LPS Law Blog

CORPORATION VS. LIMITED LIABILITY COMPANY (LLC)

Choice of entity is always an early question encountered by entrepreneurs. Below is a summary of certain key differences between forming a limited laibility company vs a corporation:

I. Formation

An LLC is formed by filing Articles of Organization (LLC-1) with the California Secretary of State. The current filing fee is $70.  The filing requires relatively little information with respect to the identity of the members (owners).  However, the identity of the LLC members must be disclosed in the Statement of Information (LLC-12) which has to be filed within 90 days after filing of the original Articles of Organization if the LLC is a member-managed LLC.  If the LLC is a manager-managed LLC, only the manager's identity needs to be disclosed in the LLC-12.  The filing fee for the LLC-12 is $20.

In contrast, forming a corporation requires filing of Articles of Incorporation with the Secretary of State, and  payment of a $100 filing fee.  The Articles of Incorporation can be more complicated than the Articles of Organization since they must meet statutory requirements in accordance with California Corporation Code (the "Code") Sections 200-202.  An initial Statement of Information (Form SI-200C) is also a required filing within 90 days after the corporation files its Articles of Incorporation.  A $25 filing fee is charged for the filing.  Unlike with LLCs, the Statement of Information for corporation does not require the disclosure of the identity of shareholders, as it only requires the disclosure of the officers and directors.

The annual filing obligation for the Statement of Information will be discussed later in this document.

 

II. Organizational Matters

 

Bylaws vs. Operating Agreement

For a corporation, the governing document is the Bylaws.  The Bylaws typically follow Code Section 212.  In some instances, where permitted, the Bylaws' provisions may vary from the Code's statutory provisions.  The Bylaws set forth rules governing voting, meeting, notices, election of officers and directors, share issuance, and other corporate governance issues.

A counter-part of the Bylaws in a LLC is an operating agreement.  It governs the relationships among the member(s) and the management of the LLC.  Members' initial capital contribution will also be listed in the operating agreement.  Furthermore, the operating agreement often incorporates cross-purchase provisions that in a corporation are typically found in a shareholders agreement

Although neither the Bylaws nor the LLC Operating Agreement must be submitted to the Secretary of State, these two documents have to be prepared at the beginning of the formation process.

 

Organizational Resolutions

The organizational resolutions are standard resolutions setting forth the items that require approval by the board of directors of the corporation in order to get the corporation organized.  The organizational resolutions usually include the appointment of the initial director(s).  They also require the board to elect and ratify the appointment of corporate officers such as the chief executive officer, chief financial officer and secretary.  The organizational resolutions also require the board to approve the initial capital structure of the corporation.

An LLC usually does not need to have its members approve a document like the organizational resolutions during the formation stage because the operating agreement should have already covered most of the issues such as the appointment of the Manager (if it is manager-managed LLC) and the capital contribution information.

 

Tax IDs, Double Taxation vs. Pass-through Taxation

For federal income filing purpose, both the corporation and the LLC need to file a SS-4 Form with the Internal Revenue Services (IRS) to obtain their federal tax identification number (FEIN).  The FEIN number may also be required for other purposes such as opening a bank account for the company.

With respect to taxation, a corporation is subject to what is often referred to as "double taxation."  The corporation is required to prepare a separate tax return and to pay tax based on its net income at specified corporate tax rates.  Then, the remaining net income of the corporation, when distributed to the shareholders is taxed again at the individual level at the shareholders' tax rates on their personal tax filing. 

In contrast to a corporation, an LLC is by default treated as a conduit for tax purposes.  It is often referred to as "pass-through" taxation.  This means that, for federal tax purposes, all net income and net losses of the LLC pass through to the members of the LLC without being taxed separately at the LLC level.  If the LLC only has a single member, it will still be afforded single-level, pass-through tax treatment but will be treated as a "sole proprietorship" for federal income tax purposes.

 

III. Capitalization and Ownership  

 

Capitalization

In return for a membership interest, the member of an LLC may contribute money, property,  or a binding obligation to contribute any of these to the LLC in the future as provided in the Articles of Organization or Operating Agreement.  A person can also receive an economic interest in the LLC but not necessary a membership interest in an LLC.  

