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March 2012
Survival Training: How to Minimize the Risks and Costs of a “Business Divorce”
By Megan Sadler

     In these times of economic uncertainty, many business owners have been faced with a “business divorce.” The risks and costs associated with these ownership disputes can often be minimized with proper planning at the outset of any business relationship.

     Over the course of the next several months, we will explore some of the most common challenges business owners may face by examining a year in the life of “Bob Businessman.” Throughout the course of this year, Bob Businessman will grapple with the following issues:

 

(I) tracking and managing his company’s cash,

(II) bank defaults and workouts,

(III) employment-related issues,

(IV) asset protection,

(V) marital disputes,

(VI) income tax issues; and

(VII) ownership issues.

 

     For now, let’s set the stage upon which Bob Businessman’s bad year is about to begin. Bob has just learned that his business partner of 20-plus years (who incidentally has been oddly absent over the last several weeks or even months) has been speaking with an attorney about Bob’s “overreaching” management decisions and has decided to immediately sue Bob for half of the company.

     Bob’s business partner has also informed Bob to expect a court order requiring a third-party to run the company. Certainly, if Bob’s business partner carries out on his threats, the greatest harm to occur will be to the company itself as disputes among business owners often result in costly litigation, loss of customers at times, and employee morale and retention issues.

     An often underestimated or even unconsidered consequence of owner disputes is also the loss of information—whether it is through insufficient systems (i.e., Bob cannot find certain documents on the company’s server) or through intentional misappropriation (i.e., Bob cannot find his partner’s laptop because his partner took it with him and plans to keep it).

 

What should Bob do now? He should:

· locate and review his organizational documents.

· once he has gotten familiar with any agreement in place as between the owners of the company, his next steps should be to consult with his attorney; and

· Bob’s attorney should be able to answer questions that Bob may have regarding the effect of the ownership agreement, as well as address whether the provisions are relevant to the dispute and whether the issue of an oral modification may be present.

 

Agreements as between the owners of any entity typically determine the rights as between such owners with respect to their ownership interest in the company. Such agreements also often dictate certain aspects of the management of the entity—for instance, the number of directors each owner may elect, who will serve as the managers of the entity, and how compensation and distributions are to be determined.

     These agreements are typically entered into at the outset of any given business venture when the owners are working synergistically together, have significant momentum, and cannot or do not conceptualize a time when their business relationship may come to an end. When a dispute arises, to the extent such an agreement is in place, it will often dictate the outcome of the dispute. (If no such agreement exists, in certain instances North Carolina law provides limited remedies to the owners.)

 

A properly structured agreement (i.e., the “right contract”) between the owners will:

 

(1) provide for a “relatively fair” outcome in the event of a dispute;

(2) limit opportunity costs; and

(3) provide a process for an orderly transition.

 

     Additionally, the “right contract” is tailored to the specifics of the owners by contemplating worse-case scenarios as well as best-case scenarios and takes into account the industry in which the company operates and its long-term goals.

     However, once the “right contract” is in place, it is imperative that the owners periodically review this contract to ensure compliance. Non-compliance with the contract could mean a number of things including, at the most basic level, that you do not have the “right contract” in place or that the agreement has been modified or amended.

     What does all of this mean for Bob Businessman? Unfortunately, Bob likely has approximately three to 24 months of litigation to look forward to (depending on whether arbitration is required under any existing relevant ownership agreement). And, unless Bob has the “right contract” in place, the end result will likely ultimately be that Bob will either buy his partner out or be bought out himself at an amount decided by an individual (judge or arbitrator) who is not as familiar with the company or the industry in which it operates.

 

Megan Sadler is a partner at Wishart, Norris, Henninger & Pittman, P.A.
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