PATRICK MONROE LAW

Effective January 1, 2012, there are two new subtypes of stock corporations in California – a “flexible purpose corporation” and a “benefit corporation” (also known as a “B corporation”). These new subtypes enable entrepreneurs to form hybrid corporations, operating with both economic and social objectives. California is the sixth state to acknowledge entities that pursue profit as well as aim to create a positive impact on society. 

The new stock corporation subtypes differ from (a) traditional, for-profit corporations that are organized to pursue profit and (b) nonprofit corporations that must be used solely to promote social benefits. Traditionally, directors and officers who pursued activity outside of the scope of the purpose of a corporation could be held liable to shareholders. These new entities give directors and officers the flexibility to pursue both profit and social objectives without the risk of liable associated with doing so in a traditional corporation. 

Although these new subtypes provide greater flexibility to those who run them, they are new to California and have little or no legal precedent to support them. The only precedent that exists is that of other states, which California is not required to follow. This should be considered when deciding whether or not to form a flexible purpose corporation or a benefit corporation. 

For more information on these new types of California corporations and to determine if they may be right for you, contact a corporate law attorney.

As an attorney licensed in both California and Nevada, I am often asked which state is better to incorporate in. Clients often hear of advantages to incorporating in Nevada. The Nevada Secretary of State boasts many such advantages, including no corporate income tax, no franchise tax, no personal income tax, Nevada’s laws and courts are better suited for business. These advantages are all legitimate if you plan to conduct business in Nevada. But what if you are conducting business in California? 

Under California law, an out-of-state corporation, often referred to as a foreign entity, must register to do business in California if it is engaged in “intrastate” business in California.  A business is engaged in intrastate business in California if it engages in repeated and successive transactions in California. This means that a California business that transacts business in California, but incorporates in Nevada must still comply with California law. In doing so, a Nevada corporation that is doing business in California must pay the minimum California franchise tax of $800 per year, and pay California income tax on their California income.  In addition, the corporation will have additional compliance costs. 

A Nevada corporation must file annual reports in Nevada and maintain an agent for service of process in Nevada, which is usually done by paying a fee to a commercial service to act as the agent in that state.  A Nevada corporation that is registered to do business in California must file annual statements of information in California and file tax returns and pay taxes in California. 

The next question that I get asked is, “why do I have to register the corporation in California?” Failing to register with the California Secretary of State can have serious consequences.  Foreign corporations and their agents that conduct unauthorized business in California are subject to penalties and fines.  Such corporations are not allowed to file claims in California state courts.  Also, contracts entered into by such corporations are voidable at the option of the other party, thereby making the contract unenforceable. 

Before setting up any entity, it is important to consider all of the factors and determine the actual benefits of incorporating in one state versus another. Generally, a California business that operates in California will probably not benefit from incorporating in Nevada.

Corporate governance is the set of processes, customs, policies, laws,
and institutions affecting the way a corporation is directed, administered or
controlled. An important aspect of corporate governance is defining the nature
and extent of accountability. Mechanisms are designed in the corporate
governance structure to reduce the risk of legal liability among these
individuals. In other words, the strength of a corporation’s ability to protect
its directors, officers and shareholders is directly related to its ability to
properly govern itself. 

Corporate governance also affects the relationships between the stakeholders.
In a typical business corporation, the main external stakeholder groups are
shareholders, debt holders, suppliers, customers and communities affected by
the corporation’s activities. Internal stakeholders are the Board of Directors,
executive officers, and other employees. All of these stakeholders have an
interest in the corporation being governed ethically and legally. If and when a
corporation fails to govern itself according to acceptable ethical and legal
standards, those in control subject themselves to serious legal liability.  

There has been renewed interest in the corporate governance practices
of corporations in the past decade. The high-profile collapses of a number of
large corporations, most of which involved accounting fraud, include Enron
Corporation, and MCI Inc. (formerly WorldCom). Most recently, News Corporation
has come under fire for their corporate ethical violations.  

