Business_meetingWhile many small business owners seek legal counsel to assist them with the formation of their corporation, they may not understand or otherwise overlook the benefits of having continued 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 for the 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 that 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.

1) What is Required:  Upon the formation of your corporation, you mustsubmit Articles of Incorporation (sometimes known as a Certificate of Incorporation) to the Secretary of State in your domicile.  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 Commissioner 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 any stock, even a so-called “private” company may be required to either register the stock with the relevant state corporate agency or request an exemption.  We can assist you with filing the proper exemption to ensure your stock is properly authorized and issued, even if you – or you and your spouse – are the only shareholders.  We may even be able to properly exempt shares previously issued improperly. Note that shares must be actually issued for the corporation shield to be effective. Failure to issue shares may result in the corporation’s separate status to be disregarded providing exposure to third party attacks or lawsuits. This is almost always the case with internet packages – little care is given to the most basic details.

Corporations generally must also hold annual shareholder and board of director meetings and must keep minutes of such meetings. Many 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.  We 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 record books.

Additional requirements include:

  • Adequate, documented capital contributions.
  • Ensure proper tax withholding and payment of employer taxes and related withholding.  This is a common mistake corporations make.  If payroll taxes are not paid, you may be personally liable.
  • Conduct business as a corporate entity using the corporation’s name.  Ensure that your business cards refer to you as an officer or your other title to protect you personally from any liabilities.
  • Obtain all necessary licenses at the state, county, and city levels.
  • Pay the annual minimum franchise tax (California).
  • Implement and maintain good personnel practice.  Good personnel practice consists of an employee handbook that we can assist you with preparing.

2) 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 of your business.  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 such as: commingling corporate and personal funds, treatment of 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 corporation that you may not be aware of if you do not maintain strict control over corporate activities by complying with the rules above.  The actions taken by partners may lead to corporate or even personal liability.  Furthermore, disputes amongst 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 of the lax oversight of corporate affairs.  Maintaining complete corporate records and retaining knowledgeable corporate counsel can save you substantial litigation expenses, fines, and provide invaluable stress relief!  Please call if you have any questions regarding how to comply with the appropriate formalities for your corporation.

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