Any business that chooses to operate as a corporation, no matter how small, must comply with ongoing state law based requirements. For this reason, many small businesses choose to operate as limited liability companies, which are generally subject to minimal statutory requirements. Some states, such as Wyoming, have close corporation statutes that relax many of the formalities normally applicable to corporations. The majority of states do not have close corporation statutes, although close corporations, in the generic sense, may be formed under their general corporation statutes.
Therefore, generic close corporations — those generally having more than half of the value of their outstanding stock owned by 5 or fewer individuals —are subject to corporate compliance responsibilities, such as keeping minutes for regularly held meetings and adopting formal resolutions for actions taken. Failure to abide by statutory requirements can have costly consequences, as illustrated by a recent case out of the 7th Circuit Court of Appeals.
In Samaron Corp. v. United of Omaha Life Insurance Company, No. 15-3446 (7th Cir. 2016), closely held corporation, Troyer Products (formerly known as Samaron Corporation), lost out on the life insurance policy proceeds of its former President due to falsified corporate minutes. Troyer purchased a policy on Ron Clark in 2003, naming Chief Operating Officer, Dave Buck, as the beneficiary. Clark understood that the death benefit of $1 million would enable Buck to buy out Clark’s stock, giving Buck control of the company and giving Clark’s family the cash. Shortly thereafter, the parties amended the policy to make the beneficiary of the policy Troyer rather than Buck. Buck and Clark’s widow claim that everyone agreed that Troyer would turn the death benefit over to Buck. There is nothing in writing to that effect.
In 2005, Clark retired and sold a controlling interest to Troyer’s new President, Dan Holtz. Holtz then owned 61% of Troyer’s stock with Buck owning the rest. Holtz received a copy of the life insurance policy, along with the amendment naming Troyer as beneficiary. A second copy of the policy and amendment remained in Troyer’s files. Upon Clark’s death in 2011, Buck told Holtz that Troyer was the beneficiary of the policy. Holtz called United of Omaha to request the death benefits, and was told that the money would be paid to Buck. Buck then tried to use the proceeds to purchase Holtz’s stock, resulting in his removal from the board and his resignation as COO.
The issue in this case centered around the proper payee of the life insurance benefits. Specifically, the Court considered whether United of Omaha, which erroneously paid the death benefits to Buck, must re-pay the proceeds to Troyer. The lower court held that United of Omaha did not need to pay Troyer the proceeds since Troyer and Holtz were on notice of the policy terms, yet permitted Buck to claim the proceeds.
Troyer’s board met shortly after Clark’s death, at which time the company discussed that Troyer was the beneficiary of the policy. Nonetheless, they unanimously agreed to allow Buck to receive the money. No minutes were produced to corroborate the discussion, and Holtz subsequently appointed new members to the board and caused it to adopt new, falsified minutes indicating that no such decision had been made. But a recording of the previous board meeting was produced, proving that they had in fact discussed that Troyer was the beneficiary and agreed that Buck would receive the funds.
At trial, Troyer tried to claim that Holtz was misled by United of Omaha’s mistaken payment since he had no reason to believe that Troyer was the beneficiary. In light of the (i) recorded board meeting during which Buck made clear to Holtz that Troyer was the beneficiary, (ii) copy of the policy and amendment that Holtz was given when he became President, and (iii) copy of the policy and amendment maintained in the corporation’s files, the Court found in favor of United of Omaha. The Court emphasized the attribution of an officer’s knowledge to the corporation. Since the President and COO knew the beneficiary was Troyer, Troyer was deemed to have known. The Court went one step further in stating that it did not matter that a new President was named after the policy was purchased. According to the Court, “[t]here is no such thing as corporate amnesia” and the turnover in management did not “wipe out the corporation’s fund of knowledge.”
Troyer in effect waived its right to the proceeds by allowing Buck to accept them. The Court noted that Troyer could have contested the waiver by arguing that its board never adopted a formal resolution waiving its right to the proceeds. Section 23-1-34-5(c) of the Indiana Code requires that boards act by majority vote. There is no evidence of a vote having been taken or resolutions passed, but Troyer did not argue this point and therefore, the Court found in United of Omaha’s favor. As a result, Troyer suffered a $1 million loss of the insurance proceeds plus presumably sizeable legal fees.
The case is instructive for small business attorneys for several reasons:
1. Clients must be counseled on the statutory requirements that corporations are subject to when selecting the type of entity for a new business.
2. State laws vary in their treatment of closely held corporations and a minority of states relax compliance requirements through close corporation statutes.
3. Minutes should be maintained at each corporate meeting and resolutions adopted for actions taken. Having taken such statutorily required actions from the outset, rather than falsifying the minutes after the fact, would have at least saved these parties the time and expense of litigation.
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