Of all the core legal concepts that first-year law students study, property law is the most esoteric. The concept of property boils down to relative rights. Do I have more or less of a right than you do to possess, manipulate, lease, or sell this thing that I am claiming ownership of? Things get harder when we deal with intangible property. While simple possession of real property or equipment doesn’t prove ownership, it at least provides some indication of ownership. But regarding intellectual property like trademarks and copyrights, or other intangible property like interest in a partnership or a limited liability company, there often isn’t anything to possess. This has led to major problems for inexperienced cannabis business owners.
Regarding ownership interests in corporations and LLCs, it is important to make some distinctions. I’ll use Washington as an example, but most states adhere basically to the same principles. The Secretary of State’s office is in charge of forming business entities, and it maintains a database of governing persons. If I look up a company on that website, it is going to list the names of one or more people that are reported to the state as governing persons of that company. However, that listing is not proof of or even evidence of ownership. The people listed are supposed to be managers of LLCs or directors and officers of corporations. They are not shareholders (owners) of corporations, and they are not necessarily members (owners) of LLCs. Frankly, it isn’t even proof that they are governing persons. I could go in and file a new annual report for any company I wanted to and change the listing of governing persons. It is just a courtesy database made public by the state.
That notice distinction is also true of the state’s licensing agency, the Liquor and Cannabis Board. When a company goes through cannabis licensing, renewal, change of location, etc., it self-reports its governing persons and owners to the state. The state, in turn, subjects those people to criminal and financial background checks, and maintains them in a database as “true parties of interest” of the licensed business. But just being reported to the Liquor and Cannabis Board is not itself proof of ownership. The law requires a company to accurately report its owners, but that is still just a notice and reporting requirement. If a business reports its true parties of interest incorrectly, it doesn’t change who those owners are and what they actually own. If a company went through receivership or other administered liquidation, the ownership listing maintained by the Liquor and Cannabis Board wouldn’t be the ultimate authority on ownership.
How, then, is ownership of business entities actually determined? It isn’t through any type of public reporting. The United States, unlike many other jurisdictions, doesn’t tend to have any type of broad public registration of company owners. Instead, companies and individuals maintain those records privately. In our experience, most small businesses do a poor job of that.
With LLCs, the record keeping requirement is easier. Upon initial formation, the members/owners execute a limited liability company operating agreement that defines for each of them the scope of their ownership. A third party should be able to read that operating agreement and understand what right each individual has to profit distributions, liquidation distributions, profit allocations, loss allocations, etc. The agreement should also define transferability of membership and what steps need to be taken to accomplish that transfer. Someone who is buying part of an LLC would need to read that agreement to make sure that they were actually able to acquire it, lest the transfer be found inoperable. The LLC operating agreement should also contain an updated schedule or exhibit that lists the relative percentage ownership interest of each member. That schedule should be updated regularly — at least every time there is any change in membership interest.
Corporations have more paperwork, but they are also more standardized than LLCs. A corporation is initially formed by an “incorporator,” a generally meaningless title that doesn’t grant any inherent ownership rights. That incorporator appoints an initial board of directors, who take over governance of the corporation. The board of directors than adopt bylaws. Finally, they are ready to issue shares of stock. Until they do that, nobody owns the corporation. The stock is issued to individuals for some buy-in price, which could be real money or could be entirely nominal. But only upon signing a resolution approving of the issuance of stock does ownership exist. That stock is generally evidenced by a printed stock certificate that is possessed by its owner, and a ledger is kept at corporate headquarters noting the certificates that are issued. The bylaws may allow for uncertificated stock. In that case, the same information kept in the normal stock ledger is maintained at the corporate headquarters, and shareholders are given notice of what they own.
If you own an LLC or corporation and have failed to do any of this, it’s not like you have zero claim to ownership. It just means that it’s harder for you to prove it. And with intangible property, the ability to prove ownership to third parties is what it’s all about. That’s how you make money on it by accomplishing a sale, or using it to secure a loan. That’s how you convince a judge in a business dispute or dissolution claim or a receivership case that you have an actual right to business assets. So, make sure you write it down.