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Understanding & Drafting LLC Operating Agreements (with WealthDocx®) A presentation for the WealthCounsel ® Forum in Denver October 12, 2011 Peter J. Parenti,

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Presentation on theme: "Understanding & Drafting LLC Operating Agreements (with WealthDocx®) A presentation for the WealthCounsel ® Forum in Denver October 12, 2011 Peter J. Parenti,"— Presentation transcript:

1 Understanding & Drafting LLC Operating Agreements (with WealthDocx®) A presentation for the WealthCounsel ® Forum in Denver October 12, 2011 Peter J. Parenti, JD, LL.M (taxation)

2 Your Materials PDF Portfolio Individual PDFs Slide deck (handouts)

3 Agenda Intro to LLCs - background & law Overview of structural options: Types of LLCs Members and managers Jurisdiction considerations Uses of LLCs (gifting, asset protection, going concerns) Tax treatment & design options Transferring interests: buy-sell provisions in (VERY) brief A look at the WealthDocx® Interview WDx coming attractions Discussion/Wrap-up

4 Housekeeping Agenda timing - we probably got it wrong Speak up! This is a conversation, too. About the breaks? Ideas welcome!

5 Intro to LLCs Creatures of state statute Extremely flexible Few record keeping requirements Origins in partnership law Limitation on liabilities (VERY jurisdiction-specific)

6 1822 NY Statute - enable investors to limit liability exposure to investments (birth of LPs) 1916 - ULPA finalized; created uniform law for managing LP relationships, defining creditor rights 1976 - Revised ULPA (RULPA) finalized Intro to LLCs Origins of LLC law

7 1977 - Wyoming enacts first state LLC law Eventually enacted in all 50 states (far from uniform) 1995 - ULLCA finalized, amended 1996. 2006 - fully revised; dubbed “Re- ULLCA” Intro to LLCs Origins of LLC law

8 Now - Re-ULLCA substantially adopted in: ID, IA, NE, WY Re-ULLCA pending in: D.C., IN, KS, UT Intro to LLCs Origins of LLC law

9 Intro to LLCs About Re-ULLCA Elevated importance of operating agreement Not-for-profit LLCs okay More management flexibility (boards) Explicit duties of loyalty, due care Analogous to corporate directors

10 Intro to LLCs About Re-ULLCA “Shelf” LLCs valid Charging order as exclusive statutory remedy Foreclosure right on charging orders (Judicial limitations may remain)

11 Interlude: What’s a Charging Order? Charging order (protection): refers to creditor’s statutory relief against debtor member; does not admit creditor as LLC member; equals assignee interest (financial rights only) Treated very differently in various jxns

12 Overriding Assumptions Not a “basic” course Assume understanding of key estate planning & wealth transfer issues Assume limited understanding of partnership tax, accounting, LLC law nuances

13 Inside Liability: claims arising against the LLC, or among the members in the LLC Outside Liability: claims arising against a member from non-LLC related activity Intro to LLCs A few key terms

14 Intro to LLCs Separate legal entity - a legal “person” LLCs have own rights, limitations, creditors, etc. Members have no interest in underlying property; own interest in entity itself Operational life not limited to members’ lives (making succession planning essential)

15 Intro to LLCs Not subject to corporate record keeping requirements No “minutes” requirements, bylaws, regular meetings of interest holders, etc. Beware of this trap!

16 Intro to LLCs The players Manager (or managing partner/s) Oversees operations of LLC May be a member (but need not be) Unlike GP, has no liability for LLC liabilities Duties imposed by law, operating agreement Entitled to compensation for services

17 Intro to LLCs The players Members Own interests in LLC No liability for LLC activities No right to participate in management/operation (except managing members) Restrictions on transferability of interest May (or may not vote) on LLC issues

18 Intro to LLCs The players Assignees No ownership right; financial interest only No right to vote on anything No liability for LLC activities No right to participate in management/operation (except managing members) Often arises with invalid transfer of membership interest or judgement

