Is Income from Business Entity Formations Worth It?
Issues Include the Unauthorized Practice of Law

By Don H. Twietmeyer

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An often-overlooked item of follow-up work is found in the New York publication statute. Under New York Limited Liability Company Law, if an LLC fails to publish a notice of its existence once a week for six consecutive weeks and to follow up publication with the filing of the affidavits of publication within 120 days, the LLC is precluded from bringing an action in New York courts. In Prospective, LLC v. Corr (Index No. 31791/1999; Nassau County Sup. Ct., 7/26/01), the owner of an LLC that purchased property in a tax foreclosure sale found out how important this follow-up work is to the LLC. In that case, the title company required a bar claim action to provide good title to a prospective purchaser, and this was commenced by the LLC prior to filing the affidavits of publication with the Department of State. A purchase contract was later signed by the LLC, and the affidavits of publication were filed after the 120-day period had expired but before a final judgment in the bar claim action. The final judgment was obtained prior to the contract closing date. When the contract closing date passed and the prospective purchaser was unable to close, the LLC claimed that the contract was null and void and that it was entitled to keep the $130,000 deposit, as set forth in the contract. The court refused to let the LLC keep the deposit because, among other things, the LLC began the bar claim action prior to filing of the affidavits of publication and then failed to file the affidavits of publication within 120 days thereafter. Although there was a final judgment in place prior to the contract closing date, a confirming order was required to provide good title to the property, and this was not obtained by the LLC until after the contract closing date. This failure to file the affidavits of publication not only cost the LLC $130,000 that it would have been allowed to keep as damages, but the LLC also incurred significant attorneys’ fees and other costs.

The New York publication statute for limited liability companies was challenged as unconstitutional in Barklee Realty Co. LLC v. Pataki [309 A.D.2d 310, 756 N.Y.S.2d 599 (1st Dept. 2003)]. It is possible that an LLC could find itself in a position that the statute of limitations on a claim is set to expire in less than six weeks, and if the LLC fails to meet the follow-up requirement of publication, the claim would be lost. The lower court agreed that the statute would be unconstitutional because of this argument, but the appellate court held that the statute was constitutional. The client of a CPA who formed the LLC but failed to follow up with the publication requirements would probably consider legal action to recover damages from the CPA.

What would happen if the CPA formed the entity and then never ordered the corporate minute book, prepared such certificates, or prepared the initial set of minutes? The CPA may be doing a disservice in such a situation by not referring the client to an attorney. Worse, such a CPA may have undertaken the unauthorized practice of law. The formation guide that the New York State Department of State provides on its website (www.dos.state.ny.us/corp/busguide.htm) states that one need not be an attorney to form a corporation, although it recommends that all legal documents be prepared under the guidance of an attorney and says that the information on the website should not be treated as an alternative to obtaining legal advice.

It appears that filing services have considered this question and claim that this is not the unauthorized practice of law. In June 2004, an advertisement on the AICPA’s www.cpa2biz.com indicated that a CPA can avoid the unauthorized practice of law by following four simple steps:

• Provide clients with the necessary choices for formation of a business entity, such as entity name, entity type, and jurisdiction, and direct them to the filing service website for more information;
• Provide clients with a questionnaire keyed to the information that the CPA provides to them;
• Use the filing service to prepare the formation documents; and
• Perform all necessary post-filing and maintenance tasks, including the keeping of corporate minutes and dealing with stockholders.

This advice calls for caution. A hypothetical CPA who follows step 1, and makes specific recommendations about entity name, entity type, or jurisdiction could be construed as providing legal advice. Any CPA who prepares the formation documents himself using the information from step 2 would not be following step 3. It is vitally important that someone follow through with the necessary post-filing and maintenance tasks, such as initial corporate minutes and issuance of stock. If any of these post-filing tasks are completed by the CPA, this could be deemed to be the unauthorized practice of law, even under the advertisement’s definition.

