Legal Issues For Small Businesses

Materials prepared for presentation to Chattanooga Small Business Development Center

Conducting business in this day and time is fraught with opportunities for liability from matters of contract, personal injury or property damage. The intent of this presentation will be to identify certain potential pitfalls and to suggest a few ways that small, start-up businesses might be able to protect themselves and their owners.

I. Opportunities to Limit Personal Liability:

Every person in business accepts certain inherent risks of doing business, whether those arise from controllable causes, such as poor business decisions, or from external factors such as a depressed economy or natural catastrophes. The goal of every business person should be to contain these risks within the business and, within the business, to limit their effect to the extent possible.

1. Choice of Entity:

For the purpose of this discussion, we will refer to two scenarios which may not be atypical of problems that arise in small, start-up businesses. The first scenario is as follows:

Your best friend asks you to join him in a business venture. He has a great idea but needs your business expertise. You quit your job and devote full time to the project. The project takes off and the friend wants to borrow money to expand, but you are hesitant. The friend then announces that he has taken a job with another company that wants to develop his idea. You are left holding the bag. Creditors come calling with unpaid bills that your friend incurred without your knowledge and expect you to pay, personally.

The second scenario is as follows:

You are operating your new sales business out of your garage. After months of struggling, you land THE BIG ORDER from Mega Corp. that will get you going. You plop all your savings and your mortgage money into the venture to tool up to service this order. On the eve of the delivery date for the order, your supplier says that he is over-committed, that his promised delivery date was only an estimate and he will ship as he can over the next nine months. Mega Corp. sues you for breach of contract in Alaska, under a provision in their contract where you agreed to be sued there, and obtains a judgment for their incidental and consequential damages, including its lost sales and profits. They file a judgment lien on your house, your Bank calls your note and mortgage, and your wife threatens divorce. What could you have done?

The problems that our business owner experiences under both scenarios are not unforeseeable business risks. The problems become catastrophic only because they are not isolated within the particular business. One method of isolating risk is through choice of the entity within which a person does business.

(a) Sole Proprietorship. Many small businesses and start-ups are run as sole proprietorships. A person has a product or service and begins selling. A business operated as a sole proprietorship legally is indistinguishable from the person operating it. A claim against the business, therefore, is a claim against the individual and all assets held by the individual and vice versa. Consequently, from a risk-avoidance perspective, a sole proprietorship is the worst way to conduct a business. The second scenario is a case in point.

About the only way to isolate risk while operating as a sole proprietorship is to divest oneself of assets. If our owner had titled his home solely in his wife's name and if the mortgage payments and other expenses associated with the house had been paid by the wife, so that it would be apparent that the titling in her name was not a sham, it is likely that the home would have been protected from the builder's creditors. This is far from an absolute protection and, typically, is not an acceptable alternative. Titling property in the name of the sole proprietorship, such as listing "John Smith Co." on the title of company vehicles, will be of no effect.

(b) Partnership. Where two or more persons own and operate a business together, they are partners, whether or not they have any formal agreement to act as partners. As partners, general partnership law provides that they are jointly and severally liable for all of the debts of the partnership and that any one of the partners can bind the partnership, such as by entering contracts or commitments. If persons intend to operate as a partnership, a formal partnership agreement would be greatly recommended; however, a partnership agreement can only allocate risk between the partners themselves: it will not limit a partner's liability to third parties. In the first scenario, the two friends had formed a partnership.

Tennessee recognizes several forms of partnerships beyond pure general partnerships, such as limited partnerships and limited liability partnerships. If a person is doing or intends to do business as a partnership with another person active in the business, a limited liability partnership will limit each partner's liability for debts, obligations and liabilities of the partnership and other partners arising from omissions, negligence, wrongful acts, misconduct, or malpractice after the partnership was registered with the Secretary of State as provided in Tennessee Code Annotated Section 61-1-143. It would be recommended that this form of partnership be given strong consideration, although it will subject the business to Tennessee franchise and excise tax. A current general partnership can be converted to a limited liability partnership through the same registration process.

A limited partnership is not usually appropriate for a start-up. A limited partnership must have a general partner who operates the business and who is liable for all debts and obligations of the business. The general partner does not have to be an individual but can be another entity. The limited partners are passive investors who are liable only to the extent of their investment; provided, they do no participate in the conduct of the business. In most start-ups the investor cannot avoid involvement in the business and, therefore, the value of this form of entity is lost.

