What prevents a business from separating the liability and revenue into two separate entities? I know holding companies are a common way to separate the liability of business operations from the assets of a company, but is there any legal reason why businesses don't take this a step further? Suppose we setup a parent Delaware corporation corpA and two child Delaware corporations corpB and corpC (both wholly owned subsidiaries of corpA). Every contract the business engages in is a multi-party contract where corpB agrees to do all the work required in the contract and the customer in exchange agrees to pay corpC. CorpC would also own all the business equipment and assets and would agree to allow corpB to use the equipment whenever needed for no charge. Question: What's wrong with that setup? Naively, it seems like this would be a nearly perfect setup with no value but all liability in corpB and all the value but zero liability in corpC. But that can't be correct otherwise every large enough business would do this. So why doesn't this work? Is there a Delaware corporation law which prevents liability and revenue from being 100% directly into two separate entities so that corpC would still be liable for things? Is there an IRS rule which makes the free usage of corpC's equipment by corpB still subject to taxes? Something else? Any insight on this would be much appreciated! Thanks!
If it is a multi-party contract, generally all parties to the contract have liability for its breach regardless of who is supposed to receive payment. It is possible to contractually negotiate for limitations of liability in a contract, but not all liability and only with clear language to that effect. Further, if the CorpA and Corp B and Corp C all anticipated at the outset that if there was liability that CorpB incurred that it would not be paid, that would constitute both common law fraud and a fraudulent transfer under the Uniform Fraudulent Transfer Act by everyone involved (entities and individuals) because one is anticipating incurring future liability in an entity with no anticipated capacity to pay it. The circumstances would also plausibly justify &quot;piercing the corporate veil.&quot;
Its just free enterprise, right? Well ... except when there is a law that says its not allowed. I am unfamiliar with Indian law but the relevant law in Australia is the Trade Practices Act which deals with this under the category of Misuse of Market Power. In a nutshell: A business with a substantial degree of power in a market is not allowed to use this power for the purpose of eliminating or substantially damaging a competitor or to prevent a business from entering into a market. By preferring their products over a competitor's in their search engine they are "... eliminating or substantially damaging a competitor ...".
A business owned by a debtor is not itself liable for the debts of its owners. But, a membership interest in an LLC is one of your assets and is normally not exempt from creditors, so legal process may be used to collect a money judgment obtained by a creditor in a suit against the membership interest owner from this asset. There are several ways of doing this that a creditor can utilize, each of which is discussed below. Charging Orders And Writs of Garnishment The presumptive way for a judgment creditor to collect a judgment from a debtor's LLC membership interest asset to do this is to either garnish any monies the LLC owes to you with a writ of garnishment (so that the LLC would pay the amounts due to the debtor to the creditor instead), or to impose a &quot;charging order&quot; on the LLC interest, which is like a writ of garnishment that remains in force until the full amount of the debt authorizing the charging order is satisfied. The downside of a writ of garnishment or charging order is that the people who control the LLC can often defer distributions to the members indefinitely, which deprives you of the funds that would otherwise have been distributed to you, but doesn't let the creditor have those funds either. Some LLCs require that certain distributions be made to owners and require that the LLC be liquidated under certain circumstances (e.g. the completion of a real estate development project). But, those LLCs are the exception rather than the rule. Normally, an LLC only makes distributions to its members when the people who control that LLC decide to do so by a majority vote of the managers or of the managing-members as the case may be. Writs of Execution Directed To Membership Interests There is a split in authority between states (with many states not having resolved the issue) over whether you can enforce a money judgment against the owner of a membership interest not just by collecting money due to the owner as a result of the membership interest and instead use a writ of execution to seize the membership interest and sell it in a sheriff's sale to whomever bids at the sale (much like someone might seize a parcel of real estate or a car to pay a debtor's debts to a judgment creditor). In most states, even if this is allowed, the buyer at the auction gets the right to distributions from the membership interest seized, but not a vote on how the business of the company is conducted, unless the other members agree to grant the new owner voting rights or the operating agreement of the LLC provides otherwise. All of the remedies so far presume that the asset to be collected out of consists of the ownership interest in the LLC (analogous to shares of stock) rather than the assets of the LLC itself. Reverse Piercing Seizing assets of the LLC itself, rather than merely the ownership interest in the LLC, is called &quot;reverse piercing&quot;. Usually, reverse piercing is not allowed. But, there are some circumstances where reverse piercing is sometimes allowed. Almost all jurisdictions allow reverse piercing in some circumstances, but those circumstances vary considerably