Business Entities
Essential Legal Topics Every Business Owner Must Know
A most fundamental issue is the structure of your business – what gives it form. There are four principal structures: sole proprietorships, partnerships, limited liability companies (LLCs), and corporations.
Sole proprietorship
Let’s start with the simplest – a sole proprietorship, where one person owns the business. This is the most common form of business structure in the U.S. After incorporating, thousands of new businesses still operate as sole proprietorships. It’s easy to see how someone who opens a business bank account on their own, is the sole employee, keeps all the profits, and pays all the taxes can be confused about how to characterize their business. With a sole proprietorship, the owner personally owns all assets and pays all taxes on the entity’s income. If assets owned by the entity are used to pay debts or satisfy judgments, creditors can also reach the sole proprietor’s personal assets. Recently we were hired to clean up a problem involving hundreds of thousands of dollars owed to a sole proprietor. LLCs and corporations would have limited the owner’s risk. Sole proprietorships make sense for small businesses, including freelancers and other businesses operated by one individual. But unless they’re converted to an LLC or incorporated, they expose their owners to unlimited conduct liability.
Partnership
A partnership is similar to a sole proprietorship. But instead of one owner, a partnership has two or more owners. Partnerships generally have no liability shield. Each partner can be personally liable for all business debts and conduct liabilities . An LLC takes much of the liability of an individual’s personal assets away while at the same time providing management flexibility and minimizing the tax burden. A corporation, on the other hand, provides the strongest liability shield but is more strictly regulated by the D.C. government. Corporations are good for large businesses with substantial assets and complex operations.
Limited liability company (LLC)
An LLC is like a corporation for legal liability purposes, but there are few legal formalities. An LLC is formed by filing certificate paperwork with the D.C. government and a simple operating agreement signed by the members (a.k.a. owners). The members provide capital to the LLC. The LLC issues membership interests (units of stock) to the members. Members may manage the LLC or delegate management to others. The limited liability shield protects the members’ personal assets from the LLC’s conduct liabilities. But unlike a corporation, an LLC is treated as a disregarded entity for tax purposes. The business tax code creates no corporate tax. Instead, the LLC’s profits and losses are "passed-through" its members. They are taxed on their share of profits. If there are losses, the members can offset those losses against their personal income (within limits) and reduce their individual tax burden.
Corporation
The final form of business structure is the corporation. Corporations are taxed like a C corporation unless they elect to be treated as an S corporation, meaning the business is evaluated and taxed like a flow-through entity, unless it opts for a double-tax structure. Corporations are controlled by shareholders. They have a board of directors which must meet certain requirements by law. Corporate officers are usually appointed by the board.
Labor and Employment Law
There are a number of key employment laws that all employers must comply with, including: workplace safety, gender and racial discrimination, employee health insurance coverage, parental leave and overtime compensation. Obviously your business needs to comply with all of these laws; otherwise you will be subject to possible lawsuits and retribution from employees who are treated unfairly. If you do need to fire or discipline an employee, make sure that you have a legal reason for doing so – if you fire someone who you know is about to file a complaint of discrimination with the Illinois Department of Human Rights (IDHR), your actions will be viewed as retaliatory and you could be sued.
In addition to complying with these key employment laws, it is common to have formal employment contracts with key employees. A well drafted agreement can ensure that the employer has flexibility to terminate an employee for poor performance, while also avoiding the negative ramifications of letting a valuable employee leave the company. Termination can be an expensive conversation, especially when there is a disagreement on the terms of the employment agreement.
Most businesses also have human resource policies that inform employees about their rights and responsibilities, as well as the responsibilities of management. The key policies you should have in place include: equal employment opportunity (EEO), gender and racial discrimination, sexual harassment, leave for family and medical reasons, employee drug and alcohol use and a workplace violence policy.
Intellectual Property Law
Intellectual property (IP) is perhaps the most elusive and often misunderstood of all areas of the law. IP describes the intangible ideas and products of the mind, such as inventions, designs, works of art, websites and brands.
