Beware of the Limited Partnership

Prior to the advent of the Limited Liability Company in Michigan, a common planning technique involved the Michigan Limited Partnership. The Limited Partnership allows for a General Partner who has control of the entity (and usually, liability for it, also). Other investors, known as Limited Partners, are equity-only owners. They do not participate in management (other than voting on major issues) and their liability is generally limited to the amount of their investment in the partnership. In the family business context, mom and dad would set up as the General Partners and would convey limited partnership interests to their children. This allowed them to retain essentially all control of the entity, while transferring equity ownership to their children, often over a period of time. Additionally, because of the limited nature of these interests, they could apply discounts to the transfer of these interests. For a number of years, the Family Limited Partnership (or FLP) was the only way to accomplish this.
However, there are some significant negatives to the Limited Partnership form of business. Often, clients (and sometimes lawyers who didn't do their homework) were unaware, for example of the detailed formal requirements for these partnerships. Unlike a general partnership, a Limited Partnership requires a formal filing in Lansing. The statute requires a detailed form of Articles of Partnership be filed. But more importantly, every time there is any change (even 1%) in ownership, the statute requires that these formal Articles of Partnership be re-filed. I am personally aware of several instances where partnership interests were purportedly transferred, but this re-filing was never done. The statute makes clear that any attempted transfer of a partnership interest without this re-filing is void!

 every time there is any change (even 1%) in ownership, the statute requires that these formal Articles of Partnership be re-filed

Another problem with this form of business is that the General Partner has no liability protection. In many cases, in order to protect the interests of the persons acting as General Partner, a corporation would be set up as the General Partner, adding yet another layer of complexity to these already formal and complex partnerships.
When the Limited Liability Company came along, it became a much better alternative for this type of planning. LLC's are perhaps the most flexible business organization available and it is possible to structure the ownership and management of an LLC so that it is essentially identical to a FLP. And, it can be done with all the flexibility of structure that is the hallmark of the LLC form of business. The filing required to establish an LLC in Michigan is much less formal and detailed than the Limited Partnership. There is no re-filing requirement on a transfer of ownership of any amount.

clients (and sometimes lawyer who didn't do their homework) were unaware of the detailed formal requirements for these partnerships

Within the LLC statute is a little-known provision for conversion from a Michigan Limited Partnership to an LLC. We have done a number of such conversions in the past couple years. As long as the Limited Partnership is in good standing, it is very simple to convert from the complex and problem-prone Limited Partnership form of business to the flexible LLC. It is something every current FLP owner should at least consider.

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Periodic Maintenance for Your Business

We think nothing of visiting the Dentist every 6 months, and the Doctor for an annual checkup. Likewise, most of us regularly maintain our automobiles. Regular maintenance of your business is every bit as essential.

The most common business entities used in Michigan are the Limited Liability Company and the Corporation. Less common, but still often found, are general partnership and sole proprietorship. There are numerous variations of these entities which each serves its own specific purpose and will often require specialized tools and knowledge.

Corporations

Corporations were the entity of choice for many years. The primary advantage to the corporate business form is limitation of liability for its owners. Secondary advantages include the ability to structure plans for management, buy-sell provisions, succession and estate planning, and in some cases tax advantages.

But there are also disadvantages. Corporations are inherently more "formal" and require more legal maintenance than other forms of business. The Michigan Business Corporation Act (MBCA) requires certain formal actions every year. The shareholders of a corporation must elect or appoint a Board of Directors. The Board of Directors must elect or appoint a minimum of 3 officers: a President, Treasurer and Secretary (they can appoint such other officers as are convenient or appropriate including vice-Presidents).

The Act contemplates a formal annual meeting of shareholders and annual meeting of directors. But it also recognizes the many small businesses act informally. Thus the MBCA also allows a written consent resolution, signed by all the shareholders and directors to be executed in lieu of an annual meeting. While the majority of my clients do just that, we often recommend that the parties hold an actual annual meeting, with all of the businesses strategic and professional advisors in attendance. This can include the attorney and accountant for the corporation, and may also include bankers, financial advisors and insurance professionals. Getting everyone in the same room at one time often assists with the "team" of advisors all being on the same proverbial "page."

The most important thing to realize is that failure to observe this very simple annual requirement can result in a loss of the very liability limitation that was sought by incorporating in the first place!

Corporations must also pay a modest annual fee and file a Michigan Annual Report each year. Failure to do this for more than 2 years will result in the State automatically dissolving the corporation. I have had clients surprised by this more than once over the years.

