Chapter 6: Legal Aspects of Running the Business

I.   Conflicts, Legal Versus Nonlegal Advice, and Limited Liability

§6.1   Conflicts. Counsel for a closely held business likely will get to know the various individuals participating in the business. Often, one or more of these individuals will hold more than one position. They may be shareholders (members in a limited-liability company (LLC)), directors (managers in an LLC), officers, and employees. They may ask counsel for advice on a proposed action without recognizing that counsel is not representing them. Understanding this is critical when different participants may have conflicting interests in the proposed action.

For example, consider the common practice of including in the corporate and LLC articles a provision that limits director and manager liability to the entity. What if a shareholder asks whether this provision should be included? Your advice will likely be different depending on which participant you represent. Counsel for a shareholder who is not also a director might advise its client against insulating the directors from this responsibility. Counsel for a director might take the opposite view. In addition, counsel for the entity might view this in yet another way, being principally concerned with the effective and ongoing functioning of the enterprise.

Counsel needs to (1) keep in mind whom counsel is and is not representing, (2) make certain that the participants understand who is and is not represented, and (3) advise unrepresented participants to seek independent counsel. See MRPC 1.13.

Legal versus nonlegal advice. Successful business lawyers will be trusted advisors to the people who run the closely held business. Those people may ask counsel questions that are not really legal questions, such as counsel’s opinion about insurance, record-keeping and accounting procedures, the market value of property, the advisability of investing in a new line of business, and whether the workforce should be expanded. Counsel need not shy away from addressing these subjects if counsel feels capable to do so, but they should explain that counsel’s opinion is not legal advice.

Limited liability of owners. Limited liability of the owners is almost always an important concern of owners and a primary reason they prefer organizing a business as an LLC or a corporation. Counsel for an owner should be prepared to advise the owner-client on how to preserve this limited-liability protection. Preserving this protection means much more than holding annual shareholder meetings. The following sections explain how other owner actions may in fact be much more significant to preserving limited liability than holding annual meetings.

LLC versus corporate statute. The Michigan Business Corporation Act (MBCA) has a number of detailed provisions governing shareholder and board of director meetings and decisions. In addition, the MBCA specifies which of these may be varied by the articles of incorporation, bylaws, or a shareholder agreement.

The Limited Liability Company Act (LLCA), on the other hand, provides little guidance on these matters. Few statutory requirements apply to actions on distributions, redemptions, or amendments to the entity’s organizational documents. Only one section even mentions meetings and meeting notices. Section 403 requires that a manager may be removed for cause only at a “meeting” held for that purpose and that the manager be given “reasonable advance notice” of the allegations. See MCL 450.4403.

Nevertheless, third parties, such as banks, may expect or demand that the LLC act in a more specific and formal manner than the LLCA requires. Counsel for the entity must determine whether the procedures required by these third parties conform to the applicable statutes and entity documents.

Consider giving your client an introductory letter that alerts the client to various features of doing business in the entity form. If you do not represent those receiving the letter, make that clear and remind them of their ability to seek independent advice.

Sample letters are included as form 6.1 (Letter to Client Explaining Corporation), form 6.2 (Letter to LLC Client Explaining Multimember, Member-Managed LLC), form 6.3 (Letter to LLC Client Explaining Multimember, Manager-Managed LLC), form 6.4 (Letter to Individual Member Client Explaining Single-Member, Manager-Managed LLC), and form 6.5 (Letter to Individual Member Client Explaining Single-Member, Member-Managed LLC). These letters discuss limited liability and give examples to illustrate the points discussed in this section.

II.   Maintaining the Limited-Liability Shield

A. In General

§6.2   Limited liability in this context refers to the statutory rules stating that entity owners are not personally liable for entity obligations. It is misleading, if not incorrect, to say that forming a corporation or an LLC creates limited liability for its owners. Formation, by filing articles, merely gives the owners the opportunity to maintain limited liability as long as the entity is operated without fraud and with sufficient attention to separateness from its owners. All the criteria for shield piercing relate to how the owners act after the entity’s articles are filed and are all entirely within the owners’ control.

