Business Divorce: Breaking Up is Hard to Do

It has been said that a business partnership is much like a marriage. The relationship among partners can be quite fruitful, but disagreements inevitably arise from time to time.? Over the years I have represented minority owners and majority owners, partners and shareholders, corporations and LLCs in various “breakup” scenarios. These scenarios range from “cold shoulder” formalization of decision-making procedures, heated exchanges of demand letters to aggressive litigation. Sometimes a neutral mediator brings the feuding partners to a better understanding of how to move their business relationship forward if possible, or at least salvage as much value while unwinding their affairs.

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The following is a list of just some of the issues to explore with your attorney when it's time for you and your business partner to go their separate ways.?

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Fiduciary Duties

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Who has a duty and to whom is it owed? Regardless of what co-ownership agreements might say, certain individuals may owe a duty of loyalty to minority interests and others.

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Co-Ownership Agreements

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An ounce of prevention is definitely worth a pound of cure. At this juncture, you might be wishing you had taken the time to put together a better shareholder/partnership/operating agreement. In any case, make sure to understand the default rules that apply to the business relationship when there is no agreement, or the agreement is silent as to a specific subject. ?Also, beware of relying on provisions in an agreement that may actually be unenforceable because they are trumped by various overriding business statutes or case law.

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Notices, Voting and Meetings

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Unless properly waived, these formalities can be a minefield. When receiving a notice, consider whether and how to respond and then act very carefully lest you waive some of your rights. For those in control of the business, understand that just because you have the right to do something, that does not mean your actions may be voidable for lack of following certain formalities.

Right to Inspect Books and Records

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While these rights can turn out to be quite limited, business entities are almost never allowed to deny a shareholder’s proper request to inspect books and records.

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Right to Redemption

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Unless specifically provided for in your co-ownership agreements, many business entities cannot unilaterally buy out an owner. Conversely, owners do not necessarily have a right to be “cashed out” on demand.

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Transfer Restrictions

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Different entities have different rules governing how and when a business owner can transfer their interest, if at all. Some of these rules can be overridden by a written agreement, and certain transactions can trigger a limited window to demand to be bought out at fair market value.

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Liquidation vs. Dissolution

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If everyone is in agreement as to who gets what and who will assume any remaining liabilities, a plan of dissolution should be prepared to help obtain closure from a legal standpoint. Certain filings must be made with the applicable Department of State to cause dissolution and notices must sometimes be sent to creditors. Liquidation is the process whereby the business is actually wound down, the assets distributed, and the books closed, which can sometimes last well after dissolution.

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Judicial Dissolution: Voluntary vs. Involuntary

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Voluntary judicial dissolution happens when the owners jointly petition the court to decide how to liquidate the business. When the owners cannot even agree that the entity should be dissolved in the first place, certain circumstances will support a unilateral petition for the court to involuntarily dissolve the company. In both cases, courts often appoint a receiver to recommend and oversee a plan of liquidation.

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Tax Implications

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A good CPA should be consulted to determine, among other things, the tax impact of a complete or partial liquidation, substantial change in ownership, recapitalization or any reorganization resulting in multiple entities. Once the tax impact has been quantified and minimized, who pays the tax becomes yet another negotiation point.

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Continuation of the Business

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When one or more parties will continue to operate the business while others will not, numerous additional issues should be considered, such as non-disclosure and confidentiality agreements, as well as non-competition and non-disparagement agreements; whether the departing owner’s assistance will be required post separation and how or whether to compensate for the same; indemnifications and general releases, etc.

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Personal Guarantees

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Closely held business owners often personally guarantee one or more of their business’s obligations. If one party agrees to assume the entire obligation, the separation agreement should provide for some form of indemnification, and / or hold harmless. Unless the lender expressly releases any guarantor in writing, the indemnified party must have realistic expectations in terms of the costs of enforcing their right to indemnification should it become necessary and measure the potential for collecting any judgment that may result.

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Friends & Family

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Doing business with friends and family can be very rewarding, but always adds another dimension to the relationship. Know your legal rights and obligations, while never losing sight of the diplomatic, political and emotional aspects of who you are dealing with and what they really want.

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Trusted Intermediaries

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The business’ banker and accountant should be unbiased, neutral and, therefore, helpful in resolving disputes amongst business owners or at least orchestrating the financial aspects of a breakup. As such, your attorney should definitely enlist their participation. However, bear in mind that their correspondence (e.g. e-mails, text messages, etc.) and records may be subpoenaed, and they may also be compelled to testify as to what you discussed with them. Moreover, their own professional obligations to be conservative, objective and impartial usually require them to refrain from helping you pursue your interests when they might be in conflict with the interests of the business and / or your partners.

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Estate & Financial Planning Impact

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Closely held businesses are often a major component of their owners’ overall wealth. Departing or remaining owners can sometimes agree on structuring their deal in mutually beneficial ways that maximize the value of the departing owners’ compensation while simultaneously boosting the value of the remaining owners’ equity in the business. Both parties should update their estate and financial plans to adjust for what is typically a major shift in their wealth portfolio.

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Conclusion

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These are just some of the legal issues involved in planning for a business separation. The chances of closing the transaction amicably will mostly depend on the existence and quality of co-ownership agreements, as well as the goal orientation and professionalism of the attorneys on both sides.

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Questions? Contact Ed Arista at 305-444-7662

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