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Business FAQ

  1. What are the duties of the Directors of a closely held corporation?
  2. What is a Limited Liability Company and how is it set up?
  3. What are the primary advantages of an LLC that should be considered when starting a business?
  4. What are the possible consequences of personal liability for business debts and obligations?
  5. What are the benefits and drawbacks of nonprofit, tax-exempt status?
  6. What types of legal procedures should corporations maintain?
  7. What is the legal procedure for merging two companies?
  8. What is “piercing the corporate veil?”

What are the duties of the Directors of a Closely Held Corporation?
Directors of a corporation, including small closely held companies, stand in a fiduciary relationship to the company. As fiduciaries, their primary duty is to the Corporation and their personal interests are subordinate to that duty. Directors’ basic duties comprise both the duty of care and the duty of loyalty. Dealings between a corporation and its directors are held to the standard of good faith and inherent fairness. Courts will examine carefully self-dealing where the directors’ self-interest and duty of loyalty to the Corporation may be in conflict.

What is a Limited Liability Company and how is it set up?
Your business may have the flexibility of a partnership and the legal protection of a corporation if it is a limited liability company (”LLC”) – the most recent addition to the choices of new business entity. Because of its dual character of corporation protection against personal liability and partnership tax treatment, the LLC may come to replace general partnerships, limited partnerships and S corporations as the entity of choice. The LLC uses an operating agreement, similar to a partnership agreement, to control business, financial and tax provisions. The operating agreement may be oral, although it should be in writing and signed by all the LLC’s members. It is not filed with the Secretary of State. Management of an LLC may be vested either in the members or in certain designated “managers.” Managers do not have to be members of the LLC, and even corporations may serve as managers. Through its provisions, the operating agreement determines whether the LLC is taxed as a partnership or corporation.

What are the primary advantages of an LLC that should be considered when starting a business?
LLC Members are protected from personal liability just as corporate shareholders. Usually the LLC will be treated as a partnership as to tax treatment: it will be a flow-through entity for which income and losses are reported directly by its members. Unlike an S corporation, special allocations of income, expenses, deductions and losses can be made among its members, and an individual member’s losses are not limited by the amount of a member’s investment in the LLC. It differs from a partnership in that management may be by nonmembers. It differs from a limited partnership in that members may be actively involved in the LLC’s management, without the danger of personal liability faced by an active limited partner. An LLC should be used rather than an S corporation when a business plans to have foreign persons, corporations or trusts as shareholders. It is a useful entity for estate planning purposes since trusts and estates are eligible shareholders. LLC s may soon eliminate both general and limited partnerships as business entities, having the same tax treatment and management opportunities, yet with the added advantage of limited liability to all its members.

What are the possible consequences of personal liability for business debts and obligations?
Personal liability can devastate the accumulated wealth of a lifetime of work. This form of liability opens the individual to claims for a wide range of business obligations. Most people realize that personal liability may extend to business losses, but other obligations may also reach individuals, including:

  • Damage awards in lawsuits;
  • Tax deficiencies and penalties; and
  • Back wages and benefit payments.

Example: Wendy operates a trucking company as a sole proprietor. One of her drivers causes an accident that kills several people. If the company’s insurance and assets are inadequate to cover the damages awarded in the wrongful death suit, the plaintiffs may enforce the judgment against Wendy’s personal assets.

Limited liability offered by incorporation shelters business owners from personal liability. Certain types of insurance can also help cover business owners, directors, and officers. However, if an owner or director performs certain personal acts, behaves illegally, or fails to uphold statutory requirements for corporate status, he or she may face personal liability despite the corporate shelter.

What are the benefits and drawbacks of nonprofit, tax-exempt status?
Many organizations see only the financial benefits of nonprofit and tax-exempt status. Qualifying groups pay no tax on federal, state, and local taxes, and therefore can devote a larger proportion of their resources to achieving their particular goals. The status can also qualify groups for special grants or government funding, as well as special rates for services or even postage. Donors prefer contributions to these groups because they can deduct the payments from their own taxes.

