What Is An Ownership Agreement?
An ownership agreement is a legally binding contract among the owners (or a particular class of owners) of a business, an investment, or another kind of asset, and sometimes their families, that governs a variety of intra-ownership matters. The operative provisions of any particular ownership agreement will depend largely on the particular concerns of the owners with respect to the asset and each other . However, typically the provisions of an ownership agreement are organized around one or more of the following principal concerns:
The agreements are common among owners of businesses, investments, or other assets (as well as their spouses and surviving family members), both large and small, forming part of their overall estate plans. They are generally cheaper and easier to implement than many other kinds of assets protection techniques. A limited number of owners may be able to work out their intra-ownership matters by means of mutual understanding and cooperation. However, in larger enterprises, or where there is a lack of trust or consensus among the owners, an ownership agreement is essential.
Core Elements Of An Ownership Agreement
The essential elements of any ownership agreement will depend on the particular entity and industry, the relationship among the parties and, to some extent, the complexity of the business. At a minimum, however, an ownership agreement should include the following:
Parties. Who are the owning parties? If there is more than one owner of the business, do you intend to limit ownership to those individuals (or entities) only?
Ownership percentages. How much of the business will each party have? Will the ownership percentages matter? Can different owners have different rights based on their percentage ownership?
Responsibilities and duties. What will each owner’s responsibilities be? Will some have more say when it comes to day-to-day operations or other matters? Be careful not to give too much control to one owner, however, as this may cause conflict with others.
Protocols for decision-making. What will the protocols be to make decisions about the business? Will a simple majority rule apply, or will a supermajority be required? How formal must the process be? Will consensus be required for major business decisions?
Profits. How will profits be calculated? Will each owner get a share of all the profits, or will some proportions go to the business itself?
Ownership Agreement Types
Ownership agreements come in many forms, with each designed to meet the specific requirements of the type of ownership structure involved. Commonly used ownership agreements include joint venture agreements, partnership agreements, limited partnership agreements, and limited liability company (LLC) operating agreements.
Joint Venture Agreement
A joint venture agreement is the simplest and most project specific of all ownership agreements, generally appropriate for entities formed for a particular event or undertaking. In its simplest form, the joint venture agreement identifies the parties to the joint venture, establishes the term of the venture, describes the project (which can be anything from a one-time consulting assignment to the development of a residential building), provides for the allocation and payment of revenues and expenses related to the project, and defines the responsibilities of each of the parties in achieving the purpose of the venture.
Partnership Agreement
Partnership agreements have several purposes. The most common is to set forth the rights and obligations of the owners of a general or special partnership. Apart from articulating what is already required in a partnership agreement under New York partnership law, the partnership agreement is also useful when owners want to provide different rights or preferences for certain owners. For example, a partnership agreement may provide a special class of partners with enhanced voting rights or greater profit distributions or limited partners with no say in the management of the partnership but who receive a preferred return on their capital contributions.
In some cases, owners will also execute a partnership agreement to provide the framework for corporate affiliation and new business ventures where each owner agrees to contribute a certain asset or service. In the context of a group of affiliated real estate companies, for example, the owners may enter into a partnership agreement to contribute each entity’s personnel and existing client relationships to create a new business entity that provides consulting services to real estate companies in other markets. Such a partnership agreement, however, must be carefully drafted to avoid inadvertently resulting in unnecessary federal or state tax consequences.
Limited Partnership Agreement
A limited partnership agreement generally mirrors the provisions of a partnership agreement while at the same time providing distinctions between general and limited partners. Practically speaking, however, it is not necessary, and perhaps undesirable, to refer to a partnership as a "limited partnership" if the owners intend to act only as a general partnership and do not require the limited liability afforded to limited partners under the New York Limited Partnership Law. This point is particularly significant because there is an initial cost to filing a limited partnership agreement with the New York Department of State, and annual filing fees are required for limited partnerships under New York law that do not apply to general partnerships. A limited partnership agreement must be filed with the New York Department of State to receive status as a limited partnership and maintain the limited liability afforded to limited partners.
Limited Liability Company Operating Agreement
The LLC operating agreement creates the LLC’s governing agreement and defines the respective rights, preferences, and obligations of the members. The operating agreement can be similar to a joint venture agreement, partnership agreement, or limited partnership agreement, depending on the individual owners’ needs. For example, if the owners of an LLC seek the limited liability protection typically associated with an LLC, but wish to treat their interests in the LLC in a manner similar to those of partners in a limited partnership, they may consider structuring their interests in accordance with the "voting" and "profit sharing" units provided for in Section 609 of the New York Limited Liability Company Law, or alternatively by drafting an operating agreement that provides for the special classes of interests they desire.
