Dan

Welcome to Sound Business Insights. I’m Dan Watkins. This episode is about business fraud. This podcast is not intended to provide legal advice.

Neil

So Dan, today’s topic, business fraud. It’s a broad range. Let’s start with just a basic, what is it that constitutes business fraud? What’s a definition?

Dan

Well, before we do that, we’re going to get deep here and we’re going to go advanced. So, um, if you’re listening to this, you should understand that the first thing you need to do, if you think that business fraud has occurred in your business or in your dealings, is have you lost money? Or have you lost the opportunity to earn or make money? And those things are not simple questions. Something may feel wrong, something may seem wrong, or you just may know it’s a gut instinct before you’ll write to the law, go right to your damages. And in business fraud, we have a saying, if it’s off a penny, it’s off a million. Yes. If it doesn’t add up to the penny, there’s a reason.

Dan
And either it’s somebody added it up wrong or somebody’s ripping you off. And you should look into that and then listen to the rest of this episode and you’ll see all the laws that we think about when I think of business fraud. And before we dive into the specifics, this isn’t an issue. You want to investigate yourself, right? This is something you want someone from the outside taking a look at. First, you want to look right away at your own accounting, your business records as soon as you can. And then if you sense there’s anything wrong, then you know you have damages, you should reach out because many times those damages aren’t even close to what you think. Dan, tell me, what is business fraud? Well, let’s define it as five different types. Okay?

Neil

Okay.

Dan

One, let’s say business fraud, consumer fraud. If businesses are in California, they have to comply with consumer fraud statutes.

Dan
And there are a ton of them. And with these consumer fraud statutes comes a bounty that the lawmakers put out there called attorneys fees, punitive damages, interest penalties, everything in the world to help your lowly consumer take your business down. If you own a business and you are worried that your business may be violating some of these consumer laws, it only takes a couple phone calls to a lawyer that knows this stuff like us to avoid getting stuck with a hundred thousand people on a class action suing you because the label on your product was off. Right? Or because you didn’t advertise it the way the consumer protected agency wants you to. Or other reasons that I, we can go into the next number two.

Dan

Number two is business to business fraud, unfair competition, false advertising practices, and just general common law fraud between businesses.

So business to business fraud is a big topic. It happens. You’re in the marketplace, you are doing great, and all of a sudden no one’s coming to you anymore. And then you find out that the number one competitor has taken some of the elements of your website are saying bad things about you, or they’re doing a lost leader advertising BA and switch on the price. And they’re grabbing all your customers, but you have the best product and the best service. They are defrauding you out of your rightful profits. And you should, I’ll say it again, if for for unknown reason, all of a sudden you’re not making the money you used to. You might be the victim of fraud and don’t know it. Go see a lawyer who knows this stuff. We’ll spot it.

Neil

What’s the third area of fraud? You were mentioning?

Dan

Business partner fraud. This never happens until you make money. <laugh> when there’s no money. I rarely, I don’t know if I’ve ever heard of a case with business partner fraud until the business starts doing well. And then it’s so common. It’s crazy. People with all the greatest virtues you’ve ever seen in your life, you’ve known your whole life. All of a sudden your company expanding, doing well and money disappears. It’s just so tempting. It’s like gold <laugh>, gold fever. So that’s also includes shareholder fraud, officer, fraud director fraud, usurpation. That’s a fancy word for taking the company or corporate assets without any fair compensation or in secret. Yep. Um, the next one, number four, sale of business fraud. We do a lot of that. We sell hundreds of millions of dollars in companies. We merge them, we create partnership agreements for them. And we see the hardest part is when you buy a business, you want to know you’re getting what you paid for. And when you sell a business, you want to make sure you get the money, the price you agreed to, because these things are complicated. And you also don’t want to get sued later for inaccurate disclosures, some contingent liability.

Neil

So when a group of shareholders tries to set up another company and then merge with the two, reduce the value of their minority shareholders’ interest or to get rid of them all together, does that fall into this bucket? Or is that…

Dan

Yes, that happens.

Neil

Yes. What’s the fifth area of business fraud?

Dan

Criminal fraud. Criminal fraud is when the government finally gets around to hammering you. Now it’s illegal to threaten criminal prosecution to gain an advantage in a civil fraud case, yes. But when you’ve been defrauded, people get emotional and they call everybody, everybody, anyone who listen. And when they pull the trigger and send over evidence to the DA’s office or the consumer fraud agency or whatever government entity they’re going to, once they have it, they represent the people and they’re coming after that business. If they can find proof and they’re going to have criminal penalties and they’re going to have criminal jail time if they can impose it.

Neil

And in our case, the Watkins Firm handles the civil side of the fraud equation. And the government obviously prosecutes criminal fraud.

