Three Provisions You Cannot Operate Without In Your Operating Agreement

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Deciding on the entity form to use for your business depends on a number of factors, but for many entrepreneurs, an LLC is the best fit. An LLC is a hybrid entity as it provides liability protection similar to a corporation and favorable income tax treatment similar to a partnership. If you are starting or currently operating a business through an LLC, your most important organizational document is the agreement between you and your partners: the Operating Agreement. An operating agreement establishes the internal operations of the business in a way that suits the specific needs of the business owners. Once signed by the members of the LLC, it is an official binding contract.

Another benefit of using an LLC to operate your business is the flexibility LLC owners have to structure their operations and business relations with their partners. While the Kentucky Limited Liability Company Act contains default provisions for many of the organizational issues that may arise, members of an LLC may agree to operate under provisions other than the Act’s default provisions. No matter the nature of your business, your LLC should have an operating agreement that includes details such as voting rights and responsibilities, powers and duties of members and managers, allocation of profits and losses, and distribution of capital, whether the members agree to use the LLC Act’s default provisions or alternatives to the default language.

As an example of the flexibility of the Act, and also of the importance of carefully considering the effects of each section of your operating agreement, consider the following three provisions that will help your business run smoothly.

1. Transfer provisions.

An operating agreement typically contains some language about the circumstances under which a member may or must transfer his ownership interest in the LLC to another person or entity. Under the Act, a member may freely transfer membership interest to anyone. There are a number of provisions in the Act that tell us how the transferring member and the new owner are to be treated, one of which is that the new owner will not be a full member with the right to vote unless a majority of the other members vote to make the new owner a full member. If members are allowed to freely transfer their interests however, founding members may find themselves faced with new business partners they did not approve. Moreover, a member’s interest could be transferred involuntarily, such as by death, divorce, or bankruptcy. For these and other reasons, you and your business partners may decide on a transfer provision that would limit uncertainty in these situations. Terms in the operating agreement may require a majority of members to vote to allow a proposed transfer before it can occur, or give the company or the members a right of first refusal to purchase the membership interest subject to a proposed transfer. The members might agree to purchase life insurance policies to provide the funds to purchase the membership interest of a member at death. The operating agreement may also prohibit members from pledging (granting a lien on) membership interest. Putting restrictions on transferability gives members control over when, how, and why membership interests are transferable.

2. Deadlock provisions.

Management or member deadlock occurs when a company’s decision makers are evenly split on a matter and neither side will relent. It is a potentially fatal problem and, thus, should always be addressed within the operating agreement. Under the Act, the remedy for deadlock is judicial dissolution. A court “may dissolve a limited liability company in a proceeding by a member if it is established that it is not reasonably practicable to carry on the business of the limited liability company in conformity with the operating agreement.” Once the LLC is dissolved, it cannot carry on business, but must wind up and liquidate its business. There are, however, many strategies that can be put into your operating agreement to avoid this problem:

· The opposing member may be allowed to withdraw from the LLC.

· The operating agreement may require that a deadlock at the manager level be subject to a vote of the members.

· The members may agree to be bound by a coin flip.

· The members may be required to take the issue to binding arbitration.

· The members may incorporate a buy-sell provision that would require one member to provide a purchase price to the other member and then require that other member to purchase or sell the membership interest in the LLC at that purchase price such that the selling member ceases to be a member of the LLC.

With each of these strategies, the common feature is that the LLC is likely to continue as a functioning business after the deadlock is resolved.

3. Additional Capital Contributions.

A company operating agreement will usually state the amount of money or the value of property each member initially contributes to the company for operations, known as initial capital contributions. As an example, three people may decide to start a business and agree that each of them will give the company $3,000 so the company has $9,000 in start-up capital. Most operating agreements also have language about additional money from the members, known as additional capital contributions. Because the Act allows flexibility here as well, that language may state that members are not required to make additional capital contributions, or it may require additional capital contributions and allow for one member to make an additional capital contribution for another member that fails to make that contribution when due in exchange for a portion of that member’s membership interest. There are many possibilities. But frequently, when considering these possibilities, members fail to consider the effect of the additional capital contribution language on the limited liability feature of the LLC.

