The Corporate Veil

Most people think that once they have incorporated they have no personal liability .. that is simply not true.

Incorporating your business is only one step in protecting your personal assets from the creditors of your corporation. When courts impose liability on individuals for the actions of the corporation, this is called "Piercing the Corporate Veil." In order to avoid personal liability for debts and other acts of the corporation you must run your corporation like the distinct entity that it is.

While it is impossible to tell you everything you must do to avoid personal liability for debts and other obligations of the corporation, as different courts may choose to apply varying factors in varying degrees, we can give you a solid foundation of information.

First, the corporate veil is always disregarded by courts for criminal acts of the officers, shareholders, or directors of a corporation. Further, federal and state tax laws generally impose personal liability on those individuals responsible for filing sales and income tax returns for the corporation.

For most other matters, the corporate veil is most often pierced by courts in situations where the shareholders of a corporation disregard the legal separateness of the corporation and the corporation acts as nothing more than an alter ego for the shareholders' own dealings. Courts often consider many factors in determining whether or not to pierce the corporate veil. Here are some of the major factors courts look at:

• Whether the corporation follows corporate formalities( i.e., having and observing the bylaws, minutes of shareholder and board of directors meetings and/or actions, etc.)
• Absence of corporate records;
• Whether the major shareholders are siphoning money from the corporation for their personal use (i.e. when the principal shareholder takes money from the corporation to pay their home mortgage or buy gifts for themself, etc.);
• Non-functioning of other officers or directors (having officers and directors who do nothing and were put in place by majority shareholder, but are not actively involved in the corporation);
• Commingling of funds and other assets between major shareholders and the corporation;
• Inadequate capitalization (the corporation is undercapitalized at the time transactions with creditors or others wishing the corporate veil to be pierced were entered, or simply not enough capitalization to get the particular corporation running);
• No corporate assets;
• Use of corporation to transfer liability of another (usually a shareholder);
• Contracting with another without the intent to ever perform on the obligations.

Unlike a proprietorship or a partnership, a corporation is a legal entity separate and distinct from any individuals. Generally, it is represented by its directors, officers, employees, and agents, each in their respective capacities, and is operated for the benefit of its shareholders. In closely-held corporations, the same individuals tend to act in several of those capacities; this requires an effort on the part of these individuals to maintain distinctions among these capacities when they take various actions.

It is essential that minutes be maintained of board and shareholder actions. Corporate minutes are the first line of defense against the IRS, creditors, and other parties making claims against the corporation, particularly if a claim is based on a theory that the corporation should not be taxed as a corporation or afforded limited liability (piercing the corporate veil). Minutes can be the written record of meetings or the unanimous written actions of the directors or shareholders taken without a meeting. Either is acceptable, if properly done. Many closely-held corporations fail to keep even annual minutes, which greatly weakens the position of the corporation and its shareholders, directors, and officers in many circumstances. Regular minutes can also:

• Prevent IRS claims of unreasonable compensation of executives who are shareholders
• Protect against IRS claims of excess accumulated earnings
• Create defenses against lawsuits attempting to establish personal liability of directors or officers, by evidencing board business judgment and specific authorization
• Protect against spurious lawsuits of minority shareholders
• Establish authority for corporate actions for the benefit of outside parties

Minutes of a meeting should be prepared by the Secretary of the Corporation, signed, and then approved by the Board or shareholders, as the case may be, at the next meeting or in the next action. This will minimize any claim that the written minutes do not accurately reflect the action taken. Minutes should always reflect that proper notice was given or waived, who was present and who was absent, and that a quorum was present. Any abstentions or dissents on a vote should be noted for the protection of the director abstaining or dissenting. In a closely-held corporation, meetings are often held to create minutes rather than to make decisions, but holding formal meetings with parliamentary procedures tends to result in more deliberate and organized decision- making and is recommended if practical.

It is equally important that minutes be limited to material which helps and not hurts the corporation. Resolutions should be set forth. The fact that a report was given or a discussion held on a subject should be noted. Statements made by a director or the actual content of a report or discussion, however, should generally not be included, since these references tend to be damaging more often than not. Claimants of a corporation will many times establish their case on the basis of minutes which were too detailed. It is also important to maintain a climate in which each director feels free to say anything during a board meeting and know that it will be strictly confidential and not later show up in a written record describing the board's deliberations. Generally, only formal resolutions adopted by the Board should be set forth in minutes.

It is advisable to review any other detailed descriptions in minutes with legal counsel before completing them. Resolutions should be considered on the following subjects, among others:

• Compensation of officers
• Authorization of important contracts
• Acquisition of property
• Loans and guarantees
• Designation of banks
• Engagements of lawyers, accountants, and other professionals
• Declaration of dividends
• Approval of mergers
• Issuance of shares
• Sale of assets
• Authorization to sign checks, deposit funds, and make withdrawals
• Approval of financial statements and audit reports
• Compliance with governmental regulations
• Adoption of employee benefit plans

You must make sure you follow these especially when the corporation has dealings with its officers, shareholders, or directors to demonstrate that any transactions between them and the corporation are at arms-length. While this is a lot to digest and there are more things that parent corporations must follow to avoid the corporate veil's of their subsidiary's being pierced, make sure YOU NEVER:

• Co-mingle your personal assets with those of the corporation;
• Divert corporate assets for your personal use;
• Engage in activities with the intent to defraud creditors; and
• Engage in transactions with officers, directors, and shareholders that are anything but arm's length.