Dan

Well, let’s put it all together. All right? Yes. Every one of these types of fraud, if left unchecked, untreated, can be like a fast acting cancer and take you right to criminal fraud. Hmm. Whereas you could resolve a matter where you incorrectly, inadvertently, whatever you did, turned into something that someone lost money on, you could turn that into a resolution, a correction, a fix, and it’s over and it’s gone. It’s done with. And you don’t have to let it get to number five, criminal fraud or there’s no coming back from it.

Neil

So Dan, in terms of the law, are fraud and deception relatives or are they one and the same?

Dan

They’re all part of the common law and statutory fraud scheme. Omission, yes. Deception. Overt misrepresentation. Any deceptive practice can be considered of evidence of a fraud. And the reason everyone tries to reach that fraud standard is just like some other statutory claims, they introduce punitive damages, treble damages, damages in addition to your regular damages, to really entice somebody to punish you for being a fraudster.

Neil

Attorney’s fees,

Dan

Attorney’s fees, yes. All these things can come into play and there’s lots of statutes that go into it. Yes. Like we said, in consumer fraud statutes that go into it and business to business fraud statutes go into it. So once you prove the basic common law fraud, those things are going to fit right into all these statutes. So you get more than one cause of action. Hmm. You get your basic cause of action and you get the one that has all the statutory penalties.

Neil

So Dan, in a business setting a business to business situation or shareholders, a business environment, what are some of the more common examples of fraud cases that we’ve seen over the years?

Dan

Well, business to business, let’s just break that down. First, business to business. I have literally seen one company take the actual products of another company, relabel them and sell them. I’ve seen other cases where they’ll be an insider in one company, invested in another company and they’ll steal intellectual property and they’ll steal physical property and bring it over to the other company that are also invested in because they have a partnership dispute with their partner. And so they figure I’m going to steal it before I fight it out in court or before I do all the other things. And so that’s crazy in and of itself. And then your general business to business fraud, where you defame the other company, you go out and steal their intellectual property, you steal their customer list, you advertise fraudulently about them. Business is brutal. And so we see a lot of that.

Neil

Dan, what are some examples of business partner fraud?

Dan

We had a case once where there were nine different business partners with different locations and they had an accounting system. And so they had one general administrative office to run them all. And so one of our clients who was one of the partners said, you know, my accounting’s off about $5,000 every year and it’s not exactly 5,000, it’s like 3,222 or this number. And so I said, well, can you come up with any reason why it would be off? And they said, well look. So they, they looked and they had their administrative people in-house look at it. And they really couldn’t, they couldn’t say it was their fault, but they couldn’t say how it happened. So we hired one of our forensic CPAs to take a look at it. We wanted to do what’s called a spot audit.

Dan
A full audit cost a lot of money. Yes. Spot audit. Five or 10,000 bucks. They can tell you by just checking here, there and everywhere in a pattern that would say we’d find something off if it’s still off. And they found something. So then we said we need to look deeper. Well turns out that all nine partners were getting ripped off by somebody inside the hub, the administrative hub to the tune of they would charge everybody for a service when it should have just been one service split by nine. They would multiply it by nine and keep the extra money and put it in their pocket. Wow. And they did it in such a way that if they, nine times 5,000, 45,000, everybody would’ve known. But, and they did it for years and years and then that was a big deal. But it wasn’t as bad as the fact that they were also bringing in new partners.

Dan
And new partners were getting false accounting work. And they were paying money based on false representations. And so my client wanted to get out of the contract and they had about over a third of their members of their little entity who were bought in with false papers, false accounting. So we were able to enforce them to give up their interest, the general partner, because this one accountant, this one person who’s stealing money, defrauded everybody. And so we get to rescind. That’s another remedy of fraud is rescission. Yes. We got the demand rescission and a buyout based on the 12 year old price. And our client did. Great.

Neil

So while we’re on the topic of remedies, what are the basic remedies for fraud?

Dan

You get all your contract remedies and tort remedies. You get double whamming contract remedies. You get to have injunctive relief. You get to have provisional remedies. That’s injunctive relief. You have stop orders, you get to have money turnover orders. Just tell the judge, I want that money back order back. You get to have general damages of what your lost profits are. You get to have your causation damages of how much money did I actually lose? Like was I damaged? You know, not just the profits that, but I also lost money because I, whatever the facts are. Yeah. And most of the time you get attorney’s fees, interests, and punitive damages. And there’s probably more, we’re on a topic where it fits into so many statutes that we can go really use the law in your favor. And also if it’s against you, we can advise you of all these threats. And if the opposing counsel is really not up to steam, we can let you know that it sooner or later they may wake up and we can help you get it resolved quickly when you might otherwise think I can go fight on the way.

Neil

Well that naturally leads to the other side of the equation, doesn’t it? So how do you defend and do we defend at the Watkins firm allegations of business fraud and partner fraud?

