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Choosing The Correct Business Entity

By | Articles, Business

Societies have conceived new business structures since time immemorial. Fundamentally, joining together with business partners spreads the demands of capital and limits risk.

Italians made family firms, compagnia, where fathers, brothers, and sons would pool their labor and capital. Fittingly, the name compagnia derives from the Latin phrase for the act of sharing bread, cum panis. Then, companies granted by royal charter arrived, like the East India Company, an import-export business who received special privilege from the Crown to pursue a monopoly on trade between London and Asia, with offerings varying from pepper to textiles to tea. The East India Company, the mother of the modern multinational corporation, pioneered the joint stock mechanism. That innovation allowed for separation of investors and managers, broadening the pool of capital; it also spread risk and provided limited liability, and it allowed the enterprise to trade on its own account, rather than in the names of the individual owners.

Now, with a few clicks and an electronic signature, anyone can form a business entity, securing the same limited liability separation between an entity and its owners as employed by corporate giants across America.

But which form of entity is right for your business?

For many business owners, the choice-of-entity decision is driven purely by tax considerations. But the two most prevalent forms, the corporation and the limited liability company (LLC), also offer sought-after advantages of: (i) limited personal liability, (ii) easy transfer of ownership, and (iii) management separation from ownership.

Certainly, the tax benefits are relevant, like the incentive to avoid double taxation or the substantial restrictions on entities under subchapter S of the tax code — but don’t miss the legal distinctions and historical context. The LLC is structurally different than a corporation. Today, many owners form LLCs, almost by default, without considering their unique attributes, such as: (1) the primacy of the operating agreement, and (2) the application of fiduciary duties.

First, owners should consider that the LLC is as much a creature of contract as of statute. As a result, once an LLC comes into existence and has a member, the LLC necessarily has an operating agreement, whether written, oral, or implied by law. The operating agreement plays a vital role, as it establishes the fundamental rules for the relationships between the LLC, its members, and any manager.

Even so, many business owners select the LLC form but never draft an operating agreement — or perhaps worse, draft one, but neglect to sign it.

On the other hand, a corporation is not driven by private contract between individuals. Rather, there is a body of statutory and common law that, in some ways, cannot be displaced. A corporation has been judicially defined as “an artificial being, existing only in contemplation of the law; a legal entity, a fictitious person, vested by law with the capacity of taking and granting property and transacting business as an individual. It is composed of a number of individuals, authorized to act as if they were one person. The individual stockholders are the constituents or component parts, through whose intelligence, judgment, and discretion the corporation acts.”

Second, the owners should consider the obligations they intend to impress on themselves and management; for example, owners should consider whether they can limit their fiduciary duties to simultaneously pursue other ventures.

Granted, the topic of fiduciary duties raises many of the most complex questions in the law of business organizations.

For the LLC, the primary issue is to what extent the members can privately agree in the operating agreement to vary or eliminate those duties. Although a contract cannot completely transform an inherently fiduciary relationship into a merely arm’s length association, the operating agreement has substantial power to “reshape, limit, and eliminate fiduciary and other managerial duties.” For example, the classic fiduciary “duty of loyalty” means: (i) not “usurping” company opportunities or otherwise wrongly benefiting from the company’s operations or property; (ii) avoiding conflict of interests in dealing with the company (whether directly or on behalf of another); and (iii) refraining from competing with the company. Members can agree, however, to tailor those limitations and allow a member or manager to engage in other business or compete with the company. On the other hand, corporate directors and officers are not free to contract out of their duties to shareholders.

The law of business organizations has continually modernized, providing us with accessible tools to limit personal liability. But, whether your company is in real estate or technology, simply holds investments or engages in long-distance trade voyages around the Cape of Good Hope, building upon the right legal structure is critical to its long-term success. If you or someone you know has questions about how to structure their business or investments, please call our office today to schedule a consultation with Andy Anderson.

