The law of the market: honesty in contracts – the doctrine of the “frank negotiator”

0

When drafting operating contracts and shareholder agreements, members of multi-member limited liability companies taxable as partnerships and multi-shareholder commercial companies taxable as C corporations have a practically unlimited freedom of contract.

For instance:

LLC members can provide in their operating agreements the complex capital structure provided under a proposed IRS regulation designated Prop. Reg. § 1.1402(a)-2 and can thus obtain substantial self-employment tax reductions.

They may also provide in their operating agreements for “for-profit partners” – members who make little or no contribution to the capital of the LLC but who nevertheless have substantial rights to the income of the LLC.

Profit partnership agreements can be invaluable, for example, in persuading highly qualified managers to join LLCs.

Similarly, in order to meet the needs and interests of shareholders, multi-shareholder business corporations taxable as C corporations may provide for an unlimited variety of classes of corporate shares.

However, when forming LLCs and corporations whose prospective investors are sophisticated and into which they may contribute hundreds of thousands or even millions of dollars, investors may want to use complex arrangements involving financial terms that ‘no “plain vanilla” LLC is. never likely to know. These may include not only a wide variety of preferred and common investment classes, but also “sell”, “buy” and “switch” provisions well understood by sophisticated investors, but not by the parties. unwarned.

Put option clauses provide that, under specified conditions, one or more parties — the “put option” parties — may require that one or more other parties purchase all or part of the interests of the parties to the put option sale at specified prices. Not only the sale provisions themselves, but also the purchase price provisions within these arrangements are often quite complex.

The call provisions provide that, under specified conditions, parties may require other parties to sell to them some or all of the interests of other parties.

The conversion provisions provide that the parties to the conversion may convert their property

move, for example, from common interests to privileged interests. These privileged interests may include preferential treatment with respect to allocations and distributions of profits and preferential non-economic rights such as voting rights.

It is not uncommon for sophisticated investors whose attorneys draft the above provisions into investment contracts – including, for example, LLC operating agreements that function as investment contracts – may use seemingly innocent contract terms that, when enforced, can give lawyers’ clients advantages that not equally sophisticated counterparties would recognize, but sophisticated parties would not.

However, if unsophisticated parties find themselves subject to such provisions, there is a little-known legal doctrine potentially available to them, called the “frank negotiator” doctrine, which can protect them from the disadvantages that sophisticated parties seek to impose on them. . According to this doctrine, uninformed parties can deny these inconveniences on the grounds:

That when negotiating their agreement, the sophisticated parties had a legal obligation to inform them of these disadvantages – in other words, they had a duty to be “upfront”; and

That their failure to do so renders these inconveniences legally invalid.

In other words, the doctrine of the direct negotiator may prevail over the doctrine of “caveat emptor” (“let the buyer beware”); and it can protect unsophisticated parties from the most subtle deceptions by sophisticated parties.

John Cunningham is an attorney licensed to practice law in New Hampshire and Massachusetts. He is legal counsel for the law firm McLane Middleton, PA. Contact him at 856-7172 or [email protected] His website is llc199a.com. To access all of his Law in the Marketplace columns, visit concordmonitor.com.

Law in the Marketplace is a legal advice section. It airs weekly in the Sunday Business section. The author is a lawyer at Concord and is not a staff member of the Monitor.

Share.

About Author

Comments are closed.