There are pros and cons to arbitration and alternative dispute resolution clauses, which are prevalent in contracts of all descriptions. Both processes are intended to provide a less costly and time-consuming way of resolving disputes using a neutral party. There are some significant caveats, however. The quicker and less formal factual discovery process is largely within the discretion of the umpire or arbitrator, and court rules of evidence and procedure don’t apply.
While the ADR Act allows a decision to be set aside on the basis of an error in applying the law, this is not the case with arbitration awards unless the arbitration clause so provides. The qualifications and knowledge of the umpire or administrator are important and unless addressed in the arbitration clause the parties may not have control over this issue.
In New Jersey, there are two separate statutes governing alternative dispute resolution and arbitration. There is also a Federal Arbitration Act which is intended to provide maximum enforceability of arbitration agreements. The ADR Act, as described below, was passed in 1987 in an attempt to correct some of the shortcomings of arbitration. See Comment, Alternative Dispute Resolution.
The New Jersey Alternative Procedure for Dispute Resolution Act (N.J.S.A. 2A:23A-1 et seq.) (“ADR Act”) applies in two circumstances: (i) where a written contract includes an advance agreement to settle disputes under the ADR Act or (ii) where the parties to a dispute agree in writing to use ADR, whether the controversy arose under a contract or not. Such an agreement constitutes a waiver of trial by jury and a waiver of rights to appeal, except as the ADR Act allows. An “umpire” is designated in accordance with the means specified in the contract, or if no such means is specified, by initiating a summary action in Superior Court to have an umpire appointed, The umpire has complete authority to decide all issues of fact and law. The courts will not consider any intermediate appeals unless there is a showing of manifest denial of justice or a party’s interests will be irreparably harmed.
Following a 60-day discovery period, the parties submit a written statement of their factual and legal position. The umpire holds a hearing. The rules of evidence that govern court actions do not apply and umpires are charged with “assuring the informality of the proceedings.” The umpire also can decide whether any expert witnesses are necessary. An award is issued by the umpire within the time set by the agreement or is no such time is set, by the Superior Court. Within 45 days thereafter, a party can apply to Superior Court for the award to be vacated, modified or corrected. There are very limited grounds for court review of the facts as determined by the umpire. If the Court finds that the umpire incorrectly applied the law, the court has the power to modify the award.
The Arbitration and Award Act (N.J.S.A. 2A:23B-1 et seq.) became applicable to all agreements to arbitrate dated after 2003. It applies to all agreements to arbitrate contained in a “record.” If there is a dispute over whether an agreement to arbitrate existed, the Superior Court makes the determination; however, the Court cannot refuse to order arbitration due to a claim lacking merit or failing to state a valid claim. An arbitrator may award “such remedies as the arbitrator deems just and appropriate under the circumstances”, and the award cannot be appealed on the basis that a court could not or would not grant the same relief, except for punitive damages or other “exemplary relief” and attorneys fees which can only be awarded if they could be awarded in a similar legal action.
There is no formal discovery in an arbitration; this is within the discretion of the arbitrator. While pre-trial discovery can be frustrating, the intent is to allow a full development and sharing of the factual background between the parties (which in itself facilitates settlement) rather than having the parties have to guess at the evidence that will be presented by the other party, without an opportunity to prepare.
There are some dramatic changes to the way LLC agreements are interpreted and enforced under the Revised Uniform Limited Liability Company Act (the “Revised Act”), which became effective in March 2013 for newly formed New Jersey LLCs and will apply to all New Jersey LLCs as of March 2014. N.J.S.A. 42:2C-91. A few highlights are provided below.
The Revised Act may “change the deal” among members even in existing LLCs, especially if there is no written operating agreement in place. For example, an LLC is presumed to be member-managed, and every member has equal rights in management unless the operating agreement provides otherwise.
It would be fair to say that one of the reasons LLCs have become so popular for small businesses is that they require fewer of the formalities required for corporations – shareholder meetings, elections of directors, and so on. On the other hand, lack of formalities and the very flexibility allowed by the Revised Act could make any disagreements among members more difficult and expensive to sort out. The Revised Act includes default provisions that make all members “equal” regardless of what percentage of capital they contributed to the company.
Oral and Implied Terms of Operating Agreements
As noted in other posts, the operating agreement among the members is the key governing document of an LLC. Until adoption of the Revised Act, “operating agreement” meant a written agreement. Now, it means “the agreement, whether oral, in a record, implied, or in any combination thereof.”