Under certain circumstances, an LLC interest may be deemed a "security". The legal definition for "securities" is an investment in an enterprise with the expectation of profit from the efforts of other people.  Interests in the LLC often are treated as securities because one can invest in the LLC to expect the return of the profit, but someone else is actually running the business of the enterprise as in the case of a manager-managed LLC.  Some states including California expressly define LLC interests as securities.  However, if the LLC is structured as a member-managed LLC, and all of the members actively participate in the management of the LLC, then the LLC interests may not be securities.  There is little guidance as to what constitutes active engagement in management, so it can be risky to assume that LLC interests,  even in a member-managed LLC, are not securities unless the facts are abundantly clear (i.e., a three-member LLC in which all three members are equal partners who regularly participate in decision making regarding the business).  Otherwise, LLC interests should be considered as securities, and all the normal steps to comply with applicable federal and state securities law should be taken.

As for a corporation, someone must give something of value (typically, cash or assets) to purchase the stock and to become a shareholder.  A future obligation to contribute property or services is not proper consideration; however, Code Section 409(a)(1) does permit shares to be issued in exchange for a promissory note provided the note is adequately secured by collateral other than the shares themselves or pursuant to an employee stock purchase or option plan.  A corporation can vary shareholder rights by issuing different classes or series of stock.

Stock is a security and its issuance is subject to securities laws under state "Blue Sky" laws and also federal law.  In California, a corporation needs to file a Notice of Transaction with the California Commissioner of Corporations when issuing shares in a limited offering pursuant to a securities exemption under Code 25102(f).

 

Economic Allocations

Unlike a corporation, an LLC cand esignate special arrangements for economic allocations.  Through use of classes of preferred stock, a  corporation may be able to approximate the variety of economic allocations that can be accomplished in an LLC, but it requires far more effort and documentation to do so. 

 

Allocation of Profits and Losses

Dividends may only paid in proportion to the stock ownership within each class.  Code Sections 500 and 501 limit distributions to shareholders.  Unless the distribution is made from retained earnings, the corporation must satisfy certain solvency test based on its assets and liabilities. Nor may a corporation make a distribution to shareholders if the corporation is unable to meet its liabilities as they mature.

LLC profits and losses are allocated and distributed among the members as provided in the operating agreement.  In the absence of such an operating agreement provision, profits and losses are allocated in proportion to each members' capital contribution.  In the absence of an agreement to the contrary in the operating agreement, distributions of money or property representing a return of capital are made in proportion to contributions and other distributions are made in proportion to the allocation of profits.

 

Transferability of Interests

An LLC member can freely transfer his or her rights to share in the LLC's profits and losses and distributions (known as economic interests).  However, a member cannot cause a new person to become a substituted member (with voting and inspection) by virtue of a transfer unless provided in the operating agreement or by consent of majority interests of the members.

In contrast, absent an agreement among the shareholders providing otherwise, shares of a corporation's stock are freely transferrable.  In smaller or closely held corporation, however, shareholders typically enter into a buy-sell agreement specifying, in advance, the events triggering a buy-out, the method for determining the purchase price for the stock and the payment terms.

 

IV.  Operations and Formalities

 

Management Structure

Except in the case of a statutory close corporation, management and control of a corporation is vested in the board of directors, elected by the shareholders.  The directors generally establish the policies and make major decisions, but day-to-day dealings with third parties are delegated to the corporation's officers and employees.  For a small corporation, the same person many be shareholder, director and officer.

An LLC is known for its flexible management structure.  Management of an LLC may be centralized with the appointment of one ore more designated managers and managers need not be members.  Alternatively, management may be vested in all of LLC's members.  Unless the Articles of Organization or operating agreement provides otherwise, each member has the right to vote in proportion to his or her interest in the LLC's current profit.  

 

Corporate Formalities

Corporations are subject to certain basic statutory requirements and formalities that cannot be waived or modified; such formalities are not mandatory in the LLC context.  As an example, corporations must hold an annual meeting of shareholders and an annual meeting of directors (or take action by written consent in lieu thereof), and the board of directors are expected to make decisions, take action and keep records of such actions for activity that is outside the ordinary course of the corporation's business.  Below are few examples of the actions which require the board's approval:

            (a) To select and remove corporate officers and to award their respective compensation'

            (b) To authorize the issuance of shares of stock of the corporation;

            (c) To authorize or amend the corporation's stock option plan;

            (d) To borrow money and incur indebtedness for the purpose of the corporation, and to cause to be executed and delivered, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations, or other evidences of debt and securities the corporation; and 

            (e) To authorize the merger and acquisition of the corporation, including but not limited to the sale of the substantial asset of the corporation or the purchase of the substantial asset of another corporation.

