In an effort to shield their personal assets from liability for creditors and debts associated with their business, many business owners are advised to set up corporate entities. The type of corporate entity depends on the type of business, number of shareholders and other factors but the benefits are virtually the same. Creating a business entity protects the owners assets from being seized to pay any judgements or debts associated with the business.
However, many business owners who become clients of our firm are never properly advised that a failure to maintain certain formalities with regard to the corporate entity will defeat the liability protection afforded by the entity. Creditors have the ability to “pierce the corporate veil” to seek payment of judgements or debts directly from the personal assets of the owners. In order to maintain the corporate veil, the entity must be operated as a business with separate bank accounts, annual meetings and accurate records. Otherwise, the court will determine that the entity is merely an “alter ego” to the individual owners wherein the liability protections afforded by the entity are disregarded in favor of holding the individual owners personally liable.
Here are some examples of formalities that should be observed to maintain the liability protection afforded by a corporate entity:
a. Corporate Records Book. The corporate records book and financial records should be properly and consistently maintained. In Florida, the shareholders and board of directors of the company must have an annual meeting. A record of the annual meetings should be executed by the shareholders and directors and kept in the records book. The stock certificates evidencing the shareholders and their shares should be issued and a separate list of outstanding certificates should also be maintained in the event a certificate is lost or accidently destroyed.
The contents of the meeting minutes should include the date, time and location of the meeting, the names of all officers and directors at the meeting, approval of the prior meeting minutes, resolutions regarding issue discussed and voted on, a record of the voting, (for example, was the vote unanimous, if anyone abstained). Generally speaking, any major changes or decisions relative to the business’s structure or contracts should be voted on and ratified in the minutes. Some examples of dealings that should be reflected in the minutes include, but are not limited to: reorganizations and mergers, elections of officers and directors, loans, leases or any significant contracts.
b. Capitalize. The entity should be funded by purchasing shares of the corporate stock, which as indicated above, will result in stock certificates being issued to the shareholders.
c. Asset Separation. The business finances should be maintained totally separate from those of the individual shareholders. The corporate entity should have it’s own bank accounts and credit cards
d. Dividends. If the entity is required to pay dividends and fails to do so, the court may treat the entity as an alter ego.
The most important issue to understand when using a business entity for liability protection is that simply creating the entity is not enough and in order to maintain all the perks provided by the protection, the owners must make an annual or more frequent effort to maintain the records in order to prevent a creditor from “piercing the corporate veil.”