One of the most common reasons to set up a new business entity is the protection of personal assets that a properly run corporation provides. Ordinarily, a corporation is regarded as its own legal entity, separate and distinct from its shareholders, officers and directors, with separate and distinct liabilities and obligations. However, if you are not careful about how you run your business, procedures used in litigation can expose your personal assets – we call this “piercing the corporate veil.” Using this process, a creditor can try to set aside corporate protections. To do so, they need to show that the business is not a separate entity, but is an “alter ego” of the people running it. Additional personal liabilities may exist for some employment law claims.
In California, the courts use a two-part test to pierce the corporate veil and set aside the entity protections. To set aside a corporation and hold individuals liable, we look at (1) whether there is such a strong unity of interest and ownership between the corporation and the alter ego defendant that their separate personalities no longer exist; and (2) whether treating the corporation as separate from the individuals will result in an unjust result. In helping businesses manage risk, we focus on the first part of the test – making sure that personal interests and business interests are kept separate. This includes making sure that corporate formalities are taken care of, the corporation is adequately capitalized and funds are not commingled.
State Filings, Annual Meetings & Corporate Minutes
If you have the time and expertise, you can take care of your corporate formalities and maintain your corporate status without using an attorney. First, find out what state and federal filings are required for your business. Identify the forms you need to use and information you need to supply well in advance. Forgetting to file is the easiest way to lose your corporate status! Each year, schedule an annual meeting. Look at your bylaws to find out when this should happen and for any notice requirements. Annual Meetings usually take place at the beginning of a corporation’s financial year. One of the main purposes of the meeting is to elect directors for the following year. You should also confirm who (and where) the shareholders are, identify key employees (and whether there are any employees at all), confirm your employment documents are up to date, evaluate insurance needs, check the status of the corporation with the Secretary of State and review financial reports, including corporate tax returns. Any changes in the corporation’s financial status or activity should be noted, as should key events such as the purchase of real estate. Record all of these things in accurate, detailed minutes, and store the minutes with your corporate records. If you are not sure what to include, contact us to discuss a corporate checklist! If there is any doubt that you can take care of all the steps required to maintain the corporation’s status, remember we offer a Corporate Monitoring program that will guide you through the appropriate steps. Most of our clients choose this route given the importance of maintaining the corporate structure to maintain their personal assets.
In addition to the steps you need to take with corporate formalities, there are housekeeping steps you should take to keep business and personal interests separate. Maintaining separate accounting records and separate bank accounts is a necessity. There should be absolutely no co-mingling of corporate and personal assets. Don’t write checks for personal expenses from your business account, even if you intend to repay the business. If you are investing personal funds in the business, document the investments (and any repayment) carefully. If you regularly have to bail out your corporation’s bank account with personal funds, there is a chance a court could find it is not adequately capitalized, one step further towards piecing the corporate veil. Insurance is another thing to take care of. Make sure there is coverage for your business activities and that coverage for business and personal risk is billed separately. Consider how you use your employees, too. Be sure not to use them to take care of your personal errands while they are on company time. If you have employees who work for more than one business, make sure you have separate payroll records or appropriate documentation that makes it clear who they are working for and when.
Let the World Know You Are a Business Entity
When you are working on behalf of your entity, it is important people understand you are doing so in a business, rather than personal, capacity. Documents should be signed on behalf of the business entity (“John Doe on behalf of Acme Corp, Inc.”), and your business cards, invoices, checks, contracts and legal documents should all identify the business name. These small steps make a big difference – and can save you a lot of time, and money, in litigation.
Finally, if you are facing litigation, remember that corporate status is one of many things we can help with to make sure you are ready to defend your interests. We can work with you on everything from document retention to complex strategic steps to protect your interests. I am always happy to talk with clients about managing the uncertainty that a lawsuit can bring to their ability to focus on more important business and personal goals.
Naomi R. Dewey, Partner
DISCLAIMER: This Advisor is one of a series of business, real estate, employment, estate planning and tax bulletins prepared by the attorneys at Buynak, Fauver, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution or use of this Advisor.