Key Takeaways

  • Corporate formalities are essential to preserve limited liability protections and avoid piercing the corporate veil.
  • Common formalities include maintaining separate finances, holding meetings, documenting major decisions, and following internal governance procedures.
  • Failure to adhere to corporate formalities can result in personal liability for business debts or obligations.
  • Startups and single-owner corporations are particularly at risk if they fail to distinguish personal and business conduct.
  • Documenting corporate activities, from issuing stock to adopting resolutions, helps demonstrate legal separation from owners.
  • Courts may consider a pattern of neglect, undercapitalization, or fraud when deciding to disregard corporate protections.
  • Consistent compliance with state-mandated and internal formalities safeguards credibility and minimizes legal exposure.

Corporate Formalities Overview

Corporate formalities are the operating rules and guidelines a corporation must follow in order to meet its operational requirements, which in turn will allow it to maintain the corporate protections it enjoys. If it is found that a corporation has not met its obligations toward corporate formalities, a court may rule that a corporation is acting unlawfully and that the owners should be held accountable, which could mean a wide variety of penalties, including fines or even a revocation of the right to operate as a corporation.

Why Corporate Formalities Matter

Corporate formalities are not just bureaucratic checkboxes—they are legal safeguards that preserve the corporate entity’s separate existence. By observing these formalities, a business protects its owners and officers from personal liability. Courts may disregard the corporate structure—commonly referred to as “piercing the corporate veil”—if these rules are routinely ignored.

Key reasons why corporate formalities matter include:

  • Preserving Limited Liability: Formalities reinforce the separation between owners and the corporation, shielding personal assets.
  • Preventing Veil Piercing: Courts may look at formality compliance when determining whether to hold shareholders personally liable.
  • Demonstrating Good Faith: Adhering to formalities builds a record of ethical and professional conduct.
  • Securing Business Relationships: Lenders, investors, and partners often evaluate whether a corporation follows proper governance.

Common Corporate Formalities

Corporate formality requirements can vary a great deal depending on the state and the type of corporation. However, one of the most important formalities for most corporations involve the bylaws, which are internal rules that govern the running of a corporation. They define the corporation’s purpose, as well as the responsibilities and duties of those tasked with managing the corporation. Specific details covered in bylaws may include:

  • The time, location, and frequency of officer meetings, shareholder meetings, and board of director meetings.
  • Attendance and quorum (majority vote) requirements for meetings.
  • How the board of directors will be established, including how many member it will have and who will be a member.
  • How officers will be selected.
  • How committees will be formed and run.
  • The length of a director’s term.
  • How a director vacancy will be filled.
  • Job descriptions for such positions as President, Vice-President, Treasurer, and Secretary.

Bylaws usually do not cover the number of issued shares or any personal information related to individual directors, officers, or shareholders. This information is more appropriate for meeting minutes, the stock ledger, or bills of sale.

Other common areas in which corporations are required to meet formalities include:

  • The bank account. A corporation must have a bank account separate from that of any individual involved with the corporation. There can be no mingling of business and personal funds.
  • The business name. Corporate business conducted with third parties must be done in the name of the corporation, not any individual associated with the corporation. This is to make it clear that action is being taken in the name of the corporation, not any of its individual members.
  • Scheduled meetings. Corporations must hold an annual meeting for the shareholders, as well as an annual meeting for the board of directors. The date, time, and other details of this meeting should be laid out clearly in the corporation’s bylaws.
  • Special meetings. If an important corporate decision must be made, a special meeting (or meetings) must be held. Such decisions could include changing officer salaries, entering a new business venture, or opening a new bank account. Due notice should be given to the concerned parties for such meetings.
  • Record keeping. Accurate financial records and meeting minutes should be kept by the corporation. This will help curb the abuse of corporate assets and will be very useful if any legal issues arise.