An invention refers to a unique process or technical solution, which usually falls within one of the following categories: a new or useful machine, process, composition of matter or improvement thereof. Theoretically, for an invention to qualify for IP protection, it must be new, useful and non-obvious. A qualifying invention can be protected by obtaining a utility patent or design patent.
Copyright protection arises for original works authored by an individual, including printed works (books, periodicals, pamphlets), musical works, movies, websites, computer software and choreography. An author can secure copyright protection by creating the original work, but generally is required to register the work with the Copyright Office. Copyright registration is optional, but serves as evidence of validity of the copyright, gives the owner the exclusive right to reproduce the work and create new derivative works, and generally provides the copyright holder the ability to sue for infringement.
Once an individual’s work is reduced to tangible expression, like writing a paper or recording a song, it is protected from unauthorized copying and counterfeiting. That protection, however, is only as valuable as is the author’s ability to enforce it in case of an infringement or unauthorized use.
Infringement entails the unauthorized copying of an original copyrighted work, while counterfeiting is identical duplication. In contrast, a fair use of a copyrighted work allows for some degree of copying for the purpose of critique, comment, teaching or research.
A trademark is a word, name, symbol or device that identifies and distinguishes the source of a good or service. Examples include Golden Arches, Tiffany Blue and Coco Chanel’s interlocking C’s. A trademark owner can secure rights in a mark through use at common law and by seeking federal registration. Registration of a mark at the federal level creates a legal presumption of ownership and is critical in federal infringement litigation. Although copyright, trademark and patent rights are self-executing, the owner must take affirmative steps to protect those rights from infringement. Finally, IP protection is only as valuable as the owner’s ability to enforce it, or it will be rendered dormant, weak or worthless.
Contract Law: Basics and Best Practices
Regarding the issue of contracts, any business owner knows the perils of not having everything in writing. Verbal agreements do not hold water with respect to the business world. Verbal agreements can be broken by either party, which leads to major losses for business owners who are depending on verbal agreements with customers, suppliers and vendors to complete a sale and collect their profit. In most cases, people do business on their word alone, however that is not a safe or sound way to conduct business. Verbal agreements can be challenging to enforce when a problem arises. Instead of relying on verbal agreements, it is prudent to have clients sign formal contracts prior to providing services or products. For instance, when you provide an estimate to a new client, that client should sign a contract, which will outline the terms of your agreement. A contract settles the terms of any deal and basically states what each party expects out of the other party to complete the agreement. A contract is a legally binding agreement with one or more parties to do something in exchange for something else. There are pros and cons to using contracts, which business owners should carefully consider.
A legally binding contract must include six elements: The aforementioned elements below are required for a contract to be enforceable. The offer is the proposal to act or refrain from acting. The acceptance is acceptance to the proposal. The consideration is the exchange of something of value. Legal capacity means those signing the contract must be of sound mind and at least 18 years old. Mutual consent is the mutual understanding of the contract, and the genuine assent is a voluntary agreement by all parties to the contract. There are many categories of contracts however the three most common agreements are: sales, lease and employment. The legal definition of a contract is a legally enforceable agreement. A contract is a promise supported by a payment. Contracts are important for several reasons. A contract not only protects your rights and the other parties rights. It is important if the other party believes you are not performing as agreed. If you are performing as agreed and your contract is legal and valid, there will be no legal basis for anything other than the contract itself. All parties will win if you perform as agreed. If it becomes necessary to litigate, a judge or jury will be guided by the terms of the contract. For example, in the event a contract is established with respect to a sale between a supplier and a vendor, the contract will set forth the terms of the sale, and remedies in the event either party breaches the agreement. If the agreement is not upheld by either party, the offending party could be held liable for breach of the contract. The court could award damages to the non-offending party respecting the contract. This is one of many examples of breaches of a contract and repercussions of the breach to either party. Business owners are generally not contract lawyers, therefore it would be beneficial to hire a lawyer to draw up the language of the agreement. Businesses need to ensure the contracts map out the obligations and responsibilities of both parties. However, business owners can draft their own contracts. Careful attention should be given to contract language. Business owners are encouraged to use plain language and avoid legal jargon, which will make it easier for both parties to understand the terms and risks of the deal. Whatever the level of formality, a contract should contain certain major components: an introduction, statement of requirements, reconciliation of dispute, acceptance and signatures. Another suggestion is utilizing templates; however, all contract requirements will not be applicable to every contract.
