you've got the business judgment rule, derivative suits, "duty" of good faith, executive compensation, the special rules for close corporations, proxies, and so on, most of which either don't apply to LLCs etc.... or don't deserve duplicative treatment.

I have great respect for Prof. Bainbridge, and his writing has influenced me greatly, but (not surprisingly), I come out more closely aligned with my perception of Larry Ribstein on such issues, and with Jeff Lipshaw, who commented, 

I disagree about the lack of topic overlap, and suspect Larry Ribstein is raging about this in BA Heaven right now. . . .

This may reflect differences among student populations, but the traditional corporate law course, focusing primarily on public corporations, is less pertinent in many schools where students are unlikely to be doing that kind of work when they graduate. It's far more likely that they'll need to be able to explain to a client why the appropriate business form is a corporation or an LLC, and what the topical differences between them are.

I completely agree, and I would go another step to say that I find the duplication to be a valuable reinforcement mechanism that is worth (what I have seen as limited) extra time.  I am teaching a 4-credit course, though, which gives me time I never had in my prior institution's 3-credit version. 

One thing I am doing differently this year is my first assignment, which seeks to build on what I see as a need for students here. That is, I think many of them will need to be able to explain entity differences and help clients select the right option. 

I had my students fill out the form for a West Virginia Limited Liability Company (PDF here). I had a few goals.  First, I don't like to have students leave any of my classes without handling at least some of the forms or other documents they are likely to encounter in practice.  Second, I did it without any instruction this time (I have used similar forms later in the course) because I thought it would help me tee up an introduction to all this issues I want them thinking about with regard to entity choice.  (It did.) Finally, I like getting students to see the connection between the form and the statute. We can link though and see why the form requires certain issues, discuss waivable and nonwaivable provisions, and talk about things like entity purpose, freedom of contract, and the limits of limited liability.  

If nothing else, the change kept things fresh for me.  I welcome any comments and suggestions on any of this, and I wish everyone a great new academic year.  

August 19, 2014 in Agency, Business Associations, Corporations, Joshua P. Fershee, Law School, LLCs, Partnership, Teaching | Permalink | Comments (1) | TrackBack (0)

Tuesday, July 15, 2014

Does Hobby Lobby Make Pain & Suffering Available for Entities?

The Hobby Lobby decision states:

No known understanding of the term "person" includes some but not all corporations. The term "person" sometimes encompasses artificial persons (as the Dictionary Act instructs), and it sometimes is limited to natural persons. But no conceivable definition of the term includes natural persons and nonprofit corporations, but not for-profit corporations. 20 Cf. Clark v. Martinez, 543 U. S. 371 , 378 (2005) ("To give th[e] same words a different meaning for each category would be to invent a statute rather than interpret one").

The decision continues:

Under the Dictionary Act, "the wor[d] 'person' . . . include[s] corporations, companies, associations, firms, partnerships, societies, and joint stock companies, as well as individuals." Ibid .; see FCC v. AT&T Inc., 562 U.S. ___, ___ (2011) (slip op., at 6) ("We have no doubt that 'person,' in a legal setting, often refers to artificial entities. The Dictionary Act makes that clear"). Thus, unless there is something about the RFRA context that "indicates otherwise," the Dictionary Act provides a quick, clear, and affirmative answer to the question whether the companies involved in these cases may be heard. 

Thus, unless otherwise stated, any place a person can recover claims, so can “corporations, companies, associations, firms, partnerships, societies, and joint stock companies.” There are opinions that have distinguished the “fictional person” from the “natural person.”  See, e.g., All Comp Const. Co., LLC v. Ford, 999 P.2d 1122, 1123 (Okla. App. Div. 1 2000) (stating that an LLC was a "fictional 'person' for legal purposes and thus any damages due to the LLCs would be "due to it as a fictional person," and thus certain damages were not recoverable because LLCs are not "capable of experiencing emotions such as mental stress and anguish"). RFRA, per Hobby Lobby, though, does not make such a distinction.

As such, it seems to me there are places where federal law uses the term person that might now extend potential recovery to entities for things like pain and suffering or mental anguish.  Maybe I am missing something here.  Any ideas come to mind?  Maybe civil rights laws?

The ripples, it seems, are just beginning. 

 

July 15, 2014 in Business Associations, Corporations, Joshua P. Fershee, LLCs, Religion | Permalink | Comments (4)