Corporate Formalities: Protecting Your Business' Assets

By: Steve Masur

Corporate formalities are steps that your business must take to ensure that your corporation remains legally distinct from its owners. The majority of these steps include keeping separate records for corporate activity, holding regular meetings for corporate directors, and maintaining a financial independent account for your corporation.

You should be careful to observe the proper corporate formalities so that your business will not be attacked by any governmental authority or other creditor as being no more than a sham entity created to give you tax benefits or to protect you from personal liability. The most important corporate formalities which should be observed are:

The timely filings of corporate forms
The writing of corporate minutes which reflect the various actions of the corporation and the annual meeting of stockholders or action by written consent in lieu of such meeting
Communicating with third parties in a manner that clearly indicates that they are doing business with your corporation and not an individual
Separate maintenance of all financial accounts

Your corporation must keep minutes of all meetings with stockholders, Board of Directors and any committee of the board. Also, your corporation should keep a stockholder list, including addresses. Transfer agents for the corporation are equipped to maintain the stockholder list and will periodically provide updates to the list. The minutes do not have to follow any sort of form but should include information such as the date, time and place of the meeting, those persons in attendance, and the actions taken and considered by the board in a clear fashion. It is strongly recommended that all minutes not drafted by your firm be reviewed periodically to ensure that all corporate business is properly authorized.

Another indication that your corporation is conducting business as a bona fide corporation will be the maintenance of proper books and records for your corporation. Stockholders and directors have the right during usual business hours to inspect your corporation’s stock ledger, stockholder list and any other books and records. The annual meeting of stockholders is significant in maintaining the on-going nature of your corporation and confirming that you and the other members of management are respecting the separate existence of the corporation. Your corporation should hold an annual meeting of stockholders to elect the Board of Directors, to ratify the appointment of accountants and to transact any other business properly brought before the stockholders and to conduct stockholder business.

The law considers your corporation to be a separate person and therefore its financial affairs and all assets and funds should be kept separate from any individuals or other entities, assets, and funds. You should take care always to execute legal documents and take other actions on behalf of the corporation in a way that makes clear that your corporation is the party taking the action.

To reduce the risk that stockholders of your corporation will be liable for its debts and obligations, all officers, directors, and stockholders should observe the corporate procedures set forth in your state’s general corporation law and in the bylaws of your corporation. Also, you should do the following:

Carefully maintain written consents of directors and stockholders, stock records, bylaws, Certificate of Incorporation, and other corporate records
Hold meetings of directors and stockholders as necessary or appropriate and keep minutes of those meetings
Make it clear to third parties that they are transacting business with you corporation rather than any individual
Execute documents and instruments on behalf of and in the name of your corporation rather than in the name of any individual
Carefully segregate corporate assets and funds from personal assets and funds
Use corporate assets and funds only for corporate purposes not use personal assets or funds for corporate purposes
Carefully document all personal dealings with your corporation

Division of Responsibilities

In addition to taking care to ensure that your corporation’s identity remains distinct from that of any individual, all persons associated with your corporation should take care that their different roles relative to the corporation remains distinct. The Board of Directors is ultimately responsible for the management of your corporation. The Board of Directors appoints and delegates authority to your corporation’s officers. The officers handle the corporation’s day-to-day affairs, including the execution of documents and instruments under the direction of the Board of Directors. The corporation’s bylaws generally describe the principal duties and responsibilities of the officers of your corporation. Each member of the Board of Directors is charged with a duty of care and a duty of loyalty to the corporation. As such, each director must act in good faith and in a manner such director believes to be in the best interests of your corporation. Directors must act with such care as an ordinarily prudent person in a like position would use under similar circumstances. In doing so, the directors may rely on the advice of independent experts, but they must make a reasonable inquiry into the facts on which such experts base their advice. Similarly, the director must not usurp an opportunity which properly belongs to your corporation. In this regard, a director must bear in mind that your corporation must first be offered an opportunity which falls within the realm of your corporation’s business prior to a director undertaking to benefit personally from such opportunity.

Depending on your state’s general corporation laws your Board of Directors may be required to approve certain corporate actions. To approve corporate actions, the Board of Directors typically adopts resolutions by unanimous written consent or by vote at a directors’ meeting. The bylaws of your corporation describe procedures for obtaining unanimous written consent and holding directors’ meetings; you should review your bylaws whenever you have a question concerning such procedures. Forms of actions by written consent should be kept in the minute book, with the other corporate records of your corporation. The Board of Directors generally may take action at a properly noticed meeting at which a majority of the authorized number of directors is present upon a vote by a majority of those present. Special rules apply where a director has an interest in the matter to be approved. Transactions involving directors will be evaluated to determine whether the transaction is fair to your corporation, and the material terms and director’s interest are fully disclosed to and ratified by stockholders or by non-interested directors acting in good faith.

Actions that generally require directors’ approval include:

Election of corporate officers
Amendments to and repeal of the bylaws
Election of directors to fill vacancies on the Board
Issuance, sale or transfer of shares of stock
Calling of meetings of stockholders
Declaration of dividends and other stockholder distributions
Amendments to the Certificate of Incorporation
Sale, lease, conveyance, exchange, transfer or other disposition of corporate property and assets
Corporate borrowing and lending
Designation of corporate banks and authorized signatories
Adoption of business policies and plans

Depending on your state’s general corporation laws, stockholders may be required to approve of certain fundamental corporate actions. To approve corporate action, the stockholders typically adopt resolutions by written consent or by vote at an annual or special meeting of stockholders. The bylaws also describe the procedures your corporation must follow for obtaining stockholder written consent and calling and holding annual and meetings of stockholders.

Actions that generally require stockholder approval include:

Certain amendments to the Certificate of Incorporation
Election or removal of directors
Sale of all or substantially all of your corporation’s property assets
Mergers, reorganizations or dissolution of the corporation

In simpler terms, it will not always be evident whether you and the other principals of your corporation should take action as officer, director or stockholder. The easiest solution, although it is not always the best solution, is to seek and document both Board and stockholder approval of any major action your corporation is considering taking.