Most small business owners know how to provide their service or product in a timely, cost‑efficient manner. They are savvy entrepreneurs and have a great business sense when it comes to working with customers. However, providing a product or service is often the easiest part of running a business. The hardest part about being in business is usually tending to the details that do not directly equate to sales but can most certainly result in a business’s ultimate demise.
Small businesses routinely make fatal mistakes that could cost tens, if not hundreds, of thousands of dollars to correct. Ultimately these are common mistakes that can most certainly be avoided by the business owner who pays attention to the details of his or her business and seeks the advice of competent legal counsel and business advisors as appropriate.
Most of these mistakes have a common theme — a failure or refusal to properly document. Common mistakes made by business owners include:
(1) failure to maintain a proper legal form;
(2) improperly designating actual employees as independent contractors;
(3) lack of employee handbook and non-compete and confidentiality agreements;
(4) failure to properly document terms regarding attorneys’ fees and costs of litigation; and
(5) refusal to timely pay earned wages.
Failure to Maintain Proper Legal Form
Owners will go to great lengths to organize their business as limited liability companies or corporations. The reasons for doing this are generally two-fold: (1) to use the legal entity to protect the individual from liability; and (2) to transfer taxes to and through the legal entity. However, oftentimes business owners will file the basic paperwork to set up the legal entity with the Secretary of State and do nothing else to maintain the corporate form. They do not maintain the entity by filing the required business entity reports with the Secretary of State, establish bank accounts for the entity that are separate from the individual’s bank accounts, or use the proper legal name of the entity.
Conduct of the individual owner that can lead to personal liability include: (1) undercapitalizing the entity; (2) absence of corporate records; (3) fraudulent representation by corporation shareholders or directors; (4) use of the corporation to promote fraud, injustice, or illegal activities; (5) payment by the corporation of individual obligations; (6) commingling of assets and affairs; (7) failure to observe required corporate formalities; or (8) other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form.
Improperly Designating Actual Employees as Independent Contractors
All too often businesses will designate their actual “employees” as “independent contractors.” Businesses generally prefer that their workers are classified as independent contractors because it costs the business less in wages, benefits, and taxes. If a business misclassifies an “employee” as an “independent contractor,” that business may be liable to pay unpaid overtime, minimum wages, and back taxes, as well as penalties for late payment of federal and state income taxes, Social Security, Medicare, unemployment, and workers’ compensation benefits on behalf of the misclassified “employee.” A misclassified “employee” may also be entitled to benefits, including health insurance and retirement. In addition, a business could be liable for additional damages and penalties imposed by the Department of Labor for misclassified employees.
State and Federal law apply similar standards to determine whether a worker is actually an “employee” and not an “independent contractor.” Factors considered include: (1) the extent to which the worker’s tasks are an integral part of business; (2) how long the worker has worked for the business; (3) to what extent the worker is required to invest in his own equipment; (4) the nature and degree of control over the worker exerted by the business; (5) the worker’s ability to earn profits and suffer losses apart from merely being paid wages; (6) the amount of initiative and independent judgment exercised by the worker; and (7) whether the worker is organized as an independent business organization and operation.
Lack of Employee Handbook and Non-Compete and Confidentiality Agreements
There is no law requiring employers to have an employee handbook and non-compete and confidentiality agreements.
However, if a business owner wants to protect his or her business interests, using such documents is essential. An employee handbook outlines workplace rules in an efficient, uniform way.
Properly drafted non-compete and confidentiality agreements will prevent employees from leaving a current employer, only to set up shop down the street and take the employer’s customers and trade secrets. A properly drafted employee handbook and non‑compete and confidentiality agreement can provide valuable legal protections, thus allowing the business owner to continue providing quality services and products without worrying that his or her goodwill is being pilfered by employees.
Failure to Properly Document Terms Regarding Attorneys’ Fees and Costs of Litigation
Whether in the context of finalizing a purchase order with a customer or negotiating terms with a third-party contractor, business owners generally do an adequate job of identifying the services or products to be provided and the cost. However, they often will not identify who is to pay attorneys’ fees and costs of litigation in the event that a dispute arises. Absent a provision in the contract or other statutory basis, most jurisdictions (including Indiana) follow the American Rule, which requires each party to pay its own attorneys’ fees.
Refusal to Timely Pay Earned Wages
Business owners often incorrectly believe that if they make a loan to an employee and the employee subsequently ceases employment with the company, the employer can withhold the employee’s last paycheck to pay back the loan. This is not entirely correct. Under Indiana law, if an employee’s wages are not timely paid and are withheld without the employee’s consent, the employer shall be liable to pay the employee his or her wages, plus liquidated damages of an additional two (2) times his or her untimely paid wages, plus attorneys’ fees incurred in recovering the untimely paid wages. Ind. Code § 22-2-5-2. Pursuant to Indiana Code § 22-2-6-2, an employee’s assignment of wages must be in writing, signed by the employee personally, by its terms revocable at any time by the employee upon written notice to the employer, and agreed to in writing by the employer. There are also only limited circumstances under which an employee can even agree to a wage assignment, even if it is in writing and the terms identified above are followed.
There are many pitfalls for the uninformed business owner. This article only addresses some of the more common errors made by business owners on a basic level. Ultimately, however, it is important for business owners to surround themselves with competent legal counsel and business advisors who can guide their businesses through issues like those addressed in this article and others faced by business owners on a day-to-day basis.
Tony Jost represents clients in various aspects of business, and civil litigation, including commercial, real estate, employment, and complex tort litigation in both federal and state court. He counsels clients in commercial lease drafting, negotiation and enforcement, and real estate and business acquisition and financing. Tony further advises clients as to proper selection and formation of business entities, lender documentation, franchising, state and federal business regulatory matters, and general contractual matters. He can be reached at tjost@rbelaw.com
