Breaking Up Is Hard to Do: Surviving a Business Divorce

Common Issues and Strategies for Resolving Partnership Disputes

Breaking up is hard to do, but there are things business owners can do to prepare themselves—just in case. In this article, we’ll cover:

• Common issues that cause business divorce
• Strategies for navigating and resolving partnership disputes
• Tips on how to proceed when a breakup seems unavoidable

Problems with Closely Held Businesses

Conflicts between the owners of closely held businesses are common, at least relative to many other business structures.

In family-owned businesses, internal strife may be a result of concentration of control, lack of effective corporate governance structures and a lack of liquidity to deal with owners wishing to exit.

Closely held businesses must contend with minimal distinction between owners and the business. This is true both legally and operationally. Finally, many closely held businesses fail to clearly state withdrawal and dissolution rights.

Common Reasons for Business Divorce

Businesses fall apart for a multitude of reasons. You cannot safeguard against all of them all of the time. Start by understanding  the most common problems, and then guard against them.

Majority Control and Shareholder Oppression

In many businesses, one owner (or group of owners) controls a majority of the business’ equity. This division of power is particularly prevalent in closely held companies.

Often times, this creates a situation in which one decision-maker wields more influence than the many minority shareholders. Such concentration of power can lead to oppression of the minority shareholders by the majority owner.

Dividends

A majority group of shareholders may breach its fiduciary duty if it uses its voting power to withhold dividends inappropriately. Often, this is a tactic to force minority shareholders to redeem their shares (i.e., force them out at a low buy-back price).

On the flip side, the majority may also breach their fiduciary duty by declaring an unreasonable dividend that depletes the corporation’s cash reserves.

Sale of Business

Additionally, a majority may breach its fiduciary duty if it hinders the sale of the corporation inappropriately. The duty is breached if it does so without considering, or in frustration of, the liquidity needs of the minority.

Terminating a Shareholder-Employee

If a minority shareholder is an employee of the business, he may have a reasonable expectation of employment. A majority shareholder may breach her or his fiduciary duty by terminating that employee.

Other Common Problems

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

Early Planning Can Minimize Future Problems

The expression “an ounce of prevention is worth a pound of cure” is apt.

Conflicts between business partners are nearly inevitable. Thankfully, there are some creative ways for parties to negotiate up-front. 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.

IMPORTANT: Discussion should happen early, preferably at formation. Always memorialize these discussions in a written agreement.

To analogize, think of these discussions as a prenuptial agreement; a business divorce is often similar to a marital divorce. A well-drafted partnership, shareholder or operating agreement can prevent—or even resolve—a deadlock.

Provisions to include in such agreements:

• Buy-sell agreements (i.e., what happens when one owner leaves the company, willingly or unwillingly)
• Provisions to forestall squeeze-outs (i.e., when majority shareholders pressure minority shareholders to sell stakes in company)
• Triggers for dividends and declarations
• Non-competes

A buy-sell agreement typically obligates the company or its remaining majority owners to purchase the minority’s stock in certain events. Negotiating one, however, is often difficult.

When a business has two owners, one common solution is a “shotgun” provision. This provision triggers a mandatory sale in the event of disagreement and deadlock.

Getting more granular, you could also provide both shareholders the right to offer a specific price per share for the other shareholder’s shares. The other shareholder then has the option of accepting the offer or buying the offering shareholder’s shares at the price offered.

Examples of Alternative Strategies to Handle Business Divorce

• Appointment of a custodian or provisional director(s)
• Mediation by a third party
• Compelled buyout of petitioning shareholder’s shares
• Complete dissolution (in rare cases)

Alternative Strategies Through State Laws

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:

• “At any meeting held for the election of directors, the stockholders are so divided that they have failed to allow successors to directors whose terms have expired or would have expired upon qualification of their successors.”

• When the business suffers or is threatened with irreparable injury because the directors are so divided respecting the management of the corporation that the required vote for an action by the board cannot be obtained, and the stockholders are unable to terminate the division.

Mediation and arbitration are options that enable a neutral third party (other than a court) to resolve or help resolve partnership disputes.

Finally, as a last resort, a company can be dissolved because of disputes that cannot be resolved. Indeed, a dissolution provision may be included in a company’s articles of incorporation or operating agreement.

You Have a Dispute: Should You Negotiate or Litigate?

You have a dispute and the other strategies haven’t worked. What next? You can always take the legal route, but litigation is expensive and time-consuming.

Any good professional will advise that where a dispute can be settled without litigation, it should be.

Which path you take will, in large part, be a function  of whether you can trust your partner. Where reasonable people disagree, but neither party doubts the other party’s honesty and reasonableness, there may be hope. Settlement is often possible and is always the better route in such cases.

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.

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

While the end of a business relationship isn’t usually a goal of any business, it isn’t the end of the world either. There are strategies for resolving partnership disputes that can be employed both at the front end to avoid issues, and at the back end to facilitate the break-up.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Common Issues and Strategies in Business Breakups, Common Commercial Conflicts and Resolving Shareholder Disputes. This is an updated version of an article originally published on November 29, 2018.]

©All Rights Reserved. July, 2020.  DailyDAC™, LLC d/b/a/ Financial Poise™