Parents frequently transfer their ownership interests in a family-owned business to their children. This is usually done in connection with an owner’s estate planning or as part of an orderly succession of the business’ management. But what happens if an owner transfers his or her business interests in order to place the business assets or interests out of the reach of that owner’s creditors? In that case, the transfer may be avoided as a fraudulent transfer. Continue Reading Can Your Transfer of Family-Owned Business Stock or Assets be Avoided as a Fraudulent Transfer?
A judge in the Supreme Court for the State of New York recently allowed a petition for “common law dissolution” of a family-owned business filed by one shareholder to proceed despite the arguments of the other shareholders that the case should be dismissed. Yu v. Bong Yu, Docket No. 656611/2016, Supreme Court, New York County (August 15, 2018). Patrick Yu claimed that he was a shareholder of Moklam Enterprises, Inc. The remaining owners allegedly include his father, Bong Yu, his brother, Raymond Yu, and his sister, Catherine Yu. Moklam was an entity that funded the Yu family’s various real estate and business activities. While the remaining family members all had roles in Moklam’s business operations, Patrick, a lawyer, was employed only as counsel to Moklam and the other Yu family entities. Continue Reading Son’s Lawsuit to Dissolve Family Business Based Upon Relatives’ “Vendetta” Against Him Allowed To Proceed
On August 10, 2018, Massachusetts Governor Charlie Baker signed into law a piece of legislation entitled “An Act Relative to Economic Development in the Commonwealth.” This new legislation brings long-awaited non-compete reform to Massachusetts, and lays out some new guidelines for business owners to consider when determining whether or not to require employees to sign true non-compete agreements that would prohibit a departing employee from engaging in competitive activities. Continue Reading What Business Owners Should Know About Massachusetts’ New Non-Compete Law
Corporate shareholders often expect to receive dividends in connection with their ownership of corporate shares. This is particularly true when owners invest capital in or provide other services to the company in exchange for their ownership interests. But do shareholders’ rights to or expectations of dividends change when shares are acquired through gift or inheritance? This issue frequently arises in family-owned businesses where shares are transferred from one generation of owners, who may have built the business through their investment of capital and labor, to the next generation, who themselves may never have worked in, or invested in, the business.
In Jones v. McDonald Farms, Inc., a Court of Appeals in Nebraska recently was presented with a claim by Diane Jones against her two brothers, seeking a decree of judicial dissolution of the company based on the brothers’ alleged “corporate oppression” through their failure to pay dividends to Diane in proportion to her share ownership. Charles and Betty McDonald had incorporated McDonald Farms, Inc. in 1976. Their two sons, Donald and Randall, began farming with Charles in the mid-1970s and they became officers of the company in 1989, while continuing to perform all farming duties. From 1976 through 2010, Charles and Betty were majority shareholders and Donald and Randall were minority shareholders. In 2010, Betty died and her shares were devised equally to her four children, including Donald, Randall, Diane and another sister, Rosemary. In 2012, Charles gifted his stock equally to Donald and Randall. Charles died in 2014. As a result of these transfers, Donald and Randall each held 42.875% of the company’s stock, while Diane and Rosemary each owned 7.125% of the stock.
Family-owned businesses that are organized as limited liability companies typically reflect the terms of the company’s governance, along with the members’ financial rights and obligations, in a written operating agreement. The terms of the operating agreement often specifically include what, if any, payments a member is entitled to if he or she withdraws as a member of the LLC before the LLC dissolves. For example, the operating agreement may limit the right to payment of a withdrawing member to the return of any balance in his or her capital account. An operating agreement may even provide that a member is entitled to no payment whatsoever upon withdrawal. In any case, agreed-upon provisions concerning payments upon withdrawal will reflect the members’ expectations from the outset. Such provisions can also protect the LLC from having to make large and unplanned payments upon a member’s unilateral decision to withdraw at a point in time when the LLC may not have the funds to pay such a withdrawal distribution.
Family members often transfer family-business ownership interests or other assets between each other. Their discussions sometimes progress from informal negotiations to a written term sheet to a final written agreement. However, a term sheet itself can be found to be a binding agreement if the terms are sufficiently definite for a court to determine each party’s obligations and if the parties’ conduct evidences their agreement to perform according to those terms.
In Kunz v. Kunz, a Court of Appeals in Iowa recently ruled upon a claim by one family member against another to enforce a “Settlement Memorandum” which provided for the purchase and sale of stock in the family business, even though the Memorandum contemplated the drafting of later documents to finalize the transaction. In 1973, brothers Richard and Robert Kunz formed Happy Homes, Inc., a company that sold factory-built homes. Richard died in 2007 and his 50% interest in the company was transferred to his wife, Connie. Connie and Robert then began discussing the sale of Richard’s interests and later participated in mediation to aid in these discussions.
In a recent decision, the Massachusetts Supreme Judicial Court ruled that directors of a corporation owe a fiduciary duty to the corporation itself, and not to the stockholders of the corporation (as is the case in Delaware, among other states). In Int’l Brotherhood of Electrical Workers Loc. No. 129 Benefit Fund v. Tucci, SJC-12137 (Mass. Mar. 6, 2017), the Court ruled that the directors of EMC Corporation did not breach their fiduciary duties to the corporation when they approved the sale of EMC as a whole, versus selling off the constituent operations individually, which might have brought a higher price. The Court relied on the plain language of M.G.L ch. 156D, Section 8.30, which provides that a director shall discharge his duties “in a manner the director reasonably believes to be in the best interests of the corporation.”
All too often, family businesses are run in an “informal” fashion, with insufficient attention being paid to corporate formalities, including requirements set forth in a corporation’s bylaws. The Delaware Chancery Court recently ruled in Rainbow Mountain, Inc. vs. Begeman (March 23, 2017), that even in a family-owned business where all of the parties to a dispute are family members, the bylaws will control corporate actions.
In Rainbow Mountain, the defendant Terry Begeman was a member of the family that had founded the corporation. After a falling out among the family members, the group that held a controlling interest sought to remove Terry from the board of directors of the corporation, and in 2008 voted him off of the board of directors. Terry refused to accept this removal, and in 2014 the corporation filed an action for declaratory judgment seeking to confirm that Terry had been removed from the board.
Shares in family-owned businesses are often transferred between family members, whether through a sale or gift during a shareholder’s lifetime or through inheritance after an owner’s death. The parties to such a transfer should make sure it is properly documented to reflect the intention to transfer the shares. Typically, this is done through the transferor’s delivery of a signed share transfer instrument and the company’s issuance of a share certificate in the new holder’s name. In the absence of proper documentation, the transferee may not have a valid claim to the share ownership. Even worse, the company may find itself in the middle of an ownership dispute if the transferee has attempted to acquire the shares through fraud or deceit.
A United States Tax Court recently issued a decision after trial that should serve as a reminder to management and controlling shareholders of family-owned businesses that salaries or other compensation paid to family-member employees may only be deductible if the salaries are “reasonable.” In Transupport, Incorporated v. Commissioner of Internal Revenue, the Tax Court conducted a trial on the company, Transupport’s appeal of an IRS notice of deficiency. In the notice, the IRS had determined that amounts the company attempted to deduct for compensation to four sons of the company’s founder and president were not reasonable. The IRS also had disallowed the deductions to the extent of the unreasonable compensation and assessed a penalty based on a “substantial understatement of income tax.”