This expression is used when the court allows a plaintiff to reach the personal assets of the owner(s), rather than limiting exposure to just the company’s assets.

It has long been the case that American courts protect owners and directors from being sued personally for the negligence or misconduct of their companies.  That protection has been eroded, however, as a result of corporate abuses.

So, as a business owner, what can you do to protect yourself?  After all, you do not want to be sued personally when a business investment goes bad, a customer slips in your store, your company breaches a contract, your employee is negligent, etc.  The place to start is understanding the factors the court considers when determining whether to pierce the corporate veil and make the owner personally liable for damages.

Limited Liability: Relevant Factors

In business litigation, Florida courts focus on three key factors in deciding whether or not to shield owners from personal liability:5

• Was the company controlled by its owner(s) in such a way that it was merely an “alter ego” used for the owner’s benefit,6
• Some sort of improper conduct in either the formation or the use of the corporate form,7 and
• The improper conduct imposed an injury on the claimant.
• Most courts tend to focus the analysis on the second element: “A critical issue in determination of whether the corporate veil will be pierced for imposition of personal liability is whether corporate entity was organized or operated for an improper or fraudulent purpose.”8
• The central issue then becomes identification of the degree and types of misconduct that results in personal exposure. Example of what the court might look for include the following:
  • use of company to evade existing obligations (i.e. defraud creditors),9
  • a perpetual monopoly, or
  • use of company to protect against criminal liability

While understanding the legal standard provides some guidance, the courts have purposefully made the standard broad and somewhat vague.  After all, judges have learned from recent events that business owners and directors can be very creative when it comes to filling their pockets while at the same time covering their hides.

There are few things that offend the public more than seeing a rip-off end with the responsible person sipping drinks on his yacht instead of facing punishment.  Judges and legislators want to avoid that embarrassment.

For that reason, there is some “wiggle room” in the law that allows judges to use their discretion when faced with the scenario. 

Limited Liability: Guidelines

Notwithstanding the current political climate, owners can take certain precautions  with their business practices to minimize exposure. The upcoming parts in this series will delve more deeply into techniques for limiting liability, but here are a few general guidelines for starters. 

Good-Faith Dealings

Owners can limit the risk of personal liability by making good-faith attempts to pay the company’s creditors. This is not to say owners must necessarily pay company bills from their own pockets in order to avoid being held responsible for company debts. Rather, the emphasis is on “good faith.” If there is no perception of misconduct, then the company’s inability to pay its creditor’s should not obviate the liability protection. 

Criminal Activity

Also, be advised that, given today’s political and legal climate, any criminal conduct will likely expose owners to personal liability. Courts are alert to owners filling their personal pockets through unscrupulous means while allowing the company to bear the repercussions.

Commingling Personal and Corporate Finances: “Alter Ego”

The final guideline is for small business owners who are perhaps less careful about separating personal assets and liabilities from those of the business than they could be. For example, it is common for some owners to pay personal expenses with the company credit card or utilize company equipment for personal business, etc., especially when there is just one owner or the owners are a couple. While common, this kind of disregard for the corporate entity can lead to exposure.  This is a key issue, so let’s a moment to understand the rationale behind it.

The court’s concern is that commingling resources may leave the company undercapitalized, so the company may not be an autonomous entity capable of assuming its own liabilities. For example, the company might be unable to pay its debts because the owner improperly spends company funds for personal use. In that scenario, it might be unfair to leave a plaintiff whose suit is against the company without any means of recovery.

One way to alleviate this concern is for the company to maintain adequate insurance, but perhaps the easiest and most cost-effective thing to do is to respect the company’s autonomy and keep personal and business finances separate.

Of course, this short article is meant only to be a broad overview of the topic. There are other factors to consider and a myriad of strategies that can be employed to limit an owner’s personal exposure, which will be the focus of upcoming parts to this series.

If any of the points in this article strike a chord, consider meeting with a business attorney to discuss your particular situation.  Despite the cautionary tales described in this article, when it comes down to it, the burden is on the plaintiff to convince the judge to deviate from the status quo and impose personal liability on the owner/director.  With an experienced business litigator at your side, your chances of avoiding liability are still pretty good.

1 The same protection entails under certain other business forms as well, (i.e. limited liability company).

2 Also known as “disregarding the corporate fiction.”

3 The term “owner,” as used here, encompasses shareholders, directors, and other controlling parties, as the case may be.

