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The phrase “Corporate Transparency Act” is quite possibly unfamiliar to you at this time
(October 2023), but if you run a business entity in the U.S., you will certainly be hearing about it in the coming months. The regulations are not fully-formed at this writing, but my goal here is just to give you the gist so you are aware of what is coming down the pike.
- The purpose of this regulation is to enable the federal government to combat money laundering and other illegal activities that use business entities as shell companies. As of now, a Certificate of Formation filed in Delaware, for example, typically contains no information about the entity’s ownership and management, so law enforcement needs to use additional tools to obtain information.
- The Act will require entities to file a form with the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) containing basic identifying information (name, home address, copy of ID, etc.) about each beneficial owner of 25% of the entity and those who exercise substantial control over the entity, and then update the form when there are changes.
- The personal information on the form will be available to law enforcement and national security personnel, not to the general public.
- The filing requirement applies to all domestic and foreign entities (yes, including that single-member LLC you formed for your consulting work on the side), except for a laundry list of exempt entities that are subject to existing regulation already, such as banks and insurance companies, as well as larger companies (more than 20 full-time employees, located in the U.S. and over $5 million in annual sales).
- The filing requirement will go into effect on January 1, 2024 for newly formed entities after that date. Existing entities will have to comply sometime during that year, before January 1, 2025.
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]]>Below is a post I wrote about remote work in the “before days” of 2014. (I called it “Virtual Law Offices,” which was a more common term then than “remote work.”) It’s interesting to read it now with the hindsight provided by having gone through the pandemic and seeing attitudes to remote work change overnight. The points I made below, such as how it’s possible to be more efficient by eliminating a commute, were not widely shared by my colleagues back then. One thing that’s changed for me since then is that the door-to-door commute is now a bit shorter because the Long Island Railroad introduced routes directly to Grand Central Terminal, near my office. But I still don’t go in most days, since a shorter commute is still longer than no commute at all.
I live in the quaint seaside town of Port Washington, Long Island (at least, it’s as quaint as is possible 20 miles from Manhattan). Local residents have, in the past year or so, been much more likely to see me around town running errands during normal business hours than in the past. This is because my law firm is gradually morphing towards becoming a so-called virtual law firm. When I started the firm in 2010, I set up my office on 5th Avenue and 46th Street, and dutifully commuted in every day (75 minutes door-to-door each way, at best, notwithstanding the puffery of the real estate agents who will tell you only how long it takes for the train to get to Penn Station, which never happens on time anyway).
As my firm’s workload and breadth of practice has increased, I’ve been bringing in attorneys and other law firms on a contract basis to help. I don’t have the space at 5th Avenue to physically house these people, and my primary go-to contract attorney spends most of the year in Andalucía, Spain (now that would be a commute). So these attorneys do their work from wherever they want to work. The fact that they are not physically present has almost no practical effect on how we work together, which is done primarily via email and phone.
Observing the ease of these virtual relationships, I started to question why I was trudging into the city myself. Of course, I’m the face of my firm and therefore need to meet with clients from time to time. Nevertheless, 95% of what I do is email, phone calls and review of Word documents, which can be done anywhere with an Internet connection. Accordingly, I’ve been working mostly from home lately, though I often come in for meetings, in one of the conference rooms at 5th Avenue or elsewhere, as needed. This required a couple of technological adjustments – using cloud computing for my documents and email and call forwarding for calls that come into Manhattan – which has been seamless. All the time I save on commuting gives me that much more time to devote to my work and has made me much more productive overall.
It will be interesting to see whether my arrangement becomes the norm for how law is practiced in the future, particularly for areas of the law, like corporate, that are less likely to require physical presence somewhere at a particular time. It clearly works well for firms like mine – experienced lawyers working with a network of other experienced lawyers. Time will tell whether it could potentially work for the big firm setup, where young attorneys are being trained by mentors.
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]]>The post Tips on Limiting Liability for Passive Investors in Private Companies appeared first on Andrew Abramowitz, PLLC.
]]>A client in the music industry called recently, saying he’d been asked to make an investment for a 10% passive stake in a new restaurant. The client said he didn’t want to become a member (equity owner) of the LLC formed to operate the restaurant, because he didn’t want any legal liability. He understood that he could potentially lose his investment if the restaurant fails (which, believe it or not, does happen from time to time!), but his fear, as someone with a more public profile than the other members, was being an individual target for a suit against the restaurant, being perceived as deep-pocketed.
I told him that the only way to guarantee no liability or at least not being named in a suit is to not make the investment at all, but assuming he does, he should want to be a member of the LLC, to properly document the financial arrangement, i.e., that he’d put in some cash in exchange for 10% of future profits, and also, through the documentation, to appropriately limit his liability.
