Articles Posted in Corporations

Part I of this series briefly discussed Indiana’s new benefit corporation statute as well as certification of a company as a “B Corp” by B Lab and some of the possible advantages of certification and of incorporation under the new statute.  Part II begins to look more closely at the details of the new law and to consider whether it makes sense for small businesses to incorporate under the new statute.

From a corporate law perspective, benefit corporations are, first and foremost, corporations subject to the Indiana Business Corporation Law, just like any other Indiana for-profit corporation.  In our view, a corporation is not the best choice of the form of entity for most small businesses.  For a number of reasons, including the tax alternatives available to LLCs, the “pick-your-partner” and charging order provisions of the Indiana LLC statute, and the fact that LLCs have fewer corporate formalities that must be observed (which decreases the possibility that the liability shield that protects the assets of owners from the creditors of the business will be disregarded through so-called veil-piercing), we believe that a limited liability company is a better choice than a corporation for most small businesses.

The above advantages of LLCs over corporations are the same – or even greater – for benefit corporations.  For example, partnership taxation is not an option for benefit corporations; if that is important enough, a benefit corporation is not a viable alternative.  In addition, the benefit corporation adds more required corporate formalities on top of those already imposed by the Indiana Business Corporation law, increasing the administrative burden and the possibility of weakening the liability shield protecting the assets of owners from the company’s creditors.  In other words, for most small businesses, a benefit corporation will not be the best choice of entity for most small businesses, unless the advantages of incorporating as a benefit corporation outweigh the advantages of organizing as a limited liability company.

 

I sometimes run across small business owners who have set up their business as a corporation, and I often ask why they chose a corporation rather than a limited liability company (or LLC).  Sometimes the answer is that the business was incorporated before LLCs existed, or when LLCs were new and the lawyer who advised the owner was not familiar with LLCs or was not comfortable with using them, and that makes sense.  Another relatively common answer is that the owner’s lawyer or, more often, accountant advised the owner that there were advantages to being taxed as a Subchapter S corporation rather than being taxed as an LLC, so the business was organized as a corporation rather than a limited liability company.  That doesn’t make as much sense, at least not since 1997.

Although the history of LLCs can be traced back to earlier statutes in Germany and other European countries, there were no LLCs in the United States until 1977 when Wyoming passed the first LLC statute in the country.  For several years after that, the use of LLCs was suppressed by uncertainty surrounding their status for income tax purposes.

The Internal Revenue Code did not (and still does not) include provisions specifically written for taxing LLCs.  The question was whether they would be taxed as partnerships or as corporations, and the answer was not clear.  In 1995, the IRS issued guidance identifying four specific attributes Continue reading ›

A primary reason to organize a business as a corporation or a limited liability company (LLC) is to protect the owners from personal liability for the debts of the business. Sometimes, however, a court may “pierce the corporate veil” of a business to hold the owners of the business personally liable for the company’s obligations.

In deciding whether to pierce the corporate veil, Indiana courts examine and weigh several factors, including whether the owners of the business have observed the required formalities for the particular form of organization. One of the reasons we generally favor LLCs for small businesses is that there are fewer required formalities for LLCs than for corporations, which in turn means that there is not only a lower administrative burden associated with LLCs, but also fewer opportunities for business owners to miss something. However, there are a few requirements, discussed below.

1. An Indiana LLC must have written articles of organization, and the articles must be filed with the Indiana Secretary of State .

There’s almost no need to mention this one because an LLC does not even exist until its articles of organization are filed with the Secretary of State, but for the sake of being complete . . .

The articles of organization must state:

• The name of the LLC, which must include “limited liability company,” “LLC,” or “L.L.C.”
• The name of the LLC’s registered agent and the address of its registered office (discussed in more detail below).
• Either that the LLC will last in perpetuity or the events upon which the LLC will be dissolved.
• Whether the LLC will be managed by its members or by managers. (Technically, the articles can remain silent on this point, in which case the LLC will be managed by its members, but the Secretary of State’s forms call for a statement one way or the other.)

