Medical Practices: Failure to Follow Corporate Formalities Can Lead to Personal Liability…

June 6, 2013 by  


By Adil Daudi

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Attorney Adil Daudi

Benjamin Franklin once said, “an ounce of prevention is worth a pound of cure.” Although we can only question his intent on this quote, it is assumed his thought-process was that if we are able to prevent a problem from occurring in the first place, it could save a significant amount of time, effort and cost than it would in trying to rectify the damage caused.

This quote applies a great deal in the lives of physicians. The last concern physicians should have is whether their personal assets will be exposed in a lawsuit. Whether this is a concern a physician has or not, it is certainly one that deserves attention due to the increased emphasis on the new HIPAA changes, Stark laws, and Anti-Kickback reminders, where more and more medical practices are failing to follow some of the basic formalities pertaining to their medical corporations.

One of the primary reasons business owners/physicians form corporations is to protect their individual assets from the liabilities of their practice. This protection is often known as a “liability shield.” The basic premise of these corporations is that a properly organized company is treated as a separate legal entity under the eyes of the law; therefore, the owners (i.e. shareholders) of the company are shielded from liabilities of the company.

Although the majority of medical practices are formed as professional corporations, many physicians fail to take the time to understand the requirements of maintaining such a corporation, and to guarantee that the protection they desire will remain when needed most.

Pursuant to the Michigan Business Corporation Act, which was established in 1972, all corporations are required to adhere to certain requirements, such as; maintaining minutes, holding annual board of director meetings and shareholder meetings, maintaining an updated set of bylaws, etc. Unfortunately, many medical practices fail to keep their corporate record books up-to-date, as more often than not, corporate books are never looked at after the initial set-up.

Nevertheless, by failing to act, shareholders of corporations (i.e. physicians) open themselves up for liability because it becomes reasonable and quite probable, for an attorney to “pierce the corporate veil” and find the physician personally liable for the actions that occurred by the corporation. Furthermore, by failing to maintain the corporate books, thus negating the mandatory requirements, a court could be convinced that the corporation is essentially an alter-ego of the physician, and therefore, should not be warranted the protection they are seeking and ought to deserve.
The following are some requirements imposed by the State of Michigan that every corporation should follow to maximize protection:

1.    Conduct annual Shareholder Meetings
2.    Conduct regular Board of Director Meetings
3.    Maintain up-to-date Bylaws
4.    Maintain Corporate Minutes
5.    Update Corporate Record Books
6.    Maintain proper Employment Agreements for Shareholders (who are working for the corporation)

The above illustrates the importance for all physicians to implement strict best practices in order to maintain and maximize the chances of their corporation being treated separately. Keeping accurate, detailed, and copious documents is just one step of the process. All medical practices, whether they are multiple shareholders or a sole shareholder, should have well-documented records for all stock issuances, membership issuances, lease agreements, board of director elections/removals, shareholder agreements, and vote-required actions of the corporation.

Although these are just some of the corporate formalities required for all corporations, having these items well-documented shows the court that the shareholders took the necessary steps to keep the distinction between themselves as individuals and the corporation.

It should be recognized that courts have “pierced the corporate veil” for many reasons. The following is a top ten list of the most commonly used reasons courts have disregarded the corporate protection:

1.    Failure to maintain corporate records (bylaws, minutes, meetings, etc);
2.    Failure to keep corporation in good standing;
3.    Failure to identify the company as a corporation;
4.    Failure to operate multiple corporations separately;
5.    Failure to separate personal assets from business assets;
6.    Corporation being dominated by a single shareholder and disregarding its formalities;
7.    Failure to maintain separate corporate financial records;
8.    Failure to sign corporate documents in the proper corporate manner;
9.    Under capitalization; and
10.    Failure to abide and comply with the legal formalities among related companies

Ignoring or postponing the task of reviewing your corporate documents can cost you everything—your business, your home, your investments, etc. Furthermore, the more time that passes without having these corporate documents updated the more difficult it becomes to argue for that protection. Therefore, every medical practice and shareholder should take the time and consult with their corporate attorney on the current set-up of their medical practice and ensure all corporate formalities were being followed, are being followed, and will be followed in the future.

Remember: “An ounce of prevention is worth a pound of cure” – Benjamin Franklin

Adil Daudi is an Attorney at Joseph, Kroll & Yagalla, P.C., focusing primarily on Health Law, Estate Planning, and Business Law. Mr. Daudi has experience in a wide range of regulatory issues, including the Stark law, Anti-Kickback Statute, False-Claims Act, and HIPAA. He can be contacted for any questions related to this article or other areas of law at adil@josephlaw.net or (517) 381-2663.

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