CORPORATIONS, LLCS & PARTNERSHIP LAW

Business entities are an important tool for efficient operation of modern businesses and the protection of the personal assets of the owners and investors. Mirowski & Associates provides: (1) Guidance in the selection of the proper business entity for your business, (2) Speeds you through the maze of bureaucratic rules and requirements needed to successfully form a business entity (3) Simplifies the maintenance of your business entity and (4) Educates you in the proper operation your business entity. Mirowski & Associates provides a full range of Corporate & Business legal services to businesses and corporations in San Diego and throughout Southern California including: Corporate, L.L.C. and Partnership Formation and Maintenance; Business Negotiation & Contract Drafting; Business “Strategy” Counseling, Liability and Asset Protection, Buy-Sell and Shareholder Agreement, Employer-Employee Law, Civil Litigation & Arbitration (Both Plaintiff and Defendant) Intellectual Property Matters Including Trade Secret, Copyright & Trademark; Tort and Unfair Competition Litigation.

BASIC QUESTIONS AND ANSWERS ABOUT INCORPORATING

What Is a Corporation? : A corporation is an independent entity that is usually created to conduct a business. A corporation is like an individual. It can:

  • Sue or be sued
  • Borrow money
  • Pay taxes
  • Apply for business licenses in its own name
  • Enter into contracts
  • Assume liabilities

A corporation can do all of these things under its own name, without making the individual owners and investors, known as shareholders, liable. The shareholders must always keep in mind, however, that they and the corporation are separate entities, and that they must treat the corporation as such in order to take advantages of its benefits. This rule applies even when the corporation has only one shareholder.

What Are the Advantages and Disadvantages of a Corporation? One significant advantage of the corporate structure is that the shareholders are usually protected from personal liability. Of course, any shares you own are vulnerable if the corporation has excessive debt or goes bankrupt. Still, you will be liable only to the extent of your investment in the corporation; your assets beyond that ordinarily will be shielded. Another advantage is that, unlike with a partnership, you are free to sell your interest (shares) in a corporation. In addition, unlike a sole proprietorship or a partnership, a corporation’s life span is usually perpetual, even when there is only one shareholder. Particularly if you intend that your corporation grow beyond your lifetime, the fact that it can “outlive” you and that your shares are transferable, can be very helpful in getting long-term financing as your business grows.

The major disadvantages of a corporation are the expenses of start-up and the meticulous record keeping that is required to comply with the many formalities of state laws. A failure to make filings and payments on time carries penalties. In addition, all important corporate decisions must be approved by the board of directors, and sometimes may require the involvement of an attorney.

How Is a Corporation Run? Major business decisions for a corporation are made by its board of directors, which is elected by the shareholders. The day-to-day responsibility for running the corporation is typically handled by its officers. The corporation’s by-laws (its rules and regulations), which are written at the time of incorporation, (when the company is formed) specify the number and respective duties of directors and officers. Traditionally, state statutes have required all corporations to have certain officers, including a president, a secretary (the officer who keeps the corporate minutes and records) and a treasurer.

In this traditional corporate form, one person can hold any two offices — except for the offices of secretary and president — unless the corporation has only one shareholder. A corporation’s officers are usually elected by the board of directors. The directors have the power to elect anyone they wish, including themselves or family members. The board also has the power to fire corporate officers.

Members of the board of directors as well as corporate officers have what is known as a fiduciary duty to the corporation. This means that they have an obligation to protect the shareholders’ interests rather than their own personal interests. (This is true even when the board member or officer is a shareholder.) This fiduciary duty requires all board members and officers: (1) To act with honesty, good faith and diligence, (2) To act solely for the benefit of the corporation, and (3) To use their best business judgment in making decisions affecting the corporation. These are essentially the same guidelines that a reasonable person uses when running a business.

Corporate officers and directors are generally not held personally liable for the success or failure of a corporation’s actions, unless they have violated these guidelines. For example, an officer who commits fraud using the corporation’s assets could be held liable for any losses incurred by the shareholders.

How Do You Incorporate? The rules for incorporating vary from state to state. Generally, however, you must file articles of incorporation with the secretary of state of the state in which you are incorporating and pay a filing fee. Your filing will be dated on its receipt in the secretary’s office, and if it is approved, your corporation will be considered to have been formed on that date.

Are There Other Steps Necessary to Complete the Incorporation Process? Yes. Although your business is officially incorporated on the date of acceptance of your filing in the secretary of state’s office, several additional steps must be taken to get your corporation up and running. First, the initial board of directors or the incorporators (depending on the laws of your state) must adopt by-laws — the procedural rules and regulations that govern how the corporation is run. The by-laws generally cover the following considerations:

  • Meetings of officers, directors and shareholders (including requirements on the number of members who must be present at a meeting in order to conduct business, and the process of notifying people of meetings and other important developments).
  • Number, tenure and qualifications of officers and directors.
  • Procedural rules relating to the approval of contracts, loans, checks and deposits.
  • Formalities regarding share certificates, share transfers and the corporate seal, which is used to authenticate the corporation’s legal documents.
  • Procedures for amending the by-laws.

Unlike the articles of incorporation, the corporation’s by-laws do not have to be filed with the secretary of state. After the by-laws have been adopted, the following actions are taken by the board:

  • The officers of the corporation are elected.
  • The corporate seal and form of share certificate are adopted.
  • Shares are issued, provided that proper payment has been received.
  • Certain officers are authorized to open the corporation’s bank accounts and to sign checks on its behalf.
  • If appropriate, the “election” of “S” corporation status is authorized.

On the adoption of these resolutions, the corporation is usually in business. Some states may require you to file additional documents, such as your employee identification numbers, before the corporation is considered up and running.

