Category Archives: Small Business
A common question that many aspiring small business owners have is whether they actually need to hire an attorney to form the business entity they desire, more commonly these days, the LLC. Well, the short answer is no. This may surprise you coming from an attorney who practices in small business law, but the truth is that forming a business entity, including an LLC, is so simple that anyone with a high school degree should be able complete the process without the assistance of counsel. Under Ohio law, an LLC is formed the minute that the Articles of Organization are filed with the Secretary of State (and you pay the appropriate filing fee). That is, a separate, legally cognizable entity (e.g., widgets are us, LLC) exists as soon as the State files the very simple document it provides to public free-of-charge. Take a look at the standard form contained at the Secretary of State’s website and see for yourself: www.sos.state.oh.us (form 553a).
This is the reason that our firm doesn’t charge for the time spent forming the entity. As small business owners in our own right, we would feel guilty billing for such a menial task, especially when there are so many more important issues that we will spend our time on.
Forming a business entity is only the beginning, however. Just because you manage to bring a business entity into existence doesn’t mean it is set-up in such a manner that it will function as you envisioned. There remains the issue of drafting the all important Operating Agreement, that adequately covers all aspects of your particular business, and this document can (and should) vary greatly depending on several factors, including: (a) the particular industry in which the business is engaged, (b) the number of owners/investors that will be involved in the business (and in what capacity), and (c) whether the business anticipates adding or losing owners/investors in the future, and many other variables that you may not initially think of as you structure your operations.
The real value in retaining an attorney during the start-up phase of business is their ability to counsel you regarding the nuances of internal organization and control of the business, common misconceptions about personal liability of the owners, the tax consequences of various business endeavors that may be on the horizon, the ramifications of making certain types of business investments, and properly setting up the business so as to reduce problems when owners pass away, want to leave the business, or otherwise disagree with the direction that other owners want to take the company – the dreaded “Agency Problem.”
Many clients also wonder about their ownership share and whether they can pass their wealth in the company along to non-owner family members. A good small business attorney will make sure these issues are taken care of up-front.
Therefore, while you can easily form a business entity by yourself, it may not be structured so as to meet all of your personal and professional needs. And quite often there are problems down the road that could have been avoided with proper planning and advice from a small business attorney. The good attorneys will not charge you to form the entity, but rather to structure the entity in a manner that meets your particular needs.
In a previous post, we discussed the personal liability of business owners for the torts and business debts of the business. As was addressed in that post, the general rule is that owners of an LLC are not personally on the hook for these obligations. That is, afterall, the point of forming such an entity. However, this general rule (like most rules of law) is far from absolute. In very rare circumstances, courts will occasionally ignore the existence of the business entity altogether, and allow a particular plaintiff to hold the owners of the LLC liable as well. This doctrine is known as “piercing the corporate veil,” and it takes its colorful name from the theory that we should look beyond the veil of that is a corporate entity and look directly to the owners of the business for business-related obligations. That is, courts will refuse to restrict a plaintiff’s recovery to the assets of the LLC alone, and permit plaintiffs to a reach the personal assets of the individual owners of the LLC as well.
Courts do not often ignore the existence of a properly formed business entity. After all, the laws of Ohio specifically allow the formation of these various entities in order to encourage business investment. If the courts are going to ignore the legal rights of Ohio business owners, and the collective judgment of the elected legislature,
Perhaps the single most important factor considered by a court in making its determination to pierce the corporate veil is whether or not the LLC is adequately capitalized. This really makes sense when you think about it; nothing raises a red flag to the court, that an entity is just a shell for a member, more so than an LLC that has no real assets.
Unfortunately, even well-intentioned entrepreneurs that prudently sought their attorney’s advice during initial LLC formation are eventually pierced by a plaintiff’s suit due to under capitalization. Countless new businesses lack adequate funds to fully capitalize a new business and in most cases early operations are in the red. Therefore, an insurance policy is the only reasonable means of adequately capitalizing the LLC in the event of a tort liability suit. All too often, the acquiring of insurance is overlooked or ignored during the early stages of business planning, however, could ultimately make the difference in a court’s decision of whether to pierce the corporate veil.
For example, take the following hypothetical: Eddie Entrepreneur decides that he would like to open a public motocross track. Eddie’s primary assets are the 200 acres left to him by his grandfather that he thinks will be prime location for his new track. Next, Eddie seeks counsel from his attorney which advises him that an LLC is a must have considering the high risk nature of a public motocross track, and as such, appropriately suggests that Eddie lease the property to his LLC (as opposed to transferring the property to the LLC). Additionally, Eddie pays himself a reasonable salary out of the Motocross Track LLC checking account that is currently capitalized with 2,000 dollars.
Business is going great for Eddie until a customer gets injured due to Eddie’s negligence and law suit follows. Eddie’s personal liability is shielded by the LLC, right? Maybe not, if Eddie had opted for minimal insurance coverage or no insurance at all, it is quite possible that the LLC would be pierced. Choosing the right insurance policy could mean the difference between effectively protecting your assets and should be a priority of any early business plan.
In this installment of Ohio Law Blog, I will briefly address the primary reason business owners choose to form an LLC (or any business entity, really). The answer is rather simple. It all boils down to the owners’ ability to protect their house and other personal assets from loss when the business fails or is otherwise liable to third parties. Generally, when a lawsuit is initiated against an LLC for the breach of a contract or for personal injury, the rule is that the owners of the LLC are not personally liable for the LLC’s ultimate obligations, if any.
For example, suppose “Flower shop, LLC” employs a driver who negligently causes an accident during a routine delivery. On these facts, the delivery driver will be personally liable to the plaintiff for damages because he acted negligently in causing the accident. It is well settled that individuals are personally liable for the torts they commit. Likewise, “Flower shop, LLC” will also be held liable to the plaintiff under the vicarious liability rules that prevail in Ohio, assuming the accident occurred during the ordinary course of its business.
In contrast, in the run-of-the-mill situations, the individual owners of “Flower shop LLC” will be free from liability. In fact, the most fundamental of purposes behind the formation of any business entity (like Corps, S-Corps and LLCs) is to shield owners/investors from personal liability arising out of business activities, thus encouraging business investment. By setting-up a legally recognized entity like “Flower shop, LLC” to carry on the business of selling flowers, the owners have established a completely separate “being” that assumes a life of its own, acknowledged in law, which assumes responsibility for the business-related activities. In other words, the LLC is considered to exist entirely apart from its owners, although in reality the business can only act through its owners. The idea that LLCs or corporations actually exist as these individual “things,” distinguishable from their owners, is a legal fiction developed out of economic consierations.
Yet, a logical consequence of this legal fiction is the notion that owners are not liable, in their personal capacities, for the acts and omissions of the business and its agents. Rather, owners stand to lose only their equity ownership in the LLC itself, as the LLC will be forced to pay when found liable to third parties. So, while owners may ultimately lose substantial amounts of money when their companies are found liable in tort or contract law, these owners are not in danger of losing their personal life savings and other investments.
In the next installment of the Ohio Law Blog, I will address one of the rare circumstances in which courts will hold a business entity’s owners personally liable, contrary to the normal rules outlined above.