A common slip-up can undo the benefits of setting up a separate business entity, such as a corporation, a limited partnership, or a limited liability company. Failing to notify your customers, your creditors, and everyone you deal with of the legal structure of your business can cost you a lot.

First, understand who is liable for a business debt. If you are the “owner” (proprietor) of a business, but it is not a separate legal entity, then you are liable for all of the debts and other obligations of the business. Consider John’s Clothiers on Main Street. The owner, John Jones, is liable if John’s Clothiers fails to pay its supplier for its suits; he may also be liable if an employee hits a pedestrian while delivering alterations to a customer. The reason is that John’s Clothiers is not a separate legal entity.

Partnerships carry the same liability as proprietorships, but in some ways they create worse exposure for business obligations. Not only is a partner liable for his own acts and perhaps the acts of the business’s employees, but the partner is also liable for the acts of the other partner. So, if John Jones take a partner in Jane Smith, and Smith orders 100 Blue Devil ties which never sell, then both Smith and Jones, the partners, are liable for the debt. It doesn’t matter that Jones didn’t approve of the purchase; nor does it matter if he didn’t know about it.

Corporations, limited partnerships, and limited liability companies are examples of entities that limit a person’s liability for business debts. If Jones incorporates John’s Clothiers, the newly formed corporation will be liable for its debts; but Jones, individually, will not have any liability, unless he signs a personal guarantee. The same is true for limited partnerships and limited liability companies.

But, what happens if the business IS incorporated, but only John Jones and his accountant know? The answer might surprise you.

A person who contracts as if he is a proprietor, when he is in fact an agent of a legal entity, can be held liable for that entity’s debt as if a separate entity did not exist. The legal theory, known as an “undisclosed principal,” holds the agent responsible, and allows the creditor to sue the agent individually for the debts of the business.

What can you do? There are several simple steps you can take to make clear the existence of your business entity:

• All of your letterhead needs to contain the exact name of the business entity. If your company has a trade name, it’s fine for the trade name to be predominant on the letterhead; but somewhere, possibly across the bottom of the stationery, the exact business entity name should appear. For example, the top of the letterhead could boldly show “JOHN’S CLOTHIERS,” but located some where on the letterhead should be an explanation “A tradename of John’s Clothing Ventures, Inc.”
  
• If your corporate or business entity name is different from the company’s trade name, then a notice should be filed with the Register of Deeds in the county where the company trades which demonstrates the existence of the two names. The notice, entitled an Assumed Name Certificate, is a simple form that states the trade name and the true business entity name. This notice serves to put third parties on notice through the public record that the entity goes by both names.
  
• All contracts signed for the business entity should CLEARLY reflect that the signing person is signing in a representative capacity. John Jones should sign his contracts:
  
  John’s Clothing Ventures, Inc.
  by John Jones, President
  
  or
  
  John’s Clothing Ventures, Inc.
  t/a (trading as) John’s Clothiers
  by John Jones, President
  
• All company checks should clearly be in the name of the business entity. The bottom signature line should have the business entity’s name ABOVE the signature line, so that the person signing for the entity can note that he or she is signing for the business. If the person signing is a bookkeeper, and not an officer, then the designation “agent” is fine.
  
• Make sure your business entity keeps a separate bank account, files tax returns, maintains its corporate status by filing annual reports with the Secretary of State, and keeps its obligations in its name. A good example is to make sure that any company owned vehicles are in the name of the business entity, and that the contract for insurance is in the name of the business entity.
  
• If any loans are made from you to the business entity, make sure that they are well-documented with promissory notes and agreements providing for retention of security interests in collateral.
  

In short, don’t expect a creditor to treat a business entity separate from you if YOU don’t treat it that way. If your business is set up in a separate legal entity and you are dealing with customers or creditors, MAKE IT their business to know your business!