A partnership is a legal entity separate from the partners, and the partners do not have title to or rights in particular assets owned by the partnership. A partner merely owns an undivided interest in the assets, and liabilities, of the partnership. In the first scenario outlined above, the idea around which the business was formed was likely a partnership asset.

(c) Corporation. A corporation is the most recognized form in which to limit personal liability while doing business. A corporation is a creature of statute and is an entity literally chartered by the State. A corporation is recognized by law as an entity separate from its owners, and it is on this basis that owners have been isolated from the liability of the corporation. A corporation is owned by stockholders who elect directors to set policy and oversee the management of the corporation. The directors elect officers who handle the day-to-day operations and management of the business. One person can be sole stockholder, sole director and president of a corporation, although a second person must act as corporate secretary.

Under federal tax laws, a corporation can either be a "C Corporation" or a "Subchapter S Corporation." A C Corporation is the standard corporation and is a taxable entity separate from the owners so that profits are subject to corporate income tax at the corporation level and to personal income tax when they are distributed as dividends to the shareholders. A Sub S Corporation is treated more as a partnership for tax purposed and the income and losses are passed through directly to the shareholders. To qualify for Subchapter S treatment, the number of shareholders is limited and shareholders generally must be individuals.

Tennessee Code Annotated Section 48-16-203(b) provides that a stockholder of a corporation will not be personally liable to the corporation or others for debts or obligations of the corporation, beyond liability for the stockholder's own acts or conduct. This is not an absolute protection, however. Over the years, courts have been concerned that persons create nominal corporate entities merely for protection, to the detriment of the public. As a consequence, a well established body of law has developed that will allow courts to "pierce the corporate veil" and to hold stockholders personally liable in egregious situations. These situations most often are triggered where a stockholder ignores the corporate formalities and treats the assets and operations of the corporation as his or her own. Understandably, this occurs almost exclusively with wholly owned corporations. It is imperative, therefore, to follow, and to document in minutes, the following, at a minimum:

Annually, hold a meeting of stockholders to elect directors.
Annually, hold a meeting of directors to elect officers.
Hold a meeting of directors to approve all significant transactions. While what is significant will vary depending upon the size of the business, typical significant transactions would include loan transactions, office leases, purchases large tracts of land or pieces of equipment (particularly if on credit), hiring of executive personnel, mergers with or acquisitions of other businesses, or material shifts in the nature of the business. In many cases the lenders or other parties to these transactions will require a "secretary's certificate" attesting to the approval by the board of directors. These should be red flags that such approvals should be obtained and documented in minutes.
Adequately capitalize and insure the business. This requirement is far from precise but is intended to show a good faith attempt to protect third parties from foreseeable risks. A stockholder of a demolition business without assets or insurance, will not be protected.
Do not commingle personal assets and transactions with the business. As a corollary to this, document and approve all loans and transactions between stockholders and the corporation. A corporate car for the owner/president probably is acceptable. Cars for the wife and kids who are not employees or the business will be suspect.

Recognize that "piercing the corporate veil" is a very rare event. The vast majority of litigated cases uphold the corporate protections. In the two scenarios, had our businessperson incorporated an entity to operate the business, the effects of the defaults and liability would have been isolated to the actual entity affected, and only the assets of the affected entity would have been subject to claims.

(d) Limited Liability Company. Limited liability companies are relatively new creations in Tennessee and, for that matter, in the United States. They are primarily tax-driven entities which combine the tax benefits of partnerships with the liability protections of corporations. The Tennessee Limited Liability Company Act specifically provides that a limited liability company is to be viewed as a partnership for tax purposes.

From the limited liability company acts themselves, it is readily apparent that the limited liability company (an "LLC") is a hybrid of partnerships and corporations. The owner of an LLC is designated a "member," and in member managed LLC's, the members are both owners and managers, operating the business in virtually the same manner as partners is a partnership. The Tennessee Limited Liability Company Act specifically creates the possibility of a "board of governors" and a "board managed" LLC. The board of governors is created by the members, the governors are appointed by the members, and the operation of the board of governors is virtually indistinguishable from a corporate board of directors.

