Relationships between business partners can go sour, to the point where the co-owners of a business are unable to work together and need to separate. Like a marital divorce, sometimes this is a mutual breakup, while in other instances, one owner may feel slighted by his or her former partner or partners. In either case, it is generally preferred for the parties to settle their disputes without litigation, to avoid the expense of a drawn-out lawsuit. The best way to accomplish that is to start the resolution process early and understand the available options.
What Can Cause Disputes Between Business Partners?
There are many reasons conflicts arise among business partners. Such disputes may involve the following:
- Management of the company. Owners may disagree over day-to-day operations, investments, allocation of resources and decision-making authority.
- Compensation. When owners are also employees of the 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. These include a duty of care, duty of loyalty and duty of candor. Breaches may involve allegations that an owner engaged in self-dealing, deception, or improperly usurped a corporate opportunity for himself or herself.
- 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 and how profits and losses will be divided, among other issues, often lead to breach of contract claims.
- Lack of transparency and miscommunication. These disputes may fall under breach of contract or breach of fiduciary duty, where owners are intentionally hiding information. Depending on the relevant state’s corporate laws, interest holders typically have the right to inspect the company’s books and records and may be able to get an accounting.
- Minority vs. majority shareholder rights. Minority shareholders often have some protection against oppressive treatment by majority shareholders under state law. However, this varies from state to state.
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, it may be best to sell the company or its assets and split the proceeds from the sale. By taking this step early and without 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 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 state law 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. For example, New York’s Corporation Law and LLC law establish default procedures in the absence of any terms in the shareholder agreement or operating agreement. It is important to follow these rules to avoid further conflict and litigation with co-owners.
Once the process is begun, 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, it is a good 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, state 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.
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