eMinutes Blog

Failure to Issue Stock Certificates Is A Crushing Blow to Liability Protection

February 15, 2013

What does “incorporating” mean?  In recent years, jumping online to file Articles has been referred to all over the web as “incorporating”.  You can find hundreds of websites that sell “basic” incorporation packages that provide Articles, and you can frequently upgrade to a “premium” package that might include a fake-leather corporate book and seal where you can organize your Articles.

The problem with all of this is that “incorporating” refers to a process that includes so much more than just the Articles, and if you don’t take care of the entire process, the corporation will not hold up when you need it.   Two great cases (one in California and one in New York) illustrate how entrepreneurs can get slammed when they take short cuts on the process.  In each of these cases, the Court found that the failure to issue shares of stock was grounds for holding the shareholders personally liable for debts of the business.  In the California case, for example, the court found that three individuals who had formed a California corporation to sell cars, could be held personally liable for the balance due on cars purchased for their business based, in part, on evidence that the corporation had never issued stock or applied for a permit to do so.

Messed up Articles can also be the cause of the surprise of an entrepreneur’s life.  In several cases, where the Articles are not in the proper form, courts have found the shareholders personally liable, because the corporation never  “comes into being”.  For example, in one case, the business owner was held liable for more than $18,000 owed with regard to a lease that he had intended to make on behalf of a corporation. In another case, individual was held personally responsible for more than $15,000 of obligations incurred for his nonexistent corporation.

What about entrepreneurs who innocently jump online to form a corporation without understanding that they have only completed a small part of the process?  The law is not so cruel as to not understand that sometimes entrepreneurs do their best to form a corporation properly, but get bad advice on how to do it.  In special cases, a court will determine that a “de facto” corporation exists — this basically means that the court will try to respect the fact that the entrepreneur did his or her best.  This is a pretty rare result, however.   If the business is managed in the same way as it had been before the failed attempt to incorporate, with no effort made to comply with required corporate formalities, then there is no de facto corporation and personal liability will attach.

It’s way easier to form the corporation right in the first place.

To learn how to properly form a corporation, see, What it means to properly form a corporation.

To learn more about the cases discussed in this article, see The Importance of Forming a Corporation Properly.

Our attorneys are admitted to practice law in California, New York, and Texas.
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