Many small business owners are well aware of the importance and benefits of incorporation. If properly formed and operated, a corporation shields its shareholders from personal liability. A corporation is also treated separately for purposes of taxation, either providing that the corporation is a taxpaying entity (commonly referred to as a”C-Corp”), or that tax attributes are ‘passed-through’ to the shareholders (an “S-Corp”).
While many small business owners seek legal counsel to assist them with formation of their corporation, they may not understand the benefits of having continuing legal counsel to assist with the operation of their corporation, specifically the importance of maintaining corporate formalities. Failure to draft and maintain documents related to the operation of your corporation may subject the corporation to fines from state agencies, civil liability, and, at worst, the ability of courts to disregard the corporate form and make shareholders personally liable for debts of the corporation.
Though you may believe that your business is a small, private company which does not need to follow the rules for large, public companies,the law does not make exceptions, only subtle distinctions that your attorney can explain to you.
What Is Required?
Upon the formation of your corporation, you must submit Articles of Incorporation to the Secretary of State. The Articles of Incorporation must have specific clauses by law. If you have a closely-held corporation,you must include additional clauses specified by law. No corporation may issue shares until the Articles are approved by the Secretary of State (other states have different names, including Department of Corporations). Your corporation must also draft and adopt bylaws, laying out the rules adopted by the corporation for its internal governance. Annually, a corporation must file a Statement of Information with the Secretary of the State to remain in good standing.
Prior to issuing stock, even a so-called “private”company must either register the stock with the Department of Business Oversight or request an exemption. Your attorney can assist you with filing for the proper exemption to ensure your stock is properly authorized and issued, even if you alone or with your spouse are the only shareholders. Your attorney may even be able to properly exempt shares previously issued improperly.
Corporations must also hold shareholder meetings annually, and must keep minutes of such meetings. Corporate decisions must be documented and ratified, either by director meetings or by resolutions by directors passed by unanimous written consent. Proper notice must be given for all meetings, as specified in the bylaws. An attorney can assist you in ensuring you maintain the proper minutes and resolutions for all corporate decisions.
A corporation must maintain proper accounting records and shareholder records. Even a change in the name of one of the shareholders,or for example, a transfer of title from your personal name to the name of your Revocable Living Trust, must be properly documented in the corporate records book.
Failure to Comply Can Harm You
Failure to comply with the above formalities can subject you to monetary fines, personal liability, or even loss of control over your business.
Improperly altering or falsifying minutes, knowing the alteration or entry to be false, can lead to civil damages or even criminal penalty. Failure to keep accurate financial reports may make an officer or director liable for civil damages, as can failure to keep accurate shareholder lists.
If you do not annually file the Statement of Information with the state, the Franchise Tax Board may impose fines on your corporation. Failure to file for two consecutive years could lead the Secretary of State to suspend your corporate rights, powers and privileges.
Failure to properly separate the affairs of your corporation and personal affairs may also allow a court to determine that the shareholders of a corporation are personally liable for corporate debts, which would eliminate one of the major benefits of the corporate form. A court may take into account a number of factors before making a determination, among them commingling corporate and personal funds, treatment of corporate assets as personal assets, failure to obtain authority to issue stock or improperly issued stock, failure to maintain minutes or adequate corporate records, and disregard of legal formalities among related entities.
Keeping good records and tight control over the corporation is especially important if you have business partners. Your business partner may take actions on behalf of the corporations which you may not be aware of if you do not maintain strict control over corporate activities by complying with the above rules. The actions taken by partners may lead to corporate or even personal liability. Furthermore, disputes among business partners can quickly escalate into very expensive litigation. Many of these disputes arise in corporations where actions taken by directors and/or officers are not properly documented, and one party may take advantage over the lax oversight of corporate affairs. Maintaining complete corporate records and retaining knowledgeable corporate counsel who understands your company through and through can save you tens of thousands of dollars in litigation expenses and fines, and provide invaluable stress relief!
At Lanak & Hanna, we have years of experience representing corporations and other business entities of all sizes. Please contact us to assist you in maintaining your corporate records and ensuring you are fully compliant.