The following is provided for educational purposes, and not meant to be legal advice.
What are side agreements?
On March 30, 2006, an article by Stephen Taub of CFO.com, reported that the Securities and Exchange Commission settled charges against Netopia, Inc., a maker of broadband customer premises equipment, remote management software, and broadband services, and its CEO and former CFO, regarding side agreements with a customer that increased the company's revenues.
Side letters are letters that contain terms that are agreed to on the side before, during, or after an agreement is executed. Side letters often contain terms that conflict with the actual executed agreement.
Side letters create finance concerns relating to the improper recording of revenues. In Netopia's case, revenues were improperly recorded because payments were contingent on future events. According to the CFO.com article, Netopia also incorrectly issued a press release that treated the customer order incorrectly as uncollectible bad debt. Because the transaction should not have been recorded as revenues, the company should have restated its financials.
As with the example of Netopia, there are many finance issues that result from the use of side letters, including creating inaccurate company books and records, failure to maintain adequate internal controls, and reporting false financial information. Thus, a company should not make it a practice to use side letters.
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