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Avoid Disaster With Your Single-Member LLC

Pad lock and chain securing handles to Single-Member LLC business

Do you own a single-member LLC? If so, your business can become paralyzed if you become incapacitated or die. Even a short paralysis may cause a business to collapse. Avoid this problem by doing the following:

  1. organizing single-member LLCs as manager-managed,
  2. drafting an operating agreement that both appoints a successor manager in the event of the manager’s incapacitation or death,
  3. either having the membership interest owned by a trust, or including a “transfer on death” registration for the membership interest in the operating agreement.

Why a Single-Member LLC Should Be Manager Managed?

Essentially, there are only two choices for management of an Arizona LLC: member managed or manager managed. A.R.S. 29-681. When an LLC has a single member who is active in the business, it may seem unnecessary to designate that member as the manager. After all, a member of a member-managed LLC has all of the powers of a member and all of the powers of a manager. A member of a member-managed LLC, however, cannot easily delegate management authority to a third party when the member is incapacitated, is disabled or dies. Further, on the member’s death, the management authority may suddenly be split between multiple heirs. In a manager-managed LLC, the operating agreement provides the needed flexibility and continuity of business operations to keep the business running.

Example:

Assume a 50-year-old married man who has two children is the sole owner and member of a member-managed LLC that owns and operates a profitable business. If the owner becomes incapacitated or dies, there may be initial uncertainty as to who has the authority to operate the business. Even if the spouse or children are best suited to run the business, they may not have the authority to do so. If a trusted employee is best suited to run the business, he or she also may not have the authority to do so. Leaving this issue to be sorted out by the member’s conservator, trustee, or personal representative will take time and will likely result in unnecessary business interruption and conflict. But, if the LLC was manager-managed, the member could have appointed a successor manager and eliminated the uncertainty, delay, and, hopefully, conflict regarding who will run the business.

Why Have an LLC?

A sole proprietor can form either an LLC or a “S” corporation and receive many of the same benefits discussed in this article—namely business continuity and transfer on death registration. An LLC provides more flexibility, however, for the varying situations that a business owner may encounter. Through a carefully constructed operating agreement, the owner of an LLC can designate or appoint a successor manager to act when the owner becomes disabled, incapacitated, or dies. An officer of a corporation, on the other hand, is appointed by the Board of Directors, A.R.S. 10-3840, and the (likely) sole director is elected by the sole shareholder. When the sole shareholder is also the sole director and sole officer, the business may be stuck without anyone who has clear authority to run the business or take other necessary actions to keep the business afloat upon that shareholder’s disability or incapacity. In addition, the flexibility of the LLC operating agreement presents a preferable opportunity to give a successor manager limited, but specific, powers to deal with the real-life duties of the business owner.

The Single-Member LLC Operating Agreement.

Appointment of the Successor Manager.

Arizona’s Limited Liability Company Act states that a manager shall be designated or elected and may be removed or replaced in the manner provided in an operating agreement. A.R.S. 29-681. This seems to imply that the operating agreement can designate or appoint the successor manager by including a provision similar to the following:

MANAGEMENT. The Manager shall manage the business and affairs of the Company. The Member shall serve as the Manager. The Manager shall serve as Manager until the Manager is terminated, resigns, becomes incapacitated, or dies, at which time the successor manager, if any, becomes Manager. The Member may, by vote, remove any Manager without cause and elect a successor manager. The Member may appoint a successor manager and may at any time revoke an appointment and appoint a different successor manager or no successor manager. The Member hereby appoints _____________ as successor Manager.

Transfer on Death Registration.

As with any security, a membership interest in an LLC can be registered as transfer on death. See A.R.S. 44-1801 (26) and 29-732. Transfer on death registration can simplify this succession by eliminating: (1) any guesswork about who is the holder of the deceased member’s interest; and (2) the need to probate the member’s interest in the LLC. A.R.S. 14-6307. Of course, care should be taken to ensure such registration fits in with the member’s overall estate plan. The following provision can be added to the operating agreement:

REGISTRATION OF MEMBERSHIP. The registration of the membership of the Member, [Name of member], shall be as follows:

[Name of member], transfer on death to ______________.

Practical Guidance for Who Should be Successor Manager.

There are three important points to consider when counseling the owner as to whom to appoint as successor manager.

Choose Someone Who Knows How to Run a Business.

