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Addressing buy-sell arrangements in LLC Operating Agreements and Corporate Shareholder Agreements

Monday, January 11th, 2010

I often am asked by business clients how to address the circumstances surrounding the transfer of ownership if one of the owners dies, becomes disabled, or whose employment in the business is terminated for-cause? The answer is through the use of language addressing buy-sell situations that are included in an Operating or Shareholder Agreement.

A carefully drafted buy-sell provision will address the buyout of a deceased or disabled owner’s share of the business, usually through the use of the proceeds of life and disability insurance policies taken out by the business on the lives of the owners. A buy-sell provision will also address termination of an owner’s employment with the business for-cause. A sample buy-sell paragraph will read something like the following:

Sale of Shares on Death, Disability or Termination of Employment. If, during the term of this Agreement: a) a Shareholder dies or becomes permanently disabled (meaning the Shareholder becomes unable to carry out his duties as a Director or Officer of the Company for a period of 90 consecutive days or more); or b) a Shareholder who is also an employee of the Company has his or her employment terminated by Company for-cause, then the Company shall buy, and the Shareholder, his estate or the named representative of the Shareholder shall sell, the Shares of said Shareholder to the Company.

A buy-sell provision will go on to address how to arrive at the price at which an owner’s shares may be sold for, as well as whether such price will vary depending on the circumstances surrounding the owner’s departure from the business.

A buy-sell provision will also address an owner’s potential divorce, so as to prevent remaining owners from having to own and operate the business with the spouse or other family member of a former owner.

Every LLC Operating Agreement and Corporate Shareholder Agreement should address the buy-sell provisions referenced above. This will go a long way towards solving many potential disputes involving circumstances associated with the transfer of ownership of a business before they arise.

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A Non-Compete Can Be Enforced Even When Lacking Geographic Limitation

Tuesday, December 8th, 2009

Maryland law is well settled that a non-compete must be reasonable in geographic scope and duration in order to be held enforceable. However, Maryland courts will enforce a covenant not-to-compete that does not contain a geographic limitation in certain narrow and limited circumstances. The U. S. District Court for the District of Maryland stated in Intelus v. Barton and Medplus, Inc., 7 F. Supp. 2d 635 (1998) that every non-compete must be examined to determine reasonableness based on the specific facts at hand, even non-competes that fail to contain a finite geographic limitation. The Intelus court stated:

“Competition unlimited by geography can be expected where the nature of the business concerns computer software and the ability to process information. . . Because of the broad nature of the market in which Intelus operates, a restrictive covenant limited to a narrow geographic area would render the restriction meaningless.”

In determining the reasonableness of a non-compete that does not contain a geographic limitation, Maryland courts will consider the nature of the industry and the national and perhaps global nature of the competition. In Intelus, the court concluded that the restriction was reasonably related and limited to Intelus’s need to protect its good will and client base, and therefore upheld the enforceability of the non-compete.

In Hekimian Labs, a Florida federal court, interpreting Maryland law, found that where “testimony indicated that competition within the business of remote access testing is such that the whole world is its stage” and “that there are only about 20 companies that compete in this business, and they do so on a worldwide basis,” then “to confine the restrictive covenant to a specified geographical area would render the Agreement meaningless.”

The Florida Court concluded that if the agreement did contain a geographical restriction, the offending party would only need to move outside of this restricted area and the damage to the harmed party would be the same. Because of the national and international scope of the competition between the parties, the absence of a specified geographic limitation was reasonably necessary for the protection of the party attempting to enforce the non-compete, and the covenant was upheld.

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Maryland Courts May Grant Injunctive Relief Even when an Arbitration Clause Exists

Tuesday, December 8th, 2009

Maryland law permits a party to request injunctive relief from a Maryland federal or state court even when a contract states that all disputes must be referred to arbitration. The Court of Appeals of Maryland held in Brendsel v. Winchester Construction Company, Inc., 898 A.2d 472 (2006) that:

“[A]n interlocutory mechanics’ lien is in the nature of a provisional remedy, not much different than an interlocutory injunction or attachment sought to maintain the status quo so that the arbitration proceeding can have meaning and relevance, and the predominant view throughout the country is that the availability of such remedies by a court is permitted by the Federal and Uniform Arbitration Acts and is not inconsistent with the right to enforce an arbitration agreement.”

