What happens to the business when something happens to you

A closely held business is usually two things at once: the family’s income and its largest asset. Most owners have addressed the first and almost none have addressed the second. The company was formed years ago, the operating agreement was never finished or never read again, and the question of what happens when an owner dies, becomes ill, divorces or simply wants out has no written answer.

The firm works with owners of small and family-held businesses across Suffolk and Nassau County on the documents that determine those outcomes: formation and governance, operating and shareholder agreements, buy-sell agreements and how they are funded, incapacity planning that keeps a company functioning, and succession from one generation to the next.

The distinguishing feature of this work is that the business documents and the personal estate documents are drafted and reviewed together. Reading an operating agreement without the will, or a will without the operating agreement, is how families end up with two documents that give the same interest to two different people.

See estate planning for the personal side, including powers of attorney with business authority; real estate law where property is held in an entity; and probate and estate administration where an owner has already died.

LLCs, operating agreements and business governance

Most closely held businesses on Long Island are limited liability companies, and most were formed quickly, sometimes online, with the governance question deferred. That deferral is the source of a large share of later disputes.

Formation mechanics

• Articles of organization filed with the New York Department of State, naming the company and its county.
• The publication requirement. New York requires a newly formed LLC to publish notice in two designated newspapers in the county of its office for a defined period, and then to file a certificate of publication. Skipping it can result in suspension of the company’s authority to carry on business in New York, which surfaces at the worst possible moment — usually when a bank, a landlord or a buyer asks for a good standing certificate. The counties designate the papers and the cost varies significantly by county.
• An EIN, a bank account and the discipline to use them. Liability protection depends on the company being treated as a separate entity in fact, not only on paper.
• Tax classification. How the entity is taxed is a separate decision from how it is organized, made with an accountant, and it interacts with what the operating agreement should say about distributions.

The operating agreement

New York contemplates that LLC members will adopt a written operating agreement. Where none exists, statutory defaults apply. Those defaults do not answer the questions owners care about, and in some respects they produce results the owners would reject if asked. A functional agreement addresses:

• Capital. What each member contributed, whether additional capital can be required, and what happens to a member who will not or cannot contribute
• Management structure. Member-managed, where every member can bind the company, versus manager-managed, where authority is concentrated. For a company with passive investors or family members who do not work in the business, manager-managed is usually the right answer
• Voting. What requires a majority, what requires unanimity, and what a single member may do alone — borrowing, selling assets, admitting a new member, signing a lease
• Distributions. Whether distributions are discretionary, and whether the company must distribute at least enough to cover members’ tax liability on income allocated to them
• Transfer restrictions. A right of first refusal, consent requirements, and whether a transferee gets full membership or only an economic interest
• Deadlock. A tie-breaking mechanism, mediation, or a buy-sell trigger, agreed before anyone needs it
• Death, disability, divorce, departure and dispute. Covered in the buy-sell section below
• Dissolution and winding up. How the company ends and who does what

Buy-sell agreements and funding them

A buy-sell agreement answers one question in advance: when an owner’s involvement ends, who buys the interest, at what price, and paid how. It can live inside an operating agreement or a shareholder agreement, or stand as a separate contract among the owners.

The triggers

• Death. The most familiar trigger and the easiest to fund.
• Disability. More likely than death during working years. The agreement has to define disability and say who determines it, or the provision generates its own dispute.
• Divorce. A matrimonial court can treat a business interest as marital property. A transfer restriction that keeps a former spouse from becoming an owner, and a mechanism to buy out any interest awarded, protects the remaining owners.
• Departure. Voluntary retirement or resignation, often with different pricing than an involuntary exit, and frequently paired with a non-competition or non-solicitation covenant.
• Dispute. Deadlock, or a defined act of misconduct, triggering a buyout instead of litigation.
• Other events worth covering: personal bankruptcy of an owner, a judgment creditor reaching an interest, loss of a professional license where one is required, or an attempted transfer in violation of the agreement.

