KEYTLaw » LLCs & Corporations

Veil-Piercing

On the Net — Thu, 04 Mar 2010 02:38:55 +0000

Owners of corporations and limited liability companies worst nightmare is that a creditor will sue the company and its owners and ask the court to “pierce-the-corporate-veil” and hold the owners liable for the debts and obligations of the company. Peter B. Oh, Associate Professor of Law at the University of Pittsburgh has written a scholarly article called “Veil-Piercing.” Here is the abstract of the article:

From its inception veil-piercing has been a scourge on corporate law. Exactly when the veil of limited liability can and will be circumvented to reach into a shareholder’s own assets has befuddled courts, litigants, and scholars alike. And the doctrine has been bedeviled by empirical evidence of a chasm between the theory and practice of veil-piercing; notably, veil-piercing claims inexplicably seem to prevail more often in Contract than Tort, a finding that flouts the engrained distinction between voluntary and involuntary creditors.

With a dataset of 2908 cases from 1658 to 2006 this study presents the most comprehensive portrait of veil-piercing decisions yet. Unlike predecessors, this study examines Fraud, a long-suspected accessory to veil-piercing, as well as specific sub-claims in Contract, Tort, and Fraud to provide a fine-grained portrait of voluntary and involuntary creditors. And this study analyzes the rationales instrumental to a piercing decision.

The findings largely comport with our legal intuitions. The most successful civil veil-piercing claims lie in Fraud or involve specific evidence of fraud or misrepresentation. Further, claims not only prevail more often in Tort than Contract, but adhere to the voluntary-involuntary creditor distinction. Surprisingly, though, veil-piercing presents a greater risk to individual shareholders than corporate groups.

Arizona LLCs Are Four Times More Popular Than Arizona Corporations

Richard Keyt — Wed, 03 Mar 2010 19:50:48 +0000

The Arizona Corporation Commission statistics show that for the fiscal year ending June 30, 2009, people formed 45,616 Arizona limited liability companies and 10,694 Arizona corporations. For the three ACC fiscal years 2007 – 2009, the average number of LLCs and corporations formed in Arizona were 50,193 and 12,572, respectively. This equates to four Arizona LLCs being formed for every Arizona corporation.

I have formed over 2, 300 Arizona limited liability companies since 2001, but only 62 Arizona corporations. For the reasons why there is such a big difference, see my article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?” See also“Contents of Arizona LLC Attorney Richard Keyt’s $599 Complete LLC Package” and Testimonials. To learn more about Arizona limited liability companies, see the Arizona LLC Law Library. Get a free copy of my must-have article called “10 Critical Facts Every LLC Owner Must Know.”

If My New Business Will Have Start Up Losses, Should It be an LLC or an S Corporation?

Richard Keyt — Tue, 02 Mar 2010 02:47:34 +0000

Question: I am considering starting a new business and I anticipate that it will produce losses, rather than profits for the first few years. Should I form a limited liability company or an S corporation to own and operate the business?

Answer: People ask this question of me a lot, which is why I wrote a detailed article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?“ My article explains the many reasons why I believe that the LLC is the entity of choice in Arizona. People who ask this question are mixing the type of entity formed under state law with a method of taxation under the Internal Revenue Code of 1986, as amended. When you are thinking of forming an entity in Arizona to operate a business or to own investment real property, the first question is what type of entity should I form under Arizona law? Almost always the answer is a limited liability company.

After you form your company, the next question is what is the best method of income tax for the entity? If your tax advisor says that your LLC should be taxed as an S corporation and if it is eligible for that method of tax, then all of the members of company must sign an IRS Form 2553 (the instructions) and file it with the Internal Revenue Service before the deadline for making the S corp election. An LLC taxed as an S corporation is a “pass through” entity (it does not pay income taxes), which means that losses are passed through to the owners who can deduct the losses on their personal income tax returns (if they have sufficient basis). Note: An LLC that elects to be taxed as a C corporation, an S corporation, a sole proprietorship or a partnership for federal income tax purposes does not change its character. The entity always remains an LLC created under Arizona law regardless of the method of federal income tax applicable to the entity.

Bottom line: If s corp tax treatment is important and your business is in Arizona, form an Arizona LLC and cause it to be taxed as an S corporation by filing an IRS form 2553 in the first 75 days after forming the LLC.

