Michigan Business Lawyer Blog

One of the main reasons people form Michigan corporations and limited liability companies (LLCs) is to protect themselves against personal liability for the obligations of their businesses. Under Michigan law, the risk of an owner of either a corporation or LLC is limited to their investment in the business. See Michigan Compiled Laws 450.1317 (for corporate rules) and Michigan Compiled Laws 450.4501 (for LLC rules). This is in total contrast to the rules for partnerships, which is one reason why no one in their right mind should be conducting business in Michigan as a partnership.

As with all rules, the rules of limited personal liability for owners of Michgian corporations and LLCs have exceptions.

First, an owner of these entities remains personally liable for their own personal negligence. This is true even if they are acting on behalf of their business entity. Thus, depending on the type of business one is conducting, a corporation or LLC may not provide very much protection from personal liability as a practical matter.

Second, an owner of a corporation or LLC is liable for any debts or obligations that they personally guarantee. Unfortunately, owners of small businesses are often required to personally guarantee the business's obligations as a condition of getting bank credit, desirable leases, supplier contracts, etc. This is a reality of life that further chips away at the limited liability protection that Michigan law provides to those who conduct their businesses through corporations or LLCs.

Third, there are certain situations that can result in the protective limited liability veil of a corporation or LLC being "pierced" so that the owner has personal liability for entity debts or obligations. These circumstances include (1) failing to follow the required formalities in company administration; (2) undercapitalizing the company; (3) using the business to achieve fraud; (4) failing to properly document transactions between the company and its owner(s); and failing to keep separate financial records for the company and its owner(s).

It is important that people conducting business through a Michigan corporation or LLC consult with a knowledgeable Michigan business lawyer to ensure they are following all of the requirements for obtaining and maintaining the limited liability protections these entities offer their owners.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Limited Liability Companies

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One advantage Michigan C corporations have over S corporations is the ability to reinvest profits in the corporation at a lower tax cost than S corporations. This is because the current lowest corporate income tax bracket is 15% for profits up to $50,000. The individual income tax bracket of a company's owner is often higher than 15%. So if that owner wanted to reinvest S corporation profits back into the S corporation, he or she could do so only after paying personal income tax on those profits at their personal income tax rate (because of the "flow through" tax treatment of S corporations). Since a C corporation is not a "flow through" tax entity, any profits not distributed to the shareholders (such as those reinvested back into the corporation) are taxed at the corporate level only.

So, let's say a start-up corporation decides to operate as a C corporation to take advantage of the lower tax cost of reinvesting profits back into the company. At some point, the company may exhaust its desire for reinvesting its profits, and decide that it wants to start distributing its profits to its shareholders. At this point, double taxation becomes an issue because in a C corporation, profits will first be taxed at the corporation level when they are booked, then again at the shareholder level when they are distributed to the shareholders.

The answer may be to convert the C corporation to an S corporation so that profits will only be taxed one time. The mechanics of switching from a C corporation to an S corporation are simple enough. Becoming an S corporation is simply a tax election that is made by filing the appropriate paperwork with the IRS. A corporation's shareholders can make this election any time during the corporation's existence. If the shareholders elect S corporation status, all future earnings will be taxed at their individual income tax rates, without being taxed at the corporate level.

But, corporations contemplating this move must be very careful. This is because any of the corporation's earnings before the S election will forever be marked and given special tax treatment under rules governing S corporations. If those earnings are ever distributed to the corporation's shareholders, they will be taxed as dividends and, even worse, will be subject to the double tax regime imposed on C corporations.

Corporations or stockholders who are contemplating changing their C corporation to an S corporation should consult with a Michigan business lawyer who can help them work through the possible tax pitfalls of making this move.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Formations , Corporations , Entity Selection , Tax Issues

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Under Michigan law, a contract for the sale of goods over $1000 must be in writing to be enforceable. The Michigan law covering this topic is known as the statute of frauds section of Michigan's Uniform Commercial Code (UCC). The specific requirements are:

1. Some sort of writing indicating that a sales contract has been made. Fortunately, this writing does not have to contain every term of the parties' agreement. It is enough if the writing provides a basis for believing that any oral evidence that might be offered to prove the contract rests on a real transaction.

2. The writing must be signed by the party (or its authorized agent) against whom the contract is being asserted.

3. The agreement is enforceable only up to the specific quantity of goods actually contained in the written agreement.

There are a number of special circumstances in which a contract may be enforceable even if it doesn't satisfy the requirements of Michigan's Uniform Commercial Code. These circumstances may include those where (1) goods are specially manufactured for the buyer; (2) the party against whom enforcement is sought admits that the agreement is valid; (3) the disputed goods were delivered and accepted or payment was received and accepted.