from state to state based upon both the language of the relevant LLC statute and the relevant case law. There are four main circumstances that justify reverse piercing. Single Member LLCs One is the case of a single member LLC where the creditor obtains ownership of 100% of the LLC. In these circumstances, courts have allowed creditors to dissolve the LLC and reach its assets, because neither the debtor nor any third party other than the creditor has any legitimate ownership interest in the property. Alter Ego Cases Another is the case where the assets of the LLC and the personal assets of the debtor are co-mingled or there is not clear documentation existing prior to the litigation establishing which underlying assets belong to the LLC and which belong to its owner. In these cases, reverse piercing is allowed because the existence of a company identity has been disregarded and there is no de facto distinction between company assets and personal assets. This justification for reverse piercing is sometimes called an &quot;alter ego&quot; theory. Fraudulent Transfers A third case where reverse piercing is allowed is where the contribution of the asset to the capital of the LLC was a &quot;fraudulent transfer&quot; from the individual debtor to the LLC (e.g. if the $1 million parcel of real estate was sold to the LLC for $100 at a time when the debtor was insolvent or rendered insolvent as a result of the transfer). Contributing an asset to the capital of an LLC in exchange for a membership interest with a capital account in the LLC's books set based upon the fair market value of the asset contributed to the LLC is usually not considered a fraudulent transfer, but could be in particular facts and circumstances where it has the intended effect of hindering creditors or concealing an asset. Equitable Reverse Piercing Based Upon Control Of The Entity A fourth case where reverse piercing is sometimes allowed is where the debtor does not own 100% of the LLC but has the ability to dissolve the LLC or force its assets to be distributed in kind to him, without the assent of the other LLC owners, because the debtor controls the LLC. Whether this is allowed or not is another issue upon which there is a split of authority and in many cases simply an absence of authority which would make such a case one of first impression in a state.
Controlling shareholders of a company have a fiduciary duty to other stockholders (see the section on controlling stockholder/company in the reference). That is, their decisions must be guided by the legitimate interests of the other stock holder, they can't privilege their own outcomes, or maliciously torpedo the interests of the other stockholders. If you think they have deliberately made bad decisions just to screw you, you can sue them for breech of their fiduciary duty. Of course their defense can be that they made decisions for perfectly rational reasons that respected their fiduciary duty, but simply turned out badly. You'd have to provide evidence that the decisions were reckless and/or malicious.
They aren’t The journalist is attributing a payment by the company as a cost to the shareholders. In accounting terms, that’s a fair equivalency - the shareholder’s equity will fall by the amount of the liability. In legal terms, it isn’t - the company is a seperate legal entity from the shareholders and a payment by one is not a payment by the other, even though for each shareholder, the value of their shares will change. However, markets being what they are, the change in value is unlikely to be exactly the same as the amount the company pays, the value may even rise if the market expected the costs to be bigger than they are. They may rise even if the actual costs are bigger than the expectation - markets prefer certainty over uncertainty even in bad news. Of course, the bulk of the actual cost is likely to be borne by PG&amp;E’s insurers.
Do I need to create an LLC if I already own the domain? No. Can someone legally create an LLC with the same name as my domain? Yes. Just trying to understand what the difference is between an LLC and a business An LLC, a &quot;limited liability company,&quot; is a kind of legal entity that has a separate identity from the members of the LLC. The members' liability is limited with respect to the company's liability, hence the name. A business is a commercial activity. The two concepts are independent. A person can have a business without forming a corporation, or indeed many businesses. A single corporation can also have many businesses. Back to the question about someone forming an LLC using your domain name, this raises the issue of trademark protection. In the US, at least, you can't register a trademark unless it is &quot;in use in commerce&quot; (15 USC 1051(a)(3)(C)), which means explicitly that you cannot use the mark &quot;merely to reserve a right in&quot; it (15 USC 1127). But there are many subtleties of trademark protection that are widely misunderstood by most people, so if you anticipate wanting trademark protection for a name, you will probably want to learn about how trademark protection works and likely talk to a trademark lawyer.
As the sole director and shareholder, the cleanest approach is to pay the invoice from the company account as if it were issued to the company's name. This way, you don't need to keep records (such as a director's loan account) to explain why the company is claiming a deduction for expenses paid from your personal account, and you are not paying income tax on the reimbursement. The problem with this approach, and the reason why larger companies don't use it, is that you now need to be able to prove that the invoice relates to a legitimate business expense. For a one-person company, that will usually be pretty obvious from the nature of the expenses and if not, you'll remember what happened, but this does not scale up for businesses with employees claiming reimbursement.