One important function of an LLC is that the members are not individually liable for the debts of the LLC if the LLC cannot pay its creditors. That protection from individual liability is not absolute, however. Among other things that may cause a court to ignore limited liability protection, including fraud, intentional misconduct, or the failure to maintain a real distinction between the LLC and its members, the additional capital contribution language can be read to require the members to pay LLC debt that the LLC cannot pay itself. The members may avoid this by affirmatively stating in the operating agreement that additional capital contributions are never required and the members have no personal liability for the debts of the LLC, but that may cause problems later if the LLC needs additional capital. The members may instead decide to have additional capital contribution language, but to have it drafted carefully so as to avoid unintentionally negating the limited liability protection generally afforded by the LLC. The important thing is to consider and plan for the potential needs of the LLC, and to do so in a way that doesn’t result in unintended consequences for the LLC or its members.

Every successful business encounters bumps in the roads. An operating agreement is a road map, a tool to navigate through the difficult obstacles.

© 2013 by McBrayer, McGinnis, Leslie & Kirkland, PLLC

National Institute on E-Discovery 2013

The National Law Review is pleased to bring you information regarding the upcoming ABA Conference – National Institute on E-Discovery 2013:

E-Discovery April 5 2013

When

April 05, 2013

Where

  • Proskauer Rose LLP
  • Eleven Times Square
  • New York, NY 10036-8299
  • United States of America

Nationally-acclaimed e-discovery professionals and judges will convene for a full day to analyze and discuss the latest developments and best strategies for managing the e-discovery process.

Program Focus

Attendees of this program will learn:

  • Comprehensive and practical “issue-spotting”
  • About the continuing rules amendment process directly from members of the federal judiciary, as well as leading-edge issues emerging in their courts
  • How to choose, search, and review technology that fits your case
  • Tips for cost-effective and defensible project management for both requesting parties and producing parties
  • The latest information on e-discovery of “personal data sources” including social media and personal devices
  • How to navigate “discovery about discovery,” including important privilege considerations

Immigration Reform: It’s Time for a Course Correction

The National Law Review recently published an article regarding Immigration Reform written by  Susan J. Cohen with Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.:

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The first two months of 2013 have seen a flurry of activity relating to immigration reform.  President Obama is pushing for comprehensive reform as are powerful factions within both the Senate and the House. And the political will and rising tide of opinion in favor of reform are making for unusual bedfellows, as exemplified by the recent joint statement of principles from the American Chamber of Commerce and the AFL-CIO.

But in this same timeframe, lawmakers anxious to change current immigration law to create new pathways for entrepreneurs and highly educated immigrants have introduced a number of bills designed for this purpose, including the Immigration Innovation (I²) Act of 2013 introduced by Senators Hath, Klobuchar, Rubio and Coons and the Startup Act 3.0, introduced by Senators Moran, Warner and Coons. These bills contain many excellent provisions that make tremendous sense, addressing shortcomings and deficiencies in our current law. For example, the I² bill would significantly increase the H-1B cap and would exempt graduates of U.S. advanced degree programs from the cap. It would authorize employment for the spouses of H-1B workers and would make it easier for those workers to move from one company to another.  It would also streamline the green card process and eliminate the enormous backlogs in the current system.  The Startup Act 3.0 would provide a new and much-needed work visa for foreign entrepreneurs who can attract angel or venture funding to their new U.S. ventures.

Our immigration laws are so broken and outdated that only comprehensive reform will correct  our course.  And the lawmakers who have introduced bills such as I² and the Startup Act 3.0 clearly hope that their prescriptions for specific improvements will be incorporated into any final comprehensive bill. But should comprehensive reform prove elusive, at a minimum Congress should pass some version of these bills, to attract and retain the best and the brightest of our foreign students and entrepreneurs, and help to boost and strengthen the U.S. economy.

