As a new and growing business owner, you read my articles on incorporation and essential corporate documents, and took my advice to heart. You retained an attorney and accountant, drafted and filed the basic forms, and Small Business LLC is up-and-running. However, you are not done — there are important steps to take for you to maintain the benefits of the “corporate form” and keep your personal and business assets separate. Take special note if you are a single member LLCs or single-shareholder corporation. When you are busy running your business, it is easy to overlook corporate formalities — yet whether you are a solo shop or a 50 employee corporation, these formalities are equally as necessary and important to protect your investment.
The exception to the general rule that an owner’s personal assets are protected from a business’s creditors and litigious plaintiffs is called “piercing the corporate veil.” This term of art originated from one of those archaic law school cases that no one remembers, yet practitioners and courts frequently use this phrase today. The idea behind “piercing the veil” that a business owner cannot abuse the corporate form and use it to commit fraud. If a plaintiff convinces a court that the defendant corporation or LLC is a sham, the plaintiff gets to “pierce the veil” and proceed against the business owner directly and personally, as if the corporation or LLC never existed.
Of course, there is always the possibility that an unpaid creditor will accuse your company of fraud and abusing the corporate form even in instances of legitimate business insolvency. After all, everyone wants to get paid, and if there are significant personal assets shielded by the corporate form, it may just be worth the time and money to argue.
Here are some basic tips on how you can maximize the protections of the corporate form and mitigate the risk that a court will order “piercing the veil”:
- Separate bank accounts – This might seem basic, but it is astounding how many business owners co-mingle corporate and personal funds. It is absolutely critical that you maintain separate accounts and keep track of business income and expenses separate from your personal expenses. When examining whether the corporation is a sham, this is one of the first factors that a court will consider. In other words, pay your mortgage from your personal account and buy inventory using the company credit card (as opposed to your personal VISA).
- Have an annual meeting – If you are organized as a corporation, an annual meeting is required by law. While it is not required for LLCs, having an annual meeting (and keeping a written record that such a meeting was held) is another important factor that courts will consider when deciding whether the owner is entitled to continuing “corporate veil” protection.
- Keep a binder with written consents and meeting minutes – Your bylaws or articles of organization likely provide for the ability to make corporate decisions through written consents. Your attorney can help you prepare these documents, but generally these “consents” are written evidence that a particular transaction, such as a sale of real estate, a purchase of assets, an appointment of an officer, was authorized by the company. It is good practice to pick a shelf in your office and maintain a three-ring binder with all the consents arranged chronologically. If the company holds a meeting (whether annual or otherwise), it is best practice to record meeting minutes and keep them in the same binder as the written consents.
- Maintain good standing with the State of Michigan – This is the easiest requirement to observe, yet it is frequently overlooked. Each year, the State of Michigan requires business owners to file an annual statement form and a fee. Failure to do so for a period of time is not only evidence that might cause you to lose corporate protection, but actually can cause your entity to be automatically dissolved. While it is possible to bring your company back into compliance through retroactive payments and filings, the process costs extra fines and needlessly exposes the business owner to losing the benefit of corporate entity protection.