Tax and the Business Owner
In many ways, paying taxes is part of doing business. For most, federal and state tax obligations account for the greatest annual expense outside of payroll. The costs of doing business can be difficult to estimate because of the imprecise nature of essential legal topics like taxation. Taxation is a broad and complicated subject for the present day business owner. Federal income tax obligations typically require periodic documentation and quarterly pre-payment. While the proof of payment is easy to provide, compliance will require accurate record-keeping to fulfill Federal requirements for the yearend obligation of submitting tax returns. Federal sales tax compliance is less of a problem if you are an internet based seller Tax Planning Strategies. Beyond local sales tax requirements, e-commerce entrepreneurs are required to provide their federal EIN (Employer Identification Number) to the IRS for tax purposes , as well as provide proof of certification and electronic forms to track individual purchases and sales. This is essentially what online accounting is for the independent entrepreneur. It is essential for the sake of compliance, and this real-time accounting is also an effective planning strategy for minimizing taxes due. Employment taxes are paid to the U.S. Department of Labor, and employers must ensure that they pay these taxes in accordance with DOL regulations. There are other taxes that employees are responsible for, such as unemployment taxes levied by the federal government. The information above is not instruction, but instead a survey of basic requirements that comes with doing business. It is wise to have a strong command of these obligations before venturing into business.
Litigation and Dispute Resolution
Litigation and dispute resolution are subjects that every business owner needs to consider at the outset of a new venture. No one likes to think about it, but the fact is that without careful planning and review, your business can end up in protracted litigation, or worse yet, disposing of a vital asset to fund a court judgment.
Litigation is the process just about everyone is familiar with. One party sues another and you go through the court system. A lawsuit will take several years on average to resolve and could cost $100,000 or more. For example, a mechanic’s lien claim could be for as little as $5,000 to $25,000, but the lawsuit to remove the lien could be $20,000. That’s a lot of money for a piece of paper that can only be worth what the piece of real property is worth.
If the other party has filed suit against you or your company and seeks a financial remedy then filing a lawsuit is the obvious choice for a legal remedy. But, if you have a special fact pattern where a lawsuit is not feasible as a remedy for you in the near term, such as a claim to enforce restrictive covenants, you may want to consider the following alternative path forward.
Alternative dispute resolution ("ADR") splits into two areas; mediation and arbitration.
Many contracts have ADR provisions as a means to reduce litigation costs and expedite the resolution of a dispute before it can spiral out of control with legal fees. Often, these are two-step processes which seek to resolve the matter with mediator assistance first, then an arbitrator (or a panel) second. Mediation is not binding but can be. Arbitration is binding (or not) if the parties choose to waive their right to a jury trial. In Texas, most arbitrations have limited discovery tools, which can be a hurdle to vindicating certain rights.
In mediation, there is usually some disclosure and the mediator will act as a facilitator between the parties to hammer out an agreement. This can take days or even weeks, but does not have to.
If the parties are unable to reach an agreement at mediation, they can voluntarily agree to arbitrate the dispute and have it decided by a panel or a single arbitrator. This is often a very efficient means to have someone with significant expertise in the area hear the case and issue a ruling. The downside here is that the award at the end will be final and cannot be appealed.
If the parties choose not to arbitrate, but had a valid arbitration agreement in place, the other party can file a motion to compel arbitration, to which you must respond within 20 days. If the court decides the parties should arbitrate, you will be bound by that decision and the arbitration will proceed.
Privacy and Security Laws
Data privacy and security are critical issues for businesses in today’s digital age. With the increasing amount of data being collected, processed and stored by companies, the risk of data breaches and other unauthorized access to this information has never been greater. Such breaches can have disastrous consequences for businesses, from costly litigation and regulatory fines, to reputational damage and customer attrition. The recent spate of data breaches involving some of the largest companies in the world reflects this reality.
