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The HBS Blog offers insight on Delaware corporations and LLCs as well as information about entrepreneurship, start-ups and general business topics.

Clarity, operating agreements and Delaware LLCs
By Paul Sponaugle Tuesday, August 31, 2010

I recently stumbled upon an article that I found absolutely fascinating, considering my line of work.  In the July 7, 2010 edition of Masuda Funai’s Business Update, Stephen Proctor asks,"Is a limited liability company bound by its own operating agreement?”

Now let’s think about this.  How could the LLC not be bound by its own agreement?  I mean, it is the operating agreement, after all, that sets the guidelines for management and ownership of the LLC. However, after reading further I found the real issue at hand is whether or not the LLC itself be required to sign the agreement, and if not, is the LLC really bound to it.  There are state statutes that unsuccessfully define “parties” to the agreement, or even bind the LLC as an entity separate from its members.   So what does that really mean and does it even matter?  Well, as you’re about to read, failure to clearly define such terms allowed the managing member of a Wisconsin LLC misappropriate funds and there was nothing the LLC could do about.  What you’ll also find in the article is how once again Delaware sets the bar for all things corporate.  See the excerpt of Proctor’s article below:


One of the early cases dealing with this issue held that a Wisconsin limited liability company that did not sign the operating agreement was not bound by it. (Bubbles & Bleach, LLC v. Becker No. 97 C 1320, 1997 WL 285938 (N.D. IL May 23, 1997) In Bubbles & Bleach, the limited liability company brought suit in Illinois federal court against the managing member for misappropriation of funds. The managing member moved to dismiss the Illinois federal case. The operating agreement included an arbitration clause that required arbitration in Wisconsin under Wisconsin law. The operating agreement was binding on the "parties" to the agreement, but the term "parties" was not defined. Further, Wisconsin defined an operating agreement as an agreement among the members. The court found that there was no indication that Wisconsin intended to bind the limited liability company as an entity distinct from its members. So the limited liability company was not bound by the arbitration provision in the operating agreement.

Delaware takes a completely opposite approach. In 2002, Delaware amended its limited liability company law to provide explicitly:

"A limited liability company is not required to execute its limited liability company agreement. A limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement." (Delaware Limited Liability Company Act Section 18-101, as amended by 73 Delaware Laws, c. 295, Sections 1 and 2)

(As an aside, Delaware’s defined term is "limited liability company agreement," but it can be referred to as an operating agreement, so the references are to the same agreement.)

It might have seemed that Delaware, considered a bellwether in these matters, would have settled this issue. But, as a recent Illinois case illustrates, the issue is far from settled. (Trover v. 419 OCR, Inc. 921 N.E. 2d 1249, Illinois Appellate Court, Fifth District, January 12, 2010).

Trover was a member of Far Oaks Development Group, LLC (FODG). Trover and the other members of FODG authorized the managing member, Halloran, to transfer land held by FODG to 419 OCR, Inc. (419 OCR, Inc. was owned by Halloran and Macaluso who were also members of FODG.) But Trover alleged that the agreement transferring the land included an oral promise by Halloran and Mancuso, representing 419 OCR, Inc., to pay FODG, in addition to the estimated price of the land to be sold, an additional sum of money to be determined as the land was developed and sold. Although the land was developed and sold at a profit, no additional funds were paid to FODG. The litigation by Trover was based on a derivative action on behalf of FODG alleging breach of contract and fraud.

Halloran and Macaluso sought to compel arbitration under the operating agreement of FODG. The trial court denied the motion to compel arbitration and the defendants appealed.

The court acknowledged that the arbitration provision in the operating agreement was broadly worded. In this case, some of the claims involved defendants (such as 419 OCR, Inc.) who were not members of FODG and were not parties to the operating agreement. Clearly, with respect to these defendants, arbitration could not be compelled. But the more interesting question was whether the limited liability company itself was considered a party to and bound by the terms of the operating agreement that created the limited liability company.


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How Great Companies Picked Their Names
By Carleigh Lowe Wednesday, August 25, 2010

Open Forum publishes smart, interesting articles about an array of small business-related topics. Below is an excerpt of an article in which the origins of sixteen great company names are discussed. 

Anyone who's ever had to form a company can sympathize with how difficult it can be to create a company name that is descriptive yet unique.

However, some companies have gone a less-traditional route and used some pretty unique naming conventions.
Here are some examples of interesting company names and the backstories behind them.

1. Google

The name started as a joke about the amount of information the search engine could search, or a "Googol" of information. (A googol is the number 1 followed by 100 zeros.) When founders Larry Page and Sergey Brin gave a presentation to an angel investor, they received a check made out to "Google."

2. Hotmail

Sabeer Bhatia and Jack Smith had the idea of checking their email via a web interface, and tried to find a name that ended in "mail." They finally settled on Hotmail because it had the letters "html," referencing the HTML programming language used to help create the product.

