Operational excellence for owners of small or closely-held businesses may involve certain challenges that are less applicable in larger entities. For example, the temptation may exist to operate less formally, with less accountability and oversight due to pre-existing or familial relationships. Agreements, if written, may be sparsely worded. Documentation of key business decisions and transactions may be lacking. We saw this type of sloppy governance earlier this year in Robl Construction vs. Homoly, No. 13-3607 (8th Cir. 2015). Robl involved a two-member LLC with poorly drafted governing documents and inadequately maintained records that have cost the parties a significant amount of time and money in court.
Still, Robl’s fact pattern and deficient record-keeping pale in comparison to a more recent case out of the Supreme Court of Mississippi. Scafidi v. Hille, No. 2014-CA-01261-SCT (Dec. 10, 2015) involved a dispute between two siblings (Gerald and Jo Ann) over three family corporations and land they inherited from their parents. Despite their joint ownership of the entities and the land, the estranged siblings ran the businesses more like sole proprietorships. In the roughly 8 years following their parents’ death, the siblings held only two shareholders’ meetings. No agreements were documented, nor were any minutes recorded.
Gerald made decisions pertaining to the businesses he operated without consulting Jo Ann. Gerald used funds from those businesses to pay off his personal credit card, pay for utility and phone bills, and purchase a truck. Gerald conducted side ventures on the business property, and commingled income from those endeavors with funds of the family business. For one year only, Gerald correctly split rental income related to the family business with Jo Ann, but then stopped and refused to divide the income or provide Jo Ann with any details related to the rental income. Gerald’s books, records and tax returns were found to be false and incomplete as to both gross receipts and expenditures. In the most recent years, Gerald failed to file tax returns at all.
Jo Ann, for her part, operated one of the other family businesses in a similar manner. She drew income from the business and used the funds to operate side ventures on the property she jointly owned with her brother. Jo Ann also used business funds to pay for the repair of her home’s roof, health insurance, attorneys’ fees, and a car. The forensic accounting firm hired by the court could not confirm completeness of revenues for the business Jo Ann operated, and the evidence pointed to below-market rental rates and misappropriation of funds.
The issues, procedural history and fact pattern in Scafidi are quite complex. In the very simplest of terms, the central dispute in the case related to Jo Ann’s claims for an accounting of corporate profits and expenses, a forced shareholder meeting to dissolve the corporations, and breach of fiduciary duty. The lower court determined that, because the parties had failed to observe corporate formalities, they were not entitled to the protections of the corporate form. The lower court therefore held (and the Mississippi Supreme Court affirmed) that Jo Ann and Gerald were each entitled to full ownership of one separate corporation. The third corporation was sold with the proceeds divided between the siblings. Further, the court adjusted the property lines of the property to grant each sibling a 50% interest in the land. The parties were ordered to execute the necessary documents to effectuate the court’s ruling, including deeds, bills of sale and stock certificates.
The litigation between the siblings has been prolonged and expensive, and it is likely the parties could have been spared such loss had they engaged an attorney at the time of their parents’ death. With competent legal counsel, the parties likely could have come to understand the importance of written agreements and records, proper accounting, and maintenance of separate business and personal bank accounts.
As we embrace the New Year, there are endless opportunities for making resolutions, accepting challenges and starting fresh. Flipping the calendar to January offers a clean slate, and the chance to make 2016 a more organized, productive and successful year. Attorneys can take advantage of the renewed energy a New Year brings, not only in their personal lives but also in their legal practices. Legal practitioners are uniquely situated to help small business clients embark on the New Year with the same vigor.
- Perhaps a client’s record-keeping has been disorderly and inconsistent. Offer to help your client systematize records retroactively and establish a plan for accurate record-keeping going forward.
- If undocumented changes have been made in the management structure of a client’s business, ensure that resolutions have been adopted appointing officers, if applicable, or otherwise reflecting the changes in the organization. Confirm regularly that appropriate individuals are listed as authorized signatories on business bank accounts.
- Maybe a client’s state and federal filings have routinely been late, resulting in unnecessary fees and penalties. Consider assisting your client by identifying key filing dates, and sending periodic reminders of approaching deadlines.
- Suppose a client has utilized a single bank account for multiple businesses, or carelessly used business funds for personal expenses. Explain the need to avoid commingling funds, and suggest that the client maintain separate bank accounts for personal use and each business enterprise.
- Consider conducting annual lien searches on behalf of your client’s businesses. Ensure that liens that should have been removed have been removed, and confirm that new liens cover appropriate collateral.
