UTILIZING BUSINESS AGREEMENTS AS A DETERRENT TO LAWSUITS AND AS AN OFFENSIVE WEAPON

By:  Andrew Burrows

Despite the inherent usefulness of service agreements and/or purchase agreements in memorializing the terms of a transaction between businesses (“Business to Business” or “B2B”), or between businesses and their customers (“Business to Customer” or “B2C”), many entrepreneurs forego having these documents drafted. From our experience, the primary reason for delaying or altogether avoiding having a formal agreement drafted for their business dealings is one of cost. Unfortunately, clients who do not have effective agreements and who find themselves in a B2B or B2C dispute are at a drastic disadvantage once they find themselves in the negotiation or litigation.

One of the primary benefits of effective agreements is the impact they have on litigation, or a situation that may give rise to litigation. A well-drafted service agreement or purchase agreement will lay out all the material terms for a service based business, and will ideally leave no “grey area” for the parties to dispute. Although litigation sometimes arises because of outright wrongdoing by one party, lawsuits also often arise because of a misunderstanding of the terms of an agreement between the parties. This most often occurs where the agreement between the parties is never memorialized by a writing (an oral agreement), or where the parties use an agreement that is not specifically tailored to their business. The most common example of this is finding a service agreement from the Internet and modifying it in an attempt to tailor it to the needs of the business.

Despite the  perceived initial cost savings, these patchwork agreements fail to address key areas that give rise to disputes. Although it may be difficult to rationalize shouldering the cost of a formal agreement as a business owner, the cost of preparing an agreement to protect your business is small in comparison to having your business involved in disadvantageous litigation.

Beyond the protective aspects of these agreements, a service agreement or purchase agreement is often a business’ best weapon in taking action to collect a receivable or right a wrong. A well-drafted agreement will specifically define the terms of the agreement between the parties. This is of utmost importance. First, the mere existence of a well drafted agreement will almost always cause customers and suppliers to live by it without a lawsuit. If there has to be lawsuit, the chances of good result are much better with a soundly written agreement. In these situations, litigation may be avoidable, allowing the parties to negotiate a resolution without the expensive legal fees associated with business litigation.

MICHIGAN ADOPTS DOMESTIC ASSET PROTECTION TRUSTS

By:  Tim Williams

On December 8, 2016, Michigan signed into law two bills that allow the creation of  Domestic Asset Protection Trusts (DAPT). The law goes into effect on March 8, 2017. Michigan is now the seventeenth state to allow such trusts.

The Basics

A DAPT is an irrevocable trust that protects the assets of the person who sets up the trust from the usual claims that apply to trusts. The person who creates the trust, called the "Grantor", transfers a portion of his or her assets into the trust. The Grantor is typically a lifetime beneficiary of the trust. The Grantor can also retain decision-making authority over the administration of the trust. The assets in the DAPT are not subject to the Grantor’s creditors, even though the Grantor is a beneficiary. Moreover, under recent IRS rulings, if drafted properly, the assets in a DAPT are not included in the Grantor’s Gross Estate for Federal Estate Tax purposes.

The creditor protection aspect of the law with respect to DAPTs is quite lenient. The law provides that the Grantor’s creditors may not attack assets transferred to the DAPT upon expiration of a two-year period, which begins with the date the assets are transferred to the Trust. There are only a few exceptions to this protection, including instances of fraudulent transfers and bankruptcy.

Practical Uses for a DAPT

Adult Child Needing Protection

The first situation where a DAPT is useful is one in which a person’s adult child needs to be financially supported but it is not desirable to make out-right gifts to the child annually. Circumstances that could make out-right gifts undesirable include if the child is involved in bankruptcy, insolvency, divorce, child support issues, judgments against the child, student loan default, or an IRS Federal Tax Lien.

The DAPT can be set up so that funds are available to support the child, enable the purchase of a house for the child’s use, etc., but not subject the assets or income to risk of loss if placed directly in the hands and ownership of the child.

Reducing Federal Estate Tax

A second situation where a DAPT will be useful is where the Grantor needs to reduce the size of his or her estate for Federal Estate Tax Purposes. The use of a DAPT will allow the Grantor to shift an amount of assets into the DAPT to reduce his or her Federal Estate Tax below the Federal Estate Tax dollar exclusion, thus eliminating any Federal Estate Tax at his or her passing.