 

However, a LLC is not required to hold meetings or retain such records.  For some businesses, the informality of the LLC can be an attractive alternative to the formalistic requirement of a corporation.  The LLC Act expressly provides that failure to meet certain of the formalities required of a corporation (e.g., holding annual shareholder meeting and director meetings) is not a factor to be considered in a "piercing the veil" dispute.  Nevertheless, certain fundamental changes in the form of operations of the LLC require the consent or approval of the members.  Such actions include:

            (a) Amendment of the articles of organization of the LLC;

            (b) Sale or disposition of all or substantially all the assets of the LLC;

            (c) To borrow money and incur indebtedness for the purposes of the LLC;

            (d) To authorize the merger and acquisition of the company including but not limited to the  sale of the substantial asset of the LLC or purchase of the substantial asset of another company.

Annual Filing of the Statement of Information

A domestic stock corporation shall file a statement of information (SI-200 C or SI-200 NC if no changes) with the California Secretary of State, within 90 days after filing its original Articles of Incorporation, and annually thereafter during the applicable filing period.  The applicable filing period for a corporation is the calendar month during which its original Articles of Incorporation were filed and the immediately preceding five calendar months. For example, if a corporation filed its original Articles of Incorporation on January 1, 2009, then its applicable filing period will be from August 1 to January 1 of each year.

For an LLC, the statute requires the LLC to file the statement of information (Form LLC-12 or LLC –12 R if no change) with the secretary of state, within 90 days of filing its original Articles of Organization, and biennially thereafter during the applicable filing period.  The applicable filing period for an LLC is the calendar month during which its original Articles of Organization was filed and the immediately preceding five calendar months.  Using the above example, if the LLC's originally filed its Articles of Organization on January 1, 2009, then its applicable filing period will be between August 1 and January 1 of every other year.  Failure to file the statement of information by the due date will result in the assessment of a $250 penalty.

 

California Franchise Tax

A corporation which is incorporated in or qualified to do business in California must pay the minimum franchise tax during the first quarter of each accounting period whether the corporation is active, operates at a loss or does not do business. The current minimum tax is $800.   An LLC is also subject to the same minimum franchise tax rule.  A corporation or an LLC is not subject to the annual tax if it did not conduct any business in California during the taxable year, or the taxable year was 15 days or less.  The annual tax is due on the 15^th day of the 4^th after the beginning of the taxable year.

 

V. Dissolution

 

Dissolving a corporation in California requires multiple steps before and after the dissolution. First, a Certificate of Dissolution needs to be filed with California Secretary of State.  Upon this filing, the Corporation's dissolution will be conditional and it will not become final until the issuance of a tax clearance certificate by the California Franchise Tax Board.  There is no fee charged for the filing of the Certificate of Dissolution.   Both shareholders' written consent and the board's written consent are required to authorize the dissolution process in accordance with California law and the Plan of Complete Liquidation and Dissolution of the corporation.  A plan of liquidation with conveyance and assignment is required to allow the transfer of all residual corporate assets to its existing shareholders.  During the dissolution process, the corporation  needs to send a Notice to all its creditors and claimants if any after the dissolution process commences.  The corporation also needs to file an IRS Form 966 within 30 days of the approval of the dissolution.  Furthermore, a corporation must file a request for Tax Clearance (Form 3555) with the California Secretary of State together with the Certificate of Dissolution to obtain tax clearance.  The corporation must receive tax clearance from the California Franchise Tax Board for the dissolution to be final.  Generally, tax clearance can be obtained by either filing a final tax return and paying all taxes due (if any) or by having another person assume the corporation’s tax liability.  It can take several weeks to obtain tax clearance. 

To dissolve an LLC in California, one needs to file a Certificate of Cancellation with the Secretary of State after the dissolution process is completed.  There is no fee charged for the filing of the Certificate of Cancellation.  All members need to approve and sign the resolutions which authorizes the commencement of the dissolution process.  The resolutions set forth the standard dissolution plan, which is to pay or adequately provide for all debts of the company, if any, and then distribute any remaining assets pro rata to the members.  The members also need to sign the assumption of debts and liabilities document which will let the members assume all the debts and obligations of the LLC.  Finally, the members need to execute a conveyance and assignment form which authorizes the transfer of all residual assets of the LLC to the members.

Darlene D. Chiang, Esq. is the author of this post and may be contacted at dchiang@lpslaw.com Ms. Chiang counsels business clients and financial institutions on corporate and regulatory matters.

Italian Olive Oil Producer Held Subject to Court's Specific Jurisdiction even though he never entered California

On February 23, 2009, in Luberski, Inc. v. Oleificio F.LLI Amato S.r.L., the Fourth Appellate District of the California Court of Appeal reversed an order of the Orange County Superior Court granting defendant's motion to quash service of the summons for lack of personal jurisdiction and held that the court has specific jurisdiction over defendant because the subject of the dispute is defendant's alleged non-delivery of olive oil to plaintiff in California.

