Revoked – Expired Corporate Chart Kills Malpractice Claim
[Editor’s note: This post originally appeared on the legal and accounting malpractice blog of Attorney Chris Trebatosky. It was written by Brian Mahany for US Legal Malpractice.]
EEPB is one of Houston’s largest accounting firms. It is also one of the best medium sizes firms in the nation (number 36) according to Accounting Today. Being good doesn’t mean its accountants are perfect, however. Several years ago, a company called Cohen Acquisition Corp (“CAC”) sued EEPB for accounting malpractice. CAC said that EEPB auditors failed to discover that an executive was stealing from the company.
Was EEPB guilty of accounting malpractice? Who knows? The court dismissed the case on a technicality.
CAC apparently failed to file a franchise tax return with the State of Texas in 2008. Although it probably owed no tax, most states say that returns still must be filed even if they are so called “zero returns.” By failing to file the return, the Texas Secretary of State revoked CAC’s corporate charter. Three years later, the company apparently realized the problem, filed the missing returns and had its charter reinstated.
No harm, right? Wrong.
A Texas trial judge ruled that the company had no legal standing at the time its alleged accounting malpractice claims accrued. Even though the company is now in good standing, there were consequences to not having a charter for three years.
Revoked charters are a common event. Companies get busy and forget to file returns, especially when no taxes are due. The failure to file a franchise tax return and pay a couple hundred bucks in filing fees, however, means that CAC will never get its day in court and be able to present its accounting malpractice case. (We assume that EEPB would deny any wrongdoing.)
Revoked or Expired Corporate Charters Are a Big Deal
In most states, companies that allow their corporate charter to lapse face dire consequences. In most states, it only costs a couple hundred bucks per year and a one page form to keep one corporate charter in good standing. Allow that standing to expire, however, and the consequences might surprise you.
Depending on the state you are, a revoked corporate charter means you can’t file a lawsuit or even defend itself if sued! Officers and directors can also become personally liable too.
To better explain the issues, we will use an example:
You own a small chain of hardware stores in Texas. For liability purposes, your chain of stores is incorporated… let’s call it Acme Hardware Inc.
In 2017, you move and stop getting the renewal notices from the Texas Secretary of State. No annual report or franchise tax is paid in 2017 and thereafter. Pursuant to Texas law, Acme’s corporate existence was terminated. Notwithstanding that, you continue to operate, buy and sell stores, etc.
A big construction company – your biggest customer – experienced hard times in 2016 and signed a promissory note for what it owes. After years of no payments, you file suit in 2021 to collect. The construction company files an answer and says that Acme cannot sue on the note and that under Texas law the claim is barred because it was not brought within three years after the company’s existence was forfeited.
That raises many questions. Can Acme collect on the note? Where does the company stand with respect to its assets? It’s liabilities? Are you personally liable for Acme’s “corporate” debts? Can Acme fix these issues by reinstating its charter? Does it matter that the reinstatement is beyond the three-year termination survival period? Can you sue your lawyer or accountant for failure to file your annual franchise tax return?
There are two takeaways from this post. First, corporate charters are important. The failure to spend five minutes to file an annual report can have far reaching consequences.
Secondly, if you are depending on an accountant or lawyer to make your annual report, make sure that you have a written engagement letter outlining those responsibilities.
EEPB simply got lucky in this case. We wonder, however, whose job it was to prepare the missing franchise tax returns. Although this accounting malpractice case resulted in a dismissal for technical reasons we wouldn’t be surprised to see another accounting or legal malpractice claim being filed against the company that forgot to file the returns. Such an action, assuming there was an outside tax return preparer, may be beyond the statute of limitations, however.
As a general rule, professional malpractice actions in most states must be brought within a couple years of the wrongdoing. (There are exceptions and each state has its own statute of limitations.) If you rely on an accountant or a lawyer to file your annual corporate reports, they can be held responsible for any damages you may suffer.
To learn more, visit our sister accounting and legal malpractice site. The author of this post, attorney Brian Mahany, can be reached online or by email