When you form a company, the entity is effectively a new “person” (in the legal sense) with a separate existence from its owners. This separation is fundamental for the business owner because it allows owners to protect their personal assets and limit their liability. However, the separate existence of the entity must be formally respected, otherwise, the legal “veil” that separates the entity from its owners may be pierced and the individual owners may be found liable for the debts and obligations of the entity. Maintaining this “veil” intact is what corporate formalities are all about.
What Are Corporate Formalities?
The term “corporate formalities” refers to a series of stepsneeded to properly document the separation of the owners from their company. Although the term “corporate formalities” refers to corporations, these internal processes should be implemented by all types of entities (but limited liability companies offer more flexibility) and they are essential for the proper documentation of company activities and existence. So, we will refer to “corporate formalities” somewhat loosely throughout this article, as these same processes apply also to non-incorporated entities, like LLCs. Maintaining proper corporate formalities is easy, but it requires care and diligence. Below are some tips and recommendations.
The Most Important Corporate Formalities
Following some simple rules of conduct will help you steer clear of a number of legal issues, ensure compliance, and preserve the separation of the entity from its owners. The most critical corporate formalities you will want to be aware of are as follows:
1 – Organize Your Entity
When setting up your company, be sure to hold an initial meeting (or a written statement of organization, if applicable) to approve the governing documents of your entity, select the persons with managerial control over your entity (directors, officers, managers), and issue the initial shares of stock or other certificates of ownership (if required). Starting off on the right foot is essential to establish the boundary between owners and the company.
2 – Follow the Rules Indicated in the Governing Documents.
Make sure to read and abide by the requirements described in your articles of incorporation, bylaws, operating agreement, or other governing documents to the letter. Do not deviate from them unless amendments are properly approved at a meeting or by written consent.
3 – Hold Annual Meetings
Be sure to hold annual meetings to elect officers or managers and approve business decisions. Allow owners to meet in person, vote by proxy, or consent in writing. All discussions and votes taken at meetings must be reflected in appropriate minutes (generally kept by the company’s secretary).
4 – Hold Special Meetings
Whenever anything out of the ordinary occurs, hold a special meeting to inform the owners or the board, as applicable, and obtain a vote. Out-of-ordinary events include real estate purchases, loans, signing of a large contract, hiring of a high-level executive, etc.As for minutes of annual meetings, you must keep accurate minutes of special meetings too.
5 – Maintain Separate Books and Records (do not mix)
Do not mix your personal records with the company’s. Any document or property that is in your individual name must be kept separate and apart from the company. This is especially true for financial documents and bank accounts. Your company should have a separate bank account, and you should never use company money to pay for personal expenses, or vice versa.
6 – Follow Proper Procedure When Making Changes
Always follow the proper procedure when adopting new changes such as amendments, conversions, and any change in directors, officers, or managers. Involve the board of directors, managers, and owners in the decisions as required by the governing documents. Be sure to file any changes in the public records, if applicable. Third-parties (like banks) will rely on both private and publicly available document to determine who has authority to act on behalf of your company.
Consequences of Not Maintaining Corporate Formalities
It is easy to get caught up in the daily activities of running a company and forget to maintain the boundary between personal and business. However, doing so could cost you in the end. Some of the more dire consequences of not keeping corporate formalities include the following:
- If you are a public company, you may be delisted.
- Elections held, and decisions made, without following proper procedural protocol may be invalidated.
- Creditors of your business may sue you individually and attack your personal assets.
- Third-parties may refuse to do business with you – financial institutions like lenders, banks, and insurance companies often require compliance with corporate formalities in order to provide their services.
- Your entity may be administratively dissolved by state authorities, and will be prohibited from doing business in the state.
- A lawsuit could be filed against your business – many contracts with vendors, landlords, and lenders require that company actions be “duly authorized,” which means the actions have to be approved following proper corporate formalities.
Remember, these are not the only adverse effects of ignoring corporate formalities.
Areas to Be Very Careful
Specific corporate activities may make it easier to cross formal boundaries. Some things you want to be careful of are:
Negotiations and Agreements
When negotiating an agreement, be sure to follow your company’s bylaws and involve the proper people.
Be sure all contracts are ratified and signed by the proper people, following the right approval process.
Mergers, Death, Partner Split
Things like corporate mergers, the death of a corporate officer, or a partner leaving the company can present opportunities for crossing boundaries. Be sure to ask for legal help before doing anything that could cause you grief later.
State Laws Vary
State laws regarding maintaining corporate formalities vary widely. Therefore, you should familiarize yourself with your state’s rules regarding any oversight or errors you may make.
How to Ensure Protection
The best way to protect yourself against the failure to maintain corporate formalities is to educate yourself on what they are and how they apply to your company. Then you should set in place rules and procedures to avoid missteps.
You should also consult your corporate attorney for assistance before taking any action. Contact My US Business, LLC today with your questions or concerns. We offer free consultations and can help you establish your new corporate entity correctly and in compliance with state and federal law.