Introduction: As a firm that has 25 years of corporate, business and business experience, we know that a relatively small investment in legal services in the formation, planning and maintenance of a business structure, can mean the avoidance of personal liability and the ability to make unlimited income.
Corporations – The principal advantages of corporate formation include limited liability for the owners, perpetual existence of the entity, free transferability of ownership interest, and simplicity in organization and governance. The issue of double taxation (taxing at the corporate level and at the personal level), have been addressed by permitting the corporation to elect Subchapter S status which is a provision of the federal tax code permitting the corporation to have flow-through status. That means, that the corporation will not have to pay tax and it flows directly to the shareholders. Thus there is only one tax levied against the shareholder on actual earnings of the shareholder. The traditional C Corporation is taxed at the corporate and shareholder level. Not all corporations can be S corporations. For example, a corporation with over 35 shareholders or corporations with more than one class of stock generally cannot elect S corporation status.
Limited Liability Companies – In 1993, Michigan passed the Michigan Limited Liability Company Act (LLCA), 1993 PA 23. This law governs the formation and operation of limited liability companies (LLCs) in Michigan. An LLC is a cross between a partnership and a corporation and combines the most favorable attributes of both. It is designed to provide business owners and managers with the flexibility and tax advantages of a partnership and the protection against personal liability of a corporation. For many individuals and small companies, this choice of entity is ideal for creating a structured company that provides flow-through taxation like an S Corporation (the business is not taxed, only the Members). An LLC issues membership certificates that are very much like the stock issued by a corporation to represent ownership.
Formation of a Corporation or Limited Liability Company – Generally speaking, it is relatively easy to form a corporation or limited liability company. However, obtaining all of the protections and advantages of these business structures requires more than filing the application with the State of Michigan. These applications, known as Articles of Incorporation or Articles of Organization, provide only the most basic part of the structure. It is still very important legally to have initial meetings or consent resolutions, issue stock or membership shares and adopt by-laws (for corporations) or an operating agreement (for LLC’s). The by-laws and operating agreement essentially comprise the “law” of the corporation or LLC. It controls such things as when the company will have meetings, how officers are elected, whether officers, directors or shareholders can be indemnified or defended by the company for legal actions by third parties.
Piercing the Corporate Veil – One of the most fundamental reasons that a corporation or LLC is formed is to provide protection from personal liability of officers, directors, shareholder or members. For a variety of reasons, third parties will file claims against the corporation or LLC and against officers, directors, shareholders or members. A lawsuit involving a business transaction in the name of the Company may also include claims against the individuals of the company known as “Piercing the corporate veil”. The following list includes the factors courts will consider in determining whether to impose personal liability:
commingling of funds and other assets, failure to segregate funds of separate entities
treatment by an individual of the assets of the corporation as his or her own
failure to obtain authority to issue or subscribe to shares
failure to maintain minutes or adequate corporate records and the confusion of records between separate entities
failure to adequately capitalize a corporation
use of a corporation or LLC as a mere shell or sham, instrumentality or conduit for a single venture or the business of an individual or another corporation
disregard of legal formalities and the failure to maintain arms-length relationships
diversion of assets from a corporation by or to a stockholder or other person.
This list is by no means exhaustive; however these represent key problem areas.
Successor Liability – Michigan follows the universal rule that a business entity which acquires the assets of another is liable for the predecessor’s debts under certain circumstances. The traditional rule of successor liability examines the nature of the transaction between predecessor and successor corporations. If the acquisition is accomplished by merger, with shares of stock serving as consideration, the successor generally assumes all its predecessor’s liabilities. That is why the vast majority of purchases are “asset sales”. The acquiring entity purchases only the assets of the company and is a completely separate entity. Even this will not work in all situations. For example, for purposes of unemployment liability, if the purchaser acquires 75% of the assets of a company, it will inherit that Company’s unemployment insurance rate.
In an asset sale under Michigan law, there are limited circumstances where the transaction may result in successor liability. For example, the new company could be liable for the old company’s debts where:
where the transaction amounts to a consolidation or merger;
where the transaction is fraudulent
where some of the elements of a purchase in good faith were lacking, or where the transfer was without consideration and the creditors of the transferor were not provided for; and
where the transferee corporation was a mere continuation or reincarnation of the old corporation.
Disputes among shareholders, Members and Corporation and LLC – In this writer’s experience, many disputes between members, shareholders or between themselves and the company involve a lack of clarity in the by-laws or Operating agreement for such things as:
admitting new members
buying out an existing shareholder
valuation of an interest
in cases involving multiple shareholders or members, a majority block oppressing a minority faction of the company;
either no agreement or a vague agreement regarding the payment of dividends such that conflicts arise about the retention of earnings or payments to shareholders
conflicts of interest
Contracts Between the Corporation or LLC and its Officers, Employees or Shareholders – Many Companies face many challenges in the intense competition of business. Often, the ability to protect trade secrets, formulas, processes, know-how and customer lists is absolutely essential to being successful. As such, it is very important for an LLC or Corporation to have adequate agreements between the company and its employees, shareholders, officers, directors, agents and vendors to protect its trade secrets, company business, etc. Moreover, a properly drafted agreement can eliminate or lessen the possibility of such persons leaving the company and competing directly with it using the know-how obtained from the company.
Michigan has a statute that governs non-compete agreements. This statute provides the court with specific authority to enforce, to the extent it deems reasonable, the scope of such non-compete agreements as to the geographical area and the length of time it will be enforced. Each situation is a little different so there are no hard and fast rules.
Brown and Brown, PLC considers business law and business litigation to be one its fundamental strengths. We have a 25 year successful track record of providing excellent legal service to businesses ranging from a company of one to a large international corporation.