Without any history of judicial decisions which established how certain situations would be viewed, the drafters of the Act were able to draft provisions to address problem areas under corporate law. Section 48-217-101(e) provides, for example, that failure to follow the usual company formalities or requirements will not be a ground for imposing liability upon the owners or manager. Section 48-214-102 provides that in all events the liability of a member of a Tennessee LLC is to be governed by the Tennessee LLC statute and the laws of Tennessee. The lack of judicial history may be a double-edged sword, however. The provisions of the Act, for the most part, have not been tested by the courts, and it is still to be determined whether in a given situation, a court will view an LLC under partnership law with joint and several liability or under corporate law with limited liability. It is due to this uncertainty that we suggest that selection of the more corporate-like, board managed form of LLC and taking the normal corporate actions, such as regular board meetings, may sway a court to apply the corporate body of law.

It is now possible to have a single-member LLC operated by an individual. Because LLC's are usually taxed as partnerships, and since partnerships must have two or more partners, single-member LLC's are ignored for federal tax purposes and are treated as being indistinguishable from the sole member. Single-member LLC's have been used by corporations or other LLC's for some time as a convenient way to establish subsidiaries. This is particularly helpful for tax-exempt organizations since under the IRS guidelines a single-member LLC can utilize the member's tax-exempt letter without the need for a separate application. Because of the ownership restrictions on other pass-through entities, such as Sub-Chapter S corporations, this has presented new opportunities. From a strictly legal perspective, there may be a number of reasons for individuals not to select this form through which to operate a business.

As explained above, some aspects of the history and nature of LLC's may be inconsistent with the historical legal protections afforded corporations; primarily, LLC's have roots in partnership law. Just as LLC's have been considered partnerships for tax purposes, single-member LLC's are considered, for tax purposes, as being identical with the some member: they are ignored as a separate entity for tax purposes. In this manner, they become most similar to sole proprietorships. While single owner corporations have existed and enjoyed limited liability for a long time, they have been granted that protection only to the extent that they exist as entities separate from their owners. Those corporations remain corporations with all of the formal aspects of boards and officers. Liability of sole shareholders is more prevalent than with multi-shareholder corporations for the reason that it is much easier for a sole shareholder to co-mingle assets and forget the seemingly meaningless corporate formalities. These problems are exacerbated with member managed single member LLC's are there are no formalities to keep and for many other purposes, the LLC is ignored as a separate entity. Even with board managed single-member LLC's, there are certain aspects of the LLC, such as operating agreements, which are somewhat inconsistent with single members.

In the first scenario, had our business been operated as an LLC with all of the formalities, the effects of the defaults and liability likely would have been isolated to the actual entity affected, and only the assets of the affected entity would have been subject to claims. In the second scenario, although single-member LLC's are now possible, the owner would have had to have another person involved to limit liability.

The foregoing analysis is strictly from a liability standpoint. Recognize that each entity may be subject to differing federal and state tax treatment, and it would be well to analyze the impact of that in selecting the entity appropriate for your business.

2. Use of Subsidiaries / Special Purpose Entities.

You have selected an entity with which to operate your business; however, you are an active entrepreneur and may have used the entity for several businesses or have several businesses in process simultaneously and do not want to have any liability from one affect another. At the same time, you would like to consolidate your income and losses and centralize your financing and operations.

A business owner could establish a central entity which would arrange financing and manage operations and separate entities, owned by the central entity, which would handle particular projects. Financing could be based upon the combined assets and operations but would be obtained by the central entity with funds provided by that entity to the actual operating subsidiaries. For years, corporations have established corporations as subsidiaries for this purpose.

Tennessee recently amended its Limited Liability Company Act to allow single member LLC's. Since a partnership, by definition, requires two or more partners, and since an LLC is to be treated as a partnership for tax purposes, a single member LLC is an anomaly which becomes a disregarded entity for federal tax purposes: it does not exist separate from its single member. This may create certain tax advantages. The tax laws have changed recently, particularly with regard to Subchapter S corporations (corporations that allow a pass-through of profits and losses to owners) and additional options may be available in adopting a multi-tier structure.

3. Issues with Lenders.For most borrowers, suggesting ways to limit liability to lenders is a meaningless exercise, as the lender is in a position to dictate terms. With that understanding, however, there are certain agreements and certain provisions within agreements that often are presented with the lender's standard document package that are problematic and that a lender will negotiate. Certain of the structures described above also may provide the builder with opportunities to avoid the more egregious provisions.

