To sue a lawyer for breaching her duty of care in forming a New Hampshire multimember LLC, a plaintiff must prove, on the basis of expert testimony:
- That an attorney-client relation-ship existed between the plaintiff and the lawyer at the relevant time;
- That the lawyer breached her duty of care to the plaintiff; and
- That the breach harmed the plaintiff.
See, e.g., Carbone v. Tierney, 151 N.H. 521 (2004).
As readers will know, at least since 1997, LLCs have been the entities of choice for conducting New Hampshire businesses. There are presently more than 88,000 New Hampshire LLCs, and every year, New Hampshire businesspeople form roughly 12,000 more new LLCs under the Revised New Hampshire Limited Liability Company Act (New Hampshire LLC Act). IRS filing statistics suggest that at least 20 percent of these LLCs are multi-member LLCs. And while there are no relevant statistics:
- It is likely that in forming many of these New Hampshire multi-member LLCs, LLC founders use the assistance of New Hampshire lawyers.
- The main service provided by these lawyers to these LLC founders consists not in drafting and filing certificates of formation for these LLCs, which is likely to involve little or no malpractice risk; rather, it consists in drafting operating agreements. As discussed below, this drafting may involve substantial risks.2
As readers will know, LLC operating agreements are the agreements among the members of an LLC about the legal and tax structure of LLCs and about the rights and duties of the members.
In my 25 years as a New Hampshire LLC lawyer, I’ve drafted hundreds of multi-member LLC operating agreements, and I’ve written extensively about the legal and tax issues that lawyers must address in this drafting.3 Multi-member LLC operating agreements are unavoidably complex; in my view, a good operating agreement must address at least 28 major types of legal and tax issues, and to address these issues competently, lawyers must address at least 200 subsidiary issues. Thus, significant malpractice risks are inherent for lawyers in drafting any multi-member LLC operating agreement, especially if, as is often the case, the formation or conduct of the relevant LLC involves significant financial stakes.
At this writing, there are no reported cases under the laws of New Hampshire or other states that address plaintiffs’ claims that in drafting multi-member LLC operating agreements for their LLCs, their lawyers have committed malpractice. I suspect this is so because most such claims result in settlements. However, on the basis of the above experience, I believe that there are three main types of malpractice that New Hampshire lawyers may commit in drafting these agreements.
1. Failure to meet New Hampshire professional ethics rules governing conflicts of interest. By definition, the drafting of multi-member LLC operating agreements will simultaneously affect two or more LLC members, and the lawyers drafting them may represent (i) only one of these persons; or (ii) two or more of them jointly.
Thus, whenever clients retain lawyers to draft these agreements, the first task of these lawyers must be (i) to determine which of these persons are their clients and which are not; (ii) to make their determinations clear to all of these persons; and (iii) to draft comprehensive joint representation agreements for their joint clients, to explain these agreements to them
in detail, and to obtain their signature on them. See generally, Rule 1.7, New Hampshire Rules of Professional Conduct (Conflicts of Interest); Rule 1.7, American Bar Association Rules of Professional Conduct (comments on joint representations). Their failure to perform these tasks may result in malpractice claims against them by persons who are their lawyers not expressly but by implication.
2. Failure to advise multi-member LLC clients concerning operating agreement tax issues. In order to draft an operating agreement, a lawyer must consider numerous important federal and New Hampshire state tax issues. These include, for example, issues:
a)`Whether the LLCs in question should be taxable under Internal Revenue Code Subchapters C, K or S;
b) How to structure LLC allocations to maximize the IRC section 199A deductions available to the members;4
c) How the members can simultaneously maximize their section 199A deductions and the federal tax benefits available to them by making contributions to federally tax-favored retirement plans such as SEP-IRAs;
d) How to minimize the members’ Self-Employment Tax liabilities (e.g., by the use of Prop. Reg. § 1.1402(a)-2); and
e) How to protect LLCs from the New Hampshire Business Profits Tax and their New Hampshire resident members from the New Hampshire Interest and Dividends Tax.
A failure to address any of these issues in a multi-member LLC operating agreement may trigger major federal or New Hampshire tax liabilities for affected LLC members.
Thus, if lawyers forming New Hampshire LLCs have the necessary tax competence, they must address these issues for their clients in operating agreements they draft for them; or, alternatively, if they lack this competence, they must so advise their clients and must advise them to retain lawyers or accountants who possess it.
3. Failure to take account of relevant provisions of the New Hampshire LLC Act. The New Hampshire Act contains roughly 300 separate provisions relevant to the drafting of multi-member LLC operating agreements, including definitional, mandatory, default, and permissive provisions. In drafting these agreements, lawyers must take into account each of these provisions.
For example, there are roughly 100 default provisions in the New Hampshire LLC Act—i.e., provisions that will govern an LLC unless the operating agreement provides otherwise. If a lawyer drafts an operating agreement that fails to expressly override a New Hampshire LLC Act default provision contrary to her clients’ interests and if this failure harms her clients, this may result in a serious malpractice claim against the lawyer.5
1. As its title makes clear, the focus of this article is on malpractice risks for New Hampshire lawyers in assisting their clients in forming New Hampshire multi-member LLCs. More particularly, it focuses on planning and drafting operating agreements for these clients. It is true, of course, that many New Hampshire lawyers also assist their clients from time to time in forming single-member LLCs, and operating agreements can be useful (and often indispensable) not only to multi-member LLCs but also to LLCs with only one member. However, the malpractice risks in assisting clients in forming single-member LLCs are very low. Thus, in this article I will not discuss these risks.
2. In my view, the challenging task for NH lawyers with regard to multi-member LLC operating agreements is not their drafting, but rather, their planning. However, for brevity, the text of this article will refer only to the drafting of these agreements.
3. See, e.g., Drafting Limited Liability Company Operating Agreements, Chapter 4 (“General Drafting Guidelines”); Chapter 8 (“Multi-Member LLCs”); Chapter 38 (“Tax Tasks in LLC Formations”).
4. Section 199A provides annual 20 percent federal income tax deductions to individuals on their pass-through business income.
5. I am indebted to Evan Anderson, a student and a member of the law review of the University of New Hampshire Franklin Pierce School of Law for his assistance in the drafting of this article.