Observing Corporate Formalities: Preserving Limited Liability Status

Tomorrow is the official one year anniversary of Haske & Haske, P.C! This milestone influenced my blog topic. Before we opened our doors, we incorporated our business as a professional corporation. The legal structure of our business is almost identical to an S-Corporation, except that we cannot limit our professional liability. S-Corporations are treated like partnerships for tax purposes, with the company’s income or losses recognized by the individual partners according to his or her proportionate share (and taxed at individual tax rates rather than at the corporate rate). But for all other purposes, the company is a corporation.

To protect your company’s limited liability protection (meaning its ability to shield your personal assets from the company’s creditors), it is not enough to keep the corporation’s records updated with the Secretary of State - although of course this is important. Even if your corporation is in good standing, you could lose the liability protection by failing to follow corporate formalities and keeping your company’s finances separate and sufficiently documented.

Avoiding any type of co-mingling of personal and corporate funds is essential. Why should a court treat your company as a separate entity, if you do not treat the corporation’s money as the corporation’s rather than your own? Keeping separate documentation of corporate financial transactions goes hand in hand with this concept. Once small business owners understand the importance of financial separateness and good record keeping, they are usually equipped to perform these tasks on their own, or with the help of an accountant.

However, many small business owners have no idea how to keep corporate minutes or follow their own bylaws. Observing corporate formalities is one of the most over-looked areas of corporate liability protection. Before you can observe corporate formalities, you need to be familiar with your corporation’s bylaws, which are the rules that govern how and when corporations can take certain actions. It is also important to hold annual shareholder and director meetings (yes, even if you are the only shareholder and the only director), and record the decisions made at those meetings in your company’s corporate minutes book.

Corporate minutes are a record of your company’s compliance with its bylaws. Certain decisions can only be made by shareholders. Others can only be made by directors. All decisions requiring approval by the shareholders or directors must be recorded. Without these records, your company looks less like a corporation and more like you doing whatever you want. If you can do whatever you want with the company, without following the company’s rules, courts will be less inclined to view your corporation as a separate entity. Instead, the court may decide that your company is just your alter-ego, allowing your creditors to “pierce the corporate veil” and reach into your pockets to pay the company’s debts.

Keep your corporation strong and healthy by keeping it separate from you. Separate finances. Separate records. Separate decision-making procedures as defined by the company’s bylaws. If you do not know how to run your company’s meetings or keep accurate minutes, talk to a lawyer. We love rules.