The Arizona Corporation Commission shut down two unregistered investment programs—one involving gold mining and the other concerning bonds. In total, the Commission ordered the respondents to pay $641,016 in restitution and $60,000 in administrative penalties.
Brian Langebach and Earth Explorations, LLC
The Commission issued a default order against Brian Langebach of Mesa and his affiliated company, Earth Explorations, LLC, requiring them to pay $322,000 in restitution and $50,000 in administrative penalties for fraudulently offering and selling an unregistered gold mining investment program. The Commission found that Langebach and his affiliated company—while not registered as a securities salesman or dealer—offered and sold the unregistered gold mining investment program to 23 investors in Arizona, Ohio and Utah. The Commission found that Langebach and his company misrepresented multiple facts, including claiming that he owned and operated a mine with one of the largest gold reserves in the U.S. and that he could extract gold from the rock material or aggregate material on a cost-effective or economically viable basis by placer mining.
Marvin Wilson and True North Business Ventures, LLC
The Commission ordered Marvin Wilson of Phoenix and his Scottsdale-based company, True North Business Ventures, LLC, to pay $319,016 in restitution and $10,000 in administrative penalties for fraudulently offering and selling an unregistered bond investment program. The Commission found that, while not registered as a securities salesman or dealer, Wilson and True North issued unregistered bonds to six investors. The Commission found that Wilson, who was the president and chief executive officer of True North, failed to disclose to investors that his company’s sales were rapidly declining and the business was on the verge of closing. In settling this matter, Wilson neither admitted nor denied the Commission’s findings, but agreed to the entry of the consent order.
The Arizona Corporation Commission is warning Arizona business owners that an individual or group calling themselves “Corporate Records Service” is sending out official-looking documents advertising a service of preparing filings for corporations. This solicitation, requesting payment of a $125 fee, is not a Corporation Commission document and this organization is not in any way affiliated with the Arizona Corporation Commission. The Corporation Commission does not require business owners and their representatives to file with “Corporate Records Service,” nor does it require the $125 fee referred to in the document.
The documents look very similar to Corporation Commission filing documents and the private firm making the solicitation intentionally creates confusion by using language that is similar to that in Corporation Commission documents. The forms carry an official-looking time deadline for filing and include the Arizona Corporation Commission file number assigned to the business. Further, a search of the “Corporate Records Service” return address places it as a mailbox at a UPS Store in the Ahwatukee Foothills Towne Center.
If you have received this document, please contact the Arizona Attorney General’s Office in Phoenix at (602) 542-5763, in Tucson at (520) 628-6504, or outside the Phoenix and Tucson metro areas at 1 (800) 352-8431. To file a complaint online, please visit the Attorney General’s web site at www.azag.gov. To file a complaint in person, the Attorney General’s Office has 37 satellite offices throughout Arizona with volunteers available to help. Locations and hours are posted on the Attorney General’s web site.
New Jersey business litigator Jay McDaniel posted an article on his excellent blog called “New Jersey Business Dissolution Journal” that is a must read for every person who owns an interest in an Arizona limited liability company. Jay’s article explains the five biggest mistakes people make when they form an LLC. The mistakes are the same mistakes I caution people against constantly when I form LLCs and advise the owners of existing LLCs.
Jay McDaniel is a business litigator whose opinions are based on years of experience representing business owners in disputes that arise from the ownership of businesses. Jay wrote:
“Having litigated many of these matters over the years, I see the same mistakes made early in the life of the business surfacing again and again as the source of litigation.”
McDaniel’s point is that the failure to plan when companies are created can be a very expensive blunder when a dispute among owners arises. Even though I am not a litigator (I never personally represent anybody in litigation), my experience is the same as McDaniel’s.
The list omits the mistake of not having an Operating Agreement. The following is what McDaniel says about the lack of an Operating Agreement:
“If a business does not have one, sooner or later, it will have problems and without any point of reference whatsoever, the probability of litigation is high. When that happens and the business is successful, the chances are that you will spend the price of a college education – at a nice private school – on the lawsuit.
Here’s Jay McDaniel’s list of the five biggest LLC formation mistakes (read the article to get the reasoning behind each mistake:
No operational planning
No contingency planning
No valuation planning
No succession planning
No planning for amendments to the Operating Agreement.
A small group of Arizona lawyers who think they know what is best for Arizona and the members of Arizona limited liability companies has the goal of replacing Arizona’s good LLC law entirely with a terrible uniform model law called the “Revised Uniform Limited Liability Company Act” aka “RULLCA.” Without doing an in depth analysis of the pros and cons of existing Arizona LLC law with the pros and cons of RULLCA or another model LLC act promulgated by the American Bar Association (the group never considered the ABA model) this group of self-appointed “LLC experts” decided:
Arizona’s existing LLC law should be replaced.
Arizona’s existing LLC law should be based on RULLCA.
RULLCA is deficient so the group must substantially revise RULLCA to their satisfaction.
The asset protection feature of Arizona Revised Statutes Section 29-655 that prevents the foreclosure of a member’s economic interest in an Arizona LLC should be eliminated and creditors of the member should be allowed to foreclose on that interest. Read “Why the Charging Order Exclusive Remedy Must be Saved.”
I am a member of this group of Arizona lawyers, but I have been opposed to the group and its goal from day one. The last straw for me occurred on October 4, 2012, when the group voted 11 – 4 to eliminate the charging order sole remedy and allow for the foreclosure of a member’s economic interest in an Arizona LLC. Because I fear that this group might be successful in replacing Arizona’s good LLC law that isn’t broken with an entirely new act that would move Arizona from a good LLC law state to a bad LLC law state I created a website called Save Arizona’s LLC Law. It would be a terrible mistake to replace our good LLC law.
To learn more about the disaster called RULLCA and why we need to fight to save Arizona’s good LLC law read my article called “The Threat.”
How You Can Help to Save Arizona’s Good LLC Law
Please help me fight to retain Arizona’s good LLC law. We need your help now to mobilize and prepare to defend Arizona’s LLC law. We don’t need money, but please vote in our poll and pass the word about the threat to your friends and business associates. I’ve made it very easy for you to help our cause. Just click on How to Join the Fight and follow the instructions.
