Posts in: January

When Do I Need To Register My Business in Another State?

January 19, 2016 Asset Protection, Business planning, Law, Small Business Comments Off on When Do I Need To Register My Business in Another State?

January is a time when most of us take the opportunity to reflect on the status of our lives. Many of us are setting goals and searching for ways to improve ourselves and our situations going forward into the New Year. For many business owners, this process focuses on ways to grow their businesses. Often times, this can include expanding operations beyond the borders of our home state.

If you are thinking about operating in multiple states (or already conduct activities across state lines), you may be asking yourself: “Do I need to register my business entity (LLC, corporation, etc.) in another state?” Registering, or “qualifying to do business” outside of your company’s home state is the process of filing the proper documents in another state to be granted the privilege of doing business there. Typically, this involves submitting paperwork to the other state’s Secretary of State’s office, paying an initial filing fee (and then usually an annual renewal fee), and designating a registered agent for the service of process with a physical location (not just a PO Box) in that state.

The answer to whether or not you need to register your business in another state is very fact-specific, and is a bit more complicated than it may seem. To make matters worse, even when the facts are exactly the same, the answer can vary from state to state. Here are some examples of activities that will typically require you to register your business in another state:

  • Having employees in another state. This makes sense because there are all kinds of state laws that apply to employing other people in your business (i.e. worker’s compensation, unemployment insurance, minimum wage and overtime requirements, and income tax withholding).
  • Maintaining an Office in another state. Holding regular hours and renting an office for regular visits will certainly require you to register and you’ll want the protection as well.
  • Owning or renting real estate in another state. These activities give you a “physical presence” in the other state, and also increase your chances of being subject to a lawsuit there. This is especially important in the context of owning rental properties, which is why we always suggest that a business entity that owns rental real estate either be established in the state where the rental is located or at least be registered to do business in that state.

The following are examples of activities conducted in another state that typically don’t require you to register your business there:

  1. Online, mail order and telephone sales. This is especially true when these are the only activities a business conducts within that particular state.
  2. Sales conducted through independent contractors. However, this one is tricky. If you control the activities of your independent contractors to the point that they should actually be considered employees, then your activities would generally require you to register in the other state. Whether a worker should be classified an independent contractor or an employee is a complex subject for another article and another day.
  3. Holding a meeting of the owners or management. Go ahead and hold your company’s annual meetings in Hawaii or Florida, or maybe near Disneyland in California. You don’t need to worry about registering your business there if you do.
  4. Maintaining a bank account.
  5. Collecting debts.
  6. Appearing in court, or at a mediation or arbitration.

The obvious question then becomes: “What are the consequences if I should have registered my business in another state and I fail to do so?” The answer varies from state to state, but the good news is that in most (but not all) states, the business owners will not have personal liability if the company is sued in the state where you failed to register. That being said, there can be some fairly harsh outcomes if you don’t register foreign when it is required:

  1. Your company may not be recognized in courts as being able to sue or bring legal action. This can be a big deal when your business is the victim of a breached contract, negligence, or even fraud. Without properly registering your business, you may lose the right to sue.
  2. Penalties and late fees for failure to register. Often times these fees and penalties are calculated on a “per day” basis, as in your company will have to pay, perhaps, $20 for every day it was transacting business in a given state while failing to register there. These fees can add up into the hundreds (or even thousands) of dollars relatively quickly.
  3. The state where you should have filed becomes your company’s registered agent. This means that the state is authorized to receive legal notices on behalf of your company. The problem with this is that it means your business can be sued in a particular state without the Plaintiff being required to serve notice directly on your company. The lawsuit can begin if the Plaintiff delivers notice to the state instead. The state is supposed to try and contact you if your company is served in this way, but the steps each state takes to give this notice (not to mention the time periods involved in receiving any such notice) are inconsistent at best. With only 20-30 days to respond to a Complaint, allowing the state to be your registered agent can put your business in imminent danger of being subject to a default judgment in any litigation in that state.

Beyond these statutory issues, you may run into problems trying to deed properties into the name of an unregistered business entity, as well as insurance and banking issues until you register your business in the state where the income generating property, employee, or storefront is located. Because these issues can be complex and state-specific, it often makes sense to retain legal counsel to look into the law based on your specific facts and the state(s) you are dealing with. Please contact our office if you would like help determining if registering your business in another state makes sense for you.

Jarom Bergeson is an associate attorney with Kyler Kohler Ostermiller, and Sorensen, LLP (“KKOS Lawyers”) in its Cedar City, Utah office and has extensive experience in helping client register their trademark and protecting their brand identity. He can be reached at jarom@kkoslawyers.com or by phone at (888) 801-0010.

Do You Know When, Where, and Why to Form an LLC?