In its ruling, the Maryland Court of Appeals focused on the need for courts to have the ability to preserve the status quo by granting injunctive relief while a dispute is sent to arbitration. Without this ability, the Court held, a ruling by an arbitrator could very well be immaterial, as the damage done to a party could by that time be irreparable.

The Maryland Court of Appeals’ holding finds support from the Fourth Circuit in Merril Lynch et al. v. Bradley and Collins, 756 F.2d 1048 (1985):

“Accordingly, we hold that where a dispute is subject to mandatory arbitration under the Federal Arbitration Act, a district court has the discretion to grant a preliminary injunction to preserve the status quo pending the arbitration of the parties’ dispute if the enjoined conduct would render that process a “hollow formality.” The arbitration process would be a hollow formality where “the arbitral award when rendered could not return the parties substantially to the status quo ante.” Lever Brothers, 554 F.2d at 123.”

Therefore, Maryland courts are permitted to intercede and grant injunctive relief in spite of an arbitration clause where the absence of such relief would cause the arbitration to be nothing more than a “hollow formality.”
This power exists even when a contractual provision states that the parties must refer all disputes to arbitration.

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Maryland Case on the Definition of “Solicit” in a Non-Solicitation Agreement

Thursday, October 29th, 2009

Mona Electric v. Truland, 193 F. Supp. 2d 874 (2002), as well as the appeal of that case, provide support for the position that a terminated employee who executed a non-solicitation provision when hired, but which did not contain an accompanying non-compete covenant, will not be in violation of the non-solicitation agreement if the clients and customers of the employee’s former place of business, and not the employee himself, initiate contact with the former employee for the purpose of conducting business. The District Court for the Eastern District of Virginia held:

“there is no evidence that Gerardi violated the Agreement by “soliciting” Mona’s customers. Truland hired Gerardi as a Service Account Manager. Gerardi’s responsibilities in this new position include preparing estimates and working in the field. A part of Gerardi’s position at Truland is handling customer solicitation calls. In the electrical contracting field, customers often solicit bids from the electrical contractors. Plaintiff has not presented any evidence that Gerardi has initiated calls to customers during his employment at Truland. Rather, the evidence is that Gerardi responded to customer calls to Truland for bids. Gerardi’s acts of responding to customers who solicited him for bids clearly do not violate the Agreement. Gerardi did not sign an agreement that prohibited him from competing with Mona, he signed an agreement that precisely prohibited his “solicitation” of Plaintiff’s customers. Plaintiff asserts that the Agreement prevents Gerardi from submitting estimates to customers who call him to request bids. This would turn the non-solicitation agreement into a non-competition agreement, and under the unambiguous terms of terms of the Agreement, only solicitation of Mona’s customer’s is prohibited. Thus, were the Court to find the Agreement valid, no evidence has been presented in this case that Gerardi violated the terms of the Agreement, and summary judgment should be granted for the Defendant.” Mona Electric v. Truland, 193 F. Supp. 2d 874 (2002).

