Corporate Formalities - The Backbone of Your Liability Protection
With the popularity of Limited Liability Companies (LLCs) corporations are not as common as they once were. Yet, today corporations are still advisable for many. Often business owners choose to utilize the tax savings realized through S Corps. Additionally, rollovers as business start-ups (ROBS) –requiring a corporation- are a popular mechanism for funding startups. If you own a corporation or need a crash course on corporate formalities (and how to maintain them) then this is your resource.
Corporate formalities are steps and precautions a corporation must take in order to ensure that the corporation remains legally distinct from its owners. One of the basic reasons why a business owner would decide to incorporate is to limit his or her own personal liability for business debts. However, simply incorporating is not enough. The corporation must observe corporate formalities in order to prevent a court from piercing the corporate veil (i.e. a legal doctrine allowing the court to attach business liabilities to the business owners) and hold the owner liable for corporate debts. Don't fret; corporate formalities may sound intimidating but are actually quite navigable. We will run through the corporate formalities necessary to keep the courts from piercing the corporate veil and possibly pinning liability on the owner(s).
Corporate Minutes: The Corporation must maintain an accurate report of all meetings by the board or special meetings held by the shareholders. These reports, or notes, are known as “minutes,” and are maintained in a corporate “minutes book.” It is important that the Corporate Secretary maintains descriptive and accurate minutes. These minutes can prove invaluable against attempts to disprove the separate legal entity status of the corporation by regulatory or other agencies.
Corporate Funds: Please do yourself a favor and never co-mingle corporate funds. Private assets belonging to a director, officer, or shareholder of the corporation should not ever be “mixed” with the company or corporate funds. Co-mingling can occur in simple acts such as paying company invoices directly from a personal checking account, or conversely, paying for a Ferrari 458 off the showroom floor using the company check book. Even if you are the sole owner these types of actions serve to undermine the separate legal entity status of a corporation, and can lead to direct personal liability or the loss of personal assets in the event of litigation, tax, or collections proceedings.
Board of Directors: Further, the Corporate Board of Directors must meet at least once a year as required in all 50 states. These are formal meetings during which important strategic corporate decisions are undertaken, such as large acquisitions, mergers, strategic transactional or contractual agreements with other entities. In addition, it is usually during these meetings that decisions involving corporate leadership are made, and where officer positions are affirmed, changed, and even chairman or CEOs are appointed or terminated; say hello or goodbye to that Ferrari. Attendance is a must by all directors, unless written consent of assignment of proxy vote is granted to another member of the board by the absentee member.
Contracts: All contractual agreements entered into by the corporation, at the corporate level, must be memorialized in writing, with express consent of the Board of Directors. This includes all financially binding agreements (e.g. loans, lines of credit), acquisitions (e.g. real estate, other corporate entities, capital equipment), and employment. Failure to implement valid contracts may jeopardize the separate legal entity status of a corporation. When in doubt write it out, just as long as the BOD approve.
The implementation and construction of these formalities will vary with the type of corporation formed, but the basic, essential structure is the same. These formalities are an essential component of corporate operations and are absolutely necessary. Failure to adhere to the corporate formalities can often lead to a weakening of the asset protection, and liability protection, afforded by the formation of a corporation, with consequences.
Contact Providence Law for more information.
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