A growing number of small business owners are becoming aware of the benefits afforded them by forming a corporation, often referred to as a ‘C-Corp’.
In addition to a litany of qualified tax deductions afforded C-Corps, which are not available to Sole Proprietorships, a C-Corp also protects the business owner’s personal asset in cases of lawsuits, tax liens or other creditor actions.
But forming a corporation is just the first step. Failure to maintain its structure through legally mandated documentation, issuance of stock and/or proper funding could put the corporation’s protective shield – and your personal assets – in jeopardy.
Piercing the Corporate Veil
Proper maintenance of a corporation involves taking actions that support both leadership and financial interests …in a word, documentation: actions that clearly separate the personal interests of owners (shareholders) from those of the corporation.
In order to pierce the corporate veil, a court must determine that the identity of the owner or shareholders are no longer separate, and that preserving the corporate identity would cause an inequitable result.
By issuing stock, providing adequate capitalization, proper financial records, and maintaining corporate documentation formalities, such as the corporate minute book, a clear and legitimate distinction between the interest of a shareholder and the corporation can prevail.
Unity of Interest
A court may find “unity of interest and ownership”, thus exposing the personal assets of an owner (shareholder) to legal or creditor action, if one or more of the following circumstances exist:
-- Failure to Issue Stock
The issuance of stock is a requirement of a corporation. Your financial or corporate advisor can help you determine the best entity for which to hold stock based upon your asset protection needs.
-- Failure to Capitalize
While there is no set initial investment amount stated by law, a corporation must be sufficiently funded to ensure viability and create a financial basis for a separate entity.
Courts generally find that determining adequate capitalization would include a review of the scope of work undertaken by the corporation, and the owner’s intention at the time. Was there a premeditated intention to defraud creditors or create liability greater than expected earnings? Courts will also examine the length of time that passed between an owner’s initial funding of the corporation and the entity’s indebtedness or liability.
-- Failure to Keep Separate Corporate Financial Records
Financial records and statements (banking, credit cards, loans, etc.) are critical in establishing a separate entity. Likewise, decisions made by shareholder approval regarding investments, borrowing, leasing, compensation and purchasing must be documented within the corporate minutes. This is especially true if a corporation has a single shareholder.
Corporate and personal assets, financial or otherwise, must be distinctively separate. The corporate bank account cannot be used for any purchase or expense of a personal nature.
Personal loans made to the corporation must be documented in special minutes, approving the term and promissory note.
-- Meetings of Shareholders and Directors
An active, separate corporation will hold regular meetings of its shareholders and directors. Doing so is vital to preserving the separate identity of the corporation.
The state requires the notice, holding and documentation of meetings, and at minimum, an annual meeting of the shareholders to elect the board of directors and approve any basic operational changes.
Any and all operational and shareholder decisions must be found within the corporate minute book. While it’s a basic function, and certainly one of the easiest, failing to maintain your corporate meeting and minutes documentation could add to cause for piercing the corporate veil.
-- Single Shareholder Control
When a corporation is structured with a single shareholder, it becomes even more important to maintain proper financial and operational records, including corporate minutes, respecting always, a separate identity from the individual. Failure to do so could satisfy a “unity of interest” charge and pierce the corporate veil.
-- Intension to Fraud
Forming a corporation to shield assets from seizure after a legal action has been taken against an individual, or is presumed to be impending, or to otherwise transfer assets as a means of avoiding personal obligations is deemed, by law, fraud.
Shareholders should not reduce available corporate funds to influence or reduce an impending judgment, nor mislead others regarding the corporation’s responsibility to pay for services or product. Shareholders also must not represent assets owned personally, as those belonging to the corporation.
Safeguarding Your Corporation and Personal Assets
Violations of one or more of the outlined requirements of incorporation can provide ammunition that can be used against your corporation -- and you personally -- contributing to a “unity of interest” finding by the courts and risking all that you’ve worked to protect.
By taking responsibility and representing a thorough compliance of these regulations, including, but not limited to the use of a bookkeeper or accountant for tracking income and expenses, fulfilling governmental reporting requirements, and documentation of special, as well as annual meetings of shareholders, your corporate veil will be stronger if faced with a legal challenge.
If you would like to have Leaders Without Limits audit your corporation to determine what, if necessary, needs to be done in order to restore the corporation’s separate legal entity status, call us toll-free at 1(877) 652-1868 or email your request.