Even if a CPA follows the “four simple steps” in the advertisement, he would still be doing a disservice to the client by not referring her to an attorney for legal advice prior to formation. Other choices in entity formation, such as incorporating in New York versus incorporating in Delaware, may have little effect from a tax standpoint, but more of an effect from a liability standpoint. An attorney would be able to steer shareholders toward a shareholders’ agreement, or LLC members toward an operating agreement, that has buy/sell language worked out in advance of any potential problems. Merely providing a client with choices and letting her pick one may not produce the best result, because the client will likely ask the CPA for a recommendation. The previously described advertisement was expanded on October 18, 2004, with an advertisement still on the website to say in step 1 that if a client asks for specific legal information, such as whether to incorporate in another state, the CPA should refer the client to the filing service website. What the CPA should actually do is refer the client to an attorney. Step 2 in the ad has been expanded to say that the questionnaire should track the information required to complete the forms that are found on the state’s website; alternatively, the CPA should use the questionnaire furnished by the filing service. Step 3 has been expanded to say that a CPA can also use self-help products to complete the formation documents. Step 4 has been expanded to indicate that necessary post-filing tasks, such as filing the S corporation election forms, should be done where appropriate. But instead of undertaking the keeping of corporate minutes and dealing with stockholders, the advertisement suggests that the CPA merely remind clients to perform these maintenance tasks.

Not only has the expanded advertisement backed off a bit from its initial position, it also includes four additional steps:

• Make it clear in writing that the CPA is not a lawyer and cannot provide legal advice;
• The CPA should not state or imply that he has legal expertise;
• The CPA should not provide legal advice, although the ad says that the CPA can refer the client to self-help books; and
• The CPA should have the legal forms prepared under the client’s specific direction.

The author believes that the retreat from its prior position is an implicit recognition that some work in advising business clients involves the practice of law and the giving of legal advice. The CPA may be better served to refer the client to an attorney at the outset, so that the attorney and the CPA may work together.

The Larger Picture

Various states have laws restricting the “unauthorized practice of law,” however it may be defined. For example, Florida Statutes section 454.23 states that a person is guilty of a felony if he engages in the unauthorized practice of law. In New York, Judiciary Law section 485 states that a person is guilty of a misdemeanor if he engages in the unlawful practice of law. Judiciary Law section 476-a gives the New York Attorney General’s Office the authority to investigate unlawful practice of law complaints and to seek injunctions, but if that office fails or refuses to prosecute within 20 days after a written request is made, the local bar association has the authority to prosecute the complaint if it first obtains permission from the New York Supreme Court.

Case law provides some guidance in this area. The Florida Bar v. Town [174 So.2d 395 (1965)] involved an accountant who held himself out as a specialist in the incorporation of businesses, and who had purchased several advertisements offering to handle all details of business formation. He formed a corporation for a client and prepared the corporate charter and related documents for a fee. Citing prior cases that indicated that a corporate charter constitutes an important contractual document and that the bylaws constitute a binding agreement among shareholders, the court held that “the preparation of charters, bylaws and other documents necessary to the establishment of a corporation, being the basis of important contractual and legal obligations, comes within the definition of the practice of law.” The court went on to permanently enjoin the accountant from forming corporations for others.

Although New York has no specific cases in the business incorporation area, cases in other areas of law are relevant. An early case was New York County Lawyers Association v. Bercu [273 A.D. 524, 78 N.Y.S.2d 209 (1st Dept. 1948)], where the court held that an accountant who gave sales-tax advice to a corporation to help the corporation settle a tax dispute with the City of New York had engaged in the unauthorized practice of law. This case is very fact-specific, because the accountant provided a written opinion in which he outlined the case law and gave an opinion as to why some cases took precedence over others. Also, the accountant did not provide auditing or tax preparation services to the corporation, so the tax advice was not rendered in connection with the normal work done by an accountant. The court recognized the fact that in the tax area the line is usually blurred between accounting work and legal work, but in this case the accountant crossed over the line and into the field of tax law.