The owner obviously will want to leave the business in the hands of someone who can actually run it. As a practical matter, the successor manager must be someone who knows the business, knows what must be done, at a minimum, to keep the business running on a day-to-day level, and must be someone the owner trusts. When the successor manager is in charge, by design, the owner is probably unable to provide any effective oversight or guidance for the successor manager or the business. In addition, many people may be perfectly suited to run the business for a short time in normal circumstances but may not be good successor managers. For instance, a spouse may be too distraught upon the incapacity of the owner to be an effective manager.

Spell Out the Successor Manager’s Role.

It is important that both the owner and the successor manager understand, in a general sense, what an LLC manager does and does not do. The manager, unless otherwise provided in the operating agreement, has the sole right of management and conduct over the LLC business. A.R.S. 29-654. Except as provided below or in the operating agreement, the manager exclusively decides all matters relating to the business of the LLC. Some pertinent exceptions to the manager’s authority provide that, except as provided in the operating agreement, the members have the right to amend the articles of organization or the operating agreement, to dissolve the LLC, to make interim distributions, to admit a new member, to dispose of all or substantially all of the LLC assets, to merge or convert the LLC, to incur debt outside the ordinary course of business, to approve conflicts of interest, or to change the nature of the LLC business. If left to the defaults in the LLC statutes, then, the successor manager essentially has the right to run the business on a day-to-day basis in the ordinary way in which it has been run in the past. The operating agreement, however, may (and perhaps should) provide for a very different sort of management structure by both augmenting and limiting the successor manager’s authority to better suit the situation (as explained more fully below).

Hold Successor Manager to High Standard.

Just as the client does not want to set the LLC up for failure, the owner does not want to set up the successor manager for failure (or liability) either. The best practice would be for the operating agreement should specifically set forth duties of loyalty, fairness, good faith and fair dealing. However, an unreported Arizona Court of Appeals case from 2008 suggests that Arizona courts may imply such duties where the operating agreement is silent.  While the incapacitated owner would probably assert a cause of action against a successor manager only for intentionally wrongful conduct, the heirs of the owner may well try to recoup damages for a business venture that loses value while in the hands of the successor manager. To alleviate concerns that the successor manager may have, the operating agreement should fully indemnify the successor manager to the extent allowed, and the successor manager should be carefully selected for the job. The successor manager should also be informed as to who the owner’s heirs are and, if applicable, their personality “quirks.”

Of course, this arrangement will work only if the person appointed as successor manager knows that he or she has been appointed the successor manager and actually agrees to be the successor manager! Make sure that the owner has talked with this person and communicated both what the job entails and the triggers for when the job “begins.”

Ultimately, the owner of the business will know who best fits the qualifications for acting as successor manager. The practitioner’s job is to make sure they understand what those qualifications are.

Not all Managers are Created Equal.

The operating agreement can specify exactly what powers a successor manger possesses. A single-member operating agreement should take advantage of this flexibility by delineating different powers for a manager who is a member and a successor, non-member manager. As explained above, even though by default the manager manages the day-to-day operations of the business and the members retain control for major decisions, these defaults can be modified by the operating agreement.

In the first instance, the owner as manager will always have complete power over the business, and the operating agreement can (but need not2) make this explicit. In contrast, the powers of the successor manager should be explicit. Particularly if the operating agreement grants the owner-manager unfettered authority over the business of the LLC, the operating agreement should limit the successor manager’s powers, perhaps to the statutory defaults of a manager. Those powers should then be explicitly augmented. Some augmentations that may be warranted include the power to allow (or require) the successor manager to make distributions for particular circumstances, such as to pay the owner’s recurring debts; to liquidate or sell the business if the owner has significant expenses for longer term, ongoing care; or to incur debt or engage in other activities that are outside the ordinary course of business but may be needed in dire circumstances.

Here’s an Example:

Imagine an 85-year old woman who has four children is the sole owner and manager of a manager-managed LLC that owns an apartment building. She has appointed her oldest son as successor manager and her youngest daughter as next successor manager (her other two children live outside the area). All four children are her heirs. The operating agreement grants her the full power to conduct the business of the LLC, inside or outside of the ordinary course. The owner has started to show signs of dementia, and she has saved funds to stay in a long-term care facility. The operating agreement could provide that the successor manager takes over when the owner-manager is incapacitated, disabled, or dies. The operating agreement can also provide that, if the owner-manager is incapacitated and living in a long-term care facility, the successor manager will make regular distributions of a certain amount and interim distributions to pay for the costs of the facility (and other debts) not covered by insurance or savings. The operating agreement can further provide that, upon sudden incapacity or disability requiring acute care, the successor manager is authorized to sell the property as needed to pay for procedures or acute care facilities for treating the owner or to refinance the property’s mortgage. In addition, when the member dies, the successor manager has the clear authority to collect rents, execute leases, terminate leases, pay the mortgage and the like.