On September 30, 2012, my wonderful daughter, Katie Leavitt, aka the KEYTLaw Girl, started her new job as a fashion styling specialist for Origami Owl. She was my LLC legal assistant for six years beginning when she started her senior year at ASU. She is leaving the law pursue her passions, fashion and photography. She will be involved in helping a great young company increase its sales. Origami Owl discovered Katie because of her fabulous website called Running On Happiness, a site that showcases Katie’s fashion sense, writing ability and photography skills. My wife and I will miss working with our little girl every day, but it is time for her to move on and do what she really wants to do. Katie will continue to be the KEYTLaw Girl in videos we make in the future.
On June 18, 2012, the Governor of New Hampshire signed into law New Hampshire’s entirely new limited liability company act. The law is effective January 1, 2013, for LLCs formed in New Hampshire after December 31, 2012, and January 1, 2014, for New Hampshire LLCs formed before January 1, 2013. The law is called the “New Hampshire Revised Limited Liability Company Act.”
The primary author of the new act is attorney John Cunningham who has written two treatises on limited liability companies. He and Vernon Proctor wrote Drafting Delaware LLC Agreements. John is the author of the $674 Drafting Limited Liability Company Operating Agreements (3d ed. 2012). I own, refer to and recommend both of these expensive legal how to books.
I gave the new Act a quick over view and generally liked what I saw. The Act imposes fiduciary duties on members and managers. It also provides for default statutory provisions that apply to all NH LLCs unless they adopt an Operating Agreement that provides otherwise. The one provision I do not like is the charging order provision because it allows a creditor of a member to sell the member’s interest in the LLC.
The Arizona Corporation Commission will no longer allow a new Arizona limited liability company to use a Post Office box for the LLC’s known place of business in Arizona. Arizona Revised Statute Section 29-604.A states:
“A limited liability company shall appoint and continuously maintain in this state . . . A known place of business that may be the address of its statutory agent.”
“The articles of organization shall state . . . . The address of the company’s known place of business in this state, if different from the street address of the company’s statutory agent.”
Despite the fact neither statute contains any reference to, much less a prohibition against the LLC from using a P.O box as the LLC’s known place of business, the ACC will no longer accept Articles of Organization that shown that the company’s only place of business address is a PO box.
Congratulations to Patricia Barfield, the Director of the Corporations Division of the Arizona Corporation Commission. She is the reason the ACC this week dumped its old non-pdf fillable and confusing forms and adopted new slick understandable pdf fillable forms. Here’s the index of all the new Arizona Corporation Commission forms.
Wall St. Journal: “Small-business owners often complain of feeling caught in the cross hairs of the tax code. For a change, here’s good news. The Tax Court has just blessed a new technique that owners of closely held businesses—and wealthy families—can use to pass assets to heirs with a minimum of taxes and complications. The ruling in the case, Wandry v. Commissioner, is stirring up excitement among experts.”
The taxpayers owned a limited liability company worth approximately $1 million dollars. In 2004 they created a plan by which they would make gifts each year of membership interests in the LLC to their children and grandchildren. Their gift plan provided that at no time could an annual gift to a donee exceed the then amount of the U.S. gift tax exemption (currently $,3,000). The court ruled that because of the method the taxpayers used to make the gifts it was not possible for any gift to ever exceed the amount gift tax exclusion amount therefor no gift tax was owed.
P.S. The taxpayers plan included a clause that provided that to the extent any gift ever exceeded the annual gift tax exclusion amount the excess over the exclusion amount would go to a charity rather than the donee. This type of clause gives the IRS no reason to challenge the taxpayers action because even if the IRS were successful on its claim the excess gift amount would go to the charity and the taxpayers would be entitled to a corresponding charitable deduction.
University of California, Los Angeles (UCLA) – School of Law Proffessor Stephen M. Bainbridge wrote a great article called “Abolishing LLC Veil Piercing.” The abstract says:
”Courts are now routinely applying the corporate law doctrine of veil piercing to limited liability companies. This extension of a seriously flawed doctrine into a new arena is not required by statute and is unsupportable as a matter of policy. The standards by which veil piercing is effected are vague, leaving judges great discretion. The result has been uncertainty and lack of predictability, increasing transaction costs for small businesses. At the same time, however, there is no evidence that veil piercing has been rigorously applied to affect socially beneficial policy outcomes. Judges typically seem to be concerned more with the facts and equities of the specific case at bar than with the implications of personal shareholder liability for society at large.
A standard academic move treats veil piercing as a safety valve allowing courts to address cases in which the externalities associated with limited liability seem excessive. In doing so, veil piercing is called upon to achieve such lofty goals as leading LLC members to optimally internalize risk, while not deterring capital formation and economic growth, while promoting populist notions of economic democracy. The task is untenable. Veil piercing is rare, unprincipled, and arbitrary. Abolishing veil piercing would refocus judicial analysis on the appropriate question – did the defendant – LLC member do anything for which he or she should be held directly liable.
The wheels of Arizona justice turn slowly, but Arizona Attorney General Terry Goddard Tom Horne finally got a judgment against the perpetrators of a 2008 corporate minutes scam. I wrote about the scam in 2008 in an article entitled “LLC Minutes Scam Alert.” Attorney General Goddard’s September 2009 complaint alleged:
11. From November 2008 until May 2009, Defendants disseminated at least 137,500 solicitations, using direct mail, to Arizona corporations and limited liability companies. The solicitations, under the fictitious name Arizona Corporate Headquarters, were official-looking forms which implied that a business had to complete the form and return it with an “Annual Fee” of $125 by a “REPLY BY” date to preserve its corporate status. The form is entitled “Annual Minutes Disclosure Statement.” Below this title is a date designated as the “NOTICE DATE: XIX./XX” followed by the “CORPORATE NAME: [Name of Corporation or LLC]” and the “CORPORATION NUMBER: [#######J,” which was the corporation number of the business addressee as assigned by the Arizona Corporation Commission. The form has the format of an official-looking document and includes a citation to the Arizona Corporations Code requiring a corporation to hold annual meetings of shareholders.
