When you started your company all those years ago, you were certain you didn’t need a Shareholders’ Agreement (or, in the case of an LLC, an Operating Agreement). An attorney would have charged you more than you wanted to pay at the time to draft one (as they usually do), and after all, you trusted your business partner (back then). If an issue between you ever arose, you were confident in your ability to work it out quickly and easily.
But now, you and your business partner have encountered a dispute that cannot be resolved – a fundamental difference of opinion over the direction of the company. He blames you, and he wants out. A carefully-drafted Shareholders’/Operating Agreement might have contained a buy-sell agreement that spelled out each shareholder’s right to be bought out by the other under certain circumstances. Without such an agreement, though, your partner feels trapped, as if he has no choice but to sue.
So he sues, alleging shareholder oppression and mismanagement, accusing you of failing to undertake numerous actions that were never your responsibility. Had an agreement been in place, you might have been able to point to language showing that the responsibilities you are alleged to have breached never were charged to you. Once again, a written agreement, spelling out the rights and responsibilities of all the owners, would have proven quite useful.
I have seen this situation, where the absence of an agreement between the parties has led directly to shareholder dispute litigation.
Then, to add insult to injury, after your attorney has charged tens of thousands of dollars to defend you against the shareholder oppression claim, your business partner finds a buyer and announces that he intends to sell his 50% interest to him, completing his exit strategy. Without an agreement to protect you, you are now in business with someone you’ve never met, and this stranger owns the other half of your own company. But you saved money by not having to pay for an agreement at the outset. Congratulations.
All of this can be avoided by making sure that you consult with an attorney who is conversant in shareholder dispute issues – not only when you get sued, or when you are ready to sue your business partner – but also when things are going well. As with so many things, a little legal “preventive medicine” can save a fortune down the road.
If you no longer trust your business partner, can your business be saved? This may not seem like an issue for an attorney, and may seem more suited for a psychologist. But an attorney well versed in handling shareholder disputes may be able to help save such a business. At the very least, it may be worth a try, because the alternative may be costly and disruptive shareholder litigation.
In order to determine whether the trust can be rebuilt, it is critical to know why the trust eroded in the first place. Did they have control over setting salaries and exercise their discretion unfairly? Did they inappropriately cause the company to repay themselves for personal expenses, a perq that was either abused, or simply not shared with you? Are their family members on the payroll that shouldn’t be, while they refuse to end the practice?
As bad as some of these things may be, their actions would be even worse if they were done surreptitiously. While it may be difficult to hide a friend or relative who is employed by the company, cash payments to oneself may be easier to conceal.
If you are having a dispute with your business partner that appears headed to court, you may want to consider pre-litigation mediation, which may be the best way to resolve the dispute. If the issues can be addressed before the situation gets ugly, huge dollars may be saved on attorneys’ fees, and tremendous business disruption may be avoided. An accountant, clergy member, or business-savvy family friend (trusted by both parties, of course) could act as a mediator in such a case.
Communication is often the key to salvaging a business relationship. In one recent case, we discovered that the 75% owner was treating the 25% shareholder unfairly (providing large bonuses to themselves, instead of paying dividends pro rata) because they believed the minority shareholder was diverting their efforts to another business. When they finally discussed it and the majority shareholder learned that their business partner’s “side business” was really a charity, the entire business relationship took on a different tone. The business relationship was healed simply with direct communication.
If some sort of mediation is opted for pre-litigation, you actually may achieve a better result if both parties sit in a room together, without attorneys being present. That was a difficult sentence for a lawyer to write, but it’s true – lawyers sometimes get in the way of settlements. A client reading this may think that lawyers have an incentive to keep a case going to “churn” fees. While clearly some lawyers do this, I am referring to the simple fact that lawyers and business owners often see things through a different perspective. Lawyers are paid to look for worst case scenarios, while sometimes focusing on the negatives is not conducive to getting a deal done. Nevertheless, in a shareholder dispute where litigation may be inevitable, seeking at the very least behind-the-scenes advice from an attorney experienced in shareholder litigation is critical.
There may be issues that you aren’t aware of that bear on the strength of your case, which would give you confidence, and possibly the upper hand, during your mediation discussions. For example, in New Jersey, the failure to pay dividends to shareholders, when the company could have done so, may constitute shareholder oppression under the right circumstances. Knowing this may greatly strengthen your negotiating hand. Or, you could learn that your complaints, while valid, are simply not recognized under the law as actionable, leading you to rethink just how far you want to push your particular issue.
Pre-litigation mediation may be advisable in certain circumstances, but you are looking for a successful result – not just a result. Be prepared, and be well-advised by someone who has handled cases like yours before. And don’t be afraid to sit down with your business partner and try to save a fortune on legal fees. Unfortunately, there’s plenty of work out there for us shareholder dispute attorneys.