The first and primary principle is that loans should be in the name of the business entity and not in the name of the owner.

(a) Loan Agreements in General. Be sure to READ THE DOCUMENTS! Most banks have their standard package of loan documents. Recognize that, by definition, standard forms will not be customized to your business or needs. Despite what the loan officer may say, everything is negotiable. Review the documents closely to determine the impact upon your business and the realities of your situation. Remember, too, that a default is a default, and while the lender may say that a provision does not matter or would not be enforced, it can be and can become the basis for calling the loan. Circumstances and relationships change, and while the banks will be courting you initially, if the loan becomes problematic, their attitudes will change. If the agreement calls for audited financials, for example, and you only will have unaudited balance sheets, be sure that the provision is changed. While forms cannot be changed, it is easy to draft, and sign, a simple addendum or amendment. Loan agreements should be viewed with an eye to the impact of external factors, such as cross-defaults, and provisions which would allow those external factors to cause a default. Some inconvenience is a cost of obtaining the financing, but be sure that you are not committing to more time to providing information than you have. It often is advisable to summarize certain key provisions, such as due dates and default provisions, and to have that summary available as a ready resource.

(b) Cross-default Provisions. Most bank form loan agreements will have a cross-default provision which ties the particular loan to all other loans with the same lender and which provides that a default under any one of those other loans will cause a default under the particular loan at issue. Where a loan is made individually and not in the name of the business, a default under the business loan may cross default to your home mortgage. Loan officers typically do not have the authority to alter substantive provisions of loan documents: that is a matter left to the bank's legal department. Given the bureaucratic problems of sending loan changes through channels, banks are reluctant to alter any documents. Loan officers, however, may not have the same reluctance to accept the change if it does not require amendment of documents. Cross-defaults usually apply to loans by the same lender to the same borrower. If an umbrella entity has been used and if that entity has obtained the financing for the various subsidiary operating entities, default under such loan agreements typically would be tied to financial covenants and financial performance by the parent entity. The default by the subsidiary, therefore, would have a financial impact upon the parent, but unless that impact were material, it might not cause a default under the prime loan.

(c) Security. Most lenders will require security for their loans. Depending upon the nature of the business, there be little room for negotiation; however, there are certain points to bear in mind.

Accounts receivable are the lifeblood of most businesses. Not only do they provide essential cashflow but they also become important elements of a business's customer relations. Lenders who have security interests in accounts will want to have payments directed to the lender upon default or At such time as they feel insecure, usually times when a business will need the cash the most. Lenders also will want control over settlement of disputes, negotiation of credits all matters that could reduce the level of accounts collateral. These rights insinuate your lender in your relationship with customers and may interfere with your ability to control key relationships. It, therefore, is advisable to avoid pledging accounts if possible.

Recognize that by pledging assets, a business surrenders the right to control those assets. Consequently, it is important to retain the right, absent default, to be able to sell, exchange or discard assets that are no longer needed in the business as you would in the ordinary course of your business. In a pledge of inventory, you need the right to sell in the ordinary course and also may need the right to liquidate closeouts and seconds.

Check the documentation! A pledge of personal property, such as equipment or inventory, requires a UCC-1 financing statement. Be sure that the description on the form is accurate and limited to the collateral pledged. If only specific pieces of equipment are pledged, list them by serial number. While the UCC clearly provides that the terms of the loan agreement governs and that the UCC-1 is merely for notice, future banks will not lend on unencumbered assets if there is a UCC-1 of record which could be interpreted to cover the collateral. Obtaining a release from the first bank is not always an easy or quick process.

Banks are faced with an interesting dynamic: to protect their loan, they want to exercise control the assets and operations; however, if they exercise too much control they risk incurring claims of lender liability. Recognizing this, borrowers should negotiate to retain the ability to control their business and to continue to operate in the ordinary course.

(d) Personal Guaranties; Dragnet Clauses. No one enters a loan anticipating a default; therefore, personal guaranties often are viewed as merely a necessary evil. A personal guaranty, however, can mean your house, your car and your marriage. The basic premise is that guaranties should be avoided to the extent possible. That often is not possible. It may be possible to negotiate a dollar limit for the guaranty.

