Business Law F.A.Q.

What is business law?

Business law and corporate law are broad legal topics that encompass business, commerce, consumer transactions, and the formation and management of business entities. Some of the more important areas of corporate law include sales, secured transactions, negotiable instruments, and debtor and creditor law. Business law overlaps, but also includes the formation and management of business entities. An attorney with experience in business and commercial law can help you with all of your questions.

I am an entrepreneur looking to start up my own corporation.  What business formation should I be looking into?

A business owner must be aware of the main business organization forms, their characteristics, and the law that governs their management and formation.

The Sole Proprietorship is created when an owner simply begins business. It is simple and cheap to form and is usually chosen by one-person businesses. The owner owns all of the assets. The owner also has unlimited personal responsibility for business liabilities. The owner is taxed on all income from the business at applicable individual tax rates.

A General Partnership is formed when two or more persons carry on as co-owners of a business for profit. Each general partner participates in the management, owns the assets, and shares the profits and losses. Each general partner is personally liable for business related obligations. General partners are taxed on their individual tax returns.

A Limited Partnership differs from a general partnership in that there is at least one limited partner who contributes capital, but does not have substantial management control. The limited partner has limited liability to the extent of their capital contribution to the partnership.

A Limited Liability Company combines elements of partnerships and corporations. LLCs must file articles with the state. As in a limited partnership, the owners only risk losing money that has been invested into the LLC. Only LLC assets are used to pay its debts. However, an LLC is not a separate taxable entity, and LLC owners report profits and losses in their individual tax returns.

A Corporation is a separate legal and taxable entity. One must comply with statutory formalities to set up a corporation. Barring certain exceptions, the owners of the corporation are protected from the corporation's liabilities.

What are the differences between C and S corporations?

The Internal Revenue Code allows for two different levels of corporate tax treatment.

Subchapter C corporations include most large, publicly-held businesses. These corporations face double taxation on their profits if they pay dividends: C corporations file their own tax returns and pay taxes on profits before paying dividends to shareholders, which are subsequently taxed on the shareholders' individual returns.

Subchapter S corporations meet certain requirements that allow the business to insulate shareholders from corporate debts but avoid the double taxation imposed by subchapter C. To receive subchapter S treatment, corporations:

• Must be domestic;
• Must not be affiliated with a larger corporate group;
• Must have no more than one hundred shareholders;
• Must have only one class of stock;
• Must not have any corporate or partnership shareholders; and
• Must not have any nonresident alien shareholders.

Additionally, after a business is incorporated, all shareholders must agree to subchapter S treatment prior to electing that option with the Internal Revenue Service. The limitations imposed by the subchapter may affect the transferability and marketability of corporate shares.

What types of legal procedures should corporations maintain?

Once incorporators establish a new business, the directors must ensure that it maintains 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;
• 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 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 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.
  • Example: Fred's Tractors and Fred share the same banking account. Fred signs business contracts in his own name. Fred may be liable for breaching a business contract because he and his company are legally indistinct.
• 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.

The potential for personal liability encourages businesses to observe legal requirements and to avoid damage to third parties.