It is common for entrepreneurs to form multiple companies to operate various business interests. Even when those interests are being utilized to accomplish a core mission.
For example, using a Holding Company (HC) to hold the interest in several subsidiary companies… a Payroll Company (PC), an Operations Company (OC), and a Real Estate Company (RC). Proper structuring in this scenario may relieve liability from each of the various entities, and the HC is utilized as the interest holder so monies can be funneled upwards. (Note, this is an overly simplistic schematic that should not be used as legal advice in structuring a business plan without consulting an experienced attorney.)
While the structure of this plan is important, the interest holders’ operation of the various entities is perhaps even more important. Most business owners have at least heard the phrase “piercing the corporate veil,” but there is a cousin to this legal theory known as “substantive consolidation.” In a recent case out of Massachusetts a bankruptcy court found that two separate entities, which on the face appeared to be operating different business interests, did not sufficiently distinguish their operations to avoid substantive consolidation. See, In re Cameron Construction & Roofing Co., Inc. “Substantive consolidation does not seek to hold shareholders liable for the acts” of the company; rather, it “treats separate legal entities as if they were merged into a single survivor left with all the cumulative assets and liabilities.” Cameron.
In the Cameron case, the RC and OC owner maintained some separateness in that it filed separate tax returns, separate annual reports, and separate W-2’s for employees. However, the court also found that the RC did not operate in accordance with its stated business purpose in its operating agreement (holding real estate), it’s 17 employees worked exclusively for the OC without any written agreements (i.e. subcontractor agreements), there was no written lease agreement for the OC paying rent to the RC, there was intermingling of assets, the OC was “thinly capitalized,” and neither company maintained corporate records of meetings or payments of dividends. Cameron. The end result, the business structuring failed and the court consolidated the companies.
While structuring corporate entities to limit liability exposure is a wise business tool; maintaining separation between those companies is vital to ensure the structure is upheld if, or when, it is challenged.
Not sure whether or not this type of structuring is right for your business? Contact us to learn more.