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Are Non-Compete Agreements Enforceable Against Independent Contractors in Michigan?

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This is one of those gray legal areas where the answer is “it depends on the facts of the situation.” Previously, I wrote about the basics of non-compete and non-solicitation agreements that are becoming increasingly common in all industries. At their core, non-compete agreements restrain the free labor market, and are therefore analyzed under the Michigan Anti-Trust Reform Act (“MARA”) (MCL 445.774a), which sets out a four-factor “reasonableness” test for the agreement. To be enforceable, the non-compete must: (1) Protect a reasonable competitive business interest; (2) Be reasonable in terms of duration; (3) Be reasonable in terms of geographical area; and (4) Be reasonable in terms of the the type of employment or business affected. Although the four-factor test in MARA expressly refers to “employer” and “employee,” lawyers and businesses frequently cited the same test when evaluating non-competes in other relationships, such as between two sophisticated business entities or an independent contractor.

In a 2017 opinion, Innovation Ventures v. Liquid Manufacturing, the Michigan Supreme Court clarified that the MARA test only applies to employment relationships. A different test applies to commercial agreements between sophisticated business entities. The case involved the manufacturer of 5-Hour Energy, and the Court looked at the plain language used by the Legislature to determine that the test does not apply to agreements between businesses. The Court further explained that MARA does not set forth a test for commercial agreements, but instead instructs courts to look to federal anti-trust law for similar legal analysis. The applicable test is the so-called “rule of reason,” which can be summarized as whether, under all relevant facts, the covenant unreasonably restrains competition. While the test may seem similar to the MARA four-factor analysis, it is different because it focuses on the reasonableness of the effect on the free market, rather than the impact on the restrained party.

What about independent contractors? Can a hiring party insist on a non-compete as part of the independent contractor agreement? And if so, what are the parameters for a valid non-compete for an independent contractor? First, parties are generally free to contract for anything, and so an independent contractor may certainly agree to a non-compete clause as part of their contract. Second, the non-compete will be evaluated under the same “rule of reason” as an agreement between two sophisticated commercial entities. This is because an independent contractor is not an employee – thus MARA’s four-factor test does not apply. Where MARA does not apply, the Legislature instructs courts to look at federal anti-trust law. Thus, the outcome is the same as with commercial contracts under Innovation Ventures. That means the rule of reason applies and the court will look at the effect of the restraint on the relevant market.

In applying federal anti-trust law, there is also a concept called a “per se” anti-trust violation. A “per se” violation is conduct that violates Section 1 of the Sherman Anti-Trust Act by its very nature and does not require proofs of the actual anti-competitive effect or the relevant market. Simply put, a “per se” anti-trust violation is one where there is no redeeming competition-facilitating effect. A classic example in the employment arena is the low-wage hourly worker non-compete. A restraint on an $11-per-hour janitor precluding him or her to work for a competitor serves no legitimate purpose whatsoever and is clearly abusive. A court will not enforce such a “per-se” violation. The independent contractor analysis would be similar – if there is no legitimate pro-competitive justification for the non-compete, it may not be enforceable.

One final word of warning. If you are a business considering or using non-compete clauses in your independent contractor agreements, some courts consider such clauses indicative of an employment relationship. If an individual or government agency (like the worker’s compensation agency) challenges your classification, a non-compete clause is evidence of control that weighs in favor of finding someone is an employee. And, if someone is misclassified as an independent contractor, there are a myriad of penalties, fines, and other problems that you may face.

Non-compete and non-solicitation clauses and contracts are becoming more and more standard. However, it is a mistake to blindly use them for all your employees or independent contractors. Each situation warrants its own analysis. Otherwise, your business risks not only losing non-compete litigation, but also risks other unintended adverse effects, such as a finding of an employment relationship where one was not intended.

More questions? Need a non-compete reviewed or drafted for your situation? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.


© 2021 Artaev at Law PLLC. All rights reserved.

