Keeping Good Business Records: A Preventive Law Case Study

“You can stand under my umbrella, ella, ella, eh, eh, eh”
– Rihanna

Several years ago, I represented a company that was in the process of reorganizing its business structure following a handful of mergers, acquisitions and business entity conversions over the prior couple years. It was my understanding from a couple initial phone call that the existing parent company had two owners: one majority, decision-making owner and another minority, silent owner.

I was officially retained shortly afterward, and then asked for all of the company’s records since formation over thirty years before. A few large binders came in the mail, reflecting regular activity during the 1980s, 1990s and early 2000s.

Overall, the books had been well-maintained by the prior lawyer and showed agreements, resolutions, and records of annual and special meetings with accompanying minutes. All of these told a good story of what the business had been up to during this timeframe. Documented purchases and sales of company ownership were easy to track, so I could quickly determine who owned what, and when.

Since the record books stopped in the early 2000s, I asked for the balance of the books. After all, the last book showed that the minority, silent owner had owned over fifty percent of the company (which didn’t seem very “minority” to me). There had to be some record, agreement or other document reflecting how the majority owner got control of the company, right? I then patiently waited. And waited.

Finally, I called the “majority” owner and asked where the rest of the records were. She sheepishly let me know the company had been straying from good record-keeping practices, but then gave me the name of another lawyer who had been handling business matters for the company during the mid-2000s.

I reached out to this lawyer, who was only able to recall working on a single transaction involving the sale of ownership resulting in the new majority owner. “Whew!” I thought, the last thing I needed was to be working with a shady company.

I received the documents I’d been waiting for a couple days later. I reviewed the e-mails between the lawyer and the owners reflecting the new ownership amounts, along with the attached draft agreements everyone had approved in principle. Curiously, I didn’t see that the key agreements had been signed by anyone.

The lawyer then advised that the agreements had never been signed to his knowledge. Instead, the owners just went about their business, with the “majority” and “minority” owners taking their respective new roles.

There was no further written story of the business for over ten years. In other words, the “majority” owner was actually still the minority owner of the company. And during her reign, she had made business decisions that were arguably not in the “minority” owner’s best interests from a return-on-investment standpoint.

The following phone call then ensued with the “majority” owner:

Me: “I just took a look at the record books you forwarded. Did you know you may not actually be the majority owner of the company?”

Owner: “What?!!? We signed all those ownership transfer agreements over ten years ago!”

Me: “Yeah, about that. Turns out nobody actually ever signed those agreements, so Mr. Minority is actually still Mr. Majority.”

Owner: “Oh no. What should we do?”

Me: “The plan was always to effect this transfer, so let’s discuss at the upcoming annual meeting next month. You have been having annual meetings in the last ten years, right?”

Owner: “Unfortunately not.”

Me: “Have you discussed any business dealings at all with the other owner in that time?”

Owner: [Voice growing quieter] “No.”

Me: “So I assume there would be no authorizing resolutions, agreements, minutes of any meetings, or anything signed by him memorializing that he was on board with anything you’ve done on behalf of the company these last ten years?”

Owner: [Even quieter] “That’s correct . . . this doesn’t sound good.”

Me: “When is the last time you spoke with him?”

Owner: “About ten years ago. We send him a monthly dividend check, but that’s about it.”

Me: “Do you think he’d be willing to meet with you, so you can let him know everything the company has been doing and figure out next steps?”

Owner: “I’ll reach out and see what I can learn.”

Fortunately, this story had a happy ending. The co-owner still lived at his old address and was more than happy to reconnect. The two old business partners met, broke bread, laughed and shared stories over the course of a couple days. And, our protagonist honestly and transparently relayed to her old partner everything the business had been up to over the prior decade, including all financials and key decisions by the company, both good and bad.

The two also discussed the old ownership transfer agreements that had never been signed. They both agreed new documents should be developed and signed to ensure the transfer took place as initially contemplated. Our protagonist also offered to pay her old partner an increased monthly dividend given growth and success of the business, which he gladly accepted (and was appreciative she had made the gesture). All of this further became part of the upcoming annual meeting, which he also attended and was grateful to be included.

Ultimately, the old partner conveyed he was still comfortable remaining silent on most of the decisions of the company. As such, updated governing agreements were developed and signed to ensure increased flexibility in decision-making without having to obtain unanimous consent on every decision.

Now, please note that things don’t always go this smoothly. What if the old business partner was hostile and decided to file a lawsuit against the company upon realizing he was still the majority owner? Or what if he had passed away, leaving unknown wildcard heirs as the new majority owners, who likewise could have caused disruption through protracted litigation seeking to liquidate the company and collect their cash? Outcomes like these are real, and definitely not ideal.

Your business entity should have internal governing documents in place up front (e.g., by-laws, operating agreements) that detail the respective rights and responsibilities of the owners, including what happens in the event one of the owners divorces, dies or decides to no longer retain ownership. Consider enlisting the company accountant as well, since there could potentially be tax consequences for some of these decisions.

After all of these documents are in place, make sure key business actions throughout the year are timely and appropriately authorized and documented through company resolutions, especially if required by the governing documents. And hold special and annual meetings to ensure critical decisions are appropriately discussed, confirmed and then memorialized through minutes (hint, all of these things come in handy when the unexpected arises, and an accurate story of the business needs to be told).

Along with maintaining separate business accounts and accurate financial statements, keeping accurate and regular business records is critical to preventing exposure to business disruption . . . and also exposure to personal liability for company actions.

KEEFER is your ounce of prevention.

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