Limited Liability Companies (LLCs) - the Basics for Small Businesses

If you are a small business- one to five people who wish to join to together to run a business- you probably will want to create a Limited Liability Company or LLC. In fact, you may have already done so. It is incredibly easy. All you need to do to create an LLC is to fill out a very simple form( called a Certificate of Formation) and file it with the New Hampshire (or whatever state you wish) Secretary of State, along with a registration fee of $100.00. You need only state the name of your new company, address, name of registered agent, whether or not it will be managed by a manager or by the members,  and the purpose. You also need to answer a couple of questions regarding the sale of membership interests. Voila! you have a Limited Liability Company.

Do You Need A Lawyer to Form an LLC

As you can see from the process above, the basic steps are simple and do not require a lawyer. However, (isn't there always a "however"?) you may want to reconsider that decision, especially if there are two or more of you. I have highlighted some of the issues in the sections below.

Operating Agreement

An operating agreement is to an LLC what a partnership agreement is to a partnership. The agreement sets out the understanding between the members as to what the company is going to do, the rights and responsibilities of each member, the capital contributions expected of each member, how the company will be managed, voting rights and how profits and losses are to be allocated. it should also detail if, and how, membership interests can be transferred. If there is never any misunderstanding or dispute, the operating Agreement will probably never come out of whatever file drawer you put it in. That is not reality, however. A well-written agreement will be worth its weight in gold should the day ever come when there is a disagreement and one or more members want out.  Even if you are the sole member of an LLC you may want to have a well-written operating agreement.

What if I do not have an Operating Agreement?

You will have such an agreement. If you do not have one that you approved and signed, you will have one the State of New Hampshire has written for you. The statute enabling LLCs, RSA 304-C, has fifty or more provisions that start with language such as "Unless a written operating Agreement provides otherwise..."

One such example is RSA 304-C:110. This section states that unless the operating agreement provides otherwise, a member may not compete with the company. This may be fine for many companies and exactly what you would expect. However, if you have members who are passive investors, they may not want to be restricted in that way. Real estate investors, for example, may want to invest in similar properties that could be construed as competing.

Oral Operating Agreements

RSA 304-C:40 states " An operating agreement may be written, oral or implied by a course of dealing or otherwise."  This means that if you have orally agreed to certain practices or even if you have never really discussed how you operate, you may still have an enforceable Operating Agreement. Granted, this may be tough to prove, but a written agreement would go a long way towards disproving it. 

Operating Agreements as "Pre-nuptials"

One of the most overlooked features of an LLC is the potential for disaster upon the breakup of the "marriage" for often an LLC "divorce" is as financially messy as a marriage - and while an LLC dissolution doesn't carry the same potential for emotional trauma as a real marriage, it can be extremely hard on everyone involved. When drafting an Operating Agreement, due thought should be given as to how and under what circumstances a member may withdraw from the LLC.

Manager Managed or Member Managed?

One of the questions on the Certificate of Formation is whether the LLC will be managed by a manager or by the members. In most cases, small LLCs will probably be manged by the members. Member managed is the simplest form and should be used if the members actually do participate. Manager managed forms are usually used when there are passive investors, although I will sometimes used a Manager manged LLC for estate planning purposes. NOTE: I often see LLCs whose original Certificate of Formation states that it is not managed by a manager but sometime later, the annual reports are submitted using the title "Manager". This is sure to confuse a bank if that LLC is attempting to arrange financing. 

An Operating Agreement as an Estate Planning Tool

Another use of a written operating agreement is as an estate planning tool. A small business may be a very important part of an estate- many times the business is the primary asset. if that asset is tied up in Probate for an extended time, it may devalue quickly. Until someone is appointed Executor, there may be no one to make appropriate decisions. An operating agreement may include a "Transfer on Death" clause that simply transfers a member's interest to his/her beneficiary. Done properly, this may avoid probate. Another way to avoid probate would be to have the membership interest held by the Trustee of a trust, revocable or irrevocable. This, too, would avoid probate. These are somewhat sophisticated strategies and although they may be appropriate for even very small companies, they should not be used without counsel from an attorney experienced in both estate planning and LLCs. 