On appeal, the Fourth Circuit Court of Appeals, applying Maryland law, upheld the lower court’s findings:

“Despite Mona’s assertion to the contrary, the district court held and we agree that the plain meaning of “solicit” requires the initiation of contact. (J.A. at 135.) Therefore, in order to violate the nonsolicitation agreement, Gerardi must initiate contact with Mona’s customers. Mona argues that Gerardi solicited when he submitted estimates to Mona’s customers. However, this does not fall within the plain meaning of “solicit.” If Mona intended to prevent Gerardi from conducting business with its customers it could have easily stated that in the agreement. Taking the facts in the light most favorable to Mona, there is no evidence that Gerardi solicited Mona’s customers. Therefore, summary judgment was proper and the district court is affirmed.” Mona Electric v. Truland, 56 Fed. Appx. 108 (2003). [On appeal]

Conclusion

The Mona case and its appeal give substantial support to the position that: 1) if an employee executed only a non-solicitation agreement and not a covenant not-to-compete; and 2) because Maryland courts will interpret “solicitation” as requiring some action on the employee’s behalf to initiate contact, then by itself, the employer would fail in its attempt to prevent the former employee from doing business with the business’ clients and customers, PROVIDED that the business cannot show that the employee actively solicited those customers. The employee is barred from soliciting, ie. from taking any action to initiate contact in order to gain business. Courts will strictly construe this requirement and delve into the actual conduct of the employee in order to determine whether the employee actually “solicited” customers.

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Why are limited liabilty companies (LLC’s) so popular?

Monday, September 14th, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Limited Liability

Limited Liability

Limited liability companies (“LLCs”) have become increasingly popular over the past several years as alternatives to corporations because they legally enjoy the same limited liability advantages as corporations, while also providing certain tax benefits that not all corporations do. LLCs, corporations, and most partnerships shield their owners from liability for the actions of the entity. So regardless of the corporate form, owners of these entities will rarely be held liable for the debts and other actions taken by the corporation.

The reason that LLC’s have increased in popularity is because members of an LLC garner pass-through tax advantages similar to what partners receive in a partnership. While owners of a corporation face “double-taxation,” first at the net income of the corporation and second at the individual shareholder level on the dividends the shareholders receive, LLC members are taxed only once, at the individual level on the profits they receive. With all else being equal, this tax savings is the main reason that a start-up entity will choose to go the LLC route as opposed to the corporation route.

In most other respects, LLCs are similar in nature to corporations. An LLC is suitable for one or several owners, called “members.” As a partnership agreement governs the partners’ relationship and a shareholders’ agreement governs the shareholders in a corporation, a properly drafted LLC operating agreement sets out the rights, duties, obligations and remedies of the LLC’s members.

A managing member, designated in the operating agreement, runs the day to day operations of the LLC, and there can be more than one managing member if desired by the members. LLCs may, but are not required to, appoint officers of the LLC. Members of an LLC may consist of individuals, corporations, other LLCs, or a mixture of each.

Persons desiring to form an LLC in Maryland can search the Maryland SDAT website for name availability at www.sdatcert3.resiusa.org/ucc-charter.

After determining whether a name is available, forms for an LLC’s Articles of Organization can be found at www.dat.state.md.us/sdatweb/sdatforms.html#entity.

Just remember to consult an experienced Maryland business attorney before you get started.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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What are Bylaws and a Shareholders’ Agreement for a Maryland corporation?

Monday, August 3rd, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Shareholders

Shareholders

A Maryland corporation need only file Articles of Incorporation with the Maryland Department of Assessment and Taxation in order be lawfully incorporated. Once formed, though, it is advisable that every Maryland corporation consult with a Maryland business attorney to discuss the drafting of a set of Bylaws, as well as a shareholders’ agreement.

Maryland law mandates that each Maryland corporation must have a set of Bylaws that lay out the procedures concerning the governance of the corporation. A Maryland corporation’s Bylaws may contain any provision not inconsistent with law or the charter of the corporation for the regulation and management of the affairs of the corporation.

A Maryland corporation’s Bylaws usually set out the powers, duties, rights and obligations of its directors and officers, including how many directors the corporation may have, the procedure for calling shareholder and Board of Director meetings, how and where corporate records are to be maintained, stockholder reports, voting and proxy procedures, how stock may be transferred, how directors are elected and removed, how officers are appointed and removed, as well as numerous other matters related to the corporation as a whole.

