De Facto Corporation Doctrine Also Applies to an LLC

One of the main reasons to establish a corporation is to avoid personal liability for the corporation’s debts.  However, the protection may not be available if there was some defect in the way the corporation was formed, or the corporation had not yet been formed when a contract is signed.

In Duray Development, LLC v Perrin, the issue was that the defendant had signed a contract and Articles of Organization to create a new limited liability company on the same date.  However, the Articles were not officially accepted by the State of Michigan until a month later.  The plaintiff tried to hold the defendant individually liable for the contract because the limited liability company did not legally exist on the date the contract was signed.

Michigan Courts have recognized the concepts of “de facto corporation” and “corporation by estoppel” for years as they apply to corporations.   The de facto corporation provides that a defectively formed corporation—one that fails to meet the technical requirements for forming a corporation—may still receive the protection of a corporation if the incorporators attempted in good faith to form the corporation, signing the necessary documents.

Corporation by estoppel is not a legal status, but an equitable remedy.  The court will hold that when a body assumes to be a corporation and acts under a particular corporate name, and a third party dealing with it under such assumed name believes it Is actually dealing with a corporation, the third party is estopped (prevented) to later deny its corporate existence.

These two concepts typically arise in situations where the court has to assess corporate versus individual liability. The issue of first impression before the Michigan Court of Appeal in Duray Development, LLC v Perrin (decided April 13, 2010) was whether these same legal doctrines apply to limited liability companies, which is a newer type of entity.  The Court of Appeals held that because the Business Corporation Act and the Limited Liability Act relate to the common purpose of forming a business and because both statutes contemplate the moment of existence for each, they should be interpreted in a consistent manner.  Therefore, the Court of Appeals ruled that the de facto corporation doctrine is also applicable to limited liability companies.

The Court of Appeals did not decide whether the doctrine of “corporation by estoppel” also applies to limited liability companies, because the defendant did not raise the issue at the Circuit Court level, so the issue was not properly before the Circuit Court.  However, the Court of Appeals’ reasoning in Duray Development strongly suggests that this legal doctrine will also apply to limited liability companies.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Overview of the Professional Entity

In Michigan, persons in a learned profession requiring a license or other legal authorization to practice, including but not limited to, physicians, dentists, attorneys, and certified public accountants, must incorporate as a professional entity rather than a general business entity.  The choice of professional entity will depend on a variety of factors, including tax considerations.  The most popular professional entity choices are the Professional Limited Liability Company (“PLC” or “PLLC”) and the Professional Services Corporation (“PC”).

Unlike general business entities, there are certain restrictions on Professional Entities.  Both Professional Corporations and Professional Limited Liability Companies are required to operate for the specific purpose of providing one or more professional services.

Generally, all shareholders of the Professional Corporation or members or managers of the Professional Limited Liability must be licensed persons in one or more of the professional services the Professional Entity renders. However, persons in certain professions must comply with additional requirements when structuring their professional entity.  For example, all of the members or shareholders of certain health and legal professional entities must hold the same professional license.

A shareholder or member that wants to transfer or sell his or her shares or membership interests cannot do so except to another licensed person who is eligible to be a member of the PC or PLC.

Another important aspect of the professional entity is that it provides protection to its shareholders and members from personal liability for the PLC or PC’s acts, debts or other obligations.  However, the professional shareholder or member may still be personally liable under common law for his or her negligence or malpractice, or the malpractice of others under the member or shareholder’s direct supervision and control.

This article was written by Natalie C. Najarian, Associate at Demorest Law Firm.

Business Purchasers: Beware of Seller’s Michigan Unemployment Tax Experience Account

If you are purchasing a Michigan business, then you need to be aware of Section 22 of the Michigan Employment Securing Act.  If you are not aware of how Section 22 can affect you transaction, please read the article “SUCCESSION TO MICHIGAN UNEMPLOYMENT TAX EXPERIENCE ACCOUNT OF PURCHASED MICHIGAN BUSINESS” by Steve Dunn.

Click here to download a PDF.

This article was written by Stephen J. Dunn, Of Counsel to Demorest Law Firm.

So You Want to Buy a Bar…

If you’re looking to buy a business, there is a lot to know before you actually make an offer.  This is especially true if you’re looking to buy a business that owns a liquor license, such as a bar or restaurant.

Once you’ve found the bar that you want to buy, the first step is to sign a purchase agreement.  The purchase agreement should cover everything that you and the seller have agreed upon – purchase price, payment method (e.g. cash, promissory note, etc.), timing of various steps, all terms and conditions, default provisions, naming rights, etc.  (See our article on Merger Clauses for the importance of including everything in one document).  The purchase agreement should also provide a date for closing, which will not occur until after the liquor license is transferred.

Note that Michigan law requires that all liquor inventories be purchased in cash.  Therefore, if your purchase includes any type of financing (such as a promissory note or loan), the purchase of liquor inventory must be specifically excluded from the purchase agreement and must be done in cash at closing.

