The limited liability protection offered to corporate shareholders (the “corporate veil”) is by far the most important and distinctive advantage of incorporating a business.  To continue enjoying the benefits of such protection, however, it is important that entities properly observe corporate formalities and properly maintain their corporate records and accounts.  This will help a company maintain its corporate status and help protect its shareholders from personal liabilities.

 

Despite the liability protection offered corporate shareholders, it is possible under certain circumstances for a plaintiff, a judgment holder, and even the IRS to “pierce the corporate veil” in which the corporate shareholders become liable for corporate debts.  Courts consider the following when determining whether to pierce the veil:

1.                  The failure of the corporation to keep and maintain corporate record books and hold required meetings;

2.                  Intermingling of funds between the corporation and its shareholders, and the failure to maintain arms-length relationships between the corporation and related entities; and

3.                  Undercapitalization of the corporation.

 

In the event of a lawsuit or audit, one of the first things that will be requested is an entity’s corporate records.  This includes all resolutions, amendments and minutes from meetings held by members of the entity.  Even if the entity is small and closely held, minutes and resolutions are still required and must be kept up to date. 

 

Maintaining proper corporate records also creates a paper trail of the entity’s decisions and transactions, and allows someone to understand the thought processes of the company.  Corporate records detail the official standing of the entity and help to establish the background record required to facilitate corporate transactions.  Inaccurate maintenance of the records can turn the simplest of corporate transactions into a costly experience for all involved.  The corporate record book must be able to demonstrate share ownership of the company, reflect when and to whom shares of stock have been transferred, and contain the original stock certificates or share register of the owners. 

 

In general, following basic corporate formalities, including:

 

1.                  Holding an annual shareholders meeting;

2.                  Holding regular meetings of the Board of Directors;

3.                  Avoiding any mixing of personal and corporate assets; and

4.                  Keeping corporate records up to date