By Cliff Ennico
“I started a web-based business a couple of years ago and set it up as a limited liability company (LLC) owned by me and two other investors.
“I was involved in a couple of other projects at that time, so I hired someone I knew would be familiar with the business — let’s call him ‘Joe’ — to act as the company’s general manager.
“He really wasn’t the manager of the company or even an employee in any legal sense — he was an independent contractor because we wanted to save money on payroll taxes — but we allowed him to use that title.
“Things have gone fairly well with the business, but earlier this year, Joe announced his departure from the company to accept a full-time job with benefits. We gave him a nice party and wished him well.
“That’s when the trouble began. No sooner was Joe out the door than we learned he did a lot of things without letting us know. For example, we found he had signed us up for half a million dollars’ worth of product we can’t deliver due to supply chain issues.
“Of course, he is no longer returning our phone calls.
“We’ve tried explaining to these people that Joe wasn’t acting on behalf of the company, but they are lawyering up and insisting we are bound by some of the really crazy things Joe signed us up for. What can we do in a situation like this?”
Sadly, I would recommend you find a really good bankruptcy lawyer.
There are a number of things here that went seriously wrong.
First, anyone who is working full time for your company is an employee for legal and tax purposes. You do not have the ability to decide whether someone is an employee or an independent contractor: There are a set of rules that determine whether or not someone is an employee or an independent contractor (see the page titled “Know Who You’re Hiring — Independent Contractor (Self-employed) vs. Employee” on the IRS website), and that’s what the government relies on if they ever audit your company.
The IRS does not care what you call somebody, or even whether you have an agreement with them saying they are an independent contractor. As an IRS agent once told me, “If it walks like a duck, waddles like a duck and quacks like a duck, don’t tell me it’s an independent contractor.”
It sounds like you owe the government a ton of money in back payroll taxes. Better speak to an accountant or, better yet, a good tax lawyer to find out how much trouble you’re in.
Second, whenever you call someone a “general manager,” “president,” “CEO,” “vice president” or another similar title, you are telling the world that that person has authority to make decisions and act on behalf of the company, even if that isn’t really the case.
Lawyers call it “apparent authority” (see the Wikipedia entry on “apparent authority” for more information), but the concept is very simple: If I am dealing with your company’s general manager and sign a $1 million contract with her, I have the legal right to assume that she is authorized to bind the company to that agreement. Unless that person specifically tells me that she is not authorized to commit to the contract and “has to speak to the boss first,” I have the right to sue your company for damages if the contract is breached.
The bottom line is that your company is on the hook for whatever Joe did in his capacity as general manager.
Lastly, where were you and your partners while all of this was going on? You obviously trusted Joe to do his job well when you retained him, but where is the contract saying he had to clear business dealings over a certain size with the three of you (or maybe just you) before he committed to anything?
Where was your oversight of Joe’s activities? Did you require him to make presentations at board meetings? Did you even ask him to keep you informed of things he was doing in the company’s name?
Yeah, I agree that Joe has a lot to answer for here, but it sounds as if the three of you enabled him by giving him way too much authority and then turning a blind eye to what was going on. In the words of President Ronald Reagan, “Trust ... but verify.”
On a related note, I’m seeing a lot of startups lately — most, but not all, formed by younger people — that are rejecting the traditional “corporate hierarchy” of responsibility and accountability. Far too many entrepreneurs believe — incorrectly — that a company can do just fine without employees, bosses or a corporate ladder.
“We’re all partners here,” I hear them say (and it makes me cringe). “There are no bosses or employees. We’re all equal.” Democracy is a great way to run a country, but it’s a terrible way to run a business. When everyone’s a “vice president” and there is no “president” (don’t laugh: An entrepreneur recently proposed exactly that management structure to me), anyone can create problems for the company without any internal checks on their activities.
Joe knew that, and you are now learning it the hard way.
Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.”
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