Limited Liability is a Valuable Asset. What Are You Doing to Protect It?Posted August 21, 2012 by in Articles & Publications
When I ask a business person for reasons why he or she wants to operate as a corporation, I often hear, "Because I want to limit my personal liability." Clearly, a worthy objective. But what steps are you taking to preserve your individual limited liability? Is it enough simply to file incorporation papers and the various state and federal tax returns to protect your status? Or, are there other steps you should take to safeguard your limited liability?
To help you decide what actions are appropriate, it may be useful to re-examine what limited liability means and why you want to maintain that status? In a properly constituted corporation, its owners and agents, when acting on behalf of the entity, are not held personally responsible for its debts and obligations. This protection is not available to an individual who does business as a sole proprietor or to partners in a general partnership.
Because a corporation is an "artificial person," it can act only through the activity of its agents. In order to establish this relationship between the entity and its agents, certain formalities should be followed, such as, the holding of meetings, the keeping of minutes, the proper execution of documents. These formalities, in turn, demonstrate to the outside world that you are acting within your legal authority as an agent of the entity and not for yourself.
You might ask, "Why bother with these formalities now? They involve extra time and money. If a problem comes up, we can always recreate the proper documentation." Such logic counters the well-proven adage: an ounce of prevention is worth a pound of cure.
While either path has its "costs," in the long run, taking reasonable preventative steps should prove to be the least expensive and most effective course of action. Keep in mind that just at the point when it is critical for you to prove that you acted on behalf of the corporation could be the very time when not all of the original decision makers are available to recreate the needed documentation. Or worse internal problems may have developed among the entity's principals preventing cooperative actions from being taken. An extreme cost of not taking preventative steps could be that a court would not respect the corporate status and not recognize your limited liability.
What do I mean by taking reasonable preventative steps? One step is always to sign documents on behalf of the entity indicating your title. Another is to conduct periodic meetings of the relevant decision makers and record in minutes, at a minimum, who was present, what decisions were made, which officer was directed to carry out what decision. Such records should then be kept in an official minute book.
Even though the rush of business activity may outpace your regular meeting schedule, you should set aside a special time each year to memorialize prior major decisions that were made on behalf of the corporation. Year end could be designated that time. Given that tax planning is always looming out there, when making tax-related decisions, use the opportunity to write down what other actions were taken during the year on behalf of the corporation.
A parting thought: if you do not respect your corporation, it is hard to expect others to respect it.