A business dispute with your co-owner can often be resolved in litigation. But the question remains – if you sued your business partner because of improper action on his part, what remedy would you seek?
Many people assume that, when you sue your business partner, it is like any other case in which you are suing for damages. For example, I have been approached by numerous prospective clients seeking to sue a business partner for damages after finding out that he was being – to put it charitably-“overly generous” in giving himself corporate benefits (cars, bonuses and the like). But a case for damages may not be the best available option.
In most cases, the business partner (often a majority owner, or at least a 50/50 owner) took excess funds from the company. Although this may in effect damage the other owners, the claim (at least under New Jersey law) belongs to the company. In other words, if your 50/50 partner helped himself to $100,000 worth of personal benefits, he effectively stole $50,000 from you, and $50,000 from himself. Usually, the right to seek reimbursement of the funds improperly taken belongs to the company.
However, a better remedy may be available. A co-owner instead may allege shareholder oppression, and seek the right either to buy out his business partner or to be bought out. This may not always be the plaintiff’s option, as it is up to the judge to determine who will be the buyer, and who the seller. Therefore, a business owner must understand that he may file the suit looking to buy out his co-equal shareholder, only to have the judge rule that he must sell, instead.
An attorney experienced in such lawsuits can often help a client assess what the most likely outcome in such a case may be, and how to focus the case to help achieve the desired result. For example, careful attention must be paid to facts showing why you are the one who, deserves to maintain ownership of the company, and why your partner should be judicially compelled to sell to you. Obviously, this will be easier if you can actually show that your business partner was embezzling or stealing from the company, but most cases are not so black-and-white. An experienced attorney can help you determine what facts should be emphasized, and how to obtain the evidence you will need.
Shareholder litigation: Those two words designate an action that can be profoundly disruptive to a business, because the mere existence of such a pitched battle between owners can bring a closely held company to a grinding halt.
When shareholder litigation is pending, the owners obviously have issues with each other severe enough to warrant filing suit. Those cases can involve allegations as nasty as fraud, mismanagement, or even embezzlement. Often, one shareholder has had his or her employment terminated, and is no longer on site, but is on the outside, looking in. Even more often, the shareholders involved in litigation against each other are still working together – or trying to – sometimes in very close quarters. This may be the most difficult type of shareholder litigation of all, especially when the shareholders are family members.
Shareholder litigation where the owners still work together can seem to take over a company. Every decision made, every act undertaken, is viewed through the litigation prism. Why is he asking me to do this? Do we really need it done, or is he somehow trying to make me look bad or set me up? Why is she asking for that document? Does she need it for the business, or is it going to be a trial exhibit? Obviously, such an atmosphere can be poisonous, and sometimes even fatal, to a company.
It goes without saying that, during the pendency of shareholder litigation, decisions should be made with the company’s best interest at heart. Of course, while this may describe your thought process, it may not describe your fellow shareholder’s, leading to confusion and even chaos. For example, when one owner tells the bookkeeper to approve and reimburse for a certain expense, but the other owner directs the payment not to be made, the situation can become very tense, whether the expense is an advertisement, business travel, or a new computer. Or, when one shareholder wants to grow the business, but the other insists on maintaining the status quo until the litigation is over, the impasse can be detrimental and demoralizing to the other employees.
When your business partner does any of the above, and acts in a way that harms the company, the action you take may be based entirely on the judge in your case. In New Jersey, some judges are more receptive to getting involved in business disputes between litigants, and some less so. Some judges will attempt to resolve such disputes on a conference call, while others will require the filing of a formal motion for relief. Often a judge will appoint a “Special Master” to resolve such disputes, either with both parties agreeing to abide by the resulting decision, or with the right to appeal that decision to the judge. However the judge decides to resolve the issues, an attorney with experience in shareholder litigation is critical.
It takes a special touch to present such issues to the court or Special Master, and not sound like your client is a whiner. Often a client will be tempted to complain to the court about every little issue. However, an attorney experienced in such cases will know what issues are important enough to bring to the court’s attention; and which ones should just be ignored – at least for the time being. When interviewing an attorney to represent you in shareholder litigation, ask what creative solutions he has utilized to help his clients deal with a business partner as unbearable as you know yours will become once the Complaint has been filed.
I have posted several times (most recently in January) about termination of an employee/shareholder constituting oppression, because this type of misconduct by majority shareholders happens all the time. If one had a reasonable expectation of continued, even indefinite, employment, the act of termination itself could constitute shareholder oppression under New Jersey law, possibly giving the terminated shareholder the right to be paid for his or her shares. Or, if one is terminated and then receives no financial benefit for his shares, the mere lack of dividends could be grounds for the terminated employee/shareholder to obtain a buy-out, especially if the majority shareholders continue to give themselves huge (and undeserved) bonuses.