So Do I Need a Lawyer to Set Up My LLC?

If you can successfully draft an operating agreement that takes all of the above factors- and many more that I do not have time or space to list- into account, then maybe you do not. However, the lack of professional advice could prove to be far more expensive than the fee an attorney would charge. In short, yes, you do need an attorney!

This is a short overview of some of the issues surrounding LLC formation. It should not be construed as all-encompassing nor as legal advice. This blog cannot create a lawyer-client relationship.Each case is different and LLC formation will be fact specific, that is, what is right for one may not be right for another. Please consult a qualified attorney experienced in these matters.00

US Supreme Court: Inherited IRAs not safe from Bankruptcy!!!

The US Supreme Court recently ruled that inherited IRAs are not "retirement accounts" for purposes of bankruptcy protection. Normally, a tax qualified retirement account is not available to creditors in a bankruptcy action. The Court ruled, however, that an inherited IRA, that is, an IRA inherited from someone other than a spouse, does not qualify for such protection. See Clark v. Rameker 

What does this mean for estate planners? If a client has  a large IRA and wishes to provide a retirement pool for his or her heirs, an inherited IRA is a very good tool. However, if that IRA is available to creditors or if the heirs can take the money out prematurely- called a "blow out"- the plan may fail. An answer to this problem is an IRA conduit trust, sometimes called an IRA Trust,an IRA Beneficiary Trust,  an IRA inheritance trust, a stand alone IRA trust or an IRA protection trust.

If children and grandchildren who inherit IRA funds keep the funds in the IRA over their lives and 

only take the required minimum distributions each year (the “stretch-out”), the amount of money that can be earned, accumulated and paid to the beneficiaries can be staggering. To illustrate how this compounding can work, I have calculated how much money a beneficiary can receive from a parent's $100,000 IRA account; I have used two different ages (10 and 35) for the beneficiary and have assumed that the account averages an annualized 8% return: 

 

Age      Years Paid Out      Paid Out        Remaining in Account     Total 

35             49                  $1,223,584           $5,046                   $1,228,630 

10             70                  $4,279,898           $1,083,614            $5,363,512 

 

This wealth accumulation strategy only works if the beneficiaries retain the inherited funds inside the IRA account. If a beneficiary takes all of the funds out of the IRA account at the time of the client's death (called a “blow-out” because it blows the stretch-out), this wealth accumulation technique will be lost. One of the reasons to create an IRA Beneficiary Trust is because it can insure the stretch-out and can prevent a blow-out. This blow-out happens more often than you may think. The beneficiaries may not be aware of the tax rules and their distribution choices, so they may immediately withdraw the IRA's at the first opportunity (or worse yet, do a prohibited rollover!). If the “stretch-out” isn't done properly by the beneficiaries and income taxes are paid up front shortly after the IRA's are inherited, the heirs may lose hundreds of thousands of dollars (or more). Even if you assume that your beneficiaries will do the right thing (that is, keep the funds in the IRA account for their lives to maximize the income tax “stretch-out” of the IRA's), the IRA's may still be seriously exposed to one or more of the following threats that can arise years after: 

1. Divorce. 
2. Poor spending habits
3. needs-based governmental programs

The New Hampshire Legislature is considering a change in the statute authorizing a Durable Power of Attorney for Healthcare. The proposed change would create a new category of decision-maker: Surrogate (under the current statute, one who is authorized to make such decisions under a written Power of Attorney is an "Agent".) A Surrogate would be selected by the healthcare provider if an Agent or Guardian is not "available, willing and able to act".  The provider is expected to choose from a list of priorities in the statute. the list is:

                 a)  The patient’s spouse, or civil union partner or common law spouse as defined by RSA 457:39, unless there is a divorce proceeding, separation agreement, or restraining order limiting that person’s relationship with the patient.

                  (b)  Any adult son or daughter of the patient.

                  (c)  Either parent of the patient.

                  (d)  Any adult brother or sister of the patient.

                  (e)  Any adult grandchild of the patient.

                  (f)  Any grandparent of the patient.

                  (g)  Any adult aunt, uncle, niece, or nephew of the patient.

                  (h)  A close friend of the patient.

