Correcting Business Formation Mistakes: Solutions To The Problem

Article by Joanne Cassidy

Fact # 1:  Mistakes Happen

It may be disquieting to know that lots of business people make mistakes when forming or maintaining an entity, but hopefully it is comforting to know that most mistakes can be corrected.

Fact #2:  All Companies Require Initial Documentation

When someone decides to start a business, there are a lot of decisions to be made, not the least of which is what type of entity to create for the company.  Once that decision is reached, the business owner then has to file the appropriate formation documents with the office of the secretary of state, and prepare internal documents, such as Operating Agreements or Bylaws, Shareholder Agreements and Organizational Consents.

Fact # 3:  Accurate Filing Is More Complicated Than It Looks

Some people choose not to hire a business or corporate attorney to form the company for them.  They go online, find a form, and fill it in, file it and they think they are good to go.  Others hire a business company to provide the documents, do the filing and provide the corporate book.  All that is simple enough.  The problem arises when the business owner really does not understand his documents and starts carrying on business in contradiction to his formation documents.

Examples of Common Mistakes

1. Issuing Too Many Shares

The company is authorized by its Certificate of Formation to issue 100 shares.  The shareholders of this company decide to issue 1000 shares. Maybe they’re adding shareholders to raise capital or issuing additional shares to a valuable employee as part of an incentive plan. Think of the company’s authorization of shares as shares held in a bank.  Issued shares are shares that the bank actually sells to shareholders.  For instance, if the company, through its Certificate of Formation authorizes 100 shares, there are 100 shares in the bank.  If the company then sells 1000 shares, where did those extra 900 shares come from?  The answer is: they didn’t.  They never existed, even though the owners may have been reporting their existence for over a decade. That’s a mistake that needs to be corrected.

2. Limiting the Existence of a Company

Another common problem occurs when the Certificate of Formation states that the company will be in existence for a specific number of years.  For instance the Certificate of Formation might say the company will be in existence for 30 years. Why 30?  Why not perpetually? My guess is that the organizer of the company looked at an old form and the form said to use 10 years or 30 years or some other number of years. The concern is that the corporate charter would expire after 30 years and, most likely, no one would even know.  Basically, the corporate entity would go away, leaving the owners with potential liabilities they never intended to assume.

Fact #4:  These Errors (And Many Others) Can Be Corrected

Formation errors can be corrected by filing a Certificate of Amendment or a Certificate of Correction with the office of the Secretary of State.  For instance, in example #1, we could change the number of authorized shares to a big number, thereby making the issuance of 1000 shares entirely legal. A Certificate of Correction dates back to the original filing of the Certificate of Formation, making everything that the owners had previously reported to be true when they reported it.  If we correct the error with a Certificate of Amendment, the change becomes effective when it is filed, which would mean that the business was unknowingly misreporting ownership of the company for decades.  I usually recommend filing a Certificate of Correction, a concept even the secretary of state’s office sometimes has trouble with, although it is authorized by law.  Problem fixed.

In example #2, the error could be corrected either by filing a Certificate of Amendment or a Certificate of Correction.  It really doesn’t matter which document is used since there probably was never a company filing or report that required the company to give the number of years of the company’s expected existence.  Keep in mind, though, that the filing fee for a Certificate of Correction is $15 and the filing fee for a Certificate of Amendment is $150.

Fact #5: Correctly Filing Company Formation Documents is Important

In my work as a business and corporate lawyer, I’ve seen, and corrected, lots of mistakes in formation documents.  Most of them have been the result of a “do it yourself” filing.  I truly believe that having an experienced business and corporate lawyer prepare and file your documents for you will avoid preventable errors and ultimately save you time, money and aggravation.