BUSINESS LAW: Corporations

The Law Offices of David D. Murray provides all of the services necessary to support our corporate clients, including advice and formation of the appropriate business entity (i.e., partnership, corporation, limited liability partnership, limited liability corporation, or personal corporation), contract preparation and negotiation, updating of corporate books and minutes, business planning, corporate governance, business purchases and sales.

Besides limiting the owners, officers and directors of the company from certain personal liabilities, incorporating a business can have other advantages, among them overall tax treatment. We suggest you obtain individual tax advice from a tax professional who can advise you on all aspects of your personal tax matters. Taxation is complex. Our firm does not provide tax advice and we provide the below tax-related information just to show some of the options that are available for you to discuss with your tax accountant.

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WHAT IS A CORPORATION?

A general corporation is a separate and distinct legal entity recognized separately from its shareholders, officers, and directors. It is purely a creature of statue. If properly formed and operating, a corporation shields its shareholders from corporate liabilities. Rights and obligations of the corporation, its directors, and shareholders are clearly spelled out in the General Corporation Law of each state. These statutory rights and obligations may be altered, within limits, by agreement. A corporation is also a separate entity for purposes of taxation.

LIMITATION OF PERSONAL LIABILITY . . .

Corporations afford the principals and shareholders freedom from the liabilities of the business if the corporation is validly formed, complies with the formalities necessary, and is adequately capitalized.
This is especially important when a principal has significant income or assets outside the business.
A corporation's director who acts in good faith, and in a manner that the director believes to be in the best interest of the corporation and its shareholders, exercising such care as an ordinarily prudent person would use in similar circumstances, is generally not liable for any alleged failure to discharge the duties of a director. Officers of the corporation, as its agents, are not personally liable for acts done within the scope of their authority. The corporation may, to a limited extent, indemnify its directors and agents against monetary damages.

The limited liability afforded by incorporation is of less practical value than might be expected, especially for closely held businesses. First, insurance is ordinarily available to cover anticipated liabilities. Second, shareholders in newer, smaller corporations are often required by creditors to execute personal guarantees for major commitments undertaken by the corporation. Third, an individual may not avoid liability for his or her tortuous conduct by transacting business through a corporation.

Tortuous conduct, either negligent or intentional, subjects an individual to liability. Corporations have a potentially unlimited duration. Unless specific actions are taken to dissolve the corporation, either voluntarily or involuntarily, a corporation will continue to exist.

LIQUIDITY OF CORPORATE STOCK AND ASSETS . . .

A sale of a corporate business may take place through a sale of either the assets of the corporation by that corporation or the shares of the corporation itself by the shareholders. Shares of stock in a closely held corporation, however, are often no more readily transferable than interests in other business entities. This is primarily because of the restricted market for shares of stock in closely held corporations and the significant restrictions that can be placed on the ability to dispose of shares in a closely held corporation.

ADVANTAGES OF INCORPORATION . . .

An advantage of incorporating is in the centralized management that a corporation provides. The management and control of a corporation is delegated by the shareholders by shareholder election to a board of directors that, in turn, appoints the officers, whose position it is to implement the policies of the board of directors. Therefore, unless special voting or other rights are given to minority shareholders by the corporate articles of incorporation or bylaws, a shareholder with majority control is able to control the management of a corporation, even if there is dissent from minority shareholders.

When incorporating, various corporate formalities that do not apply to other entities must be followed. These corporate formalities usually involve filings with the State, which entails the payment of fees. All significant corporate actions undertaken by the board of directors must be documented in the minutes of the board of directors meeting or by action by unanimous written consent of the directors. Also, shareholders' meetings must be regularly noticed and held and the actions taken should be recorded and maintained in the corporate records. Failure to adhere to the corporate formalities may result in the shareholders, officers and directors being held personally responsible for debts and other liabilities of the corporation.

Corporate Formalities . . .

A corporation can be created only by compliance with General Corporation Law of the state of incorporation. This usually requires filing of Articles of Incorporation with the appropriate state entity (usually the Secretary of State) and payment of the requisite state fees and taxes.

A corporation is required to have a board of directors, corporate officers, annual shareholders meetings, and to maintain separate books and records. Failure to observe such formalities may result in the personal liability of shareholders for corporate debts. However, where the corporation has only one shareholder, many states, including California, allow that one shareholder to act as director and all officers (President, Secretary, and Treasurer).

Corporations are required to have annual shareholders meetings and director's meetings, and to properly record notices and minutes thereof in the corporate minute book, signed by the appropriate corporate authorities. Failure to keep up the corporate formalities can result in the piercing of the "corporate veil"
of liability protection, resulting in the shareholders, officers and directors being personally liable for corporate debts and responsibilities.

Therefore, it is very important that legal counsel be consulted in this regard. Beware of corporations that are set up by accountants, that often overlook the corporate formalities, in favor of tax treatment. It takes both a competent tax accountant and a competent lawyer to protect your corporate entity and to advise you under both tax laws and the general laws that apply to your corporation.

Separate Legal Entity Status . . .

A Corporation or a Limited Liability Company is a separate legal entity existing under authority granted by state law. It has its own identity separate and apart from its shareholders/owners. Sole Proprietorships or Partnerships may not offer this type of separateness.

Broad Range of Corporate Powers . . .

As a separate legal entity, a corporation has the power to act in any way permitted by law and by its own corporate charter. For example, a corporation can enter into contracts, buy and sell both real and personal property, sue and be sued, and can even be responsible for breaking the law (i.e. committing a crime).

Access to Small Claims Court . . .

In most jurisdictions, any officer or director or employee can appear in small claims court on behalf of the corporation. In some states, including California, there may be restrictions on how many small claims actions a corporation can bring in one year.

Separate Liability for Corporate Debts . . .

As a separate legal entity, a corporation is responsible for its own debts. Normally, shareholders, directors, and officers are not responsible for corporate liabilities. If the corporation suffers losses, the corporation itself must bear those losses to the extent of its own resources, and not the personal assets of the individual shareholders. In effect, however, shareholders indirectly bear these losses by a decline in the value of the stock they hold in the corporation. Note however, that shareholders, directors, and/or officers may be held liable for the debts of the corporation where the court imposes "alter-ego liability"
or where the individual has personally guaranteed the corporate debt.

Perpetual Duration . . .

A corporation is capable of continuing indefinitely. Its existence is not affected by the death or incapacity of shareholders, directors, or officers of the corporation.

Duration of Corporation Compared to LLC . . .

A Limited Liability Company (LLC) has a limited existence. Absent a contrary agreement, an LLC is dissolved upon the death, withdrawal, or bankruptcy of a Member, unless the business is continued by unanimous vote of the remaining members. Although the operating agreement can be drafted to avoid such a result, the life of the LLC is still limited to the termination date established in the Articles of Organization.

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You are encouraged to seek qualified counsel for advice regarding your individual legal issues.

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