Reference no: EM133197532
Busy Body Quilt Shop, Inc.
After Barbara met her business partner Edgar at a quilting expo, she decided to incorporate her quilt shop business formally. She established the "My Busy Body Quilt Shop, Inc.," with her as the majority shareholder. As part of their due diligence, Barbara and Edgar kept good financial records and paid the shop's business taxes on time each year. However, Barbara didn't feel the need to hold formal shareholder meetings, since the business was just the two of them. Barbara also didn't see any need for a separate business checking account. If there were bills to be paid or materials to be purchased, she and Edgar would use their personal and business credit cards or their individual checking accounts.
The business was doing great for a while, but then Edgar fell ill, and now he has not been able to help Barbara run the shop for over a year. Despite her efforts to work out payment plans with creditors, Barbara cannot keep the accounts current. The company that she and Edgar purchased their long-arm quilting machine from has threatened to sue Barbara personally if she does not come up with the money the shop still owes. Barbara thought her business status as a corporation protected her from personal liability. Is she correct?
No, Barbara is subject to liability for the business debt. Corporations must not exist solely on paper, which is the case with Barbara's business. Failing to observe formalities can result in shareholder liability. Barbara has not treated her business like a corporate entity. Corporations must hold formal shareholder meetings, keep accurate records of those meetings, and follow state law with respect to incorporation rules. Barbara has failed to hold shareholder meetings regularly. The law is clear with respect to keeping separate business financial accounts. Barbara has failed to completely segregate corporate assets and instead has been commingling funds. For these reasons, a court likely will hold her personally responsible for the quilt shop's debt.
Explain the advantages and disadvantages of operating a business as a corporation.
Background Information
Small business owners often avoid traditional incorporation because it is expensive, subject to double taxation, and very time consuming, in that it requires extensive record keeping. However, operating a corporation does have several advantages. Unlike a sole proprietorship, a corporation has a perpetual existence. A sole proprietorship ceases to exist when the owner dies. A corporation, however, survives and continues to operate long after its founders have all passed away.
Limited liability is another advantage of operating a corporation. Corporations are legal entities separate and distinct from their shareholders. This separation insulates shareholders from liability associated with corporate debt or misconduct. Shareholder liability is generally limited to the shareholder's capital contributions.
It is important to note that shareholder limited liability status does not protect corporate shareholders in all situations. Shareholders are liable for their own conduct. If a shareholder engages in negligent or criminal conduct while acting on behalf of the business, both the business and the shareholder can be held liable. Courts also will pierce the corporate veil where shareholders dominate and control the corporation for the purpose of committing a crime or some other serious misconduct. For example, shareholders may attempt to defraud creditors through bogus asset transfers that are far below fair market value, or a corporation may seek to avoid existing legal obligations by creating a subsidiary, as sometimes occurs in labor disputes involving union contracts.
Undercapitalization of a corporation also may lead to shareholder liability. Corporations must be sufficiently capitalized to pay corporate debts. The corporation also must secure sufficient liability insurance in case of a lawsuit. If it does not, a court may hold shareholders liable for judgments levied against the corporation.
Of all the corporate entities, the close corporation runs the highest risk for having its corporate veil pierced. A close corporation is operated by a small group of individuals, usually family members. It is not subject to the stricter rules governing corporations. Thus, abuse of power due to shareholder domination is always a concern. Proper checks and balances may not be in place, so controlling shareholders can operate the corporation without oversight from a board of directors.
Navigate to the threaded discussion and respond to the following prompts:
One of the key advantages to forming a corporation is that its owners are immune from personal liability for business debts and other obligations arising from operation of the corporation. This immunity from personal liability is commonly referred to as the "corporate veil." Explain why you support the corporate veil, or why you do not support such immunity from personal liability for corporate debts and other obligations.
Your initial post is due by the end of the fourth day of the workshop.
Read and respond to at least two of your classmates' postings, as well as all instructor follow-up questions directed to you, by the end of the workshop.
Your postings should also:
Be well developed by providing clear answers with evidence of critical thinking.
Add greater depth to the discussion by introducing new ideas.
Provide clarification to classmates' questions and provide insight into the discussion.