Despite the benefits of the DAPT to persons in situations such as those described above, care should be taken to consider the Capital Gain Tax consequences when planning a Federal Estate Tax Reduction DAPT. The IRS may take the position that the Grantor has “gifted” the capital gain tax to the beneficiaries. This is known as carryover tax basis. If assets are transferred at death, the Capital Gain Tax is forgiven.

Overall, the Michigan DAPT can be a powerful tool in both estate planning and asset protection planning. Considering whether a DAPT is appropriate involves many considerations. Therefore, an attorney that specializes in estate planning and estate tax issues should be consulted to ensure a DAPT is appropriate for your situation.

Purchasing Intellectual Property

By: Ashley Prew

A sometimes overlooked part of a business transaction is the sale of intellectual property rights.  Specifically, any trademarks, service-marks, patents, and copyrights that a business owns need to be handled properly in the sale of the business. Unfortunately, some of our clients have purchased trademark and service-marks in the course of acquiring another business, but failed to receive legal title via proper transfer to the new business owner at or immediately after the closing.

If a business owns and then sells a federal trademark or service-mark, the required transfer of title document is an Assignment of Interest that is filed with the United States Patent and Trademark Office (“USPTO”).  The assignment can be compared to a deed for real estate.  If the assignment is never recorded or filed with the Trademark Office, then ownership remains with the previous owner.  If this occurs, additional expense will be incurred later when the discovery is made and the mistake has to be corrected. In addition, if there is a dispute over ownership, costly litigation may result to resolve the ownership dispute. 

Properly addressing the intellectual property rights of a company in the Asset Purchase Agreement or Buy/Sell Agreement is only the first step in ensuring the trademark or service-mark is properly sold in the transaction.  Beyond these agreements, it is up to the parties to ensure that the Assignment of Interest is both executed prior to or at the closing, and then properly filed with the United States Patent and Trademark Office. After the ownership transfer is properly recorded with the USPTO, it becomes the new owner’s responsibility to ensure it adequately protects the intellectual property interest. Some of these protective acts include continuously using the mark, filing the required renewals with the USPTO, and taking steps to ensure competitors do not infringe on the registered mark. 

When purchasing, selling, applying for, or maintaining a federal trademark or service- mark, it is important to ensure you have an attorney who can advise you on the required steps to protect this intellectual property. If you have questions regarding trademarks, service-marks, or copyrights, please do not hesitate to contact us directly.

What is a board of directors all about?

By:  Adrienne B. Knack

In Michigan, corporations (including non-profits) are required to have a board of directors.  The board is responsible for overseeing the affairs and activities of the company or organization.  The board of directors is elected by the shareholders of a corporation, including the chairperson of the board of directors.  The company’s bylaws will dictate how the board operates.  The bylaws will also indicate how many directors need to be on the board.  This can be as few as one director, which is very common for a single shareholder corporation. 

One of the more important things that the board of directors is responsible for is selecting the company’s officers – president, secretary, and treasurer.  The officers are responsible for the day-to-day affairs of the company and running the business.  Michigan requires an annual meeting of directors to select each year’s officers.  This is usually done on the first Tuesday in March each year.  Michigan also requires there to be an annual meeting of shareholders whereby the directors are elected each year. 

The bylaws of the company will also dictate how often the board will meet.  The bylaws can be set up so that consent documents can be prepared and signed every year in place of having actual, physical meetings of the directors and the shareholders.  This is typical for companies that have a single officer, shareholder, and director.  On the other hand, some organizations have ongoing affairs that need to be addressed by the board of directors, so monthly or bi-monthly meetings are necessary.  For other organizations, annual meetings are all that is needed.

For a company that requires an actual, physical board meeting, the protocol for the meeting varies based on the organization.  Typically, an agenda for the board meeting will be sent out to the board members in advance of the meeting.  Often, this will constitute notice of the meeting to the board of directors pursuant to the bylaws.  The agenda will include reports of the officers and committees, new business that the board needs to discuss, and old business from a prior meeting.  The secretary will take notes (minutes) of the meeting to report back to the shareholders what the board discussed and decided.  The minutes also memorialize the board meeting and should be kept with all important company records.  The minutes will include all motions brought in front of the board, notes on the discussion, who seconded a motion, and whether or not the motion passed.  Motions are required to be made, seconded, discussed, and voted on to adopt (or deny) significant proposals before the shareholders and directors, such as the organization borrowing funds, potential mergers or sale, adding a new line of business, etc.  Typically, the “significant” events are outlined in the company’s bylaws.

