a test of legal rudiments
We are pausing today to review some of the most fundamental protections every small business should have against this kind of attack. They are called “legal rudiments,” because they are the most basic, least expensive sources of protection available to a business. They can be very effective against an attack, earning back their minimal cost many times over. On the other hand, if they are ignored or improperly implemented they can leave assets exposed to an opportunistic creditor.
Limited Liability
Probably the cheapest form of protection available in this society is the use of a legal entity. These include corporations and limited liability companies, both of which offer the kind of limited liability sought by most people. Such entities are like real people in the eyes of the law. They can sue and be sued, and they can own property and conduct business. Used properly, they prevent creditors from reaching the personal assets of business owners to satisfy their claims against the business. We will talk about corporations in this issue, and will discuss limited liability companies next time.
Piercing the Corporate Veil
The limited liability offered to the owners of a corporation, called “shareholders,” is very nearly absolute. In response, people who sue businesses owned and run by corporations have been working hard for decades to find ways to “pierce the corporate veil,” and thus gain access to the owners’ assets. The traditional method of mounting this attack is for the creditor to demonstrate that the shareholders have failed to observe what are called the “corporate formalities.” As a cumulative result of these attacks over many decades, it has become critically important that shareholders know and respect various formalities of corporate existence.
It is important to realize that no one, except a proactive corporate attorney, will warn a shareholder in advance of the need to respect corporate formalities. Most shareholders only learn the importance of maintaining the corporation as a separate identity when they are attacked by a creditor in court for failing to have done so. For the most part, it is then too late to take effective corrective measures.
A point that is too often missed is that all of the rules discussed in this article apply to corporations that have only one, or only a few, shareholders. In fact, if anything these rules are more important to smaller businesses than they are to large ones. This is due to the tendency of small business owners to view their businesses as mere extensions of their individual selves. From a legal standpoint, it is hard to imagine a more destructive viewpoint.
Corporate Records
A corporation is a fictional legal entity. It exists only because the law says it exists, and the law imposes certain obligations. To fully establish and maintain that existence, certain records must be created and maintained by the shareholders. The first of these are the share certificates themselves, which should be written and delivered to each shareholder. In addition, the corporation keeps a log of who owns each issued share of stock. By law in the state of Florida, it is this internal record of share ownership that determines who owns the corporation’s stock and in what proportions. Accordingly, the failure to maintain that record constitutes a failure by the shareholders to respect the corporate formalities.
Corporations are usually governed by a Board of Directors, the members of which are elected annually by the shareholders. The Board members, in turn, hire the corporate officers to run the day-to-day operations of the corporation. The shareholders should keep records of their periodic elections, and this is another of the “corporate formalities.” In fact, without those records the shareholders will generally be charged with the very strict, “fiduciary” responsibilities normally attached to the Board. Likewise, written records should be kept of the identity of the corporate officers, as they are the ones who can be held liable in court for the corporation’s daily operations. Such records are normally kept as “minutes,” or the official record, of the annual meeting of the shareholders. These records are an important part of the corporation’s legal formalities, and if they are not kept in good order the corporation’s creditors will likely be able to reach the personal assets of the shareholders.
Board of Directors
The Board of Directors of every corporation should meet at least once a year. The purpose of these meetings is to evaluate the performance of the corporation’s officers, and to determine the strategic course of operations over the coming months. In practice, these meetings normally take place regularly during the year, as the corporation’s top management makes plans for the future. However, perhaps the most common failure by shareholders is to inadequately document these meetings. In some cases, minutes are not kept for ten or fifteen years, and must be prepared in a mad rush to respond to an inquiry. While such “make up” actions are certainly better than nothing, they still leave the shareholders somewhat vulnerable to the corporation’s creditors. The best protection possible is to prepare minutes of every meeting as it takes place.
Officers
Corporations cannot take any action except by individuals who are authorized by the Board to act on the corporation’s behalf. These are normally called officers, and are appointed by the Board. In Florida, the same individual may simultaneously hold more than one office and, where there is only one shareholder, often does. However, if no officers are appointed at all, this can be evidence that the shareholders have failed to observe corporate formalities.
It should also be kept in mind that a corporation’s officers are also its employees, and should be paid as such. The failure to pay the officers something for their efforts is an obvious failure to observe corporate formalities.
Corporate Name
It is important that the corporation conduct all of its business under its own name. This means that all corporate documents, such as letterhead, business cards, signage, invoices and other business forms bear the corporation’s name. That name must include an indicator of corporate status, such as “Inc.,” “Corp.,” “Ltd.,” or the like. Moreover, such documents should not bear the name of any of the shareholders, unless it is clear the capacity in which the shareholder’s name appears. Particular attention should be paid to this point in the use of email to conduct corporate business. If the email can be interpreted as coming from the shareholder in his or her individual capacity, and not as a director or corporate officer, then the creditor will have access to the shareholder’s assets to satisfy any claim that may ultimately arise. We routinely recommend the use of email corporate letterhead to avoid this problem.
Likewise, all agreements concerning the corporation’s affairs should be written and signed as the act of the corporation. Any agreement signed on behalf of the corporation that does not clearly indicate that it gives rise only to corporate rights and obligations, can be used by corporate creditors to reach individual assets.
