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CHANGING THE GUARD IN BUSINESS ENTITIES: Business Succession in Corporations, Partnerships & LLCs

CHANGING THE GUARD IN BUSINESS ENTITIES: Business Succession in Corporations, Partnerships & LLCs. Presented to UTAH ASSOCIATION OF CPAs WINTER CONFERENCE December 14 & 15, 2006 Salt Palace Convention Center Presented by BRENT R. ARMSTRONG Armstrong Law Offices, P.C.

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CHANGING THE GUARD IN BUSINESS ENTITIES: Business Succession in Corporations, Partnerships & LLCs

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  1. CHANGING THE GUARD IN BUSINESS ENTITIES:Business Succession in Corporations, Partnerships & LLCs Presented to UTAH ASSOCIATION OF CPAsWINTER CONFERENCE December 14 & 15, 2006 Salt Palace Convention Center Presented by BRENT R. ARMSTRONG Armstrong Law Offices, P.C. 50 West 300 South, Suite 150 Salt Lake City, Utah 84101 Tel. 801-359-5511

  2. All happy families are happy in the same way, whereas all unhappy families are unhappy in their own unique way. Leo Tolstoy in Anna Karenina BRENT R. ARMSTRONG Utah Association of CPAs

  3. DISASTER WARNING!!! Withouta well-crafted agreement among owners in place at the beginning that covers death, disability and termination of employment of an owner, every entity with multiple owners could encounter financial disaster for one or more owners! BRENT R. ARMSTRONG Utah Association of CPAs

  4. LIGHT-WEIGHT PARTS CORP. Example 1 Eric met Ed at an industry convention. They had both worked in the specialty parts industry for several years. Ed was 10 years older than Eric. After talking, they decided to start their own parts distribution business, based in Utah. BRENT R. ARMSTRONG Utah Association of CPAs

  5. Example 1 Ed had his lawyer form a Delaware corporation. Since Ed supplied cash to start the business, shares were issued 80% to Ed and 20% to Eric. Ed promised Eric, orally, that ownership would be equalized once business became profitable. BRENT R. ARMSTRONG Utah Association of CPAs

  6. Example 1 There was no buy-sell agreement or shareholders agreement. There were no written employment agreements for either Ed or Eric. BRENT R. ARMSTRONG Utah Association of CPAs

  7. Example 1 Years passed and Light-Weight Parts Corp. became very profitable and both Ed and Eric enjoyed significant 6-figure incomes plus perks and fringes. But, Ed kept delaying on his promise to equalize ownership and refused to reduce his promise to writing. BRENT R. ARMSTRONG Utah Association of CPAs

  8. Example 1 Finally, after 15 years of profitable business, when Eric was 55 years old, Eric demanded that Ed make good on his promise of equal ownership. Ed refused. The dispute became heated. BRENT R. ARMSTRONG Utah Association of CPAs

  9. Example 1 Rather than work out a solution, Ed, as controlling shareholder, caused the Board of Directors to fire Eric. Eric hired lawyers and filed suit. BRENT R. ARMSTRONG Utah Association of CPAs

  10. Example 1 Since Light-Weight Parts Corp. was a Delaware corporation and since the dispute related to ownership of shares in that corporation, the lawsuit had to be filed in Delaware. BRENT R. ARMSTRONG Utah Association of CPAs

  11. Example 1 Eric had to hire lawyers in Delaware – in addition to his Utah lawyers – and all court proceedings were held in Delaware. BRENT R. ARMSTRONG Utah Association of CPAs

  12. Example 1 To find employment, Eric had to move to another state. BRENT R. ARMSTRONG Utah Association of CPAs

  13. Example 1 Delaware law favors controlling shareholders. After battling for many months and spending all of his savings on legal fees, Eric had to give up and settle for what Ed would pay him for his shares – less than 1/10 of their value. A complete disaster for Eric. BRENT R. ARMSTRONG Utah Association of CPAs

  14. EVEN WITH A WRITTEN AGREEMENT IN PLACE, DISPUTES OFTEN ARISE WHERE AN OWNER’S EXPECTATION (OR NEED) IS NOT MET. BRENT R. ARMSTRONG Utah Association of CPAs