Corporate governance is necessity for both large public corporations,
as well as small private corporations. In fact, small corporations often fail
to implement and follow proper corporate governance procedures due to a lack of
awareness, experience and legal counsel. Such failure may range from something
as simple as not filing the proper statement of information with the Secretary
of State to something more serious such as commingling corporate and personal
assets and expenses.  

Any one action that constitutes improper corporate governance, or a
combination of actions, could result in the corporation’s failure to protect
the individuals who own and operate it. Corporate governance is an ongoing
obligation that, if done properly, will maintain the legal protection that
corporations are meant to provide for their stakeholders.

Generally, corporate bylaws describe the manner in which a corporation must be governed. Under California Corporations Code Section 212, a corporation’s bylaws must set forth, among other things, the number of directors of the corporation and any circumstances that could lead to an increase or reduction in the number of directors. This law not only applies to corporations with multiple shareholders, but also to corporations with a single shareholder.

In addition, the bylaws may contain any provision, not in conflict with law or the articles of incorporation, for the management of the business and for the conduct of the affairs of the corporation, including but not limited to:

• Time, place and manner of calling, conducting and giving notice of shareholders’, directors’ and committee meetings 
• Qualifications, duties and compensation of directors
• Appointment and authority of committees of the Board
• Creation of annual reports and financial statements to the shareholders.

Bylaws may be adopted, amended, or repealed using specific procedures set forth in state statutes and the bylaws themselves.  A copy of the bylaws must be kept at the principal executive office of the corporation, and must be made available for shareholder inspection at all reasonable times. The bylaws are a contract between shareholders and the corporation and among shareholders themselves.

Bylaws should not be confused with what are commonly referred to as “buy-sell agreements.”  Buy-sell agreements typically only govern the distribution, sale or transfer of shares in the corporation. The topic of buy-sell agreements will be covered in a future blog post.

A corporation that does not have bylaws could be considered an invalid business entity, thereby exposing the owners to individual liability for acts of the alleged corporation. If a corporation does not have bylaws and other necessary documentation such as meeting minutes and statements of information, it is advisable that such documents be prepared and properly filed in order to maintain the protections that corporations afford their shareholders.

Periodically, owners of corporations, LLCs and the agents who are designated to receive service of process on behalf of these entities receive official looking letters that direct corporations to pay money and disclose information to a private company. The company will claim that it derives its authority from the California Corporations Code. The private company will often have an official-sounding name like “Business Filings Division.”

These solicitations are not from the California Secretary of State and are not being made by or on behalf of any governmental entity. Although a business entity can use an intermediary to submit filings and fees to the California Secretary of State’s office, no business is required to go through another company in order to file its documents.

In addition, these private companies may also be fronts for committing fraud, since many of the statements made, and forms offered, by them are inaccurate and do not meet the requirements of the California Corporations Code. A corporation that falls prey to these companies will have paid money for a service that is not needed or is never rendered. In addition, the corporation will have disclosed valuable information that could be used to commit identity fraud on the corporation, its directors and officers.

Forms that meet the minimum content requirements of the California Corporations Code and instructions for these filings are available through the California Secretary of State’s website at www.sos.ca.gov/business/be/forms.htm#corp. Most required forms and filings can be obtained on this website and have very small fees, usually under $100.

If you receive a suspicious letter that claims your business is required to pay money and disclose information, you should cross reference it with the California Secretary of State requirements, your own records and seek out legal counsel before deciding whether or not to respond.

Every California stock corporation must file a Statement of Information with the California Secretary of State within 90 days after filing the initial Articles of Incorporation. The Statement of Information must also be filed annually thereafter.

A corporation is required to file a Statement of Information even though it may not be actively engaged in business during the applicable filing period. Statutory filing provisions are found in California Corporations Code section 1502. Failure to file the Statement of Information by the due date will result in the assessment of a $250 penalty (California Corporations Code Section 2204; California Revenue and Taxation Code section 19141).

