Are You Being Too Informal? A Case Study - We have found that small businesses tend to operate their business without the stringent formalities of a large company. This sounds like a benefit to having a small business – however – not only is it incorrect as small businesses need to operate with certain formalities, but when they don’t, we see drastic results.
There is a case that came out of the 8th Circuit a couple of years ago which illustrates that premise. Robl Construction v. Homoly involves a two member LLC with shoddy governing documents and poorly maintained records. These two things cost all parties a great deal of money and a large amount of time in court.
This article, however, will focus on a case named Scafidi v. Hille that came out of the Supreme Court of Mississippi. The dispute here was between two siblings dealing with 3 family corporations and land that was inherited from their parents. While there was co-ownership, the siblings ran the businesses more like individual sole proprietorships.
The owners failed to operate without the needed formalities. For Example:
- In 8 years, only 2 shareholder meetings were held
- No Agreements were documented in writing
- No annual meeting minutes were kept.
One owner would operate without consulting the other owner at all. In fact, he would use company money to pay off personal credit cards, conduct side businesses and commingled income of those with the family business. The record keeping of all of this was not only incomplete but false at times.
The other owner was not innocent in this either. She operated in much the same way as her brother as stated above.
The main issues in contention during this case involved the sister’s claims for accounting, forced shareholder meeting to dissolve the company and breach of fiduciary duty.
The outcome was detrimental to both: The court held that because the parties completely failed to observe corporate formalities, they were NOT ENTITLED TO THE PROTECTIONS OF THE CORPORATE FORM. As such, the court held that each were entitled to full ownership of one separate corporation. The third corporation was sold. The property they inherited was divided with property lines and each sibling received ½ of the interest.
This is not uncommon with small businesses who think they can “get away” with informalities. The case example not only cost thousands of dollars, but took hundreds of hours battling each other in court. The sad part is that this could have all been avoided. Had they engaged corporate counsel, they could have been properly advised and come to understand the importance of formalities and written agreements.
It is not too late if you are in a similar situation and find yourself being a little too informal where formality is necessary. Get in front of good corporate counsel immediately and they can assist with making the necessary changes/modifications to get you back on track and out of a Scafidi situation.
by Donald W. Flaig, Esq.