Protect Your Liability After Converting to a Corporation or LLC

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Converting your sole proprietorship or partnership into an LLC or corporation will protect your personal assets from being taken to pay off new business debts, but you can't get rid of your personal liability for old business debts. That means that your past business creditors could still come after your house, car, and other personal assets if you don't pay your old debts. In addition, in most states, if you don't pay or settle your old debts before you form a new corporation or LLC—or have the LLC or corporation take over the debts and pay them in a timely fashion—the creditors of your old business can get a judgment against the new corporation or LLC and seize assets of the corporation or LLC to sell to pay the old debts.

Use Only Your New Business Name

To fully establish your new limited liability status, you should now sign all paperwork, invoices, checks, and contracts in your new capacity—for example, President of Sidewinder LLC. Also make sure to change all letterhead, invoices, and marketing material to reflect your new corporate or LLC name. Keep all new personal and business financial transactions totally separate, as an essential step to preserving the limited liability that your new LLC or corporation affords you. For example, all checks should be written from your LLC account and clearly state you are an LLC, and no personal bills should be paid from this account. (Transfer funds from the business account to your personal account first.)

You should also change the name on your business license, tax registration certificate, or seller's permit to reflect your new corporate or LLC name. Depending on your locality, you may be required to apply for other new licenses and permits under the corporation's or LLC's name as well.

Notify Suppliers, Customers, and Clients

After you convert to a corporation or LLC, you need to notify all of your suppliers, customers, and clients that your company is now a corporation or an LLC. It is essential that you send a letter to them saying that you have changed your business structure and you are now operating under a new name (which can be the same as your old name but must include "LLC" or "Inc."). Then you should make a clear request that they do business with you in your new name from here on.

Follow Notification and Publication Rules in Your State

California, Georgia, Maryland, Virginia, Wisconsin, and the District of Columbia have a "bulk sales law," which applies to companies that manufacture goods or sell inventory from stock (and in California, to restaurants). Bulk sales laws are designed to prevent business owners from evading creditors by transferring their business assets to another company.

The bulk sales law requires you to give your creditors notice that you have transferred the assets of a sole proprietorship or partnership to a new corporation or LLC under a new name, and that the new entity assumes the debts of the prior company. In some states, this notice also must be published in a local newspaper, recorded in the county land records office, or sent to the Secretary of State. Your local newspaper or recorder's office should be able to help you with this notice.

Follow Corporate and LLC Formalities

To avoid any possibility that a creditor could later claim your corporation or LLC is a legal sham and your business is merely a sole proprietorship or partnership, it's crucial to act like your business is now an entity separate from you. 

The most important rule to follow is to hold and document regular meetings as required by your corporate bylaws or LLC operating agreement, giving proper notice to all owners of the meetings. Also be sure to follow proper procedures on electing officers and voting on other matters.

If you don't follow these formalities, it will make it easier for a creditor to say that you did not have a real corporation or LLC—that the corporation or LLC was just a sham to help you defraud creditors and that it was really just you running the business. (When a creditor makes this claim successfully, it's called "piercing the corporate veil.")

For example, if you are having financial difficulties and want to sell off significant assets or lay off a significant portion of your workforce, you should call a special meeting of your board of directors, at which you communicate the details of your financial situation to request approval for the sale or layoff. Document the directors' approval in a resolution and insert it in the minutes of the meeting.

Information and forms for recording minutes and resolutions. See The Corporate Records Handbook: Meetings, Minutes & Resolutions or Your Limited Liability Company: An Operating Manual, both by Anthony Mancuso (Nolo).

Avoid Personal Guarantees

Remember that to protect your personal assets you must refuse to personally sign business contracts or make personal guarantees on leases, loans, or contracts. If a particular vendor balks at supplying you under these terms, you can usually find someone else who will work with you, especially if you establish business credit by paying up front for the first order or two.

To get a bank loan or line of credit, you may not be able to avoid giving a personal guarantee—unless you can convince the bank that there are enough corporate or LLC assets to secure the debt. Think twice before taking on this serious legal burden.

How can you expect suppliers to give you credit terms without a personal guarantee? You can establish a good business credit record for your corporation or LLC just as you can establish good personal credit. To start, get a trade line of credit from several suppliers and a couple of business credit cards.

Building a track record for your LLC or corporation. Dun & Bradstreet offers a program called CreditBuilder that, for a few hundred dollars, helps you report your payment history to establish good business credit. For more information, go to smallbusiness.dnb.com.

by: , J.D.

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