4 Must Have Legal Documents for New Business Owners

Whether you are a one-man computer whiz coding the next blockbuster iPhone app, or a five-employee manufacturer making parts for a Tier 1 auto supplier, you need basic corporate forms to protect your assets and investments. A limited liability company (or LLC) is the preferred way to organize and obtain this protection. Plus, if you ever apply for a business loan or decide to sell your business, having an organized and up-to-date corporate record book will do wonders to enhance your value. After all, when Google offers to buy your start-up for a couple million dollars, the transaction will go much smoother with an up-to-date Operating Agreement, corporate consents, assignment documents, and annual statements for the buyer to review.

I recommend the following 4 must-have corporate documents for every business owner:

  1. Articles of Organization –  If you registered your LLC with the State of Michigan, you already filed the basic Articles as part of your initial paperwork. These Articles effectively form your LLC, set forth its name, purpose, duration, and designate a registered agent (or contact person) for your company. Even if you are a sole proprietor, it is worth spending the initial $50 filing fee (and the $25 renewal each subsequent year) to create an LLC. That way, your personal assets are separate from your business assets and are protected from both creditors and litigants.
  2. Operating Agreement — While all LLCs have Articles of Organization, not all bother to have their attorney draft an Operating Agreement. An Operating Agreement sets the rules for how the company is run, including how many votes it takes to make a decision, who owns how many shares, and how shares are valued and transferred. This is a critical document that can prevent many disputes down the line, especially when there are multiple owners involved.
  3. Written Consents/Resolutions – Written consents, or resolution, are records of the business’s decisions. The Operating Agreement will set forth the process for making decisions through written consents (as opposed to meetings). Even if you are the sole owner, it is critical that you draft and maintain written consents whenever the LLC acquires property, makes a distribution, sets a salary, has its annual meeting, or takes another material action. Written decision records help prevent future disputes and also ensure ongoing protection of the corporate form for the owners.
  4. Assignments – If you decide to transfer shares to another LLC member or give an investor an equity stake, the share sale must be documented in an Assignment. The typical assignment document will set out the purpose of the transaction, the value exchanged, the final distribution of shares, and will address the assumption of company liabilities (if any) by the transferee. It may be tempting to simply exchange cash for a promise of membership, but a formal assignment will clearly define the parties’ rights and responsibilities, which will prevent future disputes.

Establishing the proper corporate forms and drafting the paperwork need not be expensive. An attorney will generally be able to register your LLC and draft an operating agreement for a couple thousand dollars. Written consents and assignments can then be created on an as-needed basis. This up-front investment is well-worth the protection that it provides for your assets, as well as protection from disputes and even intra-company litigation down the road.

BONUS TIP – just as critical as a good attorney, a business owner should consult with a reputable insurance provider and a CPA. A solid insurance policy and a tax expert to review your financials will protect you from the unexpected and likely save you money in the process.

Have more questions? Contact Dan Artaev at dan@artaevatlaw.com or 269-930-0254 to set up your free initial consultation.

© 2020 Artaev at Law PLLC. All rights reserved.

Terror From Beyond the Grave: 5 Critical Mistakes To Avoid When Terminating Your Company

It is a classic horror movie plot line. The good guy finally killed off that scary monster/evil janitor/gremlin. Hooray! Triumphant, the hero turns his back to celebrate with fellow survivors when SUDDENLY the monster/evil janitor/gremlin rises from the dead to take down that one final victim! In the business world, if you do not take the proper steps to terminate your corporate entity and ensure that it is “dead AND buried,” (which I swear is a real term of art) the entity can come back from the grave. The undead entity will then cause all kinds of problems and could even result in potential personal liability for the unwary business owner.

First, termination does not mean a business has failed. Even if your company grows and is successful, there may be a time that you need to terminate its existence. The most common example is when you sell your business. If it is an asset sale, the buyer purchases the real estate, equipment, customer lists, intellectual property, etc., but leaves the corporate entity for the seller to dispose of.

