The Consequences of the Corporate Self-Inflicted Wound

Liability Protection and Its Formalities

One of the main reasons clients ask us to form corporations or limited liability companies (LLC) is for the liability protection afforded by those entities. This is the so-called “corporate shield” or “corporate veil,” despite the fact that this protection is available to both corporations and LLCs.

And, yes, this is an excellent protection for the owners of the entities. Essentially, the owners’ personal assets are not available to creditors of the entities, only the assets of the entities themselves.

But what many fail to realize is that this protection is not indefinite. The owners, known as shareholders for corporations and as members for LLCs, must respect the separate identity of the entity. Under California law, each of these entities is a “person” separate and apart from the owners so long as all corporate or company formalities are honored. One of those formalities is keeping the entity “active” as defined by the secretary of state.

To be active, all of these entities must:

  1. file a Statement of Information with the secretary of state every year for corporations and every other year for LLCs;
  2. pay the annual fee of $800 regardless of whether the company is profitable or doing any business; and,
  3. file tax returns for the entity with the state of California.

Failure to do any of these things can result in your entity’s status going from “active” to “suspended.”

And there are hefty consequences for being suspended.

Consequences If Your Entity Is Suspended

The Court of Appeal in the case of Cal-Western Business Services Inc. v. Corning Capital Group (2013) ruled, “A corporation that has had its powers suspended ‘lacks the legal capacity’ to prosecute or defend a civil action during its suspension. The ‘corporate powers, rights and privileges’ of any domestic corporate taxpayer may be suspended for failure to pay certain taxes and penalties. (Rev. & Tax. Code, § 23301.)

What Does This Mean For Your Business?

This means the suspended corporation cannot sell, transfer, or exchange real property in California, and contracts entered into during the time of suspension is voidable through legal action. Nor, during the period of suspension, may the corporation prosecute or defend an action, seek a writ of mandate, appeal from an adverse judgment, or renew a judgment obtained before the suspension. The purpose of Revenue and Taxation Code section 23301 is to ‘prohibit the delinquent corporation from enjoying the ordinary privileges of a going concern,’ and to pressure it to pay its taxes.’”

Thus, if you are delinquent on sending in the Statement of Information for your entity, it might get suspended, which means that it can’t sue anyone or even defend itself, and any contracts that the entity signed while it was suspended can be voided or set aside.

Talk to a Santa Clarita Corporate Law Attorney at Kanowsky & Associates

These are not the only corporate formalities, but they are often the ones that I see entities fail to follow, resulting in the corporation or the LLC being suspended. And, frankly, if I’m representing a client in a lawsuit and I find out the LLC on the other side is suspended, I use that as a valuable weapon. I have gotten lawsuits dismissed or claims for hundreds of thousands of dollars reduced to $10,000 or less. Self-inflicted wounds are the worst because they are so easy to avoid. ©

Are you a business owner in the Santa Clarita Valley? Our corporate formation and operation lawyers at Kanowsky & Associates are backed by years of experience and ready to advise you. Contact us online or call (661) 449-2297 to schedule a consultation. Se habla Español.

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