Five Considerations When Structuring a Business

Drafting a business' operating, shareholders, or partnership agreement requires understanding parties' expectations and intentions, then expressing those concepts in an understandable and legally enforceable document.  There are basic default provisions that are common, and statutes that fill in any gaps, but every business relationship is unique and every agreement requires care and attention. 

Here are a few common considerations:

CONTROL

Decision-making authority can be a point of contention in any type of relationship.  In a business, we generally approach this issue by defining the scope of major decisions versus day-to-day matters, and then address each separately.  

The common presumption is of course that the majority owner has near-total control (subject to fiduciary duties and the minority owner's dissolution rights).  However, a minority owner can have a controlling vote on everything or anything; parties can agree that everything must be by majority or unanimous; decisions can be divided into spheres of influence; or you can have nearly any other arrangement you can imagine.  

Different business types have different statutory defaults.  In a partnership or some LLC's, every partner or member can presumably act independently and bind the business in day-to-day matters without the knowledge or consent of the other members.  By contrast, in a corporation, the shareholders have no authority beyond electing a board, which then appoints officers, who manage the day-to-day operations.  

How to approach the issue of control is often driven by the practicalities of the business relationship.  Frequently, for example, one party controls the checkbook and bookkeeping while another is in the "field" (or shop, or factory, or warehouse, etc.).  Other times, you can have a largely silent partner, who still needs to have access to information.  These clauses need to be clear enough to intelligibly reflect the parties' intent, but flexible enough to remain applicable as the business grows and develops.

CONTRIBUTIONS AND DISTRIBUTIONS

Capital contribution and distribution arrangements can vary widely, particularly where parties are providing different levels or types of contributions.  This is one of the most important areas where parties need a clear agreement reflecting their expectations, and can be one of the most common areas of dispute down the road.  

In a corporation, an owner buys their shares and owns the corresponding percentage of the company, with corresponding dividend rights, and a proportionate vote towards who sits on the board (and thus, indirectly, towards the timing and amount of dividends). These rights can be adjusted in a shareholders agreement, but are largely fixed, and represents the arrangement most people think of with respect to contributions and distributions. 

For partnerships and LLC's, the default statutory provisions basically recommend a written agreement, and impose a pro-rata distribution in the absence of one.  In a general partnership (as opposed to LP's or LLP's), capital accounts are maintained, and there are ongoing financial obligations. An LLC is something of a hybrid between a partnership and corporation, where membership "units" can be purchased similar to shares, but ownership percentages can effectively be subject to adjustment based on disproportionate future contributions in the absence of an agreement to the contrary.

Business owners need to decide, among other things: who contributes what; whether up-front money is a loan or capital contribution; whether there are obligations or rights to contribute further capital; and how non-monetary contributions are treated and valued.

DISPUTES

I often recommend a dispute resolution clause in any business agreement.  These can be as simple as requiring parties attempt an amicable resolution prior to litigation, either in the form of a "meet and confer" between themselves, or a non-binding mediation.  

A very helpful type of dispute clause requires parties to raise disputes in writing within a specified time period or else the issue is waived.  It is similar to the notice of claim requirement that protects municipalities.  The effect of such a clause is to limit any litigation to narrowly defined issues.  The risk, however, is that legitimate claims can be waived.  Accordingly, these clauses must be carefully crafted, and understood by the client.

Arbitration clauses have positives and negatives.  They arguably streamline litigation, particularly discovery, which can save money.  At the same time, you are paying private arbitrators, which can negate or exceed any cost savings.  Some attorneys will argue that selecting a business-savvy arbitrator has benefits, but in New York our Federal judges are exceptional and the State courts in Nassau, Suffolk, and the City have specialized commercial divisions.  

The major difference between judicial intervention and arbitration is the degree of discretion given to the arbitrator.  Not only does the arbitrator replace the jury in finding facts (if applicable), but they are also not bound by the law in the same way as a court.  

Attorneys-fee clauses can be very helpful, and I generally recommend them in business agreements, but it is something not every client will want.  Commercial litigation can be costly.  The ability to shift fees helps make an injured party whole, and can discourage parties from trying to use litigation cost and delay as a pressure tactic to renegotiate.  At the same time, however, there are situations where such clauses are not advisable.  For example, a majority-owner with substantially greater resources than the other party or parties may not want such a clause, as their risk would be disproportionate to the benefit to them.

