TOPICS DISCUSSED BELOW:

• Proper Operation of Corporations
  • Use of Corporate Name
  • Pre-existing Contracts and Relationships
  • Meetings and Actions of Shareholders and Directors
  • Employment Agreements
  • Maintaining Separate Corporate Identity
• Liability Protection and Insurance
  • Contract Liability
  • Vicarious Liability - Liability for Employees' Actions
  • Liability for Shareholder's or Officer's Own Actions
  • Negligent Hiring or Supervision
  • Importance of Insurance

Proper Operation of Corporations

Many people operate their business through a corporation to take advantage of the protection of limited liability that is provided by the corporate form. If you are operating through a corporation, you should follow proper procedures to increase the likelihood that the corporation will, in fact, provide you with the desired protection.

Use of Corporate Name - You should always make it clear to the public and to your customers that you are a corporation. When you undertake any action on behalf of the corporation, the other party to the transaction should always know that you are acting on behalf of the corporation and not on your own behalf. Everything you do should reflect the full and accurate name of the corporation, including the corporate designation. A corporate designation is part of your corporation's name - "Inc." - "Ltd." - "Co." or the complete words "Incorporated" - "Limited" or "Company." If your full corporate name is too long or cumbersome, you should register a fictitious name for your corporation and use the full fictitious name. For example, "Robert and Helen Jones House Cleaning, Incorporated" could register "R & H Cleaners" as its fictitious name. The name should be registered by the corporation - not by the individual shareholder.

The full corporate name or a registered corporate fictitious name should be on your website, e-mails, letterhead, bills, stationery, other papers, business cards, telephone listing, signs and all advertisements. Any bank accounts used by the business should be opened in the name of the corporation or its registered fictitious name. All leases, contracts and other arrangements should be entered into on behalf of the corporation. The corporate seal should be affixed to all documents you are signing on behalf of the corporation. When signing documents on behalf of the corporation, you should always sign using the corporation's name in the following format:

EXACT CORPORATE NAME, INC.

By: ______________________________

John Smith, President

Pre-existing Contracts and Relationships - If you have any existing contracts or any existing loans or insurance policies that predate the formation of the corporation, they should be changed to reflect the corporate name. If you incorporate an existing business, written notice should be sent to former suppliers, customers and others with whom you deal, confirming the formation of the corporation. This will help to enable you to use the corporate shield in defending claims by those with whom you deal.

Meetings and Actions of Shareholders and Directors - The corporate form may offer both liability limitation and tax advantages to a shareholder, however, these advantages can be lost if the formalities are not followed. Your relationship with your corporation may be on a number of levels. You may be a shareholder, director, officer and/or employee. Even if you are the only person acting in any of these capacities, your activities should be done in ways that maintain the proper formalities. There are distinctions between the various capacities in which you might act and these distinctions should be maintained. The corporate directors have the responsibility of controlling the policy, actions and functions of the corporation. The officers serve at the pleasure of the board of directors and perform those duties and obligations determined by the board. Therefore, it is appropriate for the shareholders to hold an annual meeting for the purpose of electing the board of directors and for the board of directors to hold an annual meeting for the purpose of electing officers. Minutes of all regular and special meetings should be prepared and maintained. Any transaction of significance should be reviewed by the directors and recorded in the minutes of the meetings. It is important to keep these corporate records current.

Employment Agreements - It is good practice to have an appropriate employment agreement for each key employee of the business, including its principal shareholder. This helps establish that the corporation is following corporate formalities. When properly prepared, employment agreements can also limit former employees from competing with your company after they leave and can protect your company's trade secrets.

Maintaining Separate Corporate Identity - The corporation is a separate economic and tax-paying entity from its shareholders, and this distinction must be maintained. It is important that the shareholders not pay personal expenses with corporate checks. You should never pay your home mortgage payments, food bills or any other expenses unrelated to the corporation with checks written on the corporate checking account. You should not withdraw money from the corporation whenever you need it, but should be on a salary with payments made on a regular basis. One cannot overemphasized that the corporation should be maintained, operated and regarded as a corporation rather than as an individual business or sole proprietorship.

Liability Protection and Insurance

There is a widespread misconception that the owners and officers of a corporation are protected from all forms of liability merely by the formation of the corporation. This is not an accurate statement of the law. As the shareholder or officer of a corporation, you can still incur personal liability for your own actions despite that you have formed a corporation.

Contract Liability - As long as the proper corporate formalities are followed and all documents are signed in the manner suggested above, owners and officers should not incur any personal liability for contract obligations of the corporation.

Vicarious Liability - Liability for Employees' Actions - The corporation will also generally protect owners and officers from personal liability for the actions of the corporation's employees. A sole proprietor is legally responsible for the actions of his or her employees. That is known as vicarious liability. For example, a sole proprietor is legally responsible for personal injuries to a third party who is hurt in an automobile accident caused by the negligent driving of the employee while on the employer's business. This vicarious liability arises out of the employment relationship itself. Where the corporation is the employer, the corporation is legally responsible for the actions of the employee but the shareholder or officer is not personally responsible for the employee's negligence.

Liability for Shareholder's or Officer's Own Actions - The corporate form will not protect an owner or officer from his or her own negligence. This is the area where the misconception is greatest. Many people believe that because they formed a corporation, they are no longer liable for their own actions and that they can "hide" behind the corporate shield. This is simply not so - people are always legally responsible for their own actions. If an owner (shareholder) or officer performs some action himself or herself on behalf of the corporation - that person is responsible for his or her own actions as the actor, and the corporation is also responsible as the employer. Thus, a corporate shareholder driving his automobile on behalf of the corporation is personally responsible for the results of his own negligent driving. The fact that the corporation is also responsible for his actions does not relieve the driver from his legal responsibility.

Negligent Hiring or Supervision - Corporate actors also can be responsible for their own negligent actions (or omissions) in other ways. A corporate officer or supervisor might be negligent in hiring or supervising others. For example, he might hire a habitual drunkard to operate heavy equipment and the equipment operator might cause an accident while in a drunken condition. The drunken operator would be legally responsible for his own actions; the corporation as employer would have vicarious liability for the negligent actions of its employee; and the corporate officer might legally be responsible for his own negligence in hiring that operator or in failing properly to supervise the operator. The supervisor is not liable as the "employer" - he does not have vicarious liability - as he would if he were a sole proprietor. Rather, he has direct personal liability because of his own negligence in hiring or supervision. As indicated above, a person is always legally responsible for his or her own actions. He is not automatically liable - his negligence in hiring or supervision must be established separate from the negligence of the equipment operator. However, if negligent hiring or supervision is established, the corporate form will not protect the supervisor or officer from his own negligence.

Importance of Insurance - Despite the formation of a corporation, a business should continue to maintain adequate liability insurance. This includes general liability, workmen's compensation, products liability (if applicable) and any other liability coverage appropriate to the particular business. A business umbrella policy is also worth investigating. Insurance can protect the business against the costs of defending claims - legal fees, expert witness fees, litigation costs, etc. - that often can be very expensive even if a claim is successfully defended or eventually settled. Insurance policies should also be reviewed to confirm appropriate and adequate protection for the shareholders, directors, officers and employees of the corporation.

Copyright 2013 - 2014  Marc H. Jaffe

Disclaimer - This article is only meant to provide general information about the operation of Pennsylvania corporations and corporate liability protection. It is not an attempt to answer all the questions that may arise in the operation of a corporation nor is it intended as legal advice. You should consult an attorney with your specific questions about the operation of your own corporation.