A Maryland corporation may, but is not required to, have a shareholders’ agreement. A shareholders’ agreement is an agreement between the stockholders of a corporation that governs the rights and obligations of the shareholders. First and foremost, a shareholders’ agreement will state the individual equity in the corporation as held by the shareholders. A shareholders’ agreement typically states how new shares of stock are issued, and addresses issues surrounding restrictions on stock repurchase and transfer, including how stockholders of a company may sell their shares, what happens to the shares upon the death or disability of a shareholder, whether other shareholders have the right to purchase another shareholder’s stock upon death or disability, what procedures are used in order to assign value to stock shares, and what happens to stock upon the breach of a shareholder agreement by a stockholder.

A shareholders’ agreement will also govern how the day-to-day operations of the company are managed, how a Board of Directors will be elected and terminated, what decisions require majority, super-majority or unanimous consent of the shareholders, how the Board will appoint Officers of the corporation.

The resolution of shareholder disputes through mediation, arbitration or litigation, or a combination thereof, may also be included in a shareholders agreement, as well as what law governs any dispute.

When you are in the start up and formation stages of your new business, consult with your business attorney regarding the drafting of Bylaws and a shareholders’ agreement.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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Issues Surrounding a Maryland Breach of Contract Case

Thursday, July 23rd, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Breach of Contract

Breach of Contract

If you are forced to file suit in Maryland for breach of contract, do not let a poorly drafted contract hurt your chance of prevailing. Do not lose a case that you should win simply because of faulty contract language, language that could have been avoided had you retained an experienced Maryland business attorney to assist.

A contract drafted in Maryland with little or no input from a Maryland corporate lawyer can fail to include several necessary components that help to make a contract legally enforceable. These deficiencies can be fatal to your business’s chance of prevailing in a lawsuit. As a result, make sure that an experienced Maryland business attorney reviews your contracts, and that such contracts address, at minimum, the following five points:

1. Jurisdiction: If you want the ability to sue in Maryland courts, your contract must contain language where the parties submit to the jurisdiction of Maryland state and/or federal courts. This language allows you to sue a business in Maryland courts, even if the company is not incorporated in, or have offices in, Maryland. Without this language in your contract, you will most likely be forced to sue the corporation in its home state. Suing out of state can be significantly more expensive and time consuming.

2. Choice of Law: A Maryland choice of law provision states Maryland law will be used to decide the dispute. Many non-lawyers confuse choice of law with jurisdiction, and interpret the phrase “Maryland law will govern this contract” to mean that a dispute has to be heard in Maryland. That is not the case. Rather, this clause simply means that regardless of where a dispute is heard, whether in Maryland Circuit Court or Virginia or anywhere else, Maryland law will be used to decide the matter.

3. Non-compete and non-solicitation clauses: Do you want to prohibit the other party from competing with you entirely, or just stop them from soliciting your clients? If the former, then you are in need of a non-compete clause, which must be limited in geographic scope, limited in duration, and narrowly defined to protect only the interests of your business in order to be enforceable. Maryland courts will typically enforce reasonable non-competes. However, a non-compete that overreaches will often be struck down. If the latter, then you need a non-solicitation agreement, which allows the other party to compete with you, provided they do not solicit your current or former clients. A non-solicitation clause need not have geographic or time limitations so long as it only forbids the solicitation of your clients by the other party.

4. Default and Termination provisions: Make sure that your contract’s default and termination provisions are clear with regard to: a) what breaches may be cured and what breaches cannot be; b) what the time period exists for any cure; and c) whether amounts due over the life of the contract still owed even if the contract is terminated.