Where Should You Incorporate? The general rule of thumb for the small business owner is to incorporate in the state in which you intend to operate your business. You may incorporate in another state but BEWARE: A number of businesses offer cheap incorporation packages in States which have inexpensive “franchise” taxes on corporations. THEY DO NOT TELL YOU THAT YOU MAY BE SUBJECTING YOURSELF TO ADDITIONAL TAXES AND FINES. See Dangers of Incorporating Out of State herein. Because individual business circumstances vary, you should carefully consider which state to incorporate in. In making your decision, you should bear in mind that states generally impose a tax (commonly known as a “franchise” tax) on corporations that are either incorporated under their laws or do business within their borders. Therefore, if your business is incorporated in one state, but headquartered in another, it will probably be subject to taxes in both states.

How Long will it Take to Become a Corporation? Quite literally, you can be a corporation within hours as all a corporation needs to be effective is to file a simple document called the “Articles of Incorporation” with the Secretary of State’s office. Our office can do this if we are provided with the basic information and fees as described in our Corporation Fill-In Sheet. Yet, we note, if the name you select is not available, the Secretary of State will reject your Articles and therefore you will not be a corporation until a useable name is selected and accepted. In addition, the completion of the finalizing paperwork may take a few weeks.

THE DANGERS OF INCORPORATING OUT OF STATE
Foreign [Non-California] Corporations & LLCs

Corporate laws differ from State to State in varying degrees. A number of States (other than California) have attempted to attract businesses and revenues by allowing non-residents to easily incorporate in their States and requiring less than California in minimum taxes and reporting. Yet, if a Corporation is going to have significant business or shareholder “contacts” or “presence” in California, it is usually preferable to incorporate in California. In fact, Non-California Corporations (“Foreign” Corporations under California Law) have a number of disadvantages as follows:

Requirement of Qualification: A foreign corporation shall not transact intrastate business without having first obtained from the Secretary of State a certificate of qualification. (Corp. C. § 2105). This requires filing a form, proof of good standing in the foreign jurisdiction and filing fees paid in addition to those paid to the other jurisdiction. Therefore, the Foreign Corporation may result in the duplication of fees. The Corporation must also file a Certificate pursuant to Ca. Corp. Code § 1505. Finally, the Foreign Corporation is required to file a Statement by Foreign Corporation every two years.

Taxes: A Foreign Corporation “doing business in California” will have to pay state franchise taxes to the State of California (Rev. & Tax C. § 23151). It may also have to pay franchise taxes in its state of incorporation, even if not doing business there. Thus, a Foreign Corporation may potentially expose the corporation to double taxation.

Corporate Rules: No matter where the Corporation is formed, many provisions of California’s General Corporation Law apply if the corporation has a sufficient “presence” in California (Corp. C. § 2115). In addition, all Foreign Corporations are required to bi-annually file informational statements and designate agents within the state. See Corp. C. § 2117.

Securities Laws: California corporate securities law applies to any offer or sale of a security “in this state” regardless of the issuer’s state of incorporation.

Consent to Service: A Foreign Corporation must file a consent to service of process for any action arising under corporate securities laws. (Corp. C. § 25165). Service may be made by complying with Corp. C. § 2110-2111. (See Form 5E).

PSEUDO-FOREIGN CORPORATION RULES:

A “Pseudo-Foreign Corporation” [Corp. C. § 2115(a)] is any corporation that has:

  1. 1. More than 50 % of its voting securities are held of record by persons having addresses within California, and;
  2. 2. More than 50% of its business (based upon a three factor formula including property, payroll and sales) is done in California.

Unless the Corporation:

  • (a) Is wholly Owned Subsidiaries of Foreign Corp. and said parent corporation is NOT subject to Corporation Code § 2115. Corp. C. § 2115(e)(3), or
  • (b) Listed on National Market. Corp. C. § 2115(c)

As to these “Pseudo-Foreign Corporations”:

California Law Applies Exclusively: A “pseudo-foreign corporation” is subject to specific provisions of California law to the exclusion of the foreign law. Among the laws that apply are: major shareholder protection provisions, annual election, cumulative voting, director’s duties of care to shareholders, limitations on indemnification and distribution.

Disclosure of status: A “pseudo-foreign corporation” must respond within 30 days of receiving a written request from any shareholder of record, officer, director, employee, agent or creditor inquiring as to its status. Failure to truthfully respond risks penalties of $25 per day (maximum $1,500) plus in the court’s discretion, court costs and reasonable attorney’s fees. Corp. C. § 2115(f), 2200.

FAILURE TO QUALIFY

Penalty (Criminal Prosecution): Any foreign corporation which transacts intrastate business and which does not hold a valid certificate from the Secretary of State:

  • May be subject to a penalty of $20 for each day that unauthorized intrastate business is transacted. Corp. C. § 2203.
  • Shall be deemed to consent to jurisdiction in California. Corp. C. § 2203.
  • May be guilty of a misdemeanor. Corp. C. § 2258.

Bringing Actions: The general rule is that a foreign corporation which has failed to qualify with the State may not bring an action in state Court prior to compliance with Corp. Code § 2105 and paid a penalty fee, in addition to all taxes and fees which were due. Corp. C. § 2203 (c).

Defending Actions: Foreign corporation transacting intrastate business, which has failed to qualify with the Secretary of State, may defend action brought against it in state court even if it cannot maintain action. United Medical Management LTD. v. Gatto (1996) 49 Cal. App. 4th 1732. Raynolds v. Volkswagonwerk (1969) 275 Cal. App. 2nd 997.

SO – MAKE SURE YOU UNDERSTAND WHAT IT MEANS TO FILE YOUR CORPORATION IN A STATE OTHER THAN WHERE YOU WILL OPERATE.