Setting the price

Whatever method is chosen, the agreement should state whether discounts for lack of control or lack of marketability apply, because that single question can move the number substantially.

Funding the obligation

1. Cross-purchase life insurance. Each owner insures the others and uses the proceeds to buy the deceased owner’s interest. Simple with two owners; the number of policies grows awkwardly as owners are added.
2. Entity-purchase insurance. The company owns policies on each owner and redeems the interest. Administratively simpler, with different tax and basis consequences that belong with the accountant.
3. Disability buyout coverage for the disability trigger, which life insurance does not address.
4. Installment payment over a defined term, evidenced by a note and secured by the interest being purchased, where insurance is not available.
5. A combination — insurance for what it covers and installments for the remainder.

What happens if an owner becomes incapacitated

Death is planned for. Incapacity usually is not, and it is more disruptive because nothing is resolved — the owner is still an owner, still holds voting rights, and still has to sign things that now cannot be signed.

What stops working

• Checks and transfers requiring that member’s signature
• Any decision the operating agreement requires unanimous consent for
• Loan documents, lease renewals and guaranties the lender expects that owner to sign
• Tax filings and elections requiring a member signature
• Access to accounts, systems, vendor relationships and passwords held by that person alone

Without authority in place, the company’s options narrow to an Article 81 guardianship proceeding — a public court case, brought while the business is already struggling, with a court evaluator, a hearing and continuing supervision afterward. The guardian is then a stranger to the business with fiduciary duties to the incapacitated person rather than to the company.

Layered planning

1. A power of attorney with express business authority. New York’s statutory short form can be supplemented so an agent may vote a membership interest, sign company documents, deal with the company’s bank and act on tax matters. Generic forms often are not adequate here, and banks scrutinize them.
2. Operating agreement provisions on incapacity. Who manages, how incapacity is determined, whether voting rights are suspended, and how long the arrangement lasts before a buyout trigger takes over.
3. A definition of disability that someone can actually apply. A physician certification standard, a defined period of inability to perform duties, or a determination by the other owners under stated criteria — not a term left undefined.
4. Practical continuity. A second signer on the operating account, documented access to systems and records, and a written description of what the person actually does day to day.
5. Disability buyout funding where a permanent exit becomes the outcome.

These provisions are drafted alongside the owner’s personal documents. See estate planning for the powers of attorney and health care directives that sit on the personal side of the same problem.

What happens to a business interest at death

Three sets of documents compete to answer this question, and they are frequently inconsistent with one another.

The order of operations

1. The operating or shareholder agreement comes first. If it restricts transfers, grants the company or the other owners a purchase right, or obligates a buyout at death, that governs. A will cannot give away what the owner had already agreed not to transfer.
2. Then the will or trust directs whatever interest actually remains transferable.
3. Then New York’s default rules apply to whatever neither document addresses.

Where the agreement is silent, the result is often that the estate or the heir receives an economic interest — a right to distributions — without becoming a member with voting and management rights, unless the remaining members consent. The family ends up holding a stake they cannot control, cannot vote, and cannot readily sell to anyone, while the surviving owners decide whether to distribute anything at all.

Practical consequences the family faces

• Valuation for estate tax purposes. A closely held interest has to be valued, and the value used for tax may differ from the buy-sell price unless the agreement is structured to be respected for that purpose — a technical area worth addressing at drafting.
• Liquidity. Estate obligations may come due before the business interest produces any cash, which is a principal reason buyouts are funded with insurance.
• Basis. An interest passing at death generally receives a new basis, which affects what a later sale produces.
• Authority to act. An executor or trustee needs authority to deal with the interest, and the governing documents may or may not recognize that authority.
• Continuing personal guaranties. A deceased owner’s guaranty of company debt may remain an obligation of the estate, so the estate stays exposed to a business it no longer controls. Release should be negotiated as part of any buyout.

