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In my last posting, I started discussing the difficulty involved in simply “getting before the judge” so that he can “hear my story,” and the fact that it’s usually not that easy in a shareholder dispute litigation. This time, I want to elaborate on such requests, including real life examples in shareholder disputes of when a judge is likely to intervene early, and when she is not.
At the outset, although no one reading this is likely interested in all of the nuances, a simple primer on the standard for granting what courts refer to as “injunctive relief” is in order. Generally speaking, a court will not grant an injunction unless you are trying to prevent harm that is both imminent and which could not easily have a dollar value placed on it (“irreparable harm”).
(At this point, I must comment on something that has been plaguing me since law school. Many lawyers I know have never understood the concept of something that cannot be remedied by money damages. The classic example given in law school is land, which is unique. If you lose your land, no money could ever get you THAT land back. However, our court system puts a price tag on a lost arm, or even a lost life. So, when you try to explain the concept to a client, the quizzical looks are perfectly understandable. But I digress …)
In shareholder disputes, clients often are forced to seek the same relief in nearly every case. Access to the company’s books and records is often something a minority shareholder is denied, and is quite possibly the easiest thing to get a Court to order at the start of a case. Additionally, countless clients have asked to have their termination (as an employee) stopped by the Court. However, this is often an easy one for the Court, as money damages can almost always compensate one wrongfully terminated. As a result, few judges in New Jersey will intervene to stop a termination and order that a shareholder/employee may go back to work.
Even more common is the client who wants the Court to enjoin his business partner from stealing from the company. This is a tricky one, since the threshold of “irreparable harm” is likely met. After all, stealing could literally end a company’s existence, which most courts deem irreparable harm despite the fact that the business can be valued and have a dollar figure attached to it. However, you also have to prove that stealing is very likely occurring, which is often not terribly easy prior to taking discovery. Proving such an allegation will be extremely fact and case sensitive. However, I have yet to see the case where a clear-cut, open-and-shut case can be made on day one that stealing is occurring. Usually, your unscrupulous business partner does a better job than that of covering his tracks and hiding improper transactions. He will always have an excuse for all of his dealings, whether fabricated or not.
An experienced shareholder dispute litigator will know how to uncover what really has happened, and make the best possible presentation to the Court. However, getting the judge to act quickly is no easy task.
When clients first come in for a consultation regarding potential shareholder dispute litigation, they are normally upset over some recent, often traumatic, event. Some have just been fired, while others have recently discovered that their business partner, whom they trusted, has been stealing from the company. Whatever the particular issue is, many clients want to get right to the end of the case and have the judge award them whatever relief they are seeking. Prospective clients often say they want to get before a judge, NOW, and tell the judge what their business partner has done. Surely, after hearing what happened, the judge will put a stop to it.
Nothing would be better for clients, and the system generally, than if it were this easy. But often it’s not. Usually, there are numerous steps that simply cannot be avoided before you can tell your story to a judge and expect relief.
The usual discovery process normally cannot be bypassed. As much as you know in your very soul that you are right, and that your business partner is a snake, you simply cannot assume that the judge, who has never met either one of you, will take what you say at face value and discount the lies that your business partner is sure to tell. There is no substitute for evidence, and you are paying your lawyer to win, not just to get you an audience with the judge.
In order to put you in the best possible position to win, your lawyer will have to go through a careful analysis of what evidence you will need and how you will go about getting it. You must exchange documents with the other side and obtain certain other information, like the identity of any expert that either side will retain. Deposing witnesses is within your attorney’s discretion, but it is a tremendous risk to skip this crucial step simply to save time and money. Moreover, you will not be able to get around the fact that the other side will likely want to depose you.
And, quite often you will need an expert, often a forensic accountant, to prove your allegations. For example, I had one case where my client insisted that his business partner was stealing from the company, but the books and records reflected that the monies taken were documented as “officer loans.” A forensic accountant was able to determine that the “loan” documentation did not appear until after my client first complained about the missing cash. It did not take very long to settle that case, once the other side saw what our forensic accountant had uncovered.
It is crucial to hire an attorney experienced in shareholder dispute litigation, who knows how to focus the discovery so that precious resources are not wasted.
These steps all may seem obvious, but I cannot stress enough how many clients simply want to get in front of a judge and don’t see why it will take so long to get there. It is the attorney’s job to explain all of this to the client. In my next posting, I will discuss those rare instances in which an oppressed minority shareholder MAY be able to get in front of a judge right away, at least to obtain some limited relief.