 

Plaintiff is an entity operating in California that ordered 12,000 cases of olive oil from defendant, an entity operating in Italy.  Plaintiff paid $406,000 to defendant, which was supposed to ship the olive oil to plaintiff by way of Long Beach, California, but the shipment never arrived.

 

After plaintiff filed suit, defendant contested personal jurisdiction.  Defendant asserted that it was formed under the laws of Italy, is located in Partanna, Italy, and has no direct presence in the state of California.  Defendant further contended that it has sold only a small amount of olive oil to a few California customers, that it provides no services in California, and that it has no employees, banks, assets or offices in California.

 

The trial court granted defendant's motion to quash service of the summons because it found that defendant's contacts with California were not substantial, continuous, and systematic, and because defendant did not purposefully and voluntarily direct its activities toward California in order to obtain benefit from the state.

 

After reviewing the pertinent state and federal authorities, the Court of Appeal agreed with the trial court that defendant was not subject to the general jurisdiction of the court because defendant's contacts with California were not substantial, continuous and systematic.

 

The Court of Appeal noted, however, that, even if a nonresident defendant does not have substantial and systematic contacts with California to establish general jurisdiction, the defendant still may be subject to the specific jurisdiction of the court.  A court may exercise specific jurisdiction over a nonresident defendant only if: (1) the defendant has purposefully availed itself of the benefits of the forum; (2) the controversy is related to or arises out of the defendant's contacts with the forum; and (3) the assertion of personal jurisdiction over the defendant would comport with fair play and substantial justice.

 

The Court of Appeal noted that the controversy clearly arises out of defendant's contacts with California because the lawsuit concerns defendant's alleged failure to deliver olive oil to plaintiff  in California.  In concluding that defendant purposefully availed itself of the benefits of the state of California, the Court of Appeal relied upon defendant's agreements to maintain responsibility for the olive oil until it reached California and to deliver the olive oil to plaintiff in California.  Thus, defendant had the expectation that the goods it was placing in interstate commerce would be utilized in California.  The Court of Appeal also found that California courts have a strong interest in enforcing contracts providing for performance within the state.  Accordingly, the Court of Appeal reversed the order granting the motion to quash service of the summons and required defendant to defend against plaintiff's allegations.

Jack V. Valinoti Esq. is the author of this post and may be contacted at jvalinoti@lpslaw.com   Mr. Valinoti is a business litigator and has successfully represented a variety of domestic and foreign clients, including Italian companies, in commercial disputes in California.

E-PROXY COMPLIANCE REQUIREMENTS

The 2007 amendments to the eProxy delivery rules promulgated by the Securities Exchange Commission ("SEC") present potential cost and time savings for reporting financial institutions that elect to follow them to furnish proxy materials, including the proxy statement, proxy card and annual report, to shareholders.

Essentially, the eProxy delivery rules significantly reduce the paper delivery requirements by providing a "notice and access" method that consists of (1) posting the proxy materials on an internet website; and (2) mailing shareholders a written notice of availability of the proxy materials.

The notice of availability ("Notice") must comply with the following provisions:

I. Mandatory Legend

The Notice must include a prominent legend in bold-face type that states the following statements:

• Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to Held on [insert meeting date].

• This communication presents only an overview of the more complete proxy materials that are available to you on the Internet.  We encourage you to access and review all of the important information contained in the proxy materials before voting.

• The [proxy statement][information statement][annual report to security holders] [is/are] available at [insert Internet website address].

• If you want to receive a paper or e-mail copy of these documents, you must request one.  There is no charge to you for requesting a copy.  Please make your request for a copy as instructed below on or before [insert date] to facility timely delivery. [put the instruction for making the hard copy request].

II. Mandatory Information

The Notice must also include the following information in understandable terms.

• The date, time and location of the meeting or, if action is to be taken by written consent, the earliest date on which the action may be effected;

• A clear and impartial identification of each separate matter intended to be acted on and the issuer's recommendations, if any, regarding those matters, but no supporting statements;

• A list of the materials being made available on the website;

• A toll-free telephone number, and email address and a web address where the shareholder can request a copy of the proxy materials, for all meetings and for the particular meeting to which the Notice relates;

• Any control/identification numbers that the shareholder needs to access his or proxy card;

• Instructions on how to access the proxy card, provided that the instructions do not enable a shareholder to execute a proxy without having access to the proxy statement and annual report;

• Information on how to obtain directions to be able to attend the meeting and vote in person; and

• A telephone number that the shareholder can call to ask questions about the solicitation process.

