So You Formed the Wrong Business Entity?

By March 17, 2017 March 3rd, 2020 No Comments

Recently, I’ve noticed that many professional services businesses including physicians, law firms, etc. are formed as a corporation or limited liability company, rather than a professional services corporation or a professional limited liability company. These businesses are unaware that licensed professionals who wish to limit personal liability when operating a business are required to form a professional entity (such as a professional limited liability company) instead of the regular nonprofessional counterparts (such as a limited liability company). For more information on this requirement, please refer to my January blog post .

What are the consequences of operating a professional service business as a nonprofessional entity instead of a professional entity? Because a nonprofessional business entity is disqualified from providing professional services, such as chiropractic and physical therapy services, courts will not recognize the existence of such a business entity. The liability shield that business owners hoped to create when forming a business entity to protect them from personal liability is nonexistent. Business owners operating an invalid business entity are potentially as exposed to personal liability as those who did not incorporate or form a limited liability company.

In addition, courts have refused to enforce contractual obligations between an invalid business entity and a third party. If the invalid entity is unable to obtain payments from a third party that would otherwise be legally obligated to pay, such invalid business entity may not be able to rely on the courts to enforce the payment obligations. To illustrate, suppose Physical Therapist Sally Smith formed her business as a corporation, Sally PT Inc. Sally PT Inc. hired XYZ, LLC to create a website and paid XYZ $10,000. XYZ never created the website, and Sally PT Inc. brought suit. Because the courts would not recognize that Sally PT Inc. is a valid business entity, the courts will not enforce the contractual obligations between Sally PT Inc. and XYZ. To avoid this terrible outcome, Sally Smith should reform her business as a professional corporation.

Assuming that all business professionals would like to be paid for their services and be able to enforce contracts with other parties, we urge that if you have mistakenly formed the wrong type of entity for your professional service business to consider taking steps to remedy the situation. Correcting this type of mistake in order to conform with the Professional Services Corporation Act is relatively simple. Our firm can help you through this process.

Photo credit: Army Medicine on Flickr

This post is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with an attorney.

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