Clients starting small businesses are usually encouraged to operate as a formal entity, either as a corporation or a limited liability company. And while most people understand that the purpose of incorporation is to protect the owners from individual liability, there are circumstances where that protection can be bypassed- and the owners find themselves personally liable for the debts of their company.
The most common cause of losing corporate protection is the failure to observe corporate formalities. Operating as a corporate entity means more than filing a certificate of formation and paying an annual fee. Pursuant to New Jersey law, corporations are required to maintain bylaws and limited liability agreements are required to maintain operating agreements. Records must be kept of share allocations and transfers, ownership certificates must be issued, entities must hold annual meetings of shareholders or members, and minutes must be recorded to memorialize those meetings- even if the company is just you and your wife! An effort should be made to separate corporate expenses from personal expenses and your business account should not be used to pay for your home expenses.
A collection litigator’s favorite strategy is to demand copies of corporate records to determine whether corporate formalities have been observed. If there are no such records, a request can be made of the court that the “corporate veil be pierced,” alleging that the corporation seems to be a mere sham. If that request is granted, the “veil is pierced” and the owners of the company could be held personally liable for the debt being collected.
If you have concerns about your small business, please call us for a free consultation.