Dan

Yes, we do all the time. Whether it’s intentional, unintentional, a mix of the both. Whatever it is, we defend it because it’s not just whether you did or didn’t do it, it’s how much should you pay? If I’m driving 85 on the freeway, I shouldn’t get the death penalty <laugh>. And if you make some poor judgements at a time where you felt justified to do so and then they catch it, you shouldn’t lose your entire company. There should be a price for that. Or there should be this big fact. Perhaps they just don’t have enough evidence to prove it. Mm-hmm. <affirmative>, that’s it. We are champions of our client’s. Cause no matter what,

Neil

Is it difficult to prove elements of fraud?

Dan

Yes. It’s a different element. It’s different proof stage. There’s a different element of proof, different instructions to the jury. They have to find clear and convincing as opposed preponderance of the evidence. Which means instead of 51%, I would say, you know, 65, 70 5% yes. Are higher. And without a doubt is 99%. So you know, they have harder proof element. So yeah, those are all the things that we do as lawyers. I don’t want to get all cut up in that <laugh>, but those are things we think about when we advise our clients on whether they’re being sued or they’ve been ripped off. We want to make sure that we provide the best representation.

Neil

Dan, what are some examples of sale of business fraud cases that are quite common?

Dan

This is one of my favorite areas because we do litigation for it and we do transactions. We buy and sell companies. So you have to understand the business of selling a business. Yes. And so before we talk about the fraud part, let’s talk about how we buy and sell a business. Okay. If you are sophisticated and they’re not anyone could, almost, almost anyone can buy somebody’s business for free. It’s crazy. But you have somebody, let’s say with a valuation, they’re making a hundred thousand dollars a year. Right? And they’ve got $75,000 in accounts receivable, they have some overhead, they have this and that. And someone in comes in and makes an offer of uh, buy it for 300,000. Right? And then they make all these other conditions and they say, but I need a note of, you know, five years to pay it off. And you say, I agree to a note and you agree the payment and the interest and then you do the deal.

Dan
If your lawyer and your CPA are mostly your CPA doesn’t recognize that there should be a comparison of the interest rate on the money versus the risk it takes you to make that a hundred thousand versus the percentage of profit your company makes to capital investment, then you are trading your 5% note and giving them a 30% game. So the interest on 300,000 over five years is going to be what, 50, 60,000. And you gave away all the profit generation from your company for five years for 50, 60,000. You gave away 500,000, which they use your money to pay you back. Right. And pay off the note with the principal. So they’re going to make time and 200,000 on you <laugh>, they just got a free business. So all those kind of things should be looked at. Even if you don’t do this on a day-to-day operation, find a lawyer that likes this stuff, that enjoys the whole strategy of it all.

Dan
Because instead of saying no, no, no, and pointing fingers, that’s just their beginner offer. And you have to have a lawyer who employs good accountants and CPAs to strategize an offer that they may like. So you can see how it gets complicated. Absolutely. Now let’s talk about the fraud part. I mentioned the first part because if your lawyer doesn’t know how to buy and sell businesses, how are they really going to recognize what the tricks of the trade are when it comes to fraud or failure to disclose or all those other things and what’s important mm-hmm. <affirmative>, because it might seem like a minor thing to you, but to lawyers like us at the Watkins firm, we see these issues and we say, wow, you lost a lot more money than instance. Whatever the disclosure was, you lost. You know, the profit, you lost this, you lost that. So we’d definitely like to dig in deep when it comes to the accounting and when it comes to talking to you about your understanding of what the meeting of the minds and the deal was between you and the buyer or you and the seller. That aside, let’s talk about you buy a business and all of a sudden somebody opens up a business across the street. We’ve had that Hmm. Many times. Yes.

Dan
They literally opened up a business across the street and your lawyer was good. They put in all the clauses, they put everything you wanted in there. You can’t do that and everything else. But you sold your company for 300,000, they moved in across the street and it’s going to cost you $150,000 to sue them. And they hold their money in this company and that trust and that entity and they have some money overseas. And so now you’re in a situation, a power struggle. I think one of the first things we talk about was power struggles.

Neil

Absolutely.

Dan

You are right. You have all the law, you have the contracts and they’re in a power position because they don’t care if you get a judgment,

Neil

You’ve got to go get the money and you can’t.

Dan

So you’ve got to strategize for that. When you do the deal, which we do, you’ve got to ask a lot of what ifs and hopefully you got a lawyer with a lot of what ifs to talk about those kind of issues. And then when it comes to collection, you’ve got to have a law firm that’ll focus on collectability before they spend your money. Because we love cases with the fraud, but a person who commits fraud is probably thinking about if I get sued, they won’t get any money. So do a background check on these people too. Hmm. A person that’s had a lot of lawsuits and you’re going to sell your business to them. It’s kind of odd. You rent an apartment to somebody and you do a massive background check, right?

