Delaware Corporate Law Update

Updates on Delaware Corporate Law by Evan O. Williford, Esq., Delaware Corporate Litigation Attorney.

Registered Agents

Every business entity formed in Delaware – whether a corporation, LLC, or some other form – is required to have a “registered agent”.  A registered agent is a person or business physically located in Delaware that can receive documents and forward them on as necessary.

Why have a registered agent when someone can just send mail to business headquarters?  Because Delaware business entities and their managers can be sued in Delaware courts, someone must be present in Delaware to receive “service of process” (that is, typically the complaint along with a summons ordering the defendant to respond).  This reduces the risk that a business will intentionally avoid being served and thus having to defend itself in court.

There are many registered agents to choose from; they can be found quickly online and are often very inexpensive.  Some registered agents serve hundreds or thousands of businesses.

Once a registered agent has been hired, the business must designate that registered agent on a filing with the Delaware Division of Corporations.  A business can change its registered agent anytime by making a filing with the Delaware Division of Corporations noting the change.  You can find any Delaware business entity’s registered agent on the Delaware Division of Corporations’ website.

If a business entity fails to maintain a registered agent, then the Delaware Division of Corporations will serve as a fallback registered agent.  Eventually the entity’s certificate of incorporation or formation may be canceled, however, making it difficult or impossible for the entity to function legally.

Advertisements

Filed under: Basic Law of Corporations

Forming a Delaware Entity

So how does someone actually form a Delaware entity?  As it turns out, the actual tasks required to form one are not that expensive, nor do they take a lot of time.   But it is important to understand in advance why you want to form such an entity, as that will affect various choices you make along the way.  And, of course, it is always a good idea to get the advice of a qualified lawyer.

First, you must decide what kind of entity you want.  For example, do you want to form a corporation or a limited liability corporation (“LLC”)?  There are a number of other forms, though the ones specifically mentioned are among the most common.  We have discussed these common entity forms and their characteristics in a previous post – keep those in mind when selecting an entity form, do your own research and thinking, and seek qualified legal advice.

You will also need to choose a name for the entity.  That name will have to follow certain rules that you can find out from the Delaware Division of Corporations.  For example, obviously, it cannot be the same as an existing business.  There are other rules, such as that a corporation must including a word like “incorporated” or “corporation” (or an abbreviation like “inc.” or “corp.”).

If the entity will not have an office in Delaware, you will need to hire a “registered agent” and put their contact information on the forms you file with the Division of Corporations.  A registered agent is a person or company whose job it is to accept service of process if your entity is sued in a lawsuit in Delaware.  Hopefully that will never happen!  But the good news is that registered agents are relatively cheap.  A number of companies provide that service for a relatively low yearly price; information regarding them is available online.

It is a very good idea – and sometimes necessary – to put together certain organizational documents.  We have briefly discussed in a previous post what organizational documents are and how they create rules for that entity.  An attorney can help you do that, or you can look online for various resources, such as sample documents, to help you do that yourself.  If you are doing that yourself, be very careful to make sure that all the rules make sense for the entity you are forming.  Many lawsuits are caused or made worse when an entity has rules that apply not because they made sense for that entity, but because someone just adopted them without thinking about it!

Next, go to the Division of Corporations’ website and find out what they need from you to form your entity.  They will charge a filing fee, depending on what type of entity you want to form and whether you are in a hurry.  They will also tell you whether you need to file the entity’s organizational documents, and if so which ones.  When your paperwork is ready, mail or fax it to the Division of Corporations.

Now you have formed your own Delaware entity!  A Delaware entity has certain things it must do every so often in Delaware to maintain its good standing.  For example, corporations must file an annual report and pay a franchise tax; other entities similarly have to pay an annual tax.  Keep in mind there are a number of other things you may want or have to do that are outside the scope of this post, such as (1) getting an “Employer Identification Number” from the U.S. Internal Revenue Service; and (2) registering to do business in the State of Delaware, or another state.

Filed under: Basic Law of Corporations

Types of Delaware Business Entities and Limited Liability

The most well-known business entity, of course, is the corporation.  There are many others, however, such as limited liability companies (“LLCs”).  Each one has its own characteristics.  Which should a business owner choose?  That depends on their circumstances.

The corporation has a well-defined structure that most people dealing with it will be familiar with.  Its day-to-day business is run by certain key people called “officers.”  The officers themselves are hired, fired, and supervised by “directors,” who sit on what is known as a “board of directors.”  And the corporation itself is owned by “stockholders,” who can in turn elect the directors.

