Harriet and Harry Homeowner have much to think about, given their financial condition and their entrepreneurship. Harry Homeowner has his own computer consulting business and Harriet is a realtor. Having reviewed the bankruptcy issues facing them, they are now concerned about preserving the businesses they have built up over the years. Harry is well known in the Valley for the truthful and honest manner in which he consults with clients. He takes the time to explain the computer systems and software his clients may need, and has even developed a slide presentation and training manual for his clients. Harry’s main competition is the big box electronic stores that sell computers and software, but leave the customers on hold with their 800 numbers or with kids who may know computers, but know little about customer loyalty and satisfaction. Harriet is also well known around town for her quick recognition of her client’s taste, needs, and standard of living in which they seek to be accustomed in a home to be shown by Harriet. She is attentive and responsive, often sacrificing her family time for her client’s demanding weekend schedules. Both are concerned that a pending bankruptcy may bring ruin to their goodwill and reputation around town.
Harry and Harriet have some information they gathered about corporations, limited liability companies, partnerships, and limited partnerships from the California Secretary of State’s Website at www.ss.ca.gov/business/business.htm, but are still confused about which they should choose, when may be best time to elect a new business entity, and the cost associated with it. The Homeowners realize their decision is one of the most important they will make, and do not want to make a mistake.
Harry and Harriet both seem to understand that a corporation is a fiction of the state, through which shareholders own stock, a board of directors is elected to make decisions about policy and business direction, and management follows through by implementing the decisions of the board. In California, a corporation may have as few as one shareholder and up to 35 shareholders before the incorporation process is made more complex by state securities laws. Harriet understands that a corporation will give the shareholders protection from liabilities incurred by the corporation, but she is concerned about whether creditors can get to them personally, notwithstanding.
In order for the corporation to maintain its identity and protect shareholders, the shareholders and the board must maintain all of the corporate formalities of minutes, resolutions, meetings, taxes, accounting records and segregation of personal and corporate affairs. Even though it may seem simple, and typing services or paralegal services offer to perform incorporations, Harry understands that the ongoing business of maintaining the corporation goes beyond his expertise or that of a paralegal, and he is considering paying the attorneys’ fee for an incorporation and first year’s maintenance. Luckily, his attorney has a fixed fee he charges that includes the state’s fees. Harry understands very well from his own clients who were sued personally that the “corporate veil” can be “pierced” if all of the “i’s” are not dotted and “t’s” crossed. Harry remembers how much trouble his landscaper, Larry, got in by not having workers’ compensation insurance, and how Larry, even though he was incorporated, was held personally liable his worker’s injury.
Before deciding on a corporation as a form of doing business, Harriet asks about partnerships, limited partnerships and limited liability companies. Her understanding is that a partnership is two or more people coming together for the purpose of making a profit. That is the definition given under the Uniform General Partnership Act as adopted in California. A limited partnership is governed by the Uniform Limited Partnership Act. Under California law, professional limited liability companies are not allowed, but in other states, a professional limited liability company will protect its members from all liability, including professional liability. In all states, a limited liability company gives the members the tax benefits of partners. A general partnership, as opposed to a limited partnership, has a managing general partner who may not have a financial stake in the partnership, but who has pulled together the investors, who are given limited partnership interests. Partnerships are best governed by written agreements, and not merely handshakes. Because neither Harry nor Harriet work with others or have other investors, they understand that a general or limited partnership is not for them. As of January 1, 2000, however, a single member limited liability company may be formed in California. As with a corporation, a limited liability company operates through an Operating Agreement, whereas a corporation operates with bylaws.
With the information about the different business entities in mind, Harry and Harriet return to their attorney advising them in the course of their financial planning. As the Homeowners discussed with him last month, their interest in the new business entity is an asset of their bankruptcy estate. In a Chapter 13, with their receiving regular pay checks from the business entity, the Chapter 13 Trustee will be able to evaluate the financial ability of the Homeowners to reorganize with regular income. Sole proprietorships, with the individuals often taking income and expenses as they may without regard to corporate/business formalities, are particularly troublesome for a Chapter 13 Trustee. Should they decide to liquidate all of their credit card debt through a Chapter 7, the Chapter 7 Trustee may look more closely at the value of the interest in the business entity, but cannot take possession of it directly and liquidate it for the benefit of the Homeowners’ creditors in preference to the business entity’s creditors. So, the Chapter 7 Trustee will be more interested in the transaction by which the assets of the individuals were transferred to the new business entity as the capital contribution in formation.
Once again, Harriet and Harry realize that these decisions are complex and will require careful thought and planning with the professional advice of their attorney and accountant. The accountant will assist in evaluating the best business entity from a tax perspective and to make sure the sole proprietorship’s assets from Harry’s computer business and Harriet’s real estate business are transferred properly and given their proper treatment under federal and state tax laws. The attorney will work closely with them in drafting the corporate bylaws or limited liability company operating agreement. In each case, consideration must be given to a buy out in case of death or divorce, key person, health, and liability insurance, and possibly short term available financing. All agree that those and other matters will be left to next month’s discussion.