4 Under the same principle, plaintiffs can reach assets of other companies belonging to the owner.

5 8 Fla. Jur 2d Business Relationships §13 (2006); Mullin v. Dzikowski, 257 BR 356 (SD Fla. 2000); Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984); Seminole Boatyard, inc. v. Christoph, 715 So. 2d 987 (1998).

6 For example, where the owner commingles his money with the corporation’s money, or the owner uses corporate property for private purposes. Basically, any evidence that the owner does not respect the corporation as a separate entity could be used to meet the “alter ego” element.

7 Dania Jai-Alai Palace, 450 So. 2d 1114; Hilton Oil Transp. v. Oil Transp. Co., S.A., 659 So. 2d 1141, 1151 (Fla. 3d DCA 1995); Ally v. Naim, 581 So. 2d 961, 962 (Fla. 3d DCA 1991).

8 Kanov v. Bitz, 660 So. 2d 1165 (3d DCA 1995).

9 Undercapitalization of the business and/or failing to maintain liability insurance to cover damages resulting from the company’s negligence or intentional wrongdoing are traditionally looked at to determine these first two elements.

~ Jeffrey Harrington, Esq.

It is true the American legal system is set up to shield owners/officers from corporate liabilities, but nothing draws public outcry like an executive who fills his pockets through misdeeds and then hides behind the corporate skirt.  

It is the perception of corrupt business practices with no punishment that leads judges and legislators to weaken corporate protections and put officer heads on the chopping block.

So, in this climate of suspicion, what can a business owner do to limit liability for company activities? in this section, we will focus first on what not to do.

I. Shell Companies

By “shell company,” we mean a company that is set up for specific business transactions but which has no significant assets.  In Florida, where our firm is headquartered, it is extremely cheap and simply to set up a new company.  That is intended to encourage entrepreneurship, which is a good thing.  What is sometimes not a good thing is the ease of setting up a new company also lends itself to creating “throw away” companies.

So, if an unscrupulous person wants to rip people off, he or she can open a company, do bad things and then abandon the company.  And repeat . . .

Judges are wise to this tactic.  If your company is accused of misconduct, a judge will be curious to see how vested you are in the company.  Was the company properly capitalized at the start, or was it run on a shoestring?  There is nothing wrong with running a company on a tight budget, but you do not want it to seem like you were never serious about building a viable business.

Consider other countries around the world, such as European countries, where it is not nearly so quick and easy to start a new company. In fact, the process is rather involved and requires significant capitalization upfront.  This tends to have a chilling effect on startups and, perhaps, reduces the likelihood of abuse.

Of course, many small businesses will be started with minimal capital and grow organically. There is nothing wrong with that. It is one of the things that makes the United States an attractive destination for the entrepreneurial-minded.

If you are starting your company on a small budget, then consider purchasing an insurance policy (such as an “errors and omissions” policy).  Judges tend to view that as a good-faith attempt to be a responsible business owner.

II. Alter Ego

Another important consideration is whether the business owner treats the company as a separate entity, rather than just an extension of himself.  As a small business owner, it is easy to form bad habits — such as using the company card to pay personal expenses, commingling company funds with personal funds, using your personal card to pay company expenses, making company decisions with no semblance of corporate process, etc.  These are very common practices, which Florida courts tend to view as reducing the company to a mere “alter ego.”

Many small business owners think: “What difference does it make? It’s all my money, anyway.”

Of course, there is some truth to that. That is why in business litigation we refer to the “corporate fiction.”  After all, it is a fiction . . . one that you should foster, not disregard.

Think about it this way. If your company gets itself into a situation where it cannot pay its bills or is being sued, then you are going to want to separate yourself from the company’s creditors as fully as possible.  If someone gets a judgment against the company, you do not want him coming after your personal property, your personal bank account, etc.

Should that situation come up, your argument will be “Hey, that is the company’s debt, not mine.”  By and large, that is a good argument, and the courts will support it.  However, you can’t really have it both ways.  If you want the judge to treat your company as a separate entity that is responsible for its own obligations, then you need to have treated the company that wayall along.

More on Business Law

To protect against corporate liability, you want to avoid weakening the corporate fiction. So, you do not want to give the impression that you were planning to “tank the company” all along, and you do not want to make the company your alter ego.

Next week, we will discuss affirmative measures you can take to foster a strong corporate fiction, thereby strengthening your protection against corporate liability.

~ Jeff Harrington, Esq.

