Small Business Pitfalls: Why Attorneys Make Cents

Most small business owners hesitate enlisting the help of an attorney until they’re forced to. It may be a cost perception, or it may feel like an indulgence your growing company can’t afford. There are a number of reasons, however, why having an experienced business law attorney at your side makes not just sense, but cents.

Here’s the first of a two-part series offering a number of reasons it makes the most sense to have an attorney right from the start.

Avoiding Unnecessary Complications

From the moment you decide to start a business, you begin reaching out to experts in a variety of areas to help you make sure you start out properly. Hiring the right attorney is likewise a sound investment in the future of your business. Working with new business owners is perhaps one of the most enjoyable aspects of my practice, because I can help you bring great ideas and exceptional talents to a waiting market while avoiding the snares and legal pitfalls that await you as you navigate the minefields of running a profitable operation.

Right Business Structure

My first step in helping a new business is to consult with you and discuss the different options available. Choosing what type of entity: corporation, limited liability company, or general partnership, is a crucial step. While most new business owners operate from the assumption that they may have to form a corporation, I work with my clients to understand the many reasons why an LLC can be a much sleeker way to do business for many, avoiding the annual reporting requirements while still getting many of the tax advantages of an S corp.

Filing Requirements and Contract Negotiations

When starting a new business, it’s absolutely crucial to understand the paperwork required - requirements not only from the IRS but at the state and local level too that you might not even be aware of.

I really appreciate when clients come to me asking for guidance about employment issues and contracts. Constantly changing laws have made the employer–employee relationship more complex, especially for businesses that hire independent contractors. If the contractor-employee line is crossed, it can create an IRS nightmare and an unpleasant exchange with the Washington Department of Labor and Industries. Not only will carefully considered policies and practices help your business avoid litigation, but they allow you to instill a sense of trust and leadership that will help you as you grow. When you care about your people and your partners, you must think about your legal relationships with them.

Next month, I’ll share more about the cents in hiring a business attorney.

Business Attorneys Are a Form of Indemnification

How many times do you agree to a company’s terms of service or sign an agreement without actually reading what you’re signing? While you may be willing to simply click the button and agree to the terms of service to create your account with Amazon and watch that movie you’re anxious to stream, the same attitude can cost your business more than you could imagine.

One of the most important aspects of owning your own business is protecting yourself from damages caused by other people. An experienced business attorney can help you protect your business and assets, creating a shield through carefully constructed language.

Let’s say you own a hotel and you’re having a contractor come in to do some work on the lobby and the contractor’s ladder falls, taking out a chandelier and injuring a guest. The contractor would be responsible for the damages, right?

That all depends on what kind of indemnification clause you agreed to in the contract you signed. I don't know how many times I have had clients come to me with contracts they’d signed without reading or understanding them, leaving them open to significant loss caused by the negligible hands of others.

In the hotel example, let’s say the contractor’s contract indemnified him, his employees and his company so that any damage done by his crew was the responsibility of the hotel. A contract constructed this way basically gave the contractor a get out jail free card with the hotel. The hotel would not only be responsible for the damages but liable for any civil suit brought by the guest. Without proper indemnification, you can be liable not only for the damage caused by the contractor, but also medical bills and other provisions if anyone is injured.

Properly constructed contracts that provide clearly spelled out indemnification protect you and your business from other people's mistakes. I recently negotiated a very favorable contract for a company that leases trucks for film productions. The contract is worded in such a way that if anything happens to that vehicle that is not the sole fault of my client, the film company pays 100 percent of the damages.

Should the film company that negotiated the lease with my client have negotiated for better terms? Yes. Did they? No. I was able to get a very positive provision in my client’s contract that shields his company from risk. Indemnification and contract negotiation require the skill of an experienced attorney. It's important as a business owner to make sure your rights and interests are properly represented and protected.

The law is a complex animal, and too often people try to take on legal contracts and negotiations themselves without the help of lawyers. This leaves them open to costly mistakes and manipulation by others who have the legal knowledge. Indemnification is only one aspect of contract negotiation, but it is an important one. Think twice before creating a contract yourself (or signing one you don’t understand), because it could lead to significant costs down the line.

Your Legal Entity Is the Life Jacket of Your Business

Living in the Seattle area, it’s probably not too surprising to discover that I have a boat. I love owning a boat, but one thing about living on the Sound that I’ve learned is that there’s a lot of prep that has to be done before the boat gets launched. The same thing is true about launching a business.

There’s more to consider when launching a new business than what the name should be, and a lot of the decisions you make about the business should be made before you start. One of the most critical decisions you’ll make about your business is what kind of legal entity to create. It can be very confusing. Many calls I receive for help are from people who are half-way through trying to set up their business using an online service like LegalZoom and they suddenly realize just how complicated the matter can be.

Everything from how you handle banking to how you are taxed will be affected by the type of entity you create, so choosing the right type for you and your business is crucial. In the coming months, we’ll explore the advantages and disadvantages of different types of legal business entities in more detail.

Business Types

There are several different options you have when forming your business. Which you choose depends entirely on the needs of you as a person, the needs of the business, and the number of people involved in the ownership of the company. There is inherent risk in operating a business, but choosing the right entity formation can help minimize your risk.

