Small Business Horror Story #1: Shady Partner + Generic Operating Agreement = Disaster

Whenever I sign a new monthly retainer client, I conduct what I call a “legal checkup” on the business. I review the company’s formation documents, licensing, employee or contractor agreements, lease agreements, service agreements, customer contracts, etc. to find improvements I can make to better protect the company and its owners.

Wait, let me clarify. I *request* the client provide me these documents so I may review them. Often, it takes the business owner(s) a while to gather the information and sometimes they simply ignore my requests, preferring that I instead focus my efforts on putting out fires. While I’m a great firefighter, my real value lies in working proactively – modifying these documents before a fire breaks out to better protect the company.

One particular client was a two-member LLC. We’ll call the members Jack and Bill.* Jack requested the initial meeting with me, apparently without informing Bill. Bill walked in during our meeting, demanded to know “who the hell” I was, and threw a fit, yelling at the top of his lungs that “we don’t need no &*%$ attorney!” Following that outburst, I gently asked Jack for a copy of the company’s operating agreement. He said it was the generic one that came with the leather binder he got when he formed the company and he had no idea where the binder even was. Seeing the overwhelming odds that this partnership was going to crumble sooner rather than later, I made a more urgent request to see the operating agreement, and I requested the operating agreement every few days for the next two months with no response.

A month ago, Jack called to say Bill was leaving the company and refused to elaborate further. Assuming Bill’s exit was on less than amicable terms, I again asked for the operating agreement to make sure Bill’s exit was in compliance with its provisions. I also suggested to Jack that Bill be removed as a signer on all company bank accounts as soon as humanly possible. No response.

Last week Jack called in a panic. While he was at the bank removing Bill as a signer on the account, Bill was at a different branch of the same bank, withdrawing $21,000 in cash from the company’s checking account.

Because Bill was still, at that moment, a signer on the account, the bank had no choice but to give him the money.

And because the operating agreement didn’t restrict an LLC member’s ability to take money out of the account, Bill didn’t breach any agreement.

And because Bill pulled the money out in cash, there was no way to stop payment.

Jack’s only option at this point is to file a lawsuit against Bill, hope he wins, and then hope that he can collect the money. Of course, a lawsuit would drag on for months and more likely years, tying up company resources in what is probably a losing battle. Plus, even if Bill lost, he could file bankruptcy and then the company would have lost the original $21,000, plus attorney fees, plus time lost while embroiled in a lawsuit.

Lessons learned:

1) Make sure your operating agreement is thorough and addresses issues such as when a member can withdraw money from the account; don’t rely on the generic operating agreement that came with your leather binder (if you even got a leather binder),

2) If someone leaves the company, remove them from the bank account IMMEDIATELY. Unless you notify the bank that someone is no longer an owner, the banker has no way of knowing not to give an owner access to company funds,

3) If your business partner throws a fit when he finds out you’ve called a lawyer to help the company, maybe he has something to hide and you should dig a little deeper into what he does with his time.

* Names have been changed to protect the innocent.