One of the most significant advantages of forming a corporation is obtaining personal liability protection. Unlike a sole proprietorship or a partnership, a corporation is an independent legal entity that is separate from its directors and officers. Therefore, officers and shareholders are typically not responsible for the debts and obligations of the entity. But in order to maintain this core distinction, directors and officers are required to avoid activities that may result in the imposition of personal liability by a court.
When officers and shareholders act or fail to act in a manner that maintains the separate identity of the corporation, the courts can set aside the corporate form and “pierce the corporate veil.” Essentially, directors and officers are prohibited from engaging in transactions and agreements that either evidence self-dealing or fail to maintain an explicit separation between personal and corporate financial matters. In practical terms, how can directors and officers comply with corporate governance standards in order to safeguard their personal liability protection?
Maintain separation between corporation and directors. Directors cannot commingle personal and corporate assets under any circumstances. When a director or officer commingles assets, the court may conclude that the corporation is essentially operating as the “alter ego” of the Board and the corporate veil should be pierced. Directors should create separate bank accounts and tax returns for their own assets. In addition, directors should avoid borrowing corporate funds for personal use or using personal funds for business purposes. Officers should never guarantee corporate payments or act as creditors for corporate liabilities.
Act in the corporation’s best interests. A director who takes actions that do not appear to be in the best interests of the corporation will be required to justify his decisions by demonstrating the fairness of the transaction. Directors should avoid even the appearance of self-dealing to preclude the accusation that they did not act with undivided loyalty to the corporation.
Avoid illegal or fraudulent activity. Directors who engage in activities that are illegal or fraudulent will relinquish the protection afforded by the limited liability structure. These activities include undertaking transactions that the corporation cannot finance, wasting corporate assets, and acting dishonestly in any manner.
Contact Shane Coons at 949-333-0900 or visit his website at www.ShaneCoonsLaw.com to find out more about his practice.