January 12, 2016 Asset Protection, Business planning, Small Business, Uncategorized Comments Off on Do You Know When, Where, and Why to Form an LLC?

One of the most common business entity types that is formed today is the limited liability company (LLC).  We have many clients who come to us because they are unsure how to form an LLC or they want to make sure it is formed correctly.  But often times, I hear people say that they know how to form an LLC (that’s easy right, just file a one pager with the state, right? – wrong, at least doing it the right way it is not that simple).  Often times, it is just as important to understand when, where, and why to form an LLC, not just how to form an LLC.

Compared to a corporation, a partnership (general or limited), or a sole proprietorship, an LLC is still a relatively new form of doing business.  Its popularity has grown quickly and is outpacing these other, older entity types.  Generally, the LLC has certain “bells and whistles” that the other entity types do not have, but it is very important to understand that each situation is unique, and the LLC may not be the most appropriate entity type for your situation.  It is also very important to understand that even if the LLC is the most appropriate entity type for your situation, you should understand the benefits, features, uses, and limitations of the LLC.  Moreover, the laws pertaining to LLC’s continue to change (see below*).  With that, here’s a brief overview of some of the features and limitations of the LLC and also a few situations (among many others) when an LLC makes sense:

LLC FEATURES AND LIMITATIONS:

  1. TAXES. For tax purposes, the LLC is like a chameleon – it can present itself to the IRS in different forms.  In some circumstances, it makes sense and is permissible to make a tax election to have your LLC taxed as an s-corporation.  Under limited circumstances, it can make sense and is permissible to make an election to have your LLC taxed as a c-corporation.  By default, an LLC that consists of one member is taxed as a sole proprietor and an LLC that consists of more than one member is taxed as a partnership.  As a general rule, an LLC in of itself does not open a door to previously closed opportunities to claim certain tax deductions – Any income tax deductions that are otherwise available to your business under the tax code are available whether or not your business is operated out of an LLC.  The LLC as an entity does not pay income taxes, but rather, any tax due is paid by the members of the LLC on their respective tax returns at their personal tax rates.  Contrast that with a c-corporation where income taxes are paid by the business AND its owners/shareholders.
  1. LIMIT PERSONAL LIABILITY FOR MEMBERS. For liability purposes, the LLC serves to protect the members from being personally liable for the debts and liabilities of the LLC – the only risk/liability for a member is if the business fails, they may lose the investment/contribution(s) made to the LLC.  However, an LLC cannot protect its members from a member’s personal guaranty on a loan, fraud, or negligent rendering of professional services.
  1. LIMIT MANAGEMENT’S LIABILITY. The LLC manager is also not liable for the debts and liabilities of the LLC so long as the manager acts within the scope of her duties as manager and does not commit fraud or sign a personal guaranty on a loan.  Contrast that with a limited partnership, in which the person managing the business, i.e., the general partner is exposed to the debts and liabilities of the business.
  1. PRIVACY. For privacy purposes, in certain states, the identifying information of the members of the LLC is kept from the public record.  For those who place a high priority for privacy, this can be a way to achieve that.
  1. RAISE CAPITAL. For purposes of raising capital, an LLC is an often-used business entity type because it allows for different levels of ownership with preferred returns, etc. for the various ways in which to structure deals for investors.    However, when it comes to selling ownership in an LLC, it is typically not as simple as selling stock in a corporation in terms of income tax reporting from the sale.  As with any asset, taxable gain, if any, is identified by determining the tax basis of the asset.  With corporate stock, the basis in the stock is typically the cost to acquire the stock.  However, when a member sells their ownership interest, the basis computation is not that simple and can consist of what is known as a blended basis (Rev. Ruling 84-53).  To that end, it should be noted that as a general rule, an LLC that is taxed as a partnership should be overseen by a competent tax professional because partnership tax is one of the most complex areas of the tax code.  It should also be noted that if you form an LLC with the intent to bring on investors, you should absolutely work with a competent attorney to put together a private offering or PPM under what is known as a “Reg D” exemption or find some other exemption under state and federal securities law.

SITUATIONS WHEN AN LLC TYPICALLY MAKES SENSE:

Situation 1: You want to limit your personal liability from your operational business.  You and your business partner have a business together and would like to limit your personal liability of the debts and liabilities of your business and of the debts and liabilities arising from your business partner’s actions.  This limitation of liability is sometimes referred to as “inside liability”.  This is a good reason to form an LLC, and one of the benefits of forming an LLC, as opposed to operating as a general partnership.  An LLC is typically a good entity  to “marry” a business partnership and thus the operating agreement can address similar items that would be found in a partnership agreement.

Situation 2: You want to limit your personal liability from an investment property.  You own an investment property and would like to limit your personal liability of the debts and liabilities associated with the investment property.  This is a good reason to form an LLC and one of the benefits of forming an LLC, as opposed to owning the property directly in your name.

