The Importance of Attending to Corporate Formalities

Business Law: Corporate Formations: On this blog, we have previously discussed the fact that registering a business name with the State may be insufficient to adequately protect the corporate owners from individual liability. (Please see Simply Registering a Company Name is Insufficient to Avail Business Owners of the Protections of the Corporate Shield). The logical next step for a business owner would be to move beyond the sole proprietorship model and register the business with the State.

However, it is important to keep in mind that this too may not be sufficient. Establishing a corporate presence, whether in the form of a limited liability company, limited partnership or a corporation, is important in order to create a liability shield that will help insulate the business owners’ individual assets. There are various ways of piercing this veil and creditors may nevertheless be able to try to access those individual assets.

One way of doing this is for a creditor to argue that the corporation is really a sham, and not operating as a true organization. Rather, the argument would be that the individual owner of the company is really acting in his individual capacity, rather than through a separate legal entity. One of the ways in which this attack is made would be by showing that the requisite corporate formalities were not attended to.

In this regard, simply forming the company with the state and obtaining a tax identification number may be insufficient. Instead, a business owner should do everything possible to bolster the corporate shield and to prove that the corporation has an operation and existence that is separate and apart from the individual owner(s). This is particularly important for small businesses and entrepreneurs.

The best way to start this is to have all of the appropriate corporate documents put in place. If the company is a limited liability company, it should have, at a minimum, a signed operating agreement, meeting minutes, organizational resolutions and a ledger of its members. Similarly, a corporation should have, at a minimum, bylaws, a shareholder’s agreement, meeting minutes, organizational resolutions, issued stock certificates and maintain a ledger of those distributions. All of these documents need to be signed and issued, and not just exist in blank form.

In addition, both types of organizations should have annual and special meetings and should have those meetings memorialized in the corporate form. This may sound silly if the business is owned by just one person, but that is precisely the situation in which it is even more important to attend to these formalities. This is because where there is just one or two owners, the argument can be more easily made that they are really acting in their individual capacities. Thus, even a sole-owner should ensure that he is, from a legal perspective, operating the business in accordance with corporate formalities to help enhance the valuable corporate shield.

Comments/Questions: ljm@gdnlaw.com

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