Failure to Observe Corporate Formalities Put Your Personal Assets at Risk

As most business owners know, the primary purpose of forming most business entities is to insulate business owners, directors, and officers of the business from liability to third parties. In certain circumstances courts and third parties may ignore the existence of a business entity and hold business owners, directors, and officers personally liable for the debts and obligations of the business. One way to do this is to “pierce the corporate veil,” essentially arguing that the business entity itself is a sham. This normally occurs when business owners, directors, and officers fail to treat the business as a separate and distinct entity from themselves. The argument is not limited solely to business entities that area corporations.

Historically, courts look at many factors in considering whether to pierce the corporate veil. One factor considered is whether business owners, directors, and officers observe corporate formalities. Unfortunately, too often I see that even the simplest formalities are overlooked by business owners. One such formality is holding regular meetings of the business owners, and just as importantly, documenting the existence of those meetings.

Business owners should check any corporate bylaws, LLC operating agreements, and even partnership agreements that apply to their businesses. Likely, these documents require at least an annual meeting of the business owners and the failure to comply with these requirements presents an opportunity for a third party creditor to claim that the business entity should be disregarded as a sham.

An annual meeting of shareholders need not be a complicated event. Often, these meetings may be held telephonically or by other electronic means. Topics to consider include the election of board members, appointment, removal, or retention of LLC managers, dividend or distribution policies, financial performance, business goals and strategies, voting on any actions requiring shareholder, member, or partner consent, etc. Memorializing the occurrence and content of these meetings in the form of minutes is extremely important and may be offered as proof against claims to pierce the corporate veil.

Entities with a single owner should not disregard the importance of holding business meetings, which may be evidenced through the use of minutes (as absurd as that might seem), or as an alternative should execute an annual consent or resolution of the business owner in lieu of a meeting.

Some of these actions may seem tedious, but the relatively short amount of time a meeting may last, and the ease of preparation of minutes or a consent of company owners in lieu of a meeting could tip the scales in favor of a court rejecting claims to pierce the corporate veil.

I’ve long been a fierce critic of LLCs making tax elections to be treated as S corporations (and have written about this topic in a prior FGMC newsletter). The only argument presented to me in favor of LLCs taxed as S corporations over corporations taxes as S corporations, is that Colorado’s limited liability statutes do not require an annual meeting of the members of an LLC. While this statutory fact is true, I counter that argument by stating that LLCs should hold annual meetings of the LLC members (at least) for all the reasons previously mentioned. The simplicity of holding and documenting a meeting should only encourage business owners to do so. The investment of what might only be one or two hours a year I often describe to clients as the most cost-effective business insurance policy they will ever own.

It’s very common for a client to use one of the attorneys at FGMC as registered agent for the clients’ business entity. Generally, one of the responsibilities our attorneys take on as a registered agent is to file the annual report with the secretary of state for that business entity, that is required under Colorado law. In connection with the filing of an annual report consider inquiring about our firm to assisting you in the preparation of annual minutes or a consent of the members. It’s an inexpensive proposition that one day may pay off handsomely, and our firm would be happy to assist you.

Steven Weiser

Special Counsel


Previous Post
Welcome Our Newest Associate Nate Mortensen to the FGMC Team!
Next Post
So You Think You May Want To Sell?

Sign Up for Our Newsletter