Protect your business

Some historians suggest that the development of the joint stock company – the predecessor of many modern business entities - was a significant reason that Europe and the West achieved modern economic dominance before much of the rest of the world. Historically, the separation of one’s ownership in business from the liabilities of the business itself was more or less an accidental conclusion.

Today, most small business owners establish business entities specifically to achieve asset protection, and in doing so, many small business owners focus on correctly establishing the business entity. However, many forget that, like finely tuned machines, entities require occasional maintenance to efficiently and properly achieve their purpose. In addition, different forms of entities can change the way that business transactions should be approached and the type of contract that should be used to accomplish the business’ goals.

Publicly traded companies are uniquely affected by various principles of entity law and several different state and federal regulations. While we have assisted companies - and worked on transactions - big and small, much of the generalized discussion that follows is designed to address small or privately held Texas businesses (of course, what qualifies as a small business is a subject of debate, especially in today’s political arena).

We have assisted numerous small business owners in drafting the documents that dictate how business entities are governed. Among other things, properly drafting documents like operating agreements, bylaws, or partnership agreements defines who can be owners and how ownership is achieved; sets forth what happens if one owner dies, becomes disabled, gets divorced, or becomes bankrupt; explains what causes the business to terminate its existence and how; and permits the maximization of tax advantages in coordination with your certified tax professional. For some entities – especially those involved in the provision of professional services like medicine, engineering, or architecture – it is especially important to consider custom drafted terms that allow the company to repurchase shares from owners who commit ethical violations or otherwise violate rules issued by their respective licensing board. For entities seeking a minority owned, woman owned, veteran owned, or similar disadvantaged / historically underutilized business entity classification, custom drafting may be necessary for a business that otherwise qualifies for those classifications to ensure seamless certification by the state or its designees.

Over the past decade, Texas has modernized its entity law and benefitted small business owners in the process. Historically, corporate entities required somewhat burdensome documentation to perfect asset protection including a requirement for regular meetings, meeting minutes, and various resolutions and authorizations. However, by statute and by court opinion, Texas has essentially relaxed these requirements for small business owners thereby minimizing the need for constant documentation and, with the broad acceptance of the limited liability company (which requires far less in the way of documentation than traditional corporate entities), business owners in Texas have several options for asset protection that require less paperwork and consume less time and resources.

Of course, straddling the bare minimum or lower limits of what the law allows or permits is rarely the best position to be in from a legal perspective. Thus, regardless of what is permissible, we recommend that business owners document certain transactions with the appropriate resolutions, contracts, or other documents in order to both achieve the intended purpose of a proposed transaction and to ensure that the important distinction between ownership and the entity is maintained. At the Law Offices of Victor W. Luke, we can assist with both.

We have worked with business owners in the past who established their entities well over a decade ago. As you might guess, the law has changed since then, but many businesses are stuck in the past in terms of how their governing documents are assembled (or worse, they don’t have any governing documents). Many business owners aren’t aware of this, but by 2010, all Texas entities must be compliant with the relatively new Texas Business Organization Code. Entities that were established on or after January 1, 2006 are automatically covered by the new Code, but entities established prior to that date continue to be governed by the old statutes such as the Texas Business Corporation Act, Texas Limited Liability Company Act, and Texas Revised Partnership Act. What does this mean? In many cases, it is as simple as using the appropriate law to perform transactions, but in other cases, it actually requires amendments to an entity’s governing documents. In some cases, we might recommend that a proposed transaction be performed now under the old law or that the entity voluntarily "opt in" to the new law prior to performing the transaction. As is common with the law, our advice will differ depending on the facts. One way or another, it is often best to ensure that an entity’s governing documents are up to date.

To follow on the discussion of documenting appropriately and keeping abreast of changes in the law, we at the Law Offices of Victor W. Luke always encourage our clients to ensure that the appropriate transaction is used to accomplish an entity’s goals. In many instances, small business clients seek to simplify their day to day operations. Converting an older, rigid entity to a more flexible entity can be beneficial in that the conversion process allows an entity to change its corporate form to take advantage of a tax provision or to allow for less cumbersome paperwork without sacrificing the entity’s operating history, credit history, or corporate name. Similarly, mergers can be used to simplify operations for businesses with multiple subsidiaries or commonality of ownership (where appropriate). In other instances, we can use mergers to accomplish the goals of two distinct businesses that wish to permanently join forces. Until 2010, both methods rely on following the appropriate law to work effectively (pre- or post-Business Organization Code).

We also often encounter ‘stale’ entities that no longer serve their original purpose and management and owners who are less than active in maintaining them. In these situations, we can assist with dissolution paperwork to properly terminate an entity’s existence while ensuring that owners continue to have the appropriate asset protection.

Let’s assume that you own 75% of the shares in a company and you have two fellow owners in the business (as partners, shareholders, or members) who equally own the remaining 25%. Let’s assume that you, the owner with the clear majority of shares, wish to perform a transaction that you know will adversely affect the other two owners holding 12.5% of shares each, and the other shareholders disagree with your proposal. You’re clearly in the majority, so what you choose do should dictate what the company does, right? Of course, the answer isn’t quite so obvious. Generally speaking, the management of - and majority in interest holders of ownership interests in - Texas entities have a duty to minority interest holders to act in a manner that benefits the entity as a whole as opposed to benefitting the majority at the expense of the minority.

More often than not, this issue arises when the majority is seeking to expel what we like to refer to as a ‘malcontent’ minority interest holder. Frequently, the entity’s governing documents don’t exactly address the situation, and the company is forced to look to the statutes to determine the best or most appropriate course of action (which, interestingly, is slightly different under the new Business Organization Code when compared to the old statutes). One way or another, it is important to understand that the minority in interest owners in a company can hold the majority accountable for their actions, especially when the majority seeks to perform an act that will adversely affect the minority or will significantly benefit the majority, but not the minority.

Along these lines, it is important for the individuals responsible for running an entity to be aware of the duties that they are entrusted with in terms of how the company is operated. Even the management of privately held companies need to be aware of their responsibilities in a post-Enron world regarding accountability for the company’s misdeeds initiated by management. This is especially true where there are multiple, unrelated owners in an entity, but also technically true in an entity owned by a husband and wife duo.