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30 • 2012

The Importance of Properly Forming a Corporation

A number of steps must be taken to properly form a corporate entity so as to preserve the principals’ limited liability for doing business in the corporate form. See, What it means to properly form a corporation. For example, Articles of Incorporation including certain specified information must be filed with the Secretary of State.  If the Articles are properly prepared and consequently accepted for filing by the Secretary of State, then the filing is conclusive evidence of the formation of the corporation. See, e.g., Cal. Corp. Code § 209; N.Y. Bus. Corps. Law § 403.

On the other hand, if the Articles are not in the proper form, such that no corporation ever comes into being, then the individuals may be held personally liable for any obligations incurred on behalf of the nonexistent corporation. See, e.g., MTV Networks v. Lane, 998 F. Supp. 390, 393 (S.D.N.Y. 1998); Bay Ridge Lumber Co. v. Groenendaal, 175 A.D.2d 94, 96, 571 N.Y.S.2d 798. 800 (2d Dep’t 1991); Imero Fiorentino Assocs., Inc. v. Green, 85 A.D.2d 419, 420-21, 447 N.Y.S.2d 942, 943 (1st Dep’t 1982). For example, in Clinton Investors Co., II v. Watkins, 146 A.D.2d 861, 536 N.Y.S.2d 270 (3d Dep’t 1989), the individual 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. Similarly, in Brandes Meat Corp. v. Cromer, 146 A.D.2d 666, 537 N.Y.S.2d 177 (2d Dep’t 1989), the individual was held personally responsible for more than $15,000 of obligations incurred for his nonexistent corporation.

Individuals faced with such unexpected personal liability may argue that they attempted to incorporate and so were doing business as a de facto corporation. But individual responsibility can be avoided in such cases only if a “colorable, good faith attempt” was made to comply with state law prescribing the method for incorporating and if there was an assumption and exercise of corporate powers thereafter. See Cooper v. Leslie Salt Co., 70 Cal.2d 627, 634, 75 Cal. Rptr. 766 (1969); In re Hausman, 13 N.Y.3d 408, 412, 893 N.Y.S.2d 499, 501 (2009). 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. See, e.g., Wall v. Mines, 130 Cal. 27, 37, 62 P. 386, 390 (1900) (there was no de facto corporation where “there were no meetings of the members or [directors], no election of officers, no bylaws adopted, no certificates of shares or membership issued, no seal adopted or used, [and] no records or minutes kept”). Of course, if the time is not taken to insure that the proper steps are followed even to have the corporation properly formed in the first place, then it is unlikely that any greater effort will be made to see that corporate powers are properly exercised thereafter by holding meetings, keeping minutes, etc.

Another step that must be taken at incorporation is the issuance of stock certificates prepared in the manner prescribed by state law. See, e.g., Cal. Corp. Code § 416; N.Y. Bus. Corp. Law § 508. The failure to issue stock, although not conclusive evidence, is an indication that would-be incorporators were actually doing business as individuals. See Automotriz Del Golfo De California S.A. De C. V. v. Resnick, 47 Cal. 2d 792, 796, 306 P.2d 1, 4 (1957). As such, even if the company’s Articles of Incorporation were filed with the Secretary of State, a court may consider the failure to issue stock in considering whether individuals may be held personally liable for debts incurred on behalf of their business. Id. at 798, 306 P.2d at 4; see also VSS Sales, Inc. v. Uni-Seal Valve Co., No. B144966, 2002 WL 440407, *4 (Cal. Ct. App. 2d Dist. Mar. 21, 2002) (unpublished) (review denied) (“[The failure to issue stock in the corporation is grounds for piercing the corporate veil, although it is not conclusive in establishing that the corporate form was the mere alter ego of the defendant.”). In Automotriz, for example, the court affirmed the trial court’s ruling that the three defendants, 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. 47 Cal. 2d at 798, 306 P.2d at 4. Such cases imposing personal liability on individuals, despite their having made some effort to incorporate in accordance with state law, amply demonstrate the importance of insuring that the corporation is, in fact, properly formed.