Staying Alive

Could a former business come back to haunt you?
Magazine Contributor
5 min read

This story appears in the June 1997 issue of Entrepreneur. Subscribe »

Q: I have a high-liability service business with no pending legal threats at this time. I want to discontinue this business and get into something with less liability, but I've been told I need to keep the existing corporation "alive" for several years to keep my personal liability protection on past work.

I always thought that past work would not be a threat if the corporation was closed down. I would appreciate any input you can give.

David Hobbs

Shawnee, Kansas

A: Steven C. Bahls, dean of Capital University Law School in Columbus, Ohio, has 12 years of experience teaching business organization and entrepreneurship law. He and his wife, writer Jane Easter Bahls, are co-authors of Entrepreneur's "Legal Aid" column:

The answer to your question depends on where you live because corporations are governed by the laws of each state. Every state has a statute covering corporate dissolution, but they're anything but uniform. Here's an overview.

In all states, when you dissolve a corporation, you have to pay off its debts or make provision for its liabilities before you can take the assets out and divide them among any other shareholders. It's not clear, though, just what it means to "make provision for liabilities." It might mean setting a pool of money aside in a separate fund for paying whatever liabilities arise or obtaining an insurance policy that would cover unforeseen liabilities.

In a high-liability service business like yours, it's hard to tell whether you'll have a lawsuit or some other liability after you close the business. Maybe you'll have no claims, but some corporations face multimillion-dollar lawsuits after they stop doing business. If that happens, you and any other shareholders would be seen as holding the assets in trust for the corporation's creditors. So if you've sold the business's assets and invested the proceeds in your new venture, someone who claims to have been injured because of your old business could sue you personally.

Fortunately, they can only recover the amount of money you received from the old corporation. Say there's a million-dollar claim against the former corporation, but when you closed the books, you received only $100,000. In that case, you can be held liable only for up to $100,000.

Since you're planning to start a new venture, chances are you won't have wads of cash sitting around to pay whatever debts might conceivably arise from your old business. That's where insurance can help. When you're preparing to dissolve the old business, be sure you notify your insurance company. Many insurance companies offer special policies covering losses incurred prior to the dissolution but not filed until afterward.

Most likely, your dead corporation won't haunt you forever. Most state statutes require creditors of a corporation to sue within a specific time period, usually three to five years. Others have no limitation.

So you have to make a decision about keeping the corporation alive. The absolutely safest route would be to retain the corporation with all its assets for however long the statute of limitations runs in your state. But since you need the money for your new venture, you can make your best guess at what liabilities you'll have, provide for them with cash or insurance, and take the rest of the assets out. Once the reasonably anticipated debts are paid, you can dissolve the corporation.

Q: I just started a business with two partners. Is there any way we can put together a partnership agreement inexpensively, without an attorney's help? The lawyer I went to wanted more than $800 to do this for us.

Jonathan Lure

New York City

A: Anton M. Rosandic, an attorney with The Benice Group in Irvine, California, specializes in general corporate law, securities law and corporate finance for start-up and emerging-growth companies:

It's possible to set up a simple partnership agreement on your own; however, I'd only advise it for the short term. Down the line, you'll probably need the help of a lawyer, as your agreement may face other legal issues.

Although preparing a simple partnership agreement is not difficult, to make sure it's right for you, ask yourself, "Do I trust my partners?" Legal entities protect and define the relationship between partners as much as they protect your business. Partners are jointly liable for all a business's debts. This means that if your business fails, creditors can look to you for full debt payment. Other types of entities, such as corporations, offer more protection; however, they may not be right for you.

If you decide to proceed with the partnership, start your research at your local law library. They are listed in the phone book under "Government Offices." Use of law libraries is always free, and in them you'll find books containing sample partnership agreements.

Since partnership law is different in each state, look for books referring to legal forms or transaction forms specific to your state. In California, for example, you'll find California Legal Forms: Transaction Guide (Matthew Bender & Co.), California Forms: Legal and Business (Bancroft Whitney), and California Transaction Forms: Business Entities (Bancroft Whitney). Books like these provide general partnership agreements that you can copy and fill in with your own information. Alternatively, you can go to a local law school library, which will also offer the materials for free. Bookstores may have what you're looking for as well.

When properly executed, even a simple partnership agreement will result in a legally binding contractual agreement between you and your partners. But this should not serve as a long-term document since you may need to reorganize your business down the line. As your business grows, you should seek expert advice for all your legal, accounting and tax issues.

Contact Sources

The Benice Group, 19700 Fairchild, #230, Irvine, CA 92612, (714) 475-4300.

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