12. The forms contain a warning, in boldface capital letters: “TO ENSURE APPROPRIATE PROCESSING AND FULFILLMENT, PLEASE RETURN THIS FORM WITH YOUR PAYMENT TO: ARIZONA CORPORATE HEADQUARTERS-BUSINESS DIVISION – 5025 N. CENTRAL AVENUE, SUITE 573, PHOENIX, AZ 85012.” The address is a private mail box used by Defendants and located in a UPS Store.
13. The form also contains a warning that “[fjailure to comply with certain requirements could cause your corporation to lose its limited liability status. If so, personal liability exposure to tax agencies, or other creditors could possibly be put on the directors and shareholders for failing to document formalities.” Thereafter each form states that it should be submitted “with the ANNUAL FEE OF $125.00 WITHIN 15 BUSINESS DAYS.”
14. The back of the forms utilized by Defendants states that payment should be submitted “along with the Annual Minutes Disclosure Statement for proper processing and fulfillment of the Annual Minutes for your corporation.” It directs payments be sent to the ”Business Division” of Arizona Corporate Headquarters.
15. Defendants represent that in exchange for payment they will prepare corporate minutes. In fact, in the limited cases in which Defendants did provide corporate minutes, those minutes reflected meetings that never took place and actions that never occurred.
17. Defendants have received over $350,000 from the thousands of Arizona corporations and limited liability companies that completed the form and paid the $125.00.
In February of 2012 Attorney General Horne obtained a judgment for $338,225 damages plus $48,900 attorney fees against defendants Y.M.S., Inc., a Nevada corporation, Gaston Muhammad, aka Gaston Greene and Ronna Muhammad, aka Ronna Greene.
On April 12, 2012, the Arizona Corporation Commission announced that it sanctioned multiple individuals and their affiliated companies whose unregistered investment programs—most of which involved real estate—caused investors to lose over $8.57 million. The Commissionordered that amount in restitution and a total of $377,500 in administrative penalties.
First, the Commission ordered Kent M. Axtell of Phoenixand his affiliated companies to pay $1,142,747 in restitution and a $75,000 administrative penalty for committing securities fraud in connection with an unregistered real estate investment program. The Commission found that,while doing business as Sherlock Homes and Finding Homes for Investors, and as the sole member of Executive Real Estate Solutions, LLC, Axtell sought investor funds to buy and sell real estate in Arizona. The Commission found that, while not registered as a salesman or securities dealer in Arizona,Axtell and his companies pooled the money of at least 26 investors and issuedpromissory notes, some of which were collateralized by deeds of trust. Further, the Commission found that, through promotional materials, Axtell touted his extensive real estate experience, representing to investors their funds would be secured with a collateral assignment in a sizable life insurance policy owned by Axtell. The Commission found that, in at least one instance, Axtell failed to record a deed of trust to secure the amount invested and used investor funds to repay another investor. In settling this matter, Axtell neither admitted nor denied the Commission’s findings, but agreed to the entry of the consent order.
In a separate case, the Commission ordered James F. Curcio of Sun Lakes to pay over $4.94 million inrestitution and a $40,000 administrative penalty for fraudulently offering and selling unregistered membership interests in limited liability companies that were in the house-flipping business. The Commission found that, while not registered to offer and sell securities in Arizona, Curcio and his affiliated companies—3CG, LLC and Choice Property Group, LLC — sold the unregistered investments to over 50 investors, promising them 15% annual returns. The Commission found that Curcio informed some of the investors they could rollover their IRA funds to purchase the unregistered LLC membership interests. The Commission found that Curcio promised investors their money would be used to purchase real estate, but Curcio and his affiliated companies actually used the money to service loans from institutional lenders who were creditors of the house-flipping business. In settling this matter, Curcio agreed to the entry of the consent order and admitted to the Commission’s findings only for the purposes of the administrative proceeding.
In the next case, the Commission issued a default order against former Scottsdale resident Arthur Fried who bilked more than $1.05 million from 16 investors. The Commission ordered Fried to pay a $150,000 administrative penalty for fraudulently offering and selling the unregistered real estate investment program. The Commission found that Fried managed four companies—Comprehensive Cash Flow Funding, Inc., WeBuyHomesinAZ, LLC, My Bargain Gift Bag, LLC and Loan Mod Shrink, LLC—and, while not registered to offer or sell securities, raised money from investors to fund the purchase, renovation and sale of real estate properties in Arizona. The Commission found that, through various sources—websites, real estate investment clubs, and advertisements in newspapers, including the Jewish News of Greater Phoenix—investors were promised a guaranteed, double-digit return with an investment secured by a first-lien position on real estate. The Commission found, however, that Fried, in some instances, did not even hold title to the real estate, and as a result, issued fictitious deeds of trusts to some investors. The Commission entered a separate default order against Fried’s business entities in March 2012.
In another case, the Commission ordered Robert Coleman Stephens of Cave Creek to pay $1,366,897 inrestitution and a $100,000 administrative penalty for fraudulently offering and selling an unregistered real estate investment program. The Commission found that, while not registered to offer or sell securities in Arizona, Stephens raised money from investors to fund a large, real estate and commercial resort development involving condominium timeshares with access to a golf course, indoor mall as well as air, car and boat racing. The Commission found that, through free seminars in the Scottsdale area, Stephens misrepresented to investors that he was a successful real estate developer when, in fact, his prior businesses had failed, resulting in multiple judgments against Stephens and his companies. Additionally, the Commission found that Stephens failed to inform investors that he would use some of their money to pay for questionable expenses, including personal vehicle repairs. Further, the Commission found that Stephens failed to secure on behalf of the investors liens against his jet aircraft, which Stephens pledged as collateral. In settling this matter, Stephens neither admitted nor deniedthe Commission’s findings, but agreed to the entry of the consent order.
Finally, the Commissionordered respondent G4i Capital Partners, Inc., a Delawarecompany, to pay a $2,500 administrative penalty for offering and selling anunregistered securities offering in Arizona. The Commission found that, while not registered as a securities dealer, G4iCapital Partners, through two websites, made a general solicitation forinvestor money to fund its government contracting and consulting operations,offering potential investors a secure, high-yield return on their investment. The Commission found that G4i Capital Partners sold the unregistered investmentprogram to a least one investor who was subsequently repaid withinterest. In settling this matter, G4i Capital Partners neither admittednor denied the Commission’s findings, but agreed to the entry of the consent order.
