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Five Easy Steps To Protect the Corporate Shield

Timothy R. Hughes, Esq.
Hughes & Associates, P.L.L.C.

Creating a corporation is an easy and inexpensive way to avoid liabilities, but its not infallible.

Most savvy business people are aware that corporations offer some protection to officers, directors and shareholders from personal liability. What many people may not know is that the corporate shield from personal liability is not infallible. These are five simple steps you can take to maintain corporate protections and avoid personal liability.

1. Avoid Tortious Conduct

The most obvious step is to avoid committing any torts. Examples of tort claims are negligence and fraud, in contrast to contracts. The corporation generally shields owners from liability for corporate debts. It does not, however, eliminate liability for your own torts.

For example, if you wreck the company car and hurt another driver, you may be personally liable for negligence. In contrast, the corporate shield may still protect you from personal liability if another employee is in a wreck. That would be an example of blocking personal liability for a corporate debt.

2. Do Not Treat Corporate Money Like It is Your Own

The corporate shield hinges upon the legal fiction that a corporation is a legal entity separate and apart from its owners, officers and directors. To maintain this legal fiction, you must treat the corporation like it is a separate entity.

You should keep separate books and financial accounts for the corporation. You would be surprised how many people write checks directly from their corporate accounts for personal debts. This sloppy and dangerous practice may result in piercing the corporate veil.

3. Disclose Your Corporate Status

You should properly identify the corporation at all times. For example, business cards and advertising should include the proper corporate name of your entity, including "Inc.", "Co.", "Corp.", or other appropriate monikers denoting a corporation. Your letterhead and stationary should include the same information. Last, but not least, any contracts entered into by the corporation must have the proper name including corporate designation. Signing a contract and not including the right name is a very easy way to become personally liable for all breaches of contract.

4. Be Very Careful Changing Business Entities

Companies sometimes close one corporation and open another. When doing so, you need to be very careful to avoid unintentionally inheriting the prior corporation's debts. Conducting a similar business in a similar location or having interlocking sets of officers, directors, and ownership can create problems.

5. Observe Corporate Formalities

Most reported cases which permit a party to pierce the corporate veil reference a failure "to observe corporate formalities". This exposure is very easy to avoid. If your by-laws indicate there will be an annual meeting of shareholders, hold the meeting. Take minutes of the meeting, sign them, and place them in a corporate notebook. The same holds true for meetings of boards of directors. Decisions requiring approval of the shareholders or board of directors should reflect a meeting and a decision.

With smaller corporations, you can hold meetings at most any place or any time so long as proper notice requirements are met. Notice can generally be waived in writing by the shareholders or directors, so the "shareholders meeting" really can be ten minutes with a bagel and cup of coffee in the office before work. With publicly held corporations, the requirements for time, place and notice become more cumbersome and infinitely more critical to follow.

Conclusion

I often tell clients that creating a corporation is the cheapest investment to avoid liability they will ever make. Corporations are not a complete panacea, but they can be excellent tools to protect personal assets. It is critical for officers, directors, and shareholders to take these simple steps to maintain the effectiveness of corporate protection.