Can You Buy Out a Majority Business Partner?
A minority shareholder will most often seek a buyout as a judicial remedy. However, in some instances, the minority shareholder may want to be the purchaser instead of the seller. Although this is never easy, it is possible, depending upon the particular facts.
If you have a chance of being the purchaser of the majority’s interest, by definition you have been successful in demonstrating that the majority shareholders engaged in wrongful conduct. Often the question becomes, just how wrongful was the conduct?
A skilled attorney should focus the court on how improper, non-business expenditures robbed the company of various opportunities. For example, it’s easy to say the majority shareholder should not have spent $500,000 on an addition to his Aspen vacation house. But, if the focus is placed on the fact that YOU would have spent the $500,000 on a particular investment that would have grown the company and created more jobs, you can position yourself as more deserving of owning the company, even though you are currently a minority shareholder.
The manner in which employees are treated can be critical, too. Showing that employees prefer you to the majority shareholder and are more likely to remain employed if you take over can be a factor in your favor. This is especially effective if they so testify, since the judge will know that they are taking risk by doing so.
It is of course easier to present yourself as the person who deserves to own the company if you have been an active participant for years, while the majority shareholder has been winding down his involvement. Anything you can do to facilitate this process, and make the transition more readily apparent, will help. The more responsibilities you have, the stronger your claim to wind up with the company. I have seen at least one majority owner who was satisfied to force the minority owner to do the lion’s share of the work for a fraction of the majority owner’s inflated salary. After we consulted, the client decided that, instead of filing suit right away, he would do the extra work for a year to bolster his claim that he, not the majority stockholders, was the one vital to the success of the company.
It worked, and the client wound up owning the company, much to the majority shareholder’s chagrin.
You have decided that the problems you are having with your business partner are so bad that you have to file litigation against him. As discussed in prior postings, the remedy in such a case is often a buy-out. Either the court will order that you will buy out your business partner, or that he will buy you out. (This is also often the remedy when minority shareholders sue for shareholder oppression, or when one 50/50 shareholder sues the other.) When a new client hears that these are the potential outcomes, the inevitable question is – how can I make sure of one outcome over the other?
In other words, one business partner may want to be the purchaser, and another may want to be the seller, but very few have no preference at all. More often than not, when business owners feud, the preference is to remain in control of the company and not be the one forced to sell. In such a case, strategizing how to become the one who gets to keep the company becomes critical.
Certain things are fairly obvious. For example, shareholder oppression cases in New Jersey are almost always decided by a judge rather than a jury. Therefore, the more you position yourself as the “good guy” in front of the judge, the more likely the judge is to like you and see you as deserving of whatever relief you are seeking. Maybe. But there is much more to it than this.
What will influence the Court far more is whatever the court considers to be in the best interest of the company. For a company with only two shareholders and no other employees, there are fewer considerations. But for a company with several employees depending on the company for their livelihood, the court will often look to whichever owner is in the best position to keep the company in business and succeeding.
By the time you see a lawyer, it may be too late to change anything, and whatever has happened up to that point is already etched in stone. For example, if you have allowed your business partner to make most of the decisions while you sat by passively, there is very little time to change this once litigation commences. Therefore, seeing an attorney as early in the process as possible is key.
All too often, a new client comes to me stating that he has been having issues with his business partner for years, but that some recent action was the “last straw.” By that point, it is too late to strategize and put yourself in the best position to try to obtain the result you seek in the eventual litigation. The earlier you identify problems in your business relationship and seek legal counsel, the greater your ability to affect the outcome. Such a strategy requires foresight, and may cause you to see a lawyer before you would prefer. But it may be better than effectively rolling the dice to see which one of you winds up with the business that you both created.
In my next posting, I’ll examine how a minority shareholder (as opposed to a 50% shareholder) can position himself or herself to be the purchaser in a forced buy-out, rather than the one forced to sell.
The Course of Shareholder Dispute Litigation Can Be Affected By The Way Your Shareholder Agreement is Drafted
Many business owners involved in shareholder dispute litigation wish they could go back in time and rewrite their shareholder agreement. Unfortunately, it is often during expensive, protracted litigation with your business partner that you learn how your shareholder agreement could have been drafted to save you a costly lawsuit, or at least alter the course of that lawsuit.