LIMITATIONS ON TRANSFER

How and under what circumstances a business owner can transfer their ownership interest is an important consideration for small businesses.   

In some situations, the concerns are financial.  There may be anticipated rounds of capital financing that can be negatively effected by a rogue party selling their shares outside of the common plan.  Even when formal financing rounds are not anticipated, it is not uncommon to want to impose limitations on sales so as to protect the value of the business.  

The more common scenario relates to control and the practicalities of running the business: each small business owner wants a say in who their partners are, but also wants the ability to exercise their judgment in selling or transferring their own interest.  

A right of first refusal is a common solution, but every situation is unique.  Another option is a conversion from voting to a non-voting or limited-voting interest upon transfer. 

These clauses are tailored to the unique situation of each business-owner.

DISSOLUTION AND WIND-DOWN

Business owners going into a new venture are not thinking about dissolving it, but their attorney needs to. 

Clients should consider when an involuntary dissolution is permitted.  I have seen agreements that require a unanimous vote to dissolve (which is potentially unenforceable and a generally bad idea).  By default, owners of more than 20% of a corporation, or any member of an LLC or partnership, can ask the court to compel dissolution.  Absent a majority vote,  the court is not required to compel dissolution in the absence of oppressive conduct (in the case or a corporation) or the inability to continue an LLC as a going concern.  The default arrangement can, in some circumstances, give too much power to minority owners to start an action, and in other circumstances can leave minority owners stuck in the business (if they are treated fairly and the business can act without them). 

A buy-out option, and price (or method for determining price) is also an important consideration.  This can also shift over time (such as a buy-out at the buy-in price for a set period, and thereafter based on a valuation formula). 

As a practical matter, when the business is wound down, in the absence of a voluntary agreement, the judicial-imposed method is the appointment of a third-party (at a cost of up to 5% plus expenses, including legal), or letting the parties fight amongst themselves.  Depending upon the type of business and the parties, the process for wind-down can also be tailored to the specific business. 

CONCLUSION

The above are five of the major considerations when structuring a business, but there are many others. A single-owner business can be relatively easily and inexpensively he set up.  An attorney can be helpful, and is a valuable resource to develop as your business grows, but is often not necessary. Once a business grows to the point that there are multiple owners, despite many small business being very successful on what are essentially handshake agreements among the owners, professionally drafted organizational documents become even more advisable.

Municipal Liability and the Spectrum of Qualified Immunity

Municipal litigation has been part of my practice for over a decade.  I primarily represented plaintiffs early in my career, and now I am mostly on the defense side as outside counsel for municipalities.

I view municipal liability, in broad scope, as a spectrum of qualified immunity.  As with all torts, the first inquiry is the relationship between the parties.  With the government, however, the relationship is complex, ever-evolving, and was historically defined by a broad application of absolute sovereign immunity.  The starting principals of civil liability are flipped when it comes to government litigation.  The equitable maxim at the basis of tort law -- where there is a right; there is a remedy -- does not apply in the same way; there are no remedies unless the government consents.  The principal that everyone is equal in the eyes of the law also does not apply: the government is special, and privileged.  

On one end of the spectrum, we have relationships where an everyday citizen is interacting with the government or its employees in a manner similar to a non-municipal defendant (i.e. an employer, property owner, or driver on a roadway). A garden variety sexual harassment case or a basic personal injury case are examples.   There may be some added statutory protections, such as filing a notice of claim and requiring prior written notice for some types of personal injury cases, but nothing too complicated.  

On the other end of the spectrum, we have relationships derived from the government fulfilling its core government functions  to the general public, which are cloaked with absolute immunity; or matters that involve major public policy concerns or highly discretionary judgments. Judges fulfilling their adjudicative duties are prime examples.  

There are two main basis for municipal liability: common law torts and civil rights litigation.  Both reflect this same relationship based spectrum, but they have different origins.  Common law torts emanate from the judiciary, whereas civil rights derive from the legislature.  They can be described as sharing the same elements as most torts (duty, breach, causation, and damages), but in a common law claim the duties have been defined and refined over time by judges based on cases that come before them, whereas in civil rights litigation the duty is based on statutes and/or the Constitution. Accordingly, I will address each separately. 

