Formation – Business Law
The simplest business structure is the sole proprietorship. This type of business is typically a mom-and-pop operation. No forms are required to be filed with the state. The person running the business is the president, treasurer, and janitor. However, there is a downside to being a sole proprietor: the entity offers no personal liability protection and there is a limited amount of growth potential for the business.
A general partnership also requires no forms to be filed with the state. A partnership requires at least two people. In a general partnership, the partners have no protection from personal liability for the debts of the partnership. Courts have held that an innocent and unknowing partner can be liable for the other partner’s fraudulent activities.
General partnerships may also arise when owners let the formation documents of another business entity lapse, cause an ineffective or incomplete merger, or make other mistakes in the process. When this occurs, it results in a “de facto partnership,” which is a general partnership; though, neither partner intended for it to be one. Choosing an experienced business lawyer can help you avoid this pitfall.
Corporations were established years ago as a way for many individuals to unite in one body that would continue in succession engaging in commerce. Society was suspicious of corporations and required them to be chartered by the state. Laws also allowed owners to avoid personal liability for business debts.
Corporations are generally formal structures with boards of directors and officers. The owners of a corporation are called the stock holders. The owners may receive dividends based upon their shares of stock. Meetings are generally required to be held, where minutes must be recorded. In the past, failure to perform the formalistic and routine tasks could expose the owners to significant liabilities. Now there is a lesser chance of liability in Texas for failure to comply with the formalistic structure.
Limited Liability Companies
The limited liability company (“LLC”) is typically the most preferred entity for business owners, due to its flexibility. In regards to flexibility, an LLC may be run by members or by managers; it can be taxed like a partnership, corporation, or a sole proprietorship; it can have a board and directors like a corporation; it can issue certificates, like shares, or it can issue uncertificated membership interests, like partnership interests; and it can require managers or members to have certain fiduciary liabilities.
When forming an LLC, the operating agreement is a pivotal document to have tailored for your particular LLC. The operating agreement outlines duties, financial responsibilities, dispute resolution, membership transfer procedures, and more. We often handle business litigation disputes arising from either a lack of an operating agreement or an incomplete or form operating agreement or from membership interests and members’ rights.
Limited partnerships require that one person or entity be the general partner. The general partner is responsible for debts and obligations of the limited partnership. Limited partners invest money and are generally not liable for the debts and obligations of the limited partnership. However, if a limited partner begins to manage some aspect of the limited partnership business, the limited partner may become generally liable for the partnership’s debts.
Limited Liability Partnerships
A limited liability partnership (“LLP”) is similar to a partnership, but the status as an LLP means that the general partners are not personally liable for the debts of the partnership. To obtain this status, the LLP must file the proper documents with the Secretary of State.
Limited Liability Limited Partnerships
A limited liability limited partnership (“LLLP”) is a limited partnership wherein the general partners, who control the partnership, are not liable for the debts and obligations of the partnership. As with the LLP, a limited partner who begins to manage some aspect of the business would be liable as a general partner and lose their limited liability protection.
The Series LLC is a very new and largely untested entity structure in Texas. A series LLC allows for multiple series to be established under a master LLC, all of which may have separate rights and obligations. A series of the LLC is not considered a separate entity or organization.
Series LLCs have two primary benefits for business owners. They provide the ability to compartmentalize debts and liabilities among the series and provide an overall reduction in administrative costs. If one “series” fails, the remaining “series” are shielded from the liability. Additionally, only the master LLC is responsible for filing formation documents, annual reports, and other documents with the Secretary of State.
The Series LLC is often the preferred entity choice for real estate and oil and gas investors and oil and gas investors because they can separate real property holdings into each series. If one property becomes a liability risk, the series structure does not require the other properties to subsidize that risk.
Tax Designations: C-Corp and S-Corp
A common misunderstanding is that a C corporation and an S corporation are another form of entity. There is no state business entity called the C-corporation or S-corporation. Instead, businesses must form one of the entities listed above and if the entity structure and ownership meet the requirements of the Internal Revenue Code, the owners may elect either C-corp or S-corp status. These terms are actually from the Internal Revenue Code and refer to the taxing designation elected by your entity.
Business owners generally favor the S-corp designation because an S-corp designated entity is taxed as a “pass through” entity. Many medical marijuana companies elect C-corp status because the liability remains with business in the event of failure.
