After legally forming a new business entity by filing their articles of incorporation or articles of organization with the Division of Corporations, many small business owners believe that they have completed all the steps necessary to operate under their new business entity, and completely ignore many corporate formalities required by statute or other applicable law. Many owners fail to realize that they have yet to name any officers, directors, or managers to manage the day-to-day operations of their new business entity, and sometimes that they have even failed to issue any actual shares or membership interests to themselves and other owners of their business entity. Therefore, such business owners have no evidence of ownership of their entity, and are thrown into a panic when asked for proof of ownership by a potential lender, insurance agent, or other party doing business with the business owner. Moreover, by failing to name officers or managers, business owners fail to provide for any person with authority to act or make decisions on behalf of the business entity. This can cause issues when the company enters into a contract it is later trying to enforce.
In addition, there are a number of additional corporate formalities that often remain ignored by business owners, including, but not limited to: (a) adopting bylaws or an operating agreement setting forth, among other things, rules and guidelines for the operations of the entity, and the authority of officers or managers to act on behalf of the entity; (b) making sure officers and managers are abiding by such by-laws or the operating agreement; (c) holding annual meetings of directors and shareholders or members and recording the decisions made during such meetings (or preparing a written consent in lieu of the same); (d) keeping minutes of important decisions made during annual or special meetings of the shareholders and directors or members (or preparing a written consent in lieu of the same); (e) preparing and updating a readily-available corporate book with accurate, detailed minutes and other records of the business entity, whether evidenced through meeting minutes or by written consent.
A systematic failure to abide by the corporate formalities referenced above is one of the factors a court may consider when deciding whether or not a creditor may pierce the corporate veil and hold shareholders or members personally liable for business debts entered into by the company. Small business entities are especially vulnerable because the failure to meet such basic corporate formalities gives the appearance of the corporation simply being an “alter ego” of its owner created only to avoid the claims of potential creditors.
To learn more about how to create and maintain corporate formalities, contact a business law attorney.