Conclusion
The protection provided by a corporate entity is extremely valuable, and relatively inexpensive. However, even unintentional failures to observe the corporate formalities can eliminate all that protection. We recommend business owners take a moment each year to review those formalities to ensure they will enjoy the protection for which they have paid.
Limited Liability
Probably the cheapest form of protection available in this society is the use of a legal entity. These include corporations and limited liability companies, both of which offer the kind of limited liability sought by most people. Such entities are like real people in the eyes of the law. They can sue and be sued, and they can own property and conduct business. Used properly, they prevent creditors from reaching the personal assets of business owners to satisfy their claims against the business. We will talk about corporations in this issue, and will discuss limited liability companies next time.
Piercing the Corporate Veil
The limited liability offered to the owners of a corporation, called “shareholders,” is very nearly absolute. In response, people who sue businesses owned and run by corporations have been working hard for decades to find ways to “pierce the corporate veil,” and thus gain access to the owners’ assets. The traditional method of mounting this attack is for the creditor to demonstrate that the shareholders have failed to observe what are called the “corporate formalities.” As a cumulative result of these attacks over many decades, it has become critically important that shareholders know and respect various formalities of corporate existence.
It is important to realize that no one, except a proactive corporate attorney, will warn a shareholder in advance of the need to respect corporate formalities. Most shareholders only learn the importance of maintaining the corporation as a separate identity when they are attacked by a creditor in court for failing to have done so. For the most part, it is then too late to take effective corrective measures.
A point that is too often missed is that all of the rules discussed in this article apply to corporations that have only one, or only a few, shareholders. In fact, if anything these rules are more important to smaller businesses than they are to large ones. This is due to the tendency of small business owners to view their businesses as mere extensions of their individual selves. From a legal standpoint, it is hard to imagine a more destructive viewpoint.
Corporate Records
A corporation is a fictional legal entity. It exists only because the law says it exists, and the law imposes certain obligations. To fully establish and maintain that existence, certain records must be created and maintained by the shareholders. The first of these are the share certificates themselves, which should be written and delivered to each shareholder. In addition, the corporation keeps a log of who owns each issued share of stock. By law in the state of Florida, it is this internal record of share ownership that determines who owns the corporation’s stock and in what proportions. Accordingly, the failure to maintain that record constitutes a failure by the shareholders to respect the corporate formalities.
Corporations are usually governed by a Board of Directors, the members of which are elected annually by the shareholders. The Board members, in turn, hire the corporate officers to run the day-to-day operations of the corporation. The shareholders should keep records of their periodic elections, and this is another of the “corporate formalities.” In fact, without those records the shareholders will generally be charged with the very strict, “fiduciary” responsibilities normally attached to the Board. Likewise, written records should be kept of the identity of the corporate officers, as they are the ones who can be held liable in court for the corporation’s daily operations. Such records are normally kept as “minutes,” or the official record, of the annual meeting of the shareholders. These records are an important part of the corporation’s legal formalities, and if they are not kept in good order the corporation’s creditors will likely be able to reach the personal assets of the shareholders.
Board of Directors
The Board of Directors of every corporation should meet at least once a year. The purpose of these meetings is to evaluate the performance of the corporation’s officers, and to determine the strategic course of operations over the coming months. In practice, these meetings normally take place regularly during the year, as the corporation’s top management makes plans for the future. However, perhaps the most common failure by shareholders is to inadequately document these meetings. In some cases, minutes are not kept for ten or fifteen years, and must be prepared in a mad rush to respond to an inquiry. While such “make up” actions are certainly better than nothing, they still leave the shareholders somewhat vulnerable to the corporation’s creditors. The best protection possible is to prepare minutes of every meeting as it takes place.
Officers
Corporations cannot take any action except by individuals who are authorized by the Board to act on the corporation’s behalf. These are normally called officers, and are appointed by the Board. In Florida, the same individual may simultaneously hold more than one office and, where there is only one shareholder, often does. However, if no officers are appointed at all, this can be evidence that the shareholders have failed to observe corporate formalities.
It should also be kept in mind that a corporation’s officers are also its employees, and should be paid as such. The failure to pay the officers something for their efforts is an obvious failure to observe corporate formalities.
Corporate Name
It is important that the corporation conduct all of its business under its own name. This means that all corporate documents, such as letterhead, business cards, signage, invoices and other business forms bear the corporation’s name. That name must include an indicator of corporate status, such as “Inc.,” “Corp.,” “Ltd.,” or the like. Moreover, such documents should not bear the name of any of the shareholders, unless it is clear the capacity in which the shareholder’s name appears. Particular attention should be paid to this point in the use of email to conduct corporate business. If the email can be interpreted as coming from the shareholder in his or her individual capacity, and not as a director or corporate officer, then the creditor will have access to the shareholder’s assets to satisfy any claim that may ultimately arise. We routinely recommend the use of email corporate letterhead to avoid this problem.
Likewise, all agreements concerning the corporation’s affairs should be written and signed as the act of the corporation. Any agreement signed on behalf of the corporation that does not clearly indicate that it gives rise only to corporate rights and obligations, can be used by corporate creditors to reach individual assets.
Conclusion
The protection provided by a corporate entity is extremely valuable, and relatively inexpensive. However, even unintentional failures to observe the corporate formalities can eliminate all that protection. We recommend business owners take a moment each year to review those formalities to ensure they will enjoy the protection for which they have paid.