123’s of Corporate Formalities
We are all well aware of the online services that are readily available for people to utilize in order to quickly form and create businesses. It can be easy to assume that this one stop shop for formation provides everything you need to obtain the limited liability protection you seek. But what may not be well known is that in order to preserve the limited liability of the owners and governing authority, it is important to take certain actions to maintain the status of an entity as a separate legal entity, separate and apart from its owners. These “corporate formalities” must be observed by an entity and can include operational, corporate, and administrative procedures.
From an operational perspective, one of the more important formalities is to prohibit or prevent comingling of assets. All funds received by an entity after it begins operations belong to the entity and should be deposited into one or more bank accounts opened in the name of the entity. No other person’s or entity’s funds should be commingled with those of the entity. An entity must respect the difference between its bank accounts, property, equipment, and other assets, including the personal assets of its owners. Because an entity is a separate legal entity, attempts by owners to transfer, encumber, dispose of, or personally use an entity’s property would be no more proper than an attempt by that owner to transfer, encumber, dispose of, or use another owner’s personal property. Owners must recognize that the assets are the property of the entity, not the owners. Similarly, an owner should not intermingle personal assets with the assets of an entity.
From a corporate perspective, an entity may have internal governance requirements relating to how it is being managed, decisions are being made, or how/when meetings are conducted. It is not only important that these requirements are followed but more importantly that the owners and governing persons are properly documenting such actions to create the corporate record necessary to provide evidence that these formalities were followed.
From an administrative perspective, many times there are periodic filing requirements with state agencies for a particular entity. Failure to timely file required forms can result in financial penalties, inability to bring suit in court, revocation of an entity’s charter, or right to do business which can result in significant consequences for it and its owners (including personal liability for its debts being placed on the owners).
It cannot be overemphasized the importance of maintaining the status of an entity as a separate legal entity, separate and apart from its owners. Corporate formalities must be observed by an entity as privileges, such as limited liability of the owners, may otherwise be lost. This is of a particular significance in the case of the one-person, family, or other closely-held entity because disregarding the entity as a separate legal person may become an issue which is commonly referred to “piercing the corporate veil.”
For assistance in understanding or implementing corporate formalities, please contact Jay Reyero at email@example.com.