19 Structural Options Two basic forms: Multi-member LLCs (MMLLC) Tax as partnership, S-corp, C-corp (sole prop. only if members are H&W) Single-member LLCs (SMLLC) Tax as sole prop./ Disregarded Entity (DE), S-corp, C-corp (not as p’ship b/c no “partner”)

20 Member-managed: one or more (not necessarily all) members serve as managers Manager-managed: appointed manager(s), not necessarily members Managers may be individuals or entities Structural Options

21 Our general preference... Don’t rely on default member management; draft manager provisions into agreement When appropriate, use entity manager (i.e. Management Trust) Structural Options

22 Structural Options “Special Purpose” LLCs Wyoming Close LLC Member w/d only with consent of all other members Return of capital only with unanimous consent W/D member may only demand cash as return of capital LLC dissolved only by unanimous consent

23 Nevada Restricted LLC Assets in LLC may not be w/d during restricted period Limited access intended to drive discounts, further frustrate creditors Articles of Organization must opt in to restricted statute & state lock-in period Structural Options “Special Purpose” LLCs

24 Professional LLCs (PLLCs) Enables professional practice to enjoy limited liability & administrative ease of LLC structure Not all states, not all practices Structural Options “Special Purpose” LLCs

25 Series LLCs Assets, members, liabilities shielded within various series (isolating claims) Proper record keeping essential Valid in 9 states (see list in outline, p. 12) Beware jurisdictional nuances (e.g.,CA franchise tax on each series!) Structural Options “Special Purpose” LLCs

26 “Family” LLCs (FLLCs) All members in same family (or entities controlled by or FBO family members) Not legally different than business LLCs Beware tendency to cut corners! (we’ll cover in detail under §2036 discussion) Structural Options “Special Purpose” LLCs

27 LLC Tax Choices LLC tax flexibility... Disregarded entity/sole proprietor Partnership (Subchapter K) Subchapter S corporation Subchapter C corporation

28 LLC Tax Choices Sole Prop./Disregarded Entity Wholly owned by one individual, or Wholly owned by H&W (Note: DOMA applies) “Disregarded” as separate taxpaying entity under Fed. Income Tax Laws Pass-through treatment

29 LLC Tax Choices Sole Prop./Disregarded Entity Pass-through... All income, gains, losses, pass through entity (not separately taxed); items taxed as if held by individual owner Subject to tax treatment at owner’s level

30 LLC Tax Choices Sole Prop./Disregarded Entity Pass-through... Contributions/distributions of property not taxable event LLC debts and expenses may be taken as deduction for owner

31 LLC Tax Choices Sole Prop./Disregarded Entity Benefits: Simplicity Flexible use of assets Inside basis step-up on 3d party acquisition Limited Liability

32 LLC Tax Choices Sole Prop./Disregarded Entity Limitations: No employee equity benefits (ESOPs, ISOs) No choice of tax year (calendar only) All earning subject to Self- Employment Tax (SET)

33 LLC Tax Choices Partnership (Sub-K) Roots in “aggregate” theory: Separate legal entity, but taxed as an “aggregation” of individuals. Results in pass-through treatment; entity not separately taxed Flexible allocation options per ULPA, RULPA, IRC §704(b) Special Allocations (discussed in greater detail in next section)

34 LLC Tax Choices Partnership (Sub-K) Partnership tax treatment available for LLCs following Rev. Rul. 88-76 LLCs had to meet requirements of the old Kintner Regulations Much easier with newer “check the box” Regulations (Kintner & check the box discussed in next section)

35 LLC Tax Choices Partnership (Sub-K) Benefits: Pass-through tax treatment Flexible allocation of gain & loss Inside basis step up on sales or transfers at death (IRC § 754)

36 LLC Tax Choices Partnership (Sub-K) Limitations: No employee equity benefits (ESOPs, ISOs) Certain events can trigger gain from sale of interests, deemed termination of LLC Disproportionate distributions can trigger unwanted tax consequences

37 LLC Tax Choices Subchapter S Pass through entity treatment More stringent requirements for who can participate Only one class of stock No more than 100 shareholders Must be U.S. citizens or residents Generally no entities, except QSSTs, some estates, 501(c)(3)s

