Proper legal entity detective work leaves no stone unturned and is helping financial organisations clean-up their dormant business structures. Priya John, a senior LEM practitioner with MorganFranklin Consulting in London, explains more about this crucial work.

Businesses tell governments they don’t like surprises. Yet it can be a revelation when major companies dig deeper into their own structure. It is not unusual to find long-forgotten dormant bank accounts from divisions that have been cut or closed, or portfolios of properties once run by managers long since retired.

These are the nice little surprises.

The other side of this is the lingering liabilities that have the potential to sting a business. And this is an increasing concern for companies across Europe, and for buccaneering private equity houses with stretched resources taking over large businesses.
The solution is a systematic investigation of a company’s legal entities across a number of jurisdictions. Legal entity management (LEM) involves a combination of detective work, tact and diplomacy working inside organisations, and the ability to ferret out financial information from some unlikely sources. It is regularly a dose of common sense. Such projects can also be office political and it can be difficult to get everyone on the same page: legal, financial, treasury and tax, so making the business case for LEM has to be done at the beginning.

Why do it? The reason companies merge or buy another is to release substantial cost savings and create efficiencies for future growth. However, there are legal entity risks which stem from such activity, including new regulations, audit findings and resource planning. There is, inevitably, a round of redundancies in the finance and support functions, yet this can happen at a time when the newly-enlarged organisation has doubled its legal entities.

Here there is something for private equity companies, who might do a lot of ‘data room’ due diligence when purchasing a business, but what is not known simply can’t appear in a seller’s documentation. LEM involves trawling through old ledgers, dusty files of legal documents and ensuring the pension positions are clear, and this can take time and patience.

So the first step in a proper Legal Entity Management process is rationalisation. This means looking at the entire entity, including the tax position, property portfolios, bank account holders, and pension liability, and reviewing the whole structure. Many organisations look to address the symptom of poor LEM rather than dealing with the underlying root cause.

Of course, every company is different in how its approaches its structure and business model. A good board makes the decision on how they want this structure constructed and run. Yet after years of acquisition and consolidation there is a clean-up job to be done, that can not only save millions, but mitigate future risk. Often senior managers, with heads down on daily matters, don’t even know what is in their structure, yet LEM can uncover assets – or more dangerously – major liabilities.

Companies often conduct partial legal or tax reviews of their operations believing this is enough, yet this fails to include every part of the company.

It is scary when you don’t know what you’ve got. It can be very messy too. Things do slip through the cracks all of the time. It is very important that diligence on the whole company is undertaken. However, this can be difficult for an in-house person because it is often a full-time job co-ordinating and capturing the findings.

Recent examples have been major banks with substantial commercial property accounts that were overlooked and forgotten, and a major international oil company with obscure bank accounts that no-one in the existing business knew about. These accounts can then be officially pulled into the treasury structure, swept upwards and used for proper investment purposes.

When key people move on, resign or retire, often with a clear-your-desk-and-be-out-by-lunch-time dismissal regime, knowledge can disappear overnight leaving no legacy and few traces. Most major organisations have a legal entity data system which was set up to capture all this kind of information, yet often no-one is clearly designated to keep it up-to-date, and vital data goes missing. Most times, the systems are completely inadequate and require regular review. Worse still, time is wasted re-inventing the wheel, when proper LEM will show up the gaps.

I have worked in several large organisations to rationalise legal entities, preparing an annual review process to ensure data repositories are up to date and maintained. It is a methodical and rewarding task because a proper repository becomes the vital place for accurate business data, and is used on a daily basis. It is important to take a holistic business-wide approach to data management. You need to communicate across the company that your data repository is being updated. Some key people might not even know an up-to-date repository exists and may use old data and inaccurate that they have at hand. That’s dangerous.

LEM is rewarding when you uncover assets, but liabilities are just as important. It is then about finding the right information before you close down the unwanted entities. Often companies liquidate dormant entities without doing any real due diligence. In some jurisdictions this might be fine, but in places, such as the UK, this can store up problems for the future. In the UK, there is a long period of up to 20 years to bring a dormant legal back to life to get the assets out. This process of retracing steps can be extremely time-consuming and therefore costly. Few people will remember anything about what the entity did many years ago and how or why it was dissolved.

When you are closing down or merging companies you want to make sure you are taking a proper note. If there are employees in company X, and you want to close it, then you have to make sure you capture this in the documentation.

Some companies have a distinguished history and heritage and no one in the existing organisation might realise that there were outstanding obligations or take the relevant steps to make sure that all outstanding items are cleanly closed out or transferred to an actively managed company.

A specialist LEM adviser will made recommendations for the organisation to consider and review. Typically, closure papers then go to the board for its sign-off, although there isn’t always a formal process to get started on the due diligence.

In the UK, cleaning up is a matter of working with liquidators so they can review the recommendation to close down an entity, although in the US the process doesn’t require a liquidator and an approved LEM specialist can handle the closures in tandem with the company secretary and the legal department. In the UK, there are other forms of closure that don’t require liquidator support, but the safest and most risk-averse way is to engage a liquidator. It is a matter of getting the companies as clean as possible before going to the liquidators because this is far cheaper for the client. A LEM adviser should create a standard check list based on all items that need to be reviewed, and then signed off by the legal, tax, treasury, finance teams and HR teams. The finance director gets the final sign off as in the UK liquidation process he or she will be signing a declaration of solvency.

It is specialised job, it requires knowing which stones to pick up and what to look for underneath. It is about having experienced people who stand between you and the liquidator to make sure that everything is being considered. And finding out these little surprises and dealing with them internally can often save a great deal of public grief in the future.

About MorganFranklin
MorganFranklin Consulting, with headquarters in Washington, DC, and the City of London, provides business operations, financial advisory, and IT consulting solutions to companies in a wide range of industries including telecommunications, energy, retail and technology. The firm supports clients in implementing their strategies and plans for growth, compliance, and business improvement. In 2012, MorganFranklin was named in Consulting magazine’s “Best Firms to Work For” list and the Inc.500|5000 list of the fastest-growing private companies in America. To learn more about the company and its capabilities, visit www.morganfranklin.co.uk.