I want to revisit this issue because I have seen majority shareholders actually ratchet up this type of misconduct in light of the stubbornly high unemployment rate. Unscrupulous business partners have made the argument that they can’t be blamed for firing a minority owner, because the economy is so bad and unemployment is so high. One adversary even thought this should be an absolute defense to his action – what I dubbed the “things are tough all over” defense. A majority owner who wants to throw out his business partner will often resort to any morsel of an argument he can latch onto.
Don’t buy it. If you are a minority owner of a New Jersey company, and the majority owner uses the economy as an excuse to terminate you or eliminate your job, you do not lose your rights as an owner. You still have the same rights of inspection of certain corporate financial documents; and you still have the right to receive some benefit for your shares, if at all financially possible. Use these rights, and find out as much about the company’s financial picture as you can. You may see that your firing was necessary only to permit your business partner to line his own pockets, with you now out of the way.
Perhaps even more importantly, your termination in and of itself might amount to shareholder oppression or misconduct, entitling you to be paid for your shares. Quite often, the termination occurs after a dispute between business partners has arisen – such as over a suspected fraud, or asking too many financial questions. Remember, a court will take this timing into account when determining whether you should be paid for your shares.
In the past, when writing about “corporate divorces” and disputes between business partners, I have stressed the importance of documentation and making sure that certain things are in writing. However, I have recently encountered a case making perhaps the best argument possible about the need for documentation – a co-owner claiming that his business partner did not actually own any interest in the company.
There are many closely-held companies out there in which the owners have never gotten around to issuing stock certificates. As ridiculous as it may sound, it may be the case that the only evidence one has of ownership is the tax returns of the company. Amazingly, the majority owner actually claimed in one recent case that the tax returns reflecting his brother’s ownership were inaccurate – a “mistake” by the accountant.
The novel (and absurd) argument is likely to go nowhere, but it has cost my client many months of unnecessary litigation, and an enormous amount in legal fees. However, much of this aggravation could have been avoided with a letter or an email from before the litigation started, asking why he was never issued his stock certificates.
There are numerous other things that could, and should, be documented somewhere. The exact percentage that one owns is an obvious fact to have documented. And, if a chief complaint is the absence of financial disclosure and sharing of documents, this is more easily proven if contemporaneous written complaints exist, rather than merely complaining after the fact. One of the more common issues that often needs to be proven, but is difficult to do without documentation, is the fact that you are not the one involved in any way on preparing financial information for inclusion in the company tax returns. Yes, the accountant may be able to corroborate this, but he may not. Often the accountant will have no idea how the documents that are delivered to him were prepared.
Disputes between business partners, even fights leading to a company’s demise, sometimes arise almost overnight. But, more often than not, the aggrieved shareholder has some inkling for years, or at least many months, that something may be amiss, or at least not quite right. No matter what you’re feeling toward your business partner, everything should be documented at all times.
David Roberts and his partner, David Strickler will be speaking at Real Life Series – Pre-Nuptial Symposium: A Business Marriage, sponsored by Raritan Valley Community College and Small Business Development Center on May 23, 2011 at Norris McLaughlin & Marcus’ Bridgewater office. For more details on topics to be covered, click the link below.
Disputes between business partners are often won and lost on the documents.
Of course, if the dispute with your business partner involves fraud or theft – a shareholder or partner who has been stealing from the company, or enriching himself unfairly with excessive bonuses – the company’s financial documents will be critical to proving your case. General ledgers and check registers will (or should) show where the money went. Bank records will also likely yield a paper trail. More often than not, the existence of those records is not in dispute. Rather, the argument arises about what those documents mean.
The records I am referencing are much more basic, and can point to the very core issues about the relationship between the owners. For example, many owners of closely held businesses do not even realize that there are no documents establishing the very existence of their ownership. In one case I have seen, a member of an LLC stated that the K-1’s issued by the accountant over the years were a “mistake,” that the minority member of the LLC was not even a member, and was lying about his ownership interest.
While this may be an extreme example, a more common one is where shareholders have an understanding amongst themselves regarding how they govern their relationship, but it was never reduced to writing. Multiple owners operating a corporation without a Shareholders’ Agreement, or an LLC without an Operating Agreement, can lead to disastrous consequences.
