Cannabis Business and Corporate Separateness, Part II

In the first part of this post, we emphasized the importance of maintaining strict boundaries between your non-canna and you canna businesses, saying, “Basically, treat everything you do personally and everything your businesses do as if you were all strangers.” Today we reiterate that message, and describe in more detail how and where you might go wrong.

As we previously stated, the “personality” of a corporation allows companies to conduct its business separate and apart from that of its owners, while at the same time insulating those owners from company obligations. But where can you go wrong? What might cause you personally (or your other, non-canna business) to be on the hook for your canna business’s debts or misdeeds?

In legalspeak, the answers to these questions are found in the doctrine of “corporate disregard,” also called “piercing the corporate veil.” This doctrine essentially describes the circumstances when a court might look beyond the corporate form and impose liability on a corporation’s owners and/or on a corporation’s sister companies.

Here are a few of the most common mistakes and misdeeds that result in a piercing of the corporate veil:

  • Commingling and financial mismanagement. This may take many forms. Perhaps you pay one company’s bills out of the other company’s bank account. Or maybe you have separate accounts for your multiple businesses, but operate mainly out of one account and make all your deposits into that single account. Maybe when one business is a little short of cash you transfer some funds from your personal account to the business to bridge the gap. If you do this more than once or twice without a proper paper trail, it begins to get difficult to tell what money belongs where, and a court then becomes justified in looking beyond the debtor company’s coffers to pay claims.
  • Undercapitalization. This is similar to the last point. If you continually operate your business on the verge of insolvency, choosing to make risky investments or give lavish raises instead of ensuring your company maintains enough assets to pay its bills, once again, it may appear to a court you are abusing the privilege of limited liability through incorporation.
  • Corporation in name only. A corporation in name only situation may also involve commingling of funds or undercapitalization, but is sometimes more sophisticated. Say you own two companies, A and B. If Company B operates only for the benefit of Company A, by holding funds and making loans to A but conducts no business of its own, this may lead a court to look to A to make good on B’s promises and obligations. Such circumstances may arise from your own carelessness too: if you use your companies’ names or titles, email addresses, phone numbers, business cards, etc. interchangeably with each other or with your personal information, it begins to look as though you don’t care whether they are separate. If your companies are interchangeable with one another, or with you individually, there’s no longer a reason to keep their liabilities separate either.
  • Alter ego. Alter ego is closely related to many of the situations above, but often comes about when a parent corporation closely controls the activities of its subsidiaries such that the corporate boundaries erode away. This may happen when all or most of the ownership interest is held by the parent, when there is significant overlap between management or board members, or when principals dip into company coffers whenever it suits them. When there is such strong “unity of interest,” expect unity of liability as well.
  • Promoter liability. If you are in the early stages of developing a business you should also be aware of the doctrine of “promoter liability.” A promoter is most often the entrepreneur, who, in the course of developing his new business, gets ahead of herself and signs a contract or lease in the company name before setting up a proper corporation or limited liability company. If the contracting partner is unaware that the business doesn’t yet technically exist, he may be able to go after the owner personally if problems arise later.

The lines between these various doctrines are often blurry, but the lesson itself should be clear: maintain clear boundaries  between youand your companies, and between your companies themselves. Document and create paper trails. Keep finances separate. Set up your company before you start throwing its name around. You must constantly be aware of how you present yourself and your businesses to the outside world.

All of these lessons apply to any kind of business, but you should be especially mindful and careful in maintaining corporate separateness when operating in the cannabis industry. Cannabis can still be controversial, and it is still illegal under federal law. You do not want to give a debtor or a hard-nosed judge any excuse to impose the debts or obligations of your cannabis business beyond that single entity.