5. Dispute Resolution: Choose the type of dispute resolution system that you feel best fits your business. Mediation, arbitration and litigation are options, and they can be used in compliment of one another. Regardless of what method of dispute resolutions you choose, always allow your business the option of filing for emergency injunctive relief in Maryland court when necessary to avoid irreparable injury to your business.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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Trademarking Your Business Name and Logo

Wednesday, July 15th, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Most business clients who come to me with trademark questions believe that filing a trademark is a complex and expensive process. Nothing could be further from the truth. While it is true that the entire trademark registration process usually takes 12-18 months, the actual filing of a trademark application can be done in a few hours. Once filed, the trademark application works its way through the U.S. Patent and Trademark Office (“USPTO”) with little work needing to be done. The filing fee paid to the USPTO is a mere $325.00. So for a couple hours of work by you or your business attorney along with a $325.00 fee, your business is entitled to have exclusive ownership of a mark, in your business’s line of products or services, across the United States.

What exactly is a trademark? A trademark is a word, phrase, symbol or design, or a combination of words, phrases, symbols or designs, that identifies and distinguishes the source of the goods of one party from those of others.  Words that you may trademark are the name which your business operates under and holds itself out to the public as (think “McDonald’s” or “Microsoft”).  A phrase you may trademark are words that identify or distinguish the source of your product or service (think Nike’s “Just Do It” or Gatorade’s “Is It In You?”).  A symbol or design may also identify or distinguish your business from another (think Apple’s “apple” found on every Iphone, MAC and Ipod, as well as the symbols found on nearly every luxury car like the Lexis, BMW or Mercedes.)

How would your business benefit by obtaining a federal trademark registration? While you are not required to register for trademark protection, doing so provides server advantages, including notice to the public of your claim of ownership of the mark, a legal presumption that you own the mark nationwide, and the exclusive right for you to use the mark on or in connection with the goods or services set forth in your registration.  In other words, you may advertise your name, logo, phrase, symbol or design that identifies your business’s product or services withour fear that someone else could come along and steal those identifiers from you.

You can search the trademark database to check on a trademark’s availability by going to www.uspto.gov.

A trademark registration remains valid for 10 years, provided you file an affidavit that you are continuing to use the mark between the fifth and sixth years following registration.

With all of the above in mind, isn’t it worth it to have the name you do business under, along with any slogan, design or logo your business uses, registered to your business nationwide in the category of goods or services you provide? To me, the answer is a no-brainer.

Visit the USPTO website, as it is a very useful and informative site. It contains a list of frequently asked questions at http://www.uspto.gov/web/offices/tac/tmfaq.htm#Basic001, as well as the basics of what you need to know about trademarks at http://www.uspto.gov/web/offices/tac/doc/basic.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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Maryland Business Start-Up and Formation Issues

Monday, July 6th, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Why incorporate?

The first question a Maryland prospective business owner may ask is “why should I incorporate?” The reason to incorporate one’s business is to achieve limited liability, which means that a business owner is liable to third parties only up to the amount that the individual has invested in the business. A person that owns a business individually puts all of his or her personal assets at risk in the event the business fails. By incorporating, a business owner’s personal assets are shielded from creditors of the business in the event the business is unable to meet its debts as they become due.

What form should my business take?

After making the decision to incorporate, a prospective business owner must ask “what corporate form should my business organization take?”  Businesses can take the form of a corporation, partnership, or limited liability company (LLC). (As an aside, LLCs are creatures of statute that are organized, not incorporated, and therefore are not considered corporations as the term is legally defined. Nevertheless, LLCs do enjoy the same limited liability advantages as corporations and partnerships, and are therefore included as part of the discussion as what form a business should take.)

In order to determine what form your business should take, you should consult an experienced business accountant and corporate attorney, since each form of business has separate advantages and disadvantages, as well as differing tax treatment.  There is no exact answer for every business owner, as each determination can be made only on the unique facts of that business owner’s situation.

Once the choice is made as to corporate form, business owners can search the Maryland SDAT website for name availability at  www.sdatcert3.resiusa.org/ucc-charter/.

After determining whether a corporate name is available, forms for Articles of Incorporation (for corporations), Articles of Organization (for an LLC) and Certificate of Organization (for partnerships) can be found at www.dat.state.md.us/sdatweb/sdatforms.html#entity. The Articles must be filed with the Maryland Department of Assessments and Taxation along with the appropriate fee.

