The Legal Audit

Most business people are familiar with the audit performed by their accountants. The purpose of an accounting audit is to verify the accuracy of the financial information appearing on the company’s financial statements. A legal audit is similar in that the legal affairs of a business are subjected to an independent rigorous review by a trained professional who reviews the business’ existing practices, procedures, and documents to uncover potential legal problems. The legal audit begins with a review of basic corporate documents: the articles of incorporation, bylaws, minutes of the shareholder meetings and the stock book showing all past stock transactions. The audit then looks at operating documents: contracts with third parties, loan documents, leases, and a host of agreements regarding employment, trade secrecy, copyrights, and patients to name a few. Next, the audit examines ongoing practices and procedures for potential liability. These would include hiring and firing practices, insurance coverage, and workers compensation.  Below is a list of the most common documents that should be reviewed. Your attorney can determine if you need the original documents or if copies are satisfactory. Partnership or LLC Agreement Corporation documents

  1.  Articles of incorporation
  2. Bylaws
  3. Annual report
  4. Minutes
  5. Wage continuation plan
  6. Medical reimbursement plan
  7. Stock certificates
  8. Sub-chapter S election
  9. Incentive stock option plan
  10. Non-qualified stock option plan

Change of registered office/agent Employment agreement for owners Employment agreement for employees Trade secrecy/covenant not to compete Buy/sell agreements Deferred compensation plan Office and factory leases Equipment leases Authority to do business in other states Licenses Bonus plans Loan Agreements and related documents Guaranty and indemnity agreements Contracts with third parties Qualified retirement plans

  1. Profit sharing
  2. Money purchase
  3. 401(k)
  4. ESOP
  5. Split dollar agreements

A legal audit is like a physical exam aimed at discovering problems while they are easily treatable.  When the legal audit uncovers a problem, remedies can almost always be resolved quickly, economically, and completely. If the problem is allowed to fester until a third party brings it to your attention, the solution is seldom cheap and is usually found only after negotiation and involvement of other parties such as lawyers, accountants, or employees (possibly disgruntled). Avoid being consumed by the time and money demands of legal problems. Listen to Benjamin Franklin, “an ounce of prevention is worth more than a pound of cure.” Let me emphasize here: The legal audit is a precursor to a more intensive “due diligence review” that will be undertaken when your business is sold to a third party.  No one will want to acquire the business if it is rife with litigation exposure, unsigned corporate documents, missing stock certificates, and the like. Undertake the legal audit now by having your attorney work through the legal audit check list above.  Save your company hundreds (and very possibly thousands) of dollars by gathering and organizing the documents ahead of time.

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