The firm reviews the entity documents and the estate documents together, which is the only way this gap gets found before it matters. See probate and estate administration for what the estate side of this looks like.

Succession planning for a family-owned business

Succession is not a document. It is a decision about who runs the business next, followed by several years of making that decision workable.

The three questions, in order

1. Who will run it? Management is a job, and the person who can do it is not always the oldest child or even a family member. Sometimes the honest answer is a key employee, an outside manager, or a buyer.
2. Who will own it? Ownership and management are separable. Non-participating children can hold economic interests without voting rights, or can be provided for outside the business entirely.
3. How do the others get treated fairly? Equal and fair are different words. A child who worked in the business for twenty years and a child who did not are not similarly situated, and pretending otherwise generates the disputes that break families.

Tools

• Voting and non-voting interests. Control concentrates with the successor while economic value is spread among the children. Available for LLCs and, within limits, for corporations.
• Life insurance to equalize. The business goes to the child who runs it, and insurance proceeds go to the others, so nobody has to sell the company to be fair.
• Staged transfers. Interests transferred over years while the senior generation retains control, with the transfers documented as they occur.
• An employment agreement for the successor defining the role, compensation and what happens if it does not work out.
• A written transition plan with a timeline, defined responsibilities and dates by which authority actually shifts.
• A sale — internal to management, to a third party, or in stages — where no family successor exists and pretending otherwise would waste the value.

Key-person risk

In many family businesses, one person holds the customer relationships, the vendor terms, the pricing knowledge and the licenses. If that person leaves suddenly, much of the enterprise value leaves with them. Reducing that exposure — documenting relationships, cross-training, distributing signing authority, insuring the risk — is part of succession work and directly affects what the business is worth to a buyer or to the next generation.

Contracts: formation, review and disputes

Most of the contract work that reaches this firm arrives in one of two states: a deal about to be signed that nobody has read closely, or a deal that has already gone wrong. The first is much cheaper than the second, and the difference is usually a few hours of review.

What has to be in writing

New York’s statute of frauds is narrower than people assume — plenty of oral agreements are enforceable — but two categories matter constantly in small-business work. An agreement that by its terms cannot be performed within one year must be in a signed writing. So must anything creating or transferring an interest in real property, including a lease for more than one year and a contract to sell. Courts can enforce an oral real property agreement where there has been part performance unmistakably referable to it, but that is a remedy for people who are already in litigation, not a plan.

Contracts for the sale of goods sit under the Uniform Commercial Code rather than the common law, which changes the formation rules, what happens when the forms do not match, and the remedies. Which body of law applies to a mixed deal — equipment plus installation, software plus services — is a real question and it usually decides the case.

The clauses that decide what happens when it goes wrong

• Payment terms tied to defined milestones rather than to satisfaction
• Scope and change orders, so extra work is billable rather than argued about
• Termination — for cause, for convenience, and what is owed on each
• Limitation of liability and consequential damages, which is where the real money is decided
• Indemnity and insurance, matched to each other rather than drafted separately
• Forum, governing law and fee-shifting — New York does not award attorney’s fees to the winner unless a statute or the contract says so, so a fee clause is often the difference between a claim worth bringing and one that is not
• Personal guarantees, which owners sign more often than they realize and which survive the company

When a contract is breached

The limitations period for breach of contract in New York is six years, which sounds generous and misleads people: the evidence decays long before the deadline does, and a shorter period may apply where the UCC governs or where the contract itself shortens it, which contracts are allowed to do. The first questions are what the agreement actually says, what the parties did afterward, what was communicated in writing at the time, and whether the other side has anything worth collecting. That last one is asked first here, because a judgment against an empty company is an expensive piece of paper. See judgments, liens and collection.

