Top 3 Provisions Food Businesses Need in LLC Agreements

A limited liability company (LLC) is an attractive option for food and beverage entrepreneurs because it provides liability protection similar to a corporation and favorable income tax treatment similar to a partnership. Plus an LLC affords its owners flexibility to structure their operations and business relationships with their partners.

The terms of how the business operates is usually established in an operating agreement. While not all states require an operating agreement, it is highly recommended for businesses with 2 or more members. Most state laws contain default provisions for the many organizational issues that arise, but not all. Regardless of what state you operate in here are the most important provisions you should include in your operating agreement to make your business run smoothly.

1. Management Deadlock

Many food businesses begin with two partners excited to bring their new concept to fruition. Since this relationship is often formed out of a friendship, the owners frequently decide to split ownership 50/50. This situation usually works fine until the relationship sours and the owners disagree on a matter. If neither side will relent, then deadlock occurs. The remedy for deadlock in many states is for a court to order dissolution of the LLC, meaning that the business can no longer operate and must liquidate.

In a recent case, celebrity chef Gordon Ramsey sought dissolution of an LLC that that developed and operated burger-themed restaurants in Las Vegas. Ramsey owned 50% of the LLC and asked his partner to withdraw, but he refused. Since the operating agreement lacked a tie breaking mechanism, the result was a deadlock. In the end the court ordered the LLC to dissolve because deadlock between the parties rendered it no longer reasonably practicable for the LLC to operate in accordance with its operating agreement.

The Ramsey case should serve as a warning to other food businesses on the importance of addressing management issues upfront when the relationship between the parties is strong. A well-drafted operating agreement can avoid this potential fatal flaw and keep the business operating.

2. Transferring Ownership

You cannot predict the future so its important to plan for potential life changing events. The default rule in many states is that members may freely transfer a membership interest in the LLC to anyone, but the new owner may be treated differently, including not be entitled to vote unless a majority of members agree to make them full members. If members are freely allowed to transfer their interests they may find themselves faced with new business partners they do not want. In certain circumstances a member’s interest could be transferred involuntarily, such as death, divorce or bankruptcy. To avoid uncertainty in these situations members may want to put restrictions on transferability in the operating agreement.

3. Additional Contributions

As the business grows it may require additional capital. Many businesses turn to their members to supply the money, which is referred to as additional capital contributions. The law in most states provide flexibility in how LLCs deal with the need for additional capital in their operating agreements, such as members are not required to make additional contributions, or it may require additional contributions and permit one member to make an additional capital contribution for another member that fails to make a contribution in exchange for a portion of the member’s membership interest.

There are many possibilities to choose from, but members should consider the effect the additional capital contribution language has on the limited liability of the LLC. Some courts have interpreted the additional capital contribution language as requiring the members to pay LLC debt that the LLC cannot pay itself. This would therefore defeat a major benefit utilizing an LLC where members are not individually liable for the debts of the LLC. However, the members may avoid this by stating in the operating agreement that additional capital contributions are never required and the members have no personal liability for the debts of the LLC. But by taking this course of action it may cause problems later if the LLC needs additional capital.

 

The important takeaway here is to consider and plan for the potential needs of the LLC, and to do so in a way that doesn’t result in unintended consequences for the LLC or its members. An operating agreement is a road map and tool to navigate through difficult challenges and obstacles.

If your have questions about your operating agreement, please contact our attorneys at Morsel Law.

How to Start a Home-Based Food Business in Michigan

So you’ve got a killer recipe for double fudge peanut butter cookies you promised your grandmother never to reveal to anyone. When you put them out at parties they disappear quicker than the Cleveland Browns chances of making the playoffs. Your friends and family have told you countless times that you could make a killing selling these cookies, but you never took them seriously. But, while recently watching your favorite showing on the Cooking Channel, you finally realize you can do what these cooks are doing and decide to launch your own cookie business. But you’ve never started a business before, let alone a food business, so where do you begin?

Since you are working with a limited budget, you rule out starting your own manufacturing facility or hiring a contract manufacturer produce the cookies for you. You narrow your options down to renting space in a shared commercial kitchen or baking out of your home. Although your friends and family rave about the cookies you give away (which they should!), you’re uncertain whether people are willing to pay for your delicious product. Based on this analysis, you decide baking in your own kitchen is the most cost effective way to go until you prove there is a market for your cookies.

Now that you’ve decided to start a home-based food business (commonly referred to as a Cottage Food business), you ask yourself: “what do I do now?” The laws and regulations governing food businesses are difficult to navigate and can seem a bit daunting, but don’t let that discourage you. In this article we will walk you through the steps to start a home-based food business under the Michigan Cottage Food Law.

