Veil-Piercing Success Rate

Corporation and other limited liability business entities are often formed for the purpose of insulating the business's owners from liability. 

For example, a corporation engaged in a business that involves a high risk of liability, such as hauling toxic waste, might choose to operate the high-risk business through a wholly-owned subsidiary.  If the toxic waste spilled, injuring numerous people, the corporation would expect that only the subsidiary would be subject to potential liability for the spill and that the parent corporation's other assets would be free from claims by the injured parties.

An exception to the general rule of limited liability are in cases where the injured party successfully "pierces the corporate veil" thereby making the corporation's owners liable for the debts of the corporation.  Veil-piercing generally applies only in unusual cases, such as when the corporation's corporate structure is designed or used in a fraudulent way. 

Section 21.223 of the Texas Business Organizations Code provides that the owners of a Texas corporation cannot be liable for either (1) the corporation's contractual obligations on the basis of claims that the owner as the alter ego of the corporation or on the basis of actual or constructive fraud, a sham to perpetrate a fraud, or other similar theory, unless the corporation is used for the purpose of perpetrating an actual fraud on the obligee primarily for the direct personal benefit of the owner, or (2) any obligation of the corporation on the basis of failure to follow corporate formalities.

Although veil-piercing is the exception rather than the rule, an article in The Business Lawyer (November 2011 - citing a report published in 2009) noted that 23.5% of reported appellate decisions in Texas involving parent-subsidiary piercing claims were successful.  That high percentage of success probably reflects the fact that only the strongest veil-piercing claims are pursued all the way through  to appellate courts.     

Buyer Beware: Texas Comptroller Certificate of No Tax Due

If you are buying the assets of a Texas business (but not assuming any of its liabilities), you cannot be held liable for any of the business's liabilities, correct?

Wrong. A potential source of successor liability for the purchaser of a business is Section 111.020 of the Texas Tax Code.

If a business or stock of goods (inventory) of a business is sold, the purchaser will be liable for the seller’s taxes due to the Texas Comptroller’s office (such as sales, excise, use and franchise taxes), unless the purchaser withholds a portion of the purchase price equal to the amount the seller owes to the Texas Comptroller’s office (including, if applicable, any interest or penalties thereon). 

Fortunately, the purchaser of a business may protect itself from successor liability under Section 111.020 of the Texas Tax Code by requesting that the Comptroller issue a certificate stating that no tax is due from the seller.  Surprisingly enough, that certificate is called a "Certificate of No Tax Due"!

The Comptroller must issue the Certificate of No Tax Due (or a statement setting forth the amount of taxes due) within 60 days after receiving the request (or within 60 days of the seller making its records available for audit), but in either event within 90 days after the date of receiving the request.

The Texas Comptroller’s office has a useful guide to Certificates of No Tax Due called “Tax Information:  Buying an Existing Business” which is available here.

2014 TECH Fort Worth IMPACT Awards

Yesterday, I attended the 2014 IMPACT Awards celebrating TECH Fort Worth and its technology-based entrepreneurial clients.  As usual, it was a great event.  Actually, it is one of my favorite events of the year. The IMPACT Awards highlight the special things going on at TECH Fort Worth and in the entrepreneurial community.

As you may know, TECH Fort Worth is a non-profit organization that assists entrepreneurs in our region with launching and growing emerging technology companies. They identify start-up companies with technologies that have a high potential and coach them toward success.

This years awards winners were:

(1)  E-mist Innovations Inc., who has developed a superior disinfectant misting delivery system that makes sprays cling to surfaces;

(2)  E-3 Water LLC, who has developed a mobile wastewater treatment system that purifies wastewater in a quick, powerful, reliable and enclosed (odorless) manner; and

(3)  SurgeryLink, who has developed a software platform for surgery scheduling and surgery team coordination that is simple, accurate, reliable and, importantly, compliant with the medical information security guidelines mandated by HIPAA.

It is inspiring to see these creative and courageous entrepreneurs making our world a better place.

Congratulations to this year's winners and to high-tech start-up companies everywhere!

Bitcoin Investment Pioneer

On March 10, the Texas State Securities Board (TSSB) issued an Emergency Cease and Desist Order against Balanced Energy LLC, a Southlake, Texas-based oil and gas exploration company.  The company claims to be the first in the oil and gas industry to accept Bitcoin from investors rather than cash.  A copy of the TSSB press release is available here.

Based on a review of the Cease and Desist Order available here, it appears the TSSB objected to the company's unregistered sales of securities to unaccredited investors and the lack of adequate disclosure of, among other things, the risks of using Bitcoin as a currency.

Putting aside those objections for the purposes of this blog, it will be interesting to see if other oil and gas companies or other companies seeking to raise capital will consider accepting investments in Bitcoin.  Bitcoin is a virtual, digital currency that allows users to send money over the Internet without using a credit card or bank account.  Privacy hawks and anti-government zealots love that Bitcoin is a money supply free from government regulation.  On the other hand, the unregulated nature of Bitcoin has contributed to its reputation for having highly volatile pricing.    

Regardless of whether or not Bitcoin takes off as an investment currency, the TSSB's Cease and Desist Order is a reminder to all companies issuing securities of the timeless requirements of US securities laws:  Every issuance of securities, such as working interests in oil and gas wells, (whether for Bitcoin, US dollars or any other currency) must be registered with the SEC and applicable state securities regulators or must be made in compliance with an applicable exemption from those registration requirements.