Second, before we get to termination, I assume you have read my other posts and properly incorporated your business. You also should have had your attorney draft the initial corporate documents. These documents will often contain the rules and procedures for the terminating the corporate entity. Following these internal rules and procedures is critical to a successful dissolution and wind-up.

Finally, and without further ado, the following is a list of the 5 most common missteps to avoid when terminating your business:

Mistake #1 – Not consulting with an attorney and an accountant. Termination is not as simple as filing a form with the State of Michigan. There are multiple considerations that control the process and are unique to your business. For example, what do your bylaws or articles of organization say about termination? Do you need unanimous consent of the equityholders or a majority vote enough? Are there tax implications and personal tax liabilities to consider? What about the timing of any liquidation distribution? Only a professional can provide fact-specific counsel for your particular situation.

Mistake #2 – Confusing “dissolution” and “winding-up.” Although both terms refer to the termination of a corporate entity, the processes are different and controlled by different statutory provisions. Dissolution is something that is triggered by an event – for example, a unanimous vote of the LLC members or a bankruptcy as set forth in the bylaws. Winding up on the other hand refers to the process of liquidating the corporate entity. In other words, dissolution is the process of making the company “dead” – whereas winding-up is a process to ensure that it is “buried.”

Mistake #3 – Assuming that dissolution alone protects you from personal liability. Dissolution alone is not enough to protect a business owner from creditors and litigants. In Michigan, the law permits a dissolved corporation to “sue and be sued in its corporate name.” MCL 450.1834(e). Same goes for a dissolved LLC. MCL 450.4805(3). Moreover, improper dissolution could lead a court to conclude that the corporate form was a sham designed to elude creditors, and result in a court order to “pierce the corporate veil.”

Mistake #4 – Failing to follow the statutory requirements. Whether your company is organized as a for-profit corporation, a non-profit, or an LLC, there are specific statutory requirements for the termination process. For example, Michigan law requires an LLC to provide specific information in its certificate of dissolution. MCL 450.4804. This is critical because proper dissolution is a statutory prerequisite to winding up the LLC’s affairs (meaning liquidation). See MCL 450.4805 and 450.4806. In other words, failure to carefully follow the dissolution process risks a subsequent argument that the wind-up process was invalid and the liquidation was illegal. Note also that there are separate laws that govern corporations and LLCs and it is imperative that you follow the correct procedure for your specific type of entity.

Mistake #5 – Neglecting creditors for the benefit of shareholders. Terminating a company does not relieve the company or its equity holders from liability for debt obligations. If you are unable to pay your lender or cannot pay an adverse judgment, then you should consider filing for bankruptcy. In the process of a normal dissolution and liquidation, Michigan law presupposes solvency and mandates that creditors get paid first. MCL 450.4808(1)(a). And of course, government tax obligations must be paid even before the other creditors. MCL 450.4808(2).

Dissolving and winding-up your business is a complex process that requires consultation with a professional. Failure to ensure that the company is “dead AND buried” presents many risks going forward and can even lead to personal liability for the owners.

Contact attorney Dan Artaev today at dan@artaevatlaw.com or by phone or text at (269) 930-0254.

‘Tis the Season for (Corporate) Resolutions!

What do you associate most with the start of a new year? I personally think of resolutions and how the gym used to get crowded with all those who resolve to get in shape. So for many, the New Year is about a new start, a chance to set goals, and a chance to catch up on everything that has been neglected in the old year. For the busy business owner, the start of the year is a great time to “resolve” to get their corporate resolutions “in shape.”

But what is a corporate resolution? A corporate resolution is a formal document that approves a company action. Despite the name “corporate resolution,” the term applies to limited liability companies too. For example, if you and your business partner decide to appoint John Smith as the new Manager, there needs to be a written record showing that the requisite number of shareholders voted to approve the appointment, and that the action is consistent with your bylaws. A sale of assets or a purchase of real estate must also be memorialized. Indeed, lenders and title companies often require a resolution to finalize a transaction, as evidence that the particular party to the transaction has the necessary authority to close. Bylaws generally provide for decisions through meetings or by written consent in lieu of meeting. In either case, an actual written corporate resolution that evidences the decision is a must. As my law school business enterprises professor always said: “If it isn’t in writing, then it did not happen.” Corporate resolutions are that “writing” to prove the the business action in question “did happen.”

