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It’s Halloween. Kids get scared by monsters and spooky Jack O’Lanterns. Adults may relive pent-up fears from the rest of the year or (hopefully) get a playful reprieve.

Here are five scary legal blowups you can avoid in your business by careful, timely planning. Start tomorrow, after resting up from the Tricks and Treats.

[Note: This post was written while I was a practicing attorney running a solo law practice. Since April 2015, I have been working with attorney, executive and entrepreneur clients as a career coach and writer, and I am not currently available for legal engagements.]

1) You have an unstable or otherwise difficult business partner and do not have proper agreements. This seems like an obvious point, but unfortunately it is often overlooked. Document your rights and obligations with your business partners before disputes arise. If you visit Avvo.com or one of the other sites at which “real people” can post questions anonymously to attorneys, a topic you will see over and over again is how to dissolve a business relationship in which there are no legal agreements governing the relationship of the parties. A little investment upfront to work out what happens in a dispute will not only save you stress if there’s a meltdown or bombshell, or your business partner suddenly disappears or dies (which does happen), but it also will contribute to amicable relations in the good times.

2) You don’t know what your lease says. I am continuously surprised at how many friends and clients come to me with questions like – can I get out of my lease early without penalty? how do I do it? Your lease may be one of your biggest expenditures as a business. You should know what it says before you sign it, and you should write it down in a memo (or at least handwritten notes) that you file with the lease, so you remember later what it says. This goes for all big ticket contracts, in fact. Know not only how much they cost to stay in, but how much it would cost you to get out of them if needed.

5) Your address is wrong with the Secretary of State or contract counterparties  and you do not receive notice of fines or litigation. If you do not update your address, you will not be notified, and this is to your detriment. Fines and penalties can pile up, and if you do not receive notice of a litigation a default judgment can be entered against you without your knowledge or ability to defend yourself. Have an individual in your organization (and a backup) who is charged with reviewing key matters if your contact information changes temporarily or permanently.

4) You do not have a federal registration for your trademark or service mark, and someone applies for it first. If you have already invested considerable time in creating and advertising your business name and are operating in multiple states, or you have a serious intent to do so, it is worth the small investment to hire an attorney and, if he or she advises, file a federal trademark application. In the long run, it is more economical – and causes less headaches and heartaches – to either (1) have your registration completed first, without the need to try to cancel a competitor’s application on grounds that you are the prior, senior user, or (2) know before expending even further time and funds in a mark that registration may not be available. (See my prior post about choosing a mark and make sure that, if your attorney advises, you complete a trademark search as well.)

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5) You have “independent contractors” on the books who are really employees. Businesses often hire individuals as independent contractors or consultants without considering the serious downside if they are reclassified as employees. Take a look at the Department of Labor’s press releases about employee misclassification for some of the enforcement activity in this area. There is no single standard to distinguish between employee or independent contractor (e.g., click here re: the FLSA or here for the NY DOL). What is clear is that simply calling someone a consultant does not mean he or she is not an employee. And the penalties can haunt you longer than any ghost on Halloween.

Law Office of Anne Marie Segal is located in Stamford, Connecticut, provides legal counsel to businesses and individuals in Connecticut and New York and advises select national and international clients. Please visit www.amscounsel.com for more information.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship, and there may be facts not discussed here that are relevant to your situation. This is a public forum. Please do not post confidential or fact-specific information regarding your legal questions on this site.

If you plan to start or have recently started your own business and are considering a single-member LLC (i.e., a limited liability company of which you are the sole owner), it is tempting to cut corners on the formalities, cost and time investment that may be associated with administering a “real business”. After all, no one can dispute profits, control or any aspect of the company with you, so why do you need the hassle? Successful or not – including the scary and exhilarating bits – it’s all yours.

The main problem if you fail to treat your LLC as a real business is that, when you actually need the limited liability protection that the LLC is meant to afford, the courts may not treat it as one either.

