Reference Articles

1) As a director of a corporation or a limited liability company, what legal duties do I owe the company and its shareholders?
2) Are Covenants Not to Compete in Kentucky Enforceable?
3) What is a LLC operating agreement?
4) What are the advantages to incorporating your business as an LLC (limited liability company)?
5) What are the requirements for obtaining a valid mechanics’/materialman’s lien on a privately owned commercial construction project?
6) Who or what is a Receiver?
7) Must a Contract be in Writing to be Enforceable?
8) Are contractual clauses limiting liability for negligence in performance of a contract (“exculpatory clauses”) valid in Kentucky?

1) As a director of a corporation or a limited liability company, what legal duties do I owe the company and its shareholders?
Corporate directors owe the fiduciary duties of care, loyalty and good faith to the company and its shareholders.

1. The Duty of Care: A director must act with the same care as an ordinarily prudent person in a like position would exercise in similar circumstances and in a manner the director reasonably believes to be in the best interest of the company.
2. The Duty of Loyalty: A director must take only those actions that are within the best interest of the company and not in his own personal interest. A director must not engage in any form of “self-dealing.”
3. The Duty of Good Faith: This duty requires a director to act honestly at all times and to conduct the company’s business with fairness and openness.

If a director of a company violates any of these elements of his fiduciary duties to the company or the shareholders, the director may be held legally responsible for monetary damages in a court at law.

2) Are Covenants Not to Compete in Kentucky Enforceable?

Yes they are, but they must be “reasonable.” The covenant must be reasonable as to time, scope and territory and it must protect a legitimate interest of the employer. The three “reasonableness” factors considered by Kentucky Courts are as follows:

1. Time Duration: The length of the covenant should be no longer than necessary to protect the employer’s legitimate interest. This will usually be from one to a maximum of six years depending upon certain factors.
2. Geographical Restriction: The geographic restricted area should be limited to the area where the employer conducts business. A nationwide restriction is not common, but has been held to be enforceable under certain circumstances.
3. Scope: The covenant can only restrict future employment or activity in the same or similar business in which the employee was engaged.

Kentucky courts have the authority to make changes to any of the above three elements of a covenant not to compete to the extent the Court finds them to be unreasonable or unfair.

3) What is a LLC operating agreement?

An operating agreement is a written document that governs the relationship between members (owners) of an LLC (Limited Liability Company). A typical operating agreement will address the following:

• Each member’s percentage ownership interest in the LLC
• The allocation of the LLC’s profits and losses among the members
• How the LLC will be managed and by whom
• The voting power and rights of each member
• The process for adding new members
• How existing members may value and sell their membership interests

Most importantly, an operating agreement allows the LLC members to avoid being subject to Kentucky’s default rules as set forth in Kentucky’s Limited Liability Company Act. This means the members can run their LLC in the manner best suited for their line of business and tailored to their specific needs. Additionally, if a dispute arises between the members, a court will look to the operating agreement’s provision to resolve the dispute.

Although Kentucky law does not require an LLC to have an operating agreement, it is an essential document if you want to insure that all LLC members are aware of their rights and responsibilities.

4) What are the advantages to incorporating your business as an LLC (limited liability company)?

Most importantly, business owners who incorporate as an LLC are provided legal protection from individual liability for most of their business debts. Their personal assets are protected from their business creditors.

The management structure of an LLC allows more flexibility than that of a traditional “S” or “C” corporation. The owners (members) of an LLC can specify each of their operational and managerial duties and provide for the sharing of the companies income, expenses and profits among other things, in an LLC Operating Agreement.

Further, there are significant and distinct tax advantages in forming an LLC over a traditional “C” corporation. Profits from an LLC business “pass through” to the owners (members) personal income tax returns, so the business’ profits are taxed at the individual’s tax rates, which are currently significantly lower than a “C” corporation’s tax rate.

These are only some of the reasons why the LLC has become the entity of choice for most start-up businesses and small business owners.

5) What are the requirements for obtaining a valid mechanics’/materialman’s lien on a privately owned commercial construction project?

Any person or company that performs labor or provides materials to a commercial construction project may file a lien against the privately owned real property upon which the project is being constructed.

If the lien claimant does not have a contract directly with the owner of the real property, KRS 376.010(3) requires the lien claimant to provide written notice to the owner of the real property within 75 days on claims amounting to less than $1,000 and 120 days on claims in excess of $1,000, after the last item of material or labor is furnished to the project.

In order to perfect the lien, the lien claimant must also file a lien statement in the form prescribed by KRS 376.080 in the office of the County Clerk in which the real property is located. The lien statement must be filed in the County Clerk’s office within 6 months after the lien claimant ceases to perform labor or furnish material and a copy of the lien statement must be mailed to the owner within seven days of filing the lien statement.

