Corporate Maintenance – The Ounce of Prevention
As the economy slows, we have seen an increase in the number of claims made against our business and commercial clients. One of the major concerns of the client is whether the business entity formed to provide liability protection will shield the owners’ personal assets from such claims against the business. In many instances a bit of preventative maintenance may serve to avoid larger and more costly problems in the future.
Corporations are formed for a variety of reasons, including limited liability for the owners, potential tax advantages, and business continuity. However, once the entity is formed, it is easy to go back to business as usual, and forget to comply with the statutory requirements and corporate formalities such as holding annual shareholder meetings and preparing detailed corporate minutes. In addition, many corporations do not have important corporate documents in place such as buy-sell agreements, updated corporate stock records, lease agreements, or employment agreements. Often, the same few individuals wear several hats at once (e.g., shareholder, director, and officer), and it is often difficult to recognize the different role that the individual may play in such capacity. Furthermore, many business owners own real property that is leased to the corporation for use in its business, creating a landlord-tenant relationship. Honoring the distinction of these roles and maintaining corporate documents and records is of critical importance for a number of reasons.
A corporation is an entity permitted by statute. As such, failure to comply with the statutory requirements of corporate operation may give rise to a potential challenge to the corporation’s validity. For most shareholders, protection against personal liability is the primary concern. For that reason, it becomes critically important to maintain corporate formalities in order to make it difficult for a creditor to attack the validity of the corporate form (“pierce the corporate veil”) and reach through to the personal wealth and assets of the shareholders. Such an action becomes possible if, after a corporation is formed, the owners continue to operate the corporation as a personal business and disregard the requirements of acting in their respective roles as officers, directors, or shareholders. The fulfillment of these statutory requirements is best evidenced by properly keeping minutes of corporate meetings.
A corporation is a separate taxpayer from the shareholders, and is subject to audit by both the Internal Revenue Service and the Oregon Department of Revenue. Corporate records are considered to be evidence in an audit, and if such records are prepared close to the time that the corporate action was taken, they are usually of great value to the corporation and shareholders. The regular preparation of corporate minutes affords corporations and shareholders an opportunity to create evidence in their favor in the event of a future audit. Detailed corporate minutes can provide evidence of discussion of a corporate business purpose for a particular transaction, justification for corporate actions, and evidence of long term objectives of the corporation. Such information may prove useful when providing evidence to the IRS or Department of Revenue when requesting a ruling, or defending a position in an audit. Testimony given by shareholders, officers and directors in an audit, which is not supported with corporate minutes and corporate records, may be viewed as self-serving and given little weight as evidence. Corporate minutes prepared on the eve of an audit are obviously of less probative value, and are usually more costly to prepare due to the time constraints and the difficulty of remembering all that should be reported and why certain actions were taken.
The types of corporate transactions that should be approved and reported at least annually include but are not limited to the following:
- Election of directors and corporate officers
- Compensation and bonuses paid to corporate officers
- Loans between the corporation and its shareholders
- Interest payments associated with corporate and shareholder loans
- Leasing of real property or personal property from or to shareholders
- Declaration of dividends
- Contributions to a retirement plan maintained for employees
- Valuation of shares for purposes of a Buy-Sell Agreement
- Justification for accumulation of earnings inside the corporation
In addition to corporate minutes, maintaining accurate corporate records such as corporate bylaws, a stock transfer ledger, a shareholder list, corporate and board of director resolutions, a Buy-Sell Agreement, and copies of important agreements or contracts involving the corporation, including leases, can provide additional evidence of compliance with corporate formalities. These documents and records provide important information regarding corporate operation, and may also help to address important issues before potential conflicts arise. For example, corporate bylaws provide the skeletal framework for the governance and operations of the corporation. Also, a Buy-Sell Agreement enables the shareholders to determine the future ownership of the corporation, and reach agreement on difficult issues such as death, retirement, or withdrawal of an owner, and how the value of the corporate stock shall be determined in such an event. Maintaining copies of all relevant agreements and contracts involving the corporation is very important in providing guidance as to the corporation’s and the shareholders’ rights, remedies, obligations, and restrictions regarding ownership and operation of the corporation’s business.
Many business owners often view the preparation of corporate minutes and the maintenance of corporate records and agreements as a nuisance. However, we encourage all of our clients to take care of these important tasks. As you may already know, our firm sends a letter to our corporate clients each year as a reminder of the need to hold an annual meeting and to prepare corporate minutes. We can assist you by scheduling a meeting with your CPA, and then preparing the minutes and any necessary annual agreements that will help you maintain the integrity of the corporate form, as well as serve as evidence in your favor in the event of an audit. Many of the issues discussed above may also apply to limited liability companies, as such entities provide many of the same protections, advantages, and opportunities as corporations.
It may be time for you to schedule a business entity “check-up” to ensure that your business entity affords you the benefits for which it was formed. Keeping regular corporate minutes and maintaining accurate corporate records should be viewed as preventative legal work; an ounce of prevention is better than a pound of cure.