Andy Anderson is an Attorney with Provident Law®. He serves businesses and individuals, counseling them as they form, operate, and protect their companies. He is a member of the State Bar of Arizona Subcommittee tasked with revising the Arizona Limited Liability Company Act. He also serves on the Board of Directors of the Christian Legal Society and he is a graduate of the James E. Rogers College of Law at the University of Arizona and the W.P. Carey School of Business at Arizona State University. Andy can be reached at andy@newnewprovidentlawyers.mystagingwebsite.com or 480-388-3343.

Property Owners Waive All Claims And Defenses Against Lender

Property Owners Waive All Claims And Defenses Against Lender After Foreclosure

By | Articles, Real Estate

Pursuant to Arizona’s deed of trust statutes, if a borrower defaults on her mortgage obligations, the lender may foreclosure non-judicially by recording its Notice of Trustee Sale with the County Recorder’s Office. See generally, A.R.S. § 33-801, et seq. Importantly, if the borrower believes that she has any claims or defenses against the lender concerning the loan, those claims must be filed before the non-judicial foreclosure takes place.

There are generally only three ways to stop a trustee sale:

  1. reinstate the loan by paying the outstanding balance or otherwise curing the default;
  2. file for bankruptcy protection; or
  3. file a lawsuit and seek an emergency temporary restraining order (TRO).

To be clear, reinstating the loan or filing for bankruptcy are the only guaranteed strategies to postpone a trustee sale; the filing of a lawsuit, on the other hand, is only successful if the Court:

  1. grants the request for a TRO; and
  2. enters the TRO sometime prior to the date and time of the trustee sale.

Based on recent history, it generally takes the Court about five business days to consider and enter a TRO. (Importantly, any lawsuit and request for TRO must have a good faith basis and is subject to sanctions pursuant to Rule 11, Arizona Rules of Civil Procedure.)

Pursuant to Madison v. Groseth, 279 P. 3d 633, 636 Ariz. Add. Rep. 23 (App. 2012), the failure to obtain a TRO prior to the trustee sale waives all claims against the lender (and the new owner), including any allegation that the lender failed to provide the borrower with proper notice of the trustee sale.

At first blush, the above holding appears inequitable and even unconstitutional – after all, how can the borrower object to lack of notice if the borrower doesn’t discover the wrongdoing until after the fact? In Madison v. Groseth, the Court of Appeals observed this potential paradox:

Under other circumstances, [requiring a borrower to obtain a TRO to halt the trustee sale] may apply to deprive borrowers of due process if the borrower does not receive sufficient notice of the trustee sale to obtain an injunction of the sale.

Id. at 635. The Court noted that in the present case, however, the borrower admitted that she received notice of the trustee sale yet failed to apply for a TRO to halt the trustee sale. Indeed, the borrower not only received notice of the trustee sale, but the borrower actually filed a lawsuit against the lender prior to the trustee sale and did not allege that she received inadequate notice of the sale. Consequently, the Court held that this waiver requirement did not deprive her of due process.

In conclusion, if a lender initiates the foreclosure process and the borrower believes that she has claims or defenses against the lender regarding the foreclosure process, the borrower must immediately file a lawsuit against the lender and request a TRO to halt the trustee sale or else the borrower will waive all claims against the lender regarding the alleged wrongful foreclosure.

Mr. Charles regularly represents lenders and borrowers in foreclosure matters. If you or someone you know has questions regarding foreclosures or buyer/lender disputes, please call or email today to speak with Mr. Charles.

Fair Housing Act

You’re Not in Kansas Anymore: A Cautionary Tale Concerning Real Estate Transactions in Arizona

By | Articles, Real Estate

This article was written by Christopher J. Charles, Esq. and Eric L. Walberg, Esq.

With interest rates hovering at historic lows and prices generally stable, many experts agree that now is still a good time to purchase real estate in Arizona. Everyone appreciates a good deal.  But some buyers approach that goal with the wrong strategy. For example, some buyers aim to keep “one foot in and foot out” in case a better deal comes along prior to close of escrow.  We refer to this as “buyer’s leverage.” Arizona is not unique in experiencing this phenomenon. But two of Arizona’s key contract interpretation rules could result in unintended consequences for the unwary buyer.