It is a good idea to document important corporate decisions in writing, either by a written consent resolution or by written meeting minutes, which should be kept in the official corporate record book.

I often find that corporate have no proof of their stock ownership. Every stockholder should have issued a corporate stock certificate in the name of the corporation, issuing the appropriate number of shares of stock to the appropriate owner. I often meet with new corporate clients who have "been incorporated" for years, and have never procured a corporate record book, have no stock certificates and no meeting minutes or consent resolutions.

Limited Liability Company

Limited Liability Company (LLC) is today's usual entity of choice. The LLC can give its owners all of the advantages that have been traditionally enjoyed by the corporation, but with less formal "maintenance" and more flexibility to accomplish the owners' goals in most instances.

Unlike a corporation, there are very few additional "formalities" required for an LLC. Like a corporation, the LLC must file a Michigan Annual Report (MAR). Different from a corporation, failure to do this does not result in automatic dissolution. Instead, the LLC becomes "not in good standing." This may be even worse that dissolution. The name becomes available for others to use and if, after a number of years, you wish to dissolve and terminate the LLC, you must pay the "back" fees and penalties, bring the entity up to date, and then dissolve it.

Aside from the MAR, there are no other formalities required. There is no requirement for officers or directors in an LLC and there is no annual meeting, minutes or written consent requirements (this does not preclude the business from documenting important decisions and events in writing and that may be a good idea in some cases).

Governing Agreements

Whether your business is a Corporation or a Limited Liability Company, if there is more than one participant, a governing agreement is essential (corporations have shareholder agreements and LLC's have operating agreements). These agreements address important management, voting, distribution, succession and buy and sell issues.

It is important that before embarking on the establishment of one of these business entities, you consult with both your tax and legal advisors. While we often see tax consultants "setting up" corporations and LLC's, unless they are also practicing business lawyers, they should not be doing so. Too often, they get the numbers and official filing done (though not always correctly), but fail to complete important legal, technical and practical steps that must be considered when establishing a business entity.

Third party services like the popular internet "legal" provider may have perfectly good forms–but that is all they are; forms. It is a bit like buying a hammer and a saw and thinking you are now qualified to build your own home.

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“Conversion” From a Non-Profit to A For-Profit Corporation

There is an old saying: "knowledge is power." Sometimes that knowledge comes from digging around to try to find answers to some of the most unique questions. In 27 years of practicing corporate law – non-profit and for-profit – I had never been faced with this question. What do you do if you have a corporation which has been established as a non-profit corporation with LARA in Lansing and has never really been started up to do the things the non-profit was originally intended to do? Can you convert to a for-profit?

My "off-the-cuff" response to the client was that I didn't think so, and that we would probably have to liquidate the non-profit, distribute any assets to a qualified non-profit recipient, and simply start over. But there were some personal and administrative reasons why the client wanted to try to maintain some continuity, so I agreed to do some research.

The Michigan Non-Profit Corporation Act (MCL 450.2101 - 3192), provides, in section 450.2601(2), that a non-profit corporation may amend its articles of incorporation to become a (for-profit) regular business corporation. The Act specifies the form and content of the Amendment and contains a number of restrictions – but the important point is that it can be done.

As always, the proverbial "devil is in the details." If the non-profit was operating and has assets, those assets may not inure to the benefit of any individual and thus, will have to be distributed in accordance with the provisions of the original Articles of Incorporation and By Laws requiring distribution to another qualified non-profit organization. Final Federal Form 990 would also have to be filed.

The conversion is possible and is specifically authorized by Michigan Law and should be considered as an additional planning tool for corporate owners and advisors.

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MICHIGAN SINGLE MEMBER LIMITED LIABILITY COMPANIES

Michigan Limited Liability Companies have become the “entity of choice” for many business ventures in the State. When the Limited Liability Company (LLC) was first recognized in Michigan, single-member LLC’s were not authorized. 1997 amendments to the statute permitted them and for many of us as advisors, it seemed like telling our Sole Proprietor Clients that converting to a Single Member LLC was the proverbial “no-brainer.”

But is it a foregone conclusion that every sole proprietor business should become a Single Member LLC?

