When we are asked to review client corporate record-keeping, it is far too often the case that such record-keeping has fallen by the wayside and been overlooked. We understand that, for small businesses and/or entities with only a handful of equity owners, corporate record-keeping can seem a tedious or expensive chore. Some clients have asked “Do I really need to hold a shareholders meeting if I am the only shareholder?”
The short answer is, “Yes, you do.” Both corporations and limited liability companies (LLCs) have internal and external organizational and record-keeping requirements that vary depending on the state of incorporation or organization. For example, corporations are typically required to hold an annual meeting of shareholders and at least one annual meeting of the board of directors. Actions taken at these meetings should be recorded and kept in the minute book of the entity. LLCs typically have more relaxed internal management requirements; however, keeping an accurate record of the meetings of the members (or meetings of the managers in a manager-managed LLC) is just as essential as in a corporation.
Many small business owners recognize the essential nature of keeping accurate financial records, while letting their corporate bookkeeping go by the wayside. This imposes real risks on the equity owners, including:
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Personal liability for debts of the entity: Most business people understand that the reason you form a corporation or an LLC is for protection from personal liability for the debts of your business. This protection may be lost, however, under a legal theory commonly referred to as “piercing the corporate veil.” Most clients will probably not be surprised that equity owners of an enterprise have been held personally liable in cases of fraud or other intentional wrongdoing, but this is not the only scenario where a court has held that the corporate veil may be pierced. A failure to follow corporate formalities has often been cited by courts as evidence that the entity was a mere fiction and, therefore, the shareholders of the enterprise should be held personally liable.
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Legal requirements: In some states the corporation or limited liability company laws require enterprises to keep adequate records of shareholder and board proceedings. Failure to do so in these jurisdictions runs the risk of statutory penalties for noncompliance.
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Documenting “interested” transactions with equity owners: If there is more than one equity owner of an entity, it is critical to formally document business arrangements between one of the equity owners (or his or her relatives) and the entity (e.g., leases of property, loans, or compensation arrangements). If the minutes of a shareholder or board meeting reflect that the arrangement was discussed and represents terms that are fair to the entity, it is much less likely that a non-interested shareholder or director will be able to challenge this arrangement in the future.
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Preparing a business for sale: Poor record-keeping can also jeopardize potential exit transactions. Prospective buyers of a business will want to examine an entity’s corporate records in addition to its accounting information. If these records are poorly maintained or nonexistent, a potential purchaser is likely to insist on an even more thorough due diligence examination of a target. Once an agreement in principle is reached, any delay in getting to the signing and closing of definitive documentation is a delay that puts the deal at risk.
This brief overview of the risks of failing to keep up-to-date corporate records is not exhaustive. While keeping your corporate records up-to-date may seem to be a distracting task from the more important business of building a successful enterprise, it is usually not particularly time-intensive. Our corporate attorneys can review your existing governance documents and record-keeping and assist you in creating templates and procedures to correct past mistakes and render future compliance a relatively painless process.