An attempt to avoid payment of accounting fees by citing Bercu was made in Grace v. Allen [407 S.W.2d 321 (Ct.Civ.App., 5th Dist., TX 1966)]. Grace involved a New York accountant who provided tax preparation services for a client who later moved to Texas. During the course of providing those services, the accountant assisted with the preparation of a protest to the IRS for prior tax years. Although the protest involved the review of case law relevant to the position being advanced on behalf of the taxpayer, the court held that this was accounting services performed in the course of preparation of tax returns. Furthermore, because the accountant was allowed to practice before the IRS, under federal law this preempted any state law on the subject.

Finally, in the New Jersey case of The New Jersey Society of Certified Public Accountants [102 N.J. 231, 507 A.2d 711 (Sup.Ct. NJ 1986)], the court modified a lower-court ruling that held that the preparation of a state inheritance tax return by a nonlawyer was the unauthorized practice of law because it required the application of legal principles. In the modification, the court held that CPAs could prepare and file state inheritance tax returns if they notify the client in writing before work is commenced that review of the return by a qualified attorney may be desirable because of the possible application of legal principles.

The Current Situation

It has long been recognized that accounting practice also involves the preparation of tax returns, and that tax advice related to those returns is part of such practice. Some accountants would like to see accounting practice for the formation of business entities evolve in the same manner. Nevertheless, in the opinion of the author, courts today limit the providing of legal advice to the providing of advice in the tax area. Providing legal advice in New York in the business formation area would involve the interpretation of the Business Corporation Law, Limited Liability Company Law, Limited Partnership Law, Not-for-Profit Corporation Law, Partnership Law, and several other New York statutes, as well as case law. This would clearly be the providing of legal advice outside the scope of the accounting practice as is generally accepted today.

Preparation of corporate documents also involves the possible application of legal principles, especially in the areas of entity type, jurisdiction, and agreements between the parties involved with the formation of the entity. New York CPA firms that provide such advice should use appropriate disclaimer language, including on their websites, that as New York CPAs they are commenting only on accounting practices in New York, and that information on other states should be referred to a CPA in another state, and that the firm’s advice should not be construed as providing legal advice.

CPAs could argue that they are merely filling in the blanks and not making decisions involving the application of legal principles, because the client is providing the information that the CPA uses to fill in the blank lines. After all, in the case of New York County Lawyers Association v. Dacey [21 N.Y.2d 694, 284 N.Y.S.2d 422, 234 N.E.2d 459 (1967)], the author of a self-help book titled How to Avoid Probate! was successful in overturning a lower-court decision that found him in contempt for the unauthorized practice of law and that enjoined him from selling his book. The court emphasized that Dacey, who was neither an attorney nor an accountant, was selling his book to the general public, and that no relationship of personal trust and confidence arose between him and the book purchasers. The book contained a significant number of self-help forms (about 95% of the book contained forms and instructions) for preparing revocable trusts to avoid probate.

Dacey was a victory for the use of self-help forms. But before taking too expansive a view of that case, it should be noted that the court emphasized the fact that there was no relationship of personal trust and confidence between Dacey and the reader of the book. If a CPA refers a client to a website after providing information on various options, the CPA is certainly taking a chance if the client uses the website’s self-help forms and that use ends up being to the detriment of the client. The client might later argue that there was a relationship of personal trust and confidence between the CPA and the client, and that the client was relying on the CPA’s endorsement of the website.

More important, CPAs should ask their malpractice insurance carriers whether they are covered for providing assistance to clients in what could be construed as the unauthorized practice of corporate law. Although some insurance carriers offer risk-management tools to minimize claim exposure in this area, with at least some carriers these tools are for financial statement services and tax services, and do not seem to encompass these corporate law activities. While professional services are defined broadly in many malpractice insurance policies, the practice of law is generally not covered. In fact, one malpractice carrier issued an article to its CPA insureds that the CPA should “stop and consult an attorney” in areas where there are “issues presenting a mix of legal, tax, and accounting questions; e.g., entity choices and classifications, as in LLCs and LLPs, and estate and gift taxation [and in] formation documents,” to name a few of these areas.

