Breaking Up Is Hard to Do: Surviving a Business Divorce

Common Issues and Strategies for Resolving Partnership Disputes

Conflict in business is common. While we generally think about conflict arising between a business and a third party like a vendor or competitor, or even internally between management and staff, it can also arise at the leadership level amongst business partners. 

Those in closely held businesses, like family businesses, are even more likely to encounter disagreement than their counterparts in other businesses. The disproportionality in partnership disputes between closely held businesses and other business structures is due to a host of reasons, including the blurred lines that tend to exist between the owners and the business itself, all of which make it difficult to separate the personal assets and decisions of the owners from those of the company. These blurred lines can lead to complexities in governance, liability, and financial management. Many of these businesses fail to clearly define the rights concerning withdrawal and dissolution, which adds fuel to the fire when conflicts arise. 

Sometimes, partnership disputes ultimately lead to a business break-up. Most, if not all, business partners would like to avoid this worst-case scenario, which is why it is essential to have a firm understanding of the issues that cause a business divorce, the strategies for navigating and resolving partnership disputes should they arise, and how to proceed when a breakup seems unavoidable.

Common Reasons for Business Divorce

Businesses fall apart for many reasons. While you can’t protect against every issue, you can start by understanding the most common problems and taking steps to prevent them.

Majority Control and Shareholder Oppression

In many businesses, one owner, or group of owners, controls a majority of the business’s equity. This division of power often creates a situation in which a few key decision-makers wield more influence than the many minority shareholders. Such a concentration of power can lead to shareholder oppression and can lead to conflict and tension within an organization.  

Dividends

A majority group of shareholders may use its voting power to withhold dividends inappropriately. This tactic is often used to force minority shareholders to redeem their shares, i.e., force them out at a low buy-back price. On the other hand, declaring an unreasonable dividend that depletes the corporation’s cash reserves can jeopardize the business’s financial stability and long-term interests.

Either scenario could ultimately put the majority shareholder(s) in breach of their fiduciary duty to the company. 

Sale of Business

Majority shareholders may also fail in their fiduciary responsibilities if they obstruct the sale of the business to the company’s detriment or do not consider minority shareholders’ liquidity needs.

Terminating a Shareholder-Employee

If a minority shareholder is an employee of the business, they often expect their job to be secure, and it is to the extent that a valid business reason must exist for their termination. Terminating them without one constitutes a breach of fiduciary duty by the majority shareholder and places the entire business at risk. 

Other Common Problems

• Inequity (perceived or otherwise)
• Fundamental disagreement over business strategy
• Fraud 
• Retirement
• Death or disability
• Market decline
• “The grass is greener” mentality

Minimizing the Impact of Partnership Disputes

The expression ‘an ounce of prevention is worth a pound of cure’ perfectly captures the essence of proactive conflict management.

While conflict between business partners is nearly inevitable, there are some creative ways for parties to mitigate the impact future conflict may have by negotiating up-front. These discussions should happen early, preferably at the formation of the business, and should always be memorialized via written agreement. 

Precautionary Agreements

Precautionary agreements give you space to resolve partnership disputes. At the very least, they provide a picture of what the result will be when resolution is not possible.

Precautionary agreements, like prenuptial agreements, help delineate the path forward in the event of a business divorce. They can clarify decision-making processes, financial distributions, and even the terms under which a partnership can be dissolved.

A well-drafted partnership, shareholder, or operating agreement can prevent or resolve deadlocks — situations where partners cannot agree on a decision or future direction for the business.

Key provisions to consider adding to your precautionary agreement include:

• Buy-sell agreements: These are crucial for detailing what happens when one owner leaves the company, willingly or unwillingly. They typically obligate the company or its remaining majority owners to purchase the minority’s stock in certain events.
• Provisions to forestall squeeze-outs: These measures offer fair exit plans and protect minority shareholders from being pressured by majority owners into selling their shares.
• Triggers for dividends and declarations: These are guidelines for when dividends will be declared, which helps maintain transparency and fairness in profit distribution among shareholders.
• Non-competes: These prevent departing partners from starting or joining competing businesses within a certain timeframe and geographical area.

While negotiating precautionary agreements, especially buy-sell clauses, is often difficult, doing so can significantly minimize the pain of partnership dispute or business divorce.  

Shotgun Provision

A common strategy for two-owner businesses is the inclusion of a ‘shotgun provision,’ which introduces a buy-or-sell dynamic in deadlock situations. This provision establishes a mechanism where one partner can offer to buy the other’s shares at a specific price. The partner receiving the offer then has two choices: accept the offer and sell their shares at that price or buy the offering partner’s shares for the same amount.

You Have a Dispute: Now What?

Negotiation vs. Litigation

The direction you choose largely depends on the trust you have in your partner. If there’s a disagreement between reasonable parties who still respect each other’s integrity and fairness, there’s room for hope. In such scenarios, reaching a settlement is not only possible but preferable.

On the other hand, if you believe the other party is objectively unreasonable or dishonest, then trying to settle with that person is likely to be a waste of money and time, and litigation may be your only choice. Keep in mind that litigation is expensive and time-consuming. Most professionals agree that disputes should be resolved outside of court whenever possible.

Luckily, there are several strategies for resolving a dispute should you find yourself involved in one that cannot be resolved via direct negotiation but does not yet necessitate litigation. 

Alternative Strategies Through State Law

State laws provide a variety of options to help shareholders address their disagreements.

Delaware, for example, permits a court to appoint a custodian for a solvent corporation when:

• Shareholders fail to elect successors for directors at the end of their terms during an election meeting.
• The corporation is at risk of significant harm because directors are so divided on management decisions that a board majority cannot be achieved for action, and shareholders cannot end this deadlock.
• The corporation ceases its business operations and does not take timely steps toward dissolution, liquidation, or asset distribution.

Mediation and Arbitration

Beyond court intervention, shareholders can also opt for mediation and arbitration. These processes enable a neutral third party, other than a court, to resolve or help resolve partnership disputes.

Dissolution

As a last resort, a company can be dissolved because of unresolved disputes. Indeed, a dissolution provision may be included in a company’s articles of incorporation or operating agreement. 

Other Examples of Alternative Strategies

• Appointment of a custodian or provisional director(s)
• Compelled buyout of petitioning shareholders

Business Divorce: It’s Not the End of the World

While ending a business relationship isn’t the goal of any business, it isn’t the end of the world either. Strategies for resolving partnership disputes can be employed both at the front end to avoid issues and at the back end to facilitate the breakup.

We think you’ll also like:

1. Consensus Decision Making: How Much Compromise is Too Much?
2. How Choosing Your Company Legal Structure Affects Business Down the Line
3. Fight, Flight, or Freeze: Dealing with Business Conflicts

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Preparing for Mediation: From Selection to Presentation of Claims
2. Complex Financial Litigation / Common Issues and Strategies in Business Breakups
3. Resolving Shareholder Disputes

This is an updated version of an article originally published on July 13, 2020 and updated on November 29, 2018.]

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