                  (i)  The agent with financial power of attorney or a conservator appointed in accordance with RSA 464-A.

                  (j)  The guardian of the patient’s estate.

There are numerous issues with this legislation starting with the fact that the Surrogate is chosen by an APRN or physician without input from the patient- the patient is incapacitated! The person chosen by the healthcare provider may or may not know the patient's wishes or may not wish to follow known wishes because of personal beliefs. I understand the need for such legislation because not everybody has a Durable Power of Attorney for Healthcare. Indeed, most new clients are quite surprised when I tell them that neither spouses nor adult children have any power under current New Hampshire law to make healthcare decisions for an incapacitated spouse or parent. I understand that we are one of only five states without such legislation. We do need some sort of Surrogate law. Indeed, I lobbied for such a law in the late 80's or early 90's. Hopefully, some of the issues with this legislation will be worked out before it becomes law. you can see the current text at HB 1434

The answer, of course, is to have a carefully considered Durable Power of Attorney drafted and executed. This way you choose who your Agent will be and you have the opportunity to have a conversation with that Agent to make certain that your wishes are known and respected. This is especially crucial in end of life decisions.

For more information, feel free to contact me at Sowerby Law Office, PLLC 603-249-5925 0r dwight@sowerbylawoffice.com

Protection for Nursing Homes or a Danger to Relatives???

Last year, the New Hampshire legislature passed a bill known as SB 138_FN. This bill was effective July 2, 2013. This bill allows nursing homes and certain assisted living facilities to bring a cause of action to recover the "costs of care" from a person who received a "disqualifying transfer" or someone who has the authority to apply for Medicaid and either does not do so or does so negligently.

Nursing homes have a fairly large problem in cases where a nursing home resident is disqualified from receiving Medicaid either due to a "disqualifying transfer" or because a a Medicaid application is never appropriately submitted. It is very difficult if not impossible for a nursing home to discharge a resident for non-payment.of their stay even though it is technically legal to do so. The issue is that the resident must have an appropriate place to go and there must be an adequate plan for their care. Other facilities will be very unlikely to accept an admission under these circumstances.

A little background: in order to be eligible for Medicaid, an unmarried individual must have no more than $2500 in total assets with some exceptions. (The rules for married couples are much more complex) The State agency will count as a current asset any asset transferred "for less than fair market value" within the last 60 months (five years). So, for example, if a Medicaid applicant had conveyed his/her house to a child or to children three years before making application, that applicant will be disqualified for Medicaid for a period of time equal to the amount of days the value of the house would have paid.

In the past, this would have presented issues for the resident that might have been solved with a hardship appeal or the nursing home would simply be stuck providing care with no compensation. Now, this statute allows the nursing home to bring an action- sue in court- the recipients of any such transfer. The liability would be limited to  the value each transferee received. Often such a transfer is made innocently in order to avoid probate and it can come as a complete surprise. other transfers that can cause havoc are any gifts made in that five year period. For example, a grandmother wants to help a granddaughter with college and pays four years of tuition. Then the grandmother falls ill and needs nursing home care. The granddaughter may be liable to the nursing home for the costs of care up to an amount equal to the four years tuition.

Even more dangerous is s a provision that will create liability on the part of a "fiduciary": ( an agent under a power of attorney or a guardian- anybody who has control over the applicant's assets and has the authority to submit a Medicaid application) For example, Mary has power of attorney over her mother who is incapacitated. Mary doesn't consult with an elder law attorney resulting in an incomplete Medicaid application. Her mother would be qualified if only a complete application had been submitted but she is disqualified because that did not happen. Under this statute, Mary is personally liable for all costs not covered by Medicaid. With today's nursing home costs sometimes exceeding $10,000 per month. Mary may soon be bankrupt. I strongly recommend that anyone thinking about becoming an Agent under a Power of Attorney obtain legal advice before accepting that responsibility and potential liability. Note: this is not  to say that one should not become an Agent, just that anyone thinking of doing that should be aware of the responsibilities and potential liabilities.

If you wish a copy of the bill as passed, please contact me at dwight.sowerby@drescherdokmo.com and I will be happy to send it to you.