             The reference to the web address must clearly indentify the location where the proxy materials are located.  It must be specific enough to lead shareholders directly to the proxy material, rather than to the home page or other section of the web site, so that the shareholders do not have to browse to find the materials.  All proxy materials to be furnished through the notice and access model for delivery of proxy materials, other than additional soliciting materials, must be posted on the Internet by the time the Company sends the Notice to the shareholders.  The Notice must be sent to shareholders at least 40 calendar days in advance of the shareholder meeting.

Darlene D. Chiang, Esq. is the author of this post and may be contacted at dchiang@lpslaw.com Ms. Chiang counsels business clients and financial institutions on corporate and regulatory matters.

 

LEGAL REPRESENTATION IN FAMILY LAW MATTERS

In today's marketplace, a great number of industries are constantly adapting to best fit the needs of the people whom they serve and the legal profession is no exception. As a result, there are many different methods by which clients can engage counsel to help them with their legal needs. Family law, in particular, is at the forefront in the field in offering clients a variety of processes by which they can resolve their legal disputes. Below is a short list of the most commonly used methods.

Conventional Legal Representation

Conventional legal representation is what most people tend to think about when they are in the process of deciding whether or not they need an attorney. In this more traditional arrangement, a clients hires an attorney to handle every aspect of the case that requires legal attention. The indefinite period of time in this sort of relationship usually involves the attorney doing work before, during, and after the case is active in the court. In this situation, the role of the client is significant, but generally limited to consulting with, and providing information to, his/her attorney.

Collaborative Law

Collaborative Law can most aptly be referred to as the "team approach." A client who chooses collaborative law hires his/her own attorney, but agrees with the other party to work through their case by not going to court to litigate. Attorneys who practice collaborative law are specially trained in the collaborative process and often work together with financial professionals and/or child psychologists to assist in the resolution of the case. One of the most significant differences between this approach and the other approaches is that clients using collaborative law are required to sign a contract indicating that they are committed to the process and that they must find another attorney should they decide at a later point to take their case to court.

Mediation

The term "mediation" refers to any process where two or more people meet with an impartial third party who facilitates a settlement of the dispute. This confidential process can take anywhere from one to several meetings with each session lasting approximately two hours.

Although there are no requirements for someone to be labeled as a "mediator," there are a wide variety of professional training programs that offer certification in the mediation process. Although sometimes clients can be hesitant, many cases are able to come to a mutually agreeable resolution and, if they cannot, parties generally find that the process has been helpful in helping them clarify the areas in which they are not in agreement.

Limited Scope Representation

In this process, the attorney will provide a limited amount of services to the client in his/her family law case. For instance, an attorney may be available to consult with the client in their office, but will not appear in court on their behalf. Conversely, an attorney may be available for court appearances only, yet not be responsible for filing and drafting any written legal documents. Since it is not required for clients to have an attorney to proceed with their family law matter, this process allows clients to have more control over their case and to minimize the amount of money that they spend on legal fees. The attorney and client contract with each other regarding which portions of the case will be handled by the attorney and which portions will be handled by the client.

 

Sandro R. Tuzzo, Esq. is the author of this post and may be contacted at stuzzo@lpslaw.com Mr. Tuzzo counsels individual clients in family law matters and is also an Adjunct Professor at Hastings College of the Law where he teaches Negotiation and Settlement.

VIOLATION OF OPEN-SOURCE LICENSE CONSTITUTES COPYRIGHT INFRINGEMENT

 

On August 13, 2008, the U.S. Court of Appeals ruled that a violation of an open-source license constitutes copyright infringement, rather than a breach of contract.

Open-source software typically includes a license requiring the user to agree that the software could be used and modified by the user free of charge, so long as the user complied with certain restrictions, typically requiring, among other things, that the user describe any such modifications and make the modified version freely available.

In Jacobsen v. Katzer, the Court held that a violation of the license agreement would constitute a breach of the copyright ownership of the author of the source code.  This may make enforcement of such violations easier.

Practice pointer:  If one uses open-source software, be certain to review and comply with all of the provisions set out in the supporting documents, including the license agreement.  This will help you both avoid any claim of violation of the open-source software and make accurate and correct representations and warranties as to your compliance should you be required to do so if your business is sold, or under other circumstances.

 

Neil Taxy, Esq. is the author of this post and may be contacted at ntaxy@lpslaw.com 

Mr.Taxy counsels a variety of business clients in copyright and intellectual property matters.