3. Volkswagen

Volkswagen literally means "people's car." Adolf Hitler initially came up with the idea for "cars for the masses," which would be a state-sponsored Volkswagen program. Hitler wanted to create a more affordable car that was able to transport two adults and three children at speeds of 62 mph. He choose the car manufacturer Porsche to carry out the project, and the rest, as they say, is history.

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Conquering Chaos
By Carleigh Lowe Friday, August 20, 2010

Small Business Trends published a very helpful article entitled "Why Chaos is Killing Small Businesses and the Formula for Conquering It." Below is an excerpt:

We are in an entrepreneurial revolution. There has been an epic shift in people starting new businesses. People leave their jobs, either by choice, or by being laid off. With big ambitions, they pursue their passions and start a business. The unfortunate truth is that most small businesses fail. In the next 12 months alone, 600,000 new small businesses will be created. By the end of the year, more than half will have to close up shop forever.

A recent report by the National Small Business Association showed that more than 41 percent of entrepreneurs are concerned about the survival of their small businesses. None of those numbers feel good to me—and I’d guess they don’t feel good to you, either. I agree with the NSBA that “more can be done to ensure entrepreneurship remains a viable, attainable option for every American.” I strongly believe entrepreneurship is the answer to many of the problems America faces.

So what turns the dream of entrepreneurship into a nightmare time after time?

It’s called chaos and it is killing small businesses everywhere. What causes chaos? What are the symptoms? All-nighters at the office. Missed Little League games. Cold dinners and disappointed families waiting for you at home. Does this sound like you? These are all symptoms of chaos.

All seems to be going well for the small business owner until they get their first customer. That’s when chaos moves in and starts to take over. Before they can come up for air they’ve been sucked under by the business.

Don’t give up. There’s a better way to run a small business. You can grow a successful small business and still have a life, if:

  • You get your mind-set right
  • You get your systems right
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Update on 1099 Requirements
By Carleigh Lowe Tuesday, August 17, 2010

A little while back we wrote an article highlighting the 1099 changes in the Health Care Bill. Here is what may or may not happen next, based on The New York Times' You're The Boss blog.

In their last week of summer legislating, Republicans and Democrats alike — on both ends of Capitol Hill — made gestures toward repealing a new tax-reporting requirement, raising hopes among small-business advocates who have lobbied fiercely against the measure. But with each side claiming the other’s maneuvers are just feints, the prospects for repealing, or softening, the new law are uncertain at best.

The reporting provision at issue is Section 9006 of the Patient Protection and Affordable Care Act, which adds “amounts in consideration for property” to the types of payments over $600 for which a business must file an information return with the Internal Revenue Service. In addition, the provision also closes a loophole that made payments to corporations exempt from the filing requirement. Under the new law, a company will have to file a Form 1099 with the IRS. for every vendor from whom it buys more than $600 in goods.

The section was intended to be a fund-raiser for the rest of the health care bill; it was projected to deliver $19 billion over the course of 10 years by making it more difficult for businesses to keep income unreported. But business groups assailed the new provisions. “This is absolutely unmanageable,” said Bill Rys, tax counsel for the National Federation of Independent Business, which is leading the effort to overturn the law.


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Pay Yourself First
By Devin Scott Friday, August 13, 2010

Pay yourself first. This is a statement most small business owners have heard at least once. In the book The Automatic Millionaire, David Bach describes this as a requirement for anyone who would like to be financially successful. He goes on to explain why, how and even shows you how to make it automatic. He states, “People should take every opportunity they can to save money because it really adds up, and the best way I know to do that is to make your savings automatic.”

Paying yourself first allows the average person to save money that he/should would normally not be able to save. This money can be used to start a business, for retirement, to take a vacation, to pay for college, to help with an emergency or whatever your goals are. Typically, a person allocates his/her money in the following order: pay bills, have fun, then save. The problem with this order is that there is never any money left over to save. People excuse this with “I don’t have enough money”  or “I don’t earn enough.”  Bach states, “Change is a funny thing. Although most people say they want to change — so they can have a better life, with more love, more dreams, and more fun — the fact is that many of us are afraid of change.”  Paying yourself first allows you to save money without even knowing that you are missing it.  Per Bach, the easiest way is to make it automatic; that is, to have your bank deduct a percentage of your paycheck and deposit it into a savings account.

Paying yourself first means you will allocate funds in the correct order: you'll save, pay bills, and then have fun. It also means that you are making a personal commitment toward saving, and that you will save a percentage of your income no matter what. How much should you save? Bach answers the question this way: to be poor, don’t save anything; to be middle class, save at least 15% of your income; to be rich, save at least 25% of your income.  If you want more nuggets of financial wisdom, you can visit David Bach's website.

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