Formation of An Entity. Why it’s important.

Proper formation of your entity is important to its official recognition and its ability to carry on its activities.  Proper formation, in the case of limited liability entities, gives an owner protection against personal liability for the obligations of the entity organized.  Some entities, like partnerships, do not require filing of documents, while others, like corporations and limited liability companies, require filing an organizational document.  When entities have been properly organized, or have filed the correct documents with the state filing officer, they are recognized as a legal entity.

If not formed properly, transactions entered into by that organization may be called into question, and may subject the owners and agents of the organization to personal liability for the organization’s obligations.
For example: Lets say Jane and John improperly filed articles of organization for their LLC.  If they enter into a five year contract with a material supplier in January, and the cost of those materials subsequently goes up, decreasing the supplier’s profits, the supplier could attack the contract on the grounds that Jane or John did not have the power to bind their company because the company had not properly come into existence.  In that manner the supplier would try to get out of the contract so that he wouldn’t have to sell to Jane and John at such a low price.
 If the price of materials goes down, cutting into the bottom line of Jane and John’s business (assuming the business does not survive and leaves the contract unfulfilled), the supplier could argue that the LLC was not formed properly and that Jane and John should be personally responsible for their company’s obligations to the supplier.
The help of local counsel can remedy these situations by issuing third party closing letters that confirm the proper formation and organization of your entity.
Photo By: Galt Museum