In Miller v. Vance [463 N.E.2d 250 (Sup.Ct. IN 1984)], the court looked at whether bank employees who filled in the blanks on standard bank mortgage forms were engaged in the unauthorized practice of law. The court determined that this did not involve the unauthorized practice of law, because no legal advice was given. Citing a prior case on the issue, it stated that “the filling in of blanks in legal instruments, prepared by attorneys, which require only the use of common knowledge regarding the information to be inserted in said blanks, and general knowledge of the legal consequences involved, does not constitute the practice of law. However, when the filling in of such blanks involves considerations of significant legal refinement, or the legal consequences of the act are of great significance to the parties involved, such practice may be restricted to members of the legal profession.” This case should cause nonlawyers to think twice about filling in blank corporate forms, because many alternative clauses could be added to corporate documents that would be of great significance to the parties involved.

If a CPA’s client asks an attorney for advice, one aspect of that advice may be to withhold payment to the CPA for services rendered, based on the fact that such services may be the unlawful practice of law. Furthermore, the attorney has specific rules to follow when it comes to the “unauthorized practice of law,” however that is defined. According to Canon 3 of the New York State Bar Association Code of Professional Responsibility, “A lawyer should assist in preventing the unauthorized practice of law.” One reason is to protect the public from obtaining legal services from a nonlawyer who may lack the competence or integrity to do the job.

Another ethical issue for CPAs to consider is the use of a third-party service to file the corporate documents. Many CPAs use such services because law firms use them. The AICPA has recently issued two new ethics rulings and revised another ethics ruling on this topic, effective for all professional services performed on or after July 1, 2005. Under these rulings, the CPA should enter into a confidentiality agreement with the third-party service provider, or obtain specific client consent to use a third-party service provider, before disclosing confidential client information to the third party. (See Ethics Ruling No. 112 under Rule 102, Ethics Ruling No. 12 under Rule 201 and Rule 202, and Revised Ethics Ruling No. 1 under Rule 301, issued by AICPA Professional Ethics Executive Committee, at
www.aicpa.org/download/ethics/2004_1028_outsourcing.pdf.)

The disciplinary rules that are part of the New York State Code of Professional Responsibility indicate that a lawyer who encounters a nonlawyer engaging in the practice of law may not aid a nonlawyer in the unauthorized practice of law (DR 3-101), nor may a lawyer divide legal fees with a nonlawyer (DR 3-102), nor may a lawyer form a partnership with a nonlawyer if the partnership activities involve the practice of law (DR 3-103). There is no duty on the part of a lawyer to report a nonlawyer who is engaged in the practice of law. A lawyer can be disciplined if he had a CPA prepare documents for him and then used his letterhead to mail out those documents without reviewing them, because this is assisting a nonlawyer in the practice of law.

An attorney is subject to the New York State Bar Association’s Attorney Grievance Committee process. After discussing this matter with other attorneys involved in the process, the author’s opinion is that the fact situation above (mailing out documents prepared by a nonlawyer without first reviewing them) would warrant filing an unauthorized practice of law charge against the lawyer and the referral of an unauthorized practice of law charge to the New York State Attorney General’s Office, which has jurisdiction over nonlawyer CPAs. It is possible, however, that the Attorney General’s Office might not consider this specific fact situation to be the unauthorized practice of law, because no legal advice was given and only forms were prepared.

A CPA/attorney working in a CPA firm, however, may be faced with a greater dilemma. Although competent to prepare corporate documents and to form corporations and other business entities, doing so while working in a CPA firm may subject the CPA to prosecution by the New York State Bar Association’s Attorney Grievance Committee.

Options

Although CPAs may be safe from prosecution for the unauthorized practice of law by not giving legal advice in connection with the simple filling-in of forms, exposure to a malpractice action is increased by not referring the client to separate legal counsel for any legal advice connected to an entity formation. CPAs who do this type of work should check with their malpractice insurance carrier. As one carrier suggested in an impact article provided to policyholders, if it involves the unauthorized practice of law, don’t do it.

Referring a client to an attorney is actually good for a CPA’s practice development and may even generate more revenue from referrals coming back. A CPA’s clients will also appreciate that the CPA is looking out for the clients’ best interest by providing them with quality legal advice.