Forfeited Corporations – Your Shield is Down
For all filing entities in Texas, forfeiture of a corporation, LLC, or other filing entity’s corporate privileges in Texas occurs when (1) the filing entity does not file the report required by Chapter 171 of the Texas Tax Code; (2) the filing entity fails to pay its franchise taxes (a.k.a. margin tax) within 45 days after the notice of forfeiture is mailed to the filing entity; or (3) when the filing entity does not permit the Texas comptroller to examine the filing entity’s records pursuant to the Texas Tax Code. Forfeiture is extremely common in Texas. When our firm submitted an open records request for all forfeited entities at the Texas Secretary of State’s office a few years ago as a research project, it took two separate Excel spreadsheets with thousands of entries to describe the number of forfeited filing entities in Texas. Keep in mind, this open records request only dealt with forfeited entities in the last ten (10) years.
What’s the Big Deal with Forfeiture?
While forfeiture of corporate privileges is an all-too-common occurrence in Texas, few businesses realize the significance of forfeiture and its potential negative impact on not only the business but its officers, directors, and governing persons. Tex. Tax Code § 171.252 states that if a corporation’s privileges are forfeited, the corporation is denied the right to sue or to defend a lawsuit in a Texas court. Additionally, and equally important, § 171.252 states that each officer and director of a forfeited corporation is liable for the debts and obligations of the forfeited corporation (subject to § 171.255). Given that the corporate liability shield is one of the most important protections people seek when incorporating, one would think that this would be enough to get everyone on board with making all their filings in a timely manner. Unfortunately, that is frequently is not the case.
Making matters worse, the liability shield being removed can result in administrative agencies taking action directly against and imposing fines directly on the officers, directors, and managers of a licensed business. Given the strict standards to which most agencies holds licensees, the “corporate shield” being down can result in enforcement actions against individuals who may not even be actively involved in that business. Thus, unlike an unlicensed business, licensed business entities have a substantial additional incentive to keep their shields up.
Why is Forfeiture of Corporate Privileges so Common in Texas?
In our experience, there are a several contributors to corporate privileges forfeiture in Texas. First, many businesses simply don’t keep up with their mail. The Comptroller contacts businesses via mail to give them advance warning of forfeiture. The Comptroller gives a number of notices prior to requiring the Secretary of State to forfeit the filing entity. Despite these repeated notices, many of these notices go unnoticed.
A second contributor to forfeiture in Texas is simply a lack of understanding of a business’s obligations. The repeated modifications to the Texas Franchise Tax have caused confusion about when reports are due and who must file a report. Generally, all taxable entities must file annual reports (with very few exceptions). Nevertheless, many businesses believe that if they do not owe franchise taxes, they do not need to file anything.
The third contributor to forfeiture is a business simply failing to file an annual public information report along with its franchise tax return. Many businesses fail to file a complete return (including the annual report) which prevents the Comptroller from accepting the filing. Thus, despite filing its proper form for indicating whether or not it owes taxes, the business simply failed to attach the information report which the Comptroller requires.
Lastly, many business owners in Texas use forfeiture to “wind down” their business. Rather than going through the process of winding down the business through filing a certificate of termination, the owners simply let the business go into forfeiture. Given the potential liability issues inherent in forfeiture, this is obviously a terrible way to wind down a business, particularly given that if a business is properly wound up, the Texas Business Organizations Code may allow it to retain its liability shield. Further discussion of the forfeiture/termination issue as it relates to winding up a business is reserved for another article.
Just as Texas grants the owners of filing entities a liability shield via the Texas Business Organizations Code (or predecessor statute), so can Texas remove that shield via the Tax Code. The bottom line is that business owners in Texas rarely give forfeiture the consideration it merits. More often than not, forfeiture of corporate privileges is discovered during some crucial moment (purchase/sale of a business, filing of a lawsuit, etc.), resulting in owners and attorneys scrambling to reinstate the business entity’s privileges.