The post BUSINESS PRACTICES: Limiting Personal Liability (Part II) first appeared on Harrington Legal Alliance.]]> https://Harringtonandsheppard.com/business-practices-limiting-personal-responsibility-part-iii/ Mon, 05 Feb 2024 21:54:07 +0000 https://www.harringtonlawassociates.com/?p=1406 This is the final part to our discussion aimed at helping owners and officers avoid personal responsibility for the obligations and liabilities their companies take on in the course of doing business. The first part provided an overview of the key issues related to corporate liability. The second part focused on what not to do. Here, we get to proactive techniques for guarding against personal responsibility.

One of the great things about doing business in the US is how quick, easy and inexpensive it is to form a company.  Florida is no exception.  And, as one of the States that has good weather and no income tax, Florida has become a target destination for entrepreneurs, both domestic and foreign.

Register with the State Department

As with all States, the Florida Department of State requires business entities of all types to be registered with its Corporations Division.  The process can be done online through the Department of State’s website.  The process can also be done by mailing in paper forms, but that takes much longer.

The information you will need to provide depends a bit on what form you want your company to take — i.e. limited liability company (LLC), corporation (Inc.), limited partnership (LP), etc.  However, there are some basics that apply to all forms:

Company name

You may find it a little more difficult than expected to select a company name.  As Solomon said: “There is nothing new under the sun.”  The name you give your company cannot be “confusingly similar” to that of an existing company.  So, you will need to be rather creative with your name choice, and have a couple of  alternates ready to go.

You should first do a Clearance Search to see if there is another active company with the same or similar name as the one you want to use.  To do that, you can use the “Search Records” tab at the top of the State Department’s website.

If you skip this step, you may very well go through the entire process only to have your registration rejected . . . and then have to start over.

Registered Agent

Every business entity must have a registered agent with a physical address in Florida.  The registered agent’s job is to receive official correspondences, such as lawsuits and communications from governmental entities.  (You probably will not use your registered agent for regular mail.)  You may act as your own registered agent, which will save on the expense of paying a professional agent.  That is not necessarily recommendable, though.  The cost of a professional registered agent is very low, and they generally keep an eye on things such as the annual deadline to renew your company, etc., in addition to being responsible for receiving official/legal documents.

You Florida company is permitted have an out-of-state office and mailing address.  Likewise, the owners/officers may provide out-of-state addresses as well.  However, the company must have an in-state registered agent with a physical address.

Owners & Officers

The owners may be listed in the company’s registration, but it not required.  Depending upon the nature of the business, and any confidentiality concerns, you can decide whether it makes sense to name the owners in the registration or not.  For example, if it is an owner-operated company, you may want to list the owner because doing so will make it easier to open bank accounts, etc.  But, if it is a company with employees, there may not be any good reason to expose the owner’s name in the public record.  (Click here for tips on limiting liability)

At a minimum, though, you will have to list a manager or director.  You have to give the State the name of the person or entity with authority to take decisions for the company.

That said, neither owners nor officers have to be human beings.  You could name another company or trust as the owner and/or officer.  That is a technique sometimes used for asset protection and/or flexibility.  Be aware, though, that ultimately a person has to sign on behalf of the entity that is acting as owner/officer, so somebody’s name will have to appear in the registration.

Governing Documents

In the US, the two most fundamental documents of a business are generically called the “Articles” and the “Bylaws.”

Articles

If you register your business in Florida, the State Department will automatically generate Articles based on the information you provide through the registration process.  After all, the Articles are simply the most basic information about the company.  Your company’s Articles will be available for download on the Department of State’s website.

Do not be confused by the title “Articles of Incorporation” versus “Articles of Organization.”  The difference is merely due to the form of the company.  Only corporations can “incorporate.”  So, if you create an LLC, for example, your document will be called “Articles of Organization.”  It’s the same thing, though.

Bylaws

Similarly, the actual title of this document will vary depending upon the form of your company:

• Operating Agreement
• Shareholder Agreement
• Corporation Charter
• Partnership Agreement

These are just different names for document that contains the details of your company’s governing rules.  This document is not generated automatically by the State Department, nor does it appear on the State Department’s website.

The bylaws will generally be prepared by an attorney.  Because bylaws are not required by the State Department, so business owners do not bother with them.  This, however, is a terrible idea.

If the company has partners or investors, then operating without bylaws is like jumping out of a plane without a parachute.  And, as a more immediate matter, all banks I know of require a copy of the bylaws in order to open a company bank account.

Taxpayer ID

This is not the place to get into taxation issues, such as whether the company will be “pass through,” taxed as a partnership, S-corp, C-corp, etc.  That is a discussion to be had with your tax attorney or accountant.  Moreover, there is no need to make those decisions at this point in the process.  First, just get the company registered with the State Department.

