Maintaining Corporate Compliance or Assume Personal Liability / Your Choice!

In the past several months, I have met with several new client’s who are operating businesses in Massachusetts in an array of services and industries. Many have come in for advice on non-corporate issues that are related to commercial leases, business agreements, employee issues, collection of outstanding invoices, claims against them, etc. In each encounter with a new client who is operating a business, the first question I ask after we complete the matter that they came in to see me for is; Is your company compliant with its filings and operations?

Shockingly, the client’s in almost all circumstances say yes, they filed their Articles of Incorporation, so they are “all set”. The vast majority of business owners incorporated on their own without a lawyer or used an on-line forms service to save on start up costs. Once they file their Articles of Organization they believe they are “all set” to enjoy the personal liability protection afforded by incorporation. The customary follow-up questions I ask them include asking if they adopted By-Laws, issued stock or membership units, adopted banking resolutions, held annual meetings, filed annual reports, maintained a corporate record book, signed agreements and contracts in only their corporate capacity, not personally. Invariable the answers to those follow-up questions is usually no.

If the answers to the follow-up questions or the majority of the follow up questions is no, then the operation of your company is not “all set”, not by a long shot! In order to enjoy the personal liability protection that is afforded to business corporations, (Corps, Inc’s, LLC’s), the law expects you to operate the corporations with the requisite formality that provides you the personal liability protection.

The reason it is so important to run your corporation and meet the corporate compliance issues is not for when you are running the business and things are going well. It is for times when things are not going well, when contracts are in breach, there are problems with the lease, customers are suing you or creditors are trying to collect from you, etc. During these times your operation of the business with requisite corporate formality is required. In the event that you have not operated with the minimum requirements the “corporate veil” of liability protection may not be afforded to you.

The general rule is that corporations are separate legal entities from their shareholders and the shareholders generally are not liable personally for the obligations of the corporation. However, the case law in Massachusetts requires you to comply with the rules to maintain that protection. In the event that you get sued a Judge will look to the “indicia” to support providing corporate protection and not personal liability. In Massachusetts the First Circuit Court of Appeals established a 12 factor test for piercing the corporate veil and allowing personal liability for the acts of the corporation. In Pepsi-Cola MetropolitanBottling Co. v. Checkers, Inc., 754 F.2d 10 (1^st Cir. 1985), the court set out the test which includes the following 12 factors to consider:

1. common ownership of related entities;
2. pervasive control;
3. confusing intermingling of business activity assets, or management;
4. thin capitalization;
5. nonobservance of corporate formalities;
6. absence of corporate records;
7. no payment of dividends;
8. insolvency at the time of the litigated transaction;
9. siphoning away of the corporate assets by the dominant shareholder(s);
10. non functioning of officers and directors;
11. use of the corporation for transactions of the dominant shareholders; and
12. use of the corporation in promoting fraud.

This 12 factor test was affirmed in Massachusetts in the case of Evans v. Multicon Constr. Corp., 30 Mass App. Ct. 728 (1991). The court in that case opined that it was not necessary that all of the factors be found before the corporate protection would be stripped and personal liability would attach. Instead the Court determined that all of the factors should be considered and on a fact specific determination the court can consider if there is enough of them to attach personal liability.

In a summary for this article, if you want to maintain personal liability protection, it is important to operate the business with corporate formality, including but are not limited to, filing Articles of Organization, adopting By-Laws by which the corporation will run, issuing stock to the stockholders, filing annual reports with the secretary of state each year, holding an annual meeting each year, maintaining the corporate records in a corporate record book, entering into agreements in your corporate capacity as “president” of the company or whatever position you hold, not signing leases or contracts personally, avoiding commingling of personal funds and obligations with those of the corporation. In the event that you have not run your business with these formalities and corporate compliance, a Judge may allow your personal assets to be exposed to pay for the obligations of the corporation.

The purpose of this article is not to scare or unduly burden the business owner, but to put them in a position to maintain their compliance to avoid the piercing of the corporate veil causing personal liability in the event of claims or litigation.

I am currently general counsel to twenty six small companies. I have incorporated and advised small businesses from the initial start-up, through operations, to exit strategy including sale or dissolution, while maintaining corporate compliance to minimize personal risk of business owners for corporate obligations.