  15. HEADLINE:Redstone’s son sues family-run firm Brent Redstone, 55-year old son of media mogul Sumner Redstone, filed suit to dissolve National Amusements, Inc. – a firm with controlling interests in Viacom and CBS and worth $8 billion – in order to gain control of his 1/6 stake in that company. His shares, received by gift from his father, are restricted by a shareholder agreement from being sold except back to the family at book value (much less than market value). Feb. 15, 2006 Wall Street Journal BRENT R. ARMSTRONG Utah Association of CPAs

  16. Corporate Dissolution by Court Action Utah Code Section 16-10a-1430 allows a shareholder to seek court dissolution of a corporation if the directors are deadlocked in management of corporate affairs or the shareholders are deadlocked in voting power for 2 annual meetings or the directors are acting in a manner that is illegal, oppressive or fraudulent. BRENT R. ARMSTRONG Utah Association of CPAs

  17. LLC Dissolution by Court Action Utah Code Section 48-2c-1210(2) allows an LLC member to seek court dissolution of the LLC if the members are deadlocked in voting power for 6 months. BRENT R. ARMSTRONG Utah Association of CPAs

  18. LP Dissolution by Court Action Utah Code Section 48-2a-802 allows a partner to seek court dissolution of an LP whenever it is not reasonably practicable to carry on the business in conformity with the partnership agreement. BRENT R. ARMSTRONG Utah Association of CPAs

  19. What is Dissolution? “a dissolved [corporation or LLC]…may not carry on any business except that appropriate to liquidate and wind up its…affairs” BRENT R. ARMSTRONG Utah Association of CPAs

  20. Winding Up The winding up of an LLC is the process of collecting all amounts owed to the LLC, selling the LLC’s assets, paying taxes and debts of the LLC, and distributing all remaining assets to the members according to their interests. UCA §48-2c-1301 BRENT R. ARMSTRONG Utah Association of CPAs

  21. Timeline Dissolution Winding Up Termination BRENT R. ARMSTRONG Utah Association of CPAs

  22. WHEN A BUSINESS IS WOUND UP, GOODWILL AND OTHER INTANGIBLE VALUE USUALLY DISAPPEARS AND ALL OWNERS GET LESS THAN IF THE BUSINESS WERE SOLD AS A VIABLE OPERATING UNIT. BRENT R. ARMSTRONG Utah Association of CPAs

  23. WARNING: SEEKING JUDICIAL DISSOLUTION OF AN ENTITY COULD MAKE THE SEEKER SUBJECT TO THE “BOOMERANG” BUYOUT!!! BRENT R. ARMSTRONG Utah Association of CPAs

  24. Boomerang Buyout In Utah, shareholder (or member in LLC) who files suit for judicial dissolution of entity is subject to buy-out by entity or other shareholders (members) for corporations see UCA §16-10a-1434 – for fair value for LLCs see UCA §48-2c-1214 – for fair market value BRENT R. ARMSTRONG Utah Association of CPAs

  25. Let’s look at an LLC example – Harry and David BRENT R. ARMSTRONG Utah Association of CPAs

  26. Example 2 Harry and David are 50/50 members (owners) of a member-managed Utah LLC that has owned a parcel of raw land for over 10 years. The land is now worth $1,000,000. BRENT R. ARMSTRONG Utah Association of CPAs

  27. Example 2 Harry David BRENT R. ARMSTRONG LLC (member/managed) 50% 50% Land worth $1,000,000 Utah Association of CPAs

  28. Example 2 Harry proposes to sell the land now, but David objects since he wants the LLC to continue to hold the land for several more years. This deadlock has continued more than 6 months. BRENT R. ARMSTRONG Utah Association of CPAs

  29. Example 2 There is no debt in the LLC and the LLC documents do not require the LLC to hold the land for any set period. BRENT R. ARMSTRONG Utah Association of CPAs

