What Are Corporate Formalities and Why Are They So Important?

Limited liability is a major reason many people choose to form a corporation or a limited liability company (LLC). This legal protection keeps a business's owners from being held personally responsible for the company's debts and obligations. However, this protection isn't automatic and can be lost. To maintain this crucial liability shield, owners must comply with specific corporate formalities. These are rules required by state law or recommended as best practices for a business to operate successfully.

Protecting Your Personal Assets from Business Debts

The primary purpose of corporate formalities is to prevent creditors from "piercing the corporate veil." This term refers to a legal situation where the owners of a corporation or LLC lose their limited liability protection and are held personally liable for the business's debts. Without this liability shield, many people would be too afraid to start a business, worrying that a company's financial troubles could destroy their personal finances.

Even though LLCs are subject to fewer legal formalities than corporations, both types of entities must follow basic procedures to maintain their liability shield. Simple actions like holding regular meetings, keeping detailed records, and establishing separate bank accounts for the business are essential. These practices prove that the business is a distinct legal entity separate from its owners, making it much harder for creditors to come after your personal assets.

Maintaining Accurate Business Records

While protecting the liability shield is a major reason to observe corporate formalities, it's not the only one. These formalities also help create and maintain a complete record of your company's activities, which is a valuable asset for the business itself. These records can be used for a variety of purposes, including:

·       Informed decision-making: Using data and historical records to make sound business decisions.

·       Tracking progress and forecasting: Monitoring long-term trends and making more reliable predictions.

·       Business continuity: Preserving essential company knowledge, which is critical during employee or leadership turnover.

·       Legal and tax matters: Providing key evidence in legal disputes and ensuring compliance with tax obligations.

·       Proof of compliance: Demonstrating to government bodies, like the IRS or local licensing agencies, that your business is following legal requirements.

How to Maintain Corporate Formalities

The specific formalities required depend on your business structure and the state where you operate. While the requirements for corporations and LLCs differ, following these best practices is crucial for both.

Corporate Formalities

Corporations must adhere to the rules established by the state(s) in which they operate. Some common formalities include:

·       Establishing and following bylaws that govern how the corporation is run.

·       Holding annual shareholder and regular board of director meetings.

·       Keeping meeting minutes to record who attended, topics discussed, and decisions made.

·       Maintaining a stock ledger and stock certificates to account for company equity.

·       Opening a corporate bank account that is separate from owners' personal accounts.

·       Registering a business name, if different from the corporate name.

·       Maintaining comprehensive business records of all corporate activities and tax filings.

LLC Formalities

Many corporate formalities aren't legally required for LLCs, but they are highly recommended as best practices. For example, most states don't require LLCs to hold formal meetings or have a board of directors. However, failing to observe these best practices can still jeopardize your liability shield.

Some of these essential LLC best practices include:

·       Conducting business in the LLC's name, not the names of individual members.

·       Maintaining a separate company bank account and avoiding the commingling of personal and business funds.

·       Creating an operating agreement that outlines how the company will be run and the responsibilities of each member.

·       Keeping accurate and detailed records of all financial transactions for at least three years.

·       Holding regular meetings and taking minutes to document key discussions and decisions.

Need Help with Corporate Formalities?

Navigating the complexities of corporate formalities can be challenging. A business attorney who understands the law can provide an objective, top-level view of what's required for your specific business. We can help you ensure you are observing all the necessary formalities to protect your personal assets and maintain the essential records needed for your company's operations.

Contact us today to schedule an appointment and make sure your business is protected.