Andrew Abramowitz, Author at Andrew Abramowitz, PLLC

Tips on Limiting Liability for Passive Investors in Private Companies

May 24, 2023 / 3 minutes of reading / By Andrew Abramowitz

A client in the music industry called recently, saying he’d been asked to make an investment for a 10% passive stake in a new restaurant. The client said he didn’t want to become a member (equity owner) of the LLC formed to operate the restaurant, because he didn’t want any legal liability. He understood that he could potentially lose his investment if the restaurant fails (which, believe it or not, does happen from time to time!), but his fear, as someone with a more public profile than the other members, was being an individual target for a suit against the restaurant, being perceived as deep-pocketed.

I told him that the only way to guarantee no liability or at least not being named in a suit is to not make the investment at all, but assuming he does, he should want to be a member of the LLC, to properly document the financial arrangement, i.e., that he’d put in some cash in exchange for 10% of future profits, and also, through the documentation, to appropriately limit his liability.

Below are some tips/considerations for limiting liability in passive investments of this type:

Limited Liability Entity – Ensure that the investment is made in a private company structured as an LLC or corporation. In these entities, investors are shielded from personal liability for the company’s debts and obligations. Their liability is generally limited to the amount of their investment. Investors can also make the investment through their own LLC for an additional layer of liability protection.
Properly Drafted Investment Agreements – Investors should carefully review and negotiate investment agreements to ensure adequate protection. These agreements should clearly define the investor’s role as a passive participant, outlining their limited involvement in the company’s management and decision-making processes, and providing for indemnification or members/shareholders. By explicitly establishing their status as passive investors, they can minimize potential liability arising from the company’s actions.
Due Diligence – Before investing in a private company, passive investors should conduct thorough due diligence. By investigating the company’s financials, operations and legal standing, investors can identify potential red flags and mitigate future risks. This proactive approach helps ensure that investors are aware of any potential liabilities the company may be exposed to, reducing the chance of unforeseen legal issues.
Insurance Coverage – Investors should ensure that the company they’re investing in has an appropriate degree of insurance coverage, in amount and type, for the particular operations of the company. Even though the policy would directly cover the company, not the individual equity owners, the insurer would defend any suit that attempts to name passive investors as co-defendants.
Legal Advice – Self-serving, but true: Be sure to engage a qualified corporate/securities attorney to assist with all of the above. In cases where the investment is for a small stake in the company and negotiation is not really possible, the attorney can at a minimum do a review of the documentation to summarize key issues and identify potential red flags.

Will I Be Replaced by ChatGPT?

April 25, 2023 / 4 minutes of reading / By Andrew Abramowitz

After reading about it for months, I finally signed up for the free version of Open AI’s ChatGPT and decided to ask it the following basic question that has come up frequently in my law practice:

If I am forming an LLC to purchase real property in New York, should I organize the LLC in New York or Delaware?

I received the following response after a few seconds:

The decision to organize your LLC in New York or Delaware depends on your specific circumstances and goals. Both states have their own unique advantages and disadvantages. Here are some factors to consider:

Organizing in New York:

If you plan to operate the LLC in New York, it may be more straightforward to organize the LLC in New York as well.
New York does not require annual reports, but does require a biennial statement, which is a report on the status of the LLC, and has higher filing fees compared to Delaware.
New York has a higher annual franchise tax than Delaware, which may be a factor if you have a high valuation or net worth.
If you plan to purchase and hold real property in New York, there may be additional state and local filing requirements, such as transfer taxes or mortgage taxes.

Organizing in Delaware:

Delaware is a popular choice for LLCs due to its favorable business laws and court system, which is well-established and familiar with corporate law.
Delaware does not impose state income tax on corporations that do not operate in Delaware, but it does impose an annual franchise tax that is based on the number of authorized shares of the LLC.
If you plan to raise capital or eventually go public, organizing in Delaware may be advantageous due to its established legal system and business-friendly environment.
If you plan to hold real property in New York, you may need to register as a foreign LLC in New York and comply with New York state and local filing requirements.

In summary, it is important to weigh the benefits and drawbacks of each state and consult with a knowledgeable attorney or accountant before making a decision.

Then, I pasted the exact same question into Google, and the first non-sponsored link was to this LegalZoom article.

It’s immediately apparent in looking at both results that the ChatGPT response is far more tailored to my question than the article identified via Google, which doesn’t even mention New York LLCs. (To be clear, this is not a criticism of the article, which seems fine, but the point is that it wasn’t written to be directly responsive to my question; it’s just the web page that the Google algorithm thought was closest to what I was seeking.)

So, would I be able to simply pass along the ChatGPT response to my client without modification? No. It doesn’t mention, for example, the annual cost to a New York client forming a Delaware LLC of engaging a registered agent in Delaware, which wouldn’t be an issue if the LLC was just formed in New York. However, this response absolutely would be a useful starting point for me if I hadn’t already answered it for clients before. It’s clear that that this will be a significant time-saver for lawyers as it gets refined.

