Most business owners form a corporation or limited liability company (LLC) so their personal assets are safely out of reach from business creditors. In the vast majority of cases (easily 80-90% of the cases we review), they fill out the necessary forms, file them with the Secretary of State along with the required fee and stop there. Unfortunately, this alone will not protect the owner from unlimited personal liability for business debts and obligations. It is a very real possibility that you could lose your home, savings and all other assets not protected by bankruptcy.
Illinois statutes and case law require substantially more. The Second District Illinois Appellate Court laid out numerous factors the courts must consider when determining whether to “pierce the corporate veil” and hold the owners personally liable for business debts. Here are some of the most frequent mistakes businesses make:
Failure to observe corporate formalities like annual meetings, minutes, elections, resolutions.
Failure to issue stock or properly authorize and record un-certificated stock..
Absence of corporate records like by-laws, tax returns, annual reports, deeds, titles, leases.
Commingling funds between owner and corporation.
Token officers or directors. If someone holds an office they must participate.
Non-payment of dividends to shareholders.
Not enough net assets in the corporation’s name considering the business risk involved. High risk ventures generally require more capital.
The courts will review all the facts to determine whether the corporation is truly separate from the owner or is only a sham or alter ego. They also look at whether allowing the corporate shield to protect the owners would sanction fraud, promote injustice or inequitable consequences. The point is, why take the chance of losing everything you’ve worked for when the cost of compliance is minimal.
Many single shareholder corporations and single member LLCs believe that holding annual meetings is unnecessary, but doing so and documenting things is a great way to memorialize what was accomplished over the past year and what still needs to be done. It really pays off when you need to look up a prior action taken and is invaluable if you ever plan to sell your business.
A common mistake many business owners make when they put money into the business after paying for and receiving their initial stock, is failing to properly document that new money as either an additional capital contribution, which requires additional stock to be issued or a loan, which requires a repayment agreement and promissory note. Many owners also occasionally take money or property out of the business for personal use and fail to properly document it as salary (subject to withholding taxes) or a dividend (requiring a board resolution).
While it’s true LLCs were intended to offer limited personal liability protection without the usual corporate formalities, they are a relatively new legal creation compared to corporations. Some recent cases suggest that when courts are faced with deciding whether to disregard an LLC and hold the owner personally liable, the judges look to older established corporate cases. It’s clearly in your best interest to do more than the bare minimum if you truly want to avoid personal liability. Remember, it’s a balancing act once you’re in court and with a little advance planning, you can greatly increase the odds you’re never held personally liable for the debts of your corporation or LLC.
At Costello Legal Services, we perform a 25 point corporate check up to ensure your company is in perfect health. Why risk losing everything you’ve worked so hard for when you can ensure your business is in full compliance with the law for a fraction of the cost of defending and possibly losing a lawsuit. Please consider giving us a call for a complimentary consultation. You, your family and your co-owners will be glad you did!
Costello Legal Services, Ltd.