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Top Ten Business Sinking Torpedoes

Through our practice, we have worked with a number of businesses who have been struck by “business-sinking” torpedoes.  Occasionally, these problems have completely sunk the business. Other times, the business just took a pretty big hit but we were able to help them through the problem with minimal damage. Following are the top ten business-sinking Torpedoes that have hit some of our clients.

  1. No worker’s compensation insurance.
    • Casual labor fallacy — “He’s only working one day so he won’t need worker’s comp coverage.” All employees have to have worker’s compensation no matter how long (or little) they work for you.
    • Subcontractor fallacy — “I can save money on this project by hiring some low-cost subs.” If you do this, get a certificate of worker’s compensation and general liability insurance naming your company as an additional insured. Warning: if the subs are not covered by worker’s compensation by their employer, you are their statutory employer and you are liable for their injuries.
    • Independent contractors — It is very difficult to hire someone that is truly an independent contractor. There are a multitude of tests to determine if someone is an independent contractor — the IRS has some tests, Colorado has different tests, and worker’s compensation has its own set of tests. For the form published by Pinnacol Assurance (the official default worker’s compensation provider in Colorado) go to https://www.pinnacol.com/acom_docs/independent_contractor_form.pdf
  2. Preferential transfers
    • If you are serendipitously paid on an old debt, but the debtor files bankruptcy in the next year, you may hear from the bankruptcy trustee telling you to give the money back to him or he will sue you and collect his attorney fees and costs plus the principal.
    • Insiders — family members or business partners — a two-year look back.
    • Everyone else — ninety days look back, however, the debtor can pay up to $500 over this ninety-day period and this amount will not be refunded.
    • Is this fair? No, this is not fair but it is in the federal bankruptcy code and you may get stuck. Some of the people who received money from Bernie Madoff got burned by this law.
  3. Employee Embezzlement
    • Cash — if you have cash, you will have theft. Put policies in place to check for theft.
    • Never trust someone to do your books without you and someone else on the outside auditing them regularly.
    • Assume someone is stealing from you (but do not say anything until you find proof).
    • Restitution? If you are lucky enough to be able to prove the theft and the employee is convicted of a crime, the court always orders restitution if you request it. Actually getting paid is not so likely.
  4. Inadequate insurance
    • Underinsured — regularly review your policy limits with your agent so you have the correct amount of coverage in force.
    • No Insurance for certain risks — regularly discuss your risks with your agent and be sure to have coverage for those things that may cause you a loss.
    • Wrong or missing endorsements — always ask your agent to answer your questions in writing and make sure that they have added the necessary endorsements to your policy. If the agent will not send you a letter, you should send the agent a letter confirming what you were told on the phone.
    • CAVEAT: Always make sure you are provided your policy by the insurance company. Then review it, especially the Declarations Page.
  5. Ripped off !!!
    • You will probably eventually do business with a crook — there are “Bernie Madoffs” everywhere.  Suggestions to check someone and his/her company out:
      • https://www.cocourts.com/ — find nearly all Colorado court cases on the person you are investigating.
      • West Law people map — your attorney may be able to provide this search — it is a nationwide public records data base search. This is often very effective in finding out what has happened in other states.
      • Order an Owners and Encumbrances (O&E) report from a title company on the home and business address of the person you are investigating to see who owns the property, if there are any liens on the property and possibly any equity in the property.  Example, you can call Land Title at 303-321-1880 and for $5 they will provide you an O&E, usually very quickly. If you are a contractor, always do an O&E on the property you are going to work on before you start to see if there are any preexisting liens.
      • Require a credit report from the person you are investigating or a Dunn & Bradstreet report on the company you are investigating. You may be able to assist the individual to get a free credit report on https://www.annualcreditreport.com/cra/index.jsp
      • https://pipl.com/ — find most of the places on the internet where the person you are investigating is located. Also be sure to Google the person as well.
      • Hire a private investigation firm to do research on the person and his company.
    • Receivables are too large — if your receivables grow too large, get help and get on top of them right away. Ideas on collecting:
      • Have your attorney write a demand letter.
      • Sue them yourself.
        1. Small claims court — No minimum, but $7,500 maximum in damages, no lawyers unless you sue a corporation that is not closely held or if the defendant wants an attorney, then it can be bumped up to County Court and the attorney will represent the defendant. Certain matters are not permissible in small claims, such as defamation and replevin.
        2. County court — No minimum, but $15,000 maximum in damages. No lawyer necessary but sometimes it would be very useful to have one.
        3. District court — no dollar minimum or maximum. You should probably have a lawyer — there are a plethora of rules and deadlines that are traps for the unwary.
      • Hire your attorney to sue them.
      • Hire a collection agency to collect. There are two types:
        1. Mailing Service — cost may be a one time or monthly fee and possibly a per case fee. Often this is not very effective since they do not sue.
        2. Full service — agency will sue the defendant but charge you the costs. Often this is very effective unless the person is judgment proof and then you are wasting money. Standard fee is 1/3 plus costs.
    • Bad checks — stay on top of these.
      • Bad check letter — if you send out a 15-day demand letter with the required language in it, you can sue for treble damages and attorney fees after the 15 days pass.
      • Collection agencies will often try to collect and, if successful, will pay you the face value of the check and they keep the rest.
    • No written contract — it is too easy to get in a hurry and not have anything in writing. It is advisable for you to have a standard contract for every customer or client if this would work for your business. If you do not have a standard contract, or if the contract is large, see an attorney for custom drafting so you are protected.
  6. Bad marketing
    • My father always said, “You can go broke buying advertising.” Spend your marketing money wisely.
    • Always study marketing (which is more than just sales) or hire a good consultant to assist you.