Below are some tips/considerations for limiting liability in passive investments of this type:
- Limited Liability Entity – Ensure that the investment is made in a private company structured as an LLC or corporation. In these entities, investors are shielded from personal liability for the company’s debts and obligations. Their liability is generally limited to the amount of their investment. Investors can also make the investment through their own LLC for an additional layer of liability protection.
- Properly Drafted Investment Agreements – Investors should carefully review and negotiate investment agreements to ensure adequate protection. These agreements should clearly define the investor’s role as a passive participant, outlining their limited involvement in the company’s management and decision-making processes, and providing for indemnification or members/shareholders. By explicitly establishing their status as passive investors, they can minimize potential liability arising from the company’s actions.
- Due Diligence – Before investing in a private company, passive investors should conduct thorough due diligence. By investigating the company’s financials, operations and legal standing, investors can identify potential red flags and mitigate future risks. This proactive approach helps ensure that investors are aware of any potential liabilities the company may be exposed to, reducing the chance of unforeseen legal issues.
- Insurance Coverage – Investors should ensure that the company they’re investing in has an appropriate degree of insurance coverage, in amount and type, for the particular operations of the company. Even though the policy would directly cover the company, not the individual equity owners, the insurer would defend any suit that attempts to name passive investors as co-defendants.
- Legal Advice – Self-serving, but true: Be sure to engage a qualified corporate/securities attorney to assist with all of the above. In cases where the investment is for a small stake in the company and negotiation is not really possible, the attorney can at a minimum do a review of the documentation to summarize key issues and identify potential red flags.
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If I am forming an LLC to purchase real property in New York, should I organize the LLC in New York or Delaware?
I received the following response after a few seconds:
The decision to organize your LLC in New York or Delaware depends on your specific circumstances and goals. Both states have their own unique advantages and disadvantages. Here are some factors to consider:
Organizing in New York:
- If you plan to operate the LLC in New York, it may be more straightforward to organize the LLC in New York as well.
- New York does not require annual reports, but does require a biennial statement, which is a report on the status of the LLC, and has higher filing fees compared to Delaware.
- New York has a higher annual franchise tax than Delaware, which may be a factor if you have a high valuation or net worth.
- If you plan to purchase and hold real property in New York, there may be additional state and local filing requirements, such as transfer taxes or mortgage taxes.
Organizing in Delaware:
- Delaware is a popular choice for LLCs due to its favorable business laws and court system, which is well-established and familiar with corporate law.
- Delaware does not impose state income tax on corporations that do not operate in Delaware, but it does impose an annual franchise tax that is based on the number of authorized shares of the LLC.
- If you plan to raise capital or eventually go public, organizing in Delaware may be advantageous due to its established legal system and business-friendly environment.
- If you plan to hold real property in New York, you may need to register as a foreign LLC in New York and comply with New York state and local filing requirements.
In summary, it is important to weigh the benefits and drawbacks of each state and consult with a knowledgeable attorney or accountant before making a decision.
Then, I pasted the exact same question into Google, and the first non-sponsored link was to this LegalZoom article.
It’s immediately apparent in looking at both results that the ChatGPT response is far more tailored to my question than the article identified via Google, which doesn’t even mention New York LLCs. (To be clear, this is not a criticism of the article, which seems fine, but the point is that it wasn’t written to be directly responsive to my question; it’s just the web page that the Google algorithm thought was closest to what I was seeking.)
So, would I be able to simply pass along the ChatGPT response to my client without modification? No. It doesn’t mention, for example, the annual cost to a New York client forming a Delaware LLC of engaging a registered agent in Delaware, which wouldn’t be an issue if the LLC was just formed in New York. However, this response absolutely would be a useful starting point for me if I hadn’t already answered it for clients before. It’s clear that that this will be a significant time-saver for lawyers as it gets refined.
Attorneys, and other white-collar professionals, have been hand-wringing in the months since ChatGPT was introduced about how their jobs could be eliminated in the long-run by AI. However, the story of the last 100 years or more is that the introduction of a new technology has initially triggered this “replaced by robots” fear, but then somehow people manage to find remunerative work in the subsequent years. Lawyers, in particular, have worried for years about developments like document review software for litigators and form purveyors (like LegalZoom) for transactional attorneys. But here we are, and as of late last year, the unemployment rate for attorneys was a microscopic 0.1%.
If past is prologue, then, these AI tools will improve and become incorporated into attorneys’ practices, without replacing the job category. If I’m wrong, well, I guess I’ll get much better at golf in the coming years.
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]]>The post Ensuring that Clients Understand the Agreements they are Signing appeared first on Andrew Abramowitz, PLLC.
