Business Divorce in California
Not every business disagreement can be solved amicably. In some circumstances, co-owners of a business are unable to work together, and the best course of action may be for the partners to separate. Similar to a marital divorce, sometimes a business divorce is a mutual separation, while other times one partner may harbor resentment or animosity towards the other. In either case, the parties involved generally wish to avoid litigation and the costs of a drawn-out lawsuit. The best way to avoid a lawsuit is to begin the resolution process early and to fully understand the available options.
What can cause disputes between business partners?
There are many things that can cause conflict among business partners. Such disputes may involve any of the following:
- Management of the company. Owners may disagree over business decisions and strategy, day-to-day operations, how to manage investments or what to invest in, allocation of resources and decision-making authority.
- Compensation. When owners are also employees of their business, compensation claims can arise based on an employment contract or other agreement.
- Breach of fiduciary duty. Generally, owners owe fiduciary duties to each other and to the business itself. These include a duty of care, duty of loyalty and duty of candor. Breaches of a duty may involve allegations that an owner engaged in self-dealing, deception or improperly usurped a corporate opportunity for themselves.
- Breach of contract. The company’s governing document, such as an LLC’s operating agreement, sets forth how the business will be run and the rights and obligations of the owners. As a result, disagreements over capital contributions, voting rights, decision-making procedures, transferring and selling shares or how profits and losses will be divided often lead to breach of contract claims.
- Lack of transparency and miscommunication. Disputes over a lack of transparency or miscommunication amongst partners may lead to a claim for breach of contract or breach of fiduciary duty, where owners are intentionally hiding information. California’s corporate law gives shareholders the right to inspect the company’s books and records.
- Minority vs. majority shareholder rights. California law protects minority shareholders from certain actions made by majority shareholders. Specifically, minority shareholders have a right to crucial information about a corporation in which they hold an interest. Additionally, minority shareholders have the right to inspect books, accounting records and the minutes of corporate meetings or proceedings. The rights cannot be limited or compromised by actions taken by the majority shareholders.
How can you structure a business divorce?
Various options exist for a business divorce, short of litigation. The first step is always to check the company’s ownership or operating agreement regarding procedures and alternatives for resolving disputes. Some common ones include:
Sale of the Business
If it seems likely that the business will not survive the conflict, the best option may be to sell the company or its assets and split the proceeds from the sale. By taking this step early and avoiding involving the courts, the owners remain in control of the sale. When owners resort to judicial dissolution, the court may appoint a receiver to manage the business and sale process, which may result in less favorable terms.
The company, shareholders or a third party can try to buy out the interests of other shareholders involved in the dispute. Typically, the company’s governing document will set forth when owners or the business can buyout an owner’s interest or force out an owner, as well as how the owner’s interest should be valued.
A dissolution is voluntary if all of the owners agree. However, if some do not want dissolution, it can be involuntary and the owner requesting dissolution must get a court order dissolving the business and dividing its assets and debts. In either case, owners must follow California’s dissolution procedures applicable to their type of company (i.e., corporation, LLC, partnership) as well as any relevant provisions in the company’s ownership agreement. It is important to follow these rules to avoid further conflict and litigation with co-owners.
Once the process begins, companies should also notify employees, creditors, lenders, suppliers, vendors and service providers that the company is dissolving and begin to “wind up” the business. Where a dissolution is involuntary, a receiver may be appointed by the court to manage the business until the dissolution is final.
The business may also be required to file with state, federal and local agencies. Even if the business does not have to file, doing so is best practice as it puts creditors on notice, and protects the company and owners from any debts or obligations that may be incurred after dissolution.
What issues must be resolved in settlement?
Settlement terms will vary depending on whether the company will continue to operate. If the company is dissolving, the parties must decide how to split assets and liabilities among the owners. Where the business will continue to exist, the core issue is typically the buyout price paid to the departing owner(s). However, as noted above, the operating or ownership agreement may set forth procedures and mechanisms for determining these issues. Absent that, California law will govern.
Conflicts are inevitable in any business relationship. Where it results in a business divorce, the key concern of the owners should be to resolve the issues efficiently, so it does not damage the value of the business. If you are seeking legal advice for your California business, contact a member of our team for next steps.
Photo by Pedro Marroquin on Unsplash
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