Once filed and approved, a federal tax identification number will usually be required for the business. You can obtain one electronically within 30 minutes in most cases at www.irs.gov.

Finally, with whatever business structure you choose, applicable corporate documents must be drafted to memorialize the agreement between the parties, ie a shareholder agreement for shareholders of a corporation, a partnership agreement for partners in a partnership, or an operating agreement for members of an LLC. These agreements are a pivotal step in the start-up process, as it will in many cases be the only document that defines the exact business relationship between the parties.  Crafting such a document requires the expertise of a business lawyer.  Other tasks that a business attorney may perform at the outset on behalf of business clients are the registration of trademarks and service marks, as well as obtaining fictional (d/b/a) names.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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What are the differences between a “non-compete agreement,” “non-disclosure agreement,” and “non-solicitation agreement”?

Thursday, June 18th, 2009

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Business clients often confuse the above terms, each of which protect business owners from a different type of harm. I will summarize the three types of agreements below.

Non-compete agreement

A covenant not-to-compete is an agreement whereby a party agrees not to compete against another party: 1) in a specific line of business; 2) for a definite period of time; 3) in a limited geographic area.

A non-compete agreement is usually found as part of a broader contract, such as an employment agreement or franchise agreement, and will take effect upon termination of the contract.

Maryland courts allow a covenant not-to-compete to be enforced provided it is “reasonable” in the activity it restricts, as well as in its geographic scope and duration. A typical non-compete looks something like the following:

Employee hereby agrees that for a period of one year following the date of termination of this Agreement for any reason, Employee shall be prohibited from acting, directly or indirectly, as an owner, manager, operator, consultant or employee of any business or business activity that is in the business of providing services similar to or competitive with Company.

Non-disclosure agreement

A non-disclosure, or confidentiality, agreement (“NDA”), is an agreement whereby a party pledges not to disclose the confidential and proprietary information of another party. NDA’s are commonly used to protect confidential information not generally made available to the public such as trade secrets, customer lists, business and marketing plans and strategy, and financial information, so that such information does not fall into the hands of competitors or even the public at large. NDA’s can be found in many employment and independent contractor agreements, as well as agreements where businesses are performing due diligence on one another prior to some type of relationship commencing.

Unlike the situation where covenants not-to-compete must be reasonable in all areas, non-disclosure agreements will be enforced by Maryland courts unless the person or company that is alleged to have violated the NDA is able to show that it learned of the confidential information from an independent, outside source. Whatsmore, an NDA need not contain any geographic or time restrictions in order to be valid and enforceable.

A typical NDA will look like this:

Employee acknowledges that Company may, in the course of Employee’s employment, provide Employee access to Company’s trade secrets, customer lists, business and marketing plans, financial information, and other confidential information related to the business of Company, including access to Company’s Employment Manual (the “Manual”). Employee agrees to retain all such information as confidential and may not use such confidential information on his or her own behalf or disclose such confidential information to any third party during or at any time after the term of Employee’s employment.

Non-solicitation agreement

A non-solicitation agreement is an agreement whereby a party pledges not to solicit the clients and customers of another party. Non-solicitation agreements are generally found in employment and independent contractor agreements, as well as vendor arrangements where one party is granted access to the clients list of another party.

Like an NDA, a non-solicitation agreement need not contain any geographic or time restrictions in order to be valid and enforceable in Maryland. A common form of non-solicitation agreement follows:

Employee hereby agrees that for a period of one year following the date of termination of this Agreement for any reason, Employee shall be prohibited from soliciting business from, or performing services for, or inducing or attempting to induce, any customer or client of Company, its subsidiaries or affiliates, to cease doing business with Company, or in any way interfering with the relationship between Company and any customer or client of Company.

Many business contracts will contain one or more of the above agreements. It is therefore important to be able to distinguish among them, and draft contracts that are specific to your business needs.

Need an Attorney to help your Maryland or DC business? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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