Neil

Absolutely.

Dan

Every time you sell, you sell your company. And I’ve seen it a hundred times. They don’t do any background check. They don’t ask for a credit report and they’re signing promissory notes. They don’t do anything. You would just normally do it, just go with the flow. I’m going to get my money. If it’s not all cash, you’re not getting your money. You should probably check it out.

Neil

So another form of sale of business fraud falls into that example we threw out earlier the merger and using a transaction to dilute or eliminate the value of partners or minority shareholder positions. How do those deals work

Dan

In those people will enter into a, a buy and sell with a standard common law stock situation. Meaning we have common shares and you’re going to get some common shares and we’re having a merger and they don’t have a shareholder agreement and nobody ever gets a shareholder agreement. It costs an extra three grand. Why would you spend that money? Hmm. But when you start making money and you don’t have a shareholder agreement, then everybody goes to the common law and turns out your uncle and their friend who own another 10% of the shares, they have majority shareholder approval and all of a sudden they have brand new cars paid for by the company and they are on the board and you are not on the board, but a simple shareholder agreement that would not be possible. We’d have super majorities, we’d have restrictions in place on what types of things the board can do because if you don’t have it, then you’re left with the laws that operate all our giant corporations in America where the CEO makes 80 million a year <laugh> and no one can stop them because that’s the law. And if everybody votes that way with their proxies and everything else, that’s the way it is. But you got your company, your small company, a shareholder agreement would stop a lot of those what ifs. So luckily operating agreements, they have those automatically in them. Mm-hmm. <affirmative>, it’s one of your choices. You can check your operating agreement and, and it stops crazy spending or crazy decision making for the most part. There’s still a way if there’s, there’s still a way if there’s a will, right? So

Neil

If you’re a minority investor or a shareholder, what are some of the warning signs that you might suggest? These are warning signs, red flags. You need to pay attention and you might need to call the Watkins firm

Dan

If you’re not getting as much money. If you’re not getting any information, no reports. If you are hearing rumors, there are laws in the state of California for just that minority shareholder, minority limited partnership owner, the minority LLC member. Those people have laws. In fact, if you or a couple of you have 5% of the company or 10% of the company, you can have a court order demanding that they turn over the books, uh, give you access to the books and records of the company immediately. I mean within weeks. And you can march right into the headquarters and say, I want to see them now. Because when I see these fraud cases, they absolutely say no. The law says you have to, no, not going to do it. What are you going to do about it? Again, the power struggle. But if you go to a lawyer that knows these local statutes and knows how to file a simple motion with a judge within, then, you know, as soon as the judge gets to it depends on the calendar.

Dan
You can have an order and you are in there and you get your attorney’s fees and you’re in there looking at their books and records, comparing them to what you have, comparing them what other investors have. And then before you know it, you’re either satisfied or you’re filing a lawsuit or the director of the company’s approaching you for a separate deal. <laugh>. And that happens a lot by the way. Yes. You kind of hitting at it. Most of these cases are resolved through settlement agreements. Yes. Usually, they’re resolved through settlement. Sadly. Usually it’s not until there’s a gun that, that someone’s head or there’s a liability. There’s exposure. Yes. There’s a threat of exposure. There’s, there’s all types of things that they’re worried about. If they’re not worried, then they just figure they got away with it.

Neil

Right. What’s the flip side of that?

Dan
What if I’m the business owner, the majority holder and some of my shareholders are grumbling. That happens all the time. It really does. Even if you’re doing everything right, you are likely to come across with somebody who’s read something on the internet that Yeah. Some conspiracy theory about all people like you, all people who drive your kind of car, whatever it is, you’re going to hit that. And you might want to reach out again to a law firm that has experience in that so that they can do a quick review of what you’ve been doing, check your books and records, run it by their trusted CPA if they need to, and just give you a clean bill of health before and then tell you how to respond and what you have to produce. No, US lawyers, we love the details of these laws. So somebody’s demanding, I want this and I want that.

Dan
We can tell you exactly what you do and don’t have to produce mm-hmm. <affirmative> and we can look it over before you produce it and make sure it satisfies the requirements and also makes you look good before all hell breaks loose. And they got a ad hoc committee of investors all rioting because some lawyer got them all fired up so they can make fees, shut them down, put the fire out, and don’t leave them any real grounds to take action. And the centralist issue of business fraud cases is simply protecting your interests, keeping your eyes open, keeping your eyes on the ball like a checkup. Right. Right. Make sure you got everything covered and then if there’s some problem, resolve it fast <laugh> before it just builds and builds and it’s, it’s quadruple the problem.

Neil

Absolutely. Thanks Dan.

Dan

Thank you. You can learn more about the Watkins firm at https://watkinsfirm.com or call our office at (858) 535-1511.