Two Warnings.

First, the use of a successor manager may not work or may require special treatment in the case of a business with a specialized license. For instance, not just anyone can become the successor manager and run a construction business, law firm, medical practice, or real estate brokerage, unless they have the appropriate license.

Second, in most cases, the owner of a single-member LLC will guarantee some of the debts and obligations of the LLC, such as long-term loans or lines of credit. A likely possibility is that those guarantees or original documents will default when the owner dies or becomes incapacitated. In this situation, a successor manager will not only face the difficulty of caring for the owner and trying to run the business, but may also be trying to deal with creditors (most likely secured with the assets of the business) who are legitimately concerned with the continued viability of the business as a going concern.

Conclusion.

While a manager-managed LLC may not be a panacea for ensuring that a business owned by a single individual survives the disability, incapacity, or death of that owner, it provides sufficient flexibility to give a business a good chance to continue. The flexibility provided by the LLC statutes can and should be utilized to provide for the client and the client’s business when such disasters strike.

Please contact Magellan Law with any questions about this article, or any other issues relating to business organizations.

This article provides general information. You should not construe this article as legal advice or a legal opinion on any specific facts or circumstances. If you have specific legal questions, consult with counsel concerning your own situation.

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What boilerplate language should a contract have?

Pen laying on unsigned contract. Does it include necessary boilerplate?

You need to sign a contract, but you aren’t sure if you’re protected. Here are two quick pointers. First, make sure you have boilerplate language to protect all parties involved. There are sentences that pretty much all contracts should have. They are kind of like a vaccination. Having it won’t hurt. But not having it could. For example, you may never be exposed to Neisseria meningitidis, but having the standard booster shot (which includes this vaccination) is still a good idea.

(The second pointer is don’t try to figure it out on your own. Lawyers have special training to figure out ambiguities and protect you. You may be thinking you save money now by proof-reading the contract yourself. But if there is an ambiguity, or something is missing in the contract, it can cost you dearly later.)

Here are boilerplate contract provisions that should be in almost inteevery contract:

Applicable Law. This Agreement shall be construed and interpreted in accordance with the substantive laws of the State of Arizona.

Binding Nature of Agreement; Assignment.  This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and permitted assigns.

Construction. This Agreement shall be construed as if drafted mutually by the parties through their respective counsel and therefore shall not be construed against either party.

Effective Date. This Agreement has been executed by the parties intending that it be effective on the effective date set forth on the caption page. The parties recognize that they effectuated a meeting of the minds among themselves on that effective date and intended that this Agreement take effect on that date even though, because of the exigencies of the modern world, the mechanics of drafting, the convenience of the parties, and the economy of travel, it may have been necessary to actually sign the document at a later time.

Counterparts. This Agreement may be executed in one or more counterparts, each of which may be executed by one of the parties hereto, with the same force and effect as though all the parties executing such counterparts had executed the same instrument. All counterparts shall be construed together and shall constitute one agreement.

Effective Place of Execution. The parties intend that the place of execution be that county and state that is set forth in the caption of this Agreement. The effective place of execution is the place that the parties intend this Agreement to have been executed incorporating all laws, for purposes of conflicts of laws, which apply to that effective place of execution. The parties recognize that, due to the exigencies of the modern world, the mechanics of drafting, the convenience of the parties, and the economy of travel, this Agreement may be executed by one or all of the parties at some other geographic location and possibly at multiple places. In spite of this, however, they intend that it be deemed executed at the effective place of execution.

*Entire Agreement. The terms of this Agreement constitute the entire agreement between the parties. The parties represent that there are no collateral agreements or side agreements not otherwise provided for within the terms of this Agreement.

Execution of This Document. All parties named in the caption as parties shall sign below and at least one of the parties shall initial all pages of all original copies of this Agreement. Furthermore, all documents such as schedules, exhibits, and like documents which are expressly incorporated herein shall be initialed by the parties and either exchanged or attached to the originals which are given to any party named on the caption page of this Agreement. It is the intent of the parties that all pages be initialed on all originals that are exchanged in order that no substituted pages or misunderstanding shall ever become possible to create problems in satisfying the intended objectives of this Agreement.

Execution of Related Documents. The parties agree to execute and deliver to the other, in recordable form if necessary, such further documents, instruments or agreements, and shall take such further action, that may be necessary or appropriate to effectuate the purposes of this Agreement.

