Carl Kanowsky, Esq.

Peter Jones, Paul Smith and Mary Johnson decided to form a new California corporation. The company made fire-retardant clothes. They named it Puff Inc.

They filed the articles of incorporation, signed a lease for their new offices, and elected the three of them to the board of directors.

Business went extremely well. The three knew how to make and sell the clothes. But they didn’t sign up with a good business CPA or attorney.

In dividing up everyone’s responsibilities, Paul was in charge of sales, Peter handled the manufacturing and Mary headed up the research and development department.

What with the crush of business, demanding families at home and the fact that the three really didn’t like each other that much, they rarely got together to discuss how things were going and to plan for the future.

Also, since each one had signature authority on the checking account, the company was paying for some of the personal expenses of the three partners, such as home mortgages and children’s tuition. Each of the partners also had a company credit card they used to pay for both company expenses and family bills.

Paul, the president, began receiving numerous notices and solicitations in the mail to handle some business requirement having to do with “corporate compliance.” He had no idea what this meant, nor did the other two. Most of the solicitations looked like obvious scams, so Paul – after consulting with his partners – decided to throw them away.

Unfortunately, one of the letters Paul threw out was from the Secretary of State’s office, telling the corporation to file its Statement of Information. So of course, this did not get filed. Consequently, the state of California suspended Puff Inc.

These practices and habits of Puff’s owners had some very nasty results for the owners.

First, one of Puff’s main customers refused to pay invoices totaling over $100,000. Paul hired an attorney to go after the recalcitrant client. The bad news for Puff was that since it was suspended as a company, it could not legally function.

A suspended corporation cannot file a lawsuit against anyone in California, or even defend against one. It cannot appeal an adverse judgment or enforce a judgment it may have received before it was suspended. Also, a suspended corporation may not sell, transfer or exchange real property.

Contracts entered into by the corporation during the suspension are voidable at the option of the other party, but not at the corporation’s option. The corporation may even lose its corporate name.

Exercise of any corporate authority or powers during the suspension period can lead to personal liability for the owners.

Now, Peter, Paul and Mary realized the importance of filing those annual statements with the secretary of state. They thought they had learned their lesson.

But the real bad news was yet to hit them. You see, a fireman, little Jackie Paper, was burned in a fire while wearing a Puff fire suit. He sued Puff Inc., and Peter, Paul and Mary individually.

Paper argued that the owners were personally liable since they hadn’t held any shareholder or director meetings, had commingled corporate funds with personal money, and used corporate credit cards to pay off family debts.

While Paper’s claim might not have had a slam-dunk winner, he had enough points that things got pretty hot for Peter, Paul and Mary. So they decided to settle the suit to avoid a trial.

Ever since these events, they make sure the corporation timely files its Statement of Information and pays state taxes. They also realized that if they want the protection of the corporation, they have to follow the rules and have annual meetings, keeping records of them, as well as clearly segregating corporate debt from personal debt.

Carl Kanowsky of Kanowsky & Associates is an attorney in the Santa Clarita Valley. He may be reached by email at cjk@kanowskylaw.com. Nothing contained herein shall be or is intended to be construed as providing legal advice.