Some common corporate actions that should be memorialized through a resolution include, but are not limited to, the following:

  • Occurrence of an annual meeting.
  • Appointment or removal of an officer, such as president, vice-president, or treasurer, including the terms of employment.
  • Issuance of new shares or membership interests.
  • Changes to the Board of Directors and any compensation packages for said Board members.
  • Calls for capital contribution.
  • Retention of a business attorney, accountant, or other third party professional.
  • Approval of any amendments to the bylaws.
  • Becoming a party to any real estate lease or equipment lease.

Corporate resolutions are an essential part of good business governance and best practices. A well-organized and up-to-date corporate book has many benefits — for example, when you finally sell your business. Or if a lender wants to see your corporate book before they approve the new line of credit or loan. Additionally, whether an entity adheres to formal corporate practices is one of the factors the courts consider when deciding whether to pierce the corporate veil. Yet many business owners – especially busy up-and-coming entrepreneurs – neglect this relatively simple but critical task.

Finally, what about single-member LLCs or solo corporations? Do they still have to keep written records of their business decisions? YES. Corporate resolutions (as well as other formalities) are equally as important when you wear the many hats of the owner, manager, and sole employee of your business. Indeed, they may be more important in the single-owner context because it not practical to hold a “shareholders meeting” with yourself or record meeting minutes with one person.

Contact attorney Dan Artaev today at dan@artaevatlaw.com or by phone or text at (269) 930-0254.

Starting a Business? Choose Your Organizational Structure!

Every business owner needs to incorporate. Forget about sole proprietorships or a partnership — running your business without formally organizing is like driving without insurance: You will be OK so long as you don’t get into an accident. But when someone rear-ends you, you will be in dire financial straits regardless of who caused the wreck.

Incorporation is “insurance” that will protect your personal assets (your house, car, bank accounts, 401k) from financial risks associated with running a business. The rule is that creditors and plaintiffs cannot come after your personal assets to satisfy a business debt or liability. There are of course exceptions to this rule, called “piercing the corporate veil.” But many business owners ask: Should I register as a corporation? Non-profit? LLC? PLLC?

As with all of legal questions, the answer is “it depends on the facts.” Your attorney and accountant will help you decide what works best in your particular situation. However, here is a basic overview of the four most common entity types in Michigan:

  1. For-Profit Corporation – The Michigan Business Corporation Act sets out the rules for corporate formation and the default provisions for corporate governance. Usually, an attorney setting up the corporation will draft two documents: (A) Articles of Incorporation, which is the basic form filed with the State of Michigan creating the corporation and (B) the Corporate Bylaws, which is an internal corporate document that sets out the corporation’s management, number of shares, stockholders, Board of Directors governance, and various other provisions. There are also various sub-classes of corporations that differ for tax purposes–for example an “S-Corp,” but you will need to consult with your accountant to determine eligibility. Corporations have been around for a long time and are generally a good choice for business owners seeking to set up a tried-but-true business structure – one that is supported by decades of case law and statutory gap-filler provisions. But again, whether a corporation is the right choice is a decision to be made only with the assistance of your legal and financial advisers
  2. Nonprofit Corporation – Michigan also has a Michigan Nonprofit Corporation Act that governs the creation of non-profit entities. Nonprofit status should not be confused with “tax-exempt”–whether an entity is considered “nonprofit” is a matter of Michigan law, while it is the federal government and the IRS that determine “tax-exempt” status. Consult with your accountant on all tax related matters! Generally, if your intent is to create a corporate entity for charitable or other non-commercial purposes, the non-profit corporation may be the best way to maximize the relevant tax advantages. From a legal standpoint, a nonprofit is created in the same manner as a for-profit corporation, with certain exceptions–for example, a charity must be registered with the Michigan Attorney General. And again, if you seek tax-exempt status, you must file the appropriate paperwork with the IRS. Click here for a detailed guide on forming a nonprofit corporation in Michigan.
  3. Limited Liability Company – This is a relatively new type of entity created through the Michigan Limited Liability Company Act in 1994. An LLC is the preferred corporate form for many small businesses due to its simplicity and modern approach to pass-through taxation. Indeed, a single-member LLC enjoys the same single taxation as a sole proprietorship, as well as the protection of the corporate form without some of the extraneous formalities of a corporation. While simple, an LLC must still file Articles of Incorporation with the State of Michigan and draft an Operating Agreement that sets forth the rules on how the LLC is run. Even when running an LLC, it is critical to observe the corporate forms to maintain limited liability and avoid the dreaded “piercing of the corporate veil.”
  4. Professional Corporations and PLLCs – Michigan Law requires certain professionals (such as physicians, dentists, lawyers, and certified public accountants) to incorporate as professional entities. Generally, a professional corporation is similar to a regular for-profit corporation and a PLLC is similar to a regular LLC. The most important distinction for a professional corporation or PLLC is that the professional remains personally liable for their own misconduct or negligence. However, the other members of a PC or PLLC remain protected from liability for the misdeeds of a single member. Thus, while professional incorporation as a solo practitioner is not a given, multiple-member entities should definitely consider the advantages of statutory liability protection.

Have more questions? Contact Dan Artaev at dan@artaevatlaw.com or 269-930-0254 to set up your free initial consultation.

© 2021 Artaev at Law PLLC. All rights reserved.

Why Annual Meetings Are Critical to Protecting Your Personal Assets From Business Debts.

As a new and growing business owner, you read my articles on incorporation and essential corporate documents, and took my advice to heart. You retained an attorney and accountant, drafted and filed the basic forms, and Small Business LLC is up-and-running. However, you are not done — there are important steps to take for you to maintain the benefits of the “corporate form” and keep your personal and business assets separate. Take special note if you are a single member LLCs or single-shareholder corporation. When you are busy running your business, it is easy to overlook corporate formalities — yet whether you are a solo shop or a 50 employee corporation, these formalities are equally as necessary and important to protect your investment.

The exception to the general rule that an owner’s personal assets are protected from a business’s creditors and litigious plaintiffs is called “piercing the corporate veil.” This term of art originated from one of those archaic law school cases that no one remembers, yet practitioners and courts frequently use this phrase today. The idea behind “piercing the veil” that a business owner cannot abuse the corporate form and use it to commit fraud. If a plaintiff convinces a court that the defendant corporation or LLC is a sham, the plaintiff gets to “pierce the veil” and proceed against the business owner directly and personally, as if the corporation or LLC never existed. 

Of course, there is always the possibility that an unpaid creditor will accuse your company of fraud and abusing the corporate form even in instances of legitimate business insolvency. After all, everyone wants to get paid, and if there are significant personal assets shielded by the corporate form, it may just be worth the time and money to argue.

Here are some basic tips on how you can maximize the protections of the corporate form and mitigate the risk that a court will order “piercing the veil”:

  1. Separate bank accounts – This might seem basic, but it is astounding how many business owners co-mingle corporate and personal funds. It is absolutely critical that you maintain separate accounts and keep track of business income and expenses separate from your personal expenses. When examining whether the corporation is a sham, this is one of the first factors that a court will consider. In other words, pay your mortgage from your personal account and buy inventory using the company credit card (as opposed to your personal VISA). 
  2. Have an annual meeting – If you are organized as a corporation, an annual meeting is required by law. While it is not required for LLCs, having an annual meeting (and keeping a written record that such a meeting was held) is another important factor that courts will consider when deciding whether the owner is entitled to continuing “corporate veil” protection. 
  3. Keep a binder with written consents and meeting minutes – Your bylaws or articles of organization likely provide for the ability to make corporate decisions through written consents. Your attorney can help you prepare these documents, but generally these “consents” are written evidence that a particular transaction, such as a sale of real estate, a purchase of assets, an appointment of an officer, was authorized by the company. It is good practice to pick a shelf in your office and maintain a three-ring binder with all the consents arranged chronologically. If the company holds a meeting (whether annual or otherwise), it is best practice to record meeting minutes and keep them in the same binder as the written consents.
  4. Maintain good standing with the State of Michigan – This is the easiest requirement to observe, yet it is frequently overlooked. Each year, the State of Michigan requires business owners to file an annual statement form and a fee. Failure to do so for a period of time is not only evidence that might cause you to lose corporate protection, but actually can cause your entity to be automatically dissolved. While it is possible to bring your company back into compliance through retroactive payments and filings, the process costs extra fines and needlessly exposes the business owner to losing the benefit of corporate entity protection.

Contact attorney Dan Artaev today at dan@artaevatlaw.com or by phone or text at (269) 930-0254.

5 Often-Overlooked Essentials When Selling Your Business

You finally got that phone call from the California venture capital firm that wants to buy your  start-up for a couple of million dollars. You are eager to sell and use that money to pursue other projects and passions. The attorneys and accountants have been retained, and the Asset Purchase Agreement has been drafted. 

But while the attorney drafted the proper asset descriptions and indemnification clauses, and the accountant has allocated the purchase price for the taxes, has your team addressed these five often-overlooked essentials? After all, the sale of a business is much more than just signing the papers and turning over the keys.

  1. Is the buyer hiring the existing employees? When transferring the assets of a business, one can easily overlook the employees who operate those assets and make the business run. Assuming that the buyer is buying the employees together with the business is a grave (and potentially costly) error. Most employees are at will and may walk out from their job if you spring a “surprise” acquisition on them one morning. This may especially be devastating in an industry like manufacturing, where qualified employees are difficult to find. To mitigate that risk, the buyer should provide offer packages to all current employees at least a few days before the sale. As a seller, it may benefit you to make a small monetary or personal gift to some of the long-time or more senior employees to thank them for their years of service and to throw a transition pizza party for the crew. Remember that the sale will be a personal and emotional event for those who work for you. While you are selling the machines and office furniture, the employees make the business run.  
  2. Are any key services performed by a family member or by the seller him or herself? In small businesses, owners often rely on their family members (or themselves) to perform certain key services (like quoting prices or estimating inventory) without a formal employment relationship. The seller should disclose any key services done by family members so that the buyer can make adequate provisions to hire someone to perform those key services. After all, the goal is to keep the business going after the sale and to provide for as few delays as possible. 
  3. What happens to the invoices and receivables received after closing? Continuing in the ordinary course of business, there will be both invoices and checks that the buyer receives post-closing. Who is responsible for the invoices for inventory received pre-closing? Who gets the checks for pre-closing product? And what about any open purchase orders – are those being assigned? To prevent future conflict, all of these topics should be addressed before the money is wired.
  4. What about the building? If the seller owns the building and is selling that building with the business, the transaction is relatively straight-forward. But if there is a lease, the seller must obtain landlord’s consent before assigning the lease. Alternatively, the buyer must enter into a new lease that starts on the day of the closing to ensure a smooth transition and continued operations.
  5. Have the customers been informed? It is a mistake to assume that the business’s customers will simply continue doing business with the new owner. Business is as much about relationships as it is about the numbers. The buyer and seller should discuss a transition plan with respect to existing customers and ensure that these valuable relationships are preserved going forward.

Of course, these are just some examples, and there will be other key topics specific to the nature of your business and to the transaction. 

Contact attorney Dan Artaev today at dan@artaevatlaw.com or by phone or text at (269) 930-0254.

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