Contracts – Business Law
A contract is a promise or legally binding agreement between two or more parties. Most business contracts will lay out the obligations of the parties, the terms of the agreement, and conditions for payment. However, even well-drafted contracts may become the subject of a lawsuit due to ambiguity or differences in opinions as to what the terms mean.
The state of Texas recognizes both written and oral contracts and certain contracts are required by statute to be in writing. Under Texas contract law, contracts that cannot be performed within one year, a guarantee to pay someone else’s debt, contracts for the sale of goods for more than $500, contracts for the sale of real estate, and marriage contracts must be in writing.
It is important to understand the terms of a contract before you sign. Often, a contract will contain a clause stating that the contract is the entire agreement. This means that any discussions held outside of the contract about what a term means will often not be considered in court. Such evidence is called parole evidence and is largely inadmissible in contract lawsuits.
Many businesses and individuals rely on “form” contract services which are abundantly available on the internet. These rarely work and often lead to costly litigation. Form contracts are not tailored for your specific business needs and often have inapplicable or contradictory terms. If you believe that hiring a lawyer to draft a contract is too expensive, then you will certainly be unhappy when you must hire a lawyer to pursue or defend a contract claim that arises out of an ill-drafted contract. Breach of contract lawsuits can be very costly.
In Texas, to establish a breach of contract claim you must prove (1) existence of a valid contract, (2) performance under the contract by the plaintiff (3) a material breach of the contract committed by the defendant, and (4) that the plaintiff sustained damages as a result of defendant’s breach of the contract. Recently, the law in Texas changed to prohibit recovery of attorneys’ fees in a breach of contract action against an LLP or an LLC.
The business attorneys at Ritter Spencer PLLC are experienced in contract negotiations, contract drafting, and breach of contract lawsuits.
Non-Compete, Employment and Non-Disclosure Agreements
The intellectual property, trade secrets, and other proprietary information of your business are valuable information subject to protection. In general terms, a trade secret is a commercial method, process, design, formula, practice, instrument, pattern, or compilation of information not generally known or reasonably ascertainable by others through which a business may obtain an economic advantage over competitors or customers. Trade secret cases usually involve competing businesses or departing employees who have taken valuable trade secret information with them at the time they departed the company.
Recently, Congress passed the Defend Trade Secrets Act, which created a federal cause of action for trade secret misappropriation. A trade secret is defined as “…all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if— (A) the owner thereof has taken reasonable measures to keep such information secret; and (B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information.”
Here in Texas, trade secrets are governed by the Texas Uniform Trade Secrets Act. Under the Texas Uniform Trade Secrets Act, trade secret is defined as “Information, including a formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or supplies, that: (a) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and (b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. Under the Texas Uniform Trade Secrets Act, you may obtain a temporary injunction, damages, and possible attorney’s fees against the individual or entity which misappropriated your trade secret.
To avoid trade secret theft and other forms of misappropriation, many businesses have their employees sign non-compete and non-disclosure agreements to prevent that information from being disclosed to a competitor or someone else. Employment contracts often contain restrictive covenants. There are many types of restrictive covenants or restrictive agreements, including non-solicitation agreements, non-circumvention agreements, non-disclosure agreements, and non-compete agreements.
Generally, non-solicitation agreements prohibit an employee or contractor from contacting customers of the business after the employee is no longer employed or working there. Non-circumvention agreements are generally required when a business is working with another business for a business opportunity. Most require that neither party will use the other party’s information in the event that a business relationship is not formed. In other words, neither party will circumvent, undercut, or take advantage of the other party, and the business deal they are in the process of forming. It is typically signed in conjunction with a non-disclosure agreement.
A non-disclosure agreement prohibits a party from disclosing information obtained from the other party that is deemed confidential. Non-disclosure agreements are often referred to as confidentiality agreements. Non-compete agreements prevent an employee or contractor from competing against the employer. Non-compete agreements can be highly controversial and are often litigated. Texas requires that they be ancillary or part of an otherwise enforceable agreement, and that they impose reasonable limitations on geographic area and time. Many of these are paired with a non-solicitation agreement.
Enforcement of non-competes, non-disclosure and non-circumvention agreements can be challenging. Often the disclosure of trade secrets or confidential information would be so damaging that money damages would not repair the harm caused. As a result, injunctive relief is often appropriate. Because of the challenges in enforcing non-competes and non-disclosure agreements, it is important to hire a business lawyer who can carefully draft these agreements for your company’s particular needs.