©1994-2013 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

White Collar Crime Institute – March 6-8, 2013

The National Law Review is pleased to bring you information about the upcoming White Collar Crime Institute:

White Collar Crime March 6-8 2013

The program will provide an in-depth analysis of three recent high visibility trials by the lawyers involved in the cases.  The many topics covered will include: ethical pitfalls and blunders in white collar practice, conducting global investigations (including issues of competing laws), data privacy and blocking statutes, trial tactics in white collar cases, Brady obligations, international issues in white collar practice (including obtaining evidence abroad), handling of, and dealing with, issues related to electronically stored materials, sentencing guidelines and arguing for a departure, updates and trends in securities and FCPA enforcement, and more!

State Law Resale Price Maintenance: We’re not in Kansas anymore

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I recently participated in a roundtable discussion on state law resale price maintenance actions presented by the ABA Section of Antitrust Law.

The discussion focused on the Kansas Supreme Court’s decision in O’Brien v. Leegin, in which the court determined that vertical price fixing was still per se illegal under Kansas antitrust laws despite the fact that such conduct is analyzed under the rule of reasons under federal antitrust law.  One of the participants suggested that the if the logic of the Kansas Supreme Court’s decision was extended, then all types of vertical restraints (i.e. geographic restrictions, non-compete agreements) which are typically analyzed under a reasonableness standard, may be subject to attack under the per se rule.  Other participants dismissed such concerns, but noted that state antitrust law can be (and often is) more restrictive than federal antitrust law.

A Deputy Attorney General for the State of California described several post-Leegin developments in state prosecutions of RPM and MAP agrements, including New York’s action against Tempur-Pedic.  The takeaway from that discussion seemed to be that, regardless of the outcome of those cases (which were resolved in favor of the manufacturer), state enforcers may still consider certain RPM and MAP agreements as per se antitrust violations.  Additionally, state enforcers may take an especially narrow view of the Colgate doctrine, which allows a business to unilaterally announce the terms and conditions upon which it will do business with its retailers/resellers.

At the conclusion of the program, one participant suggested that attorneys practicing in this area should give advice to their clients as if Leegin were never decided.  In other words, sometimes state law trumps federal law.  That is exactly what we have been saying on this blog ever since the Leegindecision was announced.

Copyright © 2013 Womble Carlyle Sandridge & Rice, PLLC

White Collar Crime Institute – March 6-8, 2013

The National Law Review is pleased to bring you information about the upcoming White Collar Crime Institute:

White Collar Crime March 6-8 2013

The program will provide an in-depth analysis of three recent high visibility trials by the lawyers involved in the cases.  The many topics covered will include: ethical pitfalls and blunders in white collar practice, conducting global investigations (including issues of competing laws), data privacy and blocking statutes, trial tactics in white collar cases, Brady obligations, international issues in white collar practice (including obtaining evidence abroad), handling of, and dealing with, issues related to electronically stored materials, sentencing guidelines and arguing for a departure, updates and trends in securities and FCPA enforcement, and more!

Federal Court Rejects Americans with Disabilities Act (ADA) Suit Over Random Alcohol Testing of Probationary Plant Employees

The National Law Review recently published an article regarding Random Alcohol Testing written by Robert S. NicholsRobert E. Sheeder, and Amy Karff Halevy with Bracewell & Giuliani LLP:

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A federal judge in Pennsylvania has dismissed an Equal Employment Opportunity Commission challenge to U.S. Steel Corporation’s random alcohol testing of probationary employees at one of the company’s most safety sensitive facilities. The Court’s ruling in this carefully watched suit is significant for employers because it represents a forceful rejection of one of the more extreme positions the EEOC has taken in interpreting how the Americans with Disabilities Act (ADA) regulates workplaces.

