13 June 2011

Pennywise or Pound Foolish?

Article featured in the Fairfield County Business Journal on June 6, 2011. 

The economic challenges of the last few years have forced companies to place an increased emphasis on containing costs. Unfortunately, cutting back on professional services sometimes backfires by deferring costs and actually can increase the total bill.

The role of a transactional lawyer is to protect clients’ interests by identifying issues that may not otherwise be considered, to ensure that documents accurately reflect the parties’ intentions, to avoid litigation, and to ensure compliance with applicable law. Too frequently a desire to cost save leads to consulting counsel after the damage is done instead of at the outset of the business activity.

The following are examples of where failure to seek the advice of counsel before engaging in a business activity can be hazardous.

1. Personal Liability. Employing a liability shield alone is not sufficient. Proper governance procedures need to be followed to ensure the shield is effective. If business and personal assets or expenses are commingled, creditors can argue that the company and its owner are the same and attempt to attach the individual’s assets to satisfy a judgment. This is not to say that suit won’t otherwise be brought against both an entity and its owner but mistakes like signing an agreement personally instead of in an officer/manager capacity can give a judge a reason not to grant a motion to dismiss the individual from the action.

2. Friends and Family Financing. Start-up companies which raise capital from friends and family members, choose not to spend for legal advice in connection with such financings. These companies often unintentionally fail to provide adequate disclosure to investors to protect themselves and their control persons from liability and fail to comply with federal and state securities laws in connection with their offer and sale of securities. Federal and state regulators will generally not show leniency simply because an offering of securities is made to friends and family. Serious consequences can ensue for violation of federal and state securities laws including giving investors recission rights-the right to get their money back plus statutory interest. Regardless of the relationship to the investor, when offering and selling securities companies need to provide adequate disclosure to protect against claims that such investors were misled or ill informed. Without a written document outlining the proposed business and the terms of the offering, claims by investors who lose their investment turn into he said/she said battles waged in front of a judge in hindsight after the investor’s money has been lost. For entrepreneurs, failure to comply with securities laws in early financing rounds can become a significant obstacle to obtaining future rounds of financing.

3. Fraud Detection. A business lawyer can provide an additional check and balance on the legitimacy of an investment transaction. Just like doctors who see the same illness or injury time after time, business lawyers see similar transactions and become very familiar with the range of acceptable or reasonable terms and sophisticated documentation. Just because the terms of a transaction are “not negotiable” a prospective investor should still have a lawyer review and apply the smell test to its documents.

Sound business judgment should come before cost-cutting measures, even in challenging economic times. Innumerable business owners would have saved on legal fees and other costs had they sought legal advice prior to entering into a transaction rather than during or after problems occur.

Category: Article