Drafting Texas LLC Agreements

Few, if any, know as much about Texas limited liability company law as Professor Elizabeth S. Miller of Baylor University Law School.  Professor Miller published a terrific article titled "Practical Pitfalls in Drafting Texas Limited Liability Company Agreements" in the Fall 2012 Texas Journal of Business Law.  It should be required reading for anyone drafting company agreements for Texas LLCs.  I could not find the article cited online, but a substantially similar article is available on Baylor's website here.

For example, Professor Miller notes in the article that the default rule under Texas LLC law is that a majority vote of the members of an LLC by number (rather than by percentage interest) is required to take many extraordinary company actions, such as approving a merger or other fundamental business transaction (See Sections 101.354 and 101.356(c) of the Texas Business Organizations Code ("TBOC")). That might come as a major shock to a member of an LLC holding say, 90% of the percentage interest, along with five other members whole collectively hold the remaining 10% of the percentage interests of the LLC!

Another default rule under Texas LLC law that might come as a surprise to LLC members is that members may take action informally without a meeting, such as by a series of phone calls or e-mails, rather than at a formal meeting of the members (See Sections 101.358 and 101.359 of the TBOC).  In fact, Section 101.359(2)(A) of the TBOC provides that a member may be deemed to have consented to a company action if the member knew about it but failed to object to the action in a timely manner.

Professor Miller reminds us that the default LLC rules can generally be modified by contrary provisions in an LLCs company agreement.  Drafters of LLC company agreements can avoid surprises by being careful to address each default provision that is not consistent with the LLC members' wishes.

Introducing the M&A Broker

What is an m&a broker?  It is a new term recently introduced by the Securities and Exchange Commission (SEC) to describe a business broker who may be involved in private company merger and/or acquisition transactions involving stock without registering as a broker-dealer. This is great news for unregistered business brokers and the small, mid-sized and family owned privately-held companies that they typically represent.

Previously, business brokers were required to be registered with the SEC if they were in the business of effecting transactions in securities, such as the sale of stock.  However, there is no SEC registration requirement to serve as a broker in the sale of assets.  So under the prior law, an unregistered business broker could earn a commission on the sale of 100% of a business’s assets, but could not earn a commission for the sale of 100% of the same business’s stock. Many felt that different treatment for stock deals and assets deals made little sense. The old rules often required buyers and sellers to structure transactions as a sale of assets, even in cases when a sale of stock would make more sense for the buyer and seller from the standpoint of tax, accounting, regulatory or other considerations.

On February 4, 2014, the SEC came to the relief of unregistered business brokers and their clients by issuing a no-action letter creating the m&a broker exemption from SEC broker-dealer registration requirements. A copy of the no-action letter is available here. The m&a broker exemption permits unregistered business brokers to be involved in transactions involving the sale of control stock of a privately-held company to a buyer who will actively control the business.  The transaction may be structured as a merger, acquisition, business sale or business combination.  There is no dollar limit on the size of the private company that may be involved in the transaction.  There are other restrictions on use of this exemption set forth in the no-action letter, including that the broker may not bind either party, provide financing for the transaction or handle funds.

Easing the regulatory burden on business brokers should result in brokers bringing more buyers and sellers to each other’s attention, thereby facilitating the closing of more business transactions, which in turn should result in fairer prices and greater liquidity for business owners seeking to sell their company.      

Risks of Electronic Contracting

How easy is it to enter into a multi-million dollar (or more) contract via e-mail?  As easy as clicking "send" on an e-mail, it would seem.

Under the Texas Uniform Electronic Transactions Act (UETA), parties can enter into a legally binding agreement by e-mail or other electronic communications, even for matters that traditionally were required to be in writing, such as agreements to purchase real property, including oil and gas interests.  Under UETA, if the parties intend to enter into an agreement electronically, an otherwise enforceable agreement will not be unenforceable solely because it was entered into electronically.

A recent court case, 2001 Trinity Fund, LLC v. Carrizo Oil & Gas, Inc., which was decided by a Texas state appeals court in Houston, illustrates the danger of negotiating the terms of a business transaction over e-mail.  In that case, the trial court analyzed a series of e-mail messages between two oil and gas companies and concluded that the e-mails collectively constituted a binding legal agreement to amend and revive their existing participation agreement.  The e-mails including statements such as:

• “I agree in principle, but need to have this interest flow directly back to me.”

• “[i]f you are in agreement in principle, then I’m assuming we can work out the mechanics.”

• “That will work.  I will call before the day is over and give you an exact time.”

• “Yes, has been my final answer.  I will give you the final date ASAP.”

• “As I told you before, I intend on being involved in the drilling program.”

The trial court initially awarded one of the parties over $10 million in damages for the other party’s breach of the alleged electronic agreement. That trial court verdict was later overturned on appeal when the appellate court reached the opposite conclusion, finding that the evidence was legally insufficient to support the jury’s conclusion that an electronic agreement existed.

Nonetheless, the takeaway is obvious.  When in discussing a business transaction via e-mail or other electronic means, one should make sure it is crystal clear whether or not the party desires or intends to enter into an electronic agreement, or if the party does NOT have such desire or intent.  Otherwise, courts may be deciding whether or not an electronic agreement exists, and you may not like its decision.