P.S. I recommend that everybody who forms an LLC consult with a good tax advisor as soon as possible after forming the entity to obtain advice on which of the four federal income tax methods (sole proprietorship, partnership, C corporation or S corporation) is best for the limited liability company. The election to change the default method of income tax (sole proprietorship or disregarded entity for a single member LLC or partnership for a multi-member LLC) must be filed within 75 days of the date of forming the LLC for the election to be effective from the date of formation. For a list of the Certified Public Accountants I recommend in Arizona see “Professionals We Recommend.”

For the reasons I have formed over 2,300 Arizona LLCs, see “Contents of Arizona LLC Attorney Richard Keyt’s $599 Complete LLC Package” and Testimonials. To learn more about Arizona limited liability companies, see the Arizona LLC Law Library. Get a free copy of my must-have article called “10 Critical Facts Every LLC Owner Must Know.”

IRS Targets Employers with Independent Contractors

On the Net — Fri, 26 Feb 2010 14:46:35 +0000

The Ballard Spahr law firm reports that the Internal Revenue Service will begin random audits of employers to determine if they have underpaid employment taxes by paying independent contractors who should have been classified as employees. Treasury regulations require disregarded entities to withhold, report, and pay employment taxes. See “Final Regulations Treat Disregarded Entities as Separate for Employment Tax and Related Reporting Requirements” and “Disregarded Entities Are Now Responsible for Their Own Employment Taxes.”

The following general information about the employee vs. independent contractor issue is from the IRS’ website.

To determine whether a worker is an independent contractor or an employee under common law, you must examine the relationship between the worker and the business. All evidence of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Relationship of the Parties. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done, through instructions, training, or other means. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job. This includes:

The extent to which the worker has unreimbursed business expenses
The extent of the worker’s investment in the facilities used in performing services
The extent to which the worker makes his or her services available to the relevant market
How the business pays the worker, and
The extent to which the worker can realize a profit or incur a loss

Relationship of the Parties covers facts that show how the parties perceive their relationship. This includes:

Written contracts describing the relationship the parties intended to create
The extent to which the worker is available to perform services for other, similar businesses
Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
The permanency of the relationship, and
The extent to which services performed by the worker are a key aspect of the regular business of the company

For more information, refer to Publication 15-A (PDF), Employer’s Supplemental Tax Guide, or Publication 1779 (PDF), Independent Contractor or Employee. If you want the IRS to determine whether a specific individual is an independent contractor or an employee, file Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Should You Reserve a Name with the Arizona Corporation Commission for Your New LLC or Corporation?

Richard Keyt — Thu, 25 Feb 2010 17:08:36 +0000

Question: What is your opinion on reserving a name for my new company with the Arizona Corporation Commission?

Answer: I never reserve a name for a new LLC or corporation unless it would be a big problem if the company did not get the name. Big problem to me means that the loss of the name would cause my client to pay a lot of money or if you think somebody who knows about your plans for a new company might reserve the name just to prevent you from getting it. In the thirty years I have been a business lawyer in Arizona forming over 2,300 companies, I have reserved a name less than five times.

Think of it this way. If you check a name with the Arizona Corporation Commission (check it here) and it is available, it means the name has been available from the beginning of time to the moment you checked it. The chance that somebody is going to get that exact name before you in the near future are slim to none.

When people do reserve a name, it is not a problem for me when we form the limited liability company or corporation if the person or company that reserved the name is a member or manager named in the Articles of Organization of an LLC or named in the Articles of Incorporation of a corporation. If that person is not named in the Articles, the holder of the name rights must assign the rights to the name to one of the people or entities named in the Articles and the assignment document must be submitted to the Arizona Corporation Commission when you file the Articles.

P.S. Early in my legal career, I was merging two corporations into one survivor corporation. I reserved the name of the new corporation. It was very important that the merger occur on a specific date. The Arizona Corporation Commission rejected my merger documents because it said correctly that I was not named in the name reservation. That’s when I learned about the need for the name holder to assign the rights to the name to somebody who is named in the Articles.

Arizona Court of Appeals Finds Officers & Directors of Arizona Corporation Personally Liable for Corporation’s Debt

On the Net — Fri, 12 Feb 2010 17:30:06 +0000

Arizona Republic: “Corporate officers can be held personally liable in some situations when their defunct firms don’t pay suppliers, the Arizona Court of Appeals has ruled. The judges maintained that lawsuits against a corporation for failing to pay a debt are valid only against the corporate entity. And when the corporation goes away, the creditors generally cannot go after the individual shareholders or directors.” The case is Arizona Tile, LLC, vs. Howard Steven Berger, Cynthia Berger and John McCarthy.

