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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
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

slide2

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

slide3

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

light weight parts corp
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

slide5

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

slide6

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

slide7

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

slide8

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

slide9

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

slide10

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

slide11

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

slide12

Example 1

To find employment, Eric had to move to another state.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide13

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

slide14

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

headline redstone s son sues family run firm
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

corporate dissolution by court action
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

llc dissolution by court action
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

lp dissolution by court action
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

what is dissolution
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

winding up
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

timeline
Timeline

Dissolution

Winding Up

Termination

BRENT R. ARMSTRONG

Utah Association of CPAs

slide22

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

slide23

WARNING:

SEEKING JUDICIAL DISSOLUTION OF AN ENTITY COULD MAKE THE SEEKER SUBJECT TO THE “BOOMERANG” BUYOUT!!!

BRENT R. ARMSTRONG

Utah Association of CPAs

boomerang buyout
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

slide25

Let’s look at an LLC example – Harry and David

BRENT R. ARMSTRONG

Utah Association of CPAs

slide26

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

slide27

Example 2

Harry

David

BRENT R. ARMSTRONG

LLC

(member/managed)

50%

50%

Land worth $1,000,000

Utah Association of CPAs

slide28

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

slide29

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

slide30

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

slide31

Example 2

What choices does David have?

-- Choice A

-- Choice B

BRENT R. ARMSTRONG

Utah Association of CPAs

slide32

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

slide33

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

slide34

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

slide35

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

slide36

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

slide37

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

slide38

Example 2

Summary of David’s Choices:

Choice A $470,000

Choice B $400,000

BRENT R. ARMSTRONG

Utah Association of CPAs

slide39

Example 2

What if entity were a corporation instead of an LLC?

BRENT R. ARMSTRONG

Utah Association of CPAs

slide40

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

slide41

ARE THERE DISSOLUTION TRAPS FOR PARTNERSHIPS?

BRENT R. ARMSTRONG

Utah Association of CPAs

slide42

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

slide43

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

slide44

Example 3

After 7 years,William dies, leaving Mary as only general partner.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide45

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

slide46

Example 3

After 4 more years, Mary dies, leaving Jones Family Limited Partnership with no general partner.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide47

Example 3

Limited partners cannot agree on who should be successor general partner.

Result: LP dissolves

BRENT R. ARMSTRONG

Utah Association of CPAs

slide48

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

slide49

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

slide50

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

slide51

Example 3

The Jones Family Limited Partnership only lasted 11 years, not 30 years.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide52

LET’S LOOK AT ANOTHER PARTNERSHIP EXAMPLE

BRENT R. ARMSTRONG

Utah Association of CPAs

slide53

Example 4

Von owns a 20% interest as a partner in a ranch general partnership that conducts its ranch business in a state with the Revised Uniform Partnership Act (RUPA).

BRENT R. ARMSTRONG

Utah Association of CPAs

slide54

Example 4

Partnership has a value of $6,000,000, consisting of land, equipment and livestock.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide55

Example 4

Due to changes in his family’s needs, Von withdraws from partnership to pursue another job and gives notice of such withdrawal to partnership.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide56

Example 4

Since partnership agreement does not specify any term for partnership’s existence, partnership is an “at-will” partnership under RUPA.

RUPA §101(8)

BRENT R. ARMSTRONG

Utah Association of CPAs

slide57

Example 4

Von’s withdrawal from partnership causes partnership to dissolve under RUPA §101(8):

A partnership is dissolved, and its business must be wound up…in a partnership at will [upon] the partnership’s having notice from a partner…of that partner’s express will to withdraw.

BRENT R. ARMSTRONG

Utah Association of CPAs

slide58

Example 4

Result: Von’s withdrawal from partnership causes partnership to dissolve and entitles Von to be paid for the “fair value” of his partnership interest – 20% of $6,000,000 or $1,200,000.

BRENT R. ARMSTRONG

Utah Association of CPAs

consequences of not having a buy sell agreement succession plan
CONSEQUENCES OF NOT HAVING A BUY-SELL AGREEMENT/SUCCESSION PLAN
  • Minority owner has no market for his shares
  • Minority owner has no employment security
  • Future owners not determined
  • No planned buyer for majority’s shares
  • Possible dissolution of entity
  • Increased uncertainty for all owners and their heirs
  • Fertile field for disputes

BRENT R. ARMSTRONG

Utah Association of CPAs

possible triggering events in buy sell agreements
POSSIBLE TRIGGERING EVENTS IN BUY-SELL AGREEMENTS
  • Death
  • Termination of employment
  • Permanent disability
  • Divorce
  • Retirement
  • Non-approved transfer

BRENT R. ARMSTRONG

Utah Association of CPAs

possible issues in succession planning
POSSIBLE ISSUES IN SUCCESSION PLANNING
  • Family system vs.business system
  • Family financial planning
  • Role permutations -- owner vs. non-owner; employee vs. non-employee; family vs. non-family
  • Goal definition
  • Exit strategies
  • Management succession
  • Sibling rivalries
  • Financial conflicts

BRENT R. ARMSTRONG

Utah Association of CPAs

possible issues in succession planning cont d
POSSIBLE ISSUES IN SUCCESSION PLANNING – cont’d
  • Hidden agendas
  • Succession fantasies
  • Emotional impacts
  • Personalities
  • Control conflicts
  • Queen-bee syndrome
  • In-laws
  • Taxes
  • Timing and transition
  • Updating

BRENT R. ARMSTRONG

Utah Association of CPAs

slide63

WHO SHOULD ASSIST IN DESIGNING AND PREPARING SUCCESSION PLANS?

BRENT R. ARMSTRONG

Utah Association of CPAs

ethical issues in preparing succession plans
ETHICAL ISSUES IN PREPARING SUCCESSION PLANS
  • Multiple owners represented by one lawyer
  • Potential conflicts of interest
  • Confidentiality
  • Informed client consent
  • Withdrawal of representation
  • Facilitation

BRENT R. ARMSTRONG

Utah Association of CPAs

slide65

IN SUCCESSION PLANNING, ONE SIZE DOES NOT FIT ALL.

BRENT R. ARMSTRONG

Utah Association of CPAs

headline ranch operator shoots brothers over inheritance
HEADLINE:Ranch Operator Shoots Brothers Over Inheritance

J, a long-time rancher in MMM County, shot and killed his two brothers who had traveled to the ranch to finalize inheritance from their father’s estate. J then took his own life. Their father had left the ranch in equal shares among his 5 children, without any special consideration for J who alone had cared for the ranch and livestock for over 20 years.

BRENT R. ARMSTRONG

Utah Association of CPAs