The form of the organization offers advantages in itself. Since nonprofits exist as corporations, they possess all the benefits of corporate status. The corporate form shields owners and managers of the organization from personal liability for the group’s actions, subject to certain legal exceptions. Nonprofit incorporation formalizes the group’s goals and helps maintain organizational focus as the effort grows.

Despite these advantages, nonprofit and tax-exempt status should not be an automatic goal. Drawbacks to the status include:

  • The inability to divide profits among members beyond payment of reasonable salaries;
  • Limitations on the sources of the group’s incomes; and
  • Restrictions on the use of assets to purposes justifying tax exemption.

Some organizations prefer the flexibility and potential for personal gain implicated by for-profit status. Other organizations eschew incorporation entirely. Many smaller organizations will not realize substantial advantages from nonprofit tax-exempt status after going through the intensive application process. Each individual group must weigh the pros and cons of the status carefully in light of their organizational goals and values.

What types of legal procedures should corporations maintain?
Once incorporators establish a new business, the directors must ensure that it retains its legal status. Depending on the business form, certain legal formalities must be followed for this purpose. Once incorporated, an ongoing business’s obligations include:

  • Obtaining federal and state tax identification numbers for the business and filing needed tax returns annually;
  • Issuing shares of stock as mandated by the articles of incorporation and federal securities law;
  • Establishing and maintaining corporate books and records, including accounting ledgers, shareholder records, and corporate minutes;
  • Calling and conducting an initial meeting of the board of directors or shareholders, as required in the articles of incorporation;
  • Holding future meetings at least as often as required by applicable business laws;
  • Conforming all decisions and internal procedures set forth by the articles of incorporation;
  • Recording all actions and decisions of the board of directors in the corporate minutes; and
  • Maintaining annual registration with the state government as required by law.

Additionally, some businesses must comply with licensing requirements or professional standards to preserve their status. These businesses may need to maintain further records or use special procedures or equipment based on rules for their specific industries.

In many situations, a failure to abide by corporate obligations can result in personal liability for directors, officers, or shareholders for business obligations and debts. Because of these harsh consequences and because the specific legal requirements vary depending on the business’s location and form, businesses should seek professional legal advice.

What is the legal procedure for merging two companies?
Like most corporate law, mergers are regulated at the state level. While these laws vary by jurisdiction, many parts of the merger process remain constant across the nation. Generally, the board of directors for each corporation must initially pass a resolution adopting a plan of merger that specifies the names of the corporations that are involved, the name of the proposed merged company, the manner of converting shares of both corporations, and any other legal provisions to which the corporations agree. Each corporation notifies all of its shareholders that a meeting will be held to approve the merger. If the proper number of shareholders approves the plan, the directors sign the papers and file them with the state. The secretary of state issues a certificate of merger to authorize the new corporation.

Some statutes permit the directors to abandon the plan at any point up to the filing of the final papers. States with the most liberal corporation laws permit a surviving corporation to absorb another company by merger without submitting the plan to its shareholders for approval unless otherwise required in its certificate of incorporation.

Statutes often provide that corporations formed in two different states must follow the rules in their respective states for a merger to be effective. Some statutes require the surviving corporation to purchase the shares of stockholders who voted against the merger.

Each state has its own corporate statutes that govern the mechanics of mergers. Either the state or federal government may wish to investigate the potential anticompetitive effects of a proposed merger. Because of the requirements and variables involved in merging, a corporation considering a merger should consult a lawyer who is experienced in mergers and acquisitions law.

What is “piercing the corporate veil?”
Sometimes, courts will allow plaintiffs to receive compensation from corporate officers, directors, or shareholders for damages rather than limiting recovery to corporate resources. This procedure avoids the usual corporate immunity for organizational wrongdoing, and may be imposed in a variety of situations. The specific criteria for piercing the corporate veil vary somewhat from state to state and may include the following:

  • If a business is indistinguishable from its owners in practical terms, courts will not allow owners to benefit from limited liability.
  • If a corporation is formed for fraudulent purposes, courts will allow recourse to the owners.
  • If a business fails to follow corporate formalities in areas such as record-keeping and decision-making procedures, a court may impose liability on the individuals controlling the business.

In theory, the potential for personal liability encourages businesses to observe legal requirements and to avoid damage to third parties.

Last Modified: December 5th, 2009