Previously, I have written on the importance of having a written contract, and on the importance of certain clauses, such as the choice of forum.
Of equal concern are issues involving a yachtsman’s status in the maritime world, such as whether he is a sole proprietor, also known as “on your own,” incorporated, or a limited liability company, more commonly known as an L.L.C.
A sole proprietorship is basically when a mariner works on his own without any formal, corporate standing. Sole proprietorships operate under the person’s name, such as David Jones, or even under a fictitious name, such as Davy Jones’ Locker.
Such names are available in each state and can be reserved forever for a nominal fee. In Rhode Island, the fee is a one-time cost of $50.
However, this status offers no protection for personal assets. Mr. Jones would be personally liable if ever David Jones or Davy Jones’ Locker is sued.
The next most common corporate status is that of a corporation or “incorporated”, also referred to as an “Inc.” This is the old-fashioned, typical way to limit liability. In fact, what happens when one “incorporates” is that under the law, he creates another person or entity. That entity has its own being, and a mariner would — or should — enter into all contracts in the name of that entity.
So, a supply store or traveling van that carries everything to clean a yacht might be called Davy Jones’ Locker, Inc. In all states, it is important to include the designation “Inc.” or “Incorporated” on all business cards, contracts and signs. Why? Because it designates the business and distinguishes the owner from operating as a sole proprietorship. Right? See how that flows?
The good thing about corporations or “Inc.”s is that if the corporation enters into a contract and then breaks it for whatever reason, even if the weather is bad and you could not get the job or delivery done in the stated time (a case I have seen on more than one occasion), a captain and his personal assets are not liable nor subject to seizure.
If the fellow driving that detailing van gets into an accident or there’s a vessel collision, the captain is typically not liable, although there can be some exceptions to this.
So, a corporation offers a captain far more protections than simply working under his own name or as a sole proprietorship. Many, many people start out as a sole proprietorship to see if the opportunity works out. Then, a year or big contract later, they form a corporation or LLC to gain the protections those entities offer.
The more recent type of corporate existence is that of an LLC, or limited liability company. However, these are poorly named as a limited liability company offers no more protection than that of a corporation. Even large, multi-national companies are becoming LLCs. For example, the storied Hinckley Yachts is now an LLC.
LLCs were originally created to offer the same protections as corporations, but with less paperwork. For example, there are no by-laws to follow if you are an LLC, but there are by-laws with every corporation.
Also, most states do not require LLCs to have annual meetings, but corporations, in order to stay in sound standing, are typically required to have annual meetings. The long and short of it is, at least in Rhode Island but also in and many other states, anyone wishing to be a corporation can be an LLC with less paperwork.
While LLCs typically have fewer requirements, both types of entities have certain requirements that must be followed. First, they must be created and registered with their home state.
Second, if doing business in another state, they typically must register with that state’s Secretary of State.
Perhaps most importantly, the LLC or corporation must keep its own corporate records. These are usually contained in a green or black book of corporate records. This is the history or experiences of the corporation or LLC.
Many times I have had someone walk into my office on Thames Street stating that they were a corporation or LLC, only to not have a record book reflecting this, or often have a record book that is blank inside. Often I hear that the accountant or lawyer who set up the entity “never told me” that there were requirements to record keeping when being an LLC or Inc.
Fortunately, that condition is easily repairable, because failure to follow these requirements can be shocking. Remember, a captain likely set up this corporate entity to limit his personal liability while working in the marine world or owning a vessel, a process known as the “corporate shield”.
That shield gets thrown out the window, typically, if you do not follow what are known as LLC or corporate “formalities”. This is where this gets interesting and all of what I say here can easily be confirmed or looked up online.
The process of getting around a corporation or LLC is known as “piercing the corporate veil,” that is, piercing the protections set up. It typically occurs when one does not treat the corporation or LLC as an entity separate and distinct from the person who created or operates it.
For example, besides the fact that that an LLC has its own records, so must the captain. An LLC should also have its own bank accounts, and not run its money just through the captains. It should also have its own credit card.
As I have said, an LLC is an entity separate and distinct from its creator. Years ago, whenever someone set up an LLC in Rhode Island, the credit card companies were tied into the Secretary of State’s office, so up to seven “pre-approved credit card applications” would flow in a week after the corporate entity was created.
Corporations and LLCs should have their own record book and keep records of all major transactions and occurrences, such as hirings and firings, the leasing or purchasing of vehicles, boats, leases, etc. Failure to do so can result in the dreaded “piercing of the corporate veil.”
The corporate record book should contain the by-laws or operating agreement of the LLC or Inc., stock certificates, records of corporate or LLC meetings, etc. If these are kept in good order, all is fine. Fail to keep them, and a captain may be subjected to the piercing.
The bible of corporation and LLC law is a series of books called Fletcher’s Cyclopedia of Corporate Law. It is found in all law libraries and it the size of the old World Book Encyclopedia. It is commonly cited in federal and state courts. Now, corporate law varies from state to state. Just what is enough for “piercing the corporate veil” in Maine may not be the same in California. But Fletcher’s gives a good outline of what to avoid doing wrong, and is certainly applicable in all federal courts. Here are a few tips:
Avoid “co-mingling corporate and personal assets”.
Issue “stock certificates”. These come free when you purchase a corporate or LLC record kit, yet many people and even some lawyers cut corners and fail to do this important step.
Keep corporate records, even if nothing out of the ordinary is happening. Corporate records of meetings amount to a one-page document on a laptop. After analyzing your business for the year, print it out, sign it in your official capacity and place it in your record book.
These factors are so important I actually keep a framed copy of this section of Fletcher’s on the wall of my office here in Newport. Of the four times in my legal career that I was called upon to “pierce the corporate veil”, including one that is now under way, I was successful each time based upon these factors, and persons who thought they were protected by their corporate status ended up being not so fortunate. More attention to what are deemed “corporate formalities” would have helped them.
Corporate formalities are like maintenance. You simply have to do it every year. It really does not take that long, only a few hours, and the protections they offer are immense.
Maurice Cusick has practiced corporate and maritime law in Newport for more than 25 years. Comments on this column are welcome at email@example.com.