New Perspective on Corporate Documents

October 25, 2012    

BIRMINGHAM BUSINESS LAW BLOG

Posted on October 25, 2012

“We believe it’s absolutely essential for family members to develop the initial draft of a shareholder agreement, thoughtfully considering the questions set forth below. Attorneys may be very helpful in the process, but too often they have set ideas about what makes a good shareholder agreement. They approach the task of preparing one with a different perspective than family members do. Attorneys may have biases regarding ownership dilution, the use of insurance, or ideas about in-laws and ownership. Too often, attorneys use standardized shareholder agreements that are unlikely to be responsive to the particular needs, values, and goals of your family and your business.”
– Developing Family Business Policies, Craig E. Aronoff, Joseph H, Astrachan, John L. Ward

I use this quote for my fellow attorneys; this is what they are saying about us – when they are being nice. Although the quote was made in the context of family businesses, in reality, the quote is applicable to the entire shareholder/operating agreement process. When they are not being politically correct, the same sentiment manifests itself in a good deal of vitriol over fees and confusing and complicated documents. Inevitably, clients neglect their corporate documents or turn their livelihood over to the Internet, making a risk adjusted calculation that the business is better off saving on legal fees.

Lawyers must be more responsive in the incorporation process. Our process must be more flexible, more time efficient, and less costly. The design and structure of a corporation is a continual process and not a one-time event. However, because lawyers focus on the immediate transaction in front of them (the incorporation, the new shareholders, the new investor, etc.), clients only review these documents upon big occurrences. As a result, the business and the level of the documents are often mismatched. Sometimes when the big occurrence happens, the documents are outdated or out of whack, and at that point, it is too late to change. However, steady and consistent review leads to better results. Lawyers and clients need to approach business structure as a process, not an event.

Some specific recommendations I would make as a general matter of doing business are:

1) Standardize the terms and procedures behind them. There are certain terms consistently used in operating agreements and shareholder agreements (right of first refusal, drag along, tag along, etc.). Because word processors allow documents to be easily replicated, documents contain the procedures to follow in order to have these protections. These procedures are generally the same, but often each one has its own nuances. Except in limited circumstances, these nuances add little if any value to the process, yet cost a good deal of time and effort in reviewing, marking up, and explaining to the clients. We need to be able to simply state, “X has a right of first refusal over Y’s shares,” and let that be all that is necessary to effectively and efficiently encapsulate the agreement.1

2) Documents need to be understood by business people. Lawyers love to wordsmith great process and procedures. Lawyers like to be creative problem solvers. Oftentimes, this is a great way to bridge an impasse. However, caution must be taken when you go off script. If you have a provision that is unique, you have a room for error and confusion. Sometimes thinking outside the box is not the right thing for lawyers to do.

3) Allow lay people to develop policies and take minutes. Lawyers have an aversion to minutes and policies. Documenting can sometimes lead to issues and unfilled promises, and in litigation, a policy that is implemented, but not followed, is worse than no policy at all. With those caveats, lawyers need to encourage people to take good minutes and have good policies. Lawyers can review for pitfalls. Generally, these good corporate practices will make companies function more smoothly.

4) Remember structure, particularly board structure, has tremendous flexibility. I had a potential client sit my down once and say, “In these situations, I want this voting percentage to control, and in these lesser situations, I want this voting percentage to control. I know this is complicated, and I have been told it can’t be done.” After a little bit of unpacking, I realized that not only could it be done, but it was already incorporated in the ownership structure. Certain votes happen, pursuant to the corporate code, at the shareholder level with a majority of shareowners controlling, and certain votes happen at the board level with a majority of directors or managers controlling. This structure, which is probably as old as the Boston Tea Company, has worked for a long time, and it has the flexibility to handle many corporations. If you can leave it alone and resist the temptation to mess it up with additional contractual obligations, your business will have a good structure in place. If you then follow that process (and that process is really not difficult to follow), you will go far.

While these suggestions are primarily geared toward lawyers, business people need to bear some of the responsibility. In the passage from the opening quote, the follow-up is that the shareholders need to come together and tell their attorney, “We want our business to be managed in this particular way. This approach is a good one.”

You should be able to tell your attorney:
1) Where you want to go as a business.
2) How you make decisions.
a. Which decisions reside with which group and which ones go to a larger group.
b. What works for you.
3) What your plans are if the collective vision is no longer shared by everyone (i.e. you are fighting).

If you have these issues worked out, and if you continue to look back to be sure the answers still hold, you can more efficiently and effectively manage your lawyer. (And if you can manage your lawyer, you usually spend less time with him or her.)

Mike Goodrich
Goodrich Law Firm, LLC

1 — How might this be accomplished? If you asked me over drinks, I would suggest that an organization be formed that exists for the purpose of promoting good corporate governance (the Institute for Better Small Business Corporate Governance). Such an organization would publish a guidebook that would contain the best practices around these terms. By reference in organizing documents, such procedures would be incorporated into the business structure. However, this suggestion would come during what my lovely wife refers to as my crackpot theory stage.

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