What do you know about the entity with which you are contracting?

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By Christie McCall

Individuals and businesses often dedicate many hours to negotiating the terms of a contract, but it can all be worthless if you don’t really know who you’re contracting with.

Who you contract with might be just as important as the contract terms you so carefully negotiate.

If a contract breach occurs, the gold you seek may be in a bank under a different name.

Careful consideration and inquiry regarding corporate structure can lessen the possibility of being left without remedy.

By way of example, consider the situation where you agree to provide services to Company X. You have carefully negotiated all terms of the agreement, including written assurance that the person signing on behalf of Company X is authorized to do so, and requiring 30 day net payment of all invoices.

After many months of working together successfully, Company X falls behind on payment. Because of your successful working relationship, you allow three months to pass before severing the relationship and pursuing legal action.

It is at that time that you learn that Company X was formed solely to enter the contract with your company. You also learn that the employees you have been working with on your contract and all other assets you perceived as being owned by Company X are actually the employees and assets of Company Y utilized by Company X through a contract.

In fact, Company X has no assets, leaving a little chance of collecting your unpaid invoices.

You will probably feel mislead, however, such corporate structure and means of doing business is not illegal per se.

The legal concept of alter ego may permit you to pierce the corporate structure to reach the assets of Company Y for purposes of collecting the debt owed by Company X. Whether such piercing will be permitted, however, is based on a number of factors which will, in short, require you to show Company X and Company Y did not observe corporate formalities and operated as a single entity. The facts may not bear out these circumstances so as to permit piercing. In any event, you will be adding an additional burden of proof to the lawsuit to collect on your invoices.

To avoid this type of outcome, consider these steps.

First, ask more detailed questions about the entity you’re contracting with, specifically its corporate structure. For example, what other companies are associated or affiliated with the entity you are contracting with, what is the name of the entity that holds the corporate assets, who employs the staff you will be working with, and when was the entity you are contracting with formed? If you are apprehensive about asking such questions and concerned about whether such “suspicion” may affect the business relationship, recall that the value of the contract you are about to enter depends in large part on the value of the entity with which you contracting. A shell entity eviscerates the value of the contract. Could the party with which you are negotiating simply misrepresent the corporate structure and answers to these other questions? Yes. Such misrepresentations, however, could give rise to a cause of action against the individual making those misrepresentations. Though this does not resolve the collection conundrum, such acts of fraud are generally not dischargeable in bankruptcy and, therefore, expose the party making the misrepresentations to more significant long-term consequences and collection possibilities.

Second, conduct independent research about the company. At a basic level, you can perform Internet searches about the company and and others it might be associated with. In addition, each state’s secretary of state maintains a list of entities registered to do business and trade names. Most such lists are available on-line, and many are searchable by organizer. In this way, you can determine other entities linked to the entity or individual with whom you are working. This may lead to additional questions about relations among the entities, which you can explore further to assure yourself that you are contracting with the best possible entity.

Third, if your inquiries lead to concerns that are not adequately addressed, request an individual guaranty or that any related entities you identify participate as additional contracting parties. Alternatively, ensure that deposits and progress payments protect you against potential loss in the event of non-payment. If a deposit and sufficient progress payments are not feasible, you should not delay in taking action to enforce the contract should non-payment occur.

Taking these steps will not guaranty you a remedy after a contract is breached, but they will provide greater assurance against an empty name.