There are a number of advantages offered by the LLC form of entity. Most importantly, the LLC offers protection to the owner from liability which may arise from the activities of the business. Perhaps the next most important advantage is the ability to accomplish centralized filing of the entity statewide, at the Michigan Department of Labor and Economic Growth (DLEG). The DLEG filing gives the entity a statewide name and prevents others from using that name. It also allows the used of “assumed names” on a statewide basis. Another perceived advantage is that of protection of the individual member from his creditors. As we will see below, there may be some question about whether that confidence is misplaced. Additionally, as the “LLC” gains notoriety, the name may give the business a perceived bona fides as a business that it did not already enjoy as a sole proprietorship.

But there are always other considerations. Contrary to popular view, there is no “cookie cutter” business form that fits all or even most businesses. Careful consideration needs to be given to the actual goals and circumstances of the particular business activity. Often, when reviewing the efficacy of LLC status for a new client, we will conclude, after some thought and discussion, that another form of business (or businesses) better suits the client’s overall goals.

There are always tax and financial considerations. There are times when corporate, partnership, or other ownership form may create more advantage to the owner than an LLC. This may arise because of income tax rate structures, other activities of the owner, or government program options available to the business.

There is always a concern with whether a business operated by a married couple falls within the IRS default classification of single member or partnership. While there is some authority that the IRS will treat a married couple, filing jointly, as a sole-member LLC, there may be other reasons why the “partnership” form may be preferable.

One item that often catches an unsuspecting sole proprietor, recently turned Single Member LLC by surprise is insurance coverage issues. Insurers often take the position that they now have to cover not only the proprietor (individually), but the new (and technically separate) entity. This can involve multiple policies (and premiums) that didn’t previously exist.

It is also sometimes a surprise to the new LLC owner that their financiers do not readily embrace their newly formed entity. One of the biggest “liabilities” for most small business owners, is their business loans. Banks will typically require the owner(s), individually, to sign a personal guaranty of any business loans. Occasionally, commercial lessors of premises will also require personal guaranty. In my experience, employees of financial institutions often do not “understand” the premise of a Single Member LLC and will insist upon an Operating Agreement for the entity. On the theory that it is easier not to “fight city hall,” we have routinely prepared them as part of our setup, but have done so knowing that the LLC statute provides that they are “unenforceable” (MCL 450.4215).

Many advisors have touted the LLC (including the single member variety) as a method to protect the individual member from creditors. In a partnership, or limited partnership historical context, it is not possible for a judgment creditor to obtain control of the assets of such a partnership. The best that they can hope for is something called a "charging order." From a creditor's perspective, that has limited utility, and may even have some negative consequences (the IRS has taken the view that the holder of a "charging order" is liable for tax liability that passes through that order). The charging order analysis has been extended to the LLC, as it is very much like a limited partnership in that context.

I believe that we need to be very careful in advising our clients regarding “asset protection” schemes and methods, however. In 2003, a Colorado Bankruptcy Court held that the bankruptcy trustee could take possession of the assets of a Colorado Single Member LLC. Although the Michigan Statute is significantly different and would arguably yield the opposite result, many commentators take the view that a creditor will probably be able to get to the assets of a Single Member LLC if they have a judgment against the sole owner.

It is important to seek counsel experienced and knowledgeable in these issues when structuring a new business or converting an old one.

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Understanding How DELEG Treats Business Entities

Formal Michigan business entities, Corporations, Limited Liability Companies (LLC), Limited Partnerships, and variations, all derive their legal authority by filing appropriate documentation with the Michigan Department of Energy, Labor and Economic Growth (DELEG), Commercial Services and Corporations Division. Once established, it is incumbent on the business to maintain their "good standing" with the state, by periodic annual filings.

Ironically (to me) while these periodic filings are pretty simple (and more often than not, pre-filled out when sent), I see a lot of clients neglecting the simple chore of signing (ocassionally correcting) and sending them in with their annual fee.

The rule for corporations is that if the annual filing is not made (and the fees not paid), for 3 consecutive years, the department automatically dissolves the corporation. Indeed, while I am not personally an advocate of this, many practitioners whose clients wanted to dissolve their corporations, simply purposely failed to file for 3 years.

Those familiar with this might expect that the LLC, in many ways an essentially similar entity in terms of the DELEG adminstrative requirements, would be treated the same. In fact, the Michigan LLC statute does not provide for automatic dissolution, and DELEG takes the position that an LLC may not be dissolved in any other manner than by filing appropriate documentation.This can create an interesting result where filing has not been done. After failure to file and/or pay the annual fee for 3 years, an LLC is put in the status of being "Active, but not in Good Standing." In order to dissolve such an LLC, DELEG requires that it first be put back in Good Standing (by filing all back fees and Michigan Annual Reports). Only then will they accept and file a Certificate of Dissolution!