38 LLC Tax Choices Subchapter S No special allocation; pro-rata only No IRC §754 Elections Post-formation contributions of capital triggers gain to contributor Distribution of property to member triggers gain Member may include LLC debt only to extent of actual loans by member to LLC

39 LLC Tax Choices Subchapter S Benefits: Pass-through tax treatment Fairly clear rules for restricted stock & stock options for members (IRC §421) Limited Liability

40 LLC Tax Choices Subchapter S Limitations: Restrictions on eligible equity participants (often not an issue) Only one class of equity participation (often IS an issue) Possible to accidentally lose S-corp status by invalid transfer

41 LLC Tax Choices Subchapter C NOT Pass through; entity taxed as separate taxpayer Entity taxed on gains (deductions on losses) Members taxed on distributions Treated under “Entity theory”: Entity is legal owner of property Shareholders only own interest in entity

42 LLC Tax Choices Subchapter C Benefits: Required for publicly-traded entities Clear rules for employee benefits Multiple levels of stock ownership Limited Liability

43 LLC Tax Choices Subchapter C Limitation: Double taxation (entity + shareholder) can be very costly

44 Overview of Asset Protection Issues Basic asset protection issues Inside Liability - Claims against the entity itself; claims among the members (“inside” the company) Outside Liability - Claims against a member from “outside” (i.e., a third party creditor)

45 Overview of Asset Protection Issues Liability limitation by statute Inside liability: Members not personally liable for claims against LLC Exposure limited to interest in LLC LLC itself responsible for claims against entity

46 Overview of Asset Protection Issues LLC should contain adequate assets/maintain adequate insurance to satisfy legitimate claims Failure to maintain sufficient assets may lead to veil pierce, trigger equitable relief

47 Outside liability: Non-debtor members not liable for claims against other members Judgment creditor’s relief against debtor member is limited to the charging order Obtains rights of assignee: financial rights only Overview of Asset Protection Issues

48 Asset Protection How clients mess it up No protection from: Claims arising before LLC formed Malfeasance “Super creditors” (IRS, SEC, EPA, FTC) Veil pierce if LLC not treated like real entity, alter ego, etc. Remedies vary greatly by jurisdiction

49 Asset Protection Designing LLC for Protection Entity manager Voting restrictions Limitation on withdrawal from entity Limit ability to demand distributions Limit on transfer of interests

50 Asset Protection Designing LLC for Protection Mandatory additional capital contributions Redemption of interest subject to charging order Multiple layers of entities (e.g., LLC owned by series of other trusts, LLCs, corp.) Isolating assets, liabilities Multiple entities, series LLCs

51 Asset Protection Designing LLC for Protection Limit on liquidation provisions Convertible interest (e.g., “downgrade” to limited interest in case of claim etc.) NOTE: restrictions also can drive down valuation, open arguments for inclusion under §2036

52 Charging Orders See outline §2.09 & Part V No access to “non-economic rights” (e.g., voting, rights to information, rights to manage) No right to force liquidation or distributions Liable for ratable income, gain, tax liability (i.e., “phantom income”)

53 Charging Orders Strength of protection depends on jurisdiction (see table at Part XIV of outline) Some explicitly prohibit foreclosure, equitable remedies Not likely available for SMLLCs Intended to protect non-debtor members from becoming unwitting partners with others’ creditors (Olmstead, Albright)

54 Charging Orders Recall - Re-ULLCA would statutorily allow foreclosure of charging order! Business-friendly states should consider cutting from LLC law

55 Charging Orders Functions as lien against debtor’s LLC interest Distribution allocation to debtor member pays to creditor/assignee Assignee treated as substituted partner/member for income tax purposes (Rev. Rul. 77-137)

56 Dealing with Charging Orders Disproportionate distributions Breach of fiduciary duty? Making loans to members Document it! Limit distributions to contributing members Establish different classes of members/partners Preferred & common (not for S-corps)

57 Asset Protection LLCs/entities best with other tools Adequate liability insurance Statutory exemptions Vary dramatically by state Separate property trusts

