What does this mean?
The most common corporate formalities are
- Annual reports
- Records and minutes of annual meetings
- Records of votings, meetings and resolutions where the board makes decisions
They’re like a paper trail of your business’s decision-making process. Think of it it being like accountability for your business - it shows how the company was managed.
Does this apply to me?
If you are organized or registered in some way as a business, then yes. States vary on their requirements, and often LLCs aren’t required to maintain corporate formalities. However, they’re smart for everyone to do to avoid reasons like the one noted below.
Why is making this mistake going to hurt my business?
If you fail to comply with these formalities, the state can just disregard whatever entity or identity you have set up. This means the owner or owners of the company will be directly liable for whatever the company owes. So you’ll lose whatever protections you thought you had.
Not only this, a more common problem is when people make a decision that blows up in the worst way and one or more people later say they never agreed to that decision. Imagine you have 10 shareholders and the majority approve a decision to lease a space or hire a controversial employee. And the decision ultimately costs the company a lot of money.
This could be compounded by some of those shareholders later saying they never actually agreed to the decision and trying to sue the top shareholders for a breach of fiduciary duty of care--arguing that it was reckless to make that decision. This is why resolutions and minutes matter--their proof for when you need it, like in situations like this.
Finally, if you’re ever looking for investors, they’ll want to see a good paper record of the decisions you’ve been making. This can only help.
You can avoid these problems by:
You can avoid all that if you just do the paperwork. It’s not an everyday thing, some of them are even one-off things. Check out our checklists on Steps required after forming your LLC or Corporation, it also includes other things you need to take care of apart from these corporate formalities.
Example
Will sets up a Salesly, LLC with his partners, Chet and Byron. A few months into the company, they all unanimously agreed over drinks to hire a controversial marketing firm to promote their product. Nothing was in writing.
The marketing firm was a bit too controversial and ran fraudulent ads promoting Salesly overpromising everything and Salesly couldn’t deliver. Salesly was sued in a class action for fraud and Chet and “Byron the Rat,” as Will calls him now, conspired to say they never agreed to hire the marketing firm. Instead, Chet and Byron tried saying Will made that decision on his own and sued Will as well for breach of fiduciary duty of care for making such a poor decision. Will’s argument was that they all unanimously agreed but the court believed Chet and Byron more because it was a 2 against 1 and 2 people are easier to believe.
Will could’ve prevented all this by following corporate formalities and documenting this decision in a resolution.