The purchase agreement should also include provisions about the liquor license, including the purchase price and a provision covering what will happen if the liquor license cannot be transferred.  This is because the license itself cannot be transferred just through a purchase agreement.  Rather, the purchaser has to apply to the Michigan Liquor Control Commission (“LCC”) to transfer the license.  The purchaser then must undergo a rigorous application process in order to be approved to buy the license.  This process can take months, so purchasers must be patient!

While the liquor license transfer is pending, you should conduct due diligence on the operations of the bar.  If you plan to keep the bar open continuously before and after the closing, you should plan accordingly for a seamless transition.  Once the liquor license transfer has been approved, you can hold a closing and complete the sale.

This article was written by Melissa L. Demorest, Associate at Demorest Law Firm.

What is a Franchise?

The sales and operation of franchises are heavily regulated under both federal and state law, but do you know what makes the business relationship between two companies a franchise?

There are three criteria that establish whether a contract is a franchise agreement.  All three criteria must be present for there to be a franchise relationship:

1.    The franchisor grants the franchisee the right to engage in a business of offering goods or services under a marketing plan or system prescribed by a franchisor. This requirement is satisfied if the franchisor prescribes in a substantial way how the franchisee must operate its business.  For example, McDonald’s franchisees operate their restaurants in the same way. A Big Mac is the same from one store to the next.

2.    The franchisor grants the franchisee the right to use a trademark, service mark, tradename, logo or other symbol designating the franchisor and its affiliates.  The McDonald’s golden arches are a well-known example.

3.    The franchisee is required to pay a franchise fee, either directly or indirectly.  This is typically an up-front fee and/or monthly royalty payments.  However, it can include “indirect franchise fees” when the franchisee is required to pay other amounts to the franchisor, such as being forced to buy goods in excess of a bona fide wholesale price, being forced to buy products beyond the franchisee’s needs, or being forced to buy tickets to events.

Whether the business relationship between two companies constitutes a franchise often becomes the focus of the parties’ attention when there is a dispute.  There can be serious consequences for a company that is determined to be a franchisor if it failed to comply with the complex federal and state franchise laws.

Before two companies enter into a business relationship, each side should consider whether the relationship constitutes a franchise agreement.  If it is a franchise agreement, then the parties need to consult with an attorney that is familiar with franchise laws.

This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm. Click here to view his professional resume.

Michigan Leads the Way With a New Corporate Form – The L3C

As of January 2009, Michigan is one of the few states to offer a new form of business entity.  If your business is for profit, but its primary focus is to accomplish socially beneficial acts, you may want to organize as a low profit limited liability, or an L3C.

The L3C is structured like any other limited liability company, with all the flexibility and advantages of a normal limited liability company, including being treated as a “pass through” entity for federal tax purposes.  However, the L3C must satisfy certain criteria to prove that its main goal is not to make a profit.

L3C’s are designed to qualify as a recipient of Program-Related Investments, or PRIs.  PRIs are IRS-sanctioned investments made by private foundations to support a charitable project or activity.  As a result of their charitable purpose, PRIs receive special treatment under federal tax law.

Historically, foundations have been reluctant to invest in for-profit businesses through the use of PRIs because of complex and costly IRS requirements to do so.  The L3C removes many of these hurdles and costs.

Hopefully, the L3C will make it easier for foundations to invest in Michigan’s community and economic revitalization.

This article was written by Natalie C. Najarian, Associate at Demorest Law Firm. Click here to view her professional resume.

Leaders tout Entrepreneurship | Detroit Free Press

The Detroit Free Press (Freep.com) has been following all of the developments at the National Summit this week in Detroit and posting the latest to their blog (See excerpt below).  This morning the hot topic was the recent rise in entrepreneurship.

It is essential that new businesses have all of their ducks in a row so that they are protected personally from the debts and liabilities of their new ventures, they take the best advantage of tax laws, and so that they are prepared for future success.

We advise contacting an attorney, as opposed to going it alone.  Demorest Law Firm, PLLC provides these services and can help you start your new company, and then help it to grow.

Excerpt from Freep.com Blog

11:42 a.m. | According to several business and academic leaders at the summit this morning, now is the time to start that business you’ve always dreamed about.

“Entrepreneurism is going to be the key to the economic recovery not just in this country but in the world,” James Turley, CEO of Ernst & Young LLP, declared at a town hall this morning.

Nearly a decade after the dot com bust, becoming your own boss is hip again.

Mary Sue Coleman, president of the University of Michigan, boasted to the audience that 15% or 6,000 of the students recently admitted to the school had started a business during high school.

“We’re in the perfect time in the history of this country to encourage this,” she said. “Let them loose.”

U-M now provides 100 courses that are in some way engaged in entrepreneurism, Coleman said.

What exactly does being entrepreneurial mean?

One panelist, Eva Chen, CEO of Internet security firm Trend Micro Inc., had the perfect Twitter-like response: “Using limited resources to create something that you want.”

By Katherine Yung

via Leader: Ford ready to compete | Freep.com | Detroit Free Press.