58 Fighting Fraudulent Conveyance Claims Interests reasonably reflect member value contributed (equivalent value) Adequate insurance to cover claims Adequate assets left OUTSIDE of entity (maintain solvency) Preserve entity for other partners/members (fairly weak)

59 Funding the LLC State law issue: Funding in entity name, or is name of manager required?

60 Funding the LLC Business interests Transfer existing business by assignment of stock, stock power, etc. Consider segregating operations, receivables, assets in separate entities

61 Funding the LLC Business equipment Transfer by assignment, bill of sale Lease to operating LLC Planning opportunity - gift business equipment LLC to children’s trusts, lease payments fund trust without additional gift

62 Funding the LLC Cash Transfer by retitling account into LLC name Proper TIN/EIN for account (use LLC’s)

63 Funding the LLC Installment notes Transfer by assignment, lien transfer (with notice) If note is tax deferred (IRC §453), later transfer of LLC interest triggers tax on deferred gain

64 Funding the LLC Life insurance LLC-owned as alternative to ILIT May not get full removal from estate, but may get reduction Exception to transfer-for-value rule - transfer to insured or “partner” of insured (IRC §101(a)(2)(B))

65 Funding the LLC Life insurance - annual gifts thru LLCs Pay premium gift to LLC: More accounting intensive (managing capital accounts, paying premiums) Capital account “Crummey” powers Grant immediate w/d right like ILIT Crummey

66 Funding the LLC Marketable securities Gifted shares held by partnership at death of partner retain original basis Must comply with IRC §§351(e) and 721(b) Transfer account by registration

67 Funding the LLC Closely-held securities Must comply with bylaws of company IRC §1244 (small business) stock loses tax favorable treatment

68 Funding the LLC S-Corp stock Partnership not permitted shareholder; will convert to C-corp taxation for corp BUT - LLC wholly owned by permitted shareholder may own S- corp stock

69 Funding the LLC Real estate Environmental concerns - support entity management, especially if LLC business generates contaminants (agribusiness, pharmaceuticals, etc.) Make sure donor pays reasonable rents for use of contributed property Potential property tax increase (CA Props. 13, 58)

70 Funding the LLC Encumbered property Contribution likely triggers due- on-transfer clause If encumbrance > basis, transfer to LLC triggers gain

71 Funding the LLC Personal residence Make sure donor pays reasonable rents for use Likely loss of homestead exemption (avoid in jxns w/ adequate homestead protection) Consider transfer to LLC with retained LE

72 Funding the LLC Retirement Accounts DON’T DO IT! Transfer loses tax deferral, accelerates tax liability

73 Funding the LLC Layering entities to isolate high-risk assets (planes, cars, ATVs, boats) Another opportunity for series LLCs

74 Family LLCs Often used to achieve tax-leveraged transfers (thru discounted interests) Pure tax motives generally fail Structure the FLLC (or FLP) carefully & treat as business

75 FLLCs Non-tax benefits (& objectives) Protect family assets Provide structure to train children how to manage wealth Create framework for asset management Maintain predictability, control Consolidate assets & institutionalize investment strategy

76 FLLCs Non-tax benefits (& objectives) Preserve “heirloom assets”, vacation properties, etc. Provide more efficient transfers (LLC interests instead of fractionalized assets) Protect family wealth from children’s divorces Provide planning flexibility

77 FLLC or FLP? LLC provides asset protection to all; LP must have general partner, who is exposed (LLC 1, LP 0) LP and LLC interests generally not subject to foreclosure; charging orders only (tie; LLC 2, LP 1) More case history for LPs (LLC 2, LP 2) Possible §2704(b) valuation issue for LLC if transfer restrictions stricter than state law (no point; depends on state law)

78 Break

79 Valuation 3 important concepts Value determined by hypothetical “willing buyer, willing seller” Gift tax computed on value received, not on underlying asset value Estate tax computed on value held by decedent at death, not on value transferred to others

80 Valuation Hypothetical buyer/seller - value computed on what was actually transferred, not the impact of the transfer on donor/recipient Seeks to determine true economic value as going concern, not valued on underlying assets (“liquidation value”)

81 Valuation FMV determined using all relevant factors Fair appraisal of assets Appraisal of entity’s earning capacity Starts with “pre-discounted” value

82 Valuation Holding companies (not operating businesses) Often valued on net asset value Operating companies Factor earnings capacity IRS tendency - choose the one that results in highest value!

