This article is the second in an ongoing series about issues experienced by my clients in actual mergers and acquisitions of businesses in Los Angeles and Orange County.
The Corporate Book
One of the first requests I make to clients that are preparing for the sale of their company is to review the corporate book. I assume that the corporate book will have the following in it:
1. Articles of Incorporation and any amendments thereto. (§200) (§903)
2. Bylaws with any amendments thereto (§211)
3. Minutes of meetings of the shareholders (§1500)
4. Minutes of meetings of the board of directors (§1500)
5. Share Certificates (cancelled / current / unissued) (§417)
6. Most recent Statement of Information containing information to the Secretary of State
7. most recent Statement of Information with “No Change” status
8. Any shareholder agreements (§706), option agreements or other agreements affecting the ownership of the company.
The percentage of instances in which all of this is contained in the corporate book when delivered to me is about 10%. Dismal to say the least.
All business owners know that they should keep minutes, but rarely does it actually happen. They ask me “what is the big deal” and “I can just prepare them when I need to.”
Well, that may or may not be the case.
Most businesses do have ready access to the Articles of Incorporation and the bylaws with amendments.
Less likely is up-to-date minutes. There are many issues that may arise when minutes are not current, but as an initial matter let’s review what minutes are.
Cal. Corp. Code Section 600 requires corporations to have annual meetings of the shareholders for the purpose of electing directors and such other matters as may arise in the meeting. (§600(b))
A Purchase and Sale Agreement will contain a representation (a “rep”) stating that the company is in compliance with California law, and has been at all times prior to the sale. If the corporation has not been having annual meetings in compliance with California law, this representation will be false.
In a Purchase and Sale Agreement, the company will also make a rep that the books and records are accurate and current. Again, if the corporation has not been having annual meetings (§600(b)), this representation will be false.
Also included in the minute book are the stock certificates. An issue that has arisen when completing a sale transaction involves a parent gifting shares to his children or grandchildren. It is a little gift that the parent or grandparent can feel good about doing, but doesn’t require a cash outlay.
This can have a lot of impacts on the corporate documents. If the company is anS-corporation, this transfer will be part of the tax returns. If the company is a C-corporation, this transfer will not be part of the tax returns. If it isn’t properly documented in the corporate book through the use of stock certificates, the ownership of the company may be at issue. Buyers do not like to see unclear ownership records.
An additional issue that may arise with these gifts is that the true ownership of the corporation is not accurately documented in the minutes (§1500). Did each of the shareholders receive notice of a meeting of the shareholders (§601(a))? Did each of the shareholders approve a unanimous consent in lieu of a meeting (§603(b)(1))?
Also, if the documentation isn’t clear, the separate property nature of the gift may be an issue. How is the ownership of the shares titled? Gifts from parents are generally regarded as a personal sole and separate property and not community property. If that isn’t properly documented there will be issues when it comes time for the sale of all of the shares of a company. Does the child and his or her spouse both need to sign the sale documents or just the child?
What if a child dies before a sale? Is that stock subject to probate? If the company does nothing at the time of the death, how will the owner of the company be able to truly rep to a buyer that all of the shares are correctly titled and the appropriate person (or people) are selling their ownership interest.
As an example, John owns 90% of the shares of ABC corp. He has gifted 10% of ABC Corp to his daughter, Natalie. Natalie is married, but only her name is on the stock certificate. Natalie passes away in 2010. John negotiates for the sale of ABC corp. to a third party in 2016. John will have to make a rep that he is the sole owner of the company (not true) or that all of the owners of the shares agree to sell their shares (also potentially not true). If the shares held in Natalie’s name are considered her sole and separate property because they are a gift from her father, then they would pass via intestate succession (or testate succession if she had a will) through a probate. Until a probate has been opened and a personal representative appointed, no one has the right to sell Natalie’s shares.
If the shares are not considered her sole and separate property because she received them as compensation for her hard work on behalf of the business, then her spouse is an owner of some, if not all of the shares, in Natalie’s name.
John and ABC Corp. now have some interesting decisions on their hands. Open a probate? Argue that the shares were Natalie’s sole and separate property? The buyer is going to require clear title to each share it is purchasing.
Going through a probate or negotiation with Natalie’s widow will be timely, costly and an detriment to a potential buyer. John could have avoided this by keeping accurate books and records (§1500), having a shareholders agreement (§706), clearly documenting the shares as a gift, repurchasing the shares on Natalie’s passing, or any other number of potential solutions. Waiting until a sale is imminent is the worst time to try to clear these issues up and will (most certainly) derail a potential sale.
In addition to title issues, how will John now document the last five years of meetings of the shareholders if Natalie was an owner but deceased? She certainly cannot execute documents stating she was present for a meeting or consented to actions in lieu of a meeting from the grave!
Next Blog Post: Who owns my company? Stock options, minority shareholders, ex-spouses, and community property interests.
The author of this post is Brooke Pollard. If you wish to contact Brooke directly, please email her at firstname.lastname@example.org.