In one case, a minority shareholder claimed that he was entitled to serve on the Board of Directors at all times. For over ten years this was not an issue, as he and his fellow shareholders (his two brothers) had always gotten along. When the economy turned sour, the business hit a rough patch. The relationship between the owners became strained and the 1/3 owner was removed from the Board. When I asked to see the Shareholders’ Agreement that set forth his right to always serve on the Board, he dug deep into his batch of ten year old papers and came up with a Shareholders Agreement that said exactly what he thought it did – but it was unsigned and unenforceable.
It is amazing to hear how many closely held business owners either have no essential documentation, such as a shareholders agreement, or documents that are sorely outdated, such as an agreed upon valuation that is a decade (or more) old. It is downright scary to hear how many such owners think they have proper documentation, but truly don’t.
Protect yourself. Inventory what documentation you have. And if you do not have documentation that protects you and states what you think it should, you should see an attorney about updating the company records. It may not be too late to make sure you don’t get stuck spending a fortune to prove what you know to be the truth, when a suit between the business owners inevitably arises.
Lately I have been giving seminars to accountants on how members of that profession should handle business disputes between owners in closely held businesses. In fact, just last week I gave a presentation on this issue to the accountants at JH Cohn, one of the region’s largest accounting firms. (I was disappointed that I did not get to meet their spokesperson, Joe Torre, but at least they provided lunch.) Preparing for these seminars got me to thinking how the company accountant can be a minority owner’s ally in a business dispute between business partners.
To start with, it is critical for a business owner to realize that the accountant often represents the company, and not the individuals. Therefore, when you, as a minority shareholder, ask an accountant for corporate documents, he/she may not have to give them to you. In fact, he/she may be prohibited from turning them over if ordered not to by the company president or majority shareholder. However, that does not mean that the accountant cannot be a useful ally to a minority shareholder.
Often by the time someone reads an article such as this that they found in a Google search, it is too late, and the bitter dispute with one’s business partner has already materialized. However, if it is not too late, and the dispute is only feared, and has not yet passed the point of no return, there are actions that you can take, often with the help of the company accountant, which can help prevent the dispute from taking place.
For example, it is quite often the failure to share corporate financial information that leads to disputes. When a minority shareholder feels that he or she is being kept “in the dark,” problems are often not too far behind. However, the accountant is usually a “trusted business advisor” of all of the business partners, and can be the one who helps establish some guidelines regarding what financial information is to be automatically shared with all shareholders (or members, if an LLC). If the accountant can be convinced to recommend rules under which information is freely shared among all the owners, perhaps the majority shareholders will listen and establish such guidelines in the beginning.
Some accountants, depending on the personalities of the individual owners involved, may not want to inject themselves in such matters. However, others may decide that clear rules regarding the free flow of financial information to even the minority shareholders may help keep him or her out of future conflicts among the shareholders. He may even realize that the free flow of information may maintain the relationship between all of the owners, and may even help save the business from being torn apart. Because once oppressed minority shareholder litigation is begun, it rarely is a good thing for any New Jersey company.
I have previously written about one of the most common forms of business partner dispute – the case of an employee/shareholder who is fired as an employee. Of course, one’s shares cannot be taken away, but without a job, the shares may seems useless.
I previously discussed the fact that, when a shareholder can successfully show that he or she had a reasonable expectation of continued future employment, termination can constitute what is called “shareholder oppression” and may entitle a shareholder to the remedy of a forced buy out of his or her shares. However, lately I have had clients come in seeking advise about suing their business partner who do not fit neatly into such a category. For one reason or another, they probably could not demonstrate that they had a “reasonable expectation” of lifetime employment.
When a shareholder is one of the company’s founding members, it may be possible to argue that his “reasonable expectation” was that share ownership would be tied to employment, and vice-versa. But, when someone joins a company as an employee/shareholder that was formed by others long ago, it is a much harder argument to make.
Fortunately, if you find yourself in a dispute with your business partner, leading to your termination, that does not necessarily mean you are entirely out of luck. While the termination of employment itself may not be considered oppression under New Jersey law, it is likely that the majority shareholders will engage in additional acts that may constitute oppression.
If a significant (but still a minority) shareholder is unfairly fired, chances are quite good that other acts of unfairness will follow. For example, shareholder distributions may cease, financial records may not be shared, and critical information about the company may be withheld. Additionally, majority shareholders often just can’t help themselves, and wind up taking the terminated employee’s salary and dividing it among themselves. If it can be shown that this was improper, and resulted in excess compensation to the majority (rather than a dividend that must, by law, be paid pro rata to all shareholders), oppression may still be shown and the majority could be compelled to buy out your shares.
Therefore, when a dispute with your business partner arises, and you are terminated as an employee, make sure you consult with an attorney who is familiar with all aspects of shareholder oppression under New Jersey law. Just because one avenue of relief is not available to you, does not mean that there are not others that are.