What is a professional service corporation?

California law permits the establishment of a form of business organization called a ‘Professional Service Corporation’ between persons who belong to specified professions, i.e., persons who have a professional license. These include any type of professional activity that may be lawfully rendered pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act or the Osteopathic Act.

The distinctive characteristic of this form of business is that all the shareholders/members are required to be members of the specific profession. For example, a professional service corporation consisting of doctors and providing medical services can have only duly licensed doctors as its shareholders. The nature of the business is restricted to the services that the shareholder/members are licensed to perform. The name of the corporation requires to be followed by the term ‘Professional Corporation’ or the suffix ‘P.C.’ and should contain the name of at least one shareholder.

Formation

A professional service corporation is formed by filing the articles of incorporation with the relevant authority, adopting the by-laws and drafting the shareholders agreement. The by-laws govern the daily functioning of the corporation, while the shareholders agreement governs the relationship between the shareholders.

Advantages and disadvantages

The primary advantage of establishing a professional service corporation is that it limits liability of the members only to activities that are related to the professional services rendered. Members of a professional service corporation would not be held personally liable for causes of action not related to the service rendered – for example., liability arising out of a slip and fall accident on the premises. However, members would be liable for acts by an employee not supervised by a member. Members also remain personally liable for acts of negligence and professional malpractice of other members. Professionals in California are barred from forming limited liability companies so forming a professional service corporation is less of a choice, but rather the best available option to ensure limited liability.

Another advantage provided by this form of business organization is that may provide some tax advantages and favorable tax treatment in some situations. Professional service corporations may also be able to benefit from better group insurance plans, disability, health and accident plans.

Like corporations, shares held by shareholders of a professional service corporation are freely transferable with one important restriction. They may only be transferred to another member possessing the required license for providing services. For example, shareholders of a professional service corporation providing chiropractic services may only transfer their shares to another duly-licensed chiropractor.

However, it does not come without its disadvantages. Professional service corporations are subject to double taxation – wherein the corporation pays tax on its profits, and the members pay tax on any income/disbursements they receive. While this can be avoided by careful tax planning, it is an important consideration.

The other disadvantage concerns the fact that the professional service corporation is a separate entity. This means, that like a limited liability company, it is required to comply with certain legal requirements. These include conducting annual meetings, maintaining corporate records, maintaining minutes of meetings and the like. A board of directors comprising of the shareholders manage the day-to-day functioning of the entity.

Foreign professional service corporations

Foreign professional services corporations are permitted to establish and operate in California, andare subject to the laws of its state of incorporation. However the professional service is required to be one that is authorized in the California Business and Professions Code for performance by a foreign professional corporation. Reference to a ‘foreign professional services corporation’ here is a reference to an organization incorporated in a state other than California.

The concept of creation of a security interest over real property is popularly understood. Most people take out a loan to purchase a home, and provide the bank with a mortgage over the home to secure the loan. Similarly, it is also possible to create a security interest of personal property. Personal property refers to those properties that are not ‘real property’, i.e., anything that is not land. Personal property could be either tangible – for example, consumer products and automobiles; or intangible – such as intellectual property rights.

The easiest way to understand this would be by taking the example of an installment purchase. Consider this situation: You buy a television from a company called Better Buy by making a down-payment and then make subsequent monthly payments for a specified period. Better Buy has a security interest over the television until you make the last payment. In the event that you default on the monthly payments, Best Buy has the right to seize the television to make good their loss.

This article intends to provide you with a basic understanding of how this security interest is created and how it works. In case you are a lender, understanding this would be helpful in ensuring that you secure your loans.

Creation of a security interest over personal property:

Creation of a security interest over personal property is governed by the Uniform Commercial Code, and requires compliance with certain legal formalities.

Creation of a security interest is done by drafting a security agreement. A valid security agreement should identify the parties, acknowledge and describe the obligation/debt being secured, lay down the terms of repayment, identify the collateral (personal property) and its value, and may specifically grant the lender a security interest in the collateral and the right to repossess upon default. It is sufficient if the security agreement is signed by the debtor alone.

It should also contain the circumstances under which the debtor will be in default. 

Perfection:

What happens if there are competing security interests? For example, after buying the television from Better Buy, you borrow $500 from your neighbor so you can buy a cabinet for the television. You sign a security agreement giving your neighbor a security interest over the television to secure the $500 loan. Now there is an issue of competing interests – both Better Buy and your neighbor have a valid security interest over the loan. In case you default on the payment due to one of them, a dispute arises regarding the rights of both parties over the television.

In order to resolve this issue, it is important to ‘perfect’ a security interest.

Perfecting a security interest is a way of establishing its priority over competing security interests, as well as over a trustee in bankruptcy. Generally, competing security interests have priority in the order in which they were perfected, so it is important to perfect a security interest as soon as possible.

The easiest and most common way to perfect a security interest is by filing a ‘Financing Statement’ with the Secretary of State in the state having jurisdiction over the transaction. A valid Financing Statement should contain the identities of all the debtors (including their full addresses), the identity of the creditor or person holding the security interest, and a description of the personal property subject to the lien.

Typically, a Financing Statement is valid for five years from the date of filing. It may be renewed by filing a ‘Continuation Statement’ six months before the expiration. Subsequent to renewal, the Financing Statement is valid for another five years.

The other method to perfect a security interest is by taking possession of the concerned personal property itself. However, this method of perfection is available only to certain kinds of property such as negotiable documents, actual currency, tangible chattel paper, etc. A person may perfect an interest over certified securities by taking delivery of the security.

Amendment and assignment:

In order to continue to be valid, a Financing Statement is required to be amended in the following circumstances: (i) a change or addition of debtors, (ii) assignment, transfer or addition of secured parties, and (iii) addition, subtraction or change in collateral. Amendment is also required in case of a change of address of the debtor.

A secured party can assign his right to receive payment under the Financing Statement to another party by entering into an appropriate contractual arrangement. However, the name of the secured party that appears on the Financing Statement filed with the Secretary of State will be considered the only valid creditor. It is therefore to the interest of the new assignee to arrange for the Financing Statement to be amended immediately.

In case of default:

If the debtor defaults on its obligations under the terms of the Financing Agreement, the secured party may exercise its remedies as stated under the Security Agreement. If the secured party is entitled to take possession of the collateral under the terms of the Security Agreement, it may do so (without breaching the peace). Alternatively if repossession is not possible without breaching the peace, the secured party may approach court and obtain the necessary orders to take possession of the collateral. The debtor is usually held liable for all expenses in connection with this proceeding.

Upon taking possession, the secured party may (i) sell the property and apply the proceeds towards the debtor’s obligation; or (ii) accept ownership of property in partial or full satisfaction of the debtor’s obligation.

In case of competing interests, the security interest that was perfected first takes precedence. If you are a lender holding a security interest, always ensure that the Financing Statement is filed immediately and is up-to-date at all times.