More caution for investors:
Evenwhen selling a legitimate product, some promoters do not recognize theinvestment program they have created is a security. Determining whetheran alternative investment program is a security is not always easy to determineand depends upon the unique facts and circumstances of the transaction and noton what a promoter calls the investment product. Even when investing with someone they know, investors shouldverify the registration of sellers and investment opportunities and investigatedisciplinary histories by contacting the Arizona Corporation Commission’sSecurities Division at 602-542-0662 or toll free in Arizona at 1-866-VERIFY-9. TheDivision’s investor education web site also has helpful information at www.azinvestor.gov.
Question: I want to form a limited liability company that will obtain a federal firearms license (FFL). Are there significant differences between a “vanilla” LLC and one that will hold an FFL for the sale or manufacture of firearms?
Answer: Yes. Although Arizona LLC law is the same for all LLCs formed in Arizona regardless of an LLC’s intended purpose, LLCs that intend to obtain an FFL for the sale or manufacture of firearms require an Operating Agreement that contains provisions that relate to the LLC’s purpose and the need to comply with federal weapons laws.
I work with attorney David Goldman, the Guntrust Lawyer, to prepare a special type of trust called a gun trust for Arizona residents. David is an expert on federal weapons laws and he has a wealth of information about gun trusts and firearms law on his website. This what David says about LLCs that will obtain an FFL:
“One of the biggest problems with many FFL’s is that they use regular operating agreements or corporate bylaws. There are some specific issues why using a canned or shell company documents may not be appropriate and why you should consider using agreements that are specifically drafted for FFLs.
Your Operating Agreement or By-Laws needs to deal with specific FFL related issues as well as issues that are common to the firearms industry. Prohibited Person issues must deal with not only the owners or manages as mentioned above, but also employees. These documents should mandate policies that need to be in place for issues regarding federal and state requirements and recommendations.
Part of the process included determining the proper licenses as we often see that FFLs are confused about what is manufacturing and what is gunsmithing and the requirements of each. Many FFLs sell parts and then assemble them for clients and are actually manufacturing firearms because of the way the transaction and work is structured. They often do not have the licenses nor collect the required excise taxes.
If the business entity is used correctly, the business entity can stop the liability from going to the owners and managers. Many corporate and LLC docs can prohibit some of the activities that FFL, their owners, managers, and employees engage in. If you are violating the terms of your agreement, your business entity may not shield you from the actions or liability
Properly drafted agreements allow for growth including taking on new members or shareholders which could provide additional resources to the business. Today a prohibited person may not know they are prohibited and traditional operating agreement do not shield them from prohibited transactions or activities. Your agreement should help a person determine if they are prohibited as well as guide them in which activities they may and may not participate and who needs to be updated upon such a change.
A properly drafted business agreement can help you sell the entire business with the licensing already in place. Most FFL’s when sold have to go through a new authorization process because they are not properly structured and/or do not allow for this type of transition.
Thinking about how the ownership of the business is structured and dealing with this in the business agreements can allow the business to pass down through the generations and keep it within the family.”
In addition to the industry specific business agreements, it is important to properly prepare your FFL and/or SOT applications so that they are not rejected and they should be designed and incorporated into an overall plan to provide insulation from problems down the road.
FFL’s are historically weak in business and the understanding of the complex rules and regulations regarding the firearms industry. Many have skated by in the past, but with the new 100% compliance audits, it is more important than ever to be setup correctly or modify your existing business rules and documents to comply with the industry.”
“While some individuals may turn to online corporate formation providers or contact their family attorney, neither of these avenues can provide the proper legal advice on setting up either a Corporation or Limited Liability Company (LLC) for an FFL, unless the provider has experience with the firearms industry and pertinent issues. I have developed FFL-specific By-Laws (for a Corporation) and Operating Agreements (for an LLC) that deal with these issues and set the foundation for any firearms industry specific issue that may arise.”
Hire Arizona LLC Attorney Richard Keyt & Firearms Attorney Joshua Prince to Prepare an Operating Agreement for an FFL LLC
The Operating Agreement I prepare for people when I form an Arizona LLC does not contain language that should be in the Operating Agreement of an LLC that will be an FFL for the sale or manufacture of firearms. If you have or intend to have an Arizona LLC that needs this special industry specific Operating Agreement I recommend that you hire Pennsylvania attorney Joshua Prince and me to prepare the unique industry appropriate Operating Agreement needed for this type of LLC. See Josh’s blog topics on Firearms Law and Gun Trusts.
Joshua Prince’s primary area of law practice is federal firearms and weapons laws. For more information about this special Operating Agreement or if you have questions about why your LLC needs it call Josh at 610-845-3803. When Josh and I work together on an Operating Agreement, he is responsible for the federal firearms portions and I am responsible for the Arizona law portions. If you hire Josh and I to prepare a firearms law specific Operating Agreement, the fee you pay us includes Josh’s services to prepare and file all of the paperwork required to get the type of FFL or licenses needed from the BATF for your LLC (the fee does not include filing / application fees or costs). Josh does so much work in this area that he uses the services of a retired BATF agent who reviews applications and makes sure there are no problems before submitting them to BATF.
The New York case of Duff v.Curto, 2012 NY Slip Op 30264(U) (Sup Ct Suffolk County Jan. 25, 2012), by Suffolk County New York Justice Emily Pines involved a claim by one LLC member that the other member failed to contribute money to the company. Duff claimed he contributed $523,000 to the capital of Fairlea Court Holding, LLC, of which Gary Duff and Peter Curto, Jr., were the only two members. Duff claimed that Curto breached the Operating Agreement because he did not contribute any money to the company and that Curto was unjustly enriched.
They signed an Operating Agreement that said:
“[u]pon the execution of this Agreement, each Member shall contribute cash and/or property to the Company as set forth opposite their names in Exhibit A”
Exhibit A stated that each member had a 50% interest in the company, but it did not show that either member was to contribute any capital to the company. The Court said:
“The Court finds that the documentary evidence provided raises an issue of the parties intent in placing the 50% figure in the Agreement and does not definitively dispose of the plaintiff’s claim”
The Court found that Duff reported on his tax returns that he loaned $309,000 to the LLC and that Curto never agreed to contribute any money to the company.
