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Key and Commonly Misinterpreted and Disputed Operating and Partnership Agreement Provisions

It is critical to understand the needs and motivations of an entity’s partners/members when drafting the governing documents at the outset of a new venture in order to avoid disputes or unintended consequences as an entity matures.

In a far-reaching discussion on this topic, Berdon LLP hosted a panel discussion in early August that was sponsored by Hydra Collective, a networking group comprised of young professionals primarily in the law, accounting and finance professions. The panel was moderated by Berdon’s Michael A. Garcia, CPA, CFE, CFF, J.D., a principal in the Firm’s Litigation, Valuation & Dispute Resolution Group.

The panel covered numerous topics concerning key and commonly misinterpreted and disputed operating and partnership agreement provisions and featured the following panelists, each of whom are members of Hydra Collective:

  • Ross A. Hurwitz, CFA, Berdon LLP;
  • Kyle M. Lawrence, Esq., Moritt Hock & Hamroff LLP;
  • Matthew E. Rappaport, Esq., LL.M.; and
  • Robert M. Van De Veire, Esq., Malecki Law.

Hurwitz drew upon his extensive business valuation experience to cover the potential impact that certain provisions could have on the valuation of a partnership or membership interest. Specifically, he discussed provisions regarding management, voting rights, distribution policies, and withdrawal and transferability restrictions, among others, and how these provisions could potentially impact discounts for lack of control and lack of marketability when valuing minority interests in closely held entities. Hurwitz also expanded upon this topic in a discussion regarding drag-along and tag-along rights — a subject matter upon which he has previously co-authored an article.

Panelists also touched upon the most recently proposed regulations pertaining to Internal Revenue Code (“IRC”) §2704, for which the 90-day comment period began on August 4, 2016, regarding its potential impact on the use of valuation discounts for fractional interests in family-controlled entities. Matthew Rappaport, a co-founder of Hydra Collective and a tax planning and structuring attorney, described the proposed regulations and shared his opinion that if the regulations pass as written, “it will be substantially more difficult to use valuation discounts when transferring fractional interests in family controlled entities.”

Rappaport noted that other key taxation issues to consider when drafting partnership agreements include certain safe harbor provisions for special allocations under IRC §704, the intent of which is to curtail allocations based purely on tax rather than on economic consequences.

Lawrence, an attorney with approximately 10 years of experience representing clients in all phases of corporate and commercial transactions, corporate financing, and entity formation and structuring, discussed the key considerations he relays to his clients while drafting operating and partnership agreements.

According to Lawrence, chief among the many concerns clients should have when forming an entity “is knowing who they are and could be in business with now and in the future” and what the partners’ or members’ rights and responsibilities are in relation to one another. Lawrence also shared his thoughts on provisions regarding management, decision making and authority; capital contributions, including remedies for partners’/members’ failure to make additional capital contributions when required; withdrawal, expulsion and addition of partners/members to the entity; and transferability and buyout provisions.

Van De Veire, whose practice focuses primarily on arbitration and litigation in the securities and banking industries, spoke about the potential ramifications that dispute resolution, choice of law, and venue selection clauses in operating and partnership agreements could have on an entity’s partners/members. Van De Veire elaborated upon the benefits and drawbacks of selecting dispute resolution through the courts, binding and non-binding arbitration and spoke about the importance of drafting precise and specific indemnification provisions, which is especially important for agreements governed by New York law. He also discussed common situations in which the securities laws could unintentionally be invoked (such as when drafting promissory notes), triggering registration and other compliance requirements mandated by securities laws.

In addition to facilitating the panel discussion, Garcia — a forensic accountant who, for almost 10 years, has provided litigation support services for a diverse array of matters spanning across many industries — added to the panel’s discussion based upon his experiences regarding partnership and post-acquisition disputes. Specifically, Garcia provided several examples where the unintentional misuse of accounting terms of art within agreements led to disputes between business owners and even affected the analysis and quantification of economic damages. He also addressed how imprecisely drafted inspection rights provisions could lead to costly delays and additional disputes amongst business owners.

For more information regarding this panel discussion or Berdon’s Litigation, Valuation & Dispute Resolution Group, contact either Michael Garcia at MGarcia@berdonllp.com or Ross Hurwitz at RHurwitz@berdonllp.com.