The High-touch Legal Services® Blog • For Startup/Early-stage Companies

I recently had a Q-and-A dialogue on Avvo with an LLC member-manager who had a falling out with the other (50%) member and wanted to know whether he could form a separate business that would compete with the existing LLC. An edited version of our exchange appears below.

Q. I have an LLC with a partner. We each own 50% of the business (its an e-commerce store) and we’re member-managers. I’d like to buy him out, but his price is higher than I’m willing to pay. I have been pondering starting another e-commerce store selling kind of the same thing. Question is a) Would an e-commerce business out there competing for new customers constitute a breach of fiduciary duty? b) Would it be possible to rescind title as manager in the LLC which would eliminate that non compete fiduciary duty of a manager?

A. According to CEB’s Selecting and Forming Business Entities, 2d ed., Section 11.19:

• As a member-manager, you have a fiduciary obligation to the LLC and the other member that, among other things, precludes having an adverse interest (which is what the competing store would be).
• Assuming that you can resign as manager while retaining your membership (one would need to look at the Articles of Organization and the Operating Agreement to determine whether and how this is possible), CA law would not impose a fiduciary duty on you, but courts have held in analogous situations (limited partners in partnerships) that a fiduciary obligation can exist under certain circumstances (such as access to confidential information).

In summary, I see no way you can compete with the LLC with complete safety. If you cannot agree upon a buyout amount, dissolution might be the best way to proceed – please see the post at the link below.

Q. Our op. agreement is a tiny legalzoom thing, so why wouldn’t I be able to resign as manager?

A. My concern is that the Articles of Organization (apparently) state that the LLC is managed by all of the members. While I know of no statutory or case authority on this point, it may be that the only way for you to resign properly would be to amend the Articles to specify that the LLC is managed by one manager (the other member).

Related posts:

• Can I form an LLC without a lawyer?
• How to Kill Your Company when that’s the Only Choice

Photo credit: Rafael Reverte via stock.xchng

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

Earlier this year, I wrote about how business founders who agree to split earnings from their venture can find that they have unintentionally created a general partnership (Beware the Unintended Partnership). The problem: Any partner can subject all of the partners to unlimited personal liability for partnership obligations!

This post provides an overview of how an unintended, or otherwise undesirable, California general partnership can be terminated.

Half or more of the partners can decide to wind up the business of the partnership and dissolve it (California Corporations Code Section 16801(1)).

At that point, the partnership will continue only for the purpose of winding up its business, and its existence will terminate once the winding up is completed (Corporations Code Section 16802(a)).

Because a general partnership is not required to register with the Secretary of State when the partnership is formed, there is no requirement to file any document with the Secretary of State at the time of dissolution. (This is in contrast to dissolving a corporation or limited liability company, for which filings are required – see How to Kill Your Company when that’s the Only Choice).

However, after dissolution, one of the partners may file a Statement of Dissolution to put third parties on notice that the partnership has been dissolved (Corporations Code Section 16805(a)).

Corporations Code Sections 16806 and 16807 specify partners’ respective responsibilities for paying partnership debts and rights to any remaining assets.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

Last month, I posted Your Business is Dead – Are You Liable for its Obligations?, which stated that, generally, once a business is dissolved, the owners will be personally liable for the business’s obligations only to the extent that the owners received distributions at the time of dissolution.

A significant exception to the foregoing rule, however, concerns company personnel who are responsible for making, but fail to make, withholding payments to the Internal Revenue Service.

26 U.S.C. Section 6672 says, in part, that “Any person required to collect, truthfully account for, and pay over any [income or FICA] tax who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall…be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.”

Note that this section applies to persons who are responsible for withholding amounts and paying them to the IRS. These persons might include, but are not necessarily limited to, business owners, officers, directors, and accounting or HR personnel.

Note, too, that their personal liability can extend to the total amount of withholdings that the IRS did not receive!

26 U.S.C. Section 7202 is a parallel criminal statute that establishes a maximum penalty of $10,000 and five years in prison.

Significance for entrepreneurs: If your business is in financial trouble, make sure that employee withholdings are forwarded to the IRS. Do not use those withholdings for other purposes such as meeting payroll or paying suppliers – you would be better off filing for bankruptcy protection.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

Last month, I wrote about how to terminate a company’s existence by dissolution (How to Kill Your Company when that’s the Only Choice).

Since then, people have asked me what their personal responsibility is under California law if the corporation or LLC had outstanding obligations at the time it was dissolved.

Assuming that you go through the dissolution process properly and that you do not have any “alter ego” problems, your personal liability generally will be limited to the amount of any distributions that you received at the time of dissolution.

This limitation is set forth in Corporations Code Section 2011 with respect to corporations and Section 17355 with respect to limited liability companies.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

Yesterday I wrote about ways that businesses with two equal owners can avoid management deadlocks (Resolving Small-business Disputes: The 50-50 Deadlock). Today I am writing about dissolution, i.e., termination of the company’s existence – the only reasonable outcome if a serious deadlock cannot be resolved.

The essence of the dissolution process for a California corporation is as follows:

• Fifty percent (or more) of the shares can vote to dissolve the corporation (Corporations Code Section 1900).
• The board of directors is responsible for winding up and settling the corporation’s affairs, and the corporation continues to exist solely for that purpose (Corporations Code Section 1903).
• Once the corporation’s affairs have been wound up and settled, the board files a certificate so stating and arranges to file a final franchise tax return, if that has not already happened (Corporations Code Section 1905).

The process is somewhat similar for dissolving a limited liability company (LLC), except that certain statutory requirements can be modified by the LLC’s articles of organization or operating agreement:

• A majority of the voting interest of the members can vote to dissolve the LLC (Corporations Code Section 17350).
• The managers or, if none, the members may wind up the LLC’s business (Corporations Code Section 17352), and the LLC continues to exist solely for that purpose (Section 17354).
• Once the LLC’s affairs have been wound up, the managers or members file a certificate to cancel the articles of organization and arranges to file a final franchise tax return, if that has not already happened (Corporations Code Section 17356).

Forms required for dissolution in California are available at the Secretary of State’s website. The only slightly good news in this situation is that there is no fee to file dissolution forms.

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Follow-up: For information about owners’ personal liability if the business has outstanding obligations at the time of dissolution, please see “Your Business is Dead – Are You Liable for its Obligations?“.

Photo credit: Simon Howden via freedigitalphotos.net

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.