I always recommend that new businesses consider formally incorporating their business. Operating under a corporate entity can provide an invaluable shield against personal liability and can also be helpful when it comes time to sell a business, among many other reasons.
One downside to formal incorporation is that the law requires certain formalities in order to maintain active corporate status. One obvious requirement is that the business must pay its taxes to the state on a timely basis. One other requirement is to file a statement of information every two years and to notify the state when certain corporate changes go into effect (California Corporations Code section 1502).
Failure to file and pay taxes or to file the required statement of information can result in the Secretary of State declaring that your corporation has been suspended.
Losing active recognition of the state has various consequences, one of which is that the business loses the ability to participate in the legal system.
This means that a business, if its registration is suspended, can not file lawsuits â€” or, and this is a big one â€” can not defend itself in court (see Palm Valley Homeowners Assn., Inc. v. Design MTC (2000) 85 CA4th 553).
Plaintiffs attorneys can use this to their advantage by filing a lawsuit against a suspended corporation knowing that the business would not be able to defend itself â€” and thus being subjected to a default judgement.
As you can see, failing to properly maintain a corporation or LLCâ€™s status with the government can have dire consequences.
The good news is that the Corporations Code allows a suspended corporation to cure it suspended status by filing the required statement of information or by satisfying its past-due tax liability. Faced with an inability to participate in a pending legal proceeding, a business owner should take immediate action to cure its suspended status so as to avoid a default judgement.
Rick Morin is an attorney that represents Sacramento businesses in legal disputes with employees, problem clients, difficult vendors and the government. He can be reached at the office at (916) 333-2222.