Several high-profile data security breaches have been targeted to consumers, or pre-sale customers, but it’s becoming increasingly common for cybercriminals to turn their focus on business employees as a major target for stealing sensitive data. Such attacks can take the form of phishing scams where hackers operate sham email accounts to trick employees into divulging passwords or other security information. Other manifestations can be more malicious, such as spear phishing scams where senior management are targeted for highly sensitive financial information and electronic fund transfers.
Several new laws now requiring compliance with strict data security obligations have recently come into effect. The EU’s General Data Protection Regulation (GDPR) went into effect on May 25 of this year. Other laws such as the California Consumer Privacy Act (CCPA), which goes into effect January 1, 2020, are right around the corner. Although the GDPR primarily governs data collection and processing activities directed to EU residents (regardless of where in the world that data is coming from), the five primary rights afforded to EU citizens under the regulation (data portability, subject access, rectification, erasure, object to and restrict processing) are likely to make their way to the United States in the coming years, influencing legislation such as the CCPA and others on the horizon. Hong Kong’s Personal Data (Privacy) Ordinance stipulates an employer’s responsibilities to protect the privacy of employee personal data, which is driving similar legislative efforts in other parts of Asia as well. Last year’s string of devastating ransomware attacks, in which businesses were brought to a standstill, has spurred a plethora of governmental reaction, with increased training and awareness campaigns for covered entities.
One of the real-world impacts of these laws and private initiatives, is an increase in privacy and security-focused professional liability exposures for businesses that are involved in the collection and processing of personal information. Organizations of all sizes now need to closely examine their business relationships and determine if specific data security contract language on the part of vendors and customers is appropriate or necessary. This also may involve expanding traditional protection and indemnity provisions, to include certain cyber coverage needs.
Businesses have a legal obligation to protect their customers’ personally identifiable information (PII). This was emphasized in In re SuperValu, Inc. Customer Data Security Breach Litigation, where the U.S. District Court for the District of Minnesota ruled today that a grocery store chain had a duty to its customers to use reasonable measures to protect their PII.
However, the legislation is rapidly evolving and will vary by industry and geography. All businesses must evaluate their specific data processing activities and regulations that apply to them, and then conduct a risk assessment of those areas. Such an assessment will involve careful review of contractual obligations, internal information security controls, and industry-specific standards and regulations. There are now well-established best practices for managing that risk; for instance, organizations are advised to consider encryption and tokenization as the best method to reduce the impact of a data breach. Businesses should invest in education and training for employees, and also develop an incident response and crisis management plan to minimize the potential damage of a data breach.
Environmental Regulations Affecting Businesses
As the world becomes more aware of the deterioration of the environment, legislation targeting businesses to abide by sustainability as well as structural laws and regulations becomes more common. The Environmental Protection Agency controls environmental standards on the federal level. Every state has a matching agency on the state level, and sometimes in larger cities or towns a local office also oversees environmental protections.
Some of the major federal environmental regulations that affect business are the Clean Air Act, the Clean Water Act and the Comprehensive Environmental Response, Compensation and Liability Act, better known as CERCLA, which governs Superfund sites. The Resource Conservation and Recovery Act deals with ensuring proper handling, storage and disposal of hazardous waste in an effort to battle illegal dumping and protect groundwater sources . The Occupational Safety and Health Act helps to ensure safe working conditions for employees, and the Toxic Substances Control Act places obligations on businesses that deal with hazardous chemicals.
One of the Environmental Protection Agency’s primary focus areas is the reduction of greenhouse gases, something that many consider as caused significantly by the growth of the Industrial Age. These greenhouse gases refer to carbon emissions and others that settle in the atmosphere, thus increasing the planet’s temperature and causing adverse effects such as insect infestations and melting ice caps. A business that causes or contributes to the emission of greenhouse gases may be subject to additional regulations on its scope of operations as well as civil penalties for violations.