This is Why You Incorporate

HagenowIndividuals looking to start a business often question whether it is worth the hassle and expense of actually setting up a corporation and drawing up the necessary papers to establish that corporation particularly when the business is “just me.”  Traditionally the reason for going to that trouble and expense focuses on making sure that the individual, and therefore that individual’s personal assets, cannot be seized by creditors of the business in order to satisfy debts owed by that company.  If the company has not been set up and run as a separate legal entity, then the law looks at the company’s assets and the individual’s assets as being one and the same, and a creditor of the company can look to the person’s individual assets to pay any debt owed to that creditor.

Nevertheless, people still question whether it is truly worth it to incorporate.  We generally counsel people that it is well worth spending a little money to help protect personal assets; almost like an insurance policy that you buy and hope that you never have to use.   At the same time, after the corporation has been established, it must not co-mingle its assets with those of the individual owners.  In other words, it is important to keep things in separate “buckets” so that there can be no question what assets belong to the company and what is the property of the individuals.  The more “blurred lines” there are, the more chances there are that a company’s creditors will look to the personal assets of the owners.

A recent Indiana case has reinforced the principle that Indiana courts recognize the separation between a company and its individual owners.  This is true even if there is only one owner of the corporation.  The case actually involved a classic slip and fall that was suffered by the president and sole owner of a corporation.  That corporation was a tenant in a commercial building.  The corporation had the same name as the owner.  In the lease, the corporation had agreed that the landlord was not liable to the “tenant” due to any negligence of the landlord.  Believe it or not, these types of releases are enforceable under Indiana law when included in commercial leases.

The lease at issue in this case was signed by the person who had fallen, but he signed in a representative capacity, i.e., as the president of the corporation/tenant.

After the slip and fall occurred and the president of the corporation was injured, he filed a lawsuit against the landlord for negligence in failing to clear the snow and ice from the sidewalk in front of the building. The landlord filed a motion asking the court to rule as a matter of law that the release in the lease prevented the injured individual from filing the lawsuit due to his relationship with the tenant.  The trial court and the Indiana Court of Appeals both rejected the landlord’s argument.  The Indiana Court of Appeals noted that the lease was only between the tenant corporation and the landlord.  The injured person was not a party to the contract.  In addition, the Court of Appeals rejected the landlord’s argument that the plaintiff and his corporation were “interchangeable” because the corporation was a small professional corporation that bears the same name as the plaintiff.  On this issue, the court specifically noted:

If we accepted this argument, the corporate form of numerous professional corporations in this state, such as medical and legal practices, could and would be ignored routinely.  That is not a tenable result, and it is contrary to the laws providing for the creation of such corporations and their recognition as legal entities separate from their creators, shareholders, and officers.

The Court of Appeals therefore ruled that the injured individual’s lawsuit could proceed against the landlord.  While there may be other reasons why that individual may not succeed in the lawsuit, the important point made by this decision is that courts will continue to recognize that a corporation, even if it consists only of one person, is a separate legal entity from the individual owner of that corporation, and will continue to be recognized as such so long as the owner follows the proper formalities and does not “blur the lines” between the business of that corporate entity and the owner’s personal business.  Therefore, it is well worth the effort and limited expense involved in establishing a separate legal entity to protect not only one’s individual assets, but also potential claims that the individual may have against others.