246 Planning and Forecasting
But the stockholders will normally escape personal liability for trade debt and,
most important, for torts.
This major benefit of incorporation does not come without some cost.
Creditors may, on occasion, be able to “pierce the corporate veil” and assert
personal liability against stockholders, using any one of three major arguments.
First, to claim limited liability behind the corporate shield, stockholders must
have adequately capitalized the corporation at or near its inception. There is no
magic formula with which to calculate the amount necessary to achieve ade-
quate capitalization, but the stockholders normally will be expected to invest
enough money or property and obtain enough liability insurance to offset the
kinds and amounts of liabilities normally encountered by a business in their in-
dustry. Thus, the owner of a f leet of taxicabs did not escape liability by cancel-
ing his liability insurance and forming a separate corporation for each cab. The
court deemed each such corporation inadequately capitalized and, in a novel
decision, pierced the corporate veil laterally by combining all the corporations
into one for purposes of liability.
It is necessary to capitalize only for those liabilities normally encoun-
tered by corporations in the industry. The word normally is key because the
corporation obviously need not have resources adequate to handle any circum-
stance no matter how unforeseeable. Also, adequate capitalization is necessary
only at the outset. A corporation does not expose its stockholders to personal
liability by incurring substantial losses and ultimately dissipating its initial
capitalization.
A second argument used by creditors to reach stockholders for personal li-
ability is failure to respect the corporate form. This may occur in many ways.
The stockholders may fail to indicate that they are doing business in the corpo-
rate form by leaving the words “Inc.” or “Corp.” off their business cards and
stationery, thus giving the impression that they are operating as a partnership.
They may mingle the corporate assets in personal bank accounts or routinely
use corporate assets for personal business. They may fail to respect corporate
niceties such as holding annual meetings and filing the annual reports required
by the state. After all, if the stockholders don’t take the corporate form seri-
ously, why should their creditors? Creditors are entitled to adequate notice
that they may not rely on the personal assets of the stockholders. Even Phil,
the software entrepreneur imagined earlier holding stockholder ’s and direc-
tor ’s meetings in his shower, would be well advised to record the minutes in a
corporate record book.
A third argument arises from a common mistake made by entrepreneurs.
Fearful of the expense involved in forming a corporation, they wait until they
are sure that the business will get off the ground before they spring for the at-
torneys’ and filing fees. In the meantime, they may enter into contracts on be-
half of the corporation and perhaps even commit a tort or two. Once the
corporation is formed, they may even remember to have it expressly accept all
liabilities incurred by the promoters on its behalf. Under simple agency law,
however, one cannot act as an agent of a nonexistent principal. And a later