The general rule of Arizona law is that the shareholders, officers and directors of an Arizona corporation and the members and managers of an Arizona limited liability company are not liable for the debts and obligations of the company. There are, however, many exceptions to this general rule. This case illustrates one of those exceptions. Arizona Revised Statutes Section 33-1005 requires contractors who receive payments intended for subcontractors and materialmen to hold the money in trust for the intended payee. This statute is the basis for imposing liability on the corporation’s officers and directors beca1use they had a duty to see that the money was paid to the proper payee, but instead they paid other corporate debts that the officers and directors had personally guaranteed. In short they used money intended for Peter to pay the corporation’s debt to Paul because if Paul did not get paid, Paul could collect the debt owed by the officers and directors under their guaranties.

Westcor, Pediatrician Spar over ‘Prasada’ Name for Medical Practice in Surprise

Richard Keyt — Sat, 06 Feb 2010 16:19:33 +0000

Arizona Republic: “A Sanskrit word meaning ‘gracious gift’ or ‘clarity’ has resulted in anything but for two Surprise business entities. A doctor who recently opened his first practice, Prasada Pediatrics, is involved in a trademark-infringement dispute with Westcor, the developer of the master-planned community of Prasada. Dr. Brian Lawrence Young, whose wife’s mother is Buddhist, said he chose the name for its Sanskrit meanings. ‘We live in Surprise, so we know that there’s a significant need for pediatrics in Surprise,’ said Young, who moved to the Valley from New Jersey in 2005.”

Is this a case of the big company with a deep pocket using its ability to spend money on legal fees intimidating the little guy? Consider what Harvard University’s Berkman Center for Internet & Society says about the topice “What Constitutes Trademark Infringement:

If a party owns the rights to a particular trademark, that party can sue subsequent parties for trademark infringement. 15 U.S.C. Sections 114, 1125. The standard is “likelihood of confusion.” To be more specific, the use of a trademark in connection with the sale of a good constitutes infringement if it is likely to cause consumer confusion as to the source of those goods or as to the sponsorship or approval of such goods. In deciding whether consumers are likely to be confused, the courts will typically look to a number of factors, including: (1) the strength of the mark; (2) the proximity of the goods; (3) the similarity of the marks; (4) evidence of actual confusion; (5) the similarity of marketing channels used; (6) the degree of caution exercised by the typical purchaser; (7) the defendant’s intent. Polaroid Corp. v. Polarad Elect. Corp., 287 F.2d 492 (2d Cir.), cert. denied, 368 U.S. 820 (1961).

So, for example, the use of an identical mark on the same product would clearly constitute infringement. If I manufacture and sell computers using the mark “Apple,” my use of that mark will likely cause confusion among consumers, since they may be misled into thinking that the computers are made by Apple Computer, Inc. Using a very similar mark on the same product may also give rise to a claim of infringement, if the marks are close enough in sound, appearance, or meaning so as to cause confusion. So, for example, “Applet” computers may be off-limits; perhaps also “Apricot.” On the other end of the spectrum, using the same term on a completely unrelated product will not likely give rise to an infringement claim. Thus, Apple Computer and Apple Records can peacefully co-exist, since consumers are not likely to think that the computers are being made by the record company, or vice versa.

A search of the U.S. Patent & Trademark Office’s database shows that an Arizona limited liability company called Westcor/Surprise, LLC, has obtained two federally registered trademarks. They are:

Registration Number: 3684454. For Prasada as a standard character mark in the following classes: (1) IC 036. US 100 101 102. G & S: Shopping center services, namely, leasing of shopping centers; real estate leasing, real estate management. FIRST USE: 20050600. FIRST USE IN COMMERCE: 20050600, and (2) IC 037. US 100 103 106. G & S: Real estate development and site selection; construction services, namely, planning and building, construction consulting for commercial, residential, and medical facilities. FIRST USE: 20050600. FIRST USE IN COMMERCE: 2005060.
Registration Number: 3138577. For Prasada as a words, letters and/or numbers in stylized form in class IC 036. US 100 101 102. G & S: Shopping center services, namely, rental and management of shopping center space. FIRST USE: 20050518. FIRST USE IN COMMERCE: 20050518.

