A Family Business Can Avoid Litigation With Clearly Written Agreements
By Brent Boutwell, CPA, ABV, CFE
Most business owners recognize the need for formal, written contracts when forming a new entity or in real estate transactions. However, many of our clients are involved in litigation, in part, because they did not put simple agreements with family members in writing. It can be a costly mistake, both in terms of legal expenses and broken relationships.
The most obvious advantage of writing down the family members’ decisions in an agreement is to document key terms for posterity. Clarity around those terms at the outset may be even more important. Codifying the agreement forces some level of specificity that can solve potential issues before conflicts arise. The act of writing an agreement together can even highlight potential challenges or points of contention that need to be worked through.
There should be a written agreement any time money is loaned to a business or family members. One agreement can govern multiple loans but only if it is clear what transactions the agreement covers.
Loan agreements should address these terms at a minimum:
- Interest rate
- Frequency of interest compounding, or notation that interest does not compound (aka simple interest)
- Repayment timeline
- Consequences of late payment
While these may seem obvious, the disputes we see often involve transactions where some terms were overlooked. The most overlooked terms tend to be the frequency of interest compounding followed by the consequences, if any, of late payment. When loans are not paid according to the original terms, the interest may continue accruing according to the contract rate, or a prejudgment interest rate may be applied according to statutory rates.
Transactions considered contributions, rather than loans, should ideally be governed by a well written shareholder agreement already in place. Attorneys help businesses craft shareholder agreements to ensure all necessary matters are considered and written in language that will not be misinterpreted. But even simple agreements that do not require advice from an attorney should be written down.
An often overlooked opportunity for documenting agreements is in board meetings. A best practice is to document decisions made and topics discussed at all board meetings and to have attendees sign or acknowledge their acceptance of the board meeting minutes. Family businesses often hold meetings informally and do not keep meeting minutes. But board meetings are a recurring opportunity to ensure decisions and the consent of members are appropriately documented. Even a brief, bullet-pointed list of plans or resolutions could save family businesses thousands of dollars in future legal fees.
When disputes arise and there is an absence of written contracts, experts will likely review emails along with other data. Emails can be helpful, but the disjointed and often vague nature of casual correspondence can result in ambiguous communication. Even more often, it is unclear that the terms proposed in a final email were agreed to by the recipient.
As forensic accounting experts, we use financial data to determine how each family business owner was paid. Unfortunately, without clear documentation, disagreements ensue about how each owner should have been paid, which often leads to costly litigation that involves judges and juries. Many times, the issues we see could be avoided, or at least much easier to resolve, if the parties had documented their initial understanding from the beginning.