• Legal Entities and Formalities: Making Sure Your Business Protects You
  • May 15, 2015 | Author: Nicholas H. Vander Veen
  • Law Firm: Smith Haughey Rice & Roegge, P.C. - Grand Rapids Office
  • A primary reason to form a corporation or limited liability company is to obtain limited liability protection: the owner’s personal assets are protected from the claims of the company’s creditors. One of the most common issues I observe among many small business owners is the propensity to take actions that put their limited liability protection at risk. Losing limited liability protection can result from a failure to follow or observe the generally simple, but numerous, rules and formalities. Whether it is because of a lack of funds, time-constraint issues, or a misplaced I-can-do-it-myself attitude, some small business owners fail to seek the advice and answers they need, thus opening themselves up to potential personal liability for company debt. With that in mind, the following are some simple rules to remember.

    I. A Separate Legal Entity
    Sole proprietors fail to understand that there is no legal distinction between the individual and the business (and all of the liabilities running a business entails) unless they form a legal business entity under the laws of the state in which they reside. Therefore, if you do not operate your business as a limited liability company or corporation, your personal assets are exposed.

    II. Identifying the Correct Contracting Party
    A mistake commonly made when entering into business contracts is failing to identify the business entity as the contracting party. If not done clearly and correctly , contracts (such as leases and supply agreements), debts, and other liabilities intended to be on behalf of the company may be interpreted, instead, as personal liabilities. For this reason, the company, not the owner, should be the contracting party.

    III. Signing in the Correct Capacity
    Even when correctly naming the company as the party to the contract, many business owners sign only their name with no designation of their title or capacity for the entity at the end of the contract. When signing on behalf of the company, the signature block should contain the name and title of the person signing.

    IV. True Ownership of the Assets
    I sometimes encounter clients who have properly formed an LLC or a corporation, but have forgotten to transfer to that company the assets used in the business. This results in an undercapitalized company that could fail to provide the limited liability protection for which it was designed.

    V. Comingling of Funds
    Company funds should be kept in a company account and used for company debts and liabilities. Personal funds should be kept in a personal account and used for personal debts and liabilities. Comingling funds (mixing personal and company funds in a single account or using the funds of one to pay the debts of the other) is dangerous and jeopardizes the company’s limited liability protection.

    VI. Maintaining Appropriate Formalities
    Corporations act through officers, directors and other authorized agents. Limited liability companies act through members, managers, or other authorized agents. Make sure that you properly identify who has the authority to make certain decisions on behalf of your entity. Otherwise, you jeopardize the limited liability protection your company is designed to provide.

    VII. Filing the Annual Report
    One of the easiest and often overlooked or forgotten formalities to maintain is the need to file annual reports on behalf of the entity. Failure to timely file an annual report can lead financial penalties against the business entity or even suspension or dissolution by the state.

    VIII. Planning for Succession
    Entities without bylaws, operating agreements, or separate shareholder agreements probably do not have a structure in place for dealing with unplanned or unexpected succession and change of ownership.

    This list is not a complete or exhaustive list of all potential missteps and mistakes that can jeopardize the protections afforded by forming a limited liability entity. The adage “an ounce of prevention is worth a pound of cure” is very true when it comes to maintaining your company’s limited liability status. It takes the specialized knowledge and experience of an attorney to properly navigate and ensure you succeed in using a legal entity to protect yourself from personal liability associated with the operation of your business.