Meaning
Financial or legal assertions exist without documentation in the official records of a company. These unrecorded claims can include verbal promises of equity, unpaid debts to vendors or potential lawsuits that have not yet been filed. They represent a hidden risk for any person who is buying or investing in a business.
Finding these gaps in the record is a primary goal of the due diligence process.
Hidden Liability
Debts that do not appear on the balance sheet can significantly change the value of a firm. An unrecorded claims situation might involve a former employee who believes they were promised a bonus that was never paid. If there is no written record of the promise, the current management might not even know the claim exists.
These surprises often arrive at the worst possible time for the company.
Verification Gap
Discrepancies between the memories of the founders and the physical files create a point of failure. When a founder makes a deal without writing it down, they create an unrecorded claims risk. A record of a conversation is not the same as a signed agreement.
Over time, different people will remember the same event in different ways, leading to a dispute that is hard to resolve.
Disclosure Risk
Sellers are usually required to list all known problems in a disclosure schedule during a sale. Failing to mention unrecorded claims can lead to a charge of fraud or a breach of contract. The buyer will want to see that all potential obligations have been identified and handled.
Keeping thorough records from the start is the only way to avoid this problem.