The Statement of Information must be accompanied by a $20 filing fee and $5 disclosure fee. Changes to information contained in a previously filed statement can be made by completing and filing a new Statement of Information. If this statement is being filed before the next annual filing is due then there is no fee.

A Statement of Information filed with the California Secretary of State becomes part of the public record and is available for viewing by the public for a small fee.  It is important for filers to understand the implications of the information contained in the statement.

The Statement of Information must contain the names and addresses of the officers and directors of the corporation. Such information can be used to identify who has the authority to act on behalf of the corporation and thus who is responsible for any action taken. This has obvious legal implications for those individuals named in the Statement of Information. To learn more about the requirements and implications of filing a Statement of Information, you should visit the California Secretary of State’s website or contact an experience corporate lawyer.

A common question I get from small business owners is, “Should I incorporate?” I usually answer the question with a few questions of my own about the business to get an idea about which corporate structure will be most beneficial to the owner.

In California there are several choices to consider when “incorporating” a business:
•   C Corporation
•   S Corporation
•   Professional Corporation
•   Limited Liability Company (LLC)
•   Limited Partnership (LP)
•   Limited Liability Partnership (LLP)

Choosing the proper business entity can benefit you in several ways, but the most significant are by limiting legal liability and by limiting tax liability.

Limiting Your Legal Liability

If you are doing business as a sole proprietor or general partnership, your personal assets are vulnerable in any business litigation. Owners of corporations enjoy limited liability protection and are, in general, not personally responsible for business debts and liabilities. This corporate protection means creditors cannot pursue your personal assets (house, car, savings) when a financial dispute arises.

Limiting Your Tax Liability

There are tax benefits to incorporating. If you decide to form a C Corporation, it is a separate taxable entity that pays taxes at the corporate level. You can shift your income to take advantage of lower tax rates. For example, if your corporation makes $100,000 in profit you can keep $60,000 in the corporation and pay yourself a $40,000 salary. By doing this, you limit your individual tax rate to $40,000 of income. The benefit to the corporation is that the $60,000 profit is only taxed at a 15% corporate rate.

If you decide to use an S Corporation you can significantly limit your self-employment tax, which is currently 15.3% of the first $106,800 of income. With a corporation, only salaries, not profits, are subject to self-employment taxes. After paying yourself a reasonable salary and paying self-employment tax on that salary, the remaining profits of the S Corporation can pass through to you free from self-employment tax. This can often save a self-employed owner of an S Corporation thousands of dollars in self-employment tax.

There is no “best” entity. Each business and business owner is subject to different laws and will have different legal and tax planning needs. A business owner should seek the advice of an experienced corporate attorney to determine which entity, if any, best suits his or her needs.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, I inform you that any U.S. federal tax advice contained in this communication is not intended or written, and cannot be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein.

A fictitious business name is any name other than the name of an individual person or a business entity (corporation, LLC, LLP, etc.) under which a business operates.

Businesses are required to register fictitious business names with the clerk of the county in which they are based. The purpose is to give notice to the public of who is legally responsible for the name and the actions of the business operating under it. Since fictitious business names have no legal relevance, someone or some entity must be held accountable. Failure to register the fictitious business name can lead to penalties and even worse, legal liability that may be attributable to the individual who is perceived to own the fictitious business name regardless of who actually owns it.

You do not have to register a fictitious business name if (1) you use the exact name of your business entity as registered with the California Secretary of State, such as “Name, Inc.” or “Name, LLC”) or (2) you use your first and last name and a description that leaves no question as to what your business is, such as “Patrick E. Monroe, Attorney at Law.” 

The next issue is who or what entity should own the fictitious business name. If you operate your business as a sole proprietor, then you as an individual are the owner of the fictitious business name. If you operate your business using a business entity, then the entity owns the fictitious business name. This is an important distinction since designating yourself as the owner of the fictitious business name will effectively negate the protections gained by the use of a business entity.