Firm News

Groundbreaking Decision on Non-Compete Agreements

Non-compete agreements traditionally have been disfavored but, under certain circumstances, have been enforceable in Texas.  In follow up to rulings in recent years that lighten the burden for employers to enforce non-competes, the Texas Supreme Court has reached another important decision that strengthens the ability of employers to enforce non-competes. In Marsh USA Inc. et al. v. Cook, Case No. 09-0558 (Tex. June 24, 2011), the Court held that a non-compete covenant contained in a stock option plan was enforceable. The Court reasoned that stock options are sufficient consideration for a non-compete because they give rise to the employer’s interest in protecting the "goodwill" of its business. 

 This holding is a significant departure from past holdings where courts for many years viewed that providing financial consideration was not sufficient for a non-compete agreement. Only the provision of confidential information, trade secrets, special training, and/or other proprietary information supporting a company’s goodwill was sufficient consideration. In Marsh, the Court established a new test that will pave the way to additional avenues for employers to take in seeking to protect the goodwill of their businesses.

by Jim Stanford and Michael S. Byrd

Creditors Rights

Is a Limited Liability Company Always the Right Choice?

Given the significant flexibility of a limited liability company (“LLC”) in terms of formation, corporate governance, and tax status, LLCs are emerging as the preferred entity choice for private business. However, because of a recent ruling in the case McNamee v. Department of Treasury, Internal Revenue Service 488 F. 3d 100 (“McNamee”), a careful evaluation of your business objectives, financial and tax considerations, and desired level of liability protection should be made in determining the right entity for your situation. In McNamee, the Second Circuit Court of Appeals affirmed a federal trial court’s ruling that the owner of an LLC can be held personally liable for unpaid payroll taxes of the LLC.

One of the benefits of an LLC, which also may be its Achilles’ heel in certain situations, is the ability to elect to treat the entity as a corporation or a partnership (or sole proprietorship if only one member) for federal tax purposes. An LLC exercises that option simply by filing IRS Form 8832 to elect to be treated as a corporation. In the absence of such an election, an LLC that has only one owner is disregarded as a separate entity and will be treated as a sole proprietorship for tax purposes.

According to the Treasury Regulations of the Internal Revenue Code, as discussed by the court in McNamee, if a single-
member LLC elects to be treated as a corporation, the owner will avoid tax liabilities that may otherwise fall upon him if the LLC were disregarded as an entity. However, the owner is subject to double taxation since the LLC is taxed once at the corporate level and once at the shareholder level. If a single-member LLC elects not to be treated as a corporation, either by affirmative election or by default, the owner will be liable for the tax obligations incurred by the LLC, but the owner will avoid double taxation.

Sean McNamee was the singlemember owner of the nowdefunct accounting firm W.F. McNamee & Company, LLC (“WFM, LLC”), which on average employed six persons. Mr. McNamee did not elect to have WFM, LLC treated as a corporation for tax purposes. Thus, under the Treasury Regulations, the LLC was disregarded as a separate entity and was treated as a sole proprietorship for federal tax purposes. WFM-LLC failed to make some of its required payments of payroll taxes with respect to its employees. The IRS assessed those taxes against Mr. McNamee personally and placed a lien on his property, having disregarded WFM-LLC as a separate entity. The court ruled against Mr. McNamee, and he was found personally liable for the unpaid payroll taxes. It is unclear whether the case will be appealed to the Supreme Court.

However, it is important to note that the IRS proposed Treasury Regulations in 2005 would eliminate this liability. Although the proposed regulations had no bearing on the case in McNamee, since they have not been adopted, it is a good sign of what the law may eventually be with respect to LLCs and payroll taxes. The proposed regulations would treat subchapter S subsidiaries and single-owner eligible entities that currently are disregarded as entities separate from their owners for federal tax purposes (e.g., singlemember LLCs), as separate entities for employment tax and related reporting requirement purposes. According to the proposed regulations, the Treasury Department and the IRS believe that treating the disregarded entity as the employer for federal employment taxes purposes will improve the administration of the laws and simplify compliance.

An LLC may still be an excellent choice for a business in many situations, but these developments  highlight the need for careful planning with both your attorney and CPA prior to selecting the type of entity to form for your business.

By James M. Stanford