Protecting A Business Entity’s Limited Liability

The most common and compelling reason to form a corporation to operate a business is to provide limited liability. If done properly, the debts and the liabilities of the business attach only to the business and the business’s assets. With certain exceptions (such as wage payments and certain employment related taxes), those debts and liabilities do not attach to the shareholders or their assets.

Unfortunately, inattention to the legal requirements of operating a corporation and to operational discipline can undo all the good that the shareholders sought to achieve when the corporation was formed. Failing to keep and maintain the corporation as an entity separate from the shareholders can result in a court allowing a creditor or a plaintiff to “pierce the corporate veil” and to bring a suit against the shareholders directly.

Following is a checklist of “dos and dont’s” that a shareholder should keep in mind with respect to preserving the corporation’s limited liability status:

  • Do not use corporate funds to pay shareholder bills or shareholder funds to pay corporate bills. A corollary to this—do not take so much money out of the business that it cannot independently pay its bills;
  • Do not intermingle corporate funds and personal funds in any checking account—conduct all corporate financial activities out of an account set up for and titled in the name of the corporation;
  • Do keep good corporate financial records that reflect all money put into the Corporation whether as a loan or as an equity investment. Generally, a loan should be evidenced by a promissory note, an equity investment by a share certificate. Likewise, keep clear records of all money taken out of the corporation, whether as salary, dividend or other distribution;
  • Do keep a good corporate book. This involves keeping important papers, such as the Articles of Incorporation, bylaws, stock share certificates and shareholder and director minutes in a book (or at least in one place), so they can easily be produced.
  • Do conduct yearly meetings of the shareholders and the board of directors and do make sure that there are minutes/resolutions kept for each year. Among other things, the shareholders meeting should involve the election of directors and the directors meeting should involve the appointment of officers. The minutes should reflect these and other important decisions made in the corporation’s business.
  • Do make sure your corporation’s stationery and invoices use the corporation’s proper name, including its correct corporate designator (such as Inc., Corp., and so on).
  • Do not conduct personal business on corporate stationery
  • Do use correct officer titles when signing contracts.

While the above is geared to discussions of corporations and their shareholders, keep in mind that similar rules apply to other limited liability business entities. The most obvious example is the aptly named limited liability company (“LLC”). The list of do’s and don’ts is largely the same, with the possible exception of annual meetings which are not required of an LLC under Pennsylvania law and of the documents that are kept in an LLC’s “book.” The LLC would normally have a certificate of organization rather than articles of incorporation and an operating agreement rather than bylaws. One hint related to this issue, for purposes of documenting the separateness of a member (owner) of an LLC from the LLC, an operating agreement should be used even when there is only member.

With a little bit of discipline, it is easy to maintain the protections a corporation or a limited liability company provides to business owners.

— Rod Fluck

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