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Why Should We Worry About Corporate/LLC Formalities?

 

 

 June
2013 Edition

 

Real Estate   Business   Litigation   Bankruptcy

    (MSBA Certifed Specialist) 

  

Greetings! 

 

I received a call a while back from a potential client who was advised by her banker to call a lawyer to "fix" her corporation so that they could open a company bank account.  She didn't understand why it wasn't enough that she downloaded Articles of Incorporation from the Secretary of State website, signed them and mailed them in.  After all, she had her Certificate of Incorporation in hand - and she was NOT happy to spend a few hundred bucks now to "complicate" her business with a bunch of useless legal mumbo jumbo.

 

Besides, she wondered, other than getting her account approved, what made it worth that cost?  In my mind I kept hearing her say,  "Lawyer?  I don't need no stinking lawyer!"   That attorney-client relationship never panned out. - Steve

 

 

peerless fan 

 

 A big fan of - preventative formality!

 

Attention to detail and form now can side-step costly, aggravation later.    
 
 Start-up companies these days are formed on a shoestring.  If there's an expense that can be spared, many new-venturers will jump on it.  Company/corporation formation is no exception.  And although it's understandable, going too far to save a buck can be a major problem later.
 
 
 

I could recite the esoteric and boring rationale behind the need for proper corporate/LLC documentation, but it would be mind-numbing (for us both) and it's Friday.  So I'll illustrate instead.

Situation #1.  Two 50/50 owners each decide the other is at fault for the company's stagnancy.  The owners are paid "salaries" for their services, rather than profit-based dividends.  No corporate formalities have been followed since the company was formed, and the only documentation that exists was the result of requirements imposed in connection with banking transactions over the years.  (You can't get a loan unless someone is authorized to sign the note and mortgage, and you can't have authority to sign unless there's been a resolution, etc.)  The owner who happens to have been the primary bookkeeper, and who therefore was tagged as "president", decides to save the company's budget by exercising his "authority" to terminate the other owner as an "employee".  Fortunately the company has bylaws and procedures to challenge authority and to replace officers - but the shareholder vote is an inevitable deadlock.  There is no mechanism for breaking the deadlock set out in the Bylaws, and neither owner is inclined to make any concessions to the other. 

Welcome to the wonderful world of business-paralyzing litigation!

Situation #2.  Three equal owners of a corporation start out right, with basically a complete set of corporate documents, then operate a productive business for several years.  But they purchased form- corporate documents, filled in some blanks and signed them - never really understanding what they were signing, or why.  Eventually one owner divorces her spouse, resulting in a major battle over valuation and entitlement to the shares of the company.  Another owner runs into hard financial times and files bankruptcy, resulting in a dispute with the trustee over the value and/or disposition of the shares.  In both the divorce and the bankruptcy the shares are at risk of transfer to successors who know nothing about the business, but would love to see its assets liquidated.  There's nothing in the documents about dissolution triggers, transfers by operation of law, share redemption or re-acquisition - and no one has considered the re-valuation of the shares since the company was formed.

Not only is the company in jeopardy, but there's potential for three lawsuits AND a dispute with the bankruptcy trustee.

Situation #3.  Company is formed with 50/50 owners, married to each other.  The only corporate foundational documents are the Articles of Incorporation (Secretary of State version), the Certificate of Incorporation, and the applications for tax identification numbers.  The company acquires real estate by virtue of a vaguely documented transaction that involves a bank loan to a third party, secured by company property.  The owners learn to despise each other (for unrelated reasons) and they divorce.   Neither owner appreciates corporate process, nor the legal requirements or ramifications of the roles either has played in connection with the company or the property, but both recognize that the company and the property are ideal instruments to use in making the other miserable.  The third party gets tired of servicing the loan, so starts a lawsuit to determine rights and obligations, and to liquidate the property.

 Situation #4.  Company is acquired by one owner. No room for conflict there, right?  Think again.  Dispute arises when an informally appointed officer becomes disgruntled with the owner and the company, so terminates after nearly 5 years.  Along the way he insists he was offered equity in the company for his services, and he wants either his shares OR their equivalent value in cash.  No documents support the claim directly, but some corporate actions were not inconsistent with his claim, and there's a lack of documentation that effectively DISPROVES the claim.  Neither side having anything conclusive upon which to rely, nor any reason to acquiesce to the other, litigation ensues.

 These situations are for illustration, but they are all based on actual cases.  Can't happen to you?  Well, I stopped at four because I hate to pile-on.  Disputes based on corporate structure, operation and ownership have been staple in my practice since I started this business lawyer-thing in 1996. 

It takes a lot of new-company formation files to equal the receipts generated by just one corporation/LLC dispute.  'Nuff said?  

  

Let me know if you have questions or comments about these topics or others. 

Visit my website, www.lodgelawoffice.com, to read more about me, my practice and areas of law that are relevant to you and your business.
Sincerely,



Steve Lodge, Esq.
Steven J. Lodge, PLLC

2006 First Avenue N, Ste. 201

Anoka, MN 55303

(763) 427-9066 (main line)

(763) 205-3058 (direct line)

(763) 447-3627 (fax)

steve@lodgelawoffice.com

 

 

Nothing in the email is intended to constitute legal advice.  The contents of this message are only a cursory description of general terms and their usage in a typical real estate transaction setting.  Your transaction and the documents you have signed or may sign may not be consistent with these descriptions.  You should consult with an attorney who focuses his/her practice on real estate matters before signing any real estate or loan instruments.