Where You Can Sell

In Michigan, cottage foods may only be sold by the producer directly to the consumer at farmers’ markets, farm stands, roadside stands and similar venues. Cottage foods cannot be sold to a retailer for resale or to a restaurant for use or sale in the restaurant. Cottage foods cannot not be sold over the Internet, by mail order, or to wholesalers, brokers or other food distributors for resale. Cottage Food businesses may take orders over the phone as long as the cash transaction and delivery of the product is face to face; however, Internet orders are prohibited. Shipping or third-party delivery of cottage food products is also prohibited.

Permitted Foods

Under the Cottage Food Law, only non-potentially hazardous foods that do not require time and/or temperature controls for safety are permitted to be made in a home-based kitchen. “Potentially hazardous food” is food that can be safely kept at room temperature and do not require refrigeration. Examples of permitted foods include: Breads; Similar baked goods; Vinegar and flavored vinegars; Cakes, including celebration cakes (birthday, anniversary, wedding); Sweet breads and muffins that contain fruits or vegetables (e.g., pumpkin or zucchini bread); Cooked fruit pies, including pie crusts made with butter, lard or shortening; Fruit jams and jellies in glass jars that can be stored at room temperature (except vegetable jams/jellies); Cookies; Dry herbs and dry herb mixtures; Dry baking mixes; Dry dip mixes; Dry soup mixes; Dehydrated vegetables or fruits; Popcorn; Cotton Candy; Non-potentially hazardous dry bulk mixes sold wholesale can be repackaged into a Cottage Food product (similar items already packaged and labeled for retail sale cannot be repackaged and/or relabeled); Chocolate covered pretzels, marshmallows, graham crackers, Rice Krispies treats, strawberries, pineapple or bananas; Coated or uncoated nuts; Dried pasta made with eggs; Roasted coffee beans or ground roasted coffee; Vanilla extract (Note: these products require licensing by the Michigan Liquor Control Commission); Baked goods that contain alcohol, like rum cake or bourbon balls (Note: these products require licensing by the Michigan Liquor Control Commission).

Prohibited Foods

Potentially hazardous foods are not permitted to be made in a home-based kitchen. Examples of prohibited foods include: Meat and meat products like fresh and dried meats (jerky); Fish and fish products like smoked fish; Raw seed sprouts; Vegetable jams/jellies (e.g., hot pepper jelly); Canned fruits or vegetables like salsa or canned peaches; Canned fruit or vegetable butters like pumpkin or apple butter; Canned pickled products like corn relish, pickles or sauerkraut; Pies or cakes that require refrigeration to assure safety like banana cream, pumpkin, lemon meringue or custard pies, cheesecake, and cakes with glaze or frosting that requires refrigeration (e.g., cream cheese frosting); Milk and dairy products like cheese or yogurt; Cut melons; Caramel apples; Hummus; Garlic in oil mixtures; All beverages, including fruit/vegetable juices, Kombucha tea, and apple cider; Ice and ice products; Cut tomatoes or chopped/shredded leafy greens; Confections that contain alcohol, like truffles or liqueur-filled chocolates; Focaccia style breads with fresh vegetables and/or cheeses; Food products made from fresh cut tomatoes, cut melons or cut leafy greens; Food products made with cooked vegetable products that are not canned; Sauces and condiments, including barbeque sauce, hot sauce, ketchup, or mustard; Salad dressings; and Pet food or treats.

Limitations

Currently, Cottage Food businesses are limited to $20,000 per year in gross sales. The limit will increase again December 31, 2017 to $25,000 per year. You need to maintain sales records and provide them upon request to a food inspector.

Licenses and Permits

Under Michigan law, if you qualify to operate as a Cottage Food business, you are exempt from obtaining a food establishment license. There are no application forms to complete, no registration process and you do not need to obtain a food license or permit. However, the Cottage Food Law does not exempt you from the requirements of the Michigan Food Code, such as not distributing adulterated (unsafe) food.

Local Zoning

Home-based food businesses should be aware of local laws and ordinances, including zoning and small business permitting. It is important to check with your local health inspector to determine whether your home is properly zoned for a home-based food business.

Labeling

If your product is only sold within the state in which you operate, then you are exempt from federal labeling requirements. However, your label must comply with the labeling requirements under the Cottage Food Law.

In Michigan, your product label must contain the following:

  • Name and physical address of the Cottage Food operation (P.O. Box addresses are not allowed)
  • Name of the Cottage Food product (all capital letters or upper/lower case)
  • Ingredients in descending order of predominance by weight. If you use a prepared item in your recipe, you must list the sub ingredients as well (For example: soy sauce is not acceptable; soy sauce (wheat, soybeans, salt) would be acceptable).
  • Net weight or net volume (must also include the metric equivalent)
  • Allergen labeling (as specified in federal labeling requirements)
  • Must include the following statement: “Made in a home kitchen that has not been inspected by the Michigan Department of Agriculture & Rural Development” in at least the equivalent of 11-point font (about 1/8″ tall) and in a color that provides a clear contrast to the background (all capital letters or upper/lower case)

Hand-printed labels are acceptable if they are clearly legible, written with durable, permanent ink and printed large enough to equal the font size requirements listed above.

