Why Worry About Statutory Formalities? Two Reasons:
• Private Lawsuits and
• Government Audits
Every state has revised statutes that describe exactly what a government created business entity must do to maintain a “Corporate Veil”. A “Corporate Veil” is a layer of protection that separates individuals involved in a business from the business entity.
The “Corporate Veil” is easily pierced when statutory formalities are not maintained. Formalities include:
• holding and documenting annual owner meetings,
• documenting authorizations with resolutions,
• issuing and tracking ownership certificates,
• maintaining a separate bank account. and
• keeping licenses up-to-date.
BizDoc helps maintain these formalities.
National, state, and local tax authorities can ask for meeting minutes, resolutions, and other documentation to ensure that statutory formalities have been adhered to approving any expenses taken as deductions. If "no documentation" is found, deductions can be DISALLOW.
In fact, here are samples of state statutes requiring proper documentation. All states and Canadian provinces have similar laws.
As of January 1, 1996, the Arizona Revised Statutes now require that a number of specified records be kept by or on behalf of an Arizona corporation. Any records not maintained in written form (example: computer stored) must be capable of being converted into written form within a reasonable time. The following written records must be kept:
•Minutes of all meetings of the board of directors and shareholders, a record of all actions taken by them without a meeting, and a record of all actions taken by committees in place of the board of directors. A.R.S. §10-1601(A).
•Appropriate accounting records. A.R.S. § 10-1601(B).
•Shareholders' record, listing names and addresses of shareholders and numbers of shares owned of each class, alphabetically by class of shares owned. A.R.S. § 10-1601(C).
•Articles of incorporation as amended or restated to date. A.R.S. § 10-1601(E)(1).
•Bylaws or restated bylaws as amended to date. A.R.S. § 10-1601(E)(2).
•Any resolutions of board of directors creating classes or series of stock and fixing rights and preferences, if shares of those classes and series are outstanding. A.R.S. § 10-1601(E)(3).
•Minutes and records of shareholders' meetings and actions for past three years. A.R.S. § 10-1601(E)(4).
•Written communications to shareholders, including financial statements, for past three years. A.R.S. § 10-1601(E)(5).
•Names and business addresses of current directors and officers. A.R.S. § 10-1601(E)(6).
•Most recent annual report delivered to the Corporation Commission. A.R.S. § 10-1601(E)(7).
•Shareholders' agreements. A.R.S. § 10-1601(E)(8).
•Piercing the Corporate Veil : It is important to treat the corporation or formal association as a separate and distinct entity. Failure to do so may allow a creditor to pierce the corporate veil and subject a shareholder's personal assets, such as bank accounts and other property, to the satisfaction of the debts and liabilities of the corporation. Note: Treating the corporation like a corporation includes, among other corporate acts, issuing stock certificates which represent share ownership, electing directors and officers, filing the biennial report, keeping annual shareholder meeting minutes and maintaining a corporate bank account and financial records.
•Authorized Shares : Every corporation must issue shares of stock. Shares represent ownership of the corporation. The corporation, itself, owns the assets. The number of authorized shares is what may be issued. For example, a corporation may be authorized to issue 1,000 shares, but only issue 200. You may purchase blank stock certificates and issue them to those who own an interest in the corporation. Stock certificates can be purchased at various office product stores.
•Minn. Stat. Ann. § 332B.303(2) – “The case law that states the conditions and circumstances under which the corporate veil of a corporation may be pierced under Minnesota law also applies to limited liability companies.”
TITLE 30 CORPORATIONS
CHAPTER 1 GENERAL BUSINESS CORPORATIONS
PART 16. RECORDS AND REPORTS
30-1-1601. CORPORATE RECORDS
(1) A corporation shall keep as permanent records minutes of all meetings of its shareholders and board of directors, a record of all actions taken by the shareholders or board of directors without a meeting, and a record of all actions taken by a committee of the board of directors in place of the board of directors on behalf of the corporation.
(2) A corporation shall maintain appropriate accounting records.
(3) A corporation or its agent shall maintain a record of its shareholders, in a form that permits preparation of a list of the names and addresses of all shareholders, in alphabetical order by class of shares showing the number and class of shares held by each.
(4) A corporation shall maintain its records in written form or in another form capable of conversion into written form within a reasonable time.
