This is part 4 of a 7 part series highlighting common legal missteps of small businesses.
Mistake #4: Failing to maintain corporate formalities.
As I discussed in the last entry, one of the main reasons to incorporate is to protect your individual assets. In this entry, we discuss the importance of maintaining “corporate formalities.” This is required to ensure that your individual assets remain protected throughout the life of your business. In other words, failing to maintain corporate formalities can result in a court or the Internal Revenue Service (“IRS”) “piercing the corporate veil” and holding you personally accountable for your corporation’s debts.
Not to worry, the threshold to pierce the corporate veil is high; in most instances, a finding of some form of fraud are required. Examples of fraud include the business owner concealing corporate assets or comingling personal and corporate funds. In these circumstances, the court reasons that the entity is a mere “alter-ego” of the individual and, therefore, the individual is not entitled to corporate veil protection.
So, what can you do to ensure your entity remains protected under the corporate veil? First, ensure you maintain a distinct wall between your entity’s finances and your own. Simple mistakes such as paying a personal debt with a company check, making loans to yourself with corporate funds, or signing a contract in your own name, as opposed to in the name of the business, tend to indicate that the entity and the owners are not distinct.
Secondly, ensure the entity has the appropriate documents in place: an Operating Agreement, if a limited liability company; or By-Laws, if a corporation. To the extent those documents require annual meetings of either members, managers, shareholders or directors, ensure the entity holds these meetings and keeps a detailed record of the meeting’s minutes (the “Minutes”). The Minutes should be prepared by the Secretary of the entity, signed, and then approved by the members, managers, shareholders or directors, as the case may be. The Minutes should indicate the entity provided proper notice of the meeting or reflect that notice was waived. Further, the Minutes should indicate the number of individuals present and whether this number represents a quorum and voting results, to extent there are abstentions or dissents.
By following these simple steps you can ensure your individual assets remain protected.
Moisan Legal P.C. is a boutique law firm focusing on representing entrepreneurs and businesses in a variety of legal issues. Matthew J. Moisan can be reached at 646.741.5222.