If you have any questions or concerns about the issues raised in this article, please contact attorney Bettie Kelley Sousa at 250-2000 or by email at bsousa@smithdebnamlaw.com. 

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SUBCONTRACTOR LIEN RIGHTS

Subcontractors may encounter difficulties in collecting payments for work performed on construction projects. However, a subcontractor is not left out in the cold if he does not receive such payment. An unpaid subcontractor that supplied labor or materials for the improvement of real property may be entitled to a lien against: (A) funds or (B) the improved real property. 

(A) LIEN AGAINST FUNDS
A first tier subcontractor may have a lien on funds owed to the general contractor by the owner. Second tier and third tier subcontractors may also have a lien against the funds owed to the party with whom they dealt. However, a second and third tier subcontractor’s right to a lien on funds held by an owner may be cut off by the general contractor or person higher in the chain if that person is owed no monies at the time or after the notice of lien is served. A second and third tier subcontractor will nevertheless want to serve a notice of claim of lien on all parties. This is because it will preserve a second or third tier subcontractor’s right to wrongful payment against any party paying out money to someone higher in the chain after notification of the lien. Finally, a subcontractor more remote than a third tier subcontractor may only have one remedy. That remedy is a lien on funds owed to the person with whom they contracted. 

A lien on funds is perfected by giving notice of the lien to the party against whom the lien is asserted. For example, if a third tier subcontractor asserts a lien on funds owed by the owner to the general contractor, the third tier subcontractor will serve the owner with the notice. If the third tier subcontractor asserts a lien against funds owed by the general contractor to the first tier subcontractor, then the third tier subcontractor will serve the general contractor with the notice. A lien notice must take the form set forth in the statute governing lien rights. Regardless of what entity the lien is asserted against, the lien claimant is only entitled to the amount owing to the entity above him in the construction chain.

There is no statutory deadline for the filing of a lien on funds, and the lien on funds does not need to be filed at the courthouse. One should not wait, however, to serve the notice of lien on funds because once a higher tiered subcontractor is paid, the lien on funds will be cut off as to all subcontractors lower than the paid subcontractor. 

(B) LIEN AGAINST THE REAL PROPERTY
Even though a lien on funds may be cut off by payment, a first, second, and/or third tier subcontractor may be afforded a second remedy. The second remedy is a subrogated lien against the improved real property. 

Subrogation means one party “stepping into the shoes of another.” First tier subcontractors may have a subrogated lien against the real property via the right of the general contractor. A second and third tier subcontractor may have a lien against the improved real property via the right of the first tier subcontractor. A second and third tier subcontractor’s lien against the property may still be valid even if the first tier subcontractor is not owed any money. Subcontractors more remote than third tier subcontractors do not have lien rights against the property. 
A second and third tier subcontractor’s right to a lien against the real property may be cut off if either: (a) the contractor, within 30 days of acquiring a building permit, posts a Notice of Contract on the building site and files a copy of the notice with the Clerk's office in the county where the property is located, and the second or third tier subcontractor fails to serve the contractor with a Notice of Subcontract or; (b) after posting and filing the Notice of Contract and service of the signed Notice of Subcontract, the contractor serves the second or third tier subcontractor with a Notice of Payment. Where, however, the contractor fails to post a Notice of Contract, a second and third tier subcontractor may still have a lien against the real property. 

One may enforce a subrogated lien by: (a) providing the owner and contractor with notice of the lien within 120 days of last furnishing of labor or materials; (b) filing a lien and the notice of lien and; (c) perfecting the lien by filing a complaint within 180 days of last furnishing labor or materials. The claim of lien and notice must be served and filed in the county where the Project is located. 

Please contact Jim Dill at 919-250-2116 or by email at jdill@smithdebnamlaw.com if you have any further questions or for general inquires.

