Failing to properly form your corporation or limited liability company creates unnecessary personal risk.

Quite often clients will come to me with an already formed entitiy.  When I ask for corporate records, they can’t produce any because they’ve never been created or they are so out of date, they are basically non-existent.  Operating without proper documentation for your corporation or limited liability is a significant risk. For little time, effort and money you can properly form and run your entity.

One of the main purposes of formation of a corporate entity is to protect you from personal liability for actions of the company.  Proper formation of a corporate entity and following the corporate formalities helps ensure that the liabilities of the company, such as debts and judgments, can only be satisfied by assets of the company and not with the personal assets of the company owner(s) or shareholder(s).

Minnesota’s corporation and limited liability company formation statutes create the presumption that when the Articles of Incorporation or Organization for an entity have been filed with the Secretary of State and the required fee has been paid, an entity is formed and an owners liability is protected. 

A lot of accountants and some attorney’s tell you this is all you need to do to properly form your company.  NOT ME! And in my opinion, not any attorney worth his or her chops: There is an important exception to the liability shield, particularly applicable in a closely held entity where there are few shareholders.  An entity needs to be treated as a separate company from the personal activities of the members or owners.  If it instead is an “alter ego” of the owners, and the shield from personal liability creates an unfair result to a creditor or other person, a court may find the owners personally liable.   

As a part of my practice, I provide my clients not only the tools to properly set up their corporate liability protection, but also provide tools and resourses to continue that protection from year to year with little additional attorney help. 

For example, imagine an entity with two owners who are also the only employees of the company.  Imagine if one of the owner-employees got into an accident while in the course of business and was sued.  If the entity has significantly less assets than the plaintiff was seeking, a judgment against the company would be worthless to the plaintiff.  In such a situation the plaintiff will likely try to reach the personal assets of the owners. 

To do this, the plaintiff would attempt to “pierce the corporate veil” by showing that the entity is really an “alter ego” of the owners and should not be afforded the protection from personal liability.  If, in the above example, the owners have treated the company as a separate legal entity and not disregarded the corporate formalities in carrying on the business, a court will be more likely to protect the personal assets of the owners.

In order to determine if the owners have treated the company as a separate legal entity in such situations, Minnesota courts looks to the following factors:

  1. Undercapitalization in light of the corporate undertaking.  This means that the company needs to be funded adequately for the business that it is conducting.
  2. Failure to observe corporate formalities.  Come back tomorrow to read more indetail about the corporate formalities.
  3. Nonpayment of Dividend.  It is important that you follow the rules set forth in your bylaws and operating agreement as related to the payment of dividends.
  4. Insolvency of corporation at the time of the transaction. If the entity takes on additional business while it is insolvent, a court may find this unfair and misleading.
  5. Siphoning off corporate funds at the time of the transaction.  It is important to record and have reason for all withdrawals from the company. You should also make sure that all loans to and from the company, including loans between owners and the company are properly documented.
  6. Non-functioning of officers and directors.  This means a company needs to have directors and officers that act on behalf of the company. 
  7. Absence of Corporate Records.  Corporate records are evidence that you have contemplated more than just the formation of your Corporation and that you are running it as a separate entity from yourself.
  8. Use of the Corporation as merely a façade for individual dealings. This is a culmination of all of the above factors.  By following corporate formalities and acting as a separate entity it shows that you are not merely using the corporate name to conduct your personal business.

 Making sure that your company does not commit any of the above and instead acts as a separate entity from its owners adds weight to the presumption of personal liability protection.  It is not a complete insurance against personal liability.  For example in instances of breach of fiduciary duties and misconduct against the Corporation, an owner can still be liable to the entity and to third parties for his or her acts that are independent from the company.  But, following these recommendations is the first step in protecting owner personal liability against acts by the company.