Lesson for Arizona LLCs
Arizona LLC law provides that no member of an Arizona limited liability company is liable to contribute money or property or services to the LLC unless the member agrees to do so in writing. Arizona Revised Statutes Section 29-702.A states:
“A promise by a member to make a capital contribution to the limited liability company is not enforceable unless set out in writing and signed by the member.”
If you have an Arizona LLC and want to create a legal obligation on the part of one or more members then the LLC must obtain a written document signed by the member(s) that states the amount of money or the description of the property or the nature and extent of the services and when the money or property or services must be contributed. The best place for these provisions is the Operating Agreement.
Question: I received an email message that asked “Can your law firm provide the services that our business needs or should we should use Legal Zoom?”
Answer: We are a small business law firm, but unlike Legal Zoom, we are licensed attorneys. We can provide all of the legal services typically needed by small businesses. If you need legal advice you should hire an attorney. LegalZoom is not a law firm and does not employ attorneys to provide legal services. In fact, here is the disclaimer language I got from the bottom of LegalZoom’s home page on March 4, 2012:
“LegalZoom is not a law firm and is not a substitute for an attorney or law firm. Communications between you and LegalZoom are not protected by the attorney-client privilege or work product doctrine. LegalZoom cannot provide legal advice“
Anybody who is considering using LegalZoom should ask: “Why does LegalZoom warn that it IS NOT A SUBSTITUTE FOR AN ATTORNEY?” I found a page on LegalZoom’s website that inadvertently answered this question. If you click on the link above and then scroll to page three you will see this legally incorrect and misleading statement LegalZoom makes about an LLC Operating Agreement:
“Personalized operating agreement, including provisions protecting officers and managers from liability“
This statement illustrates perfectly why you do not want LegalZoom to be your lawyer or provider of your legal services. No language or provisions in an Operating Agreement can or will protect a member or manager from liability. People who sue the LLC and its members or managers NEVER SIGN and are NOT PARTIES TO the Operating Agreement so they are not bound by any provisions it may contain.
LLCs Must Comply with Applicable State LLC Laws
Members and managers of an LLC may be protected from liability by the LLC law of a state, but only if the LLC operates in compliance with applicable LLC laws. If you do not know what your state’s LLC laws are then it is unlikely your LLC will comply with those laws and your LLCs and members and managers may become personally liable when a court pierces the company veil and holds the members and/or managers liable for the debts of the LLC. For an example of this LLC nightmare read my article called “Colorado Court Pierces LLC Veil & Holds Single Member Liable for LLC’s Debt.” The reason I wrote and give all of my LLC client my book called the “Arizona Limited Liability Quick Start Guide” is educate my clients on Arizona’s LLC laws and what the LLC must do to comply with the laws and prevent a court from piercing the company veil and holding the members liable for the debts of the LLC.
KEYTLaw’s Legal Services
In addition to forming LLCs, KEYTLaw attorneys provide the following legal services:
1. Federal trademark law – preparing and filing trademark applications with the U.S. Patent & Trademark office and taking legal action for trademark holders against infringers.
2. Contract law - preparing and reviewing contracts of all types.
3. Entity administration – preparing Buy Sell Agreements and documents to add or remove members of LLCs, shareholders of corporations and partners of partnerships.
4. Real estate law – preparing or reviewing contracts to buy, sell or lease Arizona real estate of all types, including commercial leases for businesses.
5. Employment law – preparing employment agreements, independent contractor agreements, employee policies and procedures and employee manuals.
6. Copyright law – preparing and filing copyright registrations with the U.S. Copyright office, and taking legal action for copyright holders against infringers.
7. Patent law – preparing and filing patent applications with the U.S. Patent & Trademark office.
8. Nonprofit law – forming Arizona nonprofit corporations, including preparing IRS Form 1023 and applying for an obtaining income tax exemptions from the IRS for charitable organizations.
9. Commercial litigation representing plaintiffs and defendants in all types of typical business lawsuits.
10. Landlord tenant law – preparing and reviewing residential leases and representing landlords, including evicting residential and commercial tenants.
KEYTLaw is currently a six attorney firm. We will add another attorney when my son Richard C. Keyt, CPA, graduates from ASU’s law school in May of 2012 and passes the Arizona bar exam.
If you have any questions about legal needs for your business, please call me, Richard Keyt, at 602-906-4953, ext. 1. If I can’t answer the questions I will put you in touch with the KEYTLaw attorney who can.
On May 1, 2011, the Editorial Board LLCs, Partnerships and Unincorporated Entities Committee, Business Law Section, of the American Bar Association published its proposed Revised Prototype Limited Liability Company Act. The following is the Committee’s summary its proposed LLC act:
1. Articles of Organization Changed to Certificate of Formation.
The term “articles of organization” has been changed to “certificate of formation” to better align the Act with current limited liability company acts.
2. Operating Agreement Changed to Limited Liability Company Agreement.
In an effort to better signify the nature of the agreement among the members by referring to the agreement in a manner consistent with the general and limited partnership statutes (which refer to the agreement of the partners as the “partnership agreement”), the term “limited liability company agreement” has been used in lieu of the term “operating agreement.”
3. Consolidation of Provisions on Limited Liability Company Agreement Override.
Following the RUPA formulation and subsequent uniform act formulations, the Act places in one section (section 110) the various provisions that may not be modified by the limited liability company agreement. This centralization allows for the elimination of the phrase “unless otherwise provided in the limited liability company agreement” or similar phrases throughout the Act and the ambiguity that results in the absence of the proper override language. Therefore, all provisions within the Act are default provisions that may be modified by the limited liability company agreement unless modifications are prohibited under section 110.
4. Elimination of Manager-Managed and Member-Managed Dichotomy and Statutory Actual and Apparent Authority.
The Act changes significantly the original Prototype Act in that it eliminates the member-managed and manager-managed bifurcation of management structures and the statutorily conferred actual and apparent authority of members and managers in those paradigms. Instead, the Act provides that a person’s actual or apparent authority to bind the limited liability company will be determined with reference to the limited liability company agreement, decisions of the members in accordance with the limited liability company agreement or the default rules of the Act, a statement of authority, or law other than the Act such as the common law of agency. This approach allows drafters to provide for managers, officers, boards of directors, and other forms of governance that were difficult if not impossible to accomplish under the original Prototype Act.
