Family owned corporations are subject to the same statutory requirements regarding entity governance as non-family owned businesses. Thus, in order to fully comply with the applicable statute for the state where the business is incorporated, a family business should pay attention to all provisions that require annual or other ongoing action by the company. These include:
- Holding annual shareholder meetings
- Holding formal elections of directors at shareholder meetings,
- Documenting actions taken by the unanimous consent of the directors without a meeting
- Maintaining complete records of the company’s operations and finances
Many companies also have detailed provisions in their by-laws that spell out additional duties of directors and officers, along with shareholders’ rights and responsibilities.
Regardless of the clear requirements of the applicable statutes or the by-laws, family owned businesses sometimes take a more relaxed approach to these formalities. This level of informality is usually not a problem for the family members in their day-to-day ownership or operation of the business when there is close contact and communication among the various stakeholders. However, when disputes arise between the owners or management, or when transactions with third parties come into play, the lack of corporate formalities can become an issue.
In a recent decision, the Massachusetts Appeals Court considered whether the absence of corporate formalities barred a claim against a family member who was found, after trial, to have breached his fiduciary duties as a corporate officer and to have misappropriated corporate assets for his own benefit. In Houser Buick, Inc. v. Philip Houser, three related family owned companies, all involved in the automobile dealership business, sued Philip Houser to recover money that they claimed Philip had converted from the corporations.
…when disputes arise between the owners or management, or when transactions with third parties come into play, the lack of corporate formalities can become an issue.
On appeal, Philip argued that the corporations lacked authority to bring the lawsuit against him because there had not been a prior meeting of the directors or a vote of the directors to authorize the suit. The Court rejected this argument because the other two directors – Harvie and Paul Houser – had themselves signed the complaint on the companies’ behalf, because there was no indication that Philip would have participated in the meeting even if it had been called, and because there was “no indication that a corporate meeting would have been anything other than a formality as only a majority vote of the directors was necessary to take action.” The Appeals Court continued: “Perhaps most importantly, Philip was a long-time director, officer, and shareholder of the closely held plaintiff corporations, all of which historically had paid little attention to corporate formalities in terms of meetings and even record keeping. In the circumstances of this case, therefore, Philip cannot reasonably rely upon the absence of a formal meeting to shield himself from liability for his misdeeds.”
In rejecting Philip’s arguments on the lack of corporate formalities, the Appeals Court also quoted decisions from other Massachusetts appellate courts, which in earlier cases had highlighted the perceived differences between governance of family businesses and governance of “ordinary business entities.” For example, the Massachusetts Supreme Judicial Court had once noted that in a “laxly handled family situation, where no rights of creditors or outsiders are involved, . . . undue emphasis cannot fairly be placed upon strict compliance with corporate formalities.” Similarly, the Appeals Court itself had observed in an earlier case: “Where rights of creditors or other outsiders are not involved, actions taken without compliance with corporate formalities have frequently been held to bind shareholders.”
The Court’s ruling in Houser Buick is limited to the facts of that case and should not provide comfort to family businesses, in general, that corporate formalities are not important. In fact, while it affirmed that Philip could not hide behind the lack of formalities in his own defense in this case, the Court issued the following cautionary note to highlight the general importance of such formalities: “While we do not condone an absence of formalities in operating closely held corporations, neither will we allow a director who had been complicit in years of informality, including years without any formal directors meetings, to rely on the absence of a formal meeting to shield him from requiring to respond to allegations of misappropriation.”
Finally, the Houser Buick Court had quoted an earlier decision of the Appeals Court in which the Court had once noted that “family business entities are typically operated in a decidedly looser matter than ordinary business entities.” Whatever the validity of this broad brush generalization, it is clear from the Houser Buick decision that the level of informality that a court may tolerate depends largely on whether the person pointing to the lack of formality was involved in creating or maintaining that condition. A court may come to an entirely different conclusion if it were, for example, a non-officer or minority shareholder who was complaining of a lack of corporate formalities by the directors, officers or majority shareholder.
Further, as noted, a court may come to a different conclusion as to the level of formality needed, even in a family business, where rights of creditors or other third parties were involved. Indeed, it is entirely common for third parties dealing with family businesses, such as lenders, investors, or possible merger partners, to require formal documentation of corporate authorization for material decisions and transactions, as well as maintenance of complete and accurate corporate records. In the end, and despite the added paperwork and processes, family businesses would benefit far more from complying with required corporate formalities regarding decision-making and record-keeping than they would from ignoring such requirements on the assumption (often incorrect) that no one will ever make an issue out of the lack of formalities.