COMMON LAW TORTS

Starting at the low end of the spectrum for common law torts, you have ordinary negligence cases.  A government worker driving in the course of employment is more-or-less just another driver on the road, subject to an ordinary negligence standard of care.  

With the flip of a switch, however, you are no longer dealing with just another driver, but rather an emergency vehicle with lights and sirens.  The relationship changes, pushing the situation further down the spectrum of qualified immunity, and the driver's standard of care decreases from a "reasonable person" standard to a recklessness standard and the rules of the road no longer apply to them.

Another good example of qualified immunity can be seen in negligent security claims. I had a case against the NYC Housing Authority years ago where a broken emergency door lock created a safe-haven for criminal activity, but was ignored at the risk of innocent by-standers living in the building, and my client was shot in the spine and rendered a paraplegic.   In that case, the municipality was acting in a mostly proprietary function, and was subject to similar standards as a landlord or parking garage.  It had a clear direct relationship with the class of people foreseeable harmed, which was highly comparable to a private actor.

In the middle of the spectrum, I once represented a plaintiff that was assaulted in the subway while in view of transit authority personnel.  The lower court found that there was no duty to intervene, but the appellate division found a limited duty to at least promptly alert the police, to the extent it could be accomplished safely.  It is a much more limited relationship, and this a very limited duty, but not so far down the spectrum as to be subject to absolute immunity. Subways are definitely government run, but don't necessarily have to be, and are not at the core of government administration.  

In contrast, a claim that police failed to patrol a particular area or properly respond to a complaint -- while seemingly similar to security in a housing project or a subway station -- is much more closely tied with the government's broader relationship with society as a whole in performing it's core government function, and thus would generally be subject to immunity. 

At the cutting-edge between qualified and absolute immunity are tort cases involving special relationships, highly discretionary or specialized judgments, and major public policy issues.  

For example, I represented the surviving family of a suicidal officer who should not have had his gun returned; as well as the family of a person who was pushed onto the subway tracks by someone who should not have been released from a psychiatric hold.   In both cases, the relationship was limited to third-parties foreseeable but indirectly harmed, and the argument for liability was that, under the facts of those cases, the government failed to exercise any discretion and instead made unreasoned and wholly arbitrary decisions.  The scope of the duty was proportionately narrow to how close the function was to a core high-level government function (i.e., adjudication, legislation, diplomacy, policy making, etc.), and thus was highly qualified.  Any type of discretionary judgment would have created immunity, but a lack of judgment gave a very narrow path for recovery, and both cases settled.  Notably, subsequent case law has been even more clear that the special relationship has to be personal, not to the public at large, which may have created a stronger defense to the subway case.

CIVIL RIGHTS

Civil rights, including civil liability for the violation of constitutional rights, are statutory creations.  

The Bill of Rights created "rights" against the government shortly after the formation of the country, but no mechanism for civil redress if those rights were violated.   A hundred years later, after the civil war, the Fourteenth Amendment at least partially abrogated sovereign immunity for the States and authorized Congress to pass its first civil rights laws, including 42 USC 1983.  This statute creates a private right of action for the deprivation of constitutional and other legal rights by persons acting "under color of law."  Another hundred years later, we had the civil rights movement, which led to Title VI (discrimination in administering federal funding), Title VII (employment discrimination), Title VIII (Fair Housing Act), and Title IX (discrimination in education).  

These civil rights laws, although legislatively created, follow the same pattern of relationship-based spectrum of qualified immunity, ranging from the same standards as a private actor to absolute immunity.  

A basic sexual harassment or employment discrimination case will appear very similar regardless of whether the defendant is a municipality or a private employer, and the standards are the same.  Even here, however, immunity issues develop  as the relationship moves towards core government functions.  I worked on a sexual harassment case against the Saudi Arabian mission to the United Nations once where a purely ministerial worker would have had a good claim, but since the worker's responsibilities leaned more towards diplomatic and policy functions, sovereign immunity kicked in.  There are also ancillary issues that make these types of cases unique when brought against a municipality.  I defended a case a few years ago that was a garden variety hostile work environment case against a Town, which was fairly easily dismissed on motion, but the defense and indemnification issues under the general municipal law for the individually-named supervisor were more complicated than the case itself.