I highlighted the classes for Westcor/Surprise’s two registered marks because its trademark/service mark rights extend to these areas. The registrations are for International Class 36 (real estate affairs) and 37 (building construction; repair; installation services). Note that Westcor/Surprise did not register Prasada in International Class 44, which is for medical services. Hmm! Could it be that Westcor/Surprise did not register its trademark for Prasada in IC 44 because it’s use of Prasada does not involve medical services?

Westcor/Surprise has not sought to register a federal trademark for Prasada as a medical practice or doctors’ office, which is nothing like shopping center services or real estate development. Do you think there is a likelihood of confusion between a doctor’s medical practice called “Prasada Pediatrics” and a huge shopping mall and master-plannded community many miles away called “Prasada”? Do you think anybody would go to Prasada Pediatrics because they intended to shop at the Prasada Pediatrics mall? I’m having a hard time finding a likelihood of confusion unless perhaps it is Westcor/Surprise, LLC, that is confused because it cannot tell the difference between a shopping mall and a children’s doctor’s office.

Beware of Parent – Subsidiary LLC Structure

On the Net — Mon, 25 Jan 2010 14:27:20 +0000

A question asked of me a lot is “should I form a parent limited liability company to own and manage susidiary LLCs formed to hold separate real estate properties?” My answer is usually no. The potential problem with the parent – subsidiary structure is that it breaks one of the fundamental rules of asset protection which is segregate assets into separate LLCs so that if a financial disaster occurs with one property it will not cause a loss of the the values of any other properties. It’s the “don’t put all of your assets in the same basket” theory. By creating a parent – subsidiary structure, you are putting all of your eggs in the same basket at the parent level. A recent Florida case illustrates perfectly the point I am trying to make.

Ward on Iowa Limited Liability Companies: ‘The issue of a parent company’s liability for the debts of its wholly-owned subsidiary arises once again in 17315 Collins Avenue, LLC et al v. Fortune Development Sales Corp., 2010 Fla. App. LEXIS 201 (Fla. App, January 15, 2010). Wavestone Properties, LLC owned all of the membership interests of 17315 and was its managing member. Wavestone, like so many parent companies, did not conduct any operations, have employees or bank accounts (this last point is a little unusual). Based on these fact the court concluded that the parent and subsidiary were alter egos and met the first prong of the two-prong test to pierce the corporate veil.”

People in Control Are Personnally Liable for Unpaid Payroll Taxes of Companies

On the Net — Sat, 23 Jan 2010 17:23:32 +0000

Companies with employees should never fail to pay payroll taxes not just because its required by the law, but also because people who control a company’s finances can be personally liable to the IRS for the unpaid trust fund portion of payroll taxes. Employers such as corporations (for profit and nonprofit), limited liability companies, limited partnerships and other organizations are required to withhold and pay payroll taxes to the federal government. Internal Revenue Code Section 6672 imposes personal liability for unpaid payroll taxes on all people who have the power to control the liable entity’s finances and determine which creditors are paid. People who can become liable for a company’s unpaid payroll taxes includes officers and employees of a corporation, employees or managers of a limited liability company and employees and general partners of a limited partnership if the person has a duty to collect and pay payroll taxes to the government. See “What is the Trust Fund Recovery Penalty?”

The most frequent fact pattern involving the assessment of the penalty is when an employer fails to collect and pay over income tax withheld from the employees and the employees’ share of Federal Insurance Contribution Act (FICA) taxes or railroad retirement taxes. These taxes-withheld income tax and the employee’s share of FICA or railroad retirement taxes-are collectively referred to as the trust fund taxes.

Reverse Piercing is a Flawed Theory

On the Net — Thu, 21 Jan 2010 21:26:07 +0000

Ward on Iowa Limited Liability Company Law: “PIP, Inc. v. Kaswa Corporation, 77 Cal Rptr. 3d 96 (Dist. 4, 2008) highlights the problem with the theory of reverse piercing. As you know, piercing the corporate veil is an equitable theory applied to pierce the liability protections of a corporation to get at the assets of the shareholder to satisfy a corporate debt. It is an appropriate remedy when a shareholder uses the corporate form to evade personal liability or to commit a wrong. . . . Reverse piercing is used to apply corporate assets to satisfy the debt of a shareholder.”