Archive for the ‘Corporate Formalities’ Category

They say that half of marriages end in divorce. This (perhaps made-up) statistic is equally true for business partnerships. Like an in-love, engaged couple, entrepreneurs often see their business partner relationship through rose-colored glasses. It hardly enters their mind that they could disagree on things, have different visions, and expectations, or that one side would abuse the relationship.

An operating agreement (for simplicity, the term will refer to all types of agreements between business partners, shareholders, members, etc.) is akin to an engaged couple’s prenuptial agreement. But it can and should be much more than that. Like the name implies, it should govern how the business is to work. In particular, what are the agreements among the partners? What role will each partner have in the work, in the management, in the finances? Will any partner receive a salary? How much? Are partners entitled to a job? What fiduciary duties does each owe to the business? How will profits be distributed. What about losses; will the partners have to invest more in the business? Will there be other employees? What happens if there is not enough business income to pay employees? What will the exit strategy/buyout be? Are the parties married to one another for any future business of the same type?

Many entrepreneurs have not even addressed all of these and other critical topics. This can be a recipe for future disagreements, or worse. Sometimes people go into a business in good faith, but they have different expectations about the business. If you are the primary financial backer, is your sweat equity partner expecting a salary from day one? If so, are you okay with funding the salary until the business generates substantial revenues?

Having litigated major and bitter disagreements between business partners, I have seen the ugly divorces of the business world. The infidelity. Desertion. Dishonesty. No one believes it will happen to them, but business partners lie, cheat and steel. They will fire you and freeze you out of a business. They will expose the company to liability. They will become drug addicts or non-functioning alcoholics. They will hire their do-nothing son-in-law who drives you crazy. They will spent all the profits on their own salary and salary of family members. The will start a competing business and try to take all the clients. They will exploit any ambiguities in an “off the shelf” operating agreement you got on-line. They will die, and their clueless spouse will become your business partner (a cross-sell agreement with life insurance is a topic for another day). Or you will die and they will take advantage of your spouse. I’ve seen all these things and more.

Your best first defense against misunderstandings is misdeeds is a specifically tailored operating agreement. This doesn’t mean that it is a panacea, or that you are defenseless. But courts respect operating agreements, especially if they are negotiated and tailored to the business at issue. You hope that your operating agreement keeps you out of court, but if you have to litigate or arbitrate over your business, you will be in a much, much better position. The relatively small amount of time and money that you spend at the beginning of the business formation (or before significant disputes develop) is some insurance against spending that same money hundreds of times over.

By Adam P. Whitney

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With apologies to Mitt Romney, corporations are not people.  Neither are LLC’s, Limited Liability Companies. That’s true for giant, publicly traded companies.  It’s equally true for your small or mid-sized business, even if you are a 100% owner.  I think that what Romney should have said is that corporations are made up of people.  They are owned by people.  They are operated by people.  People sit on the boards of directors.  People work at corporations.  In fact, corporations can only take action through people, their officers, employees, agents, etc.

But business entities are not people.  You don’t want them to be.  Do not think of your company as your alter ego.  This kind of thinking can get you in trouble.  The reason that you filed incorporation papers in the first place was to limit your personal liability.  While even that is not foolproof, do not undue your good business decision to incorporate by treating your business like your alter ego.

It should go without stating that you should not use your business accounts to pay your personal debts.  But I want you to go further and to stop thinking of your company as you, and you as your company (unless you are truly a sole proprietorship).  Do not think or say “me” when you really mean “Me, Inc.”.  As a business litigator, I see this all the time – in contractual dealings, in depositions and in court.  Don’t do it.  Get out of the mindset that your company is you and that you are your company.  While you may be the face of your company, don’t unwittingly expose yourself to personal liability by allowing people to think that you and your company are one in the same.

When you sign a contract for your company, be clear that it is a company contract, and that you are signing “as President,” or whatever your title is.  I’ve blogged about these issues before:

https://damnedif.com/2011/03/15/youre-damned-if-you-dont-respect-corporate-formalities/

If you need helping separating yourself from your business to avoid personal liability, give me a call at 617.338.7000.

By Adam P. Whitney

Sometimes business and family don’t mix well. Family business disputes can be particularly emotional. I’ve seen it all, brothers against brothers, sisters against brothers, sons against fathers, etc., etc. Jealousy and greed can bring out the worst in family relationships. A wise judge recently told me that (when it’s sibling against sibling) sometimes it all comes down to who got the better bicycle for Christmas when the parties were growing up. It’s not really that simple, but there is a kernel of truth there.

I’ve represented both employers and employees in family businesses. When things go bad in these situations, things can get really nasty. The adage that the ones you love can hurt you the most holds true here. I recently settled a case for a fired stockholder-employee for $1.4 million, who was fired by his elderly father after working for the company for thirty years. We alleged that his sister, also a long-term employee, manipulated the elderly father into turning against my client, who was a superstar salesman. This case was reported in Massachusetts Lawyers Weekly as one of the biggest settlements of 2011.

http://masslawyersweekly.com/2012/02/15/son-fired-from-family-business-after-30-years/
http://masslawyersweekly.com/files/2012/01/LargestVS2011.pdf

It’s inevitable that if you have a private business, you will have to consider whether to have family members work there. Sometimes private businesses grow into a family; sometimes your family grows into your business. The more successful the business, the more pressure there will be to hire family members. You may have siblings who need a job. You may have adult children who you want to bring into the business and eventually take over for you when you retire. You may start a business with a son or parent or sibling. All of these things are very common. Things are always hunky dory at the beginning. Maybe even for years.

