Many benefits exist in choosing to create a corporation or limited liability company (“LLC”) as your business entity. However, what attracts most people to these entities is the protection they afford the business owner(s) against personal liability for the business’ obligations, debts, and other liabilities. Whatever reason prompts your decision to form a corporation or LLC, if you are like many smaller businesses, once the formation process is over its back to business as usual.
However, in order to keep the protection against personal liability associated with a corporation or LLC, the business must engage in, what are known as corporate formalities. Corporate formalities are formal actions that must be taken by a corporation or LLC in order to maintain the benefits associated with that business entity. These corporate formalities may be required under California law, by the bylaws, and/or by the operating agreement of your business.
When your business is formed as a corporation, many of the corporate formalities exist as part of California’s Corporations Code (“CCC”). These formalities include: (1) holding annual meetings (CCC § 600); (2) regularly electing directors (CCC § 301); (3) keeping meeting minutes (CCC § 1500); and (4) maintaining accurate corporate records (CCC § 1500). While these are only a few of the corporate formalities existing for corporations in the State of California, these formalities are often overlooked or put off by smaller businesses because they are either unknown to the business or are intended to be complied with later, as the actual running of the business takes priority.
If you select an LLC as the entity type for your business, the corporate formalities are less stringent than those of a corporation, and less likely to be required by California law. For example, California law does not require an LLC to hold an annual meeting, which lessens or eliminates the need to keep meeting minutes, and an LLC need not have a board of directors. California law does require that an LLC maintain accurate records, however. (CCC § 17701.13).
It is also important to pay attention to the corporation’s obligations listed in the bylaws, or the LLC’s obligations listed in the operating agreement, as both of these documents may provide additional corporate formalities for the business.
Generally, the shareholders, officers, and directors of a corporation cannot be held personally liable for corporate debts, obligations, and other liabilities since the corporation is its own separate entity. However, courts may disregard the separate corporate entity of a business and attach personal liability in certain circumstances; an act known as piercing the corporate veil. In determining whether or not it is appropriate to pierce the corporate veil, one of the factors courts consider is adherence to corporate formalities. (See Tomaselli v. Transamerica Ins. Co (1994) 25 Cal.App.4th 1269; Auer v. Frank (1964) 227 Cal.App.2d 396; Wheeler v. Superior Mortg. Co. (1961) 196 Cal.App.2d 822.) Where corporate formalities are disregarded, this factor tends to weigh in support of a personal liability finding.
As with corporations, California law also provides personal liability protections to members of an LLC due to the LLC’s separate entity status. (CCC § 1773.04). And while this same statute allows the corporate veil of an LLC to be pierced, it expressly provides that the failure to hold meetings of the members, or observe corporate formalities associated with said meetings shall not be a factor tending to establish personal liability. This acknowledges the fact that annual meetings are not statutorily required. However, courts are not prevented from considering the disregard of corporate formalities, related to holding member meetings or otherwise, where the LLC’s operating agreement provides for such formalities.
Although it may not guarantee protection against personal liability where a plaintiff personally names an owner, officer, director, or manager of a corporation or an LLC, by complying with the statutory, bylaw, and/or operating agreement corporate formalities you may help tip a court’s assessment in your favor.
The Corporate Memory
Protection against personal liability aside, ensuring that complete and accurate corporate records and meeting minutes are maintained also serves as a means of preserving the corporate “memory.” (Hurwitz v. Gross (1907) 5 Cal.App.614, 621.) The corporate “memory” may be used as evidence in the event the business brings or defends against a lawsuit. (Union Trust Co. of San Francisco v. Dickinson (1916) 30 Cal.App. 91, 99.) By complying with your business’ corporate formalities, not only are you taking an active role in maintaining your business’ separate legal status, but you are producing the corporate record which can be used should a lawsuit arise between your business and an outside plaintiff, or your business and an inside plaintiff.
Although many of the corporate formalities associated with running a corporation and LLC may seem tedious and insignificant, it is necessary to observe them. But keep in mind that this observation need not be overly formal and should not be intimidating.
If your business is a corporation, or your LLC’s operating agreement requires an annual meeting, make sure that the meeting is timely held. However, don’t feel as though this meeting needs to be a big production. Depending on your business’ culture, the annual meeting may be as formal or informal an affair as desired. The important part is to provide proper notice for the meeting, actually hold the meeting, and keep meeting minutes (this is also true for any special meetings held). While meeting minutes are intended to be a concise and accurate statement of what occurred at the meeting, it is generally recommended that you include the date, time and location of the meeting; the purpose of the meeting; the person(s) present and/or absent; if notice was provided or waived; and what motions, actions, or resolutions took place at the meeting.
By paying attention to your business’ corporate formalities now, you are taking a proactive step toward maintaining the personal liability protection you likely sought in choosing to form a corporation or an LLC.
Article by Hannah C. Kreuser, Esq. in 2019. Ms. Kreuser is part of Porter Law Group, Inc. in Sacramento, California. www.porterlaw.com.