If your owner-client has chosen limited liability for the business entity, your owner-client will not want to lose it. At the same time, your owner-client and other participants will not want to bother with “unnecessary” notices of meetings, waivers of notices, drafting and redrafting of minutes, and so on. You must tell your owner-client what steps are necessary and advisable to achieve the client’s desired level of comfort in maintaining the limited-liability shield.

As counsel for any individual, whether shareholder, director, or employee, keep in mind three key limits on the protections offered by the entity’s limited-liability shield.

First, this limited liability does not protect a person, owner or otherwise, from liability for that person’s own negligence. Individuals remain responsible for their own carelessness, regardless of whether they are acting as an agent. For example, a corporate president who carelessly causes an automobile accident on the way to a corporate business meeting would be personally liable for negligence. It would make no difference that the president was acting within the scope of the president’s authority as an agent of the corporation. In addition, the injured person does not need to pierce the corporate shield to hold corporate officials liable for their individual tortious misconduct. Department of Agric v Appletree Mktg, LLC, 485 Mich 1, 779 NW2d 237 (2010).

Personal negligence can consist of negligent supervision or training. The limited-liability shield would not protect an active owner from liability for negligent supervision of others. If your individual owner-client is personally active in the business and there is a significant risk of tort liability from the owner’s actions, operating in a limited-liability entity may not provide the kind of protection your owner-client expects. For example, if someone is injured on a jobsite being run by your client’s construction company, and your owner-client was personally on the job site, your client may face a negligent-supervision claim.

Second, the limited-liability shield does not protect a person from that person’s personal contractual promises, such as a guaranty of a lease or loan to the company. In an action alleging that officers of a corporation had personally guaranteed the entity’s debts, the court of appeals noted the “nearly universal practice” that an individual officer or shareholder is liable for the corporation’s obligations only if that person signs individually. Livonia Bldg Materials Co v Harrison Constr Co, 276 Mich App 514, 523, 742 NW2d 140 (2007) (quoting Geresy v Dommert, No 243468 (Mich Ct App June 3, 2004) (unpublished)). The court stated that this individual signing is typically indicated when the person signs twice, once as an officer and once as an individual. The corporate officer signed only once, with the title of president under his signature. Therefore, the court held that there was no personal guarantee of the corporation’s debts. Id. at 524.

Third, an agent of an entity may also incur personal liability when the entity does business under any name other than the complete LLC or corporation name (including the “LLC” or “Inc.” at the end) without filing an assumed name certificate with the state of Michigan. Any name other than the complete name of the entity is an “assumed name.” Both the MBCA and the LLCA require filing an assumed name certificate for that name. The filing is good for five years. The state will send the filer a notice when refiling is needed to extend the certificate. See MCL 450.1217, .4206.

Note that this applies even if the agent omits only “LLC” or “Inc.” from the name. For example, if your owner-client’s entity name is “Amalgamated Industries, LLC,” and the client’s website, business cards, stationery, etc., refer only to “Amalgamated Industries,” the entity is doing business under an assumed name and the statute requires filing an assumed name certificate.

In addition, the failure to file the certificate creates the possibility of personal liability on the entity’s employees and owners. This liability is not statutory. Michigan cases base this liability on the common-law rule that an agent has personal liability for the agent’s actions on behalf of an undisclosed principal. See Harmon v Parker, 193 Mich 542, 545–546, 160 NW 380 (1916); Detroit Pure Milk Co v Patterson, 138 Mich App 475, 478–480, 360 NW2d 221 (1984).

Entities offer different degrees of limited liability. In corporate and LLC entities, the owners (shareholders or members) have no liability for the entity’s obligations. But compare the MBCA and LLCA sections, as they have some subtle wording differences that Michigan courts have yet to explain. Compare MCL 450.1317(4) with MCL 450.4501(4).