But, inevitably, personal feelings will get in the way of running the business. Your family members may feel that they are different than other employees. They may feel that the same rules do not apply to them. They may overvalue their worth to the company. They may think of themselves as an owner when they are not. They may be jealous of you as the owner. The opposite is true too. Sometimes the family-member employee is taken for granted. Sometimes other family members are jealous of the other family-member employee who is a superstar, as in my recent case.

If you make decide to hire a family member, here are some general guidelines to avoid some nasty problems:

– Treat your family members like other employees and hold them to the same standards.
– Similarly, try to separate personal feelings and issues with business issues.
– Consider carefully the issue of stock ownership (see my post on terminating stock-holder employees). There are a lot of issues here, such as buy-sell provisions, which are beyond the scope of this post.
– Have clear written employment agreements and comply with the law. Family members can and will sue you for violations of wage statutes, etc.
– Communicate frequently on expectations for salary and ownership potential for the future. Your adult child may think that you are retiring at sixty and giving her the business. You may plan to work until eighty and/or sell the business. These different expectations can lead to big problems.
– Similarly, don’t let issues and problems build for years. Family members can turn into Rogue Employees, too.
– Consider arbitration clauses. Although I’m not always a fan of arbitration, you may not want your family’s dirty laundry aired out in court.

If you are a private business owner or a stockholder in a close corporation, I can help you with these issues. Call me at 617.338.7000.

Adam P. Whitney.

Business people who incorporate often think that the corporate form protects them from lawsuits. That is true only to a point (you are not protected for wrongful acts that you personally commit), and only if you respect corporate formalities. If you do not, you could unwittingly be inviting personal liability, or liability for a parent or sister company. The whole point of incorporating (including forming an LLC) is to limit exposure for that specific corporation. But your effort to limit exposure doesn’t end on the date of corporation. Even taking simple steps can go a long way toward limiting this exposure. Here are some simple things you can do.

1. When you sign any contract, proposal, purchase order, invoice, letter, etc, be clear that you are signing in your corporate capacity. Don’t ever simply sign “Joe Smith.” If you do, you could get personally sued and your opponent will claim that they thought they were doing business with you personally. The claim could be total b.s., but shame on you for exposing yourself like that. How should you sign it? Easy: “Joe Smith as President of J.S. Corp.” You can even add “and not personally,” to make it clear. In fact, your company should be clearly identified as the contracting party.

A short war story makes the point. I defended a law suit a few years ago where three business people started a business, duly incorporated their new business, and hired a contractor to put up a substantial commercial building. The owners then did not heed the above advice; they referred to one another as “my business partner.” The also failed to make clear that contracts were in their corporate capacity. When the corporation eventually ran out of funds, the contractor sued the business “partners” personally, claiming that he thought it was a partnership and did not know about the corporation. The claim had enough traction to make it all the way to a jury trial. We convinced the jury that the contractor knew who he was dealing with because he received checks from the corporation and some of his own invoices listed the corporation. But you don’t want to rely on a jury’s good judgment.

2. If you operate more than one corporation, such as a parent or sister corporation, or even if you have corporate partners, be very clear with whom a third party is contracting. Do not use shorthand names to describe your company. Make it clear to corporate partners and clients that each corporation is separate and one cannot bind the other, and that a contract with one does not bind the other. How you do this in practice depends on precisely how you do business.

Another short war story makes this point. I defended a company called Jones Plumbing Systems, Inc. (names changed to protect the innocent). The owners of Jones Plumbing Systems, Inc. decided to go into business with a supplier named Smith, and together they formed a new corporation called Jones Plumbing Supply, Inc. All well and good. To give the new company some recognition, they referred to the two companies collectively as “Jones Plumbing Group.” This would not really be a problem if they had followed Rule No. 2. However, Smith got sloppy and started entering contracts as “Jones Plumbing Group,” even though it was not a legal entity. Smith turned out to be a poor businessperson, and the owners of Smith Plumbing Systems cut their ties with him. However, the damage was done. Jones Plumbing Group could not pay its debts, so a creditor sued Jones Plumbing Systems, Inc., claiming that it thought it was doing business with Jones Plumbing Systems, or with a joint venture called Jones Plumbing Group. Here, the jury found for the creditor, undoubtedly thinking that this was merely a corporate shell game on behalf of Jones Plumbing. We were able to convince the trial judge that Jones Plumbing Systems committed no violation of c. 93A, so the damages were limited to single damages and the plaintiff had to pay its own attorneys’ fees.

3. Follow corporate formalities. There is a theory in Massachusetts and other states called “piercing the corporate veil.” That’s a fancy way of saying that a plaintiff can get at the assets of a stockholders or a parent corporation if the corporation did not follow corporate formalities. This theory is too complicated to explain in detail here, but generally you need to make sure that you are keeping business accounts separate and not commingling monies or assets, that the corporation has adequate insurance or assets and is not just an empty shell, and that you keep corporate records and books like one would expect of a corporation. There are twelve factors in all that a court will look to, but the key is whether the corporation is a sham and has perpetrated some wrong or fraud on a third party.

By Adam P. Whitney, 617.338.7000.