These formalities are imperative to maintain proper legal standing for a corporation and keep separation between the entity and its shareholders, officers, and directors as individuals. If these formalities are not complied with, the personal assets of shareholders, officer and directors may be at risk despite the purported protection of the corporate form.  The company should also be sure that its business insurance policy includes officer and director coverage.

TAX ISSUES WHEN SELLING OR TRANSFERRING REAL ESTATE

By:  Tim Williams

Michigan has some unique tax provisions which can negatively impact the sale, transfer, and/or purchase of real estate. Being aware of these rules is important when making decisions with regard to selling, purchasing, and gifting real estate in Michigan.

In addition, there are several Federal and Michigan tax provisions to be aware of when selling or transferring real estate.

“UNCAPPING’ FOR PROPERTY TAX PURPOSES

Under Michigan law, the increase in a property’s value for property tax purposes cannot exceed the rate of inflation. This value, known as the “Taxable Value”, is used for property tax calculation and assessment. After the economic reverie following the Great Recession, it is quite common for real estate in Michigan to have a lower Taxable Value upon which property taxes are determined, as compared to the Assessed Value, which is not limited by the rate of inflation.

If property is sold or transferred in Michigan, the purchaser will pay property taxes on the assessed value of the property, as opposed to the taxable value. This sale or transfer permits the municipal taxing authorities to mark-up the value of the property for tax purposes, causing the purchaser to pay much higher property taxes than the seller had been paying. This is known as “uncapping” and it can be quite expensive. On investment and rental real estate, uncapping can factor heavily into the annual carrying cost of the real estate.

There are some exceptions to uncapping, many of which are quite complex. The most common exceptions include transfers between husband and wife, transfers from one family generation to the next, corporate real estate involved in a transaction which is a tax-free merger or consolidation, transfers pursuant to a court order, and transfers out of a probate estate to the decedent’s heirs and beneficiaries.

A transfer out of a living trust to a beneficiary will result in uncapping unless the beneficiary is the person who set up the trust or that person’s spouse.

MICHIGAN REAL ESTATE TRANSFER TAXES

Michigan has a State Real Estate Transfer Tax and a County Real Estate Transfer Tax. The taxes are levied upon the sale of real estate. Together, these taxes are levied at the rate of $8.60 for every $1,000 of value or sale price or fraction thereof. Therefore, the sale of a home for $300,000 will trigger a tax on the seller of $2,580.

There are some exceptions to these taxes as well. One exception that is particularly prevalent is a transfer where no money changes hands. This can occur when real estate is gifted, when it is transferred in satisfaction of a judgment of divorce, and when a spouse transfers the real estate to himself or herself and his or her spouse. Another common exception is transfers made by U.S. Federal agencies as sellers, such as the Department of Housing and Urban Development and the Department of the Interior.

Other exceptions include the entering into of a land contract, a transfer from a parent to a child, transfers to a limited liability company if the ownership percentages in the company are equal to the ownership percentages before the transfer, and a transfer from an owner to a new joint tenant where the owner remains a joint tenant.

FEDERAL AND MICHIGAN CAPITAL GAINS AND ORDINARY GAIN TAXES

For Federal income tax purposes, gain on the sale of real estate is taxed at either a flat 15% or 20% rate. High income taxpayers pay capital gains tax at the 20% rate.

For Michigan tax purposes, gain on the sale of real estate is taxed at the rate of 4.25%. Thus, the combined Federal and Michigan tax rate on gain on the sale of real estate is either 19.25% or 24.25%.

There are some exceptions to the imposition of the capital gains taxes. Married taxpayers can exclude up to the first $500,000 in gain on the sale of their principal home. Single taxpayers can exclude up to $250,000 in capital gain.  The principal residence exemption can be used on the principal residence as long as the owner occupies the home for at least two years within the five year time period immediately before you sell it.

Other exceptions include “like-kind exchanges” and transfers of real estate to a company owned by the person transferring the real estate.

Certain situations give rise to ordinary gain as opposed to capital gain. This includes gain from the sale of business or rental real estate, upon which the depreciation deduction was taken. Gain from the sale of business and rental property will be partially taxed as ordinary gain and not at capital gains rates. This places the rate on the ordinary gain portion as high as 39.6%.