There are good practical reasons for the traditional requirement for agreements to be in writing, and to interpret a written agreement as expressing the final terms of agreement – replacing negotiations, prior incomplete drafts and so forth. Otherwise, the terms of an agreement might have to be reconstructed from many different records (visualize paying an attorney to pore over all of the e-mails between the parties), testimony, and whatever evidence would show an “implied” agreement (such as a pattern of conduct between the parties). It would seem that proving the terms of an agreement could be far more complicated now, especially with the “combination” language in the Revised Act, unless the agreement includes an express “merger” clause stating that it represents the final and complete agreement of the parties and only can be amended in writing signed by all parties. (This is an example of language that non-lawyers would not necessarily recognize as important.)
Member-Managed LLCs Have “Equal Rights” in Management Regardless of Ownership Percentage
A key section of the Revised Act is “Management of Limited Liability Company” (N.J.S.A. 42:2C-37). LLCs are presumed to be managed by the members – and every member has “equal rights in management”, per capita rather than by percentage ownership. In the former statute, members had the right to participate in management according to their percentage interest in the company. If you contributed 75% of the capital, you would be entitled to 75% vote on decisions and 75% of the distributions of profits.
Other language in the same section of the law may have been intended to clarify things by stating: “A difference arising among members as to a matter in the ordinary course of the company’s activities may be decided by a majority of the members.” Note, this does NOT say a majority of capital contributed. If you have an even number of members – say, two – even if you contributed different percentages, there will not necessarily be a “majority of members” to resolve disagreements.
Unanimous Agreement Required for Decisions Outside Ordinary Course of Business
Under the Revised Act, unanimous agreement by members is needed for decisions “outside the ordinary course of business,” again regardless of ownership percentage (in comparison, if certain decisions had to be approved by the shareholders of by a New Jersey business corporation, the presumption is that a majority of shares would decide the vote unless the Certificate or By-Laws expressly provide otherwise.)
Members have Equal Rights to Distributions Regardless of Percentage of Ownership
The Revised Act also changed the presumptions about sharing of profit distributions, if no written operating agreement is in place. Distributions are to be made equally to members, regardless of their capital contributions.
Review and Clarification of Operating Agreements is Strongly Advised
The items noted above are only a portion of the changes put into effect under the Revised Act. We strongly recommend that clients have their LLC agreements put into writing – or, if there is already a written agreement, have the agreement reviewed in light of the Revised Act.
When launching a small business, most people are not sure whether they need to form a company or not – and if so, should they form a corporation, or use another form such as an LLC. They also may be unsure whether they should organize under the law of their “home state” or choose another state, such as Delaware.
The reasons for forming a company are generally understood – limiting liability (keeping your personal assets, other than those you specifically put into the business, safeguarded from business losses). A professional-seeming business presence can be another reason.
It can seem deceptively easy these days to “do it yourself” in setting up a company. Many states including New Jersey have created user-friendly web sites to help you get things underway. In the excitement of getting the business launched, legal documentation and expenses may seem like a boring distraction. Commonly we see people take the first step – filing a certificate to set up a corporation or an LLC – without realizing that there are other crucial steps to completing the set-up of the company. Even with the best of intentions, if postponed at the beginning, those actions have a way of continuing to be postponed indefinitely.
Completing the organizational process for a company is surprisingly complex, even if you are the sole owner and contributor. If others are investing in your business, then you REALLY owe it to yourself (and to them) to answer questions about the company’s operation before money changes hands. A business plan is a crucial first step. In New Jersey, help and mentoring is available from various sources. The following link is an 80-page Guide to Doing Business in New Jersey that is thorough and helpful: http://www.nj.gov/njbusiness/pdfs/Doing_Business_in_New_Jersey08.pdf. This guide addresses many issues beyond writing a business plan, including basics of setting up a company, resources for funding, suggested topics that should be covered in governing documents, several pages on franchises, and ongoing requirements once your business is launched, depending on how you conduct business (for example, if you have employees, you will have responsibilities for unemployment insurance, workmen’s compensation, and income tax withholding).
Corporations, partnerships and LLCs have different organizing steps and documents, and the steps as well as the legal framework are different in different states. Corporations have more formalities on an ongoing basis which it’s important to keep up with (even if they seem silly – like the sole owner, each year, re-electing himself director and president). Corporations are governed according to by-laws (different from the certificate filed with the state). LLCs are more flexible – potentially either a good or bad thing, as failure to spell out details in an operating agreement (again, different from the certificate filed with the state) will leave more legal questions open than would be the case with a corporation. While a company formed in one manner (corporation, LLC, etc.) generally can convert to another, it’s not simple or inexpensive so making the right choice at the outset is preferable. This link from New Jersey’s business website lists some of the pros and cons of each. http://www.nj.gov/njbusiness/starting/basics/business_basics.shtml
In choosing what state to organize in, it’s important to be advised on the differences in the law between one state and another, and make sure your documents follow suit. Delaware has a well-developed background and is often chosen for an interstate business, or to facilitate the eventual sale of the company. Most public companies are organized in Delaware. The following link is their pitch for using Delaware: http://corp.delaware.gov/pdfs/whycorporations_english.pdf However, there are additional costs involved, such as maintaining a Delaware “registered agent.” In addition, an out-of-state company is required to file for authority to do business in their “home” state, and possibly other states in which the company maintains an office or does business.
