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Understanding business formation: Corporations -- II

Last month, our blog continued its efforts to help budding entrepreneurs understand all of the business formation options available to them by examining corporations, focusing specifically how they are formed and how they are organized.

To recap, all that is required to form a corporation, a legal entity that exists independently of its three-tiered management structure of directors, officers and shareholders, is filing articles of incorporation with the appropriate state entity along with a fee and any other requested documents. In today's post, we'll examine the important issue of liability as it relates to corporations.   

Corporate liability

One of the defining aspects of the corporation is that it's viewed as its own entity in the eyes of the law, such that it's completely separate from shareholders who enjoy what is known as limited liability.

In other words, the law is structured in such a way that it constructs a sort of figurative barrier between the corporation and the shareholders, meaning the shareholders typically cannot be held personally liable for the actions or debts of the corporation.

It's important to remember, however, that since the shareholders enjoy limited liability, not absolute liability, they may be held responsible by the courts in certain limited circumstances, a phenomenon referred to as "piercing the corporate veil."

Courts are likely to pierce the corporate veil when certain factors are present, including:

  • There is little to distinguish the business from the owners, such as a lack of separate bank accounts or business contracts executed in the names of the owners rather than the corporation.
  • Corporate formalities, especially as they relate to decision-making and recordkeeping, are not observed.
  • Formation is accomplished for fraudulent purposes

We'll continue our discussion of corporations in a future post, examining the so-called double taxation to which corporations are subject.

If you have questions or concerns about corporations or business formation in general, consider speaking with an experienced legal professional.

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