2. An Indiana LLC must have a registered agent and a registered office within the State of Indiana.

The purpose of this requirement is to give people who sue the LLC a way to serve the complaints and summons. The registered office must be located within Indiana, and it must have a street address. A post office box is not sufficient. The registered agent must be an individual, a corporation, an LLC, or a non-profit corporation whose business address is the same as the registered office’s address.

The registered office and registered agent must be identified in the articles of incorporation and in the business entity reports (discussed below) filed every other year with the Indiana Secretary of State, but the requirement to have a registered office and registered agent applies all the time, not just when those filings are made. If the LLC’s registered agent resigns, the LLC must name a new one and file a notice with the Secretary of State within 60 days.

In addition, LLCs formed after July 1, 2014, are required to file the registered agent’s written consent to serve as registered agent or a representation that the registered agent has consented. That new requirement was established by Senate Bill 377, passed by the 2014 General Assembly and signed into law by the governor.

3. An Indiana LLC must keep its registered agent informed of the name, business address, and business telephone number of a natural person who is authorized to receive communications from the registered agent.

This is another new requirement contained in Senate Bill 377. It takes effect on July 1, 2014.

4. An Indiana LLC must maintain certain records at its principal place of business.

The required records are:

• A list of the names and addresses of current and former members and managers of the LCC.
• A copy of the articles of organization and all amendments.
• Copies of the LLC’s tax returns and financial statements for the three most recent years (or, if no tax returns or statements were prepared, copies of the information that was or should have been supplied to the members so they could file their tax returns).
• Copies of any written operating agreements and amendments, including those no longer in effect.
• A statement of all capital contributions made by all members.
• A statement of the events upon which members will be required to make additional capital contributions.
• The events, if any, upon which the LLC would be dissolved.
• Any other records required by the operating agreement.

 

[Note: Ind. Code 23-18-4-8(e) provides that the failure to keep the above records is NOT grounds for imposing personal liability on members for the obligations of the LLC. It’s more likely to become an issue in the event of a dispute among the members. Thanks to Josh Hollingsworth of Barnes & Thornburg for reminding me. MS:4/7/2014].

 

5. An Indiana LLC must file a business entity report with the Secretary of State every two years.

The report is due at the end of the month that contains an even-numbered anniversary of the filing of the articles of organization. Failure to file the report within 60 days of the due date is grounds for administrative dissolution of the LLC.
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[This is the third post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here’s the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company’s owners are not liable for the LLC’s obligations.
Part 6. Options for an LLC’s management structure.
Part 7. Options for an LLC’s tax treatment.]

Let’s get back to our trek toward a discussion of the basics of limited liability companies. The first two types of business structures we’ve looked at — sole proprietorships and partnerships — have two significant features in common. First, the owner or owners are liable for the obligations of the business. Second, the business itself does not pay taxes. Instead, the income and other tax items are “passed through” to the owner or owners, who pay tax on the income. Things change with corporations, the third type of business structure.

Although corporations are not as old as sole proprietorships or partnerships, business organizations with at least some of the characteristics of corporations have been around for centuries. For example, the oldest corporation in North America, Hudson’s Bay Company, was incorporated in 1670.

Perhaps the most important feature of a corporation is that the owners of the corporation — called stockholders or shareholders — are NOT liable for the obligations of the business. And that’s very good news for people who owned stock in Lehman Brothers, which melted down into the largest bankruptcy in American history. Or, going back a little further to previous record holders, people who owned stock in Enron and Worldcom. Even though the people who owned stock in those corporations may have lost everything they invested, they were not liable to the corporations’ creditors, and they did not get pulled into the corporate bankruptcies. That protection against shareholders being held liable for the corporation’s obligations is sometimes called a liability shield or a corporate veil, and it doesn’t exist for sole proprietorships or general partnerships.
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