Guaranties often have what are called "dragnet clauses." These are provisions which tie the guaranty to any and all loans, now and in the future, between the guarantor and the lender. These should be avoided at all costs. One never knows what loans may be entered in the future. The lender also may be much more reluctant to release this form of guaranty upon payment of the prime loan. A guaranty should be specific, so that the guarantor and the lender know exactly what is covered. It also should be established that the guaranty will expire upon payment of the guaranteed obligations and the guaranty returned. A guarantor needs to be reminded to demand the return of the guaranty: a guaranty with a dragnet clause can be a lasting liability.

There are two types of guaranties, guaranties of collection and guaranties of payment. A guaranty of payment is the most typical and allows the lender to proceed against the guarantor upon default without any obligation to pursue the actual debtor. A guaranty of collection requires the lender to first pursue the debtor and may require that all remedies against the debtor be exhausted before recourse against the guarantor. Obviously, this is the preferable form; however, most lenders will not accept it. An unsophisticated lender or a private lender may well accept a guaranty of collection. It also may be possible to negotiate some middle ground with a requirement of some specific collection effort before the guaranty becomes enforced.

(e) Writings. As with any contract, all material provisions and all amendments or modifications should be documented and signed by both parties. This is especially true for loan documents. Where terms of a form contract are changed, an addendum or amendment should be drafted containing the changes and should be signed by both parties. If the bank agrees to waiver a default or breach, the specifics of waiver and its extent and duration should be documented.

(f) Miscellaneous Documents. At a loan closing, you will be flooded with a variety of documents. You also may be in the hands of a closing agent rather than the loan officer with whom you have been dealing. As the closing agent will not have authority to change documents, it is advisable to obtain the documents for review in advance of closing. There may be "routine" forms that come with consequences. All entities should have enacted resolutions approving the loan before closing. The bank, typically, will have a "Secretary's Certificate" certifying to a resolution in the bank's format, which invariably is different from the company's. Be sure that the resolution is not broader than what the board or other governing body authorized; for example, bank resolutions for opening an account often also authorize corporate borrowing by any officer or the purchase and sale of bank instruments such as certificates of deposit. The board may not wish the officers to have that authority. The bank may well require that accounts be opened at the bank in order to qualify for the loan. While that may be unavoidable, recognize that the bank may have a right of setoff against those accounts which would allow the accounts to be frozen or taken in the event of a default.

II Shareholders' Agreements; Buy/Sell Agreements. Where you have business partners, it is imperative that you discuss at the beginning the operation of the business, the relative rights and obligations of the business partners and what will happen if any of a variety of occurrences should cause the "partnership" to end. The agreements and understandings should then be incorporated in a partnership agreement, if a partnership, in a shareholders' agreement or buy/sell agreement, if a corporation, or in an operating agreement, if an LLC. Especially with start-ups, the business partners may have different degrees of dedication to the business, may have differing abilities to weather financial troubles and may be making contributions with different values. It is not unusual for business partners in start-ups to reach a parting of the ways, which, in most cases, may be on a totally amicable basis. The leaving owner usually wants his investment back, and the business, typically, is not in a position to pay it immediately. The parties also may have very different views as to the value of that investment. In other cases, the owners may have reached oral agreement on everything, but one owner has now died, and his widow wants to be compensated for the deceased's, and her, time, effort, blood sweat and tears. A partnership agreement, shareholders' agreement or a buy/sell agreement can establish binding agreements as to the method for valuing ownership interests (such as book value rather than market value, or a certain multiple of average earnings), can establish the time within which a payout must occur, and can provide a mechanism for either or both the business or the other owners to have the option or obligation to purchase the interest. Knowing in advance what the potential liabilities might be, the business can purchase "key man" insurance or other forms of life insurance to fund the purchase.

III Contracts.

A business lives and breathes by contract and failure to perform its contractual obligations is a usual source of liability and failure. The following are some basic suggestions.

1. Control the Contract. No business drafts contracts that are disadvantageous and rarely contracts that are truly neutral. In accepting another's form contract, therefore, one can assume that the terms have been worked and reworked to provide the most benefit and protection to the drafter. Where possible, offer to draft the contract or present your form as the basis for negotiation.