Another area that is often a source of confusion is the use of an "Assumed Name." Corporations and LLCs may use an Assumed Name, but filing is made in Lansing at DELEG, not, as some clients assume, in the County Clerk's office. (nder Michigan Law, Certificates of Co-Partnership and "d/b/a" certificates (of assumed name for individual proprietorships) are filed in the County Clerk's office where those entities do business).

For Corporations and LLCs, the Assumed Name or d/b/a Certificate is filed with DELEG. This "central filing" has the effect of protecting the name from use by another corporation or partnership in Michigan. An Assumed Name Certificate expires after 5 years unless renewed! This is different from most Corporate and LLC filings which are perpetual in most cases unless dissolved. This means the user of the Assumed Name must be vigilant and have some kind of tickler system. If an LLC is not in good standing, their Assumed Name is not in good standing either and another entity may apply for and use it.

It is important to understand that these are just filing requirements with the State of Michigan. While DELEG will not give a name being used (or a name they believe is too similar) to another applicant, this does not necessarily mean the name is yours as a legal matter. There are Trademark and Trade name issues, which may--in litigation--ultimately supercede DELEG's determination.

One can see that this is an area fraught with pitfalls. My prior experiences with it is one of the reasons form my "legalwhatever.com" Rant earlier this month. It is important that the rules be negotiated and that the entity maintain its "good standing" status for many reasons, including readiness for a lawsuit, IRS audit, loan by a financial institution, or "suitors" for the purchase of the business or an investment in it.

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My First Rant

I have become an XM Radio listener. I enjoy being able to tune in the major news outlets like CNN, FOX and NPR, as well as some of the Sports Stations. Recently, I have begun to ocassionally enjoy the Comedy stations, too.

XM (and Sirius) once touted "commercial free" listening. While I liked that, the realist in me acknowledges that any service has to be somehow paid for, so I don't hold against them that they indeed advertise.

What I do find offensive is the onslaught of advertising (perhaps in other places too) of so-called Internet "Business Legal Services." You know the commercials:

"We aren't a law firm, but we were founded by lawyers." "Even my brother-in-law, the lawyer was astounded at how good the documents were." " We had it checked out by a nationally known professor at a Law School."

And so on.

I know.....this sounds, not only like a rant, but like whining about the competition. Frankly, I don't care about competition. I have been blessed (as I have previously mentioned on my Michigan Estate Planning Blog) with some truly wonderful relationships with other professionals and with many loyal clients. I am not concerned about competition. Indeed, my conservative political leanings lead me to continue to believe that competition is healthy. What I am concerned about is the misleading nature of these commercials--and the corresponding sites.

Sure, they provide documents (often reasonably well-written). Sure, they provide filing services with State Departments of Commerce (ironically, most states now offer direct filing services for the customer that would allow filing the documents without the assistance of the "dotcom" companies). What they do not do is give advice and counsel on which forms to file, and more importantly, why or why not. Nor do they do any analysis on whether the entity format is even correct for the client.

Forms are just that -- Forms. They do not think or analyze.

And, there is simply no "one-size-fits-all" legal entity or form. Nor is there any quick, shortcut to properly establishing a business entity. A business entity is not automatically properly created just by filing and signing forms. I cannot think of a worse result than for a client to believe it has been properly set up as a corporation or a limited liability company, to rely on that, only to find out too late that the protections or status sought are simply not there, because the job was not completed properly.

So there it is. My rant. I firmly believe these "services" do a great disservice both to business and to the professionals who advise businesses.

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Why I Started This Blog

Those of you who know me must be wondering, by now, whether I have time to do anything else, and if I have become addicted to "Blogging."

A significant portion of my business involves the set up and maintenance of business entities for clients. I also assist clients with business succession planning, often in conjunction with estate planning for them. But I thought the Business Topics justified their own place, with issues often separate and distinct from Estate Planning. Today, specialization seems to be the norm, in practice and on weblogs. So another Blog is born.

I will address Business and Business Succession topics here, as well, perhaps, as the occasional rant on current web and media-based practices. There are a number of fascinating legal and current issues relating to small businesses, ranging from mundane issues such as corporate maintenance, to more "exotic" issues involving intellectual property (copyright, trademark, trade secrets and the like), and internet-based issues, and things in between, such as taxation, sales issues, employment issues, noncompetition, buy and sell agreements, insurance and many others.

I hope you will find the information here useful and informative and that this will become a resource for business-law information.

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