Below is an example of an approved label:

MADE IN A HOME KITCHEN THAT HAS NOT BEEN INSPECTED BY THE MICHIGAN DEPARTMENT OF AGRICULTURE & RURAL DEVELOPMENT

Chocolate Chip Cookies

Joe’s Cookie Company
123 Chocolate Lane
Dessert City, MI 48009

Ingredients: Enriched flour (Wheat flour, niacin, reduced iron, thiamine, mononitrate, riboflavin and folic acid), butter (milk, salt), chocolate chips (sugar, chocolate liquor, cocoa butter, butterfat (milk), Soy lecithin as an emulsifier), walnuts, sugar, eggs, salt, artificial vanilla extract, baking soda

Contains: wheat, eggs, milk, soy, walnuts

Net Wt. 3 oz (85.05g)

If you have questions about starting a cottage-food business, please contact one of our attorneys at Morsel Law.

Avoid Ice in Your Cocktails at All Costs

Everyone has a favorite go-to cocktail they order when they visit their favorite watering hole. But if the drink is made with ice, you may want to reconsider.

While it’s not new news, a recent article described interviews with several bartenders who noted that restaurants may not clean their ice machines regularly. While the Food Code in most states govern the cleaning standards for ice, these standards vary. Mold and bacteria have regularly been found in ice machines, which can lead to serious illness. Even bartenders who fail to wash their hands can contaminate ice, which can spread disease.

The key for restaurants and bars to avoid contamination is to treat ice with the same safety precautions that they would treat food. This includes training employees on how to properly handle and store ice.

If you have questions about food safety for your business, contact our attorneys at Morsel Law.

FDA posts new FSMA compliance dates

Is your food business affected by Food Safety Modernization Act (FSMA) rules? FDA launched a new website listing the staggered FSMA compliance dates, some based on the size of a business. FDA also has provided a graphic timeline that shows these staggered compliance dates by month and year.

The rules that include compliance dates, in the order they became final, are:

  • Preventive Controls for Human Food
  • Preventive Controls for Animal Food
  • Produce Safety
  • Foreign Supplier Verification (discussed in an earlier blog post)
  • Sanitary Transportation
  • Intentional Adulteration

There are no compliance dates for the Accredited Third-Party Certification rule since it is a voluntary program. However, FDA launched a website earlier this year where an organization can apply to be recognized as a Third-Party accreditation body.

If FSMA applies to your business, then you may want to take a look and make sure you will be ready before these deadlines. If you have questions about FSMA compliance, contact our attorneys at Morsel Law.

FDA Approves Peanut Allergy Prevention Claims on Baby Food Labels

It’s now recommended to introduce peanuts to young infants.

FDA has announced that companies will be able to label baby food products with advice about how the early introduction of peanuts in an infant’s diet may reduce the risk of developing a peanut allergy. This marks the first time the FDA has permitted a qualified health claim of food allergy prevention. These labels will be allowed on foods containing ground peanuts suitable for infant consumption, but not whole peanuts, which may be a choking hazard for young children.

The full story can be found here.

If you have questions about FDA labeling regulations, contact our attorneys at Morsel Law.

Your Organic Food May Not Be Organic

The USDA’s Inspector General recently released its annual report on the National Organic Program (NOP). The report found widespread problems with the NOP that could result in “reduced U.S. consumer confidence in the integrity of organic products imported into the United States.” The report cites the USDA’s Agricultural Marketing Service’s (AMS) failure to reconcile organic standards between different countries, verify documents at U.S. ports of entry and conduct mandatory audits of major exporters.

In visits to seven U.S. ports of entry, the IG found produce shipments of all kinds are fumigated at the border to prevent pests from entering the country. That practice, according to the IG, runs counter to the assurance U.S. consumers get from the NOP that “foreign agricultural products maintain their organic integrity from farm to table.” The IG recommends that the NOP come up with performance measures for timely audits and suggests adoption of a schedule to review each participating country every two years.

The failure of the AMS to do their job is inviting trouble. Food fraud is big business and will probably be even more so after this report is shared across the globe. If a farmer can sell his non-organic wheat as organic for twice the price, he might consider it, or he might not. But what about a wholesale broker run by a criminal enterprise looking for new sources of income, would they think twice about reclassifying products as organic to make more profit? Probably not.

Hopefully the IG report will lead to significant changes for the NOP, but in the meantime consumers should be vigilant about identifying the source of their organic foods. Maybe you’ll think twice about spending extra money on organic food that probably isn’t organic.

