Many business owners underestimate their legal exposure when it comes to running their businesses. Lawsuits can land anytime and from anywhere: from a disgruntled employee, client, landlord, consumer, lender, the government, or from an almost infinite array of characters. These lawsuits may evolve into a judgment, and if your business cannot pay the judgment, then your personal assets, such as your house and personal bank accounts, may end up in the cross-hairs of your new judgment creditor.
To avoid this risk, many business owners choose to do business under a formal corporate structure such as the corporation or the limited liability company. It is a well known fact that these structures limit the liability of business owners to the amount they initially invested in their company.
The problem, however, is that while many business owners correctly decide to do business under a formal corporate structure, they don’t appreciate the responsibility of maintaining that structure. They fail to realize that limited liability status is earned, not given.
The good news is that earning and maintaining that limited liability status is relatively straight forward. In short, the company must be treated as its own living, breathing entity, separate from the business owner. Business owners must treat their company as they would treat a stranger. If they are dealing with the company’s assets, they must deal with them as if they were dealing with a stranger’s assets.
Thinking about a company in this way makes it easier to understand why certain corporate formalities must be observed, such as, for example, maintaining corporate minutes, keeping company and personal accounts separate, adequately capitalizing the company, titling company assets in the company’s name, not using company assets for personal use, and having bylaws in place for a corporation or an operating agreement in place for an LLC. The company must stand on its own two feet.
One of the most important yet most neglected formalities is taking minutes that properly document decisions and resolutions made by shareholders and directors, in the case of a corporation. Minutes, in the case of a limited liability company, are not required, but strongly recommended for the reasons outlined in this article. Taking, signing, and filing minutes internally in a corporate minute book are integral steps you can take to help preserve the limited liability status of your company.
Why are corporate minutes so important? They serve as an audit trail of decisions made by the company. The law wants to make sure that the business owner and the company are not one and the same, that the business owner is dealing with the company at an arm’s length, and that all decisions are made for the benefit of the company, not for the business owner. Corporate minutes can be used as proof, amongst other factors, that you have upheld the law’s intent when a judgment creditor is targeting your assets.
Failure to take minutes can provide a court reason to “pierce the corporate veil,” i.e. ignore limited liability protections, and hold the business owner personally liable for actions of the company. While piercing the corporate veil is considered to be an exception to limited liability protections promised by the corporate structure, you should know that courts commonly pierce the corporate veil when there are enough facts to allow them to do so. In fact, courts have been found to pierce the corporate veil 30% to 40% of the time .
Understanding this reality is particularly important for closely-held businesses and businesses that have a small number of shareholders. It becomes even more important for closely-held businesses that are owned and managed by the same people, and it becomes even more important when the same owners and managers own and manage several businesses that all transact with one another.
These types of businesses are at risk because of the ease with which assets can flow between the related parties and the related companies without proper formalities in place. This gives judgment creditors a window of opportunity to argue that all related parties and all companies are one and the same. If the defendant company has no assets, the judgment creditor might be able to reach the assets of the business owner. Similarly, if company 1 has no assets, the judgment creditor might be able to reach assets in company 2.
Properly recorded minutes establish the company’s intent, in writing, so that a court is less likely to misinterpret the dealings of the company with its owners, managers, subsidiaries, affiliated companies, etc. For example, in a corporation with only one shareholder, minutes can document a resolution issuing a specific amount of dividends to its shareholder on a monthly basis, pursuant to what is allowed by its bylaws. This tells a court that the company intended to issue dividends to its shareholder and by extension, tells a court that there were no improper dealings. The company and owner are two separate beings treating each other as such.
In contrast, absent any recorded minutes, this same shareholder would look like he or she is dipping into the company bank account on a monthly basis, and the perception would be that this shareholder is treating the company’s bank account as his or her own. Here, the court may view the shareholder and the company as one and the same and will thus be more willing to hold the shareholder accountable for any debts or actions of the company. Needless to say, using the company’s bank account as your own will factor towards destroying that limited liability protection.
While taking proper minutes, on its own, isn’t the only action required to preserve your company’s limited liability status, it certainly is one of the most important. We strongly encourage all business owners to make corporate minutes a priority as these basic documents could end up saving your house (and cash) on a rainy day.