Attorneys, and other white-collar professionals, have been hand-wringing in the months since ChatGPT was introduced about how their jobs could be eliminated in the long-run by AI. However, the story of the last 100 years or more is that the introduction of a new technology has initially triggered this “replaced by robots” fear, but then somehow people manage to find remunerative work in the subsequent years. Lawyers, in particular, have worried for years about developments like document review software for litigators and form purveyors (like LegalZoom) for transactional attorneys. But here we are, and as of late last year, the unemployment rate for attorneys was a microscopic 0.1%.

If past is prologue, then, these AI tools will improve and become incorporated into attorneys’ practices, without replacing the job category. If I’m wrong, well, I guess I’ll get much better at golf in the coming years.

Ensuring that Clients Understand the Agreements they are Signing

January 20, 2023 / 3 minutes of reading / By Andrew Abramowitz

We all know that most users of web-based products (which is to say everybody) do not read the lengthy terms of service that they are asked to accept with a click before proceeding. These users make a probably reasonable calculation that the stakes are pretty low given the nature of the transaction and that by clicking “accept,” they are not agreeing to bequeath their estate to Apple or Microsoft. But what about agreements that are more significant to the signer, like an agreement to sell one’s business to a buyer? Does the seller need to read every word and understand them before signing? Their lawyers will usually say yes, because after all, the seller is the one signing the agreement and giving up the business, not the lawyer. But like all experts, lawyers can sometimes forget how utterly foreign contractual language is to lay people and need to take steps to ensure actual comprehension beyond a mere CYA admonition to read every word. Of course, some clients have had long business experience and have seen many agreements of a particular type, so the need to hand-hold needs to be tailored depending on the client.

When people think of legalese, they primarily are concerned with arcane words such as “heretofore” or whatever. But a more significant factor in client incomprehension, I think, is that they don’t have the background knowledge with these agreements to know the purpose of various provisions and how they all interact. For example, in a typical agreement for acquisition of a business, there are provisions relating to the seller’s potential liability to buyer after the closing, including various defined terms such as Fundamental Representations, Cap, Basket and Survival Period. These concepts are, needless to say, not experienced by the average person in their lifetime, even if it’s a well-educated lifetime. But the idea behind all of it is not terribly complex and is very important to the parties in an M&A deal: The buyer should be compensated for damage that occurs after closing if the seller misrepresents facts about the business being purchased when the agreement is signed, but assuming this misrepresentation is not intentional/fraudulent, there should be reasonable limits placed on the amount of compensation and the length of time after closing during which the buyer can bring this up. So, while it’s unrealistic to expect clients to start using all of the contractual lingo in ordinary conversation, it is important for the lawyer to impress upon the client the importance of, to take the above example, ensuring that representations in the agreement are correct to avoid post-closing liability.

So, my message to fellow lawyers is to try to remember how clueless you were as a law student and junior associate and, accordingly, guide your clients with the goal of ensuring true comprehension of important concepts.

The Real Cause of Large Legal Bills

November 4, 2022 / 3 minutes of reading / By Andrew Abramowitz

I was recently representing a seller in a proposed acquisition. The purchase price was under $20 million – in the context of M&A, a relatively small deal. The purchaser was represented by one of the top 10 most profitable law firms in the world. The firm organized a due diligence call, blocking off two hours for the attorneys to ask questions of the seller that related to legal matters. I was the sole attorney on the call for the seller. From the purchaser’s law firm, there were a couple of corporate/M&A attorneys, and then one representative from each of any applicable specialty practice area: tax, employee benefits, real estate, intellectual property, etc. As far as I could tell, each of these specialists spent the whole time on this long call, waiting their turn and then taking, like, five minutes to ask the specific questions applicable to their specialty. The presumptive cost of that call to the purchaser, aggregating all those high billing rates for a couple of hours each, was, to my boutique firm way of seeing things, completely unfathomable.

Clients assessing prospective law firms will often focus on a single number: the hourly rate of the highest-ranking partner assigned to the matter. Witness all the ink spilled in recent years on how rates for many partners at large firms have blown well past $1,000 per hour. (This helps my marketing efforts, frankly, as it’s easy for me to show that my firm’s rates are lower than those at large and mid-sized firms in New York.) After bills are rendered, clients will sometimes question the amount of time it took for a particular attorney to handle a particular task. But as my anecdote about the conference call illustrates, often the real driver of cost is the firm’s staffing practices and whether the firm will seek to prioritize efficiency. On most matters handled by my firm, I am the only person from the firm on any call. Other attorneys are very much involved in the matter, handling behind-the-scenes tasks such as drafting, but they will generally not spend those couple of hours on the call with me; rather, I briefly summarize for them the upshot of what they need to know. To the extent other specialty attorneys are involved on my team, they will also communicate with me separately and generally not participate in a group call unless it’s primarily about their area.