In a limited-liability partnership (LLP), the statutory limited-liability shield was dramatically expanded effective August 1, 2018. See MCL 449.46. For LLP liabilities arising on or after August 1, 2018, partners in a registered LLP are not responsible for any partnership liabilities and are not liable for contract or tax obligations of the registered LLP arising after that effective date. This dramatically expanded the liability protection for partners and brought Michigan into line with the large majority of other states.

For LLP liabilities arising before August 1, 2018, the limited-liability shield applies only to certain tort obligations and does not apply to tax or contractual obligations of the partnership. See the discussion of LLPs in §2.8. In a limited partnership, the limited partners are not liable for partnership obligations—but only if the limited partners do not participate in the control of the partnership.

Some corporate and LLC agents can be protected against monetary liability to the entity and its owners for certain types of personal negligence in managing the entity if the appropriate statutory language is placed in the articles (or alternatively, for LLCs, in the operating agreement). See MCL 450.1209, .4407.

What are the consequences of losing the limited-liability shield? The owners will incur personal liability for one or more entity obligations with possibly disastrous financial consequences. The entity and its owners may suffer adverse tax consequences if the state or the Internal Revenue Service (IRS) recharacterizes entity income and expenses as personal income and expenses. Deductions can be lost, marginal tax rates can increase, interest and penalties on overdue taxes can be imposed, etc. In summary, losing the shield causes a general failure of the very reasons for which the owner-client chose that entity in the first place.

B. Corporations

1. Piercing the Corporate Veil

§6.3   Shareholders are not liable for corporate obligations. MCL 450.1317(4). Destroying this corporate limited-liability shield is commonly referred to as “piercing the corporate veil.” Michigan courts have addressed corporate veil piercing in an almost endless variety of facts. See Herman v Mobile Homes Corp, 317 Mich 233, 26 NW2d 757 (1947) (corporate veil pierced, and court listed 17 factors to consider); Green v Ziegelman, 310 Mich App 436, 873 NW2d 794 (2015) (court pierced liability shield of single-shareholder corporation); Glenn v TPI Petro, Inc, 305 Mich App 698, 854 NW2d 509 (2014); Department of Consumer & Indus Servs v Dineschandra Shah, 236 Mich App 381, 600 NW2d 406 (1999); Burrows v Bidigare/Bublys, Inc, 158 Mich App 175, 404 NW2d 650 (1987) (corporate veil not pierced in professional corporation).

The traditional analogy of limited-liability protection to a “veil” might suggest that the protection is translucent and mysterious, but there is nothing translucent or mysterious about the statutory language giving this protection. This text uses the better analogy of a “shield”—something solid that a corporation or LLC gives to its owners.

Despite the many different factors a court typically examines, one factor is always required: a plaintiff must show fraud to pierce the limited-liability shield. Dutton Partners, LLC v CMS Energy Corp, 290 Mich App 635, 802 NW2d 717 (2010).

The decision in Florence Cement Co v Vettraino, 292 Mich App 461, 807 NW2d 917 (2011), is worth noting because it lists at least eight different ways that the corporation and its individual shareholders failed to keep corporate financial operations distinct from those of the shareholders. Besides finding the necessary fraud, significant defects included the following:

1. a failure to follow sufficient corporate formalities beyond the filing of the articles of incorporation;
2. severe undercapitalization;
3. a pervasive failure to document transactions between the owners as individuals and the corporation; and
4. a general failure to keep financial records of the corporation separate from those of the individual shareholders.

The fraud and each of the listed items above were all within the control of the owners.

2. Requirement to Keep Minutes

§6.4   The MBCA contains several specific requirements regarding corporate formalities. Under MCL 450.1485, a corporation must keep (1) books and records of account and (2) minutes of the proceedings of its shareholders, board, and executive committee, if any. The statute fails to define books and records (let alone how those two terms are different, if at all) and gives no guidance on the required content of minutes.

