Corporate Law
Author: Andrew Hennigar & Mike Weber
What would you say if someone described to you an actual instance of a company’s failure to keep adequate corporate records and observe corporate formalities costing that company over $100,000 in cold, hard cash – not lost opportunity, but an actual payment? That was the cost of obtaining a B.C. court order to rectify a series of share issuances effected without proper board approval, and without proper record keeping. This company was unable to attract growth capital until it could show investors a record book that accurately reflected its capitalization. While perhaps an extreme example, far too often we see companies incur significant, and avoidable, costs associated with necessary corporate “clean up” that could be avoided if best practices were followed from the start.
Record keeping and observing corporate formalities by a board of directors is critically important for three reasons.
- First, it is the law. All Canadian corporate statutes require companies keep certain records at its records office, and grant shareholders and others the right to inspect certain records upon request. While you may think you can overlook this requirement in the early days of your company’s existence, doing so creates a bad habit that you will need to unlearn as your company looks to issue shares outside of your initial founder group.
- Second, in connection with any significant transaction, such as an equity raise, loan, sale, or IPO, one or more parties is certain to conduct due diligence of the company to assess the risk of a dispute arising over who owns shares in the company, or whether a previous transaction was validly undertaken. If a company’s house is not in order, a prospective investor, lender, underwriter, or even customer may pass on the opportunity for fear of inviting themselves into a future conflict. Similarly, overall transaction costs can be greatly reduced if your company does not have to retroactively create a corporate record to ratify actions previously taken without observing proper formality.
- Third, record keeping and observing corporate formalities is a key element of directors discharging their fiduciary duties. For many aspects of a director’s fiduciary duty, a “due diligence” defense is typically available against a shareholder claim of wrong-doing. If faced with such a claim against a board of directors, the first step is to examine the record of what lead to the board’s decision, and the process by which formal approval to take the action was obtained. If your board plays fast and loose with the formality of its proceedings, it undercuts any defense that it was duly diligent in reaching its decision. The rhetoric so often lobbed against sloppy boards to their detriment is: how could the board have been duly diligent in reaching a decision if it didn’t even take care enough to document its process?