ACTION STEP

In order to avoid the pitfalls of selling or buying real estate, seek the advice of a qualified attorney. A real estate attorney can often structure the transaction so as to avoid, or at least minimize, the negative impact of the Michigan and Federal tax rules impacting real estate transactions.

PROTECTING YOUR PERSONAL ASSETS AS A BUSINESS OWNER: IS FORMING A CORPORATION OR LIMITED LIABILITY COMPANY ENOUGH?

By: Andrew Burrows

Many business owners seek to form a formal business entity for the primary purpose of protecting their personal assets from any future legal claims there may be against their business. Although forming a corporation or a limited liability company (“LLC”) is surely a step in the right direction, this protection can be lost if the business owner does not comply with other formalities required by Michigan law. These formalities must be complied with in order to ensure that a potential lawsuit or creditor’s claim against the business does not reach the business owner’s personal assets.

HOW MAY MY PERSONAL ASSETS BE AT RISK?

In a civil lawsuit, a business defending a lawsuit may lack sufficient funds to pay the entire judgment that is awarded to the plaintiff. In order to ensure recovery for the full amount, plaintiffs will often argue a legal theory called “piercing the corporate veil” in order to allow the plaintiff to move beyond the assets of the business and recover directly from the personal assets of the business owner. This is not to say all businesses are at risk from this. Piercing the veil is only proper where the court perceives there is abuse of the corporate form, which is simply another way of saying that corporate formalities are not being followed by the business owner. It is also important to note that under Michigan law, piercing the veil is applied to LLC’s by courts in the same manner as corporations.

In addition, a plaintiff may name the individual directors and officers of a corporation (or members and manager of an LLC) as defendants in a lawsuit in order to have additional pockets to reach and to intimidate the directors and officers into settling the case. The best means to protect against this is for the business owner to add directors and officers liability coverage to the general liability insurance policy maintained by the company. This coverage will protect directors and officers (to the same extent as the business) for the types of claims and lawsuits the general liability policy covers.

WHAT FACTORS ARE CONSIDERED BY THE COURT WHEN DETERMINING WHETHER FORMALITIES HAVE BEEN COMPLIED WITH?

Outside of engaging in illegal acts such as fraud, here are a few of the most common reasons Michigan courts may permit a plaintiff to pierce the corporate veil:

1.   Absence of Corporate (or LLC) Formalities: 

This is most commonly a problem for businesses that have attempted to create an entity, but have not retained an attorney who specializes in assisting business owners and entrepreneurs. In starting their business, many entrepreneurs will pay an attorney a one-time fee to prepare the necessary documents to form a corporation or LLC. Sometimes business owners who have attempted to set up a corporation or an LLC on their own only use inception documents consisting of only a short document called the Articles of Incorporation (for corporations) or Articles of Organization (for LLCs).   There are several other documents, however, that must be prepared beyond these Articles to ensure all formalities are met.  Additionally, there are documents required to fulfill these formalities every year the company is in existence.  An experienced business attorney will prepare all of the required documents for the business.

2.  Commingling Personal and Business Funds:

    If you operate your business under a corporation or LLC, it is imperative that you open a separate bank account under the name of your business entity. It is equally important that all transactions of the business flow through the business’s bank account and none of the business transactions flow though the owner’s personal bank account. It is equally important that none of the owner’s personal expenses and transactions flow though the corporate bank account. Although personal funds may be contributed to the business as a capital contribution, for all intents and purposes, the contribution must be treated as a formal transaction (ex: shareholder exchanges cash for stock in the corporation).

3. “Undercapitalization”, a/k/a Siphoning Funds to a Shareholder (Corporation) or Member Interest Holder (LLC):

A business must maintain enough capital to sustain itself as a separate entity and not operate as a mere façade for the personal operations of a shareholder. Some small business owners, especially those who operate a single-shareholder corporation or single-member LLC, may distribute all annual profits of the business to themselves as dividends, leaving their business’ bank account barren. It is a violation of Michigan law for a business entity to pay all or almost all of its cash to its owner(s) if doing so leaves the business unable to pay its creditors in the normal course of business.

In this situation, courts are reluctant to allow business owners to shield their personal assets, and may reach the personal assets of the business owner to satisfy a judgment. The simple solution here is to keep the appropriate amount of capital in the business to support its operations and run such operations independent of the personal needs of the business owner(s).