For example, in one recent case, the Court wound up appointing what is called a “Provisional Director” to break ties between two fifty/fifty owners of a subchapter S corporation. Unfortunately, the Provisional Director began making all sorts of decisions that went against my client’s interests. The decisions may have made some business sense, but they were clearly not what my client wanted to occur.
With better planning up front, this situation could have been avoided. A Provisional Director is a court-appointed member of the board of directors of a corporation, and has all the powers to act as a director, essentially breaking any tie. However, in New Jersey, he or she is not a shareholder and cannot act as a shareholder. Of course, in a small, closely-held business, the shareholders are almost always the directors. But on this point, the distinction is critical. If the shareholder agreement provides that certain decisions can be made only by the shareholders, and takes certain issues out of the hands of the directors, a tie between shareholders in a shareholder vote cannot be broken by a court-appointed Provisional Director, at least in New Jersey.
In my case, the client desperately did not want raises to be given out, fearing that the increased pay would only be used by his co-owner to pay his attorneys’ fees, further fueling the litigation the client thought should not have been started in the first place. Had the attorney who drafted the shareholder agreement thought about possible future shareholder dispute litigation, he could have drafted the document to require unanimous shareholder approval for salary increases and the award of bonuses. But no such foresight was present at drafting, and the fifty percent owner’s fate was decided by a court-appointed stranger who knew very little about this – or any – company.
Many of the articles I write on this blog have a common theme: attempting to help the reader avoid problems before they occur. Once again, steps taken at the outset can make a huge difference should shareholder dispute litigation become necessary. And if your shareholder agreement – assuming you can find it – does not contain such a provision, it’s never too late to amend it; provided, of course, that all shareholders agree to the changes.
New Case Reaffirms the Difference Between Corporations and LLC’s When It Comes to Rights of Minority Owners
I have written extensively about the difference between the law in New Jersey protecting a minority shareholder in a corporation, and the law protecting a minority member in a limited liability company (LLC). Most lawyers practicing extensively in this area of law have long argued, and believed, that the statute protecting minority shareholders in a corporation from what is considered “shareholder oppression” does not apply to LLC’s (much as we may want it to). The New Jersey Appellate Division reaffirmed this principle in a recent, unreported decision, Hopkins v. Duckett.
The importance of this legal distinction cannot be stressed enough. Actions such as the failure to give dividends to shareholders (in certain circumstances), termination of a shareholder as an employee, and excess payments to themselves by the majority shareholders have all been held to constitute shareholder oppression, often giving rise to the right to be bought out of a NJ corporation. However, these same acts may not give rise to the right to be bought out of an LLC. Instead, the rights of a minority member of an LLC may be much more complicated, and the remedy may not include a buyout of the minority member’s interest.
Of course, the rights and obligations under an LLC in New Jersey may also be much simpler, assuming the LLC’s Operating Agreement does not prohibit withdrawal. If it does not, in NJ, a member may simply withdraw from the LLC and have the statutory right to be paid for his membership interest a much less expensive, procedure than a shareholder oppression lawsuit. However, the Operating Agreement often bars such withdrawal, and then a very careful analysis of the facts is necessary to determine a minority member’s rights.
A minority member of an LLC may still protect himself, even if the majority members insist on prohibiting withdrawal at the time the Operating Agreement is drafted. Absolutely nothing prevents the members of an LLC from adopting the rights and remedies set forth in the shareholder oppression statute, thus making them applicable to an LLC by contract. This could be a fair compromise between simply permitting withdrawal, and providing no relief at all. What is absolutely critical, though, is to utilize the services of an attorney who is well-versed in this area of law. Lawsuits brought by minority members against my corporate clients have been thrown out because the attorney on the other side based his entire case on the shareholder oppression statute, when the company at issue was an LLC. Those clients learned the hard way that this area of law can be complicated and wished they had done more due diligence in hiring their attorney.
Email as Evidence – The Difficulty of Email Between Business Partners
You and your business partner are having a serious dispute, and litigation may be inevitable. How do you communicate with each other prior to the suit being filed?
In some cases, you and your business partner both work in the same building, while in others one of you works from home or does not actually work for the company. When disputes about how to run the business appear serious enough that they may result in litigation, how you communicate with each other may be critical regardless of your respective roles in the company.
Documentation of facts is always important, and the lead-up to shareholder litigation is no different. Obviously, most written communication today occurs via email. How you word these emails matters. For example, no matter how much your co-owner’s conduct has annoyed you, or even harmed you, the tone and tenor of your written communications may matter in court. They are likely to be evidence of relevant issues. In fact, their use as evidence is, in some instances, the main reason that they are being written. So it is critical to keep in mind that it is very likely that a judge will be reading these emails at some point in the future.