The first of these two unique rules is that the court cannot rewrite contract terms. On the other hand, the second rule allows the court to consider oral or other extraneous evidence outside the “four corners of the contract” in interpreting an agreement (i.e., a broad interpretation of the “parole evidence rule”). This article explores these Arizona-unique contract interpretation rules and their relationship to each other in the context of real estate agreements.

The ready, willing, and able buyer cannot maximize his leverage without an appreciation and impact of these two Arizona-unique rules on the following “boiler plate” contract provisions:

This agreement constitutes the entire agreement of both parties, and all previous communication between both parties whether written or oral with the reference to the subject matter of this agreement is canceled and superseded.

In the event that any provision of this agreement is deemed vague or unenforceable, the parties agree that the [judge/arbitrator] shall rewrite the provision to be enforceable and/or to reflect the intent of the parties.

Including the latter contract provision in an effort to insert “flexibility” and maximize “buyer’s leverage” could have the unintended consequence of bogging the buyer down in litigation, thanks to the above contract interpretation rules.

For example, a common issue addressed in real estate contracts is the financing contingency. The ready, willing and able buyer might wish to keep its “options open” by requiring that the financing contingency language be drafted in such a manner that he can “escape” the deal if another more advantageous deal comes along. The buyer can demand and may receive a rather vague financial contingency provision that on its face places little or no parameters on the source or terms of financing it might be required to pursue, believing that negotiating such vague terms might prevent the buyer providing more information about its efforts than it might want to divulge to the seller. By insisting on this “flexibility,” however, the buyer may unwittingly open itself up to litigation in Arizona because the seller is able to press the buyer to provide more detail about its efforts to secure financing than the buyer is accustomed to providing in other states. lf the buyer balks at providing this information, the unique contract interpretation rules in Arizona can provide the leverage to the seller against the buyer by asserting that either the brokers or parties involved in the negotiation of the agreement envisioned that the buyer would pursue a certain type of financing. In the end, the seller can claim that although the explicit terms of the agreement do not set forth what efforts the buyer must undertake or agree to, the parties cannot release the buyer from its contractual obligations by claiming a failure to obtain acceptable financing for the purchase of the real estate.

In the example above, the next move by the buyer might be to point out to the seller that the financing contingency language in the contract is so broad that the buyer need only claim the inability to obtain “acceptable” financing, and the contract is terminated. The problem with this approach is that it opens the door to the second Arizona-unique rule of contract interpretation: that court cannot rewrite the contract, notwithstanding inclusion of a contract provision expressly providing to the contrary. The seller will counter that the buyer is simply trying to insert certainty into a contract that did not contain certainty, something an Arizona arbitrator or judge cannot do. This would require the court to delve deeper into the “real intentions” of the parties, and to look to oral or other evidence outside the “four corners” of the contract. Ultimately, this results in a potentially vicious cycle of investigation into the contract that the buyer may never have envisioned at signing. Because the Arizona court cannot re-write the contract, there is no clear end game for either side.

The buyer’s leverage is a function of how many deals it can be involved with at any one time, and how motivated the seller is to close the deal to possibly become the ready, willing and able buyer himself. The dynamics of the real estate deal are rarely known by the parties and can change quickly. But often the parties (including brokers) fool themselves by believing they understand these dynamics. For example, the respective brokers or other agents (including legal counsel) can be fully informed of the motivations of both parties in entering the deal. But in the course of due diligence, the seller or buyer might be introduced to a totally unrelated alternative deal that they simply cannot pass up, making the closing (or failure to close) so important that they are willing to risk the relationship by killing (or forcing) the deal.

The moral to this story? Draft clear and complete contracts (including well-drafted amendments or addenda) to maximize the chance of smooth transactions and to reduce the risk of disputes or litigation.

If you or someone you know has questions regarding real estate contracts, please call today to speak with Mr. Charles.

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