ACTION STEP: PREVENTING A PLAINTIFF FROM REACHING YOUR PERSONAL ASSETS

The first step is to engage an attorney who specializes in assisting business owners and entrepreneurs and direct them to do a review of your business documents and operating procedures. By putting a plan in place to create or update these documents to comply with current law, a savvy business owner can ensure their business complies with all requisite formalities, as well as ensure that the business is being run and managed in a way that does not abuse the corporate (or LLC) form under Michigan law. 

Funding Your Revocable Living Trust

By: Ashley J. Prew

Some of the most common questions we receive from estate planning clients are regarding which assets should be owned by or payable to their Revocable Living Trust.  The process of transferring assets into a Revocable Living Trust during life or upon death is known as “funding” the Trust.  The Revocable Living Trust funding process is a crucial, yet often overlooked, step in the estate planning process. Properly titling and setting up beneficiary designations on your bank accounts, investments, and other assets ensures that if you become incapacitated during life, or pass away, your relatives are able to handle your affairs without initiating a probate court proceeding.  Since every estate planning situation is different, if you have specific questions about whether or not your assets are properly held in order to avoid probate, you should consult with your estate planning attorney.  With that being said, the following are some general considerations to make when determining ownership and beneficiary designations if your estate plan is complete and includes a Revocable Living Trust Agreement.

How do I fund the Trust?

Funding your Revocable Living Trust is the last step in the estate planning process and it is done after your Revocable Living Trust is executed and in existence.   This includes making sure that all of your assets are properly designated so that they will either pass to your Revocable Living Trust or a living beneficiary when you pass away.  The key item to remember is that if an asset is owned by an individual and not by their Revocable Living Trust, or their Revocable Living Trust is not the named beneficiary of the asset, that asset will require probate when the individual dies, even if they have a Will and a Trust.

Therefore, it is important that when you meet with your estate planning attorney, you disclose all of your real estate ownership interests, business ownership interests, and the types of accounts in which you hold your liquid and investment assets.  At the end of the estate planning process, Williams & Knack, P.C. provides you with a letter detailing the necessary steps to fund your Revocable Living Trust that are tailored to your specific situation, and follows your wishes in terms of how property is to be distributed to your beneficiaries upon your death. 

When should I fund the Trust?

The answer is right away, but many people have questions about whether assets need to be owned by their Revocable Living Trust while they are still living.  Generally, the answer is typically no, unless your situation includes special circumstances.  Remember that properly funding your Revocable Living Trust requires proper beneficiary designations and that does not necessarily mean that there will be any change in account ownership.  The instructions our firm provides in the letter referenced above will properly accomplish funding the Trust, but only if they are followed completely and accurately.

Are there any assets that should not be put into the Trust when I die?

The answer to this question depends on your financial and family situation, but generally we do not recommend naming a Revocable Living Trust as a beneficiary of any IRA, 401(k), or other “qualified” retirement funds and annuities. The reason for this recommendation is there are significant income tax advantages to naming your spouse, your adult children, or other persons as the beneficiaries of these types of accounts.  A living beneficiary can continue to defer the distribution and withdraw the balance of these accounts slowly over a period of years.  The amount they will be required to withdraw is based on certain factors including your age when you die and the beneficiary’s current age, life expectancy, and the beneficiary’s relationship to you as the account owner.  Alternatively, if you name your Revocable Living Trust as the beneficiary of this account, when you die, the Trustee will likely be required to liquidate and distribute the funds in the account within five years from the date of your death.  The assets in the account will then be taxed all at once, and as a consequence, will be subject to the higher taxation rates for Trusts. Furthermore, the assets will not be able to earn interest, dividends and capital gains, compounding tax free.       

Something to keep in mind, however, is that if your situation includes minor children or a special Trust for amenities for a beneficiary with a disability or if it is not your intention to have your beneficiary have complete access to the funds immediately upon your death, this recommendation would not apply to you.

Conclusion

As indicated, funding your Revocable Living Trust is specific to your own personal, family, and financial situation.   In addition, if you obtain a new account or a new piece of property, you need to take the steps to fund your Revocable Living Trust (or designate a beneficiary) with those accounts and assets as well.  We recommend that you confirm your beneficiary designations at least every few years to make sure that none of your assets will fall to probate.  If you have questions regarding funding your Revocable Living Trust and designating beneficiaries, please do not hesitate to contact our office directly.