Tips For Avoiding a Bad Business Break Up

Make a note of that!

There once were three members of an LLC. We’ll call them Ann, Brian and Chris. Back in 2009, Ann, Brian and Chris formed Strategic Partners LLC. They formed the LLC properly, had an operating agreement, and held monthly meetings of the members. Strategic Partners LLC had a stated corporate purpose to provide consulting services to Fortune 1000 businesses.

For the first two years, Ann, Brian and Chris went out to lunch for their monthly meetings. They celebrated their successes, talked about challenges and planned for the future. After the first two years, the meetings became bi-monthly. And after four years, they were quarterly. Sometimes, Brian was on speakerphone, rather than present in person.

In 2014, Chris began investing in real estate on behalf of the LLC. Ann didn’t really like that and expressed her concern at one or two of the lunches. Brian told Ann he agreed with her, but often that was after the lunch when Chris wasn’t present. Chris decided to use some of the operating account monies to help with the down payment on a new investment he wanted to make. He sent an email telling Ann and Brian the amount he took out.  

Two months later, the firm lost its two largest clients, severely impacting its cash flow. When they went to make payroll, pay vendors and make tax payments, the operating account was severely depleted. They were unable to make the payments timely. The real estate investments were unable to be sold on an expedited basis in order to provide the needed cash.

In response, one employee, a key manager, quit; and one vendor imposed new terms and conditions in the existing trade agreement, raising prices significantly. Ann, Brian and Chris began to fight. Accusations went around as to who was responsible. Ann and Brian blamed Chris for the cash shortage; Chris blamed Ann and Brian for losing the clients.

Everyone hired lawyers.

The first thing the lawyers asked for were the corporate records, to see who had the authority to take certain actions. Was Chris authorized to deviate from the corporate purpose and begin investing in real estate? Who approved the removal of the cash from the operating funds and in what amount? What were the roles each of the three members had in the organization? And who was responsible for client services and retention?

Unfortunately, no one had ever taken good notes at the meetings. And, to the extent anyone had taken notes, they were incomplete, focusing only on the one or two items that interested the note taker. None of the notes were shared with the other members, either for comment or approval.

The lawyers then had to look to email records, memos, and other documentation. Ann, Brian and Chris had to sit down with multiple lawyers and testify as to what happened, when and how.

During this time, Ann decided to leave the firm, frustrated with her business partners and the fighting. Brian struggled to keep the remaining clients happy. Chris wanted to split the business and take the real estate portfolio with him.

Proper corporate governance could have helped prevent this entire situation from taking place. Here are a few practicals:

  • Hold meetings in the office, preferably in person (less distractions, better focus);
  • Designate one person to be the Secretary for the meetings;
  • Ensure that the notes are complete enough to provide the background behind corporate actions (e.g., why was something decided), how the decision was made (e.g., by vote, unanimous consent, etc.), who was to implement the decision, the cost involved, and action items outstanding;
  • After the meeting, the minutes should be circulated to all attendees for review and comment;
  • Either before or at the next meeting, the minutes should be finalized based on feedback and stored in a secure location;
  • At the next meeting, action items should be reviewed.

What happened to Ann, Brian and Chris? This was a simplified (and anonymized) account of a real LLC. It ultimately went bankrupt. The members all sued one another. The IRS began auditing. The firm’s professional liability insurance refused to pay. And only the lawyers made a lot of money.

If you are unsure what corporate records you need to keep, consult with a qualified attorney in your jurisdiction. An attorney can also review the records existing for completeness and help you supplement anything that is lacking. Run your business like the professional entity it is. Your investment is worth it.

 

The opinions expressed are those of the author. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

Francine E. Love
Principal attorney at Love Law Firm, PLLC which dedicates its practice to New York business law
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