You're Observing Corporate Formalities, Aren't You?

Posted on July 13, 2010 by Eliot Wagonheim

 

The first response I usually get from most businesspeople when I mention “corporate formalities” is a puzzled look. Which is not surprising, since the term is rarely used except by lawyers.  The second response is invariably a request by my clients for another cup of my famous high-octane coffee, since the mere mention of “corporate formalities” usually results in the realization that the meeting isn’t over yet (the end of a meeting with me being the highlight of most of my clients’ days). Fortunately, high-octane coffee is plentiful around my office. In extreme cases, I can even produce a finger or two of single-malt scotch if I notice my client snoring and slumped over in their chair mid-discussion.

But I digress. “Corporate formalities” is a term with which you ought to become familiar if you intend to run, or are already responsible for running, a business.

The reason I even bring this arcane term of art up is because of an admonition I included in my last blog (which you can access by clicking here. In that blog, I suggested that even if you make proper filings with the appropriate State agencies to set up your company, you would still not be adequately protected from company liabilities if you failed to also adhere to “corporate formalities” and maintain proper corporate records. So, what did I mean by that?

Let’s discuss a major misconception about “incorporating” (which is a term I use to mean forming any corporate entity, whether an LLC, corporation, partnership, or something else).  The misconception is that all one need do to obtain the “magic bullet” of limited liability is to file a document with the proper State agency, and voila! -- instant “teflon” for the company’s owners.  But the reality is quite different.

You see, incorporating involves a trade-off between you and the State (you didn’t really think that the State was going to give you a freebie, did you?). In exchange for limited liability for the owners of a company, the State insists that the company adhere to certain laws, keep certain records, and adhere to certain procedures.  Those laws, records, and procedures include the following:

  • The company must keep a separate bank account, and cannot commingle its funds with its owners’ funds and bank accounts. (Note that this is more straightforward in theory than in practice. I’ve seen numerous businesses get tangled up in banking and segregation of funds issues that could potentially lead to loss of the owners’ limited liability).
  • The company must make certain information public, such as the identity of the owners, the address of its corporate headquarters, and the identity of its agent for service of process.
  • The company must carefully authorize and document all actions taken by the company, usually in the form of signed resolutions (this is one of the most frequently overlooked corporate formalities, and potentially one of the most serious if the company is ever sued by a shareholder, employee, or customer).
  • The company must not engage in activities that are extraneous to its corporate purpose, or that properly belong to the owner or owners (e.g., don’t have your company pay for your tickets to Tahiti, or take on any tasks related to your spouse’s widget factory).

The bottom line is that the failure of your company to adhere to corporate formalities can result in a “disregard” of the corporate form by a court if your company is ever sued. Legally, this is known as “piercing the corporate veil,” and it’s a disaster by any measure. How? Well, if the court awards damages to the person suing your company, it means that YOU, as an owner of the company, are personally liable for those damages. It could also result in fraud and shareholder actions being upheld against you, and the literal unraveling of your company. 

Finally, let’s take the example of a corporate acquisition: your company has been approached by a competitor with a buyout offer, or you decide that, after 15 years in business, you want out and you want to sell your company. As a mergers and acquisitions attorney, I can tell you that the first thing the lawyers on the other side are going to ask for are your corporate books and records. Because the acquirer wants to know what they’re acquiring, and they want to ensure that they’re not inheriting any potential liabilities that they don’t want to inherit. Inadequate books and records can quickly scuttle a potential deal.

Again, I would urge you to ask yourself the following question: Is the modest cost of keeping adequate corporate books and records worth the potential personal liability, or the risk of scuttling a potentially lucrative sale of the company? Only you, as the business owner, can answer this question.

Has your company properly adhered to corporate formalities? Need help getting your corporate house in order? Give me a call. 

 

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Fall (Corporate) Housekeeping

Posted on October 5, 2009 by Michael J. Lentz

In an unfortunate rite of fall, Maryland law requires the State Comptroller “immediately after September 30 of each year,” to prepare, and send to the State Department of Assessments and Taxation (“SDAT”), a list of every Maryland corporation that has not paid any tax due (other than a purely local tax) by October 1 of the year following the year in which the tax was due. The requirement also applies to Maryland Limited Liability Companies (LLCs), and includes a failure to make any required unemployment insurance contributions or reimbursement.

When SDAT receives the list from the Comptroller, it sends each entity on the list a notice that the entity’s charter will be forfeited if the taxes due are not paid by the date stated in the notice. Unfortunately, mailing of the notice is sufficient – failure to receive the notice does not affect or delay the forfeiture or annulment of corporate existence. 

 

Most companies, though, find another aspect of the forfeiture law even more troubling, as it is a trap for the unwary business owner. Maryland entities, as well as those formed outside of Maryland but subject to jurisdiction in Maryland (which likely means doing business in Maryland) must file an annual report, and pay the annual report fee.  Because the form, found here, is called a personal property tax return, many business owners understandably believe that they need not file the form unless the business owns property in Maryland. 

 

Unfortunately, this is not so. The filing requirement (and $300 annual fee) apply to domestic and foreign corporations, limited liability companies (LLCs), limited liability partnerships (LLPs) limited partnerships (LPs, Business Trusts, and Real Estate Investment Trusts (REITs), whether or not they own personal property in Maryland. Immediately after September 30 of each year, the Comptroller certifies to the SDAT a list of entities that have not filed their personal property returns. The SDAT then issues a “proclamation” forfeiting the charters of all non-compliant entities. When a forfeiture occurs, the SDAT will mail notice of forfeiture to the affected entity, at the entity’s address on record with the SDAT.

 

There are two significant consequences to forfeiture: first, any person who knowingly transacts business in the name of a corporation whose charter has been forfeited and not revived is guilty of a misdemeanor “and on conviction is subject to a fine of not more than $500.” Second, once a corporation’s charter is forfeit, the corporation in its own name can no longer maintain or defend any suit in any Maryland court. Rather, the directors of the corporation become trustees for the assets of the corporation. 

 

Revival of a forfeited charter is a fairly simple matter. First, the forfeited corporation must correct the problem that led to the forfeiture. Once this is done, the corporation should file Articles of Revival (form and instructions here). For an LLC, LLP, or LP, file Articles of Reinstatement (form and instructions here).    

 

As a matter of careful housekeeping, the forfeited entity should, after revival, adopt resolutions expressly ratifying all actions taken during the period for which it was without a charter. 

 

Bottom Line:  Make sure that your business has paid all necessary taxes and has filed a Personal Property Return for 2009, even if the business does not own any property. If you are unsure, you can check the SDAT website listing entities subject to forfeiture.   You can also check whether your company entity is in good standing via the SDAT’s Charter Search Page.  If your entity has been forfeited, revive it promptly; this will avoid many headaches later. 

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