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Corporate Formalities - the practice of a company of keeping its affairs in order.
* Hindsight - understanding the situation only after the event has happened. * Monday morning quarterback - person who passes judgment on decisions made by others after the event. * Shortcut - a means of saving time or effort. REPEAT AFTER ME: There is no such thing as a good short cut. You can't take the elevator, you have to take the stairs.
Take Hank, the small business owner who decides after a long and fruitful venture to sell the business. He made "hay" while the sun was out, but is ready to take it to the barn. Hank's two "silent partners" who own a minority interest in his small business corporation have enjoyed the fruits for some time, but neither has the ability or desire to carry on the business. Without a natural successor, a sale is Hank's best and only exit plan.
After a long period of negotiations with a potential buyer, an agreement is reached to sell the assets of the corporation for $2,000,000.00. However, after the deal closes, the minority shareholders start to make noise about the purchase price. The text book definition of "fair market value" is a price that is agreed upon by a willing buyer and seller under no compulsion to sell. While Hank was under no compulsion to sell, he was more than ready to sell. Would the buyer have paid more? Maybe so, maybe not.
Enter the Monday morning quarterbacks.
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he minority shareholders are not happy with the purchase price and decide to file suit to rescind the sale for: (1) failure to properly observe corporate formalities regarding the sale of substantially all of the assets; and (2) breach of fiduciary duty to minority shareholders alleging the price was too low.
As the majority shareholder, Hank had complete voting control with respect to all business decisions. He did well and no one complained about their dividends, so over the years, Hank took his de facto control for granted. In real terms, he was the business. And with this mindset, Hank operated the business as he saw fit without the need for meetings, resolutions, notices or annual reports, or any other basic corporate formalities. It was just too much trouble. Eventually, he unilaterally made the decision to sell the assets of the business in good faith, but on his own terms.
Insert hindsight.
Hank failed to properly notice the minority shareholders of the pending sale, or properly document the approval process to authorize the sale from the business standpoint. And so the decision, which was made in good faith for fair market value, is subject to challenge, which will be an expensive prospect.
Leveraging the Business Judgment Rule. There is a well established principle of law that affords corporate directors (or managers of other business entities) protection from the constant threat of lawsuits arising out of corporate decisions. Generally, a court will not impose liability for any decision made in good faith and with reasonable diligence - even if the decision turns out to be a horrible business decision. The rationale is that directors and managers should be free to take reasonable business risks without the fear of lawsuits. As such, a court will not second guess properly documented good faith business decisions.
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t is very difficult to overcome the protection of the Business Judgment Rule.
However, it is the process of decision making, and not necessarily the decision itself, that is often the focus of court scrutiny. Without a decision making process, there may be no protection from the Business Judgment Rule. Hank had no process and now he has some exposure.
Good governance is the key, which requires attention to the most basic
corporate formalities. At a minimum, this requires establishing and documenting a process for decision making, periodically electing or appointing officers, directors or managers and filing annual reports, minutes and resolutions reflecting business decisions. Specific record keeping requirements exist under law, including a requirement to keep minutes or records of business decisions.
It is easy to overlook, shortcut or even ignore corporate formalities. However, good governance should be routine business practice. Every business owner should adopt and follow a process for decision making and keep records of the decision making process. Difficult and expensive legal situations can be avoided with just a few preventative measures.
REMEMBER: There is no such thing as a good short cut.
You can't take the elevator, you have to take the stairs. |