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NORTH CAROLINA RESTRICTIONS ON HIGH COST HOME LOANS

Over the last few years, there has been great interest among lenders and government regulators regarding the practice of making “high cost home loans” (HCHL). This interest has led to the implementation of state and federal laws designed to discourage, and often prohibit, these loans. North Carolina was the first state in the nation to pass its own statute restricting HCHL. Since passage of the North Carolina statute, several other states have passed similar legislation, and now there are numerous federal statutes and regulations that govern this form of lending. Our state’s law is found in North Carolina General Statute Sec. 24-1.1E. While the vast majority of lenders that engage in high cost lending are honest and strive to ensure compliance with the law, some do not, and our State’s law, like all such laws, is designed to avoid abusive and predatory lending practices. 

If a borrower is an extreme credit risk, a HCHL may be the only avenue available to obtain credit and therefore, this type of loan is not prohibited in North Carolina. These loans are closely scrutinized, however, and certain actions by lenders, and certain fees and charges incurred with the loan, are clearly prohibited. An individual that needs to borrow against the equity in his home for an emergency, such as to avoid foreclosure, to pay other creditors, for health purposes, etc., may be subject to an unscrupulous lender, who, seeing the desperate state of the borrower, may tack on unfair and harsh fees, points and other charges as a condition for the loan. Individuals with equity in their home may be enticed to refinance their existing mortgage, or simply to borrow against the equity in the property, while having no realistic ability to repay the loan according to its terms. In this situation, an unscrupulous lender may hope that the borrower will default, and that upon the default, the lender can attempt to purchase the property at foreclosure, thereby reaping the benefit of the equity in the property at the expense of the borrower. There are many other scenarios that would fall under the restrictions imposed by our state’s high cost loan statute. 

Not only are these laws passed in order to significantly impact the ability to make a HCHL, but also to limit the circumstances where such loans would be permitted. Indirectly, these laws are also designed to discourage high cost loans by making it more difficult to sell the loans on the secondary market. Many private and government agencies that either purchase or guarantee loans will not do so if they believe that the loan is in violation of a state or federal high cost loan statute. The assignee of a high cost loan may, in certain circumstances, also be liable to the borrower for damages. The assignee could also find the loan that it purchased or guaranteed significantly modified by a Court as a result of a lawsuit filed by the borrower. Such loans may be subject to a reduction in the interest rate and/or monthly payment, or waiver of all or a part of the interest due over the life of the loan. In addition, making a loan that is a violation of our state’s statute may be considered an unfair and/or deceptive trade practice under Chapter 75 of the General Statutes. That chapter allows for recovery of, among other things, attorneys fees and treble damages. The potential assignee liability makes many purchasers and guarantors cautious. This caution has led to closer scrutiny of the loan-making process to ensure that any loan that borders on a high cost loan meets or exceeds all state and federal requirements. The assignment of the loan does not, however, relieve the original lender from liability. North Carolina’s statute, for example, specifically prohibits a lender from “... shifting any loss, liability, or claim of any kind to the closing agent or closing attorney for any violation of this section.”

If a loan: (1) meets certain principal amount requirements set out in our statute, (2) is incurred by an individual, (3) primarily for personal, family or household purposes, and (4) is secured by the borrower’s principal residence, which can include a mobile home, then the loan is subject to our state’s statute and could be considered a HCHL if certain other conditions are met. One of those conditions relates to fees and points charged on the loan. For example, assuming that the above four requirements are met, under North Carolina law, if the total points and fees paid by the borrower for a loan over $20,000.00 exceeds 5% of the total loan amount, then the loan may be a HCHL. The calculation of the fees and points charged can include not only payments made directly to the lender, but also payments made to a mortgage broker involved in the transaction. Fees and charges included in this computation vary, but as an example, attorney’s fees normally incurred in a loan closing are not included in the computation, unless the borrower did not have the right to choose the attorney. For the most part, a borrower has that right, but many lenders steer customers to an attorney that the lender may have a fee agreement with, and the question then arises whether the borrower actually had the option to use another attorney. Therefore, the issue for the lender is often a matter of disclosure and documentation, in order to show that this option was offered to the borrower. 

