For corporate clients of Navigato & Battin, you likely received a letter in the mail accompanied by a questionnaire, asking about your corporation’s activities for 2018. One purpose of this questionnaire is to allow our office to draft unanimous written consents for your corporation’s shareholders and directors in lieu of annual shareholder and director meetings, should you wish to utilize these options. We published an article about the importance of annual minutes a while back, which can be found here.
California requires all corporations to hold annual shareholders’ meetings where, at the very least, directors are elected. While California does not require annual meetings for the directors, we recommend the directors meet after the shareholders elect them. Luckily, California allows both shareholders and directors to execute unanimous written consents instead of holding these meetings.
But why are these minutes or consents important? One of the main reasons corporations are formed is to protect those who own the corporation (i.e., the shareholders) from liability. For example, if a corporation enters into a contract requiring it to pay a certain amount of money each month and the corporation later defaults on the contract, the shareholders generally will not be liable for the amounts owed by the corporation.
To avoid people taking advantage of this protection, the so-called “corporate veil” (which otherwise shields the corporation’s shareholders from liability) can be pierced if certain circumstances are found by a court, which may lead to individual shareholder liability for what seemed to have been corporate debts or liabilities. Piercing the corporate veil is a two-step process. First, a number of factors are considered to determine whether the shareholders have treated the corporation as an “alter ego.” These factors include: commingling of corporate and personal funds, failing to observe corporate formalities (including maintaining corporate minutes), and failing to contribute sufficient capital. Second, allowing the shareholders to be shielded from liability must result in an “injustice.”
Based on the first step, it is critical to maintain your corporation’s annual minutes, whether they be in the form of actual minutes from a meeting or in the form of a unanimous written consent in lieu of the meeting. Additionally, funds belonging to the corporation must not be commingled with your personal funds, and vice versa. This factor is generally problematic with single-person corporations. However, it can be easily avoided with careful accounting to ensure corporate monies are deposited into the corporation’s bank accounts and only distributed to the shareholders through proper methods. Lastly, your corporation must be properly capitalized throughout its existence.
The second step usually poses a trickier analysis. The basic idea, though, is that shareholders of a company should not be able to wrongfully hide behind the company to avoid liability which really should be assessed against the individual shareholders. Usually when a court finds the first step is satisfied, meaning one or more of the shareholders has treated the corporation as his “alter ego,” this second step is also satisfied. When a shareholder uses the corporation as his own personal piggy bank (commingling funds, not properly accounting for money being distributed to the shareholder and/or loaned or contributed to the corporation, and disregarding corporate formalities), it is more likely that a court may find that the shareholder should not be able to avoid individual liability by using the corporation as a shield. In those cases, the corporation is seen as a sham, and the court may “pierce the corporate veil” in order to assess liability directly against the shareholder(s).
To make sure your corporate books and records are up to date, contact us at Navigato & Battin.