Forming a corporation or a limited liability company to operate a business is an excellent way to insulate the owners of a business from personal liability. For the sake of brevity, I’ll refer to both corporations and LLCs interchangeably as an “entity”.
In essence, a corporation or LLC stands between a business owner and his or her creditors, limiting liability for a debt or an adverse judgment in a lawsuit.
Corporate Shield and Corporate Formalities
A corporate shield requires maintenance in order to be effective, and effective maintenance requires careful observance of “corporate formalities” – the steps that must be taken to document the existence of an entity separate and apart from its stockholders or members. The failure to observe corporate formalities can result in the dismantlement of a corporate shield, or what is more quaintly known as “piercing the corporate veil”.
Maintaining a corporate shield is not especially difficult, but it does require consistency, attention to detail and timeliness. Following is a list of steps that business owners should take to maintain an effective corporate shield.
Properly Form the Entity in Accordance with the Laws of the State
The separate entity must be properly formed in accordance with the laws of the state in which it is organized. The formation document – a charter, articles of incorporation or certificate of formation, must contain the information required by statute; must be signed by a person authorized by statute, and must be accompanied by the required filing fee. Some states, such as New York, have publication requirements that also must be observed.
Hold and Document an Organizational Meeting
After the formation document has been properly filed, the next step is to hold and document an organizational meeting. This is an initial meeting of stockholders or members. At the organizational meeting, the stockholders/members elect directors and officers, adopt by-laws, or, in the case of an LLC, an operating agreement, that defines and describes how the entity will govern itself, and describes the limits of authority of the officers of the entity. Minutes of and resolutions passed at the organizational meeting should be kept in a record book and stored in a secure place.
Timely File Annual Reports and Pay Filing Fees
An entity must timely file annual reports and pay any report filing fees, and must timely file all required tax returns (regardless of whether any tax is payable), and timely pay any tax due.
Corporation statutes in most states require at least one annual meeting of stockholders/members and of the board of directors. Additional meetings should be held as required by the entity’s governing documents, and as needed to authorize actions outside the ordinary course of business, such as borrowing by the entity, or the sale or acquisition of a significant asset. Minutes of all such meetings should be kept with the entity’s records.
It is important that stockholders/members and do not exceed the authority given to them under the entity’s governing documents, and that the entity is not used as a vehicle to transact business for the personal benefit of a stockholder/member.
- Do not commingle personal funds with those of the entity.
- Do not use personal accounts to pay entity expenses, or entity accounts to pay personal expenses.
- Do not make loans to stockholders or members except in strict accordance with the governing documents.
- Be guided by the principle that the affairs of an entity and those of its owners must be kept separate and apart in order to maintain the integrity of a corporate shield.