Respect the Corporate Identity - Tips for the Business Entrepreneur.
February 18, 2012
Corporations and limited liability companies (LLCs) are the organizations of choice for operating a business in our modern USA. The reason is clear - The corporate structure1 offers limited liability to the equity owners of the organization. The personal assets of the equity owners are not at risk for the debts and obligation of the business entity. Operating under the corporate structure offers the owners an additional level of protection from claims against their homes, cars, brokerage accounts, jewelry, etc.
The reason for this is statutory. State legislatures have determined that the economic benefits from allowing individuals to organize under a corporate structure for business purposes is substantial. Moreover, courts will defer to this decision by legislatures. Courts will protect the limited liability protections offered by the corporate structure.
There is, however, a significant exception to this general rule - a legal doctrine known as "piercing the corporate veil ." In certain situations, courts will allow claimants to attack the personal assets of equity owners for claims arising from corporate activities. There is extensive case law on why courts will allow claimants to pierce the corporate veil. For the small business entrepreneur, the case law can be succinctly stated as follows: Respect the Corporate Identity.
Courts reason that if an individual equity owner does not himself or herself consider the corporation to be a separate and distinct entity, but rather he or she uses the corporate entity as an "alter ego", then the court has no reason to respect the distinction either. Courts will determine the individual owner's true feelings about his or her entity by the owner's actions. In other words, whether a court will pierce the corporate veil depends on whether the owner has respected his or her entity's separate identity.
There are four actions a small business entrepreneur should consistently practice to assure that he or she respects the corporate distinctiveness of his or her corporation or LLC:
1) First and foremost, the small business person should never co-mingle assets. What belongs to the equity owners belongs to the equity owners, and what belongs to the corporate entity belongs to the entity. Corporate assets do not become personal property of the equity owners until the corporate entity distributes those assets to the equity owners. Corporate entities should have their own bank accounts, tax identification numbers, financial books and records, credit card accounts, etc. The small business persons should never pay his or her home mortgage bill, cable bill, personal credit card bill or other personal expenses from the corporate account. Corporate salaries, bonuses and distributions should be paid into the owner's personal bank account, and then used for personal expenses.
2) Second, when undertaking corporate activities that have legal effect, the small business person should clearly identify that he or she is acting on behalf of the corporate entity as its authorized agent. More usefully, this means, for example, that (i) proper signature blocks should be used when entering into legal contracts2 and (ii) business cards should identify the name of the individual, the name of the corporate entity, and the individual's title with the corporate entity (e.g., President, Chief Executive Officer, Manager).
3) Third, corporate communications should announce that they concern the corporation's business. To accomplish this the small business person should diligently use corporate letterhead and corporate email signatures. This last point should be particularly emphasized. A small business person who uses email for corporate business purposes should set up an automatic signature to identify his or her name and title and the corporate entity's name. This is particularly true when using a gmail, hotmail or other generic email account.
4) Lastly, corporate formalities should be maintained and respected. Keep in mind, however, that the necessary corporate formalities can vary significantly. LLCs are less formal than corporations. Generally, the more persons comprising the equity owners, the more formalities required. Nominal formalities would be required for a single member LLC; while a public traded corporation with thousands of stockholders will require substantial formalities. At a minimum, a corporate binder should be maintained which contains (as applicable) the articles of formation, bylaws, operating agreement, stockholders agreements, resolutions of significant decisions, certificates and ledgers of equity, IRS correspondences and other items related to the existence of the corporation or LLC as a legal entity.
The common sense rule of thumb is: Respect the Corporate Identity. If the equity owner respects his or her entity, then the court will also do so, and the limited liability protections offered by the corporate structure will be honored. Moreover, there is an additional, non-legal reason for doing so. When the individual thinks of his or her business enterprise as distinct and separate from him or herself, he or she begins to focus on making the business activities more cost effective and profitable. Decision-making is guided by the best interests of the corporate entity and not the best interests of the individual owner. This is what our society - and our law - requires.
1 For purpose of this article, the word "corporate" will also include the limited liability company structure. While this is not technically correct, it is sufficient for purposes of this article.
2 An example of a proper signature block would be as follows:
Thomas Jefferson, Manager of The Monticello Project LLC