Would a court pierce the entity’s limited-liability shield merely for failure to keep minutes of one or more shareholder or director meetings? Probably not. The failure to follow corporate formalities appears to be only one of many factors that courts would consider in shield-piercing cases, and fraud appears to be a necessary element. Nevertheless, counsel should remind entity clients of this statutory obligation to keep financial records and minutes. The entity may take action without a meeting by signing a written description of the action (called “actions by written consent” in the statute) instead of minutes of actual meetings.

3. Requirement for Annual Shareholder Meeting; Consequences of Failure

§6.5   The MBCA requires the shareholders to hold an annual meeting. MCL 450.1402. Would a court pierce the entity’s limited-liability shield for failure to hold one or more annual shareholder meetings? No. Fortunately, the statute states that the failure to hold the annual meeting at the designated time does not affect otherwise valid corporate actions. MCL 450.1402 also provides that the failure does not work a “forfeiture” or give cause for a dissolution of the corporation, except as MCL 450.1823 may provide. MCL 450.1823 permits a circuit court to dissolve a corporation on proof of both of the following:

1. the directors of the corporation are unable to agree on material matters respecting management of the corporation’s affairs or the shareholders of the corporation are so divided in voting power that they have failed to elect successors to any director whose term has expired or would have expired on the election and qualification of their successor and
2. as a result of a condition stated in (1), the corporation is unable to function effectively in the best interests of its creditors and shareholders.

Note the protection this gives to a corporation that has not documented annual shareholder meetings or even board meetings for a period of years but has nevertheless functioned effectively without serious unresolved disputes among the directors or shareholders. The statute does not allow attacks on such a practice without a showing that the corporation is not able to function. Therefore, counsel to a shareholder should be careful not to overstate the risk of failing to carefully document formal meetings, especially when the shareholders may also act as the directors and principal employees of the business.

Dissolution may impose personal liability on the shareholders if the statutory procedures for dissolution are not followed. See the discussion of corporate dissolutions in chapter 11. A pattern of failing to hold annual shareholder meetings may contribute to a minority shareholder’s claim of oppression (see §6.17).

If the shareholders do not hold an annual meeting, the board of directors must schedule the meeting as soon as it is convenient. MCL 450.1402. A shareholder may ask the circuit court to order a meeting if the annual meeting is not held within 90 days after its designated date or if no date has been designated for 15 months after the corporation was organized or after its last annual meeting. Id. Furthermore, the shareholders who are present at that court-ordered meeting constitute a quorum for transaction of business regardless of the quorum rules in the corporate documents.

4. Board Meetings

§6.6   Unlike the required annual shareholder meeting, the MBCA does not require any meetings for directors, annual or otherwise. May a board of directors choose never to meet? Technically, yes, because a board can act by unanimous written consent instead of voting at a meeting. MCL 450.1525. The larger question would be whether the directors are interacting sufficiently to meet their duties to manage the corporation. The statute leaves the subject of regular and special board meetings up to the corporation’s bylaws. MCL 450.1521. Although the MBCA provides different rules for regular and special meetings, it fails to define the difference between a “regular” and “special” meeting. When drafting bylaws, counsel may want to consider defining the difference between regular and special meetings or dispensing with the regular or special distinction entirely when addressing meeting requirements.

Would always acting by written consent without ever holding a meeting satisfy each director’s fiduciary duties to act in the corporation’s best interests? It appears so, as the written-consent option is blessed by statute.

What about a closely held corporation with two directors who neither hold formal “director meetings” nor ever sign written consents to action without a meeting? For example, assume these two directors are also the corporation’s two shareholders and are full-time employees, one of whom is president and the other is vice president. They see each other every day, confer on every major corporate decision, and run the business successfully. Would these informed day-to-day contacts constitute “meetings”? Nothing in the statute would prevent the conclusion that they are.

