The Professional Company

Terms:

Group/Entity:
A concept that we touched on briefly before in the context of partnerships was whether a court would choose to treat a professional corporation as a “group” – made up of individual members – or an “entity” with independent legal significance. While this distinction may sound like splitting hairs, it is very important both to PCs and partnerships. Under a “group” concept, certain rights and responsibilities are not imputed between members of the firm. However, if a state or court determines that the PC should be treated as an “entity,” then certain obligations, most notably personal liability, have the potential to belong to not just one, but all of the stake holders in the firm.

Malpractice:
You are probably fairly familiar with the idea of malpractice in a medical setting. However, it is important to realize that any professional certified by the state can be guilty of committing malpractice. Thus, lawyers, accountants, architects and even engineers and other such professionals can be held liable for committing malpractice. Such professions, because they require a greater degree of skill and education, are often heavily regulated by the state, and a heightened standard of professional responsibility is imputed to all such members of the field.

Introduction to the Professional Company / Professional Corporation

The professional company (PC) otherwise known as a professional corporation (or in some instances as a professional association) is a business form reaching the point of extinction in the business world. The professional company format was originally conceived to alleviate some of the problems ascribed to the rigid “partnership or corporation only” nature of the business community prior to the growth of LLC's and LLP's. However, unlike the LLC and LLP, the growth of the PC form was never particularly accepted by the business community for reasons both legal and economic.

EXAMPLE: Jeremy, Xavier, and Lynn are all CPAs. They decide that they want to form a new firm in order to organize their interests and operations. Because they are all CPAs, they consider forming a professional corporation in order to gain the liability shield that such a form gives them.

Businesses that might be professional companies:

small organizations of healthcare providers or doctors
small law or accounting firms

Characteristics

The ultimate demise of the professional corporation will probably be traced back to the extreme limits the form places on its potential owners and to the liability of the owners. While intended to correct the problems that the partnership and corporation forms present, the professional corporation often creates more problems than it remedies.

Formation
A PC is formed by submitting a filing with the state, indicating all of the individuals who will be members of the PC. It is incorporated by the state in the same way that a normal corporation is created. In making the filing, the company must indicate what profession it will be engaged in along with providing evidence regarding the certification of all the PC's members as practicing professionals in that field. Because the professional corporation is limited to one specific line of business, and all owners must be professionals in that business, the professional corporation is generally reserved for those service industries that are governed by a state-based system of certification. The result of this limitation is that only certain businesses, most typically law and accounting firms and medical service practices (and occasionally other lines of work such as engineering and architecture) are allowed to register for PC status.

Ownership and Operation
The management of a PC is within the sole control of those professionals who registered with the state at the inception of the firm or during its subsequent expansion. While a PC can hire as many employees as it chooses, none of those employees can be members of ownership unless they, too, are certified as members of the profession that the PC practices. See 15 Pa.C.S. § 8996.

Taxation & Liability
The nature of the PC is such that questions of taxation and liability often become largely intertwined. There is, unfortunately, no set of rules that generally govern all issues of taxation and liability for all PCs. In fact, states, and to an even greater extent, state courts, have a hard time dealing with PCs when problems arise in their operations.

More often than not, taxation of a PC will be based on a corporate model. Thus, when dollars are distributed from the PC, they are not distributed as partnership takes on profits, but rather as dividends from a corporation, and are thus taxed in that matter. However, some states do treat the PC more as a partnership and allow the PC to act as a pass-through entity.

Similarly, liability in the PC is often a tricky issue. Some states treat the PC as a group of members. As such, these states do not extend liability from one member of the PC to another. What is meant here is that while certain aspects of the PC, such as its contracts and management, may be imputed to all members, personal tort liability for malpractice in the course of conducting a professional relationship is not imputed between members. However, other states and courts treat PCs under what might be referred to as an “entity” concept. In these states, personal liability for torts is imputed to all members of the PC despite the fact that only a single member perpetrated the malpractice.

Ultimately, there is no hard-and-fast rule to determine the nature of PCs in all states. Moreover, some states even fail to do a truly adequate job of delineating the rights and responsibilities of PC members in their own laws. The result is that if, as a legal professional, you find yourself working for a PC client, refer to experts within your firm or local case law to determine just how the firm is treated in the jurisdiction.

EXAMPLE: Anna and Tommy formed a PC five years ago for their dental practice. Unbeknownst to Tommy, Anna has been committing malpractice for the last few years by over-tightening braces on her orthodontics patients. Having discovered this fact, and that a group of patients is planning to sue, Tommy consults an attorney. Tommy’s attorney informs him that in their state, the courts have tended to ignore the corporate liability shield of the PC and impute liability to all members if the firm has functioned more like a partnership than a corporation. Thus, the attorney tells Tommy to look at how they have been handling their earnings, distributions, taxes, and how intertwined Tommy and Anna’s practices are in order to determine the entity / group status of the firm.

Capitalization and Fund Raising
As was stated previously, only members of the PC’s designated profession are allowed to act as owners of the firm. Given this situation, it should not be surprising that only individuals who will ultimately be members of the PC are likely to contribute funds to the firm. Additional funds for later growth and expansion of the firm are possible through normal channels, such as banks and private loans. It is somewhat unclear in the law whether or not a PC, as a corporation, would be eligible to conduct a public offering in all states or federally. The problem with offering ownership of the PC to the public is that ownership has to be limited to members of the field. However, it is highly likely that any firm contemplating such an offering would convert the firm to a standard corporation first, simply to avoid any pricing anomalies unfairly imputed to the firm solely on the basis of its business form.

Liquidity
Liquidity in a PC is fairly limited. While PC interests, absent an agreement in the PC to the contrary, are freely transferable, that freedom only exists as to sales of the member’s interest to other members of the profession. In practice, however, it is very infrequent that a PC will simply allow free transfer of interests in the company, even to other members of the profession, because of the potential liability issues that would attach with the entrance of a new member who was not approved of by the entire firm.

EXAMPLE: Tony has been a member of a legal PC for the past 7 years. He wants to retire now, and is interested in selling his interest in the PC to his nephew who is a new attorney. However, upon reviewing the shares he holds in the firm, Tony realizes that in order to sell his shares, he must first get prior approval of the other shareholders in the PC. Tony, despite the fact that he is irritated by the inconvenience this causes, understands the necessity for the provision because he would not want to see all the other shareholders in the PC get sued if his nephew, as a new attorney, commits malpractice.

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