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How Large Sums of Cash Can Impact Shareholder Dispute Litigation

A common problem in shareholder dispute litigation is that many companies deal in cash.  Shockingly, not every mid-sized, closely held business that generates a substantial amount of cash reports all of it to the various taxing authorities.  (I know – you’re shocked, too, right?)  How could this impact shareholder dispute litigation?

The first way is rather obvious.  When it comes time to value the company, whoever is looking for a higher value – or at least a truthful, accurate value – would want the cash to be counted.  If it isn’t, then you aren’t really getting an accurate read on the company’s income, which is the most critical element in an accurate valuation.  However, what happens when the court hears that significant cash was unreported?

In New Jersey, judges are duty-bound to report to the appropriate taxing authorities any tax improprieties of which they become aware.  This could be catastrophic for the company, and for whoever personally was responsible for the failure to pay the taxes.  If you were involved at all in any such decision-making, you must realize that you have potential liability.  However, that does not mean that you have to sit back and take unfair, oppressive action from the majority shareholders.  Often, they will have more to lose than you do – sometimes much more.  This is especially true if they were the ones in charge, and you merely had knowledge.  Often in such a situation, a minority shareholder is scared to file suit.  However, when this fear is overcome and suit filed, majority shareholders are quite often scared to let the case go before a judge.  Many shareholder disputes are settled, because of tax issues, on the eve of the issue coming squarely before the judge.

Although I most often write about representing minority shareholders in business dispute litigation, I represent majority shareholders as well.  When I do, and when I represent the company, I often must advise my client against letting a case get to the judge, precisely for tax reasons.  It happens all the time.

There is a second way that unreported cash impacts a shareholder oppression action, and this one is a much more difficult issue.  Many times, clients say that cash was not only unreported, but split among the shareholders and never even deposited into the corporate account.  An in-depth forensic analysis of the company may prove that cash was missing.  (If you had no sales, where did all your inventory go??)  However, while all the shareholders were getting along, there was no reason for anyone to turn a microscope onto what was transpiring.

What many potential litigants fail realize is, that there may be more than missing cash at issue.  In more than one case, I have seen majority shareholders, who were receiving their “fair share” of the cash over the years, suddenly feign shock and outrage at “discovering” that cash is missing.  Guess who they point the finger at?

In one case, the minority shareholder was also an employee, responsible for collecting cash and distributing it among the shareholders.  He kept no records and could prove nothing.  The majority shareholders realized that they could blame this minority shareholder for “missing cash.”  When he questioned why the company was paying over $200,000 for the wedding of the majority shareholder’s daughter, the employee/shareholder was fired and accused of stealing cash.

Fortunately, we were able to come up with witnesses who saw the majority shareholders with enormous sums of cash which could not otherwise be explained.  As a result, we were able to favorably settle the case.  But the minority shareholder, for too many years, had no idea how vulnerable he was making himself.  And the majority shareholder was his brother – as is so often the case.

The lesson is, be very careful about how you conduct yourself and what position you are putting yourself in.  You do not want to be vulnerable to someone else’s easily concocted lie.  If you are concerned that what you are doing may impact your rights in the future, talk to a lawyer now, in a conversation that would be protected by the attorney-client privilege.  But if you think you are being defrauded or oppressed by your business partners, don’t give up, even if there may be some “cash skeletons” in everyone’s closet.  At least seek legal advice to see if you have options.

I should probably end by saying that, of course, it’s always better to just pay all applicable taxes in the first place.  But you may not be in control of that decision.