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

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CHANGING THE GUARD IN BUSINESS
ENTITIESBusiness 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. 50 West 300
South, Suite 150 Salt Lake City, Utah 84101 Tel.
801-359-5511
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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
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DISASTER WARNING!!! Without a 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
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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.
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Utah Association of CPAs
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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
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Example 1
There was no buy-sell agreement or shareholders
agreement. There were no written employment
agreements for either Ed or Eric.
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Utah Association of CPAs
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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
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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
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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.
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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Example 1
Eric had to hire lawyers in Delaware in
addition to his Utah lawyers and all court
proceedings were held in Delaware.
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Utah Association of CPAs
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Example 1
To find employment, Eric had to move to another
state.
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Utah Association of CPAs
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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
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EVEN WITH A WRITTEN AGREEMENT IN PLACE, DISPUTES
OFTEN ARISE WHERE AN OWNERS EXPECTATION (OR
NEED) IS NOT MET.
BRENT R. ARMSTRONG
Utah Association of CPAs
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HEADLINE Redstones 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
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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
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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
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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
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What is Dissolution?
a dissolved corporation or LLCmay not carry
on any business except that appropriate to
liquidate and wind up itsaffairs
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Utah Association of CPAs
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Winding Up
The winding up of an LLC is the process of
collecting all amounts owed to the LLC, selling
the LLCs assets, paying taxes and debts of the
LLC, and distributing all remaining assets to the
members according to their interests. UCA
48-2c-1301
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Utah Association of CPAs
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Timeline
Dissolution
Winding Up
Termination
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Utah Association of CPAs
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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
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WARNING SEEKING JUDICIAL DISSOLUTION OF AN
ENTITY COULD MAKE THE SEEKER SUBJECT TO THE
BOOMERANG BUYOUT!!!
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Utah Association of CPAs
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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
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Utah Association of CPAs
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Lets look at an LLC example Harry and David
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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Example 2
Harry
David
BRENT R. ARMSTRONG
LLC (member/managed)
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50
Land worth 1,000,000
Utah Association of CPAs
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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.
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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Example 2
What choices does David have? -- Choice
A -- Choice B
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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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
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Utah Association of CPAs
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Example 2
Choice B David can assert his right to purchase
Harrys LLC interest at fair market value UCA
48-2c-1214
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Utah Association of CPAs
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Example 2
FMV must consider all relevant facts and
circumstances and all relevant discounts or
premiums. UCA 48-2c-904
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Utah Association of CPAs
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Example 2
Suppose court determines that a value discount
of 20 applies to Harrys LLC interest? What
then?
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Utah Association of CPAs
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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
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Utah Association of CPAs
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Example 2
Summary of Davids Choices Choice
A 470,000 Choice B 400,000
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Utah Association of CPAs
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Example 2
What if entity were a corporation instead of an
LLC?
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Utah Association of CPAs
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Example 2
Where Harry, a shareholder, sues for judicial
dissolution, corporation (or David, the other
shareholder) has the right to buy Harrys shares
for fair value without any discounts or
premiums. UCA 16-10a-1434
BRENT R. ARMSTRONG
Utah Association of CPAs
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ARE THERE DISSOLUTION TRAPS FOR PARTNERSHIPS?
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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Example 3
After 7 years,William dies, leaving Mary as
only general partner.
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Utah Association of CPAs
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Example 3
No changes are made in governing documents for
Jones Family Limited Partnership to provide for a
successor general partner.
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Utah Association of CPAs
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Example 3
After 4 more years, Mary dies, leaving Jones
Family Limited Partnership with no general
partner.
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Utah Association of CPAs
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Example 3
Limited partners cannot agree on who should be
successor general partner. Result LP dissolves
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Utah Association of CPAs
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Example 3
Utah Code 48-2a-801 provides A limited
partnership is dissolved and its affairs shall be
wound up uponthe death of a general partner
unless there is at least one other general
partner andthe partnership agreement permits
thepartnership to be carried on by the remaining
general partner, or
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Utah Association of CPAs
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Example 3
continuation of 48-2a-801 within 90 days after
the death of the last general partner, all
partners agree in writing to continuethe
partnership and to the appointment of one or
moregeneral partners.
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Utah Association of CPAs
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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.
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Utah Association of CPAs
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Example 3
The Jones Family Limited Partnership only lasted
11 years, not 30 years.
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Utah Association of CPAs
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LETS LOOK AT ANOTHER PARTNERSHIP EXAMPLE
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Utah Association of CPAs
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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).
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Utah Association of CPAs
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Example 4
Partnership has a value of 6,000,000,
consisting of land, equipment and livestock.
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Utah Association of CPAs
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Example 4
Due to changes in his familys needs, Von
withdraws from partnership to pursue another job
and gives notice of such withdrawal to
partnership.
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Utah Association of CPAs
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Example 4
Since partnership agreement does not specify any
term for partnerships existence, partnership is
an at-will partnership under RUPA. RUPA 101(8)
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Utah Association of CPAs
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Example 4
Vons withdrawal from partnership causes
partnership to dissolve under RUPA 101(8) A
partnership is dissolved, and its business must
be wound upin a partnership at will upon the
partnerships having notice from a partnerof
that partners express will to withdraw.
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Utah Association of CPAs
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Example 4
Result Vons 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
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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 majoritys shares
• Possible dissolution of entity
• Increased uncertainty for all owners and their
  heirs
• Fertile field for disputes

BRENT R. ARMSTRONG
Utah Association of CPAs
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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
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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
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POSSIBLE ISSUES IN SUCCESSION PLANNING contd

• 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
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WHO SHOULD ASSIST IN DESIGNING AND PREPARING
SUCCESSION PLANS?
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Utah Association of CPAs
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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
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IN SUCCESSION PLANNING, ONE SIZE DOES NOT FIT
ALL.
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Utah Association of CPAs
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HEADLINERanch 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 fathers
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