I had an interesting conversation this weekend regarding corporate formalities. Many of you who read this are small companies, LLCs and Corporations, with a few sole proprietorships thrown into the mix. The purpose of adopting a corporate form is, primarily, loss limiting. For example, when you start to have employees providing care on your behalf, you may incorporate to protect your personal assets from being attached if your employees have a car accident on the way to an client?s home.
There are many other reasons you may have taken on a business form, but if you wish to be protected by that form, you should treat the corporation as a separate entity. Many new small business owners will "cut corners" on the corporate form. For example, writing a check on the company account for a personal expense. In my opinion that is a bad idea. I heard a story recently about a small company whose owner was using the company accounts and credit cards to purchase furniture, clothes, etc. As a result, the company's accounts became overdrawn and the company did not have funds available for a brief period of time. The company's funds had been completely intermingled with the owners personal funds.
Commingling assets in this fashion is one of the factors courts consider in determining whether owners should be personally liable for the obligations of the company.The funny thing is that for most small operations, the owner will often end up with the lion's share of the profit coming directly to them. In turn, they can use that money however they wish. But rather than taking the step of writing a company check to themselves as salary or a distribution, depositing that check in a personal account, and then writing a personal check, they often simply write a company check for the personal item or expense. The logic behind that is usually that they don?t see what the need for the extra steps outlined above, because it is "my money anyway."
In most jurisdictions, commingling corporate and personal funds is one of the factors the courts will consider in whether or not to "pierce the corporate veil." Piercing the corporate veil is the term the courts use to discuss allowing a plaintiff to sue the individual shareholders or members of corporation or LLC. If the court decides to Pierce the corporate veil, you will be liable individually. In other words, writing company checks for the owners personal expenses, can eliminate the protection provided by the corporate or LLC form. (Of course, court's review a number of factors besides commingling in making this decision, but why give them this factor to consider.) You should be very conscious of the need to keep corporate and personal funds separate.
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In an earlier post, I discussed the differences between a corporation and a limited liability company. In that post, I mentioned the lack of case law governing LLCs, in comparison to corporations. (And offered my opinion that the courts would look to corporate case law in deciding LLC questions.) Well, the Indiana courts recently ruled on an issue in relation to LLCs that was previously undecided.
The opinion from the court came down on May 22 and addresses, amongst other things, the fiduciary duty, or duty of good faith and fair dealing, members of a small LLC owe to each other. The case involves a suit alleging self-dealing by a member of an LLC. One of the issues in the case was whether the members of an LLC owe a fiduciary duty to fellow members.
In this case, the Court acknowledged the limited amount of case law regarding LLCs generally and mentioned the complete lack of case law on the question of the duty owed by members (owners of an LLC are called members). The Court then analogized an LLC with few members to a closely held corporation. A closely held corporation is a corporation with relatively few shareholders with shares that are not traded on a public exchange. The court then ruled that the members in an LLC owe the same fiduciary duty to fellow members as do shareholders in a closely held corporation.
I mention this case, primarily, because it reinforces the idea that for small corporations and small LLCs, there are few, if any, practical differences. I also mention it, because it illustrates that when a closely held company (corporation or LLC) begins to have disputes amongst the owners, the owners should keep in mind they have an obligation to their fellow owners. For those owners that fail to abide by that duty, the fiduciary duty does provide the other owners with legal remedies.
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