Proper Corporate Maintenance
By Michael A. Penn, J.D.
As discussed in a separate article entitled "Choice of Business Entity Considerations - Part I", one of the first decisions the small business owner must make is choosing the proper legal entity in which to operate the business. Most people believe the only choices are: (i) sole proprietorship, (ii) general partnership, (iii) limited partnership, or (iv) corporation. However, as discussed in the above referenced article, there are several other legal entities from which to choose, such as: (i) limited liability partnership, (ii)limited liability company, and (iii) limited liability limited partnership. This article will focus on and will address those business owners who have already made the decision to incorporate, and who have in fact incorporated the business.
One of the primary reasons for incorporating is to limit the personal liability of the owners of the company. As a sole proprietor or general partner in a partnership, the business owner exposes himself to a host of potential liabilities. Such liabilities include injuries to persons or property due to the intentional or negligent acts of employees, injuries caused by the malfunction of a product, and liability claims for injuries that occur on the premises of the business. Additionally, the unincorporated business owner could face personal liability for all of the debts of the company in the event the company falls on hard times or fails.
Most business owners who have incorporated recognize the potential pitfalls that could otherwise exist without incorporating. However, without proper maintenance of the corporate structure, the protection that the business owner sought by incorporating may very quickly evaporate. Courts across the country, including Georgia, recognize a concept known as "piercing the corporate veil." This concept allows a creditor of the corporation to bring a claim directly against the shareholder(s) of a company where the corporate structure is not maintained. The Georgia courts have stated that the corporate entity will be disregarded where it is shown that, "the shareholders disregarded the corporate entity and made it a mere instrumentality for the transaction of their own affairs; [and] that there is such unity of interest and ownership that the separate personalities of the corporation and the owners no longer exist."
The question therefore becomes: What constitutes the proper maintenance of the corporate structure for the purpose of preserving protection of personal liability? In its simplest sense, in order to protect the personal assets of the shareholder(s) of a corporation for the acts of the corporation, the company must maintain a separate identity from its owners. This is done in several ways, as set out below.
A. Maintain Separate Roles
First, it is imperative that the separate roles of the shareholders, directors, and officers be respected. This becomes even more important, and admittedly more difficult, with a one person corporation.
Shareholders: Shareholders are the owners of the corporation. Their ownership interest is evidenced by the issuance of stock certificates noting the number of shares in the corporation they own. Shareholders do not own the assets of the corporation, whether tangible (i.e. equipment and inventory) or intangible (i.e. the name of the company or a customer list). The assets are owned by the corporation itself, and if such assets were in the name of one or more of the shareholders prior to incorporation, they should be transferred to the corporation. Shareholders do not manage the business, except with regards to electing the board of directors, which in turn appoints the officers of the company, and with regards to making only the most important decisions, such as the sale of all of the assets of the company, or merging with another company.
Shareholders must act as a group, and actions are taken at meetings, or by written consents signed by all of the shareholders. The Georgia Corporate Code requires the shareholders of any Georgia corporation to hold an annual meeting each year. Additional meetings may be necessary if the need for shareholder approval for certain corporate action arises. Minutes of such meetings or written consents should be created to document these actions.
Most importantly, the assets of the corporation, including profits, should only be distributed to shareholders by way of compensation, dividends, or other distributions specifically approved by the board of directors. As discussed below in greater detail, a shareholder's withdrawal of funds from the corporation without proper approval or for improper purposes will jeopardize the corporate protection otherwise available to the shareholder(s).
Directors: The board of directors, which can consist of one director, is responsible for the management of the corporation. The directors appoint officers, who carry out the day-to-day activities of the corporation. The directors make the major decisions of the corporation, including issuance of stock and payment of dividends. It is important that the board of directors adopt formal resolutions evidencing their decisions with regards to such matters. Additionally, the Georgia Corporate Code requires the board of directors of any Georgia corporation to hold an annual meeting each year, and minutes from that meeting or a written consent in lieu thereof, should be created.
Officers: The officers of a corporation are employees of the corporation who carry out the day-to-day activities of the corporation in accordance with policy set out by the board of directors. Typically, the officers consist of a president, secretary, and a treasurer. The specific roles of each officer is set out in the corporation's bylaws, which should be adopted by the board of directors. Officers are reminded that their activities for the company are done in a representative capacity, and all signatures should reflect that representative capacity.
B. Avoid Commingling Funds and Assets
The second way to maintain the corporate identity is to avoid the commingling of funds and assets. Such commingling could occur between the Corporation and shareholders, as well as between the Corporation and a second business venture of the shareholder(s). If the shareholder(s) own a separate business, it is important to respect the separateness of the two entities and to avoid transferring funds from one business to another without proper documentation, and for improper purposes. Of course, if one company were to loan money to the other company in exchange for a promissory note or other loan agreement, this would be a proper transaction.
As mentioned above, if assets being utilized by the corporation are actually owned by a shareholder, the assets should be transferred to the corporation, or the corporation and the shareholder should enter into a lease agreement. Further, the shareholder(s) must be especially cautious to avoid the use of corporate funds for personal expenses, or for other business ventures. This act alone is the single greatest cause of piercing the corporate veil.
C. Maintain Complete and Accurate Records
The third method of maintaining the corporate identity is by maintaining complete and accurate corporate records. First and foremost, a shareholder's ownership interest should be documented by way of a share subscription agreement and by the issuance of a stock certificate. Second, decisions made at the annual meetings of the shareholders and directors should be documented in written minutes or annual consent actions. Finally, all major decisions of the board of directors and shareholders should be evidenced by minutes of a meeting, written consents, or written resolutions.
The easiest way to keep all corporate documents in order is by the use of a corporate minute book. A well-organized corporate minute book will go a long way toward proving that the owners of the corporation respect the corporation as a separate entity.
The above discussion is certainly not intended to be an all-encompassing list of ways to protect the personal assets of the shareholders of a corporation, as such a list would be impossible to create. However, following these relatively simple guidelines will put the shareholder in a stronger position to protect his or her personal assets from the creditors of the Corporation.
The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.