Family real estate, LLCs and FLPs

Families hold real property in entities for reasons that are usually sound: liability separation, a structure for multiple owners, an orderly way to transfer interests over time. The structure has to be built with the family’s other planning in view, or it creates as many problems as it solves.

Why an entity

• Liability separation. Rental and commercial property held in an LLC separates the property’s liabilities from the owners’ personal assets, provided the entity is respected in practice — separate accounts, adequate insurance, leases in the entity’s name, no commingling.
• Multiple owners with a rulebook. An operating agreement supplies the decision process, the funding obligations and the exit mechanism that co-ownership by deed does not, and it can head off the partition dispute that otherwise arrives.
• Transfers in increments. Percentage interests can be transferred over years, which a deed cannot practically do.
• Continuity. The entity keeps holding the property when an owner dies, so the deed does not have to be re-recorded and the leases do not have to be reassigned.

Family limited partnerships and family LLCs

An FLP or a family LLC concentrates control in a general partner or manager while limited or non-managing interests are transferred to the next generation. Because the transferred interests lack control and are not readily marketable, they may be valued for transfer tax purposes at less than a proportionate share of the underlying property. That treatment depends on the structure being genuine and respected, on a real business purpose, on the formalities being observed, and on the senior generation not retaining benefits inconsistent with the transfers. These structures draw scrutiny and the valuation work belongs with a qualified appraiser.

What to check before putting property into an entity

1. The mortgage. Most mortgages contain a due-on-transfer clause. Lender consent should be obtained rather than assumed.
2. Title insurance. A conveyance to a new entity may affect coverage under an existing policy.
3. Property tax exemptions. STAR, veterans and senior exemptions generally depend on individual ownership and occupancy, and transferring a residence to an entity can forfeit them.
4. Basis and gain. How the transfer and any later sale are treated, and whether a step-up at death is preserved or lost.
5. Medicaid planning. A transfer of an interest may be treated as a gift for long-term-care purposes. See elder law and Medicaid planning before any transfer is made.
6. Insurance. Policies have to name the entity, or a claim can be denied.
7. Publication. A newly formed New York LLC still has to satisfy the publication requirement.

Documents to bring

The first meeting goes faster and produces better advice if you bring whatever you have of the following. Missing items are normal — bring what exists.

• Formation documents — articles of organization or incorporation, and the certificate of publication
• The operating agreement, shareholder agreement or partnership agreement, with every amendment
• Any existing buy-sell agreement, whether standalone or inside the governing agreement
• A current list of owners and percentages, and any prior transfer or admission documents
• The last three years of business tax returns and current financial statements
• Life, disability and key-person insurance policies, with owner and beneficiary information
• Leases, loan documents and every personal guaranty any owner has signed
• Deeds for real property the business owns or occupies, plus mortgage statements
• Each owner’s will, trust and power of attorney
• Employment agreements, non-competition covenants and any deferred compensation arrangement
• Licenses, franchise agreements and any regulatory approvals the business depends on

What working with the firm looks like

1. Free initial consultation. A phone call or a half-hour meeting to understand the business, who owns it, who runs it, and what is prompting the call.
2. Document review. Formation filings, the operating or shareholder agreement and every amendment, leases, loans and personal guaranties, insurance policies, and the owners’ existing wills, trusts and powers of attorney.
3. A gap analysis. Where the entity documents and the personal documents contradict one another, where a trigger has no mechanism, and where an obligation exists with no funding behind it.
4. A written recommendation and a fee quote. What should be drafted or amended, in what order, what it costs, and what can reasonably wait.
5. Coordination with your accountant and insurance advisor. Valuation method, tax classification, insurance ownership and beneficiary designations have to match what the agreements say.
6. Drafting, negotiation and execution. Agreements prepared, explained to each owner in plain language, negotiated where interests differ, and signed with the required formalities.
7. Implementation and periodic review. Interests assigned, filings made, insurance placed, and the package revisited when an owner changes, the business changes, or the governing rules change.

Frequently asked questions