The default method of taxation imposed by the IRS on a multimember limited liability company is the partnership method. While I was studying for my masters degree on income tax law at the New York University law school I remember my partnership tax class professor telling the class that partnership tax was the hardest tax class in the entire graduate tax program. He was right then and this area of tax law has only gotten more complicated. This article summarizes the major partnership tax issues that concern all LLCs taxed as partnerships.
“When blushing couples walk down the aisle, they hope to live happily ever after, promising ‘ ’til death do us part.’ Even with such high hopes, many savvy couples sign prenuptial agreements in anticipation of the possibility that the marriage might not turn out as they had planned. Indeed, many individuals will not enter into a marriage without having such an agreement in place. How many would enter into a marriage today if it were possible that their state might not permit them to divorce at all?
When a marriage isn’t going well, all states have a judicial mechanism whereby the unhappy couple can divorce without either spouse having to prove fault, and many states provide the option of proving fault as well.1 However, when the “marriage” is one of members in a Limited Liability Company (LLC), the availability and mechanisms of dissolution vary from state to state. Some states have default rules whereby one member can force a dissolution,2 while other states require the consent of at least a majority of members.3 In states requiring majority consent, a minority member may still be able to obtain judicial dissolution, but to do so, the minority member must not only state that the “marriage” is irretrievably broken but must also prove this assertion to the satisfaction of the court by meeting standards that range from relatively easy to nearly impossible to achieve.4 Furthermore, with the paucity of case law on the subject and the lack of judicial consistency as to which body of law the courts will apply, determining which standards the court will likely apply is a gamble at best–making it difficult for the member to prepare its case appropriately. If the member is unsuccessful in predicting the court’s standards and proving that its case has met them, the member will find itself stuck in the marriage indefinitely, with its capital tied up and no say as to the decisions that affect its investment. This has not always been the case.”
When On February 2, 2012, the Colorado Court of Appeals issued its opinion in the case of Martin vs. Freeman, a case that is important for all limited liability company owners who want to avoid becoming liable for the debts of their LLC.
The Facts
Dean C.B. Freeman was the sole member and manager of Tradewinds Group, LLC, a Colorado limited liability company. Tradewinds only asset was an airplane that it owed free and clear with a value of approximately $300,000. Tradewinds hired Robert L. Martin to build an airplane hangar for its airplane. Tradewinds sued Martin in 2006 for breach of the construction contract. In 2007 Tradewinds sold the airplane for $300,000. After making sure that all creditors were paid Freeman caused the LLC to pay him all funds that remained in the LLC’s bank account. Thereafter Freeman paid all of Tradewinds’ litigation expenses from his funds.
In 2008, the trial court entered a judgment in favor of Tradewinds. Martin appealed and won the appeal. The Colorado Court of Appeals found that Tradewinds’ damages were speculative and sent the case back to the trial court with directions to enter judgment in favor of Martin. The trial court ruled in 2010 that Martin was the prevailing party and awarded him $36,645.40 in costs.
When Martin won the $36,645 judgment against Tradewinds Group, LLC, it did not have any because it had sold its only asset and paid all of the company’s funds to its sole member, Dean Freeman. Martin then sued to pierce the LLC veil and collect Tradewinds’ debt from Freeman, the sole member of the LLC.
The primary issue before the Colorado Court of Appeals was should the court allow Martin to pierce the LLC’s veil and hold its sole member liable for Martin’s judgment against Tradewinds Group, LLC? The appellate court stated:
“To pierce the LLC veil, the court must conclude
the corporate entity is an alter ego or mere instrumentality;
the corporate form was used to perpetrate a fraud or defeat a rightful claim; and
an equitable result would be achieved by disregarding the corporate form.”
The Colorado Court of Appeals in a two to one decision ruled that all three criteria existed and that Dean C.B. Freeman was personally obligated to pay the judgment owed to Robert L. Martin.
1st Factor: Alter Ego
The majority’s opinion says that courts consider a variety of factors in determining alter ego status, including whether:
“the entity is operated as a distinct business entity;
funds and assets are commingled;
adequate corporate records are maintained;
the nature and form of the entity’s ownership and control facilitate insider misuse;
the business is thinly capitalized;
the entity is used as a mere shell;
legal formalities are disregarded; and
entity funds or assets are used for non-entity purposes.”
The Court does not, however, tell us if alter ego status exists if a majority of the factors exist or if all all of the factors must exist or it is is merely a gut feeling determined by the court that sufficient factors exist to justify a finding that the company was the alter ego of the member. The Court found the following facts that justified its conclusion Tradewinds was Freeman’s alter ego:
“Tradewinds’ assets were commingled with Freeman’s personal assets and the assets of one of his other entities, Aircraft Storage LLC;
the records concerning Tradewinds’ substantive transactions were inadequate;
the fact that a single individual served as the entity’s sole member and manager facilitated misuse;
the entity was thinly capitalized;
undocumented infusions of cash were required to pay all of Tradewinds’ operating expenses, including its litigation expenses;
Tradewinds was never operated as an active business; legal formalities were disregarded;
Freeman paid Tradewinds’ debts without characterizing the transactions;
Tradewinds’ assets, including the airplane, were used for nonentity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation;
Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only significant asset, the airplane, were diverted from the entity to Freeman’s personal account.”
2nd Factor: Defeat of a Rightful Claim
The Court stated:
“The second prong of the veil-piercing test is whether justice requires recognizing the substance of the relationship between the corporation and the person or entity sought to be held liable over the form because the corporate fiction was ‘used to perpetrate a fraud or defeat a rightful claim.”
The Court went on to make the unfortunate statement that there is no Colorado case that ruled “that a party seeking to pierce the corporate veil must show wrongful intent.” The Court found:
“We conclude that defeating a potential creditor’s claim is sufficient to support the second prong. We further conclude, as a matter of first impression, that wrongful intent or bad faith need not be shown to pierce the LLC veil.”
