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March 15, 2018 by Andrew L. SmithDownload PDF


Protecting Your Small to Mid-Sized BusinessAndrew L. Smith

It is crucial to retain the services of an attorney when it comes to protecting your business. This may include, but not be limited to: business formation; choosing a legal entity; business litigation; contract drafting; employment relations and litigation; and, several other aspects.

Most importantly, as an owner of a business entity, you can potentially be at risk for increased litigation. Therefore, it is very important from the outset to choose an entity that meets the demands of your particular business situation.

Sole Proprietorships

A sole proprietorship is the simplest business entity form. A benefit of this form of business is that it does not pay business taxes like other businesses. All income or losses generated by a sole proprietorship are reported on the sole proprietor’s individual income tax return. The disadvantage of this type of entity is that New Jersey law views the sole proprietor and business as one entity; consequently, the sole proprietor becomes legally responsible for all debts, liability, and obligations of the business.

Partnerships

In New Jersey, when two or more persons associate to carry on as co-owners of a business, a partnership is formed. Partnerships may include general partnerships, limited partnerships, and limited liability partnerships. Each form of partnership has its own formation and legal requirements, along with statutory rules concerning the level of protections afforded against personal liability on behalf of the individual partners. It is advised that prior to starting a partnership, competent legal counsel be retained in order to review the requirements and provide advice as to which form is most beneficial given the particular business situation. Lastly, tax considerations should also be evaluated by a competent attorney.

Limited Liability Companies

A limited liability company has characteristics of both corporations and partnerships. However, there are many more formational formalities as opposed to partnerships or proprietorships. A limited liability company is formed by filing a certificate of formation and filing fee. Additionally, the company must file an annual report. Unlike partnerships, the limited liability company shields its members and managers from personal liability for the business’ debts. However, not all liability is shielded.

Additional Formation Considerations

One of the most common misconceptions is that a limited partner or other corporate member is always shielded from legal and financial liability as a result of the business formations, stated above.

However, in New Jersey, it is possible for the courts to “pierce the corporate veil” in order to attach liability to an individual member or partner. As a result, it is crucial to set up your business in a manner that provides enhanced legal protections to your individual members and/or partners. When faced with business litigation, courts often apply the following test to determine if a member can be sued personally even though the business structure may not ordinarily allow for such an imposition of liability:

In order to pierce a corporate veil, there must be a finding that the corporate insider so dominated the corporation that it had no separate existence but was merely a conduit for the individual. To determine whether there has been such dominance, courts engage in a fact-specific inquiry considering whether the entity was grossly undercapitalized, the day-to-day involvement of the individual, and whether the entity fails to observe corporate formalities, pays no dividends, is insolvent, lacks corporate records, or is merely a facade. The party seeking an exception to the fundamental principle that a corporation is a separate entity from its principal bears the burden of proving that the court should disregard the corporate entity. Once the corporate veil has been pierced, courts can impose a corporation’s liability upon the individuals found to have exploited the corporate form.

Thus, the choice of an entity is one of the most essential decisions to make when setting up your business plan and structure.

Conclusion

This blog constitutes only a brief summary of the different business forms available. Additionally, there are tax, legal, business planning, and other relevant considerations applicable to the successful formation and operation of your business. Retaining legal counsel at the start of your business can help protect you, your finances, and everything you have worked hard to achieve.