DFI PUBLISHES QUARTERLY DATA ON CALIFORNIA COMMERCIAL BANKS

The California Department of Financial Institutions has just issued its Quarterly Report. The Quarterly Report presents summary statistics for DFI licensees, which include banks, credit unions, offices of foreign banks and trust companies with a one-year comparison.  According to DFI, the situation for commercial banks based on  the latest data available is as follows:

For the one-year period ending June 30, 2008, the number of state-chartered banks increased by 5.4% to 216 at the quarter end, compared to 205 a year previous.  Assets were up from $214.6 billion to $230.5 billion, an increase of $15.9 billion, or 7.4% over the same period, while loans were up 10.4%, from $152.0 billion to $167.8 billion.  Total equity capital decreased $1.0 billion, from $27.9 billion to $26.9 billion at the end of the quarter, causing the equity capital to total asset ratio to decline from 13.00% to 11.69%.  Deposit growth did not keep pace with loans, increasing 4.3% to $158.7 billion, which caused the loan to deposit ratio to increase to 105.73% from 99.89% at the close of the Second Quarter 2007.
 
For the first half of 2008 state-chartered banks reported $406.7 million in losses, off $1.7 billion or 130.9% from the $1.3 billion in net income reported at the close of the Second Quarter 2007.  This was due in part to the increase in loan loss provisions, from $163.1 million to $1.2 billion, an increase of 619.6%.

The net interest margin was down from 3.62% to 3.38%.  Loan loss reserves were up 68.0% from $309 million at midyear 2007 to $519 million at the close of the current quarter; however, noncurrent loans more than doubled going from $853.8 million to $3.3 billion, which caused reserve coverage of noncurrent loans to decrease from 205.53% to 75.60%.  Other real estate owned also more than doubled, going from $43.1 million to $255.3 million. 

Additional information is available on the DFI website under the Financial Statistics page and the financial data published by the Federal Reserve Bank, Federal Deposit Insurance Corporation and National Credit Union Administration.  

 

Nina P. Kwan, Esq. is the author of this post and may be contacted at nkwan@lpslaw.com Ms. Kwan counsels business clients and financial institutions on corporate and regulatory matters.

A BRIEF PRIMER ON THE WAIVER OF SUBROGATION

             The right of subrogation is the right to pursue someone else's claim as if it were your own.  For example, if a landlord's building burns down due to the negligence of a tenant, without a waiver of the right of subrogation, the insurance company could pay the landlord for the value of the building, and then sue the tenant to recover the amount it paid to the landlord.  The insurance company is subrogated to the landlord's claim, meaning it may pursue the landlord's claim against the tenant. The tenant is not protected by the landlord's insurance policy and the tenant's own insurance may be inadequate to cover the loss to the building. The tenant will end up having to pay the insurance company out of pocket for the loss. 

 

             This scenario could also arise with the landlord at fault and the tenant as the injured party. For example, a landlord's negligence which starts a fire in the common area could result in the destruction of a tenant's expensive computer equipment.  The landlord would have the same problem of having to pay the tenant's insurance company for the loss if there is no waiver of subrogation.

 

             However, leases frequently contain a waiver of subrogation provision, which limits this right to pursue someone else's claim.  A typical waiver of subrogation provides that if either the landlord or tenant suffers loss or damage which is caused by the other, but which is covered by the injured party's insurance,

 

                          1) the injured party waives any claim it might have against the other to the extent that it is compensated by an insurer, and

                          2) each party agrees to obtain from its insurer a provision acknowledging this waiver and agreeing that the insurance carrier will not be subrogated to the rights of the injured party to the extent that these rights have been waived.

 

             Thus, the waiver actually deals with the subrogation claim and also the basic liability between the parties. 

 

             For example:

 

"8.6 Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby."  (from AIREA Lease form)

 

             In the example above, a waiver of subrogation provision would mean the insurance company would not be able to subrogate to the landlord's claim and sue the tenant.  Likewise, the injured landlord would not be able to sue the tenant to recover damages for a loss that is insured by the landlord's insurance company. 

 

             The waiver is in effect so long as it does not violate any of the terms of the insurance policy. If the policy does not permit a waiver and a waiver is included in the lease, the policyholder may be in danger of losing its insurance coverage.

 

Neil Taxy, Esq. is the author of this post and may be contacted at ntaxy@lpslaw.com Mr. Taxy counsels a variety of business clients in real estate transactions, commercial and residential.