To be clear, I am not saying that having multiple attorneys on a call is necessarily inappropriate or part of a conscious effort to jack up fees. But I do think that if clients are looking to exercise some oversight on legal costs, they would be better served by looking at a calendar invite for a Zoom meeting, seeing how many attorneys have been asked to join and inquiring about whether that is necessary, as opposed to arguing after a bill is rendered that a particular agreement should take three hours to draft, rather than five hours, without really knowing exactly what’s entailed in the process of drafting one.

Deciphering Real Estate Jargon for Corporate Attorneys

October 24, 2022 / 5 minutes of reading / By Andrew Abramowitz

A small but significant part of my firm’s practice involves doing corporate and securities work on real estate development deals. I’m not a real estate lawyer (or, a “dirt lawyer” as they sometimes call themselves, in a bit of rather harsh-sounding self-deprecation), who handles core real estate transactions like purchases and leases of real estate, but I collaborate with those attorneys by forming entities and drafting their operating agreements, and ensure compliance with securities laws when there are outside investors helping to fund the projects.

The operating agreements for the entities formed for the project need to address the economics of the deal, including how any earnings from the project are divvied up between the developer (or, the “sponsor”) and the outside investors. These structures tend to be quite complex, and they have their own jargon that corporate attorneys who practice outside the real estate industry will find quite forbidding, even those who have plenty of experience with sophisticated transactions. Therefore, I thought it would be helpful to decipher a bit of that jargon as a service to the uninitiated among the corporate attorney community. I won’t address here the various other terms of art in real estate finance (cap rates, loan-to-value ratio, etc.) that aren’t directly relevant to the attorney needing to draft the operating agreement, nor will I address operating agreement concepts that are common outside the real estate context on the assumption that, if you’ve made it this far in this post, you know them already.

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Business Divorces

September 20, 2022 / 2 minutes of reading / By Andrew Abramowitz

Although the majority of the transactions I advise on can be described as additive – one company acquiring another one, a company selling newly-issued stock to a new investor – I do spend some time on subtractive (is that a word?) matters, including business divorces. In its simplest form, this term refers to a decision of two business partners to wind down a business, often because some tension has developed in the relationship, just like a personal divorce.

As a purely transactional lawyer, I would only get involved in a business divorce if the parties want to resolve it amicably, without bringing a claim in court, though it can be useful to get the parties moving toward a solution to raise the specter of litigation and its associated costs and delay. In the world of family law, there are attorneys who specialize in collaborative or cooperative divorces, and I try to play a similar role in business divorces by encouraging compromise, even though I’m clearly representing one side and looking out for that party’s interests. Any effort to achieve total victory in these situations is likely a fool’s errand, or at least a very stressful and expensive errand.

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The SEC’s SPAC Proposal and Projections

April 7, 2022 / 3 minutes of reading / By Andrew Abramowitz

The SEC has issued its long-expected proposed rules regarding SPACs. Here are the proposing rule release and the shorter press release. The SEC has always been skeptical of SPACs, and the rules are generally designed to impose new disclosure requirements on SPACs that make the rules more aligned with those applicable to traditional IPOs. One of the reasons SPACs had their moment in the sun recently is that they are easier to complete than IPOs, so the rules, if enacted, could have the effect of severely dampening the market for SPACs, even if they do nothing to directly restrict them from being done. In fact, the general expectation that rules like these were coming down the pike has, anecdotally, been a factor in the SPAC market slowing down recently.

One of the key areas in the proposed rules relates to projections. Under current rules, companies merging with a SPAC can include projections about the company’s future expected results and can benefit from a safe harbor protecting it from litigation if the projections don’t come to pass, as long as the projections are accompanied by a disclaimer and the companies don’t have actual knowledge that they won’t come true. In contrast, companies going public the traditional way don’t have the benefit of this safe harbor. The proposed rules would eliminate the safe harbor in the SPAC context, which would have the practical effect of precluding most projections from being presented.

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The London Stock Exchange’s Proposal for Private Company Trading

January 18, 2022 / 2 minutes of reading / By Andrew Abramowitz

The Wall Street Journal reported exclusively on plans by the London Stock Exchange to create a special market for the shares of private companies for limited public trading. The plan itself is not yet public, so the Journal was only able to report on limited aspects of what is contemplated. In the same way that U.S. private companies have increasingly been able to access public-like markets with new exemptions like Regulation CF, Rule 506(c) and Regulation A+ and the development of secondary trading markets for large private companies, this is an effort across the pond to provide some of the benefits of public market access to small and fast-growing companies.

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Andrew Abramowitz

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