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Your Business Online Newsletter

More Than Just Formalities: Operating Agreements, Shareholder Meetings, and Piercing the Corporate Veil


Joseph L. Mulvey
Attorney, Rubin & Levin P.C.

 

Whether you own an interest in a corporation, limited liability company, subchapter-S corporation, or any other closely-held business, you have to remember that it is a separate and distinct entity from you as an individual.  The liability shield that you receive by conducting business through that entity can be swiftly bypassed if the entity does not follow the appropriate business formalities in maintaining its existence separate and apart from its members/shareholders.

The legal doctrine known as “piercing the corporate veil” is a means by which creditors can disregard the corporate entity and assess liability against the members/shareholders directly.  In order to prevail on such a claim under Indiana law, courts considers evidence of:

(1) undercapitalization; (2) absence of corporate records; (3) fraudulent representation by the corporation's shareholders or directors; (4) use of the corporation to promote fraud, injustice, or illegal activities; (5) payment by the corporation of individual obligations; (6) commingling of assets or affairs; (7) failure to observe required formalities; or (8) other shareholder acts or conduct ignoring, controlling or manipulating the corporate form.

Freeland v. Enodis Corp., 540 F.3d 721 (7th Cir. 2008).  In other words, these are the kinds of facts that courts look to determine whether an entity truly is separate and distinct from its members  or whether it is a mere “alter ego” of those individual owners.

Many of those who have an interest in a closely-held business entity conduct the business of that entity on an informal or face-to-face basis. Indiana law does not require LLCs, for example, to have operating agreements or conduct regular meetings to operate in Indiana.  While corporations are required, under Indiana law, to have annual meetings, many times these do not take place or are not properly documents.

While the efficiencies of operating in such a manner are obvious, the failure to conduct at least annual meetings (and to have the minutes of those meetings properly recorded, voted upon/accepted, and kept by the appropriate corporate officer) in accordance with requirements set forth in a duly accepted operating agreement or set of bylaws can be significant.
Here are some tips that can help your closely-held business avoid veil-piercing concerns:

  1. Keep company and personal finances separate!  This is far and away the most important factor considered by courts in determining whether an entity is an alter ego of its members/shareholders.  Do not use company financial accounts/credit cards for personal reasons or vice versa.  If additional capital calls are necessary in order to provide cash infusions to maintain the business, a meeting of the members/shareholders should be called and the capital calls voted upon and accepted (language relating to capital calls should be articulated in your operating agreement/bylaws).  Conversely, salaries for members/shareholders should be specifically set forth in the operating agreement and any distributions made in regular and formalized fashion in accordance with respective ownership interests of the members/shareholders.
  1. Have a signed operating agreement (for LLCs) or set of bylaws (corporations) that delineates the number of members and their respective ownership interests.  When ownership interests change hands, draft, vote upon, and sign amendments to the operating agreement (LLCs) or bylaws (for corporations where ownership interests are not reflected by certificate) to reflect the revised ownership interests.
  1. Conduct in-person meetings of the members/shareholders on at least an annual basis—have this requirement stated in the operating agreement or bylaws.  Specifically designate a member as secretary to record the minutes of the meeting and circulate those minutes for acceptance by the members.  Also, be sure that the records of the minutes are retained by the secretary in an organized fashion.

If you need assistance drafting or amending your operating agreement or bylaws or otherwise have specific questions relating to the sufficiency of your business’s routine practices, please contact Tim Hurlbut with Rubin & Levin, P.C. at thurlbut@rubin-levin.net.  


 
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