83 Valuation Going concern value Capitalize past & projected net earnings Acknowledges member’s financial interest; no ownership of underlying assets

84 Valuation Not a going concern... Interest considers value of contributed assets & potential distributions Various discounting theories (following slides)

85 Valuation Discounting Restricted securities - discount applies for stock that can’t be sold without registration Portfolio discount - for non-diversified entity portfolios Blockage, absorption - factors time required to absorb large block of securities Fractional interest Promissory notes - look to collateral value, interest rate, risk of default, etc.

86 Valuation Discounting Lack of marketability - less attractive, more difficult to sell Minority Interest/Lack of Control - also applies to restricted or non- voting interests

87 Valuation Premiums Control premium - looks to level of influence interest holder has over entity Can holder unilaterally influence entity operations, management, etc.? “Implied Control” - Strangi case: looks at facts and circumstances to determine whether decedent had control, despite entity structure, documents

88 Valuation Premiums Control premium - Hackl case: Member/partner retained so much control (limited interests so restricted) that annual gifts of entity interest didn’t qualify for §2503(b) annual exclusion GP/management could manipulate entity to point that limited interests had no present substantial economic value

89 Valuation §§2701-2704 - apply only to transfers among family members

90 Valuation §2701 - gift tax valuation rule Generally best to structure family gifting entities with one class of interest Voting/non-voting can still be one “class” Section applies when donor had interest in property both before and after gift, and donor retained right to receive pmts not based on percentage ownership held

91 Valuation §2702 - gift tax valuation rule Special rules for determining value of trust retained by donor GRAT, GRUT, GRIT, QPRT Does not apply to LLCs, LPs

92 Valuation §2703 - governs leases, buy/sell agreements among family members Disregards sell & use provisions unless restrictions are comparable to arms-length transactions Is there a valid business purpose for restriction? Is the limitation a tax planning “device”? Is the price comparable to arms-length transactions?

93 Valuation Who is “family” for purpose of Chapter 14? “Natural objects of one’s bounty” (Reg. §25.2701-2(b)(5))

94 Valuation §2704(a) - lapsing rights Occurs when presently-exercisable right is restricted or eliminated Transfer of minority interest by controlling owner not treated as lapse

95 Valuation §2704(a) applies if... There is lapse of voting/liquidation right, and Individual holding right immediately before lapse and one or more family members hold before & after lapse control entity Impact - lapse of right treated as transfer

96 Valuation §2704(b) - applicable restrictions Limitation on ability to liquidate entity that is more restrictive than applicable state law If restriction lapses after transfer to family member, or transferor or family member (alone or together) has right to remove liquidation restriction

97 Valuation §2704(b) - does not apply if: Restrictions arises through financing or participation by non- family member, so long as restriction is commercially reasonable; or If the restrictions on liquidation are not grater than required by state law.

98 Valuation §2704(b) - impact: transferred interest subject to restrictions are valued as if restriction does not exist (removes discount)

99 Valuation Penalties Substantial overstatement of valuation ≥ 200% of correct value or adjusted basis claimed on return, and Results in > $5,000 underpayment of tax Penalty = 20% of underpayment

100 Valuation Penalties Estate or Gift Tax Understatement If value reported ≥ 50% of correct value Penalty = 20% of underpayment. Doubled to 40% if value claimed > 400% of actual value, or if only 25% of correct value is reported

101 Members, Managers, and Entity Managers GP or managing member responsible for operations GP personally liable for entity liabilities (LPs; not LLCs) In both cases, management fees appropriate for services rendered

102 Management Individuals or entities as managers? In LP, individual exposed to GP liability; may protect with entity Much less of an issue depending on asset mix In LLC, no exposure to manager liability In both cases, entity provides greater continuity of life