Whether buying or selling, it is very important for Michigan businesses to involve a good Michigan business lawyer in any important sales contract to make sure it is enforceable and provides those businesses with the benefit of their bargain.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Contracts

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We've all heard the horror stories about businesses entrusting sensitive and private company information to employees, only to have those employees leave the company and use its sacred data to compete against the very company who provided it to them. This type of event can have a devastating effect on small businesses. It is important for any business that wants to keep its competitive advantage to take the appropriate steps to protect its proprietary information and trade secrets from departing employees.

Protecting a business's information when an employee leaves doesn't start when that employee leaves. Rather, it starts when the employee first hires in by requiring them to sign a non-compete agreement. Requiring employees to sign a non-compete agreement when the employee joins the company can provide a high level of protection by limiting that employee's ability to make competitive use of the company's important information after they leave the company.

But, it is important to have a competent Michigan business lawyer prepare the non-compete agreement so that it complies with Michigan law and provides the expected level of protection. Agreements that overreach in breadth and scope may be enforced on a limited basis or may be invalidated entirely.

Michigan non-compete agreements are subject to the Michigan Antitrust Reform Act and state and federal case law interpreting that statute. Under this law, in order to be enforceable, non-compete agreements must (1) be designed to protect an employer's reasonable competitive business interests; (2) have a reasonable duration; (3) have a reasonable geographic scope; and (4) prohibit competition only in a clearly defined line of business.

Properly prepared and implemented non-compete agreements can provide the basis for obtaining an injunction prohibiting an ex-employee from using a business's information against it. This remedy provides a business with a powerful remedy to protect its competitive business interests against dishonest ex-employees who would otherwise seek to unfairly compete with their former employers.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Employment Law , Non-Compete Agreements

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In its "first ever high court performance survey", the prominent Michigan legal journal Michigan Lawyers Weekly has released the results of its survey of lawyers who practice before the Michigan Supreme Court regarding the quality of the justices who sit on the state's highest court.

The legal journal conducted its survey between Nov. 28 and Dec. 17, 2007. It contacted every lawyer who appeared before the court during any one of its last six terms and asked them to rate the justices. The journal contacted 774 lawyers, of which 79 took part in the survey.

The survey asked the lawyers to rate the justices on a 1 to 5 scale based on their "overall" performance, how they compare to other justices, as well as on eight defined "judicial characteristics." On the scale, a rating of 5 was "excellent," and 1 was "poor".

Once considered one of the country's top supreme courts, thanks in large part to the contributions of Justice Thomas Cooley, the Michigan Supreme Court has in recent years been criticized by some as being an an overly enthusiastic participant in "tort reform". These critics claim that the court has been intellectually inconsistent in its opinions, with a bent toward favoring insurance companies and large corporations to the detriment of Michigan's consumers and working class.

No matter how you feel about the Michigan Supreme Court, or the justices serving on it, the survey published by Michigan Lawyers Weekly is a very interesting piece of reading that anyone interested in Michigan's legal landscape should review.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: General Topics

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Most business people in Michigan these days can be heard grousing about the sorry state of Michigan's government. While I agree with most of these complaints, there is one thing that the state government in Michigan has done a fantastic job on. It's the Department of Labor and Economic Growth's web page for its Bureau of Commercial Services.

This web page contains a vast repository of information and tools useful to Michigan businesses and their counselors. It contains everything from business and licensing services, to useful forms and publications and a nifty calendar of events. To me, one of the most useful features of this site is the business entity search, which allows users to look up businesses registered with the State of Michigan, and even look at electronic copies of documents filed with the state such as articles incorporation and the like.

It would be well worth it for every business person in Michigan to take a few minutes to explore what this site has to offer. It is one thing our state government has done a great job at, and it is a terrific example of how a state government can leverage technology to provide exceptional services to its constituents.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: General Topics

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My last post may have given the impression that everyone should be rushing out to structure their business as a C corporation. So, in this post, I thought I would follow up with some cautionary information regarding some of the negative tax aspects of running a business as a C corporation.

These negatives include the following:

1. Double taxation. C corporations are taxed on corporate income and then shareholders are also taxed on distributions the corporation makes to them. But, a well-advised smaller C corporation should never have to pay corporate income tax because there are legal techniques to reduce its corporate level income tax to zero by paying appropriate salaries, bonuses, and fringe benefits.

2. C corporations are subject to the personal holding company tax. Basically, this is a penalty tax that the IRS imposes on corporations the IRS regards as an incorporated investment account. Active businesses shouldn't have to worry about this tax, as it targets corporations with 60% or more of their income coming from investments (i.e., dividends and royalties).