Legal Factors In An Ownership Agreement
Agreements amongst owners of a closely held company can address a broad array of issues, from transfer restrictions to the resolution of disputes to management of the entity. As with any contract, thought must be given to the specific laws that apply to an ownership agreement. Such laws might be state-specific or industry-specific (i.e., licensed professional organizations). One example of a state-specific law is that Virginia limits non-compete agreements for physicians, dentists and other licensed medical professionals to two years from the date of termination. In Virginia, non-competes for this group for longer than two years will be deemed unenforceable by a court. An example of an industry-specific law is the District of Columbia Securities Trade Act, which requires that, among other things, any sale of stock of an entity organized under the laws of the District requires statutory notice to the District before the closing of the sale .
While many of these laws are not unique to ownership agreements, other laws that may arise in the context of an ownership agreement include the following:
Permits to Transact Business. If the entity is foreign to Washington, D.C. or Virginia and making any sales in Washington, D.C. or Virginia, the entity may want to consider obtaining a permit to do business in the District of Columbia or Virginia, respectively.
Anti-Kickback Laws. While Health Care Anti-Kickback laws are industry specific, practitioners should be aware of potential Anti-kickback issues relating to referrals of individual patients.
Tax Inclusion. Tax issues for various types of entities, including state and local taxation for transactions and operations, the allocation of ownership amongst members in accordance with IRS and state guidelines and other tax issues should be considered.
Financing. The ability to issue debt and equity securities is limited to the terms and conditions approved by the applicable laws and regulations.
Creating A Solid Ownership Agreement
The facts surrounding each ownership agreement will be different – i.e., each ownership agreement is custom tailored to the business. However, from a practical perspective and as a guide, when drafting an ownership agreement the following should be included to ensure that the document is comprehensive and effective:
● Clear Definitions. Terms and definitions should be the same or similar at all times, and consistent throughout the document.
● Drafting Language/Exclusions. Drafting language in an ownership agreement and exclusionary clauses may contradict other documents, aiding in confusion. Ownership agreements (and other internal documents) should be reviewed more frequently than once every five (5) years to align with changing laws, regulations, and business operations. When drafting language, be proactive and deliberate about its effect (or chain reaction) on other documents. Exclusions should not be a direct contradiction, but should mirror in nature the clauses and/or scenarios that the exclusions are written to avoid.
● Alternative Dispute Resolution. Alternative Dispute Resolution (ADR) clauses should be included in ownership agreements, as opposed to at the end of the document (as may have been suggested in the past). ADR clauses identify the forum of where a resolution will be reached. Once the dispute has been filed with the court, a waiver – which should be included in the initial filing paper – may have to be signed, thereby making the inclusion of an ADR clause in the initial filing paper and the ownership agreement wholly ineffective – an issue that was created due to poor drafting or lack of a missing clause. An ADR clause must identify the forum (exclusive of the court), the rules that will govern the forum, the place (i.e., city and state) where the forum will be located, the governing body of the forum, and whether the opinion is binding or advisory.
● No "One Size Fits All" Approach. "One size fits all" drafting is always the wrong approach to take with ownership agreements, internal documents, and addendums. Provisions that are standard for the industry may not apply to your specific business. Always include the exceptions to each provision in the document, and avoid one-sentence red flags, which are typically created by taking away too many rights.
● Don’t Hide Important Information. The ownership agreement is the starting point in many scenarios, i.e., the ownership agreement governs the articles of incorporation, the bylaws, and other internal documents. When these documents are inconsistent with the ownership agreement, they can render the language in the ownership agreement completely ineffective.
Amending And Ending An Ownership Agreement
There are times when the parties to an ownership agreement need or wish to modify or even terminate their agreement. Common reasons for modification include the need to change a term or condition in the agreement, such as the circumstances under which one owner must buy out another, change in management responsibilities, changes in the ownership percentages among owners, and so forth. Reasons for terminating an agreement include changes in law or regulations that render the agreement illegal or unenforceable, establishment of a limited liability company the formation of which renders obsolete a stockholders’ agreement, inapplicability of a buy/sell trigger event that terminates an owners’ agreement upon the happening of the event, and constructive or mutual agreement of the parties to terminate the agreement .
Necessary steps to modify or terminate an agreement in some instances include obtaining unanimous consent of all of the parties, obtaining the consent of a majority (or super-majority) of the parties to the agreement, or filing a petition and obtaining approval of a court. Parties can usually choose for themselves how to implement such modifications and termination, but should always seek competent legal advice before doing so. Modifying or terminating an ownership agreement while allegedly waiving rights under the agreement, or without otherwise following the provisions of the agreement regarding the termination or modification of the agreement, often results in costly litigation.