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Law in the Marketplace: Should your corporation bother with bylaws?

For the Monitor
Published: 4/1/2021 8:25:01 PM

 

Many New Hampshire courts have held that if a corporation fails to comply with “statutory formalities” under the New Hampshire Business Corporation Act (the “BCA”) and acts with what the court views as serious unfairness towards one of its creditors, the court will “pierce the corporation’s veil”; that is, it will hold the corporation’s shareholders personally liable for the creditor’s claims even though the BCA generally prohibits such a result.

The principal relevant corporate “formalities” include:

■appointing initial directors and officers,

■issuing share certificates to all shareholders,

■issuing corporate bylaws (which are internal rules of governance to be observed by the corporation’s directors and officers),

■complying with those bylaws by, among other things, actually holding shareholder and director meetings in accordance with bylaw requirements, and

■recording and maintaining reasonably detailed minutes of those meetings and of corporate transactions with third parties, such as major suppliers and customers.

But it is a significant burden for small privately-held New Hampshire corporations to comply with the above formalities; and compliance requires the assistance of lawyers and the payment of lawyers, and thus the payment of potentially costly legal fees.

Thus, a great many New Hampshire corporations, even if they are fully aware of their duty to comply with corporate formalities, simply don’t comply. But the less they comply with these formalities, the more they open themselves up to successful veil-piercing claims by creditors.

And even if their lawyers advise that veil-piercing claims are very hard to win (which is the case) and that there is only a small chance that the creditor claim in question will prevail, clients may decide that in order to deal with an unlikely but potentially disastrous outcome, they must settle the claim on terms they would normally never consider.

There is a marvelous seeming solution to the above dilemma – namely, Section 7.32 of the BCA, entitled “Shareholder Agreements.” In essence, Section 7.32 provides, amazingly, that if there is an agreement among the shareholders of a particular corporation that they and the corporation’s directors shall have no duty to issue certificates of incorporation or share certificates, adopt bylaws, hold shareholder or director meetings, keep written records of corporate meetings or transactions, or comply with any other corporate formalities whatsoever under the BCA, then:

■they need not comply with them; and

■they can operate their corporations as flexibly and informally as if they were LLCs.

However, there are at least two significant reasons why, in a veil-piercing case, a New Hampshire corporation may not be successful in resisting a creditor’s veil-piercing claim on the basis of Section 7.32:

■First, there is no case in New Hampshire or in any other state holding that Section 7.32 or any similar provision will suffice to overcome a veil-piercing claim based on a corporate failure to comply with corporate formalities.

■Second, under Section 7.32(a)(8), the courts will respect a shareholder agreement under that section only if it is “not contrary to public policy.” The meaning of the quoted phrase is unclear, but it could be readily interpreted by a court to invalidate all or a part of any Section 7.32 shareholder agreement.

■Third, “veil-piercing” is a judge-made law that provides, in effect, that the courts may hold the shareholders of a corporation personally liable for a creditor’s claims if this is required by “equity” – i.e., by the judge’s subjective sense of fairness. Few legal concepts are fuzzier than the concept of corporate fairness.

Thus, I doubt many New Hampshire corporate lawyers would recommend that their corporate clients rely on a Section 7.32 agreement to avoid veil-piercing. This is especially the case because New Hampshire corporate and LLC law make it relatively easy for New Hampshire corporations to make “statutory conversions” to LLCs without any adverse legal or tax consequences, and LLCs are subject to virtually no statutory formalities except a requirement taxable income to maintain certain basic company records they would likely maintain in any event. In particular, there is an IRS “private letter ruling” that specifically holds that if a corporation that is subject to federal income tax as an S corporation makes such a conversion properly, there will be no negative federal income tax consequence from the conversion.

Indeed, if a lawyer is aware that her corporate client isn’t complying with BCA corporate formalities and isn’t likely ever to do so and yet she fails to advise her client about the availability of a statutory conversion of the client’s conversion to an LLC and if the corporation someday succumbs to a veil-piercing claim, it’s not inconceivable that the lawyer will face a malpractice claim.

The bottom line: If you’re a corporate shareholder or director and you know your corporation faces a veil-piercing risk for failure to comply with corporate formalities, don’t run your company as a corporation; convert it to an LLC.

 

 

(John Cunningham is a Concord, NH lawyer of counsel to McLane Middleton, P.A. His practice is focused on LLC formations, general business and tax law, advising clients under IRC section 199A, and estate planning. His telephone number is (603) 856-7172, his e-mail address is lawjmc@comcast.net, and the link to his website is www.llc199A.com.)


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