(a) Battle of the Forms. In the sales context, the Uniform Commercial Code (the "UCC") provides a structure for basic contract formation by providing many standard terms and interpretations. It also provides a mechanism for resolving disputes between contract forms, the "battle of the forms". Simplistically, if Business A presents a contract of sale to Business B, Business B replies with either a different contract or an acknowledgment with different terms and neither contract is signed, the final contract will be comprised of only those terms in both contracts, those terms supplied by the UCC and those terms of the first contract, Business A's, that are not rejected or materially altered by Business B's. All other terms drop out. Business A, for example, presents a contract that excludes all warranties and Business B replies with a confirmation that provides that Business A gives full warranties. Under the UCC, both terms drop out, but since the UCC provides certain standard warranties and since the waiver language in Business A's contract has been eliminated, the statutory warranties may now apply. As a consequence, if you originate the contract be sure to read all responses from your contracting parties and be sure that you have reached agreement on the terms that are important to you. If you are the responding party, be sure that your reply rejects the terms that are objectionable. As a safety net, if you are the originating contract and you send a confirmation of the order with the terms that you want, those terms may become the contract, particularly if the other party does not respond.

(b) Be Assertive, but be Reasonable. The context of every business transaction differs, but as a general rule, nothing sours a relationship quicker than a totally one-sided agreement. If you have the bargaining leverage, be sure to obtain the provisions you need, but consider carefully the emotional and business consequences of extracting that extra pound of flesh. If you are at the other end of the spectrum, you might play on this same sentiment to obtain at least some concessions from the dominant party.

2. Basic Contract Terms and Considerations. It cannot be emphasized enough how imperative it is to READ THE CONTRACT! Whether it is your biggest customer or your termite inspector, everyone will assure you that either that their contract is merely a standard form and not to worry or that the contract is the contract is the form they always use and they cannot change it. Everything is negotiable, and if the other party wants the business they will find a way to make the required amendments. While every contract is different and will be dependent upon the particular facts and circumstances, there are certain considerations that may be universal.

(a) Completion Dates; Delays and Damages. Do not commit to more than you can deliver. If you have any hesitation, build in some leeway. If your performance is dependent upon performance of others, build in contingencies (see below). Limit the options and damages available if performance is not timely. If performance is in installments, try to provide that delay in one shipment does not entitle the buyer to cancel the entire contract. Scenario two is an example of the consequences of not addressing these matters.

Avoid any provision that allows the other party to obtain incidental or consequential damages. Direct damages are usually calculated on the basis of the cost of alternate performance. You agree to sell widgets for $1.00 but cannot deliver. The buyer is forced to pay $1.50 for widgets from an alternate source. Damages are based upon the $.50 additional cost. Incidental and consequential damages are costs peculiar to the other party that are tangential to the contract and that may not be known to the other party. You contract to sell widgets for $1.00 but cannot perform. The buyer was going to install the widgets in a whosit to be delivered under a separate contract. Your breach caused the buyer to lose its contract, worth $1 million in profits, and to go out of business. Incidental and consequential damages could include the $1 million of lost profits and the costs of in more subjective terms of having to go out of business.

(b) Warranties. You may be willing to make certain warranties about your products or services and the parties to whom you sell products or services make require certain warranties that are acceptable. The UCC, however, also provides certain implied warranties, including a warranty that the goods will be fit for the particular purpose of buyer. Those purposes may not always be known to the seller, or if they are, can be addressed specifically in the contract. Consequently, it usually is advisable to include a provision that waives or eliminated all warranties, express or implied unless specifically included in the written contract.

(c) Contingencies. If your performance is dependent upon external factors, such as performance by suppliers, good weather, installation of equipment or preparation of a site, these should be included in the contract, so that it is clear to both parties that failure to perform due to these contingencies is excused. Building in contingencies could have saved the business in the second scenario.

(d) Termination or Cancellation. The bases for and consequence of termination or cancellation should be specified in the contract. Not every contract will continue as expected. It may be that a long-term contract becomes unprofitable and one party desires to cancel. It may be that the performance of suppliers is such that a contract dependent upon that performance needs to be terminated. It may be that the parties merely want to be able to terminate the relationship at will upon certain notice. All of these matters should be specified in the contract and the consequences, if any, should be addressed.

