People form corporations for many reasons, and probably chief among them is to take advantage of the corporation’s protection against personal liability for the debts and liabilities of the corporation related to the property owned or business operated by the corporation.
While there are some limits on the protections that a corporation provides (e.g., criminal acts, not signing contracts in corporate capacity, active participation in corporate torts), many people form the corporation and forget to observe corporate formalities and obligations. This is especially true as to small, closely held corporations. One of the primary reasons to “pierce the corporate veil” and pursue the individual shareholders, directors and officers for personal liability is when the corporation is found to be a sham entity and the corporation is simply the “alter ego” of the principals.
A corporation can be found to be a sham entity when (i) personal funds and the funds of the corporation are commingled; (ii) the formalities of the corporation have not been observed; or (iii) the corporation is inadequately capitalized (essentially, the corporation was not seeded with sufficient funds for expected operations).
Commingling Funds. This should be straightforward: corporate funds should be used for corporate purposes, and not for the personal use of the shareholders, directors or officers. If you want to use corporate funds, then first distribute the money in the form of a dividend or salary. Likewise, your personal funds should not be used for corporate purposes. If you are a principal of a corporation and the corporation needs funding, do not pay the corporate liability or obligation with personal funds. Instead, a loan can be made to the corporation, and such should be evidenced by a written promissory note, with a corporate resolution approving the loan.
Corporate Formalities. The corporation needs to have Bylaws and hold annual meetings of the shareholders and directors with written minutes of the meetings. At these meetings, at minimum the shareholders should be nominating and electing directors for the following year and the directors should be nominating and electing officers. Other business of the corporation is typically discussed and approved at these meetings, such as the making of deferred compensation contributions, officer salaries, the purchase of equipment, the hiring or firing of employees, and other business. Many corporations make decisions throughout the year, and these decisions should be authorized through special meetings with minutes or by a written Resolution without a meeting.
The last thing you want is to find your corporation in a lawsuit and served with discovery seeking your corporate compliance documents—especially if you have neglected this obligation. You can be assured that plaintiff’s counsel will seek to press personal liability. It is easy to take the steps in advance and protect yourself from such a result.
If you own or operate a corporation, you should review your Bylaws and corporate compliance documentation. Counsel should be contacted if you have any questions regarding whether you have satisfied the requirements.