3. C corporations must deal with an accumulated earnings tax. This cuts into the C corporation's advantage over other entities to accumulate its profits to fund growth. The IRS imposes this 15% tax on C corporations that accumulate earnings in excess of $250,000.

4. C corporations are subject to the corporate alternative minimum tax. C corporations can be hit with this tax if they take advantage of certain out of the ordinary tax preference items such as income from life insurance or by postponing tax obligations by using the installment method of tax reporting.

Luckily, these four tax disadvantages are unlikely to pose much of an issue to smaller C corporations. So, companies that have net annual income over $100,000 should check with a qualified business lawyer or tax adviser to see if operating as a C corporation might be right for them.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations

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Usually the most important factors that go into a business owner's decision to incorporate have nothing to do with tax issues. Rather, most business people incorporate because they want to shield personal assets from trade creditors and litigation. (Corporate stockholders, unlike sole proprietors, are not personally liable for business obligations.)

However, once the decision to incorporate is made, the next decision that must be made is whether to set up the corporation as a C corporation or an S corporation. The "C" and "S" refer to subchapters in the IRS code that govern each corporation. There are big differences in tax treatment of C corporations and S corporations.

S corporations are pass-through entities. In other words, there is no corporate income tax on an S corporation. Instead, the profits flow through to the shareholders who are taxed at their personal income tax rates on corporate profits. In addition, S corporations allow active shareholders tax advantages such as sharing in operating losses, which are common in business start-ups.

But, while S corporations are terrific for many small businesses, they are not for everyone. There are a number of possible operational and tax disadvantages to S corporations. Potential operational disadvantages include limits on the number of shareholders, limits on the types of shareholders, and the requirement of having only one class of stock. Possible tax disadvantages include immediate taxation of earnings (the downside of pass-through entities) and limited employee fringe benefits.

Depending on a business's operations and structure, a C corporation may be a better choice than an S corporation. Generally speaking, most of the "heavy hitters" out in the business world are C corporations. The reason is that C corporations allow for the widest variety of tax-advantaged fringe benefits. There is usually more flexibility in the capital structure of a C corporation, which can also be an advantage over an S corporation. Some of the tax advantages of C corporations include the ability to retain earnings for future growth, income splitting possibilities, increased options for fringe benefits, enhanced ability to claim operating losses (on the corporate level only), tax breaks on dividends received from other companies, and the ability to claim charitable deductions, which other business entities can't. Typically, once a company's annual net income exceeds $100,000, it should seriously consider becoming a C corporation if it isn't already.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations

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At some point, virtually every business will need to borrow money to finance its operations or expansions. Financing can be used to fund working capital or other financial needs such as funding inventory, equipment, buildings, plants, and general business growth. Businesses obtain loans from a number of different sources that range from the traditional (banks) to the more exotic (finance and factoring companies).

There are many different kinds of loans; one size definitely does not fit all. Therefore, it is imperative that a business seeking a commercial loan gets the kind of loan that it needs, and that works well for that particular business. Loan options include lines of credit, term loans, real estate loans, equipment leasing, factoring, and industrial revenue bond financing.

Any Michigan business that is getting a commercial loan should seek the advice of a competent Michigan business lawyer (with real estate financing experience) to help them in the process. A commercial borrower's lawyer has four main responsibilities to his or her client. First, a borrower's lawyer will help ensure the borrower understands the loan itself and is actually getting the loan the borrower thought it was getting. Second, the borrower's lawyer will review the loan documentation and try to get the appropriate changes made to protect the borrower in the areas that are important to the borrower. Third, the borrower's lawyer will review the loan's terms and conditions so the borrower fully understands its rights and responsibilities under the loan. Fourth, the borrower's lawyer will attend the loan closing and help facilitate a smooth cap to the loan transaction.

It is best for a business to involve its attorney as early in the loan process as possible. Ideally, a business will be in communication with its lawyer before the loan commitment letter is signed. This will help make it possible for its lawyer to fully assist and protect the borrower in the loan negotiation process.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Business Financing , Financing , General Topics

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Most Michigan businesses start off with much optimism and good will among the owners. Everyone is on the same page and shares a vision for making the business a wild success. However, as with many things, once the honeymoon phase of the venture ends, the owners may wind up not having as much in common as they thought. In fact, business owners often wind up strongly disagreeing with each other regarding a number of business issues ranging from basic operations to critical strategic planning matters.

Often, minority shareholders (i.e., those holding less than 51% of the corporation) fail to insist on having the corporate formation documents contain an adequate level of protection for them should differences arise with the majority shareholders regarding how the corporation should be managed. Often, the shareholder with the most shares ultimately winds up with control of the corporation and successfully squeezes out minority shareholders. Squeeze outs can take many forms, such as being locked out from the corporation's premises, employment termination, expulsion from board positions, discontinuation of dividends, and partial or complete denial of access to corporate information.