Fair Notice of Default. The parties are desirous of giving one another fair notice of any default before sanctions are imposed. In the event of an act of default with respect to any provision of this Agreement, no party may institute legal action with respect to such default without first complying with the following conditions:

Notice of such event of default must be in writing and faxed, E-mailed or mailed to the other party by U.S. Certified Mail, return receipt requested.

Such written notice shall set forth the nature of the alleged default in the performance of the terms of this Agreement and shall designate the specific paragraphs(s) hereof which relate to the alleged act of default.

Such notice also shall contain a description of the action to be taken or performed by the other party to cure the alleged default and the date by which the default must be remedied, which date may not be fewer than 30 business days from the date of mailing the notice of default.

Force Majeure.  Neither party shall be liable to the other party for any delay or omission in the performance of any obligation under this Agreement, other than the obligation to pay monies, where the delay or omission is due to any cause or condition beyond the reasonable control of the party obliged to perform, including, but not limited to, strikes or other labor difficulties, acts of God, earthquakes, acts of government (in particular with respect to the refusal to issue necessary import or export licenses), war, riots, embargoes, or inability to obtain supplies (“Force Majeure”).  If Force Majeure prevents or delays the performance by a party of any obligation under this Agreement, then the party claiming Force Majeure shall promptly notify the other party thereof in writing.

Good Faith — Attorney’s Fees and Costs. The parties desire that each raise only good faith disputes for mediation, arbitration, or litigation. To discourage the bringing of such proceedings without a good faith reason, this provision is enacted. If, upon failure of any party to this Agreement to comply with any of the terms or conditions hereof, to enforce any payments herein stipulated, or to enforce any provision hereof, the losing party will pay to the prevailing party reasonable costs, except witness fees, and expenses, including attorney’s fees and the value of time lost by the prevailing party or any of its employees in preparation for or participating in any arbitration or litigation in connection herewith as determined by the court or arbitrator. All lawsuits under this Agreement shall be filed in the courts of the county and state where this Agreement was executed.

Interest. If, by reason of any default or act of one party under this Agreement, it is determined by agreement, mediation, arbitration, or litigation that the party owes another any sum of money, interest shall accrue on that sum at the rate of 10% per annum from the date the sum was first due until paid.

Interlineations and Initials. The parties recognize that, because of the exigencies of the modern world, the mechanics of drafting, the convenience of the parties, and the economy of costs, they may have made minor changes in their own handwriting in this Agreement. These minor changes have been initialed by all the parties, if any changes have been made, fore and aft of the change on all originals to prevent any extension or alteration of that change by any of the parties or others. Unless otherwise indicated by the placement of a date beside the change, these changes were intended by the parties to have occurred as of the effective date of this Agreement. Any interlineated changes made by the parties after the effective date of this Agreement shall be initialed by all parties and dated and have the date itself initialed fore and aft by all parties to this Agreement.

Interpretation. Whenever any word is used in this Agreement in the masculine gender, it shall also be construed as being used in the feminine and neuter genders, and singular usage shall include the plural, and vice versa, all as the context shall require.

Marginal Headings. The marginal headings of the paragraphs of this Agreement are for convenience only and are not to be considered a part of this Agreement or used in determining its content or context.

Materiality.  All covenants, agreements, representations and warranties made herein shall be deemed to be material and to have been relied on by the parties in entering into this Agreement and shall survive the execution and delivery of this Agreement.

Modification. Any modification or amendment of this Agreement shall be in writing and shall be executed by all parties.

Notices. Copies of all notices and communications concerning this Agreement shall be mailed to the parties at the addresses written on the caption pages hereof. Any change of address also shall be communicated to the other parties in writing and in English. Any document which may adversely affect the rights of any party to this Agreement shall be dispatched by fax, E-mail or U.S. Certified Mail, return receipt requested. For all documents mailed to persons in the continental United States, the time period of all notices shall begin running on the day following the date that the document is postmarked. For documents mailed to persons outside the continental United States, the time period shall begin running on the date that the document is received by the other party.

Incorporation of Recitals.  The prefatory language and Recitals made and stated above are incorporated by reference into, and made a part of, this Agreement.

Integration; Time of the Essence.  This Agreement and its exhibits and documents incorporated herein constitute and embody the full and complete understanding and agreement of the parties hereto and supersedes all prior understandings, whether oral or written.  Time is of the essence in all matters associated with this Agreement.  No representation, promise, inducement or statement of intention has been made by any party hereto which is not embodied in this Agreement, and no party hereto shall be bound by or liable for any alleged misrepresentation, promise, inducement or statement of intention not so set forth.

