Another basic but very important legal requirement for corporations involves compliance with what are known as “corporate formalities”. As the name suggest, corporations must comply with certain formal legal requirements to maintain its shareholders’ personal liability shield. (Corporate formalities should be followed by LLC’s as well, albeit to a lesser extent, as discussed below). Basically, following the requirements and procedures set forth in the bylaws or other organizational documents of the business, drafting corporate resolutions and keeping detailed corporate minutes, holding annual elections and issuing stock are referred to collectively as “corporate formalities.”
It is essential a written record of the proceedings and discussions of each regular or special meeting of the shareholders, directors and/or officers of the corporation be kept. This written account is referred to generally as “corporate minutes”. Actions taken by the directors or officers of the corporation are memorialized in writing by a “resolution.” While not necessarily legally required, corporate minutes and resolutions help establish that the corporation has acted at all times as a separate entity from its owners (this is an important principal of piercing the corporate veil, discussed below).
TIP! Preparing and keeping proper corporate minutes and resolutions can create defenses against claims attempting to establish personal liability of directors or officers (by evidencing good business judgment or granting specific authorization for certain actions), prevent IRS claims of unreasonable compensation of executives who are shareholders, protect against IRS claims of excess accumulated earnings, protect against frivolous lawsuits of minority shareholders and/or establish authority for corporate actions for the benefit of outside parties.
While there are no hard and fast rules regarding the frequency and content of your company minutes, I recommend maintaining minutes of each regular and special meeting of the shareholders, directors and officers of a corporation. Minutes can be the written record of meetings, or the unanimous written actions of the directors or shareholders taken without a meeting. Either is acceptable, depending on state law. Many of my clients fail to keep even annual minutes, which greatly weakens the position of the corporation and its shareholders, directors, and officers from maintaining their personal liability shield in many circumstances.
Minutes of a meeting should be prepared by the secretary of the corporation and executed by the secretary and all other corporate officers or directors in a small, closely held corporation. Some states may require that certain procedures and formalities be followed by state statute. So, if you’re confident enough to research the applicable business laws controlling your corporation or LLC, you will want to pay strict attention to these requirements.
Of course, by now you know I recommend a corporate attorney to handle all such matters. Keeping good and accurate minutes and corporate resolutions will minimize any claim that the written minutes do not accurately reflect the corporate actions were taken. As stated, this is just one avenue in which a claimant could attempt to pierce the corporate veil and assert personal liability on the owners, as discussed below. Besides noting the general substance of each meeting, minutes should also always reflect: i) that proper notice was given to each required participant, or waived; ii) who was present and who was absent; and iii) weather a quorum was present. Holding formal meetings and following the procedures according to the bylaws or operating agreement is strongly recommended.
TIP! Finally, it is also important that minutes be limited to material which actually doesn’t hurt your business. For instance, the fact that a report was given or a discussion was held about anything material should be noted in the minutes. But, actual statements made by a director, officer or shareholder, or the actual content of a report or discussion should generally not be included. You should avoid noting anything in your company minutes which may reflect the actual thoughts or business judgments of any directors or officers. These references tend to be damaging since a future plaintiff may be able to establish a claim based on these detailed minutes. I would limit the minutes to only include those resolutions that the company adopts and you should review the minutes with your legal counsel before completing them.
As stated, resolutions should also be executed by the directors or officers, as the case may be, in order to affirm each significant event or corporate action other than the day to day operations of the business. Resolutions are similar to minutes, but actually formally affirm or adopt an action by an officer, director or shareholder (or member or manager in an LLC) in writing.
Resolutions should be made for the following major company actions, at a minimum:
- Election (or appointment) of any officers and/or directors of a Corporation;
- Compensation of officers and/or directors, including salaries and bonuses;
- Authorization to enter into significant contracts;
- Acquisition or sale of company property or other assets;
- Entering into loans and guarantees and the making of loans;
- Engagement of professionals, such as lawyers and accountants;
- Payment of dividends to shareholders;
- Approval of mergers or reorganizations;
- Issuance of shares, corporate repurchase of shares or acceptance of any transferee of stock;
- Authorization to sign checks, deposit funds, and make withdrawals of company funds;
- Approval of financial statements, annual budgets or any amendments to the same;
- Capital improvements and major equipment purchases;
- Adoption of employee benefit plans;
- Company dissolution and elections to wind the company down;
Of course, this is just a sample of a few of the major items you should consider. None of these items are necessarily required to be adopted by resolution. However, I recommend adopting at least all of these actions by resolution. In general, don’t worry about the routine, day-to-day operational actions and smaller purchases by the company. You should stick with more significant company actions and unusual transactions, such as elections, sale of company assets, capital improvements, business investments and acquisitions, any annual contracts entered into by the business, etc.
I also recommend keeping a corporate book to hold all company minutes, resolutions, organizational documents, such as the Articles of Incorporation, bylaws or operating agreement, all company regulatory filings, a ledger of stock or membership certificates and a copy of all significant contracts and employment agreements. (When you use our business organization services, we provide this for you.)
LLC’s & Corporate Formalities
LLC’s, unlike corporations, enjoy less stringent legal requirements. No annual meetings of the members (or managers) are typically required to be held under most state statutes and no stock is required to be issued. Additionally, in most jurisdictions, the failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business as a ground for imposing personal liability on the members or managers. For instance, Section 10-10(c) of the Illinois Limited Liability Company Act states: “The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.” 805 ILCS 180/10-10(c) (1998).
TIP! You should follow the corporate formalities your LLC has in common with corporations, such as keeping minutes and resolutions. It is always better to play it safe and take the conservative route, and this holds especially true with e-commerce due to potential exposure to multiple jurisdictions. The concept of piercing the corporate veil, which I will discuss in a future post, involves an analysis of a variety of factors, including following corporate formalities for both corporations and LLC’s.