CALIFORNIA PROHIBITS GRADUATED FILING FEES IN PROBATE ADMINISTRATION

Prior to March, 2008, the California courts imposed a graduated filing fee for petitions to administer decedents' estates.  For the smallest estates (under $250,000), the filing fee was $320.  For the larger estates (over $3.5 million), the filing fee was $3,635 plus 0.2 percent of the amount over $3.5 million.

In March, 2008, this system of graduated filing fees was declared unconstitutional.  Estate of Claeyssens (2008) 161 Cal. App. 4th 465.  The court found that the graduated filing fees amounted to an estate tax, which impermissibly amended the California initiative prohibiting estate taxes. 

Since the issuance of this case, as a practical matter, courts have generally stopped imposing the graduated filing fees.  There are bills winding their way through the California legislature that will likely set the filing fees at a flat $330 or $355. 

 

 

Molly F. Jacobson, Esq. is the author of this post and may be contacted at mjacobson@lpslaw.com Ms. Jacobson counsels individuals and business clients in estate planning and small business matters.

VENTURE FUND ORGANIZATIONAL ISSUES FOR NON-U.S. PERSONS: A BRIEF CHECKLIST

Below is a brief, general overview of certain basic venture fund organizational issues, and related tax planning issues applicable to foreign investors:

 

Organization

A typical venture fund (“Fund”) is organized as a limited partnership (“LP”). Most LPs are established under the laws of the State of Delaware due to (1) the comprehensive nature of Delaware corporate law, and (2) the history and predictability of such jurisdiction.  A Fund is ordinarily sponsored through the efforts of one or more key individuals (the “Principals”). The Principals ordinarily organize and own an entity, often a limited liability company, to serve as the general partner of the Fund (the “General Partner”). The General Partner can also function as the manager or investment adviser of the Fund (the “Manager”). Alternatively, the Principals can organize another “sister” limited liability company for this purpose. Investors subscribe for interests in and become limited partners of the Fund (“Limited Partners”).

Funding

Under the terms of the Fund’s partnership agreement (the “Partnership Agreement”), the General Partner and the Investors would each have commitments (“Commitments”) to make capital contributions (“Capital Contributions”) in specified maximum amounts to the Fund. Typically, the General Partner is expected to make a Commitment of at least 1% of the total Capital Contributions, and the Limited Partners agree to provide the remaining 99%. This traditional allocation is derived from prior legal requirements, but today it usually varies between 1% and 5%. Capital Contributions are used by the Fund, under the exclusive control of the General Partner, to pay Fund expenses (“Fund Expenses”) and make investments (“Portfolio Investments”) in a manner consistent with the investment strategy or guidelines established for the fund (the “Investment Guidelines”).

The common practice is to schedule an initial closing of the sale of interests in the Fund once a specified minimum level of Capital Commitments has been achieved. The Fund then retains the ability to add investors in one or more subsequent closings.  In most cases, the period ranges from three to twelve months. Later investors are then required to retroactively contribute pro rata to the expenses of the Funds.

Management

The Manager is responsible under the terms of the Partnership Agreement (or, under the terms of an investment advisory or management agreement, as applicable) for identifying and evaluating prospective Portfolio Investments, monitoring Portfolio Investments on behalf of the Fund, and recommending sales or other exit strategies (“Exits”).

In return for these services, the Manager is paid an annual management fee (“Management Fee”). The Management Fee is expected to cover salaries of the Principals and other operating costs (collectively, “Management Expenses”). A typical annual Management Fee ranges between 1.5% and 3.0% of the size of the Fund. A smaller Fund tends to charge a higher Management Fee and vice-versa a larger Fund.  Most venture funds begin operating with a Management Fee based on the total value of the Commitments, and then transition to a formula combining Commitments and Contributions.

Profits by the Fund are generally divided according to a formula that provides the General Partner with a share (typically 20%) of the profits (the “Carried Interest”) attributable to the investors’ Capital Contributions.  The timing of the distribution of the Carried Interest, as well as the order in which it is paid first, can vary. For example, the Carried Interest may apply to incremental profits in excess of a base rate of return (i.e. 8%) (“Hurdle Rate”). Or in case where early investments generate profits and later investments do not, payment of the Carried Interest to the General Partner can be subject to an obligation to restore some of those profits to investors (“Clawback”).

