Incorporating a business can provide business owners protection from personal liability. However, a creditor could still undertake “piercing the corporate veil” to hold a business owner personally liable for the debts of the company. Creditors are most often successful in piercing the corporate veil when a business owner operates the company as a branch of the owner, rather than as a separate entity. Below are general guidelines to maintain the corporation as a shield from personal liability:
- Do Not Comingle Funds. This is the most important rule. Do not use the corporate check book to pay for groceries. Think of the corporation as its own person. You would not just take money from a third party for your own use without asking permission first. The same applies here.
- Maintain Corporate Formalities. The company needs to have annual meetings. The Articles and Bylaws (or other agreements) provide the rules to run the corporation. The company must follow these rules.
- Maintain Records. The company needs to keep a record of the annual meeting and all major decisions. A corporate record book helps greatly in this area.
- Identity of Officers. This especially applies when a second corporation is organized. The identity of the officers in this second corporation needs to be clear to all outside observers to ensure it is not merely a shell corporation.
- Capitalization. The company must be properly capitalized. Constantly taking the corporate bank account to zero does not reflect well on the company being maintained as a separate entity.
- Fraud. Do not abuse the power of the corporation. Fraudulent activities or behavior by a shareholder, officer, or director may subject that individual to personal liability.
Experience has shown the majority of small business owners follow the above checklist except for maintaining corporate formalities. However, even though following these formalities may be time-consuming and require additional effort, doing so could help avoid significant personal liability in the future.
For more information or for assistance in incorporating a business or to discuss other issues related to your business operations, contact us.
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