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.
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
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
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
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
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
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
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
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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