EEOC’s Restrictive Interpretation of Employer Rights

The EEOC has adopted a very restrictive view of an employer’s right to conduct across-the-board medical examinations or inquiries of current employees even when the examination or inquiry is plainly motivated by workplace safety concerns. According to the EEOC, employers are prohibited in most circumstances from conducting generalized medical examinations, including random alcohol testing or periodic physical examinations of current employees.

The EEOC has pointed to a provision of the ADA that provides that an employer may not “require a medical examination and shall not make inquiries of an employee as to whether such employee is an individual with a disability or as to the nature or severity of the disability, unless such examination or inquiry is shown to be job-related and consistent with business necessity.” 42 U.S.C. § 12112(d)(4)(A). Conducting random testing for the unlawful use of drugs, as opposed to testing for the use of alcohol, does not create the same legal impediments because a test for the unlawful use of drugs is generally not regarded as a “medical examination” under the ADA.

The very limited exceptions to this prohibition on across-the-board medical examinations or inquiries of current employees that the EEOC has recognized include examinations of certain public safety employees in police and firefighter positions as well as, of course, examinations or inquiries that are required by other federal agencies, such as the Department of Transportation.

EEOC Lawsuit Against U.S. Steel

In the U.S. Steel suit, the EEOC argued that across-the-board medical examination or inquiries, including random or other generalized alcohol testing, could not be justified by the business necessity defense even in a highly safety sensitive work environment. Rather, the EEOC has taken the position that alcohol testing can only be justified based upon individualized suspicion that the particular employee to be tested was under the influence of alcohol at work.

U.S. Steel argued in a motion for summary judgment that given the highly safety sensitive nature of the plant at issue, where employees work with materials that are at temperatures of more than 2,100 degrees, random testing was justified as a matter of business necessity.

The judge in the case granted U.S. Steel’s motion and dismissed the EEOC’s claims finding that the random alcohol testing of probationary employees was justified by the business necessity defense. The Court first pointed out that there was no disputing that safety in and of itself can be a matter of business necessity. As a result, according to the Court, the only question remaining was whether the policy of random alcohol testing served that asserted business necessity. After analyzing the facts at issue, the judge found that the alcohol testing policy plainly served the business necessity of workplace safety.

In doing so, the Court specifically rejected the EEOC’s position that across-the-board medical examinations or inquiries of current employees could only be justified in the case of law enforcement or firefighting employees. The Court explained that there was no legitimate basis for not extending the same rationale to employees in other highly safety sensitive positions. Also, the Court noted that in this instance selecting employees for testing based on individualized suspicion would not work effectively because personal protective equipment obscures the U.S. Steel employees’ faces and speech.

Additionally, the Court concluded that the random alcohol testing approach was not inconsistent with the ADA’s goal of preventing employers from targeting specific employees with disabilities based upon stereotypes and misconceptions. The Court pointed out that, after all, random testing, as opposed to individualized suspicion testing, was not potentially based upon conclusions about particular individuals with disabilities.

The Court also noted that the testing program at issue was the product of negotiations with the union representing plant employees and not a process unilaterally imposed by the employer.

Takeaways

The decision in the U.S. Steel case offers employers new hope that more federal courts will reject the EEOC’s very restrictive view of the right to conduct across-the-board medical examinations or inquiries, including, across-the-board random alcohol testing of employees in certain safety sensitive positions. While this decision is encouraging, employers need to recognize that the EEOC continues to adhere to its position regarding this issue and other federal courts may ultimately side with the EEOC. Nonetheless, the Court’s decision in the U.S. Steel suit is an encouraging sign for employers that courts, recognizing the importance of workplace safety, may adopt a far more reasonable and pragmatic view than the EEOC on this question of across-the-board medical examinations and inquiries of current employees.

© 2013 Bracewell & Giuliani LLP