Partial Invalidity. If any term, condition or provision of this Agreement or the application thereof is judicially or otherwise determined to be invalid or unenforceable, the remainder of this Agreement and the application thereof shall not be affected, and this Agreement shall otherwise remain in full force and effect.

Power and Authority. Each party executing this Agreement in a representative capacity warrants to the other party that he has the right, power, legal capacity, and authority to enter into this Agreement. No approval or consent of any other person shall be necessary in connection with the execution, performance, and delivery of this Agreement.

Settlement of Disputes. This provision is enacted to protect all parties to this Agreement in the event of unusual changes in circumstances which occur outside the control of the parties and which create an undue and unreasonable hardship on any of the parties or gross inequities between the parties because of such an unusual change in circumstances. If any of these conditions occurs, this Agreement shall be modified by first communicating with the other party and attempting to resolve the dispute. If that does not work, the parties will submit the dispute to mediation. [Consider also including: If mediation is unsuccessful, then the parties agree to submit the dispute to binding arbitration using the rules of the American Arbitration Association.]

Statutes and Contracts Not Being Breached. Each party to this Agreement represents and warrants that the execution and delivery of this Agreement by such party, compliance with the terms and provisions of this Agreement by each party, and such parties’ consummation of the transactions as contemplated under this Agreement will not breach any statute or regulation of any governmental authority, domestic or foreign, or acceleration of any of the terms, conditions, or provisions of any agreement or instrument to which each such party is a party, or to which each such party is or may be bound, or constitute a default or event of termination thereunder.

Waiver. Any waiver by any party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach hereof.

[*For sales of goods contracts, use the following: “No waiver by either Supplier or Distributor with respect to any breach or default or of any right or remedy and no course of dealing shall be deemed to constitute a continuing waiver of any other breach or default or of any other right or remedy, unless such waiver be expressed in writing signed by the party to be bound.]

NOTE: This blog post is NOT intended as legal advice. While having these boilerplate clauses in contracts is normally good, every situation is different. You MUST consult with an attorney before acting on the information provided in this blog or on this website. If you want help, contact us.

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Own an Arizona Business? You Need to Know This …

Photo of sign in business window that reads, "Sorry We're Closed."

Does your family depend on your company’s income? Are you hoping to pass your business on to a loved one?

If so, read on. Here are common scenarios, and the solution.

You have a serious illness, and have no Durable General Power of Attorney that specifically provides for management of your business. In this case, someone will need to go to court and get appointed as a Temporary Conservator. Sounds easy enough. But what if your family gets into a dispute over who should be appointed?  That could delay the process by months. And meanwhile, your business has no one to manage it. Once a Conservator is appointed, that person has authority to continue to run things under A.R.S. 14-5424 (C)(3). BUT the status is less than clear on whether the Conservator can turn around the business if it suffered during your illness or during the court proceeding. The statute allows the Conservator to “continue” the business. But I’ve seen that be interpreted as not requiring the Conservator to take proactive steps to help fix or correct problems as needed.

You have a serious illness, and you DO have a Durable General Power of Attorney. In this case, you probably think you’re in the clear. But … most Power of Attorney documents that I’ve seen do NOT include language specifically allowing the agent (aka “power of attorney” holder) to continue to operate a business. If businesses have any sort of license, this can also be catastrophic.

Your business is in a Living Trust. You might be slightly better off with this situation. But, two common problems are (a) having a business license in your personal name and (b) the trust document not specifically permitting the continuation of the business by a successor trustee. Again, your business could suffer while you try to fix this problem somehow. In most instances, the only solution is to go to court and ask for permission for the trustee to continue the business. Meanwhile, the business flounders.

You die, and the business is not owned by a Trust. The Arizona Probate code merely requires the Personal Representative (aka executor) to administer your estate expeditiously in the best interest of the estate. That is interpreted to mean basically that the Personal Representative just needs to list it for sale. If your enterprise lost clients during your illness, the PR need not do anything to try to turn the business around. (For the record, I disagree with this interpretation of the statute, but I’m sharing how the Arizona courts treat this situation.)

Bottom line: Talk to your estate attorney and come up with a continuation plan in case you are out of the picture. Have someone picked to take over the business who actually knows how to run the business. Then make sure that somehow that person will have authority to do what is required. If your venture is licensed, the license should be held in an LLC or corporation if that is allowed. Then make sure there is a clearly documented transition plan in place for that entity.