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One of the main reasons why business owners decide to incorporate is to take advantage of the asset protection that it affords. However, incorporating your business is only the first step in protecting your personal assets from the creditors of your corporation. Merely incorporating is not enough to enjoy protection of limited liability. You also need to consistently observe Corporate Formalities. Adhering to Corporate Formalities is not all that difficult or particularly time-consuming, and it is certainly worth the extra time an effort when it comes to ensuring that your asset and liability protection strategies are properly carried out.
So what exactly are Corporate Formalities and why are they so important?
Corporate Formalities are procedures using documentation to legitimize and track the corporation’s business affairs. The requirements can be complex or quite simple depending on the makeup of your company. Moreover, they are a set of specific tasks that a business owner performs which help to maintain the LLC’s distinction as a separate and independent legal entity.
3 Reasons Why Corporate Formalities are Important
- In order for a business owner to be fully protected personally by their Corporation or LLC, practicing Corporate Formalities on a regular basis is an absolute must. Failure to observe Corporate Formalities may enable a creditor to disregard the corporate veil and seek personal liability against the Managers and/or Members of the corporation. This is known as “piercing the veil”- a legal maneuver in which the creditor tries to establish that the corporation failed to operate as a separate and distinct entity thus causing the individuals involved to become personally liable for the debts and other such obligations of the corporation.
- An important factor which a court considers in deciding whether the limited liability protection should be pierced (ignored) is whether corporate formalities have been followed in the operation of the corporation and in its documentation.
- Limited liability for stockholders is the foundation of corporate law — absent fraud or a failure to follow corporate formalities, stockholders, in most cases, are only at risk for the amounts invested in the corporation. But, if corporate formalities have not been followed, stockholders can be at risk that creditors and claimants may be able to pierce the shield of limited liability and reach the stockholders’ personal assets to satisfy corporate debt.
Compliance with corporate formalities is also important to assure that all affiliated and/or sister corporate entities are only liable for debts incurred by each separate corporate entity. The biggest challenge of managing a small to mid-size company’s compliance requirements is finding the time to stay on top of everything else that needs to be done. Managing the ever-growing list of requirements and deadlines can be overwhelming, and the threat of fines and/or work stoppages can cause untold stress and worry.
So, what does a business owner need to do to properly observe corporate formalities?
Ongoing formalities made easy
While corporations face the strictest ongoing formalities, limited liability companies (LLCs), limited partnerships (LPs) and limited liability partnerships (LLPs) should also take steps to protect their entity status. Below is a list of ongoing formalities that corporations must follow and that are also recommended for LLCs, LPs and LLPs. Our Corporate Compliance Assessment Service can assist with each of these.
- Create and regularly update bylaws (corporations), an operating agreement (LLCs), or a partnership agreement (LPs/LLPs).
- Hold and properly document an initial meeting of directors (corporations), shareholders (corporations), members/managers (LLCs), or partners (LPs/LLPs).
- Hold and properly document annual meetings of directors (corporations), shareholders (corporations), members/managers (LLCs), or partners (LPs/LLPs).
- Issue ownership certificates (stock certificates, membership certificates or partnership certificates) to all owners.
- Record any changes in percentage of ownership, any new owners added, etc. in a stock (corporations), membership interest (LLC), or partnership interest (LPs/LLPs) in a transfer ledger.
Corporate compliance is crucial to maintaining your corporation. Conducting regular reviews, performing documentation reviews, meeting filing deadlines, keeping complete financial records, detailed meeting minutes, adherence to the corporation’s bylaws and other such governance requirements… are all key components in observing Corporate Formalities. Failure to respect these obligations may lead to heavy government fines and the possible dissolution (closing) of a corporation.
With changes being made constantly to statutory and regulatory obligations, it becomes increasingly important to ensure that full compliance is maintained at all times.
“A reputation takes many years to build, but only momentary carelessness or indecision to lose. Having an effective corporate compliance program can protect a company’s reputation and help prevent and detect problems before they grow.” Rob Biskup, Director Deloitte Financial Advisory Services LLP