(e) Authority; Execution. The parties need to be sure that the other person signing is authorized to do so or, at least that it is reasonable to assume such authority. A sole proprietorship acts through its owner. A general partnership acts through its partners any of whom by law can bind the partnership. A limited partnership acts through its general partner, and that capacity should be acknowledged. A corporation acts through its officers, but the authority of other than senior officers, the president or vice presidents, should be verified. An LLC acts through its members, if member managed, or its managers if board managed or if the members have appointed managers. Since it is not always clear how an LLC is structured, the authority should be verified. Verification can be in the form of a representation or warranty in the contract.

If you are signing on behalf of an entity, be sure that it is clear and that your capacity is clear as well. Especially with form contracts, it may be necessary to write in the pertinent information. Since it may be unclear to the other person whether you are signing as an individual or on behalf of an entity and since they be relying on your performance or responsibility as an individual, courts have held signers to be individually liable unless certain signing formalities are observed. Both the entity and the signers capacity should be included. The safe form of execution, therefore, is:

"ABC [Inc., LLC, LLP, LP, or Partnership]

By: _____________________

Joseph Smith [President, Member, Manager, General Partner]"

(f) Writings. Most contracts contain what is called an "integration provision" which states that the writing is the entire agreement between the parties and supercedes all prior written or oral agreements. There also, typically, is a provision that states that all amendments must be in writing and signed. Recognize that these provisions cover the initial contract as well as future modifications! If a verbal understanding is not contained in the agreement itself, it may not be enforceable. Similarly, addenda and exhibits which alter the terms of the basic contract may not be enforceable if not signed or initialed by the parties. Any handwritten, marginal changes to a form contract likewise should be initialed. If an oral understanding is reached during the course of the contract and a formal amendment is not practical or possible, a short letter confirming the understanding may provide critical documentation should there be a later dispute. Recognize that people come and go, and the person with whom you have a clear understanding and terrific relationship may be gone when it is time to enforce the contract.

IV. Knowing Which Labor and Employment Laws Apply.

Labor and employment law is an ever-developing field, filled with possible traps and snares for the employer. While it is beyond the scope of these materials to discuss all of the significant labor and employment laws which affect small businesses, at a minimum the business owner should know which laws apply to his or her venture. Below is a summary of labor and employment laws, with references to how many employees the employer must have before the laws apply.

Discrimination laws:

Title VII (federal race, color, national origin, religion and sex discrimination law, including sexual harassment):

15 employees in each of 20 consecutive calendar weeks of the preceding or current year

Equal Pay Act (federal law concerning wage discrimination between men and women):

1 or more employees

ADEA (federal Age Discrimination in Employment Act):

20 employees for each working day in 20 consecutive calendar weeks in the current or preceding calendar year

ADA (federal Americans with Disabilities Act):

15 employees in each of 20 consecutive calendar weeks in the current pr preceding calendar year

Tennessee Human Rights Act (Tennessee state law forbidding race, sex, age and disability discrimination):

8 employees (full-time or part-time)

Tennessee Maternity Leave Act:

100 full-time employees at the site where the employee works

Family and Medical Leave Act (FMLA)(federal leave and reinstatement law for serious health conditions and birth or adoptions):

50 employees during 20 or more calendar weeks of the current or preceding year;
and the employee must have worked at least one year, and at least 1250 hours in the last year

Fair Labor Standards Act (FLSA)(federal wage and hour law – overtime and minimum wage):

1 employee, if the employer is engaged in interstate commerce

Tennessee Workers' Compensation Law:

5 employees

Tennessee Unemployment Compensation Law:

1 employee

Tennessee Jury Duty Statute:

5 full-time employees

Tennessee Plant Closing Notification Laws:

50-99 full-time employees

WARN Act (federal plant closing notification laws):

100 full-time employees

Occupational Safety and Health Administration (OSHA):

1 employee

Immigration Reform Control Act (ICRA):

1 employee

COBRA (federal continuation of group health insurance benefits law):

20 employees on a typical business day in the preceding calendar year

Tennessee statute concerning conversion of group health insurance:

1 employee

V. Conclusion.

Even the most businessman who has ironclad contracts and keeps files full of written documentation will be subject to perhaps unexplainable liability. While this discussion has touched on a variety of legal issues and suggestions, the one we would most wish to emphasize in conclusion is to consider carefully the structure of your business or businesses, so that if your worst nightmare should occur, you have isolated liability and retained the ability to walk away and start afresh.

View all articles by Bob E. Lype