The vast majority of small business LLCs and corporations in California may lack legal standing due to being improperly formed.
To be properly formed under California law:
- LLCs must file articles of organization with the Secretary of State. These articles must be formally adopted by its members along with a signed operating agreement during its initial organizational meeting and recorded in the first minutes and retained in the LLC legal book. This includes LLCs that elect to be taxed as corporations.
- Corporations must file articles of incorporation with the Secretary of State. These articles must be formally adopted by its directors along with a signed set of bylaws during its initial organizational meeting and recorded in the first minutes and retained in the corporate legal book.
Without legal standing:
- Your LLC or corporation could be barred from defending itself in court or from bringing suit for damages against another.
- Your company’s contracts could be deemed invalid by the courts, thus allowing others to get out of their obligation to your company.
- Your home and personal assets could be subject to liability from business judgments or creditors.
- Legal disputes could be costly due to the difficulty in determining liability for failing to follow protocol outlined in the documents, when they don’t exist.
- S corporation owners could pay more in taxes and lose tax-free fringe benefits if the IRS were to re-characterize the company to a sole proprietor or partnership.
On-going compliance is essential to retain legal standing
Even LLCs and corporations that were properly formed can lose their legal standing if State formalities and on-going compliance isn’t maintained. Contracts and agreements should be drafted in the company’s name and signed by an authorized representative. Minutes showing management decisions and other official records should be kept in the corporate or LLC books.
Caution for single member LLCs: In most states and courts, a single member LLC is not protected against the creditors of the member, but there are three ways to fix that:
- The single member should approve an operating agreement and create sufficient legal documentation to prove separation between the member and the company by following corporate law.
- The single member could convert to a multi-member LLC by issuing a small ownership interest (e.g. 2%) to a key employee, contractor, friend or relative; or,
- The single member LLC could formally elect to be taxed as a corporation.
(See our article: “Alter Ego Blunders—Piercing the Corporate Veil” for a discussion on additional ways business owners can lose their asset protections.