Corporate Formalities Checklist: Comply with Corporate Formalities to Ensure Limited Liability

Comply with Corporate Formalities to Ensure Limited Liability

By Michael G. Kerbs – The Business Press Guest Columnist

As published in Riverside, San Bernardino and the Inland Empire by The Business Press on November 24, 2010.

Corporate shareholders and board members often make the mistake of thinking they can’t be held personally liable for their corporation’s debt. One local construction company realized this the hard way by failing to follow its corporate formalities.

Upon forming the corporation, the individual overseeing its management did all the necessary steps to file the Articles of Incorporation and adopt bylaws. However, this individual never actually signed the stock certificates, never held any shareholder or director meetings and never kept separate financial records for the corporation.

More importantly, the corporation never set up its own bank account, and the individual paid his individual expenses and the business’ expenses out of the same account. Because the individual failed to recognize that the corporation was a separate entity and commingled his affairs with those of the corporation, he was found to be liable for all the corporation’s debts. Ultimately, he had no choice but to file for bankruptcy.

From time to time, we will hear similar stories about corporate owners who lose their homes, their cars and most of their personal assets because they are misled to believe that by simply forming a corporation they are granted limited liability. But in order to be protected by limited liability, a corporation must act like an independent legal entity and follow through with its corporate formalities of properly addressing corporate records, regular meetings and financial statements.

Corporate records, meetings

When a corporation is formed, it enacts bylaws which are the rules that the corporation operates by. In most bylaws, it is specified that the corporation is to conduct regular meetings for the individuals managing the corporation, its board of directors, as well as annual meetings for its shareholders. Minutes of those meetings should be prepared and maintained to show that the corporation held its required meetings and to establish that the corporation properly authorized activities relating to its business.

Another important corporate record is its Articles of Incorporation, which must be filed by the corporation when it is formed. The Articles of Incorporation are filed with the Secretary of State and are proof of the corporation’s existence. The Articles of Incorporation describe the purpose of the corporation and authorizes it to issue its stock. Once the Articles of Incorporation are filed, the Secretary of State issues a Certificate of Incorporation which declares the corporation to be a legal entity. All of these documents should be maintained in a corporate binder with the minutes from all meetings.

One common occurrence for individuals forming a corporation is that they often neglect to issue the actual shares of stock for the corporation. Ownership interests in a corporation are evidenced by certificates of stock. Copies of the issued stock certificates should be kept and documented in a stock ledger. The ledger should provide information regarding the shareholder’s name and address, the date of the issuance and number of shares and documents the shareholder’s signature acknowledging receipt of the certificates.

Financial statements

Corporations must document all of their financial activities and maintain a current balance sheet that is separate from the owner’s personal finances. Failure to maintain separate finances is the number one reason for imposing personal liability on the owner of a corporation.

The corporation must also keep detailed records of all financial transactions, and to the greatest extent possible, make its regular payroll and dividend payments consistent. If possible, both monthly and annual financial statements should be prepared, which will be helpful in preparing the corporation’s tax returns.

Ongoing compliance to all corporate formalities, including holding shareholder and director meetings and maintaining detailed financial records, is key to protecting one’s personal assets. Corporate owners that don’t follow through with these actions will to be liable for all the corporation’s incurred debt.

Michael G. Kerbs is President of Reid & Hellyer, a law firm based in Riverside that practices primarily in litigation, real estate, business, bankruptcy and mediation. He can be reached via 951-682-1771 or mkerbs@rhlaw.com.