If you have questions about products labeling, contact our attorneys at Morsel Law.

FSMA Small Biz Compliance Guide Published by FDA

The Food and Drug Administration recently released a guide to help small businesses comply with the Produce Safety Rule mandated by the Food Safety Modernization Act (FSMA).

The FDA said its guide could help farmers determine whether they were eligible for a qualified exemption, which would modify the requirements they are subject to under the Produce Safety Rule.

The main compliance dates for small businesses and very small businesses under the Produce Safety Rule are Jan. 28, 2019, and Jan. 27, 2020, respectively, but certain agricultural water requirements have extended compliance dates.

If you have questions about FSMA compliance, contact our attorneys at Morsel Law.

Label Reviews Are Critical For Food Importers

I previously posted a similar article discussing the importance of label reviews for domestic produced products here. But a recent event reminded me to reiterate the importance of accurate labeling, especially for food importers. Non-compliant labels can cost you time, money and even your relationship with customers.

A few weeks ago, JFC International Inc. issued a voluntary recall for rice seasoning products shipped to the United States. Apparently, the recall was initiated after the company discovered the product was not labeled in English, which is required under U.S. law. Also, because the label was not in English, it is deemed to have failed to disclose allergens contained in the ingredients. Important to point out is that this isn’t JFC International Inc.’s first time being involved with a recall event; they issued a similar recall in 2016 for failing to label in English and undeclared allergens.

This event is an important illustration of how important it is to review your labels prior to shipping your products to the United States. First, one of the most common misbranding mistakes for imports is failure to label in English. This seems like a simple fix, but you would be surprised how often this occurs. Importers should require the shipper to forward a copy of the label prior to shipping to confirm compliance with U.S. law. Now this won’t stop mistakes by workers at the warehouse who load the EU labeled products onto a pallet instead of the U.S. bound product, but if you include language in your contract that makes the shipper responsible for all costs to correct the misbranding in the event the wrong product labels are attached, they will quickly change their quality control practices. This is especially true for shippers who have had to foot the bill after a container is stopped by U.S. Customs.

Second, does a voluntary recall trigger coverage under your product recall insurance policy? Generally, coverage isn’t triggered unless there is an “actual” contamination, which is usually proved by product testing or other evidence. For JCF International, if the recall was initiated for misbranding due to failure to label their products in English, the coverage would be denied. However, because the product contained “actual” allergens, then coverage would probably be triggered. But if the product didn’t contain allergens, then coverage would be denied. Even if the product didn’t contain allergens the company would still need to recall the product because it is still considered misbranded and in violation of the FDC Act, but the recall would potentially result is significant non-reimbursable expenses.

Most food label misbranding violations can be prevented through quality control measures. Importers should, if they have not already, institute best practices to minimize the risk of a potential violation that result in having to respond to FDA Notice of Action letter. These practices should also address who bears the cost and burden to deal with a misbranding violation. Prior planning can help ensure your business identifies and minimizes potential risks commonly associated with the food import industry.

If you have questions about labeling, contact our attorneys at Morsel Law.

Deadline to List Calories on Restaurant Menus Quickly Approaching

As of May 5, 2017, chain restaurants with 20 or more locations are required to provide nutrition labeling of “standard” menu items. Restaurant owners should, if they haven’t already, start preparing for the compliance deadline. In addition to restaurants, this requirement also applies to food facilities in entertainment venues, such as movie theaters and amusement parks, take-out food establishments, bakeries, convenience stores, grocery stores and supermarkets.

These menu labeling requirements were published on December 1, 2014 as a final rule by the Food and Drug Administration (“FDA”), as required under the Affordable Care Act. If you are a small business owner these new rules will have a significant impact on your operations. What it means is that calorie counts will have to be displayed for popcorn at a theater, food from a salad bar, hot dogs from a convenience store and takeout pizza. In addition, vending-machine operators with at least 20 locations also will be required to post calorie counts.

Calorie information also will be required for some alcoholic beverages served in bars and restaurants. This would apply to beverages listed on menus and menu boards, however, this would not apply to mixed drinks ordered at the bar. Craft brewers should take notice. Even if the rules may not directly affect beer manufacturers, those that sell their brews to chain retailers may be forced to supply calorie counts or take their products elsewhere.

While the purpose behind these rules are to combat obesity in America, where over one-third of meals are consumed outside the home, the effect is to burden retailers with significant compliance costs. Retailers are now faced with the choice of passing this additional cost onto the consumer or eliminating certain products from their menus. While not an easy decision for businesses to make, non-compliance can lead to legal action by the FDA.

The rule’s requirements for determining caloric content and labeling menus are highly detailed and complicated. Therefore, if your small business needs assistance in complying with the rule, please contact us at Morsel Law.