The Court’s ruling effectively throws out the second prong of the three prong alter ego test and ignores 100+ years of corporate law. If a company has assets sufficient to pay its debt, the creditor does not need to sue the owner and try to pierce the corporate/company veil. It is only when the company cannot pay its debt that a creditor will sue the owner in an attempt to collect the company’s debt from the owner.
The corporate and LLC law of most if not all states provides that a fundamental asset protection concept is that the owners of the entity are not liable for the entity’s debts or obligations. It may be appropriate in some cases to find that a rightful claim of a creditor should be paid by an owner of the company after a court finding that the company was the owner’s alter ego and used to perpetrate a fraud, but the mere fact that the creditor was not paid should never be considered and used to find the owner liable. If people will be held liable for the debts of a company simply because the company has unpaid debts it will have a chilling affect on business and prevent many people from investing in businesses that would hire employees.
3rd Factor: Equitable Result
The Court did not discuss the facts that support a finding that an equitable result would be achieved by disregarding the corporate form, nor did it rule on the issue. Apparently Colorado now has a two prong test to determine if the when a Colorado court will pierce the company veil and hold the owner of an LLC liable for its debts.
Let’s hope this case is appealed because it is bad law for the owners of LLCs, corporations, limited partnerships, limited liability partnerships and limited liability limited partnerships.
What Martin v. Freeman Means for LLC Members
Some commentators have written that this case is another reason people should shy away from the single member limited liability company. I disagree. The court did not discuss that the fact the LLC had only one member was significant. What was significant to the court was the historical facts as to how the LLC operated and conducted its affairs. The case stands for the proposition that LLC owners, both single and multiple members) must follow the formalities of operating the company or risk having the veil pierced and the owners becoming liable for the LLC’s debts.
Consider the facts that the Court found that cased it to conclude that the company was Freeman’s alter ego:
1. Tradewinds’ assets were commingled with Freeman’s personal assets and the assets of one of his other entities, Aircraft Storage LLC: This is a fundamental no no. Never allow assets of a member to be commingled with the company’s assets.
2. Tradewinds maintained negligible corporate records: Again this is a no brainer.
Your LLC must maintain a good set of financial books. Use Quickbooks. Have an experienced Quickbooks expert set it up. It’s not too expensive. Make sure all income and expenses are entered and properly annotated.
If you loan money to your LLC, the books must show the date and amount of the loan and the loan should be documented by a promissory note signed by the LLC and a resolution signed by all of the members that authorizes the loan.
If you transfer assets to the company, prepare a Bill of Sale signed by the transferor that lists the assets transferred as of the stated date. If you are an employee of the company, sign an employment agreement with the company and have the members sign a resolution authorizing the LLC to enter into the employment agreement.
If the company enters into a contract with a third party have the members sign a resolution authorizing the LLC to enter into the contract.
3. The records concerning Tradewinds’ substantive transactions were inadequate: The tasks listed in the prior paragraph apply here too. In addition, one of the best things every LLC should do is routinely document all significant major actions taken by the company with minutes or resolutions signed by the members. Here is a partial list of company actions that EVERY LLC should document with minutes or resolutions:
Contributions of money or property by a member to the LLC.
Loans of money by a member to the LLC.
Adding or removing a member.
Changing the percentage ownership of a member.
Employing a member or key employee.
Hiring an independent contractor.
Buying, selling or leasing real property or personal property with significant value.
Entering into contracts with third parties.
Purchasing insurance.
Applying for licenses such as a real estate broker’s license or a contractor’s license.
Doing business in another state.
Entering into an Operating Agreement with the members.
Entering into a Buy Sell Agreement with the members.
An annual meeting of members and managers (if manager managed).
It is imperative that the members of the company document all significant actions taken by the company with minutes or resolutions. I know from being a business lawyer since 1980 that very few companies have the self discipline to document their actions. Routinely documenting transactions is one of the most important things the members of an LLC should do to prevent a court from finding that the company was the alter ego of the members.
Solution to the Lack of Records Problem: I recommend that every LLC hire Just a Minute, LLC to prepare minutes or resolutions to document all significant actions taken by the company. Just a Minute is an automated minute preparation service that reminds members by email messages every month to document recent transactions. It only takes one member to click in a link in the email to go to Just a Minute’s website where the member is given the option to enter transactions in up to eleven different categories. The member simply answers the questions asked in the online form and submits the information to Just a Minute that will then prepare written minutes or resolutions and email them to the member. The members only need to sign the document and put a copy of the signed minutes or resolutions in the company’s records. Just a Minute automates the LLC transaction document process. In my opinion as an LLC attorney it is a no brainer. Every LLC should purchase Just a Minute’s monthly minute service so the members can easily document transactions with minutes or resolutions. To learn more about Just a Minutes services, click on the image below.
4. The fact that a single individual served as the entity’s sole member and manager facilitated misuse: Note the Court said that having a single member “facilitated” misuse. It did not say that having a single member LLC is always a negative factor. The Court recognized that doting the eyes and crossing the tees is less likely to occur with a single member LLC because it takes more self discipline to have meetings with yourself and document those meetings. This fact of life is another reason why it is particularly important for single member LLCs to follow all of the formalities of operating the LLC and using a minutes service like Just a Minute.
5. The entity was thinly capitalized: The law requires that every LLC to be adequately capitalized, but it does not give LLC owners a clue as to what that term means. Adequate capitalization for an LLC means the company must always have sufficient assets for its needs, but the law doesn’t tell LLC owners exactly what constitutes adequate capitalization. LLC owners only know if their company is adequately capitalized years later if they are sued and a judge or jury rules one way or the other on the issue. Another problem is that adequate capitalization is a moving target because the number changes as the LLCs business facts and circumstances change. If the LLC does not have sufficient assets to meet its capital needs then it is not adequately capitalized. However, if the LLC does have sufficient assets to meet its capital needs a court could still find the company was not adequately capitalized. Remedy: Make sure the company has sufficient capital to pay its expenses plus a reserve of as much as you can afford and hope that if your LLC is ever challenged the judge or the jury will rule in your favor. Read “What Is Adequate Capitalization in an LLC?“
6. Undocumented infusions of cash were required to pay all of Tradewinds’ operating expenses, including its litigation expenses: This is a common problem that is easily avoided. If your LLC needs money there are two ways to get the money: (a) one or more members make a capital contribution to the company, or (b) the company borrows money from one or more members or a third party lender.
