Points of Business Interest - February 2003

Points of Business Interest

»» The Importance of Being Earnest

Our firm has recently been involved in several disputes in which a person asserts that he is shareholder of a corporation, despite the failure of the corporation to issue any stock certificate evidencing ownership of the shares or follow other formalities such as organizational meetings appointing directors and officers. Under Illinois law, the failure to obtain a stock certificate normally does not mean that a person is not necessarily a shareholder. These cases involve a fundamental failure on the part of the principals in the corporation to make sure that the corporation is properly established. To organize a corporation requires more than simply filing Articles of Incorporation with the Illinois Secretary of State.

Properly establishing a corporation involves a good deal more work than just filing articles with the Secretary of State. In many cases, a Stock Subscription Agreement should be prepared and executed. In all cases, organizational actions, either through meetings of shareholders and directors and/or informal actions in lieu of those meetings, should be documented, at which time by-laws are adopted, directors are elected by the shareholders, and officers are elected by the directors. In addition, other actions, such as the approval of an S-election (previously Sub-chapter S) for tax purposes, authorization to open bank accounts and loan documents and other actions may also be taken.

Stock certificates and transfer sheets should be executed and any other documents should be completed that are required to validly establish a framework for the operation of the corporation should be completed. Again, while failure to take these steps may not prove fatal to the operation of the corporation, it creates a very difficult situation in the event that a third party seeks to hold the corporate principals personally liable or that there is a dispute between the corporate principals.

The cost of properly incorporating a business is paltry compared to the cost of litigating disputes and the exposure to personal liability that was probably one of the reasons for incorporating in the first place.

After the corporation is established, it is essential that the corporation continue to follow corporate formalities, by having annual shareholders' and directors' meeting or executing informal actions in lieu of those meetings to regularly go over and approve corporate business. In addition, any decision that requires the action of the shareholders or directors should be properly documented in the minutes of a special meeting or an informal action in lieu of a special meeting. Again, the cost of keeping the corporate records current is minimal compared to the risks in not doing so. In the event that a third party, such a creditor, seeks to go after the principals of the business personally, the creditor will be seeking to "pierce the corporate veil." In order to avoid that, the corporation should make sure that it follows all corporate formalities, including those described above. In addition, the corporation should maintain proper corporate financial books and records, should use corporate funds only for corporate purposes (even if you are the only shareholder/director/officer, do not use the corporate checking account to pay your home utility bills, credit card, etc.).

Make sure that all of your business signs, statements, checks, business cards and all other representations to the public show the existence of the corporation. The only way that this can be avoided is in the event that an assumed name filing is made with the Secretary of State or if the business is a division of a corporation, in which case signage, etc., for the division should say "Acme Screen Door Company, a division of Acme Industries, Inc." Also make sure that all individuals signing on behalf of the corporation do so in their capacity as agents of the corporation. If you sign a bill of lading or receipt for the corporation, you should do so by signing your name, followed by your title and the corporate name. In this way the recipient of that document cannot assert lack of knowledge of the corporation's existence.

It is essential that your insurance agent be aware of your corporation. It makes no sense for you to personally insure assets that you do not own, as they were previously transferred to the corporation. Make sure that the corporation's assets are insured and risks, such as liability insurance, business interruption insurance, and the like are obtained. The saying that into every life a little rain must fall it true; do yourself a favor and purchase an umbrella.

Even more certain than rain is death. If you have more than one shareholder, your corporation should have a buy/sell or redemption agreement to deal with the death, disability or other withdrawal of one of the principals from the business. A full discussion on all the possibilities in such an agreement is beyond the scope of this article, but such an agreement is a must for any small business.

All this may seem like a lot of work, distracting you from what you incorporated your business to do. It actually involves very little work at any one time, and it is designed to guaranty you the fruits of your efforts.

»» What does "you" mean?

Check the terms of your firm's corporate auto policy, to determine who is covered. In a Federal Circuit Court of Appeals case, the Court construed an employer's business automobile policy coverage, which used the term "you" in the policy, to not extend to the corporation's employees, even though they were acting in the course of employment. As a result, it is essential that you review your policy coverage to make sure that employees are covered if they drive company cars.