Nevertheless, counsel for virtually any corporate participant would recognize that failing to document actions can leave important matters up to memory and subject to uncertainty. Counsel should help these people avoid these risks by helping them establish an efficient yet effective method of documenting their actions. After all, MCL 450.1485 requires documentation of director actions but does not define the required form or procedure for that documentation. See §6.40 for a discussion of how to correct a past failure to keep minutes and §6.42 for a discussion of ratification.

Meeting frequency and documentation detail will vary with each entity’s circumstances, including the number of owners and directors, the frequency of major actions, and the custom and comfort desired by the various corporate participants. Different people may have differing interests in the level of detail kept in corporate records. More detail on director meetings is provided in §§6.34–6.37. Note that the MBCA allows shareholder meetings, but not director meetings, to be held entirely through electronic transmission. Compare MCL 450.1405 with MCL 450.1521.

5. Officer and Committee Meetings and Actions

§6.7   MCL 450.1485 does not require minutes of officer actions or committee meetings (other than the executive committee). Counsel for a corporation with committees may want to advise the entity to document at least briefly that the committee met and what actions or recommendations were made. This can be done easily by referring to those activities in the minutes of a director meeting (or action by consent). This is especially important if your entity client uses an executive committee to make certain decisions without first consulting the entire board. The MBCA does allow committees to have board powers with certain exceptions. See MCL 450.1528.

C. Limited-Liability Companies

1. Piercing the Limited-Liability Shield

§6.8   A member or manager of an LLC is not liable for LLC obligations. MCL 450.4501(4). This is essentially the same “full” limited-liability protection that corporations offer to shareholders. Unlike corporations, however, liability shield-piercing cases involving LLCs are not nearly as well developed. Most commentators agree that the LLC limited-liability shield would be pierced in generally the same circumstances as it is for corporations. If so, first determine whether the necessary fraud element was present. Then, look for the same factors that the courts examine in corporate shield-piercing cases (described in §6.3). See Lakeview Commons Ltd P’ship v Empower Yourself, LLC, 290 Mich App 503, 802 NW2d 712 (2010) (piercing claim against LLC denied, but successorship claim could go to jury).

2. Lack of Statutory Guidance

§6.9   LLC shield piercing should be no different from the corporate context, with one significant exception. The MBCA provides detailed specific guidance on many corporate formalities, such as notices of meetings, how notices may be given, voting procedures, waivers of notices, rights of certain entities to vote interests, meeting adjournments, and who runs meetings. The Michigan LLCA, however, provides almost no guidance whatsoever on these matters. For example, the LLCA has no annual member meeting requirement.

When comparing the two statutes, you may conclude that an LLC needs no meetings, minutes, signed actions by consent, or other documentation. Technically that would be correct because the LLCA does not address these matters. Careful counsel should advise against ignoring these procedures. The LLCA does not tell you to ignore documentation of LLC formalities; the LLCA is merely silent on the subject. Advise your client-member and client-manager to document appropriate actions periodically, at the very least annually. See §§6.45 and 6.46 for more detailed suggestions.

This lack of specific guidance for LLCs gives you the advantages of flexibility, simplicity, and efficiency. But that same lack of guidance creates disadvantages for you and your client because the statute does not address many of the questions that are likely to arise in the ongoing conduct of the enterprise.

For example, assume a manager-managed LLC with three managers. Could two of the managers approve an action by less-than-unanimous written consent without a meeting and without informing the third manager? The LLCA does not answer this question. However, the MBCA answers the same question regarding corporate directors specifically and emphatically: directors may not act without a meeting by less-than-unanimous written consent. Consent without a meeting must be unanimous to be effective. MCL 450.1525. The rule is different for shareholders, cf. MCL 450.1407, and arguably may be varied for directors by a Section 488 agreement. See §6.44.

