This is the fourth in a 10-part series exploring legal mistakes that can be fatal to a business (even a seemingly well-established one). The illustrations and guidance provided are designed to help you spot these mistakes early. Each of these mistakes is preventable with proper planning and preparation.

Last month, I discussed the dangers of failing to segregate business funds and enterprises. When you operate too many business ventures out of the same company, you place all of your ventures at risk. Business owners who make the effort to set up a formal business entity often fail to plan ahead when their business ventures start veering away from the main enterprise. It’s often unintentional at first, but if you fail to properly segregate your business enterprises into distinct entities (and, likewise, separate those enterprises’ funds), a court and creditors may find it easy to go after all of the business’s assets to cover a single enterprise’s liabilities.

When expanding your business into new ventures, it’s always a good idea to separate the venture into its own entity. The separation will allow you to make business decisions based on the merits of each business unit, rather than simply absorbing the expense of an unproductive venture into the profits of a more productive one.

So, you’ve taken the steps to properly incorporate, maintain, and segregate your business ventures. Congratulations! This article will discuss how to avoid the devastating consequences of failing to properly respond to legal notices with which your company might be served. 

Read on for an illustration of how easily mistakes can arise, how fatal they can be for even the most successful business, and how to avoid them entirely with dedicated planning. 

Mistake 4: Failing to Use a Registered Agent

Anne had no delusions of grandeur when she started her cooking school. Anne organized her business as a limited liability company. She set up a separate bank account for the business, rented a location for the school, and began holding classes. Three years later, Anne was thrilled that she could make a secure living doing what she enjoyed most. Anne could not believe how successful her little school had become.

The school’s success made it all the more perplexing when she was suddenly unable to make a relatively inexpensive purchase using the school’s debit card at a kitchen supply store. Anne had made a sizable deposit of tuition payments just the day before, so she knew that the account had more than enough money to pay for the purchase. When she called the bank, Anne was stunned to learn that the account had been frozen pursuant to legal action.

Anne panicked: the next day was payday and even though she still thought of it as her “little school,” it carried a sizeable biweekly payroll liability for the 10 teachers who ran classes every week and the two support staff. In addition, Anne had just mailed checks to a substantial number of her vendors to cover supplies for the coming weeks’ classes. Those vendors would be cashing their checks in the next few days.

After several hours of investigation, Anne learned why the account had been frozen. Miranda, the school’s receptionist, had inadvertently failed to pay the last invoice on one of the school’s former credit cards that Anne had asked Miranda to stop using. Miranda had filed the last statement away thinking Anne had already closed the card. When Miranda continued to receive payment notices, she thought they were simply junk mail asking the school to re-enroll in the closed card. She stopped even opening the envelopes from that credit card company after a while, treating them as junk mail.

Having never received a payment on the last invoice, the credit card company had sued the school. The process server left the lawsuit paperwork with Miranda while Anne was teaching a class one afternoon. Miranda read through the papers and was incredibly embarrassed by the situation she realized she had created. She was unwilling to face the problem and was worried about losing her job, so she shredded the lawsuit papers and never told Anne. She had heard stories about credit card companies threatening suit but never actually following through and she thought this might one of those cases. Having never seen any further paperwork from the credit card company, Miranda thought she was in the clear and all was well.

Because the school did not respond to the lawsuit, however, the credit card company eventually obtained a default judgment. No further notice was ever given to the school and, having heard nothing in response to the lawsuit and judgment, the creditor then attempted to collect the judgment by serving a post-judgment Writ of Garnishment on the school’s bank. It was only because the bank officer who received the Writ happened to be a student at the school that the account was only frozen rather than immediately turned over to the credit card company.

Anne promptly hired an attorney who was able to have the Writ of Garnishment released and the judgment set aside because of Miranda’s subterfuge. But even though the attorney worked quickly, she was unable to get the account unfrozen and the judgment set aside for three full payroll cycles. Anne was forced to deposit substantial personal funds back into the business account to cover payroll. In addition, Anne spent hours on the telephone with her vendors explaining why her payments to them had been returned by the bank. In order to preserve her relationship with her vendors, Anne felt she had no choice but to pay the hundreds of dollars of ‘insufficient funds’ charges her vendors had incurred when her school’s checks bounced. And even though the default judgment was eventually reversed, Anne still owed the remaining balance on the last credit card bill and a significant interest payment on top of it.

As the monthly invoices from her attorney arrived, Anne tried not to think about the cruise she had to cancel to pay her attorneys’ fees.

How to Avoid Mistake 4

Texas law requires that every corporation or limited liability company identify a registered agent to receive certain legal notices, including certain legal notices in litigation and notices from the Texas Secretary of State. If a company fails to respond properly to a document served on its registered agent, it may be subject to devastating legal consequences.

Anne thought she was being frugal when she identified herself as the registered agent for the school at formation of the company, but she was actually laying the groundwork for legal difficulties. Unless you’re the person who always opens and reviews all mail and notices sent to your company, you should not serve as the registered agent for your business. Rather, identify a registered agent who is available to receive service of process and who knows what to do when it is served with legal notice. There are many third-party services and law firms that can act as your company’s registered agent. Those businesses will accept and forward service of process and legal notices to the right parties in your company to ensure nothing inadvertently slips through the cracks.

In the next article, I’ll address the fatal mistake of a business failing to protect your business’s intellectual property.