Texas asset protection lawyers hear such questions as “What documents should be included or created when forming a new LLC?” or “Why is it necessary to do anything more than file a bare minimum Certificate of Formation?”
Clients asking such questions are usually motivated by a desire to keep things both simple and inexpensive. They suspect that lawyers want to over-complicate projects with lengthy documents in order to collect higher fees. After all, in Merry Old England (from whence much of our law is derived), lawyers were actually paid by the word–this is true–and solicitors of the day were rewarded for creating long documents full of obscure verbiage.
Properly documenting an LLC has nothing to do with this dubious history. First, there are organizational, management, and accounting issues to be dealt with. Secondly, when involved in litigation relating to an LLC, one of the first things a plaintiff’s attorney will demand to see is the company book with all relevant documentation. If this documentation does not exist, or is inadequate, the plaintiff may seek to pierce the company’s liability barrier. This occurs with exasperating regularity in spite of Texas’ actual fraud rule.
It is not just the quantity of LLC documentation that matters but its quality and sophistication. LLC documents should contain asset protection clauses and provisions from the very beginning of the formation process. Formation documents can be several pages long and include reference to such matters as series specifications, notice of restrictions on sale or transfer or membership interests, and division of membership interests into Class A and Class B. Since the Certificate of Formation is a filed document and public record, creditors are put on notice from the outset that this particular company is the real thing. LLC documents should include:
(1) the Certificate of Formation (“COF”);
(2) a comprehensive company agreement;
(3) the minutes of the first meeting of members (organizational meeting);
(4) signed and issued membership certificate(s);
(5) signed consent by the registered agent; and
(6) warranty deeds and bills of sale conveying assets into the LLC or its individual series.
All of the foregoing documents should be organized and kept in a company book with labeled tabs. The company seal should also be kept with the company book. Although the seal has no true legal effect in Texas, it adds ceremonial and decorative value to official company documents and be should applied to membership certificates in the space provided.
The Certificate of Formation
The COF supplies the essential information required by the Business Organizations Code and Secretary of State in order to establish a traditional or series LLC. It may also contain such additional information concerning the business and operations of the company as the initial members may wish to make public. For confidentiality and anonymity reasons, however, the COF should include no more information than is prudent or advisable to maximize asset protection.
Every company must have a registered agent. This person’s name and physical address (not a post office box) must be specified in the COF. The COF must also disclose the name and address of the company’s initial manager. Note that the manager’s address may be a post office box. In fact, we recommend a post office box or office address rather than disclosing one’s home address. The third name is that of the organizer, often an attorney who (like any other organizer) must be an authorized representative of the company.
If the company is to be a series LLC then the Business Organizations Code requires that the COF contain a “notice of limitation on series liability.” It is recommended that the COF go into considerable detail on this, clearly stating that each series is independent and is not responsible for the debts and liabilities of other series or the company at large.
The Company Agreement
The company agreement governs internal operations. It should be designed to maximize asset protection and will be one of the first documents produced in discovery if the company is sued, since it is not recorded with the Secretary of State or anywhere else. The plaintiff will want to see, first, if one exists and second, if it contains any provisions that may be an impediment to recovery.
The company agreement should not be confused with the organizational meeting of members. Although the content of these two documents may occasionally overlap, they are conceptually different and are designed to address separate items and issues.
Company agreements are fairly lengthy and should be customized to fit the circumstances. However, all company agreements contain certain key provisions including but not limited to:
Series LLC provisions. Designation of the company as a series LLC and a description of series characteristics, operations, membership, and management.
Voting of percentage interests. A quorum should be defined. Most decisions should made by majority vote, but major decisions may require either a supermajority or unanimous vote.
Two classes of membership. These are Class A (“regular” members) and Class B members who are defined to be any persons who gain membership or influence by means of a court judgment, execution upon a judgment, assignment of a membership interest in satisfaction of a debt, charging order, or contested divorce. Class B members have very few rights in the company–basically the right to receive notices and be present at meetings. They cannot vote. This structure assures that members do not wind up in a disastrous partnership with other members’ creditors or ex-spouses, since these persons are usually seeking to dissolve the company or sell off its assets for cash.
Restrictions on sale or transfer of membership interests. Language to the following effect should be included: “No Member may assign, convey, sell, encumber or in any way alienate all or any part of that Member’s Membership Interest without the prior written unanimous consent of all the other Members, which consent may be given or withheld, conditioned or delayed, as the remaining Members may determine in their sole discretion, without any requirement that such consent not be unreasonably withheld.” Including a provision of this kind is critical to the successful operation of a small company. Basically, each member has a right of first refusal to purchase the interest of every other member. If there are multiple members, then the membership interest to be sold will be divided pro rata among members choosing to exercise this right.
Dispute resolution. The members should agree to mediate unresolved disputes prior to resorting to litigation or the filing of a complaint with any government agency.
The First Meeting of Members
The organizational meeting should address a whole array of items pertaining to the company’s start-up. Important elements include:
Persons present. The initial paragraphs of the minutes recite the date and location of the meeting as well as persons present. The attorney who drafted the company’s formation documents is often listed as present and being the one who prepares the minutes.
COF. The members approve the details of the COF and the various expenses incurred in forming the company.
Company purpose. A general purpose statement is preferred, e.g., “any and all lawful purposes for which a limited liability company may be organized under the Texas Business Organizations Code.” The minutes may go on to state that the company will focus its attention upon a particular business such as investing in real property.
Initial members and percentages. The initial members, their respective initial contributions (whether in the form of capital or services rendered), and their respective percentage interests in the company should be specified.
Approval of company agreement. The company agreement should be reviewed and approved.
Election of managing members. A managing member or comanaging members are designated with the operational authority to manage day-to-day operations.
Official seal. The company seal should be affixed and approved.
Membership certificates. The form and issuance of membership certificates should be approved.
Organizational expenses. Expenses incurred incident to forming and establishing the LLC should be approved and ratified. Reimbursement for company organizational expenses should be approved.
Appointment of registered agent. The registered agent and registered address should be recited and approved.
Assumed names. These are often recited and approved.
Series LLC provisions. Provisions establishing the company as a series LLC are included, along with approval of conveyance of assets into individual series.
Banking and bookkeeping. This section should approve obtaining an EIN, opening an operating account, and check-writing authority.
Conclusion. The concluding paragraphs of the minutes should resolve that the company may commence business, state that members waive notice of the meeting, and approve the minutes. All members sign.
Annual and Special Meetings
For company maintenance purposes, the company should have at least one formal meeting per year–”formal” in the sense that it is reduced to writing and included in the company record book. The basic elements of the annual meeting are review and ratification of the preceding year’s actions by the company, its managing members, and officers; specific approval of any major decisions; recognition of any unusual events or circumstances not in the company’s ordinary course of business; and election of new managers and officers who will serve in the forthcoming year.
It is also advisable to hold special meetings to approve any major decision, approve the purchase or sale of real property, approve a loan to the company, or accept new members. Special meetings addressing such issues may be held anytime.
LLC documents contain common elements that should be addressed in the case of every new company. However, enterprises vary. Their purposes and members are different. The formation and organizational documents should be carefully drafted to reflect these differences. They should also provide tough protection from creditors and plaintiffs who may seek to pierce the veil and hold individual members liable for debts and actions of the company. Ongoing annual and special meetings should be held to preserve to maintain records and the independent legal character of the company. All relevant documents should be organized and contained in the company record book.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes and any statutes or cases referred to should be checked for updates. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and agrees in writing to do so.
Copyright © 2013 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.