Why is this important? In most shareholder dispute litigation, the judge is going to decide the case, not a jury (at least inNew Jersey). Therefore, his or her opinion of you is critical. If your emails to your business partner (and future litigation adversary) seem overly harsh, or are written in a way that inadvertently puts you in a bad light, unintended repercussions down may result. While documenting the facts, you must appear reasonable at all times. When you are involved in shareholder dispute litigation, you want to be the one in the white hat while your adversary is the perceived outlaw.
In one case, a 1/3 shareholder let his frustrations boil over at the female majority owner who was using the company as her personal piggy bank, and in his anger used a slur that should not be used against a woman. Although he was totally justified in all of the allegations that he made in the email, the female judge did not appreciate his choice of words when the document wound up as an exhibit in court three years later.
To protect yourself in such a situation, follow these two rules:
- First, when attempting to document the facts, imagine that the email (or letter) is being copied to the judge who will preside over your likely future lawsuit against your partner.
- Second, make sure you are accurately documenting what you want to memorialize, and that what you are attempting to say comes across clearly. More than once I have had to tell a client that the email he thought confirmed a date or an event was not written clearly enough to ensure that the other side was not left any “wiggle room” to weasel out of the issue. A client who was sure his email instructed his business partner not to do something was sickened when I had to tell him that the email was not strong enough because it said only that he “didn’t think” his partner should do it. That’s a far cry from directing him not to.
Although no one likes to spend money on legal fees, the best approach is to consult with an attorney well versed in shareholder dispute litigation as soon as you suspect there may be an issue. Having an attorney trained to handle business partner litigation review critical emails before they are sent just may prove invaluable down the road.
Is the Next Generation Ready to Take Over Your Business?
Having your child work in the family business that you helped grow from the ground up may be the thing you are most proud of, possibly in your entire life. Knowing your business will not die with you can be a truly liberating feeling. But when you do not own 100% of the company, and you have a business partner to answer to, that means that your child has to answer to him, as well. Of course, the same goes equally for your business partner’s child, who has to answer to you. But if neither of you sees everything that the other’s child does, how do you evaluate their performance?
For example, suppose your business partner’s child works on the plant floor, learning the business from the ground up. How do you know if he is doing a good job? Even if your supervisor tells you that he is, is it true? Or, does the supervisor believe that your business partner’s son is his future boss? If he does, can you trust that you are getting an independent assessment of his skills and talents? Or do your current employees simply want to curry favor, leading them to give favorable reviews out of a sense of self-preservation?
The question goes both ways, of course. If your child is receiving “rave reviews” from your supervisory staff, is your staff just sucking up to you?
The ability to accurately assess the talents of the next generation may not be important to you, especially if it’s your own child being discussed. Not surprisingly, many small-to-medium-sized businesses think this is a greater issue when it’s their partner’s child under the microscope. But this issue may be more critical than you realize.
The abilities of those who will take over from you will directly affect whether the company remains a success while you are supposed to be enjoying retirement. One set of clients learned the hard way that their own children were incompetent. The clients decided to sell the business to the children over time, rather than to an independent purchaser for cash up front. Within two years, it was apparent that both of the founders would have to come out of retirement to save their business, as well as their retirement income, from ruination.
Ensuring quality management into the future can also avoid ruinous shareholder dispute litigation. Allotting equal pay and responsibility to both succeeding children, when one is a superstar, and the other is incompetent, is a recipe for disaster; resentment and expensive litigation between business partners often results from such a situation. Sometimes, it is far better for one child to manage the company, while the other has a lesser role equal to his talents. As long as both have an equal ownership stake, they would be serving the company’s best interests.
Obviously, if there were a way for you to determine for yourself how well your respective children are performing, that would be ideal. But this often is not possible for a variety of reasons. Or one partner may think that his child is fantastic, but that his partner’s child has much room for improvement – while the other partner sees it exactly the opposite way. Then what?
In my last posting (discussing Second Generation Shareholder Litigation), I discussed the wisdom of setting up the successor generation with a mechanism to have compensation set by an outside consultant, to avoid shareholder dispute litigation over salaries taken. A similar thing can be done with performance evaluation, although it may not be easy, depending on the type of business involved. If an outside consultant is impractical, having reviews and assessments performed by your most trusted senior manager, who has no fear of retribution from the next generation, can also lead to a more impartial result. If at all possible, having an assessment performed by someone truly independent, who does not fear reprisal, could save you and your business partner from literally putting the company, and your respective futures, into the wrong hands.
