Delaware Business Lawyer Blog

I was listening to the radio this morning on the way to work, and a commercial came on for a company that helps small businesses with incorporating. Among other things, they said you don’t need an attorney to incorporate, and that by incorporating, you’ll protect your personal assets. Well, it’s true that you can incorporate without an attorney. But it’s also true that you can try to run across a busy street with your eyes closed. Of course, you may not reach your destination by closing your eyes before stepping into traffic. The same holds true for incorporating without an attorney.

Anybody can incorporate. Fill out a one page form you can download, attached a check, and mail it to the Division of Corporations. Very, very easy. But, if you don’t have an attorney, and all you do is incorporate, you’re actually setting yourself up to be held personally liable for your corporation’s debts. That’s right. Unless you adhere to all of the formalities required by law, your personal assets will NOT be protected.

Think of a bullet proof vest that’s worn to protect a cop. Now think of a corporate veil that protects your personal assets. Well, in the same way a criminal can use armor piercing bullets and injure the cop, the corporate veil can be pierced to get to your personal assets if you incorporate without an attorney and don’t know about all of the formalities you have to deal with.

In a future article, I’ll talk about these formalities. In the meantime, if something sounds too good to be true, it usually is.

Incorporating in Delaware. The process is easy. In fact, the forms you need are available for free on the Division of Corporation's website. So you download the form, send it in with a check, and you're a Delaware corporation. If you've done your research, you'll know that a taxpayer identifcation number is needed. If you haven't done your research, you'll find out soon enough when you try to open a bank account in your corporation's name.

If you intend to do business in another state (besides Delaware), you'll be required to become qualified in that state to do business as a foreign corporation.

But you're not finished. You should also have organizational documents, such as a statement by the incorporator, resolutions by the shareholders, resolutions by the directors, by-laws, stock certficates, a corporate seal and more. If you have partners, you'll also need a buy-sell agreement.

Over the years I've had a number of clients retain my services long after their accountant helped them become incorporated in Delaware. Unfortunately, the accountant did not let them know about these other documents, or that they should get help from a Delaware business attorney. In most cases, it's not too late to work with an attorney and correct the problems.

So if you're in the situation described above, it would be in your best interest to schedule an appointment withh an experienced attorney to review where you are and where you need to be.

As a Delaware lawyer who represents businesses around the country and in Europe, I’m frequently asked whether Delaware is the best state to incorporate in. If you like statistics, 63 percent of the Fortune 500 are incorporated here. In total, there are more than 800,000 companies incorporated in Delaware.

These statistics don’t tell the entire story. There’s an interesting report that was recently published called the 2010 U.S. Chamber of Commerce State Liability Systems Ranking Study. Various factors were considered, including the impartiality, competence and fairness of judges, how tort and contract litigation is treated, timeliness of dismissals, etc.

This comprehensive report ranks Pennsylvania, California and Florida among the worst states. Delaware is ranked #1.

When 2 or more owners of a Delaware limited liability company disagree on the direction their business should take, it makes a world of difference if they have an operating agreement. If the agreement was prepared properly, it contains a method for resolving disputes. If there is no operating agreement, one of the owners might file a lawsuit in the Delaware Court of Chancery seeking the Court’s help in dissolving the LLC.

The standard for judicial dissolution is whether it’s reasonably practicable for the LLC to continue to operate. The Court will dissolve a Delaware LLC management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as a voting deadlock or where the defined purpose of the entity has become impossible to fulfill.

Delaware law doesn’t really specify what a court must consider in evaluating the "reasonably practicable" standard. Nevertheless, the courts which have considered the issue usually look at the following factors:
(1) the members' vote is deadlocked at the Board level;
(2) the operating agreement gives no means of navigating around the deadlock; and
(3) due to the financial condition of the company, there is effectively no business to operate.

It’s very easy to form an LLC in Delaware. The first thing you have to do is decide on your company’s name. Whatever name you choose must contain the words “limited liability company” or the abbreviation “LLC.” You’re allowed to include in the name any of the following words: “Company," "Association," "Club," "Foundation," "Fund," "Institute," "Society," "Union," "Syndicate," "Limited" or "Trust,”or you can use an abbreviation for any of the words.

Once you’ve chosen your name, you have the right to reserve it so that nobody else takes the name before you can get your documents filed with the State. To reserve the name, you need to file an application with the Delaware Secretary of State’s office. Upon receipt of the application, the Secretary of State will check to see if the name is available, and assuming it is, will reserve the name for you for 120 days. You have the right to renew the name reservation for additional periods of 120 days.

When you’re ready, the next step is to file in the Secretary of State’s office a document called “certificate of formation.” The certificate of formation can be a very simple document, and at a minimum it has to state the name of the LLC, the name and address of your LLC’s registered agent and the address of your LLC’s registered office.

The date your LLC is created is the date the certificate of formation is filed in the Secretary of State’s office.

Although the formation of an LLC is rather simple, the next step is to create an operating agreement that governs the conduct of the business, and explains the rights of each of the partners. The operating agreement is extremely important, and should always be prepared by an experienced attorney.

A young man recently formed a Delaware corporation on his own. Instead of consulting with a Delaware business attorney before he filed the necessary papers with the State, all he did to make sure he could use the name he wanted was to check the Delaware Division of Corporations website. He happily discovered that the name he wanted to use was available.