Our state has placed other restrictions on lenders deciding to make a HCHL. For example, North Carolina requires that before the loan is made, the lender must receive certification that the borrower has undergone mortgage counseling from a counselor approved by the North Carolina Housing Finance Agency. In addition, the lender may not make a high cost loan unless it reasonably believes, at the time the loan is made, that the borrower has the ability to repay the loan as required by the loan documents. This analysis is based in part upon the borrower’s current employment status, income, and any other financial resources. Again, this most likely places a burden upon the lender to document the borrower’s ability to repay the loan and the basis upon which the lender relied in coming to that conclusion.

Many loans are originated by mortgage bankers or mortgage brokers. Under North Carolina law, if the mortgage banker or broker is listed as the original payee in the loan documents, then it will be considered a “lender” for purposes of our State’s law and is thus liable for any HCHL that does not meet statutory requirements.

To make matters even more complicated, there have been numerous federal laws and regulations imposed on high cost, or what is often termed “predatory” lending. Many of these federal laws impose more stringent requirements on such lending and in many cases, can even preempt the state laws. All of this leads to the conclusion that while high cost lending is permitted in North Carolina, such lending is governed by many state and federal requirements. If you intend to engage in lending that may fall into this category, it is a good idea to familiarize yourself with these various laws. 

If you have any questions about these laws, please contact Jeff Rogers at 250-2000 or by email at jrogers@smithdebnamlaw.com.

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AN INTELLECTUAL PROPERTY PRIMER

Intellectual property rights are key business tools that can enhance profit margins, market share, and name recognition. With many companies, particularly the so-called “new economy” companies, intellectual property may be the most significant asset, if not the only asset, that a company may have. Without these intellectual property rights, companies with financial clout or superior distribution channels may copy your approach and take over your market. Understandably, investors also like to see business plans that include provisions protecting and exploiting these intellectual property and proprietary rights. In addition, rights to intellectual property can be licensed, assigned, or sold, thereby providing the intellectual property owner access to manufacturing capacity, access to markets, or access to the financing necessary to exploit the intellectual property in a productive and profitable way.

There are four major categories of intellectual property protection: (1) patents, (2) trademarks, (3) copyrights, and (4) trade secrets. Each type of intellectual property has a specific function and provides a different kind of protection. Thus, each type of protection should be considered and used where appropriate. In some cases, protection may be available in one or more categories. For example, computer software may be eligible for protection under patent law and/or copyright law and/or trade secret law. Other forms of protection exist for confidential and proprietary information, know-how, moral rights, and other “intellectual” or “intangible” assets that may be valuable to a company or individual.

You may already know that you are the most inventive and creative person on the planet, perhaps even the universe. Unfortunately, you may not have the resources or the desire to build a manufacturing plant, or you don’t know much about marketing and product distribution, or any other number of factors may stand in the way of getting your product or idea into the marketplace. Relax! You may still be able to realize your dreams of untold riches because any of the above intellectual property rights (patents, trademarks, copyrights, trade secrets, confidential information, and know-how) can be licensed, sold, or assigned. You could then sit on the porch and collect your royalties, or licensing fees, or both. In addition, if you really want to build your own manufacturing plant, intellectual property can be used as collateral to secure financing from banks, financial institutions, investors, and venture capital firms.

Over the next few issues of Legal Insights, John McNeill will explore each of these forms of valuable intellectual property protection methods, their advantages and disadvantages, and how they are used. He will spend time looking at what patents, trademarks, and copyrights are; what is a trade secret and how to keep it secret; who can help you protect the intellectual property and who can help you commercialize it; licensing strategies, and so on.

If you have any questions regarding intellectual property rights, please contact John McNeill at (919) 250-2101 or by e-mail at jmcneill@smithdebnamlaw.com. 

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