Tax issues for offshore investors

Normally, a foreign Limited Partner is not subject to U.S. federal income tax, so long as the Fund operates in such a way that it is not deemed to be “engaged in a trade or business in the United States” and its income is “not effectively connected with the United States.”^[1]

A Fund is typically not deemed to be “engaged in a trade or business in the United States” solely as a result of acquiring or disposing of investment and the ancillary activities associated with that. However, as a precaution with foreign Limited Partners, it is very important for the Partnership Agreement to either (1) prohibit the Fund to invest in activities that would make the Fund be deemed to be “engaged in a trade or business in the United States” (i.e. investments in operating companies classified as partnerships), or (2) permit the foreign Limited Partners to organize an alternative investment vehicle.

Likewise, so long as the Fund invests in stock and does not invest in activities associated with real estate or real property holding corporations, the income would normally be “not effectively connected with the United States”^[2]. An important point in this respect is that income from advisory activities (i.e. advisory services to Portfolio Companies) would, however, be deemed to be “effectively connected”. As such, to reduce the risk of U.S. tax exposure to the foreign Limited Partners, the Fund ought to be structured in such a way that either (1) prohibits the provision and remuneration of advisory services, or (2) has the Manager, and not the Fund, earn those advisory fees, possibly crediting them back against Management Fees, as permitted by law.

One exception to the general exclusion from U.S. federal income tax for foreign Limited Partners is for dividend and interest income received by the Fund. Tax on this type of income would be withheld in the U.S. on account of the foreign Limited Partners.

Finally, it is important to note that regulatory concerns and tax planning for investors outside the United States, in their jurisdictions, could also affect the basic structure outlined above and, if necessary for the investors, lead to the creation of multiple entity fund structure, grouping investors into “feeder” entities, each created in accordance with the tax preferences of the investors. These entities can be other limited partnerships, tax-haven corporations, offshore business trusts or other entities.

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Specific tax and organizational planning, including an analysis of the applicable securities law offering exemptions, will be possible once the target fund size, number and jurisdiction of the investors have been defined.

 

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.com Mr.Daste counsels a variety of technology startups and entrepreneurs in capital raising and operational matters.

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[1] See Treas. Reg. Section 1.864-2(c)(2)(ii). Scottish American Investments Co. v. Commissioner 12 T.C. 49 (1949).

[2] See I.R.C. Section 897

BREVI NOTE IN MATERIA COSTITUTIVA PER UN VENTURE FUND AMERICANO

• Un venture fund e' tipicamente costituito come una "limited partnership" in Delaware. Cio' e' dovuto al fatto che le normative del Delaware non solo permettono questo tipo di veicolo, ma anche garantiscono un livello di trasparenza e affidabilita' di prim'ordine.

• Il venture fund viene gestito da una "managing company", solitamente costituita come "limited liability company" (in Delaware o California) e controllata dagli organizzatori del fondo.

• La managing company funge da "general partner", mentre gli investitori diventano "limited partners" nel fondo. La principale differenza tra le due categorie di partners e' che il general partner svolge un ruolo attivo di management. E' fondamentale preservare questa divisione, in quanto grazie alla struttura di limited partnership, i profitti realizzati dal fondo vengono assegnati direttamente agli investitori, senza dover "passare" attraverso il fondo come entita' legale separata e, quindi, venire tassati in entrata.

• La raccolta di capitali per il fondo avviene generalmente in due fasi: nella prima fase, il fondo raccoglie "commitments" dagli investitori; nella seconda fase si passa alla raccolta di fondi diretta. Questa seconda fase a sua volta puo' avvenire in due tempi: il fondo fissa una data iniziale per la raccolta di un certo numero di commitments, dopodiche' stabilisce un periodo (variabile, dai 3 ai 12 mesi) durante il quale altri investitori hanno la possibilita' di partecipare.

• La raccolta, essendo svolta da un'entita' del Delaware operante in California, e' soggetta alle normative federali e statali americane riguardanti appunto l'emissione quote di partecipazione da parte del fondo. La raccolta in un venture fund solitamente avviene nell'ambito di queste normative, sfruttando regole che permettono la raccolta di capitali senza bisogno di prospetto o di approvazione formale da parte degli organi regolatori americani.

• La tipica struttura di un venture fund costituito in Delaware e concentrato in investimenti in startup companies permette la partecipazione da parte di investitori stranieri, individualmente, e senza che essi debbano essere soggetti al fisco americano nel caso di distribuzione dei profitti.

• L'investitore straniero resta ovviamente soggetto alle normative fiscali in vigore nella sua giurisdizione per quanto riguarda la propria quota di profitti/capital gain.

 

Matteo G. Daste, Esq. is the author of this post and may be contacted at mdaste@lpslaw.comMr.Daste counsels a variety of technology startups and entrepreneurs in capital raising and operational matters.