Situation 3: Your business and its associated value are at risk of estate tax consequences upon your death.  The LLC can be a great estate planning tool in this way.  In this situation, the LLC has become a popular alternative to what is known as the Family Limited Partnership.  In effect, during your lifetime, you transfer ownership of your business to your loved ones (or to a trust for their benefit) yet you retain control and management of the business until your death.  This transfer of ownership of your business to your loved ones can happen gradually to take advantage of the annual exemption for gift tax reporting purposes.   Although the number of taxpayers who are subject to estate taxes is relatively low due to the relatively high federal estate tax exemption, there are a number of states whose estate tax exemption remains relatively low and there is always the concern that the federal estate tax exemption will be reduced in subsequent years.

Situation 4: You have a self-directed IRA and want to invest in real estate, etc. An LLC can be formed to be owned by your IRA.  Such an LLC is beneficial in this situation because of its convenience and ease of administering your self-directed IRA investments and also because of its limited liability protection.  Without an IRA LLC, an IRA that owns investment real estate directly on title puts the IRA and the other assets of the IRA owner at risk of liability that may arise from the investment property.  The IRA LLC can significantly reduce that risk of liability.  You should not attempt to form an IRA LLC on your own.

Situation 5: You own assets and you want to shield them from personal creditors.  This is sometimes referred to as “outside liability”.  This is a situation when the effectiveness of the LLC in this situation will greatly depend on your circumstances.  For example, each state’s laws vary when it comes to the remedies of a personal creditor to pursue the income and assets of an LLC that you own.  In some states, the only remedy a personal creditor can use to pursue the income and assets of an LLC that you own is to get what is called a Charging Order from the judge.  This means that the personal creditor has to sit and wait for the LLC to distribute income to you – if you never distribute income from the LLC to you – the personal creditor gets nothing from your LLC.  However, beware that if the personal creditor can successfully pierce the veil of the LLC, then all bets are off.  Even though this Charging Order protection limits you from receiving income from your LLC, this is much better than the alternatives.  In other states, a personal creditor can effectively “foreclose” on your LLC ownership.  Still, in other states, a personal creditor can dissolve the LLC entirely and liquidate the assets of the LLC.  All of this is very state specific so it will be a matter of sitting with a competent attorney to discuss your situation.

*Note about Situation 5:  A lot of “cat and mouse” games are played in this arena of asset protection and this is an area of the law that continues to develop.  Either through statutory revision or case law, some states have decided that the available remedies to a personal creditor should depend on whether the LLC owner is owned solely by the judgment debtor or whether there are other owners/members in the LLC.  Moreover, even if there are other owners/members, if all of them are judgment debtors to the creditor, that fact can affect the outcome.  (United States v. Zabka, 900 F. Supp.2d 864 (C.D. Ill. 2012)). For example, listing your spouse with you as an attempt to “beef-up” the asset protection may not help you if your spouse is named in the judgment with you.  Also, the saying “substance over form” is relevant here.  Simply listing someone else as a member of your LLC, even if they aren’t named in the judgment with you,  may not be as fool-proof as you might hope – for example, if in the proceedings, it is shown that this other member was simply a “straw man” and not an “actual” member who made contributions, received profits, etc.  Moreover, there may be a question of which law applies.  A recent case in Florida presented a situation where the defendant had setup an offshore LLC with the expectation to protect some of her assets from a personal creditor (Wells Fargo Bank v. Barber, 2015 WL 470589 (M.D. FL 2015)).  In the case, she argued that the laws of the offshore jurisdiction, which would severely limit the remedies of the creditors, should govern, and not the laws of her domicile state.  The court decided that the laws of her state of domicile should decide what remedies are available to the creditor and not the laws of the offshore jurisdiction because it was held that ownership of an LLC is intangible personal property.  This result allowed the creditor to foreclose on the LLC.   That being said, one of the expectations of asset protection strategies is that if “push comes to shove”, it will hold up in court.  But as has been pointed out many times in this area of asset protection, although a strategy may not be fool-proof if an actual court-proceeding is under way, these methods can sometimes be effective in their objective to deter a court-proceeding from commencing in the first place.   In other words, even if setting up an entity simply to protect your assets from personal creditors is not 100% fool proof, it may nevertheless be an effective deterrent to personal creditors.

In sum, the LLC, despite its widespread use and simplicity in some respects, can be quite nuanced and even the experienced client can encounter unintended consequences with setting up and administering an LLC AND may not be aware of all of its benefits and uses.   Therefore, it is important to sit down with legal counsel to discuss your situation, and help you understand the benefits, uses, and limitations of the LLC.  Even though an LLC can be formed on your own or with the help of a website, it may end up costing you much more in the end than the dollars you saved in setting it up yourself at the beginning.

