The Myths of Corporate Formation and Compliance - Part II of II

Posted almost 5 years ago. Applies to California, 1 helpful vote

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1

Liability Protection

The reason for forming a corporate entity in the first place is to have the liability protection if the corporation is sued and so that the corporation can sue in its own name. However, in order to have this protection, the corporation must a) be completely formed; b) adequately capitalized; c) corporate governance completed annually; and d) be in good standing with the Secretary of State. Additionally, owners may not commingle funds or run the company as an "alter ego," e.g. running private costs and expenses for oneself through the corporation. There are formation requirements in addition to annual requirements that are commonly referred to as corporate governance or compliance. Failure to file or late filing will result in monetary penalties.

2

File Annual Statement of Information

The State of California requires that an Annual Statement of Information be filed within three months of filing your initial Articles of Incorporation and thereafter on an annual basis on the anniversary day of your Articles. A nominal annual fee is charged by the Secretary of State and penalties may be imposed for not filing such or for a late filing. You are responsible for meeting the deadlines: the Secretary of State will not remind you.

3

Conduct Annual Board of Director and Shareholder Meetings

Annual corporate Board of Director and Shareholder meetings must occur and minutes must be prepared in order to keep your corporate records up to date. These minutes must nominate and elect directors, approve the prior year financial records, and ratify the acts of the officers and directors at a minimum each year. The Board minutes further will nominate and appoint officers of the corporation. Transactions that have occurred throughout the past year should be evaluated to determine whether or not they warrant documentation through resolutions and other documentation e.g. the shareholders have loaned the corporation monies throughout the year. A resolution in this instance would be required together with a promissory note. There are other transactions that may have occurred such as equipment purchases, contract execution, premises leased, credit lines established, etc. that would require independent resolutions.

4

Have a Corporate Records Book

The corporate books consist of the original Articles, Restated and Amended Articles, Bylaws, Organizational Meeting Minutes, Annual Board of Director and Shareholder Minutes, Buy Sell Agreement, Shareholder Agreements, Close Corporation Agreements, Application for Federal Tax Identification Number, S-Election Application, Stock Transfer Ledger, Stock Certificates, and Notice of Exemption from Registration. I also recommend that corporate loan agreements, promissory notes, leases, patent registrations and trademark registration certificates and assignments be included within the corporate records book. Nonprofit corporations have different documents, and are not addressed within this article. The documentation of the annual transactions provides a defense to an alter ego theory being asserted against the principals of the corporate entity in the event of litigation. A Defendant may subpoena the corporate records book in order to look for deficiencies, lack of compliance with annu

5

Corporate Documentation is a Must

The documentation of the annual transactions provides a defense to an alter ego theory being asserted against the principals of the corporate entity in the event of litigation. A Defendant may subpoena the corporate records book in order to look for deficiencies, lack of compliance with annual filings, evidence of commingling funds, and other evidence of running the corporation as a separate person for personal purposes and gain in order to pierce the corporate veil. If the liability of the corporation does not hold up under this scrutiny, then the Defendant will pursue the principals personally attempting to reach their personal assets beyond the corporation. Should this occur, the purpose of having a corporation is for not.

6

Piercing the Corporate Veil

In certain limited instances, creditors or litigants can attempt to impose personal liability on principals in a Close Corporation by claiming that the corporation is a sham, a device created merely to defraud creditors, or is being run as a sole proprietorship (e.g., there has been a commingling of corporate and individual property, the entity was not properly formed, formalities have not been followed, or the entity was not properly capitalized). The process of imposing individual and personal liability is referred to as "piercing the corporate veil," or "disregarding the corporate entity." Ordinarily, a party seeking to pierce the corporate veil will have a heavy burden in attempting to persuade the courts to disregard the corporate entity.

7

Maintain Your Corporate Liability Protections

In order to maintain your corporate liability protections it is crucial to keep your corporate records up to date and the annual filings, including the corporate tax return, timely. Corporate records governance and compliance and keeping such up to date is crucial to asserting a defense in litigation and be able to commence litigation as well as defend litigation through the corporate entity and shield your personal assets and wealth. Taking the time to effectively communicate with your corporate counsel and allowing the corporate governance process to occur on at least an annual basis by your counsel is essential to maintaining the corporate liability protections.

Additional Resources

California Corporations Code

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