He opened a bank account in his corporation’s name, he ordered letterhead, and he ordered business cards. He got a taxpayer identification number from the IRS, and he got his business license from the Delaware Division of Revenue.

A few months later, he got a letter from a lawyer demanding that he cease and desist using the name because the lawyer’s client, who ran a similar business, had been using the same name for many years.

When he contacted me, this young man was in a state of high anxiety. He didn’t know what he had done wrong, and he was scared. He was worried about all the money and time he had spent just getting his business ready to open for business.

The simple and rather common mistake my client made was in limiting his name availability search to the Division of Corporations website. He didn’t realize that the only obligation of the Division of Corporations was to make sure that a new corporation’s name is distinguishable in their records from the names of other companies who were already registered. On this point, names don't have to be very different to be distinguishable on the Division of Corporations records. For example, the name "Transamerica Airlines, Inc.," is considered distinguishable from the name, "Trans-Americas Airlines, Inc."

In my next article on this topic, I’ll address what my client could have done to make sure the name he wanted for his corporation was in fact available.

For Delaware businesses that are starting out, there are a lot of resources available at your fingertips. Here are several links that you should find helpful.

Delaware Division of Revenue - Services For Business Taxpayers

Delaware Guide For Small Businesses

Delaware's Business Resource

Delaware Economic Development Office

Delaware Small Business Development Center

United States Small Business Administration

Service Corp of Retired Executives (SCORE)

Delaware Division of Corporations

As a Delaware attorney who helps clients form corporations, one of my first questions when someone says they want to incorporate is “why?” And the answer that’s most frequently given is “I want to protect myself from personal liability.” That’s a legitimate reason, but we’ll come back to this in just a moment.

It’s incredibly simple to form a corporation in the State of Delaware. Download a 1-page form from the Division of Corporations, fill it out, and send it in along with your check That’s all it takes. But it’s also simple to walk across the street with your eyes closed. All you have to do is step off the curb and start walking. The problem with walking with your eyes closed is that you might not get to the other side. And the problem with incorporating without a Delaware attorney is that you might not protect yourself from personal liability.

Corporations are required to follow certain formalities. Here in Delaware, our law provides a lot of flexibility to make these formalities as easy as possible. But, if you don’t have bylaws, you never hold corporate meetings, you have no corporate minutes, you pay personal debts out of your corporate checking account, and you do other things that unfairly shield your company’s assets from its creditors, you run the risk of being held personally responsible for your corporation’s debts.

There’s no specific formula that the court in Delaware applies in these types of cases. However, if the court finds that in the interests of justice, your failure to follow corporate formalities requires that you be held personally liable, the court will do so by piercing the corporate veil.

Creating a Delaware corporation is easy, but without proper advice and a push in the right direction, you’re taking a big risk if you try doing this without a Delaware attorney’s help.

Most clients who walk into a lawyer’s office to start a business assume that if they become incorporated or form a limited liability company, they’ll be protected from personal liability. That’s not entirely correct. Let’s look at the following example.

You’ve decided to start a small limousine service. You’ll be one of the drivers, and you plan to hire two other drivers who will be employed by your corporation. If one of your drivers is negligent and crashes into another car, he will be personally liable for the harm he causes. In addition, your corporation will also be held legally responsible for the injuries because an employer is responsible for the negligence of an employee if he was acting within the scope of his employment at the time of the accident. That’s because of a well recognized doctrine called “respondeat superior,” or “vicarious liability.” The good news is that as the owner of the company, you yourself will have no personal liability for the injuries caused by the employee.

Now let’s take the same example, but now you’re the driver of the limo that gets into an accident and causes injuries. In this situation, you will be held personally liable. Why? It’s because a person is always legally responsible for any injuries that are caused by his negligence. Just like the employee who was driving in the first scenario, this time you were the driver, you were negligent, and your negligence resulted in someone getting hurt. In the first scenario, you escaped liability because (1) you weren’t negligent, and (2) you weren’t the driver’s employer (the corporation was the employer).

I can’t tell you how many times I’ve been asked to represent a client who finds himself in a messy dispute because his business partner who he thought would always be there voluntarily or involuntarily leaves. A voluntary departure occurs when a partner no longer wants to be involved in the company. An involuntary departure includes death or disability. The partner who’s leaving (or his spouse in the event of death) believes his ownership interest in the company is worth a lot more than my client thinks it’s worth, and my client is being threatened with a lawsuit to determine the price. Even worse is where the spouse of the deceased partner announces that she inherited her husband’s ownership interest, and now wants to be actively involved in the day to day operations and management of the company.

The first thing I ask my client to do is to bring in the corporate documents so I can review them. What I’m looking for is a buy-sell agreement that my client and his partner hopefully entered into when they formed their business relationship. There are many kinds of buy-sell agreements, but they almost always contain a procedure that the partners agreed to follow if one of them eventually leaves. By creating a buy-sell agreement, the partners chose to control their company’s destiny by reaching an agreement on these issues while they were getting along and treating each other fairly. Thus, instead of allowing a judge to decide what will happen, the buy-sell agreement provides the answers to the questions that arise, such as:

1. How is the value of the departing partner’s share of the business determined?
2. Does the owner who stays have to come up with the cash needed to buy out his partner's share
3. Can the departing partner sell his share to a stranger?
4. Does the company have to go out of business?
5. Can the deceased partner’s wife show up at work and act as an equal partner?