103 Corporation as manager Perpetual existence Compensation paid to directors of management corp Other benefits (stock options, etc.) available Tax choice of entity discussion applies Management

104 Corporation as manager Considerable complexity Tax returns, bylaws, meeting formalities Shareholders (use RLT) Concerns about piercing corporate vale. Management

105 Management Trust Revocable or irrevocable grantor trust Client may serve as trustee Client should not be beneficiary May receive compensation for management services, but shouldn’t be entitled to any beneficial interest As grantor trust, no additional tax return required Management

106 LLC as manager (or GP) Must provide perpetual existence; avoid unplanned termination of management LLC (thus terminating main entity) May have compensated employees (unlike management trusts) Tax flexibility (sole prop., partnership, S-corp, C-corp) May situs in any jxn (think asset protection, reliable case law) Management

107 Gift & Estate Tax Primary risk: inclusion of undiscounted value of contributed assets in transferor’s estate Argument centers on retained interest; IRS seeks (and often wins) alleging application of IRC §2036(a)(1) or (a)(2)

108 §2036(a)(1) Quoted in outline at 10.01 Paraphrase: Estate includes value of property transferred for less than full consideration, but where transferor retained possession or enjoyment, or right to income from transferred property

109 §2036(a)(1) Most success where IRS establishes poor entity structure, operations Decedent continued to treat entity property as personally owned Establish express or implied understanding to allow decedent to continue to enjoy property after transfer Does not have to be legally enforceable

110 §2036(a)(1) Notoriously bad facts Decedent commingling property (personal & entity) Paying expenses from commingled funds Directly receiving income from entity assets, operations Living in residence transferred to entity (without adequate rent)

111 §2036(a)(1) Markers of implied agreement Testimony establishing understanding of continued use Decedent enters into “business” dealings only with family members Improper/incomplete titling of assets, often by minority partners Incomplete or late loan payments Improper management of capital accounts Improper allocation of income on entity property

112 §2036(a)(1) Strangi Corporate GP had sole discretion over all distributions Corporate GP delegated authority to decedent’s son-in-law (decedent’s attorney-in-fact) Son-in-law made distributions to designated recipients Court found decedent retained “right to income”; controlled property through attorney- in-fact

113 §2036(a)(1) Strangi, citing Pardee “[§2036(a)(1)] does not require that the transferor pull the ‘string’ or even intend to pull the string on the transferred property; it only requires that the string exist.” Estate of Pardee v. Comm’r 49 T.C. 140, at 148 (1997)

114 §2036(a)(1) Strangi-cited factors of implied retained interest Transferred majority of assets to partnership (98% of all wealth) Continued to occupy property (residence in LP) Commingled assets Disproportionate distributions (he owned 99%) Entity funds used for personal (& estate) expenses Transaction “looked like” a testamentary arrangement

115 §2036(a)(1) Planning Points Transferor can serve as manager or GP (Mirowski) Tax savings are legitimate plan objective (Holman) Mechanics of formation & operation are essential! (Kelley, Holman, Mirowski) LLCs work too (even SMLLCs; not just LPs) (Mirowski) Maintain sufficient assets outside of entity

116 §2036(a)(2) Quoted in outline at 10.05 Paraphrase: Estate includes value of property transferred for less than full consideration, but where transferor retained right, unilaterally or with others, to control beneficial enjoyment of or right to income from transferred property

117 §2036(a)(2) Success often hinges on structure, not operations Often triggered by powers retained by managing member or GP

118 §2036(a)(2) Kimbell Expressly provided that GP had no fiduciary duty to LPs Exclusive authority to make distributions, with few guidelines in agreement Operationally, Kimbell did everything right

119 §2036(a)(2) Kimbell Inclusion under §2036(a)(1) & (2) Not arms-length transaction; Kimbell was “the only party” in partnership deal No bona fide sale for full & adequate consideration, so analysis of retained interest was unnecessary

120 Bona-fide sale exception Preempts application of (a)(1) & (a)(2) §2036(a) relies on a gratuitous transfer; doesn’t apply to bona fide sale

121 Bona-fide sale exception Entity should include actual business, or pooling of assets Formalities of formation, funding, operations should be carefully followed