    • Always do SEO — search engine optimization is all the rage. Locate someone competent to advise you on what to do or to do it for you, including using Google Ad Words (which you could easily do yourself).
  7. Partner from hell
    • Business partners are like a marriage. Some people can make it work and others cannot. Choose well
    • Have an agreement on how to divide assets or do a buy out if one of the partners leaves the company
    • Have an agreement on who does what and how much each person will be paid for wages
  8. Inadequate structure at the formation
    • Never be a sole proprietor — Be sure your company is an entity. At the very least, set up a single member LLC, which is a disregarded entity for IRS purposes. You will not have to file extra tax returns with this type of company. Before you chose an entity, though, you should get some advice from your attorney or tax preparer on the best type of entity for your situation. Many times subchapter S corporations are a better fit for small businesses. There are many entity options:
      • Sole proprietorship. You as an individual are doing business under a trade name. This is normally the least desirable type of entity since you have personal liability.
      • Partnership.
        1. General partnership — you and your partner(s) are jointly operating a business for profit. This is not a very desirable type of entity either because you have personal liability for all the acts of the other partner(s).
        2. Limited partnership — one or more of the partners has unlimited liability but generally each partner is not liable for the acts of the other partners. This is still not usually a preferred entity.
        3. Limited liability limited partnership (LLLP) — usually used by professionals so that the partners are not liable for the acts of the other limited partners except to the extent of their investment.
        4. Family limited partnership — generally used for estate planning purposes. It creates an entity into which a person’s assets are transferred and then from inside the entity, transfers are made to other family members to get the assets out of the estate of the original owner.
      • Limited liability company — this is often a very useful way to set up your business. It is essentially a partnership but with limited personal liability for the owners, similar (but different) from the limited liability afforded corporations.
      • Corporation — this is a fictitious entity that you create.  At its creation, it becomes the equivalent of a person in the eyes of the law.
        1. “C corporation” files its own tax return and pays taxes on any money left in the corporation at the end of the year. If you take this out later, you pay double tax — corporate income tax (which was already paid) and personal income tax (on the money you take out).
        2. “S corporation” is a pass through entity. Therefore, it will issue a K-1 to you at the end of the year and all the S corporation’s income for the year will appear as income on your tax return. It prevents the double taxation that a C corporation may have. Most small businesses should be an S corporation.
      • Unincorporated association — this is a group of people who agree to come together as a unit to accomplish a purpose. This is often seen in startup churches. It is generally a bad idea since each of the members may have personal liability for any and all the acts of the other members.
    • Be sure you operate the company separately from yourself (do not co-mingle assets or pay personal bills from the entity account or pay the entity’s bills from your personal account.
  9. Inadvertent personal liability
    • Learn how to sign correctly so you are binding the entity, not yourself.  Make sure that every document you sign looks like this: ABC Company, Inc.By: Bob Smith, President
    • Payroll Tax Warning: If you are on a bank account into which payroll taxes are to be withheld or to be paid from, you probably have personal liability with the IRS for the payroll taxes even if you are not an owner of the company. Therefore, if the company fails to remit the withheld trust fund taxes, or fails to properly withhold payroll taxes, the IRS may come after you for all of the taxes.
    • Some contracts I have reviewed (telephone book advertising) contain a provision in the fine print that says no matter how you sign at the end of the contract, you are agreeing to be personally liable for the amounts due in the contract. Strike this type of provision.
  10. Stinking bad lease terms
    • Lawyers — as much you may dislike the extra costs, have your lease reviewed by an attorney before you sign.
    • Common lease provisions you may come to hate:
      • Landlord can move you to a different unit within the complex without your approval.
      • Landlord charges CAM (common area maintenance) fees — this is giving the landlord the functional equivalent of a blank check (often overhead and other internal landlord staff and expenses are paid from this).
      • NNN — triple net leases are common. If you sign a triple net lease, you will be responsible for all expenses connected with the property such as taxes, utilities, insurance payments, maintenance, and repairs. If you move into a property that has not been well maintained or that is simply old, you may have some significant repairs to pay (HVAC, clogged plumbing, replace underground piping, electrical problems, roof leaks, etc.). Always hire an inspector and an engineer before you move in if you are going to sign a triple net lease of even if you are just responsible for maintenance and repairs.
      • Monthly rental amount escalator clauses — after a year or two, your rent automatically increases. This stinks if the rent exceeds the actual cost of living increases or actual rent values in the area.
      • Duration of the lease is too long or too short. If you build up a good business but the landlord can do the same thing in your location, he may let your lease expire, boot you out, and then open up the same business as you were operating. You may also want to ask for an option to purchase to protect against this.
      • A provision in the lease that says only you are responsible to pay attorney fees and costs in the event of a dispute. The contract should say the prevailing party receives his/her legal fees and costs.
      • Indemnification — you agree to indemnify the landlord for everything under the sun but the landlord has no or only limited responsibility for anything.
      • Landlord has no or very limited responsibilities — make sure that the landlord is responsible for at least roofing, walls, HVAC replacement or significant repairs, electrical, doors and windows. Be sure who has to clear the ice and snow. Slip and fall claims can be downright costly.
      • A requirement that you have more insurance than is necessary for the risk your business may incur.
      • A requirement that you have a regular maintenance contract in place for the HVAC system. This is probably a good idea if you are responsible for the HVAC, but this contract is potentially very expensive. Be sure you budget for this.

Call us at the Pearman Law Firm, P.C. if you need help to navigate through these or any other legal issues.