Once that is done, you will need to apply for an Employer Identification Number (EIN).  In many cases, that can also be done online here.

If nobody associated with the company has a Social Security Number or ITIN, then the application for an EIN cannot be done online.  That is a bit unfortunate because applying by fax or mail can take much longer.

From a legal point of view, there is no urgency to get the EIN.  As long as the company has a taxpayer number by the time it is ready to file a tax return, you will be fine.  However, most companies need a bank account sooner rather than later.  And, all banks I have seen require an EIN in order to open a business account.

Local Business License

Rather annoyingly, most cities and counties in Florida use alternate terms for describing a business or occupational license.  Some municipalities in our area use the term “Tax Receipt.”  Just the same, if you call or go to the website, you can get the information you need by asking for a “business license.”  Everyone knows what you mean.  It is a small fee you will need to pay the local municipality(s) where your business is located.

Do be aware that you will probably need to pay a separate fee to both the city and the county where your business has its address.

Miscellaneous

With just the items listed above, you will have the basics in place to start a business in Florida.  Obviously, if your particular business requires licenses or permits, those are separate matters you will need to address in order to legally operate your business.

There are some strategic decisions to be made along the way, which are more difficult to address in a generic article.  That is why you should always consult an attorney along the way.  You will find additional information here describing some of the key considerations.

~ Jeff Harrington, Esq.

Just because you intend to do business primarily in one particular state does not mean that you necessarily have to set up your company in that state.  On the contrary, you can organize your company in any state (or even foreign jurisdiction) and then register that company to do business in the state where you do most of your business.

You have probably heard that large corporations tend to select Delaware as their state of incorporation.  Usually, these companies are not headquartered in Delaware.  In fact, they probably do not have an office in Delaware at all.  So, why have a Delaware corporation if your business has nothing to do with Delaware?  And, does it have to be Delaware, or are there other advantageous “jurisdictions” to consider?

Corporations start up by “incorporating.”  All other forms, such as LLCs and partnerships, start up by “organizing.”  It means the same thing.

That is why the governing document for a corporation is called “Articles of Incorporation,” while the equivalent document for other companies is called “Articles of Organization.” 

Tax Implications

Let’s start by dispelling a common misconception.  It is true that some US states charge income tax, while others do not.  However, you should not be under the impression that you can avoid state taxes merely by setting up your company in a state that has no income tax.  That would be a fatal mistake.

Corporate taxation is determined by where the money is generated, not by state of incorporation. 

So, for example, if your company’s office is in California, and you sell widgets to Californians, you cannot escape state taxes merely by organizing your company in Nevada.  If only it were that easy, right?  You can be sure that many, many people have tried to do just that.  And, when the Department of Revenue catches on . . . well, it’s not pretty.

Therefore, when determining the jurisdiction for domiciling your company, tax implications should not be a primary consideration.  If you are going to try to escape state taxes by setting up in a different state, you do so at your own risk.

Confidentiality

This is one of the big differences among the different jurisdictions.  Just how easy is it for the public to see your business and personal information?

Transparent States

Some states, such as Florida, are extremely transparent.  A good deal of business information, including owners’ names and addresses, are easily accessible online.

For lawyers, this is very useful.  When we need to sue a company, we just go online to the Department of State’s website (www.sunbiz.org), and we can get most, if not all, the information needed for the lawsuit right there.  It’s great.

On the flip-side, however, this transparency may not always be the best from an owner/officer perspective.  Besides making it easy for lawyers to prepare lawsuits, Florida companies also open themselves up to “trolls.”

If someone wants to find out whether you have enough assets to be worth suing, they can do a quick search online and see all the ventures you have going in Florida.  Similarly, if you have neighbors or family members that might be prone to jealousy, they can also easily find out what you have going on financially.

This “concern” is very situational, of course.  For many small business owners, having your information in the public record may be of absolutely no consequence. 

In that case, just go ahead and organize in the state where you are doing business.  That is the simplest and most convenient thing to do.  It will simplify setting up company bank accounts, minimize the need for a professional registered agent, etc.  It’s just easier.

Privacy-Conscious States

There are a number of states that are much more protective of a company’s confidential information.  If you go to the State Department’s website in one of these states, you will be able to see that a company exists.  In some cases, you may even be able to see whether the company is currently active.  But, that is about it.  No other corporate information will be available to the public on those websites.

