5 Ways to a Messy Business Divorce
(September 6, 2016) As business litigators, we routinely review corporate documents such as operating and shareholder agreements. Most times, those documents are signed with the best of intentions and when the owners are simply trying to make sure they are “on the same page.” But when a dispute arises – which is when we typically get involved – often times the owners do not even realize what they did, or did not, agree to. Taking some lessons from recent cases we have litigated, the following is a list of five ways business owners set themselves up for a messy and expensive business divorce.
1. Cut and Paste: Services such as LegalZoom and Rocket Lawyer offer form corporate documents such as operating and shareholder agreements, and anyone can do a simple Google search and find sample language to use. Simply cut and paste that language into your own corporate documents, thereby ensuring that you agree to provisions that you do not understand or have no applicability to your business. That way, your lawyers can spend time and money arguing over the meaning and intent of language that was never analyzed in the first place.
2. Have No Exit Strategy: Just as no spouse enters marriage thinking of divorce (well, there may be some exceptions), few business owners enter the relationship thinking about how they will get out when things don’t go as planned. If you want drawn-out, expensive litigation, make sure to omit any provisions about how an owner can withdraw from the business, how that owner’s interest will be valued for purposes of a buy-out, and the options of who can buy the ownership interest.
3. Be 50-50: With two owners, it’s only fair that each owner gets an equal vote on all business decisions, right? With equal voting rights, the company can’t do anything without complete approval from all owners. When one owner does not agree, the company will be unable to act and the only option may be to file a lawsuit to break the deadlock. Absent some other agreement, the company will then have to dissolve.
4. Require Unanimous Approval: Include a provision in your operating agreement stating that it cannot be amended, absent unanimous approval of all members. Although your business, the economy, and the owners’ goals may change over time, and changing the agreement may make sense for the company, one owner will control whether or not the agreement can be amended.
5. Forget Corporate Formalities: Don’t hold meetings. Don’t keep accurate books and records. Don’t issue shares or member certificates. Don’t open a separate company bank account. And certainly don’t use any financial software to track your income and expenses. That way, figuring out what the company did, what was approved by the owners, and what an owner’s interest is worth will be as difficult as possible.
While some of these provisions may make sense in certain circumstances, the important point is this: owners should think critically about these issues at the outset and make sure their agreements truly protect their interests. Failing to do so only increases the likelihood of problems down the road.More Publications