Whether you are counsel for the LLC, a manager, or a member, you should consider whether addressing these subjects in the operating agreement benefits your client. Exercise caution when requiring specific procedures for member and manager actions. Make sure your client is willing and able to comply with them. A judge may not sympathize with your client’s failure to follow the very procedures it imposed on itself. Even before actual litigation, it may certainly affect your leverage in resolving a governance dispute.

On the other hand, a long-established pattern of conduct might constitute a waiver of written requirements. Do you really want your client subjected to these fact-based disputes? Avoid them by tailoring your client’s written procedures to match your client’s business practices and preferences.

3. Manager-Managed Limited-Liability Companies

§6.10   Manager-managed LLCs will require more of your attention to formalities than will member-managed LLCs. A manager-managed LLC, like a corporation, has two levels of management: one level with authority to manage the enterprise (the managers who resemble in some ways corporate directors or general partners) and a second level with ultimate authority to control the managers (the members who resemble corporate shareholders or limited partners in some ways).

Managers owe the same fiduciary duties to the LLC that corporate directors owe to the corporation. Managers are not required to conduct any particular meetings under the LLCA, much like directors are not required to meet on any regular basis under the MBCA. Nevertheless, managers must take actions to run the enterprise, and those actions should be documented periodically.

D. General Partnerships

§6.11   Partners in a general partnership have no limited-liability shield to pierce because general partners are jointly and severally liable for the debts and obligations of the partnership. MCL 449.15. Even people who are not partners can be jointly liable if they are deemed “partner[s] by estoppel” under MCL 449.16. Under that section, nonpartners who nevertheless represent themselves as partners (or knowingly and silently stand by while letting others represent them as partners) can incur personal liability to certain third parties. Id. This rule also applies to LLPs and limited partnerships. MCL 449.2106.

E. Limited-Liability Partnerships

§6.12   The 2018 amendments to MCL 449.46 gave LLP partners full liability protection to partners for liabilities created on or after August 1, 2018. Michigan courts have not yet ruled on piercing the limited-liability shield created by a partnership that makes an LLP registration under MCL 449.44 of the Michigan Uniform Partnership Act (MUPA). The LLP registration is effective immediately on filing the election with the Michigan Department of Licensing and Regulatory Affairs (LARA), Corporations, Securities, and Commercial Licensing Bureau, Corporations Division, and is effective for one year. MCL 449.44. The remainder of MUPA contains no specific guidance on partnership formalities. Counsel for an individual partner should take care, however, to observe any procedural formalities for the LLP filing that may be in a written partnership agreement.

Remember that in Michigan a partnership can be created without a written agreement. Furthermore, the partnership does not need to have a written partnership agreement to be eligible to file an LLP registration.

The LLP statute requires that a majority in interest of the partners sign the LLP registration. Counsel for a partner will want a written partnership agreement to address whether filing of the LLP registration is required. In addition, counsel for that partner and the LLP will want to ensure that the filing was properly approved. If the LLP one-year effective registration period expires, the limited-liability protection expires at the same time. MCL 449.44.

F. Limited Partnerships

§6.13   Limited partners, like LLC members and corporate shareholders, are not responsible for partnership obligations unless the limited partner is also a general partner or the limited partner “takes part in the control of the business.” See MCL 449.1303 (Michigan Uniform Limited Partnership Act (MULPA)). If the limited partner’s participation is not substantially the same as that of a general partner, the limited partner is liable only to people who have actual knowledge of the limited partner’s participation in control. Id.

Fortunately, the statute contains a long list of activities that a limited partner may do without losing the limited partner’s limited-liability shield. See MCL 449.1303. Counsel for a limited partner can consult numerous cases discussing whether limited partners engaging in a variety of management actions were able to maintain limited-liability protection. Counsel for a limited partner should advise their client to follow whatever specific partnership formalities for meetings and other actions that may have been inserted into the written partnership agreement or listed in the filed certificate of limited partnership.