The First Amendment, among other things,  gives us the right to speak as private citizens on matters of public concern, without fear of retaliation, except that this right can vary for government employees depending on the nature of the speech and of the employment.  In all of the First Amendment retaliation cases I have handled, whether the particular speech was as a private citizen or an employee has been a key issue.  In one case, a jury found that specific speech as a private citizen was a substantial motivating factor in retaliation, but the verdict was thrown out.  The appellate court looked back at the citizen/employee issue, and found that the evidence pointed much more strongly towards the retaliation being for different outspoken statements that had been made within the person's duties of employment rather than statements made as a private citizen.

Fourth Amendment cases are a great example of how liability standards differ in proportion to how close or far the conduct is from high-level governmental functions.  

Excessive force cases involve a street-level direct relationship.  They are subject to an objective reasonableness standard, based upon what a reasonable police officer would do in response to the circumstances prompting the use of force.  By making it a reasonable police officer standard, rather than a reasonable person standard, and officer acting within their training, policies, and practices has qualified immunity.  The law is very protective over the broader policy-based part of the inquiry, but less protective over the narrower fact-sensitive portion.  

My first experience with an excessive force case, and my first time on the record in Federal court, was while I was an intern for the Port Authority during law school.  I was handcuffed as part of a demonstration for the jury.  Handcuffs hurt, and a "reasonable person" might arguably debate whether they are necessary in benign circumstances, but a "reasonable officer" would say they are permitted in any arrest. 

Later, one of my first trials as an attorney was also an excessive force case, where the plaintiff's knee cap was shattered while he was being arrested for illegally selling batteries on the subway.  (I realize this is my third example involving the subway).  The plaintiff in that case claimed he was violently thrown to the ground for no reason; the police explained that he tried to avoid being handcuffed by jumping away in some type of ill-fated ninja move and essentially hurt himself.  

False arrest and false imprisonment cases arise under the Fourth Amendment.  In a warrantless arrest, the government has the burden to prove probable cause; add a warrant, and the relationship is changed by adding court involvement, creating a presumption that pushes the matter further down the spectrum and shifts the burden to the Plaintiff to prove that the warrant was the result of some type of fraud on the court.  

This shift in the spectrum of qualified immunity is further highlighted when dealing with malicious prosecution; or, rather, the common misconception of malicious prosecution.  Prosecutors, when performing their prosecutorial function, are entitled to absolute immunity.  There is no malicious prosecution against the person or agency actually prosecuting.  Thus, in municipal liability context, malicious prosecution is generally a state law tag-along to a false arrest claim.  Under state law, the damages for false arrest terminate at arraignment, and any damages thereafter must be based on a malicious prosecution claim (which requires, among other things, actual malice and a favorable termination).  Federal law generally does not recognize malicious prosecution as a separate constitutional tort, but instead views it as a continuation of damages emanating from a false arrest.  The defendant is not the prosecutor, but again the law enforcement officers, on the theory that they "initiated" the prosecution improperly.  Notably, the state law malicious prosecution claim requires an element of actual malice or bad faith, further emphasizing the role of a direct relationship in determining the standard of liability.  

More towards the far end of the spectrum, the Eighth Amendment gives post-trial inmates a right against cruel and unusual punishment, which results in a "deliberate indifference" standard of care.  A jail physician is not subject to ordinary malpractice; and corrections officers are not subject to the same type of excessive force claims as police officers.  The relationship between inmates and the government is very different, resulting in a very different and much more deferential standard.

Right near the absolute immunity end of the spectrum, there are policy-based civil rights cases.  These can be discrimination actions directed toward policies and practices, rather than discrete transactions, or "Monell" claims, where a policy or practice is allegedly unconstitutional.   These policy-based cases are the crux of the Fourteenth Amendment's remedial purpose, but are properly viewed very cautiously by the Judiciary.  Justices of the Supreme Court have even described them as "dangerous." These actions can be used to curb major civil rights issues, like ending segregation in schools, but the courts are careful not to unreasonably extend that power into micromanaging municipalities and governments.  These cases raise fundamental issues - addressing important problems where appropriate, but also pushing the limits of standing and judicial authority.  

ABSOLUTE IMMUNITY

At the very end of the spectrum is absolute immunity.  The primary example is judicial immunity.  If you disagree with a judge, you can appeal, but you cannot sue the judge personally.  Similarly, review of administrative agency determinations and actions, except in limited circumstances where they may also trigger a civil rights claim, are limited to Article 78 review.  In either case, you can seek a reversal of the underlying decision, but cannot sue for money damages.