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THE AMERICAN SYSTEM OF BUSINESS:
LIMITED LIABILITY ENTITIES
Introduction:
Most of our clients are
interested in entering into business in America, hoping to try their
skill and luck by competing in the largest and most open market in the
world. Most are also confused by the myriad state and federal regulations
and the seemingly chaotic legal system that results in massive litigation
being filed constantly and seems to require written contracts for even the
most simple transactions. To people used to a business climate where a hand
shake is all that is needed to confirm a transaction, the American system
seems absurdly complex, formalistic, and hostile.
But if that was truly
the case, the United
States would not be the economic giant
that it is. The American system works precisely because it is not chaotic.
The rules are different than in the rest of the world, but are fully
predictable and easily integrated into a business context. With the right
planning, it is easier to do business in the United States
than anywhere else in the world.
Structure of Business Entities
As in much of the
world, most businesses in the United States are formally
organized into legal entities that engage in particular businesses. Most
businesses are either sole proprietorship (owned by one person), general
partnerships (two or more people engaged in business under a written or
oral agreement), or, more commonly, the entities which allow for limited
liability, namely corporations, limited liability companies,
or limited partnerships. All the types of entities described
above are easily formed and easily run, and the choice of which to use
depends on the risk an owner wants to take, tax considerations, and how
many people will be involved in the ownership.
Most entities can be
created in a matter of days and the creation normally involves filing
certain documents with the taxing and government authorities, executing
either an agreement or creation documents, and learning the mechanics of
managing the structure.
The most important
factor is usually whether the entity has limited liability. What
this means is whether a debt or legal judgement against the entity can be
applied against the individual owners. In the case of sole
proprietorship and general partnerships, a judgement against the
entity is the same as a judgement against the individuals owning it and
each individual is fully liable for all debts of the entity. In the case of
corporations, limited liability companies and limited
partnerships, this is not the case: a judgement against the entity
should have no direct effect on the individual assets of the owners so long
as they did not execute personal guarantees or violate the rules for
running the entity.
The ability to limit
your exposure and not "risk everything" in the business is a
crucial advantage to selecting an entity with limited liability and we
normally recommend that businesses commenced in the United States be
corporations or limited liability companies.
Litigation and the United States
Judicial System
The United States is
justly famous for two central aspects of its business life: first, a
vibrant and free economy that allows most people to engage in an open and
fully developed economic life; and, second, a legal system which is
extensive, expensive and subject to trial by jury with potential punitive
damages being assessed against the defendant.
In the United States,
any person has a right to commence litigation against any other person and
being sued is a common experience for the person engaged in business,
whether domestic or foreign. If you engage in business on a regular basis
within the United States,
or if the wrong complained of is alleged to have occurred in the United States,
you are subject to jurisdiction of the United States Courts.
Unlike much of the
world, the party that wins in the United States normally does NOT
receive attorneys fees and costs incurred from the losing party. This
means, of course, that litigation is much more likely to occur since even a
party with even a weak case can risk filing suit without risking paying all
the attorneys fees of both sides.
Further, if a party is
accused of unethical or fraudulent activity, even in a business context,
the other party is allowed to seek "punitive damages" which are
levied against a defendant to punish them for such wrongful conduct.
Punitive damages are not based on the amount in dispute, but on the
jury’s opinion of how much would "hurt" the defendant
enough so that they will no longer engage in such activity. Thus, a one
hundred thousand dollar judgement for fraud could easily have a five
million dollar punitive damage levied. This firm has achieved such verdicts
in the past and it is not that uncommon.
No other jurisdiction
in the world allows such damages and it should be recalled that it is a
jury (a panel of average citizens required to appear and judge the matter
by majority vote) that will determine if punitive damages are appropriate
in most cases.
Protection Against Legal Risks: the
Four Steps
It is the combination
of the attractive business market combined with the danger of expensive
litigation that creates the dilemma faced by many potential business
owners. The rewards appear great but the risks seem remarkable. However,
it is relatively easy to create a system of structures and practices that
minimizes the risks without interfering with the ability to do business.
One simply must carefully plan how to commence business in this particular
market.
We feel that there are
four basic steps to maximize your protection:
The first step is to create an entity that has
limited liability and to adhere to the rules that maintain such limited
liability.
The second step is to obtain good liability
insurance and to carefully shop the various insurance policies available.
The third step is to utilize a series of form
contracts (written documents executed by all interested parties) that
radically alter the litigation forum and dangers one faces. For instance,
one can provide in the contract that the losing party pays the attorney
fees of the winning party. Further, one can eliminate the danger of a jury
trial by providing that arbitration (a private trial which is enforceable
in a court of law) will be used to resolve disputes rather than litigation
in the American courts. One can even contractually ban punitive damages.
Lastly, one creates a "team"
of professionals comprised of attorneys, certified public accountants and
bankers, to provide resources and advice and one consults with them before
any significant move is undertaken.
The four step method of
commencing business in the United Stated radically alters the cost benefit
analysis and should be undertaken by anyone seeking to enter the United States
as a business.
Preventative Law
One reason the United
States dominates the world economy is that instead of governmental
directives created to control the economic market it uses a "market
approach" to control by allowing the participants free access to the
Courts. By means of judgements obtained against each other rather than
governmental decree, the system maintains its relatively open and ethical
ethos. Thus the car companies who secretly ignore product defects face
massive punitive damages. Thus the cigarette companies who hide the results
of their health studies and lie about the effects of smoking now face
billions of dollars in punitive damages.
Whether one likes the
system or not, if one is to do business in the United States one must master
the system and use the numerous tools available to minimize the risk and
maximize the benefit. One business person put it well: the only real first
class citizens in the United
States are the corporations.
The most important
lesson to remember is this: if you prepare for the risks ahead of time, the
cost of preparation is a fraction of the cost of not being prepared. To
seek to enjoy doing business in the United States while ignoring the needs
for legal and contractual protection is to expose oneself to the
vicissitudes of the market and be subject to the vagaries of the jury
system of law. In that light, creating the right structure is a necessity,
not a luxury.
These Articles are
to give the reader a general description of certain areas of the law. Legal
advice is necessary to apply these legal concepts to your particular
situation. The Reader should obtain competent legal advice before
relying on the Articles.
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