Capital Contributions: A capital contribution is a gift of money or property by a member of an LLC to the company. The company is not obligated to repay the contribution at any time except on liquidation if the contribution was not previously repaid. The company should document all capital contributions by: (a) making a proper entry in the company’s books that the member made a contribution of $x on a specified date, and (b) having the members sign minutes or a resolution that authorizes and approves the contribution.
Loans: Regardless of who loans money to the LLC, the loan must always properly documented by: (a) having the LLC sign a promissory note that states the loan amount, interest rate and repayment terms, and (b) having the members sign minutes or a resolution that authorizes and approves the loan. For more on this topic see my article called “How Do I Loan Money to My LLC?“
Undocumented infusions of cash are a routine event in most LLCs, but that does not make it right. Protect yourself by always documenting cash infusions. It’s easy to do and could make the difference between whether a court will one day allow or refuse to allow a creditor of the company to get a judgment against you. Undocumented cash infusions should never happen if you use a minutes service like Just a Minute, LLC, to automate the preparation of minutes on a monthly basis.
7. Tradewinds was never operated as an active business: Tradewinds only purpose was to own and operate Freeman’s airplane. It did not have any customers or generate any revenue. This factor is what other courts call the business purpose doctrine. A concept in asset protection law is that a court may disregard the formation of an entity like an LLC or a corporation if it has no business purpose. For example there is no business purpose to transfer title to your home to your solely owned LLC while you continue to live in the home. If the only reason you put property into an LLC is to protect it from the claims of your creditors, then the plan probably will not work. Imagine what would happen if you take the witness stand and the plaintiff’s attorney asks why did you put your home in the LLC and you answer to prevent my creditors from getting it. You lose. Because Tradewinds did not have a business, customers or revenue, it failed the business purpose test.
8. Legal formalities were disregarded: Yes the are legal formalities that apply to operating LLCs and your LLC must comply with all of them. One of the reasons I wrote my 170 page book called the Arizona Limited Liability Company Quick Start Guide is so I could explain to my LLC clients and purchasers of the book what the formalities are for Arizona LLCs. Every LLC must comply with the legal formalities of its formation state.
9. Freeman paid Tradewinds’ debts without characterizing the transactions: This is a no brainer. Members should never pay the LLCs debt. The LLC should never pay a member’s debt. DO NOT DO THIS. If your LLC needs money, write a check payable to the LLC and deposit the funds in the LLC’s bank account then pay the debt with the LLC’s money. Don’t forget to properly document the transaction as a capital contribution or a loan. If you need LLC money to pay your debt, have the LLC write a check to you so you can deposit the funds in your account and pay from your account. Don’t forget to properly document the distribution of money as a loan, compensation or a return of capital (if you have a positive capital account balance). Document the distribution with a promissory note (if a loan) and minutes or resolutions signed by the members.
10. Tradewinds’ assets, including the airplane, were used for nonentity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation: The LLC allowed another entity to use its $300,000 airplane without paying any compensation and without a written agreement. Why? This type of transaction is a red flag asking for trouble in more ways than one. No person or entity should ever use LLC assets for non-LLC purposes unless the LLC enters into a written agreement with the user and the user compensates the LLC for the reasonable value of the use.
11. Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only significant asset, the airplane, were diverted from the entity to Freeman’s personal account: The Court is wrong on this factor. The LLC was not assetless. It owned a $300,000 asset free and clear. It sold its assets and distributed the proceeds to its only member. The Court calls this “diversion” of assets, but this is the common and accepted method of liquidating an LLC or a corporation. The law does not require companies to retain cash in the company in perpetuity after the company liquidates its assets. It is not right that the Court found this fact to be a negative factor.
Conclusion
This case is a wake up call to all LLCs that do not dot the eyes and cross the tees. If your LLC is not religiously following the legal formalities of your state’s LLC law and properly documenting LLC transactions, especially transactions with members, then the company is setting the groundwork for a court ruling that the company veil should be pierced and the member(s) should be liable for the debts of the company.
Does your LLC properly document all significant transactions? If not, then I have two statements for you:
If your LLC has not been documenting LLC transactions with minutes and resolutions, you won’t be doing it in the future.
The only way your LLC will be able to properly document transactions is to hire a company like Just a Minute, LLC, to automate the documentation process.
Here are some other articles on this important topic:
“With the stripping of the requirement to prove wrongful conduct and expansion of liability for contingent claims, the ruling diminishes the limited liability protection afforded to all corporations and LLCs operating in Colorado. Incorporation in a jurisdiction with more robust liability protections seemingly provides no remedy – the Martin Court applied Colorado LLC statutes and case law without discussion of why Colorado law should apply to Tradewinds, a Delaware LLC. The ruling also highlights the renewed importance of maintaining adequate corporate records and practices as a means of avoiding ensnarement under the first prong of the veil-piercing test.”
“Update Corporate Records and Follow Required Formalities. Many closely held businesses do not keep their corporate record books up to date. In the event of a lawsuit against the company, a plaintiff’s attorney can attempt to “pierce to corporate veil”. This means the corporation will essentially be ignored and the owners (shareholders) will be personally liable for the corporate debts. Following basic corporate formalities, including
Holding an annual shareholders meeting;
Holding regular meetings of the Board of Directors;
Avoiding any mixing of personal and corporate assets; and
Keeping corporate records up to date.
will all help to insure that the assets of the owner(s) of the business are insulated from any judgment against the business.”
Forbes: “If you’re aiming to stiff creditors, litigants or an ex-spouse, should you hide your money in Nevis or Nevada? Forget about hiding money offshore from the Internal Revenue Service–unless you want to risk the penalties, back tax bills and threat of prosecution that thousands of American clients of ubs now face. But what about protecting your cash from vexatious litigants, a grasping ex-spouse or pesky creditors? Then offshore trusts are still an option, but a far less attractive one now that legal reporting requirements for offshore holdings have become more onerous and some U.S. judges have taken to jailing folks who won’t (or can’t) turn over offshore assets. That’s good news for the lawyers and bankers promoting domestic asset protection trusts instead.
