Consequences of Failing to Properly Incorporate Your Business

What Are the Consequences of Failing to Properly Incorporate Your Business?

What Are the Consequences of Failing to Properly Incorporate Your Business?

brusk-dede-tjd5CfdDPRA-unsplash

If you want to incorporate your business, state laws establish various requirements that you must fulfill to properly obtain the protective benefits offered by doing business as an entity.  You can choose to incorporate in a state other than where you will operate the business, but you must comply with the laws of the state where you are filing.  Sometimes, business owners are unaware of all the rules or make technical errors and they fail to properly incorporate.  That can have significant repercussions resulting in personal liability for shareholders.  There are instances when courts will forgive mistakes, but best practice is always to avoid making them.

De Jure vs. De Facto Corporations

A de jure corporation is one that was formed in compliance with a state’s laws.  It is a legally recognized, properly formed entity and is distinct from its shareholders.  Among the benefits of being a de jure corporation is that the shareholders are afforded personal liability protection.  Generally, shareholders are not personally liable for the debts of the business with a few exceptions.  This is because a corporation has a separate legal existence from its shareholders.

Generally, a de facto corporation is a business that failed to properly incorporate but operates as if it was a corporation.  The situation arises when the company did not comply with the technical requirements of the law for good-faith reasons or errors.  The owners are not aware of their mistakes and continue to conduct business as a corporation.  Although a corporation was not duly formed, in limited cases, the shareholders and representatives can still avoid personally liability for the company’s debts.  The purpose of this doctrine is to provide liability protection where there was not any.

Requirements of a De Facto Corporation

Typically, shareholders or company representatives invoke the doctrine of de facto corporation when they are sued personally by a third party.  They want the same protections they would receive as if the business was a lawful corporation.  To succeed, they must establish the following requirements:

  1. There is a law under which the corporation might be organized. This requires referencing the state’s incorporation statute.
  2. The company founders must have attempted, in good faith, to incorporate but failed to fully comply with the state’s incorporation requirements. The good faith of the founders is the key issue.  If they tried to file but knew that their paperwork was defective and did not correct it, they did not act in good faith.
  3. Evidence to show that business is being carried out as a corporation. The owners must be operating as a corporation, such as by transacting business and signing documents under the corporate name.

If a company meets the requirements of a de facto corporation, its shareholders and representatives can still receive limited liability protection from third parties similar to the protections afforded to the shareholders of a de jure corporation.

Corporation by Estoppel

Further, if a business is neither a de jure nor de facto corporation, shareholders and representatives of the company may still receive some liability protection with respect to a particular transaction or contract dealing if the opposing party acted as if it were doing business with a corporation.  This is known as corporation by estoppel.  It is an equitable remedy used to shield someone who acts “as if” he or she was acting on behalf of a corporation or with a corporation.  Essentially, a court decides that it is not fair under the circumstances for the shareholder/representative to be held personally liable in the transaction because the opposing party believed that it was doing business with a corporation and thus should have had an expectation that a liability shield existed.  As a result, the court determines that the plaintiff should be estopped from now denying the existence of a valid corporation.

Conclusion

Complying with state laws regarding incorporation is vital to ensuring that shareholders and representatives obtain the intended protections of corporate law.  While shareholders and company representatives may get a reprieve from personal liability under the doctrines of de facto corporation and corporation by estoppel, they still must litigate and prove their case.  In both instances, it is essential to consult legal counsel to avoid costly results, including allowing third parties to make claims of the personal assets of shareholders and representatives.  Contact an experienced attorney for advice on the best ways to incorporate your business so that your shareholders and officers can avoid unintended consequences cause by defective incorporation.

Photo by Brusk Dede on Unsplash

Related Posts

Notice

This Blog is made available by Romano Law PLLC for general informational and educational purposes only, not to provide specific legal advice. By using this Blog you understand that there is no attorney client relationship between you and Romano Law PLLC or any individual contributor. You should consult a licensed professional attorney for individual advice regarding your own situation.

Request A Consultation

Please give us a call:

Schedule an appointment:

Or send us a message:

  • This field is for validation purposes and should be left unchanged.