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We all know that most users of web-based products (which is to say everybody) do not read the lengthy terms of service that they are asked to accept with a click before proceeding. These users make a probably reasonable calculation that the stakes are pretty low given the nature of the transaction and that by clicking “accept,” they are not agreeing to bequeath their estate to Apple or Microsoft. But what about agreements that are more significant to the signer, like an agreement to sell one’s business to a buyer? Does the seller need to read every word and understand them before signing? Their lawyers will usually say yes, because after all, the seller is the one signing the agreement and giving up the business, not the lawyer. But like all experts, lawyers can sometimes forget how utterly foreign contractual language is to lay people and need to take steps to ensure actual comprehension beyond a mere CYA admonition to read every word. Of course, some clients have had long business experience and have seen many agreements of a particular type, so the need to hand-hold needs to be tailored depending on the client.
When people think of legalese, they primarily are concerned with arcane words such as “heretofore” or whatever. But a more significant factor in client incomprehension, I think, is that they don’t have the background knowledge with these agreements to know the purpose of various provisions and how they all interact. For example, in a typical agreement for acquisition of a business, there are provisions relating to the seller’s potential liability to buyer after the closing, including various defined terms such as Fundamental Representations, Cap, Basket and Survival Period. These concepts are, needless to say, not experienced by the average person in their lifetime, even if it’s a well-educated lifetime. But the idea behind all of it is not terribly complex and is very important to the parties in an M&A deal: The buyer should be compensated for damage that occurs after closing if the seller misrepresents facts about the business being purchased when the agreement is signed, but assuming this misrepresentation is not intentional/fraudulent, there should be reasonable limits placed on the amount of compensation and the length of time after closing during which the buyer can bring this up. So, while it’s unrealistic to expect clients to start using all of the contractual lingo in ordinary conversation, it is important for the lawyer to impress upon the client the importance of, to take the above example, ensuring that representations in the agreement are correct to avoid post-closing liability.
So, my message to fellow lawyers is to try to remember how clueless you were as a law student and junior associate and, accordingly, guide your clients with the goal of ensuring true comprehension of important concepts.
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There are those who are addicted to the new online word game, Wordle, and then there are those who gripe about their friends who post their Wordle scores on social media every day. This being a blog about corporate and securities law and transactions, I am not writing to opine on this question, though the fact that I’m mentioning the game at all probably tells you where I stand.
The New York Times recently agreed to acquire Wordle from its Brooklyn-based creator, Josh Wardle, as reported by the, well, New York Times. According to the newspaper/acquiror, the purchase price is “in the low seven figures.” I’m not sure whether that means a million-ish or some amount that is less than $5 million, but in any event, it is a nice payday for Mr. Wardle for a product released just a few months ago.
The New York Times is a public company and would have to promptly disclose terms of the acquisition with a greater degree of precision than “low seven figures” if the acquisition was material to the company, but the Times is of a size where this particular acquisition is not deemed material (even though it was material enough to be reported on by itself as a news item). The Times did make a material acquisition about a month prior, when it acquired the sports publication The Athletic for $550 million, which it then reported on a Form 8-K.
Because the Wordle acquisition wasn’t publicly reported via SEC filing, we don’t know any more than the vague range for the purchase price, but let’s assume for purposes of this post that the transaction was extremely simple: the Times paid Mr. Wardle the seven-figure sum in cash, and perhaps also agreed with him on some sort of short-term consulting arrangement for his help in integrating the game into the Times’ other game offerings. On one hand, I can see why he would take that deal: it’s a nice chunk of change for a few months of work, and maybe three weeks from now, game players will move on to another obsession, so he wanted to strike while the iron was hot.
However, let’s consider the other possibility, that it becomes an institution for years to come, even after the initial craze passes (something like Sudoku). In that case, letting it go for what seems like a nice cash payment won’t look so wise in retrospect, while the Times reaps many millions from it over the years. If I was advising Mr. Wardle, I would have advised him to incorporate provisions in the agreement to enable him to benefit from the blowout success scenario. (Again, I want to stress that the agreement isn’t public, so I can’t say for sure that this didn’t happen.) The agreement could incorporate milestone payments, i.e., the initial seven-figure payment up front, but then additional payments if and only if the game is a big success for the Times, and the Times would be obligated to use reasonable efforts to make that happen. Or there could be some form of royalty-type payment, where he’d share in a small percentage of the Times’ earnings from the game.
First-time sellers of companies are presented with the possibility of getting paid what seems like an unfathomably large amount, but it’s important for those in that position to take a deep breath and try to negotiate the best possible deal, or in certain circumstances, hold off on doing a deal at all.
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