Keeping Your House in Order: Why Corporate Clean-Up Matters

When entrepreneurs start a new business, there are several foundational documents that attorneys usually recommend.  These include shareholder agreements for corporations and operating agreements for limited liability companies, and may also include bylaws, employee handbooks, executive compensation agreements, employment agreements, and long-term incentive plans.  Depending on the business, lawyers may also draft templates for use with third parties like contractors, vendors, and joint venture partners.  As a company launches and begins to grow, it is not unusual for it to continue using these initial documents for years to come, even as the nature of the business and the laws applicable to it begin to change.  The increasing disconnect between the documentation on file can create gaps that can lead to unnecessary liability exposure that could be reduced by a few minor tweaks from time to time.  So, it is wise to periodically clean up your corporate documents.

Frequently Asked Questions – Corporate Clean-Up

Q: I already paid a lawyer to draft my corporate documents.  If they got it right the first time, why should I bother with additional check-ins?

This is a fair question.  After all, legal work comes with an expenditure of both time and resources, and it is natural for a company to want to keep its original documents for as long as possible.  In many cases, this is doable.  Corporate laws are usually slow to change.  This means that, barring a change in a company’s ownership structure or corporate governance procedures, there is not normally a need to revisit a company’s shareholder or operating agreement every single year.

This said, the law does change.  For instance, the way Service-Disabled Veteran Owned Small Businesses (SDVOSB’s) are regulated is changing as these companies are brought under the jurisdiction of the Small Business Administration.  Thus, corporate provisions that would have been fine when the company was founded could now jeopardize a company’s eligibility for SDVOSB status.

Due to changes in the law, a quick check-in once or twice a year is a good use of company time.  When a company performs these regular checks, their lawyer will often let the company know that everything is clear to remain in status quo, giving the business owners continued security that they can keep operating as they have been.  Those changes that are recommended by corporate counsel tend to be small-scale and easy to make, resulting in a light lift on the company’s part. 

Things become more problematic when a company goes for years, or even decades, without revisiting its corporate documents.  In these cases, it is likely that there have been not only changes in the law, but also changes in the way that the company operates.  Since it is always advisable for the content of a company’s corporate documents to align with the way that it carries out business in order to maintain the integrity of the “corporate veil,” (i.e., the legal liability shield around a company that protects individual owners from liability) companies that go for long stretches of time without checking in with their lawyers may require large-scale edits as well as fixes to curb liability that may have arisen from non-compliant corporate documents.

Thus, a quick e-mail or phone call to your lawyer once or twice each year is a good way to save both headache and expense later when it comes to a company’s most important paperwork. 

Q: We’ve had the same employment documents for years, and we’ve never had a problem.  If it’s not broken, why fix it? 

It is true that many employees don’t bother to educate themselves about changes in the law.  Even when they do, most employees are hesitant to make waves by pointing out disconnects between their documentation and the laws that apply to them.  Yet it only takes one disgruntled employee or random audit from a state department of labor for a company to be staring down the barrel of thousands of dollars in judgments, penalties, and legal fees.  Here again, it makes much more sense to check in with your attorney every so often to determine whether there are any updates you should plan to make to your standard employment documentation.

D.C., Maryland, and Virginia have all made major changes to their employment laws over the last several months.  These range from the rules governing restrictive covenants to questions employers can ask job candidates, to the types of leave an employer is required to offer.  Being aware of these changes and ensuring compliance can keep employers from having to face expensive, time consuming, and harmful legal proceedings down the road.

Employers can also give themselves additional protections by taking advantage of employer-friendly changes in the law.  For instance, even though it was passed more than five years ago, many employment agreements still don’t contain the “magic words” provided for in the federal Defend Trade Secrets Act.  By taking the time to make a three-sentence addition to their agreements, employers can give themselves the ability to recover attorneys’ fees and obtain punitive damages in federal trade secret cases.  This can add up to a greatly enhanced award at little cost to an employer, and all it takes is a quick call to your company lawyer.

Q: What about my third-party contracts?  I’ve been doing business with the same companies for years, and I’m worried they won’t want to work with me if I update my documents.

This is a common concern, but one that usually isn’t well founded.  As companies work together, they discover what protocols work and what don’t, and often develop extra-contractual workarounds and side arrangements that become part of their regular course of dealing.  Ideally, these changes should be worked into the contracts between the two companies, so that both sides are not only aware of one another’s expectations, but contractually bound by them.  Revisiting agreements also allows companies to weed out those provisions that don’t work for them, are no longer relevant, or have caused confusion in the past.  Again, clarity is key, and ensuring that your agreements accurately reflect what you are doing in practice saves trouble later if either party were to try to insist on the terms of an outdated contract.

In terms of messaging, letting your business partners know that your new documents are part of a company-wide update and ensuring that you don’t make changes that would represent a material departure from what you have done in the past are usually enough to facilitate a smooth transition.  In the event the changes you want to make are substantially different – for instance, if you are raising your prices or changing your billing or performance practices – it is important to explain why you are looking to make the changes at issue.  If your counterparty kicks up a fuss when you suggest changes, especially changes that reflect what you have been doing in practice, this itself is valuable, and may suggest that they are no longer an ideal partner for you.  While this epiphany can be inconvenient in the short term, it can provide an amicable off-ramp that would otherwise have resulted in a major dust-up had you continued to do business until a major issue presented itself.

In the end, updates are a natural part of doing business, and most third parties expect them periodically.  The trick is to ensure that your updates are fair, well communicated, and accomplish the goals you are looking to meet by implementing them.

Q: If I’m interested in a corporate clean-up review, what should I do?

The first thing to do is to figure out where you stand now.  If you’ll be working with the same lawyer that drafted your original documents, you should just let them know that you haven’t made any internal edits to their drafts and ask them to review the copies they have on file to see whether any updates are advisable.  This process should be very easy, and it shouldn’t take long for you to get an answer.

If you’ll be working with a different lawyer, or if you sourced your documents independently from the Internet or a third-party service like LegalZoom or ZenBusiness, you should gather your legacy documents and send them over to the lawyer with whom you’d like to work.  Many lawyers are willing to perform a high-level review to let you know whether and to what degree edits are advisable.  They should also be able to give you an estimated cost for bringing your documentation into compliance, which can help you to budget and give you an idea of your potential liability if you decide not to make changes.

Ultimately, entrepreneurs get to decide whether they are willing to invest in their companies’ futures by keeping up with the kinds of changes that may recommend in favor of company updates.  The real danger is ignorance – willful or otherwise.  When a business owner is fully informed, he or she can at least make a fully considered decision about what changes, if any, are best for the company.

Ryen Rasmus is an Attorney with The Lipp Law Firm, PC in Fairfax, Virginia.  Ryen specializes in corporate transactions and intellectual property and can be reached at Ryen@LippLawFirm.com.