The recommended terms of governing documents need to be tailored to the state law. While each state would include certain common elements, others are state specific and therefore there is no one-size-fits-all form.
The prospective owners of a company, whatever form you choose, each should have the opportunity for an independent review of the governing documents and should sign a subscription agreement.
In these days of Facebook, LinkedIn, Twitter and large numbers of contacts it may seem natural to use this means to publicize your business launch and perhaps invite investment. Beware!
In general, federal and state securities laws do not permit businesses to offer or sell interests in that business without “registration” of the securities or an exemption. There are piecemeal exemptions that have various limitations and requirements – such as, that all of your investors are financially sophisticated and able to bear the loss of their entire investment; that they have been provided access to the type of information that would be included in a registration statement; and so on. Other exemptions apply only to offerings within a certain state.
In proposed rules published on October 23, 2013, the United States Securities and Exchange Commission is opening up the possibility of raising capital from investors through a process known as “crowdfunding.” This describes raising small amounts of money from broad groups via the Internet. There would be a limit of $1 million raised within a 12 month period, and caps on how much each investor could invest depending on their financial situation. Certain facts about the company and its management and owners would have to be provided to the SEC, and the offering would have to be done through a registered “portal”. President Obama in 2012 signed into law the “JOBS Act” which, among other things, ordered the SEC to propose rules for this practice. The rules are now subject to a 90-day comment period, then will likely be revised.
The accompanying press release states in part:
Washington D.C., Oct. 23, 2013 —
As noted previously, the first step in setting up a new company, registering it with the state, may not seem so hard. The form is very short. In New Jersey it can be completed and submitted online. However, the crucial governing documents of a company are the terms adopted by the company to govern itself, within the parameters set by the law (for a corporation, the by-laws; for a partnership or limited partnership, the partnership agreement; for an LLC, the operating agreement.)
A web search turns up many companies offering corporate kits, and some will include sample by-laws or operating agreements (note, these still need to be completed and adopted – they are a form with blanks). In general, those forms are lacking in some of the most crucial particulars that are specific to your business and your relationship to any other investors or managers.
The by-laws, partnership agreement or LLC operating agreement are the governing documents that determine issues among the members and managers.
Just a sampling of the possibly awkward – but important- things to address:
(i) If a party is making a capital contribution of professional services, “expertise”, “time and effort” or the like, what is the dollar value being put on that contribution? What are the standards for amount of time invested (full time? part time? as needed?) and quality of the effort?
(ii) Is the company managed by a manager, or by the members? If the latter, and there is an even split of opinion on a matter, how will it get resolved?
(iii) Can a director/general partner/manager be removed? How and when?
(iv) Under what circumstances can an investor choose to, or be asked to, withdraw?
(v) Can additional owners be admitted? Who needs to consent to this? (Adding more owners raises working capital but “dilutes” each person’s ownership).
(vi) Who has authority to borrow money or to sign contracts for the company?
(vii) Are there going to be classes of membership, some of whom may receive different allocations, distributions or dividends than others?
(viii) Can investors sell their interests to anyone else? (usually, not)
(ix) What happens in the event of the death, disability, bankruptcy, divorce or other adverse event with an investor or manager? Will the company be dissolved? Do his heirs get his interest? Is there a buy-out?
(x) Does everyone share the same understanding about loaning the company money, versus making an equity investment? Have they acknowledged in writing that there is no market for their shares and no guarantee of receiving their investment back? Investors should sign a subscription agreement with these and additional disclosures, to help protect the company and its managers from charges of securities fraud.
(xi) Do you understand the parameters for trying to raise money from other people? In theory, you cannot offer or sell securities without a prospectus in a form prescribed by the United States Securities and Exchange Commission. While there are certain exemptions that fit most small-business situations, you have to know and stay within their boundaries. All certificates should bear a legend such as that below.
“THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO THE SECURITIES UNDER SUCH ACT OR AN OPINION IN FORM AND FROM COUNSEL REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED.”