What It Means to Properly Form a Corporation

Many entrepreneurs are generally aware that it is a good idea to form a corporation or a limited liability company when starting up a new business, in order to protect individual assets from being used to pay corporate debts. In fact, insulating business people from being held personally liable for their firms’ obligations is one of the primary reasons for doing business under a corporate form. See, e.g., Superior Transcribing Serv., LLC v. Paul, 72 A.D.3d 675, 676, 898 N.Y.S.2d 234, 235 (2d Dep’t 2010) (the general rule is that “a corporation exists independently of its owners, who are not personally liable for its obligations, and that individuals may incorporate for the express purpose of limiting their liability”).

But most people are not aware of just what it means to properly form a corporation, which consists of much more than just downloading a form and filing Articles of Incorporation with the Secretary of State. In addition, once formed, a corporate entity must also be properly maintained, for as long as the firm is in business (and even for a time after that), in order to protect the principals’ personal assets. If all of the proper steps are not taken throughout the life of the entity, then the “corporate veil” may be pierced under the alter ego doctrine and individual assets put at risk. In short, it is not enough just to obtain a certificate of incorporation and then go on doing business as usual as though the corporation had never been formed.

Every state has its own requirements for forming a business entity, but the process generally begins with determining name availability and then reserving a name, which must be in a certain format, each of which requires the payment of a fee. See, e.g., Cal. Corp. Code § 201; N.Y. Bus. Corp. Law §§ 301-303.

Articles or incorporation (or a certificate of incorporation, depending on the state) must then be prepared and filed with the state, along with a fee. There are both required and optional provisions that must or can be included in the articles. See Cal. Corp. Code §§ 202, 204; N.Y. Bus. Corp. Law § 402. For example, at a time when there is widespread concern over directors’ liability for corporate actions, it is important to include in the articles an optional provision limiting directors’ liability to the fullest extent permitted under the relevant law. See Cal. Corp. Code §§ 204(a)(10), 204.5; N.Y. Bus. Corp. Law § 402(b).

At the time the corporate entity is formed, bylaws governing the conduct of its affairs must be adopted at an organizational meeting. See Cal. Corp. Code §§ 211, 212; N.Y. Bus. Corp. Law §§ 404, 601. Other actions taken at the organizational meeting, of which minutes must be kept, include authorizing, among other things, the election of officers and directors, the establishment of bank accounts, and the issuance of corporate stock. Stock certificates must be qualified, prepared in the required manner, and issued to shareholders. See, e.g., Cal. Corp. Code § 416; N.Y. Bus. Corp. Law § 508.

Once formed, a corporation must also be properly maintained. An annual meeting of shareholders must be held. See Cal. Corp. Code § 600(b); N.Y. Bus. Corp. Law § 602(b). Other meetings of shareholders and directors may, and should, be held at the very least to discuss and authorize important business decisions. Minutes of all such meetings must be kept. See Cal. Corp. Code § 1500; N.Y. Bus. Corp. Law § 624(a). States generally require the filing of reports and the payment of franchise taxes on an annual basis. The failure to pay such taxes can eventually result in the involuntary dissolution of the corporation. See, e.g., Cal. Corp. Code § 1801.

This is by no means an exhaustive list of everything that must be done to properly form and maintain a business entity. While many of the required steps may seem ministerial, the importance of taking each and every one of them cannot be overstated. In determining whether a corporation is merely the alter ego of the shareholders for purposes of piercing the corporate veil to impose personal liability for corporate obligations on the shareholders, courts examine a variety of factors, a number of which focus on “the disregard of legal formalities” in forming and maintaining the entity. Associated Vendors, Inc. v. Oakland
Meat Co., 210 Cal. App. 2d 825, 840, 26 Cal. Rptr. 806, 815 (1st Dist. 1962). For example, failing to accomplish even such a seemingly mundane task as maintaining proper corporate minutes can be factored into the equation. See, Avoiding Alter Ego Liability with Proper Corporate Minutes.

Given that protection from personal liability is often the single most important reason that entrepreneurs form corporations, it makes sense to insure that all of the necessary tasks are done right from the beginning to the end of the entity’s life.