(5) A corporation shall keep a copy of the following records at its principal office:
(a) Its articles or restated articles of incorporation and all amendments to them currently in effect;
(b) Its bylaws or restated bylaws and all amendments to them currently in effect;
(c) Resolutions adopted by its board of directors creating one
(1) or more classes or series of shares, and fixing their relative rights, preferences, and limitations, if shares issued pursuant to those resolutions are outstanding;
(d) The minutes of all shareholders' meetings, and records of all action taken by shareholders without a meeting, for the past three (3) years;
(e) All written communications to shareholders generally within the past three (3) years, including the financial statements furnished for the past three (3) years under section 30-1-1620, Idaho Code; and
(f) A list of the names and business addresses of its current directors and officers.
In fact there's a book that helps lawyers Pierce Corporate Veils by reviewing successful court cases.
Piercing the Corporate Veil By Stephen B. Presser
"This treatise helps you interpret the "piercing the veil" doctrine in any state jurisdiction or federal court. It examines differences among piercing doctrines in state and federal courts and analyzes each state’s leading case law. Provides historical and analytical overviews of each jurisdiction’s piercing doctrine, along with alphabetical summaries of laws from each state, the District of Columbia, Puerto Rico, federal courts, and U.S. Supreme Court. Includes common law topics and reviews issues on limited liability companies; examines veil-piercing laws of several foreign countries."
Overview of the Book
• This is a guide for attorneys who are faced with multiple-jurisdiction piercing problems.
• It provides in-depth analysis of leading cases involving piercing,
• emphasizes recent cases,
• clearly explains common law of the jurisdiction where the business is incorporated,
• provides solutions to piercing problems concerning the laws of a particular jurisdiction, and
• helps formulate a rock-solid argument for your brief.
The following are some of the court cases from the book:
Hollowell v. Orleans Regional Hospital
Outlining Reasons to Pierce the Corporate Veil
1998 WL 283298 (E.D. La. 1998). The court held that the “veil” afforded by the LLC form can be pierced if the LLC was acting as the “alter ego” of its members or if the members were committing fraud or deceit on third parties through the LLC. The court noted that a ruling on the veil piercing issue requires a fact-intensive review of relationships, and declined to grant summary judgment to either party. The court also noted that La. law requires focusing on the five elements:
(a) asset commingling;
(b) failure to follow statutory formalities;
(d) failure to separate bank accounts and books and records; and
(e) failure to hold meetings.
Tom Thumb Food Markets, Inc. v. TLH Properties, LLC
Minnesota Veil Piercing Case Law
1999 WL 31168 (Minn, App. 1999). The court applied Minnesota corporate veil piercing case law, as required by the Minnesota LLC Act.
The court ruled that the elements of veil piercing are:
(a) the entity ignores corporate formalities and acts as the shareholder’s alter ego and
(b) the liability limitations of the corporate form result in injustice or are fundamentally unfair. The appellate court reversed the trial court’s veil piercing conclusion because there was no evidence that a member’s misleading statements concerning property ownership were intended to mislead the plaintiff. In addition, the court ruled that the plaintiff had “unclean hands” because its conduct contributed to the breach of lease.
Tom Hackl v. Commissioner of Internal Revenue
Tax Penalties for LLC Mismanagement
Mr. and Mrs. Hackl had formed an LLC for a tree farming business. They issued ownership in the LLC as gifts to their children and other family members. The Hackls identified these transfers as tax excludable gifts in their tax return, which they would normally be. But because the Hackls had not properly structured and governed their LLC, the IRS and the Tax Court charged them hundreds of thousands of dollars of gift tax penalties.
Coleman v. Coleman
The $6 Million Veil Piercing
An owner of four successful businesses lost $6 million in a family dispute when his corporate veils were pierced by the court. He had ignored corporate formalities and had commingled personal and business funds.
His reasoning? He "preferred to conduct corporate business personally rather than in the corporate name, because it was more convenient than observing appropriate corporate procedures."
Falcone v. Night Watchman, Inc.
Even Attorneys Can Get it Wrong
An attorney had a law firm and was also sole stockholder of a restaurant. His restaurant was sued by a supplier for nonpayment. The corporate veil was pierced and the attorney held personally responsible for the debt. He had failed to maintain proper records, officers, and compliance requirements for either his restaurant or his law firm. The veil piercing risk didn’t hit his radar screen until after he was sued – and he was a practicing attorney!
Simply put, protect the benefits of a government created business entity by adhering to the statutory formalities that are absolutely required to maintain a veil of protection.