122 Bona-fide sale exception Red flags Creating & funding entity shortly before death Not leaving sufficient assets outside of entity (leaving decedent insolvent) Funding with personal use property, especially without adequate lease & rents Operating entity for decedent’s personal use No adequate negotiation among partners

123 WealthDocx® LLC Assembly



126 Coming Attractions

127 Break

128 ETHICS BONUS (time permitting)

129 Ethical Issues Significant issues common to estate planning Potentially compounded with HNW/asset protection, & gifting strategies Are you competent? Who is client? Adequate representation for all parties? Conflict of interest? Enabling fraud?

130 Ethical Issues Are you competent? Model Rule 1.1 elements: Relative complexity & specialized nature of engagement Lawyer’s experience Training, experience in specific area Feasibility/advisability of referring to other counsel

131 Ethical Issues Are you competent? Getting competent Through study Through co-counsel with more experienced attorneys When law is unsettled, attorney must do adequate study to provide sound counsel If uncertain, document preparation & competency carefully

132 Ethical Issues Who is your client? Specify with engagement letter/agreement Consider stating (in writing) who is not your client (e.g., other family members, partners) Representing client as individual, or entity created? Both?

133 Ethical Issues Duty to Inform Document your recommendations in writing Use care to comply with Circ. 230 Don’t make promises of asset protection elements, discounts Document issues discussed, not specific outcomes Alert clients of advantages/risks of planning, failing to plan

134 Ethical Issues Engagement Letters Specify in writing: Identity of client (and non-clients) Scope of services to be performed Specifically excluded services (to prevent misunderstanding) Fee arrangement, payment schedule (including refundable portions if client terminates) Other probable costs (filing fees, etc.)

135 Ethical Issues Conflicts of Interest Often avoidable by good engagement letter NOTE: Rule 1.7 prohibits representing client if directly adverse to another client, unless lawyer reasonably believes representation will not adversely affect client relationship, and both clients consent after consultation

136 Ethical Issues Conflicts of Interest Waiving conflicts - Notify nature of conflict in writing to all “potential clients” Notify of remedies if conflict presents problem Obtain signatures from all involved Conflicts will ebb and flow during engagement; revisit periodically to avoid problems for clients, attorney

137 Ethical Issues Criminal or Fraudulent Activity Model Rule 1.2(d) - lawyer shall not counsel client to engage or assist client in conduct lawyer knows is criminal or fraudulent; may discuss legal consequences of any proposed course of conduct

138 Ethical Issues Criminal or Fraudulent Activity Civil and criminal penalties Document communications carefully Affidavit of Solvency Designed to provide attorney “CYA” Sworn statement by client that they retain adequate assets outside of entity; not insolvent by engagement

139 Ethical Issues Liability To Client: Duty + Breach of duty + Proximate cause + Damages = tort claim for malpractice

140 Ethical Issues Liability Generally not liable for failed asset protection plan if implemented correctly & according to prevailing law May be liable to others if creditor can establish that atty complicit in rendering client insolvent, facilitating fraud, etc.

141 Ethical Issues Liability To third parties In family/business engagements, consider notifying in writing who you do represent Liability may still attach despite lack of privity (see next slide) Punitive damages possible for facilitating fraud

142 Ethical Issues Liability To what extent was transaction intended to affect claimant? Was harm foreseeable? Degree of certainty of claimant’s injury? Causation “Moral blame” for attorney conduct? Policy to prevent future harm?

143 Ethical Issues Liability Criminal penalties If BK court can establish complicity in defrauding creditors, client and attorney may be prosecuted Fraud, or as aiding and abetting fraud Money laundering

144 Ethical Issues Liability Criminal penalties Withdraw from representation in writing, disaffirm work product

145 Ethical Issues Clear, consistent, written communication Ethical issues arise throughout engagement, not just at beginning Do homework, set appropriate expectations in writing, deliver on agreed-upon services As “situations on the ground” change, communicate clearly and in writing with all affected No substitute for clear, copious notes

146 Case Studies (Time permitting)

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