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The Importance of an Attorneys Fees Clause

Thursday, January 20th, 2011

I was recently asked to litigate a breach of contract claim on behalf of a party who was wronged by the breach of another party to a contract. The kind of contract is immaterial for the purpose of this article. It could have been an independent contractor agreement, or employment agreement, or an asset purchase, stock purchase, non-compete, or non-solicitation agreement, or any one of a dozen other types of contracts. Regardless, as I have said previously in these posts, there are certain contractual provisions that should be found in just about every contract. What may be possibly be the single most important provision, from my perspective, happened to have been omitted from this particular contract, that is, a provision addressing the potential recovery of attorney’s fees resulting from litigation.

I say that this may be the single most important provision in a contract not in a substantive sense, as the material terms of the contract must of course be included with specificity. The services to be performed or the products to be sold are obviously vital, since without which there may be no meeting of the minds and thus no contract in the first place. And there are other material provisions related to the deal itself that must be included as well, ie the duration of the agreement, compensation, termination, etc.

But aside from the substantive points of the deal, there is not a more important procedural, boilerplate, provision than a provision addressing attorney’s fees. Why? Because in many cases, the lack of such a provision makes litigating over a contract a financially untenable idea. A party to a contract may have the facts and the law on its side. The case may essentially be a slam dunk, if such things exist. However, if at the end of the day, the damages available to the winning party only barely exceed the amount the party paid to its attorney’s to prosecute the case, then regardless of how great a case it is, the filing of a lawsuit or arbitration makes little sense from a bottom line perspective. None of us, clients or attorneys, litigate in order to achieve moral victories. If maintaining a lawsuit does not make sense from a financial point of view, then regardless of right and wrong and getting even, I always advise my clients to consider the case strictly from a business perspective, leaving aside emotion.

That is why it is such a huge benefit when a contract at issue contains a prevailing party clause with regard to attorney’s fees. This magic language allows a wronged party to sue with the understanding that if the facts and the law support her case, then she will be made whole in regard to not only the actual damages she sustained as a result of the breach of contract, but in addition, all costs, expenses and attorney’s fees she expended in litigating the matter. Please then, I ask you to review EVERY agreement your business has signed, as well as every agreement you sign from here on out, and prior to execution, include a provision similar to the following:

“In the event of litigation [or arbitration] for any matter arising out of or related to this Agreement, the party prevailing in any such action shall be entitled to recover from the losing party its reasonable attorney’s fees and all other legal costs and expenses, including filing fees, expended in the matter.”

The importance of this provision cannot be overstated, since attorney’s fees on even a fairly “routine” matter can easily run into the tens of thousands of dollars, and for more complex cases against defendants with deep pockets, it would not be a surprise to see attorneys’ fees in the hundreds of thousands of dollars.

Why a Single Member LLC Needs an Operating Agreement

Wednesday, October 6th, 2010

Maryland law does not require that a sole member limited liability company (“LLC”) have an existing, enforceable operating agreement on file. Nevertheless, there is an excellent reason to draft and execute one: by executing an LLC operating agreement, the single member of the LLC has drawn a line of protection guarding that person against personal liability for the business debts and obligations of the LLC.

Specifically, Maryland courts have held that the protection from liability that exists by virtue of the LLC’s formation can disintegrate if the LLC fails to observe certain corporate formalities. One of these formalities is the existence of a valid operating agreement. Having an operating agreement in place can protect the single member from liability when a third party attempts to sue the individual member in order to satisfy an obligation resulting from a debt of the LLC.

Without an operating agreement, it may prove more difficult for the sole member to avoid liability. Courts sometimes blur the line between a sole member LLC with its protection from liability for its individual owners, and a sole proprietorship where such protection does not exist. However, this line becomes more clear cut, and courts will as a result hesitate to “pierce the corporate veil” and hold an individual liable for the LLC’s debts, when corporate formalities like having an operating agreement are complied with.

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.

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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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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