Filing the Articles of Organization

Insurance & Asset Protection

When forming the limited liability company (LLC) or corporation, each business entity must be created by filing articles of organization with the state in which the owner has decided to form the business. The business owner is free to form the entity in any state, and not merely in the state in which he will be doing business. Delaware and, to a lesser extent, Nevada have emerged as popular sites for business formation.

When forming an LLC, a formal document known as the articles of organization must be filed with the state. In the case of the corporation, the articles of organization are usually termed "articles of incorporation."

When a corporation (as opposed to an LLC) is being formed, a statutory close corporation usually will be a better choice than a conventional corporation. The statutory close corporation must be formed by way of specialized articles of organization. These specialized articles specifically use the language required by the particular state's close corporation statute. Not all states permit the formation of a statutory close corporation.

The entity legally comes into existence when the articles are accepted by the state. Thus, it is important to be able to prove, if necessary, that the articles were filed. The state will return a stamped copy of the articles. The stamp will note the effective date of the formation of the entity. For an additional fee, the state will return a certified copy of the articles.

A Records Kit can be purchased with pre-printed ownership certificates. One copy of the stamped (or certified) articles should be kept in the entity's Records Kit. Another copy of the articles should be kept in a separate secure location.

The entity should issue ownership certificates to the owners and record the issuance, including the consideration received in return, in its Records Kit and its accounting records.

Standard forms for the articles of organization (for an LLC, statutory close corporation or conventional corporation) are available from each state. The business owner can fill in the necessary information on the form.

Ideally, however, the articles of organization for an LLC or a corporation will be tailored to the business owner's specific requirements. No two situations are identical.

A Sample Articles of Organization is included in the Business Tools section. While each filing is unique to itself, there are a number of common elements that, at a minimum, make up standard articles of organization:

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Generally, only articles of organization are necessary by law to create an LLC or a corporation. However, the small business owner should not be misled into thinking that these are the only documents necessary to form a sound business venture.

The small business owner operating an LLC or a statutory close corporation should also have an operating agreement, which includes a buy-sell agreement.

In a conventional corporation, bylaws take the place of an operating agreement, and the buy-sell agreement will be a separate document from the bylaws. Although in a closely held corporation, a shareholder agreement, which includes a buy-sell agreement, typically is used along with the bylaws.

These documents allow the business owner to control such things as voting, management, division of profits and disposition of ownership interests.

Note that only the articles of organization are filed with the state. For this reason, many small business owners never adopt an operating agreement, bylaws or a buy-sell agreement. This is a mistake because, absent an operating agreement, the opportunity to control voting, management structure, profit sharing, etc., is lost.

In addition, this may be an even more dangerous mistake from an asset protection perspective. State law generally requires that a conventional corporation adopt bylaws after it is formed. However, no penalty is prescribed for failure to adopt bylaws. In many cases, because the bylaws are not filed with the state, the failure will not be discovered.

Nevertheless, if the failure is discovered, it may be at the most inopportune time (i.e., when the corporation faces a financial crisis). A plaintiff could use this failure to prove that the entity is defective or to pierce the veil of limited liability. In either case, the end result for the owners could be unlimited, personal liability for the business's debts.

By implication, a statutory close corporation must adopt an operating agreement, because the operating agreement takes the place of the bylaws. (A statutory close corporation also can employ bylaws in conjunction with an operating agreement, although this is usually unnecessary).

Thus, in the case of a statutory close corporation, a failure to adopt an operating agreement may have the same unfortunate consequences as a failure to adopt bylaws in a conventional corporation.

Moreover, articles of organization for a statutory close corporation must make the ownership interests subject to a buy-sell agreement. This condition usually is satisfied by incorporating a buy-sell agreement into the operating agreement. Thus, a lack of an operating agreement could mean that the statutory close corporation is invalid.

The majority of states do not require an LLC to adopt an operating agreement. This is consistent with the informal operating rules that apply to the LLC. Nevertheless, an LLC operating agreement provides the owners with formal guidance on issues such as voting, management and division of profits. Without this guidance, it is much more likely that disputes among the owners will arise and that piercing of the veil of limited liability will be applied by the courts.