You and your long time friend have developed a great business idea, obtained financing, hired employees, and are planning to open the doors to your business in two weeks. The business is set up as an LLC using a software program that you purchased at an office supply store. The program is user friendly and prompts you to enter the names and addresses of the owners and a beautifully polished LLC operating agreement is produced.
You purchase the building in which the business is housed using your credit and provide $50,000 of operating capital to the business. You and you friend agree that he will be the full-time manager of the business in lieu of providing capital to the business. Your friend convinces you to place his name on the deed to the building stating that it will be easier for the business to obtain financing with both of you on the deed.
Your business opens and you and your friend miraculously manage to turn a profit within a few months. You are very pleased with the business operations and are excited about the future prospects of the business. Your friend mentions to you that he would like to obtain a line of credit for the purpose of purchasing new equipment, hiring an additional assistant, and sales trips. The one caveat is that your credit will be used to obtain the credit line. You obtain a $100,000 line of credit and you allow your friend to have access to the line of credit.
After a year or so, your friend is interested in taking some business trips to promote the business and convinces you to assist with managing the store. As you have never really been a “numbers” person, your friend does all of the accounting and simply provides you a check at the end of each month representing your portion of the business profits.
While your friend is on the business trips, you start to notice that there are very few bills that arrive at the business. You think this is strange and contact your friend who says that he has established a post office box to prevent identity theft. As that seems to be a logical explanation, you forget about the bills and proceed with running with the business.
During the third year of the business, you receive a summons to appear in Court regarding the business credit line. The Bank in which you hold the credit line claims that you have breached the terms of the credit line agreement. You call your friend and he tells you that he does know what happened because the business’s bills are always paid on time. You call the Bank and request all of the statements from the past two years. The statements show that the bills have never been paid and that your friend has used the credit line to fund personal trips to Europe and South America.
The Bank is able to pierce the “corporate veil” and sue you personally because your friend commingled business and personal funds, failed to adequately capitalize the business, and personally signed several agreements. The Bank does not bother suing your friend because he has no assets and obtains a personal judgment against you for $120,000 plus attorney fees.
Although you have taken a tremendous financial hit, you are able to keep the business afloat and embark on removing your friend from the business. You dust off the LLC agreement and discover that the basic agreement has no provisions that address removal for bad acts, no provisions to buy out a member, and no provisions that address the manner in which the accounting of the business should be handled. Your former friend is a joint owner of the property that the business is housed and you do not have an inexpensive path to remove him from the business.
To prevent such an occurrence, it is imperative to have an attorney draft a customized LLC operating agreement to protect your interest if things go South among the LLC members. This relatively inexpensive directive can prevent the hypothetical legal problem referenced above.