Another popular entity form is the LLC.  One of the big advantages of the LLC over a corporation is that it is possible to greatly customize how that LLC is structured, far beyond what is possible with a corporation.  With great freedom comes great responsibility, however.  Those forming an LLC should make sure that its structure, typically specified in detail in a document called an “LLC Agreement,” matches what is needed for the business.

Another consideration for those forming a business entity is taxation.  Some entities may elect with the U.S. Internal Revenue Service to pass income through to their owners, such as “S Corporations,” while others are taxed twice, once at the entity level and again at the owner level.  Those considering this issue should consult their accountants as to which tax treatment is best for them and what business forms qualify.

A key feature of many business forms is “limited liability.”  That means business owners are not generally liable for the business’s debts.  Thus their “liability” has been “limited”.  This was an important historical reason behind the rise in popularity of the corporation.  Investors wanted the ability to take risks by investing their money into a business without the possibility that if the business failed its creditors might go after them.

To form a Delaware business entity like a corporation or LLC, one needs to file the appropriate forms with the Delaware Division of Corporations, as will be discussed in another post.  But what happens if a business is run without creating a legal business entity?  The answer depends upon the state the business is operating in, but one possible result is the formation of a “sole proprietorship” or “general partnership”.  Such entities typically do not have limited liability.  That is one of many reasons it is important to properly form a business entity with a state like Delaware.

Filed under: Basic Law of Corporations

Governing Documents

While the state of Delaware creates rules that Delaware entities have to follow, all Delaware entities have some flexibility to create rules for themselves (though some, like LLCs, have more than others, like corporations).  They create those rules in “governing documents.”  What those are depends on what kind of entity it is.

Let’s start with the classic business entity, the corporation.  It typically has two core governing documents: (1) a “certificate of incorporation” (also called a “charter”); and (2) a “bylaws”.

The certificate of incorporation must be filed with the Delaware Division of Corporations (so it is “public” in the sense that anyone who wants to pay for a copy can get one).  This is a short document that must contain certain basic information or rules about the corporation, including certain details about the corporation’s stock and the name of the person forming the corporation.  It can also contain other rules, like eliminating directors’ liability to pay money for breaches of the fiduciary duty of care (we’ll talk about fiduciary duties in another post) or requiring the corporation to pay directors’ legal fees if they get sued.

The corporation can also have bylaws.  This is typically a longer document that contains more detailed rules, such as the procedures for its annual stockholder meetings and its board meetings, how stock is issued and transferred, and the duties of its officers.  If there is a conflict between the bylaws and the charter, the charter wins.

An LLC does not really have anything like a charter.  Rather, it is only required to file a “certificate of formation” with the Division of Corporations, which only needs to include its name and registered agent.  LLCs are sometimes preferred because of this additional privacy.

The primary governing document for an LLC is an “operating agreement” or “LLC agreement,” which basically serves as the LLC’s charter and bylaws all rolled up in one.  It is even more important because an LLC has much greater flexibility than a corporation to create its own rules.

There are many sample charters, bylaws, and LLC agreements on the internet.  But beware!  It can be very complicated to create business rules that work with existing law and to anticipate and provide for potential emergencies or disagreements.  If you are going to use a form, think very carefully about how you want the business to function and carefully edit the form accordingly.  But usually it is far better to hire a lawyer with business governance experience to draft the documents.  Once a lawsuit is filed it is too late to make rules that would have prevented it.  As Benjamin Franklin once said, “an Ounce of Prevention is worth a Pound of Cure.”

Filed under: Basic Law of Corporations

Why Delaware?

You may have noticed that many large U.S. and international businesses are incorporated in the U.S. state of Delaware.  (For that matter, the authors are Delaware lawyers.)  Why is that?  After all, Delaware is a small state and very few large businesses are headquartered there.

The United States of America has a federal system of government:  national law governs some subjects while state law governs others.  Business formation and governance (the way the business is structured and controlled) is one subject typically governed by state law.  Thus, each state has its own laws governing businesses formed in that state.

Delaware has a long history of laws allowing businesses to form the entities most appropriate for their needs.  Those laws are designed, and amended typically every year, to allow a flexible response to any business conditions that might be encountered while also protecting the rights of investors.