KRS 376.090 states that the claimant’s lien will be dissolved unless a lawsuit is filed within 12 months from the date the lien statement is filed in the County Clerk’s office. Unfortunately, there are numerous “pitfalls” a lien claimant can encounter when attempting to properly perfect a mechanics’/materialman’s lien. Kentucky’s statutes set forth different requirements for liens on public projects and residential projects. You should consult with an attorney to insure you comply with all of the statutory requirements when filing a mechanics’/materialman’s lien.

6) Who or what is a Receiver? A Receiver is an independent or neutral person or entity appointed by the Court to manage money or property during the course of a lawsuit. A Receiver exercises powers for the common benefit of all parties in interest, owing loyalty only to the Court and acting solely for the benefit of the property concerned, even if the Receiver is recommended by or appointed at the request of a party to the lawsuit. The Receiver reports only to the Court, and shall not favor or be influenced by any of the parties to the lawsuit.

The Receiver is typically obligated to file monthly, or at least regular reports with the Court itemizing all funds or property it has received and/or spent.

Traditional types of Receivership are as follows:

1. Preserving real property during a foreclosure proceeding when the property is in danger of being lost, removed, or materially injured;
2. Protecting commonly owned property or funds in dispute or in danger of injury, waste or dissipation;
3. Enforcing a judgment;
4. Disposing of property subject to a judgment or to preserve such property pending appeal;
5. Winding up of a dissolved corporation;
6. Managing the affairs of a corporation whose owners are deadlocked and cannot agree as to management decisions or that is facing insolvency.

The appointment of a Receiver can be a powerful tool when properly utilized by a party in a lawsuit.

7) Must a Contract be in Writing to be Enforceable?

No, not all contracts must be in writing to be enforceable. In general, oral contracts are just as valid and enforceable as written contracts (except in certain instances as discussed below). However, the party alleging the existence of an oral contract must be able to prove with reasonable certainty that both parties intended to enter into a contract and must be able to prove the substance of the terms of the contract. If proven, a court may enforce a valid oral contract, including any damages for breach of the oral contract, to the same extent as a written contract.

Despite the general enforceability of oral contracts, Kentucky, like most jurisdictions, has adopted the “Statute of Frauds.” The Statute of Frauds is a statutory requirement stating that certain kinds of contracts must be memorialized in a signed writing. Traditionally, the statute of frauds requires a writing signed by the defendant in the following circumstances:

• Contracts in consideration of marriage (not marriage itself)
• Contracts which cannot be performed within one year
• Contracts for transfer of an interest in land (real estate contracts)
• Contracts by the executor of a will to pay a debt of the estate with his own money
• Contracts for the sale of goods above a certain value (usually $500 under the Uniform Commercial Code)
• Contracts in which one party becomes a surety (acts as guarantor) for another party’s debt or other obligation.

Unless the alleged oral contract falls into one of the defined categories of the Statute of Frauds listed above, the oral contract is enforceable if its terms can be reasonably proven.

In Kentucky, oral contracts are governed by the five (5) year statute of limitations for enforcement purposes, and written contracts are governed by the fifteen (15) year statute of limitations.

8) Are contractual clauses limiting liability for negligence in performance of a contract (“exculpatory clauses”) valid in Kentucky?

An exculpatory clause is a provision in a contract under which either (1) one party is relieved of any blame or liability arising from the other party's wrongdoing, or (2) one party (usually the one which drafted the agreement) is freed of all liability arising out of performance of that contract. For example, a dry cleaner's receipt that includes a disclaimer freeing him or her from any liability for damage to the item to be cleaned during the dry cleaning process.

Exculpatory clauses are generally valid and enforceable in Kentucky when entered into between parties with equal bargaining power. However, exculpatory clauses exempting liability for negligence are generally disfavored in Kentucky courts and are strictly construed against the party relying upon such clause. Especially if the party who drafted the exculpatory clause or agreement is the same party seeking to rely on the clause to escape liability. The exculpatory clause must clearly set forth the negligence for which liability is to be avoided. Clear and explicit language is required to absolve one from liability. A general or vague or “catch all” exculpatory clause will generally not be valid or enforceable in Kentucky.

Further, an exculpatory clause cannot contract away damages caused by willful or wanton negligence, generally encompassing reckless behavior or a conscious disregard of the rights or safety of other. A contractual clause limiting liability would also not be valid if it was procured by fraud or other wrongful or illegal conduct.

A common type of exculpatory clause involves limiting liability on a secured loan or mortgage solely to the secured collateral. In other words, if there is a default, the contract states that damages will be limited to execution on solely the collateral (i.e., foreclosure on the property covered by the mortgage).

What happens if an exculpatory clause or limita­tion of liability clause is not valid? In this situation, a party may sue pursuant to any other valid legal remedy, such as for the actual damages the party incurs.