Sole Proprietorship. A sole proprietorship is the simplest and the least costly to create. However, it does not offer any protection for personal assets against risk. Basically, the individual is simply operating under his or her own name or using a business name for doing business by filing a DBA form with their county clerk. The individual owns and operates the firm, assumes all the debt and liability of the firm, and files taxes using his or her own social security number at the end of the year.

Partnerships. A partnership is similar to a sole proprietorship. It is easy to form, with minimal start up costs. The only difference is that two or more people come together to form the business and agree to work together as co-owners of the business, usually under a partnership agreement or contract.

Limited Liability Corporations. Limited liability corporations (LLC) have become the most popular form of business entity, combining the strength of a partnership with the protection of a corporation without assuming the corporate tax structure. The terms of an LLC as an entity are governed by state statute, so laws will vary from state to state.

C Corporation. A C corporation is so named because it is governed by subchapter C in the IRS code governing corporations. A C Corporation files taxes as an entity and must have shareholders who elect a board of directors to make business decisions. The risks associated with a C Corporation are minimal compared to the other forms of business, but the costs associated with start up can be quite high.

S Corporation. To overcome the singular disadvantage of a C Corporation, in which both the corporate entity and the individuals who share in its profits are taxed on the same income, an S Corporation can be organized. The organizational structure of an S corporation is similar to that of a C Corporation, but in an S Corporation, the members can elect to be taxed individually for the profits generated by the business rather than be required to pay corporate taxes. The S Corp—as well as the Limited Liability Entity—has the added benefit of providing the owners savings on Self Employment Tax.

The forgoing information should be considered informational only and not construed as legal advice. Before selecting a business entity, a person should consult an attorney in his or her jurisdiction.

Erosion of the Economic Loss Rule in Washington

A recent Washington Court of Appeals case expanded the right of homeowners to recover damages from contractors whose negligence causes damage to their homes and property. At the same time, the opinion expanded the potential liability of contractors. In Jackson v. Trenchless Construction Services, the homeowner sued a contractor who was under contract with the prior owner to install a waterline on the property. The homeowner alleged that the work was performed negligently and sued in tort.

For years, the mantra in construction law in Washington has been there is no tort of negligent construction. The only remedy had been breach of contract based on the economic loss rule: An economic loss is a defect of quality as evidenced by internal deterioration. But when a loss stems from defects that cause accidents involving violence or collision with external objects, that is a physical injury and tort remedies apply.

This rule has allowed negligence cases to proceed when a contractor’s negligence caused bodily harm. In this recent case, no one was injured. The water pipe did not rupture or explode, rather the homeowner alleged that the manner in which the work was performed caused instability in the slope that in turn caused the landslide. The court found this distinction sufficient to allow the case to proceed in tort.

What ramifications does this have? For homeowners whose property is injured by contractors who worked on the property in years past, this expands the right to recover damages. This is especially critical in light of the fact that homeowners insurance policies typically exclude coverage for land movement. For contractors, not only does it suggest they must exercise due care, but also suggests they need to be properly insured.

Seattle Biotech at a Turning Point

A recent article in the Puget Sound Business Journal (“Biotechs on the Brink” by Clay Houtzman) suggests that 2011 is a turning point for Seattle’s growing biotech and life sciences industries. More optimistically, from my perspective 2010 was the turning point for the positive, and 2011 will put Seattle on the map for this growing industry.

Bristol Myers Squibb’s purchase of Zymogenetics in 2010 led not to the closing of Zymo’s iconic offices in South Lake Union, but instead to a commitment to keep the 280 jobs in Seattle. Dendreon’s continued success as well as that of Seattle Genetics spurs the growth of other companies that support clinical drug trials, including clinical research organizations, biostatistical consultants, data management companies, and independent medical consultants.

Perhaps fostering the growth of the biotech and life science industries in the Puget Sound area is Washington State’s comparatively favorable tort law. Punitive damages are unavailable in Washington, unlike in many other states. Thus, lawsuits seeking damages for adverse drug reactions are relatively rare in this state.

Professional Services and Construction Liens

Can a construction professional file a construction lien for professional services when the services do not actually result in a physical improvement to real property? A recent opinion from the Washington Court of Appeals suggests the answer is “no.”

In Colorado Structures, Inc. v. Blue Mountain Plaza, a contractor drilled core samples at a construction site to determine the feasibility and cost of developing the property. The development did not go forward because of lack of financing, and the contractor filed a construction lien, including a lien for professional services involved in drilling and evaluating the core samples.

The Court first noted there are four key elements to a valid construction lien:

(1) Furnishing services or equipment;
(2) For the improvement of real property;
(3) At a contracted price; and
(4) At the request of the owner.

The court accepted that the drilling of core samples was professional services, but because the core samples did not result in an actual improvement to real property, the court rejected the claim that a valid lien was created.

This would seem to be at odds with the definition of “professional services”, which includes services rendered “in anticipation of providing improvements to real property.” But the lesson is clear: For a construction lien to be valid in Washington, the improvements must be made. This puts contractors at risk when they perform professional services prior to finalization of funding for a project.