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Business Startups: Don’t make these mistakes.

Happy Friday!

I love reading Michigan Court of Appeals decisions.

Even if it is not a significant decision related to a novel legal issue, cases usually do a good job of demonstrating pitfalls for people to watch out for.

Take for instance, the Phillips v TruFit case decided on February 9th of this year.

This case provides helpful advice for start up businesses and Commercial Landlords.

Facts:

Trufit Fitness Studios, LLC was a startup business that, as a tenant, entered into a commercial lease with Phillips-Johnson Properties, LLC, as a landlord, to operate a commercial gym.

“Defendant Tyler Koronich was Tru Fit’s sole shareholder and manager. Koronich signed the lease on behalf of Tru Fit I, but did not execute a personal guarantee.” (Landlord’s mistake. We’ll get to Tenant’s mistake soon enough).

Koronich also executed a security agreement in favor of Landlord.  Phillips-Johnson Props. v. Studios, 2016 Mich. App. LEXIS 229, *1-2 (Mich. Ct. App. Feb. 9, 2016)

 

Unfortunate realities common to many startups: lack of cash flow.

Like many startups, Trufit inevitably was having cash flow problems and fell behind in payments rather quickly.

Trufit dissolved.

It had its attorney send a letter to Landlord notifying of dissolution, and Landlord’s right to make a claim against the LLC.

Enter: Successor Company – Trufit 2.

Around this same time, “Tru Fit Fitness, LLC (“Trufit 2”) was formed. It purchased Trufit’s website and other assets, and leased space near Trut Fit’s former premises and began operating a gym.  Id. at Page 2.

(Note to Startups – for reason that you will see below, not necessarily the best idea.)

Obviously, landlord did not like this development. Landlord sued Trufit, Trufit 2, and the owners of both, Koronich and Lankford for a host of claims including:

“foreclosure on security interest, fraud, unjust enrichment, piercing the corporate veil, successor liability, conversion, and tortious interference with a contract and business relationship.”

yikes.

The Trial Court produces a Strange Result.

After several motions were filed and argued the trial court found in favor of tenant (yes, that’s right, the tenant, Trufit).

The court found that the Landlord was limited to its claim against the LLC – the only assets of the LLC totaled $1,655.73 – and that’s all that Landlord could recover.  

the Court was not convinced that any “fraud” occurred.

Frivolous?

Moreover, the Court, chastised the landlord for not getting personal guarantees when it could have done so.   The Court found that landlord’s fraud claims werefrivolous. 

The Court of Appeals reversed.

The Court of Appeals went into a long explanation of the legal doctrine ofsuccessor liability.

A while back I wrote a post about successor liability.  Essentially, a successor entity will be found liable for the debts of the old company, among other reasons, “where a new corporation is a mere continuation or reincarnation of the old corporation.”

Here, the facts, if proven true at trial, could show that Trufit 2 was a successor entity of Trufit – and could be held liable for the obligations of Trufit.

Takeaways:

1. Start up businesses – take advantage of your limited liability protection, but do not think you can avoid your debts simply by starting up a new business entity that is a mere continuation of one you dissolved.

2. Property owners/landlords – get a personal guarantee for your tenants. 

3. Litigation should be a last resort. Besides the fact that it is an expensive process, judges and juries can rule in unpredictable ways producing unforeseen outcomes.  

Questions? Comments?

E-mail: Jeshua@dwlawpc.com

www.dwlawpc.com

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