Observe corporate formalities and limit personal liability

 

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New business owners wear many different hats. A single new entrepreneur may own all of the corporation’s shares, fulfill all of the responsibilities of the statutory officers, and serve as sole director, business development star, marketing executive, messenger, and janitor. Under these circumstances it is very easy to let the corporate formalities lapse, especially since these formalities don’t seem to drive the bottom line. Unfortunately, informality can expose the unprepared business owner to personal liability.

One of the main benefits of forming a corporation is the limited liability that its owners have for the corporation’s activities. When the corporation observes appropriate corporate formalities, the shareholders will not be personally liable for the corporation’s debts. This protection is often referred to as the “corporate veil.”

Segregate business activities from personal activities. One of the most important things entrepreneurs can do to protect their personal assets is to segregate them from the business’s assets. If funds are comingled, if the company is not adequately capitalized, if the owners are paying for personal expenses with money set aside in the company’s accounts, then it will start to look as the though the company is the “alter ego,” or an extension, of the owners. As such, the owners will have a harder time convincing a court that they should not be personally responsible for the corporation’s debts.

Follow good corporate governance practices. Owners need to read the company’s operating agreements, bylaws, and articles of incorporation, and follow the procedures that they describe. The company should record significant decisions with director and shareholder consents or meeting minutes, and pay attention to rights granted to investors.

Understand the roles of directors, shareholders, and officers.  Each of these positions have very different responsibilities and should act appropriately, even if the roles are held by the same people.

Look like a company; behave like a company. Companies get insurance, pay tax returns, obtain federal employer identification numbers, and are accountable to shareholders and directors – among other things. Entrepreneurs who observe the appropriate formalities will be in a better position to avoid creditor attempts to pierce the corporate veil and impose personal liability on the company’s owners.

This article is provided for general education purposes. Please check with a legal or tax advisor for legal or tax advice.

For more information:  Write to Delida at syobexaminer@gmail.com or visit The Law Office of Delida Costin.