John, Alexandria, Mary, Martin, and Yvette, formed the Jammy Sleepwear Company over thirty-five (35) years ago. They were equal partners and formed a corporation. On the advice of their attorneys, the entered into a shareholders’ agreement that contained buy-sell provisions. This type of agreement is sometimes referred to as a “buy-sell agreement”.
Their buy-sell agreement contained various provisions, including under what circumstances a departing shareholder’s shares would be purchased, what the purchase price of those shares would be, and the terms of payment. Since the business was in its infancy, they agreed it would be valued at its “book value”, meaning that the value of the assets on its financial statements, less all obligations, would be the business’s value. There was no adjustment for good will or other intangible assets. Also, the increase in value of any assets would not be taken into consideration. The purchase price to a departing shareholder was to be paid in twelve (12) months, in equal monthly payments. The business was required to purchase a departing shareholders shares.
Since they formed the business in 1980, they acquired other businesses and purchased real estate through a separate LLC. They did not think to have a buy-sell for the LLC.
John has announced he would like to retire, but he has objected to the purchase price as being “unfairly” low. He has advised the other owners that he will keep his interest in the real estate, since it will provide him with a “good stipend” during his retirement. Shortly thereafter, Mary announced her retirement.
The remaining owners are concerned that the business will not be able to support payments to John and to Mary. Also, the remaining owners would prefer that John and Mary also sell their interests in the LLC.
Unfortunately, the shareholders (and LLC members) did not regularly review their buy-sell agreement. As the value of the business grew, the amount of the payments increased and would put a strain on the cash flow of the business. If more than one owner were to retire, it would cause a bigger strain. Either the business would have to borrow money, the owners would have to make capital infusions, new investors would be needed, or the business would need to be sold.
Some buy-sell agreements address these types of situations, by limiting the amounts that must be paid out to departing owners on an annual basis. For example, the payments cannot exceed a specific dollar amount or a percentage of gross profits. Also, when the owners buy real estate to be used by the business, they might consider including the real estate as a part of the buy-sell process.
Buy-sell agreements should be reviewed periodically to ensure they continue to meet the needs of the business and its owners. Levin Ginsburg has been advising business owners regarding legal aspects of their businesses, including buy-sell agreements for almost forty years.
Please contact us with any questions you have regarding your business (including any buy-sell issues) at 312-368-0100 or Morris Saunders at email@example.com.
Under Illinois law, corporations and limited liability companies (“LLCs”) are required to file annual registrations with the Illinois Secretary of State in order to maintain their entities in good standing. Pursuant to the Limited Liability Company Act (the “LLC Act”), the Secretary of State may administratively dissolve an LLC if it fails to timely file its annual registration, mirroring the requirement imposed upon corporations in the Business Corporation Act (the “Corporation Act”).
If a company is administratively dissolved, the company will be reinstated upon the filing of the outstanding annual report(s) and an application for reinstatement, along with payment of all outstanding taxes and fees. Upon reinstatement, the actions made by the company during the period of administrative dissolution are “ratified and confirmed” pursuant to the “relation-back” provisions of the LLC Act or the Corporation Act.
Recently, a provision of the LLC Act was examined by the Illinois Appellate Court in CF SBC Pledgor 1 2012-1 Trust v. Clark/School LLC, 2016 IL App (4th) 150568 (Sep. 8, 2016). In this case, the Plaintiff, a Delaware mortgage trust, assumed a mortgage and security interest in an eight-building apartment complex which was owned by the defendant, Clark/School LLC. Under the security agreement, the loan was made on the lender’s reliance of the Defendant mortgagor’s “continued existence” as an LLC, including “all things necessary to preserve and maintain [its] existence and to ensure its continuous right to carry on its business.” The Defendant unfortunately failed to timely file its annual registration with the Illinois Secretary of State, ultimately leading to its administrative dissolution in December 2013.
Due to the Defendant’s administrative dissolution, the Plaintiff initiated a mortgage foreclosure action against the Defendant for failing to “preserve and maintain its existence” as an LLC. The lower court determined, and the Illinois Appellate Court subsequently affirmed, that the Defendant committed an event of default by failing to maintain its status in good standing and held for the Plaintiff. The Defendant unsuccessfully argued that the relation-back provision of the LLC Act prevented the Defendant from liability under the security agreement because it validated any actions that were taken from the date of the Defendant’s dissolution through the date of its reinstatement by the Secretary of State.
The predicament in CF SBC Pledgor was a novel issue under established Illinois LLC law; thus, the Illinois Appellate Court looked to precedent under the Corporation Act. The relation-back application of the Corporation Act only pertained to ratification of the corporation’s actions; however, it did not automatically protect the corporation from possible breaches under third-party contracts. Looking to the Corporation Act, the Court found that the relation-back provision will not “impose a legal fiction that belies actual real world facts.”
In that regard, a company cannot use the relation-back provision of its respective governing law in order to escape liability for committing a breach in a contractual agreement whereby the contracting party is relying upon the company to maintain its “continued existence” as a legal entity in good standing with the Secretary of State.
A company should pay prudent attention to its required filings and its obligations under its third-party contracts so as not to inadvertently breach such contracts. Otherwise, as was the case in CF SBC Pledgor the consequences may be harsh.
For more information on this topic or how you can protect your corporation or limited liability company, please contact:
Pamela Szelung at:
firstname.lastname@example.org or 312-368-0100.