Delaware also has a separate court, the Court of Chancery, which over the years has evolved into a court that specializes in resolving many business disputes.  Cases involving Delaware entities, particularly regarding their formation and governance, will often be brought or transferred to that court.  Its five judges specialize in resolving those cases fairly and predictably under Delaware laws and the court’s past decisions interpreting those laws.  Therefore, a business has some assurance that if it forms in Delaware a lawsuit brought in that state of formation will proceed predictably.

For these reasons and more, businesses that are large or seek investment will often form in, or move to, Delaware.  Small U.S. businesses, particularly those that anticipate doing business only in one state, might consider forming in that state instead.

Filed under: Basic Law of Corporations, Uncategorized

An Introduction to Corporations and Other Legal Entities

Note — This is the first in an anticipated series of articles for laypersons about basic matters of the law of corporations and other business entities.  They may also make interesting reading for those with more knowledge.  Every now and then it is good to go back to the basics.

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?” — First Baron Thurlow Edwards

What are corporations?  Even those who don’t work with them hear about them a lot.  They send most of the bills we pay.  They open up new factories overseas.  Sometimes one corporation buys another corporation.  Sometimes we even talk about them like they are people.  But they are not like any human person you’ve ever met — you can’t shake their hand, nor can you “kick” their “body” (as Baron Edwards lamented).

One answer is that a corporation is an idea.  Ideas can be powerful things, even though they don’t physically exist.  Money is only green pieces of paper.  Yet people will do all sorts of things to get it, because money is an idea that everyone has in a sense agreed to share, that these little green pieces of paper can be exchanged for other things we want, like doughnuts, cars, or houses.  Similarly, the law and society have agreed to treat corporations, for certain purposes, like a human person.

In fact, a better question than “What is a corporation?” is “What is a legal entity?”  It doesn’t have as much ring to it (and the word “entity” might bring to mind a ghost or a Star Trek episode), but it is a better question because a corporation is only one kind of legal entity.  Other kinds are partnerships, limited liability companies, and trusts — to name a few.

Legal entities are fictional legal persons.  They have their own identity in the eyes of the law, for a number of purposes.  So when a corporation is running a business, like your telephone (or cell phone) company, for many purposes it is the corporation that is sending the bill, not each of the people working for it.  Even those who run or supervise it like its president or one of its directors.

And, like different people, different legal entities have their own characteristics.  For example, many legal entities, including corporations, have a feature called limited liability.  That is, the owners of a corporation (its stockholders) are not ordinarily liable for its debts if the corporation should fail.  That is a very helpful feature for investors, who are interested in paying $200 or $400 for a few shares of the next Microsoft — but don’t want creditors coming after their cars if it turns out to be the next pets.com.

Also, because the corporation or other entity is the business and not any of its employees or managers, they generally aren’t responsible for a corporation’s debts either.  Most (but not all) business entities are themselves taxed on their income, rather than their owners being directly taxed for that income.

It is these features that Baron Edwards possibly had in mind when he complained that a corporation has no body to be kicked and therefore cannot be expected to have a conscience.  But while a corporation itself is only an idea, and can’t think or do anything for itself, those who run and work for it can — and should — have the “conscience” to which Lord Barlow refers.

There are various ways the law has of motivating individuals (or “natural” persons) to not use the corporation as a tool to misbehave, or to fine or punish them if they do.  For a manager to make a business mistake in choosing a business model, causing the corporation to fail, is one thing.  Causing a corporation to dump toxic waste in the local river or pay bribes to government officials is another thing.  There are certain misbehaviors for which a corporation’s managers or employees can be sued or even criminally prosecuted for, even though they were working for the corporation on its business.  Also, managers and officers of a corporation have what is called a “fiduciary duty” to the corporation, and if they disobey that duty, causing harm to the corporation and thereby its stockholders, under certain circumstances and in extreme cases they can be sued for damages or other remedies.

Much of corporate law is set up to preserve a tricky balance:  preventing and redressing misbehavior, on the one hand, but at the same time encouraging business innovation and risk taking.  Risk-taking doesn’t always work out, but when it does can produce companies like Microsoft and innovations like new medicines and other technologies, which benefit everyone.

Filed under: Basic Law of Corporations

Pages

Disclaimer

Delaware Corporate Law Update solely reflect the views of Evan Williford of The Williford Firm, LLP. Its purpose is to provide general information concerning Delaware law; no representation is made about the accuracy of any information contained herein, and it may or may not be updated to reflect subsequent relevant events. This website is not intended to provide legal advice. It does not form any attorney-client relationship and it is not a substitute for one.