By Attorney Kelly Rains Jesson and Associate Attorney Danielle Nodar
Forming a corporation in the state of North Carolina is pretty easy to do yourself, but that may get business owners into trouble. Numerous corporations exist without any bylaws and without issuing any shares (especially those who do-it-themselves). Failing to complete all the steps can have negative consequences.
A corporation is owned by its shareholders. Shortly after a business is incorporated, it should issue shares to the owner(s). If there are no shares issued, there are no shareholders, and thus no owners. Why do so many business owners fail to complete this step? Probably for two reasons: (1) they don’t know this is the way it works and (2) in order to incorporate, all the Secretary of State’s office requires is that Articles of Incorporation be filed with its office. It does not require proof of bylaws or shares.
Shareholders do not manage the business just because they are shareholders. The Board of Directors manages the business. For small, family businesses, the shareholders and the directors are often the same people. However, these are still two distinct roles. Most business owners that have not issued themselves shares are simply acting like directors of the corporation.
To incorporate, the incorporator (could be a future director, shareholder, or third party, like an attorney) files Articles of Incorporation. North Carolina law states that if no directors are named in the Articles of Incorporation, the incorporator shall hold a “meeting” (can be informal) to name the initial directors. “The incorporators or board of directors of a corporation shall adopt initial bylaws for the corporation.” N.C.G.S. § 55-2-06 (emphasis added). The law states that there SHALL be bylaws, not that there MAY be bylaws. The bylaws govern the management and affairs of the corporation. The bylaws state how shares will be issued, how directors will be named/replaced, and how the company is managed.
So why should you care?
First, the liability protection corporation owners enjoy is at risk if you do not follow the corporate formalities required by North Carolina law. You risk having a creditor ask a court to “pierce the corporate veil,” making you personally liable for debts and judgments of the corporation. When a court “pierces the corporate veil,” it determines that the corporation and owner are basically the same, with the corporation serving as merely a shell for the owner to act. If this finding occurs, your personal assets can be used to satisfy corporate debts, which defeats one of main purposes of owning a corporation in the first place.
Second, you will probably not be able to obtain an SBA loan if you do not have bylaws. These loans are backed by government guarantees. The government wants to make sure it is not lending to an entity that has not been set up properly. The SBA wants to make sure the bylaws do not contain provisions that make the loan risky.
Finally, another reason why we talk to our clients about shares and bylaws is for estate planning purposes. When a person passes away, they leave their property to beneficiaries. Shares of corporations are personal property. If a business owner has not issued himself or herself shares of the corporation, what is there to pass to their beneficiaries?
Further, as we explained above, corporations are managed by the board of directors and not the shareholders. Therefore, even if a shareholder owner passes their shares to their beneficiaries, that does not mean that the beneficiary now suddenly starts managing the company as a new director. If you are the sole director of your corporation, who will take over management when you pass away or are sick? The bylaws of a corporation will govern what happens when a director passes away or otherwise becomes unable to act.
We can do some pretty creative estate planning with owners of corporations. We can help them restrict management or ownership of shares to family members. We can ensure that their shares stay out of probate through using trusts, saving their families money.
For assistance with drafting bylaws, issuing shares, and implementing an estate plan, give Jesson & Rains a call!
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Kelly Rains Jesson