Keeping Your Corporate Shield

One of the main reasons that individuals form corporations is to shield themselves and their personal assets from individual liability for corporate acts. Courts allow this benefit only if the corporation remains properly organized, adequately capitalized, and completely separate as a legal entity. If a court finds that the corporate privilege has been abused, the court may disregard the corporate entity, exposing the corporation’s shareholders to liability for the corporation’s acts relating to that abuse.

The legal theory on which shareholder liability is based is generally called the “alter-ego doctrine.” A plaintiff attempting to create shareholder liability will try to “pierce the corporate veil” to prove that the corporation is merely an agent (or the “alter-ego”) of the individuals behind it. Plaintiffs attempting to pierce the corporate veil and assert the alter-ego doctrine must generally prove two things: (i) first, that there is a unity of interest and ownership between the corporation and the shareholders, such that the corporation and the shareholders are no longer separate or individual; and (ii) second, that an injustice or fraud will occur if the corporation’s actions are treated solely as the acts of the corporation.

One of the most overlooked areas in separating the interests of a corporation from that of its shareholders is the documentation of the corporation’s actions. Good corporate maintenance means keeping minutes of shareholders’ and directors’ meetings and documenting the authority for major corporate actions. It is usually the duty of the Corporate Secretary to make sure all meetings are properly noticed and minutes of meetings are prepared and distributed.

The business and affairs of the corporation are handled by the Board of Directors, and all corporate powers must be exercised by or under the Board’s direction. The officers of the corporation carry out the day-to-day functions of the corporation pursuant to the direction and policies established by the Board. The Board should make decisions as a group; the individual directors should not act alone. The Board should make decisions involving corporate policy, election of officers and determination of the officers’ duties and compensation, issuance of securities, adoption, amendment or repeal of the Bylaws, participation in various business transactions, execution of material leases and contracts, declaration of dividends or redemption of shares, determination of the corporation’s budget, corporate borrowings, and other major corporate transactions.

Various actions of the corporation also require shareholder approval. Some of these actions include: the election of directors, the merger, consolidation, reorganization, or dissolution of the corporation; the sale or transfer of all or substantially all the corporation’s assets; and amendments to the Articles of Incorporation and, in some cases, the By-laws.

A corporation is required under California law to hold an annual shareholders’ meeting. The date, place and time for the meeting is usually designated in the Bylaws, or the Bylaws may specify a procedure for fixing such information. The first annual meeting must be held within 15 months of incorporation and future annual meetings must be held within 15 months of the previous meeting. If a meeting is not timely held, a shareholder may apply to the superior court for an order demanding that the meeting be held.

Both directors’ and shareholders’ meetings require “notice.” The corporation’s By-laws state how notice must be sent, and how much time before the meeting notice must be received by each shareholder and/or director. Notice is not required when:

1. 100% of all voting shareholders/directors are present at the meeting and do not object to the lack of notice; or
2. All voting shareholders/directors sign a “Waiver of Notice”; or
3. Directors/shareholders are acting “by consent.”

The shareholders may act “by consent” when more than 50% of those shareholders entitled to vote on an issue agree to take the action without a meeting by signing a written consent that documents the action agreed upon. (Note that the corporation’s Articles or By-laws may specify a higher or lower percentage.) The consenting shareholders are required to send a notice to all of the other shareholders of the action taken within a reasonable time after they take action by consent.

The directors may act “by consent” only when 100% of the directors agree in writing that an action should be taken without a meeting. When directors act by consent, the Corporate Secretary is responsible for sending a copy of the minutes to all directors for their signature.

Any actions requiring the approval of the directors and/or shareholders should be documented in writing — either in the form of “minutes” of meetings actually held, or in the form of a “written consent” signed by all directors and, where shareholder approval is necessary, at least a majority of the shareholders. These minutes and written consents provide proof of the corporation’s separate legal entity apart from that of the shareholders. They are an important tool in keeping the “corporate veil” that shields shareholders — and their assets — from liability for corporate action.