You’ve presented a number of different scenarios, without a lot of specifics, so I’ll start from the top, and from a US perspective. A very generic term that would come up in this situation is material misstatement. one might say that an account or line item is overstated or understated, or a misstatement could arise from the omission of a necessary note, because notes are an integral part of the financial statements. Financial statements are said to be materially misstated if the misstatement would affect the choice of a typical decisionmaker. There’s no explicit standard for what is or isn’t material, but in practice, auditors often choose some small fraction of net income as the threshold. Materiality can also be caused by positive vs. negative earnings, or other thresholds, like financing agreements which might oblige the company to keep its current ratio above a certain level, for example. In the US, the rules to which the statements have to be materially correct are known as GAAP (Generally Accepted Accounting Principles) and they are codified in the Financial Accounting Standards Board's Accounting Standards Codification (FASB ASC). Depending on how the scheme is arranged, issues in the realm of “buying stuff as a “customer” to make the business look good” include: Substance over form: it may not be appropriate to recognize as a sale at all. If the net effect is a transfer of cash from the owner or manager to the business, while the goods find their way back into the company warehouse, that could be considered as paid-in-capital, or even a liability, rather than a sale. Owner bought some product to inject cash, and put the goods back in the inventory? That’s cash from the stockholder, not a customer sale. Somebody in management moved a truckload of product to his storage unit, only to return it after year end? That might be more accurately characterized as a loan, not a sale. I don’t know of any specific terms for this exclusively, but there have certainly been cases where companies moved inventory to undisclosed warehouses in an effort to hide fictitious sales from their independent auditors. Edit: Another term for certain sales without commercial substance is a “roundtrip transaction” or “roundtripping.” Disclosure notes: even if there is commercial substance to the transaction, it may require disclosure notes, such as those for related party transactions, as required by ASC 850. Transactions with related parties must be disclosed even if they are not given accounting recognition (ASC 850-05-5). Examples of related parties are given in ASC 850-05-3, including “an entity and its principal owners, management, or members of their immediate families,” among others. Under the relevant definition, a person does not need a formal title to be considered a member of management (ASC 850-10-20). The related party disclosure is not required in consolidated financial statements, for transactions that are eliminated in the consolidation process (ASC 850-10-50-1). For sales from a public company to a bona-fide external customer, there’s also the major customers disclosure, but the threshold for that is 10% of revenue, which is much more than enough to materially impact the bottom line. Generally, transactions between a parent company and a subsidiary will be eliminated in the preparation of the parent’s (consolidated) financial statements (ASC 810). This means if the parent company A sells goods with a carrying value of $30 to its subsidiary, B, at a price of $50, A doesn’t recognize that $20 gross profit until B sells the goods to an outside party. Internally, B might carry the goods at $50 on B’s books, but A would have to cancel it out so that only $30 of that appears on A’s consolidated balance sheet. The consolidation method is applied when one business has a controlling interest in another, and in summary it means that the parent company reports A+B’s financials as if it was all a single entity. That means B’s assets and liabilities, revenues and expenses, are all reported as part of A. It also means any transactions between B and A are transactions within the entity; you wouldn’t recognize a gain or loss (nor revenue and GP) if your marketing department sold office equipment to your engineering department, and you don’t get to with subsidiaries either. Consolidation requires not only eliminating revenues, cost of goods sold, and excess carrying value of inventories on intra-entity transactions; it's also gains and losses on things like equipment, meaning the same transaction could require a consolidation adjustment twenty years later to eliminate excess depreciation expense. Long story short, ASC 810 deals with consolidation, and those rules apply when you create or purchase a subsidiary to buy your stuff, or use a subsidiary to pass the same $200,000 back and forth. When the parent entity does not have a controlling interest in the investee (the basic threshold is 50% of voting shares, or by some other agreement) but does have significant influence (representation on the board or other factors in ASC 323-10-15-6), then it will be treated as an equity method investment. Instead of adding the line items together, it's a single asset and A's portion of B's earnings are a single line item on the income statement, but the adjustments are similar to those in a consolidation. Another kind of revenue recognition game which companies used to play involved bill-and-hold arrangements, wherein the customer (or the “customer,” or a salesperson without any real input from the supposed customer) would place an order, and the company would send (or at least, prepare and book) an invoice (revenue), but not ship the goods until the customer actually asked for them. These days, the rules on revenue recognition are fairly guarded against these kinds of things, but some other examples of “sales” that aren’t really sales include consignment arrangements, repurchase agreements (could be a sale with right of return, or depending on terms could be effectively a lease or a financing arrangement), and the gross vs net revenue issue for principle/agent situations (airline and hotel booking sites are a popular example. If they’re an agent they’re required to report their commission on a net basis but would likely prefer to look bigger by calling it a $110 sale and $100 cost of goods sold, instead of just $10 revenue). If you’re interested in management schemes to mislead the users of financial statements, check out the SEC’s online archive of Accounting and Auditing Enforcement Releases (AAERs) here. Some of them just deal with individual professionals who should know better, but they can be pretty interesting, whether they involve poor ICFR, or intentional deception on the part of upper management (it's on management either way).