Michigan law provides remedies to minority shareholders who are being squeezed out of their companies, or who are being subjected to some kind of unfair oppression by majority shareholders. Shareholders who believe they are being treated unfairly may bring what is known as a Section 489 action in their local county circuit court. A Section 489 action is based on the Michigan statute found at Michigan Compiled Laws (MCL) 450.1489.

Under this statute, minority shareholders have remedies for "willfully unfair and oppressive" conduct. Potential defendants in a Section 489 action may be not only corporate directors, but also ‘‘those in control of the corporation". Those in control of the corporation are usually, but not necessarily, the majority shareholders.

Relief available under Section 489 includes injunctive relief, forced purchase of the minority shareholder's stock at fair value, liquidation and dissolution of the company, and monetary damages. Section 489 has been the subject of much litigation and occasional legislative action. Those who believe they are the victims of minority shareholder oppression should carefully choose a Michigan business litigation attorney to assist them with resolving their matter.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , General Topics , Litigation

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A typical Michigan business owner has invested a tremendous amount of time and energy into building up his or her business. But, many neglect one of the most important things they can do to protect their business and their families: succession planning.

Although it can be daunting to undertake business succession planning, it is truly critical for business owners to face this issue head on. One of the worst things a business owner can do is to wait to tackle business succession planning until circumstances force the owner or his or her family to consider the future of the business. This is because by then it might very well be too late to prepare and implement the desired or appropriate succession plan. Even in the best of circumstances it can sometimes take between three to five years to put a comprehensive business succession plan into place.

Many business owners think that succession planning is concerned only with naming a successor. But, there are a number of other issues that are addressed in a comprehensive succession plan. A good plan should address such issues as how the business owner plans to reduce his or her role, how the business owner communicates his or her departure to employees, and what will happen to the employees' benefits.

It is important to remember that business succession planning is a process, not a one time event. It is also important to use the appropriate professionals to assist in the process, such as knowledgeable business lawyers, accountants, financial planners, and even investment bankers in certain situations.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , General Topics , Limited Liability Companies

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While limited liability companies (LLC's) are the right choice of entity for many Michigan businesses, in some situations, using a corporation instead of an LLC may be the better choice. This post discusses some of the specific advantages for a Michigan business to use a corporation instead of an LLC to conduct its affairs.

1. Unlike LLC's, corporate profits are not subject to Social Security and Medicare taxes

As with sole proprietorships or a partnership, profits and salaries of an LLC are subject to self-employment taxes. Self-employment taxes are Social Security and Medicare taxes. The rate of these taxes are currently equal to a combined 15.3% rate. Unlike LLC's, with a corporation, business owners will have to pay Social Security and Medicare taxes only on salaries, not profits. This may provide for greater planning opportunities for entrepreneurs to legally avoid paying higher Social Security and Medicare taxes.

2. Corporations enjoy greater respect and acceptance

LLC's are still a relatively new business entity form. As such, not everyone (including some accountants) is as familiar with them as they are with corporations. In some cases, banks, financing companies, and certain kinds of vendors may be hesitant to extend credit to LLC's. Also, a number of states, including Michigan, restrict the type of business an LLC may conduct.

3. Corporations are able to offer a greater variety of fringe benefits at a lower tax cost

One of the biggest advantages corporations have over other business entities, including LLC's, is in the area of fringe benefits. Thanks to the tax code, corporations can offer a better variety of fringe benefits than other business entities. A number of retirement, employee stock purchase, and stock option plans are available only for use only by corporations. In addition, sole proprietors, partners and employees owning more than 2% of an S corporation are required to pay taxes on fringe benefits such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking. Stockholder-employees of a C corporation are not required to pay taxes on these kinds of benefits.

4. Corporations can lower taxes through a process called income shifting

One of the drawbacks of the corporate form is that C corporations (the type of corporation that has the most options for fringe benefits) are subject to double taxation. In other words, the corporation is taxed on its profits, and then the stockholders are taxed on any distributions the corporation makes to them. Despite this double taxation issue, in some situations corporations can offer greater flexibility for tax planning than LLC's. For example, a closely held C corporation with competent legal and accounting advisers rarely pays tax on its profits due to a number of techniques. Moreover, a C corporation can employ a very useful technique called income shifting to take advantage of lower income tax brackets and shift income from high tax brackets to lower tax brackets.

Choosing the right entity for a business is a serious decision that should only be made in consultation with a trusted business attorney. The stakes are high and the wrong decision can cost a business dearly.

Posted by Michael J. Hamblin | Permalink | Email This Post

Posted In: Corporations , Limited Liability Companies

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