[Note: This post was written while I was a practicing attorney running a solo law practice. Since April 2015, I have been working with attorney, executive and entrepreneur clients as a career coach and writer, and I am not currently available for legal engagements.]

The Concept of Limited Liability

If you are going into business for yourself, there is no requirement to form an LLC or any other legal entity. There are quite a number of small businesses that operate as sole proprietorships, especially in the early days of the business when there is little or no revenue generation. The reasons to form an LLC or other entity vary, from simply appearing “more professional” to raising capital or engaging in tax planning, but obtaining limited liability status is certainly a key motivator.

In contrast to the single-member LLC, a sole proprietor simply operates a business in his or her own name. Let’s say Katie Lynn designs handbags, for example, and sells them from her home. Her business transactions are all done through her own name. Katie has personal liability for her own conduct as well as any debts of her business. If she purchases fabric, rents display space or incurs other liabilities that she later cannot afford to pay, Katie’s creditors can come after her home or other personal assets.

If Katie forms a limited liability company – let’s call it KL Designs LLC – she can now take a step back from the business if – and this is the important point to note – she takes appropriate care in the operation of her LLC. Simply forming an LLC one day and making no other changes to her business operations will not afford Katie the protection she expects. She needs to run KL Designs LLC not as an extension of Katie Lynn but as a separate entity or “legal person”.

Veil Piercing

The risk that Katie now runs, as the sole owner of an LLC, is that she has spent time and money to create KD Designs LLC but will be liable for its debts nonetheless. To be clear, there are instances where an LLC owner can be personally liable despite any entity status, including:

– personally and directly injuring someone,

– personally guaranteeing a business loan or other liability, or

– intentionally or recklessly committing fraud or illegal acts.

An LLC owner can also be personally liable if he or she does not treat the entity as a separate legal entity. In that instance, a court can hold that Katie or another business owner is essentially operating as a sole proprietorship and disregard the LLC status. Below are some ways sole member LLCs can protect themselves against “veil piercing”, which is the legal term used to analogize that the entity is simply a facade or “veil” covering the owner rather than shield against liability.

Operating Agreement

The central document for an LLC is the operating agreement. An operating agreement sets forth the obligations of the member(s) with respect to ownership percentages, capital contributions, profits and losses and other rights and responsibilities. It also overrides any default rules on the governance of LLCs in the relevant jurisdiction, which may or may not be what the owner(s) intended. As a sole owner of an LLC, having an operating agreement and following what it requires to authorize or take action by the entity are the first steps to demonstrating that the business is separate from one’s individual affairs.

Funding the LLC and Insurance

Undercapitalization – i.e., lack of sufficient funds to operate the business – is another reason a court may pierce the veil of an LLC and hold the owner(s) personally liable for the company’s debts. LLC owners need to invest sufficient cash in the business to fund its expenses and should hold sufficient liability insurance to cover lawsuits and claims (which will also be available to cover instances where the limited liability status is not respected).

Separation of Business and Personal Assets

An LLC owner should obtain a federal employer identification number (EIN) and keep bank accounts and financial accounting separate for the LLC and his or her personal assets. The absence of corporate records and commingling (mixing) of business and personal assets are two factors that courts consider in determining whether the piercing-the-corporate-veil test is met.

Transacting Through the LLC

All agreements and business transactions should be conducted through the name of the LLC. If we consider our example above, all contracts, invoices and other documents that Katie enters into on behalf of her handbag business should be in the full name of KL Designs LLC (including the “LLC” designation) and signed by Katie in her capacity as president (or another title) of the company.

The above considerations are crucial for any owner of an LLC, including a single-member LLC, who wants to preserve the limited liability status that an LLC is intended to afford.

None of the information posted on this site constitutes legal advice or forms an attorney-client relationship. This is a public forum. Please do not post confidential or fact-specific information regarding your legal questions on this site.