To maintain your liability protections, the law has created a fiction that is called the “corporate veil”. That means that a business is considered a separate entity, apart from its owners. As such, owners are not held liable for the debts of the business unless the corporate veil is “pierced” as a result of the owners not maintaining this separate existence.
Keep Corporate Record
The corporate record is an important part of maintaining that wall between the owners, and the business.
This record is a depository of all relevant legal documents showing that the business is its own entity. It contains, among other things, the certificate that the state gives showing that the business has been granted legal status. It should also contain your bylaws or operating agreements; shareholder agreements; and minutes of director and shareholder meetings. Keep your tax documents there too – your s-corp approval and tax returns.
This list is not comprehensive, but each document properly kept is one brick in that wall you were building in Part I of this series.
Follow All Legal Formalities
Keep your business registered, that’s basic. File and pay your annual renewal.
Your bylaws or operating agreement should contain procedures for shareholder and director voting on certain business activities. For example, your bylaws may say that the CEO cannot authorize expenditures of more than $50,000 without shareholder approval. Do that = follow these rules set up that show the business is separate from the owners.
These documents may even limit what kinds of business the entity can engage in. Don’t go beyond that, or a court may find that the owners did not follow the rules for the entity.
Properly Capitalize the Business and Use Business Funds Only for the Business.
This means that the business should have sufficient operating capitol to maintain continuous operations. A business, once it’s up and running, should not be constantly “asking” the owners for money.
Use business funds only for business. The business is set up to pay profits to the owners. This must be done in accordance with the bylaws / operating agreement, and the tax rules. The business should not be paying for an owner’s auto lease (unless necessary for the business), cable T.V. bill, vacations.
Using this “pre-tax” money is tax fraud, and can show that the owner treated the business as a part of himself, and not a separate entity.
Conclusion on Maintaining the Corporate Veil
These tips, and the tips from Part II, are not guaranteed. A judge is going to do whatever he does. But by establishing procedures to ensure that all corporate formalities are followed, you will stand a good chance of keeping the businesses liabilities within the business.
If you need help setting up or reviewing your business operations to make sure you have the “corporate veil” in place, call me in North Carolina at (312) 671-6453 or email me at palermo@palermolaw.com.
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