October 2016

Downloaded Forms May Not Be Enough In Business Formation

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By J. JACKSON WASTE

I’m consistently surprised by the number of business owners I talk to, especially in this industry, who haven’t formed a business entity. A business entity is a legal entity, such as a corporation or a limited liability company (“LLC”), under which a business is operated. If you’re doing business on your own without a business entity, then you’re operating as a sole proprietorship, even if you use a trade name or “dba.” The differences here are substantial and well worth understanding.

Let’s say that you own and operate a vape shop. A customer comes in to pick up some new juice, and your giant chandelier falls on his head. Or maybe he slips, cartoon-style, on an inconveniently discarded banana peel. Or maybe he buys some hot-garbage- flavored juice and yaks so hard after the first hit that he ends up in the hospital with a torn oblique thinking that his appendix burst. Either way, something has happened, and you’re now facing a lawsuit. Business owners hate it, but the reality is that lawsuits are just a fact of life for anyone operating a business these days, and the vapor products industry is, despite the fact that it’s full of some of the world’s most laidback people, sadly no exception.

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Now, let’s make things a little bit worse. The plaintiff wins the lawsuit, and the shop owner is looking at a substantial judgment. If the shop owner was operating as a sole proprietorship, then the plaintiff could satisfy that judgment against the shop owner himself. That means that the owner’s savings account, house, car, wages, and so forth are all theoretically at risk. If, however, there was a validly formed, properly run corporation or LLC in place, then only the assets owned by that business entity would be available to satisfy the plaintiff’s judgment. This is the single greatest advantage to forming a business entity, and it’s called “limited liability.”

Many people I talk to understand the concept of limited liability, but what they don’t always understand is that it’s not automatic. It’s not enough to just form a corporation or LLC and call it a day. You actually need to run it properly and adhere to various formalities if you want it to work for you. If you don’t, someone who sues you can “pierce the corporate veil” and go after your assets personally, meaning that you aren’t getting the single greatest benefit – limited liability – out of your business entity.

Piercing the veil, in addition to being a pretty decent name for a metal band, is a concept whereby courts disregard the corporate entity and impose liability directly on the business owner. Exactly when and where the corporate veil gets pierced depends on the state, the judge, and the facts of each case, but there are some general guidelines to keep in mind.

In general, courts are more likely to pierce the corporate veil and hold you personally liable if the corporation feels like a sham entity set up purely to shield you from liability.

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In making this evaluation, courts look to a variety of different factors. One of the biggest factors is whether you the business owner actually treat your corporation like it’s a real, separate business. Do you have separate bank accounts for the corporation? Do you keep separate records and only pay the businesses’ bills from the corporate checking account? Or do you co-mingle your personal money in the same account as the corporation uses, paying your personal mortgage from the corporate account? It’s crucial to maintain the corporation at all times like it is truly what’s running the business, not like something that you just set up in case you get sued.

Another factor that courts look at when deciding whether to pierce the corporate veil is whether corporate formalities were followed. Did you have the right number of meetings every year?
Were minutes taken? Do you have by-laws, articles, officers, and a board of directors? Are you making the required annual payments to your state’s Secretary of State?

Have taxes been filed for the corporation? Formalities like this can seem minor, and may even feel silly in a corporation with only a few officers or shareholders, but they can be a lifesaver if you ever get sued.

At the end of the day, the point is that businesses entities can be extremely useful, but it isn’t enough to just form one using downloaded legal forms and walk away hoping for the best. It’s crucial to talk to an attorney who can advise you not only how to form the entity, but also how to operate it so that you actually get the benefit of that entity. Otherwise, you’re just crossing your fingers and hoping for a banana-peel-free floor.