  30. Example 2 Harry files suit seeking court dissolution of LLC, in the hope that he can force land to be sold and receive his 50% of sales proceeds. BRENT R. ARMSTRONG Utah Association of CPAs

  31. Example 2 What choices does David have? -- Choice A -- Choice B BRENT R. ARMSTRONG Utah Association of CPAs

  32. Example 2 Choice A: David can allow LLC to be dissolved and its affairs wound up – meaning the assets sold, debts paid and the excess distributed to the members. BRENT R. ARMSTRONG Utah Association of CPAs

  33. Example 2 Choice A: Land sales price $1,000,000 Less: sales costs (6%) (60,000) Surplus to members $ 940,000 Amount to each member = $ 470,000 BRENT R. ARMSTRONG Utah Association of CPAs

  34. Example 2 Choice B: David can assert his right to purchase Harry’s LLC interest at “fair market value” UCA §48-2c-1214 BRENT R. ARMSTRONG Utah Association of CPAs

  35. Example 2 FMV must consider all relevant facts and circumstances and all relevant discounts or premiums. UCA §48-2c-904 BRENT R. ARMSTRONG Utah Association of CPAs

  36. Example 2 Suppose court determines that a value discount of 20% applies to Harry’s LLC interest? What then? BRENT R. ARMSTRONG Utah Association of CPAs

  37. Example 2 Choice B: Land sales price $1,000,000 50% of land value (500,000) $ 500,000 Less: 20% discount (100,000) Harry will receive $ 400,000 BRENT R. ARMSTRONG Utah Association of CPAs

  38. Example 2 Summary of David’s Choices: Choice A $470,000 Choice B $400,000 BRENT R. ARMSTRONG Utah Association of CPAs

  39. Example 2 What if entity were a corporation instead of an LLC? BRENT R. ARMSTRONG Utah Association of CPAs

  40. Example 2 Where Harry, a shareholder, sues for judicial dissolution, corporation (or David, the other shareholder) has the right to buy Harry’s shares for “fair value” – without any discounts or premiums. UCA §16-10a-1434 BRENT R. ARMSTRONG Utah Association of CPAs

  41. ARE THERE DISSOLUTION TRAPS FOR PARTNERSHIPS? BRENT R. ARMSTRONG Utah Association of CPAs

  42. Example 3 As part of their estate planning, William and Mary Jones are advised to put assets into a family limited partnership, with themselves as the only general partners, and to make gifts to their children of limited partner interests. BRENT R. ARMSTRONG Utah Association of CPAs

  43. Example 3 William and Mary follow that advice and formed the Jones Family Limited Partnership – with a term of 30 years. They make annual gifts to their children for several years. BRENT R. ARMSTRONG Utah Association of CPAs

  44. Example 3 After 7 years,William dies, leaving Mary as only general partner. BRENT R. ARMSTRONG Utah Association of CPAs

  45. Example 3 No changes are made in governing documents for Jones Family Limited Partnership to provide for a successor general partner. BRENT R. ARMSTRONG Utah Association of CPAs

  46. Example 3 After 4 more years, Mary dies, leaving Jones Family Limited Partnership with no general partner. BRENT R. ARMSTRONG Utah Association of CPAs

  47. Example 3 Limited partners cannot agree on who should be successor general partner. Result: LP dissolves BRENT R. ARMSTRONG Utah Association of CPAs

  48. Example 3 Utah Code §48-2a-801 provides: A limited partnership is dissolved and its affairs shall be wound up upon…[the death of a general partner] unless… there is at least one other general partner and…the partnership agreement permit[s] the…partnership to be carried on by the remaining general partner, or BRENT R. ARMSTRONG Utah Association of CPAs

  49. Example 3 [continuation of §48-2a-801] within 90 days after [the death of the last general partner], all partners agree in writing to continue…the partnership and to the appointment of one or more…general partners. BRENT R. ARMSTRONG Utah Association of CPAs

  50. Example 3 As part of winding up of Jones Family Limited Partnership, its assets are sold (before the time planned) and the proceeds distributed to partners. BRENT R. ARMSTRONG Utah Association of CPAs

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