Protecting the Second Generation from Oppressed Shareholder Claims
In my last post, I addressed how you and your business partner, as equal 50% shareholders, can protect yourselves from claims brought by the next generation once you begin to turn over the company reins. This time I want to discuss other difficulties that can be encountered when turning the company over to your children, and how to protect your children from oppressed shareholder claims.
When only one of you has a child who will work in the business, but ownership will still be divided between both your offspring, problems – although not insurmountable once – may arise. The biggest area of dispute is likely to be compensation. The next-generation shareholder who has worked in the business for years, and who knows the finances inside-out, will likely wind up setting his own salary. And every dollar that he gives himself as a bonus is one dollar less that can be paid out as a dividend and split evenly.
How is the shareholder on the outside supposed to know whether he is being treated fairly? If you and your business partner have passed on the company to your children, should you care how they get along in the future?
I don’t have to tell you that you should care, because if you’re reading this article, you probably do care. And why shouldn’t you? You worked for years building up the company. Why would you want to see it torn apart by shareholder dispute litigation between your children?
You can take steps now to prevent such fights, including making sure that mechanisms are in place for transparency, especially with respect to the finances. One client set up a mechanism for an outside consultant to set all salaries for the company, providing in the shareholder agreement that all shareholders had to agree on the choice of consultant. This particular client and his business partner had never had a disagreement in over thirty years in business, so some people thought that having salaries set by a consultant was unnecessary. But he saw that his son and his business partner’s son did not see eye-to-eye on several things, and he knew that only one of them would work in the business.
This approach might be a waste of $5000 per year. Or, it just might be the thing that prevents shareholder dispute litigation from tearing the next generation apart – and with it, the company that the partners spent the better part of their lives building.
Surviving in business is difficult with a business partner, especially when you are both 50% shareholders, with neither of you in total control. Cooperation and trust are critical, and the relationship could have fallen apart at so many different times over the years. Disagreements about the future direction of the company likely have occurred, but you survived them all. As you approach the age where you can begin to see your retirement on the horizon, questions inevitably arise about the future of the company once you are no longer there. When you are a co-owner, you also have to consider whether your business partner has the same vision of the future that you do.
You would be surprised to know just how many savvy business partners have never addressed – or even discussed – a succession plan. Do you both want to sell at some point? If so, when? Do you both want the next generation to run the business? What if one of you wants to sell, but the other wants the children to take over? If your children run the business, will you give away all your shares first, or will and your partner continue to maintain ownership control?
It is critical that these issues be decided as early as possible, certainly before it’s time to implement a succession plan, whatever that plan may be. Although these are corporate planning issues, the statute (at least in New Jersey) governing shareholder oppression and minority shareholder rights has a large impact on how these issues should be addressed.
If the plan is to leave the business to the next generation, it is quite common to gift shares over a period of years as an estate planning tool. To protect the founding generation, shares are often gifted as non-voting shares, so that control is maintained. But, in New Jersey, those new minority shareholders now have certain rights – even if they are your children. They may sue for shareholder oppression, which is defined in a variety of ways, and, under the statute, includes the broad category of “unfairness” towards the minority.
One recent client gifted his shares to his son, while his business partner did the same with his daughter. Instead of being grateful for the windfall, both children (in their 30’s) felt entitled, and complained about the large salaries being taken by the majority shareholders who had not only gifted them their shares in the first place, but still ran the company, as they had for three decades. Those complaints turned into a lawsuit, and the majority shareholders soon wished that there had been some way to address this issue up front, rather than through expensive shareholder litigation.
Even if you are correct in your belief that your child would never sue you, are you as confident that your business partner’s child would never sue him? Or you?
Although it is unavoidable that a minority shareholder would have certain statutory rights in New Jersey that cannot be waived, there are ways to craft a new shareholders’ agreement that can limit the exposure to such a suit. For example, the new shareholder, when he receives his shares, could acknowledge in a new shareholder agreement that he is aware of everyone’s salaries, recognizes such salaries to be fair and justified, and concedes that he is to have no role in the future in setting salaries. This one precaution would protect, to a certain degree, one generation against the claims brought by the next. But, what of the second generation itself?
How to prevent claims between or among the members of the next generation – claims that could tear apart your business, and your legacy – will be dealt with in my next posting.