When a Corporation Backfires

When a Corporation BackfiresNearly every small business owner has faced the choice of what type of legal structure to use. Each one offers certain advantages and disadvantages that a prospective owner must consider. Corporations, for example, are popular with small business owners who want to protect against liability.

Once created, a corporation is a separate entity from its owner. So, if anything goes wrong, the corporation will be responsible for any debts and liabilities that the business may incur. This means that the owners’ other assets will be out of reach even if it means the corporation will go bankrupt and default on its debts.

However, before this protection kicks in, business owners must make sure that they are following the ‘corporate formalities’ usually associated with a corporation. The phrase ‘corporate formalities’ is a term of art and includes factors that courts will use to determine whether a corporation really exists or whether it is the alter ego of it owner.

Courts look at whether the corporation is treated as its own entity. Specifically, they look at whether the required filings are in order, e.g. annual reports, whether  the corporation has its own bank account and whether that account is mainly to conduct corporate business, whether the board of directors are meeting regularly, and any other factors that may determine whether the corporation is legitimate or just a sham liability protection.

If a court finds that the owner did not follow the formalities, it will allow creditors to ‘pierce the corporate veil’ and reach personal assets. This outcome is not uncommon for small businesses that do not have the adequate procedural safeguards. On the other hand, this is seldom the case in businesses that rely on professional legal help for setting up and running a small business, especially a corporation.

If you are considering starting a small business or need to protect a current one, you should have an experienced Illinois small business attorney on your side.