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Weekly UpdatesOWNERS AND MANAGERS of businesses spend countless hours considering the risks and potential claims and liabilities to which they and their businesses may be exposed by virtue of their business operations. Claims by employees, contractual liabilities, products liability, accidents at the workplace, actions of employees within the scope of employment, company indebtedness ... these are but a few of the causes of sleepless nights for business owners and operators.
Businesses have various means through which to limit potential exposure. The managers of a business, for example, could decide that the risks and potential liabilities associated with a certain activity outweigh the potential benefits to the business. Accordingly even potentially profitable activities may be avoided due to their potential to expose the business to legal liability.
Rather than avoiding certain activities altogether, management could consider appropriate methods to minimize legal exposure from those activities. Obviously, businesses frequently evaluate the safety of their products, operations and workplaces. Lawyers can be engaged to assess a business's compliance with applicable laws and regulations.
A business can engage insurance experts to assess appropriate insurance policies and coverage amounts. Coverage for personal injury and property damage, workers' compensation, employment claims, and directors' and officers' insurance is widely available. The contents of any insurance policy should carefully be reviewed to assess whether the scope of coverage and any applicable exclusions from coverage are appropriate considering the activities and exposures of the business. Any legal claim against a business, regardless of its merit, can be distracting and expensive to defend. As such, one substantial benefit of many insurance policies is thatsuch policies obligate the insurance carrier, rather than the business, to assume and pay for the defense of claims against the business that are covered by the policy.
In addition to considering insurance coverage and risk management practices and procedures, business owners and managers are well advised to consult legal counsel to evaluate legal structures that could provide limited liability to the owner and the business. For those not entirely familiar with the concept of "limited liability", it generally refers to the attribute of certain legal entities that would limit recovery for liabilities of the business to the assets of the business and not the separate assets of the business owner. In other words, if a business operates within the structure of a limited liability entity, business owners would not personally be liable for the liabilities of the business. By contrast, in a business operated by a sole proprietor or partnership, the personal assets of the business owner or owners are exposed to claims and liabilities arising out of the business.
Common examples of limited liability entities include corporations and limited liability companies. The Delaware Limited Liability Company Act, a statute under which many limited liability companies are organized, for example, provides:
The separate legal existence of a limited liability entity, such as a corporation or limited liability company, typically commences upon the filing of what can be a relatively simple organizational document with a particular state. For corporations, this document generally is called a certificate of incorporation or articles of incorporation, and for limited liability companies, a certificate of formation or articles of organization.
The initial formation of a limited liability entity can be a simple process, but it could be a costly mistake to neglect continuing obligations or formalities necessary to maintain the separate legal existence of the entity. While the presumption is that the separate legal status of a corporation or limited liability company be respected, in certain circumstances courts can disregard that separate legal status and impose personal liability on the owners of the business. Such cases involve what is commonly referred to as "piercing of the corporate veil" because the limited liability protections are disregarded and the personal assets of owners can be accessed to satisfy liabilities and claims of the business.
Cases involving corporate veil piercing frequently involve closely held entities (including wholly owned subsidiaries) in which the separate legal existence of the owner or owners and the business are not clearly defined or maintained. Courts tend to base decisions to pierce the corporate veil on a review of all relevant facts and circumstances, and rarely is one factor determinative. Factors that have contributed to courts' piercing the corporate veil include:
* Corporation formed and controlled for fraudulent, illegal or unjust purposes or to mislead creditors:
* Absence of formalities of corporate existence;
* Inadequate capitalization (insolvency); and
* Personal use or commingling of corporate funds.
If a court considers an entity to be a mere "alter ego" or "instrumentality" of its owner, piercing the corporate veil is a distinct possibility.
In light of the above, owners and managers of corporations, limited liability companies and other limited liability entities should be cognizant of continuing formalities and requirements that should be observed in order to maintain the separate legal existence of the entity, including the following:
* Making all initial and periodic organizational and tax filings. An entity may have reports or filings and tax payments due on an annual basis in each state where incorporated or organized and qualified to do business.
* Operational and governance procedures. The entity should have its own bylaws or operating agreement and procedures. The bylaws and procedures should be followed by the entity and its governing body. An entity's separate governing body should have separate periodic meetings.
* Maintaining separate books and records. Meeting minutes, corporate records, including stock and ownership certificates and records, and books of account should be separately maintained for the entity. The entity's assets, liabilities and finances should be distinct from those of its owners and affiliates.
* Use of entity name. The entity should use its proper corporate name of official communications and contracts.
Management can consider various ways to minimize potential liabilities arising from the business. If a business is incorporated or organized as a limited liability company or other entity, management should be aware of continuing formalities and legal requirements with respect to the legal entity. Failure to adhere to those formalities and requirements could affect whether the separate legal status of the entity is respected in the course of any litigation.
About the Author: James S. Wilson
(1.) Delaware Limited Liability Company Act [section] 18-303.
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