Risks of Failing to Follow Corporate Formalities

Failure to comply with corporate formalities can expose shareholders, directors, and officers to serious consequences, including:

  • Loss of Limited Liability: If a business is treated like a personal piggy bank or if decision-making lacks documentation, courts may treat it as a sole proprietorship or partnership.
  • Piercing the Corporate Veil: This legal remedy allows courts to hold business owners personally liable for corporate debts or misconduct when formality requirements are ignored.
  • Undermined Credibility: Non-compliance can harm your reputation with investors, banks, or potential partners.
  • Legal Challenges: Disputes between shareholders or with third parties may be harder to resolve without proper records or meeting minutes.

Courts may assess multiple factors when determining whether corporate formalities have been breached:

  • Commingling of personal and corporate funds
  • Lack of board or shareholder meetings
  • Undercapitalization at the time of formation
  • Inadequate corporate records
  • Failure to follow bylaws or state law requirements

Corporate Document Formalities

Along with the proper actions you must take to correctly run your corporation, there are a number of corporate documents that should be used in the appropriate situations. Aside from the Articles of Incorporation, which is used to establish your corporation, important corporate documents include:

  • The Letter of Resignation of Incorporator. This document is used when the incorporator resigns from their position upon completion of the corporate registration process. It will list the names of the corporation’s initial directors and include a statement of resignation by the incorporator.
  • Bill of Sale. This is issued by the board of directors when authorizing a sale of corporate shares. It will go out to all shareholders during a new issue of stock.
  • Corporate Resolution. This is a document highlighting a corporate action that has been passed by the board of directors. It could cover who has been authorized to act on the corporation’s behalf or the details of the sale of corporate real estate.
  • Certificate of Incumbency. This document confirms the identity of a corporation’s signing officer. It will sometimes also be used to confirm the names of shareholders or directors or the contents of the minute book. The document usually functions to prove that an individual has the authority to sign contracts for their corporation.

Best Practices for Maintaining Corporate Formalities

To avoid legal risks and maintain the integrity of your corporate structure, follow these best practices:

  1. Keep Corporate Records Up to Date:
    • Maintain a corporate minute book with meeting minutes, resolutions, bylaws, and stock ledgers.
    • File annual reports and statements required by your state.
  2. Hold and Document Meetings:
    • Conduct regular meetings for the board of directors and shareholders—even if the company has only one shareholder.
    • Record minutes of all meetings and keep them accessible for inspection.
  3. Adopt and Follow Bylaws:
    • Ensure bylaws are drafted, adopted, and reviewed periodically.
    • Adhere to the procedures outlined in the bylaws regarding decision-making and corporate governance.
  4. Avoid Commingling Funds:
    • Use separate bank accounts and credit cards for business transactions.
    • Reimburse expenses properly rather than directly using corporate accounts for personal spending.
  5. Issue Stock Properly:
    • Record all stock issuances in your stock ledger.
    • Document consideration paid for shares and provide shareholders with certificates or equivalent documentation.
  6. Stay Compliant with State Requirements:
    • Renew licenses and permits as required.
    • Update registered agent information and file required state documents on time.

Frequently Asked Questions

  1. What are corporate formalities in simple terms?
    Corporate formalities are the legal and procedural rules a corporation must follow to operate as a distinct legal entity and maintain its liability protections.
  2. What happens if a corporation doesn’t follow corporate formalities?
    If a corporation fails to comply with required formalities, courts may pierce the corporate veil and hold owners personally liable for business debts or obligations.
  3. Are corporate formalities required for LLCs too?
    LLCs generally have fewer formalities than corporations, but they still need to maintain separate finances, proper documentation, and adherence to their operating agreements.
  4. Do single-member corporations need to follow formalities?
    Yes. Even if a corporation has only one shareholder, it must still follow corporate formalities to maintain legal separation and protect personal assets.
  5. How can I ensure I’m meeting corporate formality requirements?
    Follow your state’s corporate statutes, adopt clear bylaws, hold regular meetings, maintain detailed records, and keep personal and business finances separate. An experienced business attorney can help you stay compliant.
     

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