(FYI, if you avoid working with attorneys like you avoid the plague and you are tempted to use a website to form your LLC, we have a service called the paralegal setup that has fees which are comparable to the fees you might pay to a website to form your LLC.  Even then, 30-60 minutes with an attorney prior to the paralegal setup can be very helpful as the paralegals would not be able to give legal advice and the attorney can understand your situation and advise on the basic questions of what, where, why, etc. related to your LLC or other business entity.)

Please contact our office to setup a consultation to discuss your situation and any or all of the items mentioned herein.

Kevin Kennedy is an associate attorney with Kyler Kohler Ostermiller, and Sorensen, LLP (“KKOS Lawyers”) in its Phoenix, Arizona office and has extensive experience in helping client register their trademark and protecting their brand identity. He can be reached at kevin@kkoslawyers.com or by phone at (888) 801-0010.

Private Money Lending: Is My Loan Secure?

January 5, 2016 Law Comments Off on Private Money Lending: Is My Loan Secure?

Private lending (commonly referred to as “Hard Money” in the Industry) is often touted as a safe vehicle for individuals who are new to real estate investing for learning the basics of evaluating a deal, or by experienced investors seeking to generate passive income through a balanced portfolio of loans.  We are often called upon to advise investors on evaluating their hard money loans, which is critical since most are using their hard earned savings or retirement, and so you want to make sure you are doing everything you can to make sure you are adequately protected.  As a private lender, important details to ensure the security of your investment include the following:

  1. Make Sure Your Loan is Secured by the Property – For most real estate investors, this is common sense, but our office consistently receives calls from private lenders asking us about options when the borrower fails to pay, only to find out that, because they failed to secure their investment by the real estate, their only recourse is to sue their borrower and hope their borrower has assets to pursue.   In most cases, the borrower (especially if it is an entity) does not have assets to pursue,  and so the Lender in such situation has no other choice but to completely write off the loss.  Making sure that your loan is secured by a mortgage or deed of trust on the property is absolutely critical to protecting your investment, but just having the lien is not enough.  You must also understand whether you are in a judicial or non-judicial foreclosure state, and what the foreclosure process in that state entails since the timing and expense of foreclosures can vary greatly depending on the state.  Moreover, you must make sure the transaction documents (usually a note and mortgage/deed of trust) are properly drafted to fully protect your interest.   For example, do the transaction documents and does the title company involved confirm the priority of your interest (i.e. that you are the senior lienholder, 2nd position junior lienholder, etc.)?  Do the transaction documents confirm that you will be protected in the event of certain adverse events (e.g. that are you covered by hazard insurance, title insurance, etc.).  Not all legal documents are created equal so make sure your legal documents adequately protect your interests.
  1. Perform Due Diligence on the Property as if you are the Buyer – We often say if you are going to be the bank, “act like a bank.” As a private lender, when you are deciding the scope of your due diligence, you should be thinking to yourself “What would a bank do in this situation?”  While the type of due diligence that is appropriate for any particular deal will vary depending on the deal, we always advise clients to evaluate a deal as if you were going to be owner of the property because, if anything goes wrong, you could very well become the owner of the property.  That means performing adequate due diligence on issues such as title, the value of the property, the solvency and qualifications of the buyer, the likelihood that the deal (whether it is a fix & flip or a buy and hold) will be successful,    Don’t rely on the bare assurances of your borrower that the deal will be profitable, but do your own independent due diligence as to the details of the investment.
  1. Consider Personal Guaranties – Most institutional lenders such as banks will not lend on residential real estate without qualifying the creditworthiness of the individual borrower and will not lend to entities such as corporations or LLCs. Obviously corporations and LLCs can and often do go defunct, and unless you have reserved your right to seek recourse from other “creditworthy individuals” through personal guarantees, you may be left with the only option of suing a defunct entity that has no assets which, in most cases, is just throwing “good money after bad.”
  1. You Call the Shots – Anyone who has ever tried to get a mortgage (especially recently) will know all of the various requirements lenders impose as a condition to approving your loan.  As the one with usually the most “skin in the game,” there is no reason why, as a private lender, you should not also demand that your borrowers meet your own stringent requirements to approve the loan.   This is not the time to be “shy” or make decisions based on emotions.  Remember hard money lenders are in high demand in real estate investment circles and we always remind our clients who are contemplating deals that there will always be another deal.   Don’t risk your hard earned savings or retirement on a deal that you have not received sufficient information, or on a borrower who is balking at providing full transparency about the deal.

There will certainly be more details than what could be covered in this article on how to evaluate your specific deal.  The attorneys at KKOS Lawyers are here to assist you in answering your questions about your private money deal.