Most of the states in New England tend to guard corporate information, as do the common “asset-protection” states, such as Wyoming, Nevada and Alaska. 

Again, what is best for individual business owners is situational, but an argument could be made that it is really a better business practice to set up in a state that will protect your company’s confidential information.

There is a bit of a trade-off, however.

Registered Agents

If you are going to set up your company in one state, but then do business in another state(s), you will need to hire a registered agent in the state of incorporation/organization.

Example:  You live in Florida and plan to do business in Florida, but you want to incorporate in Delaware.  At the time of incorporation, you will be required to provide a “registered agent” that has a physical location in Delaware.   So, unless you have a buddy in Delaware that is willing to act as registered agent for your company (not a great idea, by the way), then you will have to hire a professional registered agent in Delaware.

The purpose of a registered agent is to receive official documents on behalf of the company, such as lawsuits, governmental correspondences, etc.  Registered agent services are not particularly expensive (less than $100/year is common), but it is an extra step.

Double Registration

Continuing the example above, hiring a Delaware registered agent is not the end of the initial set up.  Since you are planning to do business in Florida, you will still need to register your Delaware company as a “foreign company doing business in Florida.”

If you live in Florida, you have the option of acting as your own registered agent (also not a great idea), so you do not necessarily have to hire a professional company for those services.  Still, you will need to maintain two registrations in two different states.  So, that too is an extra measure.

Thankfully, in the US, all states make it relatively easy and inexpensive to register a business.  The biggest thing is remembering to file annual renewals in both states and keeping the registered agent paid.  If you miss a renewal deadline, your company will be “inactive” or, even, “dissolved.”  And, to reinstate, there is usually a fairly nasty penalty ($400-600).

Asset Protection States

The main reason big corporations have traditionally incorporated in Delaware has to do with the governing statutes.  First of all, Delaware is the state with the most extensive case precedent when it comes to business matters.  That is advantageous because it prevents surprise.

Since almost every corporate situation you can possibly imagine has been litigated at some point in Delaware, you know ahead of time where the Delaware courts stand on all essential issues.

The predictability of Delaware courts is valuable to companies, especially those doing business on a large scale.

Second, the Delaware laws have traditionally been owner/officer/director friendly.  At some point in history, Delaware made conscious decision to be protective of owners/officers/directors in order to encourage companies to incorporate in Delaware.  It worked.

Simply put, Delaware law makes it more difficult to impose personal liability on owners, officers and/or directors for the bad luck, negligence or, even, misconduct of their companies. 

Owners, officers and directors are the decision-makers for their companies, and they like the protection.  So, everyone flocked to Delaware.

Now, because Delaware has been so successful at attracting businesses, certain other states have basically adopted the same laws.  They don’t even try to be subtle about it.  If you look at the case law, you will find judges openly stating “we follow Delaware law.”

As a result, these days, it is no longer necessary to set up in Delaware in order to get the benefits traditionally associated with Delaware.  I refer to the group of states that actively vie for your company’s business through these kinds of incentives as “asset protection states.”

Best Jurisdictions

Delaware

Naturally, you cannot go wrong with Delaware.  The only drawback is that it is a little more expensive than the competition.  At this point, Delaware sees itself as the “gold standard,” so you have to pay a little more to be there.

Nevada

The first state to aggressively compete for corporate filings was Nevada.  I think Nevada wanted to establish itself as the “Delaware of the West.”  And, it was largely successful in this regard.

Progressive states like California and Washington tend to offer more protections to consumers and employees, and less to owners/officers.  So, that created a great opportunity for Nevada to set itself up as the closer-to-home alternative to Delaware.

Unfortunately, Nevada, your recent overhaul of your Corporate Divisions website, and accompanying fee hike, is a disaster.  Your system has become terribly frustrating to deal with.  Even your own employees hate it.  On top of that, you decided to start charging more???  No, I’m out.

Wyoming

These days — at the moment, at least — my favorite asset-protection state is Wyoming. 

Wyoming has a simple, user-friendly online system for registering companies, and the fees are cheaper than the other jurisdictions I have looked at.  Also, you can get a human being on the phone when you need one, and the human will be nice to you.

As for asset-protection, Wyoming staunchly adheres to Delaware law, so you get the same liability limitation features in Wyoming as you would in Delaware.

Other Options

I know from my research that there are some other good options out there as well, most notably Alaska and South Dakota.  I am sure they are lovely.  I just have not had a lot of personal experience with these other jurisdictions.

~ Jeff Harrington, Esq.